Good day, ladies and gentlemen, and welcome to the AMERISAFE second quarter 2017 earnings conference call. At this time, all participants are in a 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 during the conference, you may press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Vince Gagliano, Chief Risk Officer. You may begin.
Good morning. Welcome to the AMERISAFE 2017 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. 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 results expressed or implied in these statements if the underlying assumptions prove to be incorrect or as a result of risks, uncertainties and other factors, including 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 CEO.
Thank you, Vincent, and good morning, everyone. Before I discuss the operations this quarter, I'd like to provide some color regarding the workers' compensation industry in general, as competition continued to intensify this quarter. As reported by NCCI in May, the workers' compensation industry, excluding state funds, reported a 94% combined ratio for 2016, which was unchanged from the 94% combined ratio reported for 2015. To add perspective, the P&C industry's combined ratio increased from 98% in 2015 to 101% in 2016. Workers' compensation was the only line within the P&C lines whose combined ratio did not worsen from 2015 to 2016. Also adding to the competitive environment, loss costs continued to decline in the second quarter. NCCI reported through May, approved rates were down 6.7%.
I share this industry overview to provide background, as we are pleased with this quarter's 81.9% combined ratio and the financial strength of AMERISAFE, which was achieved by focusing on underwriting discipline and consistent approach in handling our claims and expenses. On to the second quarter's operational results. As I've already stated, competition increased this quarter, our gross premium written decline of 15.7% reflected it. The decline was driven by both policies written in the quarter, as well as audit and related adjustments for policies written in prior quarters. Of the policies written this quarter, renewal premium was down 6%. Policy retention remained high at 92.2% for those policies for which we offered renewal. Our renewal premium was obviously impacted by declining rates.
In the aggregate, pricing in the quarter, as measured by ELCM, was 168, down from 173 in the second quarter of 2016, slightly higher than 165 in the first quarter. While comparing consecutive quarters is not apples to apples, I do feel this emphasizes our commitment to risk selection with appropriate pricing for long-term stability. For audit premiums and other adjustments, audit premiums themselves were positive. The change quarter over prior year quarter for audit and all premium adjustments was a headwind to top line, decreasing gross premiums written $4.1 million. On to losses, the loss and LAE ratio for the quarter was 56.1%. The current accident year ratio was 69%, the prior accident year loss ratio was a negative 12.9%. Here are some key metrics to note regarding loss expenses.
Reported claims in the calendar year were down 5.1%, the open inventory of claims was down 5.8% for the first half of 2017. The $10.7 million of favorable development this quarter resulted primarily from favorable case development, most impacted accident years 2015, '14, and '13. Delve more into the financial metrics, I will now turn the call over to Neal.
Thank you, Janelle, good morning, everyone. For the second quarter of 2017, AMERISAFE reported net income of $15.5 million, or $0.81 per diluted share, compared with $16.6 million or $0.87 per diluted share in last year's second quarter, a decrease of 7%. Operating net income in the second quarter of 2017 totaled $15.7 million or $0.82 per share, slightly below last year's $0.85 per share in the second quarter. Revenues in the quarter decreased 7.8% to $89.9 million compared with last year's second quarter. Net premiums earned decreased 8.8% to $82.7 million when compared to the second quarter of 2016. Net investment income was $7.5 million in the second quarter of 2017, an increase of 20.5% when compared with last year's second quarter. The significant driver of this increase was the decline in value of a limited partnership hedge fund in last year's second quarter.
This limited partnership is marked to market through net investment income each quarter. Without the hedge fund, net investment income was up 9.6% compared to the second quarter of 2016. The tax equivalent yield on our investment portfolio at the end of the quarter was 3.3%, up slightly from 3.2% at the end of the second quarter of 2016. There were no impairments of securities or significant realized gains or losses during the quarter. The investment portfolio continues to be high quality, carrying an average AA- rating. Our duration of the portfolio at quarter end is 3.69, and we hold 57% in municipal securities, 25% in corporate bonds, 11% in U.S. Treasury and agencies, and the remainder in cash and other investments. Over the past year, our allocation to municipal bonds has increased slightly, and our allocation to corporate bonds has decreased slightly.
Approximately 51% of our investment portfolio is classified as held-to-maturity, which is in a net unrealized gain position of $11.5 million. These gains are not reflected in our book value as these bonds are carried at amortized cost. With regard to operating expenses, our total underwriting and other expenses decreased 10.5% in the quarter to $20.2 million, compared to $22.6 million in the same quarter last year. We saw decreases in insurance assessments and commissions during the quarter compared to last year's second quarter. By category, the second quarter of 2017 expenses included $6.6 million of salaries and benefits, $6 million of commissions, and $7.6 million of underwriting and other costs. Our expense ratio for the second quarter was 24.4%, compared with 24.9% in the second quarter last year. Our tax rate decreased to 30.1% in the quarter, down from 32.4% in the second quarter last year.
The decrease reflects the larger amount of tax-exempt income compared with taxable income during the quarter. Return on equity for the second quarter of 2017 was 13.1%, compared to 13.7% for the second quarter of 2016. Our operating ROE for the quarter was 13.3%. On July 25th, the company's board of directors declared a regular quarterly cash dividend of $0.20 per share, payable on September 22nd to shareholders of record as of September 8th. Finally, just a couple of other items of note. Book value per share at June 30th, 2017, was $25.02, up 5.5% from year-end. Our statutory surplus was $406.4 million at June 30th, 2017. That was also up $12.4 million from year-end. Finally, we'll be filing our 10-Q for the second quarter later today after the market close.
That concludes my remarks, and we would now like to open the call up to investors for our question and answer session. Operator?
Thank you. Ladies and gentlemen, if you have a question at this time, please press the star then one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. Once again, if you do have a question, please press star then one. The first question is from Matt Carletti of JMP. Your line is open.
Hey, good morning.
Good morning, Matt.
Congrats on a nice quarter.
Thank you.
Just really wanted to dig into one topic, that's just being the top line, which is clearly of, I would say, lesser importance than the bottom line, but nonetheless, hoping you could provide a little more color on it. I apologize, I got on a few minutes late, so if you already covered this, my apologies. The 12% decline in voluntary was, I think, a bit larger than maybe the market was expecting. Anything stick out there? Is that a sort of trendable number in your mind, or were there maybe a large client or something like that that skewed it? By month during the quarter, did it kind of build across? Was there one month that seemed to have more competition than the others?
Yeah. Let me start with this, Matt. I'll give you three aspects of the voluntary premium decline.
Okay.
The first would be the rates themselves. We've been talking about that loss cost has been continually declined. For our renewal policies that were coming into this quarter, this was basically our third year where those policy holders were getting net rate changes of significance to us. That environment continues to happen. That puts pressure on the premium dollars themselves, as well as the large policies. We've talked about that the last two quarters specifically. As competition has increased, we find multi-line carriers wanting to write comp, demanding to write comp, and that typically for AMERISAFE trickles into our larger policies first. We've definitely seen a shrinkage in the large policies.
Okay.
The third component would be new business itself. New business was down in the quarter. I think that speaks just to the competitive environment that we're facing in terms of companies seeking premium. Your question about was it prolific throughout the quarter, I think, was a great question. No, it wasn't. The quarter started off more rocky than we would've liked and improved as the quarter went on. That was a good sign for us.
Yeah, that's definitely encouraging. Okay, great. Really appreciate the color, again, congrats on a very nice quarter.
Okay, thank you.
Thank you. The next question is from Mark Hughes of SunTrust. Your line is open.
Yeah. Thank you. Good morning.
Good morning, Mark.
The increase in ELCM sequentially, very good to see. It seems like you're almost pushing the line a little harder on pricing even as competition picked up. Was that just something that you looked at at the end of the quarter and, I won't say were surprised, or was it something that you deliberately implemented that you're going to be a bit more aggressive on the pricing front?
Right. That's a really good angle. We individually underwrite every account, so we do monitor the ELCM in the aggregate, but we do base it on the risk that we're evaluating at that time. I can tell you, in the quarter, I was surprised at some of the lower ELCMs that we have that quoted and failed. There are some pricing out in the marketplace that is, well, significantly below AMERISAFE. At that point, we're not going to chase the price that low. It's just not what we do.
Right. The ELCM, you had success with your renewals. That's more reflective of your renewal book. You're pricing less new business. Therefore, the ELCM is maybe a mix shift, so to speak. Does that make sense?
Yeah. That's a good way of looking at it. Our renewal book averages out somewhere around 75%, in terms of premium dollars, about 75% of our premium, and the other, obviously new business. Quarter over prior year quarter, the ELCM was down for both new and renewal. We've talked about this before. When we're talking about the competitive environment, we are most interested in protecting that renewal book. That's where I think 92.2% policy retention is a good number. It's a high number. Would I like that number to be higher? Absolutely.
Mark, I think sometimes we see a mix shift in that maybe the retention was in states where we had higher ELCM, so that can drive the number a little bit in terms of what's happening, where we renewed. As Janelle mentioned, there were some quotes out there that were pretty low relative to an ELCM and much lower than where we would want to go.
Any particular end markets, trucking, construction, that were notably better or worse?
We're not seeing any specific trends that I think are of note. I'm probably going to be a little bit more cautious on this call than maybe we have been in prior calls in giving state-specific data because it is highly competitive out there, and I wouldn't want to give away competitive data. Obviously, you know our larger segments are construction and trucking. You can see declines in both. From an audit perspective, oil and gas was still negative audits, but the payrolls were improving from prior quarters, so we take that as a good sign.
Right. The audit premium was in the negative overall, correct? Those audits.
No, actually audit premiums themselves were positive. Now, when we add them in with endorsements and cancellations, yes, they were negative, but audit premiums themselves were positive. It's the quarter-over-quarter change that was the $4 million decrease. The only class of business where we've actually had negative audit premium in the aggregate is oil and gas.
Right. I'm sorry. Payroll audits and related premiums decreased premiums written by $2.6 million in the second quarter-
Right
compared to an increase of $1.5 million. That 2.6 is the year-over-year change.
No, the 2.6 is audit premium endorsements and cancellation premium.
Oh, okay. Why the change in endorsements in cancellation premiums?
We see, typically you see this in competitive environment, you see more cancellations. We've seen a slight uptick. It's not been dramatic, but certainly we're seeing more cancellations than we saw last year. Someone gets a better rate partway through their cycle and cancels the policy with us. Doesn't happen as often, but that drove some of the change in the quarter.
Yeah. Does that have a seasonal component to it? Is that more likely to happen at mid-year, or is that consistent throughout the year? It doesn't really matter seasonally?
It's pretty consistent. It's just it tends to be in more competitive markets, and it also tends to be in those classes of business that have the highest rates, right? They're much more price sensitive if you're a roofer versus if you're a landscaper, for instance.
Right. Okay. Anything from a distribution perspective? Are brokers doing something different this time around, treating you differently? Is that having any influence?
Brokers are in some regards in the same predicament that insurance companies are. They're looking for premium because their base of their commission is premium. They're very protective of their large accounts, in placing those and making sure that they get renewed at appropriate rates for the client, that the client can accept at the same time at commissions that are beneficial to the agent.
Right. You don't think that distribution is a factor. I know competition and the more competition in the middle and large markets are an issue.
Yeah. That's a good point. I haven't really seen a swing in the distribution. No.
Okay. The expense ratio If you continue to sustain top-line decreases, I might ask this last quarter, do we expect the expense ratio to tick up? Are you prepared to make adjustments to the cost structure to keep it in the mid-20s, let's say?
Yeah, Mark, I'll give the same answer I gave last quarter, which is we sort of expect the expense ratio to be 24-25. Obviously, if net earned premium declines, we'll be towards the higher end of that range. We're not expecting any dramatic changes. We're aware that we're in a soft market, and we have to continue to manage our expenses the way that AMERISAFE typically has with a pretty frugal culture and a focus on underwriting.
You might go to the top end of that range, but not necessarily above it?
Yes.
Okay. Any early read on July? The sort of better improvement you saw or better dynamics you saw through the quarter, how does July look?
I appreciate you asking, Mark, but we typically wouldn't give out those numbers until the quarter is over, because as I mentioned with the second quarter, it varies month by month.
Yeah. Okay, all right. Thank you very much.
Thank you, Mark.
Thank you. As a reminder, if you do have a question, please press the star, then one key on your touchtone telephone. The next question is from Randy Binner of FBR. Your line is open.
Hey, good morning, thanks. I just have a couple. Just going back to investment income, was there anything unusual outside of the mark to market on the alternatives, like bond prepayment or anything unusually good in the quarter, just from a kind of a core yield perspective in the general account?
Yeah, I think we've been increasing our duration and investing in higher yielding securities, particularly when yields spiked up in the muni market and overall in the fourth quarter. We're starting to see some of that come into the portfolio. There were some calls during the quarter that did influence investment income a little bit, but that is sort of the components. It can be volatile. It certainly was up still 9% or so without the hedge fund adjustment.
Okay. Yeah, that's helpful to have in the model. Just on capital, presuming that the top line continues to be managed in light of a competitive market, the premiums to capital measure gets to be pretty darn low. I'd just kind of be curious how you're thinking about that. I mean, the company's been well capitalized, I got you at like 0.8 to one right now, premiums to surplus, that can move lower even with special dividends. Is there any change in how you're thinking about it? Because I feel like you're kind of moving from being over-capitalized to maybe really over-capitalized, I don't know if there's any thought of kind of how to manage that if you have to continue to be really selective in a soft market.
Randy, that's a good question. Our board does discuss our capital situation every quarter, when they look at the regular dividend, they'll continue to evaluate that. Certainly, you're talking about all the right dynamics in terms of the things that they look at when they look at capital. What are we going to need that capital for? Organic growth, M&A, whatever it might be, what is the likelihood? Being disciplined about returning that back to shareholders if we cannot use it through dividends and other means. They'll continue to look at that. You're right. If the ratio continues to go lower, it certainly causes us to be more well capitalized than in the past.
Is there any thought that there could be some opportunity out there from a business perspective? Is the market just, if you go back maybe three or four years, there was this idea that some folks could have some issues out there, some blocks might become available. Seemed like maybe there were a couple things that came around, they went for pretty high prices. Are we just past that part of the cycle now? Where would any kind of strategic opportunities be within comp? Meaning to allocate some of that capital to writing more business in size or in bulk.
Right. I think when you're talking about buying books of business in a declining environment, I'm not quite sure what we would be buying at this point.
Right
the end consumer is expecting rate declines. Given our underwriting discipline, I would assume we'd be a little bit more pricey than they were accustomed to or looking for. If we were to purchase a renewal book, I'm not quite sure how much of that we would actually retain.
We do look at it from time to time, and it is something that we think about as a use of capital. I think as Janelle points out, it's probably less likely in this market than a few years ago.
Right. Okay, perfect. Thanks a lot.
Thank you. There are no further questions in queue at this time. I'll turn the call back over to Janelle Frost for closing remarks.
Thank you. AMERISAFE has a consistent history of turning risk into opportunity through the experience and performance of its employees, evidenced this quarter in our 89.1% combined ratio. Our commitment to maintaining discipline enhances our financial stability for the protection of our policyholders and our shareholders. Just this month, Ward Group named AMERISAFE to its 2017 Ward's 50 in the P&C industry. This recognition was for outstanding financial results in the areas of safety, consistency, and performance over a five-year period, 2012 to 2016. Congratulations to the AMERISAFE family on this achievement. Well done. With that, I'd like to thank you for joining us on the call today. Have a good day.
Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.