Amerisafe Inc Q3 FY2023 Earnings Call

Good day. And welcome to the AMERISAFE 2023 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kathryn Shirley. Please go ahead.

Good morning. Welcome to the AMERISAFE 2023 third 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. During the third quarter, momentum in our top line grew with an increase in in-force policy count as well as an increase in audit premium. However, our expense ratio was elevated due to some infrequent items during the quarter which Andy will provide more detail on. The overall workers' compensation market has remained fairly stable since the last quarter with declining rates partially offset by wage inflation. Our underwriting discipline is demonstrated in our ability to maintain strong margins throughout many market cycles. In the third quarter, we reported a combined ratio of 90.6% and a return on average equity of 11.8%. Our top line increased 3.9% compared with the third quarter of 2022 with voluntary premiums for policies written in the quarter growing 1.1%. We continue to see strong retention in policies for which we offer renewal with a retention rate of 95% for the quarter. Moving on to losses, the accident year loss ratio remained steady at 71%. During the quarter, our claims handling practices drove better-than-expected outcomes, resulting in favorable prior year development of $10.2 million or 15.2% loss ratio points. These reserves were primarily released from accident years 2019, 2020 and 2021. As it relates to loss trends, frequency and severity were both in line with our expectations, trending lower than compared with the previous year at nine months. It's been a while since I used the term 'lumpy' in my prepared remarks, but when reporting favorable claims trends before the end of an accident year, I am reminded that there is no seasonality to when severe claims happen. While the market remains challenging, we continue to utilize our focus on high hazard risk to position the company for outperformance within the industry. High retention with policyholders demonstrates our strong position, while we work to attract new business, delivering robust returns to shareholders. Before returning the call to Andy, I wanted to discuss our special dividend. The company's Board of Directors declared a special dividend of $3.50 for shareholders of record as of December 1, 2023. This dividend reflects the operational excellence of AMERISAFE and our commitment to shareholder value creation through capital deployment and returning excess capital when appropriate. With that, I'll turn the call over to Andy to discuss the financials.

Thank you, Janelle and good morning to everyone. For the third quarter of 2023, AMERISAFE reported net income of $10 million or $0.52 per diluted share and operating net income of $11.7 million or $0.61 per diluted share. During the third quarter of 2022, net income was $11.4 million or $0.59 per diluted share and operating net income of $14.1 million or $0.73 per diluted share. The lower net income was primarily driven by certain items in the quarter, driving the expense ratio higher as well as less tax-exempt interest income leading to a higher tax rate compared to the third quarter of 2022. Gross written premiums were $70.8 million in the quarter versus $68.2 million in the third quarter of 2022, growing 3.9% on a year-over-year basis. Payroll audit and related premium adjustments increased premiums written by $5.6 million, compared to an increase of $3.4 million in the third quarter of 2022. While audit premium was strong this quarter, we continue to expect some flattening out in coming periods. Ceded premiums increased by $1.6 million for the quarter compared to the prior year quarter, primarily due to costs related to additional reinsurance coverage. Our total underwriting and other expenses were $22.4 million in the quarter, a 14% increase compared with the $19.6 million recognized in the prior year quarter. This increase resulted in an expense ratio of 33.6%, compared with 28.9% in the third quarter of 2022. The increase was primarily due to a $1.6 million reduction in reinsurance profit-sharing commission due to adverse development from an older treaty, a $600,000 increase in commission expense, and a $400,000 increase in regulatory assessments and fees. Our tax rate was 19.2% compared to 15.5% for last year's third quarter, largely due to a lower proportion of tax-exempt income versus underwriting income in the quarter compared with last year. Turning to our investment portfolio, in the third quarter, net investment income increased by 16.1% to $8.1 million from $7 million in the prior year quarter. The increase was driven by higher yields on cash, as well as higher investment rates on fixed maturity securities. For the quarter, the yield on new investments increased approximately 230 basis points, driving our tax-equivalent book yield to 3.77%, which is 60 basis points higher than the third quarter of 2022. Realized gains for the portfolio on securities sold were $5.1 million in the quarter compared with $600,000 during the third quarter of 2022, primarily related to realized gains on an equity security. The investment portfolio is high-quality, carrying a AA minus credit rating with a duration of 4.3 years. The composition of the portfolio is 56% in municipal bonds, 27% in corporate bonds, 4% in US Treasuries and agencies, 6% in equity securities, and 7% in cash and other investments. Approximately 57% of our bond portfolio is comprised of held-to-maturity securities. Due to the notable increase in rates during the quarter, the net unrealized loss position was $35.1 million at quarter-end. As a reminder, these held-to-maturity securities are carried at amortized costs, and therefore unrealized gains or losses on these securities are not reflected in our book value. Our capital position is strong with a high-quality balance sheet, solid loss reserve position, and conservative investment portfolio. At quarter-end, AMERISAFE carried roughly $950 million in investments, cash, and cash equivalents. Our company paid its regular quarterly cash dividend of $0.34 per share in the third quarter. This quarter, the Board declared a quarterly cash dividend of $0.34 per share payable December 15, 2023, to shareholders of record as of December 1, 2023. And finally, just a couple of other topics. Book value per share was $17.51, an increase of 5.7% from year-end 2022, and operating return on average equity was 13.2%. Finally, tomorrow, Friday, October 27, 2023, we will be filing our Form 10-Q with the SEC after market close. With that, I would like to open the call for the question-and-answer portion of the call.

Thank you. Our first question today comes from Mark Hughes with Truist.

Thank you. Good morning.

Good morning, Mark.

Did you give the ELCM number, Janelle?

150.

Are you noticing any trends related to medical inflation? There’s a lot of discussion about rising employee benefits costs and health care expenses. What are your thoughts on that?

It is certainly the main concern in the industry and in workers' compensation. I believe, and I know many others do as well, that due to the rising costs of health care, we will eventually see these changes reflected in the workers' compensation system. However, I can't provide specific data at this moment, aside from some anecdotal evidence. There isn't anything significant that I can say has truly affected the industry. Nevertheless, I do think this issue is front and center for industry professionals. When considering reserves, companies are likely adopting a more cautious and thoughtful approach regarding medical cost expectations in their reserves, depending on their perspective. AMERISAFE depends heavily on our case reserves. Our case managers have consistently taken a long-term view on medical case inflation within their individual reserves, which has been beneficial in the past, and we have not altered that strategy. Therefore, we are carefully watching the situation and seeking opportunities for savings as we typically do, especially as I sense changes in the medical landscape.

Yes, yes. The top line ex-audit premiums and I think we calculate it a little differently than you presented, but this is the first positive number since the first quarter of 2018, if I'm looking at it properly. Not a dramatic change, but is there anything going on that's helping to support the top line here?

Yes, I'll explain that there are a few factors at play. We've seen some policy growth over the past few quarters, which is a positive sign. However, the decrease in rates hasn't directly translated into higher premium income despite the growth in policies. This quarter saw continued rate declines, but we achieved even greater growth in policy counts. I credit this to the dedicated efforts of AMERISAFE employees who are enhancing their relationships with agents and improving the ease of doing business, ensuring we make the right connections within the agency. They deserve recognition for their impactful work. I don't see this as a shift in the marketplace; rather, it's an internal effort by AMERISAFE to drive change. Additionally, wage inflation is acting like a rate increase. We've discussed wage inflation in several previous quarters, reporting figures of 12%, 10%, and 8%. This quarter it has decreased to 5.9%, yet it's still above the industry average in terms of wage inflation. This situation is indeed advantageous for us, both in terms of current premiums and audit premiums. We're not observing significant shifts in new employee counts, indicating that the overall economies for our insurers remain strong, though not to the extent of experiencing a labor shortage in adding new workers.

Yeah. Could you give the number of large claims through nine months?

We ended the quarter with eight claims within case incurred over $1 million. If you look at that compared to where we were last year, I think that was 11, so still slightly down from where we were last year.

Yeah. The reinsurance treaties where you had the adverse and you had to reverse the profit sharing or reduced profit sharing — what was the circumstance there? Did that impact your own reserves?

This is a very good point. Yes, these were older treaties prior to 2017 where there were claims that had some adverse development, which caused that ceding commission or that profit sharing associated with those treaties to reverse. So it had been accrued over a period of time. We used the term 'infrequent'; I didn't know how to describe it because it's not something that happens often, but that profit commission was on older reinsurance treaties. But you're absolutely right; it didn't impact the net aggregate development that we experienced in the quarter. It was just particular to those years.

I'll ask one more question, and I know this might seem a bit forward, but regarding the accident years of 2020 and 2021, which were influenced by COVID, you're clearly recognizing gains from those years. What insights do you have about their development?

That's a great question. I would say that our expectations for the COVID years differ somewhat from the industry's perspective. While our claim counts were down, we still experienced severe claims. These claims are evolving in a manner consistent with other accident years. At this point, I think they are within our expectations for 2021 and 2022, or 2020 and 2021. It's important to note that in 2021, we had a catastrophe claim in the fourth quarter, which has not evolved any differently than we anticipated at the end of that accident year.

Great. Thank you very much.

Thank you, Mark.

Our next question will come from Matt Carletti with JMP.

Hey, thanks. Good morning.

Good morning, Matt.

Mark covered a lot of ground there, so I don't have to…

Yes, he did.

And he was not being rude. Could you just maybe dive in a little deeper on the question he had about growth and specifically some of the focus on what you're doing at agencies? I noted you appointed a new Chief Sales Officer this summer. It feels like there's a little more concerted effort towards making sure no stone is left unturned within your underwriting appetite. Could you just expand on that a little bit?

That's a great way to put it, no stone left unturned. I'll start with this: underwriting appetite and our discipline in risk selection has not changed. You're absolutely right. We brought in a Chief Sales Officer, Ray Wise. And as you phrased it, I feel that we've elevated the focus within the company on our agent customers and our agent relationships. We've had a Head of Sales in the past, but they were not at the executive level. It's really about having a person at the table when we make strategic decisions focused on that agent customer and what we need to do from that standpoint. I look for good things to come from that relationship. At the same time, we have had a concerted effort in trying to change the ease of doing business working with our agent customers, and our employees have really pushed hard on that. Sometimes it takes a while for these things to take root, and I feel like that momentum is starting to take root.

Perfect. That makes a lot of sense. Thank you for the color.

Thank you, Matt.

Yes, thanks. Just a couple more.

Hey, Mark.

Any commentary on the construction end market? The concept of the next job is very important. How are you seeing that?

Right. My best gauge of that is what's being reported to us in payrolls on a monthly basis. In our construction book, the payrolls have been relatively strong. They show both wage growth and some new employee count but not large increases. From that aspect, it is holding up quite well. I always like to remind people we report construction as an aggregate group. The largest class within that is roofing. Roofing risk is something we consider ourselves experts at. Roofing is not always necessarily new construction. There’s a maintenance component that I think we benefit from. Even if there is a lag or a downturn in commercial construction, I feel like that part holds up pretty well; it’s pretty resilient.

And then what are your thoughts on capital? I know there is a nice special dividend. Where is that going to position you? I guess you've got no debt if I'm looking at it properly, so kind of your underwriting leverage. If you did leverage up with debt, how much more capacity could you add?

Yes, I'll say this about the special dividend. You're so right to think about it in terms of leverage. AMERISAFE has been profitable from an underwriting standpoint for a very long time. That has enabled us to build excess capital. When those rates started declining and the market really started softening, the question the Board asked itself was what to do with this capital? Do we invest it in writing unprofitable business? Do we protect our margins? Obviously, our decision was to protect margins. This led us to declare special dividends to return that capital to shareholders. At this point, we're starting to see some growth, which is great, as the decision was to return capital to shareholders. We've said all along, as we are able to grow organically and put that capital to work to generate the returns that our shareholders are accustomed to, I would expect there may be some change to that. But as of right now, there's momentum, but we're not there yet. There's always the possibility of mergers and acquisitions. You mentioned we have no debt on the balance sheet, so that's another use of capital if we were to go out and acquire something. We have a share repurchase program as well, and while we haven't purchased shares recently, there's still a little over $12 million left in that program.

I appreciate that. And then loss cost trends, I don't know if you put that in the release or made a comment, but just curious what you see out of the NCCI?

Yes, I think NCCI's latest number for 2023 and going into 2024 is averaging around 7.5%. So, loss costs that became effective this quarter for AMERISAFE average around 5%. So still rate declines or still loss cost declines but perhaps a slowing in that decline. But if I'm completely candid, I don't see anything on a macro basis in the industry in terms of data being reported or what other CEOs are sharing that will move the needle anytime in the near future in terms of approved loss costs. I think that's just something we're monitoring.

Okay. All right. Appreciate it. Thanks Janelle, and thanks Andy.

Thank you.

Thank you. And that does conclude the question-and-answer session. I'll now turn the conference back over to Janelle Frost for any additional or closing remarks.

We are pleased with the quarter's results, particularly when driven by the fundamentals we focus on: disciplined underwriting, proactive safety, and extensive claims management. Thank you for joining us today.

Well, thank you, and that does conclude today's conference. We do thank you for your participation and have an excellent day.