James River Group Holdings, Inc. Q4 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the James River Group Q4 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Brett Shirreffs, Head of Investor Relations, and please go ahead.

Thank you, Deedee. Good morning, everyone, and welcome to the James River Group Fourth Quarter 2021 Earnings Conference Call. During our 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 of our most recent Form 10-K, Form 10-Qs and other reports and filings we've made with the SEC. We do not undertake any duty to update any forward-looking statements. I will now turn the call over to Frank D'Orazio, Chief Executive Officer of James River Group.

Brett, thank you for that introduction. Good morning, and welcome to everyone on the call. We have quite a bit of information to share with you regarding our fourth quarter results as well as the meaningful strategic actions that we announced with our earnings last night. James River took significant steps in an attempt to put our historical prior year development from our casualty unit behind the organization as we look to significantly downsize that business and emphasize our insurance operations. In doing so, we believe we've extinguished our final legacy hurdle and had our new Chief Actuary complete a deep dive of all three operating segments while receiving external validation points along the way. With these actions behind us, our focus is on continuing to leverage the sector's robust underwriting conditions while we continue to make James River a stronger and more profitable specialty E&S leader. We have confidence in our group reserve position after confronting legacy issues head-on in 2021 with the actions we've taken, including the two retrospective reinsurance transactions that we completed in the last several months. On a group basis, our IBNR now represents 64.4% of our total net reserves. This is up from 55.3% a year ago and is the highest level of IBNR at the company since early 2018. I'm pleased with the progress that we've made organizationally while remaining focused on profitably growing our E&S and Specialty Admitted segments. The reserve actions of the quarter somewhat obscured the fact that our E&S and Specialty Admitted businesses reported strong results in the fourth quarter with combined ratios in the mid- to low 80s and $27 million of combined underwriting profit, excellent results that I want to expand upon. The E&S segment reported a combined ratio of 82.1% as well as 12% growth in gross premiums. Underwriting profit of $24 million was the second largest quarterly underwriting profit ever for the segment, and that did not include the benefit of any positive reserve release, highlighting the profitability of the business we're currently writing. Growth in E&S was driven by continued strong performance in Excess Casualty as well as Allied Health, manufacturers and contractors, excess property and our small business unit. Our core E&S book grew 14% in the fourth quarter and 19% for the full year. Rates were up 9.5% across the E&S segment in the fourth quarter and 13.3% for 2021. It's impressive that we've now had two consecutive years of renewal rate increases in excess of 13%, which is meaningfully ahead of both our view of loss cost trends and the rate increases implied in our loss picks for the year. The fourth quarter of 2021 represented the 20th consecutive quarter of rate increases for the E&S segment, compounding to 49% over that period and providing confidence in the strength of our loss picks and the margin we're building in the business that we're writing today. For the full year, our overall E&S segment surpassed $830 million in gross premiums, and our core E&S book reached $800 million in gross premiums, which was growth of $130 million over last year or almost 20%. This is an impressive milestone for a business that was $334 million of premium just three years ago at the end of 2018. While we've added significantly to the top line over that period, we've done so over some of the best market conditions of this century while remaining bottom line focused. The hallmark strength of our core E&S underwriting expertise is clearly evidenced by our results this quarter. Turning to Specialty Admitted. This segment had another very strong quarter with gross premium growth of 9% and a combined ratio of 84.7%. Gross fee income increased 27% from the prior year quarter to $6.5 million. Fronting and program premiums were up 11%, which was similar to the growth we reported last quarter. Our individual risk workers' compensation premiums were down 5.5% for the quarter and 10% for 2021 as we remained focused on managing the portfolio prudently in what continues to be a countercyclical marketplace for workers' compensation. Growth in the quarter for our fronting business was driven primarily from existing programs. We continue to have a healthy pipeline of opportunities and wrote one new program in Q4, have already found two new programs during the first quarter, so we're off to a good start for 2022. Getting back to the reserve actions of the quarter. As we discussed in our November call, our new Chief Actuary, Dave Gelinne, was in the process of completing reserve reviews for all three underwriting segments and what would be his first full quarter as Chief Actuary. While those comprehensive actuarial reviews suggested no changes in our reserve positions for both our E&S and Specialty Admitted segments, our thorough analysis of our Casualty Reinsurance segment resulted in a $115 million reserve adjustment given the unexpectedly high emergence in 2021, particularly in the fourth quarter. Despite the history of relatively small but persistent adverse charges from this segment, the magnitude of the development was both unexpected and extremely disappointing. The bulk of the adverse development was driven by less than a handful of cedents and most of the charge emanated from the 2014 to 2018 underwriting years. By all accounts, very different underwriting conditions in today's marketplace. The underlying coverage of most of these treaties was primary general liability, including exposure to construction and construction defect. To a lesser degree, treaties contributing to the charge also had aspects of premises and financial lines exposures. Actual reported and paid losses in the Casualty Reinsurance segment significantly exceeded expected indications in 2021, particularly in the fourth quarter, causing us to refine several of the assumptions used to determine our best estimate of ultimate losses for this segment. We responded to the elevated loss emergence by making significant adjustments to our assumed tail and development factors. In particular, we placed significantly more weight on incurred loss development methods, particularly for treaties with exposure to construction operations. Roughly half of these treaties are no longer in force, and those that are have undergone significant underwriting and pricing changes as the segment has heavily derisked the portfolio over the last three years. We believe those actions are clearly evident in the meaningfully improved loss experience we see in the most recent underwriting years. After the reserve movements this quarter, our IBNR represents 66% of net reserves in the Casualty Re segment. This is up from 59.2% at the end of the prior year and at the highest level in more than seven years. In addition to the reserve strengthening, we moved quickly to provide our shareholders additional certainty around the size of the charge and protection against further development for the segment. We believe that with the legacy transaction that we've just signed covering the bulk of the segment's reserves, we've meaningfully improved the confidence associated with the casualty reserve portfolio as well as our overall balance sheet. Sarah will describe the loss portfolio transaction in a bit more detail momentarily, but I would quickly emphasize two points. For one, our counterparty in this transaction, Fortitude Re, is a sophisticated A-rated legacy reinsurer with greater than $4 billion in surplus that we're very pleased to be working with. Secondly, I view the transaction, which is being executed at less than $7 million above our Q4 held reserves, as further validation of the actuarial work that we completed in the quarter. With our reserves for our Casualty Re segment now significantly strengthened and further bolstered by the legacy transaction with Fortitude, we expect to substantially reduce Casualty Re premiums in 2022. I expect we could see a premium reduction of $100 million or so based on our 2022 plan, which is driven by portfolio optimization and profitability, not volume. We do still view the market as attractive given the strength of the rate environment and terms and conditions, but expect to be selective relative to the makeup of that portfolio while deploying the majority of our capital in our E&S and Specialty Admitted businesses. Before I move on, given the reserve development we are announcing in the Casualty Re segment this quarter and the impact that construction defect exposure has had in driving the charge, I wanted to spend a moment discussing why we have not also seen emergence present in our E&S segment and provide some qualitative rationale for that sentiment. For one, our E&S segment has historically not written large homebuilders or general contractors who construct massive-scale multifamily housing. We also don't write construction wraps either on an owner-controlled or contractor control basis. These structures and programs tend to be vulnerable to latency because they had very long products and completed operations coverage extensions. We haven't written these programs in our E&S segment, but a few of our larger cedents in the casualty re portfolio did underwrite these structures. So then what do we write? Our manufacturers and contractors' unit in our E&S segment tends to target artisan and trade contractors with average premium sizes of $25,000 to $30,000. And we try to avoid many of the most problematic states for the class. Finally, we write no new residential construction in our small business or contract binding units. Before Sarah provides greater detail, I'd like to comment briefly on capital and the strength of our balance sheet. Moving forward, I'm very excited about our new relationship with Gallatin Point Capital and the $150 million investment in convertible preferred stock they will make in support of our company. Gallatin is a highly regarded private investment firm that specializes in investments in financial institutions. Our Board has approved the appointment of Matthew Botein, a co-founder and managing partner of Gallatin Point Capital, to serve as a member of our Board, following the receipt of any necessary regulatory approvals. Several members of the management team and the Board have recently spent considerable time with Matt and his colleagues, and it's clear that they view our franchise and our future with the same appreciation that we do. We're very excited to be in partnership with Gallatin Point and have Matt join our Board. Together with the reserve actions taken earlier in 2021 for our runoff commercial auto portfolio and the legacy solution we announced in September, we believe our balance sheet is strong and very well positioned to continue to support the fantastic opportunities we're seeing in our two U.S. insurance segments. In the last 16 months, the company has significantly increased our reserve balance, executed two legacy reinsurance transactions to substantially reduce reserve risk, raised meaningful capital and brought on new, experienced senior management in our actuarial and claims functions, as well as hired a group CEO to provide improved underwriting governance. We have made investments in our technology, updated and improved our enterprise risk management plan, and have continued to improve our governance by adding three new independent directors to our Board, each with meaningful and impressive insurance industry experience. We've done this while growing the company by 20% over the past year. James River will continue to be a dynamic and entrepreneurial underwriting organization as we build upon our industry-leading insurance franchises. What we've highlighted in the actions taken since I've joined the organization is the blueprint for how we're going to manage and govern the company. And frankly, there's no turning back. With the actions that I've taken since joining James River, I see a very bright future for the organization and an opportunity for the company to achieve its earning promise and potential. This is an exciting time for James River. And with that, let me turn the call over to Sarah.

Thanks, Frank, and good morning, everyone. Given Frank's extensive comments on the current quarter, I'm going to focus my comments on a brief review of the operating results and then the transactions we are announcing today as well as capital and guidance. We've made significant progress in strengthening our balance sheet, while our E&S and Specialty Admitted businesses continue to shine. Last night, we reported a net loss for the quarter of $66.3 million and an operating loss of $67.5 million. As Frank detailed, this is heavily impacted by the $115 million of reserve development in our casualty reinsurance segment. Across the group, quarterly net earned premium growth outpaced that of the year, an increase of 15% on the year and 20% on the quarter. The accident year loss ratio was 66.7% for the quarter and 67.1% for the year. The quarter benefited from strong earnings in both our Excess and Surplus Lines and Specialty Admitted segments. Moving to expenses. Our expense ratio was 13.9% for the quarter and 23% for the year. The quarter benefited from 6.6 points of sliding commission offsets related to the casualty reinsurance reserve additions and the year 1.8 points for the same impact. Given our performance on the year, we reduced our compensation expenses which had a 2-point impact on the quarter and about a 1-point impact on the year. Final comment on quarterly operating performance. Net investment income for the fourth quarter was $12.1 million, a decrease of 45% from the fourth quarter of last year and about 20% from the prior quarter. The decline is due to decreased returns in the renewable energy portfolio, especially compared to an exceptional quarter for that asset class in the same quarter last year and a decline in assets in the portfolio, given the commercial auto LPT we executed in September. I'd like to now spend a few minutes on the transactions, capital and 2022 guidance. We are releasing our quarterly earnings a bit later than we typically do as it was imperative to us to complete our reserve work, but at the same time, deliver on the validation and security that we believe the loss portfolio transfer transaction and capital raise together provide. Doing so simultaneously was a critical strategic objective. I note that earlier this morning, A.M. Best released a press release and commented that our ratings, which are A- with a stable outlook, remain unchanged following the earnings and strategic actions we disclosed last night. Our reserve committee completed and finalized its reserve work in early January. Following Frank's comments during the third quarter call, we began working with Tiger Risk on a potential loss portfolio transfer transaction in late 2021 as our new Chief Actuary completed his work in parallel. We received the final indication on the Fortitude LPT in early February and worked expeditiously with our partner, Fortitude, during February to negotiate the contract that we signed last Wednesday. As we announced last night, we've entered into a loss portfolio transfer transaction with Fortitude. It's related to the majority of the reserves in our third-party Casualty Reinsurance segment. The transaction will enable us to strengthen our focus on our U.S. insurance businesses while reducing potential future reserve volatility as we shrink our exposure to the reinsurance business. It's been executed by both parties and is pending only regulatory approval for Fortitude. We will pay $335 million of premium for the $400 million aggregate limit. And of that $335 million, $25 million of that will be in cash and the balance completed on a funds withheld basis, wherein we retain the underlying assets. We expect to recognize an after-tax loss of $6.8 million in connection with the transaction during the first quarter of 2022, and the impact of the 2% crediting rate on the funds withheld assets will flow through our expenses. Adjusting for the $6.8 million expense, which is a consequence of increasing reserves to the inception of the LPT, the transaction will provide us with $65 million of net limit above our held reserves for the portfolio. As Frank mentioned, it will cover the majority of the segment's reserves and importantly, the majority of the construction and construction defects in the portfolio. The portfolio was designed to both significantly derisk our exposure to further emergence in casualty reinsurance and to help enable a transaction during early '22, especially given our accelerated timing. We are very pleased to be working with such a high-quality and A-rated legacy carrier in Fortitude Re. Second, on the convertible preferred of Gallatin Point. First, a moment on process and strategy. As we work to complete the reserve work and LPT, our objective was to raise equity capital as needed for rating agency purposes but at a premium to market trading price. And our work with Citi enabled us to deliver on this objective. Our capital and ratings are allocated across the group, and I believe it's very unlikely we could have raised less capital to maintain the rating outcome that was reiterated this morning. The Gallatin Point affiliate will purchase $150 million of convertible preferred securities, which will pay a 7% coupon beginning in June. The transaction is expected to close this morning. The securities are convertible at a premium of 27.5% to either the lower of our volume weighted average price of our stock during the 5 trading days preceding our earnings release of last night or the volume weighted average price of our stock from today through March 7. We have the ability to force conversion in 2 years if the stock trades for at least 20 consecutive days above 130% of the conversion price. Voting rights of the preferred are capped at 9.9% on an as-converted basis, and the conversion price is subject to customary anti-dilution adjustments. We intend to contribute the majority of the proceeds of the capital raise to our insurance operating subsidiaries. I echo Frank's comments in saying that we are thrilled to have Gallatin Point and all of the thoughtful strategic expertise and experience they bring on board. With regard to capital, we are allowing cash to build so that we can continue to support the operating businesses in a robust environment that we believe has meaningful room to run. As part of this assessment of capital in the event of the past year, we made the decision to reduce our quarterly dividend from $0.30 per share to $0.05 per share per quarter, beginning with the cash dividend declared earlier this month by our Board of Directors. The dividend reflects our current growth profile, which remains robust. We will balance capital with growth opportunities and consider moderate regular increases annually according to our opportunity set. Our balance sheet and ratings are critical to us. Our expectation for 2022 is to earn a low double-digit return on tangible common equity across the group with strong underwriting profits in both of our U.S. segments and to grow our tangible book value per share. We believe our franchise, current operating conditions, and balance sheet have set up our small account casualty E&S operation to deliver a very strong performance. As mentioned, and also cited specifically in the investor presentation entitled Frequently Asked Questions, which we filed last night, the loss portfolio transfer will have an impact on our income statement. This includes the $6.8 million that we will record as adverse development in the segment in the first quarter of '22, the higher current accident year losses of $5 million, and the interest credited on the LPT funds withheld assets. Together, I believe these will limit the opportunity for the Casualty Reinsurance segment to achieve a profit this year but provide us with significant balance sheet comfort. With that, I'll hand it back to Frank.

Thanks, Sarah. Operator, I think we can open up the lines for questions from our listeners.

Our first question comes from Cullen Johnson of B. Riley Securities.

When we look at the dividend cut, do you think of that as maybe more of a temporary measure? Or is that more saying that capital is kind of highest and thus use is supporting the growth of the E&S book and at a more fundamental shift of your capital management strategy?

Thanks, Cullen. We appreciate the question. That's obviously a very good one. We think about our dividend as really rightsized for the growth opportunity that we continue to see. I think that I just kind of go back to my comments there that we expect to, through our Board and our internal processes, look at moving that up annually as part of a regular process. But I'm not expecting significant volatile movements up and down in that. We think it's almost about a 1% yield. It's rightsized according to the growth opportunity and also is fairly consistent across the board with some of the other folks who have similar business profiles and returns as we do.

Okay. Great. That's helpful. And then we touched on with the Uber loss portfolio transfer, we kind of saw a decline in the size of the investment portfolio and that kind of flowed through to investment income. And we'd see a kind of similar size reduction with the Casualty Re transaction as well?

I think it will be a little bit different potentially here because the way this transaction works is most of the assets will remain on our balance sheet instead of going over, that's the construct of the funds withheld on this portfolio. So we'll retain the assets, but we will pay the 2%, otherwise known as 50 basis points a quarter crediting rate on that declining balance of assets. So said a different way, we would expect to have a return on our assets ahead of 2%. So that return would be netted against ideally what would be a slightly higher return than that. So it's not going to be a full transfer and a full give up of all the assets in that way.

Our next question comes from Matt Carletti of JMP Securities.

Matt Carletti at JMP. First question, I hope that's a question on E&S and just understanding kind of the picture of the accident year loss ratio picture you've been making. So if we look back historically, I think inception to date since kind of beginning of James River fully developed high 50s is probably the profile of kind of where accident loss ratios have gone. And clearly, your booking I think, 67 or so is where this year was or '21 was at least. And Frank, I think you termed it as best conditions we've seen in the century. So my question is, has anything changed in terms of mix in the book or otherwise, that should lead us to believe that we should look at history as we think about where recent years could go in what you're terming as one of the best pricing cycles in at least people's careers. Or is that more just we have to let the process play out, obviously, and see where the losses develop?

Thanks for the question, Matt. So I would point to your latter part of your commentary there that we're going to be more patient as an organization and let reserves season. I would suggest that our process is fairly conservative in terms of taking a look at the rates that we were able to get on our renewal business in the prior year, look at what is excess of our view of loss trend and have a very contemporary view of what loss trend is by product line and then only accept a portion of that increase when calculating our loss ratios for the following year. So fairly conservative. If you're looking at maybe the jump between 2020 and 2021, 2020, certainly, we had the reduction in claims frequency of, call it, 20% to 30% on an exposure-adjusted basis. And what I said at the time was we weren't going to assume that, that was the new run rate of the new normal. And so we were going to assume that claims frequency would return to pre-COVID levels. And so that's why you saw maybe a jump between '20 and '21 relative to the loss ratio picks.

Okay. Great. And then just one question on Casualty Re. And I guess the question is, why remain in it at all? I mean I appreciate your comments that you'll shrink the book significantly, expect $100 million to come out. But my question is kind of why remain there at all? Why not just cut it off clean and be core E&S with a fee income fronting business? And secondarily, if you were to cut it completely, would that at all change kind of capital requirements for the organization? Or would that not have an impact on that?

Sure, that's a good question. Casualty Re is part of our 2022 strategy because we believe that given the current market conditions and demand for reinsurance, we can be profitable in that area. Excluding the costs associated with this and previous transactions, we anticipate making profits in 2022. Rates for this segment increased by approximately 12% to 13% last year. However, our team is not planning to pursue aggressive pricing and will be significantly reducing the size of the portfolio, as I mentioned earlier. The actions we've taken this quarter provide us with more flexibility, allowing us to be selective about the business we underwrite. We will continue to assess our market assumptions and adjust our strategy as necessary. Regarding your point about capitalization, I want to emphasize that our ratings and capital are managed at a consolidated group level. In other words, maintaining our Casualty Re unit as a functioning entity did not affect the amount of capital we raised.

That's right. Some of my comments relate to the fact that I don't believe not writing that business would affect the amount raised, perhaps just to clarify that in my own words.

Agree.

Our next question comes from Mark Hughes of Truist.

Frank, what gives you confidence that most of the reserves you have are effectively managed with this LTP portfolio? How much remains on your books that you still have exposure to?

Sure. So let me step back to what I committed the company to during the November call. So I said that we were going to be addressing the casualty reserves after what's been a series of adverse charges. As I said, we do that in Q4. We finished that work in early January. And as I said, we made significant adjustments to our tail and developmental factors and put more weight on the incurred loss development methods that drove the 115 charge that we talked about. But given the company's reserving history or recent reserving history, we wanted to further validate that point and provide some additional certainty to shareholders. So we explored the legacy marketplace with a goal to have something meaningful to announce, providing that certainty with Q4 earnings, as Sarah said earlier. So our Casualty Re segment, just to give you some background, that reserve portfolio currently includes about 480 treaty participations historically, dating back to when the segment first started running business in 2008. Many of those treaties have long been inactive, just relative to claims activity and just not concerning. What we tried to accomplish in selecting the subject business was capturing a majority of the reserves, including our largest treaty relationships and treaties where we've had meaningful reserve strengthening, but also treaties that would capture the most significant exposure to construction classes. So we wanted a high percentage of the total reserves. We wanted treaties that have driven our reserve strengthening. We wanted to cover concerns with latency or latent exposures like construction defect. And we needed to allow counterparties the opportunity to review a subject portfolio that would allow us to execute a transaction in the time frame that we were talking about while protecting ourselves from further reserve volatility. And that's what we believe we accomplished with this transaction. We didn't get the final terms completed from the legacy market until February, as Sarah said. So it really was a separate work stream than the work of our Chief Actuary. So again, just provide another validation point in the quarter. Beyond that, obviously, we went through the capital raise process as well as obviously discussions, as you might imagine with A.M. Best. So we feel we picked up additional validation points along the way relative to the actions that we took. And hopefully, that gives you some sense of how we came to where we ended up on the subject portfolio.

Yes, I appreciate that. Sarah, on the expenses, you've obviously got some one-timers here hitting in Q1, but kind of run rate expense ratio, if you think about the company as a whole and then the E&S and specialty admitted, I wonder if you have any thoughts you might share, there's been a lot of moving parts lately.

Sure. And thank you for the question because there have been a lot of moving parts just given the reserve issues kind of related to that as well as, of course, incumbent compensation changes and in various COVID impacts, et cetera. So I appreciate there are a lot of moving pieces. If I think about it, Mark, and I think about 2022 or kind of go-forward years, in particular, I think that our expense ratio remains at a significant advantage to our competitors. So it's in the mid- to high 20s. I'm going to call it, 26% to 28% on a run rate basis, and we've obviously beaten that pretty significantly this year down to the 23%. And then within the segments, you saw that kind of manifest through the compensation changes in particular this quarter and some of the commission offsets in casualty re. But I think about the rollout being there around 20% in each of the 2 U.S. segments. Obviously, to the extent Specialty Admitted continues to grow as it has, it's got a nice offset on ceding commissions, et cetera, through the fronting business as does E&S. So that's how those 2 kind of around about 20% or a little bit better numbers could move. And then Casualty Re, I think that's a low 30s expense ratio, call it, 32-ish percent, and it's really hard for it to be any different than that because that's almost entirely driven by the ceding commissions on Casualty Re, in particular, even that we've got a very small expense base and a small team there as well. So hopefully, that provides you a little bit of color in context as to how that manifests itself ideally over the next year or so.

Good. That's great. I appreciate that. What is the pace of runoff for the withheld funds considering the 2% fee? Also, at what point does that entirely shift over to Fortitude?

Yes, that's a good question. It's outlined in the contract that after about 5 years, any remaining funds will transfer to Fortitude along with the balance. Essentially, we will reduce the withheld funds at that time and return any remaining assets. This balance will decrease as claims are settled. We view the Casualty Reinsurance segment as having a potential 3- to 5-year tail, which is a broad estimate. This aligns with our expectations regarding the release of assets after the 5-year period. We anticipate a gradual decline from the current $310 million over the next 5 years. It's important to note that the $335 million, which includes the $310 million amount, is as of October 1. We will continue to pay claims going forward, meaning the balance will never actually remain at the $310 million level; that figure represents a peak, and it will decrease from there. Consequently, the 2% interest on that balance will also decline over time.

Our next question comes from Tracy Benguigui of Barclays.

Let's go back to your dividend cut. You mentioned part of the thinking was reassessing how your dividend yield stacks against other growth stocks. So I guess, help us get excited about your growth prospects because what I saw was that casualty re premium growth outpaced your core E&S book. I know going forward, that's going to be more subdued. But if you could just touch on what happened this quarter and how much more growth we could expect from E&S in 2022?

Sure. That's a great question, Tracy. To begin with Casualty Re, I mentioned this might come up during our Q3 call. We recorded less than $8 million in Gross Written Premiums (GWP) in Q3, but we also had several million dollars in treaty adjustments and growth in our underlying business that was in the double-digit millions range, alongside some new business in Q4. All of these were commitments made before we decided to reduce the segment and prior to the results of our segment reserve review. Regarding our growth prospects, our core Excess and Surplus (E&S) grew about 14% in Q4. In E&S, we either met or exceeded last year's GWP production in nearly every month, except for one or two. November was one of those months due to some actions taken on a small number of accounts, specifically underwriting decisions in three departments. In our Energy group, we decided not to renew a large account, which resulted in a $6.5 million budget hit. That account was presented to me for referral and discussion with our segment President, Richard Schmitzer, and our segment actuary. Similarly, in Excess Casualty, we made tough decisions on three other renewals that impacted us by about $3 million. We also achieved a significant win in our commercial auto segment. In our core E&S operation, we typically issue policies in the $20,000 to $25,000 range, so losing those larger accounts has a more pronounced effect. November production was slightly down, which had a minor impact on Q4, but we rebounded well in December, and the outlook for the first quarter is looking very strong as well.

I'm going to elaborate on the dividend because that was a great question. Frank has discussed the dividend and growth in detail. I mentioned in my comments that we expect to achieve a low double-digit return on equity for 2022. We are seeing a strong return on our business, and it makes sense to continue investing that capital. This is a key element of our strategy. If we can maintain strong returns from our most capital-intensive area, the core E&S business, we will continue to invest and aim for strong and consistent returns on equity.

Can you discuss the balance sheet protection provided by your LPT? How did you determine the $65 million net limit? I'm curious how that compares to your expectations. Was that more or less than what you anticipated during the negotiations?

I don't know that it was more or less per se. Dave completed his deep dive and comprehensive reserve review in early January, that produced the $115 million adverse development charge, which in and of itself is a very significant reserve move. But also as validated by the other strategic actions that we've taken in the quarter. As far as that LPT limit, we view that as just bolstering kind of the step that we took. And quite frankly, when you're in a legacy market to get a limit that's more than 50% of the charge that you just took based on the premium that we paid for the structure, I mean, it obviously, I think, gives some credence to their view of the reserves as well. So we are very comfortable to tack on, again, like I said, a pretty significant limit on top of that just relative to the $115 million.

And then just following up on that. You did say post-reserve actions, our Casualty Re reserves will sit above your third-party central estimate, so how should I think about the $400 million you're carried in that additional cover relative to the central estimate. Could you express that as a percentage of redundancy?

We haven't disclosed that, Tracy. I believe we've been quite clear in stating that it's above the central estimate. This quarter, we booked $425 million in reserves for the segment. Of those reserves, 66% are incurred but not reported, which is significantly higher than last year. I want to emphasize that our reserves exceed the central estimate, but we don't think it's appropriate to share the exact percentage level.

Our next question comes from Brian Meredith of UBS.

Sarah, I wonder if you could tell us what the implications are on your tax rate from the kind of big decline here in the reinsurance business? Or do you have any...

Yes, sure. I think a couple of things here, Brian. As we think about this, tax rate is related to obviously the decline in the business, but we also have a significant balance of invested assets that remain from unit environment as well. But if I could be just almost a little bit simplistic about it. I think about the 2022 tax rate of being, let's call it, anywhere from 19% to 21%. Obviously, that's dependent on where we make the money and how we make the money when, but I would think about that as a fairly consistent rule of thumb with the year ahead.

Great. And then, Frank, I'm just curious, what's the reaction been, I guess, quarter-to-date? And I guess we'll find out over the next couple of weeks of your distribution to all of the issues that have been happening from a balance sheet perspective. The E&S business as well as just willingness of people to transact business with you on the fronting business.

Sure, Brian. So we've been very pleased, quite frankly, with the loyalty and support that we've received both from our wholesale distribution partners as well as our program managers in the fronting business, very supportive. I received a note today from the CEO of one of our largest distribution partners just kind of congratulating us on this transaction and continuing to pledge support. I think I've said just relative to the fronting business for those several months where we were on negative outlook from A.M. Best, we didn't lose one renewal within our program space. So really no issues in that regard. Our A- stable rating is very strong and being supported by our distribution partners across the segments.

Our next question comes from Meyer Shields of KBW.

So one, I guess, broader one specific question on the Excess and Surplus Lines segment. I guess, the specific question would be, shouldn't some of the older accident years' redundancy that Frank didn't use the word rude, I want to put words in your mouth. But you talked about the conservatism relative to history. Shouldn't some of that have manifested itself in the fourth quarter? And maybe more broadly, how should we think about the loss trends that are embedded in Excess and Surplus reserves? And what should we watch to ensure or to monitor that?

Meyer, I just want to make sure I got the first part of your question.

Okay. Basically, we saw, I mean, 17,000, I think, of reserve releases of Excess and Surplus Lines, but the business has decent tail. You talked, I think, very reasonably about wanting to let that mature. I would have thought that some of that would have matured in the fourth quarter just because some of the reserves pertain to older accident years.

Right. So I mean, listen, we feel very confident in the strength of our reserves in the segment. But it didn't manifest itself in a release for the quarter at this point in time. It's not suggesting anything more than that.

I think I'll go ahead and address what I believe we heard regarding some trends in the underlying portfolio. I'll start and then turn it over to Frank. We experienced 13% rate increases in E&S for the last two years. Our loss picks were set with the assumption of much lower rate increases than what actually occurred. That's an important consideration when thinking about margins. I’ll let Frank elaborate on this further. Additionally, when looking at our book, it’s important to note that while no one is exempt from social inflation, our SMB business likely has significantly less exposure compared to some larger carriers. This should provide some insight into future loss trends. Frank, those are a few of the points I’m considering.

Yes. So obviously, we're closely watching inflationary trends in the industry in our business. So we talk about it quarterly. We continue to secure rate in excess of loss cost trend regardless of some moderation in rate increases. We also have the benefit of capturing inflation-driven exposure growth when we rate our policies as most of the premium formulas are driven by our revenue metric and roughly another, call it, 45%, 50% of the portfolio is adjustable based on growth in revenues over the policy year. So we feel there's a little bit of a hedge in there just relative to capturing additional premium that's impacted by inflation. But listen, like the rest of the industry, we'll continue to watch the trends closely and very seriously to determine whether the bottleneck dynamic on demand eases as supply chain issues eventually moderate or if it's something more persistent. But again, we'll watch it very closely. Sarah mentioned social inflation. We do have the SME focus within the portfolio, which I think shields us a bit because we don't have the large corporate profile. That's not kind of what defines our E&S book, certainly.

I believe the final point I want to emphasize is that working alongside Frank over the past year has provided a clear insight into his vision and approach, particularly regarding patient reserves. You touched on this in a previous question he addressed, but I want to highlight its significance for this quarter.

Okay. And then just a brief technical question. Is the 2% on the funds withheld, that can be paid out of Bermuda? Or is it a taxable expense?

That will be paid out of Bermuda. That's correct, Meyer, and it will essentially be treated as an interest expense or a contra expense. You won't see it netted against net investment income or underwriting income, but it will be paid as a fee from the Casualty Reinsurance business.

I would now like to turn it back to Frank D'Orazio for closing remarks.

Thank you. I want to thank everyone listening on the call for their time today and for the questions we received this morning. I look forward to speaking with you again in a few weeks to discuss our Q1 results. But I'd also like to express my appreciation for the staff of James River for the countless hours of hard work and effort over the course of 2021. Collectively, your focus on our corporate objectives and ability to grow the organization by roughly 20% in the current environment has made James River a stronger and more profitable company with a brilliant future ahead. Again, thank you to everyone on the call for joining us this morning and enjoy your day.

This concludes today's conference call. Thank you for participating, and you may now disconnect.