James River Group Holdings, Ltd. (NASDAQ:JRVR) Q3 2023 Earnings Call Transcript November 10, 2023
Operator: Welcome, everyone, to the James River Group Quarter Three 2023 Earnings Conference Call. I would now like to turn the call over to Brett Shirreffs, our Head of Investor Relations. You may begin your conference.
Brett Shirreffs: Good morning, everyone. And welcome to the James River Group third quarter 2023 earnings conference call. During the call, we will be making forward-looking statements. These statements are based on current beliefs, intentions, expectations and assumptions that are subject to various risks and uncertainties, which may cause actual results to differ materially. For a discussion of such risks and uncertainties, please see the cautionary language regarding forward-looking statements in yesterday’s earnings release and the risk factors of our most recent Form 10-K and other reports and filings we have made with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.
In addition, during this presentation, we may reference non-GAAP financial measures such as adjusted net operating income, underwriting profit, tangible equity, tangible common equity and adjusted net operating return on tangible common equity. Please refer to our earnings press release for a reconciliation of these numbers to GAAP, a copy of which can be found on our website at www.jrvrgroup.com. Lastly, unless otherwise specified for the reasons described in our earnings press release, all underwriting performance ratios referred to are for our business that is not subject to retroactive reinsurance accounting for loss portfolio transfers. I will now turn the call over to Frank D’Orazio, Chief Executive Officer of James River Group.
Frank D’Orazio: Thank you for that introduction, Brett. Good morning, everyone, and welcome to our third quarter 2023 earnings call. I am pleased to be joining you today to provide additional color on our third quarter results, while also sharing some thoughts around marketing conditions and the strategic priorities that James River continues to focus on. In addition to reporting our third quarter results, this morning, we are excited to announce the sale of our Casualty Reinsurance business, JRG Re, to Fleming Insurance Holdings, a portfolio company of Altamont Capital Partners. This transaction marks a significant milestone for the organization as it will bring ultimate finality to our exposure from our legacy reinsurance platform.
Having also sold the renewal rights to our individual risk workers’ compensation business during the third quarter, moving forward, James River will be focused on the E&S and fronting markets, sectors where we have scale, market leadership and strong teams in place to take advantage of market opportunities. This transaction will provide a clean exit from the reinsurance business, eliminate future reserve volatility and freeze up capital to focus on our areas of growth. We also believe the sales simplifies the James River story, while paving the way for more consistent earnings. Turning to our results, the third quarter continued to show the positive momentum we have as an organization and strong underlying trends in our ongoing businesses.
We again delivered profitable underwriting results in both our E&S and Specialty Admitted segments, while our investment portfolio continues to perform well with record investment income during the third quarter. We have seen a modest acceleration of some already positive trends in our E&S business, including renewal rate increases and submission growth, clearly a favorable indication of the strength and durability of this market cycle, while we also continue to execute on portfolio management actions across our business as we remain focused on bottom line profitability. For the third quarter, we reported adjusted net operating income of $18.3 million or $0.48 per share. Our return on tangible common equity ex-AOCI, was 13% for the quarter.
Tangible common equity per share of $10.25 has increased 9.3% before dividends through the first nine months of the year as both our underwriting profit and strong investment returns have contributed to this growth. Our tangible common equity per share, excluding AOCI, was $15.27 at the end of the third quarter and up 11.2% year-to-date. Now let me provide a little more color on our segment results and market conditions. As I have stated previously, we continue to view the E&S environment as highly attractive. Competition remains rational across most of our E&S underwriting units, and we have seen renewal rate change trend higher in each sequential quarter this year, topping out at 12.4% in the third quarter. This increase is the latest of 27 consecutive quarters of positive pricing, bringing the compound renewal rate change to 77.2% since 2017.
Renewal rate increases remain broad-based across our portfolio, with most underwriting divisions achieving rate change in the high single or low double-digit range through nine months. While rate increases in our Excess Property division continue to lead the segment, the remainder of our E&S business, all casualty lines, achieved rate increases of 9.1% during the third quarter, consistent both with our experience during 2022 and another indicator that our nonproperty divisions are producing healthy increases in rate. Excess Property, Excess Casualty and Energy all showed meaningful double-digit rate increases, while General Casualty rates increased 8.9% during the third quarter. Our 15 underwriting divisions continue to build on our strong relationships with wholesale distribution.
Total submission growth of 8% during the third quarter was driven by new business submission activity and was our strongest submission growth rate in three years. Excess Casualty and General Casualty both recorded double-digit submission growth in the quarter at 14% and 24%, respectively, with several other units in the high single digits. Policy count increased 9% during the third quarter, again, supported by some of our larger underwriting units. General Casualty policy count increased 25%, while Excess Casualty was up 19% and Manufacturers and Contractors increased by 12%. Overall, we continue to be encouraged by pricing and market trends, which suggests that the current attractive market conditions should lead us well into 2024. Consistent with our actions last quarter, we have deliberately been more cautious on certain classes of Commercial Auto, particularly food delivery, and have made efforts to reduce exposure.
These actions led to a 44% decline in Commercial Auto gross written premium, representing a $7 million reduction relative to the prior year. We believe this action is prudent as we look to continue to generate strong profitability across our portfolio. Our core E&S gross written premium growth was 10.3% in the third quarter, excluding Commercial Auto, and 10.8% on a year-to-date basis. This performance was driven by strong growth in General Casualty, Manufacturers and Contractors, Energy, Excess Property and Sports & Entertainment. Throughout the third quarter, we saw year-over-year growth rates accelerate in each month. We closed the quarter with nearly 16% growth in core E&S premium in September, which is one of our strongest monthly growth rates during 2023.
Looking across our underwriting divisions and reflecting on the rate improvements we have achieved throughout 2023, we are confident in our outlook for profitable growth. The E&S segment reported a combined ratio of 88.4% and underwriting profit of $18.3 million for the third quarter. We did not record any catastrophe losses in the period, however, we did experience $7.8 million in adverse prior year development as we made the decision to shore up reserves from older accident years from 2015 to 2018 in our General Casualty line of business, where the industry has seen some adverse emergence trends. Partially offsetting this strengthening was a reduction to estimated losses in the current accident year based on general rate trends and significant portfolio management actions and improved risk selection as we’ve exited several loss-leading classes over the last few years and have taken other underwriting actions.
As a result of these favorable pricing dynamics as well as our portfolio management actions, we reduced our current accident year losses by $8 million in the quarter to reflect these trends and the impact on year-to-date results. Our E&S accident year loss ratio for the first nine months was 65.8% or 64.1%, excluding the impact of reinstatement premiums. This compares to an accident year loss ratio of 65%, excluding catastrophes, in the prior year period or a 90 basis point improvement year-over-year. All in, we remain excited about the opportunity set in front of our E&S segment and we have an exceptional team in place to continue to execute on our growth plans, while maintaining attractive margins. Turning to Specialty Admitted. As I mentioned earlier, during the third quarter we announced the sale of the renewal rights of our individual risk workers’ compensation business to the Amynta Group.
The sale encompassed the full operations including underwriting, loss control and claims. This business had generated $48.5 million of gross written premium on a trailing 12 month basis. This strategic action immediately followed the non-renewal of our large California workers’ compensation program that we discussed last quarter and was a natural next step, allowing our Specialty Admitted segment to focus on fronting and program business moving forward. We believe there is a strong opportunity for disciplined growth within the space. As has been the case throughout our history, we will continue to focus on supporting profitable programs with a conservative approach to reinsurance, security and collateral. Segment results for the quarter included 10% growth in fronting and program gross written premium, excluding workers compensation.
We saw growth from several new programs initiated during the third quarter and also experienced continued growth from existing programs, which included meaningful rate increases in certain areas. Specialty Admitted underwriting profit in the third quarter was $2 million and the combined ratio came in at 92.5%. Lastly, turning to our Casualty Reinsurance segment, results for the quarter continue to reflect the earnings of treaties written in prior years as well as various premium adjustments. The underwriting loss was $4.2 million and included $4.7 million of reserve strengthening from business not subject to the LPT. Reserve development was driven by movement on a few specific treaties, primarily from treaty years 2016 to 2019, driven by primary GL exposure.
There were also several treaties that experienced a modest level of favorable reserve movements during the quarter as a result of claim settlements and loss experience. Additionally, we experienced $7 million of reserve strengthening on treaties covered under the LPT, reflecting deterioration from construction and construction defect exposures. The remaining limit on the retroactive reinsurance that we put in place two years ago is now $38.3 million. Our third quarter results reflect the continued effort of our dedicated employees to refocus James River around our core competencies. Our underwriting franchises remain leaders in their respective specialties and remain well positioned to take advantage of attractive E&S market conditions and fronting market dislocations.
As I’ve said before, our focus remains on deploying capital where we can achieve consistent and attractive returns for shareholders. And with that, let me turn the call over to Sarah.
Sarah Doran: Thank you very much, Frank. Good morning, everyone and thanks for joining us today. First, a bit more on the transaction that we just announced. As Frank mentioned, earlier this morning, we executed definitive documentation to sell the business and entity underlying our Casualty Reinsurance segment to Fleming Holdings. As Frank mentioned, this transaction and the sale of the renewal rights of our individual risk workers compensation book we announced and closed in September are key final pieces of our work these past few years to streamline the organization focus on our core strengths where we have significant market advantage. We’re thrilled to be at this point. We believe our franchise is well positioned according to its strengths and to drive compelling returns for shareholders, and that our colleagues at JRG Re are very well positioned to help Fleming grow.
The sale will be a full separation via the stock purchase agreement we executed with Fleming. Consideration will consist of $138 million of cash at close and $139 million of a pre-closing dividend. The pre-closing dividend does not require regulatory approval. We expect to contribute the transaction proceeds to our existing U.S. insurance businesses. The transaction is subject to customary closing conditions, including approval by the BMA. Given the sale at a 25% discount to book, which is entirely consistent with runoff entity sale transactions, we expect to have a loss on sale of approximately $93 million or $2.50 per share, which we will record next quarter, the fourth quarter as we move the business into discontinued operations. We expect the transaction to be largely neutral to earnings with a loss of investment return, but elimination of what has been historical underwriting volatility in the segment.
Similarly, we expect to be able to meaningfully improve earnings stability, owning to a larger contributions from our E&S business and less from exposure to the reinsurance business. Finally, it is expected to be accretive to 2024 return on tangible common equity, excluding AOCI by approximately 250 basis points. We have had preliminary conversations with both our rating agency and regulator, and while it’s early days, those conversations have been positive. To be clear, given the balance sheet and in particular reserves that we are selling, we do not need to raise capital to affect the full separation. We are very grateful for the help of our advisors on this transaction, Citi, Howden Tiger and Debevoise and their many months of thoughtful collaboration to get to today.
Back to the quarter briefly. For the third quarter we’re reporting adjusted net operating income of $0.48 per share compared to $0.41 per share in the prior year quarter an increase of 16%. Tangible book value per common share was $10.25 at September 30. It has increased 7.7% from the start of the year or 9.3% before dividends. During the third quarter, AOCI accumulated other comprehensive loss decline by $40.2 million due to unrealized losses on our available for sale fixed maturity portfolio due to the rise in interest rates. Excluding the impact of AOCI, our tangible book value per common share has increased 10.1% from the start of the year, or 11.2% before earnings. We continue to have solid underwriting performance, strong net investment income and consistent growth in our core businesses.
We’re delivering $18.3 million of adjusted net operating income, including $7.6 million of underwriting profit and $26.3 million of net investment income on a pretax basis for the quarter. Our group combined ratio was 96.2%, roughly a 2 point increase over the prior year quarter, mainly driven by a higher expense ratio and unfavorable reserve development in our Casualty Reinsurance segment. We did not experience any catastrophe losses in the quarter and while higher than the prior year our expense ratio of 27.6% in the third quarter is consistent with the targets we provided on our fourth quarter call. So with that, I would like to turn it back to the operator to open the line for questions.
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Q&A Session
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Operator: Thank you. [Operator Instructions] And our first question comes from the line of Mark Hughes from Truist. Your line is open.
Mark Hughes: Yes. Thank you. Good morning.
Frank D’Orazio: Good morning.
Mark Hughes: A lot of good news, but I’ll focus on the adverse in the E&S. Could you talk a little bit more about what you’re seeing? And clearly the 2015 through 2018 in the General Casualty has been a challenge for lots of folks, for the industry as a whole. What did you see? What prompted you to take the action now? And then what are the total reserves that are still outstanding for those 2015 through 2018 accident years?
Frank D’Orazio: Sure. So listen, I agree with you, Mark. Like much of the rest of the industry, we saw some signs of pressure on our General Casualty reserves from the soft market years. So during the quarter, we chose to address what we perceived as some signs of weakness in the 2015 to 2018 years. That caused us to make some adjustment to reserves and shift some IBNR. Obviously it’s a disappointing development to see, but this is an industry dynamic, as you mentioned, and it’s clearly extending the current pricing cycle to our benefit. So, stepping back, I do take comfort overall based on the persistent strength of the rates that we’ve achieved now more than 77% cumulatively during the cycle, with major improvements in underwriting and no signs that this market is letting up.
And yes, you have to take that in concert with the overall conservatism that we’ve embedded in the last few years. So we believe we’ve been very conservative in our recent accident year loss picks. And at a time when we brought a lot more underwriting oversight and discipline into the organization, produced substantial rate and have made meaningful changes to risk selection and exclusionary language, as well as other portfolio management tools. And the benefits of those actions gain strength year-after-year in these market conditions. So like the rest of the industry, we’re watching the older software market, excuse me, the older soft market act and ears very closely. But I look at everything we’ve done and continue to do for several years now in terms of rate improvements and underwriting actions.
And that certainly gives me a lot of confidence overall.
Mark Hughes: Did you take any favorable development, say, in the 2019 through 2022 accident years, as an offset? Not as an offset, but did you recognize any favorable development?
Sarah Doran: I don’t believe so, Mark, we can go. We don’t have all the details in front of us there, but I don’t believe that we did on any of the prior years.
Mark Hughes: Okay. So this was kind of net-net, this was the…
Sarah Doran: Sorry, let me understand your question. The $8 million is net-net, absolutely right.
Mark Hughes: Yes, the $8 million is net-net. But I’m just curious whether there is some – the adverse in those older years might have been higher, but offset by gains in subsequent years during the harder market conditions.
Sarah Doran: Nothing that I can think of right now, we’re happy to go back and look. But again, the focus was more so on the $8 million.
Mark Hughes: Yes. Okay. And then, look, if we think about General Casualty reserves that are still outstanding from 2015 through 2018 is there kind of a rough number for what’s left within the areas where you saw some emergence?
Sarah Doran: Mark, I’m sorry we don’t have that number right in front of us, but we are happy to follow up on those details. Apologies.
Mark Hughes: Yes. Okay. All right. Very good. Appreciate the answers.
Operator: Thank you. The next question comes from the line of Matt Carletti from JMP Securities. Your line is open.
Matt Carletti: Thanks. Good morning. I just had a question on kind of the other comment in the press release about the material weakness around some of the accounting for one of the reinsurance transactions. Can you just walk us through? I guess question one is the $10.4 million of net income overstatement for the six months, is that reflected in the equity and book value numbers we see at 9/30 in the press release or is that yet to come? And just practical impact of what it means and how it gets remedied? Thanks.
Sarah Doran: Sure. Yes, it’s in there. If you look on Page 15 of the press release, you can see that the second quarter is restated. So the $10.4 million is in there for the six months. $10.4 is net income, reinstatement premium is $12.3 million that’s running through there as well. From a practical perspective, it was an error that was found in the very early days of our close in the third quarter, which we found related to the second quarter. And as you may recall, Matt, because I know you’ve been covering us for a while on our specialty casualty treaty at least up until this year, when the structure changed, it had a significant reinstatement component when we’ve had some large losses that eat into the layer, triggers reinstatements out of the box.
And we also had this phenomenon in the third quarter of 2021. So we had three larger losses in the third quarter, excuse me, in the second and first quarter of this year. I think they were all energy. And that’s just the impact of the timing at which we had booked the premiums.
