AMERISAFE, Inc. (AMSF) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the AMERISAFE 2016 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mr. Vincent Gagliano, Chief Risk Officer. Please go ahead, sir.

Good morning. Welcome to the AMERISAFE 2016 third quarter 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 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 Janelle Frost, AMERISAFE's President and CEO.

Thank you, Vincent, and good morning everyone. This quarter AMERISAFE’s favorable results were driven by our continued discipline. Discipline in our risk selection and pricing, discipline in our claims handling, and discipline and managing costs. We firmly believe maintaining that discipline is appropriate as the workers' compensation market softens. The industry has reported a profit in the last few years. However, both in NCCI and [A&S] consider industry-wide loss reserves to be deficient. At the same time underlying loss costs continue to decline. This combination will tempt underwriters to chase premium and sacrifice underwriting profits. Our focus has been and will continue to be to protect the underwriting margins. That focus enabled us to return value to our shareholders. This quarter our Board evaluated our capital position and that return in value included an extraordinary dividend of $3.25. The extraordinary nature of this dividend is reflective of our perception of the workers' compensation market conditions and the Company's continued ability to produce earnings for our shareholders. Now into operations. Premium written in the quarter was down 2.4%, audit and related premium adjustments declined $1.2 million. We are focused on policy count given the softening rate environment as I've been saying all year. We did grow voluntary policy count by 3.6% in the quarter which was a good result. However, with a loss costs in most states falling, premium for voluntary policies written was down 0.9%. New business was down 7.3%, but renewal business was up 0.5%. Our effective loss cost multiplier was 1.71 down from 1.77 a year ago and down slightly from 1.73 last quarter. Relative to losses we remained at 67.9% loss in LAE ratio for the current accident year. Both frequency and severity for the current accident year were consistent with the prior accident year at the same point in time. Our claims reported in calendar year 2016 were down 1.2% from 2015. As for prior accident years we experienced favorable case development in the quarter which led to a reduction in losses incurred of $10.5 million. Accident years 2008, 2013, and 2014 experienced the most favorable development as we focused on closing claims and returning injured workers to work. Our open claim count at the end of September 2016 was 4.1% lower than at the end of third quarter 2015. After the favorable development our loss LAE ratio for the quarter puts 56.2% compared to 54.1% last third quarter. The best summary of these operational results is a combined ratio of 80.3% and a pre-tax underwriting profit of $20.8 million. I'll now turn the call over to Neal to discuss the financial results.

Thank you, Janelle, and good morning, everyone. For the third quarter of 2016, AMERISAFE reported net income of $17.9 million or $0.93 per diluted share compared with $17.9 million or $0.94 per diluted share in the same quarter last year. Operating net income in the quarter was $17.8 million, also $0.93 per share, $0.01 per share decrease from the third quarter of 2015. Revenues in the quarter increased by 0.8% to $98.2 million compared with the third quarter of last year. Net premiums earned decreased 0.6% to $89.9 million when compared to the third quarter of 2015. Net investment income was $8 million in the third quarter of 2016, an increase of 15.6% when compared with last year's third quarter. The increase was largely due to the increase in value of a hedge fund investment, which is mark-to-market through net income each quarter. On a year-to-date basis, investment income is down 1.9% from last year. The tax equivalent yield on our investment portfolio was 3.2% in the quarter, compared with 3.3% in the same quarter last year. There were no impairments or significant realized gains or losses during the quarter. The investment portfolio continues to be high quality, carrying an average AA- rating with an average duration of 3.12 and with 52% in municipal securities, 30% in corporate bonds and the remainder in cash and other investments. 51% of our investment portfolio is classified as held to maturity, which is in net unrealized gain position of $19.5 million. These gains are not reflected in book value per share as these bonds are carried in amortize costs. With regard to operating expenses, our total underwriting and other expenses decreased 6.7% in the quarter to $20.8 million compared with $22.3 million in the third quarter of 2015. We saw decreases primarily in assessments and commissions compared to the third quarter last year. By category, third quarter 2016 expenses included $6.3 million of salaries and benefits, $6.4 million of commissions and $8.1 million of underwriting and other costs. Our expense ratio for the third quarter was 23.1% compared with 24.6% in the third quarter last year. Our tax rate increased to 31.2% in the quarter, up from 30.7% in the third quarter last year. The increase reflects the larger amount of taxable income compared with tax exempt income during this year as a result of the increased amount of favorable prior year developments on a year-to-date basis. Return on equity for the third quarter was 14.2%, compared to 14.9% for the third quarter of 2015. Operating ROE for the third quarter was 14.4%. On October 25, the Company's Board of Directors declared a regular quarterly cash dividend of $0.18 per share, payable on September 23, 2016 to shareholders of record as of December 15, 2016. In addition, as part of our Ongoing capital management efforts the Company's board declared a special dividend of $3.25 per share for shareholders with the same record and payable date. This brings the total amount of special dividends paid out in the last three years to $7.75 per share. And just a few additional items to note, book value per share increased 11.7% from your end to 26.51 at September 30, 2016. Our statutory surplus rose to $395.2 million at September 30, 2016 up $23.8 million from year end. In addition so far this year we have paid $37 million in dividends from the insurance companies up to the holding company, AMERISAFE, Inc. AMERISAFE will file our Form 10-Q. for the third quarter tomorrow afternoon after market close. That concludes by remarks and we would now like to open up the call to analyst investors for questions. Operator?

Thank you. [Operator Instructions] Our first question is from the line of Matt Carletti of JMP Securities. Your line is open.

Hey, thanks. Good morning.

Good morning, Matt.

Couple questions, I guess I'll start with one on kind of just, but the market and what you're seeing. If you look at some of the kind of published market wide surveys are rate trackers for workers comp and I know that that's - they're catching a lot of things, your books very targeted and that's very broad. We saw a slight kind of correction in the downturn of rates in the past couple of months. You know kind of down 3s and 4s became down 2s and down 1s from July to August to September. What are you seeing in your book, we just say its stable, we just say it's kind of that sort of same trend. Is it something opposite of that?

Matt, we're still seeing increasing competition in the market is continuing to soften, the last graph that I saw from NCCI is showing loss costs filings they were 32 decreases approved and six increase.

For the same one, yes.

Yes. So we still believe the underlying loss costs are declining and partially driven by experience. But as I mentioned earlier in this market the declining loss cost when we believe there is efficiency still in the industry is going to cause some turmoil in the marketplace.

That makes sense. Okay. And then one other I guess just more along the - talk about reserves and the development you've seen, more so a read through question. I know that years like say 2015 are too early for you guys to look at - at least from a release standpoint. But as you look at these older years 2014 in particular kind of being the most recent one and ones before that developed favorably, one kind of what are the implications for 2015 as we go into 2016, since you are kind of lowering the bar at which those are set at and what are the early reads are you seeing actual come in better than indicated in say 2015 but it’s just too green and we need to wait and see. Or is it coming in more as expected?

It's coming in more than - I think it’s coming in as expected. I think as you mentioned 2015 is still a green year, we are in a lumpy business. It just takes a few claims for things to get a little escalated for us, I think I've said this before on prior calls. I believe that we as in most companies probably honed in on our reserving practices on a case basis after the Great Recession and I think that's what you're seeing in our reserve - our case reserve releases that we've seen from exiting years 2012, 2013 and 2014. So going into 2015, I think maybe we were maybe more realistic about what we were facing in terms of return to work and the duration of claims. But at the same time we're getting less premium per dollar for those exposures.

Got it. All right thanks. Thank you for the answers and congrats on a very nice quarter.

Thank you.

Thank you. Our next question is from the line of Randy Binner of FBR Capital Markets. Your line is open.

Hey, good morning. Thanks.

Good morning.

If I missed it I apologize, I’ve been jumping from different calls. But did you mention with the statutory surplus was at the end of the quarter? And if that - what that number would be after the payment on the special?

Yes, Randy this is Neal. We did mention statutory surplus at the end of the quarter was $395.2 million and that was up $23.8 million from year-end. We had already paid $37 million up to the parent company though. So you start to have to take those two into account to get to statutory earnings. We will also pay an additional amount up to the parent company to help fund the special dividend that we've declared and that will be paid on at December.

So maybe minus another 30 for their pro forma is that about right.

Yes.

Okay, cool. So that’s my question which is been very - to see the special I think that's great for shareholders. But despite that large payment your premiums and surplus which is our crude measure of operating leverage from the outside is still not even up to one X. And so I guess kind of synthesizing the comments from Janelle having to stay disciplined in the market. What's a reasonable operating leverage goal for AMERISAFE kind of over the next year or so?

Yes. We have a long-term target, we think that our GAAP operating leverage right now is running bouncing around 0.8 or so, long-term we think that that GAAP operating leverage to get to 1.0. We won't disclose a target for where we could get in the next year. But our Board continues to focus on the capital position of the company and discuss it each quarter and then make a determination about what is the best method to return capital to shareholders and what is sort of the future as we look at the market as we go through different cycles. So long-term that 1.0 is still a long-term target that we would like to strive towards.

So there's a point maybe like a couple years ago where it seemed like distress in the market would yield some under opportunities from AMERISAFE. Potentially just taking business maybe picking up distressed company or a block? Is it going to safe to say that that whatever if that opportunity existed? It's kind of past you know just trying to think of a plausible way that or any color you can give on kind of opportunities you see in organically on the market is trying to get a sense of how likely it might be that you can use this capital for something productive rather than the special?

We constantly look at M&A opportunities and as we move through this softening market there is potential, but there may be books of business or pieces of business that other people are concerned about we have you know done some small purchases of blocks of business in the past and we certainly would look at them again. We're not necessarily interested in buying balance sheets, but it is something that we continually think about in terms of our capital position and use of capital. But it would have to be a great return for shareholders.

I’ll just do one more in the 1.71 ELCM. So I believe that implies 59% loss ratio and you're running still actually a loss ratio at 68% I mean these are rough numbers because there's a little bit of gab versus stab but pretty conservative and so I guess you know should we expect that kind of conservative spread on where you run the accident loss versus ELCM did persist it's not a new. It's seemingly building in a lot of redundancy into the book which is fine. Just trying to get your perspective on how wide that that might continue to run and you know how some of the macro factors in the workers' comp space fit in that.

Good question. As far as the entrance of the 1.71 I would keep in mind that would be assuming that the loss costs are correct. And as you know loss costs seem to have large swings in them which doesn't and it takes a period of time for that to work itself into the book. Secondly, as far as the AMERISAFE reserving practices I think we've been very consistent over our history. Particularly in our current accident year selection of where we think our book may be we look at frequency, we look at severity and as I was mentioning to Matt earlier we are in a lumpy business. So our standard practice has been you know we said that last bit where we think it should be the beginning of the year. What we think ultimately the cost will be. And if there is something throughout the year that indicates us either in the trends or frequency and severity paid to encourage anything to that nature closer to closure rate that we think makes that estimate in correct we would adjusted. But most of those adjustments in my mind would be upward and nothing it wouldn't go down unless or something extremely compelling otherwise given the type of business that we are right we typically wait 30 to 36 months as of the inception of a policy year to make those type of adjustment unless there's something extremely compelling which we did earlier in the year for accident year 2016. Typically - adjusted that to the second or third quarter but we had enough case reserves that were favorable to us that we made the adjustment in the first quarter. So I do think we are responsive to that but as you know our responses are very deliberate and very consistent.

All right. That’s all I have. Thanks a lot.

Thank you. [Operator Instructions] Our next question is from the line of Mark Hughes of SunTrust Robinson Humphrey. Your line is open.

Thank you. Good morning.

Good morning, Mark.

Good morning, Mark.

The audit premium was a negative for the first time in quite a while was that concentrated in any particular in the market to or broad-based.

Yes. So audit premium along just audit premium not counting endorsement cancellations that effect we’re still positive in the quarter. So we are seeing negative audit premium come through obviously oil and gas industry and I actually in this quarter was in our roofing business. We saw some negative audit premiums. But as I told audit premium was positive this quarter just less positive that was in previous quarters and the declines were pretty much across the board with the exception of trucking, which we've talked about with you and others on the call and how we felt like trucking is strong throughout this passing cycle and that prove to be true with the audit premiums.

Right, so the audit premium was just down $1.2 million from last year. Last year’s third quarter - if I got my number right here, that was flat in terms of the audit premium?

All in, including our endorsement cancellations, that's correct.

Right, and so this year?

Our cancellation number was higher this year than it was last year.

Right, okay.

And our number was positive, but it was lower than last year. So all-in that that’s where we got to the minus $1.2 million.

Right and the number that you gave is sort of an all-in number?

That’s correct.

Right, so last year’s all-in was flat. This year’s all-in was negative 1.2 million, but you’re saying that the audit premium was actually positive and it was…?

The audit premium number was positive. It was still a negative change from the prior year. But it was only less [$1,000].

Right, and then what was the cancellations, what was the - what accounted for the remainder of that $1.2 million?

So the remainder of that was basically driven by cancellations, so we had more cancellations in the quarter than we did in the prior year’s quarter.

Right, what causes that?

It could be a couple of things, one is cancel flat, so if - and insured books bind the policy when the certain period of time moves that policy to someone else will cancel it flat, and so basically the entire premium gets undone, but it shows up at the cancellation premium. Or if you were to cancel uninsured for some reason due to an audit that we've done and it wouldn’t be non-renewal, it’s just the cancellations.

Okay. The underwriting expense was better this quarter and I think you would refer to assessments and commissions. Is there some reason why the commission rate is lower? I know written premium was flat to down a little bit was the commission rate lower this quarter?

The overall effective rate for commissions was lower this quarter. I think part of that is some of the sales initiatives we have ongoing. We have a number of agents that lost their preferred status in the quarter, some of which regained it going into the fourth quarter, but for the third quarter, we do evaluation based on a six month period. So there were agents who lost their preferred status which mean a lower commission rates. But as we get our sales initiative going and as we get our agents on board is what we're trying to achieve. I would expect that to go back to its normal rate.

Great. Was the 2Q more or like the normal run rate?

No. I would say 2Q was lower. I would think it would be more in line with Q1.

On commissions.

Yes. Okay. I guess what I'm thinking about the expense ratio overall. If I do expenses and public policy holder dividends to about 26% in the second quarter, this quarter you're about 24%, again that's combining the two categories. Is the 26% closer to what we had to think about on a go forward basis?

That's a good question. I think you've seen that our dividend ratio has increased this year as we're competing with dividends more in several states where that's the only way you can compete. So I think the dividend ratio is probably the - year-to-date basis is a good go forward rate. And then the expense ratio we're continuing to try to manage our expenses in a disciplined fashion as Janelle has mentioned. And so that 24 range I think is typically what we have stated for the year. We've been slightly below that, but we always like to try to manage that in line with our plan and do everything we can to manage that expense ratio.

Okay. Janelle, you gave a specific number for change in frequency or Neal down 1.2%, some over that number?

That was the change in our claims reported for the calendar year.

Great. Okay. So kind of a proxy for frequency?

If you wanted to infer that, perhaps.

And then how about large losses. What did you see in 3Q and how is that trended year-to-date.

Yes. On a year-to-date basis and when we talk about large losses, we typically talk about something in excess of $1 million even though our retention started to. On a year-to-date basis we're at 10 claims in excess of $1 million. I think we ended the year last year with 14. But I think we're on it, if you want to call that on pace, again, we never know when they're going to happen so it's kind of - it happens when it happens for us, but there's nothing in the larger loss number that would cause us any anxious as far as our accident year selection for calendar year 2016.

And then the net investment income got a little bit of a bump from the hedge fund gains. Is that what normally triggers that, is that kind of broader stock market or just - is this something else entirely?

Yes. I would say the broader stock market, I think you've seen volatility this year as relates to what's going to happen with interest rates and the Fed and so there's been a lot of volatility in the first quarter and also in the second quarter. This third quarter there's been a pretty significant gain. I think on a year-to-date basis that's about what we would expect, but obviously the net investment income was lumpy in the first three quarters of the year.

And if that goes against you in the subsequent quarters, is that worth to the volatility?

It's something that we continue to look at and focus on as we think about our investment strategy and it is something that we're assessing.

Okay. Thank you very much.

Thank you, Mark.

Thank you. And that concludes our Q&A session for today. I'd like to turn the call back over to CEO, Janelle Frost for any further remarks.

Thank you. We believe AMERISAFE is well positioned both from a capital perspective and from an operational perspective. Our mission is to provide quality insurance services to our customers through diligent risk assessment. We deliver an exceptional product with integrity through professional, knowledgeable and dedicated employees. That level of commitment is what allows us to maintain our consistency, focus and frugality and in return provide value to our shareholders. Thank you for joining us today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.