Good day, ladies and gentlemen. Welcome to the AMERISAFE 2016 third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. If anyone should require operator assistance, please press the star, then the zero key on your touch-tone telephone. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mr. Vincent Gagliano, Chief Risk Officer. Please go ahead, sir.
Good morning. Welcome to the AMERISAFE 2016 third 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 could materially differ because of 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 statements. I will now turn the call over to Janelle Frost, AMERISAFE's President and CEO.
Thank you, Vincent. Good morning, everyone. This quarter, AMERISAFE's favorable results were driven by our continued discipline. Discipline in our risk selection and pricing, discipline in our claims handling, and discipline in managing cost. We firmly believe maintaining that discipline is appropriate as the workers' compensation market softens. The industry has reported a profit in the last few years. However, both NCCI and AM Best consider industry-wide loss reserves to be deficient. At the same time, underlying loss costs continue to decline. This combination will tempt underwriters to chase premium and sacrifice underwriting profits. Our focus has been and will continue to be to protect the underwriting margin. That focus enables us to return value to our shareholders. This quarter, our board evaluated our capital position. That return in value included an extraordinary dividend of $3.25.
The extraordinary nature of this dividend is reflective of our perception of the workers' compensation market conditions and the company's continued ability to produce earnings for our shareholders. Now on to operations. Premium written in the quarter was down 2.4%. Audit and related premium adjustments declined $1.2 million. We are focused on policy count given the softening rate environment, as I've been saying all year. We did grow voluntary policy count by 3.6% in the quarter, which was a good result. With loss costs in most states falling, premium for voluntary policies written was down 0.9%. New business was down 7.3%. Renewal business was up 0.5%. Our effective loss cost multiplier was 1.71, down from 1.77 a year ago and down slightly from 1.73 last quarter. Relative to losses, we remained at a 67.9% Loss and LAE ratio for the current accident year.
Both frequency and severity for the current accident year were consistent with the prior accident year at the same point in time. Our claims reported in calendar year 2016 were down 1.2% from 2015. As for prior accident years, we experienced favorable case development in the quarter, which led to a reduction in losses incurred of $10.5 million. Accident years 2008, 2013, and 2014 experienced the most favorable development as we focused on closing claims and returning injured workers to work. Our open claim count at the end of September 2016 was 4.1% lower than at the end of third quarter 2015. After the favorable development, our Loss and LAE ratio for the quarter was 56.2% compared to 54.1% last third quarter. The best summary of these operational results is a combined ratio of 80.3% and a pre-tax underwriting profit of $20.8 million.
I'll now turn the call over to Neal to discuss the financial results.
Thank you, Janelle, and good morning, everyone. For the third quarter of 2016, AMERISAFE reported net income of $17.9 million, or $0.93 per diluted share, compared with $17.9 million or $0.94 per diluted share in the same quarter last year. Operating net income in the quarter was $17.8 million, also $0.93 per share, a $0.01 per share decrease from the third quarter of 2015. Revenues in the quarter increased by 0.8% to $98.2 million compared with the third quarter of last year. Net premiums earned decreased 0.6% to $89.9 million when compared to the third quarter of 2015. Net investment income was $8 million in the third quarter of 2016, an increase of 15.6% when compared with last year's third quarter. The increase was largely due to the increase in value of a hedge fund investment, which is marked to market through net income each quarter.
On a year-to-date basis, investment income is down 1.9% from last year. The tax-equivalent yield on our investment portfolio was 3.2% in the quarter, compared with 3.3% in the same quarter last year. There were no impairments or significant realized gains or losses during the quarter. The investment portfolio continues to be high quality, carrying an average AA minus rating with an average duration of 3.12 and with 52% in municipal securities, 30% in corporate bonds and the remainder in cash and other investments. 51% of our investment portfolio is classified as held to maturity, which is in a net unrealized gain position of $19.5 million. These gains are not reflected in book value per share as these bonds are carried in amortized cost.
With regard to operating expenses, our total underwriting and other expenses decreased 6.7% in the quarter to $20.8 million, compared with $22.3 million in the third quarter of 2015. We saw decreases primarily in assessments and commissions compared to the third quarter last year. By category, third quarter 2016 expenses included $6.3 million of salaries and benefits, $6.4 million of commissions, and $8.1 million of underwriting and other costs. Our expense ratio for the third quarter was 23.1%, compared with 24.6% in the third quarter last year. Our tax rate increased to 31.2% in the quarter, up from 30.7% in the third quarter last year. The increase reflects the larger amount of taxable income compared with tax-exempt income during this year as a result of the increased amount of favorable prior year development on a year-to-date basis.
Return on equity for the third quarter was 14.2%, compared to 14.9% for the third quarter of 2015. Operating ROE for the third quarter was 14.4%. On October 25th, the company's board of directors declared a regular quarterly cash dividend of $0.18 per share, payable on December 29th, 2016, to shareholders of record as of December 15th, 2016. In addition, as part of our ongoing capital management efforts, the company's board declared a special dividend of $3.25 per share for shareholders with the same record and payable dates. This brings the total amount of special dividends paid out in the last three years to $7.75 per share. Just a few additional items to note. Book value per share increased 11.7% from year-end to $26.51 at September 30th, 2016. Our statutory surplus rose to $395.2 million at September 30th, 2016, up $23.8 million from year-end.
In addition, so far this year, we have paid $37 million in dividends from the insurance companies up to the holding company, AMERISAFE, Inc. AMERISAFE will file our Form 10-Q for the third quarter tomorrow afternoon after market close. That concludes my remarks, and we would now like to open up the call to analysts investors for questions. 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, please press pound key. Again, to ask a question, please press star one at this time. Our first question is from the line of Matthew Carletti of JMP Securities. Your line is open.
Hey, thanks. Good morning.
Good morning, Matt.
A couple questions. I guess I'll start with one on kind of just the market and what you're seeing. If we look at some of the kind of published market-wide surveys or rate trackers for workers' comp, I know that they're catching a lot of things. Your book's very targeted. That's very broad. We saw a slight kind of correction in the downturn of rates the past couple of months. Kind of down threes and fours became down twos and down ones from July to August to September. What are you seeing in your book? Would you say it's stable? Would you say it's kind of that sort of same trend? Is it something opposite of that?
No, Matt, we are still seeing increasing competition. The market is continuing to soften. The last graph that I saw from NCCI showing loss cost filings, there were 32 decreases approved and six increases.
I saw the same one, yeah.
Yeah. We still believe the underlying loss costs are declining, partially driven by experience. As I mentioned earlier, in this market, declining loss cost when we believe there's deficiencies still in the industry, is going to cause some turmoil in the marketplace.
That makes sense. Okay. One other, I guess, just more along the talk about reserves and the development you've seen. More so a read-through question. I know that years like, say, 2015 are too early for you guys to look at least from a release standpoint. As you look at these older years, 2014 in particular, kind of being the most recent one and ones before that developed favorably. One, what are the implications for 2015 as we go into 2016, since you're kind of lowering the bar at which those were set at? What are the early reads? Are you seeing actuals come in better than indicated in, say, 2015, but it's just too green, and we need to wait and see? Or is it coming in more as expected?
I think, well, it's coming in as expected. I think as you mentioned, 2015 is still a green year. We are in a lumpy business. It just takes a few claims for things to get a little escalated for us. I think I've said this before on prior calls. I believe that we, as in most companies, probably
honed in on our reserving practices on a case basis after the Great Recession. I think that's what you're seeing in our case reserve releases that we've seen from accident years 2012, 2013, and 2014. Going into 2015, I think maybe we were more realistic about what we were facing in terms of return to work and duration of claims. At the same time, we were getting less premium per dollar for those exposures.
Got you. All right, thanks. Thank you for the answers, and congrats on a very nice quarter.
Thank you.
Thank you. Our next question is from the line of Randy Binner of FBR Capital Markets. Your line is open.
Hey, good morning. Thanks.
Morning.
If I missed it, I apologize. I've been jumping from different calls. Did you mention what the statutory surplus was at the end of the quarter, and what that number would be after the payment of the special?
Yeah, Randy, this is Neal. We did mention statutory surplus at the end of the quarter was $395.2 million, and that was up $23.8 million from year-end. We had already paid $37 million up to the parent company, though. You sort of have to take those two into account to get to statutory earnings. We will also pay an additional amount up to the parent company to help fund the special dividend that we declared, and that will be paid out in December.
Maybe minus another $30 for their pro forma. Is that about right?
Yes.
That sets up my question, which is, to see the special, I think that's great for shareholders. Despite that large payment, your premiums to surplus, which is our crude measure of operating leverage from the outside, is still not even up to 1x. I guess kind of synthesizing the comments from Janelle on having to stay disciplined in the market. What's a reasonable operating leverage goal for AMERISAFE kind of over the next year or so?
Yeah. We have a long-term target. We think that our gap operating leverage right now is bouncing around 0.8 or so. Long term, we think that that gap operating leverage could get to 1.0. We won't disclose a target for where we could get in the next year. Our board continues to focus on the capital position of the company and discuss it each quarter, and then make a determination about what is the best method to return capital to shareholders and what is sort of the future as we look at the market as we go through different cycles. Long term, that 1.0 is still a long-term target that we would like to strive towards.
There was a point maybe like a couple of years ago, where it seemed like distress in the market would yield some underwriting opportunities for AMERISAFE, potentially just taking business, maybe picking up a distressed company or a block. Is it kind of safe to say that if that opportunity existed, it's kind of passed? Just trying to think of a plausible way that, or any color you can give on kind of opportunities you see inorganically on the market. Just trying to get a sense of how likely it might be that you can use this capital for something productive rather than the special.
We constantly look at M&A opportunities. As we move through this softening market, there is potential that there may be books of business or pieces of business that other people are concerned about. We have done some small purchases of blocks of business in the past. We certainly would look at them again. We're not necessarily interested in buying balance sheets, but it is something that we continually think about in terms of our capital position and use of capital. It would have to be a great return for shareholders.
I'll just do one more on the 1.71 ELCM. I believe that implies a 59% loss ratio, you're running still accident year loss ratio at 68%. These are rough numbers because there's a little bit of GAAP versus stat, pretty conservative. I guess, should we expect that kind of conservative spread on where you run the accident loss versus ELCM to persist? It's not new. It's seemingly building in a lot of redundancy into the book, which is fine. Just trying to get your perspective on how wide that might continue to run and how some of the macro factors in the workers' comp space fit in that.
Good question. As far as the inference of the 171, I would keep in mind that would be assuming that the loss costs are correct.
Yeah.
As you know, loss costs seem to have large swings in them, it takes a period of time for that to work itself into the book. Secondly, as far as AMERISAFE's reserving practices, I think we've been very consistent over our history, particularly in our current accident year selection of where we think our book may be. We look at frequency, we look at severity. As I was mentioning to Matt earlier, we are an lumpy business. Our standard practice has been, we set that loss pick where we think it should be at the beginning of the year, what we think ultimately the cost will be. If there's something throughout the year that indicates to us either in the trends of frequency and severity, paid to incurred, anything to that nature, closure rate, that we think makes that estimate incorrect, we would adjust it.
Most of those adjustments, in my mind, would be upward. I'm not saying it wouldn't go downward unless there's something extremely compelling. Otherwise, given the type of business that we write, we typically wait 30 to 36 months after the inception of a policy year to make those type of adjustments, unless there's something extremely compelling, which we did earlier in the year for accident year 2014. Typically, we wouldn't have adjusted that to the second or third quarter, we had enough case reserves that were favorable to us that we made the adjustment in the first quarter. I do think we're responsive to that, as you know, our responses are very deliberate and very consistent.
All right. That's all I have. Thanks a lot.
Thank you. As a reminder, if you have a question at this time, please press star one now. Our next question is from the line of Mark Hughes of SunTrust Robinson Humphrey. Your line is open.
Thank you. Good morning.
Good morning, Mark.
The audit premium was negative for the first time in quite a while. Was that concentrated in any particular end market or broad-based?
Yeah. Audit premium alone, just audit premium, not counting endorsements, cancellations, to that effect, we're still positive in the quarter. We are seeing a negative audit premium come through, obviously in the oil and gas industry. Actually, in this quarter, it was in our roofing business, we saw some negative audit premium. As a total, audit premium was positive this quarter, just less positive than it was in previous quarters. The declines were pretty much across the board with the exception of trucking, which we've talked about with you and others on the call, how we felt like trucking was going to hold strong throughout this softening cycle, and that proved to be true with the audit premium.
Right. The audit premium was just down $1.2 million from last year. Last year's third quarter, if I've got my number right here, it was flat in terms of the audit premium.
All in, including endorsements, cancellations. That's correct.
Right. This year.
Our cancellation number was higher this year than it was last year.
Right. Okay.
Our audit number was positive, but it was lower than last year. All in, that's where we got to the -$1.2 million.
Right. The number that you give is sort of an all-in number.
That's correct.
Right. Last year's all-in was flat. This year's all-in was -1.2. You're saying that the audit premium was actually positive.
The audit premium number was positive. It was still a negative change from the prior year, but it was less than $100,000.
Right. Then what was the cancellations? What accounted for the remainder of that $1.2 million?
The remainder of that was basically driven by cancellations. We had more cancellations in the quarter than we did in the prior year's quarter.
Right. What causes that?
It could be a couple things. One is cancel flat. If an insured books or binds a policy with us and within a certain period of time moves that policy to someone else, we'll cancel it flat. Basically, the entire premium gets undone, but it shows up as a cancellation premium.
Yep.
If we were to cancel an insured for some reason due to an audit that we've done or, well, it wouldn't be non-renewal, it would just be cancellation.
Yep. Okay. The underwriting expense was better this quarter. I think you had referred to assessments and commissions. Is there some reason why the commission rate is lower? I know written premium was flatted down a little bit. Was the commission rate lower this quarter?
The overall effective rate for commissions was lower this quarter. I think part of that is some of the sales initiatives we have ongoing. We had a number of agents that lost their preferred status in the quarter, some of which regained it going into the fourth quarter. For the third quarter, because we do valuation dates on a six-month period. There were agents who lost their preferred status, which meant a lower commission rate. As we get our sales initiative going and as we get our agents on board with what we're trying to achieve, I would expect that to go back to a normal rate.
Right. Was the 2Q more like the normal run rate?
No. I would say 2Q was lower. I would think it'd be more in line with Q1.
On commissions.
Yeah. Okay. I guess when I'm thinking about the expense ratio overall.
Yeah
If I do expenses and policyholder dividends, you're about 26% in the second quarter. This quarter, you're about 24%. Again, that's combining the two categories. Is the 26% closer to what we ought to think about on a go-forward basis?
That's a good question. I think you've seen that our dividend ratio has increased this year as we're competing with dividends more in several states where that's the only way you can compete. I think the dividend ratio is probably the year-to-date basis is a good go-forward rate. Then the expense ratio, we're continuing to try to manage our expenses in a disciplined fashion, as Janelle has mentioned. That 24% range, I think is typically what we have stated for the year. We've been slightly below that, but we always like to try to manage that in line with our plan and do everything we can to manage that expense ratio.
Okay. Janelle, did you give the specific number for change in frequency or Neal, down 1.2%? Was that the number?
That was the change in our claims reported for the calendar year.
Right. Okay. Kind of a proxy for frequency?
If you wanted to infer that, perhaps.
How about large losses? What did you see in Q3 and how has that trended year-to-date?
Yes. On a year-to-date basis, when we talk about large losses, we typically talk about something in excess of $1 million, even though our retention starts at two. On a year-to-date basis, we're at 10 claims in excess of $1 million. I think we ended the year last year with 14. I think we're on, if you want to call that on pace. We never know when they're going to happen, so it happens when it happens for us. There's nothing in the large loss number that would cause us any angst as far as our accident year selection for calendar year 2016.
The net investment income got a little bit of a bump from a hedge fund gain. What normally triggers that? Is that kind of broader stock market or just something else entirely?
I would say the broader stock market. I think you've seen volatility this year as relates to what's going to happen with interest rates and the Fed. There's been a lot of volatility in the first quarter and also in the second quarter. This third quarter, there's been a pretty significant gain. I think on a year-to-date basis, that's about what we would expect. Obviously the net investment income was lumpy in the first three quarters of the year.
Yeah. If that goes against you in the subsequent quarters, is that worth the volatility?
It's something that we continue to look at and focus on as we think about our investment strategy, it is something that we're assessing.
Okay. Thank you very much.
Thank you, Mark.
Thank you. That concludes our Q&A session for today. I'd like to turn the call back over to CEO, Janelle Frost, for any further remarks.
Thank you. We believe AMERISAFE is well-positioned, both from a capital perspective and from an operational perspective. Our mission is to provide quality insurance services to our customers through diligent risk assessment. We deliver an exceptional product with integrity through professional, knowledgeable, and dedicated employees. That level of commitment is what allows us to maintain our consistency, focus, and frugality, and in return, provide value to our shareholders. Thank you for joining us today.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day