Old Republic International Corp Q1 FY2022 Earnings Call

Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Old Republic International First Quarter 2022 Earnings Conference Call. Thank you. Joe Calabrese with the Financial Relations Board. You may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for the Old Republic conference call to discuss first quarter 2022 results. This morning, we distributed a copy of the press release and posted a separate financial supplement, which we assume you have seen and/or otherwise have access to during the call. Both of the documents are available at Old Republic's website, which is www.oldrepublic.com. Please be advised this call may involve forward-looking statements as discussed in the press release and financial supplement dated April 28, 2022. Risks associated with these statements can be found in the company's latest SEC filings. This afternoon's conference call will be led by Craig Smiddy, President and CEO of Old Republic International Corporation, and several other senior executive members as planned for this meeting. At this time, I'd like to turn the call over to Craig Smiddy. Please go ahead, sir.

Thank you, Joe. Good afternoon, everyone, and welcome again to Old Republic's First Quarter Earnings Call. With me today, I have Frank Sodaro, the CFO of ORI, and Carolyn Monroe, the President of our Title Insurance business. Well, ORI produced another highly profitable quarter in both general insurance and Title Insurance, even though we saw increases in mortgage interest rates begin to influence our Title Insurance revenues and operating income. And we certainly will provide more insight on that as we go through our prepared remarks. Net premium and fees earned were $1.9 billion, while pretax operating income was at $237.5 million, and our consolidated combined ratio was a very profitable 91.9%. In general insurance, net premiums earned increased by 6%. And even though Title Insurance net premiums and fees earned increased by 3%, we're not expecting revenues to come in higher for the remainder of the 2022 quarters relative to their respective 2021 quarters. We still expect both general insurance and Title Insurance to produce highly profitable underwriting results for the remainder of the year. So we think our broadly diversified portfolio of P&C and Title Business is well positioned to continue to deliver long-term profitable growth. And with that, I will now turn the discussion over to Frank. Frank will then turn things back to me to provide more insights on our general insurance business. We'll follow that by Carolyn, who will discuss our Title Insurance business. And then as always, we'll open up the conversation to Q&A. So Frank?

Thank you, Craig, and good afternoon, everyone. This morning, we reported first quarter net income, excluding investment gains and losses, of $192 million, a 7% decline from last year. On a per share basis, comparable year-over-year income was $0.63 versus $0.69. Although down when compared to a record quarter in 2021, income was strong by historical standards. Higher operating profit in the General Insurance segment was more than offset by a decline in the Title Insurance segment, which you'll hear more about shortly. Shareholders' equity ended the quarter at $6.75 billion, resulting in book value per share of $22.23. When adding back dividends, book value decreased 1.3% from the prior year-end as the interest rate-driven decline in the value of our bond portfolio was partially offset by our operating earnings and higher stock portfolio valuations. Net investment income was up modestly for the quarter as an increase in the level of investments was partially offset by lower yields earned. The investment portfolio was comprised of approximately 70% in highly rated bonds and short-term investments, with the remaining 30% allocated to large-cap dividend-paying stocks. During the quarter, we rebalanced our portfolio by modestly reducing our stock holdings and increasing our bond holdings as reinvestment rates materially improved. We realized $65 million of net investment gains on sales and reinvested in bonds with an average yield of 2.84%, compared to a bond portfolio book yield of 2.5% at the end of the quarter. During the quarter, the total fair value of stocks increased by $165 million, while bonds declined by $510 million due to rising interest rates. The overall credit quality of our bond portfolio remains very strong, with approximately 98% of the portfolio invested in investment-grade securities. Switching now to claim reserves, all three operating segments recognized favorable claim reserve development. In total, the consolidated claim ratio benefited by 2.4 percentage points for the quarter compared to 1.8 percentage points for the same period a year ago. Now wrapping up with our runoff mortgage operations. Claim costs continued a favorable trend of lower newly reported defaults and higher cure rates on loans already in default. The group paid a $35 million dividend to the parent holding company in the quarter, and subject to regulatory approval, we expect to continue at that pace quarterly for the remainder of the year. Total shareholders' equity for the mortgage companies ended the quarter at $356 million. I'll now turn the call back over to Craig for a discussion of General Insurance.

Okay. So for general insurance, net premiums written increased by 10%, while net premiums earned increased by 6%. We continue to achieve strong rate increases on most lines of coverage other than workers' compensation, while renewal retention ratios and new business production remained very strong. Pretax operating income rose to $142.5 million, and the claim ratio was 64%, which compares to 66% for the first quarter of 2021, while the expense ratio was higher at 27.7%. The overall combined ratio though is perfectly steady at 91.6%. The claim ratio reported for the quarter was inclusive of favorable development from prior periods of 3.2 percentage points. Turning to commercial auto. Net premiums written grew by 15%, while net premiums earned grew by 4%, and the claim ratio improved to 70%. Claim frequency is still not quite back to pre-pandemic levels and claim severity continued to increase, although at a much lower trend than what we saw over the last five years or so. Rate increases are continuing in the low double digits, so we continue to think that we're staying ahead of overall frequency and severity trends in auto. Looking at workers' compensation, net premiums earned were lower by 1%, while net premiums written were lower by 3%, and the claim ratio was 62.5%. Here, claim frequency continues to increase to pre-pandemic levels and claim severity trends are slightly up. Rate decreases in workers' compensation continue in the very low single-digit range. And we think our rate levels remain adequate, given that combination relative to our target combined ratios. We continue to get strong rate increases and produce favorable claim ratios in our financial indemnity and property lines of coverage, which contributes to our lower overall claim ratio but also elevates the overall expense ratio. This is a reflection of our efforts to diversify our lines of coverage, and these lines of financial indemnity and property have grown by over 60% since 2018, while, on the other hand, our workers' compensation line has gone from about one-third of our writings to about 20% of our writings over that same period. So this combination of growth in lower claim ratio, higher expense ratio lines, and a decline in the higher claim ratio lower expense ratio line of workers' compensation contributes to the overall lower current period claim ratio and higher expense ratio. Switching to the qualitative side of things. You might have seen over the quarter a couple of press releases where we announced the formation of a new E&S company, led by E&S industry veteran, Ralph Sabbagh. And also, some succession planning developments at two of our larger general insurance operations, with Derek Hopper taking the role of President and CEO at PMA, and John Santulli moving into the Executive Chairman position there. And at Great West, with Steve Olson taking on the President and CEO role, and Jim Jensen moving into the Executive Chairman role there effective July 1. Our general insurance growth strategy and underwriting excellence initiatives continue to produce solid growth and profitability, with new business production, high retention ratios, and adequate rate levels all contributing. With that, Carolyn, I think I'll turn the discussion over to you to report on Title Insurance.

Thank you, Craig. As reported this morning, the Title group's total premium and fee revenue for the quarter was approximately $1 billion, up 3% from the prior year first quarter, while our pretax operating income of $81 million for the quarter compared to $104 million from the first quarter of 2021. Both figures were consistent with our expectations. The slight revenue increase versus the more significant decline in operating income is a function of our direct versus agency production channels. First quarter 2022 agency revenue was 8% higher than first quarter 2021, while direct revenue was 12% lower than the prior period. With the drop in directly produced revenue, which has higher fixed expenses, along with a greater proportion of agency-produced revenues that have a higher expense ratio, our expense ratio increased, accounting for the impact on operating income. Comparable revenue percentage changes for both direct and agency have steadily decreased from their high-level marks reached during the second quarter of 2021, albeit with a more pronounced impact for direct operations with agencies still aided by the approximate one-quarter agency reporting lag. In line with consensus mortgage projections, we experienced a significant drop in refinance activity in the first quarter of 2022, which is expected to continue throughout the remainder of the year. Purchase order levels were roughly in line with the prior period and continue to benefit from strong housing prices. However, we recognize the change in interest rates may affect purchase activity as we move through the remainder of 2022. Based on our policy reporting tracking, commercial premiums remain a bright spot and were up 50% over the first quarter of 2021 and trailed only the fourth quarter of 2021 as an all-time high. Commercial premiums represented 20% of total premiums in the first quarter versus 14% for the first quarter of 2021. With pending Fed interest rate increases and continued lack of available inventory, we are realistic knowing our 2022 results will not match the record-setting revenue and pretax operating income results experienced over the last two years. Although new grounds await, we will manage to the market and align our expense structure accordingly while still being mindful of the technology advances necessary for our direct operations and to continue to keep our Title agent partners in the game. We began 2022 continuing to invest in our digital future. An enhanced version of our Easy Jacket application, which is a core service in our portfolio of technologies that we offer to our agents, will be launched this quarter. Easy Jacket is an online system that produces a jacket for every Title Insurance policy issued by our agents for our insurers. This system, with a modern interface, enhanced functionality, and an increased ability to configure changes and updates quickly, will be integrated with every major closing software in the industry. In parallel, we will be using the concept of hyperautomation and its benefits, and our goal of an end-to-end digital closing solution. As we manage to a less robust market, we must gain efficiencies in our processes. This will come about from our platforms and technologies that allow elasticity to workloads and easy provisioning and deprovisioning of resources with automation to meet current business needs and demands. Thank you, and I'll turn this back over to Craig.

Well, thank you, Carolyn. I know I attended your annual meeting last week, and you all are making great progress on the technology front. And we know our Title Insurance team knows how to manage through housing cycles, and that you're very well positioned with talent, technology, and relationships. So I appreciate all your efforts. So we remain very pleased with our strong levels of profitability in both General Insurance and Title Insurance. And our diversified specialty strategy will continue to produce profitable results and significant value for our shareholders as we move forward. So that concludes our prepared remarks, and we'll now open up the discussion to Q&A where either I'll answer your question or I'll ask Frank or Carolyn to respond.

Our first question is from Matt Carletti with JMP.

Craig, I heard you touch very briefly on kind of the formation of the E&S company. I was hoping you could give us a little more detail? I mean, obviously, we all know that times are very good in the E&S markets. But more specifically, I'm hoping to get a feel for kind of how the lines of business you're approaching there might look similar or dissimilar to the kind of existing General Insurance book at Old Republic? Do you expect it to be a little more property contingent to that than we're used to with kind of legacy Old Republic? Or will it still be heavily casualty oriented?

I would be happy to answer that, Matt. Our expected mix of premiums will be approximately 70% liability and 30% property, which is quite similar to our current mix. Our focus will be solely on the non-admitted segments. While E&S can involve both admitted and non-admitted components, we will be utilizing our Old Republic Union non-admitted company. The key difference for us is that we will primarily be targeting the wholesale market, which presents a new distribution channel. Currently, most of our focus is on retail, although we do engage in some wholesale activities. More specifically, we will concentrate on small property policies for commercial exposures. We do not plan to underwrite significant property exposures related to coastal, wind, wildfire, or significant catastrophe risks. While we will naturally assume some catastrophe exposure, this will not be a property initiative focused on catastrophes. To provide more details on the classes of business, our targets will include commercial building owners, small businesses of various types, manufacturing, retail exposure, and some light hazard product exposure. We will not be covering personal or professional lines. I hope this clarifies things, Matt.

Great. They're very helpful. Absolutely. And then one just second question. I think just the numbers one, but I just wanted to circle back on the commentary you had regarding kind of the movements in the expense ratio. I just want to make sure I'm kind of hearing you right that the expense ratio has crept up the past few quarters. The loss ratio has crept down as well. And that sounds like most of that probably sticks in that business mix? Am I understanding that right, kind of how the book has shifted over the past several quarters?

Yes. I think this quarter had a couple of contributing factors as we pointed out. We did have some one-time true-ups in our employee cost and benefits. On the other hand, we did hit an inflection point this quarter relative to the first quarter of '21. And that is our commissions were a full percentage point higher driven by this combination that I mentioned. So I gave in my prepared remarks the statistics about our growing book of property business and financial indemnity business and that that had increased by 60% in three years. And then you have this compounding effect where, as most folks know, workers' compensation is a line that has a pretty low commission ratio relative to other lines, and that's gone from about 65% of our writings down to, as I said, about 20%. So you combine those dynamics, and you do get a higher expense ratio. But for the one point in expense ratio, probably about two points in the current period loss ratio, claim ratio, there's a benefit because of the lower claim ratio for those lines that we've been increasing.

Perfect. Very helpful. That clarifies it for me. Congrats on a nice start to the year.

Our next question is from Greg Peters with Raymond James.

I want to ask about the new A&S business and the growing property business. With the expansion in property, how has your strategy for reinsurance purchases changed? Do you have new reinsurance partners assisting with the growth in property, or are you continuing to work with the existing partners in this area?

That's a great question, Greg. I want to remind everyone that another property-focused initiative we announced last year was the formation of our Inland Marine business. So you're correct that we've been growing in property through that initiative, our E&S initiative, and through other companies writing property as companion products to our existing offerings. Overall, our property exposure has increased. However, our strategy, as outlined in our annual reviews and filings, is to continue managing volatility. We don't aim to be a property cat writer, which is why you may have noticed in our 10-K that we've slightly raised our overall retention on property year-to-year, but it's still quite low to manage our income statement and volatility, avoiding creating any significant capital or income statement events from writing property. This remains our strategy and philosophy. What does this mean for our reinsurance approach? It means we are purchasing more property reinsurance than before, which involves bringing more people to the table or increasing our existing partners' shares. We acquire per risk property reinsurance at a very low retention and property catastrophe cover at a very low retention with an extensive high limit, ensuring we are in a strong position to avoid exceeding that limit in a catastrophic event.

That’s great information. If you could elaborate further, you mentioned earlier that you’re not entering coastal areas and are avoiding typical risks like hurricanes or earthquakes, as well as fires. What does a typical loss look like for your property? Given the current structure of your property portfolio, what would that typical loss entail?

I want to clarify the points you just mentioned, Greg. Our portfolio does indeed include exposure to coastal winds, earthquakes, and straight-line winds. My previous comments were focused specifically on the new E&S initiative, which differs from many typical E&S initiatives that have a heavy catastrophe focus. For our per risk losses, the typical example would be a fire at a commercial building, with our retention there being under $5 million. In the case of a catastrophe, such as straight-line wind events or coastal windstorms, we would see an aggregation of losses from multiple companies within our group, all of which would combine vertically. All of our property insurance is secured on a company-wide basis, meaning everything is aggregated and treated together. Therefore, each individual company doesn't have its own retention limit; there’s a collective retention for the entire group. While I don't have the 10-K right now, our net retention in a catastrophe event would likely be below $10 million.

I'll shift to discussing the Title business. Recently, Fannie Mae announced a new way to accept transactions, allowing an attorney title opinion letter instead of a traditional Title Insurance policy. Carolyn or Craig, could you share your insights on this new approach from Fannie Mae and its potential impact on the traditional title business?

Sure. Greg, I'll start and then hand it off to Carolyn. So we're all very much aware of this development. And Carolyn and I have talked about it in great detail just to make sure we were in lockstep and staying on top of things. And generally speaking, we don't expect it to have any material impact on our business. Where we think that there may be some conflicts with attorneys providing opinions in meeting all of Fannie Mae's requirements and the various state laws relating to Title Insurance, which should be challenged on a state-by-state basis. And lastly, I'll just add that in our opinion, attorney opinions as opposed to Title Insurance appear to be lacking. They don't address all the risks. And so those are the reasons why we think that there's really not a material impact. Carolyn, did I get all that right? And do you have anything that you think you want to add to that?

No, you addressed it well. A few years ago, Freddie Mac issued a similar opinion letter, but it didn’t receive much attention at the time. Most people recognize that title premiums are primarily focused on loss elimination, which is a key reason for obtaining a title policy. We will keep an eye on it and follow the discussions, and I'm sure our trade association will do the same for us.

Thank you for the additional information. I appreciate it. Regarding your comments about a more cautious outlook for Title in light of the rising mortgage rates, how do you suggest we approach forecasting this? Should we make an educated guess? What about the earned premium for Title Insurance in 2022? How does that range look under the current conditions, if at all? I understand you may not want to provide specifics, but historically, your Title business has shown significant growth over the past five years, which has been impressive. I’m trying to get a sense of the current baseline in this environment. Any insights you could provide would be helpful. That's all I have.

Thank you, Greg. Carolyn, I'll start because this is a topic we've discussed in detail. It's a very understandable question that we're considering ourselves. Regarding refinancing activity, we believe it has dried up, and we don't anticipate a rebound. The refinancing activity that contributed to our results in 2020 and 2021 is unlikely to be a significant factor this year. However, as Carolyn mentioned, new purchase originations still appear to be strong. The housing market is tight with high demand, and interest rates, while higher than the past few years, are still relatively low by historical standards. We are cautious about the outlook for new purchase originations. At this point in the first quarter, things look steady. Carolyn, feel free to add more or correct me if I've misrepresented anything.

No, those are all correct. The only thing I would add is that with our business mix and having a strong base of attorney agents, refinances were never really our main focus. They've been beneficial over the last couple of years, but if you look back to 2019 and earlier, they weren't something we relied on heavily because of our agents. When I review the orders and analyze everything I can, I recently read an economist predicting trends that align with what I've observed in our orders and direct operations. We seem to be reverting to levels similar to 2019, which were quite good years back then, going back to 2019 and 2018. Without stating a specific number, that's how we're assessing it within the operation.

Our next question is from Boris Kuzmin with Crawford Investment.

I had a couple of questions. One on title also. Is there a way to quantify the impact of house price appreciation kind of on title premiums, like, I don’t know, the Kolar index was up something like 20%. For example, how does that translate into I don’t know your premiums? Or maybe is there some sort of beta to that that you could?

Yes, that's. It's a fair and good question. And Carolyn, if you could respond to that with relative to purchase originations.

So our premiums are up. And so as prices appreciate, then, of course, our premiums will go up as well. It varies state by state. Is that helpful?

Well, I mean, yes, it’s understandable they would go up, but is there we say, 20% appreciation in house price would it automatically sort of rate lead to 20% higher premiums when just the same house that went up in price and somebody bought it 20% higher?

Yes. No. You could never do it that way. The title premiums are done in escalation. It’s not – there’s never just a straight percentage. Every state is different, and they have different brackets that some of them go up by $10,000, they go to a higher premium. We’d actually almost have to go state by state to try to figure out what a percentage increase would be.

Got you. Okay. And another question, just kind of circling back, I think last year, there was a conversation with the Board potentially considering a share buyback program at some point. I was just wondering were wondering where that stands at this point?

Sure. I’d be happy to talk about that. So as you know, our history has been one of returning excess capital to shareholders through special dividends primarily. What we said publicly over the last year or so is that the Board is willing to consider and have considered in each case that we have excess capital, the potential of returning that capital via a special dividend or via a share repurchase authorization. So a share repurchase authorization is always on the table. And every time that we get together with the Board and management updates the Board with their views on our capital position and if we have – if we believe we’re in an excess capital position, we discuss the alternatives of putting that capital to use, which is our first choice, or returning it to shareholders, either via a special dividend or share repurchase and the various different financial implications of both of those options. So we look at both when we have excess capital.

Okay. If I may sneak in one more. In terms of your investment portfolio, you said you shifted a little bit away from equities. I think a lot of insurance companies, like in recent years, kind of pushed into alternatives or private investments or anything like that and realized some significant gains. I don’t know if this is the right time to think about those sort of things, but are there any plans to kind of diversify between – or at least, are you guys thinking about diversifying into other asset classes, let’s put it this way?

Sure. Thanks for the question. So first, I’ll just provide a little more color around the reduction somewhat in the quarter of our equities. And we were getting to a point where we had so much appreciation in our equities that it made sense to take some of that off the table. We manage very closely various enterprise risk management metrics to make sure we don’t get too out of balance between equities and fixed income. And given, as I say, our appreciation that we’ve enjoyed over the last several years in our equities portfolio, we thought it was prudent to take some of that off the table. With regard to other alternative investments, I would say that’s not on the table. We have been – we’ve had a long, stable, consistent history of being conservative, of not investing in alternative types of investments. As a matter of fact, even in this release on Page 8, we reiterate every quarter that – of the things that we don’t do in that first paragraph under the statistics. And we say those same things again in our annual – various annual communications, our annual review, our 10-K, our proxy statement, we’re very conservative, and we’re even very conservative with our equity investments, investing in less than 100 blue-chip type of dividend-paying equities. So yes, that would not be on the table.

We have no further questions at this time. I'll turn the call over to management for any closing remarks.

We appreciate the interest and the questions. We are very confident in the strong profitability of both General Insurance and Title Insurance, especially considering the strong combined ratios as we progress through the year. Our focus remains on what we can control. While we cannot influence interest rates or housing markets, we can manage our expenses and maintain our emphasis on profitability in both General Insurance and Title. This is what we have shown this quarter and will continue to demonstrate for the rest of the year—strong profitability. Thank you, and I look forward to speaking with everyone next quarter.

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