AMERISAFE, Inc. (AMSF) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the AMERISAFE Inc. Third 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, Mr. Mike Grasher. You may begin, sir.

Thank you. Good morning, everyone. Welcome to the AMERISAFE Third Quarter 2013 Investor Call. If you have not received the earnings release, it is available on our website at www.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 from -- because of factors discussed in today’s earnings release, in 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 statement. I will now turn the call over to Allen Bradley, AMERISAFE's Chairman and CEO

Thank you, Mike. Good morning, ladies and gentlemen. Thank you for joining AMERISAFE's Third Quarter 2013 Earnings Call. I'll make a few remarks and then turn the call over to Janelle Frost, our President and Chief Operating Officer; and Michael Grasher, our Chief Financial Officer, to provide more details on the operational and financial aspects of the past quarter. In the third quarter and continuing to the present day, the workers' compensation market is in a state of flux. Years of weak pricing and aggressive law selections have resulted in stressed balance sheets. Now books of business are in play, as underwriters turn their focus away from premium growth and market share toward underwriting profitability. Signs of that refocusing on underwriting discipline can be demonstrated in several ways. For example, residual markets, managed by the National Council on Compensation Insurance have reported more than a 30% increase in premium as of September 30, 2013, over the same period in the prior year. Interestingly, the NCCI notes a marked increase in the number of large workers' compensation risk being placed in these assigned risk pools. These large accounts are not the typical assigned risk of pool account. Instead, these accounts have been parked in the pool as brokers search for voluntary writers willing to undertake the business. I believe brokers are finding the appetite for these accounts, particularly those with unfavorable loss history, very, very selective. Exceptionally low investment yields, coupled with multiple years of highly unprofitable calendar year combined ratios, will, in my opinion, provide support for pricing discipline for the next 2 years or so. Like many others in the industry, I believe carriers will seize reporting favorable prior year loss development and begin reporting adverse loss development. Many industry observers have concluded that workers' compensation is a tricky line to write profitably, an opinion that was recently cited in a Wall Street Journal story. All of these factors together, we believe, should support pricing for the foreseeable future. And we see this as an opportunity for AMERISAFE to profitably expand our business during the time of uncertainty. Now I'll turn the call over to Janelle Frost to talk about the operational aspects of the company during the quarter.

Thank you, Allen, and good morning, everyone. We were pleased with the operating results in the third quarter. Our combined ratio was 92.5%, down 6 percentage points from the third quarter last year. Our top line grew $8.9 million or 11.5% during the quarter. Policies written in the quarter accounted for $10.3 million of that growth. The renewal component of this increase was driven by premium retention of 93.3%, compared to 85.3% in the third quarter of 2012. Policy retention was 91.1%, compared to 91.3% in the third quarter of 2012. In addition, new premium, new business grew 34% in the quarter in terms of premium dollars. Audit premium and related adjustments remained positive this quarter at $0.7 million. However, as expected, this represented a decrease of $2.4 million from last year's third quarter. Our effective loss cost multiplier, or ELCM, for voluntary premium in the quarter was $1.79 million, compared to $1.66 million in the third quarter of 2012. We continue to report our highest ELCM since we began publishing this measurement for those states that use loss cost as a pricing mechanism. For AMERISAFE, that excludes Florida, Texas and Wisconsin, although Texas recently began using loss cost. Relative to losses, our current accident year loss in LAE ratio remained at 73.2% this quarter. We continue to see favorable frequency trends, both on a relative and absolute basis. Our claims reported in the calendar year were down 5.4% from 4,468 to 4,228 claims. The quarter was also positively impacted by favorable development from prior accident years. Encouraging trends in case development led to $2.7 million of favorable loss development in the quarter, compared to $1.6 million of favorable development in the third quarter of 2012. This quarter's favorable development was primarily attributable to accident years 2008 and '09. Finally, our expense ratio also decreased to 22.6% in the quarter, compared to 22.8% in last year's third quarter. Mike will provide the details on the expenses, but I believe it is important to reiterate our commitment to expense management as evidenced in our lower than industry average expense ratio. That concludes my prepared remarks. I'll now turn the discussion to Mike.

Thanks, Janelle. For the third quarter of 2013, AMERISAFE reported net income of $9.7 million or $0.52 per share, compared to $7.1 million or $0.38 per share in the third quarter of 2012. On an operating basis, operating net income was $10.1 million or $0.54 per share in the third quarter of 2013, compared to $6.5 million or $0.35 per share in the third quarter of 2012, an increase of 56.2% year-over-year. As Janelle mentioned, gross premiums written rose 11.5% to $86.1 million from the year-ago quarter. Net premiums earned rose 12.7% from September 30, 2012 to $81.6 million, benefiting from the growth in net premium written achieved in prior quarters. Meanwhile, net investment income totaled $6.9 million in the third quarter of 2013, roughly 2.2% above the third quarter of 2012. The tax equivalent yield on our investment portfolio was 3.9%, compared to 4.5% in the third quarter of 2012. Average invested assets were $961.2 million in the quarter ended September 30, 2013, compared to an average of $880.4 million for the same period in 2012, an increase of 9.2%. In the quarter, we experienced the realized loss on our investment portfolio of $654,000 or $0.02 per share net of tax, compared to a $640,000 gain in the third quarter of 2012. In total, revenue for the third quarter of 2013 was $88 million, up 9.5% from the year-ago period, driven by the growth in premium earned. As Janelle mentioned, our current accident year loss ratio for the quarter remained 73.2%, compared to 76.5% a year ago. Our incurred loss and loss adjustment expenses totaled $57 million for the quarter, which included $2.7 million of favorable prior year development. This compares to loss and loss adjustment expenses of $53.8 million in last year's third quarter, which included $1.6 million of favorable prior year development. In total, our net calendar year loss ratio for the third quarter of 2013 was 69.9%, compared to 74.4% for the third quarter of 2012. Turning to operating expenses. The expense ratio declined to 22.6% from 22.8% in the same quarter a year ago, driven by higher growth rate in premium earned. Total underwriting and other expenses increased 12% to $18.5 million. The 2013 third quarter operating expense components include: $5.7 million of salaries and benefits, $6.2 million of commissions and $6.6 million of underwriting and other costs. In sum, our combined ratio was 92.5% for the third quarter of 2013 versus 98.5% for the same period in 2012. With the improvement in the combined ratio, our underwriting results were a higher mix of the total pretax income. Consequently, we experienced an increase in our tax rate to 22.1%, up from the 20.9% a year ago. For the 9 months, our tax rate was 23.4%, compared to 17.7% for the 9 months ended in 2012, again, due to underwriting results being a higher mix of total pretax income. Turning to the balance sheet. During the third quarter, we executed a reinsurance commutation on our 4 accessible 1 layer for the underwriting periods 2008 through 2010. There was no gain or loss on the commutation, simply a balance sheet transaction. As a result, the commutation reduced our reinsurance recoverable by $28.4 million for the quarter. Shareholder's equity grew to $400.7 million or $21.67 per share at September 30, 2013, growing both sequentially and year-over-year. Operating return on average equity for the third quarter of 2013 declined to 10.2%, compared to 7.1% for the third quarter of 2012. On the capital management front, we paid our third consecutive quarterly dividend of $0.08 per share on September 27, 2013. And the Board of Directors, on October 28, declared an $0.08 per share dividend to be paid on December 27, 2013 to shareholders of record as of December 13. Also, on October 28, the board voted to extend our share repurchase authorization to December 31, 2014 and to increase the share authorization to $25 million from $24.4 million. Finally, a few other numbers that may hold relevance to your models. Cash flow from operations remained strong at $99.8 million, up from $59.1 million in the 9 months ended September 30, 2012. The increase primarily reflects the impact of the reinsurance commutation. We continue to maintain excellent liquidity at the holding company level, with approximately $43.8 million of cash and cash equivalents. The $43.8 million includes the impact of the $15 million dividend to the holding company from AIIC on September 16. With the dividend, statutory surplus dropped modestly to $338.8 million from the $343.3 million in the second quarter. That concludes my prepared remarks on the financials. I will now turn the discussion back to Allen.

Thanks, Mike. With those comments, let's open the call for questions.

[Operator Instructions] Our first question comes from Matt Carletti with JMP Securities.

Just a few questions. First is on top line. I know you've talked in the past, I think, a bit on the last call of you're going through a process of kind of looking at your book and for lack of a better kind of analogy kind of buckets of, say, green light, yellow light, red light, where red light needs the rate, keep pushing it; greenlight, you know there's a ton of margin in it. And now that you've started to get a little bit of elasticity and demand because pricing is so high, maybe you can open the fire hose there a little bit. So can you walk me through kind of how that's going? Should we expect to see growth accelerate at some point? And am I thinking about it right? And that if that growth is coming from that greenlight bucket, that that's the better priced bucket and potentially, it's better margins than the average of the overall existing book?

Okay, Matt. This is Allen. The company, of course, prioritizes growth in those areas where you're making more money and less growth where you're losing money. That's not -- that's pretty basic. And, of course, what we have seen as we have commented on prior calls that we are pushing first to -- from margin expansion, and then worried about growth. In the last couple of years, we have been able to grow our business at the same time that we've been raising the pricing. We're probably going to get to a point where the pricing doesn't rise as much, but we would expect the volume may increase some. But our focus continues to be on those areas, where we are growing our business in areas we've made more money that we have better results. And we will continue to discourage that business which has been less profitable. So we don't give forward-looking guidance. I'm not going to tell you that growth is going to accelerate dramatically. But I think you can tell from our comments, we think this is an opportunity to expand profitably, and profitably being the key part of that.

Great, that's helpful. And then kind of tied through that, can you talk a little bit about how you balance that with the capital? Because, I mean, you've talked in the past about kind of premium surplus leverage ratios that you feel comfortable operating at, we're still quite a bit aways from that. And you're making good money, so the capital is growing. Do you think about special dividend, things like that? If you just talk us through kind of the thought process at where the stock is today.

It's Mike Grasher calling. I think the answer to that question is that everything is on the table, that the board takes into consideration our capital position and what lies ahead from the standpoint of the opportunities we see in the marketplace. And, again, I think as we suggested last quarter, well, everything is on the table. We're pretty much going to take a prudent approach on this until we really have some more foresight into what the true opportunities are out there ahead of us within the next 12 to 18 months.

Okay. And then one last numbers question. I couldn't find it in the filing. I know it's there, I just couldn't find it, the redomestication of the insurance subsidiary. Can you remind us, there is an expense savings to that, right? And have you estimated that? And is that primarily a 2014 event?

Primarily a 2014 event. And as when we announced that, we pointed out that in 2012, we paid $3.8 million of retaliatory taxes. If that were 2014, that bill on that same amount of money would be 0. So there is going to be some growth in that, Matt. And as you expand premium, if you expand it greatly in those states that have a retaliatory tax, the impact will go up disproportionately. I don't have that chart in front of me to tell you where we're growing, but it is primarily a 2014 account impact. There might be some in 2013, but we're not sure when that event will occur.

Our next question comes from Mark Hughes of SunTrust.

Allen, you had suggested that there would be pricing discipline for the next 2 years, and I was intrigued by the specificity of the 2 years. As you think about it, how the cycle matches up with the prior cycles, what is giving you confidence that the pricing will hold in there?

Well, I think there's a time period. And what -- one of the things I think is interesting about that, Mark, is that we all tend to watch this metric sequentially in the quarters. And as you know, the policies are 12 months in length, so you really shouldn't look at pricing in the preceding quarter. You should look to see what that pricing was in the preceding year, the same quarter. And as you look back at that, you will see, over the last 36 months, that, according to the CIAB studies, that premiums have increased about 20%, as reported by those folks surveyed, when you accumulate the pricing. If you also look at their history, and they have a long history of studying this, once the pricing goes up, the increases may continue on for a while but at a lower rate. It doesn't necessarily go back what would -- you'll read the headlines, I'm sure, in the next few weeks and say, "The CIAB study I think came out on Monday, and it showed workers' comp going up 5.8%." Okay, well that's less than the 8. -- I think it was 8.3% in the second quarter of 2013. So everybody will say that was a decrease. It is not. That 5.8% is an increase over the 8.1% increase last year and which was over a 4.1% increase in the previous year. So I think we're still going. If you look at those, the progression of pricing in those historical studies by the CIAB, I believe we're going to continue to have the support for increased pricing or it may plateau or it may even trend down, but I think it's going to remain at better levels. Another big driver in that, as you all know, is low investment yields. And I don't see that changing rapidly for the industry. And that's a big driver now, causing companies I think to focus on profitability. And when they focus on profitability, they will look at the pricing pretty rigidly.

How about the larger claims? You had kind of a flurry of those in the second quarter. Can you talk about what you saw in Q3? And is there any trend through the quarter or through October in those -- some of those larger claims?

Sure, this is Janelle. And I think at the end of the second quarter, we have reported that we had 6 claims are over $1 million. At the end of the third quarter, we're up to 9. But those quarters -- the claims that we did have in the third quarter were over $1 million but not at the 2 and plus mark that we reported in the second quarter. So they were smaller million dollar claims, if that makes sense.

Right. And then is there another sort of layer underneath that of more sizable claims? And I'm trying to think of the -- it sounds like frequency is very much under control. Certainly, pricing is going up. Your current accident year loss number, you kept the same here, through 3 quarters. What's keeping that from going down?

Well, I mean, severity is still a concern for us. Like I said, we have the claims that are over $1 million that we reported second quarter and third quarter. We like the frequency trend, especially when we have more earned premium coming in the door. As you know, we like to take a prudent approach to our reserves. Third quarter is the quarter that we have the most workers out there working, so our reported numbers tend to tick up in the third quarter. And if you remember, we mention this quite often when we get closer to the end of the year, by the end of the fourth quarter, we really do know pretty much the universal claims that we have for any given accident year. So that's our best shot at knowing how we think that accident year's going to develop as far as the number of claims that we have. So we're just being cautious about that until we know how the fourth quarter turns out.

Mark, let me add this kind of comment on that. With respect to our pricing, we know the pricing is going up. We still have that memory of 2010, which developed adversely on us. And so when you look at the $2.7 million of favorable development, none of that was -- came out of any years after -- including 2010. 2010, 2011, 2012, we've left alone. 2013 is the year we know the least about as we sit here today. And we're just trying to make sure that our decisions are appropriate. And they're the best estimates we have now, not relying just on pricing to make that selection, but really looking at the losses and seeing some of those development trends. And we see some good trends there. But quite frankly, we want to be very cautious about that. And the fourth quarter is a much better time to take a look. I'm not predicting there will be a favorable development there on the 2013 accident year, but I do think that's a better time to look at it than in the third quarter.

And Mark, I would just add that -- this is Mike. If you think about the nature of our business and the potential for the high severity claims that come through, we just don’t know until we know. And to Janelle's point, the fourth quarter is certainly a better period at the end of the fourth quarter where we actually know what the claim frequency looked like. Those claims that are coming in the door, we have a better picture of it that at that point in time.

And then a final question. Allen, if you touched on this. I'm sorry, I missed it. But kind of the flow of new applications, how is that looking? And any commentary about any of the other major players, how their -- you perceive their behavior in the market?

The flow of applications for new business in the quarter was up about 6.8%, 6.9%. It had already been at high level last year. And this year, it's at a high level. We have been quoting quite a few more in the late third quarter as the efforts of the sales and marketing department to focus submissions that come in to be in those profitable areas that I would mention to Matt. So we're seeing some of that. With respect to change in the marketplace, my comments about the marketplace being in a somewhat of a little disarray right now, we are seeing some business submitted to us from some other carriers. Quite frankly, some a bit surprised -- surprising as those are coming from construction, particularly heavy construction, and from some trucking accounts recently. Oil and gas is another area that we're seeing submissions, not surprisingly. And we're also seeing some of the economic factors indicate that the construction and the oil and gas industries are actually reporting, on a monthly basis, higher pay roles than what they had anticipated at the inception of the policies. So we're seeing some improvement in the audit premium with respect to those accounts.

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

So let me just ask a few follow-ups. I guess, on the last comment there, Allen, the -- I would take it that oil and gas and construction, trucking, is that going to be in like in energy states more, that you're seeing that like Louisiana, Oklahoma or Pennsylvania? Or is it more broadly distributed across your geographies?

The construction is not related to the energy states. The oil and gas, of course, is. And in the gulf, oil and gas can also mean maritime. It can mean manufacturing as you get in the fabrication business. So you can see some of that stuff. But it's not just the oil and gas states. The trucking -- really, my comments were about what we owned in the trucking side, what we've seen that has come to us sort of midterm on -- from some other carriers, as brokers seek to place that business. And that's where the trucking has come from. As a whole, trucking has been pretty well flat, as a whole. But in the recent weeks and months, we've seen an uptick in the trucking moving -- business, Randy, that you don’t understand is rating sensitive. It needs to move, that sort of stuff.

All right, that's helpful there. And then just a quick cleanup question on all the discussion around pricing. Did I miss if you actually said what your overall price number was for the quarter? Are there...

$179 million for third quarter of 2013, $166 million for third quarter of 2012.

Yes, that's the amount, that ELCM. But I don't know [indiscernible] kind of the percentage basis. Or do you not quote that?

We do not.

Yes, okay. And then -- but we can take it from the ELCM that you would be kind of above industry run rate on that. Is that fair?

It would be fair.

I would say that, that might be a reasonable assumption, yes. One of the problems, Randy, that I have with that net rate change report, it all depends where you start.

I know that. This is what people want.

If your pricing was low, then you report a higher net rate change even though you're -- when you get to the absolute number, you may not be as high as the other party. So we choose to report it on an effective ELCM basis as a better metric of where our pricing is.

Understood. And then, to just follow up on Matt's question about kind of the capital deployment, special dividends and everything being on the table. But I guess, your commentary have been on -- I think you said that books are in play. And so to me, that means it's not just kind of picking up more business in the market or maybe some of these items that are parked in the state -- the residual markets. But I mean, can we think about the potential for kind of renewal rates books being available in workers' comp? Your leverage, obviously, is low. Operating leverage is 1.x. You have no debt. So you could -- you could add quite a bit of premium to this platform. And I think you have the technology to scale it. So I mean, is there any color you can give us on it? If you could see kind of a bigger opportunity at business rather than just kind of onesies, twosies?

Well, the -- yes. We -- the books that are in play that we've sent -- been sent to us largely are requesting, quite frankly, rollovers to take an entire book and agreed to write the entire book. And Randy, we don’t do that. And -- but there is certainly the possibility of renewal right to transactions in those as the balance sheets are stretched and stressed. And folks have to get rid of certain books of business. So it's got to be -- we're going to maintain our pricing discipline. We're going to maintain our risk selection. We're still going to look at them before we write them. We're not going to agree to roll an entire book. Just not our approach to the business. But, yes. Are we interested in renewal rights? Certainly.

I mean, one last one, and then maybe this is a tough one to answer. But like -- you say the market's getting more disciplined. But is it still undisciplined enough that other people will just go add and roll those book? Or is there enough fear in workers' comp now that nobody is touching those?

What we're seeing is that those are blowing apart. In other words, the programs don't find a home. And that's the reason for the parked -- long -- in the parked accounts in the residual markets, that underwriters are not rolling those in and just taking them. And that the pricing is moving up in the process.

And Randy, I would just add that our experience has been that there is a lot of sticker shock for these insurers, once they see what the real world is falling into action here in terms of the pricing. So from that standpoint, I think our experience would tell us that while renewal right opportunity is out there, one may not receive the benefit of that renewal right in as much as just walking away and having an opportunity to see that business later on down the road.

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

Thanks, Kevin. I want to thank you for your participation today. But before closing, I want to tell you a story that I believe is somewhat relevant. In late 2003, after working for this company for more than 9 years, I was given the opportunity to serve as the CEO. At that time, the market had emerged from an extended soft market period where pricing was largely driven by favorably priced low-level reinsurance products. The long-term results of this soft market were not favorable. Even as prices recovered and demand was healthy in the economy, I found that AMERISAFE was without access to available capital and was handicapped in taking advantage of the turn in the market. At that time, I sought additional capital for the company. I remember a conversation with a potential investor, and I remember telling him and I quote, "these are the good old days" trying to encourage him to allow us some capital in our operating entities. I guess my arguments weren't very persuasive because my efforts to raise that capital were unsuccessful. And therefore, our ability to expand our operational leverage was limited. Many things have happened to this company since 2003. The biggest change is that we are no longer capitally constrained as we've been discussing here just a few minutes ago. This current market is not like the 2003 market. But it is the same time in the cycle when opportunity exists to expand the business with profitable margins. We're not guaranteed any term for this opportunity and it's incumbent upon us to take advantage of the opportunity to profitably expand our business. In other words, I would tell you again, "these are the good old days." Thanks for joining us.

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