Good day, ladies and gentlemen, and welcome to the AMERISAFE's 2018 second quarter earnings conference call. At this time, all participants are in listen- only mode. Later, we will conduct a question- and- answer session and instructions will follow at that time. If anyone should require operator assistance, please press the star then the zero key on your touchtone telephone. As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Ms. Kathryn Shirley, General Counsel. You may begin.
Good morning. Welcome to the AMERISAFE 2018 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 the results of risk uncertainties and other factors, including factors discussed in today's earnings release, in the comments made during this call, and in the risk factors section of our Form 10-K, Form 10-Qs and other reports and filings with the Securities and Exchange Commission.
We do not undertake any duty to update any forward-looking statement. I will now turn the call over to Janelle Frost, AMERISAFE's President and Chief Executive Officer.
Thank you, Kathryn, and good morning, everyone. We are pleased to report earnings per share of $0.88 and a combined ratio of 83.6% for the second quarter. These financial measures were achieved by AMERISAFE's discipline throughout this soft cycle. For nearly two years, I have referred to an increasingly competitive environment. Workers' compensation has become an attractive line of business in the property and casualty marketplace. Calendar year 2017 marked the third straight year of combined ratios of less than 100%. In fact, workers' compensation was the most profitable of all the P&C lines in 2017 in terms of underwriting. For AMERISAFE, this type of environment brings pressure for multi-line carriers using workers' compensation to offset less profitable lines when offering package policies.
However, our consistent small to mid-size employer, high hazard niche, coupled with our focus on maintaining underwriting profitability, offered some protection from competition in the second quarter. We achieved record policy retention of 94.3% for those policies in which we offered renewal in the second quarter. Added with some growth in new business, our premiums for policies written in the quarter were $300,000 less than the prior year's quarter. With overall policy count being relatively flat during the quarter, this slight decrease in premium was driven by the decline in underlying loss costs, which far exceeded premium from exposure growth. Our pricing for the quarter was 166, as represented in our ELCM, down from 168 in the second quarter of 2017. Overall, gross premiums written were up 7.7%, or $6.7 million in the quarter, driven by audit premium and related adjustments. Audit premium was a tailwind this quarter.
We saw audit premium increases quarter over prior year quarter in all industries except agriculture, and more so in energy-related states. I will caution that audit premium is not linear, but we do consider this quarter's increase a sign of a growing economy for our insureds. Moving on to losses, our loss ratio for the quarter was 58.5%, comprised of a current accident year loss ratio of 71.5%, and aided by 13 percentage points of favorable development from prior accident years. The current accident year loss ratio was unchanged from our initial estimate reported in the first quarter. The favorable development this quarter was completely the result of case development in accident years 2016, 2015, and 2013 and prior. This was our first quarter to adjust accident year 2016, since the accident year ended, and in line with our historical pattern of 30-36 months of aging.
This quarter's favorable case development was strong and added $11.6 million to pre-tax income. However, just as I stated with audit premium, case development, whether favorable or not, is not linear. This quarter's favorable development resulted from individual case reserve changes, not management's change in ultimate estimated losses. I feel that is an important distinction. Neal will now discuss the financials.
Thank you, Janelle. For the second quarter of 2018, AMERISAFE reported net income of $17 million or $0.88 per diluted share, compared with $15.5 million or $0.81 per diluted share in last year's second quarter. Operating net income for the quarter was $17.8 million or $0.92 per share, an increase of $0.10 from $0.82 in the second quarter of 2017. Revenues in the quarter increased 6.1% to $95.4 million compared with the second quarter of 2017. Net premiums earned increased 7.5% to $89 million when compared to last year's second quarter, driven by very strong audit premiums, which can be volatile from quarter to quarter. Turning to our investment portfolio, net investment income decreased 2.2% in the second quarter to $7.3 million, compared with $7.5 million in the second quarter of 2017.
The decrease was largely due to the increase in the value of a hedge fund investment in last year's second quarter. Net investment income without the hedge fund impact was down 1.2% compared to last year's second quarter. The company experienced net realized losses on security transactions of $1.1 million in the second quarter of 2018, compared with $400,000 in the second quarter of 2017. The tax equivalent yield on our investment portfolio was 2.9% at the end of the quarter. The pre-tax yield on the portfolio was 2.63% at the end of the quarter, up slightly from 2.54% at year-end. There were no impairments on any of the securities held in the portfolio during the quarter. At quarter-end, the investment portfolio carried an average AA rating with duration of 3.82.
It was composed of 55% in municipal bonds, 22% in corporate bonds, 18% in U.S. Treasuries and agencies, the remainder in cash and other investments. About 58% of our bond portfolio is composed of held-to-maturity securities, which were in an overall unrealized gain position of $1.2 million at quarter-end. These unrealized gains are not reflected in our book value as the bonds are carried an amortized cost. Moving now to operating expenses. Our total underwriting and other expenses were $21.3 million in the quarter, compared with $20.2 million in the second quarter of 2017. The increase was largely due to higher commission expense and premium taxes compared to last year's second quarter. By category, the 2018 second quarter expenses included $6.7 million of salary and benefits, $6.6 million in commissions, and $8 million of underwriting and other costs.
As a result of increased premiums in the quarter, which offset the expense increase, our expense ratio for the quarter was 23.9%, lower than the 24.4% in the second quarter of 2017. Our tax rate was significantly lower in the quarter as a result of the new lower 21% federal corporate tax rate. Our tax rate for the quarter was 19%, compared to 30.1% for last year's second quarter. Return on equity for the second quarter of 2018 was 15.5%, compared to 13.1% for the second quarter of 2017. Operating ROE for the quarter was 16.1%. In capital management, our company paid its regular quarterly cash dividend of $0.22 per share in the second quarter. This quarter, the board declared a quarterly cash dividend of $0.22 per share, payable on September 21st, 2018, to shareholders of record as of September 7th, 2018. Finally, just three additional items.
Book value per share at June 30th, 2018, was $23.11, an increase of 4.6% from $22.10 at year-end. Our statutory surplus was $404 million at quarter-end, up from $382 million at December 31st, 2017. We will be filing our Form 10-Q with the SEC tomorrow, August 3rd, after the market close. That concludes my remarks. Now we would like to open up the call for the question and answer session. Operator?
Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, press the pound key. Again, if you'd like to ask a question, press the star then the one key. Our first question comes from Matt Carletti with JMP. Your line is open.
Hey, thanks. Good morning.
Good morning, Matt.
Good morning, Matt.
A few questions. First one, Janelle, maybe a little higher level. Just can you comment or give us your observations on what you're seeing in your underlying classes in terms of economic activity? I know the audit premium is positive. I'd imagine that has a lot to do with it. Just as you think forward, which kind of large class codes within your book are you seeing the most promising conditions and which ones maybe aren't you seeing it yet?
Matt, for this quarter, throughout this soft cycle, we've seen audit premium of standalone. Audit premium has been positive, that's good.
This particular quarter, the audit premium alone was even stronger, even though, granted, last second quarter was probably a little comparable. We did see it, we did see it across our industries, with the exception of agriculture.
We are seeing, we infer into that that's economic growth for our insureds. We're seeing it in the audit premium that we booked. You keep in mind, in a perfect world, that's policies that we wrote in the first quarter of 2017, if you wanted to categorize it that way.
I think that's a positive outlook for our insureds. We don't see any anomalies in the monthly reporting. On prior calls, we talked about in the trucking industry where we saw some uptick after the storms, and particularly in Texas and Florida.
I think trucking overall, I think we expect to be relatively positive for our insureds in 2018.
Okay. As I think about the different ways it could come through, they could hire more employees, their existing employees could work more hours, they could have higher wages for their employees. Did any one of those stick out as being a bigger driver than the others, or is it a bit of everything?
Yeah. We've seen growth in payrolls, and at least from our initial look at just what people are reporting to us on a monthly basis, we have seen an uptick in number of employees.
Okay. All right. That's helpful. Then just a couple numbers questions, actually sticking on that theme. Neal, can you just remind us what the audit premium impact was in Q3 2017 and Q4 2017 so we know what we're comparing to as we go forward this year?
Yeah. This is audit and other related premium adjustments, it includes cancellations.
Okay. Sure.
In the third quarter of 2017, it was a $-1.1 million, in the fourth quarter-
Okay
of 2017, it was a $+2.1 million.
Okay, great. Very helpful. Then lastly, just on tax rate, it was about 18-ish% for the first half of the year. Is that a fairly good run rate to assume? Assuming there's no mix change in terms of where the profitability's coming from between underwriting and, say, the investment portfolio. Is there anything one-time-ish in there that we shouldn't think that 18% is a reasonable expectation going forward?
Yeah, there's nothing really from a one-time standpoint in the first half of the year that affected the tax rate. It really is the amount of development that we see each quarter that typically drives that. The amount of investment income from the portfolio that's tax exempt stays relatively steady.
Right. That makes sense. Great. Well, thank you very much for the color. Congrats on a nice quarter.
Thank you, Matt.
Thanks, Matt.
Thank you. Our next question comes from Randy Binner with B. Riley FBR. Your line is open.
Morning, everyone. This is Ryan Nall on for Randy again.
Ryan.
Morning. Wanted to touch on the reserve development. The years 2013 through 2015, I know we've seen as redundant past couple years, and I know you're just starting to look at 2016, but I was wondering if you have any more color there on if you're seeing lower claims incidents or anything else going on that would hint it to be a better or a redundant year going forward?
Are you referring to accident year 2018?
Correct.
Ryan?
No, 2016.
Yes.
No, 2016.
Oh, 2016.
In other words, what is he seeing with 2016 as we look at it for the first time?
Yeah. I think when we start looking at accident year 2016, I think it looks like it's going to be a good accident year. Obviously, there's volatility in there. Our claim counts were relatively flat during that period going into the accident year. I felt like we had a good handle on the case reserving. As I mentioned in the prepared remarks, the favorable development that we saw this quarter coming out of 2016, which was $3.2 million, was all case reserve changes related to that accident year. That wasn't management changing our ultimate ratio for that. It was strictly things coming out of settlements, being able to close claims, those type of activities.
Got you. Appreciate that. On frequency and severity, do you guys have any color that you could give? Past couple of quarters, you've been talking about how it's been usually across the board, especially with severity, if there's any changes this quarter.
Coming into accident year 2018, we expected there to be pressure on frequency because the underlying loss costs have been declining, there's pressure from a premium perspective. Even if I had the same number of claims, I have less premium collected for that. As we've had exposure growth, we have more reported claims now than we did at, say, the same point in time in accident year 2017. Again, all expected, I think that's just of where we are in terms of the economy. More people are working, which is good. Those people tend to have accidents. There was nothing, from at least what we told you in first quarter coming into second quarter or ending with second quarter, that changed in terms of how we view accident year 2018.
We typically talk about just the large losses just as an informational point for you guys. In claims excess of $1 million, I think we had seven reported at the end of the quarter for accident year 2018, and that's in comparison to five at accident year 2017, same point in time. Unfortunately, those things aren't linear, like I talked about before. They're random in nature as to when claims happen. That kind of gives you a picture of at least there doesn't appear to be from that aspect, the larger claims, any real difference at this point in the year.
Got you. Have you seen any increase in severity, or is it relatively same from 1Q?
Relatively the same from 1Q.
Appreciate it. Thank you very much.
You're welcome.
Thank you. I would like to remind everyone to ask a question, it's the star then the one key on your touch tone telephone. Our next question comes from Mark Hughes with SunTrust. Your line is open.
Thank you. Good morning.
Good morning, Mark.
Good morning.
On the 2016 accident year, you point out you're just now kind of opening it up and taking a look at it. Is there a little bit of a catch-up phenomenon that when you open that thing for the first time, you get perhaps a good result, and so you would look for more n ormal development in subsequent quarters, or is that not a real thing?
Yeah. Maybe I should be more clear about this is the first quarter that we've made adjustments to accident year 2016. It's certainly not the first time we've really taken a look at it. We've been monitoring it all along, and part of that monitoring is what led us to believe that, okay, we saw this case development this quarter. We feel very comfortable in releasing that because we see how the accident years develop. We've seen the claims close. We look at the open inventory for that claim. That's something we've monitored since the accident year closed, since it ended. Certainly not our first glance at it, per se.
It's just that when it reaches that 30-36-month mark, we really feel comfortable with having a really good handle, particularly on a case basis, of what the universe of claims that we have left open, what the reality of those claims are. Now, history says that can change. Medical conditions change often. At 30-36-month window, if you look at our development patterns, if you look at our Schedule P analysis, you'll see that at least from a case perspective, that's really when we really have a good handle on those particular accident years, that 30-36-month window.
Right.
That's why the case development, we feel very comfortable in recognizing, okay, this case development happened. It's not an anomaly per se. That is favorable development for the quarter.
Right. Exactly. The ELCM was up sequentially. I think in your press release, you talked about taking a little bit of a price decline, a slight price decline. I assume you were talking year-over-year there.
Quarter over prior year quarter. Let me be clear. Quarter over prior year quarter. If you think of ELCM as if we're trying to look at basically the same group of policies that renewed from second quarter of 2017, what was their pricing like coming into the second quarter of 2018?
Right.
I get what you're saying about sequential quarters, that can change by the mix of the policies that we wrote and which states are in that mix, because some states obviously have higher ELCMs than others. We find it better to compare quarter over prior year quarter. You're right, it is sequentially up from first quarter, which was a 163.
Do you think that was a mix issue, or I know this is relative to the state-calculated loss cost, you've got the couple of variables that are moving there. Your absolute pricing may be down, your ELCM could be up. Was that a little more push on price on your part, or was it some other combination of those other variables?
That's a good point. You're right. The ELCM is relative to the underlying loss cost. This is above and beyond that, if you want to look at it that way. Your question was, is it a mix issue? Again, where we grow or shrink by state does influence that number. If there's a state that has a particularly high loss cost multiplier or underlying rates, that does impact the overall number. If that's what you mean by mix issue, I would say yeah, it matters if you grew in Pennsylvania versus if you grew in Florida, which is an administrative pricing state.
Mark, I think if you look at our pattern, you can see that we're down two points over prior year, and that's consistent with the prior three quarters. If you look at all of those ELCMs, they're basically two points lower than the same quarter prior year. The trend is continuing a gradual decline in ELCM.
Right. With a little bit of seasonality maybe, or quarterly variation, perhaps based on mix, would be the point I'm hearing.
Yes.
Yes.
Anything on the inflation front? You've touched on frequency and severity. Specifically the issue of inflation. I know that has been a concern, but I'm not hearing any particular concern this quarter. Is that fair?
No. No changes really from how we view things at first quarter.
On the investment portfolio, the new money yield versus the overall portfolio yield, or should that overall yield be moving up, portfolio yield based on the new money?
New money rates are certainly higher. The yield curve is fairly flat, our new money typically that's been rolling off of the portfolio has been going into shorter corporates, two or three years, because you're getting paid enough for those relative to going out to five or seven or 10 years. The new money yield is about the same as the money rolling off of the portfolio at this point in time.
Okay. You're taking a shorter duration, less risk, presumably?
Yes.
Okay. Thank you very much.
Thank you, Mark.
Thanks, Mark.
Thank you. Our next question comes from Christopher Campbell with KBW. Your line is open.
Yes. Hi, good morning.
Good morning, Chris.
Morning, Chris.
I guess my first question is just if I'm looking at is like the premium growth and net investment income. It looked like you had pretty strong premium growth in the quarter, but the net investment income was down year-over-year. Typically, I would think those would be kind of positively related, so just anything special happening with that in the quarter?
Yeah. Let me clarify on the premium growth itself. The premium growth that we experienced this quarter, while, hey, I'm happy to report 7.7% up, was coming from audit premium and related adjustments. The policies that we wrote in the quarter were relatively flat in terms of premium dollars. If I look back over the last few quarters, for example, last quarter, those policies were 1.6%, but it's been relatively flat for quite a few quarters now. Granted, second quarter last year, we had a low comp because I think we were down nearly 11% for the policies that we wrote in that quarter, so this was an improvement. Again, the policy that we're writing in the quarter in terms of premium dollars, let me be very clear, has been relatively flat. Why is it flat?
If I told you, hey, we're retaining policies and our policy count is looking good, it's simply because the underlying loss costs have been down by high single-digit numbers. Everything that I've gained in terms of either policy count or exposure growth, payrolls being increased, I sort of lose in terms of underlying loss costs.
That makes sense.
And-
Just on the investment income. Quarter-over-quarter, we were down slightly. If you look on a year-to-date basis, because we've had some volatility, particularly in last year when we owned the hedge fund, a year-to-date basis, net investment income is up 2.3%.
Got it. Yeah, I see that. Okay, that makes sense. Just my second question is just kind of on your philosophy on the core loss ratio picks. It looks like you set them annually, but then at the end of 2017, you kind of spiked it up to 75%, and then it comes back down for the past two quarters. What's your process for kind of setting that, and then what can we look at on the outside to see when your thinking might shift on something like that?
Right.
Are there any external factors that we can look at?
Yeah. One of the things we talk about every quarter is what we're seeing in terms of the accident year. You're so right. At the beginning of the accident year, we have a thought process. We have a projection of what we think we're going to see in terms of frequency and severity, and we monitor that throughout the year. As long as we feel like the data coming in the door, the things that we are experiencing are in line with our original estimates, we keep our loss ratio estimate the same for the accident year. Harkening back to accident year 2017, when we got into the fourth quarter, we saw a spike in average severity and thought, you know what?
We're not as comfortable as we were with our original estimates, we decided now is the time to make that adjustment, and we made that adjustment. You're correct in that it was at 75% for the quarter, but we were actually raising the loss ratio itself to 70.5%. Is that correct, Neal?
Correct. Yeah, 70.5%.
It was 75% for the quarter, but it was bringing the entire estimate for the whole year to 70.5%. Coming into accident year 2018, our initial estimate is higher than where we were for accident year 2017 at 71.5%.
Right. Chris, in terms of monitoring from the outside, you'll look back in last year, we expressed concerns about severity, the severity that we were seeing in the third quarter conference call, and that it was something that needed to be monitored because we were seeing just more severe accidents, and we didn't really know if it was a trend or just more severe accidents. That is something that an outsider could monitor as we go throughout the accident year.
Okay. Great. Well, thanks for all the answers. Best of luck in the third quarter.
Thanks, Chris.
Thank you. I'm showing no further questions at this time. I'd like to turn the call back to Ms. Janelle Frost for any closing remarks.
I often use the words consistent and focus when I talk about AMERISAFE. It's fundamental to who we are. We operate in a cyclical industry impacted by payrolls, the economy, medical costs, and so on. Yet, AMERISAFE's history has demonstrated that our consistency and focus has served our policyholders, our shareholders, and our employees. It's that same consistency and focus that won AMERISAFE accolades from the Ward Group in July, being selected as one of Ward's top 50 P&C companies. This was our tenth year to be selected. Congratulations to the AMERISAFE family. Thank you for joining us today.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.