Bowhead Specialty Holdings Inc

NYSE:BOW

Earnings Call Transcript 2024-Q2

[Operator]

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.

[Operator Instructions] I would like to now turn the call over to your host. Ms. Yap, you may begin.

[Shek Yap, executive]

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 Mulcahey, our Chief Financial Officer. Financial results for the second quarter of 2024 were released earlier this morning. You can find our 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, executive]

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 23, 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 are highly experienced underwriters or 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 as 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 from accident 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, executive]

Thanks, Stephen. We ended the quarter with an adjusted net income of $7.9 million or $0.28 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 onetime IPO-related costs, the largest being $1.3 million of stock-based compensation related to management's profit interest.

Excluding this onetime noncash item, our expense ratio trend decreased since Q1 of 2024 from 32.6% to 32.3%, despite our continued investment in the start-up 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. Pretax 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 second quarter, again, excluding the impact of the IPO proceeds. The effective tax rate for the second quarter was 25.3%. We expect tax rates to be consistent with this range in the future.

And 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, executive]

Thanks, Brad. Let me provide my observations about the state of the market and the growth of each of our 3 divisions: casualty, health care 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 premium, 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 remained 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'd note that while submissions are important, they are only one of several growth drivers at our disposal in addition to rates, 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 fourth quarter.

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 second quarter 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, this is one that we plan to execute gradually.

In line with our deliberate, measured and limited rollout, Baleen premium for the second quarter 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 third quarter earnings call. With that, I'll conclude my remarks and turn the call over for questions.

[Operator]

[Operator Instructions] Your first question comes from Meyer Shields with KBW.

[Meyer Shields, analyst]

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, executive]

Thank you. The -- I think we need to look at it by different lines of business. 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, analyst]

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, executive]

When you -- I'm not sure I follow between -- 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. The -- we certainly have going back to our early years of open litigation. I think there's been a history of 40%, 50% dismissal on security 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. Keep in mind, we don't write auto on a primary basis on our primary casualty. On the excess, it is covered within those policies. And as was mentioned earlier, we've bought an auto carve-out, which we think will lower the volatility from auto claims.

[Meyer Shields, analyst]

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, all else equal, is 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 2 segments?

[Stephen Sills, executive]

So the loss ratio will be -- has been going up, not that we're booking more on a case basis. But the -- because of the mix using the formula we've been using with the advice of outside, independent actuaries, the -- 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.

[Operator]

Your next question comes from Matt Carletti with Citizens.

[Matthew Carletti, analyst]

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 products you offer in that segment?

[Stephen Sills, executive]

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 number of the amount of casualty outside of construction that's growing. We've recently, in the last month or 2, 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.

[Matthew Carletti, analyst]

Great. And then another one, if I could. A smaller business, the cyber business, have you seen anything following the CrowdStrike incident, not thinking about the loss 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, executive]

Well, we think there is more demand. And I think the -- 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 catastrophe losses. I think as what's been reported in the insurance press I think it's very manageable the way this claims. People are talking about $1.5 billion, $2 billion. But what would have happened if all these people's computers were turned into bricks and how that would have affected the industry. And I think everybody is trying to get their arms around how that's going to be evaluated in the future.

Keep in mind that overwhelmingly, a large part of our cyber book is on the excess side. And it's relatively high level except on larger accounts. So we're comfortable the way we're seeing. But we are going to see -- I'm pretty sure we're going to see an uptick in demand for the coverage.

[Operator]

Your next question comes from Pablo Singzon with JPMorgan.

[Pablo Singzon, analyst]

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 '23?

[Brad Mulcahey, executive]

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 primary side -- or sorry, on the -- more in the surplus -- excess surplus line side. So we don't see that happening here. We're able to react quicker with rates than some of those other carriers had that were in the earlier markets. So I don't think we really see that over here on our side.

We -- the industry data, when we talk about using industry data in our reserves, it's data that informs our own data. So we have some of our own limited history, and we just complemented with that industry data. So what we see is as specifically as we can to our book and just kind of complements what we see. So we're happy with our reserves and the experience that we're seeing and as we mentioned.

[Stephen Sills, executive]

Yes. 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, 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 $25 million capacity and the rates that they got on that. And then also, as Brad said, the surplus lines versus admitted.

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

[Pablo Singzon, analyst]

Yes. 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?

[Brad Mulcahey, executive]

Yes. Thanks, Pablo. I think what you're seeing is the IPO proceeds that we mentioned. We got those in late May. And obviously, it takes a while to invest $130 million in the bond market during the summer. So we expect -- 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 Singzon, analyst]

Yes. 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 you need to hold at the holdco?

[Brad Mulcahey, executive]

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

[Pablo Singzon, analyst]

Yes. Sorry, I should have phrased it better. So now really, cash is in an excess position, right? But on a go-forward basis, 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?

[Brad Mulcahey, executive]

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.

[Operator]

Your next question comes from Scott Heleniak with RBC Capital.

[Scott Heleniak, analyst]

Just wanted to follow up just on the last question, just about capital levels. And if there -- 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? And I'm just not -- I'm not talking about next quarter, I'm just talking about kind of longer term over the next year or 2.

[Brad Mulcahey, executive]

Yes. I think if you look at our creating a surplus ratio in Q2, it's obviously going to be a little bit high because we have the excess -- the upside of the 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.

Your 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 -- 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, analyst]

Yes. Okay. That's helpful. And then anything you can share on just what you're seeing on rate versus loss cost trend across the book 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 color you can share on any different areas, the rate versus loss trend?

[Stephen Sills, executive]

Yes. We're seeing -- it varies, as you suggest, by division. Casualty, we're seeing the strongest rate change, followed by the health care 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, analyst]

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

[Stephen Sills, executive]

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

[Operator]

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, executive]

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]

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