Selective Insurance Group Inc Q1 FY2021 Earnings Call

Good day, everyone, and welcome to Selective Insurance Group's First Quarter 2021 Earnings Call. At this time, for opening remarks and introductions, I would like to turn the call over to our Senior Vice President, Investor Relations and Treasurer, Rohan Pai. Please begin.

Good morning, everyone. We're simulcasting this call on our website, selective.com, and the replay will be available until May 28, 2021. Our supplemental investor package, which provides GAAP reconciliations of any non-GAAP financial measures referenced today, is also available on the Investors page of our website. Today, we will discuss our results and business operations using GAAP financial measures that are included in our annual, quarterly and current report filed with the U.S. Securities and Exchange Commission. Non-GAAP operating income and non-GAAP operating return on common equity, which we use to analyze trends in operations, make it easier for investors to evaluate our insurance business. Non-GAAP operating income is net income available to common stockholders, excluding the after-tax impact of net realized gains or losses on investments and unrealized gains or losses on equity securities. Non-GAAP operating return on common equity is measured as non-GAAP operating income divided by average common shareholders' equity and statements and projections about our future performance.

Thank you, Rohan, and good morning. I'll make some opening remarks on our first quarter financial performance and outlook, and then turn it over to Mark to provide the details on our results. I'll return to provide an update on some of our strategic growth initiatives before opening the call up to questions. We're off to an excellent start in 2021 with a 16.2% annualized non-GAAP operating ROE. This was an exceptional result in the context of a challenging economic backdrop, a continued overall low interest rate environment, and elevated catastrophe losses for the industry. It is also well above our operating ROE target of 11%, continuing our strong track record of consistent and superior results. Our first quarter results reflected strong contributions from both underwriting and investment operations. Our solid premium growth of 11%, when adjusted for the prior year COVID-19-related audit premium accrual, was driven by overall renewal pure price increases averaging 5.4% and strong retention rates. Our continued ability to generate solid premium growth in the current economic climate is driven in large part by our extremely strong distribution partner relationships, sophisticated and granular pricing and underwriting tools, and superior customer servicing capabilities. Our 89.3% combined ratio for the quarter benefited from catastrophe losses that were in line with our expectations and 4.8 points of favorable prior year casualty reserve development. Our solid underlying combined ratio of 90% is a testament to the quality of our book of business. While we have seen early signs of a return towards normal economic activity, depending on geography and class of business, overall claim frequencies in the quarter have remained below pre-COVID levels. That said, much uncertainty remains regarding the impact of late reported claims and increased severities. Therefore, our 2021 accident year casualty loss ratios remain on plan, and our 2020 casualty loss ratios remain at the levels booked at year-end 2020.

Thank you, John, and good morning. I'll review our consolidated results, discuss our segment operating performance and finish with an update on our capital position and guidance for 2021. For the quarter, we recorded excellent net income available to common stockholders per diluted share of $1.77 and first quarter non-GAAP operating earnings per share of $1.70. We reported an annualized ROE of 16.8% and a non-GAAP operating ROE of 16.2%, with meaningful contributions from both our insurance and investment operations. Our results for the quarter compared favorably with our 2021 non-GAAP operating ROE target of 11% set earlier this year, which translated to an approximately 400 basis points spread over our weighted average cost of capital. Overall, we are off to a very strong start to 2021 from a growth and profitability perspective.

Thank you, Mark. I'd like to highlight some of our major areas of strategic focus as we move through 2021. We continue to execute on our plans to generate profitable growth that significantly outperforms Commercial Lines industry results. Our solid capital position provides us with the flexibility to evaluate various growth opportunities, with a focus on those that enhance our market position with our customers and distribution partners while generating attractive returns for our shareholders. We continue to identify ways to bring additional value to our various stakeholders to further build a franchise that is positioned for long-term strategic and financial outperformance. The major drivers of our organic growth strategy in Commercial Lines are increasing our share of our distribution partners' overall premium to 12%, appointing new distribution partners to achieve a 25% agent market share, and expanding it to new states. As we've been highlighting on recent calls, we continue to invest in tools and technology that enhance our market position with our agents. The MarketMax tool, which provides our distribution partners with insights into their overall portfolio and identifies opportunities for them to grow their business with us, has now been rolled out to approximately 300 of our distribution partners, and we expect to increase this to 400 by year-end. The tool has seen strong acceptance among our partners, who are often eager to consolidate their business with fewer carriers that can offer superior service and offerings while optimizing their overall relationship. We rolled out our new small business platform for BOP products to all agents in the fourth quarter of 2020. We significantly streamlined the quoting and issuance process for these accounts and experienced a strong increase in BOP small business submissions since the rollout. During the first quarter, we expanded the platform to include coverages such as general liability and bundled Inland Marine for small contractors, with additional products and a broader rollout planned for the remainder of the year. In Personal Lines, we're on track for the third quarter launch of our homeowners product targeting the mass affluent market, a customer base that places greater importance on coverage and services. Later this year, we plan to launch coverage enhancements to our auto product designed to better serve this customer segment. We've already seen some positive momentum in our mix of business prior to the official launch. We saw solid growth in our E&S segment during the first quarter and expect improving performance moving forward as we continue to roll out our new agency automation platform that will further enhance our competitive position. As we look to the remainder of 2021, I remain extremely confident about our unique market position and strategy. We have the tools, talent, capabilities, and distribution partnerships in place to position us for continued excellent performance. We have demonstrated over the past seven years our ability to leverage these capabilities to generate consistent double-digit ROEs while profitably growing the business at a healthy rate. With that, we'll open the call up for questions.

Speakers, our first question is coming from the line of Matt Carletti from JMP.

Just a couple of questions on Standard Commercial. Mark, I always struggle to keep up. You speak fast. I believe you split out the audit premium, COVID-related headwind, the $75 million across. I think I caught $29 million on workers' comp. Maybe I'm making that up. And across, I'm assuming GL is the other piece of it. Is that correct? Are those the buckets?

You have it correct, Matt. It was $29 million in workers' compensation in Q1 2020 and $46 million in general liability in Q1 2020 for a total of $75 million. I just wanted to provide those details because the growth rate for those lines of business looks a little overstated on a comparative quarter if you don't adjust for that.

Yes. Perfect. And then yes, so following on that, I mean, if we adjust particularly workers' comp for that, it was a pretty nice acceleration in growth even adjusted for that. Can you talk a little bit about what's going on there? Is it just the return to better work activity? So is it more kind of payrolls on your existing accounts? Or is it more new business pushing that?

Yes, Matt. This is John. I'll take that. So I think you've got a few things happening there, and part of it is price related, more so for general liability than it is for workers' comp where pricing is still relatively flat. And we also see exposure starting to improve. So we saw on an all-lines basis, and I'm not breaking out specifically the individual lines. But on an all-lines basis, in Commercial Lines in Q1, our exposure was up just under 1.5%. So I think that's the other part of it. And then you add to that about a 100 basis point increase in retention rates, and those are all contributing to growth. New business was relatively flat overall. And again, mix matters in terms of the segments that we write. I would say those were the major drivers. You have strong retention, a little bit of bump up in exposure on your renewal portfolio, and some price working through there.

Okay. Great. And then just one other modeling question. The $16 million of cats in that segment, do you have the buckets? I'm assuming the bulk was commercial property, but maybe some fell into BOP and commercial auto.

Yes. Just give us a second to get to that.

Yes. Most of it sits in commercial property, but I can kind of break that out if you like. So of the $16, call it $16.1 million of cats in Standard Commercial Lines in Q1, $13.7 million came out of commercial property; and then the balance came out of BOP, which is $2.2 million. There was a little bit in commercial auto, but that was approximately $200,000. So those were the three breakouts of the cats into the different lines of business.

Okay. Perfect. Well, that's all I got. Congrats on a nice start to the year.

Thank you, Matt.

Speakers, our next question is coming from the line of Meyer Shields from KBW.

Great. John, I'm trying to understand some of the marketplace dynamics and the impact on your expectations. Basically, the premise is that we're seeing Travelers' retention rate on smaller accounts decline. And I'm wondering, is that influencing growth? And is there a difference in the quality of accounts that you write when you win them from bigger competitors compared to what you win from smaller competitors?

Yes. Those are challenging questions to address. I'll start with the second one regarding the competitor from whom the business was previously written. I don't see a difference in expected performance because we carefully analyze our new business pricing each quarter in relation to targets set by previous insurers. We keep track of where the business originates from, by class, and our pricing deviations compared to those competitors. We assess this at a detailed level. I believe there is no difference in the pricing required to win accounts from larger companies versus smaller ones. Therefore, I don't anticipate any change in profitability expectations going forward. As for the first part of your question, while I can't speak on behalf of Travelers, who is a strong competitor in the market, we focus on improving retentions in the small commercial sector due to the strength of our book of business. We concentrate primarily on two areas: managing our pricing strategy with as much detail as possible, which is why we report each quarter on our pricing expectations for different cohorts, and maintaining a consistent track record of managing pricing relative to expected loss trends over the past ten years. This consistency allows us to be a reliable player in the market for our distribution partners, avoiding significant rate fluctuations that could cause disruption. Additionally, our business mix is distinct in terms of what we underwrite. Our small business portfolio is less concentrated on small retail restaurants, which were heavily affected by the pandemic, and this may have contributed to our stronger retention rates compared to those with a different business mix.

That's very helpful. For the second question, assuming we encounter unprecedented audit premiums in the next 12 months, are there any G&A expenses related to that?

Yes. Well...

There's no G&A per se, but you would have the commission associated with it. So it doesn't come through on a written and earned basis but would have the associated commission, but not necessarily incremental G&A.

Yes. I think another aspect to consider is that the premium does come with associated risks. Therefore, I don't expect a significant increase in profitability from a loss ratio standpoint. I understand that companies will attempt to differentiate between exposure that behaves like rate and exposure that does not, which can become complex, especially when adding a vehicle, as this increases the potential for additional losses. If payrolls are rising while the number of employees remains constant, you're still encountering some increased exposure because your indemnity costs will rise relatively. I want to emphasize that we approached our audit premium accrual very cautiously, ensuring we recorded a reasonable estimate of that amount. This helps us manage the changes in exposure more proactively. I don't foresee a substantial increase in exposure driven solely by an economic rebound, as many factors influence comp and GL, particularly the audit premium and exposure changes. Additionally, there are various non-auditable lines, such as the business owners' line or the property line, to consider.

No, that's very helpful. I was really looking for some thoughts on the expense ratio, but that was immensely informative.

Speakers, our next question is coming from the line of Scott from RBC Capital Markets.

Yes, just had a few here. The first, just wondering if you could touch a little bit on, yes, frequency versus severity kind of across a couple of the major lines. Yes, I'd imagine, obviously, the frequency part of it is pretty favorable right now, given where the economy has been in the past few quarters, and we've seen that across a number of companies. But I wonder if you could talk about the severity part of it as well, particularly in workers' comp, GL, and commercial auto. We've heard, particularly in commercial auto and workers' comp, a few companies talking about some increases in severity even though the frequency is down. And just wondering what you're seeing in your book in some of those key lines.

Yes, this is John. What we're experiencing is quite similar, but I wouldn't say the severity is significantly different from what we anticipated, and it certainly hasn't reached a level that offsets the better-than-expected frequencies we've generally seen. I want to contextualize this based on our consistent approach, which involves comparing actual severities to expected severities by reviewing recent prior accident years. The question is, what is included in those evaluations? We've regularly incorporated an increasing expected loss trend in our assessments, which has helped us manage any slight movements in severity. Generally, you're correct regarding general liability and workers' compensation; frequencies have performed better than expected while severities have been somewhat worse than anticipated, but not enough to negate the positive trend in frequency. The auto sector has shown some differences, consistently influenced more by frequency than severity on those previous loss ratios. These are factors worth monitoring moving forward. It's quite challenging to provide specific insights on the most recent accident years. In 2020, for instance, with that book being immature and frequencies performing better than expected, we have noted the uncertainties surrounding severity.

That’s helpful and makes sense. I would like to know more about the reserve releases. For Commercial Lines, you noted that the releases from 2018 and earlier accident years are the highest we've seen in quite some time. I assume this primarily involves workers' compensation and general liability. Could you provide additional commentary on that, as well as on the excess and surplus lines, which experienced releases for the first time in a long while?

Sure, Scott. This is Mark. Why don't I start, and John can jump in as well. So you're absolutely right, the net favorable casualty reserve development was pretty significant in the first quarter, $35 million or 4.8 points of benefit on the combined ratio. $30 million of that, as I mentioned, was in Standard Commercial Lines and $15 million of that in each of workers' compensation and general liability. For the first time, we did see favorable claims emergence within E&S, and that was $5 million, so that $35 million in total. As I mentioned in my prepared comments, it was really 2018 and prior. If you were to break that out, just provide a little bit more specificity, about $13 million came out of the '18 year, $11 million out of '17, $4 million out of '16, and $2 million out of '15. That's the majority of $30 million of the $35 million. We essentially saw a very favorable claims emergence, which we responded to in the quarter.

So I think when you look at it by individual accident years, these are not big numbers coming through on an individual accident year basis. The other thing for comparative purposes is, if you look back over the last couple of years, we did have probably an offsetting movement in commercial auto going the other way that probably tempered some of the overall reserve release impact, which is not the case.

Yes. As John mentioned in his prepared comments, we haven't made any adjustments to the loss picks of the 2020 year, so it's still a little bit too early to respond to any trends that might be coming through on the 2020 year.

The last question is about the renewal pricing. It increased slightly in Q1 compared to Q4. Some other companies have seen their pricing level off or even slow down a bit. I would like to know if you could share more about your observations on pricing. Do you anticipate this trend to continue as the year progresses? Can you provide any insights on what you're seeing in April regarding pricing?

So we haven't and don't plan on sharing anything about April on this call. Let me just talk a little bit about the market on a go-forward basis. I do think, Scott, I know we've mentioned this in the past, each company's portfolio is different, and their line of business mix is different. What we're seeing in the marketplace from a headline price change number is being driven by high exposure lines that we don't really play in. Whether it's your professional lines, high-hazard property, or significant excess limits on more hazardous classes, those are the numbers driving the high reported pricing that we've seen. You probably are starting to see a little bit of tempering there. But on the smaller and middle market end of the pricing scale, when you look at various surveys, I would say it's been holding pretty steady. At least at the smallest end of the market, you've seen some other companies seeing some sequential improvement in their underlying pricing, similar to what we saw. It's important to reinforce, and I'm not projecting out our rate expectations for the year, but just want to talk about market dynamics that we think continue to push in a manner that suggests weight will remain strong relative to expected loss trends. The prolonged low interest rate environment has had an impact. We're pleased with our results, but we also don't get overwhelmed by the fact that we had a strong alternative investment quarter. In core fixed income for us and everyone else, new money rates are still running below what is rolling off maturities and other disposals. Everyone is feeling some pressure when projecting forward margins. I touched on in the prepared remarks that catastrophe and non-cat losses continue to be elevated for everybody. Property is a line that everyone recognizes needs to run at a much lower combined ratio in a normal loss year due to the spikes seen recently. Property pricing continues to adjust accordingly. A firming reinsurance market remains important. It's not just about pricing but also about terms and conditions in certain cases. Elevated loss trends are still a part of the equation. Some are projecting that as a new phenomenon, but from our perspective, we've seen expected loss trends of about 3% climb to around 4% that needs to be compensated in margins. Finally, while our results are strong and some of our public peers are also producing solid results, the broader Commercial Lines industry still has work to do in terms of margins. Most projections have the Commercial Lines industry hovering around a 100% combined ratio, indicating that margin improvement is still necessary despite current positive indicators.

Currently, we don't have any questions in the queue. Speakers, at this time, we don't have any questions in the queue. So with that, I'll go ahead and turn the call back over to John. John, please go ahead.

Great. Well, thank you all for your time this morning. We appreciate your participation and your questions. As always, feel free to follow up with Rohan or Mark with any follow-ups. Thank you.

Thank you.

Thank you. And that concludes today's call. Thank you so much for your participation. You may now disconnect.