Rli Corp Q4 FY2020 Earnings Call

Good morning, and welcome, ladies and gentlemen to RLI Corp.'s Fourth Quarter Earnings Teleconference. As a reminder, we will open the conference for a question-and-answer after the presentation. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain factors and uncertainties, which could cause actual results to differ materially. Please refer to the risk factors described in the company's various SEC filings, including in the Annual Report on Form 10-K as supplemented and the Form 10-Q for the quarterly period ended December 31, 2020, which should be reviewed carefully. The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing fourth quarter results. RLI's management may make reference during the call to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI's operating earnings and earnings per share from operations consist of net earnings after the elimination of after-tax realized gains or losses and after-tax unrealized gains or losses on equity securities. RLI's management believes these measures are useful in gauging core operations, performances across reporting periods, but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available on the company's website at www.rlicorp.com. I will now turn the conference over to RLI's Vice President, Chief Investment Officer, and Treasurer, Mr. Aaron Diefenthaler. Please go ahead, sir.

Thank you, Madison. Good morning, thanks for joining us on our fourth quarter earnings call. As usual we have Jon Michael, Chairman and CEO; Craig Kliethermes, President and COO; and Todd Bryant, CFO. Jon is going to begin with some opening comments. Jon?

Thank you, Aaron and welcome to the final earnings call to close out 2020. In many respects, we are ready to move on to 2021, but I would be remiss if I didn’t mention that RLI overcame many challenges during the last 12 months and delivered strong results. There is much to be proud of for 2020. Gross premiums were up 7%. GAAP equity grew to $1.1 billion after returning more than $87 million to shareholders during the year. And we achieved a 92 combined ratio. That 92 combined marks the 25th consecutive year of underwriting profit for RLI. These results could not have been possible without the hard work of our talented associates who persevered through tremendous uncertainty and change to keep our business, and more importantly, our customers' business moving forward. I'm proud of our entire team for their outstanding efforts. As usual, you'll get more details from Todd and Craig on our fourth quarter and year-end performance, and we will be glad to answer your questions at the end of the call. And before we move on, I want to take a moment to congratulate Craig. In December, I announced my plan to retire at the end of this year and that Craig will be assuming the CEO role at the beginning of 2022. Craig is a proven executive and I have complete confidence in his ability to continue leading RLI to achieve success. Congratulations, Craig. And now, I'll turn it over to Todd who will provide some financial highlights.

Thanks, Jon, and good morning, everyone. Congratulations to Craig as well. Last night, we reported fourth quarter operating earnings of $0.75 per share. The quarter's result reflects elevated catastrophe losses, which were offset by favorable benefits on prior year's loss reserves, as well as improving current year casualty results. We achieved 10% top line growth and posted an 88 combined ratio. Investment income declined modestly, while unrealized returns on the investment portfolio continued to rebound from adverse trends earlier in the year. Overall, strong net and comprehensive earnings drove book value per share up 22% for the year, inclusive of dividends, to end the year at $25.16. Pricing momentum continued in a number of our products and the pandemic's influence was muted in the quarter, with casualty posting 9% top line growth, while property and surety were up 15% and 2%, respectively. Craig will talk more about individual products and market conditions in a minute, but overall, growth in gross premiums written was driven largely by rate increases and expanded distribution. From an underwriting perspective, we posted a fourth quarter combined ratio of 88.0 compared to 92.4 a year ago. Our loss ratio declined 3.5 points to 45.8 as reserve benefits offset 6.5 points of hurricane losses posted in the quarter. In addition to catastrophe losses, we maintained the elevated current year loss booking ratios discussed the last few quarters on certain financial-related products where heightened exposure to pandemic-related losses exist. This resulted in recording another $3.5 million in COVID-19-related pre-tax losses, $2.5 million in casualty and $1 million in surety. Year-to-date, reserves established for COVID-19 totaled $18 million. By segment, amounts recorded totaled $2 million for property, $3 million for surety and $13 million for casualty. To date, we have paid less than $10,000 in actual indemnity losses on what we deem as COVID-related. Over 90% of claims received have been closed without payment, but we continue to investigate and review all claims submitted. Offsetting reserve additions in the quarter were approximately $25 million in net benefits from prior year's reserve releases, largely within the casualty segment, where the majority of products posted favorable experience. Moving to expenses. Our quarterly expense ratio remained below last year, down 0.9 points to 42.2. Relative to last quarter, however, this ratio moved higher as metrics that drive various incentive plans, combined ratio, operating return on equity and book value growth, all improved significantly during the fourth quarter. I would note, however, on a year-to-date basis, our expense ratio was 40.8, down 1.8 points compared to last year. The decline was aided by growth in revenue, modestly lower amounts earned under incentive plans as well as targeted expense reduction and deferral initiatives that began at the onset of the pandemic. As mentioned last quarter, we continue to evaluate areas of opportunity for efficiency gains and expense savings, while increasing our investment in technology, particularly those related to customer experience and ease of doing business. Turning to investments. Capital markets made up lost ground in the quarter with robust returns in the last two months of the year. Public equities were responsible for most of the quarter's 3.2% return. However, bonds put in a positive result even with higher risk-free rates. While total return was a significant contributor to the increase in shareholders' equity, investment income remains under some pressure from the current rate environment. It is not our preference to reach for risk to make up for lower rates, but to keep putting money to work, letting portfolio growth stem the tide. The majority of operating cash flow is being invested in high-quality fixed income securities. Outside of the core portfolio, our share in investee earnings was down in the quarter. Maui Jim results were influenced by normal seasonality as well as certain mark-to-market adjustments on loan to live assets. For Prime, the investee earnings continued to advance, reflective of growth in revenue and earnings they are experiencing. All in all, a very good quarter and solid year. We ended the year with $1.1 billion in shareholders' equity, our combined ratio was 92.0 for 2020, which, as Jon mentioned, represents our 25th consecutive year of reporting an underwriting profit. Once again, operating income and solid investment performance resulted in capital generation in excess of current needs, which was returned to shareholders in the form of a $1 special dividend in December. In 2020, we marked our 45th consecutive year of paying or increasing our quarterly dividend. With special dividends, we have returned over $1.1 billion in dividends to our shareholders over the last decade. And with that, I'll turn the call over to Craig.

Thank you, Jon and Todd, and good morning, everyone. Given all the challenges faced in 2020, we are proud of our success. We reported our 25th consecutive year of underwriting profit and grew top line by 7%. A great quarter overall, with an 88 combined ratio on 10% top line growth. Large parts of the market appeared to be shifting in our favor with the retrenchment of some competitors, rates increasing, and terms tightening. We still see some uneven fees ahead but are confident that with our diverse portfolio of products and underwriting discipline, we are well positioned to take advantage of opportunities presented. Now I'd like to go into a little more detail by segment. In our casualty segment, we saw 9% top line growth for the quarter and ended the year up 6%. We were able to achieve a very good underwriting result for the quarter and the year with an 85 and 92 combined ratio, respectively. Growth has been fairly widespread across the segment with our excess liability businesses leading the way. We continue to see opportunities in both our personal and commercial umbrella businesses, where we focus on the first excess layer. Our executive products group is also growing at a relatively good clip but mostly from needed rate increases. Our transportation insureds are still struggling. And as a result, we realized a 25% revenue decline for the quarter and 40% for the year. Overall, in the casualty segment, rates were up 11% for the quarter and 10% year-to-date, which is outpacing our expectations for loss cost inflation. We believe double-digit rate increases are still achievable in auto liability, excess liability, and the directors and officers product lines, which for us, make up about half of the net premium in this segment. The market remains very competitive in primary limit liability and package businesses where we target small and medium-sized professionals and contractors. In property, we grew 15% in the quarter and 11% year-to-date. We achieved an underwriting profit in the quarter but did end up in a loss position in this segment for the year. Obviously, a tough year with a dozen name storms making landfall in the U.S. Property business is where the market is hardening most broadly, with rates up 11% across the segment for the quarter and the year. Our catastrophe-focused wind and quake businesses led the way and year-to-date rates were up 35% and 18%, respectively. Our Marine business continues to find opportunities from disruption at Lloyd's, with rates up 9% for the quarter and year-to-date. Our Hawaii Homeowners book also continues to grow profitably. Surety remains the most competitive segment for us. We were able to grow the top line 2% this quarter but did end up the year down 1%. The combined ratio continues to outperform at an 85 for the quarter and 75 year-to-date. Given some of the headwinds this segment has faced, both from the fallout of the pandemic and intense competition in the surety markets we serve, our underwriters have done a great job staying disciplined and working with our producers to manage risk and produce great results. Our focus on customers with strong balance sheets and good management has been beneficial during the financial stress and economic uncertainty resulting from the pandemic. We believe that keeping the powder dry will serve us well as we are optimistic this market will eventually swing in our favor. Overall, a great quarter and a very good year. When I think about everything that has happened over 2020, it reminds me of stories my grandmother used to tell me when I was young. I remember she would tell anecdotes about growing up poor in rural Missouri. During her first 25 years on earth, she grew up with the Spanish flu, the first World War, the spread of polio, and The Great Depression. It was unimaginable to me at the time, but it now seems like we have all lived a quarter century in the past year. Like my grandmother, who lived to the age of 92, we have also been resilient and will persevere. Our company has overcome many extraordinary challenges over the last 25 years of its existence but still delivered underwriting profit every year. To get where we are today, we have adapted, adding many diverse products, building out our surety business and sizing our catastrophe business based on market conditions. What has not changed is our focus on hiring narrow and deep talent who are champions of our ownership culture, empowering them to serve our customers and reinforcing disciplined underwriting through a compensation structure that rewards underwriting profit and is paid out on real results over time. We feel good about where we are and where we are going. We will focus on our customers, look outward, adapt to the change around us, and continue to deliver value to our shareholders. We are comfortable being different because being different has worked for RLI and all its stakeholders. I want to thank our RLI owner associates for their contribution and willingness to face the challenges of 2020 head-on. Our company has a rich history of success because of the quality of people who work here. Thank you. And I'll turn it back to the moderator to open it up for questions.

Our first question comes from Cullen Johnson with B. Riley Securities. Please go ahead.

Hey, this is Cullen Johnson from B. Riley Securities. Thanks for taking my question. First, I am just looking at the accident loss ratio, specifically in Casualty doing pretty well in the quarter, and we're just curious who is kind of driving that and maybe how sustainable that might be?

It's a good question, Cullen. I think we noticed a stronger performance this quarter compared to the year-to-date figures. Last year, we experienced some adverse developments in the fourth quarter related to a couple of runoff products, which didn't happen this year. This accounts for some of the differences. On a full-year basis, although I'm hesitant to use the term mix, it is a contributing factor. Our mix is shifting towards lower loss ratio products in the casualty sector, and there's also some improvement in the current accident year. While the impact on the loss ratio isn't dramatic and the adjustments we've made with our actuaries reflect that, there is approximately a one-point difference. Looking ahead, we're definitely considering all factors related to loss trends and rates, and as we enter 2021, these elements are being taken into account.

Great. That's helpful. Looking at the surety segment, the expense ratio was a bit higher this quarter. I apologize if I missed this earlier, but was there a primary reason for that?

No, it was primarily due to incentive-related compensation. If you consider the book value growth and comprehensive earnings as a proxy, it saw a significant increase in the fourth quarter. Overall, the incremental increase in the net expense ratio for incentive compensations was around three points. However, with earned premiums being slightly lower in surety and property, the impact there will be more noticeable. Without those factors, the expense ratio would have been quite similar to the levels in the third quarter.

Great, thank you. I needed that.

All right, we can go ahead and take our next question from Jeffrey Schmitt with William Blair. Please go ahead.

Hi, good morning. You've talked in the past about how the market's sort of been coming to you from a pricing perspective. And where do we stand with that dynamic? I mean, rates continue to move up in casualty a little bit more this quarter. Are we at a point where, I guess, you could really see a lot more, write a lot more new business and premium growth moves above rate level by a greater amount or is there some kind of repositioning, I guess, going on that maybe offsets that a bit?

Jeff, this is Craig. We're constantly seeking opportunities for growth, especially in markets that are moving in our favor. We're observing market changes, particularly regarding policy conditions, which are becoming stricter. This isn't necessarily the case for us, but it does make us more competitive against others. Our policy reform is increasingly competitive. Rates in the product lines I've mentioned earlier are remaining steady, similar to the last few quarters. We haven't experienced any decrease in rate increases, perhaps slightly more momentum on the property side than before. However, the environment for some primary liabilities and smaller accounts remains competitive. We're still achieving moderate rate increases of about 2% to 4%. Some customers are struggling to afford higher rates due to shrinking exposure bases. Nonetheless, our customer retention is strong, and we feel positive about our current situation and the potential opportunities ahead.

Okay. You mentioned terms and conditions. Is this focused mainly on the more challenging accounts, or is it more widespread? I'm curious about how much impact this has on premium growth, since if you're offering lower limits, it seems you'd be charging less. What kind of impact does this have on premium growth?

Well, actually, in some of those businesses, frankly, the market is seeing that you could actually cut the capacity and still get the same premium you got last year. We've particularly seen that in the D&O space, not just for us but for competitors, they've been able to cut the limits, whether they're in half or by a substantial amount, and still get close to or the same premium they got last year. So I don't necessarily see that as a headwind. Actually, it's an opportunity. That's a good story, right? You get as much premium, but you've got half the exposure. That's a great story. So I don't see it as a headwind. I think there's still more opportunities. We like the shorter limits. So actually, this gives us more opportunity to play than these bigger limits that were out there that we would never play in before. When they needed $25 million in chunks, we would not play in that spot. So now that they're interested in fives or even tens, that creates more opportunity for us, I think.

Okay. Okay. And just one last one on loss cost. I mean we've heard competitors say they're seeing it in the 5% to 6% range for casualty, I guess. Is that in line with what you're seeing? And does that take into account some of the lower court activity we saw this year just because of the pandemic?

That's a great question. When we examine long-term trends, we would estimate that casualty trends for the niche markets we operate in are generally in the 4% to 6% range on average, depending on the product. The rates we are currently obtaining exceed that range, which gives us confidence. We have noticed a slight pause, along with a reduction in claims across our portfolio, including new and ongoing claims, even when factoring in additional COVID-related claims. If we exclude those, we're seeing a reduction in claims that's more akin to double digits, primarily in liability and many auto products. However, I expect this to rebound quickly as activity resumes, particularly since much of this is related to people not leaving their homes. We offer a personal umbrella product aimed at an older demographic, which has been disproportionately affected, but we anticipate that activity will pick up again soon.

Okay, we'll go ahead and take our next question from Matt Carletti with JMP. Please go ahead.

Okay, thanks. Good morning. Craig, I wanted to circle back. I think you made a comment when you were talking about the casualty market about commercial auto, saying it's still struggling. I think you quoted down about 25% volume in the quarter and 40% for the year. Can you unpack that a little bit? How should we think about that? How much of that volume is the result of kind of pandemic forces that they may come back to the market as things reopen? How much of that is volume that's probably gone, call it, from an underwriting basis? Or are you guys assessing risk and not going to write it? And how far through that downturn do you think we are? Are we kind of through the reductions? Or do you think there's more to go?

Okay. Matt, I understand you asked several questions. Most of the reduction we've experienced over the past year and the last quarter relates to a decrease in our exposure basis. Our retention rates have remained relatively strong, and only a few of our insured clients have gone out of business. We're feeling positive about that. However, many of our clients are facing challenges. I've spoken with some of them, and it's clear that things are difficult. They aren’t receiving the support they need, and the charter bus sector is particularly affected. This doesn't encompass all our transportation business since we also deal with trucking, ambulances, and other specialty auto services. Some of those areas continue to operate, although there might be a slight decline in mileage and activity, but we anticipate a rebound. Regarding the charter bus business, which primarily serves an older demographic, it will take time for people to feel comfortable enough to resume travel. New habits are difficult to develop, and it will take time for individuals to feel secure about traveling in buses with larger groups. We're optimistic that the trucking segment will recover more quickly. Our commercial specialty auto business is already showing signs of recovery, while other public transportation sectors, including school buses, are expected to pick up as more schools reopen. Many parents seem eager for that, based on what I see in the news. I believe we’ll witness a gradual recovery across different segments of public transportation spending.

All right, we can go ahead and take our next question from Meyer Shields with KBW. Please go ahead.

Thank you for your question. I wanted to ask about your significant exposure to construction. Could you outline your expectations regarding an economic recovery potentially occurring in the second half of the year? Additionally, is the portfolio significantly at risk due to the increase in remote work?

Meyer, I assume you're not referring to construction contextually, or is that what you mean?

No, I'm just trying to understand how much of that is commercial construction that will be less necessary going forward.

There's a good mix of construction customers. We don't engage in track homes; we prefer custom residential projects. We also handle commercial high rises, but only interior work, not exterior. We work on roads and bridges in certain regions, but not everywhere. Our contractors currently have enough work to maintain their businesses and haven't faced the challenges we've seen in the public space. The key question is whether the project pipeline will refill, which depends on the severity of the economic downturn. For now, we feel optimistic. Many customers are recalibrating their expected exposures for the upcoming year, adopting a more conservative approach than previously. A number of those policies are auditable, and any increase in revenue could benefit us through audit premiums. You might see some of those adjustments reflected in our results over the next year, but I'm confident we'll manage through it. We tend to focus on stronger contractors, and I feel positive about our future. Regarding remote work, we only deal with custom homes. While there have been occasional claims related to contractors and homeowners, these incidents are rare, with most claims arising from job sites in commercial construction. Many of our staff are moving equipment, and in surety, bonding for residential work is minimal, meaning it's not significantly affected. I don't anticipate a surge in activity due to increased work-from-home trends unless there's a reduced demand for new space, which we will observe.

Okay, that was very thorough. Switching gears a bit, can you break down the casualty reserve releases? Are they due to the frequency of claims not coming through, or is it related to severity or mix?

Yes, it's Todd. I think it's a mix. We're taking a longer-term approach to the loss and cost trend. From that perspective, if we don't see changes and are a bit slower on the actuarial side to recognize it, this will impact us over multiple years. I believe there are decent amounts in both CUP and GL from 2013 to 2018, likely more weighted towards the more recent accident years, particularly transportation. The 2018 year looks more favorable. Additionally, there's about $3 million related to the two products we exited two years ago, healthcare liability and medical professional. We are seeing the effects of that now that we're two years post-exit. Overall, the loss and cost trends have been below the expectations that were set, and this has been a multi-year situation.

Okay, that's fantastic. Thank you.

Okay, we'll take our next question from Casey Alexander with Compass Point. Please go ahead.

Hi, good morning, and thank you for taking my question. I have noticed reports of over 100% premium increases on D&O renewals and a significant shortage of D&O insurance in the market. I'm curious about your perspective on this situation. Clearly, such rate increases are influenced by losses, but what is your outlook on expanding that business? How are you planning to retain the existing business you have? Additionally, could you provide some insight into how challenging this market has become?

Sure, I appreciate the question. Any rate increase has to be considered in the context of our starting point. We don't believe we've significantly underpriced our products, but we are experiencing notable rate increases, and we will take what the market offers. This product has larger limits compared to others in our portfolio, and we can only secure reinsurance capacity through a quota share arrangement. We are keen on growing this product, especially where we see an increase in rates. We prefer to see growth coming from rate rather than volume, which allows us to expand our business while keeping exposures stable. Last year, this segment grew nearly 40% and received over a 40% rate increase, so we believe our focus should remain on that.

All right, great. That's my only question. Thank you.

Thank you.

Okay, if there are no further questions, I will now turn the conference back to Mr. Jon Michael.

Thank you all for attending. I'm glad we're into 2021. My colleague Craig is looking forward to Super Bowl. Today, he's wearing Patrick Mahomes socks. So thank you all and we'll talk to you at the end of the next quarter. Thanks.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 with an ID number of 3759198. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.