Amerisafe Inc (AMSF) 2009 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the AMERISAFE third quarter earnings conference call.

During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions.)

This conference is being recorded today, Friday, November 6, 2009.

I would now like to turn the conference over to Ken Dennard with DRG&E. Please go ahead, sir.

Thank you, Brandy, and good morning, everyone. We appreciate you joining us for AMERISAFE's conference call to review 2009 third quarter results. We'd also like to welcome our Internet participants, as this call is being simulcast over the Web.

Before I turn the call over to management, I have the normal housekeeping details to run through. You could have received an email of the earnings release yesterday afternoon, but occasionally, there are technical difficulties, so if you did not receive your e-mail with the release or if you would like to be placed on the e-mail distribution list, please call our offices at DRG&E, and that number is 713-529-6600.

Also, there will be a replay of today's call. It will be available via webcast by going to the Company's website, and, of course, that address is www.amerisafe.com. There will also be a telephonic recorded replay available for seven days, 24 hours a day, and details on how to access that feature is in the earnings release.

Please note that information on this call speaks only as of today, November 6, 2009, 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 the Private Securities Litigation Reform Act of 1995 regarding AMERISAFE's plans and performance.

These statements are based upon management's estimates, assumptions, and projections at 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 risks, uncertainties, and other factors including, but not limited to, the factors set forth in the Company's filings with the Securities and Exchange Commission, including AMERISAFE's 10-K for the year ended December 31, 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 forward-looking 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 Securities Exchange Commission.

Now, with that behind us, I'd like to now turn the call over to Allen Bradley, the Company's Chairman, President, and Chief Executive Officer. Allen?

Thanks, Ken, and good morning, ladies and gentlemen. Thank you for joining us for our quarterly conference call.

I'll make just a few comments about the quarter before turning it over to Geoff Banta, our Chief Operating Officer. He will then, in turn, introduce Janelle Frost, our Chief Financial Officer, for more details.

While our net income in the third quarter was strong, the national economy and a rationally competitive insurance market and lower loss costs and rates have combined to create somewhat of a headwind for AMERISAFE in terms of gross premiums written.

We did, however, maintain our pricing discipline, and we can demonstrate that by reporting that we -- our aggregate pricing was 1.45 effective loss cost multiplier, or 145% of the anticipated losses for those states that use the loss cost method of calculation of premium.

While we see examples of carriers currently returning to some level of pricing discipline, there are still many others who, for whatever reason, find business near or below the anticipated losses on accounts.

We continue to experience improving retention levels on our renewal business. In the aggregate, lower payrolls and loss costs have [inaudible - technical difficulty] while reducing the average policy size, but we're keeping those policies both in terms of policy count and by premium dollar. Competition for new business is very aggressive, particularly as a policy size increases.

We continue to experience declining frequency of claims on an earned premium basis although the severity of claims is rising, driven largely by the medical component of benefits.

For the eighth consecutive quarter, AMERISAFE has enjoyed prior-year claims development that is favorable.

We continue to focus on the growth of book value and return on shareholder equity. Our book value has increased 15% since year end and has increased at a compound annual growth rate of 21.8% since we first went public in November of 2005. Our ROE for the quarter was 19.3%, and for the year, it was 17.8%. We believe those results are among the best in the industry, and we are quite proud of those results.

At this point, I'm going to turn the call over to Geoff Banta for some further perspective on our operation and performance. Geoff?

Thank you, Allen, and good morning, everyone. I'll make a few comments about overall company performance and trends before turning things over to Janelle.

As Allen indicated, the current state of the economy and of the worker's compensation market continued to place stress on our top-line results, but our focus on risk selection and adequate pricing and our expertise in our high-hazard niche have enabled us to again generate superior financial returns.

Third quarter was an especially challenging one relative to our top line, as measured by gross premiums written. Over our third quarter, gross premiums written decreased by $20.4 million, or 27.3% year over year. There were three major components making up this decrease.

First of all, for policies written during the third quarter, our voluntary work comp gross premiums written decreased by 11.8%, from $75 million to $66.1 million.

Secondly, adjustments to premium from audits, endorsements, and cancellations totaled negative $7.8 million versus negative $1.9 million in Q3 '08.

Finally, the third major contributor to our gross premiums written decrease was the change in our estimate for earned but unbilled premium, or EBUB. The change in our EBUB estimate was a negative $5.4 million versus a negative $380,000 in Q3 '08.

In the third quarter, as we have done in the past, we maintained our strong pricing. As Allen mentioned, our effective LCM for voluntary work comp in the third quarter was 1.45, or 145% of the approved loss costs in the states that use that mechanism for pricing.

New business has been difficult to generate to be sure, particularly for larger policies. We have observed many of our competitors pricing new business at levels we believe are unsustainable.

Recently, we have seen some new business being lost to competitors whose pricing has approached loss cost. We have no intention of chasing after this business at prices that are lower than we feel are justified.

We are, however, continuously looking for different ways to segment our market to bolster our new business. Toward this end, we have recently entered into some new geographic territories, begun a new initiative in our maritime business, increased our commission rates in selected states, and targeted some new hazardous classes of business in certain states where our results have been exemplary.

While new business has been down, our renewal business has been exceptionally strong. In the third quarter, our policy retention was 92.5% versus 92.2% for the third quarter in 2008. As a result of the strength of our policy retention, our in-force policy count has increased 5.1% since 9/30/08 from 7,600 policies in force to almost 8,000 as of 9/30/09.

Our premium retention has also increased from 74% in Q3 '08 to a stellar 81.6% in Q3 '09. This improvement is all the more remarkable when one considers that our average renewal premium has dropped by approximately 9% over the last four quarters. We are very encouraged by these retention results.

In terms of losses, we continue to focus our efforts on closing claims as quickly as practicable, and our open claims inventory has dropped 8.4% since 9/30/08.

Worker's comp claim frequency on an earned premium basis has also continued its multi-year drop.

Finally, we are experiencing increases in medical costs consistent with the 5% to 6% estimate published by the NCCI. Janelle will be providing you with more details on our overall loss experience.

On the expense side, we continue to aggressively manage our expenses, as demonstrated by our 21.6% expense ratio for Q3 '09, up only 6.4% year over year.

Our third quarter expense ratio is even more noteworthy when one considers that our net premiums earned dropped 18.4% over the same period.

Overall and in spite of daunting economic and market challenges, in the third quarter of 2009, the insurance professionals of AMERISAFE produced net income growth of 12.8%, a solid annualized return on equity of 19.3%, and a combined ratio of 79.3%. Naturally, we are very proud of these results.

With that, I'll turn the call over to our CFO, Janelle Frost. Janelle?

Thank you, Geoff, and good morning, everyone.

In the third quarter of 2009, AMERISAFE reported net income of $15.1 million, compared to $13.4 million in the third quarter of 2008, a 12.8% increase.

Gross premiums written in the third quarter of 2009 were $55.1 million, compared to $75.8 million in the third quarter of 2008, a 27.3% decrease.

As Geoff discussed, there was a decline in voluntary premiums for policies written in the quarter, as well as decreased audit premiums for policies written in previous quarters.

Due to economic conditions and those decreased audits, we also reevaluated our EBUB estimate to be more sensitive to recent trends. This estimate was updated every quarter since it was established in the fourth quarter of 2006. However, not since the fourth quarter of 2006 has the impact to one quarter's gross premiums written been to this magnitude, which we believe is reflective of current conditions.

Net premiums earned decreased 18.4% from the year-ago quarter as a result of declines in gross premiums written for the last year.

Our net investment income totaled $6.9 million, which was 10.8% lower than the same revenue component in the third quarter of 2008.

Average invested assets, including cash and cash equivalents, were $815 million compared to $782.8 million in the prior-year period. However, pre-tax investment yield on our portfolio declined to 3.4% from 4%.

We recognized $2 million of net realized gains in the quarter, resulting from the gains on the sale of equities, as well as a gain from the sale of one asset-backed security. This compares to net realized losses of $2.9 million in the same period of 2008.

Our fixed-maturity securities are classified as held to maturity and are not mark to market unless losses are determined to be other than temporary.

During the third quarter of 2009, we did not have any other than temporary impairment.

For the first time in several quarters, we had a net unrealized gain on our fixed-maturity portfolio, totaling $18.8 million as of September 30, compared to a net unrealized loss of $16.2 million at year-end 2008.

In total, revenue in the third quarter of 2009 was 11.9% lower than the same period in 2008, totaling $67.2 million.

Our incurred loss and loss adjustment expenses were $33.4 million, compared to $42 million in last year's third quarter, a decrease of 20.5%.

Our net loss ratio was 57.4% in the third quarter of 2009, compared to 58.9% in the third quarter of 2008.

For the third quarter of 2009, that includes a current accident year loss ratio of 69% and favorable prior-year development of 6.7 million, or 11.6 percentage points.

In the third quarter, total underwriting and other expenses decreased 13.4% to $12.5 million from $14.5 million in the third quarter of last year.

Lower earned premium, the expense ratio, rose to 21.6% from 20.3% in the same period a year ago.

In total, our combined ratio was 79.3% in the third quarter of 2009 versus 79.4% in the same period in 2008.

In terms of earnings per share, our reported third quarter 2009 diluted earnings per share applicable to common shareholders was $0.74, compared to $0.65 for the third quarter of 2008.

Reported return on average equity for the third quarter of 2009 was 19.3%, compared to 20.5% for the third quarter of 2008.

Book value per share for the third quarter of 2009 was $15.94, compared to $13.86 at December 31, 2008, an increase of 15%.

In line, our reported metrics for earnings per share, return on average equity, and book value are all on an as-is-converted basis, including our C&D preferred shares.

Additionally, since our fixed-maturity portfolio is held to maturity, our book value growth this quarter does not include the impact of market gains on that portion of our portfolio, which is the case for most of our peer companies.

Finally, statutory surplus at the end of the third quarter was $308.6 million.

That concludes my prepared remarks on the financials. I'll now turn the discussion back to Allen.

Thanks, Janelle.

Allow me to offer a few closing thoughts before opening this call up for questions.

In the past few weeks, several notable executives in the insurance industry have analogized the competitive behavior in the marketplace to that of alcoholics and cowboys. Well, I believe those comments are unfair, both to alcoholics and cowboys.

There are many highly intelligent and capable people in the insurance industry. Additionally, there is a wealth of data available in actuarial information that helps us predict losses and project adequate pricing.

Further, there is a complete history written and recorded in all forms and fashions of this industry's repetitive boom and bust business cycle.

However, despite all of this data, despite all of this history, and the collective wisdom of the industry, this industry is subjugated to a pricing cycle that is directly related to financial leverage. It really is quite simple. Without paying in terms of loss of capital, there is no gain in terms of pricing.

Currently, insurance companies' book value has grown, largely as a result of a recovery in the financial markets. Slower demand for insurance coverage has caused carriers to lower pricing and expand coverage. As an industry, carriers are feeling no pain and, therefore, not adjusting pricing to responsible levels.

Absent some type of cataclysmic capital-consuming event or significant capital deterioration through adverse loss development or otherwise, introducing pain to the industry, the soft market will continue. However, one thing is certain -- the cycle will turn, capital will be lost, and the market will firm once again.

As for AMERISAFE, we are determined, like a number of other responsible carriers, only to write business when there's a reasonable opportunity to make an underwriting profit.

We believe that is the best value proposition for our shareholders.

With those comments, I would like to open the call up for questions. Brandy?

Thank you. I'll now begin the question-and-answer session. (Operator instructions)

And our first question comes from the line of Matt Carletti with Fox-Pitt Kelton. Please go ahead.

Hey, good morning.

Morning.

Morning, Matt.

Matt.

I've got a few questions. One is just with regard to the EBUB. I just want to know if I'm thinking about it right, that -- is that essentially fast-forwarding, if you will, the impact that premium audits -- or negative impact that premium audits would likely have on future quarters, thus potentially making the gross written premium comparisons in future quarters a little bit better and when the economy turns, probably being able to recognize that trend a little bit sooner?

That's exactly what EBOB is established for. It's supposed to be predicting for policies that we're writing today what the future audits of those policies are going to be.

And how those policies will earn out.

Okay.

So if we get to this -- to the point where the market really has turned, we would expect to turn the EBOB, as well. The trick is going to be figuring out when that is --

Right.

-- because as you know, Matt, it's only an estimate.

Yes, yes, exactly. Okay.

Secondly, Geoff, you mentioned in some states where you've had good success, you've entered or are looking at entering some new hazardous classes, I think I heard you say. Could you elaborate a little on that?

Well, Matt, I'd rather not in terms of the competitive information that that implies. Let me just give you an overall picture, if I might.

Sure.

We are expanding -- beginning to expand some geographically. We're opening up some territories in Alaska, we've reopened the state of Nebraska, and we're opening some new territories in Iowa. We're also considering other new territories as we evaluate the data.

We are indeed going into some new classes that fit our profile and have always fit our profile, but we're only going to do that in states where we've had very good results. But I'd rather not share with you, for competitive reasons, the actual classes we're talking about.

The maritime initiative is simply a way for us to open up that part of the marketplace to some additional opportunities which we have not taken advantage of in the past, and we've increased our commission rate in some states to 10%.

Okay, that's great. And I mean does that -- I guess just a general question on competition -- I know, Allen, you commented on it broadly. I mean does it vary widely by geography? I've heard some other not direct competitors of yours but others in the worker's comp segment this quarter kind of reference that they're seeing less competition, not necessarily good conditions but better market conditions in the Midwest and Southeast. Would you say the same or otherwise?

There is a huge variation by geography. I don't know if that's a reflection of the economies in those areas or if it's a reflection of the competitive landscape, but you've heard us talk, Matt, over several years that we don't have the same competitors in the Midwest that we have in the Southeast, that we have in Alaska, that we may have in Texas.

And there are clearly pockets where business is more robust. There are clear indications that as you move down in policy size, that business activity is more sustainable and has been -- the pricing is less elastic and the retention level is dramatically higher.

So we see some bright spots out there, but to be fair, I will have to say you know our 10-K, and I think our investors know our business.

In our construction business, which is about 42% of our overall business, we have made no secret about the fact that that's largely commercial in nature and not residential. That was fine when the residential market was going down and the commercial market was sustaining. Currently, those circumstances have reversed themselves. So we're feeling that pinch in the commercial side of the business, commercial construction side of the business. But there's still opportunities out there, and certainly the marketplace varies dramatically geographically. Wouldn't you agree, Geoff?

Absolutely.

Thank you. And our next question comes from the line of Mark Hughes with SunTrust Bank. Please go ahead.

Thank you. The other risk categories that you'd described that you're going to be targeting, are those going to keep your kind of average risk level the same? Are those higher risk and lower risk?

Let me just put it this way, Mark. The new classes that we're going into, those folks still get their shirts just as dirty as the other ones, okay? So it's still the same low-frequency, high-severity sort of metric that we're looking for. There are just some areas that we had traditionally not written. We think there's great opportunity there. We've analyzed the payroll in those areas, and so there may be some downward pressure on the cost per $100 of payroll, but that's already happening because I think we're down to $6.38 per 100, largely reflective of competitive pressures, as well as the decline of loss cost and rate.

Mark, we will not sacrifice pricing as we always have said, but Allen is right; the rate per 100 in some of the classes is a little bit smaller than what we've historically gone after, but these are still hazardous businesses, and we feel they're in our sweet spot, and we know how to perform safety. We know how to underwrite these kinds of classes.

Right. Of the 7.8 million, can you say how much of that was cancellations versus audit premium?

Janelle, do we have those figures up or--?

No, I don't have those figures handy.

How about a very rough sense?

I would say that cancellations probably have upticked a bunch -- or a bunch, some.

I would also say that we have some states where we take a side risk business on a direct basis. That portion of our business has shrunk to almost nothing, and that's reflective of a soft market where carriers are willing to write those accounts on their voluntary paper when they would not write them several years ago.

So would the cancellation be half of that amount or--?

I don't have that number, Mark. I'm sorry.

Okay. And then the nonresidential construction, what's your view now of -- you've talked about that segment, that you've got a little more maintenance flavor versus new building. How do you feel about that now? What's been kind of the very recent trend in the payroll there?

The commercial construction, where we see the largest drop-off, are really, quite frankly, on some of the larger policies. We don't see the variability around that so much in the smaller policies, the under $50,000 policies, as we see in the larger accounts. And, of course, you certainly notice it when an account -- one I looked at the other day dropped -- what was it, Geoff? -- around $400,000 down to about $60,000.

That's correct.

And on a renewal basis. Clearly, that's pretty significant when you see that. We don't see that sort of explosive volatility in the smaller accounts.

In some of the classes, Mark -- I mean in some of the accounts, again, the larger accounts, we actually see periods where they only report clerical payroll because they're keeping a skeleton staff, but they've definitely reduced the governing class group, the heavy workers, I'll say, in some businesses that are suffering through this recession. And as Allen said, they're mostly -- we see it more in the larger businesses.

Thank you. And our next question comes from the line of Mike Grasher with Piper Jaffray. Please go ahead.

Thank you, and congratulations on the quarter, everybody.

Thanks, Mike.

Thanks, Mike.

I guess a couple questions. On the lower expenses in the quarter, I think from a notional amount, expenses were down. Is there anything in particular that's happening there? I mean was it any cut in payrolls or just reduced operating expenses overall, or can you comment on that?

It is reduced overall operating expenses, and of course, what's driving the decrease is the fact that those variable expenses that are related to premium are decreasing, so insurance-related assessments, premium taxes, commissions, those type of things. There weren't a lot of -- there weren't any large one-time items in the expense reduction.

Okay, thanks for that.

And then you've commented -- I think, Geoff, you've commented about -- or Allen commented on severity rising due to medical. Are you changing your forecast at all in that regard just with a lot of the different opinions going on out there about impending inflation?

Well, let me just say what we -- I guess the principal move we're making there is we are not reducing at this time the current accident year, Mike, the 2009 accident year.

And in the past, we have made reductions as of the third quarter, but we're concerned enough about medical inflation that we're being a little more conservative this year in terms of the current accident year.

Okay, that's helpful.

And that's due to our concerns about medical inflation, especially in the prescription area.

Sure. And then your commentary around the estimate adjustment on EBUB, how does that square with, I guess, the notion or the thought that we've been in this recession now for some time. As companies have sort of right-sized their own businesses and payrolls, would we expect the audit premium to be much less going forward, or is it hard to gauge just with that thought?

Well, one of the things you need to think about, Mike, is that the audits that are coming through the door right now, think about those policies were written 15 to 18 months ago. Those are the negative ones that we're seeing now, so when we're looking at the EBUB premium, we're thinking about policies that we're binding today.

Are uninsured underestimating payrolls -- are being as pessimistic about payrolls as they're reporting to us today? We believe, yes, they are. So would those negative audits continue for another 15 to 18 months? Our belief is no, they will not.

We think we're reaching an inflection point, quite frankly, in that issue, Mike, where people have right-sized their projections of what they think they're going to be on payrolls or perhaps been overly pessimistic.

This is the first adjustment we've made in the approach to the EBUB estimate since we initially launched that in the fourth quarter of 2006, so I don't want to call it one time, but I would tell you I think it's a bit of a catch-up.

Just a slight correction, though. We have made adjustments, just not ones of this magnitude. Janelle, I don't believe we've ever -- we make a quarterly adjustment. Has it ever been over 500,000?

Yes.

Just but not a million or-- they've been minor adjustments compared to the current quarter.

Thank you. (Operator instructions)

Our next question comes from the line of Michael Nannizzi with Oppenheimer. Please go ahead.

Thank you. Hi, everyone. Just a couple quick questions, if I could.

What years, Geoff, generated the favorable development? You were mentioning the current accident year. Can you tell us which accident years generated that development?

The bulk of the prior-year development was in 2007 2.9 million.

Okay, great. Thanks, Janelle.

Welcome.

2.9 million, okay. And then do you know -- do you have handy the difference between fair value and amortized cost in the portfolio? I just want to kind of apples to apples -- as you'd mentioned, [inaudible] are available for sale. Just want to have the benefit of that number.

Sure. All in, our book value, the carried value was $821,653 and the market value was $840,457.

Great. Okay, so it's about another $19 million. Okay, great.

And then the instrument that you sold in the -- so you sold one fixed-income security, an asset-backed security in the portfolio. Can you tell us a little bit more about that?

Sure. That was the asset-backed that we actually impaired in the third and fourth quarter of 2008, and we were able to sell it because it had a major downgrade on it, so we could sell it being held to maturity and not taint the portfolio.

Oh, okay. So you didn't have to move it to available for sale and then sell it?

No, sir, we did not.

Got it, great.

And then one question just -- Allen, just broadly, and so if my numbers are right, you're writing about [8, 10's] a surplus right now down from about 1.1 times last year and about 1.5 times the year before. And I realize that preferred stock limits your capital management options right now, but can you just talk about how you think about capital management? Should the trends of increasing book value and increasing surplus and declining premiums continue if the economy stays the way it is?

That's a very fair question, Mike.

Obviously, we'd been adding capital to AMERISAFE since we went public. The board of directors and the management of AMERISAFE are very aware of the fact that our leverage ratios, our financial leverage ratios, are reaching very low levels, and we would prefer to be able to operate at a much higher level, and I think there's a balance we're going to have to achieve between right-sizing the capital and having adequate capital in the event that the market should turn and we would have growth based on pricing increases.

So we have had conversations with our C&D shareholders. I do not have anything to report at this time.

We also continue to look at the possibility of acquisitions although -- I don't want anyone to get the idea that in some sort of effort just to try to fix the leverage issues, we'd go out and make an acquisition that was inconsistent with what AMERISAFE does and how we approach our business.

We are looking at the capital management issues, and we are aware of how the leverages are dropping, and we think that perhaps some capital management initiatives in the future would have to occur.

Was [that] sufficiently vague, Mike?

Thank you, and our next question comes from the line of Beth Malone with Wunderlich Securities. Please go ahead.

Okay, thank you. Good morning.

Beth.

A few just kind of housekeeping questions. Could you give us -- do you have available what the commissions and salaries and benefits number was for the third quarter?

Yes, ma'am, sure. The commission number was 3 million 865.

Okay.

Salaries and benefits were 5 million 331, and underwriting and other operating were 3 million 339.

Okay, great. Thank you. And, also, what was the book value, the GAAP book value for the quarter?

1594.

'94. Okay, great. You talked about inflation on the worker's comp, medical inflation being an issue. Is there much that you can do in the way you structure the product or the claims management to try and mitigate that?

No, I mean our principal weapon against that, Beth, is aggressive closure of claims. That's -- otherwise, we're at the mercy of the PPOs, the medical networks, and everything that goes along with the whole healthcare medical cost issue.

And so we try -- we're always working on tweaking our networks to try to get better discounts, but the inertia is definitely toward rising medical costs, and our best weapon is closing claims as swiftly as possible, so those medical costs at their inflated rates aren't continuing to hurt us.

Beth, let me make an additional comment on that. As you know, we maintain a very low level of claims per field case manager, currently around 50 claims per field case manager. That, we believe, is money well spent.

The alienation factor of allowing someone to think they'd been forgotten by an insurance company leads to additional litigation and the elongation of claims. So we're still seeing claimants within the first two to three days after receiving notice of a claim. We're trying to get them to the right healthcare providers and to try to build that communications with them and an understanding that we're there to help them and not to find ourselves in the litigation posture.

Okay. And then in terms of the competition that's out there, is it still the same kind of players out there doing the same things? Has there been really -- it sounds like it's getting more intense, but has there been any real movement?

I don't know that it's getting more intense, Beth, but it is the same players, particularly when you talk about very large policies. That's where it's most noticeable. It is more intent. There are more hot spots or there are certain areas that are hot spots and certain areas where there's not as much competition, but as I said in my opening remarks, there are a few carriers that are backing back away from as aggressive stand. Quite frankly, I don't like naming other carriers, but I don't think AIG is quite as competitive or as aggressive as many had complained six to nine months ago.

And, Beth, as we -- what we're really interested in is watching the renewal cycle every year because as certain carriers reduce their LCMs, that means they've got a higher hill to climb in terms of increasing rates if the market does turn, and that's going to be a -- I feel -- I don't know if Allen agrees -- that that will be a competitive advantage for us when that happens. Do you agree, Allen?

I agree.

Thank you. Our next question comes from the line of Eric Swergold with Gruber and McBaine. Please go ahead.

Good afternoon, and thanks again for sticking to your disciplines.

My first question on capital management I think was addressed suitably vaguely, but my second question is with regard to the fixed income portfolio.

Like many insurers, you invest a large percentage of your book value in various fixed-income securities, and given that short rates at least are about as low as they can go and it's anybody's guess on long rates, if we do, in fact, get into an inflationary environment and rates go up, theoretically, the longer-dated maturities in your portfolio could be hit.

Are you hedging longer-dated maturities? Are you moving your maturities in and accepting lower yields? What are you doing on the fixed-income side to protect us against a potential spike in interest rates sometime next year?

We are doing the latter. We are shortening the duration of the portfolio and accepting lower yields.

Suitably conservative given your style. Thank you.

Thank you, Eric.

Thank you. Our next question comes from the line of Mark Lane with William Blair & Company. Please go ahead.

Good morning. I just had a couple quick ones.

First of all, on the last few quarters, you've given us the flow of business from AIG. Can you give us an update on that?

Mark, I didn't bring the figures with me. I can tell you that it is -- every month has been on the decline for the last quarter, and I want to -- it's becoming -- I'm almost to the point of telling our head of underwriting not to report it anymore because it's just not a real big piece of the puzzle anymore.

Okay.

You know, Mark -- this is Allen. Let me just make one quick comment around that.

It's been very interesting watching this unfold since September 16, 2008, where there was a great deal of anxiety in the marketplace initially. We got hundreds of calls and many, many submissions, and we wrote a bunch of business.

And then over a period of time as the government got involved, there was sort of a lessening of the fear. And as I read and look at the national publications, it does appear that a large number of the shareholders just rode out the storm.

And now we're back on renewing those pieces, and if you think about it, as we go through the next few months, you've got accounts that were hotly contested for retention, and it's going to be very curious to see what those carriers do that were very aggressive about pricing that business. I can tell you that our price business on the AIG business we took was not significantly different from the rest of our whole book of business.

No. And then, second, can you -- I know this was something that you've commented on the last few quarters, but with competition up and being intense, etcetera, you mentioned that your retentions based on policy count and premium were up. Why is that?

We'd like to say it's because we think we do a better job in terms of handling the accounts.

I do think that there's several factors that drive that. Once people get on the books with us, they find it easy to do business. It's a monthly reporting with -- now a number of other insurers are doing that. It's a monthly reporting. It's very easy from an execution point of view. They get a high level of safety, services, other materials to help them have a safe workplace. The claims are handled promptly. They have the opportunity to talk to a claims adjuster who's not handling 200 files and actually has time to speak with them about that.

So we've always had a high retention of business, but it's staying even higher and edging higher, both our premium dollar, as well as policy count.

And one of the things I want to be sure that you understand; with this monthly reporting, that minimizes the friction of audits, of premium audits, where many times, people feel like, "Wow, you surprised me, and you hit me at the end of this policy with a big number." This way, there's a progression as you go along, and it's not based just on [it].

I'd like to add just one comment to Allen's, and I certainly agree with what he said. What's really interesting -- what was really interesting to me as I read these numbers at the end of the quarter and is, I think, quite counterintuitive is that as -- unlike new business, as the average premium rose in the premium bands that we measure, the improvement in premium retention actually got better. We have been doing a very good job of retaining, on average, large accounts. That surprised me, I have to admit, but it's obviously a great thing for us.

Thank you, and our next question comes from the line of Ron Bobman with Capital Returns. Please go ahead.

Hi. Good morning, everybody. Congrats.

Morning, Ron.

I have two simple questions.

Allen, the anecdote you mentioned earlier, the 600K I think you said going down to 50K or something like that, that was a -- those were payroll figures, I assume, right?

That was a premium figure.

Oh, wow.

Yes. That was a premium figure, and I can't -- I think that was a construction account.

Okay. And I'm sorry, the point you were trying to make was that that firm's -- that insured's business had shrunk so much, driving the premium decline or --

Right.

-- or that's a reflection of fierce competition more than it is [inaudible]?

Oh, no, that was payrolls. Those were payrolls that were causing the drop driving that.

That's business activity.

Okay, okay. And then the second question I had, Janelle, you answered an earlier question about the '07 year representing the lion's share or a big chunk or all of the favorable development. I think it was like 2 point -- I forgot the number you said, 2.4 or 3.4.

I was wondering if that favorable development was largely coming from IBNR from that accident year or whether it was largely cased files that either were closed favorably relative to the carried reserve or just the carried reserve was being reduced to produce favorable development?

It was actually -- we had favorable case development in the 2007 accident year this quarter.

Okay, and so that was the primary driver?

That, coupled with IBNR, was the 2.9% -- or $2.9 million decrease.

$2.9 million. But case was the meaningful -- was the most meaningful component of the 2.9?

Correct.

Okay, thanks a lot. That helps. Best of luck.

Thanks, Ron.

Thank you.

Thank you. Our next question comes from the line of Seth Bienstock with TimesSquare Capital. Please go ahead.

Hey, guys. Congrats on the quarter.

Thank you, Seth.

I appreciate your not wanting to cast aspersions on alcoholics and cowboys, but was curious. What are the things that you think that for the industry could turn the fine wine of loss reserves and favorable development that we've seen in recent years into vinegar?

I think there's a couple of things. Anything -- well, I think the seeds have been sown of adverse development. I think companies are looking back with rose-colored glasses on what had happened in the last few years in terms of the development. I think there's a certain degree within the industry, I believe, of hubris about their ability to write this business below what all the statistics say you should be able to write it.

I mean the reason we publish, Seth, as you know, is -- the effective LCM on our book of business is that you can then look at our carried loss ratios and see whether or not it makes sense.

And pricing business at the cost of losses is going to produce a very -- it will produce 100% loss ratio. That's just where it's going to end up in the aggregate.

So I think -- the premiums on the books, I think you're going to see claims development start running adverse, and it's going to start running adverse as the people have got older and older claims out there. If you allow a claim to stay, it's going to bite you, and they're not closing claims aggressively. They're handling claims with 150 or 200 claims per adjuster, and they're not getting those cases resolved. I think that's one thing.

I think the second thing that there is clearly the risk on a medical cost inflation piece that is going to surprise a number of people, particularly those that have a lot of claims open in older years.

And, of course, the other thing that can change is that financial markets have lifted the book value of a lot of companies during the last six months. Anything that would reverse that would eat into that capital significantly.

So I'm going to just ask the follow-up then talk to that. I mean [inaudible] think about kind of AMERISAFE and what you guys have proven your ability to do, whether structural or otherwise, that [inaudible] it appears, there's sort of this victory of I'll say hope over data, over statistics, right? Everyone has that same data. They're able to see it.

That's [inaudible].

Why aren't other guys able to kind of figure it out?

Well, whenever we get in a period -- and you can look at the cyclical history of the industry -- we get in these periods of reserve take where pricing is recognized as being inadequate, pricing shoots up. It doesn't just go to where it should be. It goes above the necessary premium in order to support the losses. And then that leads to a period where reserves are taken down and people reduce capital and they declare a new paradigm in the marketplace. We now understand it better.

I remember very clearly the late '90s when we, along with other carriers, were pricing at or below loss cost thinking because of our history we were so much smarter than everyone else, but we ended up with 137% loss ratio on a gross basis.

The states give you data that is very, very detailed and very thorough, and it makes it very clear that the loss cost or those bases for the losses and the pricing indicates where you can expect the losses to come in.

You may beat that and you may be better than that through your underwriting expertise and the way you handle claims and the way you handle policies, but you're not going to be 20 or 30 points better than that. And right now, there are people that I think believe they're 20 or 30 points better than what the data shows.

And, Seth, remember that -- I mean you know this well -- work comp is a long-tailed lined of business, and even if you feel you're looking at development factors accurately, as you get farther out toward the tail, those become less and less -- your ability to estimate those becomes less and less accurate.

And so many of the -- it's -- behind these sophisticated actuarial models, it's still subjective judgment as factors are picked, and if you've got a rose-colored attitude toward those things with long-tailed lines, that can add up to a lot of deficiency without you really realizing it until it's too late.

Thank you. And our next question comes from the line of David Dusenbury with Dalton, Greiner. Please go ahead.

Hi. I wanted to clarify a little bit. Maybe I can get a -- do an end run around the new business-type questions.

Okay.

If we go forward four or five quarters -- let's say we're in the fourth quarter of 2010 -- do you have a sense in your planning how big you think some of these new lines and new geographies will be as a percent of total?

I don't believe we've made any projections on those, and I would -- that's going to depend on so many other factors.

I will tell you that I think Geoff -- with respect to the new classes of business, there's a lot of payroll in those, but we'll have to see just how much market penetration we get in that, so I'm going to duck that question, David.

Okay.

Good try, though.

I'll [inaudible].

So I guess my follow-up question is probably moot, as well, which would be what the impact would be on expense ratios.

Well, it certainly would be an improvement on expense ratio, but the expense ratio shows up on your earned premium. The top line is dropping. There will be some dropping in earned premium as we forward -- further, and there will be pressure on our expense ratio, but we finished last year with a 19.3% expense ratio, and we're up to 21.6 for the quarter, and I forget the number for the year. It's certainly a better place to start at 21.6 than it would be at 32, and we will continue to manage those expenses as tightly as we can.

Thank you. And our next question is a follow-up question from the line of Matt Carletti with Fox-Pitt Kelton. Please go ahead.

Hey, this is a numbers question, and I'm sorry if I missed it earlier on the call.

Can you give the change in insured payrolls and premiums in force over last year?

Yes, Matt, the change has been 5.2% downward on in-force premium; 1.1% downward on payroll. But I have to say that's not a year over year; that's a -- we measure that on a year-to-date basis.

Oh, okay. All right. Thanks. Congrats.

Thank you.

Thank you, and our next question is a follow-up question from the line of Mike Grasher with Piper Jaffray. Please go ahead.

Just noticing tax rate continuing to go lower, I guess, than what it has in the past few years. Is this -- I mean is it more the investment portfolio with munis, or is it, I guess, more coming in from the investment portfolio relative to the 35% tax rate?

Yes, it is a result of the municipal portfolio, but also in this quarter, and you'll see a description in our 10-Q, we -- because we sold some of the equities and that asset-backed that we impaired last year, if you recall at year end, we put up a valuation allowance against our deferred tax asset, and so we were able to reduce that this quarter. So that was $678,000 of favorable tax expense in the quarter, so that was about 1.1 percentage points driving the tax rate down.

Okay. That's helpful. Thank you.

Welcome.

Thank you, and our next question is a follow-up question from the line of Mark Hughes of SunTrust Bank. Please go ahead.

Thank you. I think you suggested that frequency was billed down on an earned premium basis. Is that starting to stabilize? And where do you think the industry is on that measure?

Mark, if I had to guess, it's stabilizing, but I don't have that -- I don't have the figure as to on an earned premium basis as to whether it's really decelerating. It's going to have to eventually for both the -- my opinion, for both the industry and for us even on a payroll basis because we'll get to the point where employment goes back up and companies will be hiring less experienced workers and frequency of loss will start going back up.

There's a point, almost like full employment, that we believe we'll get to and we're nearing, as a matter of fact -- Allen and I believe that -- where, practically speaking, you can't get any lower. So watch for that to slow down both in the industry and for AMERISAFE, as well.

Yes, Mark, let me comment on that. I was surprised for the quarter and actually for the year to date how much the severity has dropped. I don't have that number in front of me. I would've expected more of it to level off, but we measure that both on a payroll basis as well as on an earned premium basis, and our earned premium basis, it's still slipping downward.

Right, and you're talking about frequency, correct?

I said severity. I'm sorry, frequency.

Yes, exactly.

Thank you for correcting me on that.

Okay. All right. Well, thank you very much.

Thanks, Mark.

Thank you. And our last question comes from the line of Beth Malone with Wunderlich Securities. Please go ahead.

Okay, thank you. On the frequency issue, it would appear since it continues to go down that there's no -- there doesn't seem to be any connection between unemployment and recession and the number of claims being filed. Is that what you're seeing?

No, I would say to the contrary, as the recession drags on and unemployment goes up, our kind of employers are retaining the older, more experienced, and safer workers, and I think that's definitely -- maybe that's the reason why it hasn't started to plane yet.

In this area of high unemployment, people are both trying to keep their work comp costs down by being more safe, and the more experienced workers have stayed with the companies.

Okay, thank you.

They've laid off the less experienced.

Thanks, Beth.

Thank you, and at this time, there are no further questions. I'd like to turn the call back over to management for any closing remarks.

Okay, thank you, and thank you very much for joining us today.

Before I close the call, I want to make a comment on a personal matter.

On November 5, 1919, [Clifford Bradley] was born in Bloomington, Indiana. After spending the first dozen or so of his years in Indiana and the wheat fields of South Kansas, he moved with his family to Louisiana with the promise of cheap land, a temperate climate, and adequate rainfall.

He grew up in the Great Depression and served his country proudly in World War II. He owned and operated a small but successful business here in DeRidder, Louisiana until his retirement some 30 years ago.

He's still married and living independently with his high school sweetheart, who's a spry 86 years old. And he raised and guided to maturity four children and has served his community loyally.

Some of you know that my father attends all these conference calls, or at least most of them. He is indeed present today, so I wanted to take this opportunity in a very public way to recognize his birthday.

Happy 90th birthday, Dad.

Thank you, ladies and gentlemen.

Ladies and gentlemen, this concludes the AMERISAFE Third Quarter Earnings Conference Call.

If you'd like to listen to a replay of today's conference, please dial 303-590-3030. ACT would like to thank you for your participation. You may now disconnect.