James River Group Holdings, Inc. Q2 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the James River Group Q2 2020 Earnings Call. I would now like to turn the conference over to your host, Mr. Kevin Copeland, Head of Investor Relations. Please go ahead, sir.

Thank you, Tiffany. Good morning, everyone, and welcome to the James River Group Second Quarter 2020 Earnings Conference Call. During the call, we will be making forward-looking statements. These statements are based on current beliefs, intentions, expectations and assumptions that are subject to various risks and uncertainties, which may cause actual results to differ materially. For a discussion of such risks and uncertainties, please see the cautionary language regarding forward-looking statements in yesterday's earnings release and the Risk Factors section of our most recent Form 10-K, Form 10-Qs and other reports and filings we make with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

Thank you very much, Kevin, and good morning, everyone, and welcome to our second quarter conference call. I'm joined here this morning by Sarah Doran, our Chief Financial Officer; and Bob Myron, our President and Chief Operating Officer. As is our usual way, Sarah and I will both have a few comments, and then all three of us would enjoy answering any questions that you may have. A number of things seem worth mentioning and pointing out from my perspective. First, our returns are strong. We're reporting a group combined ratio of 95%. Our return on tangible equity this quarter was 12.9% and 12% for the 6 months. By our calculation, an investor in our IPO has enjoyed a 22.3% internal rate of return, including dividends, from our IPO in December of 2014 through the middle of last week. Our tangible book value per share grew 14.9% during the quarter. Our prospects, I think, are excellent. Our E&S segment grew gross written premiums by 18% for the quarter and 25% for the 6 months. Our in-force policy count in Core E&S grew by 28% from June 2019 to this past June. We had a 16% increase in submissions in E&S during the first half of the year. Ten of our twelve E&S divisions had increased submission flow and the trend of greater submissions continues early in the third quarter. While we are growing, we're not changing our mix dramatically, and I think that's important. Average premiums remain in the low $20,000 level. Year-to-date, nine of twelve divisions within E&S have grown. For the quarter just ended June 30, that was the 14th consecutive quarter in which we had rate increases in Core E&S. The pace of rate increases is accelerating. In the first quarter, we reported a 13% rate increase on renewal policies. In this most recent quarter, our E&S team achieved a 20% increase on renewal policies. Turning to our Specialty Admitted book. It's performing very well. The segment reported a combined ratio of 90.1% for the second quarter and 98.4% for the first 6 months of the year. During the first half of the year, our Specialty Admitted segment has signed new fronting deals that we expect will generate annual premiums of approximately $100 million and annual fees of about $6 million. We're making steady progress on building a highly diversified book of fee income-producing programs that will earn in over the next year. One of the things that we all pay a lot of attention to is the strength of our balance sheet. I believe that our balance sheet strength is increasing quarter-over-quarter. Our loss and LAE ratio in Core Excess and Surplus Lines, for the 15 years, 2003 through 2018, is 57.1%. We are currently writing more of this business than in any previous year at better rates than at any time in our past, and we're booking our current year at 65.7%.

Thanks, Adam. Let me highlight a few of the financial points from the quarter. Last night, we reported first quarter operating earnings of $0.56 per share and annualized adjusted net operating return on average tangible equity for the first half of the year is 12%. It was a very strong quarter and first half of the year, as Adam has noted. Let me jump right into investments. Our portfolio has recovered meaningfully since March 31 with a total return of 4.3% for the quarter, excluding our restricted cash balance and private investments. Our fixed maturity investment portfolio had unrealized gains of $53.5 million while the bank loan portfolio had unrealized gains of $26.6 million, offset partially by realized losses of $9.4 million incurred on the sale of approximately 40% of our senior secured bank loan portfolio. As we mentioned in April, we made the decision to significantly reduce our exposure to bank loans by selling into the rally in this asset class as we look to temper our volatility. Given the current low-yield environment, we expect net investment income to be at similar levels as this quarter throughout the year. Moving on from investments, this quarter, we posted a loss ratio of 66.4% and an accident year loss ratio of 65.6%, largely in line with the first quarter of this year despite powerful rate increases, low loss immersions and meaningfully reduced claims frequency. As Adam highlighted, the Core E&S renewal rate increases we have benefited from for over 3 years now accelerated to 20% this quarter, and reported losses have remained benign for multiple quarters, again this quarter. Core E&S makes up approximately 70% of the company's net written premiums and close to half of our net reserves.

Thank you, Sarah. And before we take your questions, which we're eager to get to, I just would like to have a little shout out, if I might, to the employees and colleagues all around James River who have been working remotely since March and doing a really terrific job. We are aware of all the strengths that remote working calls for everyone in America who's doing it right now, but we're thinking about all of our employees who are home with children and working on school arrangements and nonetheless generating more policies, more premium, more underwriting, and more claims handling while they do it. It's a remarkable feat, and we're thinking about them, fortunately, for us right now.

Your first question comes from the line of Matt Carletti with JMP Securities.

Adam, you mentioned in your opening comments about the historical running of your Core E&S business and how you're taking a more conservative approach today. Can you give us a little bit of color on how you guys think about timing or how long you typically wait to see how those years develop before you might reevaluate that loss ratio?

We review our reserves each quarter and approach it with caution. We don't celebrate success too early. There's no fixed timeframe for this process; instead, we consider the overall situation and conservatively assess any factors that might lead us to reduce our reserves. Typically, we wait, which can vary by business line. I won’t provide a specific date, but our strategy is to be prudent and conservative to avoid potential future weaknesses and ensure we operate from a position of strength. I want to emphasize that we are currently strengthening our balance sheet, and we appreciate being in this favorable position.

Great. And then just a couple of others. Could you comment a little bit on what you saw in the quarter in terms of claim frequencies? A lot of other companies have noticed reduced claim frequencies, a lot driven by the current situation. But I'd be curious about what you saw across your book, both the core book as well as with respect to the runoff commercial auto book?

I think there are two things going on simultaneously. I mentioned that we closed 15% of the claims that were outstanding in the discontinued commercial auto book during the most recent quarter, and that follows having closed 25% in the first quarter. I definitely think that pace is faster than we expected, but I don't want to declare victory early. We're still anticipating a 2- to 3-year runoff of that book.

Sure. One last numbers question on the adverse development in the casualty segment. If I recall correctly, the ongoing development you've had there has really related to a small handful of lines and older accident years that you guys have exited a while ago. How much more do we have to go in terms of the reserve base left there?

I'm going to ask Sarah to jump in here. But in general, you're exactly right. These policies are from long ago. If you're talking about the Casualty Re segment, these are policies from long ago, and they come up as a little bit of a surprise. We have shrunk the book in Casualty Re. It's a very profitable E&S quota share book that we're writing there, and it is underwritten very well by our leadership there. But it's a small book. So a relatively small claim from an older year where we had a lot of premium can overwhelm the current year results. But overall, we see that trailing off. We look very carefully at our entire reinsurance arrangement. Our Bermuda operation has historically generated about a year's worth of net income for our shareholders.

Right. Adam is referencing the benefits of our overall structure that has added income not attributed specifically to the underwriting operations of the Casualty Reinsurance business over time. A fair amount of the adverse development this year was, as Adam said, due to business that we are no longer writing, but some of it looks to be profitable in later years. So the overall level of writings where we are now has been stable with regard to those segments.

Your next question comes from the line of Mark Hughes with SunTrust.

Of the $100 million you described as new business in Specialty Admitted, did any of that show up in Q2 or is that on the comp?

It's almost all on the comp.

Okay. The loss at the current accident year losses in Specialty Admitted is 80% this quarter. Were those elevated? Or is this the right run rate moving forward?

That's the right run rate for where we are right now. Obviously, a significant part of that book is the Workers' Comp that we write.

The expense rate

Yes, Mark. It's Bob Myron. With respect to Specialty Admitted Workers' Compensation, for our individual risk Workers' Compensation business, we moved the quota share for that business from 50% to 70% on January 1. As a result, the net loss ratio booked there is elevated because we have to include 100% of UA and account for our overhead and claims handling costs. The loss ratio went up, but we’re also having more ceding commission come through as a reduction to the expense ratio. There's a technical reason for why that loss pick has increased and why it seems high.

And to that point, your expense ratio was low this quarter. I assume that included some of the reversals you mentioned, Sarah. What should the normal expense ratio be in that business, at least for the near term?

Yes. Thank you for asking that question. I would think the normalized expense ratio for that business is in the low to mid-20s.

In the E&S segment, the ceded premium ratio has been kind of in the low 30s. What's the mix of Excess now relative to that overall segment? And what should the ceded premium ratio look like going forward?

This business is by design going to be lumpy. We've seen a great opportunity to grow the Excess Casualty book. This quarter, that book grew the most within Core E&S, and it's been that way in other quarters. Right now, that book is a little bit more than 25% of the overall Core E&S book, and I don't have a reason to think that will change significantly by the end of the year. So I would think the ceded ratio would be pretty stable.

Low 30s?

That's right. Kind of low, early 30s.

What is the tax situation now, considering the number of moving parts? What should we think about taxes for the back half going into next year?

A lot of assumptions go into the tax rate. I think of it from a practical perspective as being in the low teens for this year. It was 10% for the quarter, and I think it will be a little bit higher than that for the balance of the year.

When we think about the growth in Q3, you mentioned that the trend in submissions would continue early into Q3. How do you think about these growth dynamics moving into Q3?

I think right now, we're feeling that the growth we've experienced in the first and second quarter continues early. We see some of the $100 million I referred to in the fee income associated with it begin to filter into the second half of the year. In the E&S side of the business, we're feeling that it's steady, and our growth rate is not threatened by events. We continue to have pricing opportunities, and we continue to have a good flow of business. One thing I haven't mentioned yet is we are also seeing improvements in our efficiency. Our throughput and the buildup of policies in force over time, over the first half of the year, have improved significantly due to the new technologies introduced by our IT team. For example, in our small business unit, our throughput is about 26% higher than it was a year ago because of technology introduced by our IT group. I think we feel very good about the second half of the year.

Your next question comes from the line of Randolph Binner with B. Riley.

Your top line is growing a lot in Core E&S, but it's also coming down overall, and the business is increasingly profitable. Can you fill up that operating leverage with underwriting? Or is there a thought that perhaps you'd return to a higher level of capital return?

I'll take that first, and I'm happy to have my colleagues jump in. We are doing everything we can to take advantage of this great opportunity that we have to write as much good and profitable business coming across. That is our number one goal. I think we have more than enough capital to do it. If it seems like we don't have enough opportunities, we'll be judicious in returning that capital. But right now, we're trying to put as much of that to work as possible.

Okay. The other question I have is, from a high-level perspective, this environment looks good from a hard market perspective. Why does this feel different than previous full starts where we thought pricing was going to firm?

Randy, you are a very good student of the market. First, we've had 14 quarters of rate increases. Very large E&S players are taking steps to reset their capital positions and restrict writings right now. The largest E&S market in the country is retrenching, opening up new opportunities for us. The admitted market continues to discourage large books of business, which are classic E&S writes. We are about a year into this market, and there's more pressure coming. COVID claims are coming, and low interest rate claims are coming. I don't believe all the prior year losses of underpriced business have been recognized yet. So I am encouraged to think that this market has legs. When we can deploy capital and make a good return on tangible equity, it's a good use of our capital.

No, it's good. Just one quick clarification. Did you mean there’s pressure from lower interest rates?

Low interest rates for this industry mean that the industry has to be very diligent about its pricing, as it can't rely on interest income to cover itself against underpriced long tail risks.

Your next question comes from the line of Sean Reitenbach with KBW.

Another question on the Core E&S growth. Just trying to get a sense of how much of the recent 18% growth in Q2 was decelerated due to the pandemic versus being against a much larger comp from the previous year?

Look, we haven't seen a slowdown in our growth due to COVID. This is regular growth we’re seeing. I wouldn't have expected a bigger percentage number, but I'm happy to see the outsized policy count growth that aligns with the strong top line growth.

Great. Also, can you provide an update on your investment strategy given the pressured interest rates?

We sold a portion of our bank loan portfolio to reduce volatility. Overall, I would not expect our net investment income or investment strategy to change much from where it currently sits. Our focus is on underwriting, and we think taking volatility off the table has been beneficial.

Your next question comes from the line of Ron Bobman with Capital Returns.

Can you hear me?

Yes, we can, Ron.

I had two questions. Any change in retention was the first question. Secondly, are you seeing any change in claims settlement values?

There are some changes in retention that we've spoken about previously. We've reduced our net retention in individual written Workers' Comp, but it's not going to make a huge difference overall. However, we've opportunistically taken larger positions on particular risks occasionally when we felt the pricing was good. We constantly review and keep an open mind regarding our retentions.

Looking at our Core E&S business, we've seen retention remain pretty consistent in the low 60s. We haven't seen significant changes in policy retention in Q2. The claims environment has been benign with low paid and incurred loss emergence. There is more willingness for plaintiffs to settle claims quickly, and we're achieving better outcomes during this period.

It's important to settle at the fair value of claims. While we work hard to settle claims quickly, we are committed to ensuring fair outcomes for our clients.

Your next question comes from the line of Mark Hughes with SunTrust.

Adam, I interpreted the previous question the same way regarding retention. It did make me think about a competitor who has increased their retention. Is that something you've considered as well? Is it time to do it? Do you have the capital base and profitability to go there?

We have a capital base that would allow us to increase retentions. The overwhelming part of our Core E&S book is only buying a million. A larger part of the book could buy policies with limits in excess of $1 million, particularly in segments like Excess Casualty. These are opportunities we want to look at on a case-by-case basis.

And at this time, I am showing no further questions in queue. I would now like to turn the conference back over to Mr. Abram.

Thank you, operator, and thanks to all the participants, shareholders, our friends in the analyst community, our employees, and other interested parties. I hope that everybody stays well, and we look forward to speaking to you at the end of next quarter if not before. Thanks a lot.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.