Amerisafe Inc Q3 FY2021 Earnings Call

Good day, and welcome to the AMERISAFE 2021 Third Quarter Earnings Conference Call. 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 2021 Third Quarter Investor Call. If you have not received the earnings release, it is available on our website at www.amerisafe.com. 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 due to risks, uncertainties, and other factors, including those discussed in today's earnings release and comments made during this call and in the Risk Factors section of our Form 10-K, Form 10-Q, 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 were pleased with this quarter's results, reporting a 71.5% combined ratio and an ROE of 16.1%. Competition was strong in the quarter. We remained competitive by deploying our strategy of evaluating individual risk through safety services and underwriting, promoting safe workplaces and caring for injured workers. These services performed by our expertise in workers' compensation benefited our policyholders and agents, created value for our shareholders and built a foundation on our strong balance sheet. In the quarter, we maintained a strong retention rate of 93.5%, and we also found solid opportunities to buy new business, allowing us to grow policy count when compared to last year. The associated premium for voluntary policies written in the quarter was down 4.6%. For perspective on the decrease, our average loss cost for policies renewed in the quarter were 7% lower than the prior policy period. Our overall pricing, as measured by our ELCM, was a 1.53. A headwind in the quarter was audit premium and other premium adjustments, decreasing written premiums by $2.1 million. Audit premium in the quarter was slightly negative. This was not surprising given the policies audited in this quarter covered payrolls fully impacted by the pandemic and the resulting economic slowdown. As for payrolls being reported now, which will impact future audit premium, we are seeing growth in payrolls driven mostly by wage growth and by a slight increase in the number of workers. In total, gross premiums written in the quarter was down 7.5% from the prior year quarter. Turning to losses. We experienced favorable prior year case development in the quarter as our claims handling practices reach better-than-anticipated outcomes. Prior accident year favorable development reduced loss and loss adjustment expenses by $19 million in the quarter or 28.1 loss ratio points. We are pleased that our experience and singular focus on workers' compensation enabled us to reach maximum medical improvement and return to work for injured workers, while also settling and closing claims. As for the current accident year, frequency of claims based on earned premium was up in the quarter, but has not returned to pre-pandemic levels. Severity trends are within our expectations. Therefore, our loss ratio of 72% for the current accident year remained unchanged. We continue to monitor the potential impact of rising healthcare costs on the long-term medical cost inflation. As an example, the nationwide demand for nurses and the wages healthcare systems are paying to attract and retain nurses will, I believe, impact medical cost inflation going forward. I raised this concern earlier in the pandemic, and we're seeing some slight increases in costs, particularly as we plan long-term care for injured workers. I believe this is a trend to watch. I will now turn the call over to Neal to discuss investments, expenses and capital management.

Thank you, Janelle, and good morning, everyone. For the third quarter of 2021, AMERISAFE reported net income of $19.1 million or $0.99 per diluted share compared with $23.4 million or $1.21 per diluted share in last year's third quarter. Operating net income for the third quarter was $19.8 million or $1.02 per share, a decrease of $0.14 from the third quarter of 2020. Revenues in the quarter decreased to $73 million compared with $83 million in the third quarter of 2020. Net premiums earned decreased 9.6% to $67.6 million when compared to last year's third quarter. Turning to our investment portfolio, net investment income decreased 14.4% in the third quarter to $6 million compared with $7.1 million in the third quarter of 2020. The decrease continues to be driven by lower interest rates on fixed income securities as well as higher cash balances for special dividends. The tax equivalent yield on our investment portfolio was 2.50% at the end of the third quarter. The pre-tax yield on the portfolio was 2.21% at the end of the quarter, down from 2.49% a year ago. There were no significant realized gains or losses in the quarter or in the year ago quarter. The investment portfolio is high quality, carrying an average AA minus credit rating with a duration of 3.56 and with 61% in municipal bonds, which includes 14% in taxable munis, 15% in corporate bonds, 9% in U.S. treasuries and agencies, 5% in equity securities and 10% in cash and other investments. Approximately 60% of our bond portfolio is comprised of held-to-maturity securities, which were in a net unrealized gain position of $28.2 million at quarter end. These unrealized gains are not reflected in our book value as these bonds are carried at amortized costs. Moving now to operating expenses. Our total underwriting and other expenses were $17.9 million in the quarter compared with $13.9 million in the third quarter of 2020. The increase was largely due to a $5.7 million benefit in last year's third quarter from the termination of an assessment related to a multiple injury fund. Adjusted for the benefit, expenses were $1.7 million lower in the third quarter of 2021 compared to the third quarter of 2020. These lower expenses were due to a $1 million profit sharing accrual on a reinsurance treaty as well as lower compensation and commission expenses. By category, the 2021 third quarter expenses included $6.2 million of salaries and benefits, $5.2 million in commissions and $6.5 million of underwriting and other costs. Our expense ratio for the quarter was 26.5% compared with an expense ratio of 26.2% in last year's third quarter, adjusted for last year's $5.7 million expense benefit. Our effective tax rate for the quarter was 22.6% compared to 18.5% for the same period in 2020. This was due to a higher estimate of income from underwriting and taxable investment income compared to last year's third quarter. Return on equity for the third quarter of 2021 was 16.1% compared to 19.8% in the third quarter of 2020. Operating ROE for the quarter was 17.2%. Now turning to capital management, and as announced in conjunction with our earnings release, the company's Board of Directors declared a special dividend of $4 per share for shareholders payable on November 17, 2021, to shareholders of record as of November 10, 2021. This brings the total amount of special dividends paid out in the last nine years to $25.75 per share. In addition, the company's Board of Directors also declared a quarterly cash dividend of $0.29 per share payable on December 17, 2021, to shareholders of record as of December 3, 2021. And finally, just a few other items to note. Book value per share at September 30, 2021, was $24.80, up 9.3% from $22.70 at year-end. Next, I wanted to let you know that the company recently published some additional sustainability disclosures for investors. These disclosures, which align with the SASB and TCFD standards can be found on our website under Sustainability. And finally, we plan to file our Form 10-Q with the SEC tomorrow after market close. That concludes my remarks, and we would now like to open up the call for the question-and-answer session.

And we'll now take our first question from Mark Hughes from Truist. Please go ahead.

Janelle, what did you say about audit premium? I didn't quite pick it up. What was the driver in the quarter? And then does that mean anything on a go-forward basis?

Yes. I said audit premium for the quarter was slightly negative, and that is in total. So we certainly had classes of business that still remained positive. For example, construction remained positive except for roofing. Roofing had slightly negative audit premium. Trucking was still positive. Lumber, which has been responsive for us quite well during the pandemic and even with the economic slowdown, was still positive. But oil and gas, for example, is negative. But in total, it was slightly negative for the quarter. I also mentioned in my prepared remarks, if we're looking forward, based on the payroll that we're seeing right now, we are seeing wage growth. We're seeing a slight increase in the number of workers. So that kind of speaks to maybe future audit premiums when this policy period is audited.

And we'll go ahead and recall Mark.

Yes. Thank you. If we consider the policies that will be audited in the fourth quarter, going back to mid-late 2020, I assume you might see a similar dynamic. I would have expected the audit premium to be positive. I'm reflecting from a macro perspective. Is Q4 likely to experience a similar impact? I understand that payrolls appear to be better now, but I wonder about the trend during the intervening period. I'm not sure if I'm considering that correctly, but when we think about Q4 or Q1, could there still be a slight negative impact?

I’m not certain how that will turn out, Mark. To your earlier point, if you reflect on the fourth quarter of 2020 and the first quarter of 2021, we did notice a slight boost in the economy during that time. However, it was minimally negative this quarter, so it didn’t catch us off guard or raise any significant concerns.

Yes. Yes. I guess you had the Delta variant in the interim that might have impacted the aggregate yield...

Perhaps. Yes, perhaps. Good point.

You mentioned that frequency has increased compared to last year, but it has not returned to pre-pandemic levels, and severities are as expected. Wouldn't that indicate that the current accident year should be somewhat lower?

That's a great question. We have not seen the number of claims reported return to pre-pandemic levels. That has not happened. One of the things we're monitoring is what happens on the severity side. We discussed this early on in the pandemic regarding healthcare costs and the long-term aspect of our claims. As you know, when we reserve, we factor in the most likely outcome even for the current accident year. We address those reserves fairly quickly. We're considering the ongoing costs for the services we need to pay for. There's a national debate about how long this situation will last and whether it is sustainable for the medical community, but this is our current reality.

Yes. And then the number of large losses in the quarter or year-to-date compared to last year?

We had nine at the end of the quarter.

And what was it last year, two through three quarters?

Last year, at the same time, we had 11.

Okay. So large losses, down even from a reduced level. And then how about the competition, the behavior of your either bigger or regional competitors, any difference this quarter versus prior quarters?

In the quarter itself, I would say competition remained strong, really didn't see a lot of changes in the quarter. Post quarter, I'll say there have been some rumblings of some carriers backing away from certain hazardous classes, which, of course, we like to hear.

Right. Is that in public commentary? Or you're just sort of seeing that on the ground?

We're seeing that on the ground.

Yes. Are they experiencing poor results? Or...

I can't comment on what influences other companies' underwriting decisions. However, we have observed that the current accident year loss ratio for many in the industry has increased. Whether you see that as adverse development is up to interpretation, but there is indeed a trend there. I haven't specifically noted any reports of adverse development recently, and I can't comment on the specifics of what's happening with certain carriers exiting particular business classes.

Yes. I'll just ask one more. It seems like your written premium, you still had a little bit of a dip, but it was low end, what maybe ex audit premium down 3%, if I'm thinking about it properly, low single digit...

4.6% for voluntary during the quarter. Loss cost on average, 7%.

Yes. That's kind of the middle of recent claims. Okay. All right. Very good. Thank you.

Thank you, Mark.

And we'll move on to our next question from Matt Carletti from JMP. Please go ahead.

Thanks. Good morning.

Good morning, Matt.

A couple questions. Mark covered a couple of mine. But just following up on the frequency and severity discussion. Would it be right to think that if those conditions hold, that frequency kind of stays at or below pre-pandemic norms and severities within expectations that as we think ahead to, say, next year that, that speaks to kind of a likely unchanged accident year loss ratio? Or are there other items, will there be continued loss cost pressure or otherwise that we need to think about in that equation?

Matt, currently, we are still observing approved loss costs experiencing a decline in the high to mid-single digits, which is certainly a concern. My main worry regarding severity revolves around medical cost inflation. Medical expenses constitute a significant part of our operations, especially when we need to reserve for what we anticipate these claims will ultimately cost us. From this severity perspective, it is definitely a greater concern. As for the reported number of claims, I want to note that we've seen wage growth, which we generally view positively, as it signifies the same workers earning higher wages and generating higher premiums. However, we have also noted a slight increase in the number of employees. Looking ahead, if the economy continues to improve and more employees join these higher-risk categories, that could potentially increase the frequency of claims. Although one might assume this would be factored into the loss costs, frequency has been declining for an extended period. It will be interesting to observe how quickly these new employees affect frequency.

Yes, that makes sense. I have another question. You expressed some concern about nursing wages and the cost associated with severity on the medical side. In recent quarters, you've mentioned that the pandemic led to an increase in the use of remote and virtual medicine. Has that trend continued? Do you think it has potential for lasting use, considering it can only be applied in specific situations? Do you see it as having some long-term viability that might not completely offset the severity costs but could offer some relief?

I do. I do think it will, in some instances, change how people access medical care. Certainly, severe injury, you've lost an arm, you're going to go to acute care. But I think on a long-term basis, I do think there's some impact there for all of us. If there's a silver lining to the pandemic for the industry, that could be one of them.

Well. Thank you for the answers and congrats on a nice quarter.

Thank you, Matt.

And with that, that does conclude our question-and-answer session for today. And now I would like to turn the call back over to Janelle Frost for any additional or closing remarks. Thank you. I believe the $4 special dividend reflects our operational consistency and discipline over the long term. In this season of giving thanks, it is imperative to recognize that the commitment to this discipline is rooted in the expert employees of AMERISAFE and what they do day in and day out. Thank you to the AMERISAFE team, and thank you for joining us today. And with that, that does conclude today's call. Thank you for your participation. You may now disconnect.