Earnings Call Transcript - RLI Q2 2024

Operator, Operator

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 the 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'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 would now turn the conference over to RLI's Chief Investment Officer and Treasurer, Mr. Aaron Diefenthaler. Please go ahead.

Aaron Diefenthaler, Chief Investment Officer and Treasurer

Thank you, Makaya. Good morning, everyone. Thank you for joining us to review RLI's results for the second quarter and first-half of 2024. 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 open with some high-level commentary. Todd will then give us the play-by-play on financial results. Jen will offer commentary on market conditions and further details on our product portfolio. We will then open things up for questions and Craig will close with some final thoughts. Craig?

Craig Kliethermes, President and CEO

Thank you, Aaron, and good morning, everyone. We're off to a very good first-half for 2024 with well-balanced growth and underwriting profitability across all of our reporting segments. As Todd and Jen will go into in a minute, we continue to lean into opportunities where we have the expertise and track record to differentiate ourselves. Legal system abuse, particularly in wheels-based businesses continues to be a frequent topic of vigilance within our strong collaborative underwriting and claim feedback discussions. We remain cautious where the risks are more dynamic, difficult to quantify or where we choose to proactively mitigate the volatility to the bottom line. I will let Todd and Jen share more detail on the financials and the market in general. Todd, it's all yours.

Todd Bryant, Chief Financial Officer

Thanks, Craig. Good morning, everyone. Last night, we reported second quarter operating earnings of $1.72 per share. The quarter's results reflected solid underwriting performance and a combined ratio of 81.5 and an 18% increase in net investment income. On a GAAP basis, Q2 net earnings of $1.78 compares to $1.69 in the same period last year. Underwriting income benefited from growth in earned premium, lower attritional losses in our Property segment and continued favorable development of prior year's loss reserves in all three segments. Overall, the loss ratio was down 3.5 points due to better emergence on prior year's reserves, favorable experience in the current accident year, and support from stronger earned premium. Storm losses in the quarter totaled $16 million, compared to $18 million a year ago, $15 million of that impacted the Property segment, while $1 million was associated with package policies in the Casualty segment. The scale of earned premium further contributed to an improved expense ratio, which was down more than 2 points, compared to last year. Despite tempered growth in Property, total gross premiums written were up 11% and balanced across all three segments. Casualty experienced its second consecutive quarter of double-digit growth and benefited from $12.8 million of favorable prior year's loss development with notable contributions from general liability, commercial excess, and executive products. In addition, $1 million in reductions to prior year storm losses was attributed to Casualty, all of which contributed to a slight improvement in the loss ratio and a 95 combined ratio for the current quarter. Surety achieved growth in the mid-teens and $2.4 million of favorable prior year development compared to $4.2 million of favorable emergence in Q2 2023. Prior year development can lose several million dollars in isolated periods for Surety, which can impact the calendar year loss ratio. In this case, the smaller release resulted in the loss ratio being up 5 points above last year's comparable quarter, but underlying results were similar as was the year-to-date comparison. Despite the continued growth in premium, Surety's expense ratio was up 2 points as average commissions were influenced by mix of business and our reinsurance renewal, which ceded additional premium during the quarter. Property growth remained positive, up 6.4% in the quarter with the largest contribution coming from marine and more modest increases from E&S Property. Total losses were flat compared to last year in dollar terms but were much lower as a percentage of earned premium, contributing to the excellent combined ratio of 60.3 for Q2. Property experienced $5.3 million in favorable loss development on prior accident years, largely marine-related, and posted a $1 million reduction to prior year storm losses. Operating cash flow was $142 million, down slightly from the comparable quarter as larger tax payments and the timing of several large claims weighed on the current period. Despite the decline, we are still putting a fair amount of money to work in the investment portfolio at attractive rates, well above our current book yield. Purchase activity for the quarter averaged a 5% yield and was again concentrated in high-quality fixed income. Also in the quarter, the equity portfolio posted $3.6 million of unrealized gains compared to $25 million a year ago. Despite modestly rising treasury yields, the portfolio achieved a 0.9% total return, including positive contributions from both stocks and bonds. Although credit spreads remain tight by historic standards, we are encouraged by the higher for longer rate environment. We have achieved more intermediate bond duration recently to ensure investment income is sustainable. Accordingly, duration was up one-tenth of a year to end Q2 at 4.7 years. Away from the traditional investment portfolio, investing earnings from Prime were comparable to last year at $1.6 million. Incorporating comprehensive earnings and adjusting for dividends, book value per share increased by 14% from year end 2023 to $34.64. Additionally, we announced a $0.02 increase to our ordinary dividend during the quarter, the 49th consecutive year of paying and increasing dividends. All in, a very good first-half of the year. And with that, I'll turn the call over to Jen. Jen?

Jen Klobnak, Chief Operating Officer

Thank you, Todd. I'll provide more information by segment. Premium for the Property segment grew 6% for the quarter while posting a 60 combined ratio. Top-line expansion was led by the Marine division, which grew by 20%, including a 5% rate increase. Marine continues to nurture producer relationships, creatively solve problems. Our team has been building a larger presence in the Builder's risk space and that has driven a lot of our recent success. Hawaii Homeowners' premium also increased 27% due to a combination of our focus on service and some retraction by competitors. E&S Property growth is slowing and rates are flattening. Overall premium was up 2%, while rates increased 1%. The hurricane market is stabilizing with increased competition this spring, particularly from MGAs, as they obtained more capacity from their capital providers, they increased limits and have become a little more aggressive on rates. We still believe we are achieving appropriate returns in this business. This latest hard market began in 2020. Since then, our cumulative rate change on Hurricane exposure is about 200%. We continue to manage our exposure to catastrophe business to stay within our risk appetite and optimize our portfolio. We are seeing more opportunities in the E&S space and non-catastrophe exposures. Standard markets are pulling back and that business is shifting to the E&S market. Terms and conditions have improved, including increased rates and the use of percentage deductibles as a couple of examples. The combined ratio for our Property segment improved with past rate increases earning through, while we experienced a similar level of catastrophe activity in the quarter versus last year. We don't expect a lot of changes to occur in the hurricane market during the season, and we will still see select growth opportunities in all of our Property product offerings. Surety premium was up 17% during the quarter on an 82 combined ratio. We achieved growth and underwriting profit in each of our Surety businesses. Contract Surety focuses on public construction projects, which has been a healthy part of the market. In addition, construction costs continue to be elevated, which supports premium. Contract Surety grew 25% in the quarter. We have not seen an increase in our own claim frequency, which we know has ticked up from the industry. Our commercial surety book has also grown through investments in relationships. Premium was up 20%, driven by increasing success and supporting and expanding the renewable energy sector. Transactional surety is in a highly competitive market. This product grew 6% as we continue to find new opportunities to serve producers and customers with our easy-to-use digital solutions. We renewed our Surety reinsurance treaty effective April 1, given the timing of the renewal, the impact of the harder reinsurance market was delayed for us. Like other severity-driven reinsurance renewals, we increased our retention and our costs increased as well. The increased retention for Surety helps maintain net premium balance between our three segments. We have been in the Surety market for over 30 years and continue to seek opportunities in this space using our prudent approach to risk selection and exposure management. Cash flow premium grew by 14% with a 95 combined ratio for the quarter. Rates increased 9% for the segment, which compares favorably with 7% in the first quarter. Our first Umbrella business led the way with 37% premium growth. We have been successful working with several state insurance departments to achieve both broad and targeted rate increases where they are warranted. This quarter, we recognized a 20% rate increase and we have more approvals that will be effective later this year. We also achieved growth in our Professional Services Group, which includes professional lines and package coverage. Premium was up 10% through a combination of increased marketing efforts for the construction-focused part of this business and rate increases on our auto coverages. We have had elevated auto loss activity in our package business and are addressing this issue using multiple tools such as commission, filed rate increases, and additional scrutiny at our risk selection process. This brings me to transportation, where we now see mixed results in our portfolio. Premium was up 8% for the quarter, which matches our rate increase. The industry has seen increased severity driven by legal system abuse, which others call social inflation. We are not immune to these industry trends and address them through our underwriting appetite and investment in thorough claim handling practices. We are growing our commercial specialty auto book where market turmoil has moved terms and conditions within our appetite and we're able to increase rates. We're also expanding into market niches like moving and storage to offset the unreasonable competition in spaces like traditional trucking. We believe our in-house loss control services that are applied prior to quoting in many cases have informed our underwriting process and are helping make our insurers safer. This market is slowly improving. While competitors are making some changes, we are seeing submissions increase over 20%. This allows us to be selective in the risks that we cover. As I've mentioned in recent quarters, our Executive Products Group is in a much tougher market environment, particularly in the public D&O space. Our book is weighted toward private insurance. Premium was down 4%, while rates were down 6%. Although competitors are shifting towards the private space as well, we don't see drastic pressure on terms and conditions because the private market is much larger and provides plenty of opportunity. The market is challenging, but we have been through these cycles before. Our underwriters are well-positioned as they continue to focus on the bottom line. Finally, our E&S Casualty division top-line was up 3%. Primary business struggled to grow premiums as private construction projects continue to take longer to get started. We're also competing against aggressive standard markets and MGAs. On the excess side, we had more success as there was slightly less competition given industry results have affected some carriers' appetite. The focus in E&S Casualty is on the bottom line where we continue to produce an underwriting profit and have not experienced the adverse development that has gathered recent headlines for several competitors. Overall, another great quarter for RLI. We grew premium 11% with all segments contributing. We have built needed scale in many longstanding profitable businesses. We are achieving rate increases to address loss trends and our investments in relationships and people are paying off with increased submissions. We posted an 81.5 combined ratio for the quarter with improvements in both the loss ratio and expense ratio. Loss activity has been steady, while rate increases from prior years earned through and positively impact our bottom line. We finished the first-half of the year with 12% growth on an 80 combined ratio. Our insurance product portfolio is healthy and we're in a good position to support our current and future insured and producers' needs in the second-half. Now I'll turn the call over to the moderator to open it up for some questions.

Operator, Operator

Thank you. The question-and-answer session will begin at this time. Our first question comes from the line of Greg Peters. You may proceed.

Sid Parameswar, Analyst

Yes. Hey, good morning. This is Sid on for Greg. I'm just hoping you could provide some more comments on the competition you're seeing across your three segments. And maybe more specifically what you're seeing in the E&S Property. I think you called out slower growth there, but you still see some opportunities in the non-coastal areas. So some additional comments there would be helpful.

Jen Klobnak, Chief Operating Officer

Sure, Sid. This is Jen. In the Property segment, particularly regarding CAT exposure, our main competition is coming from MGAs, some of which are supported by Lowe's. After a quiet season last year, they have become quite aggressive in taking advantage of the current market, which remains appealing. Although rates have decelerated, the starting point for rates is still very good. MGAs are now offering larger limits, while we and others have been reducing limits in recent years. We were offering just $2.5 million on new business, while others might have offered slightly more. However, MGAs are moving towards limits of 5, 10, or even 20 million in some cases. They are also broadening their coverage, including adjustments to sub-limits and definitions of coverage. We prefer to maintain precise language in our policies because it matters during incidents, so we are monitoring the coverage aspect closely. We're experiencing competition, especially with our earthquake exposure in California, where cumulative rate increases are prompting clients to reconsider their purchases. There is a healthy level of competition across all our areas. We've observed some competitors pull back, particularly in Hawaii following recent wildfires, and shifts in appetite in transportation, which allows us to explore additional business opportunities. Conversely, competition remains strong in areas like Surety, where firms continue to offer large limits even when financial performance varies widely among companies, causing us to scrutinize accounts more closely. In the Casualty book, specifically construction, smaller contractors are facing challenges, making it crucial to assess their ability to pay premiums. Meanwhile, larger contractors appear stable and capable of purchasing coverage, leading to increased competition in that sector. The diversity of our portfolio makes it hard to characterize competition overall, as different business units face different competitors. Consequently, we prioritize giving our underwriters the independence to navigate their specific markets and determine the actions needed for success in the context of competition.

Sid Parameswar, Analyst

Okay, great. Yes, thanks for the answer. And then just as a quick follow-up. I believe a couple of quarters ago, you called out increasing picks in the Casualty book and I know you're getting additional pricing, but just curious if you've seen any changes in the severity trends there, if it's been relatively stable since you made those changes?

Jen Klobnak, Chief Operating Officer

So I missed the very first part of your question. You said I saw increasing something in the Casualty segment.

Sid Parameswar, Analyst

Loss pick. Sorry.

Jen Klobnak, Chief Operating Officer

Can you repeat a loss pick? Yes, sorry. In the Casualty segment, we have a very diverse portfolio. We have noticed an increase in our loss trends over the past few years, as the severity in the industry has risen. I would like to point out that the trends we are estimating tend to be somewhat higher than our actual experience. Therefore, we consider both our own data and industry insights to better understand the situation. We also rely on our reinsurance brokers for additional perspectives. We have observed that severity has increased slightly, particularly in auto coverages, which is why we are very careful about risk selection and our claim handling practices. Addressing this issue is challenging due to the severity we are facing, and we need to explore alternative approaches to manage it effectively.

Todd Bryant, Chief Financial Officer

I would just add there too. I think Jen has a good summary. I think if you look at the overall underlying loss ratio for our Casualty book, it's fairly similar to what it was in that mid-60, 64 range. And from a loss trend standpoint, I think our rate on the Casualty side overall is a couple of points above what we're assuming rate. But again natural rate is often below what lost churn, net churn, and what we see when it comes through on an actual basis versus an estimated basis. So we feel pretty good about the Casualty book.

Sid Parameswar, Analyst

Okay. Got it. Thank you.

Operator, Operator

Thank you. The next question is from the line of Andrew Anderson. You may proceed.

Andrew Anderson, Analyst

Hey, good morning. Maybe sticking on Casualty. It seems pricing improved sequentially a couple of points really led by the umbrella product. But do you expect the Casualty segment as a whole to keep seeing rate momentum and perhaps accelerate in the second-half?

Jen Klobnak, Chief Operating Officer

I would love to see that. You're right umbrella is driving in this case. So it's really a mix change that's causing that increase from the 7% in the first quarter to 9%, First umbrella leading the way. As I mentioned, we have a couple more approvals already in the can in different states for first umbrella. So we continue to see some improvement on rate there. Other than that, you know we underwrite at an individual level, a lot of these business units we have are looking at individual risks and trying to achieve overall rate to address loss trends and claim experience that we have. So I think there is some potential for it, but you know it's a fight every day to see what a given account is willing to do based on our competition, which in some cases makes no sense to us that they've been cutting rates in some areas. So I'll stick with you and say, hopefully, rates will continue to go up, but I'm not going to put that in writing at this point.

Andrew Anderson, Analyst

Okay. And maybe on the Casualty reserves, favorable PYD was pretty good here this quarter. But could you talk about any movements you may have had on more recent accident years? Have you been adjusting those either way or holding steady?

Todd Bryant, Chief Financial Officer

Yes. This is Todd. I think the actuarial approach has not changed. There are areas, I would say we're extending the tail a little bit. Jen mentioned that in her comments with respect to transportation. So there's a bit of that. The approach is the same. I think if you look at the years from that standpoint where development was, it's pretty spread out. There's nothing big in any given year. So you're 2019 to 2023, pretty spread out some in '17. We haven't really changed our approach on a current basis, certainly not, and not as we look back over the prior years’ either.

Andrew Anderson, Analyst

Okay. Thank you.

Operator, Operator

Thank you. The next question is from the line of Scott Heleniak with RBC. You may proceed.

Scott Heleniak, Analyst

Yes, thank you. Good morning. I have a question regarding the umbrella line. There's been substantial growth of 37% in rate increases. Can you discuss the profitability of this line? It has been challenging for many of your competitors, yet RLI has performed well. Could you provide an update on the loss trends and share where you see opportunities? Additionally, what distinguishes your approach that has allowed you to manage these challenges more effectively than others?

Jen Klobnak, Chief Operating Officer

We've been involved in the personal umbrella business since the mid to late 80s and have focused on expanding this area over the last few years, particularly due to market upheaval. Competitors have changed their strategies, leading to disconnection in homeowners and auto insurance coverage, where carriers are willing to cover only one type. This environment has created a gap that we fill by offering standalone first umbrella policies. We partner with some of these carriers to assist their insureds, which drives our growth. We have a substantial amount of data, with nearly 400,000 insureds, allowing us to understand trends, loss drivers, and other insights. Our loss activity has remained stable in terms of frequency, even though the industry has experienced varying severity. We actively analyze what rates are necessary by state and insurance type, consistently adjusting our strategies. Regular meetings with producers help us identify shifting opportunities within our book. We leverage data for our underwriters to collaborate with claims and actuaries, addressing specific venues and claim trends to modify our approach as needed. As we pursue new growth, we adopt a conservative outlook on our book, recognizing that growth can lead to some challenges. We diligently monitor necessary rates and other terms. For instance, in response to industry severity, we've updated our requirement in California from a $250,000 to a $500,000 underlying auto liability limit, which we believe is a prudent step in managing potential severity moving forward. This is just one of the many factors we continuously evaluate within our book.

Craig Kliethermes, President and CEO

This is Craig Kliethermes. I want to emphasize that we invest significantly in both the claims and underwriting aspects of our operations. We possess specialized knowledge in our field. Our claims team for personal umbrella coverage is focused exclusively on personal umbrella claims. They are fully dedicated to this area and often collaborate with the relevant claim professionals from the underlying carriers. This collaboration helps us ensure the best outcomes for the insured, the defendants, and our company. The importance of having specialized claims personnel who primarily manage excess claims in the personal auto sector cannot be overstated.

Scott Heleniak, Analyst

Thank you for the detailed information. I have a follow-up regarding the significant growth in Surety. This area has been quite competitive, as you've mentioned in the past, with not many rate increases. Could you clarify if this growth is primarily due to market-wide factors such as increased construction activity and opportunities, or is it more about taking market share from competitors? What do you believe is driving this growth?

Jen Klobnak, Chief Operating Officer

In the contract area, this business unit concentrates on public construction, while many of our property and casualty products target private construction. The government effectively invests in private construction projects, resulting in a significant amount of available inventory, and our contractors have been actively bidding on these projects. Consequently, we've issued numerous bid bonds, which has led to project bonds as well. With the ongoing high prices of construction materials, this is a factor for the rating, contributing to the premium. Additionally, we have a proactive team reaching out for business. While it may seem trivial, consistently engaging with your producers and marketing regularly is crucial to the success of the product. Similarly, on the commercial side, a comparable situation exists within the energy sector and marketing. We support various industries and have developed expertise in renewable energy, which has proven beneficial. Ultimately, being present for producers, answering calls, and being available when needed is significantly driving growth in this area.

Scott Heleniak, Analyst

Okay. Great. Appreciate all the detail. Thanks.

Operator, Operator

Thank you. The next question is from the line of Meyer Shields. You may proceed.

Meyer Shields, Analyst

Thanks. I just wanted to start with a question on a point that Jen just made about asking for more business. I know you've talked about it for a while, we're seeing the success. Is there any way of benchmarking how much of this effort has already panned out? And how much more opportunity there is going forward?

Jen Klobnak, Chief Operating Officer

Meyer, it's a bit challenging to hear you, but I believe you’re inquiring about our increased marketing efforts. We have engaged with many people, and I'm interpreting your question in that context. I can say that we have been very active in the first half of the year, meeting with producers. We organized several in-person cross-product gatherings to educate them about our offerings, and the response has been positive, with many expressing interest in collaborating with us. This has been encouraging. I believe this builds momentum, and as we maintain these relationships, we can expect further organic growth moving forward. Therefore, it's not the time to become passive and wait for calls. We plan to remain proactive in the second half of the year, and we should anticipate more growth by continuing to engage with our producers.

Meyer Shields, Analyst

Okay, that's very helpful. The second question, and I guess this is on the Casualty side. I was hoping you could give us a sense of regional difference in terms of how much of social impression or lawsuit abuse you're seeing, or is it out there?

Jen Klobnak, Chief Operating Officer

In the United States, each state presents a distinct situation. Some states face different dynamics concerning legal system abuse than others. California, for example, poses significant challenges for us, and we do conduct a substantial portion of our business there. Therefore, we need to carefully assess our underwriting preferences and risk selections based on where we are willing to take risks. Once claims are received, it's crucial to act swiftly, investigate thoroughly, and understand the circumstances to mitigate any attorney tactics that could substantially increase exposure. Other states, like Florida, have implemented effective reforms that have been beneficial. Although it's too early to precisely measure the effects of these reforms, we can see improvements in claim counts and have favorable outcomes in certain resolved claims. Each state has its own characteristics. Louisiana is attempting to create a more business-friendly environment, but progress is still needed. This has made us cautious in that region. Consequently, these factors directly influence our risk appetite and underwriting practices, which are continually affected by evolving laws and case law in each state.

Todd Bryant, Chief Financial Officer

Meyer, I'll just add...

Craig Kliethermes, President and CEO

Meyer, I'll just add that we've discussed this before, but there is a very strong feedback loop between our claims, underwriting, and actuaries. Those conversations happen daily. When our claims team identifies problem areas or jurisdictions, they quickly relay that information to the underwriters. Sometimes we adjust our risk appetite with regard to specific locations, which can even vary within states. For instance, we might want to monitor certain parts of Texas more closely regarding the limits we deploy, the types of risks we write, and the insured classes we consider. This feedback loop is crucial for ensuring that underwriters have the right information, and as we've mentioned, our model allows underwriters to be very receptive to this information to help them build a profitable business.

Meyer Shields, Analyst

Okay. Thank you very much. That is very helpful.

Operator, Operator

If there are no further questions, I will now turn the conference over to Mr. Craig Kliethermes for some closing remarks.

Craig Kliethermes, President and CEO

Well, thank you all for joining today. A good quarter and first-half of the year. We believe our hallmark underwriting discipline and diversified portfolio of specialty products should translate into consistent financial outcomes over time and allow us to continue serving as a stable market for our customers. As our Founder, Gerald Stephens once said, we do it right because we all work for a company we own. We know if the company succeeds, so do we. That's different. We're not like other companies. I would like to thank all of our RLI associate owners for their contributions to our shared success and encourage them to keep delivering on the difference that works. Thank you all again for tuning in and we'll visit again next quarter.

Operator, Operator

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. Have a nice day. All parties may now disconnect.