Earnings Call Transcript - ORI Q3 2022

Operator, Operator

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 Third Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Joe Calabrese with the Financial Relations Board, you may begin.

Joe Calabrese, Financial Relations Board

Thank you. Good afternoon, everyone, and thank you for joining us for the Old Republic conference call to discuss third quarter 2022 results. This morning, we distributed a completed press release and posted a separate financial supplement which we assume you have seen or otherwise have access to during the call. Both of the documents are available at Old Republic's website. Please be advised that this call may involve forward-looking statements as discussed in the press release and financial supplement dated October 27, 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 Corporation, and several other senior executives. At this time, I would like to turn the call over to Craig Smiddy. Please go ahead, sir.

Craig Smiddy, President and CEO

Okay. Thank you, Joe. Good afternoon, everyone, and welcome again to Old Republic's third quarter earnings call. With me today, I have Frank Sodaro, our CFO of ORI; and Carolyn Monroe, President of our Title Insurance business. As you've seen in this morning's release, ORI had another strong quarter, with General Insurance producing significantly greater pretax operating income, while our Title Insurance business pretax operating income was considerably less than the record-setting 2021 results due, of course, to the effects of the increasing mortgage interest rate environment. Our reserve position remains very healthy in all three of our segments with a very high level of favorable reserve releases for General Insurance in the quarter. Our balance sheet remains strong. We returned a considerable amount of capital to shareholders during the quarter, which we'll talk about a little bit. We've reduced balance sheet volatility by reducing our exposure to equities by nearly $2 billion since the beginning of the year, reinvesting in fixed income securities at yields we haven't seen in over a decade. Consolidated net premiums and fees earned were just below $2 billion for the quarter and just below $6 billion year-to-date. Consolidated pretax operating income was $258 million for the quarter and stands at $758 million year-to-date. Our consolidated combined ratio came in at a healthy 91.4% for both the quarter and the year-to-date periods. Both General Insurance and Title Insurance continue to produce excellent underwriting results as demonstrated in their respective combined ratios. General Insurance net premiums earned increased by over 7% for both the quarter and year-to-date periods, while in the third quarter, Title Insurance net premiums and fees earned decreased by 15% alongside a decrease of 7% year-to-date. As we've commented over the last 12 months, our 2022 expectations for Title Insurance were considerably less than those expectations of the record-setting 2021 year. We think this downturn in Title Insurance and the continuing upturn in General Insurance reinforces the benefits of our long-standing diversification strategy anchored in the non-correlated P&C and Title Insurance segments, which provides for steadier earnings and shareholder returns over the long run. So with those opening comments, I'll now turn the discussion over to Frank, and then Frank will turn things back to me to cover General Insurance, followed by Carolyn, who will discuss Title Insurance. And then as always, we'll open up the conversation to Q&A. So Frank, do you want to take it from here?

Frank Sodaro, CFO

Sure. Thank you, Craig, and good afternoon, everyone. This morning, we reported third quarter net income, excluding investment gains and losses, of $206 million compared to $240 million last year. On a per share basis, comparable year-over-year income was $0.68 versus $0.79. For the first nine months of this year, operating profit was $608 million compared to $668 million last year. Although both periods were down compared to the record set last year, our earnings were very strong by historical standards. Book value per share ended the quarter at just under $19. When adding back dividends, this was a decrease of 9.4% from the prior year-end as the declines in the values of our bond and stock portfolios were partially offset by our strong operating earnings. Net investment income increased for the quarter as we have turned the corner on yields earned and experienced continued growth in our invested asset base. Our current bond reinvestment rate was just under 4.8%, and our ending bond portfolio yield improved to 3.1%. During the quarter, we continued to rebalance our investment portfolio by reducing our stockholdings and increasing our investments in bonds. As a result, we realized $181 million of net investment gains on sales of common stock. However, we also recognized $207 million of losses on bonds we either sold or intend to sell as part of our tax planning efforts. Our investment portfolio currently stands at about 80% in bonds and short-term investments, and 20% in stocks, a level with which we are comfortable given the more favorable interest rate environment. During the quarter, the total fair value of bonds declined by $385 million, while stocks decreased by $170 million. The overall credit quality of our bond portfolio remains strong with approximately 98% of the portfolio in investment-grade securities. Switching to loss reserves. All three operating segments recognized favorable loss reserve development. In total, the consolidated loss ratio benefited by 3.4 percentage points for the quarter compared to 2.3 percentage points for the same period a year ago. Hurricane Ian had a nominal effect on the current period loss costs. Mortgage insurance loss costs continued with a favorable trend of lower newly reported defaults and higher cure rates on loans already in default. The group paid another $35 million in dividends to the parent holding company in the quarter, bringing the total returns to $105 million year-to-date. I'll wrap up my remarks with a discussion about the capital we have returned since we last spoke. We paid $375 million in dividends, which included a $1 per share special dividend. In addition, up through yesterday, we repurchased about another $225 million worth of our shares. This puts us about halfway through our repurchase authorization, which we will continue to execute on opportunistically.

Craig Smiddy, President and CEO

Okay. Frank, thanks. So for General Insurance, net premiums written increased by almost 10% in the quarter, and we continue to achieve rate increases on many lines of coverage with renewal retention ratios and new business production, both remaining very strong. Pretax operating income for us rose by 15% to $168 million, and the loss ratio for the quarter was 63% compared to 65% in the third quarter of last year. That's inclusive of 4.7 percentage points of favorable development this quarter for the General Insurance group. The expense ratio was 27% with continued growth in lower loss ratio, higher commission ratio lines of coverage, driving approximately 1 percentage point of additional commission within that expense ratio. The combined ratio was a strong 90% compared to 91% in the third quarter of '21. So now I'll turn to specifically commercial auto. Net premiums written grew by 10%, while net premiums earned grew by 7%, and the loss ratio improved to 64% from 73% in the third quarter last year. Loss frequency for auto remains below pre-pandemic levels, while auto liability severity continues to increase at the same high single-digit pace that we've seen over the last year or so. On auto, physical damage severity is increasing at mid-double-digit rates. So we're seeing greater severity on the auto physical damage side. Our rate increases are in the high single-digit range, which implies that we continue to cover overall frequency and severity trends. So, we think our rate levels on this line remain adequate relative to the targets we've set for combined ratios. Looking now at workers' compensation. Net premiums written there continued to rebound, growing 11%, while net premiums earned grew 7%. And the loss ratio improved to 36% from 59% in the third quarter last year. Loss frequency for work comp continues to trend favorably, while severity is slightly up. Rate decreases in workers' comp continue in the low single-digit range for us. So here, too, we think our rate levels remain adequate relative to our target combined ratios. In financial indemnity, more specifically, the D&O line of coverage. We saw unfavorable loss development stemming from large security class action claims occurring in accident years 2018 and 2019. And we're no longer seeing the robust rate increases we saw in 2019, 2020 and '21 as new D&O market entrants are driving down rates. So we continue to keep a very close eye on the D&O line of coverage, and we'll exercise underwriting discipline, declining accounts that aren't priced adequately while aggressively managing our attachment points and limits on public company D&O. More generally, while we continue to follow loss frequency and severity trends very closely and adjust our rates for inflationary trends driving severity, including both general inflation and social inflation, we also continue to keep a close eye on case and IBNR reserves relative to these trends and adjust accordingly. So we believe our growth strategy and operational excellence initiatives in General Insurance will continue to produce solid growth and profitability with new business production, high renewal retention ratios, and generally increasing rate levels all contributing. So, I'll now turn the discussion over to you, Carolyn, to report on Title Insurance.

Carolyn Monroe, President, Title Insurance

Thank you, Craig. The Title group reported premium and fee revenue for the quarter of $968 million, down 15% from prior year third quarter. Our pretax operating income of $73 million compared to $136 million in third quarter 2021. Agency premiums were down $103 million or 12% over third quarter 2021, and direct premiums and fees were down $71 million or 28%. Increasing mortgage interest rates impacted third quarter and year-to-date comparisons, most notably with a steep decline in refinance activity that has continued throughout the year. While purchase activity has also dropped off, it has been to a much lesser extent, tempering the overall impact. Commercial activity remained strong this quarter with commercial premiums up 29% over third quarter 2021 and made up 21% of our premium total for this quarter. Our combined ratio for third quarter 2022 was 93.7% compared to 89% in third quarter 2021. This increase is primarily driven by the decreased loaded and directly produced revenue, which have higher fixed expenses. Agency commissions were down 12.6% for the quarter, roughly in line with the decrease in agency premiums. All other expenses were down by 5.2% in third quarter 2022 over third quarter '21, with personnel expenses representing the vast majority of this decrease. We believe that continuing with our strategic focus on serving our agents, which account for 81% of our revenue this quarter, creates a sustainable competitive advantage. The expense structure associated with this model has a relatively high degree of variable expenses, which is beneficial as we continue to navigate current market conditions. We'll continue to deliver on our technology roadmap and digital business plan with a focus on optimization by looking for improvements in productivity and existing revenue with better customer engagement with an automation focus. This balances between improvements in our current business portfolio and workflow while preparing for future changes and transformations. An important achievement at RamQuest, our closing software entity, is the upcoming launch of Horizon, our new web-based and modern title and escrow platform. We see this as a key piece of our technology delivery strategy for our agents as well as our own internal modernization program for our direct operations. A recent addition to our integration platform supermarket is a verification service that will help combat wire fraud, which is an ever-present focus in the industry. We will continue with the addition of value-added services to our agents utilizing our title and escrow platforms as well as our internal operations. We remain committed to combining Old Republic's Title solid business practices, procedures and expertise in the industry with our growing portfolio of technology to deliver measurable benefits and success for the industry, company and our shareholders. Thank you and I'll now turn it back over to Craig.

Craig Smiddy, President and CEO

Okay. Carolyn. Thank you very much. Well, we think we had a good quarter with strong levels of profitability in both General Insurance and Title Insurance. While our diversification and specialty strategy should continue to produce stable, profitable results going forward and long-term value for our shareholders. So that concludes our prepared remarks, and we'll now open up the discussion to Q&A, where I'll answer your questions or I'll ask Frank or Carolyn to respond. So, we'll open up to Q&A.

Operator, Operator

Our first question comes from Matt Carletti with JMP. Please go ahead, your line is open.

Matt Carletti, Analyst

I have a couple of questions. One is a numbers question and the other is more general. Regarding the numbers question, I noticed on Page 3 of your supplement that shows the loss ratios by major coverage lines, there was a significant increase in general liability this quarter. Can you provide some insights on what might be driving that?

Craig Smiddy, President and CEO

Sure, Matt. Over the quarters, we observe that this loss ratio can fluctuate quite a bit because, as you can see from the premium levels, we lack the scale found in other lines such as commercial auto and workers' comp. I’ve mentioned before that this loss ratio tends to be volatile, and while we've analyzed it for specific reasons, there isn’t anything in particular to highlight, other than it's a small coverage line for us with a more unstable loss ratio. However, if you look back over the years, it tends to stabilize.

Matt Carletti, Analyst

Okay, perfect. I wanted to revisit what you mentioned about the title technology. I saw your slide deck, and you referenced RamQuest. Could you provide more details on it? Is Pavaso, which seems to be more customer-focused and aimed at enhancing the customer experience during the title process with digital and hybrid closings, correct? Am I understanding that properly? If so, has it been implemented throughout your entire operations, or is it still in the early stages? I would appreciate any additional insights on its current status.

Craig Smiddy, President and CEO

Carolyn, I know you're very passionate about what we're doing in the way of technology in our Title business and specifically the platforms that Matt referenced. So do you want to comment on that, please?

Carolyn Monroe, President, Title Insurance

Pavaso is primarily a customer-focused platform that is mainly utilized by our lenders. It's been available for use whenever our lenders or realtor customers need it, and all of our agents have access to it. Pavaso enhances the closing experience for buyers and sellers, but the process must be initiated by the lender since it involves their documents, which are necessary for signing on that platform. We noticed increased usage of Pavaso during the refinance boom because lenders fully controlled those transactions. However, if lenders are not overseeing the entire closing process, only parts of Pavaso can be utilized. We remain prepared and are waiting for the industry to fully embrace E-Closing.

Matt Carletti, Analyst

Great. And congrats on a nice quarter.

Frank Sodaro, CFO

Thank you, Matt.

Operator, Operator

Our next question is from Greg Peters with Raymond James. Your line is open.

Greg Peters, Analyst

I guess a follow-up. I'd like to start off with a couple of questions on your General Insurance operations. And I think a good place to start might be the expense ratio. And Craig, I know you've commented on this in the past as it relates to changing business mix, et cetera. But if we look at the nine-month results, let's take away the quarter number. You're still running about 140 basis points higher in terms of your expense ratio on a year-over-year basis. So, I was hoping maybe you could sort of bridge the gap because that looks like it's more than just business mix. It looks like there's some other issues there. So maybe you can help fill in the blanks there.

Craig Smiddy, President and CEO

Yes. Well, as I indicated in my opening comments, Greg, about a point of that is the additional commission that is being driven by the line of business mix relative to the first nine months of '21. So, the majority of it is that, and then there are other expenses as well, of course, that are slightly higher. The comment that I would make is we've been pretty consistent that our target combined ratios are between 90% and 95%. I know we continue to say that our target is 25% for the expense ratio, but that's based upon the historical line of coverage mix. We were somewhat hesitant to want to change that expense ratio target if this wasn't going to be more of a permanent thing. As we continue to move through the quarters, that line of business mix is starting to show us that it's going to stick. So, we'll have to look at that more closely in the next few quarters and consider what we want to say about that expense ratio. But again, the majority of it is indeed one point of additional commission expense because of the line of business mix.

Greg Peters, Analyst

Okay. And then I guess the other question, it speaks to reserves and what's going on on an underlying basis. But the paid loss ratio continues to trend down versus what any 5- or 10-year average might look like. Your reserve development, prior year development, is trending up. So these look to be good trends. Can you talk to some of the underlying movements in those two components? Is it conceivable that the paid loss ratio continues to track down? Or are we hitting an inflection point where it sort of levels out at this point?

Craig Smiddy, President and CEO

I can't say for sure if we're at an inflection point. It is possible that the trend continues downward. We observe that our total reserves, including IBNR, show declining loss ratios. This suggests that both the paid loss ratio and the overall loss ratio, including IBNR, are decreasing consistently. This likely reflects the effectiveness of our operational excellence, pricing, and underwriting initiatives. The year-over-year increase in rates aligns with the decline in our paid loss ratios. Our current accident year loss ratios are also decreasing, and our reported loss ratios, including development, are reducing as well. Overall, this outcome aligns with our goals of improving our pricing, underwriting selection, claims, risk control, distribution, and production, and we view this progress as beneficial.

Greg Peters, Analyst

Yes, it does look like that. Maybe pivot to the balance sheet. I think I understand what's going on with the sale of your equity portfolio and going into or part of the equity portfolio and reinvesting in bonds, but maybe you could provide more color on where you think the relative percentages of your portfolio are going to balance out at, considering what's available to you in the marketplace today. Where do you see the mix of equities versus bonds in the near term, considering all the moving parts that you're looking at?

Craig Smiddy, President and CEO

Yes. I’ll start and then let Frank go into more details. We are comfortable with the 80-20 mix mentioned, which is 80% fixed income and 20% equities. Even after selling about $2 billion worth of equities this year, we did not sell at lows; we sold them during a favorable window at the highs. After reaching that 20% equity level, we feel secure and have no plans to reduce it further. We will continue to evaluate the yields on those equities. Our decision to increase our equity investments a few years ago was based on the ability to invest in blue-chip equities that offered yields significantly higher than comparable blue-chip bonds. We must remain diligent, and if conditions change, we'll assess the yields on the equities. If we find bonds offering returns of 5%, 6%, or 7%, we might reconsider our strategy. Currently, there are no plans to lower our equity holdings, and we are satisfied with the current level as long as it continues to meet our investment income objectives, which were the foundation of our strategy when we initially increased our equity investments. Frank, do you have anything to add?

Frank Sodaro, CFO

You didn't leave much to add, but I'll mention that 11% of the stocks we sold were at their 52-week high, which we're pleased about. Regarding the bond portfolio sales and tax planning, we've identified a favorable spot on the longer end of the maturity curve, and we're effectively maintaining our overall maturity. Our average maturity has stayed around 4.4 years, and we've managed to keep it there. So just to provide some additional context, we're maintaining a 98% investment grade, indicating a very high-quality portfolio.

Greg Peters, Analyst

Great. Congratulations on the quarter.

Craig Smiddy, President and CEO

Thank you, Greg.

Operator, Operator

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

Craig Smiddy, President and CEO

Okay. Well, thank you, everyone, for your interest and for the conversation this afternoon. As we said, we think we had another successful quarter. We know that we have headwinds when it comes to real estate markets and the interest rate environment, but those were expected headwinds, and we're planning accordingly. Likewise, we have some very favorable things happening in the General Insurance group as those trends in loss ratio, combined ratio, and income continue to improve and are at very strong levels. So, thank you all again, and we will see you again next quarter.

Operator, Operator

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