AMERISAFE, Inc.
Q1 2008 Earnings Call Transcript

Published: 2 May 2008

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Amerisafe first quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) As a reminder, this call is being recorded today, Friday, May 2, 2008. Now, I'd like to turn the conference over to Mr. Steve Gray with DRG&E. Please go ahead.

[Steve Gray:]

Thank you, operator, and good morning everyone. We appreciate your joining us for Amerisafe's conference call to review 2008 first quarter results. We'd also like to welcome our Internet participants listening to the call as it is being simulcast live over the web. Before I turn the call over to management, I have the normal housekeeping details to cover. You could have received an e-mail of the earnings release yesterday afternoon, but occasionally there are technical difficulties, so if you did not receive your release, or if you'd like to be placed our e-mail distribution list, please call our offices at DRG&E and that number 713-529-6600. Also, there will be a replay of today's call and it will be available via webcast by going to the company's web site, and that is www.amerisafe.com, or there will be a telephonic recorded replay available until May 9. Details on how to access that feature in yesterday's press release. Please note that information reported on this call speaks only as of today, May 2, 2008 and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening. Also, statements made in the press release or in this conference call that are not historical facts, including statements accompanied by words such as will, believe, anticipate, expect, estimate, or similar words are forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995, regarding Amerisafe's plans and performance. These statements are based upon management's estimates, assumptions and projections as of the date of this call and are not guarantees of future performance. Actual results may differ from the results expressed or implied in these statements as a result of risk, uncertainties and other factors including, but not limited to, the factors set forth in the company's filings with the Security and Exchange Commission, including Amerisafe's 10-K dated March 6, 2008 and future and other filings. Amerisafe cautions that you do not place undue reliance upon forward-looking statements contained in the release or in this conference call. Amerisafe does not undertake any obligation to update or publicly revise any information or statements to reflect future events, information or circumstances that may arise after the date of the release and call. For further information, please see the company's filings with the SEC. Now with me this morning are Allen Bradley, the company's Chairman, President and Chief Executive Officer, and Geoff Banta, the company's Executive Vice President and Chief Financial Officer. And now, I'll turn the call over to Allen.

[Allen Bradley:]

Thanks, Steve, and good morning, ladies and gentlemen. Thank you for joining us on our quarterly investor conference call. Today is a special day for those who visited Amerisafe, as yesterday was the 22nd anniversary of the issuance of our first policy in 1986 and we've been in the hazardous industry of workplace since that time. I'm going to make a few general comments about the first quarter before turning it over to Geoff to discuss the financials. The first quarter of 2008 represents the most profitable first quarter in the company's 22-year history. Our net income was up more than 41% and our combined ratio improved more than 5 percentage points from the same quarter last year. We produced a return on average shareholder equity of 20% and ended the quarter with a book value per share of $12.13. Our book value per share has increased more than 67% in the last 29 months since we went public in November of 2005. Our gross premiums written in the first quarter were $81 million, down more than 10% from the first quarter of last year, reflecting three things

[Geoff Banta:]

Thank you, Allen, and good morning everyone. As Allen mentioned, in the first quarter of 2008, our net income increased by 41.6% over the comparable prior year period, even though we experienced a 10.5% decrease in gross premiums written. Net premiums earned also decreased quarter-over-quarter by 2.1% while our other major component of revenue, net investment income, increased 12.9%. The increase in net investment income was due mainly to a $96 million increase in our average invested assets to an average of $766.5 million for the 2008 first quarter. The most significant contributors to our net income increase, however, were on the expense side of the income statement. First, our incurred loss and loss adjustment expenses decreased by 4.9% from last year's first quarter. And our loss LAE ratio decreased from 69.2% to 67.2%. While our projected current year loss and LAE ratio was 0.3 percentage points higher than that projected at the same time in 2007, we also recorded a $1.7 million favorable loss development for prior accident years, amounting to 2.3% of net premiums earned. This is the first time as a public company that we have taken down prior year reserves this early in a calendar year, but we felt that this modest take down was justified by the experience we saw in accident years 2005 and prior. The other major contributor to our first quarter net income was our underwriting expenses which decreased from $17.2 million in the first quarter of 2007 to $14.5 million in the first quarter of 2008, a reduction of 15.4%. Our expense ratio for quarter one '08 was 19.5% compared to 22.6% for the same period in 2007. The decrease was primarily due to $2.4 million of experience rated commissions from our 2008 reinsurance agreements which act as offsets to our expenses. We also recorded $458,000 less in insurance-related assessments in Q1 '08 versus Q1 '07, due mainly to favorable gross loss experience in the states to which those assessments apply. All together, our net combined ratio was 87.1% in the first quarter of 2008 versus 92.5% for the same period in 2007. In terms of earnings per share, our first quarter 2008 diluted earnings per share allocable to common shareholders were $0.59 compared to $0.42 for the first quarter in 2007. For purposes of the EPS calculations, weighted average diluted shares outstanding for the first quarter were up very slightly. Book value per share also increased in the first quarter from $11.66 as of year-end 2007 to $12.13 at March 31, 2008. This book value calculation includes the after-tax effect of unrealized losses incurred in our equity portfolio during the quarter. That concludes my prepared remarks on the financials; I'll now turn the discussion back over to Allen.

[Allen Bradley:]

Thanks, Geoff. As you know and can see in the summary, our first quarter was an excellent one. With respect to the marketplace, it continues to be very competitive. We see both the impact of competition showing up in our effective LCM as it has dropped from 154 in the first quarter of 2007, to 148 in the first quarter of 2008. The additional impact of declining loss cost in the number of the states where we do business exacerbates the impact of that competition. While our effective LCM may decline somewhat in 2008, we will continue to price our policies appropriately to cover the risk we insure. As I mentioned to you at the end of our last call, we believe that Amerisafe is well attired to avoid the difficulties of the current market. With that, let's turn it over for questions.

[Operator:]

Thank you. (Operator instructions) And our next question comes from the line of Matt Carletti from Fox-Pitt Kelton. Please go ahead.

[Matt Carletti:]

Good morning, guys.

[Allen Bradley:]

Good morning, Matt.

[Matt Carletti:]

Couple of questions. First one is probably for you, Geoff. Could you go back to the – you have some comments on the new reinsurance policy and the benefit it had to the expense ratio, could you just a little bit more color on how that works and is the kind of 20% range, is that a run rate going forward or is that more related to just experience in this quarter?

[Geoff Banta:]

No, let me tell you, I'll try to keep my comments brief but to the point, Matt, on this rather interesting agreement that is, by the way, documented in the 8-K that we released on February 15. But, if you take our gross earned premium, the gross rate that we're being charged for this FOREX of one cover is 4.85%. We then get a 30% ceding commission, which brings our net rate down to 3.4%. By the way, the ceding commission runs back through the expense lines as well, but it's different from the experience rated commission. Okay. So, we now pay a net rate of 3.4% on a quarterly basis. The reinsurers under this three-year agreement get a 14% profit share. The remaining 86% goes into an experience fund that until losses occur over the 20 million aggregate annual deductible, remain as an offset to expenses.

[Matt Carletti:]

Okay.

[Geoff Banta:]

Should losses exceed the $20 million AAD, those – that commission, that experience rated commission, those moneys begin moving to ceded losses from expenses. So, you can see that if we were to hit $25 million, let's say, for the first year, in the fourth quarter, there would be a little bit of a change and expense ratio would go up and loss ratio would go down accordingly.

[Matt Carletti:]

Got you.

[Geoff Banta:]

But, the EITF and the FASB do not allow us to accrue toward some sort of projection. You can't make that. You can't begin depositing into that loss fund until you actually have those losses – those recoverables recorded.

[Matt Carletti:]

Okay. That's very helpful.

[Allen Bradley:]

Let me just talk a little bit about the strategy that we employed in purchasing this product. There were two things, two objectives we wanted to accomplish with respect to this working layer, which is a layer that attaches at $1 million and covers the next $4 million of subject losses. The first objective was we felt like we had reliable experience over the last six years, a steady book of business and we had fairly predictable burn cost. And so, we did not want to trade dollars with our reinsurers, so we retained the first $20 million of losses as its respects the FOREX one layer. The second objective was that during this time period of a softer market, we thought it prudent to move down retention from 2 million to 1 million once you get past what could be expected losses. So we moved that down. And these two strategies combined were what led us to purchase this product, which is a three-year product.

[Matt Carletti:]

Three years, great. That's very helpful. Thank you. And then just one other question, just to put this in a category of high-cost problems, you're growing the balance sheet nicely and obviously the markets aren't as willing to comply for growth. How do you look at capital here, so you have outer year [ph] even just, kind of just talk about capital management, how you view that?

[Geoff Banta:]

We, as you know and as we've discussed on prior calls, in terms of capital management, as it respects common shareholder dividends and stock repurchases, we will be required to secure the consent of our preferred shareholders of the C&D preferred shares. That is not true with respect to acquisitions, but I don't think you go out and make a bad acquisition just to manage to your capital. That's certainly one way to do it, or under-writings and another. Not something we're interested in doing there, but we certainly are aware and are interested in viable acquisition possibilities out there. Although, I will have to tell you, just as I commented at the last conference call, I believe, the pricing I've seen on this acquisitions appears to be a bit rich for our taste.

[Matt Carletti:]

Okay. Wonderful. Thanks very much and congrats on your last quarter.

[Geoff Banta:]

Thank you, Matt.

[Operator:]

Thank you, and our next question comes from the line of Mark Hughes from SunTrust. Please go ahead.

[Mark Hughes:]

Thank you very much. Very good on the underwriting expenses, how should those trend in the next few quarters in absolute terms? Any changes we should expect?

[Geoff Banta:]

Well, looking forward, there is not a lot I can say, Mark. I don't anticipate huge fluctuations in the market we're in and with the plans we currently have in place. That's it.

[Mark Hughes:]

And then your outlook, the 94 combined ratio, assume you're just sort of sticking with your prior statement that it doesn't sound like you anticipate any sort of meaningful changes in the P&L of the company?

[Allen Bradley:]

It's a bit early to say that. And you know, Mark, we ensure the highly severe classes and earnings could be a bit lumpy if we were aggressive in projecting that. We feel comfortable that making that projection at this point and that guidance that we can support that, as in the last two years, if that changes later in the year, we will give notice of them.

[Mark Hughes:]

Understood. Any weighted average change in loss costs in Q1 across your markets? Is that a number you calculate or can share?

[Geoff Banta:]

It's a number that in – every time a state announces a new loss cost, whether it be an increase or a decrease, you understand that the loss cost announcements that you see are the average across all class codes. At that point, we do internally project the impact on Amerisafe's business if everything remain the same. The problem, Mark, is it never does remain the same. Market share in states goes up and down, industry scatter changes, all of which makes that a very difficult number to project. I would tell you that, just directionally, I look at the changes in our gross written premium and first look at the change in the effective LCM, which is the impact of competition. The rest of it is either audit premium caused by slower work activity or lower payrolls, or number two, the effect of loss cost. But we do not publish that number and quite frankly, it would be very difficult to track from time to time because of the shifting base of which the lost cost are applied.

[Mark Hughes:]

Right. So, payroll up point 0.3%, loss cost down 6 or 1.48 from 1.54, is that right?

[Geoff Banta:]

Up 4%. Yes, policy count up 0.3%, payroll down 0.3%.

[Mark Hughes:]

Okay.

[Geoff Banta:]

In-force premium down 2.3%. Of course, as you know, that's a very important metric not to have that in-force premium move up – the in-force premium move down, and the in-force payroll move up, because you're just getting more money and enjoying it – more exposure and enjoying it less. That's it.

[Mark Hughes:]

Thank you very much.

[Geoff Banta:]

Thank you.

[Allen Bradley:]

Thanks, Mark.

[Operator:]

Thank you. (Operator instructions) Our next question comes from the line of Mark Lane from William Blair. Please go ahead.

[Mark Lane:]

Good morning.

[Allen Bradley:]

Good morning, Mark.

[Mark Lane:]

Geoff, the reserve release you suggested was '05 and prior, correct?

[Geoff Banta:]

That's correct.

[Mark Lane:]

Okay, so the accident year loss ratio that you're booking the first quarter is – it looks to be lower than last year?

[Geoff Banta:]

No. It's 0.3 – the current accident year ratio is 0.3 percentage point higher. The effect when you throw in the 2.3% of net earned premium from prior year development, then takes the combination of your calendar year loss ratio down by 2 points.

[Mark Lane:]

So your accident year loss ratio is 67.2, right?

[Geoff Banta:]

Yes.

[Mark Lane:]

So last year, you had 9.5...

[Geoff Banta:]

That's calendar year. Accident year is 69.5.

[Mark Lane:]

Right, okay.

[Mark Lane:]

Yes. So it's 2.5% increase from last year, right. Okay.

[Geoff Banta:]

No. It's 0.3% if you're comparing 2007 at Q1 2007.

[Mark Lane:]

No. I'm looking at the full year, the full year.

[Geoff Banta:]

Oh, yes, you're right. That's correct. You're right.

[Mark Lane:]

Okay, all right. So on the back on the expense side, so the basic message is that the expense ratio has some experience associated with it, so as we go along for this year, if the loss ratio continues to be good, should you still continue to enjoy some of those benefits, both on the assessment side and also the reinsurance side?

[Geoff Banta:]

Exactly, right.

[Mark Lane:]

Okay. So, this is not like front-end loaded or anything like that, it's on going…

[Geoff Banta:]

It's on going and we're required to make it on going by the accounting guidance. But, let me just say that the – as you probably know, the loss based assessments which benefited us handsomely in the first quarter are probably the most predictable item in expense we have because you not only are subjected to ups and downs of case development in the states that assess those, but part of the equation is also the losses of all the other companies operating in those states. So, it's fairly unpredictable. But, as a rule, if our gross experience continues to look good, we should benefit in those states that are hitting us hard as with these loss assessments.

[Allen Bradley:]

Mark, let me mention one other thing or point on the loss expenses. If you look at the impact of the experience rating – experience account, that was $2.4 million. And our actual expenses – underwriting expenses in the first quarter after applying that, were $14.5 million. Last year, our underwriting expenses for the first quarter were $17.2 million. So, even ignoring that, there's been some downward adjustment in the expenses.

[Mark Lane:]

Okay. Perfect. Thank you.

[Geoff Banta:]

Welcome.

[Operator:]

Thank you. And our next question comes from the line of Jody Hanson from Silvercrest Asset Management. Please go ahead.

[Jody Hanson:]

Good morning, gentlemen. I'm a glass half empty type guy. On the accident year loss ratio, just going up 0.3 percentage point. I'm surprised that it didn't go up more given that your payrolls were up a little bit, the policy count was up and you are in a lumpy business. Is the reinsurance contract what's keeping that down?

[Allen Bradley:]

No, it is not. But, let me tell you the reason we moved it up and the reason we didn't move it up more.

[Jody Hanson:]

Thank you.

[Allen Bradley:]

Number one, it was moved up because we monitor very closely our case losses as we go along and to tell you the truth, it was a bit hotter in the first quarter of 2008 than it was in 2007 than it was 2006. But not by much. It was very marginal. There's a couple of things that impact that. Number one, our claims department has done an excellent job of getting the reserves up and we have had an initiative to try to close the older claims and one that has been remarkably successful. That has lowered our claims count. We have not reduced the size of our claims department and I really, honestly believe that those people have more time to spend on the claims that come in and because they've been questioned about the older claims, their getting those reserves up more adequately. Last year, our case reserve development in the second half of the year was remarkably low. And so, I think that's a tribute to Dave Narigon and the folks in the claims department that have done such a great job. The second thing, we move it up because it was a little bit hot. The reason we didn't move it up more is that we have to look back, as Mark Lane so accurately put out, at what our loss ratio ended up for last year. So, we didn't want to be overly conservative on moving it too high. As you point out well, Jody, this is a lumpy business and I can't tell you what roofers [ph] in North Carolina are going to do this afternoon when they get off from work. So, we feel it's a conservative number, it's an appropriate number and we think all of the internal metrics we use for fixing that number support it.

[Jody Hanson:]

I appreciate you welcoming too that as for the roofers in North Carolina, maybe they should go out and buy your stock.

[Allen Bradley:]

Well, I hope so. I just hope they don't buy any beer on the way home.

[Jody Hanson:]

Thank you very much.

[Allen Bradley:]

Thanks, Jody.

[Operator:]

Thank you. (Operator Instructions). Our next question comes from the line of Ron Bobman from Capital Returns. Please go ahead.

[Ron Bobman:]

I think beer on the way home is okay, beer on the way to work is the problem that you need to be concerned about.

[Allen Bradley:]

Ron, I'll have to tell you, if that's – you're right. As long as you've made it to the shop and dropped off the company truck.

[Ron Bobman:]

Yes.

[Allen Bradley:]

(inaudible) company truck.

[Ron Bobman:]

(inaudible) stock up after the press release this quarter. I had a question, it's about competition and what's the nature of the competition, and I'm sorry if you've covered this, are you seeing new entrants or at least an increased activity level for some, sort of in the passive players in these high-risk categories? Or are you just seeing more aggressive rate action from sort of the usual faces that, I assume you bump into regularly in different markets?

[Geoff Banta:]

That's a great question. If you'll allow me to, I'll kind of take a broad answer to that. It varies based on geography and it varies on policy size. I would tell you that in terms of the new entrants into the hazardous workers' comp market, we have seen some writers in certain areas that are willing to write high-hazard business that have traditionally not been in that marketplace. In some marketplaces, we see the same faces that we've seen in the past, but their appetite for smaller policies has increased. So where you used to see a particular national player, for example, at $100,000, you may now see them at $75,000 or at $50,000 again. We see more intense competition, as you will not be surprised to hear, on those accounts that are larger than we do on the ones that are smaller. The most aggressive pricing we see generally does not come from publicly traded companies; it generally comes from single-state writers, very small multi-state writers, self insurance funds, and some state funds, although not all, not all – I want to be sure that that's clear. Some are more cautious than others. And you see competition in other ways, Ron. You see lower deposits. You see relaxed underwriting standards. Speed to market has become the big mantra. "I can write your 100-unit trucking account in eight minutes." I'm sure you can't. But, I don't know that you can underwrite it. You may write it, but I don't think you can underwrite it in that time period. So those are some of the things we're seeing in the competitive marketplace. We are also, I think it would be unfair to characterize it as being ubiquitous, there are some underwriters that are cautious and are acting appropriately and I think they're doing well.

[Ron Bobman:]

Did you give us a retention figure for the quarter?

[Geoff Banta:]

I did not.

[Ron Bobman:]

Can you retain it?

[Geoff Banta:]

The policy count retention is consistent with prior years. The premium dollar retention is down. Impact of competition, lower loss cost and then that intense competition own the very large accounts.

[Ron Bobman:]

I'm sorry. In policy count retention, when you say it's consistent, so I'm sorry if –

[Geoff Banta:]

90% range. 90% of those, we offer renewal clause to [ph].

[Ron Bobman:]

Okay. And Allen, when you look at the 10% that you lost, approximately 10% of account numbers that you lost this quarter, is there any sort of common scene, whether it be a particular state or the new players coming in or it's spread across sort of the various points you made to my first question?

[Allen Bradley:]

It's spread a little bit, Ron, but there are some particular notable parts dealing with one particular industry and one particular state, I don't let our competitor know which one it is, but where we've seen some one say, this has been reported to us, we are targeting their accounts. And quite frankly, they're not using loss control, so they get the benefit of our efforts in that regard. That's something we see, but we do see from time to time particular companies targeting particular accounts, but I would say that's probably 25% or 30% of that loss and the rest is just spread across the rest of the country.

[Ron Bobman:]

And any signs of people pulling back or any incumbents getting burned that you see some no [ph] conservative practices?

[Allen Bradley:]

The problem with the incumbents getting burned is that sometimes they don't know they've been burned for a year. We do see some stabilization in Illinois, Kansas and Missouri. Also, a few underwriters that I think are prudent underwriters that have pulled back from some – that got into some high-hazard stuff and then pulled back in Oklahoma, Kansas, and maybe some in Texas. But, there's plenty of other folks right now to take their place, but this is a business of deferred gratification and deferred pain. And right now, some people are underwriting I think at levels that aren't supportable.

[Ron Bobman:]

Got you. Well, I trust that you'll stick to your knitting that sit on your hands when that unfortunately keeps happening.

[Geoff Banta:]

Thank you.

[Allen Bradley:]

Thank you. Good talking to you.

[Ron Bobman:]

Likewise.

[Operator:]

Thank you. And our next question comes from the lines of Bijan Moazami from FBR Capital Markets. Please go ahead.

[Bijan Moazami:]

FBR. Couple of questions. In particular, I'm wondering if you guys have seen any increase in litigation cost, any change or any reversal in the reformed, or any increase in the time period that people are staying on disability, given the economic environment.

[Allen Bradley:]

I think the answer to all three of those questions is we are not experiencing that. We have, as you know, Bijan, very low percentage of our claims are in litigation. We believe that's directly attributable to our practice of, when we receive notice of a loss time injury to be face to face with the climate within 48 hours, business hours of notice of the claim, two days. So, we haven't seen the unwinding of those. I will tell you that in terms of reserving for those, shall we say, in some states, some reformation in the statute. We haven't been quite as aggressive as booking those changes. We have maybe taken a bit more pessimistic view in terms of a case reserve than some. We're seeing some slight increase in severity, partially offset, of course, by lower frequency. The increase in severity and if you ask me, what keeps me up late at night with respect to claims, it's medical cost, both utilization and the number of procedures, as well as just the inflation in the cost.

[Bijan Moazami:]

Thank you.

[Allen Bradley:]

Thank you, sir.

[Operator:]

Thank you. And I'm showing that we have no further questions at this time. Please continue.

[Allen Bradley:]

So thank you, ladies and gentlemen. Thank you very much for joining us this morning on our earnings conference call. Keeping with the comments that have just been asked in the questions, during the current soft cycle, we constantly hear many people comment about the competitive activities of others in the marketplace. These comments usually are centered around pricing or coverage extensions or speed-to-market or security deposits and the like. In thinking about these comments and how we might react to those, I am reminded of the words of the British writer and satirist, Malcolm Muggeridge, who said, "Never forget, only dead fish swim with the stream." Thank you very much.

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.