Rli Corp Q2 FY2023 Earnings Call

Good morning, and welcome to the RLI Corp. Second Quarter Earnings Teleconference. After management's prepared remarks, we will open the conference up for questions and answers. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may take 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 in Forms 10-Q, all of 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 third quarter results. During the call, RLI management may refer to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI 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. Additionally, equity in earnings of Maui Jim and the related tax were excluded from operating earnings and operating EPS for 2022 due to the sales of RLI's investment in the third quarter of 2022. RLI's management believes these measures are usual in gauging core operating performance across reporting periods but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains a reconciliation between operating earnings and net earnings. The Form 8-K and press release are available at the company's website at www.rlicorp.com. I will now turn the conference over to RLI Chief Investment Officer and Treasurer, Mr. Aaron Diefenthaler. Please go ahead.

Good morning. Thank you for joining us to review RLI's results for the second quarter and the first half of 2023. As usual, we are joined by Craig Kliethermes, President and CEO; Jen Klobnak, Chief Operating Officer; and Todd Bryant, Chief Financial Officer. Craig is going to start us off with some introductory remarks. Todd will offer a play-by-play of the financial results. Jen will then comment on market conditions and further details on our product portfolio. We can then open things up for questions, and Craig will close with some final thoughts. Craig?

Well, thank you, Aaron, and good morning, everyone. I'm very proud of the efforts of all of our associate owners as they delivered again with significant top line growth, an outstanding combined ratio across all segments, and overall book value growth for the quarter. I'm very pleased with where we stand at midyear. At RLI, we come to work each day knowing that we can and must be better than the day before. Perfection may not be attainable, but we're striving for it, and we are successful because we focus on making decisions that will best serve our customers and our shareholders over the long term. The good decisions we make today may not be realized in the next quarter, but will benefit us over the next decade. We have no control over the competitive landscape, but we can decide when and how we grow. We have a broad and diversified portfolio with underwriting expertise that knows where the opportunities exist and the willingness and courage to let our portfolio evolve with current market conditions to optimize profitable growth. We have the confidence to execute because we don't let problems go unattended and, instead, exert more effort on the products and services where we can be most successful in providing differentiated services to our customers. That is what we have done to create a solid track record of success and is what we continue to do this past quarter. I'll let Todd and Jen go into more detail on the financials and the market in general. Todd, take it away.

Thanks, Craig. Good morning, everyone. Yesterday, we reported second quarter operating earnings of $1.16 per share. The quarter's result reflects solid underwriting performance and continued growth in investment. All in, we posted a combined ratio of 87.2% for the quarter, now 82.7% for the year, and experienced continued top line growth, which was up 21%. Investment income advanced 56%, as rising reinvestment rates on a larger asset base have been accrued. Operating cash flow of $174 million was up nicely for the quarter and continued to support growth in invested assets. Also important, the equity portfolio posted $25 million of unrealized gains compared to $101 million of net unrealized losses a year ago. Large equity price movements between periods can have a significant impact on net earnings, which you can see in comparative results for this quarter. Realized gains were $6 million in the quarter for funding of modest portfolio rebalancing. From an underwriting income perspective, the quarter's combined ratio was 87.2% compared to 80.2% a year ago. Larger catastrophe losses, coupled with a reduced benefit from prior year's reserve releases within the casualty segment, increased the loss ratio by six points. Storm losses totaled $18 million in the quarter, a $17 million impact in property and $1 million casualty. Spring storm activity in Texas, Oklahoma, and Florida was up considerably compared to last year and impacted our results. In addition, several of these losses on the property side were in excess of $1 million and remain within the higher retention on our property per risk treaty, which was increased to $2 million in 2023. I will certainly note a notable impact on the property segment's loss ratio. Revenue growth from rates achieved over the trailing four quarters served to moderate the overall impact of the segment's results. For casualty, the underlying loss ratio was impacted by modest additions to the current accident year in our energy casualty book. In total, though, the segment's current accident year loss ratio is similar to the first quarter's results. From a prior year's reserves perspective, all three segments benefited from favorable development. Inclusive of $2 million in catastrophe-related reductions, casualty posted $11 million of favorable emergence across a number of product lines. While down from the second quarter last year on a year-to-date basis, prior year emergence was similar to last year. As mentioned previously, reserve movements in an isolated period can vary, and evaluating trends over a longer time frame is typically more informative. Property experienced $4 million in favorable development as marine, excess and surplus, and admitted property lines posted loss reductions. For surety, favorable reserve development was also $4 million. Our approach to reserving remains the same, and the quarter's results are reflective of a consistent process for evaluating loss reserves one quarter in arrears and considering actual versus expected losses in the current period. Moving to expenses. Compared to last year, our quarterly expense ratio increased one point to 39.4%. Elevated incentive-related amounts account for nearly all of this increase, most notably, amounts influenced by growth in book value, and you can use comprehensive earnings as a proxy, which was up significantly compared to the second quarter of last year. We also continued to increase investments in people and technology to support growth, improve customer experience, and drive efficiencies. Turning to investments, the portfolio offered a 1.1% total return in the second quarter, with significant contributions from equities. These were modestly offset by declining fixed income prices as treasury yields increased in May and June. Similar to prior quarters, we continued to find attractive opportunities to put operating cash flow to work in high-quality bonds and purchased yields averaged approximately 4.6% during the quarter. Additionally, with money market funds offering yields above 5%, we held a higher-than-average cash and short-term investment balance at the end of the quarter. Overall, we are pleased with the portfolio's increasing support of operating earnings through investment income and have been layering in some intermediate maturities to ensure the support is sustainable. Incorporating comprehensive earnings and adjusting for dividends, book value per share increased by 17% from year-end 2022 to $29.65. Away from the traditional investment portfolio, investing earnings were down, but that comparison was largely influenced by our sale of Maui Jim, which contributed $9 million to last year's results. As noted last year and highlighted in our press release for comparative purposes, we have excluded earnings from Maui Jim in our calculation of operating earnings for 2022. All in all, a very good operating quarter and a strong first half of the year. With that, I'll turn the call over to Jen.

Thank you, Todd. Overall, we are pleased with our product portfolio and the second quarter's results. We continued to lean into opportunities in several areas of our property and casualty segments, producing double-digit growth for the quarter and almost 20% growth year-to-date. Much of that growth is coming through rate increases. We are experiencing broad profitability across our product portfolio and feel good about the small adjustments we are making based on customer needs and claim outcomes. We expect the impact of Florida tort reform to be a long-term benefit to the industry and hope that other states will follow. As Todd outlined, this quarter saw some higher loss ratios than last year's second quarter in the casualty and property segments. We are beginning to observe the courts opening back up and litigation discovery becoming more active. However, our new claim counts are up only slightly, a much smaller increase than premium growth. I'll give you a little color on the quarter's results by segment. Premium in the property segment grew 63% as we posted a 75 combined ratio. This market remains highly attractive, and we are continuing to take advantage of it. Excess and surplus property premium was up 86%, with hurricane rates increasing 49% and earthquake rates up 14% in the quarter. A significant portion of the industry's reinsurance capacity supporting the Managing General Agent markets renewed in the second quarter with less limit at a higher cost. This leaves the catastrophe market facing reduced capacity, including both hurricane and earthquake risk. Submissions increased over 20% again this quarter, continuing the elevated state of activity that has existed since 2022. This has been a traditional hard market where brokers are challenged to place full limits, and we are able to work with them and reduce commissions a bit to get the coverage placed. Because we want to continue entertaining new business, we have reduced the limits we offer on individual risks, increasing the number of customers we can serve. We remain disciplined around due diligence, deductibles, and policy terms for certain occupancies and building characteristics. Our hurricane exposure, as measured by exposed policy limits, is relatively flat year-to-date, while modeled exposure has grown commensurate with our growth in capital. We purchased an additional $150 million of catastrophe reinsurance limit effective June 1. The additional limit is supporting our evolving view of risk as the catastrophe models are being updated. This is consistent with our well-established approach to managing our risk tolerance. The Marine division also had a successful quarter, growing premium 15% and increasing rates by 8%. Our submissions are growing considerably as we are viewed as a problem solver for our brokers by being responsive to their needs and tailoring coverage as necessary. While other carriers look to automate all interactions, we still believe there is great value in personal relationships and individual underwriting as we demonstrate what it means to be a specialist. Spring storm activity was notable in the quarter. The storms were strong in the Southeast, including Texas and Florida, areas where we have been opportunistically growing. Despite the severe storm activity, higher retentions and growth in these affected geographies, we were able to post a 75 combined ratio. Our surety segment also posted a 75 combined ratio and grew premium by 1%. Contract surety led the way with a 10% premium increase. While previous period's growth was driven by inflation, the cost of construction materials is stabilizing and more comparable to prior periods. This quarter's growth is primarily driven by new construction projects. Commercial surety and, particularly, our large account business had a slower quarter, and premium was down 5%. This business is very competitive, and quarterly results can be heavily influenced by only a couple of bonds. Surety trends follow economic activity, so we are very closely monitoring leading indicators in the construction market as well as the general economy to evaluate the business opportunities in this space. We remain disciplined in surety as we know that economic slowdowns raise the likelihood of claims. We've been in the surety business for over 30 years and are experienced at navigating through all market conditions. The casualty segment also grew by 1% and posted a 96 combined ratio. Our top line growth reflects our consistent underwriting discipline. In response to competitive pressures, we have been reducing our market participation in several products. These are all areas I've talked about previously, but I'll outline them again. The public Directors and Officers market continues to be highly competitive. To navigate the change in conditions, we have become more selective on both new and renewal business. So our renewal retention has decreased several points. Rate change for the quarter is down 9%, and premium is down 10%. While claim counts are down this year, we saw some unusual severity and a couple of older claims in the quarter. We remain profitable year-to-date, but these claims serve as a reminder that this is a volatile business. Our team underwrites for the long term and with great care. Maintaining discipline in soft markets is critical to long-term success. Another market where we've experienced top line challenges is transportation, where the trucking portion of the market continues to be highly competitive and trucking companies' revenues and miles driven are generally down a bit compared to last year. In this business, there's plenty of claim activity and the potential for nuclear verdicts should remind underwriters to stay disciplined. Despite the difficulty of the trucking market, we are still finding opportunity within our specialty commercial auto and newly formed moving and storage niche. Premium for our transportation book overall was down 6% in the quarter, but we achieved 4% rate increases, and the book remains profitable. The last market I will highlight is the energy casualty space. You'll recall that we exited the excess portion of this business effective January 1. That decision affected our ability to offer primary-only policies, and we did not believe the business model was viable long term, so we made the tough decision to exit the primary energy casualty space as well in July of this year. In calendar year 2022, we wrote a total of $24 million of premium in energy casualty. We are already down $15 million year-to-date in 2023, including an $8 million decrease in premium in the second quarter. So you will see the remaining $9 million of premium run off mostly in the second half of 2023, with a small amount rolling over in the first half of 2024. We believe our willingness to make the hard decisions to slow growth or exit underperforming businesses before they become too big to fail is a differentiator and largely responsible for our long-term consistent underwriting success. On a more positive note, there has been opportunity in the casualty market, and we continue to take advantage of it. The personal umbrella space has been disrupted for some time. As you read in the news, there are personal lines companies reducing their participation in both California and Florida, and this trend may continue unless carriers are permitted to achieve rate adequacy. When primary carriers change their appetite in the homeowners or auto markets, the opportunity for our stand-alone personal umbrella policy increases. Our focus is to grow proportionally across the country, and we are working with our producers to ensure we're not overweight in any problematic states. We are also restricting underwriting eligibility of the more marginal risk in several states in order to maintain underwriting profitability. We continue to achieve an underwriting profit in this long-time business and are monitoring and managing our growth closely. The other notable area of growth is in our E&S primary liability book. Premium grew 10% in the quarter, driven by construction outside of New York City. The construction space is highly competitive. The private construction market is slowing a bit as evidenced by contractors' slightly reduced projected revenues. Our approach is to stay in front of our producers, be proactive in pursuing new business opportunities and provide tailored solutions to their problems. This quarter demonstrates our commitment to underwriting discipline. In the property segment, we are leaning into the market opportunity by meeting the needs of our producers and insurers while focusing on refining our appetite, rate adequacy, tightening terms and conditions, and proactive claim handling. In surety, we are being cautious about growth as economic conditions have affected a handful of our insured principles. In casualty, we exited the energy casualty space and are managing through a few challenging markets while growing in areas where our capacity and expertise are needed and where we can achieve adequate rates. This is what we do. We believe our diversified product portfolio is healthy and well positioned to navigate this evolving marketplace. I'll turn the call over to the moderator to open it up for some questions.

We have our first question. It comes from Greg Peters from Raymond James.

Great. I recognize you provided a lot of comments on the property business, but I wanted to ask a couple more questions. In the context of the growth, can you provide some perspective on how much that growth is attributable to pure rate versus exposure versus new business? It would be helpful to clarify the distinction between rate and new business, even though exposure and new business can sometimes overlap.

Sure. If we focus on the hurricane aspect, we had a 49% positive rate change in the quarter. Our retention for that business is slightly down from historical levels, typically ranging from 70% to 80%, and we're currently in the middle of that range. There is a significant amount of new business, which is subject to our new guidelines that have been in place for a while, offering a limit of just $2.5 million. We believe the rate for this new business is priced slightly higher than our renewal business. We're optimistic about this new business. Overall growth comes mainly from rate, with some from new business, mostly replacing the renewals we are losing. In terms of exposure, we remain relatively flat regarding exposed limits. Modeling exposure involves various changes based on specific nuances like occupancy and roof characteristics, making it challenging to pinpoint exact growth. These factors contribute to the dynamics within our changing property portfolio.

Perfect. And you also commented on quake. Can you provide some perspective on that, too?

Sure. While much attention is currently focused on hurricanes, the earthquake market is also undergoing changes, primarily due to capacity issues. Managing General Agents in that sector are experiencing similar challenges to those on the hurricane side, where renewals are not as straightforward as they once were with their partners. Consequently, MGAs are offering reduced limits, and insurers are also being cautious with the limits they provide in both catastrophe areas. As a result, the risks we assess are becoming more layered, requiring more carriers to complete the insurance coverage tower, which presents additional opportunities. We are also adjusting our limits and achieving favorable rates in that business. New business is priced slightly higher than our renewal portfolio, making this market quite appealing at the moment.

Great. I have some other questions that I can take offline. From a big picture perspective, you mentioned your discipline regarding energy. I'm curious about what happens to your energy underwriting team when you decide to withdraw from a market. Are they on standby, waiting for market conditions to change, or how do you manage that? I understand you have a long-term orientation.

This is Craig. So it really depends on the product. It depends how versatile the people are that we have. Obviously, we tend to hire specialists in each area. So I would say it is a little different when we decided to end participation in the marketplace versus when we've decided to shrink. When we decide to shrink in a long-time business, we typically redeploy our underwriters to do other things as well as claims people that can work on other products or work on initiatives for long-term growth when the market comes back. But when we do decide to end our participation in the market, I mean those underwriters tend to find other opportunities outside the organization.

We have our next question. It comes from Meyer Shields from Stifel.

Great. One numbers question, Todd. I apologize, but I just couldn't make out your comments. You said that, if I heard correctly, $17 million of the $18 million catastrophic losses in the quarter were in property.

Yes. Yes.

Okay. Did you break that out? Please go ahead.

And some of the package side. The other $1 million on the casualty side is some of that package business that we got with us a bit of both. So some of the General Binding Agreement really what's that impact.

Did you break out the $3 million adjustment for the prior period as well?

Yes, that was somewhat different. It involved a $2 million decrease in the casualty segment and a $1 million decrease in the property segment. However, some of that may relate to our estimations of the catastrophic impact in a given quarter, leading us to make decisions based on the information available across segments. In this case, it was also related to General Binding, which was primarily connected to the casualty segment from previous years.

Okay. That's very helpful. I'm sorry I missed it the first time. Bigger picture question, I guess, maybe for Jen. Yes, so Jen, you talked about being more cautious on underwriting surety because of economic uncertainty. Are you seeing signs of economic uncertainty in terms of how your ensure are acting, whether it's exposure units or growth plans or anything like that?

Did you say surety specifically or more broadly?

No. So the question was more broadly because you commented specifically on underwriting caution in surety.

Yes. If you consider our portfolio, we have a substantial presence in the construction sector, which is quite diverse. For instance, public construction projects are performing well, and surety in that area is also strong, with plenty of business opportunities. On the other hand, private construction is experiencing slower growth, leading to a slight decrease in revenue for both our admitted and non-admitted businesses, but not significantly—it's mostly flat with a minor dip. Participants in that market seem to be acting responsibly. Our architects' revenue has increased slightly, so overall, we are witnessing a fairly stable environment. While there are reports suggesting a possible recession, we consistently inquire with various individuals about the data, and at this moment, we are not observing any significant signs. Growth may not be rapid, but stability appears to be the current trend.

It does. It's exactly what I was looking for.

We have our next question. It comes from Scott Heleniak from RBC.

The first question was quite broad. It seems that business is performing well, and while some others are holding back, you seem to see opportunities. It has been noted that others have faced challenges in that area over the past year. Could you provide an update on this? You've mentioned some points before, but I'd appreciate more detail on why RLI has been performing significantly better than others in this regard over the past year. Is it related to rate risk selection, terms and conditions? I'm interested to know why you are excelling compared to the competition.

Are you interested in the personal space or the commercial space?

Either one or both.

There are two distinct ways we operate. In personal lines, we function as a stand-alone for umbrella operations, meaning we don't need the underlying homeowners or auto coverages. In fact, we prefer not to have those coverages, unlike most of our competitors who require both. As companies withdraw from various states for auto or homeowners policies, it creates a greater market opportunity for a stand-alone product. Our approach to this market focuses on being helpful while also ensuring profitability. We have a long-standing underwriting framework that we adjust periodically based on claims data. We maintain a robust feedback system among marketing, underwriting, claims, and actuarial teams, allowing for regular discussions on market trends and claims outcomes. Our dedicated claims staff specializes in personal umbrella claims and works closely with our underlying carriers to assess the impact of claims and determine our involvement. This focused underwriting and claims handling has enabled us to operate profitably in this business for over 30 years. However, we recognize that other carriers face challenges, and we keep close tabs on growth and regularly discuss any potential issues. The situation in the excess space is quite different. The commercial sector is more competitive, likely due to lower entry barriers, which allows new players to enter the market easily. Despite conversations around social inflation and severity, newcomers often struggle and exit, and we attempt to maintain consistency in our appetite as the market fluctuates. We apply the same feedback loop from underwriting to claims in this area as well, but the competition in the commercial space is notably more intense compared to personal lines.

It seems that the opportunity currently leans more towards personal lines rather than commercial lines. Moving on to retention, you experienced higher retention this year compared to net to gross. You mentioned acquiring an additional $150 million of catastrophe limit. Could you share your updated thoughts on your reinsurance strategy and how you plan to manage that aspect of the business with increasing reinsurance pricing, especially as we approach 2024?

Sure. So if you look at our strategy, we've been pretty committed to the traditional reinsurance space. So they've had some long-term partnerships since really the late '70s in reinsurance. And so we do tend to favor that approach. As we have grown, we continue to monitor. We have a number of tolerances, both non-modeled just policy limits in the region as well as modeled metrics that we monitor on a monthly basis. And we want to say relative to our surplus growth, we want to stay in a reasonable range there. And so it's important for us as an E&S business to take advantage of market opportunities, and that's exactly what we've done. But there's also a limit to what we can do relative to the size of our company. And so that's why we've continued to buy reinsurance. I think that the market opportunity at some point will slow down. I think the second half of the year, we may see the early signs of that, given this has been going on for a while. If you think about the second half of last year, we were already taking pretty good rate increases. We were already managing limits. We were already paying attention to deductibles and all those things. And so if you look at the change that we would expect for the second half, it's on top of already a lot of actions that were taken. So this opportunity will slow down at some point. It's hard to say when. I think as we approach January 1, we'll look at where that sits. It's very hard to talk about it now because we're in the middle of hurricane season, where not a lot happens. Once you're in the season, you don't have many new markets entering mid-season. You do have some people who fill up their buckets of exposure, and so you see a little bit of change in appetite but not much. So we really have to wait and see how the season plays out and kind of where we're at in the fourth quarter to determine what that opportunity looks like for next year. So that's kind of the thought process we go through.

Okay. That's helpful. Did you provide any additional details about the $150 million in catastrophe limit? If you did, I missed it. Is that for a specific region? Is it part of a national program? Or is it related to hurricane exposure, the additional catastrophe limit that you acquired?

It's for all payrolls, yes.

All payrolls, okay.

Yes, that's for all payrolls. So it just goes to an additional layer on top of all of our coverages that we purchased previously.

We have no further questions on the line. I will now turn the conference back to Mr. Craig Kliethermes for some closing remarks.

Thank you, everyone, for joining today. The results we report today are more a reflection of the body of work put in over the last decade than the last quarter. Some ask how we have been able to deliver the consistent results each year. It isn't magic, but it also isn't easy. We have very talented individuals with deep expertise who share our values. We make them owners through shared rewards in an ESOP, and we immerse them in a culture that reinforces all that is good in them. Then we let them build and continuously improve our business to best serve our customers. The market we currently face includes a shortage of natural catastrophe capacity, an active plaintiff bar, loss cost inflation, and uneven economic growth. Among these challenges and disruptions lie opportunities. We will continue to adapt to these market forces as well as others that emerge and continue to serve the best interest of our customers and shareholders as we have for nearly 60 years. I'm proud of our associate owners' efforts and the unique culture of ownership and shared success we have maintained. I have one more favor to ask them, keep being different because it works. Look forward to talking with you all next quarter.

Thank you. Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1 (866) 813-9403 with an ID number of 292170. This concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect.