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Innovation Group (TIG) Q2 2021 Earnings Call Transcript

By Motley Fool Transcribing – Aug 11, 2021 at 11:00PM

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TIG earnings call for the period ending June 30, 2021.

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Innovation Group (TIG 7.81%)
Q2 2021 Earnings Call
Aug 11, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon, everyone, and welcome to the Trean Insurance Group, Inc. second-quarter 2021 earnings conference call. [Operator instructions] Please note that this event is being recorded. I would now like to turn the conference over to Garrett Edson of ICR.

Please go ahead, sir.

Garrett Edson -- Investor Relations

Thank you, operator. Good afternoon, and welcome to Trean Insurance Group's second-quarter 2021 earnings call. This afternoon, the company released its financial results for the quarter ended June 30th, 2021. 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 the 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.

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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; Julie Baron, the company's president and chief operating officer; and Nick Vassallo, the company's chief financial officer.

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

Andy O'Brien -- General Partner, Executive Vice President and Director

Thank you, Garrett. We welcome everyone to our second-quarter 2021 earnings call. We appreciate your participation on this call and your continued support and confidence in Trean. We had a strong second quarter and recorded the best gross written premium growth in our company's history for the first six months of the year.

Further, we are making significant progress in all of the areas most important in delivering larger value for our shareholders. Nick will be along shortly to provide details on our second-quarter performance. One year ago in July, we completed our initial public offering. I think this is an appropriate time to remind you of what we've accomplished, where we see ourselves in the years to come in terms of our company, and driving shareholder value and how we plan to get there.

First, it's important to state this right now. As you can clearly see from our results over the past six years, Trean is firmly a growth company. We followed up on our 36% gross written premium growth in the first-quarter 2021 with 43% year-over-year growth in the second quarter, translating to 40% growth for the first half of 2021. We've been able to generate these growth figures because we develop a unique business model.

We work with owned and third-party program partners that focus on workers' comp and other underserved segments of the specialty insurance market. Our partners are deeply vetted. We develop long-term relationships with them. We have a first-class management team and with that combination of our model and our team, we are able to take advantage of the large opportunity set in front of us.

Importantly, we are achieving our rapid top-line growth while we continue to responsibly manage our risk through risk-sharing, collateral management, and appropriate reserving. Disciplined underwriting is critical to our long-term success and our approach to underwriting and risk management will not change. We're proud of our success and what we've built at Trean. And now it's time to set new goals, ambitious goals, the ones we are confident we can achieve.

Our long-term goal is to generate $1 billion in annual gross written premiums within the next five years. We will accomplish this the same way we've grown so rapidly, building, and maintaining long-term relationships with exceptional program partners. We think that this goal is achievable for several reasons: one, we operated a huge and rapidly growing portion of the insurance market. Even hitting our long-term goal of $1 billion in gross written premium, we will still own a very small share of the overall market.

The opportunity is clearly present. We project that we can generate at least solid high single-digit to low double-digit growth per year within our existing program. And we expect that we would add three to five new programs per year to supplement our current programs. In order to hit our target of $1 billion in annual gross written premiums, we need to grow in the low teens per year.

While that growth will fluctuate on a quarter-to-quarter basis, we don't run our business by the quarter, we focus on our annual performance in our long-term trajectory. And as you can see by our historical results, we grew nearly 30% annually from 2015 to 2019. And last year, we grew 18% despite the pandemic. We have the clear track record of success that makes us confident that we will reach our target.

But we aren't just focused on the top line. At the end of the day, our top-line growth has to translate into profits. Now rapid growth, such as we are having now will impact current earnings as we recognize upfront costs that are ultimately recovered as unearned premiums are realized. But how we evaluate our overall progress or our true north is simple.

We look to our annualized growth and the stability of our annualized loss ratio. If we are growing to plan and our loss ratio remains stable we will be in solid shape. And as the premiums become earned, they will eventually flow to our bottom line. To that end, we look at the growth in our gross unearned premiums, the place where our deferred earnings accumulate as one of the key measures of our long-term success.

For the first half of 2021, we have been spot on our true north. We're confident in our growth efforts for the remainder of 2021 and our longer-term strategy because we have a successful record that validates our approach by growing organically, prudently adding new programs, and retaining more of our gross premiums, we continue to put ourselves in prime position to prosper and deliver long-term value for our shareholders. Our team's constant hard work and dedication continue to pay off. We appreciate all of their efforts and remain very exciting for our future.

With that, I'll now turn the call over to Nick.

Nick Vassallo -- Chief Financial Officer

Thank you, Andy, and good afternoon to everyone on the call. Let's go right into our second-quarter results. In the second quarter, our team grew gross written premiums by 43% to a record 156.6 million, compared to 109.6 million in the prior-year period. This was driven by organic growth in our existing program partner business, the addition of new program partners and the acquisition of 7710 Insurance Company in the fourth quarter of 2020, resulting in an increase in both workers' compensation and nonworkers' compensation liability lines of business.

We remain strongly positioned for continued gross written premium growth throughout 2021. Gross earned premiums were 138.6 million for the second quarter of 2021, up 38% compared to the prior-year period due primarily to the increase in gross written premiums and partially offset by the rise in gross unearned premiums due to the addition of our new program partners whose premiums were largely unearned as of the end of the second quarter. As a reminder, since we cannot control the timing of effective dates of new policies, this lag effect is a fairly common occurrence when we onboard new program partners. Net earned premiums for the quarter were 47.9 million, more than doubling the 21.4 million generated in the prior-year period, primarily due to the growth in gross earned premiums, more than offsetting a smaller increase in ceded earned premiums.

We would like to point out that the increase in gross unearned premiums we recorded in the second quarter of 2021 is more indicative of what we would expect to see for this line item as we continue to grow. As Andy mentioned, this is a strong positive for our business. as it means that we are growing more rapidly than we previously anticipated, and those unearned premiums will eventually convert into earned premiums in time. We would also like to emphasize that as of June 30th, 2021, we have net unearned premiums reflected on our balance sheet of 73.4 million, which is an increase of 7.2 million compared to Q1 2021 and an increase of 23.4 million compared to year-end 2020.

We remain confident in our ability to onboard additional program partners and sustainably grow our gross written premiums over the longer term. Our loss ratio for the second quarter of 2021 was 62%, compared to 57% in the prior-year period. The increase in the loss ratio during the second quarter of 2021 versus the prior-year period was primarily attributable to a number of unusual large losses experienced during the first half and quarter of 2021. Our expense ratio for the second quarter of 2021 was 31.8%, an improvement of 700 basis points from the prior-year quarter, primarily due to the significant increase in net earned premiums.

G&A expense was 15.3 million in the second quarter of 2021, compared to 8.3 million in the prior-year quarter. The increase was primarily due to higher net agent commissions related to the rise in our retention rate from 21% to 35% year over year, higher salaries and benefits resulting from acquisitions made in 2020 and our expanded workforce, increased business insurance expense, and other insurance-related expenses and an increase in office-related expenses as well. In our earnings release, we've added a supplemental table in the back of the release to provide more insight and transparency into the components of our G&A income statement line. While we've noted before that we expect our G&A to remain elevated as we invest in Trean and retain more business, it's important to see that the overall G&A operating expense as a percentage of gross written premium are actually down year over year.

In other words, opex spending is rising commensurately with our growth, which means we are remaining disciplined with our overall spending. What is driving the G&A ratio higher is our increased retention, which impacts our net commissions as well as higher business insurance and insurance-related expenses. What we've noted on prior calls, it is that increased retention, which we believe will help drive significant increases in net income for years to come. All in, our combined ratio for the second quarter of 2021 was 93.8%, up 200 basis point improvement, compared to 95.8% in the prior-year period.

Underwriting income for the second quarter was 3 million, more than tripling underwriting income of 900,000 in the prior-year period. Net investment income for the second quarter of 2021 was 2.1 million, compared to 2.5 million in the prior-year period. The majority of our investment portfolio was comprised of fixed maturity securities, up 424.9 million at June 30th, 2021. We also had 101.4 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 administration and brokerage fees was 1.2 million for the quarter, driven by a reduction in management fees due to the expiration of a management contract at the end of our first-quarter 2021. As a reminder, other revenue and brokerage fees can vary significantly from quarter to quarter based on the effective dates of the underlying insurance contracts. Net income for the second quarter of 2021 was 2.1 million or $0.04 diluted earnings per share.

When excluding intangible asset amortization, non-cash stock compensation, noncash unrealized losses on embedded derivatives, and nonrecurring other expenses, adjusted net income for the second quarter of 2021 was $4.3 million, compared to 4.8 million in the prior-year period. Adjusted diluted earnings per share for the second quarter was $0.08. ROE for the second quarter was 2%, while adjusted ROE was 4.2%. Adjusted return on tangible equity, which is computed as annualized adjusted net income over average tangible equity was 8.6%.

During the second quarter of 2021, the company determined that its funds held agreement with its reinsurers contain embedded derivatives relating to a total return swap on the underlying investments. As a result, the company will now report gains and losses on the embedded derivatives, along with related investment earnings in operations. While the correction was not material to previously reported condensed consolidated and condensed combined financial statements, the prior period amounts have been restated for comparability. In an effort to provide additional visibility, we are also providing a full-year outlook for 2021 for gross written premiums to be between 605 million and 615 million, which implies year-over-year growth of 25% on the low end and 27% on the high end.

We are very pleased with our growth trajectory and first-half 2021 performance and remain well-positioned for long-term sustainable and profitable growth. With that, I thank you for your time, and we'll now open the call for Q&A. Operator?

Questions & Answers:


Operator

Thank you. [Operator instructions] And our first question today will come from David Motemaden with Evercore ISI. Please go ahead.

David Motemaden -- Evercore ISI -- Analyst

Hi. Good afternoon. I had a question just on the loss ratio. I was hoping to get some of the components there if there was any favorable or unfavorable prior-year development? And then hoping you could provide a little color around the unusually large losses that you incurred in the quarter?

Andy O'Brien -- General Partner, Executive Vice President and Director

Yeah. I'm happy to respond to that. First, so far this year, we have not had any adverse loss development in prior years. In fact, loss development to date has been better than our expectations.

So we're very pleased with that. We did have a number of large losses, goofy losses, and I can give you some examples, and I will. And so what we did is, we went with a little bit lower or a little bit higher loss ratio. And that's consistent.

In my comments earlier, I said that we're not going to change our approach to risk management or underwriting, and part of that is our conservative reserving philosophy. And you always like to hope that particularly large losses and nonrecurring loss, and we've got good reason to hope for that, but we also don't want to get too ahead of our hopes. As an example of the types of unusual losses that we have, we don't ensure private automobile liability. We ensure a small amount of property, and it's a property that's pretty well diversified.

We had a situation in the quarter where two automobile collided in the middle of an intersection, we didn't insure either one. Both companies prevened into an adjacent appealing alongside the road, crashed into the same building, and the building collapsed. We ensured the building. So you've got a big loss.

We had just a tragic situation of a person who was driving in a truck, a work truck, and went over a bump. And if they're ahead at the top of the cab of the truck, and it killed them. I mean these are just the large losses. They're -- especially in the situation of the second one, they're terrible losses.

I mean those aren't recurring situations. And so we're hopeful that as more premiums earn-out, we don't have those types of losses in the future, and that we'll be in a position to take down loss reserves in the future.

David Motemaden -- Evercore ISI -- Analyst

Got it. Thanks. Could you size, I guess, how much the -- how big of an impact those had on the loss ratio this quarter?

Andy O'Brien -- General Partner, Executive Vice President and Director

Yeah. I mean we took -- we raised it about one point, if I remember correctly. We went up maybe point and a half on the loss ratio. And our quarterly range loss ratios over the last six years, when you look from quarter to quarter, our loss ratios by quarter have varied from 31 to 32% to as high as 67%.

So we went a little bit higher within the range this time, but not a big amount.

David Motemaden -- Evercore ISI -- Analyst

Got it. And I guess this is the second quarter in a row where we've had some property losses that have impacted results. And you guys are already retaining, I think, a small amount. Is there any other sort of underwriting actions or any updates to the strategy that you guys are thinking about undertaking to kind of prevent this sort of thing from happening again in the future?

Andy O'Brien -- General Partner, Executive Vice President and Director

Yeah. It's really hard to think of ways to avoid some of these losses. I mean, gosh, how do you stop two cars from shooting each other and greening into a building. So for a lot of these losses, we've gone through, we've looked at, we've had our underwriters review the policies to see if they thought that the policies were properly underwritten.

By and large, they've come to the conclusion that they were. But I will tell you, we are taking some actions. For our new business in the aggregate, where we've got a very small retention, but we're looking carefully at what we're doing in some of our more established businesses. I mean, for example, in California, we are shrinking that book of business a bit, and we are seeking and getting some higher rate levels in that state, and this is for workers' compensation.

David Motemaden -- Evercore ISI -- Analyst

Got it. OK. That's helpful, thanks. And then maybe if I could just ask one other one just on the expense ratio.

I have -- thanks a lot for the enhanced disclosure on the -- on some of the components of the G&A expenses. I guess I'm just wondering, is there a simple rule of thumb that we can think about in terms of as you guys are increasing your retention how much of an upward impact that should have on the expense ratio just as we think about lower ceding commissions that is obviously offset by some scale benefit, but just wondering if there's a way you can help us think about that offset?

Julie Baron -- President and Chief Operating Officer

Well, I think, David, if you look at the enhanced schedule, just a second, let me flip to it. We really -- I mean, it really kind of has all of the pieces here. So we're seeing our direct commission as you can see, it's been around 19, 20% consistently. And we checked these numbers going back the last couple of years, and it's very consistent around that percent.

So that's our gross earned premium times that rate. And then the ceding commission rate, again, fairly consistent around that 32%, 33%. That's a multiple of our ceded earned premium. And you can kind of build -- you can kind of calculate that out with our changing retention, right? I mean those are kind of all the pieces that you would need to calculate that G&A.

Nick Vassallo -- Chief Financial Officer

Yes, David, another way of looking at this schedule, and the reason why we put it together the way it is, to make it crystal clear that the retention percentage delta is what's driving the decrease in ceding commission income. If you were to think that on a -- just on a spending level 7 to 8% is kind of in line with where we are from an operating expense percentage of GWP and then knowing that insurance-related expenses kind of go up with our premiums variably and our direct commission and our rate in our direct commission is around 20%. And that's been solid, as you can see in the table, it's the retention percentage change that is causing in the table, the ceding commission income offset to go up or down depending on growth in premium as well as that ceding commission. So on -- if we were to have flat top line, the ceding commission income is easily calculatable based on our average rate that you could see at the bottom.

And as that retention percentage keeps edging up, then the offset would be coming down.

David Motemaden -- Evercore ISI -- Analyst

Yup. Got it. That makes sense. And so this relationship should hold going forward, so we could just sort of model that.

That's helpful. OK. Thank you.

Nick Vassallo -- Chief Financial Officer

You're welcome.

Andy O'Brien -- General Partner, Executive Vice President and Director

Dave, there's one kind of complicating factor. That's the right word that I just like -- we've been talking, Nick and I in this -- in our opening comments commented on our unearned premium. And in the insurance business, as you know, as we write new business, we used to call it the unearned premium penalty, the new business penalty. What happens is that we pay the agent commissions upfront.

We have all these expenses that we get up front that we have to recognize immediately. But yup, we don't get to recognize the revenue that offsets those expenses until the premiums earn out. And that's actually putting a lot of pressure on our expense ratio right now. And that's why we say, look to our unearned premium because as those premiums earn out, we expect to recoup those expenses as well as recoup underwriting income.

Now the issue we have is that we're growing so much faster than what we expected. We originally were thinking 15 to 17% growth, and here we are at 25 to 27% growth. And as a result, those upfront expenses are higher than what we would have originally anticipated. I think that's a wonderful thing.

And I hope we do a good job of explaining that to you and the shareholders.

Nick Vassallo -- Chief Financial Officer

And David, just one other comment on the schedule, which I think pretty much gives the transparency that everyone wanted to see is the emphasis, and we've made, I made this in my remarks as well, the G&A operating expenses that are not tied to commissions or ceding commissions, and other variable insurance-related expense. So the G&A operating expense as a percentage of GW, it's not increasing as everyone kind of thought might be the case in previous quarters because they didn't understand the dynamic.

Operator

And our next question will come from Adam Klauber with William Blair. Please go ahead.

Adam Klauber -- William Blair & Company-- Analyst

Hi. Good afternoon. Last year, you had a combined ratio all-in and around 82%. So sitting here in August, I guess, what's your confidence by the end of this year, you'll be a couple of points above or a couple of points below that within a range?

Andy O'Brien -- General Partner, Executive Vice President and Director

And that's a tough question. That's we are -- as you can see with our comments, we are providing some more -- we're trying to provide some guidance here. I think we probably should not provide guidance about where we expect the combined ratio to be at year-end. But I guess in a helpful way I can tell you -- just point to our historical record, which is that typically, our fourth quarter is our best quarter, typically.

And typically, that's the quarter where we're much more comfortable releasing reserves. We tend to be more conservative in our reserving practices in the first half of the year than the second half of the year. And it really goes back to that saying that the only want surprises at birthday parties.

Adam Klauber -- William Blair & Company-- Analyst

Right. So what's the chance you'll actually give us any -- you've given us premium guidance, any guidance on combined ratio going forward?

Andy O'Brien -- General Partner, Executive Vice President and Director

We're not prepared to do that at this earnings release, but we are trying to be more open to the idea of giving guidance.

Adam Klauber -- William Blair & Company-- Analyst

OK. I'll put my call ahead.

Operator

[Operator instructions] Our next question will come from Pablo Singzon with J.P. Morgan. Please go ahead.

Pablo Singzon -- J.P. Morgan -- Analyst

Hi. Thank you. So I hear you -- I appreciate the conservatism in your loss for serving. But I guess my question is, -- and maybe you had already answered this somehow.

But if I look at what you've done in the past couple of years, you have taken down losses versus the first half. So I guess what changed was your practice for this year? And if you could just sort of comment on why the change this year versus the past year?

Andy O'Brien -- General Partner, Executive Vice President and Director

I'm not sure that we really haven't done much in the first half on reserve takedowns.

Julie Baron -- President and Chief Operating Officer

We've had some in the past, but they're easily case serving.

Andy O'Brien -- General Partner, Executive Vice President and Director

Pretty minor.

Julie Baron -- President and Chief Operating Officer

We really don't do any release of IBNR in the first half of the year. But if there's adjustments to case reserves, that would flow through. And it could be just that in the past, we've had some reserves that have settled at lower amounts than we expected or that we've got more information on in the first quarter and they adjusted those case reserves. But we typically have not released IBNR reserves in the first half of the year.

Pablo Singzon -- J.P. Morgan -- Analyst

OK. I think that's a helpful distinction. So the piece sort of comment makes sense. OK.

And then the second question I had is how should we think about margins in your nonwork comp lines as you're growing there? So I think at the industry level, work comp has generally outperformed most of your lines in underwriting. Is it the same for you?

Andy O'Brien -- General Partner, Executive Vice President and Director

In our other lines of business, we have -- we're keeping a small percentage net retained. And so our margin is a function of our issuing carrier fee, what underwriting risk we do keep and some of the other fee opportunities that get created over our position. We -- right now, we're probably having operating margins as I, if not higher, on the other lines compared to our workers' comp, which is one of the reasons why we're actually kind of interested in some of the other lines right now.

Pablo Singzon -- J.P. Morgan -- Analyst

OK. That makes sense. And then the last for me, could you just give comments on, I guess, your pricing outlook for workers comp? I think a couple of other companies have sort of said that maybe we're past the bottoming, maybe slightly positive. Wondering if you're seeing the same thing? And just your thoughts on wage inflation, if you're seeing that in your book? And do you see that as a positive or negative for margins going forward? Thank you.

Andy O'Brien -- General Partner, Executive Vice President and Director

We haven't seen any evidence of wage inflation yet. That would be more likely to come later in the year as premiums expire and we do premium audits. And that's when that would more be likely to show up. In some parts of the country, we are not seeing the ability to get a lot more rate.

In California, we are getting a little bit higher rate level. It's a part of a deliberate approach on our part. We've done some meaningful reunderwriting in California based on how that market has changed this past year. And so we're feeling really good about the progress we're making there.

Pablo Singzon -- J.P. Morgan -- Analyst

Got it. Thanks for your answer.

Operator

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Andy O'Brien for any closing remarks.

Andy O'Brien -- General Partner, Executive Vice President and Director

Thank you. In this earnings release, we've made a deliberate effort to try and provide some more specificity about our results, including some guidance. Our company has changed significantly over the last year or two, but I really think for the better. I'm really excited about where we're going.

I think the second quarter and the first half have been great for us. And the reasons are simple: first, our growth opportunities are better than what we originally anticipated; second, we think that the loss ratio appears to be within our accepted parameters; and finally, the reorganization efforts that we've talked about, the IT stuff that we've talked about in previous meetings. We think those are already bearing fruit. So we think we're in a great position, and we appreciate your support, and thank you for your participation on the call.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Garrett Edson -- Investor Relations

Andy O'Brien -- General Partner, Executive Vice President and Director

Nick Vassallo -- Chief Financial Officer

David Motemaden -- Evercore ISI -- Analyst

Julie Baron -- President and Chief Operating Officer

Adam Klauber -- William Blair & Company-- Analyst

Pablo Singzon -- J.P. Morgan -- Analyst

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