Global Indemnity Group, LLC Q1 FY2022 Earnings Call

Thank you, operator. Today's conference call is being recorded. GBLI's remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words, including, without limitation, beliefs, expectations or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will, in fact, be achieved. Please refer to our annual report on Form 10-K and other filings made with the SEC for a description of the business environment in which we operate and the important factors that may materially affect our results. Global Indemnity Group LLC is not under any obligation and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. It is now my pleasure to turn the call over to Mr. David Charlton, Chief Executive of GBLI.

Good morning. Thank you for joining our earnings call. In addition to Steve Ries, Reiner Mauer, our COO, Jonathan Oltman, President of Insurance Operations, and Tom McGeehan, our Chief Financial Officer, are also in attendance. I’m very pleased with their underwriting results in the first quarter as we execute our strategic plan to grow our existing core businesses, as well as substantially widen our small business commercial casualty product offerings. Gross written premium grew by 16.8% compared to the first quarter of 2021. The gross written premium of our continuing lines grew 27.3% compared to the first quarter of 2021. The increase is mainly due to organic growth and rate increases. Our commercial specialty segment grew by 16.7% to 104.3 million, driven by growth in our Penn-America binding small business, which grew 26.9%. We obtained a rate of 7.8% for this business in the first quarter and will look to continue to push this higher as the year develops. Programs grew 9.8% and strong rate increases of 12.2%. A new small commercial casualty business, including environmental, excess casualty, and professional, has built out their teams in established solid market footholds. They are actively writing business. We received strong support from our distribution partners and all are on track executing their plans. We continue to hire superior new talent. Most recently, we were very pleased to announce the hiring of Matt Carroll to lead our new InsurTech business. It will be part of our commercial specialty segment. We have two existing profitable InsurTech businesses today, collectibles and Vacant Express, which serve as a foundation for this new business that Matt has been charged with building and growing. Reinsurance had strong growth; gross written premiums in the first quarter '22 were 41.4 million compared to 22 million prior. As noted on the priorities earnings call, this is due to increased participation in the casualty quota share treaty that Global has assumed for several years. This treaty continues to obtain strong rates in a hard casualty market. In addition, we wrote several smaller casualty treaties and grew our excess professional reinsurance business by 11%. The farm, ranch, and equine segment grew by 8%. The equine mortality book, which comprises about 15% of this book, grew by 39% compared to 2021. We continue to focus on driving profitability in this book and improving results from non-cat property, primarily fires. We have seen that over 25% of our non-cat fire losses are coming from just 5% of our business. We have identified specific risk characteristics that are driving these unprofitable accounts and have been actively non-renewing these risks. We expect this action will reduce our loss ratio by several points. Gross written premium invested in lines shrank from 31.3 million in 2021 to 22.6 million in 2022. Very little business was retained as the net written premium was only 700,000. Global Indemnity is running the mobile home and dwelling book on the policies transitioned to American Family. Underwriting income also had good results; the combined ratio improved from 101.2% in 2021 to 95% in 2022. Fees incurred in the first quarter '22 were 4.3 million, compared to 16.9 million in 2021. Volatility is much less due to the lines we exited. The mix of business has now shifted to casualty. In 2021, 45% of net written premium was casualty business compared to 64% in 2022. We will continue to push towards our goal of 70% casualty business, which will be supported by growth in our three new casualty businesses throughout the year. To support the company's long-term business plan that we unveiled at last year's investor conference, beginning in May 2021, the company embarked on a program for liquidity, investment flexibility, buffer market volatility, and balance sheet solidity. The first step in this regard was shortening the 4.5-year duration of the company's fixed income securities portfolio to three years, which was achieved by August of 2021. Then in August of 2022, the company liquidated the entirety of its 76 million portfolio of traded common stocks. Finally, in April 2022, the company further shortened the duration of its investment portfolio to under two years to retire 100% of its outstanding indebtedness. We will now take your questions.

Our first question is from Julia Ferguson with Dowling & Partners. Your line is open.

Good morning. Thank you for taking my questions. My first question is about your significant reduction in the duration of your fixed income portfolio. So can you tell us what's the difference right now between your liabilities and asset duration?

Yes. Our liabilities have a duration right now that's about 2.3 years. Our fixed income portfolio today has a duration of 1.8 years.

All right. Okay, so it's not that different and under what conditions would you consider lengthening the duration again, going forward?

Well, again, when the interest rate environment becomes more stable and we have more certainty on how we perceive inflation and interest rates to perform on a going forward basis. At that point, we would be a little more comfortable extending. Now we are seeing some great opportunities. It doesn't mean that we have to keep our portfolio completely as short as it is today. And we are working closely with our investment managers. But at the moment, we do not have plans to go very far out on the curve until we have a little more certainty.

That does make sense. Yes. And what is the impact of this action on your net investment income going forward? So if you look at what the yield you mentioned, you're getting on those new securities, new money you purchased in the process of purchasing. It looks like it's still above your current fixed income portfolio yield. Am I correct?

Yes, definitely. Year-end in our 10-K we reported an overall book yield of 2.2%. We identified 390 million for sale, sold most of it. We originally put the money into two-year treasuries to park it. The two-year treasuries were yielding just about 2.5%. We've since deployed more than $200 million. We've gone mainly into corporates and a little bit into securitized. The overall duration of what we've currently been buying by moving out of the treasuries is in the duration range of 1.3 years. But we're seeing yields on that money right now at approximately 3.2%.

3.2. Okay. So to get to about 100 basis points, which is good. All right. And staying with your investments, I understand funds, limited partnerships were significant contributors to your net investment income in 2021. And I understand there was at least partially, they are reported in one-quarter lag. So how should we think about kind of expected or normalized returns on those investments going forward? I understand you increased the balance there. And I understand that you haven't sold any of that, right? So for our planning purposes or modeling purposes? What's kind of expected return on those investments? How should they think about it?

Yes. Well, the reason we're in those investments is that we do want to get some extra return. Now, of the alternative investments, we have $100 million in alternatives. On the balance sheet, we were showing $147 million in total, but a little more than $100 million of that is in a floating loan fund. Approximately 97% of what that fund invests in are mainly first lien loans. The loans are, as I said, 97% are floating rate. Right now, those yields are in about the 4.5% to 5% range. As interest rates go up, we would expect the returns on that fund to go up. Now, in the first quarter, that fund was not immune to the geopolitical events that were happening throughout the world. So supply chain problems, the Russia and Ukraine war, rising prices of oil, and inflation in general, caused a temporary decline in the market value of that fund. So for the $100 million that we had invested in that fund in the first quarter, we actually, again, solely because of market value, without any defaults, had negative income of that fund of approximately $400,000 for the quarter. Now that's an alternative that we do not book on a lag where we actually get the data timely enough that we can book it to date. So what you're seeing for that fund, what I just said is accurate. The other three funds invest in real estate debt, distressed debt, and one that we've been in for years that when Europe had Basil three hit, we've been in a fund variable that is still in its harvest phase. So that's what comprises the rest of our alternative investments. Those investments are booked on a one-quarter lag. On our alternatives in total, we would like to make more than 5% this year in our projections; we have these performing somewhere in the 5% to 6% range. No guarantees on performance, but that's where we have been.

Thank you very much for the thorough answer. Are there any market indices you would recommend for us to use as a potential benchmark for the performance of this portfolio?

At this time, that's something that we will be reassessing as we go forward. Obviously, we were on a Barclays bond index before; the duration shortening is something where our investment mix currently is really not in proportion to the benchmark. As I said, as we look at inflation and interest rates on a forward basis, there's a likelihood that we will be considering different benchmarks to align our portfolio against. Right now, it's really that we're managing to short durations and looking for yield opportunities.

Thank you. I mostly was speaking about the alternative portfolio; if there's any kind of index or proxy that the performance would be correlated to?

Yes. Most of them would be to a loan index. I don't recall the name of it. I can get that to you offline. But 100 million of the 147 million there is a loan index that I'll be able to provide you with the name.

That would be great. Thank you very much. All right. So switching gears from investments, I'm hoping to get more color on what you're broadly seeing in the ENS market; is the competition kind of picking up, is it pricing momentum and submissions still going strong? From your commentary, I understand that that's still the case.

That's correct. We're very bullish. I mean, we're seeing premiums coming into the ENS. We're continuing our rate increases and actually gaining momentum. As I mentioned, our programs went up substantially to 12.2%. We see room for more growth in Penn-America small business, so we're very bullish on the market right now and the growth opportunities that we're seeing.

All right. And how much did these new casualty lines contribute to premiums in the quarter?

This is not material in the first quarter. If you looked at, when they kicked off, just to give a little flavor, excess casualty was the first business to go live and really started to raise the premium towards the end of the first quarter into the second quarter. They're a little over a million dollars today in premium written, and the other ones are in a similar case base.

And what do you project forward for this?

Yes. We see them as being material businesses. I'm not ready to put a number on them at this point as far as forward-looking. We see the first year as building the businesses, the second year as a breakeven type business, and in the third year is when we start to see them really making an impact on profitability.

Okay, makes sense. Your reinsurance renewal is coming up on June 1, I believe, for your property catastrophe treaty. You probably are already in the process of negotiating that treaty renewal. So what kind of changes are you contemplating given that your exposure, cat exposure is down significantly?

No. I think you're right on that. We absolutely should be able to decrease the amount we purchased. And with that, we've seen the ability to achieve real cost savings as well. So that's really across our reinsurance portfolio as it pertains to property.

All right. That makes sense. I have another question regarding your press release. I noticed there was a very small amount from the prior year development, approximately 0.1 million in your continuing operations. Can you clarify what the prior period development was on a consolidated basis?

Yes. It was just over $3 million, Julia. A little more than 2 million of that came from our discontinued lines. In discontinued, we had a program where we only assumed business for one year, but it was a multi-year policy. And we were able to release reserves by about $2 million on that particular treaty. However, the way the treaty works is that there's a contingent commission. So any reserves we've released, we actually had to up our contingent commissions by exactly the same amount. So the net impact was zero. When you look at our $3 million reserves release to the net of contingent commissions, we had about $1 million of what I would call a positive contribution from prior year results to our numbers this quarter.

Okay. So it's a 1 million net favorable –

Positive, yes.

Okay. All right. Another question about your corporate expense line? What would you consider the right or reasonable run rate to use for that number? I know that you did take some cost reduction measures.

Yes, we have. We've quoted, I think on prior calls that right now we would expect on a normal year to be somewhere in the $17 million to $20 million range, $18 million to $20 million range. That's where we would expect to be probably by year-end.

Okay. On a run rate basis. Okay. I think, oh, yes. Another question. So you retired 130 million of high interest, high coupon, subordinated notes. Do you plan to replace it with any new debt issuance? I remember that during your Investor Day last year, you suggested that you would need about 150 million of additional capital to fund the growth over the next five years. So can you tell me what your plans are there?

Well, we had a couple of things happen. One, we resolved the renewal of rights to our special property. That helped free up, by the end of this year, we believe that it was going to give us back over $60 billion of capital. And it gave us an opportunity to rethink our debt strategy. This step was third-year paper and had an interest rate of seven and seven-eighths percent. It was not inexpensive. We've been to the market twice now, and we believe, with some of the things that we're doing with our company, that as we become a more seasoned debt issuer, if there is a need to raise additional capital, we would hope to do so at a less expensive price than the current debt that was outstanding.

So you are actively considering this possibility?

Well, again, it all depends. We'll be closely monitoring our growth, our reserve levels, our catastrophe exposure, and all the things that drive our capital needs, Julia. We're always watching. And as I said, one of the most significant things that happened was the sale of the renewal rights. So it gave us an opportunity to retire this debt. As we go forward, if we do have a need for capital, we'll be well in front of it, and we will think about the best way to raise capital that benefits Global Indemnity the most. We've now been in the market twice, so hopefully, if we go back out the next time, we'll be doing some really good things with the company. We feel really good about our book and the volatility that we've been able to reduce, all things that should be positive if we have to go to the markets to raise or issue debt again.

Okay. And another question on the business environment. Overall, what do you think the last cost trends are now? And do you factor increased inflation into your pricing and reserving assumptions?

No, absolutely. I mean, we were looking at, we just did a rigorous study across our books on both pricing and reserves. On the property side, especially, we see the cost of goods, which we identified in our last call in the fourth quarter, that's where we're seeing double-digit increases. On the casualty side, we're a little less exposed based on the type of business that we write. We're running a small business. We have lower limits in place, and we're not quite as exposed to social inflation. By keeping our limits low, we are getting a nice rate increase on our casualty business as well.

All right. Can you talk a little bit about your reinsurance business? I'm not as familiar, so I'm wondering if that part of your business includes a significant casualty quota share that you increased participation in. What percentage of that quarter reflects your total premium in that segment?

Yes. So this year, we actually kept the participation percentage the same, but with the rise in pricing, that drove most of the increase there. Tom, I don't know if that number, but that was probably about 90 million.

Yes. One treaty currently represents approximately 85% to 90% of our reinsurance book, and there is one smaller treaty that makes up most of it.

Okay. And that quarter share, what kind of underlying business is it covering? What kind of underlying casualty business?

100% casualty business. So it's very much in line with our strategy as a casualty writer. But it gives us nice diversification of the type of business that we write spread out, which really helps, and in a rising rate environment, the type of business that we want to be involved with.

Okay. Sorry, go ahead.

I was just going to say that we also have some excess professional liability business we've had for many years, and we continue to write a number of small casualty reinsurance deals ourselves as well, which would make up the difference.

Did you see an increase in the sitting commissions on that business this year? Because I understand there's a market trend towards higher sitting commissions given the profitability of the underlying books?

Yes. That really is going to vary by treaty. For example, we took out reinsurance in our three new businesses, and I would thought we got there.

Okay. I think that's all I have for now. Oh, sorry. Maybe one more question, if I may. On the expense ratio, I think there was an increase at least it was higher than I expected, the expense ratio in the quarter. Is there anything unusual, and what would be a reasonable run rate for the full year expense ratio, which is included in your combined ratio?

Now, what we had said before on the prior call, Julia, is that we're investing in some of our new businesses. Obviously, we're transferring half of the renewal rights. So we initially based in comparison to 2021, we had expected that our expense ratio over the course of this year would actually increase by 1.5% to 2%. After the new businesses are up and growing and we continue to get growth in our other businesses and we complete the transition of the specialty property renewal rates, we would start to see improvements of approximately 1% per year thereafter. So what you're seeing are some of those factors in play right now.

Okay. Thank you very much. I don't have any further questions.

Okay. Thank you, Julia.

Thank you, operator. Thank you for joining us for our first quarter earnings call. We look forward to speaking with you after the second quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.