Earnings Call Transcript - ORI Q2 2022

Operator, Operator

Good afternoon. My name is Julian, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Old Republic International Second 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. I would now like to turn the call over to Joe Calabrese with the Financial Relations Board. Sir, you may begin your conference.

Joe Calabrese, Financial Relations Board

Thank you. Good afternoon, everyone, and thank you for joining us for the Old Republic conference call to discuss second 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 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 July 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 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.

Craig Smiddy, President and CEO

Okay. Thank you, Joe, and good afternoon, everyone, and welcome again to Old Republic's second quarter earnings call. With me today, I have Frank Sodaro, our CFO of Old Republic International; and Carolyn Monroe, the President of our Title Insurance business. Well, Old Republic produced another highly profitable quarter in both general insurance and title insurance, even though title insurance revenues and operating income were less than the record-setting 2021 results due to the increasing mortgage rate environment. Net premiums and fees were just below $2 billion, while pretax operating income was $263 million. And our consolidated combined ratio continues to come in at a strong level, just under 91% for the quarter. In general insurance, net premiums earned increased over the prior year by almost 9%. In line with what we expected, title insurance net premium and fees decreased by 7% from that prior record-setting year. Both general insurance and title insurance continue to produce excellent underwriting results reflected in those combined ratios and both are poised to continue to deliver strong profits throughout the remainder of the year. So I'll now turn the discussion over to Frank and then he'll turn things back to me to cover general insurance, followed by Carolyn, who will discuss title insurance, and then we'll open it up to the Q&A. So Frank?

Frank Sodaro, CFO

Thank you, Craig, and good afternoon, everyone. This morning, we reported second quarter net income, excluding investment gains and losses, of $210 million, a 5% decline from last year. On a per share basis, comparable year-over-year income was $0.69 versus $0.73. For the first half of this year, operating profit was $402 million, a decline of 6%. Although both periods were down when compared to the record set last year, operating profits were very strong by historical standards with considerably higher levels coming from general insurance, along with healthy levels of operating profit from title. Shareholders' equity ended the quarter at $6.4 billion, resulting in book value per share of just under $21. When adding back dividends, book value decreased by 5.8% from the prior year-end as a result of interest rates, the effect of that on our bond portfolio, and lower valuation in our stock portfolio were partially offset by the stronger operating earnings. Net investment income was relatively flat for the quarter as an increase in the invested asset base was partially offset by slightly lower yields earned. Given our current bond reinvestment rate of just over 4% versus a bond portfolio rate of 2.7%, we believe we are at an inflection point and expect higher overall yields on a comparative basis sometime in the next few quarters. During the quarter, we continued to rebalance our portfolio by reducing our stockholdings and increasing our investment in bonds, benefiting from the materially higher reinvestment rates. As a result of that process, we realized $53 million in net investment gains on sales, and our investment portfolio ended the quarter with 74% in bonds and short-term investments and 26% in stocks. During the quarter, the total fair value of bonds declined by $315 million while stock decreased by $280 million. The overall credit quality of our bond portfolio remains strong with approximately 98% of the portfolio in investment-grade securities. We are pleased with how well our stock portfolio has performed during this market downturn. During the year, we significantly outperformed the S&P 500 as a result of our strategy to reduce volatility and by investing in large-cap dividend-paying stocks, which ended the quarter in an unrealized gain position of over $1.2 billion. Now switching to loss reserves. All three operating segments recognized favorable loss reserve development. In total, the consolidated loss ratio benefited by 1.9 percentage points for the quarter compared to 1.8 percentage points for the same period a year ago. Mortgage insurance losses 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 dividend to the parent holding company in the quarter, bringing the total to $70 million year-to-date. Total shareholders' equity for the mortgage companies ended the quarter at $325 million. I will now turn the call back to Craig for a discussion of general insurance.

Craig Smiddy, President and CEO

Okay. Thanks, Frank. So for general insurance, net premiums written increased by almost 12%, and we continue to achieve rate increases on most lines of coverage with renewal retentions remaining strong and new business production also coming in strong. Pretax operating income also rose by almost 12% to $138 million. And the loss ratio we reported for the quarter was 65% compared to the 68% we saw in the second quarter of '21. And of course, this included favorable development, which came in at 1.9 percentage points in the quarter. The expense ratio came in at 27% with growth in lower loss ratio, higher expense ratio lines continuing to contribute about one additional point to our expense rate relative to our historical line of coverage mix. The overall combined ratio was 92.5 points compared to 94% in the second quarter of last year. Turning to some line of coverage specifics, starting with commercial auto. Net premiums in commercial auto grew by 10%, while net premiums earned grew by 6.5% and the loss ratio improved to 66% from the 75% we saw in the second quarter last year. Claim frequency appears to be working its way back to pre-pandemic levels in auto, but we're still not there in our estimation. And claims severity continues to increase but nowhere near the pace we saw in previous years. Our rate increases continue in auto in the high single-digit range, which implies that we continue to stay ahead of our overall frequency and severity trends. Looking at workers' compensation line of coverage, net premiums written rebounded in the quarter and grew by 9%, while net premiums earned increased by nearly 7%. And the loss ratio improved to 52% from 60% in the second quarter last year. Here, claim frequency appears to be returning to pre-pandemic levels as well and claim severity trends are slightly up. Rate decreases in workers' comp continue in the low single-digit range. But as we've stated in prior quarters, we still feel comfortable that our rate levels remain adequate relative to our combined ratio targets for this line of coverage. In the financial indemnity line of coverage, more specifically, the public company D&O component of that, we experienced unfavorable loss development during the quarter stemming from some large security class action claims in accident years 2018 and 2019. Additionally, in the same line of coverage, it appears new market entrants are driving down rates. So we're no longer seeing the very hefty rate increases we saw in 2019, '20, and '21 and there is considerable pressure on rates as we go forward. Those rate increases on public company D&O, in our opinion, were necessary as evidenced by the security class action activity we saw this quarter. So, we're keeping a very close eye on the Company D&O line, and we will exercise underwriting discipline and our underwriters won't write accounts that aren't priced adequately. It's that simple. As always, we follow loss trends very closely. That's what we do, and we'll continue to adjust our rates for inflationary trends that ultimately drive the severity trends. And that includes both general inflation and social inflation. We'll also keep a close eye on reserve levels relative to our observations and expectations surrounding inflation and adjust our reserves accordingly. So overall, general insurance growth strategy and underwriting excellence initiative continues to produce solid growth and profitability with new business production, high retention ratios, and generally increasing rate levels, all contributing to those results. So I'll now turn the discussion over to Carolyn who will report on what's happening in our Title Insurance segment.

Carolyn Monroe, President of Title Insurance

Thank you, Craig. The Title group reported premium and fee revenue for the quarter of just over $1 billion, down 7% from the prior year second quarter. Our pretax operating income of $110 million compared to $139 million in the second quarter of 2021, a decrease of 21.1%. Agency premiums were down $46 million or 5.4% over the second quarter of 2021, and direct premiums and fees were down $33 million or 12.9%. Our commercial activity remained strong this quarter, with commercial premiums up 25% over the second quarter of 2021 and made up 22% of our premium total this quarter. Our expense ratio for the second quarter of 2022 was 87.6% compared to 85.4% in the second quarter of 2021. This increase is primarily driven by the decrease noted in directly produced revenue, which have higher fixed expenses, along with a greater proportion of agency produced revenues that have a higher expense ratio. Agency commissions were down 5.8% for the quarter, roughly in line with the decrease in agency premiums. We believe that continuing with our strategic focus on serving our agents, which accounted for 79% 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 will enable us to navigate current market conditions. All other expenses were down by 2% in the second quarter of 2022 over the second quarter of 2021, with personnel expenses comprising almost half of that decrease. We will continue to manage and align our expense structure accordingly as rising interest rates are expected to soften commercial activity as well as residential markets. While we are reporting decreases in revenue and pretax operating income for this quarter, it is important to keep in perspective that these comparisons are to a year that saw record-setting demand for housing and investments in the real estate market. Our reported second quarter results for both revenue and pretax operating income ranked fifth in terms of all-time highs, trailing only the fourth quarter of 2020 and the second, third, and fourth quarters of 2021. The accomplishments of our employees and agents continue to be significant and drive positive results for the Company. While strong underwriting support is paramount in our value-add to our agents, we also recognize the importance of technology and we'll continue to offer and advance our portfolio of technology services and solutions. This includes, but is not limited to, the recently launched enhanced easy jacket application that I spoke about on our last earnings call, an in-progress project to enhance the Starlink portal that allows agents quick access to documents and applications. Also, continuing to invest in and enhance the integration platform supermarket that will allow our agents a standardized connection to an ecosystem of applications they need, including our closing software platforms, RamQuest and eClosing, our e-recording service provider, EPN, which allows for electronic document recording with counties and also our digital signing solution, Pavaso. We remain committed to combining Old Republic's 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 to Craig.

Craig Smiddy, President and CEO

Okay. Carolyn, thank you very much. So we remain very pleased with our strong levels of profitability in both general insurance and title insurance, and our diversified specialty strategy should continue to produce stable, profitable results and value for our shareholders. So this 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.

Operator, Operator

Our first question comes from the line of Greg Peters with Raymond James. Sir, your line is open.

Greg Peters, Analyst

Throughout the years, some things never change, and it seems like the Chicago's finest are back from lunch because I can hear the sirens in the background. Craig, this has been happening for decades, which is quite ironic. I know others will have questions, so let’s begin with the general insurance business. I believe you made adjustments to the financial indemnity, but it's impressive for your company to achieve 10% top-line growth. Specifically, workers' compensation is close to 10%, which you acknowledged, and it's viewed negatively in the investment community right now due to the belief that it's a soft market. Can you provide some insight into where this growth is coming from? Is it from acquiring new business with increased unit counts? What are your thoughts on the new business you are writing?

Craig Smiddy, President and CEO

Sure, Greg. I'd be happy to. So I think one thing to start is keeping perspective on where we were at a few years ago pre-pandemic with workers' comp. And if you look back, you could refer to the financial supplement as well. You can see that we had really reduced our premiums quite significantly over the course of the years in the supplement, if you look at year '17 through '21. So, as we reported during the quarters at the beginning of the pandemic and through last year, premiums were coming down, and exposure growth was coming down, and we've seen a rebound there. So we're really getting a lift from exposure growth within our existing policies and adding new business, and at the same time, trying to hold as much rate as we can. So we would not be growing that line if we didn't think it was at a profitable level. And you can see the reported combined ratios, of course, are very strong but include favorable development, as you know. However, even on a current accident year basis, we feel very good about where those loss ratios are projected to come in at, given our target combined ratios for that line of business. So hopefully, that provides some of the color and history I think is necessary when thinking about that bump up in comp and comparing it to those prior years.

Greg Peters, Analyst

Yes. It’s important to discuss the appropriate inflation factor for your loss pick assumptions in general insurance. We’ve seen companies like Chubb and Cincinnati report increases in their loss picks. I’m curious about your perspective on how you’re approaching these inflation factors for your book of business.

Craig Smiddy, President and CEO

Definitely. And I know some of our peers, including those you mentioned, talk about a very general inflation factor. We don't really talk about it in a general fashion because you really need to look at the severity and the frequency by line of coverage in our opinion. So for instance, on comp, you look at, well, what's happening with the frequency first and then you take a look at the severity. And their medical inflation is not running anywhere near general inflation. The decreases that are still happening in rates and comp have occurred over many years because of the frequency. So, I don't like to generalize when we're talking about what kind of severity trend or inflationary trends we are building in. It really depends on the line. Now on the other side of the coin, if you look at our auto physical damage, it's quite the opposite story where the inflationary trends we're seeing there that ultimately end up in the severity trends are really high right now with labor increases, parts increases, used vehicle price increases, and the list goes on. So on auto physical damage, the trends we're seeing there are probably double digits. So you really have to look at it by line of coverage in our opinion. And with regard to your point about current accident year loss ratios there, when we look at those picks, it all depends on what kind of rates we're getting. And as I commented on auto, where we believe that we're actually getting rate that implies we're ahead of the inflationary trends, including social inflation we are seeing still on auto, there would be no reason to go back and adjust our auto accident year loss picks for this year because we're getting rate that is, in our view, ahead of the trends that we're seeing. So again, it would depend on line of coverage. We'll look at what we're seeing, and if those inflationary severity trends are coming in with more than we're getting in rate, we have to go back and look at things. But we're doing our very best to on all lines of coverage to reinforce with all of our underwriters the necessity of getting rates that are at least commensurate with the trend and preferably some cushion to allow us to absorb the unexpected.

Greg Peters, Analyst

That's a detailed response. I want to shift to discussing the Title segment for my final question. There's been a lot of talk about the lack of activity in the marketplace currently due to higher rates, yet you still delivered a strong performance. I assume part of this is due to the lagging nature of your business. Looking at the direct orders, Carolyn, they appeared to have dropped around 24% from the second quarter of last year to this year's second quarter. When things stabilize, what do you believe is a normal revenue base? Of course, we need to disregard the events of last year and the past few years; what would be the appropriate revenue level to consider for how this business might operate once things return to normal?

Craig Smiddy, President and CEO

Carolyn?

Carolyn Monroe, President of Title Insurance

Sure. When we plan, we look back and use 2019 as a baseline, excluding the last two years. We consider home price increases since our revenue is tied to sales prices, which affect our premiums. This gives us a foundational perspective. In this quarter, we were over 60 percent ahead of 2019. While there is some slowdown, the situation on the ground with our agents differs from what the reports suggest. It may take some time for the market to catch up with sales. Home prices remain strong, and despite rising interest rates, there is still demand for buying homes. The slowdown comes after several strong years, but when compared to 2019, it doesn’t seem as severe. This is how we are approaching our management strategy.

Greg Peters, Analyst

If I consider the 24% decline in direct orders as a potential indicator, could we expect revenue to also decrease by 24% in the third quarter? I'm not looking for an exact figure, just a general direction. It seems like we might see an acceleration in this slowdown as the year progresses. However, your response is a bit unclear since you mentioned that we aren't observing these changes just yet. Could you please clarify that for me?

Carolyn Monroe, President of Title Insurance

The 24% does seem like a significant percentage for the future. However, the real estate market is quite difficult to forecast. Honestly, coming into this year, I didn’t expect us to perform as well as we did in the second quarter, given all the information we were seeing. That's what informs my comment; at the start of the year, I genuinely thought the second quarter wouldn't be as strong as it turned out to be. This makes predictions challenging. In our commercial segment, 82% of our commercial business is generated by our agents, and that sector is performing well, which has positively impacted us this last quarter.

Operator, Operator

There are no further questions at this time. Mr. Smiddy, I turn the call back over to you.

Craig Smiddy, President and CEO

Okay. Well, we thank everyone very much for participating, and we will continue to work hard here to keep on top of things as the macroeconomic environment continues to change and we, as I said earlier, have every expectation that we will continue to produce very strong profitability in both general insurance and title insurance as the year continues. So we look forward to seeing you next quarter. And again, appreciate your interest and participation.

Operator, Operator

This concludes today's conference call. You may now disconnect.