James River Group Holdings, Inc. Q1 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the James River Group Q1 2022 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brett Shirreffs, Head of Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and welcome to the James River Group First Quarter 2022 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 in our most recent Form 10-K, Form 10-Qs, and other reports and filings we've made 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 Frank D’Orazio, Chief Executive Officer of James River Group.

Thank you for that introduction, Brett. Good morning, and welcome to everyone on the call. I'm pleased to be back with all of you today to provide some additional color on our first quarter as I believe the group's earnings potential is beginning to show through in these results, and we only expect this dynamic to accelerate and become more apparent in the coming quarters. We also remain encouraged by both our continued ability to execute on our business initiatives as well as the positive trends we're seeing in the market and believe they should both continue throughout 2022. One hallmark of our franchise has remained consistent despite some of the strategic actions that we've announced over the last few quarters is that our core E&S business has continued to produce extremely attractive margins and premium growth. And our first quarter this year was no different in that respect. We also continue to make progress in delivering on our business plans for our Specialty Admitted and Casualty Reinsurance segment, focusing our capital on our U.S. businesses while acting as nimble and opportunistic underwriters. Before turning to Sarah, I'd like to provide some commentary on the performance and outlook for each segment. In our E&S segment, we experienced compelling results from a top and bottom line perspective. Gross premium growth was 12.6% compared to the first quarter of 2021, with 10 of our 13 underwriting units experiencing double-digit growth, demonstrating significant broad-based expansion across the segment. Renewal rates increased 8.4% across our E&S unit, marking the 21st consecutive quarter of rate increases, totaling 52% over that period. In many instances, this is the fourth or fifth renewal cycle of positive rate increase on our renewal business as accounts are remaining in the E&S marketplace longer and for multiple renewal cycles. We believe this is a key indicator to support our belief that the favorable market conditions that the sector has enjoyed for several years should last throughout 2022 and likely beyond. Turning to profitability, the E&S segment reported a combined ratio of 83.7% and produced underwriting income of $21.5 million. The accident year loss ratio in the first quarter was 64.7%, roughly consistent with a 64.3% in the prior year quarter. While rate increases have moderated from the mid-teens level of a year ago, they continue to be above both our own view of loss costs and our own rate expectations for the year. As previously stated, we intend to remain patient in recognizing these favorable trends in our loss picks. In Specialty Admitted, we decreased our writings in workers' compensation by 12.6% while growing the rest of our fronting program book. Gross written premiums across the segment declined 1% in the quarter, driven by the declines in both our individual risk workers' compensation business and our largest program relationship that is also workers' comp focused. Excluding workers' compensation, gross written premiums in the balance of the segment grew 6.5% despite the loss of a fronting partner that was acquired in the fourth quarter of 2021. Just as importantly, we added new fronted programs in the quarter that will diversify our exposure base prospectively as we continue to have an attractive pipeline of new opportunities in various stages of diligence. Fee income in the segment increased 8.4% during the quarter to $5.6 million. Turning to casualty reinsurance, as discussed last quarter, we expect to reduce the top line of this segment by approximately $100 million during 2022 as we continue to focus our business and capital on what we believe to be the best opportunities throughout the group. We renewed several treaties during the first quarter that drove the segment's premium decline of approximately 54% versus the prior year period. Of the business that did renew in the quarter, we achieved significant rate increases as we focus on margin enhancement and portfolio optimization in the Reinsurance segment. As initially disclosed with our fourth quarter earnings release, our Q1 underwriting results in Casualty Reinsurance included $11.5 million of loss associated with the legacy portfolio transaction, which closed on March 31. Overall, we are pleased with the underlying performance of the group, remain thankful for the tremendous relationships we share with our distribution partners and firmly believe that the strategic actions we've taken over the last 18 months to derisk the balance sheet will continue to allow the earnings power of our franchise to shine through. We believe the outlook for James River is very strong. Lastly, you may have noticed we filed an 8-K on April 28, announcing the retirement of Jerry Masters from our Board of Directors. Jerry had served on the James River Board since 2014 and was the Chair of our Audit Committee and our Lead Independent Director. We have benefited greatly from his service, thank him for his much valued counsel over the last 8 years and certainly wish Jerry the best in his retirement. And with that, let me turn the call over to Sarah Doran.

Thanks, Frank, and good morning, everyone. For the first quarter of 2022, we delivered $13.9 million of operating income. This included $5 million of underwriting profit and $16.3 million of net investment income. The loss portfolio transfer agreement we executed in the first quarter, which now reinsures most of our casualty reinsurance segment reserves, elevated the group combined ratio by 6.1 percentage points and reduced underwriting income by $11.5 million for the quarter, as we previously announced. Excluding the impact of the transaction, the segment would have generated an accident year loss ratio of 60.6%. Our annualized net operating return on average tangible common equity was 11.8% for the quarter. Again, this was made lower by the discrete impact of the transaction. Our expectation for 2022 continues to be that we would 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 also grow our tangible book value per share, excluding AOCI. Moving on to our profitability ratios. Both our loss and expense ratios were down considerably from the first quarter of last year. James River continues to have a very competitive expense ratio. It was 26% for the quarter, down almost 3 points from the same quarter last year. This is due both to our focus on expense management as well as to the scale we continue to build in the insurance businesses, while revenue growth continues to outpace operating expense growth. We continue to believe that a 26% to 28% expense ratio is extremely attractive for our franchise and business mix this year. Frank largely covered the results of the U.S. segments, but it's worth spending a moment on Specialty Admitted. As we've mentioned, we reduced workers' compensation writing given the market conditions, but continue to grow the other risks in our fronting business. While claims counts have decreased in workers' comp, rates continue to be less compelling than those in other parts of our businesses. This quarter, the segment produced a 98.9% combined ratio and 79.6% accident year loss ratio. The accident year loss ratio is broadly consistent with that of the second half of last year, when we increased our then current year workers' compensation loss ratio. I would also point out that we had a few one-off impacts that influenced the segment expense ratio at different quarters last year, none of which were a factor in the current quarter. Moving on, investment income grew about 8% this quarter as we benefited from increased returns from our portfolio of renewable energy private investments. Realized losses were $5 million this quarter, almost evenly attributed to a decrease in the fair value of each of our small dividend-paying common equity portfolio and our floating rate bank loan portfolio. In addition to the strong operating cash flow we generated this quarter of $65.4 million between the floating rate exposure that characterizes our bank loan portfolio and near-term maturities and the rest of our portfolio, we expect that over 20% of our current portfolio will have the opportunity for reinvestment or reset over the coming year. During the month of April, our reinvestment rate was about 100 basis points above our current portfolio yield of 2.75%. Net unrealized investment gains decreased $86 million for the first quarter of the year, reflecting a decline in the fair value of our fixed income portfolio. As a reminder, we tend to hold substantially all of our fixed maturities and an unrealized loss position until they recover their fair value or mature and the average credit quality of the fixed income portfolio remains A+. And finally, on taxes, our effective tax rate this quarter was 24.6%. It was elevated by discrete tax items, primarily related to the excess tax expenses associated with vested restricted stock units. While there are many points of impact to our tax rate, we continue to believe that the full year rate will be closer to 21%. In conclusion, James River ended the first quarter in an excellent financial and strategic position. We have ample capital to operate in the current environment and continue to see very attractive opportunities to invest and continue to scale our company. We ended the quarter with tangible common equity of $429.9 million and tangible equity of $574.8 million, which includes the Series A preferred we issued last quarter. And with that, I will turn it back to the moderator to open the line for questions.

Our first question comes from the line of Mark Hughes with Truist.

Thank you, Frank. As we consider the progression of the cycle through 2022, you mentioned your optimism about its potential continuation into 2023. Looking at the market, what are the positive indicators that you see supporting this view?

I think the broader macro factors driving rate increases have not really shown any signs of slowing momentum in the first few months of the year. So underlying economic fundamentals and growth thus far remain very strong, and inflation has obviously emerged as a factor. So I expect carriers are going to be successful and continue to push for rate throughout the year. In terms of our home production, we saw strong growth across almost all E&S underwriting units in the first quarter, and we're seeing a good flow of new opportunities in our fronting and program business. So everything that we're seeing in the marketplace just suggests the continuation of the recent trends.

Sarah, you described, I think, 11.8% return on tangible this quarter, which included the 6 points of losses in Casualty Re. Your guidance is for low double-digit for the full year. Is that conservatism? If we add back those 6 points, should the returns be a little bit higher?

Yes. Thank you for the question, Mark. If we include the 6.7 combined ratio in the return on tangible common equity, the return on equity would be significantly higher, likely in the high teens. For the quarter, we believe we had a strong contribution from our renewable energy portfolio, which has certainly boosted net interest income beyond our expectations. However, I think there is some caution in our low double-digit return on tangible equity expectation. We are confident about achieving that target over the course of this year.

And you've mentioned that the turnover in the portfolio likely to be about 20% this year. Would it be similar next year as well?

So the 20% is a combination of what is the portfolio as floating rate and what's maturing over the year, and it's about half and half to each. And I would think that next year would be pretty similar in terms of that turnover.

Yes. Understood. In Specialty Admitted, regarding the underlying workers' comp program, was there just a change in their appetite? Was there any change in your allocation or in the nature of the relationship with that large account?

No, Mark, we're seeing some pressure on rates for the last couple of years and that large program happens to be California workers' comp focused. And so we've been bringing down our retention in terms of what we assume on that program over the last couple of years. But it's really the rate environment. Now we're not a 50-state writer. We have, as you know, an individual risk order's comp unit that focuses on the Southeast and then this large program. Broadly, I would say the rates that we're seeing in the Southeast and the individual risk workers' comp unit are behaving a bit better, closer to leveling off, but we're still seeing double-digit decreased pressure in terms of rates in a large program. And so I wouldn't say if that has any change in appetite. It's kind of responding to the market conditions rationally.

Our next question comes from the line of Brian Meredith with UBS.

A couple of quick ones here for you. First, Sarah, you're still guiding to a 26% to 28% expense ratio. I know you had a 26% here in the first quarter. And typically, if I look back historically, the first quarter is your highest expense ratio. So why is it still going to be 26% to 28%?

Sure, you're right. It is typically the highest. One of the things I want to point out is that in the fourth quarter, we significantly reduced our expense ratios. We lowered our compensation across the organization due to the company’s recent performance. We do not expect anything similar to happen this year. We feel very confident about our balance sheet and our earnings forecast. It's important to mention that the fourth quarter may have been artificially low as we look at the organization and its potential moving forward.

Got you. But if I'm looking at the second and third quarter, though.

Yes. Look, it can fluctuate in any given quarter, just given our scale, but I think the biggest piece of the annual expense ratio has really been, for example, last year, that it was down at, I think, 14% in the fourth quarter, which would have pushed it down to 23% for the year.

And then a second question, I'm just curious, given that rate continues to be in excess of trend and then it looks quite good. If I look in your E&S, the underlying loss ratio was actually up on a year-over-year basis. Any reason for that?

Well, I would say two things. One, I mean, it's just about right on the number, right? So fairly consistent with the last year, and that's going to change just based on changes in the business mix from year-to-year. But overall, don't forget the theme that we've been stressing is just that we're going to be patient relative to both the loss ratios that we set and how we let those loss ratios kind of season over time.

Great. And Frank, any significant changes in business mix that you're looking at in the first quarter or in 2022 versus '21? Any areas or lines of business that we'll see in your 10-Q that you're popping up more?

I would say that the demand remains fairly consistent with previous periods. We've primarily been taking risks in the E&S segment and acting more as a fronting carrier within our Specialty Admitted segment. The growth has been steady across most of our E&S segment, as I previously mentioned, with 10 out of 13 segments showing double-digit growth this quarter. Pricing is holding up well, and we have now achieved 21 consecutive quarters of renewal rate increases. The rate on rate is very significant, and we are observing double-digit rate increases in some lines that initially led the market change a few years ago. It’s encouraging to see that business is remaining in the E&S market with us for longer periods. This is reflected in our renewal submissions, which grew over 20% this quarter, a faster pace than last quarter and consistent with earlier quarters in this hard market. This is extremely beneficial for us. We quote about 90% of our renewals and bind a high percentage of them, generally between the high 70s to low 80s, thanks to our familiarity with the risks. The rise in renewal ratios is an efficient use of our underwriters' time for quoting renewals and effectively utilizes our capital.

Our next question comes from the line of Meyer Shields with KBW.

Two related questions. The ratio of net growth in excess and surplus went up on a year-over-year basis. So I was hoping you could talk about, I guess, what we're seeing now underlying trends in ceding commissions and maybe long-term thoughts on where net growth to trend?

I'll start by saying that if I'm looking at this correctly, the ratio has increased by a point or two, which is not significant. This reflects the sensitivity regarding our growth in any quarter. For instance, our excess casualty line, which constitutes about a third of our E&S, was a smaller percentage a couple of years ago. As that line has expanded, it has raised the ceding ratio since it is heavily reinsured. While we are seeing strong growth and rates in that line, some other lines have grown slightly faster overall during the quarter. With 13 underwriting divisions, different lines will grow at various rates in any given quarter, affecting the overall mix. Additionally, those treaties are renewing now during the summer. The treaties, partners, and structures have remained quite stable for many years at James River, so we do not anticipate major changes to either those structures or their costs. We are navigating some longer-term factors, but that is our perspective. Regarding the ceded portion and the cost associated with it, we don't expect significant changes, but it will depend on where we observe growth and rate increases across the divisions, which will ultimately influence the P&L. I hope that clarifies things.

Does the mix of net earned premium in Specialty Admitted significantly affect the contribution to orders compensation?

The contribution of net earned specifically that's your question. It was a little bit lower this quarter, just given that we've grown the fronting business, other parts of the fronting business around it, but I wouldn't say it's an appreciable change, and I'm not confident that that's going to be the case as we look at a year from now or a couple of quarters from now. I think we want to remain pretty nimble in our ability to write that business as things change and as you know, most importantly, the growth in the fronting business can be pretty lumpy because it's so kind of deal dependent, for lack of a better way to describe it. I think that's going to be consistent.

We have a question from the line of Casey Alexander with Compass Point.

Just a quick question. How the Casualty Re was gross written of about $30 million versus $64 million last year. So obviously, you're bringing it down, as you said. How would you look at that gross written compared to how you expect it to play out during the year? Is that a fairly reasonable level of gross written for the balance of the year for Casualty Re?

For the quarter, it was about $30 million, as you noted, Casey. The first quarter is typically our largest quarter for that segment, and it's larger by a significant margin. I anticipate that this figure will decrease considerably throughout the year since we have already stated our intention to reduce $100 million from the overall total. Given that the first quarter is the highest, I believe we will see smaller gross written premium quarters in that segment moving forward.

All right, that's very helpful. I have a question for Brett: do you have an idea of what you would consider a normalized level for net investment income moving forward? There's obviously a significant contribution from renewable energy, so what do you see as a normalized level going forward?

Yes. Casey, I think we break out the detail of net investment income in the earnings release there, our more stable part of the portfolio, reported a little over $13 million for the quarter. As Sarah mentioned, the renewable energy portfolio does bounce around quite a bit quarter-to-quarter. And she also provided some details in terms of reinvestment rates being higher than the existing portfolio yield. So the more stable part of the portfolio, the $13 million and change should trend a bit higher as we continue to reinvest the portfolio.

I'm showing no further questions at this time. I would now like to turn the conference back to Frank D’Orazio.

Okay. Thank you. I want to thank everyone listening on the call for their time today and for their questions that we received this morning. To the employees of James River, thank you for your hard work and dedication in delivering our Q1 results. As I suggested earlier, it is certainly a very solid start to the year. I look forward to speaking with all of you again in a few months to discuss our Q2 results. Thank you, and enjoy your day.

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