AMERISAFE's (AMSF) CEO Allan Bradley on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: AMERISAFE, Inc. (AMSF)

AMERISAFE, Inc. (NASDAQ:AMSF)

Q2 2014 Earnings Conference Call

July 31, 2014 10:30 AM ET

Executives

Michael Grasher – Executive Vice President and Chief Financial Officer

Allen Bradley – Chairman and Chief Executive Officer

Janelle Frost – President and Chief Operating Officer

Analysts

Matt Carletti – JMP Securities LLC

Mark Hughes – SunTrust Robinson Humphrey

Randy Binner – FBR Capital Markets & Co.

Robert Farnam – Keefe, Bruyette & Wood, Inc.

Operator

Good day, ladies and gentlemen, and welcome to the AMERISAFE Inc's Second 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 be given at that time. (Operator Instructions)

As a reminder, this conference call is being recorded. And I introduce your host for today's conference, Michael Grasher, Chief Financial Officer. You may begin.

Michael Grasher

Thank you, Ashley. Good morning, everyone. Welcome to the AMERISAFE second quarter 2014 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 factor section of our Form10-K, Form 10-Qs and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward looking statements.

I will now turn the call over to Allen Bradley, AMERISAFE’s Chairman and CEO. Allen?

Allen Bradley

Thanks, Mike. Good morning, ladies and gentlemen. Thank you for joining AMERISAFE's second quarter 2014 earnings call. As usual, I will make a few remarks and then turn the call over to Janelle Frost, our Chief Operating Officer and President; and Mike Grasher, our Chief Financial Officer for more details on both the operational and financial aspects of the company.

On May 8, the NCCI provided their analysis of the 2013 results of the worker's compensation line nationally. This report is the most detailed analysis of the worker's compensation line published during the year. Highlights of that report indicated several national trends. First, direct premiums written grew 730 basis points with payroll exposures contributing about 470 basis points of that increase.

Private carriers which under their terminology exclude state funds, are projected to produce an aggregate net combined ratio of 101% for 2013. Due to realized gains the ratio of investment revenue over earned premium on a net basis was the highest since 2000.

On the claims side, frequency, severity and medical cost inflation all remained benign. Manufacturing and construction employment trails pre-recession levels but are slowly improving. Private carriers net reserve deficiencies improved for the first time since 2007. And the growth of the residual market slowed significantly from 2013.

These results led the Chief Executive Officer of the NCCI Stephen Klingel to characterize the marketplace as and I quote, "balanced." I believe that this is an accurate description of where the market is at this point in time. Competition as always is still present in the market place but the pricing is not overly aggressive.

As I noted in my comments in the earnings release the principal challenge to AMERISAFE and to others in the industry is the lack of exposure expansion, meaning payroll expansion, due to a slow recovery in construction, manufacturing and other basic industries. We remain hopeful that employment in those basic industries will accelerate in the remainder of this year and into 2015.

There is of course the risk that excess capacity within the industry could occasion an increase in pricing competition. To be certain the industry has generated significant capacity and insurance operational leverage is now at a historic low. However, very low investment yields should hamper rational underwriters from becoming overly aggressive in pricing. But, as all of us know the industry is not always acting rationally.

Now with that let me turn the call over to Janelle to discuss the operational metrics of the company.

Janelle Frost

Thank you, Allen, and good morning, everyone. We are pleased with operating results in the second quarter. Our top line grew $8 million or 8.4%. Policies written in the quarter accounted for $7.4 million of the $8 million growth. New business grew 19.6% in the quarter. In addition, audit premium and related adjustments contributed $0.6 million to the growth in the quarter. This was the first quarter in the last year whereby audit premium and related adjustments were additive to the top-line.

Our favorable pricing trend continued this quarter. Our effective loss cost multiplier or ELCM for voluntary premium in the quarter was 1.86 compared to 1.77 in the second quarter of 2013. As anticipated we believe we have reached a peak in pricing for those renewal policies we know best. Our renewal premium retention slipped this quarter to 90.6% from 92.1% in the same year-ago quarter. All of the retention drop was attributed to policies greater than a $100,000, which is now what we consider our sweet-spot. Remember, our average policy size is approximately $44,000.

Relative to losses we remained at a 71.5% loss in LAE ratio for the current accident year as frequency trends were still down. Our claims reported in the calendar year 2014 were up only 3.1% to 2719 claims. Another positive indication was our total open claim count, which was up only 1.8% from the year-ago quarter. As for prior accident years, the quarter was impacted by favorable development. The encouraging trends I just mentioned and case development lead to $4.4 million of favorable loss development in the quarter, compared to $3.2 million in (inaudible) quarter of 2013.

Accident years 2009 and 2010 were primary drivers for the favorable developments. Overall our operating trends were positive and lead to 89.4% combined ratio in the quarter, down 4.4 percentage points from the second quarter last year.

That concludes my prepared remarks. We'll now turn the call over to Mike.

Michael Grasher

Thank you, Janelle. Taking a look at the financials, for the second quarter of 2014, AMERISAFE reported net income of $12.8 million or $0.68 per diluted share, compared $7.6 million or $0.41 per diluted share in the second quarter of 2013.

Operating net income reached $12.6 million or $0.67 per share in the second quarter of 2014, a 48.95% increase from the year-ago-period. Revenues in the second quarter grew 15% to $10.6 million as compared to the second quarter of 2013. Net premiums earned increased 14.1% from the year-ago quarter benefitting from favorable growth trends and our 2014 reinsurance treaty.

As Janelle mentioned, gross premiums written rose 8.4% from the year-ago quarter while net premiums written climbed 10%, the difference in the increase between gross and net reflects the impact of our 2014 reinsurance treaty as we retained an additional $1 million on the first layer and thus cede less premium to the reinsurers. Our net investment income totaled $6.8 million in the second quarter of 2014, an increase of 2.9% from last year's second quarter.

The tax equivalent yield on our investment portfolio was 3.7% in the first quarter – excuse me, second quarter of 2014, down 50 basis points from a year-ago period. Our portfolio continues to carry a AA- rating with an average duration of approximately 3.4 years and remains quite liquid. At the same time nearly 55% of our investment portfolio including cash and short-term investments is comprised of held-to maturity securities which hold unrealized gain positions of approximately $28.4 million.

Turning to the expenses, our current accident year loss ratio for the quarter was 71.5% compared to 73.2% a year-ago. Our incurred loss and loss adjustment expenses totaled $62.5 million for the quarter which included $4.4 million of favorable prior year development, primarily attributable to accident years 2010 and prior. This compares to loss and loss adjustment expenses of $56.8 million in last year's second quarter which included $3.2 million of favorable prior year development.

In total our net calendar year loss ratio for the second quarter of 2014 was 66.8%, compared to 69.3% one year ago.

With regard to operating expenses, total underwriting and other expenses increased 6.9% to $21 million compared to $19.7 million in the second quarter of 2013. Even though we experienced an increase in terms of dollars, the expense ratio itself actually declined 150 basis points to 22.5%. The decline resulted due to our domains on controllable operating expenses and despite lower accruals for ceding commission and contingent profit commissions.

Controllable expenses declined by 200,000, while our ceding commission and contingent profit commission accruals dropped by approximately $1.3 million, both relative to second quarter 2013 results. By category, the 2014 second quarter expense components include $6.7 million of salaries and benefits, $6.9 million of commissions and $8 million of underwriting and other costs. In total, our combined ratio was 89.4% for the second quarter versus 93.8% for the same period in 2013.

Finally, a few other noteworthy items. Return on average equity for the second quarter of 2014 was a 11.9% compared to 7.8% for the second quarter of 2013. Book value per share at June 30, 2014, was $23.26, an increase of 9.3% from June 30, 2013.

During the second quarter, the company paid its regular quarterly cash dividend of $0.12 per share. And on July 29, the Board of Directors declared a quarterly cash dividend of $0.12 per share payable on September 26, to shareholders of record as of September 12, 2014. Cash flows from operations remain strong, up $11.2 million to $70.6 million for the six-month ended June 30, 2014. And lastly, our statutory surplus was $376.5 million at quarter end.

That concludes my prepared remarks on the financials. And I will now turn the discussion back to Allen.

Allen Bradley

Thanks, Mike. And as you can see, it was clearly a very good quarter. Why don’t we open the call for questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Matt Carletti of JMP Securities. Your line is open.

Matt Carletti – JMP Securities LLC

Yes, thanks. Good morning.

Janelle Frost

Good morning, Matt.

Allen Bradley

Good morning, Matt.

Matt Carletti – JMP Securities LLC

Allen, my first question is – centers around capital management. Just as growth has kind of steadied out in the high-single digits, ROEs are above that level and probably improving as we go forward. You mentioned in your own opening comments that operational leverage is at or nearing kind of all-time lows not just for yourself, but for the sector. Can you update us on your thoughts on capital management, just seems that the way you're earning and just the regular dividend you are growing the capital, what are your thoughts on a special share repurchases and so forth?

Allen Bradley

Well, obviously the – it’s incumbent upon us to operate at an efficient capital base. We want to temper that with caution and with prudent behavior. I think the Board of Directors is indicating clearly by making extraordinary dividend in the end of last half of the announcement of the fourth quarter that is just aware of that and that was, I think precisely their intention.

They also, of course, as you know, Matt, increased the regular dividend by 50%. We discuss capital management in every Board meeting. It is a topic which we have an eye on. It is not my position to say what the Board will do in the future, except to say that that matter will be addressed and that it is very clear to us that unless we can expand writings to a low – to increase the operational leverage, we will have to address capital management.

Now, we can do that in several ways, obviously we grow organically, which was what we are trying to do now, we can make an acquisition. We can write poorly, which is one we are not going to do, or we can give that back in the form of some extraordinary dividends or increasing a regular dividend. Obviously, buybacks are a part of that capital management and I will remind the listeners that we have $25 million authorization to do that. We just have not been in a position where we wanted to do that at such high price to both multiples.

So it’s a good question and certainly one we had anticipated and it is something that this company will address. I wouldn’t look for it to be addressed on a quarterly basis, though, Matt.

Matt Carletti – JMP Securities LLC

Okay. That's very helpful. And then kind of the – part of that answer was organic opportunities. I know there is a lot of particularly energy and construction – construction activity related to the energy industry right in your backyard. Can you maybe give us an update on one, how you feel about the top line? It seems that it's stabled out from last quarter, actually improved a tiny bit. What do you see ahead from here kind of as you see the lay of the land today?

Allen Bradley

So, the interesting thing about what's going on in our business – in our AMERISAFE zone book of business is – our new business growth is remarkable, and much higher than it’s been in recent years. I don’t remember the percentage of the first quarter. Wasn’t it 21% plus?

Janelle Frost

Correct.

Allen Bradley

New business growth in the first quarter and the second…

Janelle Frost

19.6% in the second quarter.

Allen Bradley

Second quarter was 19.6%. So the new business growth has been remarkable. The renewal business has dropped off a little bit as we pushed that pricing pretty hard as Janelle has outlined.

One thing we are a little bit disappointed in is that we have not seen the payroll expansion in our renewal accounts that we anticipated. And I actually went back and looked at some detail and took a number of years in the first and second quarter divided out in terms of our business and how premium payments have come in as opposed to what we expected the accounts to report, so just an over and under.

And typically as you might, we expect with our type of insurers, bad weather tends to affect them in terms of payroll and that was certainly true this year in the first quarter. They recovered in the second quarter, but not the full extent, which is a little bit unusual. So there was a little bit of a weather factor there. But I think, we would really benefit from a further expansion in the payrolls.

Now, with respect to the energy business and southwest Louisiana which is looking forward to a period of a number of years of increased business. Those projects are moving along, they're still in very early stages, although we do see some efforts by the governmental entities to create the infrastructure necessary to support roads, bridges, and those sorts of thing. So we are very optimistic about that and the opportunity to write business here in energy related businesses particularly in Louisiana.

Matt Carletti – JMP Securities LLC

Great. And then just one last quick numbers question, I apologize if I missed it. What was the LCM in the quarter?

Janelle Frost

1.86

Matt Carletti – JMP Securities LLC

1.86

Allen Bradley

Same thing we reported in the first quarter.

Matt Carletti – JMP Securities LLC

Yes, yes. Well, thanks for all of the answers and congrats on a nice quarter.

Janelle Frost

Thank you.

Allen Bradley

Thanks, Matt.

Operator

Thank you. Our next question comes from Mark Hughes of SunTrust. Your line is open.

Mark Hughes – SunTrust Robinson Humphrey

Thank you, good morning.

Janelle Frost

Good morning.

Allen Bradley

Good morning, Mark.

Mark Hughes – SunTrust Robinson Humphrey

The audit premiums you pointed out improved, but you were still somewhat muted on exposures. Am I right in thinking that is kind of inconsistent?

Allen Bradley

Let’s put it this way. We were surprised that the audio premiums improved – well, I won't say, we weren't surprised, watching the cash flow, we anticipated there would be an improvement. It moved further than we expected in the second quarter. But – go ahead, Janelle, you wanted to…

Janelle Frost

Keep in mind audit premium that we are recognizing this quarter is for policies that we wrote 15 months, 18 months ago. So the increases were coming in, in things like construction, still at that point oil and gas and trucking. So when Allen was talking about exposures, he was talking about more of the policies that are actually in effect, right now.

Allen Bradley

And the way we monitor that market is to look at the cash coming in and what are reports and how many – what percentages are over or under-anticipated amounts.

Mark Hughes – SunTrust Robinson Humphrey

Right, yes.

Allen Bradley

So the seasonal adjustments you have to look at is that first quarter is going to be lower than the average, the second quarter as the weather improves, becomes more robust. Little bit disappointed that it didn't entirely overtake the first quarter.

Mark Hughes – SunTrust Robinson Humphrey

Is there something about the – audit premiums in the third quarter of last year were quite low. Is there any seasonality impact on that? Is there some reason why Q3 would just be tougher or should we look at this as you got an easy comparison and there isn't any reason there should be a downtick, relative to what you just saw in 2Q?

Allen Bradley

That was expected to improve. Last year – but drove that were again…

Mark Hughes – SunTrust Robinson Humphrey

It drew off of the $4.4 million?

Allen Bradley

It's not necessarily sequential, but because it's going to be based upon policies expiring that were written 15 months to 18 months prior, see.

Mark Hughes – SunTrust Robinson Humphrey

Right.

Allen Bradley

As you compare the third quarter of 2014 to the third quarter of 2013 if the payrolls are expanding we would expect to see better audits there?

Janelle Frost

Yeah, because the third quarter last year, Mark, it was only $660,000 positive.

Mark Hughes – SunTrust Robinson Humphrey

How about the – and you touched on this, Allen, but the new business growth, it's held pretty steady at 20%. What's your feeling about the Q3 is that so far so good, still in that range?

Janelle Frost

Yeah, we're still seeing new business growth. We've increased our quote ratio internally, so we're putting more quotes out there. I will say that raw materials, applications, commissions, however you want to call it, is down from the prior year. So – but we're making more of what we're receiving.

Mark Hughes – SunTrust Robinson Humphrey

Right.

Allen Bradley

I think a lot of that decrease is probably attributable to our, sharpening our focus about what we want more of – and so we're seeing a lot more of the business we want more of, and it's given us opportunity to quote at higher levels of quotation. And that's translating into greater writings in new business.

Mark Hughes – SunTrust Robinson Humphrey

That down 1%, was that a Q2 number?

Janelle Frost

I'm sorry, what was down 1%?

Mark Hughes – SunTrust Robinson Humphrey

I'm sorry, I thought you'd suggested that the raw material, the number of quotes.

Janelle Frost

It's down from 2Q of last year, correct.

Mark Hughes – SunTrust Robinson Humphrey

Right, they're down 1%?

Janelle Frost

No, well, I didn't say 1%, I just said down.

Mark Hughes – SunTrust Robinson Humphrey

Okay. Okay. So the raw material is down but the new business growth was still up 20%?

Janelle Frost

Correct, correct.

Mark Hughes – SunTrust Robinson Humphrey

All right. And so that trend perhaps is persisting raw material down but new business growth sounds like you think will continue to be healthy?

Janelle Frost

Yes, I would agree with that.

Mark Hughes – SunTrust Robinson Humphrey

And then, Allen, anything on this – the hedge fund, the reinsurance, any of that you're seeing anything material happening?

Allen Bradley

But not seeing a lot of the comp players in it yet. That's an interesting topic as reinsurance is the wholesale part of our business and hedge funds entering the reinsurance area now moving away from property coverages into more of the casualty lines, is a potential to create excess capacity or to provide capacity, quite frankly, the folks whose capacity has shrunk as a result of adverse development and of those sorts of things.

We haven't seen a lot of those products driving pricing, as pricing still remains very, very healthy both for new and renewal business as it is demonstrated by the effective LCM. I do think it's a fact, a development that needs to be watched very closely and we're paying close attention to what's going on with respect to these hedge fund reinsurers.

Mark Hughes – SunTrust Robinson Humphrey

Thank you.

Allen Bradley

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Randy Binner of FBR. Your line is open.

Randy Binner – FBR Capital Markets & Co.

Hey, good morning. Thanks.

Janelle Frost

Good morning.

Michael Grasher

Good morning, Randy.

Randy Binner – FBR Capital Markets & Co.

Good morning. So, I kind of mostly have an answer, but I guess on LCM – so it is obviously an all-time high, and I guess, per the comments at the end there, is it – I think you have been talking about that kind of plateauing out here, but is that – I thought it was going to plateau out maybe in the 1.70s. So where – is it possible that, that can continue to go up?

Allen Bradley

No.

Janelle Frost

I don't foresee that Randy. I mean, like I said, we are very protective of our renewal book and as I said in my prepared comments that's where we're watching it, where I think we have reached a peak.

Randy Binner – FBR Capital Markets & Co.

Okay. And then I guess, just kind of going back to the capital deployment question that Matt Carletti was asking in just a different way. I mean, I thought – I think part of the opportunities set kind of as we all – if you go back like 18 months, usually at this part of the cycle, you get a look at kind of books of business and folks getting out. Yet there is all those capital, right, as evidenced, maybe, by some of these hedge fund reinsurers.

And so is it – I mean, are we just not going to get the books this cycle? Have we missed that window and we have to rely upon – there's obviously some slack in the labor market. You are seeing that in a lot of this conversation. So any update on what the books out there, is there flow of opportunities to attach yourself to in a material way or is that just getting eaten up by all of the kind of alternative capital out there?

Allen Bradley

We're seeing opportunities with respect to books of business and most of them, but not all, most but not all are out there, because there is a problem in those books.

Randy Binner – FBR Capital Markets & Co.

Right.

Allen Bradley

They've been released by underwriters that can no longer absorb that book. There have been a lot of folks that want you to take books, but then they want, what is called a roll. They want to roll the book to you, which means take them all.

Randy Binner – FBR Capital Markets & Co.

Right.

Allen Bradley

And that’s something that’s not very exciting. So we haven’t seen a lot of quality books, we've seen some. And I would characterize them as I have in the past that things that were affordable weren't worth having and things that were worth having weren't affordable.

Randy Binner – FBR Capital Markets & Co.

Right. Which is probably all a function of just an excess capital level in the environment overall, at least in part, right?

Allen Bradley

Yes, I think you are probably right about that. But it's interesting, Randy, even though those are out there. Our new business growth rate is remarkable.

Randy Binner – FBR Capital Markets & Co.

Oh, it's good. I mean, don't get me wrong, it's really good. It's just not – you just have a significant amount of excess capital. Your leverage – operating leverage is way below where it could be, and so the – that per the earlier conversation there is no question, right?

Allen Bradley

Absolutely. There is no question, but that our operating leverage has – while we've increased premium from 2010 about $144 million, the – we've also earned a lot of money in the meantime. So we have a lot of growth of the equity.

Randy Binner – FBR Capital Markets & Co.

All right.

Allen Bradley

So that’s the challenge and we're well aware of it. And I think the Board is going to respond to that and act in an appropriate and prudent fashion.

Randy Binner – FBR Capital Markets & Co.

Right, understood. And so, I guess, can we infer from that – this is going to be my last question that you are going to stick to your net-ins [ph] no – you are not looking west to big states that still have pricing?

Allen Bradley

Let's see, what's out west?

Randy Binner – FBR Capital Markets & Co.

Texas.

Allen Bradley

That particular state you are referring to is probably not on the top of our shopping list. Adding additional class codes within our current area of operation and prudent geographical expansion is an alternative.

Janelle Frost

High hazard.

Allen Bradley

High hazard, high hazard.

Randy Binner – FBR Capital Markets & Co.

Yes, sure, high hazard. But like any jurisdictions that are good maybe particularly right now or potentially?

Allen Bradley

Well, I don’t want to give too much competitive – Janelle is looking at me and I don't think she is happy. So I'm not going to give any competitive information out. But yes, there is some places that and there is some industries within current states, some particular job classifications that we avoid and have avoided in the past that currently we are looking at maybe deploying some capital on those areas, some of them may be energy-related who knows.

Randy Binner – FBR Capital Markets & Co.

Gotcha. All right. Thanks a lot.

Allen Bradley

Okay. Thanks, Randy.

Randy Binner – FBR Capital Markets & Co.

Yep.

Operator

Thank you. Our next question comes from Bob Farnam of KBW. Your line is open.

Robert Farnam – Keefe, Bruyette & Wood, Inc.

Hi, there. Good morning.

Allen Bradley

Good morning, Bob.

Janelle Frost

Good morning.

Robert Farnam – Keefe, Bruyette & Wood, Inc.

I think my question is kind of rolling on with Randy's question. I wanted to know are there any particular classes that you are getting success in with your new business. So I'm not sure if that's answerable or not, but I'm just curious what new business you are writing and where is it?

Janelle Frost

Our new business growth in the quarter, not surprising, came from construction and a large portion roofing and manufacturing.

Robert Farnam – Keefe, Bruyette & Wood, Inc.

Okay, good. And the larger accounts that have you have lost – it sounds like you've lost a couple of larger accounts, what types of classes were those in?

Janelle Frost

Trucking and some construction, but mostly trucking.

Robert Farnam – Keefe, Bruyette & Wood, Inc.

Mostly trucking. Okay. That is it for me. Thanks.

Allen Bradley

Thanks, Bob.

Operator

Thank you. I'm not showing any further questions in queue. I'd like to turn the call back over to Allen Bradley for any further remarks.

Allen Bradley

Thank you. Well, the second quarter was a very good quarter for AMERISAFE and we experienced a number of positives, growth in gross written premium of 8.4%, while maintaining pricing at historically high levels. We had significant prior period favorable development that resulted in a 66.8% loss in – net loss in LAE ratio.

A respectable 22.5% expense ratio, an increase of 2.9% in our next investment income, which increased our net income to 67.1% over last year, increased our ROE to a 11.9%. And even after the payment of an extraordinary dividend and two regular dividends allow the company to increase its book value per share this year 3.6% to $23.26.

AMERISAFE remains very well positioned to provide continued superior returns to our shareholders while maintaining our underwriting margins and profitability during a period of rational premium growth. Thanks for joining us today.

Operator

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

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