Rli Corp Q2 FY2025 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 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 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 fourth 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'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 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's Chief Investment Officer and Treasurer, Mr. Aaron Diefenthaler. Please go ahead.

Good morning, all. We hope everyone is having a great summer. We appreciate you joining us to review RLI's results for the second quarter and first half of 2025. We have the usual participation for today's call, Craig Kliethermes, President and CEO; Jen Klobnak, Chief Operating Officer; and Todd Bryant, Chief Financial Officer. In typical form, our agenda will begin with Craig offering some overall remarks. Todd will outline the financial results, and Jen will present color on market conditions and our product portfolio. We will then have the operator open the line for questions, and Craig will close with some final thoughts. Craig?

Well, thank you, Aaron, and good morning, everyone. We appreciate your participation on today's call and look forward to addressing your questions after Todd and Jen walk through our results. We are pleased with our second quarter results, which include an 84.5% combined ratio and underwriting profitability across all segments. While top line growth was flat, reflecting significant softening in the commercial property market, we continue to see healthy underlying growth across most of our diversified niche product portfolio. Year-to-date, book value per share has grown 16%, inclusive of dividends on an 82% combined ratio and double-digit growth in net investment income. At RLI, we take a long-term view with a focus on discipline, continuous improvement and sustainability. We concentrate on what we can control and adjust our strategy as market conditions evolve. For example, in wheels-based exposures where legal system abuse is prevalent, we're taking significant rate and being more selective. In property, we're choosing not to compete where the risk/reward profile doesn't make sense. Strong companies are willing to address challenges head on, pulling back where needed and leading into the products where the risk return is in balance. That's how we operate and how we are incentivized prioritizing profitability and long-term value creation over short-term results. Despite some select challenges, we still see attractive opportunities truly across most of our portfolio. Our success is not measured by being the largest market, but by consistently delivering strong profitable results to our shareholders and serving our customers with expertise and care through all market cycles. That is what we will continue to focus on as we have for the last 60 years. With that, I will turn it over to Todd, who will provide some detail on our financial results. Todd?

Thanks, Craig. Good morning, everyone. Yesterday, we reported second quarter operating earnings of $0.84 per share, supported by solid underwriting performance and a 16% increase in investment income. As a reminder, per share data reflects the 2-for-1 stock split that was due to shareholders at the end of 2024 and distributed in June. Underwriting income benefited from continued growth in earned premium and positive results on the current accident year were bolstered by favorable development on prior year's reserves across all three segments. Our total combined ratio was 84.5%, up from 81.5% last year, reflecting modest increases in the underlying loss and expense ratios, though both remain in line with expectations. Overall, top line was flat between periods. Our Casualty and Surety segments posted growth, while Property declined reflective of increased competition and rate pressure on catastrophe-exposed business. On a GAAP basis, second quarter net earnings totaled $1.34 per share versus $0.89 in Q2 2024. This comparison was heavily influenced by the relative price performance of equity securities between periods as $44 million of unrealized equity gains this quarter outpaced the $4 million of unrealized gains for the same period last year. Turning to segment performance. Property experienced a 10% decline in gross premiums, which was influenced by rate decreases in E&S Property. However, our Marine and Hawaii Homeowners products continue to deliver growth. Jen will provide additional detail on subsegment market conditions shortly. Contributing to Property's bottom line was $10 million of favorable prior year's development, including $5 million in reductions related to Hurricane Helene, where losses continued to trend below initial estimates. Storm losses and catastrophe events in the quarter totaled $12.5 million, which was marginally below last year. While the loss ratio improved slightly, the expense ratio increased 3 points driven by changes in our reinsurance and higher acquisition-related expenses. All in all, Property continued its strong performance, posting a 62% combined ratio in the quarter. In Casualty, gross premiums advanced 7%, and we posted a 96.5% combined ratio for Q2. The segment benefited from $15.5 million of favorable prior year's reserve development, partially offset by a higher underlying loss ratio and a $1.5 million in Q2 catastrophe losses related to certain package policies. Prior year's reserve benefits were realized across multiple products with notable contributions from general liability, excess liability, and personal umbrella. We continue to closely monitor wheels-based exposures, an area we've discussed previously at length. Reserve actions taken in the fourth quarter of 2024 appear to be sufficient and we continue to approach more challenged coverages with rate increases and underwriting actions to address the current loss environment. Surety's gross premium was up 7% over last year, with all subsegments experiencing growth. The combined ratio for the quarter was 87.9% and underwriting income benefited from $2.3 million of favorable reserve development. The expense ratio rose, reflecting higher acquisition costs and increased investments in technology and people. Turning to investments. Operating cash flow for Q2 totaled $175 million, up $33 million from last year, providing a solid foundation for continued portfolio activity. April's market volatility offered an opportunity to attractively add to our equity allocation, while the balance of the quarter was again focused on high-quality fixed income where treasuries and corporate bonds governed most of the effort to add income. Average purchase yields were 4.7% in the quarter, which is 70 basis points above our book yield. On a total return basis, the market's welcome recovery in May and June resulted in a positive 2.9% return for the quarter, capping an excellent first half of the year. Beyond our traditional invested assets, our investee earnings totaled $2.5 million in the quarter. Incorporating comprehensive earnings of $1.55 per share and adjusting for dividends, book value per share increased 16% from year-end 2024. All in all, we are pleased with our second quarter and first half performance. And with that, I'll turn the call over to Jen. Jen?

Thank you, Todd. Two of our three segments experienced solid growth in the quarter with a 7% increase in premiums, both Casualty and Surety. This was offset by anticipated headwinds for E&S Property where market conditions remain challenging. As a reminder, we do not have top line goals at RLI. Our product leaders, who are closest to the business, determine when is the right time to grow to take advantage of attractive market conditions and when it is time to shrink because terms and conditions reduce the likelihood of producing an underwriting profit. We do not have a targeted mix of business between Property, Surety, and Casualty. Again, the mix that we produce is based on the relative opportunities in each of those segments and has fluctuated materially over market cycles. In the most recent hard market, we grew our E&S Property group to take advantage of the attractive market conditions until it became a large part of our product portfolio as it was producing considerable returns. Now as conditions soften, our underwriters are emphasizing selection and discipline. In total, the Property segment's premium declined by 10% in the quarter, influenced by win rates, which were down 13% compared to last year. Competition has increased from MGAs and admitted carriers where abundant capacity has been less disciplined on rate and more importantly, terms and conditions. Entering the hurricane season, our exposure is down 10% from year-end, while rates on business we can write are still above our benchmark pricing and include acceptable terms and conditions. The earthquake market is also challenging as more small businesses in California decided to self-insure this peril. Submissions are down 7%, while rates are down 9% in the quarter. Our brokers know we are a stable market, providing excellent service that will pay what we owe when claims arrive. We are well positioned to support our insurers, should there be events that hit our shores this year, and we continue to resolve claims from prior events in a timely and dependable manner. Our other product offerings within the Property segment continue to find profitable growth opportunities. Marine premium was up 2% in the quarter, driven by Inland Marine, while competition has increased in the ocean cargo space. Hawaii Homeowners premium is up 35% this quarter as we continue to roll over business from markets that withdrew or retracted after the Maui wildfires. Our team's dedication to service is helping us win new business, and we achieved a 16% rate increase in the quarter. Loss activity for these products has been as expected, and they contributed nicely to our bottom line. The Surety segment premium grew 7% in the quarter, led by our Commercial Surety book. We renewed our reinsurance treaty effective April 1, and purchased more limit so we can offer additional support as our accounts bonding needs grow. Our Contract Surety premium moderated in the quarter after strong growth in the last few years. We are continuously reviewing credit quality and supporting contractors to build projects that are appropriately sized for their capabilities. Several new bonding requirements, continuous marketing efforts, and easy-to-use digital tools are helping us win business in this segment. We're looking for more growth in this high-performing segment and are focused on enhancing our capabilities for our producers and principals. We are also improving processes for our underwriters to have more time to focus on underwriting and servicing our customers. Casualty premium also grew by 7% in the quarter. Personal umbrella led the way with 24% growth, including a 9% rate increase. We have an approved rate filing with an effective date starting July 1, that will positively impact the second half of this year. New business policy counts in certain venues have slowed as we have increased required underlying limits and worked with our producers to diversify our business geographically. We are continuously learning from our data and refining our approach to the market. Our E&S Casualty division, which writes primary and excess liability coverage, generated strong growth and underwriting profit in the quarter. The top line was up 13% as we stay in front of our producers and ask for business, resulting in an increase in submissions of over 20%. Although we're seeing opportunities for growth throughout the country, we are competing against both standard and non-admitted markets that are leveraging their auto offering to win the liability business. We are a bit more cautious on auto coverages as this exposure requires specialized underwriting to be successful. Our primary and excess teams collaborate to offer our producers a comprehensive service-oriented solution. Speaking of auto exposure, rates in our transportation division were up 12% in an environment that remains highly competitive. We have had a handful of accounts cancel and move midterm for less premium and have lost accounts at renewal due to competition. We manage this business with the bottom line in mind and have leaned into helping our insurers improve their safety practices through our in-house experienced loss control team. We believe our focus on safety is a differentiator and attracts a better mix. With elevated severity in the auto industry, we use both rate increases and risk selection to target a profitable bottom line. For all auto coverages across our portfolio, we achieved a 14% rate increase in the second quarter. We are sharing information across business units related to application questions, underwriting guidelines, and claim experience, so our underwriters can learn from each other. We are being more selective in offering auto liability coverage in our packaged products. Overall, we had a great underwriting result in the second quarter. We stuck to our business model of making decisions with our bottom line and long-term success in mind. We're looking for underwriters who have a similar mindset and are always open to growing in new classes if we find the right talent. While the softening property market conditions create headwinds for our top line, we have planted seeds throughout our portfolio that will grow over time under the right conditions. We've added coverages or found adjacencies that help our producers solve our customers' needs. We have a strong community that works together to support our customers and each other. We see opportunities to profitably grow in areas of our portfolio where it makes sense as we navigate more volatile market conditions. And now I'll turn the call over to the moderator to open it up for questions.

And our first question today comes from Gregory Peters of Raymond James.

I want to revisit your comments about the increased acquisition costs in Property. Could you expand on that? Please provide more details on the situation regarding acquisition costs in both Property and Casualty. Are you experiencing pressure on the Casualty side given the current rates, or are those costs declining? Please give us an overview of the trends in that area.

I'll start here, Greg. I believe Jen can provide some additional insights. There is some pressure on the commission side, particularly in Property and Surety. We're also experiencing a noticeable mix shift, especially in Surety. We're writing less energy business, which has resulted in a low acquisition expense ratio. Additionally, as Jen mentioned in her opening remarks, we've made significant investments in technology, enhancing the digital experience and customer relationship management. This has led to some pressure on commissions in both segments. Overall, our book value growth for the quarter was quite strong, and some retirement and incentive plans take this growth into account. This trend is seen across all segments. Jen, feel free to add more details.

Yes. I would like to mention that we purchased a bit more reinsurance to enhance our co-participations in our catastrophe treaty, along with an additional one in Surety. As a result, this affects our expense ratio slightly.

Got it. Obviously, there's a lot of discussion in the marketplace about the softening of pricing in certain lines. And obviously, Casualty seems to be holding up well. Maybe you could give us some perspective on where the pricing pressure is coming. Is it more in the wholesale brokerage channel? Is it more in the retail channel? Just give us some perspective on how pricing is shaking out by distribution channel.

That's an interesting question. I would say I'm not sure if we can point to a distribution channel. We think about it more in our segments and in our products. I think generally, there's just been a lot more competition in certain places. For example, in the E&S Property space that we compete in, we've had about 20 new entrants in that space over the last 2 years. That's a combination of new MGAs or carriers that are reentering that space because they saw that the returns were so good. And so that has pressured those rates just with more miles to feed there. On the Casualty side, sometimes it's hard for us to relate rate change, especially if you're trying to compare to other carriers because it depends on the coverage we provide. We tailor our coverage, for example, in our E&S Casualty Group to where we offer probably slimmer coverage. We actually charge maybe a little bit less because we're offering less coverage. And when you look at our rate change, it's a bit unremarkable because we're starting from a position where we tend to make an underwriting profit. Other carriers over the last couple of years have disclosed adverse development and construction liability coverages. And so they're probably needing to get more rate in that space. So we look at it from the standpoint of rate adequacy. We balance the pressure to give back some rate with kind of risk selection component. So there are walkaway rates that we have in most of our lines of business that these actuaries help describe to the underwriters so that we understand where we're at from a profitability standpoint and where is that relative to where the market is at that point. So that's kind of an environment description of what we're dealing with. I don't know if you have any follow-up questions.

I guess just related to that, I'm just trying to get the sense with rates going down in certain lines, there's always the profit sharing component and contingent commission component. And I'm just wondering how that settles out with the downward rate pressure coming in certain lines of business.

Yes. If you look at our portfolio, we don't have many lines that actually have rate decreases going on. We have a very small book of work comp that covers our architects and engineers. And so that obviously has had rate pressure over the last few years. In our D&O portfolio, our rate for this quarter was actually minus 2%, so coming back towards flat. And so the only other piece of the portfolio to speak of in terms of rate decreases would be the E&S Property component, which I've already spoken of.

The next question comes from Matt Carletti from Citizens.

I apologize for asking another straightforward question about the market conditions. We have a good understanding of the Property side. I was wondering if Jen or Craig could provide more insight into the Casualty area. Specifically, regarding the larger segments like transportation and general casualty, how would you assess your current position? What is your perspective on loss cost trends? Do you anticipate a continued need for significant rate increases in these segments to keep pace with loss costs or to achieve acceptable returns, or do you think we might be closer to the point where, similar to Property, a peak may be in sight?

So Matt, I'll begin by discussing transportation. You inquired about loss cost trends. We are still experiencing significant double-digit inflation for commercial vehicles. This applies to trucking, public auto, and more specifically, the bus sector, but not taxis or anything similar, along with some specialty commercial auto. Our underwriters are factoring in double-digit loss cost inflation, which is why Jen mentioned a rate increase of around 12% to 14% for the quarter. These increases are essential for our underwriters. We continue to face competition in this area, and while the previous question was about MGAs, there is still considerable MGA competition in the transportation and commercial auto segments, which is surprising given that we consider this area a focal point for issues with the legal system. Sometimes, people need to face challenges before they learn. Our underwriters are prepared to walk away from business if they do not receive the necessary increases. They are also implementing loss control measures to help reduce costs. Ultimately, it comes down to selection. We believe we have some of the best underwriters who possess deep knowledge in specific areas. They can identify accounts that may only require moderate rate increases to remain profitable, while other accounts might need 30% to 40% increases to be viable. For those situations, we are unlikely to write that account. Jen, would you like to add anything else?

The biggest pressure is on our largest accounts, as other companies or MGAs are seeking premium. Accounts with over $1 million in premium are particularly targeted, and we have lost a few of those. Consequently, our portfolio has decreased somewhat and now comprises more smaller accounts compared to the larger ones we previously held. There has been a shift in our mix, but our underwriters remain focused on rate and risk selection, which is crucial for staying ahead of industry trends.

The next question comes from Meyer Shields from KBW.

I think it might have been Jen who touched a little bit on mix shift within Surety. And I was hoping we could dig a little bit deeper. I'm just trying to understand the change in the accident year loss ratio or accident year combined ratio compared to the first quarter because it doesn't look like it was from the expense side.

Last year, in the first quarter, we experienced a significant loss in Commercial Surety, which impacted our loss ratio. Additionally, we had some reinstatement premium that affected the expense ratio in that quarter. When comparing the first six months to the previous year, the impact is not as pronounced. The increase in the loss and expense ratios for Surety is partly due to the extra reinsurance layer we added on April 1, which has brought some additional costs. Contract Surety has seen considerable growth over the last couple of years due to our investments in staffing and marketing, as well as providing excellent service, although inflation has also played a role. Commercial Surety has kept pace to some extent, as we have also invested in that area and collaborated closely with our producers to secure business. We have enhanced our portfolio of transactional business by improving the capabilities available to our producers, making it easier for them to conduct transactions online. Overall, these factors have contributed to the growth of our portfolio. I don't believe the mix within the portfolio has changed significantly, except for a slight reduction in our oil and gas segment, as we are shifting our focus more towards solar farm projects and similar initiatives, which have a different cost structure.

We experienced a larger favorable development in Surety during the first quarter compared to the second quarter. Both quarters were positive, but the first quarter showed a significant increase, as reflected in the loss ratio. Regarding the expense ratio, it's not greatly different from the first quarter when taking into account commissions, premium taxes, and policy acquisition costs; it's slightly higher, but we continue to invest in technology, which is crucial for easing business operations. Additionally, we are focused on building new relationships. We are committed to these investments and are willing to accept a slightly higher expense ratio in exchange for maintaining a low loss ratio.

Okay, that is very helpful. I appreciate that. For my second question, several states have implemented some reforms recently. I'm curious to know if it’s possible to see any benefits from those reforms in terms of actual loss emergence, even though I understand it's still early to evaluate.

Meyer, this is Craig. I think it’s still early for Georgia and Louisiana, but there seems to be a shift in how underwriters are approaching those markets, showing a greater willingness to engage compared to their previous cautious stance. In Florida, I’ve heard from some of our claims team that we’re seeing benefits from recent tort reform, which is boosting our underwriting team's confidence and increasing their desire to write more business there. However, there’s ongoing pressure to roll back some of that tort reform, and we're hopeful people will be patient since it's already leading to reduced rates, especially in Property, and to some extent in Casualty. This is alleviating some pressure on rate needs. We would like to see more states follow suit, although we’re aware of efforts to push for more transparency around third-party litigation financing across various states. The outcome of that legislation remains uncertain, but we believe it’s crucial for the industry. It helps us understand who we are negotiating with, whether it’s a real injured person or a sovereign wealth fund involved in our tort system, which we view negatively as it raises costs long-term, ultimately affecting consumers. Not a good situation. Jen, do you want to add anything? The APCIA is actively lobbying for the insurance industry to benefit consumers in the long run.

And the next question comes from Andrew Andersen from Jefferies.

I think you've previously talked about construction touching about 1/3 of your business. Could you maybe just talk about what you're seeing in that market as it seems to be maybe slowing, but the Surety premium is still pretty good and as is the Casualty side. So just maybe some color on what you're seeing in construction and how that may impact the segments.

Certainly. It seems that during the last quarter, there was some hesitation due to various legislative priorities at the federal level, leading to a degree of uncertainty. However, in the second quarter, the situation has stabilized somewhat. In our construction sector, we engage in various ways. We have units dedicated to public construction, primarily in our Surety division, and units focused on private construction, particularly in our E&S and package products. We have specialists for general contractors as well as subcontractors, and we also cover contractors' equipment and builders risk. We analyze the market from multiple perspectives. Overall, the industry appears to be quite robust in most regions. Part of the industry's health contributes to our success, alongside our strategy of actively meeting with our producers regularly and continually soliciting business. This approach has positively influenced our submissions, which have increased by double digits across most of our business lines. It's essential to assess the situation to proceed with underwriting, and this trend has been advantageous for us. We are not observing any indicators that would warrant caution regarding the industry's growth; it seems to be in a sound state at this time.

And then just within Casualty, I think if we take the $1.5 million of cat loss, it kind of gets to a flat ex cat, ex PYD loss ratio quarter-over-quarter. I guess, one, is that a good way of thinking about it for maybe the balance of the year? Because it seems that rate is maybe slowing, and I would imagine you're still holding a pretty high conservative loss trend assumption.

We have been cautious about how we book reserves, and I don't expect that to change. As Jen mentioned, we're achieving rates that we believe exceed the loss trend, but we will remain cautious, particularly regarding the wheels-based exposure. That approach will continue.

There were no further questions. I will now turn the conference over to Mr. Craig Kliethermes for some closing remarks.

Well, thank you all for your interest in our company and for your questions today. At RLI, we have a strong, healthy balance sheet with very diversified product and investment portfolios. This offers security to our customers, flexibility and opportunity to our product managers, and consistent profitability to our shareholders. We do things differently here and intentionally so. We will continue to make decisions that are in the long-term best interest of our customers and our shareholders that allow us agility to respond in challenging and opportunistic markets. Being different is what we are known for and being different has delivered again to all our key stakeholders. Thank you to all our employee owners for their hard work delivering the difference that works. Thank you, and we'll talk to you next quarter.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so on the RLI homepage at www.rlicorp.com. This concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect.