Earnings Call Transcript - AMSF Q2 2020

Operator, Operator

Good day, everyone, and welcome to the AMERISAFE 2020 Second Quarter Earnings Conference Call. Today's call is being recorded. And at this time, I'd like to turn the conference over to Kathryn Shirley, Chief Administrative Officer. Please go ahead.

Kathryn Shirley, Chief Administrative Officer

Good morning. Welcome to the AMERISAFE 2020 second quarter 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 may differ materially from the results expressed or implied in these statements. If the underlying assumptions prove to be incorrect or as a result of risks, uncertainties and other factors, including the impact of the COVID-19 pandemic on the business and operations of the Company and our policyholders and the market value of the securities in our investment portfolio. Other factors that may affect our results are 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 statements. I will now turn the call over to Janelle Frost, AMERISAFE's President and CEO.

Janelle Frost, President and CEO

Thank you, Kathryn, and good morning, everyone. AMERISAFE and the workers' compensation industry began the year facing rate declines and strong competition. Then a pandemic disrupted the market, the economy and the workforce. This first 212 days of the year shifted focus for many companies and tested fundamentals. For AMERISAFE, our fundamentals are crucial in these unprecedented times. We are serving our stakeholders with disciplined underwriting, proactive safety and intensive claims management, which produces consistent returns, quality insurance services, and financial stability. This quarter, those fundamentals led to favorable prior year case development and a combined ratio of 78.5%. I will begin with our niche focused fundamentals. We insure small-to-midsize employers working in hazardous industries. Thus far, in this pandemic, those industries appear to be less impacted than main street businesses such as retail and hospitality. Therefore, in the quarter, our gross premiums written were down 7.7% from the second quarter of 2019. Voluntary debt premium was down 6.4%, driven by underlying loss cost declines. Policy count written in the quarter was up 2% with strong policy retention of 93.7%. Pricing, as reflected in our ELCM was 158, down from 161 in the prior year quarter. The market remains highly competitive, and there is additional uncertainty on what the second wave of infections will mean for employers. Audit premium and related adjustments added $0.5 million to top line, which was a decrease of $1.3 million from the second quarter of 2019. Audit premiums for policies audited in the quarter remained positive. We were pleased during the quarter that our insurers were reporting payrolls, which meant they were working. However, in anticipation of the pandemic and subsequent recession's impact on policy's estimated annual premium, we did record a decline of $1.4 million in the estimate for anticipated future audit premium, known in the accounting terms as earned but unbilled premium. EBUB is not often a quarterly topic because the estimate does not meaningfully fluctuate. However, you can find a description in the critical accounting policy section of our 10-K. As to our fundamentals, our disciplined underwriting, proactive safety and intensive claims management led to a loss ratio of 49.4%, down 9.5 points from the second quarter of 2019. The current accident year loss ratio remains 72.5%, same as the first quarter of 2020 and the full year of 2019. For the current accident year, frequency declined with fewer reported claims and severity was within our expectations. We had 10 COVID-19 claims reported with minimal incurred losses. The primary driver of the declining loss ratio was favorable case development from prior accident years. We continue our focus on achieving maximum medical improvement, returning injured workers to work and closing claims. The result was $17.5 million of favorable development, primarily attributable to accident years 2015 through 2018. I will now turn the call over to Neal to discuss expenses and other key financial measures.

Neal Fuller, CFO

Thank you, Janelle, and good morning, everyone. For the second quarter of 2020, AMERISAFE reported net income of $23.9 million or $1.24 per diluted share compared with $17.9 million or $0.93 per diluted share in last year's second quarter. Operating net income for the second quarter was $19.4 million or $1 even per share, an increase of $0.10 or 11.1% from the second quarter of 2019. Revenues in the quarter decreased to $89.1 million compared with $91.8 million in the second quarter of 2019. Revenues were positively impacted by $5.6 million in unrealized gains on equity securities offset by premium declines with net premiums earned decreasing 8.4% to $76 million when compared to last year's second quarter. Turning to our investment portfolio, net investment income decreased 10.3% in the second quarter to $7.3 million compared with $8.2 million in the second quarter of 2019. The decrease was driven by lower interest rates on fixed income securities, particularly on cash, overnight and short-term investment securities. The tax equivalent yield on our investment portfolio was 2.87% at the end of the second quarter. The pre-tax yield on the portfolio was 2.55% at the end of the quarter, down from 2.83% one year ago. There were no significant realized gains or losses for the portfolio during the quarter. The investment portfolio remains high quality carrying an average AA credit rating, with a duration of 3.74 with 60% in municipal bonds, 17% in corporate bonds, 11% in U.S. treasuries and agencies, 3% in equity securities, and 9% in cash and other investments. The 60% in municipal bonds includes taxable municipal bonds, which now make up 8% of the overall portfolio. Approximately 60% of our bond portfolio is comprised of held-to-maturity securities, which were in a net unrealized gain position of $33.1 million at quarter end. These unrealized gains are not reflected in our book value as the bonds are carried at amortized cost less an allowance for credit losses. Moving now to operating expenses, our total underwriting and other expenses were $21.1 million in the quarter compared with $19.7 million in the second quarter of 2019. Last year's second quarter expenses included favorable downward adjustments of $1 million in variable share price-based incentive compensation and $0.6 million in favorable lower insurance assessment costs. By category, the 2020 second quarter expenses included $7.5 million of salaries and benefits, $5.8 million in commissions, and $7.8 million of underwriting and other costs. As a result of the decline in earned premium as well as the higher expenses in the quarter, our expense ratio was 27.8% compared with 23.8% in the second quarter of 2019. Our tax rate for the quarter was 18.5% compared to 19.3% for last year's second quarter. This is largely due to more tax-exempt income on our investment portfolio than last year's second quarter. Return on equity for the second quarter of 2020 was 21.3% compared to 16.3% for the second quarter of 2019. Our operating ROE for the quarter was 17.9%. In capital management, our Company paid its regular quarterly cash dividend of $0.27 per share in the second quarter. This quarter, the Board declared a quarterly cash dividend of $0.27 per share payable on September 25th, 2020 to shareholders of record as of September 11th, 2020. And finally, just a couple of other topics. Book value per share at June 30th, 2020 was $23.94, up 7.4% from $22.29 at year-end. Our statutory surplus was $402 million at quarter end, up from $360 million at December 31st, 2019. And lastly, we will be filing our Form 10-Q with the SEC today, after the market close. That concludes my remarks and we would now like to open up the call for the question-and-answer session.

Operator, Operator

Thank you. Our first question today is from Matt Carletti with JMP Securities. Please go ahead.

Matt Carletti, Analyst

Good morning, thanks. I have a couple of questions. First, could you provide more insight into the loss trends you are observing? Specifically, can you update us on the number of large losses? I know you shared this information last quarter, so how does it compare to your expectations? Additionally, as we consider the recent strong development from prior periods, what does that suggest for accident year loss ratios? The baseline has shifted compared to a few years ago, so are there any implications or adjustments you are making in your current evaluations?

Janelle Frost, President and CEO

I'll begin, and Neal, feel free to add your thoughts. Regarding your first question about the large losses, we had five claims at the end of the quarter with reserves exceeding $1 million. In comparison, we had seven claims at the same time last year, which is in line with expectations. As always, I want to note that this is a lumpy business.

Matt Carletti, Analyst

Right, right.

Janelle Frost, President and CEO

We are not surprised by the current loss trends, which align with our expectations. In 2020, we observed a decrease in claim frequency, and while we are primarily focused on severity, this decrease is noteworthy. The claims reported for this quarter dropped significantly, approximately 25%, leading to an 18% decline in reported claims year-to-date, which is a positive sign. Severity has remained within our anticipated range. However, there is uncertainty regarding how the pandemic will influence the ultimate costs associated with our claims, not just the COVID-specific cases I mentioned earlier. Companies have adapted creatively to provide care for injured workers, and there have been commendable efforts by our employees in this regard. The critical question remains whether this will impact the long-term outcomes of these claims, such as delays in achieving maximum medical improvement or extending the duration of claims. It is still too early to determine the long-term effects accurately. We approached 2020 with confidence and used the same loss selection as in 2019, anticipating no deterioration. So far, it is hard to draw definite conclusions from the trends we are observing six months in, especially with the pandemic adding uncertainty. However, I feel optimistic about the situation. The story for AMERISAFE this quarter revolves around our disciplined approach to claims, which has remained consistent despite the pandemic. While our claim inventory was somewhat lighter, we continued our efforts to close claims and reach settlements, yielding some favorable outcomes. Specifically for accident year 2018, we saw an increased claim closure rate this quarter, which is not indicative of a lasting trend but was notable. This can be attributed to the situation of injured workers and their representatives being more inclined to consider settlement options. Overall, there seemed to be a more open response regarding the prior year development for at least accident year 2018. I apologize for the lengthy response. Did I address your question?

Matt Carletti, Analyst

No, you did. That makes a lot of sense. Just one other question, could you elaborate on the impacts of COVID that you might have observed? I know it’s not a significant concern for AMERISAFE, and I'm not referring to the ten claims you mentioned, but I'm interested in the exposure and payroll aspects. Were there specific industries or regions within your portfolio where you noticed a greater impact? I heard about the EBUB adjustment, which was minor, but if you could explain that further, it would be helpful.

Janelle Frost, President and CEO

Sure, I can do that. We were pleased early on, and as mentioned during our first quarter call, it looked like our insurers were functioning well. This was a positive sign for us, and we've continued to observe that, with very few zero reports as a percentage of our total business. Our insurers are performing effectively, although they are certainly affected by COVID, just like every employer in the country. We emphasize safety and want our insurers to prioritize it as well. Considering the industries we insure, many involve outdoor work, which seems to provide some protection against the virus transmission. This appears to be beneficial. Interestingly, we did not observe major differences in the industries' impacts; however, oil and gas likely experienced a more significant effect, which may relate more to oil prices than to COVID itself.

Matt Carletti, Analyst

Right. That's really helpful.

Janelle Frost, President and CEO

So, did I answer your question?

Matt Carletti, Analyst

It does, yeah. That's great. Well, well done, and best of luck. Thank you.

Janelle Frost, President and CEO

Thank you, Matt.

Neal Fuller, CFO

Thank you, Matt.

Operator, Operator

We'll take the next question from Randy Binner with B. Riley. Please go ahead.

Randy Binner, Analyst

Good morning. That was very helpful regarding the losses. The only part I didn't catch in Matt's responses to his questions was whether I could clarify that there was a lower number of large claims this year.

Janelle Frost, President and CEO

There were five.

Randy Binner, Analyst

Okay, is that normal?

Janelle Frost, President and CEO

I think we are at this point last year we were at seven. So, it's not dramatically different either way.

Randy Binner, Analyst

Okay. And then, I guess on net investment income, the 10-year treasury yields is at its lower level ever today. So obviously there's a lot of headwind there and it seems that the run rate for investment income is coming down across the board for insurance companies. So is this kind of the right level or can you mention for us how much we might lose in kind of prevailing yield in the portfolio as we roll forward in our models?

Neal Fuller, CFO

Yeah. Randy, this is Neal. A lot of the change in terms of us being down 10.3% was really on the short end in terms of what we could get on short overnight investments and stuff within the one-year period. Because the portfolio is out there and it turns off cash periodically that needs to be reinvested, the overall decline from here, I think, will be much more gradual in terms of the net investment income. But it will be, I think, an overhang for us and also for the industry over the next several years, as the economy recovers. I think one of the things we've seen with that before is that sometimes causes people to be a little bit more disciplined on the underwriting side because they need to earn an underwriting profit to be able to get an appropriate level of return for their shareholders.

Randy Binner, Analyst

Thank you for the information. Regarding the expense ratio, I might have missed something. Is it typical for the ratio to be lower in the first half of the year? Based on previous trends, it seems to also drop in the latter part of the year. Should we anticipate a lower expense ratio, particularly in the fourth quarter, as we look ahead?

Neal Fuller, CFO

Yeah, in the fourth quarter, we typically have a little bit lower expense ratio because there are accruals for guarantee funds and if the assessments are not made then those accruals come down. So that's usually a positive impact on the expense ratio in the fourth quarter. In terms of our overall expense ratio, the challenge is, net earned premium continues to come down and as loss costs come down, we have a lot of fixed costs that we really cannot jettison. So that puts pressure on the expense ratio. We expect it to continue to sort of be in this level, I think right now. Last year there were several beneficial things that we pointed out that caused the second quarter expense ratio to be lower than it would have been otherwise. About half of it is really due to the decline in net earned premiums in terms of the increase in expense ratio this quarter and about half of it was due to the actual increase in expenses.

Randy Binner, Analyst

Got it. Okay, that's perfect. Thank you.

Neal Fuller, CFO

Thanks, Randy.

Operator, Operator

We will now go to Mark Hughes with SunTrust.

Mark Hughes, Analyst

Thank you. Good morning. Just talk about new business activity, your ability to, I guess, sign up new, the new policyholders or the pace of submissions. Are you fully back to normal? And then within that, what's the competitive environment at this point?

Janelle Frost, President and CEO

Competition remains very strong, and the pandemic has affected new business flow not just for AMERISAFE but also for agents. Stay-at-home orders have limited their ability to prospect for new clients. Like many companies, AMERISAFE is focused on protecting our renewals as there is minimal new business being considered, and the submission flow remains low. We reported a decline in the first quarter, and that trend continues with little recovery compared to other areas as the pandemic has progressed. I want to commend AMERISAFE's employees in sales and underwriting for their efforts to strengthen relationships with agents. We experienced some success this quarter in converting quotes into policies, but new business has decreased more than I would prefer. What was the second part of your question regarding the pace of submissions? I apologize for asking.

Mark Hughes, Analyst

Yeah, I think you have the right idea. There seems to be some conversation around the possibility of workers' compensation pricing stabilizing or potentially increasing in the near future. Do you have any thoughts on that?

Janelle Frost, President and CEO

I don't anticipate any immediate impact on pricing from the pandemic, as I believe there won't be enough data to understand its true effects. Whether considering the first or second wave, we're still far from grasping the costs involved and what will ultimately be covered. Therefore, I don't foresee the pandemic directly affecting rates. However, the ongoing low interest rate environment, which shows no signs of improving soon, may influence rates, possibly reflecting more on discipline than on actual rates. I'm not particularly optimistic about rates increasing or stabilizing soon.

Mark Hughes, Analyst

I have another question that might be difficult to answer. Considering your book of business, which has a significant amount of construction, it's clear that the next job will be crucial for many of your policyholders. How should we understand your book of business regarding insulation from volatility, especially in the new construction market?

Janelle Frost, President and CEO

You're right to be concerned about the job market. I think our insurers are doing their part, but the crucial question is whether the next job will materialize. The forecasts I've seen don’t indicate that significant projects are being canceled at this point. Most reports suggest that projects are merely being delayed or postponed, which I see as a positive sign that the situation may not mirror previous recessions. Recently, I came across a report comparing job loss trends across different skill levels in this recession versus the last one. Previously, the middle-skilled jobs that our insured companies are involved with had the highest losses, whereas this time, it seems to be the lower-skilled jobs in sectors like hospitality and retail. I view this shift as a favorable change. This recession has also involved different stimulus measures, which I believe have positively impacted our insured base, particularly small to mid-sized employers, allowing them to retain their staff. If projects are delayed by a quarter or two, that could be an encouraging sign. However, there remains uncertainty regarding the construction industry’s future. There's ongoing speculation abouthow remote work may affect commercial construction. If the demand for office space declines, it might impact that sector. On the flip side, with fewer people using public transportation, we may see increased driving, which benefits sectors like roadwork and excavation, areas in which we provide insurance. Ultimately, there's a lot we don’t know about how these factors will play out.

Mark Hughes, Analyst

And then just one final question. You mentioned the ELCM, which I believe was 1.58 this quarter. This is based on the state's loss costs. I'm curious about the recent state developments, and I’m not sure about the timing of when the state-by-state information will be released, but do you have any insights on how those loss cost calculations have been trending recently?

Janelle Frost, President and CEO

Certainly. In my opening remarks, I mentioned that our voluntary debt decreased by 6.4% for the quarter, primarily due to the decline in loss costs. For the rates that were implemented this quarter in our states, particularly in some of the larger ones, the average impact was a reduction of 9%. We are still experiencing high-single digit rate declines, and I would say we have underlying improvements.

Mark Hughes, Analyst

Yeah. Is that something you track on a quarterly basis when the new rates go into effect quarter to quarter?

Janelle Frost, President and CEO

Yes, we do. We do.

Mark Hughes, Analyst

What was that 9, how does that compare to Q1?

Janelle Frost, President and CEO

Great question. Let me, I don't have that with me...

Mark Hughes, Analyst

Because I think you said I think the 9 is…

Janelle Frost, President and CEO

You know, I somewhat remember it being 12. But don't quote me on that. Let me find out for you.

Mark Hughes, Analyst

Okay. And I think that was all I had. I appreciate all the good answers.

Operator, Operator

And I would now like to turn the call back over to Janelle Frost, President and CEO for concluding remarks.

Janelle Frost, President and CEO

This is our second quarter reporting under the cloud of the coronavirus pandemic. We are pleased with this quarter's results and we accept the challenges and uncertainties ahead. We do so because of our firm foundation of a strong balance sheet, our proven operating model, and the employee experience and dedication to serve our stakeholders. Thank you for joining us today.

Operator, Operator

And that concludes our conference for today. I’d like to thank everyone for your participation and you may now disconnect.