Bowhead Specialty - Q2 2024

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Bowhead Specialty Second Quarter 2024 Earnings Call. Our host for today's call is Shirley Yap, Chief Accounting Officer and Head of Investor Relations. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I would like to now turn the call over to your host. Ms. Yap, you may begin.

Shirley Yap (Chief Accounting Officer and Head of Investor Relations)

Thanks, operator. Good morning, and welcome to Bowhead's second quarter 2024 earnings conference call. I'm Shirley Yap, Bowhead's Chief Accounting Officer and Head of Investor Relations. Joining me today are Stephen Sills, our Chief Executive Officer, and Brad Mulcahy, our Chief Financial Officer. Financial results for the Q2 of 2024 were released earlier this morning. You can find your earnings release in the investor relations section of our website. Before we begin, I'd like to remind everyone that this call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors should not place undue reliance on any forward-looking statement. These statements are made only as of the date of this call and are based on management's current expectations and beliefs.

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by these statements. You should review the risks and uncertainties fully described in our SEC filings. We expressly disclaim any duty to update any forward-looking statements except as required by law. Additionally, we will be referencing certain non-GAAP financial measures on this call. Reconciliations of these non-GAAP financial measures to their respective most directly comparable GAAP measure can be found in the earnings release we issued this morning and in the investor relations section of our website. With that, I'll turn the call over to Stephen. Stephen?

Stephen Sills (CEO)

Thank you, Shirley, and thanks again to our stockholders and analysts for joining us on our first earnings call as a public company. Before I get started, I'd like to take a moment to thank all of the Bowhead team members who helped us through our initial public offering. On May 23rd, we began our first day of trading on the New York Stock Exchange under the symbol BOW. We are very excited to begin this new chapter in the company's evolution. We founded Bowhead just under 4 years ago and are incredibly proud of the hard work our over 200 employees have contributed to the company's rapid success to date. For those who weren't able to join us on the roadshow, I wanted to reiterate who we are and highlight our key differentiators.

We are a growing specialty insurance company operating substantially within the specialty excess and surplus lines market. About 80% of our premium is in the growing and profitable E&S market, where being free of rate and form restrictions provides the flexibility to rapidly adjust to emerging market opportunities. For our company to be successful, underwriting must come first. From the top down, underwriting profitability is our North Star. It is ever present within our people and our culture. This strong in-house underwriting culture is complemented with a fully integrated and accountable value chain. Product development, actuarial, claims, legal, operations, IT, and our long-term distribution relationships must all work together seamlessly for us to be successful. This accountable value chain allows us to deliver our custom solutions to clients while consistently generating underwriting profits.

Not only are we successful today, but we were designed to deliver differentiated profitability across market cycles, not just in hard markets. We've created primary and excess capabilities across our products as part of our cycle management strategy. Within the lines that we write today, our highly experienced underwriters are subject matter experts with a proven track record of generating underwriting profits. Underwriting authority has to be earned, even for experienced underwriters just joining our team. For each line, we spend considerable time discussing and agreeing on how risk should be evaluated, and we encourage close collaboration throughout the organization. We also have long-standing relationships with our select group of distribution partners, which is based on expertise, service, and mutual benefit. We believe that dealing with Bowhead is a privilege, not a right.

Furthermore, we have a highly experienced and entrepreneurial management team, backed up by the depth of over 200 people across the country. We operate in a hybrid model that enables us to bring on the best people regardless of where they reside. This is my third time starting and running a publicly traded specialty insurance business, and this group is easily as good as any team I've been a part of. Critical to investors, we have a clean balance sheet with no reserves for maximum years prior to 2020 and no Property Cat exposures. We have no intangibles, no complicated LPTs, and a simple and conservative investment portfolio. Lastly, we have a track record of robust growth with attractive profitability and strong returns.

I believe that we have supportive market conditions and that our platform and balance sheet, including the capital we raised in our IPO, positions us well for continued profitable growth.... With that introduction to Bowhead, let me turn it over to Brad Mulcahey, our CFO, to discuss the details of our quarter. Brad?

Brad Mulcahey (CFO)

Thanks, Stephen. We ended the quarter with an Adjusted Net Income of $7.9 million, or 28 cents per diluted share, with an adjusted return on average equity of 11.7%. Gross Written Premiums accelerated more than 50% to a record of $175.5 million. We saw premium growth from each of our divisions, with Casualty growing the most and representing a larger portion of the book compared to last year. Rate improvement, particularly in Casualty, continues to contribute to the increase in our top line. The Loss Ratio for the quarter ended at 65.5%, an increase of 4.6 points from the prior year.

I would like to highlight that in light of our high levels of IBNR, which was 92% of our net loss reserves at the end of this quarter, we've currently elected to utilize loss picks informed by industry data rather than only using internal data from our limited operating history. These expected loss ratios are unchanged from Q1, and the movement in the aggregate loss ratio from last year reflects a shift in the mix of our business to a greater percentage of our book being in casualty, where industry loss ratios have deteriorated, as others have reported. During the quarter, we did not take down any reserves, nor did we experience any loss activity in excess of our own expectations. The expense ratio for the quarter ended at 33.8%, an increase of 1.9 points from the prior year.

The acquisition expense ratio increased slightly by 0.3 points to 8.4% due to the change in product mix. The operating expense portion of the ratio increased 1.6 points to 25.4% due to our continued investment in the business, as well as certain one-time IPO-related costs, the largest being $1.3 million of stock-based compensation related to management's profits interest. Excluding this one-time non-cash item, our expense ratio trend decreased since Q1 of 2024 from 32.6% to 32.3%, despite our continued investment in the startup of Baleen, which Stephen will discuss later. Overall, the effect of the loss ratio and expense ratio contributed to a combined ratio of 99.3% for the quarter.

Before moving on from the underwriting results, during the quarter, net written premiums were impacted by the start of a new ceded reinsurance treaty. This treaty allows Bowhead to cede a portion of its auto exposure within the excess casualty book. The premium retention impact of this treaty will vary each quarter as the underlying exposure varies. But for Q2, the impact was about a 1-point reduction in retained premium. Now turning to our investment book. Pre-tax net investment income more than doubled to $8.8 million in the current quarter. Our portfolio increased more than 30% since year-end, which was influenced by an additional $131 million of net IPO proceeds.

Excluding the IPO proceeds, which were not invested for the full quarter, the portfolio had a book yield of 4.6%, while the new money rate was 5.5% at the end of the quarter. This combination of new money rate above the roll-off yields and an increasing asset base positions the company well for future investment income growth. In addition, credit quality of the portfolio remains at AA, and duration increased from 1.9 years to 2.1 years in the Q2, again, excluding the impact of the IPO proceeds. The effective tax rate for the Q2 was 25.3%. We expect tax rates to be consistent with this range in the future.

Lastly, our stockholders' equity was $339.9 million, and book value per share was $10.41 at the end of the quarter, an increase of 30% from year-end. With that, Stephen, I'll turn it back to you for your thoughts on the quarter.

Stephen Sills (CEO)

Thanks, Brad. Let me provide my observations about the state of the market and the growth of each of our three divisions: Casualty, Healthcare, and Professional Liability. I'll also give a brief update on our growth initiative, Baleen, which is our streamlined underwriting platform for hard-to-place, smaller dollar E&S policies. As Brad mentioned, on a consolidated basis, Bowhead wrote $175 million of premiums, growth of over 50% compared to a year ago, which was driven by strength across each of our divisions. Looking at our book, submission and quote growth remains strong at levels in line with overall premium growth. We also quoted more business than last year, indicating that the submission growth is within our appetite.

We've noted that while submissions are important, they are only one of several growth drivers at our disposal, in addition to rate, new business wins, and future operational efficiencies. By division, Casualty was the lion's share of our premium growth, up over $50 million or close to 80% compared to a year ago. This growth was driven by the strong rate environment due to the disruptions in the marketplace dynamics from older accident years. We believe that these favorable tailwinds for Bowhead will continue for the foreseeable future. Additionally, in Q3, we're expanding our casualty team to include environmental underwriting expertise, which we expect to offer in the Q4. Our Healthcare Liability division grew by over 46%, driven by good rate and retention on renewals, plus strong new business. Our Professional Liability business, which includes Cyber, grew by 7%.

We continue to see pressure in the Public D&O space. While the market is competitive, our Public D&O book increased by 4% from last year. Overall, we continue to see a long runway for the favorable market we're experiencing. To be very clear, Bowhead is not reaching for growth, but in the current environment, the growth dynamics are attractive given the risk-adjusted returns we can generate. Lastly, before I open the call for questions, let me give a brief update on Baleen, a new division we launched late in the Q2 of 2024. Baleen focuses on small, hard-to-place risks, written 100% on a non-admitted basis. It is a streamlined, low-touch, flow underwriting operation that supplements the craft solutions we offer today.

This is a business that we believe has significant growth potential, but with this being a low-touch, flow underwriting model, is one that we plan to execute gradually. In line with our deliberate, measured, and limited rollout, Baleen premium for the Q2 of 2024 was minimal. While we don't expect Baleen to contribute meaningfully during 2024, we plan to report Baleen's first full quarter premium during our Q3 earnings call. With that, I'll conclude my remarks and turn the call over for questions.

Operator (participant)

If you would like to ask a question at this time, please press star, then the number one on your telephone keypad, and you will be placed in the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you have a question, please press star, then the number one on your telephone keypad now. One moment while we compile the Q&A roster. Your first question comes from Meyer Shields with KBW. Your line is open.

Meyer Shields (Managing Director)

Great, fantastic. So I wanted to start by asking about distribution and, I guess the pace of additional agency appointments over the course of the quarter.

Stephen Sills (CEO)

Thank you. I think we need to look at it by different lines of business. You know, recall that we're kind of in 16 different lines, even though there's 3 divisions. So, the number that are being increased, let's say, in casualty, is considerably smaller than what we might find in private commercial business. So it really varies, but, each time we open somebody, we're looking for commitments that they're going to support us versus, just having access to us.

Meyer Shields (Managing Director)

Okay, that's helpful. You talked a little bit about the pricing pressure in some components of professional lines, and I was wondering whether or how much that's impacting the relative loss ratios between professional lines and casualty?

Stephen Sills (CEO)

When you... I'm not sure I follow. When you say between professional lines and casualty, we're seeing when we look back at what we've seen on professional lines, we think that's developing very favorably. We certainly have, going back to our early years, open litigation. I think there's been a history of, you know, 40%-50% dismissal on securities class actions. So there's still things that are open, but we're very comfortable with that. Casualty, the biggest concern has been the auto business. You know, keep in mind, we don't write auto on a primary basis, on a primary casualty. On the excess, it is covered within those policies.

As was mentioned earlier, we've bought an auto carve-out, which we think will lower the volatility from auto claims.

Meyer Shields (Managing Director)

Okay. No, I understand that. Just when we look at the loss ratio, I think the increase year-over-year is predominantly because there's more casualty in the book, and casualty also equals a higher loss ratio than professional lines. And I'm wondering whether the change in pricing in professional lines and the change in pricing in casualty, how that's moderating the delta of the loss ratio between those two segments.

Stephen Sills (CEO)

The loss ratio will be has been going up, not that we're booking, you know, more on a case basis, but because of the mix, using the formula we've been using, with the advice of outside independent actuaries, because of the relative flatness in the professional book versus the large growth in the casualty book, I think we're showing higher loss ratios because of that mix.

Meyer Shields (Managing Director)

Okay, fantastic. Thank you very much.

Operator (participant)

Your next question comes from Matt Carletti with Citizens. Your line is open.

Matt Carletti (Managing Director and Senior Equity Research Analyst)

... Yeah, thanks. Good morning. Stephen, I was hoping you could dig into the casualty growth a little bit and give us a little bit of color on some of the, maybe the underlying lines. Are there a small handful of areas of the business that are really driving the growth, or is it pretty broad-based across all the different, you know, products you offer in that segment?

Stephen Sills (CEO)

We've started to move away from, and certainly not, or at least in terms of the mix. The mix has become more than just construction. It was, at the beginning, there was a lot of heavy project business, construction business. We've added substantially to the team of casualty underwriters, and that's led to an increase in the amount of casualty outside of construction that's growing. We've recently, in the last month or two, we've added several very high-ranking casualty underwriters to the organization, which we believe will be a plus in terms of the followings that they have that will attract more business to us.

Matt Carletti (Managing Director and Senior Equity Research Analyst)

Great. And then another one, if I could, is smaller business, but the cyber business. Have you seen anything following the CrowdStrike incident? Not thinking about the law side of it, I think we have our hands around that, but more so just reaction in the market, whether it be from an underwriting perspective, or from a demand perspective from potential buyers.

Stephen Sills (CEO)

Well, we think there is more demand, and I think we're comfortable with what we're seeing in terms of what's been reported to us with claims and things like that. But I do think the industry is starting to evaluate more the potential of, you know, catastrophe losses. I think as what's been reported in the insurance press, I think it's very manageable the way this claim is. You know, people are talking about $1.5 billion, $2 billion, but, you know, what would have happened if all these people's computers were turned into bricks? And, you know, how that would have affected the industry. And I think everybody's trying to get their arms around how that's going to be evaluated in the future.

Keep in mind that, overwhelmingly large part of our cyber book is on the excess side, and it's relatively high-level excess on larger accounts. So, you know, we're comfortable in what we're seeing, but we are gonna see—I'm pretty sure we're gonna see an uptick in demand for the coverage.

Matt Carletti (Managing Director and Senior Equity Research Analyst)

Great. Thank you very much for the insights. Appreciate it.

Operator (participant)

Your next question comes from Pablo Singhal with J.P. Morgan. Your line is open.

Pablo Singhal (Equity Research Analyst)

Hi, good morning. Some insurers have been adding reserves to post-2020 accident years. Are you surprised by that trend, and did you see those reserve movements in the industry data when you did your review in late 2023?

Brad Mulcahey (CFO)

Yeah. Hi, Pablo, this is Brad. Thanks for the question. I think we were initially surprised by that, but as we looked at it more, most of that's happening on the, on the primary side. Or sorry, on the, we're in the surplus, excess surplus line side, so, we don't see that happening here. We're able to react quicker with, with rates, than some of those other carriers have, that were in the, in the earlier markets. So I don't think we really see that over here, on our side. We... You know, the industry data, when we talk about using industry data in our reserves, it's, it's, you know, it's, it's data that informs our own data.

So we have some of our own limited history, and we just complement it with that industry data. So, you know, what we see is cut as specifically as we can to our books, and just kind of complements what we see. So we're happy with our reserves and, you know, the experience that we're seeing as we mentioned.

Stephen Sills (CEO)

Yeah, I think our mix is different from what you're seeing in the group that's adding to reserves. The mix of type of business. Keep in mind, you know, as Brad said, we're more excess than primary. Our limits are much smaller than what's typically been put out in the past. Remember, a lot of the opportunity that's coming to us is people going down from, you know, $25 million capacity, and the rates that they got on that. And then also, as Brad said, the, you know, the surplus lines versus admitted. We don't-

Pablo Singhal (Equity Research Analyst)

Yep, uh-

Stephen Sills (CEO)

We don't write. We also don't write, you know, auto per se, commercial auto, commercial trucking. Obviously, as I said before, you know, we pick up some of it when we write excess casualty, but we're not writing, you know, primary trucking risks or even excess pure trucking risks.

Pablo Singhal (Equity Research Analyst)

Yep. Thanks, Stephen, that makes sense. And then just second and last for me, maybe this is better for Brad. So I think at the end of the quarter, you had $180 million of cash on the balance sheet. How much of that do you expect to reinvest into fixed income assets over time, and at what pace? Thank you.

Brad Mulcahey (CFO)

Yeah, thanks, Pablo. I think what you're seeing is the IPO proceeds that we mentioned. We got those in late May. And obviously, you know, it takes a while to invest $130 million in the bond market during the summer. So we expect, you know, we always have a little bit of cash laying around. We have some pretty big bills to pay our reinsurers in particular, but most of that is in process for being invested. I think Q3, you'll see a better kind of run rate without that IPO noise in our cash versus investment split.

Pablo Singhal (Equity Research Analyst)

Yep. And sorry, just to put a bow on this, how much cash do you think you need to run the company at, right? So on a run rate basis, how much cash do you need to hold it as a whole group? Thanks.

Brad Mulcahey (CFO)

How much cash do we need to run as opposed to what we sit at the holding company? Is that the question?

Pablo Singhal (Equity Research Analyst)

Yeah, sorry, sorry, I should have phrased it better. So, now clearly, cash is in an excess position, right? But on a go-forward basis, and you mentioned that you need to hold some amount of cash, right? What is that amount of cash you need to hold on a go-forward basis? Thank you.

Brad Mulcahey (CFO)

It really, it really varies every quarter. So what we do is, we basically invest everything that we don't need, and that number changes every month. We do it twice a month, actually. So, it kind of... I wish I could give you a solid number, but it really truly changes every quarter.

Pablo Singhal (Equity Research Analyst)

Got it. Thank you.

Operator (participant)

Your next question comes from Scott Heleniak with RBC Capital. Your line is open.

Scott Heleniak (Senior Equity Research Analyst)

Yeah, good morning. Thanks. Just wanted to follow up just on the last question, just about capital levels and is there a premium to surplus level ratio that you're targeting over time? And also, how are you thinking about use of debt? Anything that you can kind of share on that? I'm just not talking about next quarter. I'm just talking about, you know, kind of longer term over the next, you know, year or two.

Brad Mulcahey (CFO)

Yeah, I think, if you look at our premium to surplus ratio in Q2, it's obviously going to be a little bit high because we have the excess, the upsized IPO in there. So I would look more towards our Q1 number or our prior full year number to get kind of a run rate for that. The other question on the debt, you'll notice we did execute a revolving credit facility in Q2. That gives us the opportunity to add debt. We think the business, you know, the next time we need capital, that might be a route to go just to have a little bit better returns on the business to add some debt, but I think we're a little ways from that.

Scott Heleniak (Senior Equity Research Analyst)

Yep. Okay, that's helpful. And then anything you can share on just what you're seeing on rate versus loss trends, loss cost trend across the book? Just, just by I don't know if you can share by segment or anything like that, and if there was any major change versus Q1. I know casualty rates have been ticking up pretty much across the industry. So if there's any, any color you can share on, on the, any different areas, the rate versus loss trend.

Stephen Sills (CEO)

Yeah, we're seeing it varies, as you suggest, by division. Casualty, we're seeing the strongest rate change, followed by the healthcare business and then by the professional lines business. And as was mentioned earlier, we use industry picks, but we're not seeing a change in our business in terms of loss trends from what we've originally expected.

Scott Heleniak (Senior Equity Research Analyst)

Okay. So is it ticking up by much in the casualty areas? You know, Q2 versus Q1, is it a few points or is it more than that, or?

Stephen Sills (CEO)

We would say, yes, that it is kicking up a lot.

Scott Heleniak (Senior Equity Research Analyst)

Okay.

Stephen Sills (CEO)

All right.

Scott Heleniak (Senior Equity Research Analyst)

Appreciate the answers. Yep.

Stephen Sills (CEO)

Sure. Okay.

Operator (participant)

At this time, there are no further questions in queue. I'd like to turn the call back over to our presenters for any further remarks.

Stephen Sills (CEO)

Okay. Thank you, Morgan. I'd like to thank everyone for joining us on our first earnings call as a public company, including Bowhead's team members that made this all possible. We're very excited about the opportunity ahead of us and look forward to executing on our strategy. Our differentiated underwriting model puts us in a position to generate strong growth at attractive returns within the large and underserved E&S market. Thanks again, and we'll talk to you along the way.

Operator (participant)

This concludes the Bowhead Specialty Second Quarter 2024 Earnings Call. Thank you for attending, and have a wonderful rest of your day.