James River Group Holdings Inc (JRVR) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the James River Group Holdings 2014 year-end and fourth quarter results conference call.

(Operator Instructions)

As a reminder, today's call is being recorded. Participants on this call should be aware during the course of this conference call, the Company will make forward-looking statements which are based on its current expectations. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are described in the Company's final prospectus filed with the Securities and Exchange Commission in connection with its initial public offering.

Additionally, the Company will discuss non-GAAP financial measures, including references to underwriting profit, net operating income and return on tangible equity. Reconciliations of non-GAAP financial measures to GAAP financial measures are included at the end of the Company's earnings release, which is posted under the Investor Relations section of its website, www.jrgh.net.

I'd now like to turn the call over to your host for today, Mr. Adam Abram, Chairman and CEO. Sir, you may begin.

Thank you, Ben, and welcome, everybody, to our first earnings call since our IPO in December. We had a very good year. And with me this morning to announce our results and respond to questions are Bob Myron, our President and Chief Operating Officer, and Gregg Davis, our Chief Financial Officer.

We'll start with some highlights from the quarter and from the year. We enjoyed substantial growth and good underwriting results for both the quarter and the year that drove slightly higher underwriting profits, better net operating income, and greater earnings per share than we had forecast. Details about our growth and results can be found in our press release.

Just a few words about the release, though. You may note that there's a discussion of net operating profits or operating income, as opposed to just profits or income. As this is our first quarter reporting since our IPO, we wanted to filter out significant expenses related to the IPO and instead focus on the regular earnings power of our Company.

Very important to us is that each of our underwriting units reported underwriting profits for the year and for the fourth quarter; and we believe our balance sheet is as strong or stronger than ever as we enter 2015. We continue to enjoy reserve redundancies and we reported substantial reserve releases during the quarter. We made a slight -- it's about approximately $3 million -- upward adjustment to our Reinsurance segment reserves to adjust two treaties from 2011 and prior during the fourth quarter. Our experience is that acting quickly to address any perceived weakness in reserves is the best way to build and maintain a strong balance sheet.

At year end, our IBNR reserves were 70.3% of net reserves, up slightly from 2013. Our tangible book value at December 31 was $16.33 per share, and it grew 3% in the quarter. Our operating return on tangible book value was 4.1% for the quarter and 12.4% for the year. We're quite pleased with that.

Given our earnings profile and our confidence about the year in front of us, the Board has declared a dividend of $0.16 per share to be paid at the end of March. The payment of this dividend is just entirely consistent with our history of active capital management. Since our formation at the end of 2007, we've paid approximately is $100 million in dividends to our shareholders and repurchased another $111 million in shares.

We expect in 2015 that our E&S segment will continue to grow, though at a more modest pace than the 31% we enjoyed in 2014. Margins in that business are holding and they are very robust overall. We enjoyed a 2% exposure adjusted rate increase in 2014 in the E&S segment.

Now we're aware that others are reporting decreases in rates for Commercial Casualty business. We've not seen that so far in our E&S segment in 2015 in our renewals, though it's early in the year. But margins in the E&S Casualty business are strong, and given the continuing benign loss trends in this segment, we're confident we can make our targeted returns, even if rates per unit of exposure do contract a bit during the year.

In 2014, our General Casualty, Manufacturers and Contractors, and Energy divisions within the E&S segment were all sources of growth. So it was pretty broad, the growth in our E&S segment. We expect growth in each of these divisions again in 2015, though we're cautious a little bit about growth in our Energy book. But overall, as we enter 2015, we anticipate high single-digit growth in our E&S book, with consistent underwriting profits.

Our Specialty Admitted segment continues to enjoy good results in workers' compensation, while selectively expanding into the fronting and program areas, which we think will be sources of future profits. Our workers' compensation business is a great foundation, as we carefully expand into these new areas. We wrote about $30.1 million of workers' compensation business in 2014 and reported good margins on that book for the year.

The exposure adjusted rates we're now getting from workers' compensation are the highest we have realized in the decade since we first formed our workers' compensation company. For 2015, we're focused on the modest growth in our workers' comp business and more robust growth in our fee-generating program and fronting business.

At this point, I'd like to turn it over to our Bob Myron, our President and Chief Operating Officer, to talk about our Reinsurance segments and investments. Bob?

Thank you, Adam. Our Casualty Reinsurance segment had a good result for 2014. Third-party gross written premiums totaled $207 million in the year. We reported a 99.6% combined ratio on this business for the year. 90% of this business is quota share that is written on a propositional basis with sliding scale commissions and other loss mitigation features that protect our downside.

We feel very good about the Reinsurance book our team has put together, as well as their prospects for 2015. The majority of the third-party Reinsurance book is from E&S carriers; and over the past 12 months, we have retained over 80% of the book. Because our book has a large component of quota share treaties, we are particularly sensitive to the underlying rate trends of the cedents we reinsure. Over the past year, we observed that the underlying exposure adjusted rates have increased by mid-single digits.

Now with respect to investments. Approximately 65% of our group-wide net operating earnings in 2014 came from investment income. Accordingly, we are quite focused on our investment portfolio and its returns. As of December 31, the carrying value of our investment and cash portfolio, two-thirds of which is in Bermuda, was approximately $1.3 billion. We have a modest unrealized gain in the portfolio, which has an overall book yield of 3.57% and average duration of just under 3 years as of December 31, when you include all components of the portfolio, including the bank loans.

Given the current rate environment, we obviously face some challenges regarding available yields on reinvestment. Fortunately for us, a relatively small portion of the fixed income portfolio will be rolling over this year. We are looking to extend duration a bit on reinvestment to achieve an overall duration of three years.

Over the past seven years, we have had some good success with investing in bank loans, project financing, alternative energy projects, mezzanine debt and some equities, principally preferreds. Today these classes represent roughly one-third of our overall investment portfolio. But it is worth noting that in aggregate, our portfolio has a weighted average credit rating of A.

Now with respect to earnings guidance, for 2015, we expect our diluted net operating income to be between $1.95 and $2.00 per share. Note that we are using a weighted average share count of 29.4 million shares to calculate this amount. It is our expectation that the last two quarters of the year will have better results than the first two quarters, as we have historically recognized more favorable reserve development, and therefore better underwriting performance, in the latter half of any given calendar year.

With those comments, we'd like to turn it over to Gregg Davis, our Chief Financial Officer, to talk in greater detail about our financial statements and results.

Thanks, Bob, and good morning to everyone on the call. Combined ratios for the Company were once again excellent, with a 90.3% for the quarter and 93.5% for the year. This includes favorable development of $8.3 million, or $7.1 million after tax, for the quarter, and $27.4 million, or $23.9 million after tax, for the year.

For the quarter, this favorable development was 48% of that of the prior year. For the full year, this development was 73% of the amount in the prior year.

A few points to consider in relation to our reserves. Our balance sheet remains strong. Our overall underwriting performance has continued to be strong. We're seeing benign loss trends. We have negligible loss cost inflation. We are closing claims at a very satisfactory rate. And finally, IBNR as a percentage of our total reserves has increased.

I'd like to point out that our expense ratio has decreased for the Company in both the quarter and the year to 30.9% and 33.6%, respectively. This was most pronounced in our Specialty Admitted Insurance segment, where the expense ratio has decreased significantly from the prior year.

Moving to investments, our cash and invested assets have increased approximately 1% for the quarter and 8% for the year, to the $1.3 billion Bob referenced previously. Our net investment income was $9.8 million, which is slightly less than the $10.7 million amount of the prior year and was affected by both the $70 million dividend we paid on September 30, 2014, as well as the lingering low-yield interest rate environment. All this despite the $125 million increase in net written premiums.

During the quarter, we incurred $13.1 million in pre-tax other expenses, primarily relating to the cost of our initial public offering. For the year, these other expenses were $16 million, again, mostly associated with our IPO. This $16 million is comprised primarily of $2.8 million of legal fees, $2 million of auditing and filing-related fees, and $10.2 million associated with the conversion of awards under an old equity incentive plan, all as detailed previously in our final prospectus for the IPO and all of which have been excluded from our net operating income.

It is additionally important to highlight these non-operating items, since they were instrumental in contributing to our $2.7 million income tax benefit for the quarter. Most of the dollars associated with the conversion of the previous equity plan was allocable to US domiciled employees and, therefore, contributed to a loss on the books of the US companies. Coupled with some year-end tax true-ups and energy credits we were able to utilize, the result was a tax benefit of $2.7 million for the quarter.

So we had net income for the quarter of $8.9 million and $44.7 million for the year. But to see how the year really progressed, one needs to exclude the effects of one, the IPO, and two, all of our realized gains and losses, as well as some other noise. Accordingly, I'd like to focus on our net operating income, which was $18.8 million for the quarter and $58.4 million for the year. These compare very favorably to the amounts in the prior year of $18.3 million for the quarter and $58.9 million for the year, particularly since the favorable development was substantially less than the amounts taken in the prior period and quarter.

To tie this in where Adam began, this translated into a 4.1% and 12.4% operating return on tangible book value for the quarter and the year. This compares favorably to the prior year amounts of 3.9% and 11.4%, respectively.

This concludes our prepared remarks. Operator, Ben, could you please open the line for questions? Thank you all.

(Operator Instructions)

Operator? Operator?

Adam, this is Mark Hughes. Can you hear me?

Yes, Mark. Good morning.

Okay. Well, good morning. Maybe they turned it to an open line. I thought I would just jump right in. Maybe they will come back along.

Great. Great.

Could you talk a little bit more about the E&S strength in new business, gross written premiums in the quarter? You had mentioned Manufacturing, Contracting. You still had some hopes on the Energy book. Just a little more sense of what's going on in that segment. A very good result this quarter.

Yes, we continue to enjoy -- and it's relatively broad. Now we're careful, there are certain parts of the economy that are growing less rapidly or more susceptible to competition than others. But as long as the contracting fields in the United States economy are growing, I believe our E&S business will continue to grow nicely. And then I think our team in Richmond has done a sensational job in new product development. And they've taken us into some exciting new areas that are related to the changes in the economy, where we're also able to grow there. So the traditional business of Contract -- Manufacturers and Contracting -- really drives a broad base of growth. Our Excess Casualty division has done very, very well as part of the growth in small- and medium-sized businesses across America. And then our new product development has been terrific.

Submissions were up in 2014, and we feel good about that for 2015. The underlying exposures as our clients grow is very beneficial to us, because a lot of our business is exposure-rated. And then finally, these new parts of the economy have also been pretty exciting to participate in. And that's exactly what the E&S market is built for, to address new risks in our economy. And I think our team's done a great job of that.

Good. On the rate, I thought you shared with us that 2% in your book and I think within your Reinsurance book, the underlying rates on this quota share is mid-single digits. How did that look in the fourth quarter? What's your sense of where we're starting out here in early 2015?

The rates across the year started to contract a little bit. We still had a gain in the fourth quarter rate in our E&S business. However, it's slowed. And so I think that as we go into 2015, we're cautious about rate increases. We don't need -- in order to achieve our goal, we don't need rate increases. We did continue to see strength in the first month of the year in rates in our E&S business. I just don't want to predict that, though, because I'm listening to others who are also in the market and they're having more modest results than we got in our particular book.

Yes. And I would say on the Reinsurance side -- this is Bob Myron -- I'd say on the Reinsurance side that the underlying rate increases were really pretty consistent throughout the year. I wouldn't say that we saw any tapering. And just given where we are in 2015, it's a little bit early to be garnering that information, just because of a little bit of reporting delays. But we felt great about what the rates that the underlying cedents were getting pretty much across the Reinsurance book and across several different lines of business.

The Specialty Admitted, the combined ratio there, close to 90%, was quite good, helped by some favorable development. Is closer to 90% the new normal in that segment?

No, I think -- you know, I don't want to take an aggressive stance with regard to that right now. I will say this, we're getting really good rates and we're doing a super job on the underwriting of that core workers' comp book in the Specialty Admitted business. We're spending money to build the capability on our program and fronting business. Though I think we'll get to scale in that business this year in the program and fronting business. I'm pretty confident of it. We had good growth on that in 2014 and we think that will continue in 2015.

So I don't want to say -- we will make an underwriting profit. That's our expectation. For the Specialty Admitted business, I don't want to predict a low 90s combined ratio there.

And finally, Gregg, did you give specific tax rate thoughts for 2015?

Yes, maybe it's a little bit more of a question around guidance. I think we're not specifically guiding to a rate, but if you look at the existence of a 70% intercompany quota share and the fact that we've got close to 70% of our invested assets in Bermuda and you look at maybe 2013, which is the actual results are a more normalized tax rate for the year, probably can give you some pretty good ideas of where we expect to end up. I would tell you it would be within a range, but sort of low double digits.

Okay. All right. Good. Thank you very much.

Thanks, Mark.

Thanks, Mark.

Randy Binner, FBR Capital Markets.

Great. Thanks. Good morning. I wanted to pick up -- and this is a little bit of what Mark Hughes was asking on Admitted -- but you did have a great combined ratio there, but to me, at least relative to our model there and also in E&S, the expense ratio is very favorable. And I read and heard comments that that was driven by better earned premiums, so amortizing your expenses against that. But still, the expense ratio seemed awfully good in the fourth quarter. So trying to get more color on what drove such a good expense ratio result in the fourth quarter, if there were one-timers and a little more color there to help us think about how to model that going forward.

It's just earned premium. There are no one-timers in there that we can think of, Randy.

Okay.

Yes, go ahead.

And that statement applies both to Specialty and E&S?

Yes, that's definitely the case. With the growth that we had in E&S with the significant ramp up in gross written and net written and therefore net earned, there was a tapering off, of course, to the expense ratio, really getting increased benefit from scale. A very similar thing with the Specialty Admitted segment, where as we started to get materially more earned premium in from the programs and fronting area and we started to get some of the benefit of the fees and also group volume workers' compensation book --

One thing is that a portion of the fees that we earn in the program business comes through as a decrease in expenses. You're probably looking at in the Specialty Admitted segment at the 39.4% expense ratio. And that does have the benefit, which we think will be continually, of fee income that's coming in and driving down expenses.

Okay. Understood. We were modeling that, and those comments are helpful. Just jumping over to investment income, just a couple of details. One, were you fully invested in the fourth quarter, or were there funds -- it was mostly selling shareholder rights, though -- I think you were fully invested. But just want to confirm that there was not excess cash on the sideline during the quarter. And then were there any one-timers in the fourth quarter, like bond prepayments or anything else that may have affected the net investment income number?

You know, there really wasn't anything like that. And I would say that we think about -- there certainly was some cash and short-term investments that are earning negligible or relatively low yields. And you can see those numbers on the balance sheet. But I would say that, in many respects, has really been intentional in the idea of managing duration and interest rate risk. And we've chosen to be a bit shorter overall than, I think, probably the peers for P&C generally, because we've been very cautious about interest rate risk.

And instead, we've chosen to use the expertise of the people around the table and on the Board to make some smart investments in some other areas. And that's where a third of the portfolio is in a little bit more of the outside-the-box stuff like we talked about. So I think we are going to put a little bit of that excess cash in short-term investments to work early in the first quarter and bring the duration up a little bit, as I mentioned. So I guess to answer your question, the answer is yes, but it was intentional. It was really duration and interest rate management.

And just one more, if I could. Adam, you mentioned that interest or demand for the fronting solution you're offering was good so far. Could you just provide any color on where you're seeing that demand? Is it from MGAs? Is it from off-shore capacity providers? Is it property or casualty? Just any color on how that effort's going.

I want to, first, say it's early days. So we're dealing with a really good pipeline, I feel. But it's still early days and we'll have to see how that emerges in terms of the spread of the sources of capital. But we're seeing this from MGAs and we're also seeing it from capital sources who are not structured today as insurance companies. And finally, we're seeing it from insurance companies that either don't have the licensure or the rating to write a particular piece of business or business in a sector or region, and wish to get into it. We see both liability and property opportunities in this business.

Okay. Great. Thanks for the answers.

Thank you, Randy.

Charles Sebaski, BMO Capital Markets.

Good morning. Thanks for taking my call.

We're glad to have you on the call. Thank you, Charles.

First question, on the capital management and the dividend that you guys announced, which sizable, I guess, just conceptually, some color on why you would go with a dividend versus the share repurchase, given the discount to book value where the stock is trading?

It's a great question. The answer is that we have a relatively small float today. You should expect that over time and across the course of our history, we will use every tool available to us that we view to be shareholder friendly and good capital management. And indeed, in the past, we have, as you probably -- certainly know -- we purchased $111 million in shares over the last seven years or so. And we would certainly do that again. But we just made an IPO. We have a very small float here. It doesn't feel to us that it's the right time to be reducing liquidity in our stock. But we are very active capital managers, and so we're paying a dividend.

That makes complete sense. A question about the guidance, and just want to make sure I heard it right. You said that the guidance for 2015 is $1.95 to $2.00? At 29.4 million shares? So there's 500,000 or 600,000 shares of dilution coming for 2015? Is that correct?

Yes, we're just trying to make a realistic and maybe a little bit of a conservative assumption of where we think the diluted EPS denominator will be. And so yes, it's about 500,000 more than the actual in the fourth quarter on a weighted average basis. So that's what we chose to do.

Is that employee comp and other for the dilution?

It's making some assumptions around stock price and options and where the stock might trade and, therefore, what ends up being in the money and treasury stock method and so on and so forth. That's really what we're doing there.

Okay. And then finally, on the Reinsurance sector, the net premium number on a quarterly basis is up and down. I guess some thoughts on how you think the -- a pretty significant contraction in the fourth quarter. Obviously, it's a smaller quarter. But how do you think that portfolio, given the rate dynamic and who your cedents are, is going to play out over 2015? Do you expect that book to contract absolutely versus 2014 or stay where it is, or any color on that?

I think, first, I'd say -- this is Bob Myron -- we're focused on -- we really like the book that we have. We really like the team that we have. And we're focused first and foremost on making an underwriting profit there. Certainly a competitive market, but we're not seeing any significant deterioration in terms of conditions on our book yet. And of course, we're getting the underlying lift of the primary pricing that's underlying it.

You know, it is a bit lumpy, as you say. It's tough to look at quarter by quarter. Sometimes a cedent might just get moved in terms of their renewal date extended three months or something, which pushes them from one quarter into another. The contracts have a tendency to be individually large and so this can cause quarterly comparisons to be difficult.

But I would focus on the fact that we've renewed 80% of the book. We like what we have. Clearly, I don't think it's the time to be going out and trying to grow this book significantly. The market is tough. But I think that we like where we are, and we're just going to keep focusing on doing a great job of underwriting that and what we have, this nice relationship book that exists.

All right. And any new E&S programs or product offering come about recently or in the Q that you want to make note of?

I don't think we're going to call those out right here. But I will say that our team has done a great job of incrementally expanding the opportunities for us in some of these new areas we've gotten in, getting new customers in. And as we roll out new products, we're finding that there are more and more customers, insureds, who need some of those products. And I think our penetration right now, and our team in Richmond has built a really tremendously broad and deep relationship with the wholesale distribution force that generates this business. And we see a tremendous number of opportunities right now. I think we are really seeing what we need to see in the market to make sure that we have a broad view and lots of opportunities to write the kinds of casualty business we really want to write. So we feel great about that.

Excellent. I appreciate all the answers.

Thank you. Operator, is there another question?

Marie Lunackova, UBS.

Good morning, everybody. I had a question on underlying loss ratios in E&S and Admitted Specialty segments. So if I look at 2014 accident loss ratio in Admitted -- I'm sorry, in E&S -- it stayed roughly stable compared to 2013. And I was wondering if you could give us some color on what the expectation would be for 2015 as far as improvement on deterioration, given the market conditions and the business mix. And similarly, for Specialty Admitted. There, actually, the annual ratio improved roughly 100 basis points. And I wonder what kind of improvement we could expect in 2015, if you could provide color?

I don't think we're giving specific 2015 forward guidance on loss ratio by segment. Let me describe for you what I think the general atmosphere is in the business, however. I have every confidence that in our E&S business that we are writing business today and in 2014 that will prove to be as profitable as our business has been historically. And now we don't -- we have a little phrase we like to use here, which is we don't declare victory early. So in the current accident year, we tend to book that a loss estimate that we think will give us time to look at the book, to observe the losses develop into make sure that we don't underperform, in terms of having to raise later a current accident year loss ratio.

Historically, because of the really great work of our claims teams, we've been able to drive that down. And very good underwriting, also, underneath that. And I think the book that we've put up in 2014 is as profitable as any year we ever put up previously. But it's going to take time for us to allow that to emerge. I will say that we look very heavily at claims openings and claims closings. We look at average cost of claims to close a claim. And we feel very, very good about the quality of earnings going forward in our E&S book.

Let me turn to the Specialty Admitted book. And I'm going to segregate this a little bit into the workers' comp book, which has been our traditional business there. And I think that the business we wrote in 2014 and the business we've seen and put on the book so far in 2015 is really excellent business. As I mentioned, this is the highest rate per unit of exposure that we've ever achieved in the workers' compensation book. And again, we pay a great deal of attention to our openings and closings of claims there, and have watched our claims team rapidly close those claims. And claims frequency is down in the workers' comp book. And by the way, claims activity and cost is benign today in the E&S book, as well.

So we feel very, very -- as good as you can about a future forecast about the core books in our E&S business and then our Specialty Admitted business. We're growing the program business and we're growing the fronting business. The fronting business we take virtually. We take almost no risk, except the very serious credit risk, which we pay a lot of attention to. In the program business, we do have more underwriting risk on our books, because we hold a larger percentage of those risks. The one thing I would point out to you is that we also earn substantial ceded commissions there that are an offset and will dramatically improve underwriting results in that program business, if you add the fee income back into our premium. That was a little complicated, but I hope I answered you.

Okay. If I could ask one more on that E&S, so you mentioned in the loss cost inflation is very benign, the current experience, but I would imagine that you're booking it at more of a historical trend? What kind of gap is there between the current loss trends and the historical ones that you assume when you're pricing the business?

Yes, I would say that we make conservative assumptions when we come up with our pricing picks, which then turn into, of course, our accident year picks. And we do make some assumption for loss trend. And what we have seen over the last few years and also very currently is that the loss trends are benign and also below our expectations, both in terms of overall trends, as well as any sort of loss cost inflation. So I would say that we feel that there's good, healthy margin there in our accident year picks relative to what's going on with the underlying loss trends.

And then at which point would you readjust your historical -- the expectation of historical loss trends for that current benign experience. It's benign year after year. Will you at some point reflect it?

Well, we do have, as we go through our reserves each year, we look by line, by year, and we do adjust our reserves each year. In the quarter we're just reporting, I think there was $8 million of reserve reduction based on those -- net reduction across the group -- based on those studies.

Okay. And then just a quick one on the Reinsurance adverse development. You mentioned it was two treaties from 2011 and prior. Was it the first time these treaties had some adverse development, or is it something that has developed before and you were just adding to the reserves for these?

It wasn't the first time we've seen some modest development there, but they're not terribly large treaties, and we think that we've got a good handle on the reserves there as of 12/31. And I would also say that the book for business written in underwriting years 2012 forward appears to be maturing and performing very, very well.

Okay. Thank you very much.

Thank you.

Thank you.

(Operator Instructions)

Brett Shirreffs, KBW.

Thanks. Actually all my questions were answered. Thank you.

Good morning, Brett.

Operator, are there any further questions?

I'm show no further questions in the queue.

All right, in which case, from rainy, windy Bermuda, we wish everybody an excellent day and thank you for participating in this call.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of your day.