Good day, ladies and gentlemen, and welcome to the Q1 2018 James River Group Holdings 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 follow at that time. If you require any assistance during the call, please press star then zero on your touch-tone telephone. As a reminder, this conference may be recorded. I would now like to turn the conference over to our host of today's call, Mr. Kevin Copeland. You may begin.
Thank you, Tanya. Good morning, everyone, and welcome to the James River Group first 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-Q, 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 Robert Myron, Chief Executive Officer of James River Group.
Thank you, Kevin, and good morning, everyone. This is Robert Myron, and with me today are Sarah Doran, our CFO, and Kevin Copeland, who you just heard from, our Chief Investment Officer, who also leads investor relations for us. We have a few prepared remarks, and then we look forward to taking your questions. The year is off to a great start. We had strong top and bottom-line performance in each of our three segments, with underwriting results showing a substantial improvement from a year ago, as highlighted in our press release. Our combined ratio for the group came in at a 96.4, and we had compelling combined ratios in all three segments, with favorable reserve development in each of them. I am thrilled by the pricing increases we received in our core E&S book, and very pleased with renewal pricing overall.
While relative to a year ago, our investment performance was down, in absolute terms, investments performed well, roughly in line with our expectations. 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 and strong growth in most of the underlying divisions. The commercial auto division grew 84%, substantially assisted by the rate increases we have obtained on our largest account. In our core E&S book, we had growth in nine of 12 divisions. In particular, we saw strong growth in Allied Health, which was up 208%, in Energy, which is up 97%, and in General Casualty, which was up 70%.
Part of this growth was from rate increases, which I will discuss more in a minute, and part of it was from increased submission activity and opportunities in some larger accounts. As mentioned last quarter, the nursing home space in the Allied Health division is very hard right now, with substantial price increases on renewals and strong flow of new submissions that are coming out of the admitted market. In divisions like Energy and General Casualty, there were a variety of underlying causes for growth, from select large single accounts written for energy contractors to the growth in the restaurant space, which I mentioned last quarter. Submissions for the E&S segment overall were up 8%. In the specialty admitted segment, we grew gross written premiums by 7% in individual risk workers' comp and 23% in the fronting division.
This growth is due to increased submission flow, the continued strong economy, and some smaller, new fronted deals that have been put on the books in the last year. In the casualty reinsurance segment, we did grow in the quarter, but as we said last year, by the end of the year, we expect gross written premium to decrease by approximately 50% from what it was in 2017, as we refine the book and focus on more profitable accounts. From a bottom-line perspective, the E&S segment had good results, but I'd like in particular to note the improved underwriting results of the specialty admitted segment and the casualty reinsurance segment. Those two segments had some of the lowest combined ratios they have had of late. Now with respect to pricing.
In core E&S, which we define as all business in the segment excluding commercial auto, renewal pricing was up 13% in the quarter. This was driven by the Allied Health division. Excluding the Allied Health division, our core E&S rates were up 8% in the quarter, which is still very compelling. 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, but net of underlying index loss cost changes, we believe margins held steady. In the casualty reinsurance segment, overall price increases were up approximately 7%. This was due to approximate 5% increase on the underlying primary contracts and a 2% increase in reinsurance treaty pricing. Let me speak a bit about accident year loss picks and reserves.
In our E&S segment, our accident year loss pick increased approximately four points 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 loss picks in the core E&S book. On a group-wide basis, our accident year loss ratio was 72.8, up 2.5 points from a year ago. Overall, I am pleased that we are able to deliver a compelling combined ratio in the quarter for the group. While at the same time booking a higher accident year pick, having favorable reserve development for the group as a whole and in all three segments. Lastly, to increase our IBNR percentage of total net reserves from 65% at Q4 2017 to 65.6% at the end of this quarter.
Lastly, commercial auto loss emergence was in line with our expectations this quarter. With that, let me turn the call over to Sarah Doran, our CFO. Sarah?
Thank you, Bob. Good morning, everyone. We are very excited about our start to the year, the prospects for our business, and our continued balance sheet strength. I'll go ahead and fill in some of the blanks on the moving pieces to the quarter and our outlook. For the first quarter of 2018, we made underwriting profits of $7.2 million, generated an operating profit of $16.6 million, and are reporting net income of $15.6 million. Before I get too far into the results, I'll take a moment to highlight the accounting change effective in the first quarter, which creates a further difference between non-GAAP operating income and GAAP net income and will likely have the effect of creating net income volatility going forward.
Effective January 1st, 2018, all changes in the fair value of equity securities are reflected in net income rather than in other comprehensive income on the balance sheet. There are now two components of net realized and unrealized gains and losses on investments in the P&L. The first are the pre-tax gains and losses from the sale of investments, which includes the valuation allowance on our bank loan portfolio, and the second is the change in unrealized gains or losses on equity securities resulting from the new accounting pronouncement. This quarter, we recognized a pre-tax loss in the value of equity securities of $1.7 million within net income, which was partially offset by realized pre-tax gains of $900,000 on investment sales during the quarter. I'll stay on investment results for just a few more comments.
This quarter, our net investment income decreased about 21% as compared to the same quarter last year. The first quarter of last year included an exceptional performance from our renewable energy portfolio. While income in our core fixed income and other private investment portfolios was up meaningfully this quarter, results from our $40 million renewable energy portfolio can be volatile as they are generally influenced by both interest rates and revaluations by the sponsor. This quarter, the rising rate environment negatively influenced the market value of these assets, and this could continue to occur to the extent rates continue to rise. These assets have been outsized contributors to our investment income over time. Despite the lower contribution this quarter as compared to the first quarter of last year, they still produced an annualized return of 10.4%.
We continue to enjoy strong cash flow from our businesses as operating cash flow this quarter was $48.5 million as compared to $16.1 million in the first quarter of last year. This is a benefit to our increased float and future earnings as invested assets grew about 3% over the sequential quarter and almost 10% year-over-year. Turning to the expense ratio, as we've said, we view this as a key competitive advantage of ours. This quarter, our group expense ratio decreased to 24.9% as compared to 29.1% in the first quarter of last year. This decrease has come through changes in business mix and increased scale. The 24.9% this quarter is equal to that of the third quarter of 2017. We believe a mid-20s expense ratio is very effective and attractive for our franchise and mix of business. Finally, a moment on taxes.
Our effective tax rate this quarter was 8.7%. As we've said before, the rate fluctuates from period to period based on the mix of income by country and tax jurisdiction, as well as the timing of option exercises and the vesting of RSUs, which generally has been larger for us in the first quarter but can happen at any time. There are a number of moving pieces to our tax rate, but 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 $465.8 million, down slightly from $474.5 million at the end of last year.
Net income was generally offset by $9 million of dividends we paid and the $18.5 million of after-tax unrealized losses from the impact of rising rates on our fixed income portfolio. Operating leverage for trailing 12 months net premiums written to tangible equity was slightly higher than last quarter at about 1.75 times to one. Bob, I think that covers everything on my list. Let me turn it back to you.
Thank you, Sarah. Operator, can you please open the line for questions?
Ladies and gentlemen, if you do have a question at this time, please press star then one on your touchtone telephone. Again, please press star then one for any questions. Our first question comes from Randy Binner of B. Riley. Your line is open.
I just-
Mr. Binner, your line is open.
All right.
The next question.
Definitely. Our next question comes from Matt Carletti of JMP Securities, and your line is open.
Hey, good morning. Bob, I was just hoping you could maybe expand on your comment about commercial auto a little bit, how you said that loss emergence was in line with expectations. Is there anything else you can point to? I know it's only been three months since what happened last quarter, but is there anything else you can point to in the daily claims trends you're seeing or things like that that give you additional comfort that the actions you took at the time were more than appropriate?
Yeah. Obviously, this is something that we look at pretty carefully. I think there isn't a lot more to say. I think we have an expectation in terms of what we think loss emergence might be, then you're always comparing that to actual, for the quarter, it was in line. That ended up with the result that we ended up having in the segment, which was a reasonable loss ratio, at least reasonable combined ratio and overall favorable development for that segment. I think it was consistent with our expectations, and we're obviously pleased about that given that we are about three months beyond the results we had there in Q4.
My only other question relates to the pricing in core E&S. I think you quoted 13% in the press release, and I think I caught you saying 8% kind of ex Allied Health. How did April look? I know it might be too little to give a number, but did the acceleration that you saw in Q1 kind of persist in April, or did it inflect one way or the other?
Yeah. We really don't have rate information for April yet, given how close we are to that month. Let me just go back to the beginning. Yeah, you heard correctly that we did get 8% ex Allied Health, which I would re-emphasize that is a really good rate increase on renewals. We are continuing to see rate increases in this current environment. In terms of April and Q2 activity, we'll have to give you an update on that when we release Q2 earnings. We just don't have a lot of data on that right now.
Okay, great. Thank you for the answers, and congrats on a nice start to the year.
Thank you.
Thank you. Our next question comes from Mark Hughes of SunTrust, your line is open, Mr. Hughes.
Yeah. Thank you. Good morning.
Good morning.
Can you give us a sense of the loss picks on the core E&S business when we think about last year or the prior year? Are those loss picks relatively steady? Have they come down given that the pricing has improved, or is there a little more conservatism in the loss picks?
Thanks, Mark. I think just philosophically, always we seek to book a, as I mentioned in my prepared remarks, a prudent and conservative pick in that respect. We've basically said always before, this is always sort of in the high 60s or low 70s. We're continuing to take a similar approach in that regard. It's really not a lot different than what we've done in the past. It may be up a little bit. I think that that's just really, again, a philosophical approach that we want to make sure that we start out of the box with earned premium, and even in the context of these pricing increases, booking something that we think is prudent and conservative.
In that commercial auto book, is there an inflection point somewhere where once you get beyond that point, you've got much more confidence in the loss emergence? When do you know, so to speak?
It's a shorter tail book clearly than the average General Liability type of business that we're writing in the rest of the segment. I think as time passes for any individual underwriting year, as time passes, you sort of gain more and more confidence. I think that really we think of 12 to 24 months beyond the end of the underlying underwriting year when you start to have increasing levels of certainty with respect to paid losses relative to ultimate and reported losses relative to ultimate, and you've got a significant amount of the claims closed. It's sort of not a four to five year thing like it might be in General Liability. It's a bit shorter than that. It does take some time. Because as you know, we're not covering any of the property or physical damage piece of these risks, so it's all liability.
Sarah, would you add anything to that?
No, that's pretty expansive. I think that covers everything. Thanks.
Does 2017 look like it's acting like 2016 in that way? Is it following a similar pattern, I guess, i.e. more predictable?
Yeah. For the largest account, the 2017 underwriting year just finished up on February 28th because this is a March 1st renewal, which I think we've said before. I would just go back to the previous comment that in general for that division within the segment, loss emergence was consistent with our expectations generally.
Thank you very much.
ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch-tone telephone. Our next question comes from Meyer Shields of KBW. Your line is open.
Thanks. Two quick questions. One, is the tail on the Allied Health book, where you're seeing all this growth, is that meaningfully different than the rest of non-core? I'm sorry, of core E&S?
I don't think it's a lot different. No. I think that if you think about the type of claims there, it might be like a slip and fall or a broken hip or something in a nursing home or something like that. It certainly is going to have a tail. No, I don't think it's tremendously different than a construction defect claim for a contractor's GL or something like that. Part of that is because we're principally writing primary there, right? It's not like it's an excess book.
Okay. No, that's helpful. When I look at investment income, if I add back the $1.7 million impact of the accounting standard change, it looks like net investment income on, I don't know, I'll call it the core portfolio, is up 23%. Is that a good base run rate going forward based on new money yields?
I think so. I don't have a view that it's going to be different. I'll ask our Chief Investment Officer, Kevin, if you want to chime in on that.
Yeah. Absolutely. This quarter would be a good run rate looking forward. Just to be clear, Meyer, the unrealized loss that went through income, that's actually booked as a realized loss. It wouldn't be in net investment income if you're modifying that line item.
Okay. I guess I'm trying to get that clear. The 11.4 is the right number?
Is the 11.4 your number for the non-private investment portfolio?
Yeah. It's the 11.436 including renewable energy and other private, I guess. Okay.
Yep. Exactly. Yeah. That would be a good run rate going forward.
Okay. No, that clarifies that. One last question. Is there any change, I know that there's a rate increase on the largest account within commercial auto, any change to the fee structure?
Yeah. We mentioned this a little bit last quarter, Meyer, that the structure itself didn't change, the way that we account for it will change, that over the next couple quarters, you will likely see, this is just geography, less fees coming through and increased premiums. We will account for more of that fee business as premium.
Okay. Should we assume that that premium carry is like 100% combined ratio?
I wouldn't.
Okay.
Yeah. Basically.
Yeah.
Some of the claims handling fees that previously were booking as fee income, there's now a requirement that we've got to book this as premium, and so it's got to flow through the P&L as written and then earned.
Loss ratio
probably a loss ratio and sort of expense ratio applied to it. Optically, for that segment, it's going to cause a decrease in what we show for fee income.
For fees, the same level of profit really. Yeah.
It's really not affecting the economics significantly.
Yep.
Okay. Yeah, that's what I meant to ask. The underwriting profit will look similar to expected. Underwriting profit will look similar to the current fee profitability.
I think that's fair.
Okay.
That's fair.
Thank you.
Remember, the renewal was just March 1. Now going forward, we'll have that as an indirect comparison from last year.
Right.
Okay.
I'm showing no further questions at this time. I would now like to turn the call back over to management.
Thank you, everyone, for your interest and your time today, and we look forward to speaking with you next quarter.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.