AMERISAFE INC annual report, FY2012

Business Context and Reporting Period

AMERISAFE, Inc. filed this Form 10-K for the fiscal year ended December 31, 2012. The company is a specialty workers’ compensation insurer focused on small and mid-sized employers in hazardous industries, principally construction, trucking, manufacturing and agriculture. It operates through insurance subsidiaries domiciled primarily in Louisiana and Texas and markets coverage in 30 states, the District of Columbia and additional licensed jurisdictions.

The filing reports full-year 2012 results, with unaudited fourth-quarter data also provided. Approximately 99.9% of net premiums earned came from workers’ compensation insurance.

Financial and Operating Metrics

Metric	2012	2011	Change
Gross premiums written	$328.8 million	$272.1 million	20.8% increase
Net premiums written	$312.5 million	$258.2 million	21.0% increase
Net premiums earned	$290.7 million	$251.0 million	15.8% increase
Total revenues	$321.2 million	$280.7 million	14.5% increase
Net investment income	$27.0 million	$26.3 million	2.6% increase
Income before taxes	$37.1 million	$27.4 million	35.8% increase
Net income	$29.4 million	$24.2 million	21.4% increase
Diluted EPS	$1.58	$1.29	22.5% increase
Net cash from operating activities	$81.0 million	$43.7 million	85.5% increase
Shareholders’ equity	$381.2 million	$349.4 million	9.1% increase

Net income represented approximately 9.1% of total revenues. Return on average equity was 8.0%, compared with 7.1% in 2011. Book value per share increased to $20.88 from $19.25.

Net loss ratio was 75.6%, unchanged from 2011.
Current accident-year loss ratio improved to 76.5% from 78.2%.
Net underwriting expense ratio improved to 21.1% from 24.2%.
Net combined ratio improved to 97.5% from 100.4%, indicating an underwriting profit before investment income.
Prior accident-year reserves developed favorably by $2.5 million, compared with $6.6 million of favorable development in 2011.
Gross loss and loss adjustment expense reserves increased to $570.5 million from $538.2 million; net reserves increased to $515.3 million from $477.3 million.
The company had 4,964 open claims at year-end, after reporting 5,721 claims and closing 5,941 claims during 2012.
Investments, including cash and cash equivalents, totaled $900.8 million at year-end, with a fair value of $944.9 million. The portfolio’s pretax accounting yield was 3.1%.
Cash and cash equivalents increased to $92.7 million from $45.5 million.
The company retired all subordinated debt during 2012. No debt was outstanding at year-end, although a $20 million unsecured revolving credit facility remained available through December 2013.

Material Changes Versus the Prior Comparable Period

Premium growth accelerated, driven by higher voluntary policy premiums, payroll audits and related premium adjustments, and increased mandatory pooling premiums.
Growth in premiums earned and improved expense efficiency contributed to higher pretax income and net income.
Loss and loss adjustment expenses increased 15.9% in absolute dollars, but the current accident-year loss ratio improved.
Underwriting expenses declined as a percentage of premiums, producing a 2.9-point improvement in the combined ratio.
Operating cash flow nearly doubled, while investing cash use declined substantially.
The company redeemed the remaining $25.8 million of subordinated debt securities and ended the year debt-free.
The board declared the company’s first quarterly cash dividend of $0.08 per share, payable in March 2013, with an indicated annualized rate of $0.32 per share.
The company adopted new insurance acquisition-cost accounting retrospectively, reducing 2011 shareholders’ equity by approximately $1.4 million and reducing deferred policy acquisition costs by $2.2 million. Prior-period figures were adjusted.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management stated that the workers’ compensation market was transitioning toward a harder market, characterized by less competition and higher premium rates. Its stated strategy is to maintain underwriting discipline, increase market penetration, expand prudently by geography, improve risk selection and pricing, and preserve capital strength. Management anticipated continued modest economic growth in 2013.

Management expected operating cash flow to provide sufficient liquidity for operations, claims, interest and holding-company expenses for at least the following 18 months. The insurance subsidiaries could pay up to $32.4 million in dividends to AMERISAFE after March 2013 without regulatory approval, subject to applicable limitations.

Reserve adequacy remains a central judgment and risk. Workers’ compensation claims are generally long-tail, lack policy limits in the usual sense, and can involve infrequent but severe losses.
Management identified medical inflation, wage inflation, claim severity, litigation, judicial decisions, regulatory changes and changing coverage interpretations as significant reserve uncertainties.
The company had $101.4 million of reinsurance recoverables at year-end, including $42.4 million that was unsecured. Reinsurance does not relieve the company of its obligations to policyholders if a reinsurer fails to pay.
The 2013 reinsurance program provided occurrence coverage up to $50.0 million, but coverage for a single-claimant occurrence was limited to $10.0 million, subject to deductibles, retentions and aggregate limits. The company retained the first $1.0 million of each loss.
The portfolio was sensitive to interest rates; management estimated that a 200-basis-point increase would reduce shareholders’ equity by approximately 5.5% under its stated sensitivity analysis.
Economic weakness in construction, trucking, manufacturing and agriculture could reduce policyholder payrolls and premium volume. These industries generated 74.0% of gross premiums written in 2012.
The company was subject to extensive state insurance regulation, dividend restrictions, residual-market obligations, guaranty-fund assessments and risk-based capital requirements.
The company reported $167,000 of year-end reserves associated with asbestos-related claims and considered potential environmental-claim exposure remote. Management stated that no current legal or administrative proceedings were expected to have a material adverse effect.
The company had purchased annuities with an estimated present value of $95.9 million to settle certain long-duration claims; failure of annuity providers could expose the company to additional obligations.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls.

Important Facts for Investors to Verify

Whether premium growth is sustained without weakening underwriting standards or pricing adequacy.
Whether the 97.5% combined ratio remains below 100% as newer accident years mature.
Development of the $570.5 million gross reserve balance, particularly severe claims and accident years 2010 through 2012.
Collectability and collateralization of the $101.4 million of reinsurance recoverables, including the $42.4 million unsecured portion.
Impact of low interest rates and future rate changes on investment income, portfolio fair values and shareholders’ equity.
Regulatory capacity of the insurance subsidiaries to upstream dividends and support the holding company’s dividend policy.
Terms, pricing and available limits of reinsurance renewals as the 2013 treaty layers approach termination dates.
Whether the first quarterly dividend and stated $0.32 annualized rate remain sustainable given regulatory restrictions and claims obligations.
The effect of the retrospective deferred acquisition-cost accounting change when comparing 2012 with prior periods.