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Amerisafe Inc  (NASDAQ:AMSF)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Amerisafe's 2018 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this call may be recorded.

It is now my pleasure to introduce General Counsel, Ms. Kathryn Shirley. Please go ahead.

Kathryn Shirley -- Executive VP, General Counsel & Secretary

Good morning. Welcome to the Amerisafe 2018 third quarter investor call. If you have not received the earnings release, it is available on our website, at www.amerisafe.com. This call is being recorded. A replay of today's call will be available. Details on how to access the replay are in the earnings release.

During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to various risks and uncertainties. Actual results may differ materially from the results expressed or implied in these statements if the underlying assumptions prove to be incorrect or as a result of risks, uncertainties and other factors, including factors discussed in today's earnings release, in the comments made during this call and in the Risk Factors section of our 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 Janelle Frost, Amerisafe's President and CEO.

Janelle Frost -- President and Chief Executive Officer

Thank you, Kathryn, and good morning, everyone. Industrywide loss cost continued to decline this quarter, making workers' compensation the only commercial line with rate decreases passed on to policyholders. Such an environment sets the stage for carriers to compete for premium dollars.

Amerisafe's history and current year results reflect our discipline to evaluate and price our risks for long-term stability and profitability. It is because of that discipline that our board declared a special dividend of $3.50 to our shareholders, while maintaining adequate capital to protect our policyholders and efficiently operate our company. In addition, our employees have created a thriving workplace, which was recognized by business interns as one of the best places to work in insurance.

Amerisafe is executing on our strategy of producing favorable returns on equity and increasing book value per share adjusted for dividends paid to shareholders. This quarter's results are consistent with our strategy and produced a combined ratio of 81.1% and an ROE of 17.4%. I will discuss the operational metrics before turning the call over to Neal Fuller to discuss financials.

Gross premiums written this quarter was down 2%, impacted by a change in audit premium and related adjustments. Audit premium remained positive this quarter, indicating insured payrolls were better than estimated. In addition to audit premium, the "related adjustment" includes endorsements and cancellations. In comparison to last year's third quarter, we experienced $1.4 million more in cancellation premium. This quarter was greatly impacted by a single large account we chose to cancel for noncompliance with safety recommendations. In total, audit, premium and related adjustments decreased gross premiums written $2.1 million this quarter.

Premium for policies written in the quarter were essentially flat, and pricing on those policies was down resulting in a 1.65 ELCM. I believe we have been responsive in balancing the continued decline in approved loss costs, while making appropriately priced risk selections, particularly when it comes to retaining policies. As a reminder, here's a list of our sequential ELCMs since the third quarter of 2017; 1.69, 1,65, 1.63, 1.66 and now, 1.65. As further evidenced, our policy retention this quarter was 93.1%.

As for losses, our loss ratio was 55.9%, comprised of the current accident year loss ratio of 71.5% and a favorable prior year loss ratio of 15.6% or $13.3 million of favorable loss development. The current accident year loss ratio remained unchanged from the first two quarters of 2018. We've seen an increase in frequency and moderate severity, but within expected ranges. As I tend to caution when discussing claims trend, we insure hazardous industries with potential for severe claims. Those accidents occur randomly, which make quarterly losses incurred lumpy. The same holds true for our ability to close on several claims. There's no seasonality, which is why the favorable development driven by individual case reserves is less predictable in any given quarter. This quarter's favorable development was primarily attributable to accident years 2013, 2014, 2015 and 2016.

I look forward to your questions later in the call and will now turn it over to, Neal.

Neal Fuller -- Executive Vice President and Chief Financial Officer

Thank you, Janelle. For the third quarter of 2018, Amerisafe reported net income of $19.7 million or $1.02 per diluted share, compared with $16.6 million or $0.86 per diluted share in last year's third quarter. Operating net income for the quarter was $19.5 million or $1.01 per share, an increase of $0.14 from $0.87 in the third quarter of 2017. Revenues in the quarter increased 0.8% to $93.5 million, compared with the third quarter of 2017. Net premiums earned were flat when compared to last year's third quarter, reflecting current market conditions and from lower audit and other related premium adjustments, which can be variable from quarter-to-quarter.

Turning to our investment portfolio, net investment income increased 1.2% in the third quarter to $7.9 million compared with $7.8 million in the third quarter of 2017. The increase was due to slightly higher yields on investments compared with last year's third quarter. The tax equivalent yield on our investment portfolio was 3.01% at the end of the quarter. The pre-tax yield on the portfolio was 2.70% at the end of the quarter, up 16 basis points from 2.54% at year-end. There were no impairments on any of the securities held in the portfolio during the quarter.

At quarter-end, the investment portfolio carried an average AA rating with a duration of 3.84. It was composed of 54% in municipal bonds, 22% in corporate bonds, 18% in U.S. treasuries and agencies and the remainder in cash and other investments. About 56% of our bond portfolio is composed of held-to-maturity securities, which were in an overall unrealized loss position of $2.9 million at quarter-end. These unrealized losses are not reflected in our book value as the bonds are carried at amortized cost.

Moving now to operating expenses, our total underwriting and other expenses were $20.6 million in the quarter, compared with $19.3 million in the third quarter of 2017. The increase was largely due to higher loss-based assessments and commission expense, compared with last year's third quarter. By category, the 2018 third quarter expenses included $6.2 million of salaries and benefits, $6.4 million in commissions and $8 million of underwriting and other costs. Our expense ratio for the quarter was 24.2%, compared with 22.7% in the third quarter of 2017.

Our tax rate was significantly lower in the quarter, as a result of the new lower 21% federal corporate tax rate in 2018. Our tax rate for the quarter was 19.5%, compared to 29.6% for last year's third quarter. Return on equity for the third quarter of 2018 was 17.4%, compared to 13.6% for the third quarter of 2017 and operating ROE for the quarter was 17.1%.

Now, turning to capital management. On October 23, 2018, the company's Board of Directors declared a regular quarterly cash dividend of $0.22 per share, payable on December 28, 2018, to shareholders of record as of December 14, 2018. In addition, as part of our ongoing capital management efforts, and as Janelle mentioned earlier, the company's board declared a special dividend of $3.50 per share for shareholders, with the same record and payable dates. This brings the total amount of special dividends paid out in the last five years to $14.75.

Several other items to note for you today. Our book value per share at September 30, 2018, was $23.82, an increase of 7.8% from $22.10 at year-end. Our statutory surplus was $392 million at quarter-end, up from $382 million at December 31, 2017. And we will be filing our Form 10-Q with the SEC tomorrow, October 26 after the market closes.

That brings me to the end of my remarks on the quarter, and we're now ready to open up the call for the question-and-answer session. Operator?

Questions and Answers:

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Randy Binner with B. Riley. Your line is now open.

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Hey, good morning. Thanks. I wanted to actually ask about the account cancellation due to safety issues just because it's -- I know that you all focus on safety a lot and do a lot of inspections. But I mean, it's unusual for that to kind of affect the numbers in the margin in the quarter. So could you expand on that? Is it isolated or not and just like to know more there?

Janelle Frost -- President and Chief Executive Officer

Yes. It's a good question. The reason it impacted the quarter, the reason we brought it up was because it was a large account. So for us, a large account is a six-figure account. This particular account was nearly $800,000. And as I mentioned, the change in the quarter-over-quarter was $1.4 million. So I felt like it was important to isolate that it was -- that in particular was one account, had that not been for that one account, the trend pie wouldn't have been so dramatic in terms of the financial results. Not saying that we don't -- regularly -- we will cancel accounts if we feel like they're not complying with our safety recommendations, but that one account was impactful to the quarter.

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Is that emblematic of anything that's happening more broadly? Or is it just something that happens when you deal with higher hazards --

Janelle Frost -- President and Chief Executive Officer

It's just something that happens. I don't second read a trend into that.

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Yes, OK, fine. And then, I guess just on the ELCM is so pretty darn good. But the workers' comp is as you saw -- with your reserve development is, from an all-in margin perspective is doing quite well. May be the best, it's done in forever, so what -- how would you characterize the competition you're seeing? Is it larger carriers? Is it packaged business? Is it -- is there any change in what we've seen trend wise so far this year?

Janelle Frost -- President and Chief Executive Officer

Can I select all of the above?

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Yes, I am sure.

Janelle Frost -- President and Chief Executive Officer

Yes, it's large carriers. Yes, it is competitive. But I would say, I don't think the competitive landscape really changed from even second quarter to third quarter. We're still seeing the same things. Obviously, anecdotically, we see things on individual accounts, but there was not something prolific throughout the marketplace. And the best way I can just -- I'll use data that's out there, articles that have been out there, the best way I can describe it is, MarketScout put out a report that said, of all the commercial lines, workers' comp was the only one that had shown decreases passed onto the policyholder. And it was 3% in the second quarter. It was 3% in the third quarter.

Yet when you look at the underlying loss costs that are being approved, they're obviously at a greater rate. So I think that's a good example, at least on an industrywide basis. That's not just hazardous industries that we write, but on an industrywide basis, I think that's a good outlook to say carriers are still demonstrating some discipline. So may be either whether we believe in the loss, whether that's we believe in the loss cost, experiences aren't the same. Or to your point, people are just having trouble believing that workers' comp can be really be profitable for a string of years in a row. And so may be underwriters are a little bit more cautious about that. And that's -- like I said, that's just industrywide data, not specific to Amerisafe. But I think it's a good indicator of even what we're seeing in terms of competition.

When I look at accounts that we may be offered renewal to and we didn't get the renewal, where we see slippage is in those what we would call lower-hazard classes for us, not lower classes as in mainstream business, but some of our lower class business in terms of hazards. That's where we see slippage. We were really not seeing that in with the high hazard of high hazard, if that makes any sense to you.

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Yes. Just because that's where you're more likely to see package, and it's easier for large carriers to attach to it. Okay. That's perfect. Thanks a lot.

Operator

Thank you. And our next question comes from the line of Matthew Carletti with JMP Securities. Your line is now open.

Matthew Carletti -- JMP Securities LLC -- Analyst

Hey. Good morning.

Janelle Frost -- President and Chief Executive Officer

Good morning, Matt.

Neal Fuller -- Executive Vice President and Chief Financial Officer

Good morning, Matt.

Matthew Carletti -- JMP Securities LLC -- Analyst

A couple of questions. Randy actually asked my first one. So we covered that. Wage inflation, can you talk a little bit about what you're seeing with wage inflation if anything so far and what you might expect? And a little bit about how beneficial that would be to, kind of, the economic model of workers' comp for you and how that would impact the bottom line?

Janelle Frost -- President and Chief Executive Officer

Right. As I stated in my earlier remarks, audit premium was positive this quarter. I think that's important for us to emphasize. It was indeed positive but quarter-over-quarter, not as robust. Yes, we're seeing wage inflation and probably, more to a larger degree, I think some of our increased payrolls are actually coming from more workers. So I think, as the economy has rebounded and may be a little bit more robust than it was previously, our insurers, our clients are adding workers to their workforce, which increases payrolls. Obviously, if we had our druthers, we'd rather it just be wage inflation because then the same workers, higher wages.

Matthew Carletti -- JMP Securities LLC -- Analyst

Right.

Janelle Frost -- President and Chief Executive Officer

But I mean, we're certainly seeing new workers in the workforce.

Matthew Carletti -- JMP Securities LLC -- Analyst

Okay, great. And then, I guess, my other question would center around losses. And you commented kind of high level on just the lumpiness of losses in the business. In terms of what you guys defined as large losses, how is -- you're nine months through the year, kind of how are you looking versus kind of your budget or what you'd expect at this point? That said, caveated by the fact that we've definitely had quarters before where you get a lot in the last week of December or something. They are lumpy.

Janelle Frost -- President and Chief Executive Officer

Yes, that's right. Thank you for pointing that out. It is not sequentially in nature. So as of the end of third quarter, we had 18 claims that were over $1 million. And at year-end, I believe that number was -- I'm looking at Neal? 21 ?

Neal Fuller -- Executive Vice President and Chief Financial Officer

Last year.

Janelle Frost -- President and Chief Executive Officer

So accident year '17 at year-end was 21. And since then, that count has come down obviously because we've closed claims or able to settle. But we're at 18 right now as of the third quarter.

Matthew Carletti -- JMP Securities LLC -- Analyst

Okay. Pretty helpful. That's all I got. Congrats on a very nice quarter.

Janelle Frost -- President and Chief Executive Officer

Thank you, Matt.

Neal Fuller -- Executive Vice President and Chief Financial Officer

Thanks, Matt.

Operator

Thank you. And our next question comes from the line of Mark Hughes with SunTrust. Your line is now open.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Thank you very much.

Neal Fuller -- Executive Vice President and Chief Financial Officer

Good morning.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Good morning, Neal. Good morning, Janelle. The loss-based assessments in the quarter, I think you suggested those were up. Could you give us a magnitude on that?

Neal Fuller -- Executive Vice President and Chief Financial Officer

I don't have the magnitude here. But what really happened is last year in the third quarter, the year-over-year comparable was very favorable. Last year in the third quarter, we saw some very significant reductions in loss-based assessments in a couple of states related to some large claims that we were able to settle and close out, so those loss-based assessments were depressed in the third quarter of last year. I would say the amount that we had this quarter was more of a normal run rate.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Okay. Your outlook on taxes, I guess, I assume that it's influenced by the distribution of earnings underwriting versus investments, but do you think that 19.5% is a good number going forward?

Neal Fuller -- Executive Vice President and Chief Financial Officer

Yes. You're right. It exactly ties to what you said. It's -- how much of it's coming from underwriting gains, and how much of it's coming from the investment portfolio. We did see the tax rate tick up this quarter and that's as a result of a more favorable development. So I think you have to assume whatever loss amounts you assumed going forward and then adjust your tax rate accordingly. But I would say that the tax rate this quarter was probably a little higher than normal, just because we had higher favorable development.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

And then the investment income was up sequentially, any one-timer, nonrecurring stuff in there? Or was that just higher yields on the portfolio?

Neal Fuller -- Executive Vice President and Chief Financial Officer

Yes. No, there really wasn't any one-timers that were influencing that or unusual items. So I think that really reflects the fact that we've been able to invest at slightly higher yields over the last six to nine months.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

And then on audit premiums. I hear what you're saying is that the -- definitely impactful to have a large account that was canceled. You had a decline in audit premium in this quarter last year, so -- and actually in the third quarter of '16 now that I look at it. It was flat in the third quarter of '15, so third quarter has been kind of a strange quarter may be. What -- I might have expected a little more audit premium with the robust economy, any thoughts there?

Janelle Frost -- President and Chief Executive Officer

When I look at it by industry, Mark, and this is why I -- to your question about the economy, when I look at it by industry, the decreases were kind of like across all of our industries. It wasn't particular to one. We actually saw an uptick in oil and gas, which we would have expected at this point compared to where we were third quarter last year. But I mean, in our major classes, it was -- they were still positive, no question, still positive. But construction was not as robust, trucking was not as robust, agriculture was actually up slightly. So agriculture and oil and gas were the two that have actually showed increases. But something as simple as maritime was actually down from last quarter -- last third quarter 2017. So I don't read into that. It's something specific to the economies of the industries that we write, simply because it was across all of them.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Just out of curiosity, the account that you canceled, was that based on a loss? And when you investigated the loss, it was the safety issue came to the fore? Or did you figure out before the loss came up?

Janelle Frost -- President and Chief Executive Officer

No, it was not related to a loss.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Okay. Still a little good investigative work there.

Janelle Frost -- President and Chief Executive Officer

I supposed so, we do follow up.

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Yes. Okay. All right. Thank you.

Operator

Thank you. And our next question comes from the line of Christopher Campbell with KBW. Your line is now open.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Yes, hi good morning. Congrats on the quarter.

Janelle Frost -- President and Chief Executive Officer

Good morning, Chris. Thank you.

Neal Fuller -- Executive Vice President and Chief Financial Officer

Good morning.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

I guess just my first question is on the case reserve development, are you seeing any industry-specific trends there?

Janelle Frost -- President and Chief Executive Officer

No. I probably should have alluded to that in my prepared remarks. No, it's really just lumpy. It's not specific to -- it's the same types of losses that we typically have.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Okay, got it. And Janelle, you had mentioned I think early on and you just said like lumpy. So why -- I guess just thinking about it, so why would -- at a high level, why would your case reserving be, I guess, less predictable? Because I was just thinking that the case reserves are kind of based on better data, than your IBNR would be. So what drives that higher uncertainty?

Janelle Frost -- President and Chief Executive Officer

I'm glad you asked that question so that I can clarify. What I meant by it's not predictable, when those case reserves changes as far as releases, when we're able to close and settle, it's certainly not predictable. When the accidents are going to happen is not predictable. How we reserve is very consistent. Our approach to our claims is very consistent and has not changed. I am sorry, apologize if that was not clear.

The end -- the part that is lumpy is when the accidents happen, I can't tell you if they're going to happen in second quarter, third quarter, or as Matt mentioned in his -- when he was asking the questions, it's happened in the last week of the year before. And that's unpredictable for us. As well as when -- my claims department is continually working these claims, particularly prior year claims, there's not a seasonality to -- do we're able to -- it seems that we can close claims or settlements are more evident (ph) in the first part of the year than the second part of the year. And the unpredictability comes from that favorable case development, the favorable development that we recognized this quarter, the $13.3 million was coming from individual case reserves.

It's not Neal and I saying, oh, well, let's look at this accident year and adjust management's estimate. To your point, the IBNR, those are coming from case reserves. So the $13.3 million this quarter was more than second quarter, even this year's second quarter. So that's more of just a fact of that how the individual case reserves panned out. It wasn't management's estimates changing. Does that clarify?

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Yes, definitely. And then just got to dig in a little bit further into that logic though, but I would say that some of your IBNR would be held for adverse case reserve development, right? So would the favorable case reserve development you're seeing on accident years like '13 through '16, is that causing you guys to rethink like how much IBNR you're holding and could there even be more reserve releases?

Janelle Frost -- President and Chief Executive Officer

Yes, certainly. We look at IBNR in relation to those case reserves each quarter. Particularly, when we get -- once that accident year reaches that 36 -- 32-months to 36-months window, that's when we really start looking at the IBNR in one case. How many cases are left open? Usually, if they're prohibited (ph), they're the ones that are still open, maybe those are not the ones that are the best claims, but those are the ones we're going to have for a while. And that's when we evaluate the IBNR. So to your point, if we start seeing that we're able to close those cases and they're closing favorable, then certainly we would adjust the IBNR.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Okay. Well great. Thanks for all the answers. Best of luck to rest of the year.

Janelle Frost -- President and Chief Executive Officer

Thank you.

Operator

Thank you. And that concludes today's question-and-answer session. I would now like to turn the call back over to CEO, Ms. Janelle Frost, for closing remarks.

Janelle Frost -- President and Chief Executive Officer

I will part with one final statement. Amerisafe is positioned both financially and operationally, to continue executing on our strategy outlined to our shareholders, fulfill our promises to our policyholders and assist our employees and community in thriving. Thank you for joining us today and for your questions.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.

Duration: 27 minutes

Call participants:

Kathryn Shirley -- Executive VP, General Counsel & Secretary

Janelle Frost -- President and Chief Executive Officer

Neal Fuller -- Executive Vice President and Chief Financial Officer

Randolph Binner -- B. Riley FBR, Inc. -- Analyst

Matthew Carletti -- JMP Securities LLC -- Analyst

Mark Hughes -- SunTrust Robinson Humphrey, Inc. -- Analyst

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

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