Trean Insurance Group Inc. (NASDAQ:TIG) Q2 2020 Earnings Conference Call August 27, 2020 5:00 PM ET
Garrett Edson – Investor Relations-ICR
Andrew O’Brien – Chief Executive Officer
Julie Baron – Chief Financial Officer
Conference Call Participants
Jimmy Bhullar – JPMorgan
Matt Carletti – JMP Securities
David Motemaden – Evercore ISI
Jeff Schmitt – William Blair
Ladies and gentlemen, thank you for standing by and welcome to the Trean Insurance Group’s Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Garrett Edson of ICR. Please go ahead, sir.
Thank you, operator. Good afternoon and welcome to Trean Insurance Group’s second quarter earnings call. This afternoon, the company released its financial results for the quarter ended June 30, 2020. The press release is available in the Investor Relations section at 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. 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. A 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. Reconciliation 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 Baron, the company’s Chief Financial Officer.
With that, I am now going to turn the call over to Andy.
Thank you, Garrett and welcome to our second quarter 2020 earnings call and our first call as a public company. We are excited to be speaking with you today and let me thank everyone for participating in our call and for your interest in Trean.
On today’s call, I will provide a bit of an overview on Trean and discuss our competitive advantage. Our CFO, Julie Baron will follow and provide some detail about our second quarter results absent per share details since we were not yet public in the second quarter.
Given that we are a newly public company, I think, it would be helpful to spend a few minutes providing some context on our business and share how Trean brings meaningful value to our clients and to our shareholders. Trean is an established, growing and profitable company, providing products and services to an underserved portion of the specialty insurance market. We are a decade insurance company and through a focused strategic plan have grown the company significantly since 2015, nearly tripling our gross written premiums during that time and generating a full year gross written premiums CAGR of approximately 30%. We have 14 product lines, we’re licensed in 49 states and Washington D.C., and we are rated A by A.M. Best.
Our efforts are primarily focused on small workers’ compensation policies and programs, particularly funding programs and we have industry-leading expertise in this and other lines we offer. 83% of our gross written premiums in 2019 related to workers’ comp and 64% of our premiums in 2019 were written through our owned managing general agents, or MGAs. In the first half of 2020, these percentages have remained relatively consistent.
We offer our products through our program partners and our owned MGAs and focus on four different methods of generating revenue, underwriting income, investment income, brokerage fees and management fees. Fee income is a significant differentiator for Trean, surprising 10% of our total revenue for the six months ended June 30, 2020 and we generate fees from multiple sources, including issuing carrier services, reinsurance brokerage, and claims administration. This approach offers us consistent, additional recurring revenue, as well as incremental touch points with our program partners.
We are also disciplined in selecting our target markets and program partners as evidenced by our 2018 to 2019 combined ratio of under 77%, 10 points better than the industry average. We’re able to achieve this result due to diligent prescreening as well as pinpoint targeting to our niche programs with a competitive advantage. We seek partners that participate in the underwriting risk of their programs, which closely aligns them with us. Our objective is to utilize our multi-service value proposition to deeply integrate with our program partners and develop long-term relationships, which ultimately enables us to generate greater and more diversified revenue streams. This is evident in the fact the average relationship with our long-term partners is approximately eight years, which is a testament to the value we continue to create for our partners.
In addition, we host a differentiated and unique in-house claims management team providing a personal and high-touch approach to processing claims that we believe leads to lower claim calls, quicker settlement of claims and reduced likelihood of costly and lengthy litigation. Our claims administration teams’ average a 16 years of industry experience and our claims per adjuster average of 80 open claims are considerably lighter than the industry average of 125 claims. This approach helps ensure the team remains efficient and responsive to claimants. Due to our disciplined underwriting and risk management processes, our top-line growth has been able to funnel to the bottom line allowing us to generate double-digit ROE.
In addition to our organic growth, we’ve accelerated our growth trajectory over the past few years through several key initiatives and transactions, including the acquisitions of American Liberty Insurance Company in 2017, as well as a large stake in Compstar, our largest producer and all of Westcap in 2018. In those transactions, we already had 10 plus year relationships with each of the company, thus we had already developed deep partnerships with those program partners and simply took the natural next step and brought them on board with Trean.
Now that you have some background in how we’ve been successful in the past, I want to shift that to how we expect to grow and create value with Trean a little longer. It’s predicated on four distinct strategies. First, we plan to continually to grow organically in our existing markets, particularly in fronting and workers’ comp, two of the largest sectors in the insurance business. Worker’s comp alone is a $54 billion premium market and we’re just scratching the surface there.
Second, we will selectively add new program partners. As I touched on earlier, we only add new programs that make it through our comprehensive vetting process, share our business philosophy and meet our returns threshold. We’ve maintained a strong pipeline of opportunities and when we find the right fit, we will add them as partners.
Third, we will also opportunistically grow through acquisitions. With our successful IPO last month, we purchased a 55% of Compstar, we did not previously own, and now fully own 100% of Compstar. As we think about future acquisitions, our focus is clearly on ensuring that an acquisition will enhance earnings per share and shareholder returns and not on growth for the sake of growth.
And finally, we will harness our growing capital base. With a successful IPO and a fortified balance sheet, we will utilize our financial capacity to increase our net retention and keep more of the good business that we are writing right now, instead of ceding it to reinsurers. This is important, because there’s nearly zero execution risk to growing through this approach. It is simply a matter of revising contracts at the renewal period. As a result, we will retain more premiums and regain some of the profits that have been ceded in the past.
We are confident in our growth efforts, because we have a successful record that validates our approach. By growing our existing business, adding new partners, opportunistic acquisitions, and retaining more of our gross premiums, we have a clear path to an incremental long-term value creation. As we navigated through the pandemic in the second quarter, we believe our results prove the effectiveness and resiliency of our business strategy. We continue to focus during this time on supporting our program partners, responsibly accepting new opportunities, seeking proper rate levels and quickly and fairly resolving claims. In worker’s comp, we are having success in maintaining at that increasing rate levels. and thus far, our COVID-19 claims have not had a material impact on our loss ratio. We believe overall that the tide is turning toward higher, more appropriate worker’s compensation rates.
However, this year’s new programs are now writing new business for us at the levels we anticipated. On April 1, we closed on a purchase of an MGA that is now rolling over profitable premium to us. And as we’ve previously disclosed subject to regulatory approval, we’ve agreed to purchase 7710 Insurance Company at its MGA. We expect the 7710 acquisition will begin adding new premium to us in the fourth quarter. We are confident about the growth potential of these new programs and acquisitions offer.
In addition, we’ve always expected that the greater portion of our 2020 growth will occur in the back half of the year, this is simply a function of when the new programs would start to produce premium. I’m pleased to say that we are seeing it happen as we expect it as our July 2020 gross written premiums were up double digits compared to July 2019.
This business has been successful since its founding in 1996 and we very much intend to build in our profitable growth in the future. Our focus is on underserved markets. We look for areas, where there is less competition, where we can generate a better risk margin for the premium that we’re taking and we have multiple products that we can provide to our customers and partners. Together, this approach provides us multiple opportunities to generate revenue and earnings, and it deeply integrates us with our partners, which feeds to more profitable and more sustained relationships.
With that, I look forward to providing you with regular updates on our progress in the quarters and years ahead.
I’ll now turn the call over to our CFO, Julie Baron. Julie?
Thank you, Andy, and good afternoon to everyone on the call. Let’s go right into our second quarter results. Demonstrating the resiliency of our business, our team grew gross written premium by 5% to $109.6 million in the second quarter 2020 compared to a $104.4 million in the prior year period. This growth was driven by the addition of new program partners in the second quarter and resulted in an increase in non-workers compensation liability lines of business. Given the very challenging operating environment due to COVID, we are certainly pleased with our second quarter gross written premiums performance.
Gross earned premiums were $100.3 million for the second quarter of 2020, 2.5% less than the prior year period due primarily to timing for both the addition of new program partners whose premiums have not yet been earned as well as the effective dates of new policies written during the quarter. Since we cannot control the timing this slide effect is a fairly common occurrence some of the onboard new program partners. Thus, we would suggest the focus be on gross written premium is the best proxy for the growth of our business.
Net earned premiums for the quarter were $21.4 million compared to $23.4 million in the prior year period, as a reduction in gross earned premiums were partially offset by a decrease in ceded earned premiums. As Andy noted in his remarks with the IPO fortifying our balance sheet, we expect to be in a better position to execute on our key strategic tenants retaining more premium. To that point, we would expect net earned premiums to grow commensurately overtime in the coming years.
Our loss ratio for the second quarter of 2020 was 57% compared to 55.7% in the prior year period. Loss activity during the second quarter of 2020 was directly attributable to the reduction in net earned premiums and offset by lower favorable loss reserved estimate true-ups taken for the second quarter of 2020 then for the prior year period.
G&A expense was $8.3 million of the second quarter of 2020 compared to $6.2 million in the prior year quarter. G&A expense in the second quarter of 2020 includes $1.8 million of additional professional fees, including legal consulting and other IPO and public company readiness efforts, as well as expenses associated with an increased workforce.
As we think about G&A expense in the back half of the year, we expect it will remain elevated due to additional IPO-related costs as we priced in July and the ongoing ramp of public company infrastructure expenses, including a significantly higher level of D&O insurance that originally anticipated, as well as our increased workforce compared to the prior year period as we prudently invest in growing our business.
All in our combined ratio for the second quarter of 2020 was 95.9% above the prior year period due primarily to the aforementioned additional G&A expenses in preparation for the IPO and building the public company infrastructure. Underwriting income for the second quarter was $0.9 million compared to $4.2 million in the prior year period.
Net investment income for the second quarter of 2020 with $1.5 million relatively compared with the prior year period. The majority of our investment portfolio was comprised of fixed maturity securities of $375.7 million at June 30, 2020 classified as available-for-sale. We also had $97 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 a third party administrator and brokerage fees was $1.5 million for the quarter. Equity earnings and net of tax was $1.2 million, but as a reminder, we acquired the remaining 55% of Compstar, we did not own upon completion of the IPO in mid-July. As a result, we would expect that line item to be significantly lower in the third quarter and beyond.
Finally GAAP net income for the second quarter of 2020 was $3.7 million when excluding one-time items adjusted net income was $4.8 million. Since we were not yet a public company in the second quarter, earnings per share was not relevant. ROE for the second quarter was $10.3 while adjusted ROE, which exclusive aforementioned one-time item was 13.2%.
As a note in the third quarter, we expect to recognize several one-time items related to the IPO, including a significant gain upon the exact acquisition of the remainder of Compstar, which will be partially offset by a one-time $7.6 million payment all tariffs in connection with the termination of our consulting and advisory agreements with them and a $3.1 million payments with certain pre-IPO unit holders entry on employees in connection with the reorganization post-IPO. All of these will be carved out when we provide our adjusted net income figure for the third quarter.
With that, I thank you for your time. And we’ll now open up the call for Q&A. Operator?
Thank you. [Operator Instructions] Our first question comes from Jimmy Bhullar with JPMorgan. Your line is now open.
Hi. I had a couple of questions. First just on expenses on the $1.8 million of IPO related expenses are how much of that is an ongoing number? And is your view on expenses little different than before given the higher D&O costs? Or was that already contemplated going into the IPO?
Yes, Jimmy, most of that – additional $1.8 is going to be IPO related. Not all of it directly a lot of it’s just as we’re paying expenses to bring up the faster reporting and some of those items. So, we will – that will taper off as we go through the year and as we fill out with a staff. As far as the D&O expense that actually came in more than double than anticipated and included in our models. We had a projection from our broker that our D&O insurance has come in around $900,000 and it actually came in at over $2 million. And there’s – I saw recently an article about D&O insurance having increased over 75% just from the first quarter to current. So that seems to be in line, but shockingly high number. So, that we had included about the $1 billion in our projections.
And then it’s on the decline in net investment income and other revenues. What were the drivers of that? And should we assume that this was a normal number or I’m assuming other revenues will bounce around, but what are your expectations for those two lines in the second quarter?
Right. So for net investment income as we discussed earlier, the first quarter is artificially high because we had the sale of a Trean intermediaries investments that we owned. So, we had an increase in the value of $2 million. So this quarter’s results for net investment income are what should be expected through the rest of the year.
Okay. And then other revenues?
Other revenue with the adoption of ASC 606, the timing of the brokerage revenues is different than it has been in the past. We obviously, we used to earn those ratably over the year. Now, they’re recognized when the contracts go into effect. So, I would say second quarter is light. So, we have a lot of reinsurance contracts that are effective 1:1, and then a few that are 7:1, a few more that are 10:1. I think an annualized number is probably more realistic of the six months number.
Okay. And then just lastly, on pricing, Andy mentioned a little bit in his comments, but what are you seeing in terms of pricing for the overall market and then specifically, for the lines that you’re producing in your book?
We’re somewhat encouraged by some of the developments we’ve seen in the market. We can’t say that we think the market has turned, but we are having success in owning the existing rates and trying get some at least modest increases. Now, there’s always an exception for that, and that’s the very large accounts that those tend to be very competitive we think still.
Thank you. Our next question comes from Matt Carletti with JMP Securities. Your line is now open.
Hey, thanks. Good afternoon. Just had a couple of questions maybe, start with the impact that the COVID and economic slowdown and things like that have had – has had on the business. What have you seen in terms of your audit and cancellation, your premiums, you can comment a little bit about, more specifically on loss trends, what you’ve seen, you gave some color on the IPO. but we’ve had a few months since then. Anything you could provide there.
Sure. Certainly, the economic slowdown has dampened to organic growth and then we have seen some of that. We’re not terribly exposed. We believe to audit premiums that a lot of our business is on a pay-as-you-go approach and we have not seen right at this time significant erosion of premiums due to audits and we’re really not expecting that. In terms of the loss situation and I guess, I’ll be careful talking about trends, because one quarter doesn’t signify a trend, especially with the COVID quarter, but the number of reported claims are lower this year compared to last year. And particularly, the number of open claims, the development of open claims during 2020 are certainly the lower rate than what we would have expected absent COVID. So, we’re optimistic about where we are from the claims perspective. We have not had ourselves a lot of COVID-related claims. I think in total, we’ve had about 100 mostly workers’ comp claims and many of those have been closed with little or no payment.
Okay, great. And then just a couple of others, you mentioned in a prior period development that is somewhat lower than the year-ago quarter. Can you quantify that what it was in the quarter?
Yes. year-to-date, I can tell you year-to-date; it was $2.8 million last year and about $2 million this year.
Okay, great. And then last question is the clarification on the D&O conversation, when you said kind of a little over $2 million versus $900,000, that’s an annual number?
Okay, great. All right. thank you very much.
Thank you. Our next question comes from David Motemaden with Evercore ISI. Your line is now open.
Hi, thanks. Good afternoon. I guess I had a question on just the loss ratio and I know you had said $2 million year-to-date favorable PYD, but I guess stripping that out and just thinking about where the accident year loss ratios are. It looks like the S1; it looked like claims were down 25% to 30% in April and may. But if I look at the loss ratio, it’s up a bit. So, I’m just wondering how much conservatism you guys have set up within those loss picks, or if you went through any of the favorable – any of the favorable attritional losses come through this quarter.
Yes. We haven’t yet recognized any favorable development based upon what’s been happening with the number of closures of claims and the reduction in open claims and new claims. We think it’s a bit premature for us to be doing that at this time.
Okay. That’s helpful. And then if I just look at the expense ratio, if I strip out the higher IPO expenses, you’re looking at the $1.8 million of higher IPO costs, you’re looking at around 30.5% to 31% of an expense ratio in the first half. I guess if I’m looking at that, is that the good baseline to think about for the second half before considering the higher D&O expenses, which sounds like that’s going to add another three to four points to the expense ratio?
Right. But we also have to keep in mind that we have our acquisition of Compstar. right now we’re paying a commission to Compstar and once we bring them in a 100% and consolidate them, we’re going to pick up the profit of Compstar, which we’ll run through that line.
Right. So, I guess, where are you thinking the expense ratio will shake out for the rest of the year and more importantly, as we head out to next year?
Just one second. I apologize, just one second, I do have that here. We expect to make up about $3 million of profit. I don’t have, I apologize. I don’t have that. I can get back to you on that.
Sure, that’s helpful. That’s helpful. And now that will be a contra expense in the expense column. Yes, okay. That’s helpful. Okay, thanks for that, Julie. And then if I could just ask one more to Andy, just on, I guess, it sounded optimistic in the opening remarks, just on the business and the value prop, I guess maybe, could you just talk about the pipeline of potential additional program partners and how that has – how that’s shaping up and how close you are to maybe converting some of those to new program partners?
Yes. We’ve been very pleasantly surprised at how strong the pipeline has been this year. Not only in terms of the number of new programs that we’re seeing, but in the quality of the new of the programs. So far now, we have five new – we have five new programs that are now actually writing business on our paper. And we have four other programs, where we think that we’ve reached an agreement in principle, and now, we’re going through the final due diligence and onboarding steps. So, we have got hopes that some or all of those will come on board over the next few months as well. So, that’s a very encouraging sign for us. And then we’re pleased with that and it’s almost unprecedented advice.
Great. Thank you.
Thank you. And our next question comes from Jeff Schmitt with William Blair. Your line is now open.
Hi, good afternoon. A question on the pipeline and you just mentioned obviously, it looks pretty strong, but how do you think about that I guess going forward in terms of compstar obviously, there’s a lot of stock involved, but is there a philosophy there, where you would look to not use stock if you can help it, or is that going to be sort of the attractor may be to get people to come on board? I mean, how are you thinking about that going forward?
Well, we’re actually not thinking in terms of using stock to attract new programs to us. We hope that we’ll be able to attract them with our value proposition, because an issue in carrier and any other services that we can offer and of the five that we have signed down this year and the four that we’re looking at all are following that pattern. So that’s kind of our thinking at this time.
Okay. That’s helpful. And then just another, I guess, detailed question on the expense ratio, obviously, a lot of moving parts, IPO costs, Compstar coming on board retention’s going to increase a lot. So, I mean, that’s going to come down quite a bit. Is there any change in your sort of outlook for 2021? I mean, there’s a low 20s expense ratio, a possibility still.
Yes. That’s still where we expect to come in.
Okay. Okay. And the D&O expense, I guess is, I mean, that’s an extra $1 million, but there’s really no other change in expense items?
Okay, okay. All right. Thank you.
Thank you. I’m not showing any further questions at this time. I would now like to turn the call back over to Andy O’Brien for closing remarks.
Well, thank you all for participating in our earnings call today. It is our first as a public company. We really do appreciate your interest in Trean, and we look forward to our future calls with you. And with that, I’ll wish you all good afternoon.
Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.