AMERISAFE is a holding company that markets and underwrites workers’ compensation insurance through its insurance subsidiaries. Workers’ compensation insurance covers statutorily prescribed benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our business strategy is focused on providing this coverage to small to mid-sized employers engaged in hazardous industries, principally construction, trucking, logging and lumber, manufacturing, agriculture, maritime, and oil and gas. Employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. Hazardous industry employers also tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. We provide proactive safety reviews of employers’ workplaces. These safety reviews are a vital component of our underwriting process and also promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns that cause underwriting, safety or fraud concerns. We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns for our shareholders.
Two of the key financial measures that we use to evaluate our performance are return on average equity and growth in book value per share adjusted for dividends paid to shareholders. We calculate return on average equity by dividing annual net income by the average of annual shareholders’ equity. Our return on average equity was 22.1% in 2019, 17.2% in 2018 and 10.5% in 2017. We calculate book value per share by dividing ending shareholders’ equity by the number of common shares outstanding. Our book value per share was $22.29 at December 31, 2019, $21.26 at December 31, 2018 and $22.10 at December 31, 2017. We paid cash dividends of $4.50 per share in 2019, $4.38 per share in 2018 and $4.30 per share in 2017.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to reduce our net liability on individual risks and to protect against catastrophic losses. Our reinsurance program for 2020 includes 16 reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Our 2020 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable limitations, deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million for any single claimant, subject to applicable deductibles, retentions and aggregate limits. Losses in the layer between $2.0 million and $10.0 million are ceded to a multi-year reinsurance treaty with an aggregate annual deductible of approximately $9.5 million and an aggregate limit of coverage of approximately $28.6 million for 2020. As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.
For example, for the five-year period ended December 31, 2019 we had recorded 70 severe claims, or an average of 14 severe claims per year for accident years 2015 through 2019. The number of severe claims reported in any one accident year in this five-year period ranged from a low of 9 in 2015 to a high of 16 in 2017 and 2019. The average reported case severity for these claims ranged from $2.2 million for the 2015 accident year to $2.9 million for the 2019 accident year. For the five accident years, the case incurred for these severe claims accounted for an average of 10.4 percentage points of our overall loss and loss adjustment expense, or LAE, ratio, measured at December 31, 2019.
In 2019, we decreased our estimates for prior year loss reserves by $65.0 million. In 2018, we decreased our estimates for prior year loss reserves by $45.6 million. In 2017, we decreased our estimates for prior year loss reserves by $34.8 million.
Premiums are earned on a daily pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2019 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2019 and the other half in 2020. On a monthly basis, we also recognize net premiums earned from mandatory pooling arrangements.
We estimate the annual premiums to be paid by our policyholders when we issue the policies and record those amounts on our balance sheet as premiums receivable. We conduct premium audits on all of our voluntary business policyholders annually, upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid us the premium required under the terms of the policies. The difference between the estimated premium and the ultimate premium is referred to as “earned but unbilled” premium, or EBUB premium. EBUB premium is subject to significant variability and can either increase or decrease earned premium based upon several factors, including changes in premium growth, industry mix and economic conditions. Due to the timing of audits and other adjustments, the ultimate premium earned is generally not determined for several months after the expiration of the policy.
Income Tax Expense. We incur federal, state, and local income tax expense. On December 22, 2017, the Tax Act was signed into law making significant changes to the Internal Revenue Code. The reduction of the U.S. corporate tax rate from 35% to 21% resulted in a non-cash charge related to a revaluation of our net deferred tax assets. This charge amounted to $12.6 million of additional income tax expense in the fourth quarter of 2017, the period in which the legislation was enacted.
In establishing our reserves, we review the results of analyses using actuarial methods that utilize historical loss data from our more than 34 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates.
Net Premiums Written. Net premiums written for 2018 were $342.4 million, compared to $341.4 million for 2017, an increase of 0.3%. The increase was primarily attributable to the increase in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 2.6% for 2018 compared to 2.5% for 2017.
Net Investment Income. Net investment income in 2018 was $30.5 million, an increase of 4.0% from the $29.3 million reported in 2017. The pre-tax investment yield on our investment portfolio was 2.6%per annum for 2018 versus 2.5% per annum for 2017. The tax-equivalent yield on our investment portfolio was 3.2% per annum for 2018, compared to 2.9% per annum for 2017. The tax-equivalent yield is calculated using the effective interest rate and the appropriate marginal tax rate as of January 1, 2019. Average invested assets, including cash and cash equivalents, increased 0.5%, from an average of $1,188.7 million for 2017 to an average of $1,195.1 million for 2018.
Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $204.9 million for 2018, compared to $209.3 million for 2017, a decrease of $4.4 million, or 2.1%. The current accident year losses and LAE incurred were $250.5 million, or 71.5% of net premiums earned, compared to $244.1 million, or 70.5% of net premiums earned for 2017. We recorded favorable prior accident year development of $45.6 million in 2018, compared to $34.8 million in 2017. This is discussed in more detail below in “Prior Year Development.” Our net loss ratio was 58.5%for 2018 and 60.5% for 2017.
Income tax expense. Income tax expense for 2018 was $15.9 million, compared to $36.0 million for 2017. The effective tax rate also decreased to 18.2% for 2018, compared to 43.8% for 2017. This decrease is mainly due to the impact of tax reform legislation which reduced the U.S. corporate tax rate from 35% to 21% in 2018 and resulted in a revaluation of our net deferred tax assets in the prior year. The impact resulted in a net deferred tax expense of $12.6 million in the fourth quarter of 2017, the period in which the legislation was enacted.
As discussed above under “Overview,” We purchase reinsurance to reduce our net liability on individual risks and to protect against catastrophic losses. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2020 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
Major components of cash provided by operating activities in 2017 were net premiums collected of $349.6 million, investment income collected of $44.0 million and a decrease of $27.8 million in amounts held by others. These increases were offset in-part by claim payments of $188.1 million, $74.0 million of operating expenditures, federal taxes paid of $28.3 million and dividends to policyholders paid of $1.5 million.
Net cash provided by investing activities was $11.7 million in 2019, as compared to net cash used in investing activities of $29.1 million in 2018 and $51.5 million in 2017. In 2019, major components of net cash provided by investing activities included proceeds from sales and maturities of investments of $358.6 million, offset by investment purchases of $345.9 million.
Major components of cash used in financing activities in 2018 and 2017 included cash used for dividends paid to shareholders of $84.5 million and $82.6 million, respectively.
The Company has a line of credit agreement with Frost Bank for borrowings up to a maximum of $20.0 million. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR (or equivalent) and are unsecured. Under the agreement, the Company pays a fee of 0.25% on the unused portion of the loan in arrears quarterly, for a fee of $50,000 annually. At December 31, 2019, there were no outstanding borrowings. Unless renewed, the agreement will expire in December 2022.
The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2016, the Board reauthorized this program with no expiration date. As of December 31, 2019, we had repurchased a total of 1,258,250 shares of our outstanding common stock for $22.4 million. The Company had $25.0 million available for future purchases at December 31, 2019 under this program. There were no share repurchases in 2019, 2018 or 2017. The purchases may be effected from time to time depending upon market conditions and subject to applicable regulatory considerations. It is anticipated that future purchases will be funded from available capital.
The Company paid regular quarterly cash dividends of $0.25, $0.22, $0.20 per share in 2019, 2018 and 2017, respectively. In addition, the Company paid extraordinary cash dividends of $3.50 per share in 2019, 2018, and 2017.
On February 18, 2020, the Company declared a regular quarterly cash dividend of $0.27 per share payable on March 27, 2020 to shareholders of record as of March 13, 2020. The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $1.08 per share in 2020.
Under Nebraska and Texas law, as applicable, each of AIIC, SOCI and AIICTX is required to invest only in securities that are either interest-bearing, interest-accruing or eligible for dividends, and must limit its investment in the securities of any single issuer, other than direct obligations of the United States, to five percent of the insurance company’s assets. As of December 31, 2019, we were in compliance with these requirements.
As of December 31, 2019, our investment portfolio, including cash and cash equivalents, totaled $1.2 billion, an increase of 0.3% from December 31, 2018. The majority of our fixed maturity securities are classified as held-to-maturity, as defined by FASB ASC Topic 320, Investments-Debt and Equity Securities. As such, the reported value of those securities is equal to their amortized cost, and is not impacted by changing interest rates. The remainder of our fixed maturity securities are classified as available-for-sale and reported at fair value. Investments in equity securities are reported at fair value.
We follow FASB ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As disclosed in Note 18 of the financial statements, our securities available-for-sale are classified using Level 1, 2 and 3 inputs. We did not elect the fair value option prescribed under FASB ASC Topic 825, Financial Instruments, for any financial assets in 2018 or 2019.
The composition of our investment portfolio, including cash and cash equivalents, as of December 31, 2019 is shown in the following table.
The table below provides information with respect to our contractual obligations as of December 31, 2019.
The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2019 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense process, see “Business-Loss Reserves” in Item 1 of this report. Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the amounts shown in the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors- Risks Related to Our Business-Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Item 1A of this report for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
We have audited the accompanying consolidated balance sheets of AMERISAFE, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedules listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
At December 31, 2019, the Company’s reserves for loss and loss adjustment expenses (LAE) was $773 million, which includes Incurred But Not Reported (IBNR) reserves of $136 million. As discussed in Notes 1 and 9 to the consolidated financial statements, the reserve for loss and LAE represents the estimated ultimate costs of all reported and unreported losses incurred and unpaid as of the reporting date. There is significant uncertainty inherent in determining the ultimate loss and LAE costs which are estimated using individual case-base valuations and statistical and actuarial analysis based upon experience for previously unreported claims and their ultimate loss and LAE costs. In particular, the estimates are sensitive to loss severity and frequency trends, changes in customers, products mix, claims management, regulatory factors, medical trends, employment and wage patterns, insurance policy coverage interpretations, and judicial determinations, among other factors.
Auditing management’s IBNR reserve estimate required the involvement of our actuarial specialists and was complex and highly judgmental due to the nature of significant assumptions used in the valuation process. The IBNR reserve estimate was sensitive to the selection of actuarial methods and assumptions, including the adjustment of historical loss severity experience for changes in products, policies, and customer base.
The Company provides workers’ compensation insurance for small to mid-sized employers engaged in hazardous industries, principally construction, trucking, logging and lumber, manufacturing, agriculture, maritime, and oil and gas. Assets and revenues of AIIC and its subsidiaries represent at least 95% of comparable consolidated amounts of the Company for each of 2019, 2018 and 2017.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new guidance requires a lessee to recognize a lease liability and a right of use asset for all leases extending beyond twelve months. This standard was effective for us beginning in the first quarter of 2019. We elected the new transition method under the transition guidance within the new standard. Therefore, prior comparative periods were not adjusted. We also elected the package of practical expedients, which among other things, allows us to carryforward the historical lease classification. We made an accounting policy election not to recognize lease assets and lease liabilities for short-term operating leases. Adoption of the new guidance resulted in the Company recognizing right-of-use assets of $0.4 million and lease liabilities of $0.3 million. The cumulative effect adjustment to the opening balance of retained earnings was minimal. Adoption of this new guidance did not have a material effect on the Company’s consolidated financial statements as the Company does not have any significant leases.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses. The current guidance delays the recognition of credit losses until a probable loss has occurred. The new guidance requires credit losses for securities measured at amortized cost to be determined using current expected credit loss estimates. These estimates are to be derived from historical, current and reasonable supporting forecasts, including prepayments and estimates, and will be recorded through a valuation account. The same method will be used for available-for-sale securities, but the valuation account will be limited to the amount by which the fair value is below amortized cost. The standard is effective for us in the first quarter of 2020. Implementation of the new guidance requires a modified retrospective approach without restatement, which means the first cumulative adjustment required will be a charge to retained earnings of $593 thousand, with subsequent changes in the valuation account reported in the income statement. The financial statement impact is determined by the nature of the portfolio held and the economic conditions at the time of implementation.
The Company’s internal working group has evaluated the remainder of the balance sheet assets, including available-for-sale securities and net premiums receivable, and determined the implementation of the new credit loss guidance in relation to those assets will have an immaterial impact on the financial statements.
Upon management’s determination that an amount due from a reinsurer is uncollectible due to the reinsurer’s insolvency or other matters, the amount is written off.
The Company recognizes income related to commissions earned by AGAI as the related services are performed.
All advertising expenditures incurred by the Company are charged to expense in the period to which they relate and are included in underwriting and certain other operating costs in the consolidated statements of income. Total advertising expenses incurred were $0.4 million in 2019 and $0.5 million in 2018 and 2017.
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2019 are summarized as follows:
At December 31, 2019, there were $15.9 million of held-to-maturity investments and $2.5 million of available-for-sale investments on deposit with regulatory agencies of states in which the Company does business.
A summary of the Company’s realized gains and losses on sales, calls or redemptions of investments for 2019, 2018 and 2017 is as follows:
We regularly review our investment portfolio to evaluate the existence of other-than-temporary declines in the fair value of investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary. The key factors we consider are:
We reviewed all securities with unrealized losses in accordance with the impairment policy described above. We determined that the unrealized losses in the fixed maturity securities portfolio related primarily to changes in market interest rates since the date of purchase, current conditions in the capital markets and the impact of those conditions on market liquidity and prices generally. We expect to recover the carrying value of these securities as it is not more likely than not that we will be required to sell the securities before the recovery of its amortized cost basis.
The Company received reinsurance recoveries of $2.0 million in 2019, $1.3 million in 2018 and $1.6 million in 2017.
Income tax expense from operations is different from the amount computed by applying the U.S. federal income tax statutory rate of 21% in 2019 and 2018, and 35% in 2017 to income before income taxes as follows:
On December 22, 2017, the Tax Act was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017. As a result, we recorded $12.6 million as additional income tax expense related to our net deferred tax assets revalued at the new lower rate of 21% in the fourth quarter of 2017, the period in which the legislation was enacted.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions as of December 31, 2019, 2018 and 2017.
Tax years 2016 through 2019 are subject to examination by the federal and state taxing authorities.
The average annual percentage payout of incurred losses by age, net of reinsurance, for workers’ compensation and general liability as of December 31, 2019 is summarized below. Since workers’ compensation has long payout periods, the table below shows less than 100% in the years disclosed. This is required supplementary information, which is unaudited.
The following table provides a reconciliation of the beginning and ending reserve balances, net of related amounts recoverable from reinsurers, for 2019, 2018 and 2017:
The foregoing reconciliation reflects favorable development of the net reserves at December 31, 2019, 2018 and 2017. The favorable development reduced loss and loss adjustment expenses incurred by $65.0 million in 2019, driven primarily by accident years 2016 and 2015 of $23.4 million and $14.5 million, respectively. In 2018 and 2017, the Company recorded favorable development of $45.6 million and $34.8 million, respectively. The revisions to the Company’s reserves reflect new information gained by claims adjusters in the normal course of adjusting claims and is reflected in the financial statements when the information becomes available. It is typical for more serious claims to take several years or longer to settle and the Company continually revises estimates as more information about claimants’ medical conditions and potential disability becomes known and the claims get closer to being settled. Multiple factors can cause loss development both unfavorable and favorable. The favorable loss development we experienced across accident years was largely due to favorable case reserve development and continued favorable severity trends compared to those originally estimated.
The Company’s insurance subsidiaries file financial statements prepared in accordance with statutory accounting principles prescribed or permitted by the insurance regulatory authorities of the states in which the subsidiaries are domiciled. Statutory-basis shareholders’ capital and surplus at December 31, 2019, 2018 and 2017 of the directly owned insurance subsidiary, AIIC, and the combined statutory-basis net income and realized investment gains for all AMERISAFE’s insurance subsidiaries for the three years in the period ended December 31, 2019, were as follows:
Property and casualty insurance companies are subject to certain risk-based capital requirements, or RBC requirements, specified by the National Association of Insurance Commissioners. Under these requirements, a target minimum amount of capital and surplus maintained by a property/casualty insurance company is determined based on the various risk factors related to it. At December 31, 2019, the capital and surplus of AIIC and its subsidiaries exceeded the minimum RBC requirement.
Pursuant to regulatory requirements, AIIC cannot pay dividends to the Company in excess of the greater of 10% of statutory surplus, or statutory net income, excluding realized investment gains, for the preceding 12-month period, without the prior approval of the Nebraska Director of Insurance. However, for purposes of this dividend calculation, net income from the previous two calendar years may be carried forward to the extent that it has not already been paid out as dividends. AIIC paid $115.9 million in dividends to the Company in 2019, $65.4 million in 2018 and $78.9 million in 2017. Based upon the dividend limitation described above, AIIC could pay to the Company dividends of up to $88.6 million in 2020 without seeking regulatory approval.
Stock options granted under the 2005 Incentive Plan were exercisable, subject to vesting requirements determined by the Compensation Committee, for periods of up to ten years from the date of grant. Stock options generally expire 90 days after the cessation of an optionee’s service as an employee. However, in the case of an optionee’s death or disability, the unexercised portion of a stock option remains exercisable for up to one year after the optionee’s death or disability. Stock options granted under the 2005 Incentive Plan are not transferable, except by will or the laws of descent and distribution.
The Company recognized compensation expense of $676,000, $726,000 and $884,000 in 2019, 2018 and 2017, respectively, related to share-based grants. The Company recognized compensation expense of $1,359,000, $976,000 and $724,000 in 2019, 2018 and 2017, respectively, related to long-term incentive awards under the 2012 Incentive Plan. The long-term incentive award is a liability award.
As of December 31, 2019, there were 4,890 shares of restricted stock outstanding under the Non-Employee Director Restricted Stock Plan, all of which will vest on the date of the annual meeting of shareholders in 2020.
The Company computes earnings per share (“EPS”) in accordance with FASB Accounting Standards Codification (“ASC”) Topic 260, Earnings Per Share. The Company has no participating unvested common shares which contain nonforfeitable rights to dividends and applies the treasury stock method in computing basic and diluted earnings per share.
Basic EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the period.
The sale or other-than-temporary impairment (“OTTI”) of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive income to current period net income. The effects of reclassifications out of accumulated other comprehensive income by the respective line items of net income are presented in the following table.
The Company’s 401(k) benefit plan is available to all employees. The Company matches up to 3% of employee compensation for participating employees, subject to certain limitations. Employees are fully vested in employer contributions to this plan after five years. Company contributions to this plan were $0.7 million in 2019 and 2018, and $0.6 million in 2017.
The Company has operating and finance leases for office space and equipment. Our leases have remaining lease terms of one month to 49 months, some of which include options to extend the leases for up to five years.
Right-of-use assets obtained in the exchange for the lease obligations were as follows:
Valuation techniques used to measure fair value are intended to maximize the use of observable inputs and minimize the use of unobservable inputs. ASC Topic 820 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:
At December 31, 2019 and 2018, the Company did not hold any securities measured at fair value on a nonrecurring basis due to impairment.
The following table represents unaudited quarterly financial data for the years ended December 31, 2019 and 2018.
The Company’s Board of Directors initiated a share repurchase program in February 2010. In October 2016, the Board reauthorized this program with a limit of $25.0 million with no expiration date. There were no shares repurchased under this program in 2019. Since the beginning of this plan, the Company has repurchased a total of 1,258,250 shares for $22.4 million, or an average price of $17.78, including commissions.