Amerisafe Inc (AMSF) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Amerisafe's Second Quarter 2011 Earnings Conference Call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to Todd Walker, Amerisafe's General Counsel and Secretary. Please go ahead.

Good morning. Welcome to the Amerisafe second quarter 2011 investor call. If you've not received the earnings release, it is available on our website at www.Amerisafe.com. Today's call is being recorded. A replay of today's call will be available afterwards. Details on how to access the replay are contained in the earnings release.

During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions and are subject to various risks and uncertainties. Actual results may differ materially because of factors discussed in the earnings release, in the comments made during this call, and in the Risk Factor section of our most recent Form 10-K, Form 10-Qs, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement.

I will now turn the call over to Allen Bradley, Amerisafe's Chairman and Chief Executive Officer. Allen?

Thanks, Todd. Good morning, ladies and gentlemen. Thank you for joining us for our second quarter 2011 conference call. As usual, I'll make a few comments about the quarter before turning it over to Geoff Banta, our President and Chief Operating Officer who will then, in turn, introduce Janelle Frost, our Chief Financial Officer, for additional financial details.

During the second quarter, Amerisafe continued to experience significant increases in gross premiums written. Improvement in audit adjustments, along with an increase in new and renewal premium written during the quarter increased the gross premiums written by 15.8% over the same quarter last year.

At the same time, for the fourth consecutive quarter, policies written during this quarter experienced an increase in pricing as reflected by our reported effective LCM, which Geoff will discuss in a few minutes.

Previously, we had postulated that pricing in the high hazard market for worker's compensation was firming, and there is, indeed, growing evidence that this thesis is well-founded.

Partially offsetting these positive trends, the 2010 accident year losses continue to increase more than we anticipated. But despite the increase in the 2010 accident year loss ratio, we experienced overall favorable development for all prior accident years of $1.2 million during the second quarter.

Amerisafe continues to diligently pursue claims resolution to bring these outstanding claims to a timely, fair, and final conclusion.

I'll now turn it over to Geoff Banta for an update on our operations. Geoff?

Thank you, Allen, and good morning, everyone. I'll make a few comments about our operational performance and trends before turning things over to Janelle to present a summary of our financials.

I'll begin by discussing our top line. Our gross premiums written were up strongly in the second quarter by 15.8% year-over-year. Also, on a year-to-date basis, our top line is up 16.3%. The second quarter increase was due mainly to substantial year-over-year increases in payroll audits and related premium adjustments. These adjustments have now improved for 10 straight months, year-over-year. Janelle will discuss the financial impact of these adjustments during her comments.

Also in the second quarter, our deck sheet work comp premium was up 1.8%. This is especially good news for us because we experienced this organic growth in the face of increased pricing, but we were helped along by very strong renewal retention and a markedly higher average premium on our new business.

In terms of our renewal business, our premium retention was a stellar 93.9% versus 84.1% in the second quarter of 2010. In the current second quarter premium retention rate is the highest we have seen since 2002, and we believe that this is an early sign of a firming market.

Our policy retention, meanwhile, was 92% in the second quarter, just slightly lower than Q2 2010, which was 92.7%. As mentioned above, our average premium was nicely up in the second quarter year-over-year but especially for our new business. These increases in average premium are the result of both increased average payroll and increased pricing.

Relative to pricing, our effective LCM for voluntary work comp in the 2011 second quarter was 1.50, or 150% of the approved loss cost of the states that use that mechanism for pricing. This was the highest pricing level we had seen since the third quarter of 2007. And it was up from 1.41in the second quarter of 2010, a 6.4% year-over-year pricing increase.

In terms of losses, our second quarter results represented a mixed bag. Accident year 2009 and prior have continued to develop favorably in the aggregate, but 2010 has had higher-than-normal development as we have seen a large number of December 2010 severe losses. Those with [incurreds] of greater than $500,000 as well as unusually high frequency for claims between $50,000 and $250,000.

The main contributors to this 2010 accident year result has been decreasing premiums from historically negative premium adjustments and an increase in losses due to increasing frequency of lost time claims. As a result, in the second quarter we added 2.4 points to our 2010 accident year net loss ratio. We also added 3.8 points to our 2011 accident year net loss ratio in the second quarter.

While we experienced slightly lower overall frequency and severity in 2011 versus 2010, we had a very high frequency of claims over $500,000, and development of these claims alone has totaled almost 14 points of loss ratio year-to-date.

If we are correct, 2011 will become the third consecutive year in which Amerisafe has posted accident year loss ratios higher than 70%. We firmly believe that our results and the results of the industry as a whole are being significantly impacted by the cumulative effects of state-mandated loss cost reductions and increases in medical costs and claims duration. But the full impact of these factors won't really be known until future years.

In the meantime, we are continuing to push our pricing, tighten our underwriting and adjust claims as aggressively as we have in the past.

With that, I will turn to Janelle to present details on our financials.

Thank you, Geoff, and good morning, everyone. For the second quarter of 2011, Amerisafe reported net income of $4.6 million, or $0.24 per share, compared to $10.4 million, or $0.54 per share in the second quarter of 2010. Our gross premiums written grew 15.8% not only from less negative audit and related adjustments but with a 1.8 percentage point growth in premiums for policies written in the quarter. Net premiums earned increased 13.7% from the year-ago quarter.

Our net investment income totaled $6.6 million in the second quarter, down 1.2% from the year-ago quarter. Average invested assets were $829 million compared to an average of $800 million in the second quarter of 2010.

The tax equivalent yield on our investment portfolio was 4.5% compared to 4.7% in the second quarter of 2010. In total, revenue for the second quarter of 2011 was $67.1 million, up 11.6% from the year-ago period.

Our current accident year loss ratio increased to 78.2% for 2011, which resulted in a 79.3% current accident year loss ratio for the quarter. This compares to 75.5% in the second quarter of 2010, and 81.8% for the full year of 2010.

Our incurred loss and loss adjustment expenses totaled $46.6 million for the quarter, which included $1.2 million of favorable prior-year development.

Accident years 2008 and prior experienced favorable development of $6.6 million offset by $5.4 million of unfavorable development in accident year 2010. This compares to our loss and loss adjustment expenses of $33.7 million in the last year's second quarter, which included $6.3 million of favorable prior-year development.

In total, our net loss ratio for the second quarter of 2011 was 77.3% compared to 63.6% for the second quarter of 2010.

Total underwriting and other expenses increased 21% to $14.9 million compared to $12.3 million in the second quarter of 2010. The 2011 second quarter expense components included $4.8 million of salaries and benefits, $4.5 million of commissions, and $5.6 million of underwriting and other costs.

The expense ratio increased to 24.8% from 23.3% in the same quarter a year ago. The primary reason for the higher expense ratio is lower experience rated commission related to our 2011 first layer reinsurance. As you may recall, these commissions act as an offset to our expenses, and in the second quarter of 2011 experience rated commission offset our underwriting expense ratio by 2.2 percentage points compared to 4.5 percentage points in the second quarter of 2010.

In total, our combined ratio was 102.7% for the second quarter versus 87.3% for the same period in 2010.

Return on average equity for the second quarter of 2011 was 5.5%, and book value per share at June 30th was $18.31, an increase of 7.6% from the June 30th of 2010.

Finally, statutory surplus was $309 million after paying a $22 million dividend in the first quarter to the holding company. Cash at the holding company is held for our share repurchase program, retiring debt, and future acquisitions. Toward those means, in July we retired $10 million of our $36 million of debt.

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

Thanks, Janelle, and I'd like to make a few comments following up on my earlier comments about the marketplace.

Recently, Steven Klingel, the CEO of the National Council on Compensation Insurance, described the worker's compensation line of business in this country as -- and I quote -- "deteriorating." With combined ratios for the line in excess of 117% for 2010, compensation riders have suffered unsustainable underwriting losses.

The pricing of worker's compensation reinsurance of the working layers of that reinsurance are firm and are rising. In the past two years, the aggregate net development for the domestic worker's compensation line of business has been adverse and is almost certain to be adverse in 2011.

With depressed investment returns, there is a sense of urgency among industry leaders to produce an underwriting profit. This sense of urgency has now manifested itself in the marketplace in terms of changes in the competitive landscape.

These four elements are essential to a turn in the market, and the presence of these elements represents an opportunity for Amerisafe. Why do I say that? Those of you that have followed Amerisafe over the years understand that we have allowed our premium volumes to fall as the opportunity to profitably write business has declined. Now the underwriting environment has begun to change, and the opportunity to profitably write business is emerging with a solid balance sheet, available capital, an established distribution system, and excess operational capacity, we are well positioned to take advantage of these circumstances, and we fully intend to seize that opportunity.

We are continuing to pursue underwriting initiatives launched earlier and, at the same time, firmer pricing and rising loss cost will allow us to grow our written premiums. We are excited about these circumstances.

Our excitement must be restrained, however. With underwriting discipline and conservatism on risk selection, because we believe loss trends will improve but will trail the increase in improvement in premium volume.

As we cautioned you in the last two quarterly calls, do not expect these opportunities to result in immediate short-term benefits but rather to form the foundation for a sustained period of profitable expansion for this company.

Now, if we could, Operator, let's open the call for questions.

(Operator Instructions) Randy Binner, FBR & Company.

I guess I just want to dig a little bit more into the recent acts in your development. I guess I wasn't clear on, I think, 14 points of loss ratio was on large claims. Was that from 2010 and into 2011? And then on those large claims, were they mostly in late 2010 or have you seen the continuation of that trend in 2011 as well?

No, Randy, I mean, admittedly, and we said this on the last call. We did have an unusual number of large claims late in December of 2010. But the 13 to 14 points I mentioned were all claims in 2011. A very unusual frequency of severities over $500,000, which included very serious motor vehicle accidents, burns, two fatalities, and two very bad falls. And it was all in 2011. Two of those claims have been closed because we settled on the fatalities. But it was what we refer to as a frequency of severity in the first half of 2011 -- all 2011 loss states.

Is there a way to think about -- because I guess the question that a lot of people would have is are the reserves trued up enough relative to what's happened? I mean, is there a way of communicating where you've put the reserve relative to a point estimate or any further color on how much we can put this development past us as we think about the loss ratio, going forward?

Well, we have normally -- it's an interesting part of our business. Historically, we have had better development on large claims than we have on maybe your $50,000 and under claims because we spend so much time on those claims. I'd say our reserving is fairly conservative on those claims. There are so many things that can go wrong with a person's health when they've gotten so badly injured. And we feel, if anything, our development is flat to positive as we look back in history at those large claims. Would you agree, Allen?

Randy, one of the ways to think about it, first of all, with respect to reserves on prior years as you think about whether or not the reserves are appropriate. Since going public we have consistently been able to maintain a course of what we thought were very prudent reserves, and those have worked out to be very prudent, and we've benefited from five and a half years of basically favorable development for each and every year.

With respect to the development in 2010, the duration of claims is extending. Those claims have surprised us. We had some late in the year, as Geoff talked about, and while we tend to get those right, it takes a while to get to a point where you know the true health of the individual.

With respect to 2011, we thought it appropriate that since 2010 had to be moved up, that we then go back and take a more conservative -- well, I won't say "conservative" -- but reassess our position with respect to 2011.

Just the passage of one day, from December 31, 2010, to January 1, 2011, did not mean that everything had changed, although we launched a bunch of initiatives early in 2010 that we see good results from. And the pricing is up, and the volume is up.

So -- that's the reason for the move in 2011. The actual move for 2011 went from 77 to 78.2. But because you have to cover two quarters, there's a catch-up provision in the second quarter of 2011. But if you look at the six month, it's 78.2.

Will that prove to be adequate? We believe so. But it's a difficult business. We can't promise that. We do know that pricing is significantly higher, and some of the underwriting initiatives that we've launched have taken hold and, as we sub-segment those, we see that results are improving.

So we're optimistic on that. We believe that the loss costs themselves, as stated in the aggregate are probably deficient. And so while you normally would think a 140 effective LCM would produce a profit, we are pushing pricing above that level because we believe those loss costs are deficient. And, indeed, now loss costs are beginning to rise. For example, I think it was Virginia that just announced an aggregate average of about 6.4% on the state. Loss cost there is, on the average, when we apply that to our book of business, Randy, it goes to over 10%.

Randy, one more thing about it, and I agree completely with what Allen said, but as it took us into the first half of 2011 to get comfortable with very complicated reserving on the December 2010 claims, I should have mentioned that of the -- well, when we get the reserve where we think we've stabilized the patient and know what the prognosis is, we think we're quite accurate on that. A few of these claims that I mentioned that add to that 13 points are still developing in terms of the claim itself. So I would say there's a couple of those claims where we aren't at the point where we know what the ultimate -- what we believe we know what the ultimate prognosis is.

So there could be, on a couple of those claims, continued development until we get our arms around -- and these are very, very ill and injured individuals that are still in trauma centers.

Mike Grasher, Piper Jaffray.

I wanted to ask, Geoff, just in terms of the duration of claim, if you were to look back, I guess, a full year, even 18 months, what does that trend line look like? And has it stabilized? If you could just comment on that, that would be great.

Mike, the duration in the first five years has been as consistent as it could possibly be, even in some very different colored accident years. Duration seven years out, in other words, the oldest claims, is moving upward and probably has moved a couple of points, anyway, as when you look at the payment patterns on the claims. And we think that is a function of it being more difficult to close the more serious claims.

By the time you get out to seven years, you're not talking huge dollars, but that's where the drift is happening in the duration -- out on the tail.

Mike, one other point on that in terms of frequency, the frequency of claims is actually dropping. We would attribute that to some underwriting initiatives as well as -- and this may sound strange at this particular point in time -- but the folks we're insuring seem to be having greater work activity, and greater work activity usually is related to a drop in duration as people have an opportunity to go back to work and are doing so.

So we've seen, for 2011 and, really, the latter part of 2010, on an earned premium basis, we've seen a drop in duration. Just to give you some additional color around that, I want to say it's through the first six months of the year, we had a less than 3% increase in the number of reported claims with a 13% increase -- 13.7, I think it was -- in net earned premium. So you can see that those two numbers together would give you an improvement in the frequency.

Okay. And then you had spoken quite a bit about premium on the revenue side and how that's improving. Can you shed a little light on the July 1 renewals?

Yes. There is nothing that I said for the first six months that would not be true about the July renewals.

Okay, fair enough.

If it turned, I probably would be less optimistic about it. But I think it's going to build. We're seeing in the marketplace pricing resistance falling back. We are seeing times where in the past we may have been 20% or 25% above what other carriers are, and we didn't even get calls back from agents now. Those quotes are being considered. And even though we're pushing some, and we're pushing some on renewals, you know, Geoff talked about two retention numbers. There's a policy retention, which is slightly down from 92.7 to 92, which is going to reflect the implementation of certain underwriting initiatives and pricing initiatives.

And then the actual renewal premium, which had spiked up, I think it was 93.9 from somewhere in the 84 range. Those are two very important metrics. That means your renewal business, the combination of work exposures and pricing initiatives have constituted a rather significant increase in that renewal business.

At the same time, the average policy size on the new business reflects some initiatives here dealing with not writing as many small policies. And that shows up rather markedly, which lowers stress on the organization as well.

Okay, and just a follow-up to that in terms of the work exposures and the pickup in activity -- is there a particular industry that maybe you're seeing it moreso than the others that you underwrite? Or is it across the board?

Well, it's not necessarily across the board. But the ones that -- I know this is going to surprise everybody -- construction, roofing, trucking, and other -- other being agriculture and machine shops, fabrication facilities and the like, along with some wholesale/retail that's related to some of our farm business -- are the main leaders. The laggers in that are logging and mechanized logging operations. But they are up significantly, it's just their work activities -- that's a really tough industry right now, particularly in the Southeastern part of the United States.

Mike, one more thing to add onto what Allen said, what's especially promising to me is not only are we increasing prices and yet growing, but we have tightened up on our underwriting such that there are some risks that a couple of years ago we would have offered a quote, and we're now declining those because we, through our sub-segmentation, discovered that there are certain classes of business, certain states, where certain experience modifiers where we just have found it very difficult to underwrite effectively given the rate levels that we are bound to in those states.

So we are declining business we haven't declined before. And added to higher prices, you would think that our premium would be still going down. And it is going up, and I'm very encouraged by that.

Mark Hughes, SunTrust.

Can you identify where you've had these -- the very large losses in 2011? Are these new policies that you've -- are they new workers coming on the job? Any way to say whether there's any sort of trend underlying that?

Well, of course, the credibility on this, with these low numbers is such that -- all I'll give you is anecdotal information, but mostly renewal business and, I would say, more new workers than I have seen in the past. More workers that have been on the job not even less than one year, I would say, predominantly, less than six months.

Several less than 90 days. That is the common problem, as you know, Mark, in our business -- the least experienced workers are at greater risk. But let me add one thing to that -- virtually all of these losses occurred on policies written in 2010. I think there may have been one that was a policy written in 2011. So these were policies that were in force during 2010.

Did you say they were initiated in 2010 or -- ?

They were written in 2010, yes, sir, right.

2010 policy, you're not, obviously, accident or calendar year.

No, they may have been renewal business, but they were policies that were in force on 1/1/2011, by and large.

And, Mark, we are one of the -- probably the most important initiative in our loss control area is getting our arms around the whole issue of training of new workers --

Worker turnover.

-- worker turnover, any language barriers that could lessen the communication between supervisors and workers who need to learn the safety procedures. We are really studying how we can better influence and maybe even underwrite from the orientation and training activities of some of our employers where these accidents occur.

Right. I think, Allen, you had suggested -- and I don't know whether you're talking about the accident year or 2010 or making the longer-term point that the duration has been extended. Is that true when you look at the accidents in the 2010 or claims from 2010 that you've seen the extension there as well?

We believe it's there on our larger cases. One of the factors that's extending duration is the difficulty in getting approval from the Center for Medicare/Medicaid Services on approval for closures of the very severe cases. Where we put aside money to cover the worker's comp-related injuries for medical treatment in the future should we reach a resolution of the case. So that's one thing that's extended duration.

But the real thing that's been the driver, according to the NCCI and according to our data, has been workers that had injuries, particularly those workers that worked for companies that later either went out of business or such greatly reduced their work activity that there was no realistic possibility of them returning to work. That's really driven by a macro factor in that, you know, the economy plays a significant role.

There was recently a study that came out that talked about the utilization of prescription medications, and we see that in some of our states, the leader of which, by the way, is Louisiana, that has more drug prescriptions, particularly for narcotic drugs, than any other state, on average, for worker's compensation loss time claim. There is a direct correlation, we believe, between extended periods off and the use of non-analgesic sort of -- well, of opioids in the treatment and the duration of claims. That's a systemic problem and something that needs to be dealt with through the legislation and regulation of worker's comp.

If you think about the last cycle where you started to see the market turn and pricing was improving, did you have the sort of same flurry of accidents and claims? Is this a function of the change in the cycle or is this some sort of just a random event?

I think this is more of a random event. The difference between the turn in the last cycle and this cycle is demand. It's the question of the demand for the product. In 2000 and 2001, even though there was a slowdown in 2001, there was still robust demand for our business. And so the reinsurance bubble that hit through Unicover and those sort of mechanisms gave way to a housing bubble. Then this spurred a lot of construction activity.

This feels awfully like -- a lot like 2000. The difference is that there is not as robust a demand. The other thing that I think is very clear that is going to replicate itself is that loss cost will start to climb. They will climb -- someone asked me the other day, he said, "Well, what do you do when there's not -- how do the loss cost time when the premium is not in great demand?" Well, the loss cost climb, because premium is not a function in determining loss cost. It is strictly a question of what losses are what payrolls are. It is like an experienced rate modifier that never looks at premium.

And there you're talking about state-approved loss cost that you use to drive your own -- ?

That's correct. And there are formulas which are used to determine that based upon loss experience within class codes. It's not driven by premium. The marketplace will determine the premium based upon demand for the product or availability of the product.

My point is that with the 117 combined ratio for the line, we do not see the major carriers of worker's comp unleashing more capacity in that line of business because you've had two consecutive years of adverse development and, as you know, the NCCI's most recent report shows that Schedule P deficiencies have risen again now to about $10 billion. So that pretty well predicts that 2011 is going to be another year of adverse aggregate development for the worker's comp industry in this country.

(Operator Instructions) Matt [Caniletti], JMP Securities.

Mike covered my question on where the work activity was coming from but, Allen, I just wanted to ask you a higher-level question, kind of, where your head is now versus, say, the beginning of the year? Am I reading you right that you sound, I'll say, more optimistic about the existence of a cycle turn and Amerisafe's prospects on a go-forward basis now than, say, even six or definitely 12 months ago?

I do. If you go back and look at our 10-K this year, and you look at the risk factors, and we actually do read those each year and think about what they say and try to put them in an appropriate priority list, the number-one risk factor that we saw was a risk of carriers taking business -- multiline, large multiline national companies that could bundle the products and use worker's comp sort of as a lever to take the entire package of the business.

And there was a clear divergence at the end of 2010 between the performance of the worker's comp industry, which was at, I think, 117.5 and the performance of the general P&C industry in this country, as a whole, that was, like, at 102, you see. So it was doing much better.

The terrible disasters that occurred in the first and the second quarter changed that profitability of those other companies and the dynamics such that they don't need to add a line, which this year is projected to be north of 120% combined ratio into the mix.

So we see them pulling out of monoline worker's comp, and we see their pricing on the worker's comp component rising to levels -- and I'm talking about the major carriers raising their pricing to levels that are much more rational and reasonable. The greatest challenge we have in the marketplace generally is not the really large publicly traded companies but more likely to be single-state riders, self-insurance funds, and the like. And we have seen a constriction of offerings from self-insurance funds but not so much from single-state riders.

So there's still plenty of competition, but as you look at the way the line is developing and the number of quotes on the high hazard business, it's shrinking. And I would still maintain, just as our founder thought about when he formed the company, and that is if you write the best operators in the worst classes of business, you'll have the greatest opportunity to produce a profit. And the hazardous marketplace is the first place people exit when the market starts to turn hard and the last place they get into when the market's soft. And we're beginning to see those people that traditionally didn't write high-hazard business that had gotten into it were now beginning to move out of that business entirely.

Got you. And would you say in some respects -- I mean, this is kind of my assessment -- that when I look at, say, the monoline worker's comp carriers, yourself and all your public peers at least -- there seems to be more pain recognized thus far than a lot of the larger companies. Do you think they, to some extent, still have their heads stuck in the sand and as that inevitably flows through, whether that's next quarter, next year, whenever that is that we're going to see a continuation or acceleration of the trend of reduced competition in your space?

I think we're going to see a continuation of reduced competition. I do think you're going to see that. I think also -- there's a couple of things. If you look at reinsurance retention levels where the primary carriers retained reinsurance, during the soft market, as it onset, more and more primary carriers retained larger -- took larger retentions because that then reduces your net premiums written and net premiums earned less so that the impact of the soft market caused people to keep larger retentions. They had excess capacity, they had plenty of capital, that wasn't a problem, so let's keep more.

The other side of that same coin says that if losses come through, you're going to feel them more directly and more quickly than when you transfer them out.

On a net basis.

On a net basis. And with respect to the very large carriers, many times they have other reinsurance arrangements and pooling and other mechanisms that make that more difficult to track. Plus, they -- the general P&C industry is perfectly happy to operate at 100% combined ratio. The investment leverage is such that they can do that.

Now, this -- although I think we do a great job on our investing activity here at this company, you heard Janelle say at the end of the second quarter 2010 we had an average cash invested assets of $800 million, and this year we have an average invested assets of $829 million, yet the yield is down. And that reflects yield in the marketplace. And that is a driver in underwriting discipline and underwriting decisions. And I think that's going to accelerate as well.

I am showing no further questions in queue at this time. I would now like to turn the conference back over to Mr. Allen Bradley for any closing remarks.

Thank you. I want to thank everyone for attending today and to listening to this. We are in a transition in this market. The marketplace, I am firmly convinced -- I am very seldom optimistic, but I am optimistic that the pricing is improving and that we've gone through the low water part of this cycle, and it will begin to gain momentum as we go forward.

With that said, remember that losses still exist and that there will be a time period where loss trends will not improve as rapidly as the need for increased premium.

With that, thank you for joining us today, and we wish you a good day.

Ladies and gentlemen, thank you for your participation. That concludes the conference. You may disconnect and have a wonderful day.