James River Group Holdings, Ltd. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results. James River is a Bermuda-based specialty insurance and reinsurance holding company; substantially all premiums are casualty-related, with operations in Excess and Surplus Lines, Specialty Admitted Insurance, and Casualty Reinsurance.
Financial performance and condition
- Revenue and premiums: Total revenue was $885.6 million, up 8.3% from $817.6 million. Gross written premiums rose 7.8% to $1,166.8 million, while net written premiums edged down 0.5% to $762.7 million as ceded premiums increased. Net earned premiums rose 10.0% to $815.4 million.
- Profit: GAAP net income was $63.8 million, up 46.5% from $43.6 million; diluted EPS was $2.11 versus $1.44. Adjusted net operating income, a non-GAAP measure, increased to $70.6 million from $47.4 million. Fourth-quarter net income was $11.6 million, versus $0.2 million in Q4 2017; diluted EPS was $0.38 versus $0.01.
- Underwriting and margins: Underwriting profit improved to $28.0 million from $5.8 million. The combined ratio improved to 96.6% from 99.2% (below 100% indicates an underwriting profit); the loss ratio was 73.6% and expense ratio 23.0%. Segment combined ratios were 92.3% for E&S, 87.4% for Specialty Admitted, and 97.5% for Casualty Reinsurance.
- Cash flow and liquidity: Operating cash flow was $290.0 million, compared with $207.8 million. Investing activities used $266.8 million and financing activities used $14.3 million; year-end cash and cash equivalents were $172.5 million. Cash and invested assets totaled $1,850.3 million. Management reported positive operating cash flow in each of the past three years.
- Debt and capital: Senior debt was $118.3 million and junior subordinated debt $104.1 million; debt-to-total-capitalization was 23.9%, up from 22.6%. Shareholders’ equity was $709.2 million; tangible equity was $489.9 million, or $16.34 per share. The company paid $1.20 per share in dividends in 2018, with no special dividend.
- Investments: Net investment income was $61.3 million, essentially unchanged. Net realized and unrealized investment losses were $5.5 million. Year-end invested assets were $1,677.8 million, with a 3.4-year average duration; a 100-basis-point rate increase was estimated to reduce fixed maturity and preferred-stock fair value by 4.3%.
Material changes versus prior periods
- E&S gross written premiums increased 23.8% to $656.5 million, and Specialty Admitted premiums rose 18.3% to $374.3 million. Casualty Reinsurance premiums fell 42.3% to $135.9 million as the company deliberately reduced that segment and redeployed capital.
- E&S growth was concentrated in Commercial Auto, which generated $322.1 million of gross written premiums. The company reported $20.7 million of adverse Commercial Auto reserve development in 2018, primarily related to one insured’s 2016 contract year; this followed $38.7 million of adverse development in 2017.
- Specialty Admitted underwriting profit rose to $7.0 million from $3.2 million, including fee income of $14.8 million versus $11.3 million. Fronting and program premiums grew 17.2%; associated business is generally heavily reinsured and retained at low levels.
- Net adverse reserve development was $17.7 million in 2018, versus $21.5 million in 2017. Net income benefited from higher underwriting profit and lower income tax expense, while investment results included larger losses. Total comprehensive income declined to $41.6 million from $52.8 million, mainly reflecting a $22.2 million after-tax unrealized investment loss in 2018.
- Effective January 1, 2018, the company generally shifted 70% of U.S.-written premiums previously ceded to JRG Re to newly formed Carolina Re, which elected U.S. domestic tax treatment, in response to the Tax Act and BEAT.
Outlook, management commentary, and risks
- Management described growth opportunities in targeted specialty markets, reported generally stable or improving rates in its U.S. primary businesses, and emphasized underwriting discipline over premium growth. It expects fronting fee income to continue growing but provided no quantified earnings or premium guidance.
- The company’s most consequential underwriting watchpoint is reserve adequacy: gross loss reserves were $1,661.5 million, including 62.4% IBNR; net reserves were $1,194.1 million. Management’s reserve sensitivity analysis showed a 95th-percentile net reserve outcome $143.4 million above the carried reserve, with a corresponding estimated $133.0 million reduction in after-tax income and equity.
- Concentration is material. Rasier LLC and affiliates generated 25.2% of consolidated gross written premiums; Atlas General Insurance Services generated 17.3%. The two largest E&S brokers represented 67.0% of that segment’s premiums. The three largest Casualty Reinsurance cedents represented 92.9% of that segment’s premiums.
- Reinsurance recoverables on unpaid losses were $467.4 million; the three largest reinsurers accounted for 52.1% of that balance. Management said material recoverables were rated A- or better or collateralized. Separately, $1,099.2 million of cash-equivalent collateral supported indemnification obligations, but the company cautioned that exposure could grow faster than collateral and that its estimates could be insufficient.
- Investment risks include below-investment-grade bank loans, illiquid private investments, credit risk, and interest-rate exposure. Non-traditional investments represented 19.9% of total invested assets. Management reported no impaired bank loans at year-end and an A.M. Best financial strength rating of A (Excellent).
- Other notable items: the 2018 effective tax rate was 9.9%, compared with 21.0% in 2017; 2018 results included a $200,000 intangible-asset impairment and $1.4 million of employee severance. Management reported no material adverse effect expected from ordinary-course litigation and no off-balance-sheet arrangements. Auditors issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Track Commercial Auto loss emergence and reserve development, particularly for the 2016 contract year and the large insured, and assess the assumptions behind IBNR and the reserve sensitivity analysis.
- Monitor concentration and renewal risk tied to Rasier, Atlas, leading brokers, and major reinsurance cedents; evaluate the collateral and collectability of reinsurance and indemnification recoverables.
- Reconcile premium growth with the decline in net written premiums and retention, and assess whether fronting fee growth offsets the low underwriting retention and counterparty exposure.
- Review investment valuations, liquidity and loss sensitivity, including bank loans and private investments, as well as the effect of unrealized losses on equity and tangible capital.
- Confirm the sustainability of earnings and dividends after separating underwriting results from reserve development, investment gains or losses, tax effects, and non-GAAP adjustments. Check subsidiary dividend capacity, debt balances and covenant compliance.