Earnings Call Transcript - ORI Q1 2020

Operator, Operator

Good day, and welcome to the Old Republic International First Quarter 2020 Earnings Conference Call. I would like to remind everyone that this conference is being recorded. I would now like to turn the conference over to Marilyn Meek with MWW Group. Please go ahead.

Marilynn Meek, Presenter

Thank you. Good afternoon, everyone, and thank you for joining us for the Old Republic conference call to discuss first quarter 2020 results. This morning, we distributed a copy of the press release and posted a separate statistical supplement, which we assume you have seen or otherwise have access to during the call. Both of the documents are available on Old Republic's website, which is www.oldrepublic.com. Please be advised that this call may involve forward-looking statements as discussed in the press release and statistical supplements dated April 23, 2020. 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 would like to turn the call over to Craig Smiddy. Please go ahead, sir.

Craig Smiddy, CEO

Thank you, Marilynn. Well, good afternoon, everyone, and welcome to Old Republic's First Quarter 2020 Earnings Conference Call. With me today, we have Karl Mueller, Old Republic International's CFO; and we have Carolyn Monroe, the President of our Title Insurance Group. In the past, Rande Yeager, our Title Group Chairman; and Mark Bilbrey, our Title Group CEO, have joined us on the call. But given that Carolyn was promoted to President of the Title Group in January of 2019 and given our close proximity to the ongoing operations within the Title Group, we thought it was best that she join us for this call and talk about what's happening in the Title operations, especially in the midst of the COVID-19 related challenges, where Carolyn has been burning the midnight oil, working with all the folks on the front lines and doing a remarkable job of keeping our Title operations executing at a very high level. So welcome, Carolyn. Appreciate having you join us for the discussion today. As we work through the challenges resulting from COVID-19, we certainly want to send all of you, your families, friends, and coworkers our very best wishes. I'd also like to take a moment to acknowledge all of Old Republic's more than 9,000 associates that have mobilized their remote working capabilities and also all those essential workers in our offices, all of whom are working to ensure that our services and capabilities for our customers, our agents, and brokers continue uninterrupted. Although in most states, we're recognized as an essential industry and essential workers, currently more than 95% of our General insurance group and approximately 80% of our Title Insurance associates are working remotely. The small number of associates we have in the offices are working to ensure that mail gets processed, checks get mailed, and that our IT infrastructure remains vibrant to support all of those working remotely. I'd also note that we're among the fortunate to be able to say that we have not furloughed any of our associates during this time. So before handing things over to Karl, I'll offer a few initial comments regarding our first quarter. As you saw in our release, Old Republic posted strong first quarter 2020 operating results relative to the first quarter of 2019, and these results were driven by an exceptionally strong quarter for our Title Insurance segment. As noted in our release, COVID-19 had minimal effect on our first quarter results. However, we also acknowledge that the effects of COVID-19 and the associated governmental responses could have a negative effect on our top line premium and fee revenues in the second quarter and subsequent quarters of 2020, and as such, these declines could also result in higher expense ratios in the short term. Our first quarter operating results again demonstrate that our strategic diversification between Title Insurance and General insurance works very well to produce consolidated revenue and earnings growth over time. So at this point, I'll turn matters over to Karl to discuss our overall consolidated financial results. I'll also ask him to address our small RFIG run-off segment. After which, he'll turn things back to me to discuss the General Insurance segment. Then Carolyn will discuss the Title Insurance segment. I'll make a few closing comments, and then finally, we'll open up the discussion to Q&A. So with that, Karl, take us away.

Karl Mueller, CFO

Good afternoon, everyone. Before commenting on the first quarter results, I'd like to add to Craig's earlier comments and recognize our accounting and financial reporting associates for their diligence and commitment during this period of turmoil resulting from the COVID-19 pandemic. Despite the fact that most of our employees were working remotely, we were able to complete the financial close without significant disruption while at the same time retaining the integrity of our internal control process. Job well done by everyone. Turning now to the quarterly results, this morning we announced first quarter net income, which excludes all investment gains and losses of almost $141 million, which is up nearly 16% from a year ago. On a diluted per share basis, that equates to $0.47, which is an increase of 17.5% from the prior year. As noted in this morning's release, our operating results were largely unaffected by the COVID-19 pandemic. However, the resulting disruption to the financial markets led to substantial declines in the fair value of our equity portfolio. The pretax fair value decline of approximately $963 million was really the main contributing factor to the first quarter reported net loss and corresponding reduction in book value. Consolidated net premiums and fees earned registered strong growth of a little over 10% to $1.5 billion. The General Insurance group increased about 2.5%, and our Title group grew by almost 24%, as Carolyn will address in a few moments. Net investment income grew nearly 2% due to a larger invested asset base and greater dividend income, which arises from the relatively higher-yielding equity portfolio, and that was offset by slightly lower yields on the bond portfolio. From an underwriting perspective, this quarter's consolidated combined ratio of 94.9% marked about a 1.1 percentage point improvement over 2019. The quarterly claims ratio trended lower, and the expense ratio ticked upwards slightly primarily due to a mix of business shift. And then that shift was more towards the Title segment, which as you know, carries a lower loss and a higher expense ratio. Consolidated claim reserves developed slightly favorable in both periods, reducing the reported claim ratio by 0.8 and 1.6 percentage points for the current and prior year quarters, respectively. We experienced favorable prior year development on the reported claims ratios for each of our operating segments to varying degrees during the quarter. This morning's release, along with the financial supplement, provides some additional detail about those historical development trends. Turning now to our financial condition, total cash and invested assets decreased to $13.5 billion at the end of March. Driving this change was the combination of strong operating cash flow of $216 million offset by, as I mentioned earlier, the substantial unrealized market depreciation in both the equity as well as the fixed income portfolios. As a reminder, the composition of our portfolio is approximately 76% allocated to bonds and short-term investments and 24% to equity securities. Our equity portfolio consists of approximately $100 million that are predominantly large-cap, value-oriented, dividend-paying companies. We manage the portfolio within our risk management framework, which does take into consideration expected price volatility. The value of our equity portfolio declined by approximately 24% during the quarter to an unrealized loss position of roughly $22 million at the end of March. As of yesterday's close, the portfolio had rebounded to a $175 million unrealized gain. Despite this significant downdraft in valuation at the end of March, we are still operating within our risk tolerance thresholds. Consequently, we have not made, nor do we expect to make any material changes to our investment strategy. Old Republic's book value per share decreased from $19.98 at the end of 2019 to $17.29 at the end of March. As previously noted, the most significant contributor to this decline relates to the $2.53 per share reduction in the fair value of the equity portfolio. Operating income of $0.47 was additive to the book value, and we returned capital to our shareholders in the form of the regular cash dividend, which amounted to $0.21 per share or $0.84 on an annual basis. This year's annual dividend payout represents about a 5% increase over last year's regular cash dividend rate. This year, 2020, marks the 79th year of paying uninterrupted regular cash dividends as well as consecutive years of increasing the dividend rate for the past 39 years. We ended the quarter with $6.1 billion of total capitalization, low debt leverage ratios, and adequate liquidity throughout the enterprise. As highlighted in the release, we believe that our strong financial position will enable us to weather these challenging times. So as Craig mentioned, let me now just briefly discuss our run-off mortgage insurance segment. From a capital management perspective, we entered this year with the anticipation of beginning to withdraw excess capital from our mortgage guaranty run-off operation. During the quarter, we did in fact obtain regulatory approval and received a $37.5 million extraordinary dividend from our two principal mortgage insurance companies. Total statutory capital at the end of March continues to remain strong and registered $410 million. The first quarter mortgage insurance results were not significantly affected by the COVID-19 pandemic, as Craig mentioned earlier. The impact on unemployment levels in real estate markets, along with the mitigating effects of the government loan forbearance programs are areas that we are monitoring closely. By definition, a mortgage in forbearance is not considered to be in default. Let's also keep in mind that this is a mature book of business. We've not written a new policy since 2011. A large percentage of the in-force file was written in 2009 and earlier years. In addition, approximately 60% of the loans that are insured have previously been modified or refinanced under the government's home affordability programs, the HARP and HAMP programs. So these factors, along with the rate at which the U.S. economy recovers, could affect future claims experience and potentially slow the return of capital from the run-off business until there is greater clarity. That said, we continue to pursue all previously mentioned options in the interest of producing the most beneficial long-term outcome for all stakeholders. With that, I'll now turn things back to Craig for discussion of the General Insurance group.

Craig Smiddy, CEO

Okay. So as the release indicates and as we show in the financial supplement, compared to first quarter 2019, General Insurance saw quarter-over-quarter operating revenue increase by 2.9% and quarter-over-quarter operating income was up 1.7%. Net premiums earned in commercial auto rose by 3.6% quarter-over-quarter, attributable to the positive effect of rate increases that we have continued to attain on the commercial auto line. In the first quarter, those rate increases remained in the high teens. On the other hand, premiums were somewhat offset by a decline in the exposure base. As can be seen in the financial supplement, workers' compensation experienced a 9% drop in net premiums earned quarter-over-quarter. This is attributable to the negative effect of rate decreases that continued in the low single digits for us during the first quarter and also from a decline in the exposure base. Thus far, the lower rate level that we have in the workers' compensation line continues to correspond with the lower claim frequency trends that we and the industry are seeing on that line. Quarter-over-quarter, the General Insurance overall composite ratio rose slightly to 95.6%, up from 95.3%, and this was attributable to a slightly higher expense ratio. The first quarter expense ratio came in at 25.8% compared to the first quarter of 2019 when it stood at 25.5%. So turning to claim ratios. Our first quarter commercial auto claim ratio came in at 77% compared with 79.1% in the same period of 2019. As demonstrated by our continuing level of rate increases for this line, along with our reduction in exposure from our risk selection efforts, we continue to work very hard to bring this claim ratio back into line with our target in the low 70s. Turning to workers' compensation, the first quarter claim ratio came in at 71% compared to 70.7% in the first quarter of 2019, and we continue to remain very pleased with this result, obviously. For commercial auto, workers' comp, and GL combined, given that we typically provide these coverages together to an account, we like to also look at that combined results, and the quarter-over-quarter claim ratio for those three combined was flat at 74.1%. Still looking at the financial supplement, you can see that the remainder of our claim ratios are very much in line with our target. Of course, all of the claim ratios we report are inclusive of favorable and unfavorable prior year claim development. In the latest quarter, we saw favorable development of 7/10 of 1 percentage point. For General Insurance, as I mentioned earlier, the remaining quarters of 2020 could prove challenging from a top line perspective, but we will continue to seek the appropriate price that we need for our products. We'll continue to focus on the long-term when it comes to managing our expense ratios. So on that note, I'll now turn the discussion over to Carolyn for her comments on Title Insurance. Carolyn?

Carolyn Monroe, President, Title Insurance Group

Thank you, Craig. While these have really been challenging times, the employees in the Title division have embraced this challenge and are working through the chaos in order to continue business and serve our customers. Despite the COVID-19 pandemic, residential and commercial sales and refinances continue to fund, and transactions need to close. Amidst this, we are ever mindful of the safety and well-being of our employees and customers. Access into our offices is generally restricted to employees only, which has really caused us to be very creative in carrying out our business. Our direct operations and our Title agents have conducted drive-through closings, set up tents outside of offices, provided single-use pens for signing documents, all while continuing to practice social distancing. My heartfelt appreciation goes out to all of our employees and our Title agents for their creativity and, most importantly, the positive and really collegial attitude that we hear about on our daily calls with the leadership team in our Title group. The COVID-19 disruptions have led to a variety of emergency state orders that impact our business. Many motorization statutes have been amended in order to comply with distancing requirements and to create avenues through which closing transactions may continue. Based on these orders, our Title technology company Pavaso, which was originally designed for electronic closings and law legislation, was able to pivot and adjust its technology to allow our agents and offices to continue conducting closings through a secure platform, which allows for adherence to social distancing restrictions. This platform provides an essential notary function that allows for the entire notarization of documents to be completed remotely. Between the ingenuity of our offices and agents and the supportive technology like Pavaso, we have been able to keep pace in our current environment. The Title group kicked off the first quarter of 2020 on a record pace. The market experienced near-record lows on mortgage rates. All-time first quarter highs were set in terms of both direct and independent agency revenue and operating profitability. For the first quarter, total premium and fee revenue was $628.1 million, which was an increase of nearly 24% over the first quarter of 2019. Agency premiums were up around 21%, and direct operating revenue approximately 31%. In terms of operating profitability, the Title group reported pretax operating income of $43.3 million for the quarter compared to $20.5 million in the first quarter of 2019, an increase of 110.6%. We ended the first quarter with some of the highest open order counts in the history of our company. We continue to adjust to doing business while operating under the various state shelter-in-place orders and social distancing requirements. We are mindful of the challenges ahead for our organization and our nation in general. Our firm belief is that with the continued unwavering commitment of our employees and the support of our Title agents, we will be more than ready for these challenges. We will rely on the same guiding principles of integrity, managing for the long run, financial strength, protection of our policyholders, and the well-being of our employees and customers that have served us well over the last 100-plus years. And with that, I'll turn it back to Craig.

Craig Smiddy, CEO

Okay. Thank you, Carolyn. So again, our first quarter operating results indicate that our business continues to perform very well. We continue to focus on underwriting excellence during these challenging times, and our capital position remains very strong with significant dry powder to weather the macroeconomic disruptions and to be well positioned when the economy eventually rebounds. I'll also note that our MD&A discussion in our upcoming 10-Q will provide additional more detailed disclosure around the risk factors associated with COVID-19. So with that, we'll conclude our prepared remarks, and we will open up the discussion for Q&A.

Operator, Operator

Our first question comes from Matt Carletti with JMP.

Matthew Carletti, Analyst

Craig, I have a few questions for you, starting with General insurance, specifically the two main business lines: transportation, particularly commercial auto, and workers' compensation. Let's begin with commercial auto. You mentioned in your initial remarks that you've noticed some exposure decrease, which makes sense. Can you share what you've observed so far regarding both frequency and severity? Additionally, as you analyze that portfolio, I'm sure some sections are experiencing positive frequency trends while others might be seeing negative revenue trends. Could you help us break that down and clarify what you're observing?

Craig Smiddy, CEO

Sure. Matt, I’d be happy to provide some insights on that. I’ll discuss auto insurance, although there are many similarities with workers' compensation. Claim counts are down, but most of our premium is based on exposure, meaning it depends on sales receipts or miles driven, and for workers' compensation, it’s based on payroll. We really need to wait for the exposure reports from our insurers and the premium audits to understand the denominator. While claim counts are down, if the denominator is fixed, we might assume that frequency is reduced, but if the denominator varies based on where the premium ultimately settles, it’s too early to conclude that frequency is down. For example, if the denominator is miles driven, we need to see the actual miles and divide the claim counts by those miles to get a clearer picture. This is different from personal auto, where the denominator might be a set annual premium, allowing for a high degree of confidence in stating that frequency is down given the drop in claim counts. However, with a fluctuating denominator, it’s more challenging to be precise about the ultimate frequency. That said, claim counts are indeed down for auto. The same applies to workers' compensation. For frequency, the most common denominator is payroll, which we analyze in various ways. We need to consider what payrolls are reported and how the premium audits look before we can determine if the drop in claim counts is a definitive indicator that frequency is down. Claim counts are down, but I want to add a comment that isn’t specific to your question. Regarding COVID-19 claims, there’s some solid analysis by NCCI and WCIRB in California that discusses their insights on frequency. In summary, it shows many factors are influencing frequency, both lowering and raising it. While COVID-19 may have contributed to some increase, other factors, like auto accidents, are arguably putting downward pressure on frequency. It's a bit of a moving target, but I hope this offers more clarity on how we view frequency in relation to auto and workers' compensation.

Matthew Carletti, Analyst

Yes. Very helpful. And then maybe just a follow-up on each one of those. On workers' comp, I'm pretty familiar with kind of how the premium audit process works, but less so on transportation. So as we think about your book and then getting that denominator right, how quickly or how often do you kind of get that information from your insurers in terms of what the exposure really is? Is it a short lag? Or is it more end of policy audit?

Craig Smiddy, CEO

Great question. Yes. Usually, we get the reports within 60 days, in some cases, every 30 days. So it's perhaps more quickly than you would in a normal premium audit situation, where, I think, for example, on workers' comp, where that's a little more elongated as far as the ultimate audit.

Matthew Carletti, Analyst

Sure. I would like to understand the scale of industry exposures, particularly in sectors like retail, hospitality, and restaurants, which are significantly affected on the revenue side. Additionally, I'm interested in the impact on hospitals and first responders related to potential regulatory changes and presumption of injury. Could you provide some insight into these areas regarding the rough exposures in your workers' comp book?

Craig Smiddy, CEO

We have minimal exposure to travel and leisure sectors but do have some exposure in health care. However, it's important to note that we do not provide general or professional liability in those cases; we only have workers' compensation exposure. Regarding the evolving presumptive regulations, we are monitoring them closely and are ready to manage claims according to state-specific regulations. Currently, over 50% of the workers' compensation claims we are seeing lack a confirmed COVID-19 diagnosis. It's worth noting that about 80% of COVID-19 workers' compensation claims do not require hospitalization and have an average cost projection of $1,400 for indemnity and medical benefits. Around 15% of claims require hospitalization, resulting in an average compensation payment of about $50,000, while approximately 4.3% require ICU care, with a cost projection of about $140,000. Less than 0.7% of claims lead to a death benefit, which is projected at around $333,000. These figures provide important context. Furthermore, over 90% of the workers' compensation claims reported so far are loss-sensitive, primarily large deductible. Based on these numbers, we expect most payments to fall within those large deductibles. Given our conservative strategy to shift towards loss-sensitive business, this situation illustrates the effectiveness of that approach. Thus, we anticipate that over 90% of these claims will be settled by the insured within their deductible limits.

Matthew Carletti, Analyst

That's very helpful. I have one last numbers question before I step back. Regarding the slight favorable development from the prior period, 70 basis points, can you tell me if the changes in the three major coverage groups were just minor adjustments, or was there a significant negative in one and a positive in another that balanced out to that 70 basis points?

Karl Mueller, CFO

Yes, Matt, this is Karl. I would say, in the current year quarter, there are not significant movements between the three primary lines, workers' comp, commercial auto, and GL. As you might suspect, workers' comp developed slightly favorable for the quarter. Commercial auto was basically neutral, and GL did have a slight bit of unfavorable development. But when you wrap it all together, it was not significant.

Operator, Operator

We have one final question in the queue. We'll now take the next question from Greg Peters with Raymond James.

Charles Peters, Analyst

I'd like to kick off my round of questioning with perhaps, Craig, you could comment on the risk management business. And specifically, the news in the marketplace about employers for low-end employees and all of the huge numbers and increase in unemployment seems like the risk for you guys is that revenue will shrink in some fashion over the next several quarters. I know you don't really want to provide guidance on that, but maybe you could talk about how your conversations are going on with your risk management accounts currently? And what kind of indications are giving you about the state of their respective businesses?

Craig Smiddy, CEO

Sure, Greg. Well, on the risk management business, the majority of the exposure for that business is retained by the risk management clients. So when you look at the premium that we take in, it really is for some excess exposure for the servicing of the business. Therefore, when I think about revenue challenges going forward, the risk management business is not the area that is of greatest concern. It's probably of a lesser concern because, again, it's us really charging a fee, more of a fee-related kind of premium for the servicing of the business where the client's taking the risk. A decline in exposure or what have you, it mostly would have come out of that portion that they're retaining. The more concerning business is our midsized business. We're not necessarily a small business provider for workers' compensation and auto; I would say that we're more of a midsized player. The bigger concern would be those midsized players that are under such financial stress that they have difficulty rebounding when the economy comes around. So I'd say we feel pretty comfortable with where we sit with regard to our risk management business.

Charles Peters, Analyst

I understand there have been several important topics to discuss, and it seems fitting for you to provide some insights on them. Firstly, you categorize a property component within your General Insurance business. Business interruption is generally linked to property coverage. I'm not asking for your opinion on the current issues surrounding business interruption, but perhaps you could share some information regarding your exposures. Are the majority of your policies aligned with the ISO form? That would be helpful.

Craig Smiddy, CEO

Sure. I'd be happy to do that, Greg. Working with the financial supplement since the majority of you folks, I'm sure, have that nearby. If you look at our property writings, they make up about 8% of our overall net premiums earned. Of that 8%, three-quarters of that is Inland Marine, which there is no BI component to that. The remaining 2% of that property is property policies that would have a business interruption component. I can tell you that 99.8% of our policies for business interruption include the exclusion for virus and pandemic-related events. So we feel very good about, well, first, that we don't have a significant exposure. Second, that we have a very tight box around that because I will find that to invalidate that virus exclusion and create contract uncertainty and to abrogate the contract that was struck between the insured and the insurer, as you very well know, from everything in the industry right now is viewed by many, including us as something that would undermine contract law and even be unconstitutional. So we feel very strongly that those virus and pandemic exclusions that we have on the vast majority of our policies will ultimately stand.

Charles Peters, Analyst

Okay. And then the other piece, it's popped up recently, would be around force majeure. I'm curious about your portfolio if you have any clauses, force majeure clauses in there, et cetera? Maybe you can speak or opine on that briefly?

Craig Smiddy, CEO

Yes. Currently, we have the force majeure clause in our surety business, and we have thoroughly examined this area. We believe there are protections in place. So far, there has been no increase in claims on our surety policies, and we are confident that our surety contractors will be able to complete their work. Most states recognize contractors as essential workers, and at this moment, we do not have significant concerns regarding our surety business.

Charles Peters, Analyst

And the surety business, within the categories you identify on Page 4, where does that surety business flow through? Is that the financial indemnity or is that the other coverages component?

Craig Smiddy, CEO

Yes. It's under footnote two, which is financial indemnity.

Charles Peters, Analyst

I want to briefly change topics. Carolyn, while you mentioned the first quarter results positively, it seems like order flow has decreased. Although you may have concluded the quarter well, the market sentiment seems to have slowed significantly. Can you give us any insight into what we should anticipate in this business over the next several quarters, especially considering the economic damage caused by the COVID-19 virus?

Carolyn Monroe, President, Title Insurance Group

Well, Greg, right now, when we look at our current orders, they're keeping pace with where we were during the second quarter of last year. While the refinances have certainly grown, we just don't have an indication of a slowdown. Our revenue and our orders are right in line with the second quarter of last year.

Charles Peters, Analyst

And so you would expect the trends of last year to continue beyond the second quarter? Or is it just you think there's just a wave of refinancing because of lower rates? Or...

Carolyn Monroe, President, Title Insurance Group

Yes. We're at an all-time low on mortgage rates. I just think it's too early. A lot of it's just going to depend on how long this pandemic goes and when people are able to get back to work. It's too early in the process to really tell what the full impact will have on us.

Charles Peters, Analyst

Can you remind us of the percentage of direct versus agency?

Carolyn Monroe, President, Title Insurance Group

85% of our revenue comes from agents, our premium revenue.

Charles Peters, Analyst

Okay, great. I have one final question for Karl. Karl, you mentioned the changes in unrealized gains and losses due to market fluctuations at the end of the quarter. You also indicated how that unrealized loss position has improved since then. Can you provide an estimate of what that means for the impact on book value per share?

Karl Mueller, CFO

Greg, I do not have that broken down on a book value per share basis. I mean, it should be a simple matter.

Charles Peters, Analyst

So is it based on your comment that the unrealized loss that you booked in the first quarter would be reversed in the second quarter if the books were to close as of yesterday? Is that correct? Is that how I read your comments?

Karl Mueller, CFO

Well, the first quarter, the change from year-end was $962 million depreciation. That's now recovered to $175 million unrealized gain. A swing of almost $200 million. So that divided by roughly 3 million shares would get you to the answer.

Operator, Operator

Thank you. And we currently have no additional callers in the queue at this time. I'd like to turn the conference back over to management for any additional or closing remarks.

Craig Smiddy, CEO

Okay. Well, we would just like to thank everyone for participating today. Hopefully, when we reconvene in about 90 days from now, we'll be in a situation that is much better for this country. Hopefully, folks are able to be back at work and the economy is back on track. We wish you all the best during the time between now and then. Again, thank you for your support and your participation in today's call. Thank you very much.

Operator, Operator

Thank you. And again, ladies and gentlemen, that does conclude today's call. Again, we thank you for your participation. You may now disconnect.