Earnings Call Transcript - ORI Q4 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 Fourth Quarter 2022 Earnings Conference Call. Joe Calabrese with the Financial Relations Board, you may begin.

Joe Calabrese, Financial Relations Board

Thank you, Chris. Good afternoon, everyone, and thank you for joining us for the Old Republic conference call to discuss the company's fourth 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 our Republic's website. This call may involve forward-looking statements as discussed in the press release and financial supplement dated January 26, 2023. 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, along with 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, President and CEO

Okay, Joe, thank you very much. Good afternoon, everyone, and welcome again to Old Republic's fourth quarter earnings call. With me today are Frank Sodaro, our CFO of ORI, and Carolyn Monroe, our President of the Title Insurance business. As some of you may have seen earlier this week, we officially kicked off our recognition of the 100-year anniversary of Old Republic, and throughout the year, we plan on engaging with all of our stakeholders, including our shareholders, associates, customers, and distribution partners as we look to celebrate this milestone. ORI had another good quarter, contributing to a strong performance for 2022, with General Insurance producing significantly greater pretax operating income in the quarter and for the year, while Title Insurance pretax operating income was considerably less than the record-setting 2021 results, mainly due to the effects of increasing mortgage interest rates. Our reserve position remains healthy in all of our segments, led by General Insurance with very strong favorable prior year reserve development in the quarter and in the year. Our balance sheet is in great shape as we continue to efficiently manage our capital position and, as the release indicates, we returned a considerable amount of capital to shareholders during the quarter and the year through both dividends and share repurchases. Consolidated net premium and fees earned for the quarter and the year were lower, reflecting the lower year-over-year Title Insurance revenues. General Insurance net premiums earned increased by 7% for the year, while Title Insurance net premium and fees earned decreased by 29% in the quarter and 13% for the year. Our consolidated pretax operating income was $300 million for the quarter and just over $1 billion for the year, while our consolidated combined ratio came in at a very profitable level of 89.6% for the quarter and 91% for the year. Both General Insurance and Title Insurance produced sound, profitable underwriting results, as reflected in their respective combined ratios. Going into 2022, our expectation for Title Insurance was for considerably less revenue and operating income than in 2021, and we remain of the view that headwinds will continue for Title Insurance in 2023. ORI's strong consolidated results once again reinforce the soundness of our longstanding diversification strategy between P&C Insurance and Title Insurance, which we believe produces steadier earnings and returns over time. I will now turn the discussion over to Frank. Frank will turn things back to me to cover General Insurance, which will be followed by Carolyn, who will discuss Title Insurance, and then, as usual, we'll open up the conversation for Q&A. So with that, Frank, I hand it to you.

Frank Sodaro, CFO

Thank you, Craig, and good afternoon, everyone. This morning, we reported net operating income of $237 million for the quarter and $845 million for the year. On a per share basis, comparable year-over-year results were $0.80 versus $0.88 for the quarters and $2.79 versus $3.08 for the full year. Although both periods were down compared to the record set last year, our consolidated earnings were strong by historical standards. Shareholders' equity ended the year at nearly $6.2 billion, resulting in a book value per share of $21.05. When adding back dividends, book value increased just under 1% from the prior year-end, driven by our strong operating earnings, offset by lower investment valuations. The comparable increase for the quarter was 12.5% due to higher investment valuations and our strong operating results. Net investment income increased nearly 18% and 6% in the quarter and year, respectively. The increase for the quarter was driven primarily by higher yields, while the year benefited from both higher yields and an increase in the level of investments. During the quarter, we completed the rebalancing of our investment portfolio. For the year, we realized $375 million in net investment gains on sales of common stocks while offsetting those gains for tax purposes with sales of bonds, giving us realized investment gains of $62 million. This effort leaves us with a comfortable portfolio mix of 80% in highly rated bonds and short-term investments, with the remaining 20% allocated to large-cap dividend-paying stocks. The average maturity on the bond portfolio is 4.3 years, with a book yield of 3.3% compared to a market yield of 3.5%. Even after reducing the stock portfolio by roughly $2 billion, this portfolio still ended the year with unrealized gains of about $1.3 billion. Now turning to reserve development, all three operating segments recognized favorable loss reserve development for all periods presented. In total, the consolidated loss ratio benefited by 7.4 and 3.7 percentage points for the quarter and year, respectively, compared to 4.6 and 2.7 percentage points for the same periods a year ago. Prior year losses have come in lower than expected, driving this level of favorable development. While the mortgage insurance loss costs continue to be favorable, the trends of lower newly reported defaults and higher cure rates on loans already in default are beginning to align with pre-COVID levels as expected. The company paid another $35 million dividend to the parent holding company in the quarter, bringing the total return to $140 million year-to-date. In the quarter, we paid $67 million in dividends and repurchased over $175 million worth of our shares for a total of just over $240 million returned to shareholders. We entered 2023 with $169 million remaining on our existing repurchase authorization, which we will continue to execute on opportunistically. I will now turn the call back over to Craig for a discussion of General Insurance.

Craig Smiddy, President and CEO

Okay, Frank, thank you for that. So for General Insurance, net premiums written increased by 1% in the quarter and 8% for the year. Of note here, premiums written in the quarter were affected by premium adjustments, including audit premiums, and our expectation is for premiums to continue to grow at a pace more consistent with what you see in the overall 2022 annual growth rate. We continue to achieve rate increases on most lines of coverage, with the exception of D&O and workers' compensation. Our renewal retention ratios and new business production remains very strong. Pretax operating income rose by 35% in the quarter and by 17% for the year to $690 million. The loss ratio for the quarter was 57%, including 10 points of favorable loss reserve development, while the full year loss ratio was 62%, compared to 65% in 2021. Turning to the expense ratio for the year, it came in at 27.4% compared to 26.5% in 2021, with continued growth in lower loss ratio and higher commission ratios adding approximately 1 percentage point of additional commission to the expense ratio for the year. The combined ratio for the year was 89.5% compared with 91.3% in 2021. Turning more specifically to a few of the significant lines of coverage, commercial auto net premiums written continued to grow at an 11% clip during the quarter, while net premiums earned grew 7%. The loss ratio for the year was 66.6% compared to 71.5% in 2021. So while this line of coverage benefited from favorable prior year loss development in both periods, auto liability loss severity continues at the high single-digit level, and auto physical damage loss severity continues at a low double-digit level, while loss frequency still remains below the pre-pandemic levels. Our rate increases on this line of coverage are in the high single-digit range, which implies that we continue to cover overall loss frequency and severity trends. We believe our rate levels remain adequate relative to our target combined ratios for commercial auto. Looking at workers' compensation, net premiums written came in lower for the quarter and relatively flat for the year, affected by the premium audits I mentioned earlier and continued rate decreases. The loss ratio improved to 46% for the year from 59% last year. Here too, this line of coverage benefited from favorable prior year loss development in both periods, with loss severity slightly up and loss frequency continuing to trend favorably. We think our rate levels remain adequate relative to our combined ratio targets. We continue to follow loss frequency and severity trends very closely, especially in this inflationary environment that we're in. We believe our specialty growth strategy and our operational excellence initiative should continue to produce solid growth and profitability for General Insurance as we move forward. So Carolyn, I'll now turn the discussion over to you to report on Title Insurance.

Carolyn Monroe, President of Title Insurance

Thank you, Craig. The Title group reported premium and fee revenue for the quarter of $836 million, down 29% from the fourth quarter of 2021. Our pretax operating income of $45 million compared to $137 million in the fourth quarter of 2021. Agency premiums were down 27%, and direct premiums and fees were down 39% compared to the fourth quarter of 2021. Our combined ratio for the fourth quarter of 2022 was 96.2%, compared to 89.4% in the fourth quarter of 2021. The combined ratio for the fourth quarter would have been 94.1% without the state sales tax assessment, as noted in the release, which we expect to recover. While increasing mortgage rates, refinance decline, and a softening housing market impacted our residential activity, our commercial activity remained strong in the fourth quarter, with commercial premiums up 13% over the fourth quarter of 2021, representing 26% of our total premiums compared to 18% in the fourth quarter of 2021. Commercial premiums reported for the full year 2022 represented an all-time high for the Title group. As we enter 2023, we'll continue to focus on commercial opportunities. During 2022, we transformed and aligned our commercial operations with an internal structure that allows us to leverage more tools, resources, and support to enhance our capacity to deliver in this sector. With technology being an integral part of our business strategy, we will continue delivering on our digital future. While we are committed to delivering on our large technology projects and platforms, as highlighted in prior calls, we are also equally committed to continual enhancements to our current technology portfolio. The ability to electronically record with counties is an essential step in our digital end-to-end process vision. Throughout 2022, our e-recording company, ePN, has had the fastest growing network of county connections of the major platforms. This growth in our network will give our offices and agents additional access to counties throughout the country for closing files electronically. As we continue to work in a market facing headwinds, we'll take advantage of the opportunity to refine, evaluate, and enhance our services to our customers with an emphasis on our growing portfolio of technology to deliver measurable benefits and success for the industry, the company, and our shareholders. With that, I will turn it back to Craig.

Craig Smiddy, President and CEO

Thank you, Carolyn. So we think our diversification and specialty strategies produced another year of solid performance and profitable results as reflected in these consolidated figures. That concludes our prepared remarks, and we'll now open up the discussion to Q&A, and I will answer your questions or I'll defer to Frank or Carolyn to respond. So with that, can we please open up to Q&A.

Operator, Operator

Our first question is from Greg Peters with Raymond James.

Greg Peters, Analyst

It does feel like life has returned to normal with the Chicago finest returning from lunch hour during your prepared remarks…

Craig Smiddy, President and CEO

We do that just for you, Greg.

Greg Peters, Analyst

The prior year reserve development is clearly unexpected. Could you provide some insight into its origin? I know you made some comments on it, but I was reviewing the table in your press release that discusses the loss ratio, excluding prior period loss reserve development. While the quarterly numbers are cut off, the annual numbers have been trending down quite positively. As you consider General Insurance for 2023 and 2024, how do you foresee this loss ratio excluding prior period reserve development evolving? Is it stabilizing or is it likely to rise? What is your perspective on its future outlook?

Craig Smiddy, President and CEO

Greg, I'll answer the latter part of your question first, and then I'll turn it to Frank to give a little more color around the reserve development that you mentioned at the beginning of your question. The loss ratio, excluding prior period loss reserve development is, as you say, trending down, and that is a result of a few things. One is we've mentioned several quarters in our calls about the effects of the compounding rate increases and we continue down that path. And as those rate increases continue to compound, we have the ability to look at the current year more favorably when we set the loss pick. Additionally, as we mentioned when I talked about the expense ratio, we are writing more lines that have lower loss ratios, but one point is the figure I gave, one point of higher expense ratio coming from commission comes along with that. At the end of the day, we might be seeing a couple of points of improvement in the loss ratio from the line of coverage mix, but there is some offset there with that higher expense ratio. So those things together are what is reflected here in this loss ratio, excluding the prior period development. So now I'll let Frank talk more about where this favorable loss development is coming from.

Frank Sodaro, CFO

So Greg, yes, it's actually a fairly similar story for the quarter and year-to-date. The quarter had $100 million of favorable development, and the year was just under $200 million. The vast majority of this is coming from workers' comp and commercial auto and it's fairly evenly split. As far as the year, the majority of all years are favorable going all the way back to 2009. The only exception that I would mention is for the year-to-date numbers; we had the public company D&O that developed unfavorably and that affected 2018 and 2019.

Greg Peters, Analyst

Just as a follow-up to your answer, Frank, you said all years. It's my impression that Old Republic's approach to reserving was sort of a lockbox approach for the first three to five years, depending on the coverage. Has that changed?

Craig Smiddy, President and CEO

I'll be happy to answer that. It has not changed. Our approach to those loss picks and taking an approach whereby we are cautious about recognizing good news and, on the other hand, we're very quick to recognize what looks to be bad news. All of that is exactly as it's always been. Your recollection is spot on when it comes to workers' compensation; five years is generally what we believe is necessary to really understand where those losses are coming in. On auto liability, we think it takes at least three years on that line of coverage to really have an idea of where it might come in. However, there are only so many constraints we can have if indications are that reserves are very redundant. We do have some requirements to perhaps recognize those, and in those cases, there could be an exception. But our reserving approach is identical to what it has always been.

Greg Peters, Analyst

So just to clarify on that, Craig. Was there an exception to the fourth quarter release, or was that just the normalized approach that you have?

Craig Smiddy, President and CEO

We did see in the fourth quarter where workers' compensation and auto liability were coming out at the very top end of the ranges. So there was some adjustment to those lines. But as Frank said, the majority of it is from years going back all the way to 2009. But when we're in a position where we have to report our earnings, and we're at the top end of the actuarial ranges, then sometimes we're forced to perhaps recognize things a bit earlier than we would want to.

Greg Peters, Analyst

It makes sense, and thank you for the insights on that. I'll just ask one more question, Carolyn, and then I'll turn it to you. There are headwinds this year and to some extent last year. It appears that the expense ratio for the fourth quarter was a bit higher than your target. Can you revisit how you intend to manage expenses as revenue fluctuates with the current conditions in the mortgage market?

Carolyn Monroe, President of Title Insurance

As we approached the end of the fourth quarter, we began to understand what the next year might look like and have made necessary adjustments within our operations. Our focus on agency allows many expenses to self-regulate according to that business model. We have experienced personnel who have navigated similar cycles in the past, including the Great Recession, and I trust our management team to monitor the situation closely. We hold weekly calls to discuss our strategies and are actively trimming any excess. We're aiming to return to the operational standards we had in 2018 and 2019 as we move forward.

Operator, Operator

The next question is from Matt Carletti with JMP Securities.

Matt Carletti, Analyst

I'll start with a follow-up on Title, and I think you covered a lot of what I wanted to ask there. But maybe the question is, we've seen in the public domain that mortgage rates have pulled back a bit from their highs. It seems like mortgage applications in recent weeks have increased slightly. Are you guys seeing any follow-through or stabilization in Title volumes in recent months that we might not have noticed in the previous quarters?

Carolyn Monroe, President of Title Insurance

No, that really hasn't hit yet. When the rates and originations change, it takes some time for it to affect the Title companies. So I would say that we aren't expecting to see any change until probably the second quarter; that’s when we will start to notice it. We're currently in that first quarter cycle we used to always experience, where people do a bit, then sit back and wait to see what will happen. Then they get serious, and we start to see movement again in the second quarter.

Matt Carletti, Analyst

I would like to revisit the topic of General Insurance, particularly regarding the reserves. Could you elaborate on the factors influencing the development? Specifically, have medical loss costs performed better than anticipated, such as in workers' compensation, or is it more related to wages? What are the key underlying drivers? I understand it spans multiple accident years, but where are the main factors contributing to this change?

Craig Smiddy, President and CEO

I'd be happy to talk about that. In this case, it's likely the same reason for both auto liability and workers' compensation, which is loss frequency. As I mentioned, loss frequency turned out to be lower than we anticipated in several of those years, resulting in some benefits. Additionally, with compounded rate increases, as those take effect and we monitor losses, we found that in some instances, our rates were higher than necessary compared to the loss cost trend in severity and frequency. It's a combination of these factors. Specifically, in commercial auto, while there was a significant spike five or six years ago, it has stabilized at an upper single-digit level for the last few years. Currently, our rate increases are aligned with this. Severity remains an issue for auto liability. For workers' compensation, there's some emerging severity, but it is much less than what you might see with general inflation or even medical inflation. This is because workers' compensation has many constraints around managed care and billing schedules set by various states, leading to a lesser impact from medical inflation. The trend in workers' comp medical costs is not as significant. There is some emerging severity, but frequency has been the key story in comp over the past decade. As technology improves and safety measures benefit from these advancements, workplace accidents decrease, resulting in lower frequency. So it remains a frequency issue in comp as well.

Operator, Operator

The next question is from Paul Newsome with Piper Sandler.

Paul Newsome, Analyst

I was hoping to ask kind of a big picture question on Title. Could you just kind of refresh and talk about how your business today is the same or different than it was in the financial crisis in that chart in 2014? And then perhaps a financial question: why would we see some of the same revenue changes related to refinance as well as why would we see some operating leverage if we use those two periods as a benchmark?

Craig Smiddy, President and CEO

So Paul, just to be clear, comparing back to the financial crisis years, '07, '08, '09?

Paul Newsome, Analyst

Yes, as well as I look at your slide presentation, it looks like we had a little bump in refi in, I think, 2013 that also affected revenues as well, right? So maybe comparing and contrasting those two periods.

Craig Smiddy, President and CEO

Carolyn, if you don't mind, I'll just give my initial thoughts and then let you fill in. So with respect to refi, that well has dried up considerably, and at this point of where we're at with mortgage interest rates. What you're seeing come through in our numbers, and you would see that in our order count, our order count is significantly down; that includes refis. As I say, they have essentially dried up at this point. Comparing back to the financial crisis, if I understood some of your question, when we look at the loss ratios and what we're seeing today, we're in a very different environment with respect to loss ratios because back in the financial crisis period, with all of the issues around mortgages and how those mortgages were underwritten, or perhaps maybe not underwritten very well, everyone was looking to find any outlet they could to try to have some kind of recovery, and that resulted in some pressure on our Title business. However, in this current environment and over the last many years, the mortgage underwriting has been tightened substantially. Therefore, some of those knock-on effects we were seeing back in the financial crisis years we don't expect to come through. So Carolyn, please feel free to add to whatever I said or modify what I've said and fill in, if you could?

Carolyn Monroe, President of Title Insurance

No, I think you've covered it. The only thing I'll add is that one of the things that we really follow are the NBA and the Fannie Mae forecast, and they give us trends of what's happened with refis. There's nothing showing that we're going to bounce back with refis like we did after those years right now.

Craig Smiddy, President and CEO

The only other thing I would just add, Paul, more specific to our portfolio, is we are different from our two larger competitors in this space in that about 80% of our business comes through independent agents. So we essentially have a variable cost model where, in downturns, we don't have the level of fixed overhead to absorb; given that the independent agents are bearing that. That's an important thing to keep in mind. The only other thing relative to those earlier time periods you spoke about is what we've done in commercial specifically at Old Republic, and Carolyn touched on where we're at with commercial in her comments. That has been a focus of ours; we've intentionally tried to expand our footprint in that space over the last several years, and that is paying some dividends, as Carolyn pointed out in her comments, where we set a record on the amount of commercial transactions, which helped offset some of the residential headwinds that we're facing.

Operator, Operator

The next question is from Greg Peters with Raymond James.

Greg Peters, Analyst

So I thought I'd sneak in with a follow-up. Obviously, it's topical to where other companies are commenting on their reinsurance renewals, and you really haven't commented on that. One of the other things that's popped up with some of the other carriers is that they're hearing that the reinsurance commission rates have come in a little bit in certain instances. So just curious about your experience with your January renewals and your view on that?

Craig Smiddy, President and CEO

Greg, I’d be glad to discuss that. Our property reinsurance renewal is scheduled for July 1st, so we hope the situation will stabilize by then. I believe most of our industry peers have a January 1st renewal. As we all have noticed, conditions are quite challenging. As we approach the July renewal, we expect higher rates for our catastrophic cover, and we must prepare for that now, considering any additional costs we need to factor into our product pricing from the start. We are already addressing this. Additionally, we anticipate needing to retain a bit more on our property and catastrophic business. As you know, we manage that with a much lower retention compared to our peers, which is one reason we don’t write as much property business relative to them. For the property business we do underwrite, we purchase significant reinsurance at relatively low attachment points to avoid introducing balance sheet volatility, unlike some of our peers. Regarding casualty renewals, it varies; for our workers' compensation reinsurance renewals, everything has remained stable. Conversely, for our umbrella liability renewals, as you might expect, the increasing severity and the judicial issues we're seeing with litigation financing and jury awards indicate that the umbrella business we underwrite will need to adjust in line with the rising reinsurance pricing we're observing. There are also other lines like Directors and Officers (D&O) where we are currently in the renewal process. This area is specific to the line of coverage; for instance, security class action frequency reached record levels in 2017, 2018, and 2019, which resulted in significant losses for the industry. However, the frequency of these lawsuits has significantly decreased since 2019. Much will depend on how reinsurers view this trend. Furthermore, when discussing umbrella liability or specific coverage lines like D&O where there is a seeding commission, it's important to note that in addition to reinsurers seeking rate increases, they may also attempt to lower the seeding commission to achieve that rate.

Operator, Operator

There are 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 the analysts for their questions. Much appreciated. As I said at the beginning of our discussion today, we're looking forward to celebrating Old Republic's 100-year anniversary with all of you. We hope that 2023 will be as successful a year for us as the last several years have been. Thank you very much, and we will talk with you all again next quarter.

Operator, Operator

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