AMERISAFE, Inc. (AMSF) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the AMERISAFE's 2018 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Ms. Kathryn Shirley, General Counsel. You may begin.

Good morning. Welcome to the AMERISAFE 2018 Second 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 may differ materially from the results expressed or implied in these statements if the underlying assumptions prove to be incorrect or if the results of risks, uncertainties and other factors, including factors discussed in today's earnings release, in the comments made during this call and in their 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 Janelle Frost, AMERISAFE's President and CEO.

Thank you, Kathryn, and good morning, everyone. We're pleased to report earnings per share of $0.88 and a combined ratio of 83.6% for the second quarter. These financial measures were achieved by AMERISAFE's discipline throughout the soft cycle. For nearly two years, I have referred to an increasingly competitive environment. Workers' compensation has become an attractive line of business in the property and casualty marketplace. Calendar year 2017 marked the third straight year of combined ratios of less than 100%. In fact, workers' compensation was the most profitable of all the P&C lines in 2017 in terms of underwriting. For AMERISAFE, this type of environment brings pressure for multiline carriers using workers' compensation to offset less profitable lines when offering package policies. However, our consistent small- to mid-sized employer, high-hazard niche, coupled with our focus on maintaining underwriting profitability offered some protection from competition in the second quarter. We achieved record policy retention of 94.3% for those policies in which we offered renewal in the second quarter. Added with some growth in new business, our premiums per policies written in the quarter were 300,000 less than the prior year's quarter. With overall policy count being relatively flat during the quarter, this slight decrease in premium was driven by the decline in underlying loss cost, which far exceeded premium from exposure growth. Our pricing for the quarter was at 166, as represented in our ELCM, down from 168 in the second quarter of 2017. Overall, gross premiums written were up 7.7% or $6.7 million in the quarter, driven by audit premium and related adjustments. Audit premium was a tailwind this quarter. We saw audit premium increases quarter over prior-year quarter in all industries except agriculture and more so in energy-related states. I will caution that audit premium is not linear, but we do you consider this quarter's increase a sign of a growing economy for our insureds. Moving on to losses. Our loss ratio for the quarter was 58.5%, comprised of a current accident year loss ratio of 71.5% and aided by a 13 percentage points of favorable development from prior accident years. The current accident year loss ratio was unchanged from our initial estimate reported in the first quarter. The favorable development this quarter was completely the result of case development in accident years 2016, 2015 and 2013 and prior. This was our first quarter to adjust accident year 2016 since the accident year ended, and in line with our historical pattern of 30 to 36 months of aging. This quarter's favorable case development was strong and added $11.6 million to pretax income. However, just as I stated with audit premium, case development, whether favorable or not, is not linear. This quarter's favorable development resulted from individual case reserve changes, not management change in ultimate estimated losses. I feel that is an important distinction. Neal will now discuss the financials.

Thank you, Janelle. For the second quarter of 2018, AMERISAFE reported net income of $17 million or $0.88 per diluted share compared with $15.5 million or $0.81 per diluted share in last year's second quarter. Operating net income for the quarter was $17.8 million or $0.92 per share, an increase of $0.10 cents from $0.82 in the second quarter of 2017. Revenues in the quarter increased 6.1% to $95.4 million compared with the second quarter of 2017. Net premiums earned increased 7.5% to $89 million when compared to last year's second quarter, driven by very strong audit premiums which can be volatile from quarter-to-quarter. Turning to our investment portfolio; net investment income decreased 2.2% in the second quarter to $7.3 million compared with $7.5 million in the second quarter of 2017. The decrease was largely due to the increase in the value of a hedge fund investment in last year's second quarter. Net investment income without the hedge fund impact was down 1.2% compared to last year's second quarter. The company experienced net realized losses on security transactions of $1.1 million in the second quarter of 2018 compared with $400,000 in the second quarter of 2017. The tax equivalent yield on our investment portfolio was 2.9% at the end of the quarter. The pretax yield on the portfolio was 2.63% at the end of the quarter, up slightly from 2.54% at year-end. There were no impairments on any of the securities held in the portfolio during the quarter. At quarter-end, the investment portfolio carried an average AA rating, with duration of 3.82. It was composed of 55% in municipal bonds, 22% in corporate bonds, 18% in U.S. treasuries and agencies, and the remainder in cash and other investments. About 58% of our bond portfolio is composed of held-to-maturity securities, which were in an overall unrealized gain position of $1.2 million at quarter end. These unrealized gains are not reflected in our book value as the bonds are carried in amortized cost. Moving now to operating expenses; our total underwriting and other expenses were $21.3 million in the quarter compared with $20.2 million in the second quarter of 2017. The increase was largely due to higher commission expense and premium taxes compared to last year's second quarter. By category, the 2018 second quarter expenses included $6.7 million of salary and benefits, $6.6 million in commissions and $8 million of underwriting and other costs. As a result of increased premiums in the quarter which offset the expense increase, our expense ratio for the quarter was 23.9%, lower than the 24.4% in the second quarter of 2017. Our tax rate was significantly lower in the quarter as a result of the new lower 21% federal corporate tax rate. Our tax rate for the quarter was 19% compared to 30.1% for last year's second quarter. Return on equity for the second quarter of 2018 was 15.5% compared to 13.1% for the second quarter of 2017. Operating ROE for the quarter was 16.1%. In capital management, our company paid its regular quarterly cash dividend of $0.22 per share in the second quarter. This quarter, the board declared a quarterly cash dividend of $0.22 per share, payable on September 21, 2018, to shareholders of record as of September 7, 2018. And finally, just three additional items. Book value per share at June 30, 2018, was $23.11, an increase of 4.6% from $22.10 at year-end. Our statutory surplus was $404 million at quarter-end, up from $382 million at December 31, 2017. And we will be filing our Form 10-Q with the SEC tomorrow, August 3, after the market close. That concludes my remarks. And now we would like to open up the call for the question-and-answer session. Operator?

[Operator Instructions] And our first question comes from Matt Carletti with JMP.

I had a few questions. First one, Janelle, maybe a little higher level. Just can you comment or give us your observations on what you're seeing in your underlying classes in terms of economic activity? It would -- I know the audit premium would be -- is positive, I'd imagine that has a lot to do with it. But just as you think forward, which kind of large class codes within your book are you seeing kind of the most promising conditions and which ones maybe aren't you seeing yet?

Matt, for this quarter, audit premium -- and throughout this soft cycle, we've seen audit premium -- on standalone, audit premium has been positive. So that's good. But this particular quarter, the audit premium alone was even stronger. Even though -- granted last second quarter was probably a little comparable, we did see it. And we did see it across our industries, with the exception of agriculture. So we are seeing -- and we're inferred to that, that that's economic growth for our insured. We're seeing it in the audit premium that we booked. Keep in mind, in a perfect world, that's policies that we wrote in the first quarter of 2017, if you wanted to categorize it that way. So we think that's a positive outlook for our insureds, the month that we don't see any anomalies in the monthly reporting. On prior calls, we talked about in the trucking industry, where we saw some uptick after the storms, and particularly in Texas and Florida. But I think trucking, overall, I think we expect to be relatively positive for our insureds in 2018.

And as I think about kind of the different ways that could come through, I mean, you have kind of -- they could hire more employees, their existing employees could work more hours, they could have higher wages for their employees. What -- does any one of those kind of stick out as being a bigger driver than the others? Or is it a bit of everything?

Yes, we've seen growth in payrolls. And at least from our initial look at just what people are reporting to us on a monthly basis, we have seen an uptick in number of employees.

And then just a couple of numbers question; actually, actually sticking on kind of that theme. Can you just remind us what the audit premium impact was in the -- in Q3 '17 and Q4 '17 so we know we're comparing to as we go forward this year?

Yes, so this is audit and other related premium adjustments, so it includes calculations. So in the third quarter of '17, it was a negative $1.1 million. And in the fourth quarter of '17, it was a positive $2.1 million.

And then lastly, just on tax rate; I mean, it was about 18-ish percent for the first half of the year. Is that a fairly good run rate to assume? And assuming there's no mix change in terms of where the profitability is coming from between underwriting and, say, the investment portfolio, but if the -- were there -- is there anything kind of onetime issue there that we shouldn't take that 18% is kind of the reasonable expectation going forward?

Yes, there's really nothing really, from a onetime standpoint in the first half of the year, that affected the tax rate. It really is the amount of development that we see each quarter that typically drives that. The amount of investment income from the portfolio that's tax exempt stays relatively steady.

Our next question comes from Randy Binner with B. Riley FBR.

This is Ryan [ph] on for Randy again. I wanted to touch on the reserve development. The years 2013 through '15, I know we've seen as redundant the past couple of years. And I know you're just starting to look at 2016, but I was wondering if you have any more color there on -- if you're seeing lower claims incidence or anything else going on that would hint it to be a better or a redundant year going forward?

Are you referring to accident year '18?

Correct, correct. No, '16.

Yes.

No, '16.

Oh, '16.

In other words, what is he seeing with '16 as we look at it for the first time?

Yes. I think when we started looking at accident year 2016, I think it's going to -- it looks like it's going to be a good accident year. Obviously, there's volatility in there. Our claim counts were relatively flat during that period going into the accident year. So I felt like we did have good handle on the case reserving. As I mentioned in our -- in the prepared remarks, the favorable development that we saw this quarter coming out of '16, which was $3.2 million, was all case reserves -- case reserve changes related to that accident year. So that wasn't management changing our ultimate ratio for that. It was strictly things coming out of settlements, being able to close claims, those type of activities.

And then on frequency and severity, do you guys have any color that you could give? Past couple of quarters, you've been talking about how it's been usually across the board, especially with severity. If there's any changes this quarter.

Coming into accident year 2018, we expected there to be pressure on frequency A because the underlying loss costs have been declining, so there's pressure from a premium perspective. Even though I had same number of claims, I have less premium collected for that. But as we've had exposure growth, we have more reported claims now than we did, say, same point in time in accident year 2017. Again, all expected, but I think that's just -- of where we are in terms of the economy. More people are working, which is good, but those people tend to have accidents. So there -- but there was nothing, from at least what we told you in first quarter coming into second quarter, ending with second quarter, that changed in terms of how we view accident year 2018. We -- in terms of -- we typically talk about just the large losses just as an informational point for you guys. In claims excess of $1 million, I think we had 7 reported at the end of the quarter for accident year '18, and that's in comparison to five at accident year '17 same point in time. Unfortunately, those things aren't linear. Like I talked about before, they're random in nature as to when claims happen. But that kind of gives you a picture of at least -- or it does appear to be from that aspect, the larger claims, any real difference at this point in the year.

And have you seen any increase in severity? Or is it relatively same from 1Q?

Relatively the same from 1Q.

[Operator Instructions] Our next question comes from Mark Hughes with SunTrust.

On the 2016 accident year, you point out you're just now kind of opening up and taking a look at it. Is there little bit of a catch-up phenomenon that when you open that thing for the first time, you get a -- perhaps a good result and so you would look for more normal development in subsequent quarters? Or is that -- that's not a real thing?

Yes. Maybe I should be more clear about -- this is the first quarter that we've made adjustments to accident year 2016. It's certainly not the first time we've really taken a look at it. We've been monitoring it all long. And that -- part of that monitoring is what led us to believe that, okay, we saw this case development this quarter, we feel very comfortable in releasing that because we see where -- how the accident year has developed, we've seen the claims close, we look at the open inventory for that claim. So that's something we've monitored since the accident year closed, since it ended. But certainly not our first glance at it per se. It's just that there's -- when it reaches that 30- to 36-month mark, we really feel comfortable with having a really good handle, particularly on the case basis, of what the universe of claims that we have left open, what the reality of those claims are. Now history says that can change, medical conditions change often. But at a 30- to 36-month window, if you look at our development patterns, if you look at our schedule P&Ls, you'll see that, at least from a case perspective, that's really when we will have a good handle on those particular accident years, that 30- to 36-month window. So that's why the case development, we feel very comfortable in recognizing, okay, this case development happened, it's not an anomaly per se. That is favorable development for the quarter.

Right. Exactly. The ELCM was up sequentially. I think in your press release, you talked about taking a little bit of a price decline -- a slight price decline. I assume you were talking year-over-year there.

That's right. Over -- quarter over prior year quarter. Let me be clear, quarter over prior year quarter. If you think of ELCM as -- if we're looking -- if we're trying to look at basically the same group of policies, so policies that renewed from first -- from second quarter of 2017, what was their pricing like coming into the second quarter of '18. I think we used to talk about just sequential quarters, but that can change by the mix of the policies that we wrote and which states are in that mix. Because some states obviously have higher ELCMs than others. So we find it better to compare quarter over prior year quarter. But you're right, it is sequentially up from first quarter, which was the 163 [ph].

Do you think that's a mix issue? Or were you -- or I know this is relative to the state-calculated loss costs, and so you got a couple of variables that are moving there. So your absolute pricing may be down, but your ELCM could be up; was that a little more push on price on your part or was it some other combination of different variables?

Yes, that's a good point. So you're right, the ELCM is in -- is relative to the loss -- underlying loss costs. So this is above -- certainly above and beyond that, if you get at it that way. So your question was, is it a mix issue? Again, where we grow or shrink by state does influence that number. If there's a state that has a particularly high -- loss cost multiplier, our underlying rates, then that does impact the overall number. So if that's what you mean by mix issue, I would say yes. It matters if you grew in Pennsylvania versus if you grew in Florida, which is an administrative pricing state.

But Mark, I think if you look at our pattern, you can see that we're down two points over prior year. And that's consistent with the prior three quarters. If you look at all of those ELCMs, they're basically two points lower than the same quarter prior year. So the trend is continuing a gradual decline in ELCM.

Right. With a little bit of seasonality and maybe quarterly variation, perhaps based on mix, would be the point I'm hearing?

Yes.

Yes.

Anything on inflation front? You've touched on frequency and severity, but the -- would you -- specifically the issue of inflation, do you -- I know that has been a concern, but I'm not hearing any particular concern this quarter. Is that fair?

No. No changes really from how we view things at first quarter.

And then the -- on the investment portfolio, the new money yield versus the overall portfolio yield there, should that overall yield be moving up, portfolio yield based on the new money?

New money rates are certainly higher, but the yield curve is fairly flat. And so our new money typically that's been rolling off of the portfolio has been going into shorter corporates, two or three years, because you're getting paid enough for those relative to going out to 5 or 7 or 10 years. So the new money yield is about the same as the new -- the money rolling off of the portfolio at this point in time.

Okay. But you're taking a shorter duration, less risk presumably?

Yes.

And our next question comes from Christopher Campbell with KBW.

I guess my first question is just if I'm looking at like the premium growth and net investment income, so we'll probably get a pretty strong premium growth in the quarter, but the net investment income was down year-over-year. Now typically, I would think those would be kind of positively related, so just anything special happening with that in the quarter?

Yes. Let me clarify on the premium growth itself. So the premium growth that we experienced this quarter, well -- hey, I'm happy to report, 7.7% up, was coming from audit premium and related adjustments. The policies that we wrote in the quarter were relatively flat in terms of premium dollars. And that's if I look back over the last few quarters just -- for example, last quarter we were -- those policies were at 1.6%. But it's been relatively flat for quite a few quarters now. Now granted, second quarter last year, we had a low comp because I think we were down nearly 11% for the policies that we wrote in that quarter, so this was an improvement. But again, the policy that we're writing in the quarter in terms of premium dollars, let me be very clear, has been relatively flat. Now why is it flat? If I told you, hey, we're retaining policies and our policy count is looking good, it's simply because the underlying loss cost have been down by high single-digit numbers. So everything that I've gained in terms of either policy count or exposure growth, payrolls being increased, are sort of loose in terms of underlying loss costs.

That makes sense. And...

And so summary, net investment income, quarter-over-quarter, we were down slightly. But if you look on a year-to-date basis, because we've had some volatility particularly in last year when we own the hedge fund, on a year-to-date basis were -- net investment income is up 2.3%.

Got it. Yes, I see that. Okay, that makes sense. And just my second question is just kind of on your philosophy on like the core loss ratio picks [ph]. So it looks like you set them annually, but then in 20 -- or at the end of 2017, you kind of spiked it up to 75%, and then it comes back down for the past two quarters. Now what's your process for kind of setting that? And then what can we look at on the outside to see when that might -- when you're thinking might shift on something like that? Like are there any external factors that we can look at?

Yes. We tried to -- one of the things we talk about every quarter is what we're seeing in terms of the accident year. Because you're so right, at the beginning of an accident year, we have a thought process, we have a projection of what we think we're going to see in terms of frequency and severity, and we monitor that throughout the year. And as long as we feel like the data coming in the door, the things that we're experiencing are in line with our original estimates, we keep our loss-ratio estimate the same for the accident year. Harkening back to accident year 2017, when we got into the fourth quarter, we saw a spike in average severity inside. You know what, we're not as comfortable as we were with our original estimates and so decided now is the time to make that adjustment, and we made that adjustment. So you're correct in that, it was 75% for the quarter, but we were actually raising the loss ratio itself to 70.5%. Is that correct, Neal, if I remember it correctly...

Correct, 70.5%.

So it was 75% for the quarter, but it was bringing the entire estimate for the whole year to 70.5%. So coming into accident year 2018, our initial estimate is higher than where we were for accident year '17, at 71.5%.

Right. And then, Chris, in terms monitoring from the outside, you'll look back -- and last year, we've expressed concerns about severity, the severity that we were seeing in the third quarter conference call, in that there was something that needed to be monitored. Because we were seeing just more severe accidents and we don't really know if it was a trend or just more severe accidents. And so that is something that an outsider could monitor as we go throughout the accident year.

And I'm showing no further questions at this time. I'd like to turn the call back over to Ms. Janelle Frost for any closing remarks.

I often use the words consistent and focused when I talk about AMERISAFE. It's fundamental to who we are. We operate in a cyclical industry impacted by payrolls, the economy, medical costs and so on. Yet, AMERISAFE history has demonstrated that our consistency and focus has served our policyholders, our shareholders and our employees. It's that same consistency and focus that won AMERISAFE accolades from the Ward Group in July, being selected as one of the Ward's Top 50 P&C Companies. This was our 10th year to be selected. Congratulations to the AMERISAFE family. Thank you for joining us today.

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