AMERISAFE, Inc. (AMSF) Q2 2020 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the AMERISAFE 2020 Second Quarter Earnings Conference Call. Today's call is being recorded. And at this time, I'd like to turn the conference over to Kathryn Shirley, Chief Administrative Officer. Please go ahead.

Good morning. Welcome to the AMERISAFE 2020 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 statement. 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 as a result of risks, uncertainties and other factors, including the impact of the COVID-19 pandemic on the business and operations of the Company and our policyholders and the market value of the securities in our investment portfolio. Other factors that may affect our results are 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, Kathryn, and good morning, everyone. AMERISAFE and the workers' compensation industry began the year facing rate declines and strong competition. Then a pandemic disrupted the market, the economy and the workforce. This first 212 days of the year, shifted focus for many companies and tested fundamentals. For AMERISAFE, our fundamentals are crucial in these unprecedented times. We are serving our stakeholders with disciplined underwriting, proactive safety and intensive claims management, which produce consistent returns, quality insurance services, and financial stability. This quarter, those fundamentals led to favorable prior year case development and a combined ratio of 78.5%. I will begin with our niche focused fundamental. We insure small-to-midsize employers working in hazardous industries. Thus far, in this pandemic, those industries appear to be less impacted than main street businesses such as retail and hospitality. Therefore, in the quarter, our gross premiums written were down 7.7% from the second quarter of 2019. Voluntary debt premium was down 6.4%, driven by underlying loss cost declines. Policy count written in the quarter was up 2% with strong policy retention of 93.7%. Pricing, as reflected in our ELCM was a 158, down from a 161 in the prior year quarter. The market remains highly competitive, and there is additional uncertainty on what the second wave of infections will mean for employers. Audit premium and related adjustments added $0.5 million to top line, which was a decrease of $1.3 million from the second quarter of 2019. Audit premiums for policies audited in the quarter remained positive. We were pleased during the quarter that our insurers were reporting payrolls, which meant they were working. However, in anticipation of the pandemic and subsequent recession's impact on policy's estimated annual premium, we did record a decline of $1.4 million in the estimate for anticipated future audit premium, known in the accounting terms as earned but unbilled premium. EBUB is not often a quarterly topic because the estimate does not meaningfully fluctuate. However, you can find a description in the critical accounting policy section of our 10-K. As to our fundamentals, our disciplined underwriting, proactive safety and intensive claims management led to a loss ratio of 49.4%, down 9.5 points from the second quarter of 2019. The current accident year loss ratio remains 72.5%, same as the first quarter of 2020 and the full year of 2019. For the current accident year, frequency declined with fewer reported claims and severity was within our expectations. We had 10 COVID-19 claims reported with minimal incurred losses. The primary driver of the declining loss ratio was favorable case development from prior accident years. We continue our focus on achieving maximum medical improvement, returning injured workers to work and closing claims. The result was $17.5 million of favorable development, primarily attributable to accident years 2015 through 2018. I will now turn the call over to Neal to discuss expenses and other key financial measures.

Thank you, Janelle, and good morning, everyone. For the second quarter of 2020 AMERISAFE reported net income of $23.9 million or $1.24 per diluted share compared with $17.9 million or $0.93 per diluted share in last year's second quarter. Operating net income for the second quarter was $19.4 million or $1 even per share, an increase of $0.10 or 11.1% from the second quarter of 2019. Revenues in the quarter decreased to $89.1 million compared with $91.8 million in the second quarter of 2019. Revenues were positively impacted by $5.6 million in unrealized gains on equity securities offset by premium declines with net premiums earned decreasing 8.4% to $76 million when compared to last year's second quarter. Turning to our investment portfolio, net investment income decreased 10.3% in the second quarter to $7.3 million compared with $8.2 million in the second quarter of 2019. The decrease was driven by lower interest rates on fixed income securities, particularly on cash, overnight and short-term investment securities. The tax equivalent yield on our investment portfolio was 2.87% at the end of the second quarter. The pre-tax yield on the portfolio was 2.55% at the end of the quarter, down from 2.83% one year ago. There were no significant realized gains or losses for the portfolio during the quarter. The investment portfolio remains high quality carrying an average AA credit rating, with a duration of 3.74 and with 60% in municipal bonds, 17% in corporate bonds, 11% in U.S. treasuries and agencies, 3% in equity securities, and 9% in cash and other investments. The 60% in municipal bonds includes taxable municipal bonds, which now make up 8% of the overall portfolio. Approximately 60% of our bond portfolio is comprised of held-to-maturity securities, which were in a net unrealized gain position of $33.1 million at quarter end. These unrealized gains are not reflected in our book value as the bonds are carried at amortized cost less in allowance for credit losses. Moving now to operating expenses, our total underwriting and other expenses were $21.1 million in the quarter compared with $19.7 million in the second quarter of 2019. Last year's second quarter expenses included favorable downward adjustments of $1 million in variable share price-based incentive compensation and $0.6 million in favorable lower insurance assessment costs. By category, the 2020 second quarter expenses included $7.5 million of salaries and benefits, $5.8 million in commissions, and $7.8 million of underwriting and other costs. As a result of the decline in earned premium as well as the higher expenses in the quarter, our expense ratio was 27.8% compared with 23.8% in the second quarter of 2019. Our tax rate for the quarter was 18.5% compared to 19.3% for last year's second quarter. This is largely due to more tax exempt income on our investment portfolio than last year's second quarter. Return on equity for the second quarter of 2020 was 21.3% compared to 16.3% for the second quarter of 2019. Our operating ROE for the quarter was 17.9%. In capital management, our Company paid its regular quarterly cash dividend of $0.27 per share in the second quarter. This quarter, the Board declared a quarterly cash dividend of $0.27 per share payable on September 25th, 2020 to shareholders of record as of September 11th, 2020. And finally, just a couple of other topics. Book value per share at June 30th, 2020 was $23.94, up 7.4% from $22.29 at year-end. Our statutory surplus was $402 million at quarter end, up from $360 million at December 31st, 2019. And lastly, we will be filing our Form 10-Q with the SEC today, after the market close. That concludes my remarks and we would now like to open up the call for the question-and-answer session. Operator?

Thank you. [Operator Instructions] And we'll take our first question today from Matt Carletti with JMP Securities. Please go ahead.

Hey, thanks, good morning. I've got a couple of questions. First one, I just wanted to start with, if you could dig a little deeper into kind of just the loss trends that you're seeing. So one is, if you could update us on where kind of the number of large losses are? I know you did that last quarter and kind of where it is versus what you might expect? And then also, as we think about -- as you look at what's going on with the prior period development, which has been quite strong of late, what that implies kind of for accident year loss ratios, because clearly the bar is changing -- the starting point bar is changing a few years back and if that has any implication or other changes you're thinking about where you're picking things today?

Yeah, I'll start, and then Neal, do feel free to chime in. I'll start with the first part of your question, which is the large losses. We had five -- at the end of the quarter, we had five claims that had reserves in excess of $1 million. So -- and that compares to, I think at this time last year, we had seven, at the same point in time, so in line. Again, lumpy business always say that every quarter, just as my caveat.

Right, right.

But yeah, not any lower or higher than what would be within our expectation. Great question about what we are experiencing loss trends and how that impacts the prior-year development? I'll start with what we're seeing in 2020. Frequency is down, I don't think that's a surprise to anyone. We are not a frequency driven business, we're a severity driven business, but our frequency is down. And when you see the 10-Q later today when it's filed, you'll see that the claims reported for the quarter were down, I think 300-somewhat claims, about 25% for the quarter. And then, for the year-to-date, that brings us to about 18% in terms of reported claims being down. So that's a definitely a positive trend. Severity has been within our expectations. The uncertainty, I think, around severity and we're talking about 2020 specifically is, what's going to happen as it relates to the pandemic and not the COVID specific claim, the 10 claims I mentioned in the prepared remarks, but more importantly, what the impact of this pandemic is going to have to the ultimate cost of our claims. I think most companies have been talking about, at least initially. There were delays, there were procedures not happening, and you know I think everyone found innovative ways of taking care of injured workers and tremendous effort by the industry, tremendous effort by the AMERISAFE employees, I applaud that. The question is, will that affect the long-term result of those claims? Will it delay, in some way, us reaching that maximum medical improvement? Will extend the duration of the claim? And that aspect, I think it's just a little bit too early to tell. We feel good about 2020. We felt good about 2020 coming into this year. You know, thinking back we are -- our loss selection for '22 was the same as -- 2020 was the same as 2019 and so we were expecting it not to deteriorate. I do think it's a little too early to tell in terms of the trends we're seeing six months in. And again, with this pandemic adding a layer of uncertainty for us to say for sure where we think 2020 will end. But I feel good about it. The prior accident years which was I think the story for AMERISAFE this quarter, again, speaks to our discipline, speaks to the way we handle claims. I don't feel that our claims approach really change throughout this pandemic, these months of what's happening. Obviously we had a little bit lighter inventory, but we were working, as we always do, to close those claims to reach settlement, to get maximum medical improvement and we saw some favorable action in that. A couple of things, I'll talk about accident year 2018, because this is the first quarter that we've adjusted 2018 and what was really driving that was, we had an accelerated claim closure rate for that accident year in this particular quarter. Now one quarter, it's not a trend make, but it happened this quarter and I truly don't believe it was anything different in terms of our efforts. I think it was more on the flip side. I think people were a little -- injured worker, their attorneys, their doctors were a little more uncertain about what's out there. Do I need a liquidity event? Maybe I should take this liquidity event. And we just seem to be able to close a few more claims. So I think it was just a more receptive audience if that's the right term to use in terms of the prior year development for at least accident year 2018. And I sort of rambled there, I apologize. Did I answer your question?

No, no, you did. Yeah. Now, that makes a lot of sense. Just one other one, I was just hoping you could dig a little bit into -- more into kind of the, what COVID impacts you might have seen? I understand it's not a big exposure for AMERISAFE and I'm not really talking about the 10 claims you mentioned, but more so just from up from an exposure standpoint or payroll standpoint. Where there certain industries within your book or certain geographies within your book where you did feel a little bit more? I mean, I caught the EBUB adjustment and that was not very big, but if you can unpack that one, that'll be helpful.

Right. Yeah, certainly I can do that. You know, we were pleased early on and I think we've even alluded -- we talked about this on the first quarter call that it appeared that are our insurers were working. So that was a positive sign for us and we've continued to see that in terms of, we're not getting a lot of zero report as a percentage of our total book of business. So, our insurers are working. Certainly they are impacted by COVID, the same as every employer in the country. I think our safety focus is this tremendous effort in terms of we stress safety, we want our insurers to stress safety. But when you think about the industries we insure, it's a lot of outdoor work. So that seem to be a magic formula in terms of the COVID it and transmittal of the virus and that sort of thing, outdoor work seem to be a little bit more protected in terms of transference. So I think that helps. The industry, it's interesting -- we didn't really see a large differential in the industries as far as the impact, I would say, oil and gas probably had a bigger impact and I'm not sure that's COVID related. I think that's more gas -- oil price related than COVID itself.

Right. That's really helpful.

So, did I answer your question?

It does, yeah. That's great. Well, well done, and best of luck. Thank you.

Thank you, Matt.

Thank you, Matt.

We'll take the next question from Randy Binner with B. Riley. Please go ahead.

Good morning I just -- that was really helpful, on the losses. I guess the only piece I didn't hear in Matt's -- the responses to Matt's questions was just, can I take too that there was a lower number of large claims, kind of year to...?

There were five.

Okay so that's -- is that normal?

Yeah, that's -- I mean, I think we -- are at this point last year we were at seven. So, yeah, it's not dramatically different either way.

Okay. And then, I guess on net investment income, the 10-year treasury yields is at its lower level ever today. So obviously there's a lot of headwind there and it seems that the run rate for investment income is coming down across the board for insurance companies. So is this kind of the right level or can you mention for us how much we might lose in kind of prevailing yield in the portfolio as we roll forward in our models?

Yeah. Randy, this is Neal. A lot of the change in terms of us being down 10.3% was really on the short end in terms of what we could get on short overnight investments and stuff within the one-year period. Because the portfolio is out there and it turns off cash periodically that needs to be reinvested, the overall decline from here, I think, will be much more gradual in terms of the net investment income. But it will be, I think, an overhang for us and also for the industry over the next several years, as the economy recovers. I think one of the things we've seen with that before is that sometimes causes people to be a little bit more disciplined on the underwriting side because they need to earn an underwriting profit to be able to get an appropriate level of return for their shareholders.

Okay. That's helpful. And then, just on the expense ratio. I apologize if I missed this, was that a normal -- it's a little hard to calibrate just with the premiums coming in, but is this -- yeah, I guess I generally expect it to run a little bit lower in the front half of the year, but then again, you tend to be lower in the back part of the year at least the last couple of years. So I guess my question is, should I -- should we expect the expense ratio to have -- to be lower, especially in the fourth quarter as we think about the rest of the year.

Yeah, in the fourth quarter, we typically have a little bit lower expense ratio because there are accruals for guarantee funds and if the assessments are not made then those accruals come down. So that's usually a positive impact on the expense ratio in the fourth quarter. In terms of our overall expense ratio, the challenge is, net earned premium continues to come down and as loss costs come down, we have a lot of fixed costs that we really cannot jettison. So that puts pressure on the expense ratio. We expect it to continue to sort of be in this level, I think right now. Last year there were several beneficial things that we pointed out that caused the second quarter expense ratio to be lower than it would have been otherwise. About half of it is really due to the decline in net earned premiums in terms of the increase in expense ratio this quarter and about half of it was due to the actual increase in expenses.

Got it. Okay, that's perfect. Thank you.

Thanks, Randy.

[Operator Instructions] We will now go to Mark Hughes with SunTrust.

Thank you. Good morning. Just talk about new business activity, your ability to, I guess, sign up new, the new policyholders or the pace of submissions. Are you fully back to normal? And then within that, what's the competitive environment at this point?

Yeah, I will say, competition is still very strong, certainly new business flow has been impacted by the pandemic, not only for the insurance company or AMERISAFE but for agents, right. So stay-at-home orders impacted their ability to prospect new business. So AMERISAFE, like many companies, are trying to protect our renewals. There is not a lot of new business being shopped. And so that submission flow is still, I think we reported in the first quarter that it was down, it continues to be down. We really haven't seen that recovering as much as we've seen other things recover throughout the pandemic. AMERISAFE -- kudos to the AMERISAFE's employees both safety sales, underwriting, really trying to make the most of those relationships and trying to evolve their relationships with the agents. And so, we did see a little bit more success in terms of quotes that we did put out this quarter, being able to convert those to buying policies. But yes, new business has certainly declined more so than I would certainly like it to. What was the second part of your question, the pace of submissions? And then there was another part, I apologize.

Yeah. No, I think you got it. The -- there seems to have been some discussion about workers comp pricing may be stabilizing or maybe even going up in some point in the future. Maybe not too distant future. Maybe we've hit the end of that down cycle here, any opinion on that?

Yeah, from your [indiscernible]. You know what, I as far as the impact of the pandemic on pricing I don't see that happening in the near future, just because I don't think there's going to be enough data collected to really know the true impact. You know, as far as this pandemic goes, whether first wave second wave -- as far as the cost related, we're a long way from knowing that. What's going to be covered, I think we're a long way from knowing that. So I can't see it, the pandemic itself impacting rates per se. Now, I do think the fact that we've been in this low interest rate environment and that that doesn't have any upside in near future that could impact rates. But that may be more of a disciplined side than the rate side. Yeah, I'm not as optimistic that rates are going to increase or flatten.

I've got another question, I don't know if you can really answer this or if anybody could. But, in thinking about your book of business, you've got a lot of construction and when we think about 2021, I think you've made the point that, it's that next job that -- that's going to be important for many of your policyholders. How should we think about the -- your book of business to the extent that you are insulated from any volatility in the -- particularly in the new construction market?

Yeah. You know, you're right. I -- my concerns lie in, I think our insurers are working. The question is, will the next job be there. All the forecasts, I've been looking at and I don't think anyone is willing to call it and say that big projects or projects are being canceled at this point. Most of the things that I read in the news are, things are being delayed or postponed. So that's a positive sign for me that it's not going to be quite like maybe the prior recessions. I saw a great report last week about the jobs. I'll use the job losses as an example. Low skilled jobs, medium skilled jobs, high skill jobs and comparing this recession to the prior recession. And in the prior recession it was that -- those middle skilled jobs AMERISAFE's work we added, the people we insure that experienced the most job loss and they -- so far, in this recession, the pandemic-related recession, it's the lower skilled jobs, the hospitality, the retail, those type of things. So again I view that as somewhat of a positive change. I think this is a little bit different stimulus. It was early on. I think that was impactful in terms of keeping AMERISAFE insured base, the small to midsize employers, keeping them going, keeping them working, keeping their employees staffed. So if those projects are just postponed one or two quarters that could be a positive sign. But again, that's a huge unknown in terms of what's going to happen with the construction industry. There has been, obviously, speculation about what work from home does to commercial construction, right. If people don't need office buildings anymore; but at the same time, people are going to be driving a lot more because they're not going to be relying on public transportation and we insure people that do roadwork and excavation. So it's a big, I hate to say, it's a big unknown, but it is an unknown.

And then just one final question. You gave us the ELCM, I think it was 1.58 this quarter. The basis for that is the state's loss costs. And I'm just sort of curious, the recent states and I'm not even that turned into the timing on when the state by state thing come out, but any observation about those loss cost calculations have been trending in -- recently?

Certainly. You know, in my opening remarks, I commented that our voluntary debt was down 6.4% for the quarter and the driving -- the driver there was the declining loss costs. So for the rates that went into effect this quarter for our states and some of those were our larger states, the average impact was down 9%. So, I mean we are still at high-single digit rate declines and I'd say we've underlying upclimbs.

Yeah. Is that something you track on a quarterly basis when the new rates go into the effect quarter to quarter?

Yes, we do. We do.

What was that 9, how does that compare to Q1?

Great question. Let me, I don't have that with me...

Because I think you said I think the 9 is…

You know I somewhat remember it being 12. But don't quote me on that. Let me find out for you. I can get back with you.

Okay. And I think that was all I had. I appreciate all the good answers.

And I would now like to turn the call back over to Janelle Frost, President and CEO for concluding remarks.

This is our second quarter reporting under the cloud of the coronavirus pandemic. We are pleased with this quarter's results and we accept the challenges and uncertainties ahead. We do so because of our firm foundation of a strong balance sheet, our proven operating model, and the employee experience and dedication to serve our stakeholders. Thank you for joining us today.

And that concludes our conference for today. I’d like to thank everyone for your participation and you may now disconnect.