AMERISAFE's (AMSF) CEO Janelle Frost on Q2 2016 Results - Earnings Call Transcript

| About: AMERISAFE, Inc. (AMSF)

AMERISAFE, Inc. (NASDAQ:AMSF)

Q2 2016 Earnings Conference Call

July 29, 2016 10:30 am ET

Executives

Vincent J. Gagliano - EVP and Chief Risk Officer

Janelle Frost - CEO and President

Neal A. Fuller - EVP and CFO

Analysts

Mark Hughes - SunTrust Robinson Humphrey

Matt Carletti - JMP Securities

Alex Combs - FBR & Co.

Operator

Good day, ladies and gentlemen, and welcome to the AMERISAFE Second Quarter 2016 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. I would now like to introduce your host for today's conference, Mr. Vince Gagliano, Chief Risk Officer. Sir, you may begin.

Vincent J. Gagliano

Good morning. Welcome to the AMERISAFE 2016 second quarter investor call. If you have not received the earnings release, it is available on our Web-site 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.

Janelle Frost

Thank you, Vincent, and good morning everyone. Thank you for joining the call today as we discuss our second quarter results. Before discussing AMERISAFE's operations, let's talk about the industry as a whole. Companies are fighting to retain renewal accounts. In many cases, the underlying rates for those risks have declined, resulting into decline in premium.

To maintain or grow top line, companies are becoming increasingly competitive, a sign of a softening market. What's preventing a soft market? I believe we have not returned to the soft market of previous cycles because of low investment yields. Underwriting profit is necessary for companies to meet ROE goals.

As I stated in our earnings release, AMERISAFE remains unwavering both in our disciplined underwriting focus on our market niche and in producing consistent and superior results. This quarter, we reported a combined ratio of 80.4%, an ROE of 13.7% and earnings per share of $0.87.

So how did that discipline work this quarter? Gross premiums written declined 2.6%. This decline was the result of audit and related premium adjustments. More importantly, for policies we wrote in the quarter, premium grew 1.1% and policy count grew 3.4%. Our policy count retention for the quarter was 93.5%, compared to 92.9% in the second quarter of 2015.

The effective LCM for the quarter was 1.73, down from 1.81 in the second quarter of 2015. Our pricing concessions have been in response to the competitive market, but without losing sight of protecting the underwriting margin. Also keep in mind, our pricing declines have been moderate and deliberate, coming off from all-time high of 1.86 in the second quarter of 2014.

As for the audit premium and related adjustments, I mentioned, this was a drag to top line and it was expected. Audit premium continued to remain positive, but not at the same levels as the previous year. This is driven by economic activity in the industries that we insure, and unless there is a significant change in the economy, I would expect this trend will continue in 2016.

Relative to losses, the current accident year selection is 67.9%, a 1.9 percentage point improvement from accident year 2015. Coupled with favorable development from prior accident years, the quarter's loss ratio was 54.2%. The favorable development was largely the result of case development experienced in the quarter, primarily in accident years 2014, 2013 and 2009 and prior. Once again, I believe these favorable results are driven by our unique claims management process, focus on maximum medical improvement, return to work and expedient resolution, yet another example of our focus on discipline.

I would now turn the call over to Neal Fuller, our CFO, to discuss the financials.

Neal A. Fuller

Thank you, Janelle, and good morning, everyone. For the second quarter of 2016, AMERISAFE reported net income of $16.6 million or $0.87 per diluted share, compared with $14.3 million or $0.75 per diluted share in the same quarter last year, an increase of 16.2%. Operating net income in the quarter was $16.3 million or $0.85 per share, a 1.7% increase from the second quarter of 2015.

Revenues in the quarter decreased by 2.4% to $97.6 million compared with the second quarter of last year. Net premiums earned decreased 5.1% to $90.7 million when compared to the second quarter of 2015. This decrease was largely due to $3 million in lower payroll audits that Janelle mentioned previously as well as an additional $0.9 million in lower assumed premium from mandatory state pooling arrangements.

Net investment income was $6.2 million in the second quarter of 2016, a decline of 10% when compared with last year's second quarter. The decrease was largely due to the decline in value of a hedge fund investment which is mark-to-market through net income each quarter. Without the hedge fund, net investment income was down 2.6% compared to the second quarter of 2015.

The tax equivalent yield on our investment portfolio was 3.3% in the quarter, compared with 3.6% 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 3.04 with 52% in municipal securities, 32% in corporate bonds and the remainder in cash and other investments.

53% of our investment portfolio is classified as held-to-maturity, which is in a net unrealized gain position of $23.2 million at June 30, 2016. These gains are not reflected in our book value per share as these bonds are carried at amortized cost.

With regard to operating expenses, our total underwriting and other expenses increased 2.2% in the quarter to $22.6 million, compared to $22.1 million in the second quarter of 2015. We saw an increase in bad debt expense, largely as a result of the change in estimate or reduction we made last year in the second quarter and a slight increase in compensation cost.

By category, second quarter 2016 expenses included $6.3 million of salaries and benefits, $6.5 million of commissions and $9.8 million of underwriting and other costs. Our expense ratio for the second quarter was 24.9, compared with 23.1 in the second quarter last year. The majority of the change in expense ratio was due to the decline in net earned premium mentioned earlier, and with the remainder due to the increase in expenses mentioned up above.

Our tax rate increased to 32.4% in the quarter, up from 28.8% in the second quarter last year. The increase reflects the larger amount of taxable income compared with tax exempt during the quarter as a result of the increased amount of favorable prior year development.

Return on equity for the second quarter of 2016 was 13.7%, compared to 12.3% for the second quarter of 2015. Operating ROE for the second quarter was 13.6%. On July 26, 2016, 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 September 9, 2016.

And just a couple of other items to discuss; book value per share increased 8.8% from year-end to $25.83 at June 30, 2016. Our statutory surplus rose to $409.4 million at June 30, 2016, up $38 million from year-end. And finally, AMERISAFE will file our Form 10-Q for the second quarter this afternoon after the market close.

That concludes my remarks, and we would now like to open the call up to analysts and investors for a question-and-answer session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Matt Carletti with JMP Securities. Your line is now open. If your phone is on mute, please un-mute it. Our next question comes from the line of Mark Hughes with SunTrust. Your line is now open.

Mark Hughes

Janelle, your point about the audit premium trends, do you expect those to continue at kind of roughly the current pace?

Janelle Frost

We do. We think audit premium will remain positive but not nearly as robust as it was last year. So it will be a drag to top line for at least, I assume, the rest of 2016.

Mark Hughes

You have I guess an easy comparison on the third quarter, but then…

Janelle Frost

I know.

Mark Hughes

The hedge fund investment, could you refresh me, what drives that and any early read on what the trend has been in 3Q?

Neal A. Fuller

This is Neal. We have a hedge fund investment at the parent company and it has a large portion of it invested in life insurance stocks. And so with the Brexit vote coming right at the end of the quarter, those stocks tanked pretty significantly and that drove down the value of the hedge fund investment, which is mark-to-market. Since that time, we believe that those stocks have risen somewhat and recovered some of their value, but we think that overall it's still down from where it was at the year-end. So, we continue to look at that investment and think about that, but that's what's causing the volatility in the net investment income.

Mark Hughes

Then the bad debt issue, you highlighted the change, I guess the change in the way you calculate bad debt, in the second quarter of last year, did I hear that properly? And if so, are you going to be lapping that? Will we see bad debt recede in the third quarter?

Neal A. Fuller

Yes, you are hearing that properly. We made an adjustment to our allowance based upon our historical experience last year second quarter and we took bad debt down by about $1.1 million. And so the significant increase you see here is just a year-over-year comparison and we don't expect to see that significant increase from a comparative standpoint in future quarters.

Mark Hughes

So it was a positive, you reduced your bad debt expense in this quarter last year, so you had a tough comp, is that right?

Neal A. Fuller

That is correct.

Mark Hughes

And then, the policyholder dividends, seemed like they were a little higher this quarter. What should we expect there?

Neal A. Fuller

We would expect them to run at about the rate they've run so far this year, probably about 1% to 1.3%. We have seen an increase in the amount of policyholder dividends as a result of activities that we have in certain states where we compete on the basis of policyholder dividends. So we expect them to be around 1% to 1.3% going forward.

Mark Hughes

And then generally, the operating expense ratio, I think last quarter you had suggested about 25%. Is that still a good number on a go forward basis?

Neal A. Fuller

Yes, we think the run rate will be somewhere between 24% and 25%.

Mark Hughes

Then how about the tax rate, tax rate was a little higher this quarter, what should we use for the rest of this year?

Neal A. Fuller

That's a good question. The tax rate is largely driven by the amount of favorable development that we see each quarter. And so, I would look just to the historical record to try to estimate the tax rate.

Mark Hughes

Right. So maybe this quarter it was a little higher than history and so we might look back at history and use that as our guidance, is that what you're saying?

Neal A. Fuller

Yes.

Mark Hughes

That is, a little bit lower perhaps? I know you don't want to say that.

Neal A. Fuller

It's going to fluctuate based upon the earnings of the Company and the amount of underwriting profit. That's largely what drives it.

Mark Hughes

Then, I think you've had some initiatives to try to grow the top line. At the same time, competition, I think as you described, has been increasing. How do I think about the competition when I look at these broader pricing surveys? They have casualty pricing flat, maybe down slightly, Gallagher said as much on their call just a little bit ago, but you described pricing being under pressure, your LCM is down a bit, down year-over-year, how do I square that situation?

Janelle Frost

That's a really good question and I guess the question everybody is looking as to where it's going to head in the next few quarters. There is definitely an increasingly competitive market. We're not seeing, and I think I said this on last call, we're not seeing the irrational behavior we've seen in prior soft markets, but we are starting to see some multi-line carriers, that have typically or in the last few years, quarters, have pulled away from workers' comp because it wasn't profitable, deciding that, yes, we will quote some workers' comp.

From an AMERISAFE standpoint, you mentioned our sales initiatives. We are starting to I think see traction there. I've talked in past about our green, yellow, red. We are seeing more greens, and so we're doing a better job of bringing in the things we want to see. But our submission counts are down, so we'd just like to see more of that.

Mark Hughes

Right. Your voluntary premium was up this quarter slightly, the first time in the last three quarters. Do you think you'd just kind of hold in this range, kind of hold your own rather than grow?

Janelle Frost

You know what, that's probably – let me rephrase that. We will protect the underwriting margin. We are trying to be as responsive as we can to the market that only add what we're willing to accept.

Mark Hughes

Right. And as you see it now, are there any new initiatives? You say you're getting more traction, but submissions are still little bit sluggish you might say. When you put all that together, does the extra traction get you a little more forward progress or is that just helping you hold steady?

Janelle Frost

It really depends on what the competitive market is going to do. I mean I think we're doing a good job of holding steady. I mentioned that we grew policy accounts, and I talked about a couple of quarters ago on the call that going into this softening market or if we reach a soft market, policy account is where I was focused because if I can maintain those policies I know I want to keep in our renewal retention rates, which was up this quarter, I felt like we were positioning the Company correctly.

Mark Hughes

And then, any notable change in the large losses? I think they were actually lower than normal earlier in the year.

Janelle Frost

Yes, when we reported first quarter, at the time that we ended the quarter, we didn't have any large losses. I think on the call I alluded to we had one come in subsequent to the reporting of the quarter but before the call. So right now, when we say large losses, that's excess of 1 million, we write account of 5 million. And just to put that in some perspective, accident years 2014 and 2015 are at 12. So that's not an unusual amount for us and there is nothing in those losses that would cause us to want to change our loss check for the year.

Mark Hughes

Understood. Thank you.

Operator

Our next question comes from the line of Matt Carletti with JMP Securities. Your line is now open.

Matt Carletti

Sorry about that before. My line went dead. Right as I clicked over, the line just went silent. Anyway, Mark covered both of my questions. I guess the one I have left is on accident year loss ratio. As we sit here, in past several quarters it sure seems like prior period development is obviously starting to come through pretty strongly from some semi-recent years. It's kind of always been in insurance where when bad things happen in prior years, it has implications for current accident year loss ratios. I guess the question is the opposite of that. If the prior years kind of keep coming through better than expected, is it right of us to think that there is probably ongoing positive implications for the current accident year pick going forward?

Janelle Frost

I believe you know AMERISAFE and you know AMERISAFE well. We are in a lumpy business, but we are conservative about what we do. There is nothing in the underlying data six months in that would cause us to believe our loss ratio needs to change at this point. Frequency is about where we thought it was, severity is about where we thought it was. So your point about the favorable development, that's case-by-case, that's just how it happens for us. We've had good things happen but bad things can happen as well.

Matt Carletti

Right. That's a very fair answer. Thanks very much and congrats on another nice quarter.

Operator

[Operator Instructions] Our next question comes from the line of Randy Binner with FBR & Co. Your line is now open.

Alex Combs

This is actually Alex Combs on for Randy Binner. I was wondering if you could touch on the breakout of accident years for the $12.4 million of favorable development.

Janelle Frost

Sure. Accident year 2014 was $3.8 million, 2013 was $4.2 million, 2012 was $1.7 million, 2011 was $0.1 million, and then 2011 and prior was $2.6 million.

Alex Combs

Okay, great. So it seems like a big portion of that release comes from that 2012 and 2013 accident years and we had a mini hard market there, and our analysis of…

Janelle Frost

I'm going to write that one down, a mini hard market, I like it.

Alex Combs

Yes, when we look at your Schedule P kind of as developed workers' comp loss ratios, we think this could kind of get to the 2006-2007 range, which is down to about 50%. So, I guess is this consistent with the way that you're looking at 2012 and 2013 data, and this would imply considerable amount of reserve it on the C going forward?

Janelle Frost

Right, we've been pretty vocal about the fact that the favorable development that we received in particularly those years that you're talking about, 2012 and 2013, have come from case development. And I've said all along, I think that those years from a case reserving standpoint probably were a change, a shift in the paradigm, if you will, because that was coming off of accident year 2010 where we got it wrong, the industry got it wrong. I think we all took a look and said, are we being realistic about how we are setting these case reserves, in particular return to work coming out of the great recession. Return to work is a large part of what we do and there weren't jobs [indiscernible]. So we factored that into our case reserving, and now I think the Company is reaping the benefits of that. So that would [indiscernible] 2011, actually 2012 and forward, which would include both 2015 and 2016.

Alex Combs

All right, great. Thanks. That's all I have.

Operator

I am showing no further questions at this time. I would now like to turn the call back over to Ms. Janelle Frost for any closing remarks.

Janelle Frost

Thank you. I began my comments calling this an increasingly competitive time in the market. There are numerous macro factors which influence the direction the market goes from here. Regardless, AMERISAFE is well-positioned for the upcoming twists and turns. Our focus on underwriting disciplined claims management and expense [indiscernible] will continue to support our commitment to our stakeholders. Thank you.

Operator

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

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