Trean Insurance Group Inc (TIG) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Trean Insurance Group second-quarter 2020 earnings conference call. (Operator Instructions).

I would now like to hand the conference over to your speaker today, Garrett Edson of ICR. Please go ahead, sir.

Thank you, operator. Good afternoon and welcome to Trean Insurance Group's second-quarter earnings call. This afternoon, the Company released its financial results for the quarter ended June 30, 2020. The press release is available in the Investor Relations section of the Company's website at www.trean.com.

I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made during the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

Joining me on the call today are Andrew O'Brien, the Company's Chief Executive Officer; and Julie Baron, the Company's Chief Financial Officer.

With that, I am now going to turn the call over to Andy.

Thank you, Garrett, and welcome to our second-quarter 2020 earnings call and our first call as a public company. We are excited to be speaking with you today, and let me thank everyone for participating on our call and for your interest in Trean. On today's call, I will provide a bit of an overview on Trean and discuss our competitive advantage. Our CFO, Julie Baron, will follow and provide some detail about our second-quarter results, absent per-share details, as we were not yet public in the second quarter. Given that we are a newly public company, I think it would be helpful to spend a few minutes providing some context on our business and share how Trean brings meaningful value to our clients and to our shareholders.

Trean is an established, growing, and profitable company, providing products and services to an underserved portion of the specialty insurance market. We are a decades-seasoned company, and, through a focused strategic plan, have grown the Company significantly since 2015, nearly tripling our gross written premiums during that time and generating a four-year gross written premiums CAGR of approximately 30%. We have 14 product lines; we are licensed in 49 states and Washington, DC; and we are rated A by AM Best.

Our efforts are primarily focused on small workers' compensation policies and programs, particularly fronting programs, and we have industry-leading expertise in this and other lines we offer. 83% of our gross written premiums in 2019 related to workers' comp and 64% of our premiums in 2019 where written through our own managing general agents, or MGAs. In the first half of 2020, these percentages have remained relatively consistent. We offer our products through our program partners and our own MGAs and focus on four different methods of generating revenue: underwriting income, investment income, brokerage fees, and management fees.

Fee income is a significant differentiator for Trean, comprising 10% of our total revenue for the six months ended June 30, 2020. And we generate fees from multiple sources including issuing carrier services, reinsurance brokerage, and claims administration. This approach offers us consistent additional recurring revenue as well as incremental touch points with our program partners. We are also disciplined in selecting our target markets and program partners, as evidenced by our 2018 to 2019 combined ratio of under 77%, 10 points better than the industry average. We are able to achieve this result due to diligent prescreening as well as pinpoint targeting to our niche programs with a competitive edge. We seek partners that participate in the underwriting risks of their programs, which closely aligns them with us.

Our objective is to utilize our multi-service value proposition to deeply integrate with our program partners and develop long-term relationships, which ultimately enables us to generate greater and more diversified revenue streams. This is evident in the fact the average relationship of our long-term partners is approximately eight years, which is a testament to the value we continue to create for our partners.

In addition, we boast a differentiated and unique in-house claims management team, providing a personal and high-touch approach to processing claims that we believe leads to lower claim cost, quicker settlement of claims, and reduced likelihood of costly and lengthy litigation. Our claims administration teams averages 16 years of industry experience, and our claims per adjuster average of 80 open claims are considerably lighter than the industry average of 125 open claims. This approach helps ensure the team remains efficient and responsive to claimants. Due to our disciplined underwriting and risk management processes, our top-line growth has been able to funnel to the bottom line, allowing us to generate double-digit ROE.

In addition to our organic growth, we have accelerated our growth trajectory over the past few years through several key initiatives and transactions, including the acquisitions of a American Liberty Insurance Company in 2017, as well as a large stake in Compstar, our largest producer, and all of Westcap in 2018. In those transactions, we already had 10-plus-year relationships with each of the companies. Thus, we had already developed the deep partnerships with those program partners and simply took the natural next step and brought them on board with Trean.

Now that you have some background on how we've been successful in the past, I want to shift to how we expect to grow and create value at Trean over the long-term. It's predicated on four distinct strategies.

First, we plan to continually grow organically in our existing markets, particularly in fronting and workers' comp, two of the largest sectors in the insurance business. Workers' comp alone is a $54 billion premium market and we are just scratching the surface there.

Second, we will selectively add new program partners. As I touched on earlier, we only add new programs that make it through our comprehensive vetting process, share our business philosophy, and meet our returns threshold. We maintain a strong pipeline of opportunities, and when we find the right fit we will add them as partners.

Third, we will also opportunistically grow through acquisitions. With our successful IPO last month, we purchased the 55% of Compstar we did not previously own, and now finally own 100% of Compstar. As we think about future acquisitions, our focus is clearly on ensuring that an acquisition will enhance earnings per share and shareholder returns and not on growth for the sake of growth.

Finally, we will harness our growing capital base. With a successful IPO and fortified balance sheet, we will utilize our financial capacity to increase our net retention and keep more of the good business that we are writing right now instead of ceding it to reinsurers. This is important because there is nearly 0 execution risk to growing through this approach. It is simply a matter of revising contracts at the renewal period. As a result, we will retain more premium and regain some of the profits that have been ceded in the past.

We are confident in our growth efforts because we have a successful record that validates our approach. By growing our existing business, adding new partners, opportunistic acquisitions, and retaining more of our gross premiums, we have a clear path toward incremental long-term value creation. As we navigated through the pandemic in the second quarter, we believe our results prove the effectiveness and resiliency of our business strategy. We continue to focus during this time on supporting our program partners, responsibly accepting new opportunities, seeking proper rate levels, and quickly and fairly resolving claims. In workers' comp, we are having success in maintaining, if not increasing, rate levels. And, thus far, COVID-19 claims have not had a material impact on our loss ratio. We believe overall that the tide is turning toward higher, more appropriate workers' compensation rates.

Four of this year's new programs are now writing new business for us at the levels we anticipated. On April 1, we closed on the purchase of an MGA who is now rolling over profitable premium to us. And, as we've previously discussed, subject to regulatory approval, we have agreed to purchase 7710 Insurance Company and its MGA. We expect the 7710 acquisition will begin adding new premium to us in the fourth quarter. We are confident about the growth potential these new programs and acquisitions offer.

In addition, we have always expected that the greater portion of our 2020 growth would occur in the back half of the year. This is simply a function of when the new programs would start to produce premium. I'm pleased to say that we are seeing it happen as we expected, as our July 2020 gross written premiums were up double digits compared to July 2019.

This business has been successful since its founding in 1996, and we very much intend to build on our profitable growth in the future. Our focus is on underserved markets. We look for areas where there is less competition, where we can generate a better risk margin for the premium that we are taking, and we have multiple products that we can provide to our customers and partners. Together, this approach provides multiple opportunities to generate revenue and earnings. And it deeply integrates us with our partners, which feeds to more profitable and more sustained relationships.

With that, I look forward to providing you with regular updates on our progress in the quarters and years ahead.

I'll now turn the call over to our CFO, Julie Baron. Julie?

Thank you, Andy, and good afternoon to everyone on the call. Let's go right in to our second-quarter results. Demonstrating the resiliency of our business, our team grew gross written premiums by 5% to $109.6 million in the second quarter 2020 compared to $104.4 million in the prior-year period. This growth was driven by the addition of new program partners in the second quarter and resulted in an increase in non-workers' compensation liability lines of business. Given the very challenging operating environment due to COVID, we are certainly pleased with our second-quarter gross written premiums performance.

Gross earned premiums were $100.3 million for the second quarter of 2020, 2.5% less than the prior-year period, due primarily to timing for both the addition of new program partners whose premiums had not yet been earned, as well as the effective dates of new policies written during the quarter. Since we cannot control the timing, the slide effect is a fairly common occurrence when we onboard new program partners. Thus, we would suggest the focus be on gross written premiums as the best proxy for the growth of our business.

Net earned premiums for the quarter were $21.4 million compared to $23.4 million in the prior-year period, as a reduction in gross earned premiums were partially offset by decrease in ceded earned premiums. As Andy noted in his remarks, with the IPO fortifying our balance sheet, we expect to be in a better position to execute on our key strategic tenet: retaining more premium. To that point, we would expect net earned premiums to grow commensurately over time in the coming years.

Our loss ratio for the second quarter of 2020 was 57% compared to 55.7% in the prior-year period. Loss activity during the second quarter of 2020 was directly attributable to the reduction in net earned premiums, and offset by lower favorable loss reserve estimate true-ups taken for the second quarter of 2020 than for the prior year period.

G&A expense was $8.3 million at the second quarter of 2020 compared to $6.2 million in the prior-year quarter. G&A expense in the second quarter of 2020 includes $1.8 million of additional professional fees, including legal, consulting, and other IPO and public company readiness efforts, as well as expenses associated with an increased workforce. As we think about G&A expense in the back half of the year, we expect it will remain elevated due to additional IPO-related costs as we [priced in] July, and the ongoing ramp of public company infrastructure expenses, including a significantly higher level of D&O insurance than originally anticipated, as well as our increased workforce compared to the prior-year period as we prudently invest in growing our business.

All-in, our combined ratio for the second quarter of 2020 was 95.9%, above the prior year period, due primarily to the aforementioned additional G&A expenses in preparation for the IPO and building the public company infrastructure.

Underwriting income for the second quarter was $0.9 million compared to $4.2 million in the prior-year period. Net investment income for the second quarter of 2020 was $1.5 million, relatively compared with the prior year period. The majority of our investment portfolio was comprised of fixed maturity securities of $375.7 million at June 30, 2020, classified as available-for-sale. We also had $97 million of cash and cash equivalents. Our investment portfolio had an average rating of AA at the end of the quarter.

Other revenue, which consists primarily of third-party administrator and brokerage fees, was $1.5 million for the quarter. Equity earnings, net of tax, was $1.2 million. But as a reminder, we acquired the remaining 55% of Compstar we did not own upon completion of the IPO in mid-July. As a result, we would expect that line item to be significantly lower in the third quarter and beyond.

Finally, GAAP net income for the second quarter of 2020 was $3.7 million. When excluding one-time items, adjusted net income was $4.8 million. Since we were not yet a public company in the second quarter, earnings per share was not relevant.

ROE for the second quarter was 10.3%, while adjusted ROE -- which excludes the aforementioned one-time items -- was 13.2%. As a note, in the third quarter we expect to recognize several one-time items related to the IPO, including a significant gain upon the acquisition of the remainder of Compstar, which will be partially offset by a one-time $7.6 million payment to Altaris in connection with the termination of our consulting and advisory agreements with them, and a $3.1 million payment to certain pre-IPO unitholders and Trean employees in connection with the reorganization post-IPO. All of these will be carved out when we provide our adjusted net income figure for the third quarter.

With that, I thank you for your time and will now open up the call for Q&A. Operator?

(Operator Instructions). Jimmy Bhullar, JPMorgan.

Hi. I had a couple of questions. First, just on expenses: on the $1.8 million of IPO-related expenses, how much of that is an ongoing number? And is your view on expenses a little different than before, given the higher D&O costs, or was that already contemplated going into the IPO?

No. Yes, Jimmy, most of that additional $1.8 million is going to be IPO-related, not all of it directly. A lot of it is just -- as we are paying expenses to bring up the faster reporting and some of those items. So we will off -- that will taper off as we go through the year and as we fill out with staff.

As far as the D&O expense, that actually came in more than double than anticipated and included in our models. We had a projection from our broker that our D&O insurance would come in around $900,000, and it actually came in at over $2 million. I saw recently an article about D&O insurance having increased over 75% just from the first quarter to current, so that seems to be in line, but shockingly high number. So that's -- we had included about [the billion] in our projection.

And then on the decline in that investment income and other revenues, what were the drivers of that? And should we assume that this was a normal number? Or -- I'm assuming other revenues will bounce around, but what are your expectations for those two lines in the second (multiple speakers)?

Right. So for net investment income, as we discussed earlier, the first quarter is artificially high because we had the sale of Trean intermediary's investment that we owned, so we had an increase in the value of $2 million. So this quarter's results for net investment income are what should be expected through the rest of the year.

Okay, and then other revenues?

Other revenue? With the adoption of ASC 606, the timing of the brokerage revenues is different than it has been in the past. Obviously we still earn those ratably over the year. Now they are recognized when the contracts go into effect, so I would say second quarter is light. So we have a lot of reinsurance contracts that are effective 1/1, and a few that are 7/1, a few more that are 10/1. I think an annualized number is probably more realistic of the six-month number.

Okay. And then just lastly on pricing, Andy mentioned a little bit in his comments that -- what are you seeing in terms of pricing for the overall market? And then specifically for the lines that you're -- what are you seeing in your book?

We are somewhat encouraged by some of the developments we are seeing in the market. We can't say that we think the market has turned, but we are having success in holding the existing rates and trying to get some at least modest increases. Now, there's always an exception for that, and that's the very large accounts. Those tend to be very competitive, we think, still.

Okay, thanks.

Matt Carletti, JMP Securities.

Just had a couple questions. Maybe start with the impact that COVID and the economic slowdown and things like that has had on the business. What have you seen in terms of audit and cancellation premiums? Can you comment a little bit about -- more specifically on loss trends, what you have seen? You gave some color on the IPO, but we've had a few months since then. Anything you could provide there?

Sure. Certainly the economic slowdown has dampened organic growth, and we have seen some of that. We are not terribly exposed, we believe, to audit premiums. All lot of our business is on a pay-as-you-go approach. And we have not seen, right at this time, significant -- a significant erosion of premiums due to audits, and we are really not expecting that.

In terms of the loss situation, and I guess I will be careful talking about trends because one quarter doesn't signify a trend, especially with the COVID quarter, but the number of reported claims are lower this year compared to last year. And particularly the number of open claims, the development of open claims during 2020, are certainly at a lower rate than what we would have expected, absent COVID, so we're optimistic about where we are from a claims perspective.

We have not had, ourselves, a lot of COVID-related claims. I think in total we've had about 100, mostly workers' comp claims, and many of those have been closed with little or no payment.

Okay. Great. And then just a couple others. You mentioned in -- prior period development that was somewhat lower than the year-ago quarter. Can you quantify that, what it was in the quarter?

Yes. Year to date -- I can tell you year to date. It was 2.8 million last year and about 2 million this year.

Okay, great. And then last question, just a clarification on the D&O conversation. When you said a little over $2 million versus $900,000, that's an annual number?

Yes.

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

David Motemaden, Evercore ISI.

Good afternoon. I guess I had a question on just the loss ratio. And I know you had said 2 million year to date, favorable PYD. But I guess stripping that out and just thinking about where the accident year loss ratios are, it looks like -- in the S-1, it looked like claims were down 25% to 30% in April and May. But if I look at the loss ratio, it's up a bit. So just wondering how much conservatism you guys have set up within those loss picks, or if you have let through any of the favorable attritional losses come through this quarter.

No, we haven't yet recognized any favorable development based upon what's been happening with the number of closures of claims and the reduction in open claims and new claims. We think it's bit premature for us to be doing that at this time.

Okay. That's helpful. And then if I just look at the expense ratio, if I strip out the higher IPO expenses, you are looking at -- in the $1.8 million of higher IPO costs, you're looking at around 30.5% to 31% of an expense ratio in the first half. I guess if I'm looking at that, is that the good baseline to think about for the second half before considering the higher D&O expenses, which sounds like that's going to add another 3 to 4 points to the expense ratio?

Right. But we also have to keep in mind that we have our acquisition of Compstar. Right now, we are paying a commission to Compstar, and once we bring them in 100% and consolidate them, we are going to pick up the profit of Compstar, which will run through that line.

Right. So I guess where are you thinking the expense ratio will shake out for the rest of the year, and, more importantly, as we head out into next year?

One second. I apologize, just one second. I do have that here. We expect to pick up about $3 million of profit. I don't have -- I apologize, I don't have that. I can get back to you on that.

Julie, that's helpful. That's helpful. And that will be a contra expense?

Yes.

In the expense about -- yes, okay. That's helpful. Okay, thanks for that, Julie. And then if I could just ask one more to Andy, just on -- it sounded optimistic, in the opening remarks, just on the business and the value prop. Maybe could you just talk about the pipeline of potential additional program partners and how that's shaping up and how close you are to maybe converting some of those to new program partners?

Yes. We have been very pleasantly surprised at how strong the pipeline has been this year, not only in terms of the number of new programs that we're seeing, but in the quality of the programs. So far now, we have five new programs that are now actually writing business on our paper. And we have four other programs where we think that -- we've reached an agreement in principle, and now are going through the final due diligence and onboarding steps. So we have got hopes that some or all of those will come onboard over the next few months as well. So that's a very encouraging sign for us and we are pleased with that, and it's almost unprecedented in our history.

Great, thank you.

Jeff Schmitt, William Blair.

Good afternoon. A question on the pipeline, and you just mentioned obviously it looks pretty strong, but how do you think about that going forward in terms of Compstar -- obviously there's a lot of stock involved. But is there a philosophy there where you would look to not use stock if you can help it? Or is that going to be the attractor, maybe, to get people to come onboard? I mean, how are you thinking about that going forward?

Well, we -- we are actually not thinking in terms of using stock to attract new programs to us. We hope that we'll be able to attract them with our value proposition as an issuing carrier and any other services that we can offer. And of the five that we have signed on this year and the four that we are looking at, all are following that pattern. So that's kind of our thinking at this time.

Okay, that's helpful. And that just another detailed question on the expense ratio. Obviously a lot of moving parts, IPO costs, Compstar coming on board, retention's going to increase a lot. So that's going to come down quite a bit. Is there any change in your outlook for 2021? I mean, is a low 20s expense ratio a possibility still?

Yes, that's still where we expect to come in.

Okay, okay. And the D&O expense, I guess, is -- I mean, that's an extra $1 million, but there's really no other change in the expense items?

Right. Correct.

Okay. All right, thank you.

I'm not showing any further questions at this time. I would now like to turn the call back over to Andy O'Brien for closing remarks.

Well, thank you all for participating in our earnings call today. It is our first as a public company, and we really do appreciate your interest in Trean and we look forward to our future calls with you. And with that, I'll bid you all a good afternoon.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.