Trean Insurance Group, Inc. (TIG) Q4 2021 Earnings Call Transcript

Trean Insurance Group, Inc. (TIG)
Q4 2021 Earnings Call
Mar 09, 2022, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Trean Insurance Group fourth quarter 2021 earnings call. [Operator instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Garrett Edson of ICR.

Thank you, Garrett. You may begin.

Garrett Edson -- Investor Relations

Thank you, Operator. Good afternoon, and welcome to Trean Insurance Group's fourth quarter 2021 earnings call. This afternoon, the company released its financial results for the quarter and full year ended December 31, 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 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; 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 -- President and Chief Executive Officer

Thank you, and welcome to our fourth quarter and full year 2021 earnings call. We appreciate your participation on our call and for your continued support and confidence in Trean. We posted a 2021 calendar year combined ratio of 93.3% and reported adjusted net income of $22.1 million, which represents an 11% adjusted return on tangible equity. This combined ratio is substantially better than the industry and -- insurance industry average and marks the 25th consecutive year in which Trean has earned a profit.

We also grew our top line above our expectations, and enhanced our infrastructure to position ourselves for continued profitable growth. Before I talk about these positives, let's address our higher-than-expected loss ratio. We try to be as accurate as we can when calculating our loss estimates. Historically, our ultimate costs have been much lower than our initial projections.

For example, in the developed year of 2017, we projected our 2017 claims would cost $35.6 million. But in hindsight, we now expect those claims to cost $23.4 million. We've always and continue to believe that favorable surprises are better than adverse surprises, and we use our loss projections in our underwriting strategy. Too low a loss projection may lead to mistakes that are more costly than too high a loss ratio projection.

Earlier in 2021, we reported on some of the large unusual losses we experienced in 2021. We expected that our lost results would average out over the course of the full year, and that was the case from May through November. Unfortunately, in December, we incurred some new large claims at the end of 2021. Large losses push up the reported loss ratio and have a multiplicative impact on actuarial loss projections.

As a result, we reported a higher 2021 loss ratio. Our elevated losses came primarily from three of our 30 programs. Ironically, until 2021, these programs were well established and had consistently produced positive results up to 2021, and as bad luck would have it, we materially increased our retention in each of these programs during 2021. When the losses began to emerge, we carefully reviewed the operations of each program to see if there were any changes in rate levels, the claims environment or underwriting practices that might have caused the elevated losses they were experiencing.

Based on that review, we believe that these are good programs that will contribute to our future profitability despite the losses they experienced in 2021. We are very encouraged that prior years' claims for these programs developed favorably during 2021. We are also encouraged that these three programs have reported positive results through February of this year. And as a result, we are expecting a first quarter 2022 loss ratio between 61.5% and 62.5% of net earned premium.

We grew gross written premiums 31% during 2021. We believe that this growth is all the more impressive considering the actions that we took with our California workers' comp business, which is our single largest program. We did this because of several adverse developments we were seeing within the state, including aggressive rate cutting as well as regulatory action regarding agricultural risk and pricing. As a result, our California workers' compensation premium dropped by roughly 18.4% in 2021, or an amount equal to 7.3% of our total 2020 gross written premium.

We believe we now have a better rated and more balanced risk pool in California and are positioned to regrow our California workers' comp business when the risk-reward ratio improves. Our actions in California underscored two important points regarding our business: first, we are committed to profitable growth, not to growth itself, and we are prepared to take rapid action to preserve underwriting discipline; second, the fact we grew so rapidly despite shrinking our California business demonstrates the strength of our overall business model and the attractive market available to us. We believe the insurance program market is large, rapidly growing, and that we have a leading position within that market. In addition, in 2021, we invested significantly and prudently in time and capital to improve our infrastructure.

Claims handling has always been a key focus for us, and we are on track to launch a new claims software system designed to support our continued growth. Throughout the year, we implemented a variety of IT upgrades to capture efficiencies in how we handle and analyze our business. We reorganized our processes to more effectively and quickly onboard new programs. Finally, we added skilled people throughout the organization to improve our capabilities and further strengthen our bench.

I am proud that we accomplished the goals while carefully controlling our expenses. We want to be both the most skilled and lowest cost competitor in our business area. We have built a strong and deep bench equipped with the culture, tools, and practices that can be the foundation for decades of future success. As such, this is an optimal time for me to transition the role of CEO to Julie for her to lead Trean into the future.

Over the past two decades, she has emerged as an exceptional leader. Her deep knowledge of the insurance business, and understanding of the Trean secret sauce that drives our company, combined with an exceptional management team, will position us to build on our success in the future. I will remain on Trean's board as its executive chairman and will continue to stay closely involved with the team's efforts in evaluating and supporting our programs. With that, I will hand it over to Julie.

Julie Baron -- Chief Financial Officer

Thank you, Andy, and good afternoon to everyone on the call. Before discussing our fourth quarter results, I want to congratulate Andy on an incredible career and well-deserved retirement from daily operations. Andy's leadership and vision for Trean has successfully grown the company into a national presence, and he has paved a clear path forward for myself and our wonderful team. I have greatly enjoyed the last 15 years working closely together, and with Andy's support as executive chairman, along with our expert management and team, I am more than ready to lead Trean into our next chapter of growth.

We are committed to our business model, and we'll continue to focus on the fundamentals that have brought us so much success. Disciplined program partner selection, prudent financial management, and being the people, people want to do business with. In addition, we will also continue to look for opportunities to expand our product, improve efficiencies, and enhance shareholder value. Now let me take you through some of our results.

In the fourth quarter, our team grew gross written premiums by 14% to $153 million. This increase was due in large part to the full year impact of nine program partners that we added last year and ongoing strong performance from existing program partners across the accident and health, commercial, commercial auto, homeowners, and other liability lines of business. Our ability to grow these lines reflect our efforts to diversify our product offering. However, this work was partially offset by a decline in the California workers' compensation business, which, as Andy discussed, we strategically undertook to decrease our exposure there.

Identifying and minimizing risk is an ongoing effort as we focus on businesses that offer more sustainable and profitable growth. Gross unearned premiums decreased 2.9 million in the fourth quarter of 2021 and increased 61.9 million for the full year 2021. As of December 31, 2021, net unearned premiums represented 91 million on our balance sheet, an increase of 6 million or 7% from September 30, 2021, and up to 41 million or 81% from year-end 2020. As we've consistently noted, net unearned premiums represent a material source of deferred potential profit.

Net earned premiums for the quarter were 58 million, a 57% increase from the prior year period, driven by both the growth in gross earned premiums and the strategic increase in our retention of gross written premiums. More importantly, for the full year 2021, we generated gross written premiums of 634 million, a 31% increase from 2020 and exceeded our 2021 outlook of 610 to 620 million. We also generated net earned premiums of 199 million for the full year, an increase of 83% compared to prior year, and grew total revenue to 218 million, both of which also exceeded our expectations. I'll now turn the call over to Nick, who will discuss our expenses and other financial results.

Nick Vassallo -- President and Chief Executive Officer

Thank you, Julie. And I also want to congratulate you on your promotion, and Andy, on all your accomplishments and your new position as executive chairman of the Trean board. While we were pleased to have surpassed the expectations that we provided in our third quarter 2021 earnings release for gross written premiums, net earned premiums, and total revenue, losses unfortunately impacted our bottom line in the quarter. Our loss ratio for the fourth quarter of 2021 was 76.4%.

As Andy mentioned in his remarks, along with the large and unusual losses we experienced in the first half of 2021, we experienced additional large claims in December of Q4. As a result, the full year 2021 loss ratio was 65.8%. General and administrative expenses were 13.8 million in the fourth quarter of 2021, compared to 15.2 million the prior year. The decrease was attributable to accrual true-ups recorded in the fourth quarter of 2020 that did not reoccur in the fourth quarter of 2021.

This was partially offset by increased salaries and benefits for our growing workforce as well as an increase in net commissions and insurance-related expenses from the growth in our gross earned premiums. Our general and administrative operating expense as a percentage of gross written premiums for the fourth quarter was 7.4%, roughly in line with the prior year period. Our expense ratio for the fourth quarter of 2021 was 23.9%, compared to 41.4% in the prior year quarter and 26.5% in the third quarter of 2021. The improving expense ratio was driven by the growth in net earned premiums and the nonrecurrence of accrual true-ups included in the fourth quarter of 2020.

For the full year 2021, we reported an expense ratio of 27.5%, exceeding our expectation of 29 to 31%. Our combined ratio for the fourth quarter of 2021 was 100.3% compared to 68.8% in the same prior year period and 88.3% in the third quarter of 2021. Underwriting income for the fourth quarter was a slight loss due to the losses reported in the fourth quarter compared to income of 11.4 million in the prior year period and 6 million for the third quarter of 2021. Net investment income for the fourth quarter of 2021 was 2.2 million, compared to 2.5 million in the same prior year period.

Excluding income on funds held investments, our fourth quarter net investment income was 1.6 million, compared to 1.7 million in the same prior year quarter. The majority of our investment portfolio was comprised of fixed maturity securities of $471.1 million at December 31, 2021. We also had $129.6 million of cash and cash equivalents on our balance sheet at December 31, 2021. Our investment portfolio had an average rating of AA at the end of the quarter.

Other revenue, which consists primarily of brokerage and third-party administrative fees, was $1.6 million for the quarter compared to $800,000 in the same prior year quarter, driven by a $700,000 increase in brokerage revenue. 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 and their renewals. Net income for the fourth quarter of 2021 was $1.2 million or $0.02 per diluted share. Adjusted net income for the fourth quarter of 2021 was 2 million, compared to 11.2 million in the same prior year period.

Adjusted diluted earnings per share for the fourth quarter of 2021 was $0.04 per diluted share. Net income for the full year 2021 was 19.3 million or $0.38 per diluted share. Adjusted net income for the full year 2021 was 22.1 million or $0.43 per diluted share. ROE for the fourth quarter was 1.2%, while adjusted ROE was 1.9%.

Adjusted return on tangible equity, which is computed as annualized adjusted net income over average tangible equity, was 3.9%. ROE for the full year was 4.6%, while adjusted ROE was 5.3%, and adjusted return on tangible equity for the full year was 11%. We are providing our initial full year outlook for 2022 for several metrics. For the full year 2022, we are expecting the following: gross written premiums to be between 655 million and 670 million.

The company expects to deliberately moderate gross written premium growth in 2022 as 31% growth in 2021 placed the company well on track to achieve its long-term gross written premium goals. It will focus its efforts in 2022 on effectively managing premium to ensure sustained net income growth. Net earned premium to be between 240 million and 250 million. This represents year-over-year growth of 21% on the low end and 26% on the high end.

Net earned premium outlook reflects expected increased retention rate throughout 2022 based on current contracts enforced. Total revenue to be between 253 million and 263 million. Expense ratio to be between 32 and 33% of net earned premium. Expense ratio reflects the aforementioned expected increase in retention, which would reduce the company's ceding commission offset to general and administrative expenses as well as additional reductions in ceding commissions resulting from adding more short tail lines of business, which typically have lower front fees.

The expense ratio also reflects expected continued operational investments in the company during 2022. In terms of our calendar year loss ratio for 2022, we believe absent any unusual activity, losses should hopefully begin to normalize during the year. Because we are mostly through the first quarter, we are providing onetime additional color on our quarterly 2022 loss outlook for the first quarter only. As Andy noted in his remarks, we expect our first quarter 2022 loss ratio, barring any material unfavorable activity in the final three weeks of the quarter, to be between 61.5% and 62.5%.

We appreciate and thank you for your time this afternoon. With that, we'll now open the call for Q&A. Operator?

Questions & Answers:

Operator

Thank you. [Operator instructions]. Our first question is from David Motemaden with Evercore ISI. Please proceed with your question.

David, is your line on mute? You may proceed with your question.

David Motemaden -- Evercore ISI -- Analyst

Sorry about that. Good afternoon. Julie, just wondering, is there any change to how you'll operate the company going forward, specifically on the strategy. I'm wondering if you could talk about the desire to increase retention in light of the losses you just experienced in '21.

Just based on the outlook you provided for 2022, it looks like you're also expecting your premium retention to tick up again in 2022. But I guess, maybe just wondering why you think that's the right move here just given the losses that you experienced in 2021. And if you are considering going back to more of a fronting type model?

Julie Baron -- Chief Financial Officer

So, David, we don't expect to change our strategy at this point. I mean, obviously, we're all -- any time -- it's time for a contract renewal. We'll see what our options are and look for whatever makes the most financial sense at the time and that we think is a good move. Right now, we don't have any plans to change anything.

We feel like these are good programs. When we saw the large losses, we did a lot of due diligence digging into the numbers, reviewing underwriting guidelines, looking at the policies that generated these large claims, and really worked with our partners and our underwriters to make sure that there wasn't something underlying that was causing an issue. And we don't believe that there is. These are some of our most profitable programs that we've had for the last five, 10 years.

And sometimes -- I mean, this is insurance. Sometimes you have a bad year, and we feel like that was our bad year, and we're looking forward to this year being a better year.

David Motemaden -- Evercore ISI -- Analyst

Got it. And maybe just on those three programs. Are those all workers' comp programs? Could you talk about how big they are from a premium standpoint? And maybe just talk -- maybe you could just give a little bit more elaboration on why you don't think this is a fundamental issue?

Andy O'Brien -- President and Chief Executive Officer

Dave, this is Andy O'Brien, I'll take a crack at that. These three programs are significant. They are significant programs. They represent a significant amount of our net premium.

As Julie mentioned, we did do a deep dive into each of these programs to see if there was any underlying change in the environment, the claims environment, the rate levels and how people were underwriting and the program's willingness to look at any changes in underwriting that might be indicated. And we came to the conclusion in all of these situations -- in all three of these situations that they were essentially good programs, and that, as Julie mentioned, sometimes in the volatility of insurance business, you get hit, and we feel we did get hit a bit this year. The increase in net earned premium in 2022 is really reflective of actions that we took in raising retentions in 2021. Over the course of the last six to nine months since we've been looking at new programs, we have been taking or retaining significantly less participations in those programs compared to what you're seeing in the overall numbers now.

And that's something that we plan to be doing as new programs come on throughout the year.

David Motemaden -- Evercore ISI -- Analyst

Got it. OK. And then maybe just one last one, just on the losses. I mean, the environment right now is obviously improving from a claims reporting standpoint.

But I don't think things are totally back to normal on that front. When I look at some of your peers, specifically, workers' comp reported claims, they're still well below 2019 levels. So what makes you think or what gives you the confidence that the provisions you've set for the 2021 large losses are sufficient? What makes you think there won't be any additional surprises from additional late reported claims.

Andy O'Brien -- President and Chief Executive Officer

Well, these were not late reported claims, Dave. I think it's probably important to clarify that. We haven't had any surprises with adverse development or claims developing beyond what we originally anticipated. One of the reasons we are comfortable with where these programs are headed is the fact that we -- each of these three programs enjoyed favorable loss development on their previous years' underwriting.

And when you're looking at a program that has historically provided -- has historically produced positive results and then has continued to do so in terms of prior years' development, that's a sign to us that losses in the current year are not indicative of an overall problem. We take comfort in the fact that our experience, as we alluded to earlier, for the first two months of this year has been very good. And in fact, two of these three programs enjoyed their most favorable reported loss development since we've been working with them during 2022. So we hope we're back on track.

As respect to large losses, we define a large loss as a loss over $250,000. At this time last year, we had 11 of them. So far this year, we've only had three. So that's another encouraging sign.

David Motemaden -- Evercore ISI -- Analyst

Got it. And yes, just to clarify on my question, I was just wondering about adverse development on 2021 accident year in 2022, 2023, just as those claims -- it's obviously workers' comp is an occurrence line. So I'm just wondering if we saw in 2020 and 2021, just there's more of a lag in terms of when the accident or when something actually occurs and when it's actually reported and if that is potentially something that you guys are worried about. But it sounds like you took the provision you think is necessary.

Andy O'Brien -- President and Chief Executive Officer

Yes. And of course, we're -- I guess, we are in the worrying business. So we worry about everything. But I guess, in looking at just the 2021 year, for example, for one of our -- for our California book of business, for the two months, January and February, the 2021 losses developed at half the rate that they developed for the 2020 and 2019 years.

So again, a very favorable sign recognizing that it's just two months, but everything is looking pretty nice after two months.

David Motemaden -- Evercore ISI -- Analyst

Got it. Thank you.

Operator

Thank you. [Operator instructions]. Our next question comes from Pablo Singzon with J.P. Morgan.

Please proceed with your question.

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

I was hoping that you could talk about your gross premium guidance for next year, just to feel that a bit. Is -- clearly, 4% is much lower than what you've done historically. Is that just a function of the California workers' comp book not growing as much as it's done? And I suppose that you are growing other programs, but it seems like the inertia from California is just overwhelming. And any thoughts on how that growth might evolve beyond '22?

Andy O'Brien -- President and Chief Executive Officer

We are projecting a slower rate of growth in 2022 compared to 2021. A large part of that, Pablo, is just that we grew so much in 2021. We don't have the financial capacity to grow at 31% per year. That's much higher than what we expected to grow last year.

And so we began in the fourth quarter to make sure that we were moderating our growth so that we could -- so that we didn't get over our skis. Long term, we are still anticipating -- we still have as our goal that we want to be a $1 billion company by 2025, and we think we're on track to achieve that.

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

And by financial capacity, are you looking at like a premiums to surplus ratio? Because you're well below one at this point, right? Or is there anything else you're considering?

Andy O'Brien -- President and Chief Executive Officer

So we look at a variety of different factors. We don't look so much as net written premium to surplus, although we do pay attention to that, but we pay attention to our risk-based capital scores. We pay attention to the AM Best, the CAR scores. And so we really look at those two issues or those two elements more to assess our leverage ratios and our growth potential than we do our net written premium to surplus ratio.

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

OK. And then on the expense ratio, I was wondering if you can help me just bridge what you did in '21 and your guidance for '22. So '21 was 27.5%, so it's 32% to 33% next -- this year. What component is that -- what component of that change is coming from the lower negative commissions versus, I guess, other expenses going up as a percentage?

Nick Vassallo -- President and Chief Executive Officer

Pablo, it's Nick. If you remember, the expense ratio is low this year versus last year because of some true-ups we had in 2020. So comparatively, it just looks lower than last year. But going from 2021 to 2022, there's a couple of factors.

One, we're going to have -- as we mentioned in the actual press release, we're expecting retention to continue to creep up in 2022 from where it is right now in 2021 mostly due to contracts that are already in place and already have been renewed at retention rates in 2021 that will carry over into 2022. As you know, we can't really adjust retentions until contracts come up for renewals. So there's a little lead time there before you can actually effectively change that contract by contract. So that's one of the reasons.

In addition, we're also, with the expected increase in retention, that will result in less ceding commission. And as you also know, ceding commission offsets our direct commissions in our G&A line item. So we're expecting less offset in next year due to that retention as well. And we're also planning to invest -- continue to invest in the company in 2022, which will increase the dollars of G&A over this year as well, but not -- but for sure, in proportion to our top line as we have been doing for the last couple of years.

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

OK. And those two components, I'll just it, the negative commission, right, as a percentage of net earned premiums and other expenses as a percentage of net earned premiums. Is there a way to break that out just bridging 27.5 to 32?

Nick Vassallo -- President and Chief Executive Officer

We wouldn't get that granular in breaking that out at this point. We're just putting the guidance out there to ensure that some of the things that we're talking about with respect to retention is understood. Prior year 2021 quarter to quarter, before we were able to -- before we decided to put out guidance in 2021, we constantly had an uphill battle with models that are out there versus what we truly felt we were going to achieve internally. That's why we are putting out the guidance right out of the gate this year for 2022.

In addition, as you remember, Pablo, when we put out starting last year, that supplemental table of G&A components, we did that so that The Street and the public can see the dynamics of the components of G&A. And as you can see in the release we put out for fourth quarter, you can see the G&A operating expense component of the total G&A expense is still sitting between that 7.5 to 8% percentage of our gross written premium. So we're not spending any more proportionately than our growth allows us to. And we've been saying that every quarter and showing that every quarter for at least the last five quarters.

So I don't know if that answers your question, but I just wanted to make sure that was understood.

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

Yes. Thank you very much. And then last one for me. I guess, if you just sort of take a step back, right? So there's pressure on workers' comp and growing other lines, it seems like you -- well, you're going to run expense ratio in the low 30s in '22.

You did give an indication for the loss ratio in the first quarter, so call it, low 60s. So moving forward, is it -- Trean look like a 90% combined ratio book? Is that sort of a decent parameter to think about going forward for Trean?

Andy O'Brien -- President and Chief Executive Officer

Pablo, I think we'd like to respectfully not take a stab at that yet. We have a really good idea, we think about where we're going to be with an expense ratio. And so we are providing guidance for that. If we say it's a 90% business, then we've kind of provided guidance for a loss ratio.

And we still want to do that at this time. We don't rule out the fact that we might provide more guidance in the future about the loss ratio. But at this point, we'd like to just stick with the numbers that we have shared.

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

All right. Thank you for that.

Operator

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Andy O'Brien for any closing comments.

Andy O'Brien -- President and Chief Executive Officer

Thank you. During 2021, we achieved a number of important goals, and we believe that we're well positioned for future success. We are committed to profitable growth. We're committed to sound underwriting and appropriate expense control.

We remain confident about our plan and prospects, and we'll continue with our strategies and philosophies. Thank you for your interest in support of Trean.

Operator

[Operator signoff]

Duration: 37 minutes

Call participants:

Garrett Edson -- Investor Relations

Andy O'Brien -- President and Chief Executive Officer

Julie Baron -- Chief Financial Officer

Nick Vassallo -- President and Chief Executive Officer

David Motemaden -- Evercore ISI -- Analyst

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

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