Amerisafe Inc Q1 FY2023 Earnings Call

Good day, and welcome to the AMERISAFE 2023 First Quarter Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the presentation over to Ms. Kathryn Shirley. Please go ahead, ma'am.

Good morning. Welcome to the AMERISAFE 2023 first quarter Investor call. If you have not received the earnings release, it is available on our website at 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 as the result of risks, uncertainties and other factors, including 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-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. AMERISAFE's long tenure in the high hazard workers' compensation market and disciplined approach to risk selection and pricing has allowed us to navigate competition and pricing pressure while maintaining solid results. We started the year with a strong first quarter performance reporting a combined ratio of 82.2%, gross premiums written growth of 6%, and an operating ROE of 19.1%. During the quarter, topline grew 6% as positive audit premiums more than offset rate declines. Our overall pricing this quarter as measured by our ELCM was 148. We continue to see strong retention in policies we offer renewals with a 94% retention for the first quarter, largely in line with our recent experience despite steady competition. As we look forward, competitive pressures and rate declines are anticipated to remain a headwind. At the same time, we anticipate audit premiums to remain a tailwind. However, the quarter-over-quarter growth comparisons should begin to flatten. Moving to losses. The accident year loss ratio remained steady with the prior year at 71%. During the quarter, our claims handling practices drove better than expected outcomes resulting in favorable prior year development of $10.1 million or 14.6 loss ratio points. These reserves were primarily released from accident years 2016 through 2020. As it relates to loss trends frequency and severity of both within our line of expectations. Frequency was trending slightly below and severity on par with the previous accident year. It bears repeating that claims trends can be lumpy when isolating quarters. As has been our historical practice, our case reserves include anticipated medical inflation, particularly given the long tail nature of severe claims. Our balance sheet is conservatively positioned as we were minimally impacted by the economic volatility this quarter. Our financial position remains strong with roughly $1 billion in investments and cash, a solid reserve position and no outstanding debt. We expect our market dynamics to remain challenging. However, given our long tenure of experience in high hazard niches and strong balance sheet, we are well-positioned to retain our policyholders and attract business while delivering robust returns to our shareholders. With that, I will turn the call over to Andy to discuss our financials.

Thank you, Janelle, and good morning to everyone. For the first quarter of 2023, AMERISAFE reported net income of $17.3 million or $0.90 per diluted share and operating net income of $16.1 million or $0.83 per diluted share. This is largely in line with Q1 2022 net income of $17.3 million or $0.89 per diluted share and operating net income of $15.9 million or $0.82 per diluted share. Gross written premiums were $82.5 million in the quarter versus $77.8 million in Q1 2022, growing 6% on a year-over-year basis. During the quarter, voluntary premiums decreased 1.1% primarily due to continued rate pressure. Payroll audit and related premium adjustments benefited the quarter by $8.9 million. Rates continue to decrease with the average decline in approved loss costs of 6.8% on a year-over-year basis. Wage growth remains strong, resulting in some offset to our top line pressures. The accident year loss ratio was 71% in the quarter in line with what was booked in the previous year. The net loss ratio for the quarter was 56.4%, which reflects $10.1 million in favorable loss development primarily from accident years 2016 through 2020. Our total underwriting and other expenses were $17 million in the quarter, resulting in an expense ratio of 24.5% compared with 22.4% in the first quarter of 2022. This quarter included a $3.3 million increase in profit sharing reinsurance commission, while the first quarter of 2022 included a $3.8 million return of assessments from the Minnesota Reinsurance Association. After netting out these two items, the balance of the increase is driven by commissions and professional fees. Turning to our investment portfolio. In the first quarter, net investment income increased 21.6% to $7.4 million from $6.1 million in the prior year quarter. The increase was driven by higher yields on cash as well as higher reinvestment rates on fixed maturity securities. Yield on new investments increased approximately 330 basis points, driving our tax equivalent book yield to 3.49% or 74 basis points higher than the previous year. The investment portfolio is high quality, carrying an average AA minus credit rating with a duration of four years. The composition of the portfolio is 58% in municipal bonds, which includes 15% in taxable munis. We have 27% in corporate bonds, 3% in US treasuries and agencies, 7% in equity securities, and 5% in cash and other investments. Approximately 60% of our bond portfolio is comprised of held-to-maturity securities. Our capital position is strong with a high-quality balance sheet to highlight loss reserve position and conservative investment portfolio. At quarter end, AMERISAFE carried out roughly $1 billion in investments, cash, and cash equivalents. Since year end, book value grew 4.9% to $17.38 and operating return on average equity was 19.1%. With that, I would like to open the call for the question-and-answer portion of the call.

Thank you. We will now take our first question from Matt Carletti with JMP.

Hey. Good morning.

Good morning, Matt.

Janelle, I was hoping you might be able to just kind of walk us through a little bit of the loss environment, just kind of your mental math on how you get to think about kind of accident year loss ratios and specifically kind of just what you're seeing with frequency and severity and kind of your expectations there, and you talked a bit about what loss costs are doing? But then also with an eye towards kind of the piece of the puzzle that is exposure growth and wage inflation and kind of how that might impact that calculus and how much of that might act like rate even though it isn't loss cost per se?

Right. That's a good way to look at it, Matt. So I'll start with talking about the loss trends themselves. It sounds like a broken record when I say this, but we're still not seeing reported claim counts rebound to pre-pandemic levels, which is good, right? That's good news. Safer employers lead to safer workplaces, all wonderful things. When I talk about frequency, I tend to talk about frequency in terms of premium dollars, not payrolls, but I'll get to the payroll in a second. So even though we've collected less premium dollars to cover those losses, even our frequency measure has been slightly down even compared to first quarter of 2022. Now granted, one quarter does not make a trend, but we just haven't seen the rebound in claims reported and which is definitely benefiting us from the frequency standpoint. From a severity standpoint, severity for the first quarter, again, one quarter does not make a trend. For the first quarter, severity was pretty much on par with where severity was for the first quarter of 2022 accident year. As we've talked about numerous times on these calls, where our concerns come in severity is given the long tail nature of our claims, how does medical inflation influence that over a long period of time? I feel like we've always taken a very long-term view of medical inflation. So I feel very comfortable about that from our ultimate loss ratio pick. And then even on the case reserving basis, I cannot give enough credit to my field case managers in terms of how they think about these claims, and they really do look out to say what could that knee replacement cost us five years from now, 10 years from now? And how many of those are going to be factored into the claim? They put that in their initial case reserves. So credit to them for how they review and think about individual claims. To your question about payrolls, sort of acting as where you're absolutely right, in Andy's prepared remarks, he mentioned that premium audits added $8.9 million to the top line for the quarter. We continue to see payroll growth. So if you think about Andy's number of 8.9%, that's reflecting policies that we wrote a year ago and how those estimated payrolls turned out relative to how we had originally estimated them to be. So you think about that time period. We're talking policies that were in effect or the work activity that happened in 2022. Each quarter, we have been trying to give a little bit of a forward-looking picture of that saying, well, what are we seeing in wage growth or payroll growth in the previous quarter? And as you know we've been reporting double-digit increases. Third quarter, it was 12.1%, fourth quarter 11%, first quarter 2023, 11%. So we think that bodes well for us in terms of continuing to see pretty robust audit premium. Now, obviously, the comparative year-over-year is going to get a little bit tougher because the audit premiums that we've seen increasing really started increasing in the first quarter of 2022. And so, as we get these quarter-over-quarter comparisons, that growth rate will tend to flatten, or would be less impactful to the top line, but still to your point about the underlying loss cost and the rate those payroll dollars are certainly adding to our premium. It was a long-winded answer; did I answer all your questions?

Very helpful. As we consider payroll growth, do you have a sense of how much of that is due to increased exposure, such as more hours worked or more employees, compared to actual wage growth, where the same person is doing the same job but getting paid more for it?

Yeah. I don't have transparency into hours worked; that would be ideal, right? If I knew that same workers extended hours, I don't know that. I know that of the 11% we saw reported to us in the first quarter, which would have been fourth quarter activity, 80% of the 11% was wage growth, absolute wage growth. So, could have been higher wages or same workers working more hours. The new employee count has been relatively benign, which we like to see, and that's really across, Matt, really across our industry groups. When we look at it, the payroll broken down by industry group, it's been pretty robust for most of them. Obviously, we saw a little bit of increase more so in roofing, maybe in our construction book than in other lines, but maritime had really strong wage growth. So, I can't even isolate it down to particular industries. I think it's just the economies for these small to midsize employers really.

That makes sense. And then you actually going to hit on something that I was going to ask as my follow-up question, and that is, do you have the number, the millions of dollars of the Q2 '22, what was the benefit from audit premiums in that quarter just so we have a baseline as we think about it in the second quarter?

Yeah. It was $5.5 million for the second quarter of 2022.

Perfect. Wonderful. Great. That's all I had. Thank you very much for the color and congrats on a nice start to the year.

Thank you, Matt.

We will now take our next question from Mark Hughes with Truist.

Yeah. Thank you. Good morning.

Good morning, Mark.

Good morning, Janelle. I wanted to explore your mental math a little further.

Absolutely.

I do have a question, on the construction you hadn't said that it was any sort of headwind or any issue, what's your feeling about that? I think you've talked about the customers are always focused on the next job, what's the latest on that?

Right. If I base it my vibe strictly on what's been reported in payrolls, I would say, well, my construction book looks really great. You're absolutely right in terms of what do the next job look like. I am not naive to the headlines that we see about the tightening in the credit market and that certainly could impact our small to mid-sized employers in terms of lines of credit being there, their credit lines being available to them from small regional banks. But we haven't really seen it in work activity yet, so I harken back to the COVID-related recession, that was one of our bigger concerns: okay, you’re working now, but is the next job going to be there? For our employers, again the small to mid-sized businesses, they had steady work throughout. So unless somehow credit tightens to the point where maybe that makes it a little bit more difficult to complete that next job or bid on the next project, I think we still have a few quarters of robust payrolls coming from those industry groups. I guess we all read the headlines about is there going to be a recession or is there not going to be a recession. Our industry groups tend to bode well in what we call mild recession. So I feel pretty comfortable about that as well.

Yeah. Maybe by the time the recession's over, they'll have continued to work on their existing backlog and then we can start on the new backlog.

That would be great.

Yeah. Hope, any large losses in the quarter, $1 million plus?

We had two, we had two claims with case reserves over $1 million in the quarter.

Okay. You give the NCCI loss costs in the release, and it looks like it's moderating a little bit. I think last quarter was seven plus and this is kind of high sixes. Is that wishful thinking, or how are you seeing that?

Yeah. It's funny, we've been saying for so long we would appreciate a slowing of the decline. So in that regard, I guess we got what we asked for, a little bit slowing in terms of the rate of the decline. We'll see; NCCI will put out the industry-wide results in a couple of weeks in May. So we'll see how the industry fared in terms of the accident year loss ratio. We harken back to that data. The last few years, every year, it's been creeping up a little bit higher, a little bit higher; I anticipate that to be the case this year as well for the industry.

When you say creeping up a little higher, it's a little less negative or more negative?

Approaching that 100 combined. If you think about it in terms of the combined ratio. The accident year, I know companies are still reporting some redundancies, but if you look at the accident year combined ratio or even loss ratio for the industry as a whole, each year it's been going up a point or two, where the combined ratio was approaching 100 last year, so we'll see what they report for 2022.

Yeah.

So that's ultimately what's going to drive whether the rates continue to decline or let's be bold and say flatten.

Yeah. Any observations about the loss development trends maybe across the sector? I don't know if that's part of your process or whether you wait for the NCCI to come out, but I wonder if you have any thoughts on what's happening more broadly around loss development?

I believe the entire industry is experiencing benefits from a decline in frequency, and that hasn't changed much. This is true for AMERISAFE and the industry overall. The uncertain factor is severity and what impact it will have. Anyone involved in workers' compensation is likely considering the effects of medical inflation and the survivability of claims, especially with the severe cases we encounter due to advancements in medical technology and innovation. Injured individuals are surviving with improved healthcare, which is excellent, but it also increases the severity associated with those claims. This ongoing concern needs to be reflected in the rates as severity encompasses more than just medical inflation. The best care is provided to these injured workers, which is important, but it also leads to higher costs for those claims.

Yeah. You've mentioned steady competition; any shading on that when you think about Q1 versus maybe the back half of 2022, a little tougher, a little easier?

No. We were able to get some new business growth in the quarter, but I'm totally going to attribute that to our employees just really hustling for that new business. Agents continue to have struggles, if that's the right word, in all the other lines of business. So everyone that's coming in for workers' comp coverage, particularly they're pricing out all of their product lines; workers' comp the decreases no matter which company they're going to be dealing with, unless they've had something obscure happen, so that agencies don't have the luxury really, if everyone calls it that, of shopping workers' comp right now. It's really about where am I going to find the auto coverage, where am I going to find the liability coverage. So, kudos to AMERISAFE; we're doing more with what we have. We would love to get a large influx of opportunities to see new business, but that requires, to your point, it requires the competitive environment to have a shift, and we really haven't seen that in quite some time.

Have you considered that this may not be as relevant in workers' compensation, and I apologize for taking up time on the call.

You're fine.

Yeah. I don't know if this is relevant for workers' comp, but maybe observations around agents being able to get appointments or have access to markets that I guess could end up being beneficial that maybe some of your bigger competitors or travelers of Hartford just isn't interested in working with the same group of agents as they might have in the past because they're kind of narrowing that relationship list. Do you see anything like that?

I have not, Mark. I haven't seen anything like that.

Okay. That is an idea.

It is. You're right.

Yeah. Okay. All right. Well, that's good for me. Appreciate it. Thank you.

Thank you, Mark.

We'll now take our next question from Bob Farnam with Janney.

Hi, there. Good morning. One question, in your reserves, so what medical inflation assumption are you using for your reserves?

We continue to think about our overall reserves in two different ways. When considering ultimate picks for 2022 or 2023, and even for 2020 back in 2022, we take a long-term approach, which generally reflects mid to high single-digit medical inflation. More importantly, with respect to our case reserves, I credit my field case managers for accurately assessing the realities of each individual case and its long-term implications. In a previous call, I mentioned home health as an example; there's a notable labor shortage in that area, presenting challenges for any company managing long-term health needs. My field case managers are accounting for this in our case reserves. If circumstances change in that sector, it could become advantageous for us in the future, but we want to ensure that our current case reserving reflects the most likely outcomes.

Right. And so, if actual inflation is not as robust as the inflation assumptions that you're putting into reserves, that portends well for future favorable reserve development as you find out that the inflation wasn't as strong.

I would agree with that statement.

Okay. And the second question I have is more about usually probably getting along with what Mark was asking. So if the industry’s accident year combined ratio is approaching 100, I don't know confidence is the right word, but how confident are you that the industry doesn't overshoot the loss cost declines and that 100 turns into a 105 or 110 over time? I know in many years past, the workers comp was not a great line in terms of profitability, but I don’t know, any sites in the near term as to where profitability will be going?

Yes, that's a great question. Historically, we tend to enter a period of declining rates where companies book their premiums and increase their loss reserves. Once claims start to be paid out, if the estimations weren't accurate and the right amounts weren't collected, that can lead to a swing in rates. For a company like AMERISAFE, we generally perform better in such environments due to our strong underwriting discipline. We believe we manage our individual risks effectively. Looking back, when the industry experiences declining rates, an adverse development usually occurs, leading to subsequent rate swings. However, I don't anticipate that the fluctuations will be as significant or that values will be as low or peaks as high as in past years, as the industry now has better data. Underwriters are more disciplined, and I don't hear much about cash flow underwriting, a practice that was more common in the past. The market cycle still seems to be active, but potentially with less extreme values. As the industry approaches unprofitability, we hope to see other multi-line carriers reduce their interest in workers' compensation, especially in severe cases, and redirect their capital towards areas experiencing better rates and more success. They may not completely exit the workers' compensation market but will likely shrink their appetite. For us, this would hint at a hardening market, although we haven't observed significant shifts in competition for about two years, partly due to COVID, where competitive levels have remained stable.

Yeah. That was kind of what was driving my question; I didn't mean to imply that AMERISAFE's combined ratio is going to be going up that high, that was more of an industry. Just wondering when the competition might start pulling back because it's not profitable anymore. So, yeah, I think you answered that and provided a good color. So thanks.

Thank you.

And it appears there are no further telephone questions, I'd like to hand the conference back over to Ms. Frost for any additional or closing comments.

First quarter was a strong start for the year, and we're pleased with the quarter's results. Equally, we look forward to continued success in 2023 as the AMERISAFE team strive to enhance our service to our agents, our policyholders, and injured workers. Thank you for joining us today.

And that does conclude today's conference. We thank you all for your participation. You may now disconnect.