Ladies and gentlemen, thank you for standing by and welcome to Q2 2018 James River Group Holdings, Ltd. Earnings Conference Call. At this time, all participants are on a listen-only mode. Later we'll conduct a question-and-answer session. Instructions will follow at that time. If you require any assistance during the call, please press star then zero for operator assistance. As a reminder, this conference may be recorded. At this time, I would like to turn the conference call over to Mr. Kevin Copeland, Head of Investor Relations. You may begin.
Thank you, Livia. Good morning, everyone, and welcome to the James River Group second 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, Chief Executive Officer of James River Group.
Thanks, Kevin, and good morning, everyone. This is Bob Myron, President and CEO, and with me today are Sarah Doran, our CFO, and Kevin Copeland, our Chief Investment Officer, who also leads IR for us. We have a few prepared remarks, and then we look forward to taking your questions. We have posted another solid quarter, generating an annualized return on tangible equity of 15%. 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 97.3, and we had good combined ratios at all three segments.
We had a small amount of net adverse loss reserve development, but it didn't have a significant impact on our underwriting results, in part because our expense ratio continues to decrease and is at a great absolute level in the quarter at 23.1. Pricing continues to be attractive in our E&S book, and I expect market conditions will continue to move in the right direction. Our investment performance was very strong. Let me talk about a few of these things in some more detail, and then I'll ask Sarah to do the same. Regarding growth, in our E&S segment, we had strong growth overall, growing in 9 of 13 underlying divisions. The commercial auto division grew 25%, substantially assisted by the rate increases we previously obtained on our largest account back in March. In our core E&S book, we grew 15.3%.
The growth in commercial auto is moderating, as in the current contract period for our largest account, we are insuring 40 states, down from 49 states in the previous contract. We mentioned this in our call with you last quarter. We still expect commercial auto to grow, just at a more modest pace than it did last year. In core E&S, we saw strong growth in general casualty, which was up 60%, in excess casualty, which was up 43%, and in environmental, which was up 20%. Submissions for the E&S segment overall were up 10% in the quarter over a year ago. In the specialty admitted segment, we grew gross written premiums by 31% in individual risk workers' comp and 26% in the fronting division. This growth is due to increased submission flow, the continued strong economy, and the increased growth of our largest fronted deal.
Over the last few months, we have added three new fronted deals, which should generate additional gross written premium growth and, more importantly, attractive fee income in the coming quarters. New business submissions for our individual risk workers' comp segment were up 47% in the quarter. This was due to the addition of several new underwriters and marketing staff in the recent past. In the casualty reinsurance segment, we shrunk by 54%, which was in line with our expectations as we refine the book and focus on more profitable accounts. Now 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. While this is a drop-off from the amount we reported in Q1, some of the decline was driven by the pricing of large renewals with favorable loss histories.
Excluding two large renewals that we booked at material price declines in our environmental and energy divisions, core E&S rates were up 4%. Another reason for the decline versus the 13% we achieved in Q1 was a much larger dollar amount of Allied Health accounts renewing in the first quarter. We only had about $3 million of Allied Health renewals this quarter. As always, going forward, we will seek the best rate increases we can achieve in the current marketplace while not materially impacting retention rates. In our specialty admitted segment, rates were down for workers' compensation 1%, but net of underlying index loss cost changes, we believe margins held steady or improved. In the casualty reinsurance segment, there was an approximate 5% rate increase on the underlying primary contracts and an approximate 1% increase in reinsurance treaty pricing in the quarter.
Let me speak a bit about accident year loss picks and loss reserves, as well as loss emergence. In our E&S segment, our accident year loss pick increased approximately half a point on a sequential quarter basis. This was due to both increased weighting of our commercial auto division earned premium, as well as our ongoing approach of making prudent and conservative accident year loss picks in the core E&S book. On a group-wide basis, our accident year loss ratio was 73.2, up about three points from a year ago for the same reasons. With respect to loss reserve development in our casualty re-segment, we had some adverse loss reserve development from business written several years ago, and nearly all of it was from excess of loss reinsurance or proportional reinsurance of excess of loss business.
The amount of business that we put on the books now of this type in this segment is negligible. I'd like to highlight that even with the adverse prior year loss reserve development in this segment, we were able to deliver a 96.8 combined ratio, which was a slight improvement from the first quarter of this year. This is because the more recent business we have put on the books in this segment is running well. While the quarter did show loss emergence above expectations, the first quarter of the year showed loss emergence less than expected. On a year-to-date basis, we are in line in that segment. Within the specialty admitted segment, looking at reported loss ratios, loss emergence has been materially lower than it was a year ago on a year-to-date basis.
Within the E&S segment and specialty admitted segments, we were basically flat on loss reserve development. In E&S, we had $2 million-$3 million of favorable development in core lines, offset by $2 million-$3 million of adverse development in commercial auto. Like in the casualty re-segment, in core E&S, we had loss emergence that was a bit less than expected in Q1 this year, and in Q2, it was a little more than expected. On a year-to-date basis, we are basically flat. In the commercial auto division, while we did book a small amount of adverse development in the quarter, on a year-to-date basis, the reported loss ratio is materially lower than it was a year ago. It is worth mentioning again that we have had substantial price increases in our largest account in commercial auto over the last two years.
We are booking a prudent and conservative accident year loss pick in the commercial auto division. Thus, we are highly confident in our overall level of reserves for both the division and the segment as a whole. The 2018 accident year in particular is off to a positive start from a loss emergence perspective. With that, let me turn the call over to Sarah Doran, our CFO.
Thanks, Bob, and good morning, everyone. For the second quarter of 2018, we made underwriting profits of $5.5 million, generated an operating profit of $17.6 million, reporting net income of $17 million. As Bob mentioned, our combined ratio was modestly improved as compared to the prior quarter, in part given our low expense ratio. While our expense ratio improved as compared to both the second quarter of last year and the first quarter of this year, we continue to believe that a mid-20s expense ratio is extremely attractive for our franchise and mix of business. Complementing our underwriting performance, investment income was up 18% as compared to the second quarter of 2017. This was principally due to our larger investment portfolio, rising yields, and strong performance from our alternatives portfolio, as has been the case through our history.
We continue to enjoy strong cash flow from our businesses, as operating cash flow this quarter was $115.6 million as compared to $49 million in the second quarter of last year. In line with this, cash investments have continued to grow and are up about 7% year to date. While we would not expect this growth to continue at current levels, our portfolio has been the beneficiary of the strong growth in our business these last few quarters. A brief note on our external reinsurance renewals, many of which occurred during the second quarter. We were pleased to renew our significant coverage at little to no change in pricing and to be able to expand coverage to match our growth in certain lines of business. We continue to use our reinsurance strategy as a key capital management tool. Finally, on taxes, our effective tax rate this quarter was 8.2%.
While there are many points of impact to our tax rate, we continue to believe that the full-year rate will be similar to historical averages and therefore likely a few points higher than it was this quarter. We ended the quarter with tangible shareholders' equity of $469.4 million, an increase over the $465.8 million at the end of the first quarter of 2018. Operating leverage or trailing 12 months net premiums written to tangible equity was 1.7 times to one. With that, let me turn it back to Bob.
Thank you, Sarah. In closing, I feel great about our prospects going forward. Pricing is up, submissions are up, loss costs are reasonable. We are getting strong growth where we are targeting it, and the continued economic expansion of the U.S. economy will continue to drive positive exposure growth. This concludes our prepared remarks. Operator, we are now ready to open the call up for questions.
Ladies and gentlemen, at this time, if you have a question, please press the star then the number one key on your touch-tone 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 please place your line on mute once your question has been stated. As reminded, to ask a question, please press the star then the number one key on your touch-tone telephone. Our first question coming from the line of Randy Binner with B. Riley FBR. Your line is open.
Good morning. Thank you. I just had a couple questions about the commercial auto activity on the reserve side in the quarter. Bob, I think you mentioned in the call that it was relatively modest and that the 2018 accident year is off to a positive start. The two questions is, one, is there a way to kind of size what that move in commercial auto was versus the offset from other E&S? That's a dynamic we've seen in years past. If 2018's looking good, just curious where the adverse came from, accident year-wise, for commercial auto.
Yeah. I think we said this, if I understand your first part of your question correctly, I said this, is that there was about $2 million-$3 million of adverse development in commercial auto offset by about $2 million-$3 million of positive development in other core E&S lines. That's how we ended up flat. In terms of where it came from, it was mostly from 2016. Overall, a very small number. I would just reiterate that we're seeing the reported underlying loss ratio in this division be substantially lower than it was a year ago. As you pointed out, we are booking what we think is a very good current accident year loss pick as we are earning premium on the current contract.
Okay. That's a big thing.
We feel good about the overall level of reserves in that division.
That would be a pretty dramatic improvement in how reserves are developing. I think that move in the 2016 accident year and 2017 was a number that's maybe like $35 million roughly. This is obviously much smaller. This is just a quarter, but still, it seems smaller, and your comments are positive. You have pricing that's better, but you mentioned loss activity is better. Just thinking about that category of risk, what has kind of supported such a significant improvement in that exposure?
Well, I think it's a number of things. I think it's, as we've highlighted, substantial price increases over the last two years, both in terms of the 2017 and the 2018 renewal. There has been some re-underwriting actions that aren't specifically related to rate with respect to share that we may take of the risk, what we're getting paid for fees from a claim handling perspective that ends up getting booked as premium. The states that we're actually insuring and how those states perform. There's some relatively state-specific performance that we've talked about before. There's a number of different factors.
I think there's less geographies you're covering in that book. Would you expect to continue to kind of shed certain geographies as you lock in on the more profitable aspect of that block?
I wouldn't say that we would, Randy. I mean, at this point in time, we're just four months into the new contract. As of right now, we don't have any expectation of any changes. Obviously, as we get into the winter, when we start renewal discussions, we'll see about that. We're still the largest insurer of these guys in terms of their U.S. risks, and 40 states is a significant number, and obviously a majority of the mileages that they have driven across the United States. We don't expect any changes right now. I mean, there could be some paring down, but I don't see it right now.
Okay. That's really helpful. Thank you.
Our next question coming from the line of Mark Hughes with SunTrust Bank. Your line is now open.
Thank you. Good morning.
Good morning.
Bob, when you talk about reported underlying losses are good, are you referring to frequency and severity, as opposed to kind of the financially reported or booked losses? I think you're making the distinction between what your experience is versus what you're actually putting up for loss reserves. Could you clarify that a bit?
Yeah. Well, I think you're exactly right. Obviously, we booked what we did in the quarter when you look across casualty, re, specialty admitted, core E&S, and then the commercial auto division. I was just adding some color around what the underlying reported loss activity, really looking at reported loss ratios, which would be paid plus change in case incurred outstanding, that ratio relative to a year ago, and those were year-to-date statistics that I was quoting. Specialty admitted is running very well relative to a year ago. Core is basically flat. Commercial auto is down, and casualty re is basically flat as well.
I think that answers another question that we were anticipating getting because other people have gotten this as well is, in particular in core E&S, which is maybe the best measurement, and we're not really seeing a big change in underlying loss cost trend. Now, we're trying to book a prudent and conservative accident year pick in case that happens, but on a year-to-date basis, we're not really seeing that.
Right. That's helpful. How about loss emergence on the 2017 accident year for the commercial auto? Can you comment about that?
De minimis. Negligible. Not a big number at all.
Okay. Coming in line with expectations?
Yes.
You said in workers' comp, your pricing is down 1%. Is that on an absolute basis it's down 1%, or is that taking into account the loss costs as well? If you follow me, is it loss cost plus 1%, or is it 1% on absolute terms?
No, it's on absolute terms, we're sort of looking at that on a pure premium basis. What we also look at, as we should, is what do we think the underlying loss cost trend is there. It's basically down. I think we think that the margins are holding or perhaps even expanding in comp. Even with a price decline, I think there's this positive margin there.
Is there some particular niche that you're finding that kind of good pricing? Is that your, I think you mentioned some expansion in staff and marketing folks, that sort of thing.
No. I don't think there's anything that we would point to in particular. The book is a lot more diverse than it was certainly when I came here several years ago. It was very focused on one state and 90% contractors business. Now contractors is one of the larger classes, but there's a number of other classes there. I'd say in general, it was pretty broad that rates are holding up for us.
We still have exposure to a state like California, for example. Still a regionally focused, largely four states for the most part book.
Yeah. For that individual risk workers' comp book.
Yeah. For that book.
Then finally, in specialty admitted, sounds like activity's picking up in terms of some new agreements. How's the pipeline behind that looking?
I think it's good. Nothing is booked until it's bound, I guess I would say, right? As Sarah has always pointed out, this definitely is lumpy, I think because you don't do anything for a quarter or two, then you get a new $40 million deal. I think the pipeline is pretty robust. It's always been a little difficult to forecast, but I think we made mention of three that we've put on that we think are going to continue to drive some year-over-year gross written premium growth and fee income growth in the coming quarters relative to a year ago.
Thank you very much.
Okay.
Our next question coming from the line of Matthew Carletti with JMP Securities. Your line is now open.
Bob, I wanted to go back to the commentary you had on the core E&S rates, and it sounds like mix shift, just changes in mix of business impacted kind of the aggregate number.
Yep.
Just looking at the individual lines, I think there's about 12 of them. Forgetting mix, just kind of looking at each line and what pricing did, how would you characterize that? Did it largely hold in kind of the levels it was at, and therefore we're just kind of seeing, say, a 4% number because of where the business was written this quarter? Or did you see a little bit of slowdown kind of in the absolute levels of increase in those lines, a little cooling off?
Yeah. That's a good question, and I think let's try and look at this on a little bit more of a normalized basis. We got 6% in Q4, 13% in Q1, but we tried to normalize that ex Allied Health, which we had seen a lot of new, but also renewals. Of course, pricing changes that we're talking about are always based upon renewals, right?
Right.
Ex Allied Health, it was 8%. Then we're trying to normalize again and basically say 4%. I would say while many of the divisions had pricing increases that were compelling, I would say one of the ones, Allied Healthcare, did not have a lot of renewals. It was only about $3 million. I would say that market is in a little bit of flux right now in trying to figure out what it's going to be. There were substantial price increases that you know about. Some of the insured response here has been, well, perhaps let's take our retentions up materially, right? Try and have this more of an excess coverage and do like a self-insured retention type of thing.
That is not business that we love from a credit risk perspective, because oftentimes we want to get collateral for whatever that large SIR is.
The way it works from a standpoint, you got to pay the claim first and then recover the SIR from the insured. We're not in love with doing that. We did get rate on what we renewed in that Allied Healthcare division, but the overall level of renewals was low, and the rate increase was a lot smaller. I think we're going to have to see where that goes. I think more broadly, the other divisions were up sort of mid-single digits in general. We're pleased with that, and we're going to continue to seek that.
Okay. Have you seen that kind of hold in, I know July is just a few days in the past, but have we kind of reached a little bit of equilibrium of rate increase in a number of those markets, maybe ex Allied Health, that you see it as sustainable in the near term?
I think it's sustainable, but we did get asked this question on the call last quarter as well. The rate information that we get, we usually get sort of several business days at least after the end of the month, right? I think it's more anecdotal that I think we're still out there getting that, but I actually don't have anything concrete in that respect.
Okay. Just my other question, just want to talk about kind of capital management expectations and kind of as we get in the back half of the year, how you're thinking about it. Obviously casualty re is shrinking, so the overall kind of top-line growth is muted while there's still good growth in E&S and specialty admitted . How should we think about that and balancing, I think you guys have shown that you're putting your capital to work, the specials have shrunk. How should we think about your capital position as we kind of approach year-end?
I think, hey Matt, it's Sarah. I think the way that we're thinking about that is to just looking at our ordinary dividend. We feel that that yield is decently in excess of where many of the peers and many of the other folks in the space are. That's a helpful balancing point. I think more importantly, you'll see us grow in both of our insurance businesses and obviously shrink in the reinsurance business for the balance of the year. We want to keep that capital for the opportunities that we've seen in both of the insurance businesses.
To get the rate that we've been getting in different pockets of E&S and to look at some of these fronting opportunities and even in the individual risk workers' comp book, just given our comments on that earlier, we feel like we're in a better spot to make a return on that. I think this is probably a year where we think more heavily about our ordinary dividend and less about the special, which has been episodic. A special is by definition a special, and that's kind of an if and when decision. We're at 1.7 times surplus now. We're up over half turn from this point last year. I guess that's how I would think about it and how we're thinking about it.
That makes sense. All right, great. Thanks for the color and best of luck.
Thank you.
Thank you.
As a reminder, ladies and gentlemen, if you have questions, please press the star then the number one key on your touchtone telephone. Our next question coming from the line of Meyer Shields with KBW. Your line is now open.
Great, thanks. Good morning. Two quick questions on investment income. 1, can you give us the new money rate? 2, is there a timeline for deploying the, I'm calling it excess cash that's been built up on the balance sheet?
Hey, Meyer, it's Kevin here. To answer your first question, we are reinvesting at rates roughly 20 basis points higher than maturing levels. As for the timing of reinvesting the funding in Carolina Re, our new reinsurance vehicle, that'll happen during this quarter. Over the next month or two, it'll be fully invested.
Okay, that's very helpful. Casualty Re, I guess sequentially, the expense ratio went down. Can you give us a sense as to maybe like a sustainable level for the rest of the year as top line trends?
Yeah, I think that where the expense ratio was this quarter is not unreasonable to stretch that through the rest of the year. It's kind of 30%-32%-ish. There are a lot of things. I caution that there are a fair amount of things that can move around. We have profit commissions attached to a fair amount of that business. Should that particular book or contract do well, that would push up the expense ratio. Certainly with the rationalization of the book and the way that we're looking at things, I think that's a fairly reasonable generic assumption.
Okay, perfect. Thank you so much.
What's your second question, Meyer? Was it on top line?
No, it was the expense ratio in light of the direction of top line.
Yeah, I would think about the expense ratio kind of where it was this quarter going forward.
Okay.
There about.
That's perfect. Thank you.
Again, ladies and gentlemen, if you have questions, please press the star and number 1 key on your touchtone telephone. At this time, I am showing no further questions. I would like to turn the call back over to Mr. Bob Myron.
Thank you everyone for your time today, and we look forward to speaking with you next quarter.
Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.