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Trean Insurance Group (NASDAQ:TIG)
Q3 2020 Earnings Call
Nov 12, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Trean Insurance Group, Inc.'s third-quarter 2020 conference call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Garrett Edson from ICR.

Please go ahead, sir.

Garrett Edson

Thank you, operator. Good afternoon, and welcome to Trean Insurance Group's third-quarter earnings call. This afternoon, the company released its financial results for the quarter ended September 30, 2020. The press release is available on 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 Barron, the company's chief financial officer.

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

Andy O'Brien -- Chief Financial Officer

Thank you, Garrett. And welcome to our third-quarter 2020 earnings call. We appreciate your participation on our call and for your continued interest in Trean. On today's call, I will walk through our higher-level quarter results and our overall strategy.

Our CFO Julie Baron will follow and provide some detail about our third-quarter results, and then we'll open it up to Q&A. We were pleased with our third-quarter performance as we embarked on public life in mid-July. We continue to execute well on all facets of our operations from driving revenue growth to flowing it through our cash flows and earnings. This enabled us to enter the fourth quarter in the strongest financial position in Trean's 24-year history, even in the face of the ongoing challenges brought about by the COVID pandemic.

Along with our successful initial public offering during the third quarter, we grew gross written premiums by 23% year over year. We increased retention of our net earned premiums to over 25%. We recorded a combined ratio of 81%, an 810-basis-point improvement over the prior-year period, thanks to our prudent underwriting approach. And we generated adjusted net income after excluding onetime items of $10.5 million or $0.21 per diluted share, producing an adjusted ROE of over 15%.

Our proven business Botto and operating strategy is clearly paying dividends for Trean and validates the resiliency of our business. We remain focused on supporting our program partners responsibly accepting new opportunities, seeking proper rate levels and quickly and fairly resolving play. At our prior call, I talked about our four distinct strategies to grow and create long-term value: growing organically in our existing markets, selectively adding new program partners, opportunistically growing through acquisitions and harnessing our growing capital base to retain more premium. The third quarter saw us execute well on all of these strategies.

Of our 23% increase in gross written premium from the prior-year period, our workers' comp segment saw a 6% growth while our nonworkers' comp liability lines more than doubled their gross written premiums from the prior-year period. The vital part of our program partner strategy involves specific targeting of each programs with a competitive edge, and our third-quarter performance demonstrated the clear value of that approach. We are continuing to maintain a strong pipeline of opportunities to add new partners in the coming quarters. In addition, at the time of the IPO, we completed the acquisition of the remaining comps to our interest.

And at the beginning of the fourth quarter, we closed on the acquisition of 7710 Insurance Company, a leader in workers' comp for emergency services in particularly underserved market, and they are already making valuable contributions to our growth. We also have a robust balance sheet, including $165.3 million in unrestricted cash, putting us in an advantageous position to execute on our growth strategy. During the quarter, we increased retention of our net written premiums to over 25%, keeping more of the quality business we are writing on our balance sheet instead of seeding it to reinsurers. As we look into 2021, we remain excited about the landscape we see for workers' comp and other insurance lines.

Given the potential for sustainable and profitable growth in vastly underserved markets, we are investing wisely in our business and providing proper support for our program partners to better reinforce our partner and customer relationships, which will lead to long-term value creation. I'm proud of our entire team for producing such strong results in the third quarter, and their ongoing hard work and efforts will help ensure our long-term success. With that, I'll now turn the call over to our CFO Julie Baron. Julie?

Julie Baron -- Chief Financial Officer

Thank you, Andy, and good afternoon to everyone on the call. Let's go right into our third-quarter results. In the third quarter, our team grew gross written premium by 23% to $132.3 million, compared to $107.5 million in the prior-year period. This growth was driven by the addition of new program partners in the second and third quarter and resulted in an increase in both workers' compensation and nonworkers' compensation liability lines of business.

We produced a very strong gross written premiums performance, particularly given the ongoing challenging operating environment. Gross earned premiums were $109.3 million for the third quarter of 2020, up 7% compared to the prior-year period, due primarily to the increase in gross written premiums and partially offset by the increase in gross unearned premiums due to the addition of new program partners in the second and third quarters whose premiums were largely unearned as of the end of the third quarter. As a reminder, since we cannot control the timing of effective dates of new policies, this lag effect is fairly common occurrence when we onboard new program partners. Thus, we continue to recommend that the focus be on gross written premiums as the best proxy for the growth of our business.

As you think about the fourth quarter, we'd also remind you that premium sometimes come in uneven blocks. So there can be some imbalance to our quarterly gross written premium. Thus, while we certainly expect to achieve a strong quarter of growth for the fourth quarter and working hard to exceed our own expectations, it is difficult to simply utilize one quarter's performance as a run rate for the next quarter. That said, we remain confident in our ability to onboard additional program partners and sustainably grow our gross written premiums over the longer term.

Net earned premiums for the quarter were $27.9 million, an increase of 26%, compared to $22.2 million in the prior-year period, primarily due to the increase in gross earned premiums more than offsetting a smaller increase in seeded earned premium. We retained 25.5% of premium in the third quarter of 2020, a 380-basis-point improvement from 21.7% in the prior-year period. With a fortified balance sheet, we expect to continue retaining more premium over time and grow net earned premiums most certainly. Our loss ratio for the third quarter of 2020 was 55.9%, a 720-basis-point improvement, compared to 63.1% in the prior-year period.

Loss activity during the third quarter of 2020 was directly attributable to the increase in earned premiums and partially offset by lower favorable loss reserve estimate true-ups made for the third quarter of 2020 than for the prior-year period. G&A expense was $7 million in the third quarter of 2020, compared to $5.8 million in the prior-year quarter. G&A expense increased $1.2 million, primarily due to higher net agent commissions resulting from an increase in written premium, increase professional fees including legal consulting another IPO and public company readiness efforts, as well as higher expenses associated with an expanded workforce in which we continue to invest. These increases were largely offset by a net reduction in G&A expenses of $3 million, resulting from synergies gained from the acquisition of Compstar during the quarter.

We are continuing to prudently invest in our business, our workforce and our growth and, as such, expect G&A expenses to remain somewhat elevated compared to the prior-year period. All in, our combined ratio for the third quarter of 2020 was 81%, an 810-basis-point improvement from 89.1% in the prior-year period due primarily to the increase in earned premiums more than offsetting the increase in losses and loss adjustment expense and GSA expense. Underwriting income for the third quarter was $5.3 million, a 118% increase, compared to $2.4 million in the prior-year period. Net investment income for the third-quarter 2020 was $1.9 million, up 8% compared to the prior-year period.

The majority of our investment portfolio was comprised of fixed maturity securities of $375.5 million at September 30, 2020, classified as available for sale. We also had $165.3 million of cash and cash equivalent. Our investment portfolio had an average rating of AA at the end of the quarter. Other revenue, which consists primarily a third-party administrator and brokerage fees, was $5.4 million for the quarter due to recording higher brokerage fees related to the effective dates of reinsurance contracts for current and new program partners and increases in estimated premiums on reinsurance contracts.

Equity earnings and affiliates net of tax was $0.4 million, lower than the prior-year period due to the company acquiring the remaining ownership interest in Compstar in mid-July and no longer accounting for its investment as an equity method investment. GAAP net income for the third quarter of 2020 was $69.3 million as we booked the $69.8 million onetime gain on the reevaluation of the Compstar investment upon our acquisition of the remaining 55% we did not own, partially offset by $11.1 million in onetime IPO-related payments. When excluding these and other onetime items, adjusted net income for the third quarter of 2020 was $10.5 million, a 62% increase from $6.5 million in the prior-year period. Adjusted diluted earnings per share for the third quarter of 2020 was 21%.

In the fourth quarter, assuming no additional share issuances, you should assume a share count of 51.1 million when calculating earnings per share. ROE for the third quarter of 2020 was 102.5% due to the onetime gain, while adjusted ROE, which excludes the aforementioned onetime items is 15.5%. Adjusted return on tangible equity, which is computed as annualized adjusted net income over average tangible equity was 25.9%. With that, I thank you for your time, and we'll now open up this call for Q&A.

Operator?

Questions & Answers:

Operator

[Operator instructions] Our first question comes from the line of Matt Carletti with JMP Securities. You may proceed with your question.

Matt Carletti -- JMP Securities -- Analyst

Thanks. Good afternoon. Julie, I'm going to start with a number's question. I was hoping we go to the loss ratio.

And could you spell out for us how much in dollars the favorable development was this quarter? And how much it was last third quarter?

Julie Baron -- Chief Financial Officer

So this quarter, we recognized about $300,000, the favorable development in the third quarter. And last year, it was slightly higher than that. I want to say it was about $350,000.

Matt Carletti -- JMP Securities -- Analyst

OK, great. And then, just more broadly, can you talk about what you're seeing in the loss cost environment? And particularly, I think in the past, you've commented a little about how COVID has been a benefit, but you've been waiting to see kind of how it plays out across the year. And if you could update us on your thoughts there.

Andy O'Brien -- Chief Financial Officer

I'll be happy to do that. Matt, this is Andy O'Brien, and thanks for joining the call. The story for us for COVID is really the same this quarter as we reported last quarter. We are still not seeing a lot of loss activity as respects COVID claims.

Those that we do have, most have been either closing without payment or were closing without a lot of payment. We do have a couple of claims that look like they could be serious. But in the scope of things, that's not a big deal. Claim counts are not increasing materially compared to last year.

In fact, in October of this year, claim counts increased less than what we would have expected for the current year. So it's really pretty much the same as we talked about last quarter. So far COVID has not had a material impact on our activities in terms of claims response.

Matt Carletti -- JMP Securities -- Analyst

OK, great. And then, maybe could you talk a little bit about just broader kind of economic activity and what you're seeing in your book? I mean, we know that you have a large California contractors exposure. What are you seeing in terms of maybe not the job they're on, but the next job, those sorts of things? Just any visibility you have into the economic activity of your insurance?

Andy O'Brien -- Chief Financial Officer

So we do not have a lot of insight into what's happening specifically within the California economy. We are hearing that things are slowing in California. And of course, if that happens, that will have an impact on us. But so far, we haven't seen a lot of change associated with a change in the economy.

Matt Carletti -- JMP Securities -- Analyst

OK, great. And then, last question, can you talk a bit about just the pipeline for -- you mentioned some of the partnerships that you, I think, had already announced and starting to come on board. How is that pipeline looking for continuing to add new partnerships going forward?

Andy O'Brien -- Chief Financial Officer

By way of just memory or just going back a bit. In the third quarter, when we talked last quarter, we talked about the fact that we had added four programs for the year through the second quarter, and that we were working on to up to five more in the second half. As respect to those five programs that we were working on, we did onboard three of those during the third quarter, and we have onboarded two others in the fourth quarter. So in total, we've onboarded nine programs this year in addition to the two acquisitions that we've made.

We're probably not going to be making any more new onboards this year. We're getting close to -- December is usually a pretty dead time for putting on new programs, and that really starts with Thanksgiving. So we've probably onboarded all the programs this year that we're going to onboard.

Matt Carletti -- JMP Securities -- Analyst

Great. Thank you for the color, and the best luck.

Andy O'Brien -- Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.

David Motemaden -- Evercore ISI -- Analyst

Hi, good evening. I wanted to just talk about the expense ratio. So it came in at 25.1% this quarter. A little bit higher than where I was expecting.

Julie, you mentioned you expected the expense ratio to run a little higher as you invest in the business. I guess, I'm just wondering what your outlook is for next year? Should we still expect that to be in the 21% to 22% range?

Julie Baron -- Chief Financial Officer

Right now, we are expecting that. It might tick up a little bit as we are retaining more business. One of the items that's included in our G&A expense is our commissions. So as we retain more business, our seating commission is reduced and that's a reduction to the commission expense.

So you'll see our G&A will tick up, but then we will have more net earned premium in lieu of that.

David Motemaden -- Evercore ISI -- Analyst

Right. So the combo of those, you're still comfortable getting to like 21%, 22% for next year?

Julie Baron -- Chief Financial Officer

At this time, we are.

David Motemaden -- Evercore ISI -- Analyst

OK, great. And then, if I could just ask, Andy, just a follow-up on the workers' comp side, just on the -- what you're seeing from a claims frequency. And I know last quarter, you had indicated that you didn't let potential frequency benefits come through results some of your peers have. I'm just wondering, is that still the case that you did not allow any of the favorable frequency to come through in the accident-year result?

Andy O'Brien -- Chief Financial Officer

We have not recognized favorable development yet in our financial results other than the small number that Julie mentioned during her introductory comments. And so that is something that we are looking at this quarter, and we'll make a decision at the end of this Quarter 4.

David Motemaden -- Evercore ISI -- Analyst

OK, got it. And then, Andy, if I could just sneak one more in. Just wondering, just to get your comments on the workers' comp pricing environment, the rate environment. Whether you're seeing rate levels bottom out here start to improve, sort of what you saw in 3Q and what you're seeing so far and what your expectations are for next year?

Andy O'Brien -- Chief Financial Officer

Yes. We have not seen great levels drop appreciably so far in this quarter and really for the year. On the other hand, we haven't seen much of an increase either. So I hope that that means that we are bottoming out.

We think that there's still a lot of competition for rate on larger accounts. And right now, we are disappointed about the ability to get the rate we would like on larger accounts. And by larger accounts, we really mean accounts that are generating more than, say, $250,000 in premium a year.

Operator

[Operator instructions] Our next question comes from the line of Jeff Schmitt with William Blair. You may proceed with your question.

Jeff Schmitt -- William Blair and Company -- Analyst

A lot of my questions were answered here. But a question on other revenue up quite a bit, I guess, above what you I think had initially expected. And is that just driven by the new program partners coming on? I mean, I think a lot of that's reinsurance brokerage, if I'm correct. But could you maybe just talk about that and how you -- what your views are on that going forward?

Julie Baron -- Chief Financial Officer

Yeah. So part of it was due to the new programs that we onboarded. And then, the rest of it is related to the new accounting standard. So you're recognizing the revenue on the effective date of the contract for reinsurance.

And so that requires an estimation of what that premium is going to be. And so, and then, you're required to do the true-ups to those. And so we did that this quarter, and we had some favorable upside. But again, in the future, that could also be a downturn if a program -- if the premiums are down.

So it was just an adjustment for the quarter.

Jeff Schmitt -- William Blair and Company -- Analyst

OK. And then, just on the investment portfolio, just the cash and cash equivalents, obviously, are pretty high. Are you rolling those into fixed-income securities? Or how should we think about that?

Andy O'Brien -- Chief Financial Officer

We have not -- our investment portfolio is very conservative. We've always taken the position that we are primarily in the underwriting risk business. And therefore, we wanted to take our risk there rather than to be aggressive on the investment side. The investment returns are very disappointing right now.

Interest rates are very low. On the other hand, the stock market is very high, and so we've been reluctant to make any big change in our underwriting -- I'm sorry, our investment philosophy, our guidelines right now. And that's something, again, that we'll be -- we look at it on a quarterly basis. And we'll be looking at that on an ongoing basis going forward.

Jeff Schmitt -- William Blair and Company -- Analyst

OK, thank you.

Operator

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Andrew O'Brien for closing remarks.

Andy O'Brien -- Chief Financial Officer

Thank you all for taking the time to join us for this presentation. We appreciate your interest in our company. We are dedicated and committed to providing good results and performing well for our shareholders. And so we look forward to visiting with you again in the next earnings call.

Thank you.

Operator

[Operator signoff]

Duration: 26 minutes

Call participants:

Garrett Edson

Andy O'Brien -- Chief Financial Officer

Julie Baron -- Chief Financial Officer

Matt Carletti -- JMP Securities -- Analyst

David Motemaden -- Evercore ISI -- Analyst

Jeff Schmitt -- William Blair and Company -- Analyst

All earnings call transcripts

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