Good day, ladies and gentlemen, and welcome to the AMERISAFE, Inc. second quarter earnings conference call. At this time, all participant lines on the telephones are in a listen-only mode, but later we will be conducting a question and answer session and instructions will follow at that time. If anyone should require operator assistance during the program today, you may dial star then zero on your telephone keypad in order to reach an operator. As a reminder, this conference today is being recorded. I would now like to turn the call over to your first speaker today, Vincent Gagliano, for opening remarks. You have the floor, sir.
Good morning. Welcome to the AMERISAFE 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 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 statement. I will now turn the call over to Allen Bradley, AMERISAFE's Executive Chairman.
Thanks, Vincent. Good morning, ladies and gentlemen. Thank you for joining AMERISAFE's quarterly earnings call. I will make a few remarks about the marketplace and then turn the call over to Janelle Frost for details on the company's performance. On May 13th through 15th this year, the National Council on Compensation Insurance held its Annual Issues Symposium in Orlando, Florida. During that symposium, the group released its State of the Line report, which provides the most definitive annual analysis of the workers' compensation market in this country. The headline news was that the combined ratio for what they call private carriers, which excludes state funds and residual pools, was 98% for calendar year 2014, which by the way, was a little bit higher than I had expected. The portion of that report that surprised me the most was the lack of aggressive use of carrier discounting and pricing during 2014.
According to the report, which contained data in states where the NCCI collects data, direct written premium rose 4.5%. The components of that change were what surprised me. 4.7% of the total premium growth, was a result of change in carrier estimated payroll. In other words, the increase in exposures or growth in wages paid. That was partially offset by 1.4% drop in premium related to change in bureau loss costs and the mix of businesses moving away from heavier construction and heavier risk to more service-oriented risk. There was a 4% increase in the use of carrier discounting in terms of the total premium written. That was quite surprising. The lack of the aggressive use of schedule rating in 2014 indicates that pricing discipline had not yet gone out the window. There was other good news in the report.
The direct premium written indicated that the economy is moving ahead at a relatively good pace. Also in the report, there was a report that there was 3 percentage points of prior period adverse development, moving the accident year combined ratio from 95% to 98%. Additionally, the Schedule P deficiencies for insurance company reserves from workers' comp decreased only from $11 billion to $10 billion. I find these factors encouraging as it should slow carriers from becoming overly aggressive in terms of pricing. The claims metrics of falling frequency and muted increases in severity were also very good news. As usual, to offset the good news, there was some not so good news contained in this report. The excessive capital and surplus in the general property and casualty market, coupled with record low operational leverage, indicates that the probability of a soft market is very high.
The workers' compensation market's underwriting profit could lure additional carriers into the line. Loss costs, which have been falling, may continue to fall, thereby amplifying the impact of increased competition. Finally, a shrinking residual market is a sure sign that some carriers are compromising underwriting discipline. Despite the challenges listed above, we believe the workers' compensation market remains relatively attractive. We expect industry pricing to slide downwards over the next few quarters. However, with favorable trends in frequency and severity, we do not view this decreased pricing as unwarranted. All things considered, it's a pretty good time to be in the workers' comp business. With that, I'll turn it over to our CEO, Janelle Frost.
Thank you, Allen, for the market commentary. Good morning, everyone. I will now move on to the operational and financial results specific to AMERISAFE this quarter. Overall, we were pleased. Our operating trends were positive, and it led to an 83.6% combined ratio in the quarter, down 5.8 percentage points from the second quarter last year. Our top line grew $2.2 million or 2.1%. This growth was driven by our renewal premium, which grew 11.4%. Our retention was up both on a policy count and premium basis. Policy retention was 92.8%, up from 90.8%, and premium retention was 87.4%, up from 83%. In addition, audit premium and related adjustments remained positive this quarter, contributing $0.2 million to growth. Offsetting the quarter's growth, our new business declined 21.2%. Our favorable pricing continued this quarter, although reflecting a decline from the previous year's quarter.
Our effective loss cost multiplier, or ELCM, for voluntary premium in the quarter was 1.81, compared to 1.86 in the second quarter of 2014. This decline in pricing was deliberate, appropriate, and reflective of the market. Net premiums earned increased 2.2% from the year-ago quarter to $95.6 million, reflecting net premium written growth over the past year. Relative to losses, we remained at a 69.8% loss in LAE ratio for the current accident year. Our claims reported in calendar year 2015 were down 4.3% to 2,603 claims. Declining frequency was a pleasant surprise since our expectation for the year was flat. As for prior accident years, the quarter was impacted by favorable development. Significant case development led to $9.4 million of favorable loss development in the quarter, which lowered the loss and loss LAE ratio by 9.8 percentage points.
This compared to $4.4 million of favorable development in the second quarter of 2014, which lowered the loss in LAE ratio by 4.7 percentage points. Accident years 2006, 2007, and 2012 were the primary drivers of the favorable development. With regard to operating expenses, total underwriting and other expenses increased 5.1% to $22.1 million. The increase was primarily attributable to less contingent profit commission in the second quarter of 2015, which typically acts as an offset to expenses. By category, the 2015 second quarter expense components included $5.9 million of salaries and benefits, $6.9 million of commissions, and $9.3 million of underwriting and other costs. Overall, the expense ratio increased to 23.1% from 22.5% in the same quarter a year ago. Our net investment income totaled $6.9 million in the second quarter of 2015, a 0.7% increase from last year's second quarter.
The tax equivalent yield on the investment portfolio was 3.6% this quarter, down 10 basis points from the second quarter of 2014. Including cash and cash equivalents, the company's portfolio was valued at $1.1 billion, with 62.2% of the securities classified as held to maturity with an unrealized gain of $18.3 million. As of June 30th, 2015, municipal bonds comprised 55% of the investment portfolio. In the quarter, we did recognize $2.6 million of realized losses, primarily due to other than temporary impairment of certain Puerto Rican securities. Overall, the investment portfolio continues to carry a double A-minus rating with an average duration of approximately 3.4 years. Our tax rate included 28.8% in the quarter from 25.1% a year ago. This increase largely reflected the increase in taxable income relative to tax-exempt interest as the ratio rose in the quarter due to the favorable development.
The end result was an operating net income of $16 million, or $0.84 per diluted share, compared to $12.6 million or $0.67 per diluted share in the second quarter of 2014. On a reported basis, net income grew 12.1% to $14.3 million or $0.75 per diluted share from $12.8 million or $0.68 per diluted share in the second quarter of 2014. Operating return on average equity was 13.8% for the quarter, up from 11.8% in the same quarter of 2014. On a reported basis, return on average equity for the second quarter was 12.3%, compared to 11.9% in the second quarter of 2014. Book value per share at June 30th was $24.87, an increase of 6.9%, and our statutory surplus was $404.9 million at the quarter end. Regarding capital management, the company paid a regular quarterly cash dividend of $0.15 per share on June 26th.
On July 28th, the board of directors declared a quarterly cash dividend of $0.15 per share, payable on September 25th to shareholders of record as of September 11th, 2015. Before I open the call for questions, I would like to reaffirm our commitment to making an underwriting profit using a disciplined approach to our business through varying market cycles. Yes, this quarter, we were able to grow top line with favorable pricing. More importantly, our underwriting margin benefited from favorable case development, spurred by intensive claims management and continued control over our operating expenses. However, we are mindful it is a quarter's result. Our long-term results carry more weight, such as we were recently chosen by Ward's as one of the top 50 P&C companies. This was our seventh time to be honored.
While it was indeed an honor, this recognition also served as a challenge to remain focused. This is a sprint, not a marathon. We'll now open the call for questions.
Ladies and gentlemen, if you have a question for the speakers at this time, you may dial star then the number one key on your telephone keypad. That's star, then one. If your question has been answered or if you would-- yourself from the queue, you may press the pound key. Our first question comes from the line of Matt Carletti from JMP Securities. Your line is open.
Hey, thanks. Good morning.
Morning, Matt.
Let's see, Janelle, you had spoken a little bit, I think, about loss trends. I heard you mention frequency being a little better than expected. Maybe you expected flatness down a little. I might have missed it, but how is severity looking versus your expectations and kind of when you put the two together, how does that leave you thinking about kind of where the accident year loss ratio is at six months versus how you progress through the rest of the year?
Right. Good question. I will caution that it is, as you said, at six months. Yes, frequency is down, we are now in the summer months, which we consider full employment months. That's when accidents tend to happen. We were fortunate by the end of the second quarter, we had only one claim in excess of $1 million, which was lower than we were at the same point in time in 2014. We are in a lumpy business. For us, current accident year is something that we're very cautious about because those claims can happen up until the very end of the year. Although I will say at this point, severity, given that we only had one claim in excess of $1 million, was improving from the prior accident year.
That remains to be seen what will happen at the end of the year.
Okay. That all makes sense. My other question, just on the favorable development. You mentioned that a lot of it came from case. Was it all case? Was there some IBNR in there, or can you give us an idea of the split and what's driving it?
It was almost entirely case.
Perfect. All right, great. Well, thanks and congrats on a very nice quarter.
Thank you.
Thank you. Our next question comes from the line of Mark Hughes from SunTrust. Your line is open.
Thank you. The 4.3% decline in claims, was that year-to-date?
That was for the quarter.
For the quarter. Was that adjusted for premium, or was that raw numbers?
That was great. That was raw numbers. That was strictly claim count.
Okay. Then the pricing, Allen, you say you expect it to slide downwards. Is that because you're seeing that start to slide downward? There are tangible signs that people are getting more aggressive competitively, or is this the pro forma turbulence ahead? It always happens. Be prepared. Winter is coming.
No, that's real. It's not Memorex. It's real, Mark. We have seen pricing at AMERISAFE. We've seen it slide down. We hear discussions in the marketplace as well as the loss cost themselves going down. As they go down, that tends to pull the premium down. One of the things that's really unique in the marketplace now, I think, and you can see it in AMERISAFE's numbers, and you can see it in the market as a whole, and that is that carriers are very focused on keeping the business they have on the books. There seems to be a lot of focus on the renewal book. We saw a very healthy growth in our renewal book as Janelle outlined. We saw fewer submissions for new business. We think all of that's consistent with it.
I think that you see carriers giving more price concessions to renewal accounts because they know that business better.
Right. In terms of price competition, I guess this is a good time to mention the 1.81 LCM still seems like it's pretty healthy in looking back at the peak of the last cycle, say 2004 or 2005, your LCM was 150 or so. Your current accident year loss pick in 2004 was 69% coming off of a kind of a one four, one five LCM. Is there some reason to think that the times are different the LCM doesn't mean mathematically what it used to mean? Is 1.8 still quite good and much better than you got at the peak of the last cycle when you had similar current accident year loss picks?
Yes. I would say the 1.8 is still quite good. We still have room there. We're never going to be the leader as far as price sensitivity and dropping prices. I think what we're doing, as I said in my comment, is very deliberate and very methodical and maybe not to everyone's pleasure, is not as fast as they would like it to be. Our end goal is to produce a profit margin, and that is extremely important to us.
One other point I'd make, Mark, on you asked the question, is there anything that's changed our view of loss cost as it was opposed in 2004 and 2005 and 2006 and those time periods. The answer is yes. We saw a definite shift in claims characteristics during the recession. We saw an elongation of claims. We saw the problems of returning people to work. We saw businesses going out of work and therefore claims becoming elongated. We've seen the rapid growth of prescription medications as a component of claims cost. We've seen a lot of those things that we're not necessarily sure are picked up in the loss cost yet. Janelle-
Right. There may be an elongation that NCCI has missed is what you're saying.
It's a retrospective rating of making a rate, and sometimes it's hard to catch the turns through that process. I'll just tell you this, that one thing that we have seen a lot of in the workers' comp business is adverse development, prior period adverse development. That begins, that is born the day that you take an aggressive current accident year loss selection.
Right. Yep. I'm looking at your operating expenses were in the mid-twenties back then. Your operating expenses are lower today. Is there something about LAE that's higher? I'm just trying to make sure that I've got the right perspective that when I say 1.8 is better than 1.5, that there's not something I'm missing.
It is definitely better. There's no question about that. 1.8 is definitely better, and it will slide down, and you'll be surprised sometimes maybe how fast it slides.
Right.
I will tell you that claims durations are longer, medical costs are higher.
Right.
While we've seen improvements in the claims dynamics, we have not seen them return to the same characteristics they existed during full employment days.
That's still captured in the loss costs. You may say there's more to come, it's still the elongation, the higher medical, all that, is still captured in the loss cost.
We hope it is.
Yeah. There's always some lag and, yeah, exactly. Okay.
You always miss a turn, every time.
Sorry to beat on that.
That's all right.
The operating expenses, Janelle, a little bit higher sequentially this quarter. I think ceding commissions were a little lower. How do we think about that going forward?
That's correct. If you recall, last quarter, we had, I think, three to four, what Mike termed then as one-time adjustments. We had some premium-based assessments that adjust some premium taxes, and there was actually a change in the accrual due to our long-term incentive plan, all in the last quarter. During the last quarter's call, I actually went back to read before today that he said, on a normalized basis, the expense ratio was 23.2%. Sequentially, the two quarters are relatively the same without those one-time adjustments that we had in the first quarter.
Would 23 be a good assumption going forward?
I like 23.
Yep. Okay. All right. Very good. Thank you.
Thank you. Ladies and gentlemen, as a brief reminder, you can queue up for a question with star then one on your keypad. That's star then one. If your question has been answered or if you wish to remove yourself from the queue, you may press the pound key. Our next question comes from the line of Randy Binner from FBR. Your line is open.
Hey, good morning. Thank you.
Morning.
Morning, Randy.
I guess I want to just follow up on the PYD that's favorable in accident year 2012. I guess this kind of got asked by Matthew Carletti. What's happening? The more recent accident years are not as mature, but 2012 is a little bit in kind of that 36-month window, I guess, where you assess what gets better. If you're talking about cases, is this you're resolving the settlement faster, there's less lawyer involvement, there's less the guy taking pills. Is that what's happening here, is more orderly kind of case claims management? Is that what you're observing for kind of call it the 2011, 2012, 2013 accident years in general?
That's a great question, Randy. Let me talk about accident year 2012 case reserves, because I think it's to the heart of your question. If you recall, we bring this up often because it's painful, and I guess I like bringing up the painful things. Coming out of accident year 2010, we at AMERISAFE and the industry experienced a lot of adverse development. We got it wrong. Our actuaries got it wrong. We got it wrong. We had underestimated what the impact of those claims were going to be from a loss ratio standpoint. We also, as Allen was talking about in the industry, we also came into a time period where we started seeing the elongation of claims, return to work issues, pain management issues.
Going back to the case reserves that are set in 2012, I would say all of those things, those things that Allen was talking about as far as the industry were true for AMERISAFE, were in the minds of our field case managers when they were setting those case reserves. The flip side of that is, yes, I do think I would love to attribute the favorable case development that we're experiencing from the accident year from the way we handle claims. I think that's a very big part of the case development that we had. Our goal is to return the claimant to maximum medical improvement, return them to work, and our claims department does a very good job of that. Fortunate for us and our shareholders, that's resulted in favorable case development for the company.
I guess what you're saying is that kind of that mini hard market of, call it 2011, 2012, 2013-
is looking like that in retrospect. There's also a little more benefit from a macro perspective.
Right. I would absolutely say that's true.
Let me just add this to that, Randy. I think the industry as a whole is seeing some improvement in the claims dynamics. It's just they're not going back to where they were in 2004, 2005, and 2006. I think that what you're seeing is, it's better than it was, but it's not as good as it could be.
Right.
When you go into a year, like we went into 2012, like we went into 2013, 2014, and 2015. 2015 less so, because we think those at least 2013 and 2012, 2013, and 2014 may indicate a turn in that. We're just a little cautious about getting overly aggressive about bringing that current accident year down or bringing back those years, but you still got a number of large claims open.
Right. Understood. Yeah. You mentioned 2004, 2005, 2006. I mean, 2006 developed loss ratio is 20% lower, I think, than 2012. There's a lot of room between those two goalposts. I want to ask two more questions. One is just kind of a detail thing. You mentioned the Puerto Rican bonds. Can you just update us on how much the exposure is, where your write-down puts you on the dollar on those, what type of bonds they are, that sort of thing?
Sure. They are sales tax bonds, and we own four of those. As I think everyone in the industry knows at this point that the, I think it's governor, came out and said that everyone's going to share the pain. We haven't experienced a loss, but we have deemed that it is likely that that is going to happen. We chose this quarter to impair them.
what's your aggregate exposure, and did you impair them to $0.70 on the dollar or something like that?
I think it was $0.40-something. It was $2.6 million. Hold on just a second, I'll get it for you.
all in, I mean, you own what, 6 million of these things? $6 million or
Yeah. Wouldn't that right? I think it was around $6 million.
That makes sense.
I'm sorry, I don't have that right here. Hold on just a second.
While you're looking for that, the other kind of specific question I have is I know that I think you brought on a new head of sales or marketing. How's that transition go, and what kind of initiatives are you starting there that are different than what you've done in the past?
Yeah. We're real excited about our hire. It is still early in the process. By the end of the second quarter, he had just reached his 90 days. We are excited about the prospects of what's going to happen. We're definitely laying the groundwork, but certainly no true impact to the results at this point.
What sort of stuff is he doing that would be different than the past?
Well, that's a good question. I don't want to give out any competitive information.
Okay, fine. Yeah.
We are working on our agent relationships. I think that's a fair way to summarize the question.
Okay. Got it.
Randy, it looks like our exposure to Puerto Rico was about $6.2 million-$6.9 million, and we wrote off the $2.6 million.
Okay.
Yes, it is.
All right. I got you. Perfect. That's all I have. Thanks so much.
Okay. Thanks, Randy.
Thank you. That's all the questions that we have in the queue at this time. I'd like to turn the call back over to Janelle Frost for closing remarks.
Well, thank you for your interest in the quarter. Thank you for joining the call today.
Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program. You may all disconnect your telephone lines. Everyone have a great day.