Thank you for standing by, welcome to the third quarter James River Group earnings call. All lines have been placed on mute to prevent any background noise. After the presentation, there will be a question-and-answer session. Instructions on how to do so will be given at the appropriate time. Thank you. It is now my pleasure to turn the call over to our first speaker for today, Mr. Kevin Copeland, Head of Investor Relations. Sir, you may begin.
Thank you, operator. Good morning, everyone, welcome to the James River Group third quarter 2020 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 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.
Thanks very much, Kevin. As Kevin said, I'm here with Sarah Doran, who's our Chief Financial Officer, and Bob Myron, our Chief Operating Officer. We're looking forward to answering your questions in a minute. Before we do that, we'd like to set the stage with a few observations about our quarter and about market conditions in general. This is one of the most favorable markets I've witnessed in 30 years. The E&S business, which is at the core of our franchise, is growing with more policies in force, substantially higher rates, and lower loss cost. We wrote 28% more E&S premium this quarter than in the prior year. New submissions were up by 9% in E&S, renewal submissions were up 27%.
The increase in renewal submissions is an indication that standard companies continue to retrench and are not seeking to move accounts from the E&S market to the standard market. Eight of our 12 E&S underwriting divisions grew. Trailing 12-month core E&S premium is $615 million, a 91% increase over the same period just two years ago. We continue to be able to get more rate per unit of exposure. This last quarter was the 15th quarter in a row we've reported significant rate increases. In eight of these 15 quarters, renewal rate increases on our E&S business have been greater than 5%. In every quarter this year, rates were up over 10%, and this quarter, rates were up 12.8%. An already hard market continues to gain strength. Year to date, our policies in force have increased by 26%.
While we're growing both premium and policy, claims counts in core E&S are down 15% this quarter compared to 2019. In the most recent months, claims frequency has been dropping rather precipitously. New claims count within E&S were down 18% in April, 31% in May, 15% in June, 11% in July, 23% in August, 9% in September, and 32% through mid-October. This drop in claims counts is all the more notable as we have more policies in force than in prior years, and earned premium from core E&S is increasing. Core E&S claims counts per million dollar in earned premium through the third quarter are 30% lower than the three-year average between 2017 and 2019. Obviously, these trends bode very well for the future. Our fully developed core E&S loss and LAE ratio from 2003 through 2017 is 54.4%.
We're carrying the 2018 through 2020 years at a 65.5% loss and LAE ratio. Our calendar year paid and reported loss ratios in core E&S is 24.5% reported through three quarters. These are among the lowest reported and paid ratios since 2005. Our expense ratio is 24.8% this quarter, down from over 30% in the first quarter. Sarah will speak in a moment about more about this positive trend in expenses. We reported a combined ratio of 85.2% for the E&S division after adding approximately $10 million to reserves for the runoff of the large commercial account canceled at the end of last year. We raised reserves on the runoff book because in September, we observed a spike in medical cost.
This unexpected rise in cost seems to be the result of people with non-life-threatening injuries having postponed surgeries and inpatient treatments due to concerns about being in a hospital or a surgical clinic during the pandemic. We continue to close claims rapidly in this runoff book, and as of quarter end, we've closed slightly more than half the claims outstanding at December 31st, 2019. At this point, we have roughly 2% of the open claims that we ever received from the commercial auto account. This is moving out rapidly. Our rapidly growing and very well priced book of E&S premium can absorb spikes in the runoff costs while still delivering very strong returns to shareholders and maintaining our 65.5% loss in LAE ratio from 2018 to 2020.
In this quarter, we were particularly glad that our focus on casualty business allowed us to avoid significant exposure to, or losses from the very difficult hurricane season or from COVID-19 losses. At the same time, the large industry losses from these events will tend to reinforce the attractive pricing we're benefiting from. Our Specialty Admitted Insurance segment is also gaining traction. Third quarter gross written premiums were 12.1% higher than a year ago. We've added eight new programs within the segment over the course of 2020. Three of these new programs have already added $15.4 million in gross premiums through three quarters, and many others are just beginning to produce premiums and fee income. We enjoyed a 22.8% increase in fee income in the first three quarters. Our net retention of gross written premiums in our Specialty Admitted Insurance segment is under 15%.
We're developing partnerships in which, while we retain some risk to align our interests with reinsurers, we're focused on earning fee income. Year to date, our return on equity in the Specialty Admitted Segment is in the low double digits. Having developed our sea legs in this division, we're directing our marketing efforts towards larger fronting programs. We believe the margins from this business, already good, can still improve. Within the Specialty Admitted Segment, we've reduced net written premiums from workers' compensation policies by about a third, as we feel pricing in that area of the market is a little soft. In our reinsurance division, we wrote $91 million in gross written premiums through 9 months, which was a 21% reduction compared to last year. Some of that reduction is only a timing difference, as the renewal moved from the third to the fourth quarter.
The reinsurance segment has reported 102.1% combined ratio for the quarter. Pricing in the segment is improving, and our internal studies show renewal rate increases, including changes in terms and conditions of 4.3%, 6.4%, and 8.7% in 2018, 2019, and year to date 2020, respectively. I'd now like to address some important and very good news for our company. We announced last evening that Frank D'Orazio, formerly the Chief Operating Officer and Chief of Staff to the CEO of Allied World, will become CEO of James River next week. Some of you will recall that I retired previously and returned in August of 2019. Our company is in a very good position, thanks to the hard work of all my colleagues.
We are in a rising market. It really seemed to me that this was a good time to introduce a new CEO who can make the transition when we are enjoying great momentum. The board conducted a very broad search and attracted many highly qualified candidates. I'm very pleased Frank will be taking the helm. I suspect some of you on this call may already know him. He has tremendous depth as an executive, having run large profitable insurance operations in the U.S. and from Bermuda. His management style and experience fit our culture. He's an underwriter by training, and he has a long history of building successful underwriting businesses. He's keenly aware of the opportunity the hard market presents. Frank and our team have already begun to work on the transition.
I will remain as non-executive chair of the board and look forward to supporting Frank and his executive team. I have no doubt we are in very good hands. I anticipate over time, under Frank's leadership and with the support of the terrific James River team, we will become even more profitable and demonstrate more capabilities than we do today. With that, let me turn the call over to Sarah.
Thanks, Adam. Let me highlight a few of the financial points from the quarter. Last night we reported third quarter operating earnings of $0.56 per share and year to date annualized adjusted net operating return on average tangible equity of 11.9%. As Adam said, market conditions are very attractive for our business, and while early still, revenue has exceeded our early estimates at the start of the pandemic. First, expenses. Our expense ratio decreased to 24.8% this quarter as compared to 34.2% in the first quarter of this year and 29.2% year to date. We mentioned on prior calls that we've been working to reduce expenses and gain efficiency. The ratio also benefited from strong growth in lines where we cede significant premium for attractive ceding commissions, such as excess casualty in our E&S segment.
Gross premiums written in excess casualty have increased over 85% year to date from the third quarter of 2019, as rate increases in that line have been either the highest or amongst the highest across our E&S book. As it's our largest line of business in E&S, it's also pushed the retention ratio in that segment down to 60% this quarter. The expense ratio has also benefited from the offset of sliding scale commissions in our casualty reinsurance portfolio this quarter. We expect that our expense ratio for the full year will be close to our year-to-date figure. Moving on. This quarter, we posted a loss ratio of 69.4% and accident year loss ratio of 66.6%, largely in line with the balance of this year, despite powerful rate increases, low loss emergence, and meaningfully reduced claims frequency.
As Adam highlighted, E&S renewal rate increases were 12.8% this quarter and have increased 30% cumulatively since the start of 2017. Reported losses have remained benign for multiple quarters, falling again this quarter. Core E&S continues to make up approximately 75% of the company's net written premiums and close to half of our $1.3 billion of net reserves. As Adam mentioned, we added $10 million of reserves to our large commercial auto account in runoff this quarter, but had a similar level of reserve takedowns from our core E&S book, which continues to run very well. The reserve increase relates to the 2017 and 2018 years. We've continued to close claims rapidly on this block, closing 14% this quarter, and are receiving very few new claims at this point, almost a year into the runoff.
Through nine months of the year, as Adam said, open claims for all years of the account represented 1.7% of total reported claims for the account. At the end of the fourth quarter of 2019, by comparison, open claims for all years of the account represented 5.2% of reported claims. Of our approximately $1.3 billion of total group-wide net loss reserves at quarter end, approximately $300 million supports the runoff block of business. This quarter, we had $12.9 million of favorable development from our core E&S business emanating from the years 2019 and prior. As Adam said, we continue to hold the most recent three years of our core E&S business at a loss ratio of 65.5%. We had adverse development of about $6.2 million in our casualty reinsurance book, but $2.9 million of this was offset by sliding scale commission adjustments, which come through the expense ratio.
The development was concentrated in a few treaties related to general liability and non-standard and commercial auto business, much of which we no longer write. We also had $2 million of favorable development in our individual risk workers' compensation business within our Specialty Admitted segment. Finally, on investments. Net investment income for the third quarter was similar to last quarter, at $15 million. A decrease from the same quarter last year, largely due to lower income from our bank loan portfolio and to a lesser degree, from our renewable energy portfolio. We sold about $100 million of our bank loan portfolio back in the second quarter, and the impact of that has been to reduce gross yields on the portfolio. This quarter, our gross yield was 3.2%, or about 70 basis points reduced from the third quarter of 2019.
Returns on our small $30 million renewable energy portfolio was decreased due to the manager's revaluation of the assets which flowed through to us. Those investments have benefited us well for many years. Lastly, I know I speak for my colleagues when I thank Adam for his deep strategic and entrepreneurial insight, his thoughtful and energetic leadership, and generous friendship. He and Bob have led us on a path of success, and we look forward to more ahead. I've had the benefit of working with Frank, and I'm very excited to welcome him as our CEO. With that, let me turn the call back to Adam. Adam?
Thank you, Sarah. Operator, we're ready to take questions if there are any.
Thank you, sir. At this time, I would like to remind everyone, in order to ask a question, please press star one on your phone. Again, star one. If you wish to cancel your request, please press the pound or hash key. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Mark Hughes from Truist. Your line is open.
Yeah, thank you. Good morning.
Morning, Mark.
The claims frequency statistics you provided are very interesting. Any judgment you formed about what is causing that? Are these delayed reports that are going to come later? What kind of influences your thinking one way or the other about how material this is to the business?
I think it's really material. What I was talking about are claims from our core E&S book, and I wouldn't expect any change in the speed or pattern of reporting of claims. I just think that frequency is going down. I do think the most likely explanation for that is the continued pandemic. We are in a happy position, and the industry is in a happy position of capital constraints across the industry leading to increases in rate, and which we regret, the diminishment of economic activity, of course, and what's implied by that. That has led to just fewer events occurring that will give rise to claims. I think that this decrease in claims for each period that we have it, is not a deferral. It is an indication that the claims will not arise later.
Every book has late reported claims, but that's never been a huge problem in our book of business because of the layers we write. Remember that we mostly buy primary layers. I think this is an indication that these years that we're holding at, I think, a cautious, careful 65.5% will develop really well. They could prove to be some of the best years in our history ever.
The increases on September in medical costs in the runoff reserves, I think you'd suggested that your observation was there was a delayed treatment. How has that progressed in recent weeks? Is there more information that bears on the duration of this step up in expenses?
Listen, earlier in the quarter, we weren't seeing it. It just really came up in the last couple of weeks of September. We just jumped on it, was our reaction to it. Let's jump on it. We're doing everything we can to unearth this information early. Sometimes it's a little bit more difficult than you think to do that, but we are trying to unearth that information and get to it as fast as possible. One thing I would say is, look, in the context of our growing core E&S book, and the way we're holding our reserves for the 18 through 20 years, and the fact that simultaneously we have so thoroughly reduced, thoroughly is probably not the right word for me, but so substantially reduced both the claims count and the percentage of open claims.
I'm really feeling just fine about where we are in that runoff. It doesn't stop us from wanting to react very quickly to a very small piece of data because we're staying on top of it. I'm not overly troubled by it.
Understood. One more question on small business. There's been a lot of question about the impact of COVID on small business. What does that mean for small mid-size account E&S underwriters? Any observations you got about the small business trends?
Yeah. Look, we're up in small business, we've done well in small business. It's not the core, it's a small division of our company. I want to make that point that our average premium in casualty is about $23,000, our small business division is a much lower average premium, though it is a growing part of our book. I think that was tremendously helped. Small businesses were boosted, I think, more than some of the rest of our book by the stimulus packages. I'm hoping and believing that there will be another stimulus package after the election. If there isn't, it won't affect our book, I don't think tremendously, because small business is relatively a minor part of our total E&S premium.
Two, because the capital constraints in the industry as a whole are what is really driving the rate increase that and prior year development that you're seeing in the announcements of many companies.
Thank you.
Hey, this is Bob Myron. Let me just add a comment there. Within our small business division, probably the biggest class therein is really small contractors. As Adam said, that continued to be fine from a production standpoint during the quarter. In our general casualty division, not surprisingly, we did see a decline in some bars, restaurants, and taverns. The other major class of that division is habitational related risks, and there's tremendous demand for E&S product and very strong pricing power in that space. Bars, restaurants, and taverns is not a huge part of that division, Mark.
Yeah. Just jumping on what Bob is saying. Sorry, Bob. Your really good point caused me to flip a page here and just check a number. I do want to say that, look, our small business division for the quarter is up. It's $6.3 million we wrote, but it's up 25%. It's not like we're seeing a decline. It is because, as Bob points out, it's got a lot of small contractors in there. As anybody who's watching residential development sales knows, there's been a real constraint on people who can build houses or decks or do renovations for you, et cetera. Our general casualty division, where we write larger risks, is also up. It was up 7.6% in the quarter.
Very helpful. Thank you all.
Our next question comes from the line of Matt Carletti from JMP. Your line is open.
Hey, thanks. Good morning.
Good morning.
Adam, I just wanted to ask you if you could help unpack the core E&S business a little bit for us. We see a lot of statistics that you give, which are very helpful. I know that rate increases can bounce around based on mix of business in any given quarter. We're also getting into the cycle where I'm pretty sure your clients are starting to get second round and third round of rate increases, we're getting that compounding effect. Can you just help us understand, as you look at your business, which of the dozen or so classes of business in E&S you view as really being the most exciting for you guys?
As you think about it, not just from a price change perspective, how do you view some of those businesses or the group as a whole in terms of absolute pricing as opposed to the other point in history?
I'm going to start with absolute pricing. We've had significant continual increases, quarter-over-quarter increases in pricing on a book that was already delivering good combined ratios before we started the price increases. I just want to start there. These price increases, I think, are helping an already healthy book. It's healthy in our case, I think, because of where we've selected to play, and frankly, because of the high-quality underwriting that's being done by our underwriting desk and our leadership teams across the company. If it weren't for their skill set I'd be less confident. They have produced great combined ratios for a lot of years, as I was mentioning, in terms of what the average has been for many years.
We grew this quarter, year-to-date, we've been growing in general casualty, life sciences, manufacturers and contractors, professional liability, small business, sports and entertainment, excess casualty, and excess property. The excess casualty growth, of course, really helps us with our expense ratio, and so does the excess property because of the way we've got that structured. It's probably worth mentioning that the way we write our excess property, we only had $2 million, roughly, of exposure to the most recent storms. It was absorbed in our reported loss ratio. One of the things we do is don't expose ourselves to catastrophe losses. We did the same thing in the excess casualty with keeping a relatively modest line there.
I do not think we are finished as an industry with the rate increases, if you look at our submission rate and you look at our higher retention rate, I think you can expect, and we do expect, to continue this trend for some time to come. I don't think we're at the top.
Great. That's very helpful. Congrats on the next retirement. I hope you enjoy it, very warm welcome to Frank.
By the way, this transition, I'll just take this opportunity to say we have been working, and the whole team has started working very closely with Frank. We're in the very early stages of it, but this transition is going very well. His management style is just really in tune with the attitudes and underwriting focus that we have as a company. He's fitting right into the culture, and he will bring new skills and deep experience to the company. He's going to add a lot to our company, and I am really excited about what we're going to see under his leadership.
Great. Thanks.
Our next question comes from the line of Randy Binner from B. Riley. Your line is open.
Hey, good morning. Yeah, Adam, congrats, and nice working with you again, until the next time you come back, I guess. On net investment income, I wanted to see, you said there were some changes there. What can get that above this $15 million a quarter run rate? Are there alternative investments or partnerships or things you can do that are different to possibly get that running higher?
Thanks for the question, Randy. It's Sarah. It's tough in the yield environment that we're all living in right now to push that much above the $15 million a quarter that we've been generating for the last little bit. I do think there are probably some things we could do around the edges, right now, I think we're trying to manage this interest rate environment as best we can, and I know our competitors are as well. Looking to consider potentially a little bit more risk over the next year or so, right now we're pretty comfortable with the portfolio that we have, having wanted to de-risk that volatility and focused on our underwriting returns and our attractive opportunities to grow core E&S and all the other things we're doing there.
We view it as a portfolio and a trade-off, while we'll look for other things, I think, the environment is what it is to some degree at this moment.
Fair enough. I apologize, I had to miss part of the call, just on fronting, I guess, there's a lot of focus here on E&S, rightfully so, just on the kind of the fronting side, what inning is that opportunity in, and can you just dimension that a little bit more? Are you getting more looks and opportunities and kind of what the demand function is there? Because the underlying risk is a little bit different.
I'm going to get Bob Myron involved in this because he's been intimately involved. We're all very excited about the advances that Falls Lake, which is our specialty admitted group, has made the new programs, which are really fee-generating programs because of the small retentions we keep. We think this is an area that has expanded as a percent really well. It's already delivering low double digits of return on equity, but I think we're just beginning. Bob, do you want to jump in here and comment on some of the work that you and the team there have been doing?
Yeah. I think it's still the early innings here. We certainly have been at it for a while, but we're continuing to invest a lot of time and we now have full E&S licensure, and we've got several statutory entities, Randy, that are involved here. I think one of the areas that we're seeing growth and opportunity certainly is in fronting for E&S related deals and/or risks. Most of this is in the commercial line space. I think that there is a tremendous demand for increasing demand for the product.
One of the reasons why perhaps in the past we haven't grown as much as we would like is that a meaningful amount of basically our gross premiums written in this segment are workers' compensation, which has been a challenge, has been a declining pricing environment, and we've been also watching classes and exposure really, really closely. That shouldn't diminish the work that Terry McCafferty and his team have done. They've put on a number of new deals this year. I would say that the size of these deals is increasing relative to what it's been in the past when we're putting on new deals or getting more interest in rollover deals. I think that has an in-force book of business already and can be meaningfully large when it comes on board for us.
We're going to continue to focus on that, working on building relationships, and developing relationships on some potentially larger transactions. The group is all working together on that. I think also we'll get some leverage from Frank in that regard too. I think the outlook is positive in terms of our ability to really grow that meaningfully in the future and really grow the fee income there.
Great. I think a fronting is being more admitted on the comp side. Can you roughly break out what your programs are right now between admitted and not admitted?
Yeah. I don't know if I have that information at hand. I would say because of the fact that we're writing $60 million of gross of individual risk workers' comp business, which is 70% ceded away and $140 million of California workers' comp related business. It's probably somewhere 70%-80% right now that's actually admitted market business, right?
Right.
The percentage of E&S has been growing.
All right. I'll leave it there. Thanks a lot.
Our next question comes from the line of Sean Reitenbach from KBW. Your line is open.
Good morning. Adam, we at KBW wish you the best, and we're looking forward to getting to know Frank. The rate commentary has been pretty positive, and it's been going on a bit. Do you feel rates are mostly adequate too, or are there still a few areas that need to see more rate in your book before you would say it's broadly adequate? Maybe how would rates be impacted, you think, if a corporate tax rate hike becomes increasingly likely?
Well, look, I think if you looked at the history that we've been citing of our historic developed loss in LAE ratio, you see that rates, we think that we've been writing business that was adequately priced for many years. I quoted the 13 years worth of experience in the 52.5% fully developed loss in LAE ratio. We feel our historic book has been adequately priced. The price increases that we're getting in the last few years, in the last 15 quarters, I think are expanding our margin. There is, of course, the question of, well, is there social inflation? Remember that we've always concentrated very heavily on the first $1 million, the primary layer here. We've already been exposed to that first $1 million, and that's not where the social inflation is really being felt.
I think these rate increases are helping. I think they are expanding our margin and think it's a really good harbinger for future results. There was a second part. Did I miss the second part of your question?
Just how you would think a corporate tax rate hike might affect rate momentum that might further accelerate rates.
Well, look, taxes are just one part of the return on tangible equity. I think if I look at our increase in rates, they're probably better or greater than what we'll see in terms of a corporate tax hike, but I'm not a crystal ball reader. The whole industry will have to face the same hike in rates, and we'll all have to respond individually to that to make sure that we maintain margins. The industry is very focused. If you just see the commentary from CEOs across the board in the U.S. P&C industry, you're seeing that there is a tremendous emphasis on what we have to do as an industry to get margin. I think that there's a lot of momentum here. While interest rates are low, the only place to go, really, is rate.
Great, thank you. Given your comments and the double-digit rate on top of rate, would it be reasonable for us to expect low to even mid-single-digit improvement in the accident year loss ratio next year?
Tempting though it is, we're not going to pre-announce.
Okay, thank you.
We do have a follow-up question from Mark Hughes from Truist. Your line is open.
Sarah, the ceding commission in the E&S, what's the typical percentage on that? Is it 25, 30, something like that?
It starts with a three.
Starts with a three.
In the 30s. Yep.
And then-
That's a meaningful benefit to the expense ratio, and obviously, we've already talked about the retentions in the segment.
Yeah. I'm sorry, I don't know if you mentioned this, but your updated thoughts on expense ratio, both within I'm actually interested kind of across the board, E&S, Specialty Admitted, and then overall, is Q3 a good barometer?
It's a good question, Mark. I think about the expense ratio. I think the 9-month year-to-date is a good barometer for where we're going to be on the year. That's going to hold true to all the segments. Although, I think the real thing that I'm not going to be able to predict, which is good, is the real strength in the excess casualty market, in particular within core E&S.
Obviously, there's been great rate in that line. It's one of the best rate performers in all of our E&S book. We've grown it substantially, and it's had a material impact on the expense ratio. I think that could continue to be favorable on the E&S expense ratio. I think there were some one-offs in casualty reinsurance this quarter. That's why I'm not particularly focused on the quarter, but really think about the 9-month numbers across the board.
In specialty admitted, it's kind of the same situation. You've got fee income that's offsetting the expenses. The year-to-date, I hear what you're saying, but then the year-to-date is different than 3Q, clearly. Is there some reason why things shouldn't be as good as 3Q, particularly in specialty admitted and E&S, or is that more conservatism?
No, I'm talking about year-to-date. We'd end the year-to-date with the full year, not particularly in the fourth quarter. I know I'm mixing and matching a little bit there.
Yeah.
On Specialty Admitted, there were some small one-offs, and there's not a lot of premium in that segment, again, with the focus on the fronted business. I think about the run rate in that segment for where we are now, and we'll get a benefit as we continue to grow the fronted business of being closer to that 20%-21% where we are on a nine-month basis there. I'm happy to follow up in more detail offline if that's helpful too.
Yeah. No, I think I'm good. I appreciate that help.
Thanks for the questions.
Once again, if you wish to ask a question, please press star one on your phone. Again, star one. Again, star one to ask a question.
Okay.
There are no further questions at this time.
We're all set if there are no more questions, operator.
Operator, thank you, and everybody on the phone call, thank you very much for your attention to our company and following us, and we look forward to reporting, and you'll be hearing from Frank next quarter. I think we're very excited with the prospect of his leadership. Thank you, and we'll speak soon.
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you all for joining, and we all disconnect.