Good day, ladies and gentlemen, and welcome to the Employers Holdings, Inc.'s Q1 2017 earnings conference call. At this time, all participants are in listen-only mode. Later, we'll conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference may be recorded. I would now like to turn the conference to your host, Ms. Vicki Mills, Vice President, Investor Relations. Ma'am, you may begin.
Thank you, Valerie. Good morning, and welcome everyone to the first quarter 2017 earnings call for Employers. Yesterday, we announced our earnings results, and today we expect to file our Form 10-Q with the Securities and Exchange Commission. These materials may be accessed on the company's website at employers.com and are accessible through the Investors link. Today's call is being recorded and webcast from the investor relations section of our website, where a replay will be available following the call. With me today on the call are Doug Dirks, our Chief Executive Officer, Steve Festa, our Chief Operating Officer, and our Chief Financial Officer, Mike Paquette. Statements made during this conference call that are not based on a historical fact are considered forward-looking statements. These statements are made in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current at the time of the call and will not be updated to reflect subsequent developments. In our earnings press release and in our remarks or responses to questions, we may use non-GAAP financial metrics, including those that exclude the impact of the 1999 loss portfolio transfer, or LPT. Reconciliations of these non-GAAP metrics are included in our new financial supplement as an attachment to our earnings press release, our investor presentation, and any other materials available in the Investors section on our website. Now, I will turn the call over to Doug.
Thank you, Vicki, and thank you all for joining us on our call today. Our first quarter was a strong start to the year. Net income before the LPT increased $0.05 or 9% for diluted share. We reported operating income of $0.57 for diluted shares, an increase of 6%, with an annualized operating return on adjusted equity of 8%. Operating return was flat year-over-year as we built shareholders' equity. Net premiums written increased 4%, related to higher final audit premium and new business. We delivered strong new business growth in the quarter as we continue to actively seek and find opportunities that meet our underwriting requirements. Book value per share of $32.20 increased 2.3%, including dividends declared in the quarter.
These favorable results reflect the successful execution of our marketplace strategies, our consistent and deliberate portfolio strategy, and underlying soft market trends, which have remained largely unchanged. Underwriting results continued to be strong, evidenced by a combined ratio of 96.6%. Our slightly lower accident year loss ratio of 63.8% reflects our expertise in pricing and risk selection, as well as our initiatives to close claims early and grow our in-force policies and premium in attractive business classes. As in recent reporting periods, our markets remained highly competitive, while in general, rates linked to improving loss costs continued to decline. In light of these market conditions, our overall retention in the first quarter remains high. Renewal premium remained relatively flat for the first quarter year-over-year, with increases in payroll exposure being largely offset by a 1.8% decrease in our renewal average rate.
We are actively engaged in multiple technology and analytics initiatives as well as the multiyear replacement of our policy administration system. I'll turn the call over to Mike for a more detailed discussion of our financial results.
Thank you, Doug. We delivered solid financial results in the current quarter, in line with our expectations. Before I begin my review, I want to point out that we recently adopted a new accounting standard that impacted our reporting of tax benefits from stock-based compensation. As a result of this new accounting standard, we recorded an $800,000 reduction to our income tax expense for the first quarter of 2016 versus what we presented a year ago. This reduction in income tax expense served to increase our net income and our earnings per share for the 2016 period, but it had no impact on our stockholders' equity or our book value per share. Net investment income for the first quarter increased period-over-period, reflecting higher investment balances and, to a lesser extent, a change in the mix of invested portfolio assets.
At quarter end, our fixed maturity portfolio at an average pre-tax book yield of 3.1% and a tax equivalent book yield of 3.6%. Net realized gains for the first quarter increased period-over-period as sizable prior year gains from sales of equity securities were largely offset by other-than-temporary impairments. Net premiums earned for the first quarter increased 2% period-over-period due to higher final audit premium and new business writings. Our first quarter combined ratio before the impact of LPT of 96.6% was slightly lower than a year ago, driven by a lower current accident year loss provision rate. Our commission expenses and the associated ratio for the first quarter were each higher period-over-period.
The increase in our commission expenses was due to higher base commissions for the current period and a favorable prior year true-up of agency incentives, which served to lower commission expenses in the first quarter of 2016. Our underwriting and other operating expenses and the associated ratio for the first quarter of 2017 were each lower than a year ago. These decreases were driven by lower bad debt expense, premium taxes, and assessments. Our effective tax rate was 21.4% in the quarter, consistent with that of the first quarter of 2016. As of March 31st, 2017, the market value of our investment portfolio was $2.6 billion, an increase of 3.6% from a year ago. At the end of the first quarter, our fixed maturities had a duration of 4.3 years and an average credit quality of double A minus, and our equity securities represented 7.7% of the total investment portfolio.
Our balance sheet remains strong, we intend to continue to actively manage our capital through common stock dividends and when feasible, common stock repurchases. Now I'll turn the call over to Steve.
Thank you, Mike, and good morning. Net written premiums for the quarter of $196.1 million were up $7.4 million or 3.9% from the first quarter of 2016. This increase occurred despite a declining rate environment in nearly all of our states, as well as a very competitive market. The primary drivers of this increase were final audit pickup as well as an increase in new business revenue. The increase in final audit pickup can primarily be attributed to increases in payroll at final audit. For policies audited during the quarter in our top 15 classes of business from a payroll standpoint, every class exhibited growth in payroll when measured at final audit compared to payroll at policy inception. Several classes exhibited double-digit growth. This growth is driven predominantly by increased hours of existing employees, as well as increases in the number of full-time equivalent employees.
This trend is a continuation of what was seen in 2016 as well. New business premium growth over the prior year first quarter was driven by growth both in states that we recently entered, such as New York, Connecticut, and Massachusetts, as well as many of our states where we have had a long-term presence, such as California and Florida. We also grew our new business year-over-year in both our traditional distribution channel of independent agents, as well as with our alternative distribution channels. Overall, our new business submissions grew 6.7% from the prior year. With respect to our alternative distribution channels, we continue to see strong growth with most of our partners in this channel. In the first quarter, these partnerships generated 25.6% of our in-force premiums, which is up over the comparable period in 2016 when the in-force premium share was 24.1%.
Retention rates on existing policies continue to be strong with no deterioration from the first quarter of last year relative to unit retention rates. This is driven by strong retention rates on our small policies, despite additional pressure from a competitive standpoint on larger middle market policies. Claim trends continued to be positive during the quarter, with overall frequency declining from the first quarter of last year and continuing strong execution on claim closure initiatives. We are currently investing in analytics initiatives in the claim management area, which in the future will enhance our already strong claim management results. Now I will turn the call back to Doug.
Thanks, Steve. We continue to deliver strong underwriting and financial results driven by our specialist approach to disciplined underwriting and our consistent and deliberate investment strategy. With that operator, we'll now take questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone telephone. Again, if you'd like to ask a question, please press star then one. One moment for questions, please. Our first question comes from Mark Hughes of SunTrust. Your line is open.
Yeah, thank you. Good morning. Did you share the specific audit premium number this quarter?
4%. $4 million, I'm sorry. $4 million.
$4 million. Then what was it in the year-ago period?
We're looking that up.
We'll see if we can pull that number up, Mark.
Okay. Then you said some classes exhibited double-digit growth. Was there any interesting points there where you're seeing a better growth in payroll?
By the way, let me back up to the first question you had. It's 4 million higher this quarter than it was the previous quarter, just to be clear on that.
Okay. Yeah.
I'm sorry, your follow-up question was?
You had mentioned that some classes were exhibiting double-digit growth. Anything noteworthy there that you would highlight?
No, I don't want to point out specific classes. In particular, some of our larger classes though, have had either double digit or close to double digit growth.
When you think about the loss trend, you've touched on this in a number of different ways. Would you say, sort of on a same account or same class basis, that pricing is still staying ahead of loss trends, pricing is lagging loss trends a little bit? How should we think about that now?
I would say, at this point, we're still considering that the pricing is staying ahead of the loss trends. We continue to have strong loss ratio results. I don't anticipate that changing in the future. I would say that we're very comfortable where the pricing is relative to the loss trends.
That uptick in new business submissions, I guess aside from the audit premium, how are you thinking about growth this year? Do you think that positive growth can be sustained if there is a little more competition?
Yeah. I am very satisfied with what we've seen this quarter. There is a lot more competition that's out there. I would say, like we've said historically, that our expectations that in terms of new business opportunities, will be potentially moderately up like it was this quarter or potentially flat. The submissions increasing is generated not only by the new states that we've entered, which is helping us, but also the fact that some of the existing states that we're in, we're leveraging our partnerships even more effectively than we have in the past, and that's led to new business submissions growth even in those states. I would say that I'm optimistic that those trends should continue.
On the capital front, what is your timing? I think you've talked about some internal capital initiatives that you might be looking to more actively deploy capital perhaps next year. What are your thoughts about when we might see either more dividends, more buybacks?
The capital management strategy is unchanged. We did increase our dividend last quarter, continued through to this quarter. In terms of share repurchase, that is always a very important tool for us in capital management. We've always been opportunistic when it comes to utilizing that tool, I wouldn't expect our view to change on that. Finally, given the profitability that we're seeing in the books, it would be our expectation if that continues, we will see a buildup in capital. The result of that is we'll either look for opportunities to deploy in the business, opportunities to deploy through an acquisition, I think our views on that are fairly well known. Finally, return to shareholders failing either of those other two alternatives.
Thank you.
Thank you. Our next question comes from Amit Kumar. Your line is open from Macquarie.
Good morning. I've got two quick follow-ups. Number one is going back to the rate versus loss cost discussion. What do you think the gap would be right now?
If I had that number, I wouldn't disclose it, but I'll certainly support Steve's comment. Our view is that it continues to be favorable.
Has it narrowed over the past few quarters rapidly? Maybe just talk about that a bit.
Well, actually, I was thinking about that as Steve was answering the question. If you look back and see the decline we had in our loss ratio over the last 24 to 36 months, clearly that's not going to continue forever. We don't see the loss ratio dropping to 10. It is clearly going to flatten, and that's going to be influenced by the competitive marketplace. At some point, the continuing loss cost trend that we're seeing in virtually every state is going to flatten out. I can't predict when that's going to happen, but at least at the current time, we believe we still have a favorable gap there.
That's very helpful. The only other question I have, just going back to the broader discussion of competition, and I know that you being a specialty underwriter sort of insulates it a bit. Can you just talk about that a bit more? Where do you see it coming from? Is it the larger companies, the smaller companies, the same players or new players? Just help us sort of put that into perspective, because most of the companies have been talking about increased competitive pressure. I'm trying to figure out where is this exactly coming from? Thanks.
Let me address that question. I'll contrast today to what we were seeing maybe 18 to 24 months ago. 18 to 24 months ago, the most aggressive competition would've been coming from a handful of market participants. They weren't always the same. It somewhat depended on what part of the country you were in.
There were some that were fairly aggressive everywhere. Contrast that to today, where we're seeing pretty consistent competition across the market. There will still be occasions where companies might be standouts in terms of how aggressive they are, but there is a broad market competition everywhere we do business, and most market participants are fully engaged in the competition. I think that's reflective of the environment virtually everywhere. In terms of our strategy, I think it's a very interesting question because what we're seeing is that our small business focus is holding up extremely well in this part of the cycle. When you start looking at accounts that are larger for us, say 50,000 and above, as an example, much more competition around price than we're seeing on the smaller accounts.
Realize that roughly 60% of our premium and 95% of our policies are coming from that smaller segment. It's doing extremely well in this market cycle, as evidenced by a very high retention rate in terms of policy units, and a very strong premium retention despite declining renewal rates.
I think our strategy is looking very good right now, and I think our specialty focus positions us very nicely in this part of the cycle.
Got it. That's actually quite helpful. I'll stop here. Thanks for the answers, and good luck for the future.
Thank you.
Thank you.
Thank you. Again, if you'd like to ask a question, please press star then one on your touch-tone telephone. One moment, please. Thank you. Again, if you'd like to ask a question, please press star then one. We have a question from Cliff Gallant.
Good morning.
Good morning.
Good quarter. The question I have is just about some of the infrastructure spending that you're doing and the technology, and in terms of how that rollout is going, to what degree was it impacting the expense ratio this quarter, and at what point you began to see the benefits of some of the investment?
Well, let's start with the observation that I made in my comments earlier that specifically adds to our policy administration system, that is a multi-year implementation and rollout. Because of the nature of that project, a large part of it is capitalized. There will be smaller amounts that are current period expenses, but that's principally a capital project. You won't start to see that fully impacting the financial statements until the implementation date. In terms of some of the other initiatives that will be driving expense, and we've commented on this previously, we are building out our analytic capability. That tends to be less of a technology expense issue, although there are components of that clearly. That tends to be more headcount related, and it tends to be more consulting related.
For the most part, those are shorter-term projects that will likely have a more immediate impact on the expense ratio. All in, some hits current, some will be capitalized, will hit future periods. I can't really detail for you exactly when those will hit, but it's really a combination of current and capital.
Okay. Well, when you think about the expense ratio and your entry into new states, how long does it take for you to sort of, I don't know, hit a run rate? I would imagine initially an entry into a new state weighs on the expense ratio, and then it takes a while for you to build a book. What is sort of that trajectory of how long it takes to hit the, I don't know what you want to call it, but the run rate that you sort of need to make it worthwhile?
Yeah. Let me describe kind of what happens there. On the front end, there will be some internal costs relating to standing up a new state. Again, those tend to be more on the technology side. Probably not material. When we enter a new state, depending on which state it is, and I'll use New York as an example, there is a requirement that we put boots on the ground so that we can actively recruit and manage our agency force. Again, that's a relatively small expense. Everything else, there's really not an incremental cost to adding an additional state beyond those two. It's a fairly quick ramp-up. Depending on the success we have, there may be a need to deploy additional sales resources, but our expectation is that those would rather quickly pay their own way.
Okay. Very good. Actually, if I have one follow-up, this is sort of more of a macro question in terms of what you might be observing out there among your sort of the small business clientele. Is there more optimism out there in terms of hiring practices and that type of thing?
Certainly our data is suggesting that to us. I can assure you, we spend a lot of time talking about this internally because what we're observing in our book of business appears to be inconsistent with what we're hearing on the national level. To my comments earlier, our specialist strategy in these low hazard accounts seems to be doing extremely well in this market cycle. I don't think our results are consistent with what you're seeing in the broader economy.
Very good. Thank you very much. Good quarter.
Thank you.
Thank you. I'm showing no further questions at this time. I would now like to turn the conference back over to Douglas Dirks for any closing remarks.
Very good. Thank you everyone for joining us today. We appreciate your participation, your good questions, and we look forward to speaking with you again next quarter. Thank you all very much.
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.