Good day, ladies and gentlemen, welcome to James River Group Holdings' Q4 2016 earnings conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If anyone should require assistance during the conference, you may press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce Head of Investor Relations, Mr. Kevin Copeland. Please go ahead, sir.
Thank you, Andrew. Good morning, everyone, welcome to the James River Group fourth quarter 2016 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 section 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. Bob Myron, our President and Chief Operating Officer, Sarah Doran, who recently joined us as our Chief Financial Officer, and I are all here together. I want to welcome Sarah and to say how glad we are to have her take a prominent role in directing our company. Welcome also to everyone who's on this call live or taking time to listen to the recorded version. December marked the end of our second year as a publicly traded company, and we really do appreciate your continued interest in our results. As a direct result of the efforts of people all around our company, we enjoyed a very profitable fourth quarter and a full year for 2016.
I think the headlines in our press release, which many of you may have seen, provide a good summary of the value our company delivered to shareholders this quarter and for the year. We had record annual net income. We enjoyed a 24.7% growth in the fourth quarter from our very profitable E&S segment and 20.1% for the full year. We doubled gross fee income from the prior year, and we think that affirms our strategy of growing fee income is working. We enjoyed a 2.3% reduction in our group-wide expense ratio, demonstrating the increasing expense advantage we have when compared to many of our excellent competitors. We earned a 14.6% operating return on tangible equity for the full year. If we added back the dividends that we take, we calculate a 17.2% growth in tangible book value for the year.
We paid $66.3 million in regular and special dividends to shareholders. This represented a 6.5% yield on the weighted average trading price of our stock over the year. As always, the metric we pay most attention to is our underwriting profitability. You may already have noticed that we've reported a group-wide combined ratio of 94.3% for 2016 and 92% for the fourth quarter. This may be an appropriate moment to confirm our guidance. We expect to earn a 12% or better return on tangible equity and to write to a combined ratio of between 92% and 95%. The value proposition we're working to deliver for our shareholder is this: we're highly experienced underwriters who seek to deliver consistent underwriting profits. We grow by seeking opportunities. We shrink when necessary to preserve underwriting profitability.
We underwrite accounts we understand at market prices we believe provide the margin appropriate for the risk we take when we promise coverage to policyholders. We're actively exploring new risks to broaden our opportunities for growth. We eschew lines of business or risk structures we believe introduce substantial volatility in our book. We're low-volatility underwriters. The capital markets underpinning the insurance and reinsurance world have changed substantially over the past many years. Alternative capital sources play a larger role than ever in addressing risk in the United States, where we're focused, and around the world. We're actively working to develop strong and mutually beneficial relationships with these new capital sources and to deliver value to them in return for earning fees that benefit our shareholders by boosting our return on shareholder equity. In part, our growth in fee income reflects that emphasis on our part.
Turning for a second to market conditions before we get to your questions, our E&S segment continues to see record numbers of submissions. We were up 12.8% for the year. We continue, as I mentioned before, to grow very nicely in this profitable area. Rates for the year and for the fourth quarter in the E&S segment are essentially flat. They were down 0.3% for the year. That's a perfectly satisfactory state of affairs for a segment that continues to produce very good underwriting ratios. During the fourth quarter, we were able to grow in commercial auto, in environmental, in excess casualty, in excess property, and sports and entertainment within the E&S segment. In keeping with our focus on underwriting profitably, we wrote less premium in Manufacturers and Contractors, energy, medical professionals, and professional liability.
I'd just like to salute the leadership and the entire team of our E&S division for their terrific underwriting in 2016. In our Specialty Admitted segment, we managed to double gross written premiums for the year from $91 million in 2015 to $182 million in 2016. In keeping with our focus on building partnerships with other capital providers, the Specialty Admitted segment retained only 30% of the written premium. Fee income in this segment almost tripled in the fourth quarter compared to a year ago. More than doubled for the year. This has been an area of focus for us in our Specialty Admitted segment. The management and team there is absolutely delivering on this goal. We salute them, too.
It's worth noting that the directly written workers' compensation book we have in this division also grew and achieved some of the best risk-adjusted rates we've seen in a long time in that segment during the fourth quarter of 2016. Our casualty reinsurance segment essentially broke even on an underwriting basis for the year and for the quarter, reporting a 100.1% combined ratio for the year and a 101.8% combined ratio for the quarter. I suspect many listeners on this call are aware that the environment for casualty reinsurance is tough. We think these are reasonable results in this environment. Our book continues to be insulated from volatility because we write no property. The book is overwhelmingly pro-rata casualty, 94% pro-rata casualty, and we take modest participations on accounts where the underlying policy limits are generally $1 million per occurrence risks.
The existence of our reinsurance segment underpins our corporate structure. You may have already noticed that our estimated group-wide tax rate for 2016 is 6.1%. We believe the book that the management team has put together here is a very solid, low volatility book of casualty reinsurance, well underwritten. Turning quickly to investments, we were pleased with the performance of our investment portfolio for the quarter and the year. Our strategy is to invest the vast majority of our portfolio in traditional high-quality government and corporate bonds. Then to supplement returns by investing a small amount of our total corpus in alternative assets where we expect to earn outsized returns and add meaningfully to our overall investment returns.
Our strategy worked well this quarter. We saw high returns and profits from renewable energy investments. All the other alternatives also made a meaningful contribution to our overall investment returns. We enter 2017 with confidence about our underwriting, bolstered by the knowledge that we begin with a solid balance sheet, appreciative of our shareholders' support and support of all of you on this phone, grateful for the excellent and thoughtful work that all of our colleagues throughout the company do. We're looking forward to another good year together. With that, let me open the floor to questions.
Ladies and gentlemen, at this time, if you have a question, please press star then one on your touchtone telephone. Once again, ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. I'm showing our first question comes from the line of Charles Sebaski with BMO Capital Markets. Your line is now open.
Thank you. Good morning.
Good morning, Charles.
I guess the first question I have is on any update on your kind of sharing economy, new economy business, not on particular lines, just if there's been growth or how much or is that contributing to E&S growth? Has there been any expansion on the client base?
I think in general, we all know, everybody knows that the new economy or capital goods sharing part of the economy continues to grow. We now have, I think, 49 or 50 total accounts that fall under this category, most of them in commercial auto. And yes, we see good growth among many of those clients for us. We think that's really a very interesting business. It's profitable business. To the extent that it's commercial auto business, it tends to have a higher accident year loss ratio, and you may see some escalation in the estimated or forecast or booked current accident year loss ratio in the E&S division where most of that business is written. It's just reflective of the higher loss ratios typically in that commercial auto business, that's offset by lower expense ratios associated with that business.
Across those lines and for all those accounts, we reserve them with essentially the same discipline that we use for our entire book of business, and try to post it in a cautious and current accident year, and then develop. We've also developed an awful lot of expertise in the claims handling side of this business, and I think that's been a key for us being able to develop some of these accounts. It's a growing area of the economy, and it grows for us, and we're very interested in that business. We think it's fascinating.
Excellent. I guess, in any announcement in general, how's the competition, or obviously it's a competitive market. Just curious if there's been any changes over the last quarter, the back half of the year, either with standard markets or new competitors, or how just the overall competitive environment across the lines is looking.
I would characterize it as competitive but highly rational. Absolutely, there are a number of carriers. There is good, healthy competition in that business for the year. I think I said that rates were down for the year, 0.3 of a percent. Actually, in the fourth quarter, rates were slightly up. We see lots of opportunities. We've never, ever had more submissions in our E&S division than we have today. This is the period of highest submission activity we've ever seen. We think there's plenty of opportunity there. There is competition. Remember that we're in the smaller end of this market, small account market, and we think there's really good opportunity there, and we think the margins are holding up quite nicely. Bob, did you want to add to that?
Chuck, just let me add that similar to what we've said in the past, there's more competition in the larger account space, and for us, that's six-figure accounts and up. That's definitely a more competitive space than where our average premium is. I would just echo that in the Excess and Surplus Lines space and also in the Specialty Admitted small account space, the competition is definitely rational, and we're putting business on the books at what we think are perfectly acceptable margins.
All right.
The last piece of that is we continue to see benign underlying loss trends.
One final thought about that is if there is a stimulus program, a meaningful stimulus program in the U.S., that will almost certainly benefit the E&S business, and particularly the small to medium-sized account sector where we write. That will do very well in the context of economic stimulus.
Excellent. I guess then just one final kind of numbers-based question, looking out over this year. Just trying to get a sense on the fee income and how that ramps up over this year, and the kind of benefit we could think that that would have on the expense offset. I know that some of that gets booked through expense offsets. Thinking about your expense ratio going through 2017, is the fee income a couple hundred basis point benefit to the expense ratio in 2017? Is that a reasonable way to think about it?
Yeah. I don't think we want to give specific guidance on where we think fee income will grow or exactly how much of an impact it would have on the expense ratio. I think that we do, however, I think generally expect it to grow as we're getting fee income from a couple of places, as you know. From fronting and programs in the Specialty Admitted segment, clearly the gross written premium there is growing quite a bit. As the gross written turns into earned, our earned fee income will continue to go up. In the servicing of claims, in particular in the commercial auto area, as we continue to get growth there in terms of underlying exposures and miles driven and the like, we would continue to expect fee income to grow in that space as well.
We're just not going to give specific guidance on dollar amounts or necessarily the expense ratio impact.
Okay. Fair enough.
I know-
Oh, please.
Oh, sorry, Chuck. I would just point out that for this quarter in particular, it was a 2.2% reduction to the expense ratio, the fee income.
Excellent. Thanks a lot for the answers, and nice quarter.
Thank you.
Our next question comes from the line of Randy Binner with FBR. Your line is now open.
Hey, Randy.
Hey. Thanks. Good morning. Yeah, I guess I kind of wanted to push a little bit on the guidance, and it's good in this environment as you've laid out. There's a 12% tangible ROE and then 92%-95% in the combined. You did deliver a higher ROE than that in 2016. I think of James River as being conservative historically, but I just want to kind of flesh out how we should think about the accident year loss pick. You mentioned in your previous comments that there's a relationship with a higher loss ratio and a lower expense ratio in a lot of the new economy commercial auto business you're writing. That's still doesn't quite get us as low as we thought that that underlying combined might be.
I guess the gist of the question is this new economy commercial auto where I'm thinking a lot of this growth is coming from, is it going to be like a lower margin, but you make up for it in volume kind of business? Is this a function of a higher accident or loss pick you're putting up because you're growing faster and it's kind of your typical profile conservatism on your initial loss pick?
Let me just start with guidance, let me go back to where you started with the question, which was about our guidance. We thought long and hard, we recognized that in 2016, our results exceeded the guidance that we offered. Really, if you think about a 12% return on tangible equity and a 92%-95% combined ratio, I think that captures the two really important signals that we're trying to send to our shareholders. One is a lack of volatility and a real focus on underwriting. Two, 12% is roughly 1,000 basis points above the risk-free rate. We think that's a signal that we think that our process and our method is going to deliver really good, consistent returns.
I think I approach providing guidance in the same way we approach taking other risks, we are careful to try to articulate goals that we think are ambitious. We are also careful not to set up a situation where we would disappoint. That's the beginning part. The second part you asked was, is the new economy business more or less profitable than the rest of our E&S business? We have targets for profitability in that E&S business. I think the new economy business meets our general targets for that profitability and return on tangible equity. We don't see an overall, if you take the entire book of our business, E&S, Specialty Admitted and casualty reinsurance, I don't think we're anticipating in 2017 a contraction in our underwriting total margins.
The number we're comfortable putting out there is a 12% or better return on tangible equity in a 92%-95% combined, which we think is, in the context of the world, an ambitious target. We'd love to beat it again, I think that's an ambitious target and it's meant to be a strong signal, not without getting over our skis or ahead of ourselves.
That's fair. On the, I guess, just a follow-up question, because this can affect the E&S, I just want to confirm there's no signal here on any sort of change in the tolerance to pay out a special dividend to the extent that your capital levels remain good and remain well supported by the reserve redundancies.
Well, our reserve redundancies and our capital levels are two different issues. To be fair about it, we're very comfortable with our balance sheet and our reserving methodology relative to the information and good insights we get from independent actuaries who look at our book. Our methodology remains consistent. Our position relative to the independent look remains consistent. That's one. Two, we are careful to announce dividends one at a time. We do think we're a well-capitalized company, and I am not today, as I sit here, concerned about our ability to handle the growth we anticipate or the business we anticipate. Our balance sheet is in good shape, and if you looked at our BCAR scores or other, you would see that we're a well-capitalized company. Anything else, Bob or Sarah, on that?
I would just reiterate that I wouldn't take that guidance to signal anything with respect to changes in capital management, but would reiterate that we look at dividends a quarter at a time, in particular, the special dividends, which we'll assess at the end of the year, if anything is to be paid in that respect.
All right. Thanks a lot for the answers.
Right.
Our next question comes from the line of Mark Hughes with SunTrust. Your line is now open.
Yeah, thank you. Good morning. Anything in the Manufacturers and Contractors segment that caught your attention this quarter? I think you said you wrote less business there. Is that a pricing issue? Is there less premium to be had there?
Well, the first thing that I would say about it, Mark, Bob Myron, is that we did grow that division for the year. There was a little bit of a reduction in the quarter. I don't think we take a lot from that. It's always been one of our largest divisions, and so I think it's probably just a little bit of a quarterly adjustment, so to speak. We did have about a 6% growth in that division for the course of 2016. We feel great about where it is and what the prospects are for it going forward. I think, as Adam said, that's certainly one of the divisions that could benefit significantly from economic stimulus, and the pricing in that division continues to be perfectly reasonable.
Right. In the reinsurance, your top line was up in the gross written premium, high single digits. Is the model still to hold that steady, or is it growing a little bit here?
In general, the model is to hold it steady. We had a large percentage growth in the quarter in that segment, but on a dollar basis, I think it was like $12 million or something. It wasn't a lot. I think it was opportunistically just a couple of more treaties than what we were expecting, and relative to last year, a couple of additional small deals. I think the team down here is going to just continue to be opportunistic. In this environment, there is certainly not a charge to grow. To the extent that small additions that are profitable cross their desk and it fits within our underwriting parameters, it's something that they would certainly do and can do.
I think the only thing I'd add on that is there was significant growth over the quarter, but not on a yearly basis. It was really just a timing difference quarter-over-quarter.
Okay.
That signals anything.
Adam, you'd mentioned the new capital sources and how you're developing relationships there, helping out presumably your fee business, Specialty Admitted. What's the pipeline look like? Are we going to see another big contract potentially emerge in 2017?
Well, we don't pre-announce any of this, but we're very interested in that business, and we're talking to a number of really, we think, very solid, very thoughtful players in that industry, and we hope to develop relationships. Can't predict timing or how it would work out, but we think it's an important opportunity for us to fully explore, and our management team is really engaged, I think, in productive ways in those conversations. We'll see what emerges from them.
Finally, you wrote less medical professional. I think that has been the trend. You pointed out fewer doctors are getting kicked out of their coverage these days. Did you see any particular transition at year-end? Or is it just more of the same?
Just I think it's continuation of the trend, and it's just a smaller pool to choose from.
Thank you.
Once again, ladies and gentlemen, if you have a question, please press star then one on your touchtone telephone. Our next question comes from the line of Meyer Shields with KBW. Your line is now open.
Great. Thanks. Good morning. One, I guess small question and one big one. Most commercial auto insurers are reporting unanticipated high frequency and severity trends. Recognize that your reserving has proven to be consistently conservative, how are you reflecting that particular dynamic in the sort of newer economy product lines?
We're spending an awful lot of time analyzing the results in granular detail. You are correct to point out that this is a tricky line of business and that this is not like taxis or some of the other more traditional commercial lines of business. This tends to be new economy rideshare where people are using their own vehicles part of the time and then driving for commercial purposes part of the time. There is a fair amount of technology associated in this. The other thing I would point out to you that much of the noise in the commercial auto business is associated with trucking, and this is passenger auto related business. It's different in that regard.
There's a very big distinction between a mid-size car going down the street and a several thousand trucks barreling down a crowded highway in terms of the consequences of those accidents. We look at it very carefully. It's a very prescribed book. We've got a lot of information on it. We spend a lot of time analyzing it. It does have a higher loss ratio, as I mentioned, than the other parts of our liability book in the E&S sector. You could see that some in the rising current period tick in E&S is that higher tick influences the overall loss ratio there. It also enjoys a somewhat lower expense ratio, which is an offset because we're really focused on the pre-tax bottom line there. I hope that answers your question.
It does. No, it's very helpful. Then sort of a speculative question. Obviously, there's a lot of chatter about lower domestic tax rates in the U.S. I guess the two areas that I would ask you to comment on are, one, whether that lower tax rate could imply more price competition from, let's say, domestic carriers that don't have the same sort of internal quota share arrangements that James River does. Second, whether it's likely to affect the demand for casualty reinsurance to the extent that there is sort of an arbitrage opportunity with a Bermuda-based reinsurer.
Well, the first thing I'm tempted to say is that we consulted with Michael Flynn during the campaign, he assured us there'd be no tax changes. That was meant as a joke, probably not a very funny one.
I liked it.
Thank you. Look, we view underwriting and every single underwriter in our company at every single level of our company are judging pricing and loss costs on a pre-tax basis. We're not sitting there making calculations or ascribing cost of capital at the underwriting level on an after-tax basis. This is a pre-tax business from our point of view, and when we say we're going to make an underwriting profit, we mean we're going to make an underwriting profit pre-tax. If the tax rates go down, that's fine. That'll play out where it is. We've done a lot of work on this. I think it's very confusing for anybody to try to predict where the Congress may or may not come out on this.
I just don't see a tax rate decrease spurring competition because I think most people who are measured on combined ratios are thinking about that as a pre-tax measure.
Okay, did that flow through in terms of your perception of the demand for reinsurance that you meet?
Yes, I think so. Look, much of our reinsurance, if you look at that book, remember that it's 94% pro rata or quota share. Many, in fact, I would say probably the majority of our partners in the reinsurance side of the business are seeking surplus relief. We're supporting them in lines of business where they need additional capital, and we have respect for their underwriting. I don't think a reduction in tax rates will dramatically affect that.
Okay, fantastic. Thank you so much.
Thank you.
At this time, I'm showing no further questions. With that said, I'd like to turn the conference back over to the chairman and CEO, Mr. Adam Abram, for closing remarks.
Thank you, Andrew. Thank you everybody who joined us. A very, very loud thank you to all of the colleagues and associates all around James River for a wonderful 2016 year and a great setup for 2017. We look forward to joining our shareholders and others on this call at the end of the first quarter. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.