Ladies and gentlemen, thank you for standing by, and welcome to the James River fourth quarter of 2019 results call. At this time, all participants are in the listen-only mode. After the speakers' presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone keypad. If you require any further assistance, you can press star zero. I would now like to hand the conference over to your speaker today, Kevin Copeland, Head of Investor Relations. Thank you. Please go ahead.
Thank you, Carlo. Good morning, everyone, and welcome to the James River Group fourth quarter 2019 earnings conference call. During the call, we will be making forward-looking statements. These statements are based on current beliefs, intentions, expectations, and assumptions that are subject to various risks and uncertainties, which may cause actual results to differ materially. For a discussion of such risks and uncertainties, please see the cautionary language regarding forward-looking statements in yesterday's earnings release and the Risk Factors sections of our most recent Form 10-K, Form 10-Qs, and other reports and filings we make 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 Adam Abram, Chairman and Chief Executive Officer of James River Group.
Thank you, Kevin. Welcome, everybody, to our earnings call. I'm here with Sarah Doran, our CFO, Bob Myron, our President and COO, and we look forward to taking your questions in just a minute. First, a few remarks about the most recent quarter, our past year, and the markets that we are operating in. We're coming off a very good quarter with strong earnings, significant growth in our most profitable core businesses, attractive rates per unit of exposure, and encouraging progress in settling claims arising from the large rideshare account that we terminated late last year. The environment is quite positive. We continue to see very strong submission growth in our core business and are able to write accounts at rates that we think are very attractive. In the fourth quarter, excess and surplus lines rates on renewal accounts were up 6.6%.
That's the 12th quarter in a row we have obtained rate increases. We anticipate this growth in small accounts. The average account size in our E&S business, after all, is in the low $20,000 range, will make up for a significant amount of the rideshare-related premium we left behind last year. The natural diversification in this business, combined with the rate increases we are enjoying, gives us confidence about the ultimate results to be realized from the business we're writing today. Our specialty admitted segment is growing, and we expect that growth to also continue, particularly in the fronting and program area, where we take modest risk and earn fee income. We are seeing more opportunities there than at any previous time in our history. We continue to struggle a bit with our reinsurance business. While profitable overall, our underwriting losses are disappointing to us.
Nonetheless, our presence in Bermuda continues to create value for our shareholders. Roughly one-half of our assets are in Bermuda. It goes without saying that the runoff of the rideshare account has our attention. We're absolutely open to adverse development cover if the economic terms are reasonable and we can continue to manage claims. The management of claims is very important. Bob Myron, along with our head of claims, Courtney Warren, have been highly focused on this process with good results. In just a few months, we have succeeded in lowering claims counts faster than we had anticipated. While we are litigating more claims when we think the claimant is asking for more than owed under the contract, our average cost of claims is going down materially.
In other words, our internal claims handling, unimpeded by any market considerations other than our obligations under the policies, has resulted in our significantly bending the claims cost curve in our favor. We had two external reserve studies performed at year-end, and we did, of course, our own internal work. We feel confident about our reserves, and the progress we are making in the runoff of the canceled account reinforces our view. Our expectation for 2020 is to earn a low double-digit return on tangible equity. As always, we anticipate making an underwriting profit as a group and in each of our segments. It is worth noting that even after the charge we took in the third quarter of 2019, our E&S unit made an underwriting profit in 2019. Of course, our specialty admitted segment reported a combined ratio of under 90% for the 2019 year.
The combined group ratio came in just over 100%. We usually, at this point, offer a bit of color regarding where we found opportunities and where we saw potential pitfalls during the quarter. I'll provide some color about which niches we are seeing the most activity in. There's good news to be reported in both our E&S and our specialty admitted segments. The E&S market is the more robust of the two right now, and one of the tailwinds we have is that the market is that we're being allowed to be more efficient, meaning our quotes for new and renewal business are more likely to be accepted in the current market conditions. Our E&S segment entertained 23% more submissions for business in 2019 than in 2018, and 27% more in the fourth quarter than in the prior fourth quarter.
Our quote ratio on new business remained basically constant during 2019. The number of new E&S accounts written rose by 39%. One reason for the increase in submissions is that some significant carriers are paring large parts of their books where they've lost money in prior years. Much of this business is in classes where we have expertise but have restrained our appetite for risk until now, when we have an opportunity to reprice these risks at more favorable rates. Some of the lines we are seeing more opportunities to quote in are small casualty accounts and in professional liability lines. As we indicated in our press release, our E&S growth has been all across the board. I'm simply making the point now that we believe the current momentum will continue across a wide spectrum of casualty risk.
Similarly, our E&S renewal book proved stickier than it has been, with almost 65% of our policies renewing. This is a few points above the renewal hit ratio we had in the past two years. Each of our E&S divisions, other than Allied Health, grew in 2019. In our core book of E&S, which we define as all of our E&S other than commercial auto, we wrote 55% more premium in 2019 than we did in 2018. This well-priced growth is welcome, and we're addressing the opportunity with an eye toward maintaining good control over our book. We've increased our E&S underwriting and support staff, and our claims staff is handling the same claims load per adjuster as we have maintained since 2013. Of course, we are deploying more sophisticated technology to assist in setting up submissions for review by our growing underwriting staff.
Our specialty admitted segment saw more modest growth than our E&S division. We believe we laid the foundation within specialty admitted for more substantial growth in the 2020 year. Our individual risk workers' compensation business grew by 15.1% as we expanded territory slightly and also distribution. We continue to see strength in our individual risk workers' compensation reserves. We're taking a cautious approach to our individual risk workers' comp business during the coming year. While loss costs do seem to be benign, rates are declining, and we plan to manage the cycle very carefully. Our fronting business, other than our single largest account in California, grew by 51%. We expect this part of our business will continue to expand as we are adding deals, many of which are just beginning to generate premium for us.
In collaboration with the producer, we purposefully contracted the account in California because of market conditions. Premiums in that program were down 27% in the quarter. The reduction in this account somewhat masked the momentum we have in our fronting business. All the specialty admitted segment grew by 3.6%. During the year, we added four new programs and anticipate 2020 will see more growth. I would remind everyone that we typically retain only 5%-10% of the risks on these accounts and earn fees from fronting. I mentioned earlier that our reinsurance segment had a tough underwriting year. We wrote $160.8 million in premium there and anticipate remaining flat to maybe down in 2020.
The majority of our business there is third-party quota share E&S accounts. We have pared it back by 50% over the last two years, shifting the mix of business away from lines and structures we previously wrote, such as non-standard auto and excess of loss. While it grew a bit compared to the prior year quarter, the growth is due to the growth in the underlying E&S treaties we are a party to. Similar to audit premium, the account goes up and we go up with it. With that color, I'd like to turn to Sarah and ask her to add her thoughts and insights about the quarter and the year past.
Thanks, Adam. Let me highlight a few of the financial points for the quarter. Last night, we reported fourth quarter operating earnings of $0.76 per share, an increase of 35% over the prior year quarter. The result reflects very attractive growth in our core E&S business and benign loss activity across our insurance businesses. Net earned premium grew over 16% in our excess and surplus lines segment this quarter, and about 40% in our core E&S business alone. The E&S segment represented over 76% of our total group net earned premiums. From an underwriting perspective, this quarter, we posted a loss ratio of 77.4% and accident year loss ratio of 73.4%, which was consistent for the full year.
In 2019, our continued high accident year loss ratio reflects our cautious approach to reserving, as well as the higher relative loss pick of the commercial auto book, which was 36% of net earned premium for 2019, following the cancellation of our largest account in October. We did not experience any material reserve development in our commercial auto line. The runoff of what was formerly our largest account is performing within our expectations, as Adam mentioned earlier. Our calendar quarter reported loss ratio was considerably lower than that of the fourth quarter of 2018. While we continue to receive new claims, since we are off risk as of December 31st, 2019, the number of reported claims has slowed, and we are actively working to close claims for fair value. At year-end 2019, open claims for all years of the account represented 5.2% of reported claims for the same period.
At the same time last year, open claims for all years of the account represented 7.2%. We are closing claims quickly. Of our approximately $1.4 billion of total group-wide net loss reserves at the end of the year, approximately $400 million of that supported our commercial auto book of business. That is split roughly 50/50 between case and incurred, but not reported reserves. We had adverse loss development of about $9.8 million in our casualty reinsurance book, which is disappointing to us, but it's worth mentioning that about half of this was offset by sliding scale commission adjustments, which come through in the expense ratio. A meaningful amount of this loss was due to one loss from the 2010 treaty year, with the balance due to higher than average claims volumes related to several accident years. We are off risk in the majority of these accounts.
We also had a $1 million takedown of reserves from our individual risk workers' compensation book. Moving on to expenses. Amounts accrued under bonus and compensation expenses were significantly less this quarter as we reduced bonus pools for senior management, given our overall performance this year. This had an effect on the expense ratio in every segment and of course, the group-wide expense ratio for the quarter and year. Turning back to cash flow, we continue to enjoy strong cash flow from our businesses, as operating cash flow was $76 million this quarter and about $290 million year to date. We earned $20.8 million in net investment income this quarter, an increase of 34% from the prior year quarter. The increase largely resulted from the October 2019 addition of approximately $1.2 billion of restricted cash that was previously held in a collateral trust off balance sheet posted by a former insured.
These funds are invested in short-term government securities. We hold them on our balance sheet as restricted cash with a corresponding fund-held liability. The agreements we have in place with our former insured provide that the required collateral increase or decrease depending upon loss development. We currently expect that the required collateral balances will decline over the next two to three years, given we are no longer writing new risks on this account. Since January 1st, 2020, we've already returned about $70 million of collateral to the former insured and therefore would expect it to continue to decline over the course of the year. We increased tangible equity over 14% for the full year, despite paying almost $40 million in dividends.
Our balance sheet and capital position are well able to support the attractive growth we continue to see in our core E&S business, and additional opportunities for growth we are realizing in the specialty admitted segment. As Adam mentioned, we expect to earn a double-digit operating return on tangible book value per share during 2020. Our opportunities to put capital to work at attractive returns for our shareholders are plentiful. Our top line will likely be down modestly in 2020 from where we ended 2019. We expect that our expense ratio will be higher in 2020 without the large account concentration. Our core E&S business has typically produced a lower developed loss and combined ratio than has our commercial auto book, building a case for a compelling group-wide loss and combined ratio.
We are and will actively and carefully manage expenses over the next few quarters as we continue our work to run out the commercial auto book. With that, turn the call back to Adam.
Thank you, Sarah. We're happy to take questions.
At this time, I would like to remind everyone, in order to ask your question, you can simply press star one on your telephone keypad. That's star one to queue for a question. Our first question is from Matt Carletti of JMP. Go ahead. Your question, please.
Thanks. Good morning.
Good morning, Matt.
I just have a few questions. I actually wanted to start with the Casualty Re segment. Sarah, you mentioned that kind of a big piece of the $9 and change million adverse in the quarter was from a 2010 treaty that popped. What sort of risk was that?
That was a casualty risk, a large account casualty risk.
Large account casualty. Okay. Adam, you mentioned in your comments about the growth there that you'd expect it to be flat, possibly down a little. I was hoping you could give us a little bit of color how that might shape over the year, because I know you mentioned kind of the E&S, I don't know what the right term is, but let's call it kind of audit premium, as it grows, it flows through to you. I'd imagine there's still some potential for that. I believe you also have a new fronted relationship there. I don't know if that's kind of all in apple to apple at this point or if that is still going to impact the early quarters of 2020. Just a little help in kind of how that might shape over the year would be helpful.
Yeah. I'll take that, Matt. I think on the new front, the relationships we started that last quarter, we expect that to continue to run over the course of next year. I'm not sure if there was an earlier question there. We're certainly managing the growth or the lack thereof. I mean, the underlying E&S treaties have grown, and that's what you saw this quarter specifically with regard to the growth versus the fourth quarter.
Yeah. Adam.
Go ahead.
You're exactly right. I mean, the book is now 81% small account-
Yes
casualty E&S, That is obviously an area where we're seeing growth in our primary operations. Therefore, we would certainly expect to see. We know that the underlying cedents are getting rate increases, They're obviously getting exposure increases and a lot more opportunities as well. I think we've got to do a careful job of managing the profitability there. There's obviously a relatively simple contractual way to manage the growth there, so to speak, by putting premium caps in our reinsurance treaties, right? To the extent that they're writing a lot more business than they originally anticipated or were sort of expecting from a budgeting perspective, you can manage that through a premium cap, and then you can make a decision to raise that or not along the way.
I think, to the extent you do, maybe there's a good reason to do it because of the type of business that they're producing and the expectation of profitability or maybe you don't, or maybe there's a small concession that you can extract by raising it. It's not as though it just will necessarily happen to us as a result of premium adjustments, and we won't have control over it.
Matt, you can answer that. I mean, probably, you almost certainly know this, but 80% of that book, I think Bob mentioned this already, is E&S casualty small account, and it is a good time to be reinsuring those accounts. That is positive. Almost three quarters, a little less than three quarters of the accounts in our reinsurance group have sliding scale commissions, which protect us. Just over 95% of it is proportional.
Okay.
I think we can manage it within a small band, but there has to be a little bit of elasticity there. We have other protections that are substantial, and we are in a market, and our clients are in a market which is currently pretty positive. We do not plan for this to be large. We are going to take our E&S play on the primary side for the most part.
Yeah.
Got you.
just finish addressing your specific question on the POP, it was a general casualty account, but it is a larger account that would be no longer our focus in the book, Matt. I think I said it, or Adam said in his prepared remarks that roughly 70% of the adverse development this quarter came from accounts that we no longer write. I think that's an important part of the way that we've shifted this book over the last two years.
Great. That's a really helpful color. Then just, Sarah, one numbers question, if I could, for full year 2019, I guess. Can you provide us with, just to help us really for modeling going forward in the E&S segment, what was the accident year loss ratio for the year for those 12 core E&S lines?
Yeah. I would say it was trying to avoid the specific number, but right around 70%.
Okay. That's really helpful. Thank you very much for the color. Best of luck going forward.
Thank you, Matt.
Our next question is from Mark Hughes of SunTrust. Your line is open. Go ahead, please.
Yeah, thank you. Good morning.
Morning, Mark.
Morning, Adam. Sarah, when we think about investment income, what's a good bogey for Q1? The extra funds came in, I think, in October. Obviously, the yield on those are a little lower. You're starting to see the runoff at least. Kind of, what's the Q1 marker? Then we can calculate the tapering from there.
Yeah. It's a great question. I think that where we came out, all things being equal, we were off a little bit in the privates in the fourth quarter, and the investments of the additional $1.2 billion that we've got on balance sheet now came in into the quarter. I think that $20 million number is not an unreasonable number for the quarter, Mark, it's a decent run rate in the fourth quarter going forward.
I don't know if this is too close in, but when we look at the core E&S or E&S on a go-forward basis, excluding the large account, what do we think about the ceded premium ratio? That has kind of bounced around a little bit. It's been a little bit higher lately, but clearly, that has been influenced by your strategy with the commercial auto. When we think about 2020, any sense of what that number ought to be?
Yeah. It will really depend on the growth in the excess casualty line because that's where we cede a fair amount, and we've had a lot of growth in that line in this run over the last four or five quarters. At a high level, I'd think of anywhere from we'd cede anywhere from 20%-30% of that book overall, the core book, Mark.
Okay. Very good. Thank you. Then in the specialty admitted, I'm sorry if I might not have picked from your earlier conversation, but when you take into account the moving parts business outside of that large account, the step down here lately, what does the specialty admitted top line look like? I think it's been mid-single digits lately. Does it get better from here, all things considered?
I think that the big impact over the course of this year is that that large account shrunk by about 25%. We're not anticipating that it's going to shrink by another 25%. We think it's at a good level now. We've taken the rate decreases. We've made the moves that we wanted to on that account. Adam, I don't want to jump over you. I'm sorry. I was just continuing from before, we would expect there would be good growth opportunities now moving forward because at the end of the day, we're basically flat from last year despite taking that leg down on a large account. I think that shows what Adam was saying, really good momentum in the rest of the fronting business.
Exactly. We've already added some programs that are just beginning-
Yeah
to produce premium. We think based on the conversations that are being had in that segment by the segment leader there, we see more business being added during the year that will come on in the second, third, and fourth quarters of this year. Two things. One is we think we will grow, we think we're also setting the stage for additional growth even further down the road. We'll grow this year, the stage should be set for continued growth. Remember, this is a line, I know you know this, Mark, this is a segment where we tend to take less underwriting risk and to be very focused on the fee income, which has a high IRR or ROTE for us.
Just one final question. I'd be curious, any thoughts or any general ideas you might share when you talk about you're pleased with some of the settlement activity in the commercial auto. I know one of the challenges has been the social inflation and higher damage awards. It sounds like you're making some progress on that. Anything more you could say on that front to give us some context?
Yeah. I think, and if Bob wants to chime in here, I would invite him to do it, but let me just start by saying that we are aware, of course, of much of the commentary that we're hearing in the industry about social inflation, we are looking very hard and assiduously for it in our book. To be honest about it, we're not seeing it. We're not seeing it in our reported claims development. We're not seeing it in frequency. We're not seeing it in average claims resolution costs. We are not seeing it in the commercial auto runoff book that Bob has been really very constructively focused on and has had great success in. Bob, do you want to add anything to that?
I wouldn't add a lot more. I guess I would just agree with Adam's comments. I think that the nature of that account being in runoff, then with respect to the rest of the book of business, with the small account casualty type of business, we're just really not seeing social inflation pervasively. We had a very good quarter from a loss emergence perspective overall when you look at the group in terms of reported loss ratios. We've looked into some of the details around this, around % of claims that are in litigation and the like, we're just not seeing a trend in our book of business. So I think it's tough for us to say, but I would attribute it to more medium and larger sized accounts. I think also-
Bigger limits
bigger limits, we don't have a tremendous amount of exposure to more traditional commercial auto, where I think a lot of people have seen that too. All in all, I think we're seeing pretty benign loss trends and not terribly concerned about social inflation. I think it would be remiss of us to not be very focused on looking out for that. We and I are staying in very close contact with our claims group in this regard.
Thank you.
Thank you. Our next question is from Randy Binner of B. Riley. Go ahead, please.
Randy, good morning. Thanks. I wanted to just ask some questions about claims because it seems like in your opening comments, you attributed some of the kind of benign or flat results on reserves in the commercial auto runoff to that. Can you outline what some of your process changes have been there? Do you have more adjusters, and can you quantify the change in closure rates that was mentioned in the opening comments?
Randy, we want to be respectful of all of our clients. We just really avoid getting into conversations where we would be revealing things that are central to a customer's business. That's part of our promise and relationship with them. I really don't want to go deep into any single account. I will say this, that we've got a runoff book. We've got a tremendous amount of focus on getting accurate information about each claim to evaluating first and then valuing each claim quickly, to rapidly paying and closing amounts that are owed, and being assertive in the context of the policy terms and conditions about sticking with the policy terms. I think that the total claims count, we're moving through claims well.
The total claims count, I think outstanding claims is lower today than I even had expected it to be at this point in our development. It is true that more of these claims are going to arbitration and litigation than previously, but previously that was a very rare event, and now it's just consistent with the standard practice in our company and across many companies in terms of the % claims where we have to get someone who wears robes to determine what's the right amount owed or if any amount is owed. This book is now being handled in a very customary way and to really good effect.
Okay, I just got one on programs. It seems as if you're adding programs for fronting programs. Can you just review for us or talk about the market dynamics around the demand for fronting arrangements in light of a soft workers' comp pricing environment in particular, but kind of a somewhat soft casualty lines pricing environment overall?
It's Bob Myron. I'll go first. I think all of, or nearly all of the new opportunities that we're seeing are not really in the comp area.
Okay.
I would say that the demand for this product, so to speak, and the way we do it, which is we have a lot of involvement in both underwriting processes as well as claims, both in terms of establishing guidelines as well as oversight. That's important to the reinsurers in this space, no question. That's our key value proposition in this area. I think the demand for that is high. There's a recognized value in doing that. I would just say, more generally and qualitatively, Terry McCafferty, who's running that segment for us, has a robust pipeline and he's getting an awful lot of overtures in that space for really sort of existing deals that are in force that could potentially move to us of relatively meaningful size.
It's much less about when we first got into this business eight years ago, sort of startup programs and the like. There's a lot of optimism there, too. In terms of the opportunities Terry's seeing, he's doing an awful lot of traveling, but very little of this is sort of outward marketing. This is a lot of stuff that's inbound to him, and then he's going out and seeing people and trying to evaluate these deals. The shingle has not really been sort of hung out in terms of trying to go out and pound the pavement to drum up business. It's just naturally coming to us.
A fair amount of this business, fortunately, is coming to us from our reinsurance partners who are seeking to get a little closer to the primary risk position, but value our contribution in terms of overriding oversight, claims administration, et cetera. These are, in many cases, what we're looking at now are established programs brought to us in partnership by both the MGAs and existing reinsurers on that book. We really like that combination. We provide a service that is valued all the way around, and they're bringing business that we think is attractive and sustainable and has a long history, and also has enough scale to be The larger scale there is very attractive of these larger programs.
All right. Yeah, that was helpful. Thank you.
Thank you. At this moment, I'd like to remind everyone to ask your question, you will need to press star one on your telephone keypad. Our next question is from Meyer Shields of KBW. Go ahead, please.
Thanks. Good morning. I want to start with a big picture question. I know there's a lot of, depending on the insurance company in question, there's a lot of commentary about whether this is or is not a traditional hard market. In the core E&S segment, it looks like we're seeing really the very typical impact on rates and maybe some standard companies pulling out. I want to sort of draw on your expertise, Adam, and say, in those product lines, does this seem like past hard markets? Is there any major difference?
You faded out for just one second, I think your question is, does this seem like a hard market?
Yes.
A traditional hard market. I think it does. It's beginning to have that warm feeling of a market where capacity is challenged. There's a lot of business that's in the market that's looking for a home and has been thrown out someplace else and is going to get repriced with significant increases, and changes in terms and conditions in some cases. Yes, in answer to your question, it feels to me like we're in a very positive, strong market position, and we're seeing it in terms of the submissions that are coming to us. We're seeing it in terms of our hit ratio, that is on new submissions, and we're seeing it in terms of our renewal ratio on our existing business and rate. All of those things are positive.
They all point to a lack of capacity in the market and an ability on our part to service that market and to get good rates and good terms.
Okay. Fantastic. A second E&S question. With regard to the ceded reinsurance, is pricing for that changing in any significant way?
This is our third-party business, Meyer, just to be clear on?
No.
what we're purchasing
that you're buying on the E&S book.
Yeah. It hasn't. Our treaties renew throughout the year, so our last significant renewal there, it's more so in the mid-year process. We have seen very consistent rate stability there. We haven't had material increases. I don't think we've really had increases, and we haven't materially changed the structures at all. Our business has performed well. I think our counterparties have performed well with us. We don't anticipate anything there, and we haven't seen that yet.
Yeah. This is Bob Myron. With the expiry of the commercial auto account, that ceded reinsurance out of E&S is entirely excess of loss.
Yep.
There's no proportional business. I agree with Sarah. There's a June and July renewals, and we saw very reasonable renewal rates back then. Yes, we've had the reinsurers have a good loss experience. I'm just repeating what she said. That's definitely part of it.
No, that's very helpful. Final question, Sarah. I know there are so many moving parts going from 2019, 2020. I was wondering if you could give any rough guidance on normalized tax rate for 2020?
Yes, that's a great question, because obviously there was a lot of noise to our tax rate over the course of this year, Meyer. I think Adam said that roughly half of our invested assets remain in Bermuda with the casualty reinsurance business and other kind of intercompany structures we have. I would think about a tax rate in the mid-teens. A decent savings from the U.S. rate, but that's ticked up a little bit over the last two years as we have more assets on shore. We continue to have a good ballast on the island. Mid-teens is where we'd come out.
Okay, perfect. Thanks so much.
Thank you. We no longer have a question in queue. I would now like to hand the call back to our presenters.
Thank you, operator. Thank you everybody who has participated in the call by asking questions or listening. We appreciate your following our company. We appreciate your interest in it, and we hope to see you, our shareholders, out on the road over the course of the next many months. We will be reporting in next quarter and look forward to that as well. Thank you.
This concludes today's conference call. Thank you all for attending. You may now disconnect.