Good day, ladies and gentlemen, and w`elcome to third quarter 2018 James River Group L td e arnings conference call. At this time, all participants are in listen only- mode. Later, we will conduct a question- and- answer session. Instruction will follow at that time. If anyone should need operator assistance at any time, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I will now turn the conference over to your host, Kevin Copeland, Head of Investor Relations. You may begin, sir.
Thank you, Nicole. Good morning, everyone, and welcome to the James River Group third quarter 2018 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 Bob Myron, President and Chief Executive Officer of James River Group.
Thank you, Kevin. Good morning, everyone. This is Bob Myron, President and CEO. With me today are Sarah Doran, our CFO, and Kevin Copeland, our Chief Investment Officer, who you just heard from us and who also leads investor relations. We have a few prepared remarks. Then we look forward to taking your questions. We have posted another solid quarter. We've generated an annualized return on tangible equity of 15.1% for the year to date, well above our guidance of 12% or greater. We had good top and bottom line performance in each of our three segments, with underwriting results showing an overall improvement from a year ago, as highlighted in our press release. Our combined ratio for the group came in at 96.0. We had good combined ratios at all three segments.
We didn't have any material property losses in the quarter from any of the noteworthy catastrophic events or otherwise, nor do we currently anticipate any material losses from events in the fourth quarter to date. We had net adverse loss reserve development in two of our segments. It didn't have a significant impact on our underwriting results. Pricing continues to be attractive in our E&S book. I expect market conditions will continue to be positive going forward. Our Specialty Admitted segment continued to see favorable loss emergence that it has year to date. This quarter generated a combined ratio of 87.3%, its lowest in recent memory, as our fronting business is now a meaningful contributor to the segment. Our investment performance was again very strong.
Let me talk about a few of these things in some more detail, and then I'll hand it over to Sarah. Regarding growth, in our E&S segment, we had strong growth overall, growing in eight of our 13 underlying divisions. The commercial auto division grew 17%, substantially assisted by the significant rate increases we previously obtained on our largest account back in March. In our core E&S book, we grew 7.4%. This was substantially driven by strong growth in excess casualty, which was up 28%, in general casualty, which was up 16%, and in environmental, which was up 126%, but on a small premium base. Growth across all three was characterized by both the addition of new accounts and meaningful rate increases on renewals.
Submissions for the E&S segments overall were up 7% in the quarter over a year ago, which is right in line with where we've been in the last two years, 7%-10% per quarter. Our average premium per account in the quarter was about $17,800, which is the lowest it's been in a few years. That's fine with us. It just means that the larger accounts are becoming more competitive, and we're happy to walk away from them if we don't think we can get good pricing. In the Specialty Admitted segment, we grew gross written premiums by 31% in individual risk workers' comp and 14% in the fronting division. This growth is due to increased submission flow, the continued strong economy, and the inception of the new fronted deals we also discussed last quarter. Submissions for our individual risk workers' comp segment were up 60% in the quarter.
This was due to the addition of several new underwriters and marketing staff over the last year or so. In the Casualty Reinsurance segment, while we did shrink the book in line with expectations, the renewal date of about $50 million of premium was pushed out from the third quarter of this year to the fourth, creating a lumpy comparison. With respect to pricing. In core E&S, which is all business in the segment excluding commercial auto, renewal pricing was up 2% in the quarter. When looking only at accounts under $100,000 in premium, renewal pricing was up 3% in the quarter. In our Specialty Admitted segment, rates were down for workers' compensation 1.2%, but net of underlying index loss cost changes, we believe margins held steady.
In the Casualty Reinsurance segment, there was an approximate 3.3% rate increase on the underlying primary contracts and an approximate 1.4% increase in reinsurance treaty pricing this quarter. Let me now speak a bit about loss reserves and our accident year loss picks. In our E&S segment, we had adverse loss reserve development of approximately $10.4 million, which was basically all from the 2016 accident year in our commercial auto division, and principally from one large account in one state. In 2017, we separately priced the state and also had a lower share of the risk that we did in 2016. In 2018, we no longer write the state. Overall, the 2018 accident year in our commercial auto division is developing well, which is a result of very significant increases in pricing, as well as other underwriting actions we have taken in this account in the last two years.
The 2018 contract is approximately three times the size of the 2016 contract. A reduction in the current accident loss pick of a few loss ratio points resulted in an IBNR takedown in the quarter that substantially offset the adverse loss reserve development from the 2016 year. We are comfortable the current year accident year loss pick is still conservative and prudent and are very comfortable with our overall level of reserves in the division and the segment. On a group-wide basis, our case reserves are strong, and our IBNR as a percentage of total reserves is at 63%, which is notable given that we have been wading in shorter tail casualty business in the last few years. On a group-wide basis, our accident year loss ratio was 67.5%, down from 78.2% a year ago, principally from this reduction in the commercial auto current year loss pick.
With that, let me turn the call over to our CFO, Sarah Doran.
Thanks, Bob. Good morning, everyone. For the fourth quarter of 2018, we made strong underwriting profits of $8.1 million, generated an operating profit of $19.4 million, and a reporting net income of $19.6 million. Our combined ratios improved as compared to the prior quarter, as both the loss and expense ratios have declined. While our expense ratio improved as compared to both the third quarter of last year and the second quarter of this year, we continue to believe that a mid-20s expense ratio is very attractive for our franchise and our mix of business. This quarter, the ratio has benefited from the continued growth of our Specialty Admitted business, as well as certain lines within core E&S that entail attractive ceding commissions. Complementing our underwriting performance, investment income grew about 10% as compared to the prior quarter, and even about 3% as compared to sequential quarter.
This was principally due to our larger investment portfolio and rising rates on our floating rate loan portfolio, which more than offset a decline in the renewable energy portfolio. We continue to enjoy strong cash flow from our businesses, as operating cash flow this quarter was $87.8 million as compared to $55.7 million in the third quarter of last year. In line with this, cash and investments have continued to grow and offer about 10% year to date. 12% year to date, excuse me. While we would not expect this growth to continue at current levels, given we have actively reduced our third-party reinsurance business, our portfolio has been the beneficiary of the strong growth in our business these last few quarters. Finally, on taxes. Our effective tax rate this quarter was 11.5%.
While there are many points of impact on our tax rate, we continue to believe that the full-year rate will be similar to historical averages. We ended the quarter with tangible shareholders' equity of $477.7 million, an increase over the $469.4 million at the end of the second quarter of this year. Operating leverage for trailing 12 months net premiums written to tangible equity was 1.5 to one times. As we mentioned in prior quarters, we have elected not to pay a special dividend this year, given the attractive opportunities we continue to see in putting our capital to work in our growing insurance businesses. With that, I'll turn it back to Bob. Bob?
Thank you, Sarah. In closing, I feel great about our performance year to date and for our guidance for the year, there's no change to that. Pricing continues to be up, submissions continue to be up. We are getting strong growth where we are targeting it, and we feel great about the performance of the most recent years in our commercial auto book. This concludes our prepared remarks. Operator, we are now ready to open up the call for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you mute your line once your question has been stated. Our first question comes from Mark Hughes from SunTrust. Your line is now open.
Yeah, thanks very much. Good morning.
Morning.
I wonder if you could talk about the adverse development in the quarter. You've given some very good detail. I'm sort of curious, at maybe a little more practical level, what you're seeing on severity. Are these cases just lingering on in the whatever settlements or payouts higher than expected? How many claims are still going through some sort of adjudication process where they could still continue to develop? Just a little more detail would be helpful.
Sure. Mark, you're talking about the 2016 year specifically?
Yes, exactly. Yep.
The underlying cause of that. Yeah, I would say that it's obviously, as mentioned in the prepared remarks, it's concentrated in Florida, and it's really a severity issue there, and it's really around UM, UIM, and That's underinsured or uninsured motorist related claims. It's not really necessarily related to litigation. It's really more of just settlements on what the absolute value of those claims are. It's really a severity thing based upon the regulatory environment in Florida, and not really frequency driven.
Anything you can say about how many open claims are there, or at least just some sense of the magnitude of the risk that you could have potentially?
Yeah
More adverse?
Yeah, sure. I don't have the statistics specifically for Florida, but I can tell you for the accident year in aggregate, 98% of the claims for the accident year have been closed. It's a pretty substantial number. I think we've said a number of times that this book of business, given what it is and also given our proactive claims handling here, it's meaningfully shorter tail and shorter duration than the rest of our casualty business.
A final question. Your underwriting leverage, is that influencing your growth outlook at all? Are you being a little more selective in the business you'll take in light of your capital situation?
No, I wouldn't say that we are. Only that we're focused on the insurance businesses rather than the reinsurance business. That's where the growth has shown up year to date, and we would continue for it to be so, Mark. That's in line with some of the tax changes that came down at the end of last year and the structural changes that we made that we've been discussing throughout the year. I wouldn't say at all that the capital is influencing the growth in our insurance businesses.
Thank you.
Thank you. Our next question comes from Brian Meredith from UBS. Your line is now open.
Yeah. Thanks. A couple questions here for you. Just curious, Bob and Sarah, 2016 year developed adversely. Why aren't the loss trends that you're seeing in 2016 also impacting your 2017 year picks? I understand it's a different rate on that business is much higher, but wouldn't the loss trends have an impact on the 2017 year also if that's kind of getting elevated?
I mean, a couple of things. First of all, we took significant underwriting and pricing action in 2017, then of course, 2018 as well. We've had pricing increases on top of pricing increases and the re-underwriting actions were principally around the shares of the risks we might take by state, for example, and some other smaller things. Given that the thing that has made 2016 so problematic has really been Florida, whereby we had a materially reduced share of that risk in 2017, along with a separate pricing for that state. That is the reason why we haven't seen it leak into 2017, and 2017 has held.
I think that another important thing in this regard is for the group as a whole, in the past, we've generally had third-party actuarial work done in the latter half of the year and in the fourth quarter. In this year, some of the third-party actuarial work that's done by outsiders that was done in the fourth quarter last year was done in the third quarter of this year, specifically around commercial auto and workers' comp and some other lines of business. The result of that work is reflected in this quarter's results.
Great. Second question on workers' compensation insurance. One very large workers' compensation insurance writer out there noted rising frequency as a result of this very low employment environment. Just curious what your thoughts are on that. Doesn't sound like you're seeing it in your book. Is it something that you're keeping a watchful eye on?
This is in workers' compensation?
Correct. Workers' compensation, your individual comp in your S pecialty Admitted business.
Yeah. I don't think we have seen a real increase in frequency. Maybe I'll weave this into the change in the accident year loss pick. We saw some elevated reported loss ratios in the first nine months of last year. It started to appear as though we were, in particular, getting some severity increases then just with a number of policies in force and/or a number of people in the workforce, some frequency activity as well. That's the reason why on a year to date through last September 30th, 2017, we ended up having a materially higher current accident year loss pick. We put in place the 50% quota share effective October 1st last year. Since that point in time, we've seen nothing but low reported loss ratios again.
They've been meaningfully low right back to the level, excuse me, that they were at in the several prior years prior to 2017. We are not really seeing frequency and severity issues in the workers' compensation book in the last four quarters.
Great.
Yeah. We're absolutely keeping an eye on it.
Yeah
as you expect us to. The increased submission count, that up 60% that Bob mentioned in his prepared remarks, is nice and powerful, but our growth has been pretty moderate, certainly as compared to that, as we want to keep a close eye and be selective around this.
Right.
I mean, comp is cyclical.
Comp is cyclical. We obviously are off a peak from a pricing perspective. I think we've got to watch it really carefully, as Sarah says, just that we will start to see loss cost inflation at some point. We're not seeing it yet, and I think to the extent we do, we're well-protected with a 50% quota share and then a meaningful excess of loss tower as well, that sits on top of that workers' comp book. We're buying $29.4 million excess of $600,000, I think. That should take any severity issues out of the equation as well. We like the ceding commission that we're getting on the quota share treaty there. I think we're in good shape to weather what might be coming. We just haven't seen it yet.
Great. Thanks.
Thank you. Our next question comes from Meyer Shields from KBW. Your line is now open.
Great, thanks. I was wondering whether it's possible to quantify, I guess, by accident year. When you look outside of Florida in commercial auto, the average incurred loss per, I don't know, 1,000 miles, how accident year 2018 compares to accident year 2016 and 2017.
The average incurred loss, I guess you're talking about that from a perspective excluding rates, right? You're just talking about absolute dollars?
Exactly.
Yeah. I think, given our mix, and the fact that with the 40 states that we have, there's some less volatile states in there and some less higher, it's down a little bit, Meyer. Then, of course, on top of that, we've gotten very significant price increases. Then I would also say that there's been some modest frequency declines. That's been because of the driver actions that our client has taken in terms of improving the driver pool. The folks that we deal with there, they're not only the heads of insurance, but also what they call safety division as well, and they've done a lot of good work on better screening for drivers, in terms of culling drivers who have had negative reviews and/or accidents and/or complaints and things like that.
That has manifested itself in the frequency numbers that we've seen as well.
Okay. No, that's very helpful. Second question, as Casualty Reinsurance, I guess setting aside the $50 million timing shift, should the shrinkage in Casualty Reinsurance premiums translate to or have any impact on the investment portfolio duration?
No, I don't think so, Meyer. I mean, the duration of our E&S business and even of the little that we retain in the Specialty Admitted business is not dissimilar to what we write in the casualty rate business. I wouldn't think that the investment duration would be that different either. If I think about the dynamics of answering your question, that's the way I think about it, at least.
Yeah. No, that's exactly what I meant. That's perfect. Thank you so much.
Obviously, we're not absolutely asset liability matching, just given it's a P&C business. Yeah.
Thank you. As a reminder, if you have a question, please press star and then one. Our next question comes from Randy Binner from B. Riley. Your line is now open.
Good morning. Thanks. I came in late, I apologize if this has been asked, can you share what the statutory Schedule P developed loss ratio is for your commercial auto line in 2016 and 2017, including this quarter?
Well, I want to be careful about providing information that's too specific to an individual client. I think the 2016 year obviously is in a significant loss position from a ratio perspective. I think that the 2017 year is not materially different than where it would've been at the end of last year. We feel very good about the conservative accident year pick that we are still booking on the 2018 year, given all the magnitude of the pricing and underwriting changes. 2017 and 2018 are still booked at levels that are resulting in underwriting profits. We feel good about those years.
On operating leverage, I think this may have been covered before, but it seems like it's around 0.8x . The way we measure it is last 12 months net written premiums over total GAAP capital. I understand that there's different ways to measure it, but because it's an offshore company, that's what we use. Just in general, that would be pretty conservative from an operating leverage perspective. I think it would be closer to one. Without the special here, but kind of a good operating outlook for the business, what's the right operating leverage? Is this the right operating leverage we should expect in 2019, 2020, and beyond?
I think that there is room. We measure it a little bit differently. We get to 1.5x-1x , and that's down a little bit from last quarter. It was 1.7x-1x . I think that we have room likely above the 1.7x-1x . We have room from an operating leverage. We obviously have room from a financial leverage perspective as well. There's a fair amount of room to run as we look at the growth opportunities in our insurance businesses over the next year or so. We just felt like that was a better use of capital, and we've been saying that this whole year than paying the special that we don't feel like we get, quite candidly, a lot of credit for, given that we've only been paying it for a couple of years.
We wanted to get the 15% operating return on capital that we've gotten on our business year to date and blow that out over the next couple of quarters with that capital as well, rather than paying the special this year.
How does your calculation work?
Yeah. We get to 1x-1.5x , Randy, which is what I said in my prepared remarks, which is just 12 months net written to GAAP capital, tangible capital.
Tangible capital. Got it.
Yeah.
Okay. Thank you.
That might be the delta.
Thank you. I'm showing no further questions at this time. I would now like to turn the call back to Bob Myron, President and CEO, for any further remarks.
Thank you, everyone, for your time this quarter. We look forward to talking to you again in three months.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.