Selective Insurance Group Inc Q2 FY2021 Earnings Call

Thanks, and good morning, everyone. We’re simulcasting this call on our website, selective.com, and the replay will be available until August 20, 2021. Our supplemental investor package, which provides GAAP reconciliations of any non-GAAP financial measures referenced today also is available on the Investors page of our website. Today, we will discuss our results and business operations using GAAP financial measures that are also included in our annual, quarterly and current report filed with the U.S. Securities and Exchange Commission and non-GAAP operating income and non-GAAP operating return on common equity, which we use to analyze trends in operations and believe 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 stockholders’ equity.

Thank you, Rohan, and good morning. I’ll make some introductory comments on the results and then highlight some of the higher-level themes impacting the industry and our company. Mark then will discuss our financial results, and I’ll return to provide an update on some of our strategic initiatives that position us for sustained financial and operating outperformance. We generated excellent financial results in the second quarter with a 17.1% annualized non-GAAP operating ROE. Both our underwriting and investment operations were strong contributors to the financial results for the quarter. For the first half of the year, our annualized non-GAAP operating ROE of 16.4% was well above our full year operating ROE target of 11%, continuing on our strong track record of excellent results. Similar to the first quarter, favorable prior year casualty reserve development and strong alternative investment income drove the outperformance, while underlying underwriting and investment performance are in line with our ROE target for the year. For the quarter, our solid net premiums written growth of 12% after adjusting for the prior year COVID-19 related personal and commercial auto credits was driven by overall renewal pure price increases averaging 5.1%, strong new business growth and stable retention rates. Our 89.8% combined ratio for the quarter benefited from moderate catastrophe losses and 2.3 points of favorable prior year casualty reserve development. The underlying combined ratio of 89% reflects our superior underwriting capabilities and the quality of our book of business. Net investment income after tax totaled $67 million in the quarter, benefiting from the exceptional performance from our alternative investment portfolio. While our alternative investments, particularly private equity, have generated outsized returns so far this year, we expect performance to normalize in the coming quarters.

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 second quarter, we reported excellent net income available to common stockholders per diluted share of $1.98 and non-GAAP operating earnings per share of $1.85. We reported an annualized ROE of 18.3% and a non-GAAP operating ROE of 17.1%, with meaningful contributions from both our insurance and investment operations. For the 6 months ended June 30, our annualized non-GAAP operating ROE of 16.4% is well above our 11% target for the year. Overall, we are extremely pleased with our performance so far this year. Consolidated net premiums written for the second quarter increased 15% compared with a year ago or 12% when adjusted for $19.7 million of COVID-19 related premium credits in the prior year period. The primary drivers of our top line growth were strong renewal pure price increases, solid retention rates and very strong new business growth in our Standard Commercial Lines and E&S segments. Year-to-date, net premiums written have increased 19% or 11% when adjusted for the prior year COVID-19 related premium items. We reported an extremely strong consolidated combined ratio of 89.8% for the second quarter. Included in the combined ratio were $22.6 million of catastrophe losses or 3.1 points and $17 million of net favorable prior year casualty reserve development or 2.3 points.

Thanks, Mark. We continue to execute on our objective of generating consistent and profitable growth by identifying ways to bring additional value to our customers and our distribution partners. Our long-term goal in Commercial Lines is to increase our market share to 3%, which is predicated on increasing our share of our distribution partners' overall premium to 12% and appointing new distribution partners to achieve a 25% agent market share. We seek to augment these initiatives by expanding into new states. Let me highlight some of our ongoing strategic initiatives. The rollout of our MarketMax tool, which provides our distribution partners with insights into their overall portfolio and identifies target accounts to grow their business with us continues to progress well. MarketMax has currently been deployed in approximately 320 of our distribution partners and is targeted to grow to over 400 by year-end. The tool has seen strong acceptance among our distribution partners and has been a key contributor to our strong new business growth over the past year. We are still just beginning to realize the full value of this investment. Our updated small business platform continues to roll out successfully. Our business owners, general liability, automobile, umbrella and cyber lines for eligible small business customers are now available on a new platform. We significantly streamlined the quoting and issuance process for eligible accounts and are experiencing a strong increase in small business submissions since the rollout. The business owners line of business, which became available to our agents in the new platform in the fourth quarter of 2020 saw new business premium increase from that line by more than 20%. In Personal lines, we successfully launched our homeowners product changes targeting the mass affluent market at the end of June. This customer base tends to place greater value on coverage and service and, as such, is less price sensitive. Our agents have responded favorably and have already begun submitting more of this business. Later this year, we plan to launch coverage enhancements to our auto product designed to better serve this customer segment. We saw solid growth in our E&S segment during the second quarter and expect continued strong performance moving forward as we continue to roll out our new agency automation platform that will further enhance our competitive position. Our focus within E&S remains on small, lower hazard accounts. This segment continues to benefit from higher pricing and increased deal flow into the non-admitted space. I also want to highlight our recently published environmental, social and governance report, Driving Sustainable Impact, which lays out how ESG values are embedded in the way we do business and are integral to the execution of our long-term priorities. These include understanding and attempting to mitigate the impact of climate change, providing customers with responsive claim services and risk mitigation solutions and developing a highly engaged team of employees and leaders. Enhancing diversity, equity and inclusion is a big part of creating an engaged culture that celebrates creativity, innovation and idea generation, and we seek to increase diversity at all levels of the organization. By acting in the interest of and providing value to all our stakeholders, we will serve the interest of our shareholders by generating sustained financial outperformance. As we look to the remainder of 2021, I’m extremely pleased with our market position and superior ability to execute. I am confident that we can continue to build on our long-term track record of performance that meets or exceeds our ROE targets. With that, we’ll open the call up for questions.

Our first question comes from Matt Carletti from JMP Securities.

John, I appreciated your comments on inflation. And at least my read is that you have a healthy respect for it. My question is, what’s your view of the industry from kind of twofold? One is, do you think others in the industry are kind of taking the inflation that we’re seeing seriously? Or do you think some people are treating it more transitory? And then the follow-on to that is, what impact do you think it will have on the longevity of the pricing cycle?

Yes. Thanks, Matt. Great question. And I always hesitate to comment too much on the industry. And certainly, we have read the comments and the responses to the questions from a number of peers who have reported to this point. And they all have different perspectives. And I think they’ll all confidently state that they’ve got it factored into their loss picks and factored into reserves. I can only speak to the discipline with which we have always managed loss trends and earned pure rate to offset loss trend in our own portfolio and the discipline we had around that because I think the important part to understand is inflation doesn’t just manifest itself in expected loss trend on a go-forward basis, inflation will also manifest itself in some ways in your actual historical loss trends versus what you expected. And as you know, looking back over at least a decade, we’ve been not just disciplined around that, but highly transparent to our shareholders and the investor community in terms of how we view loss trends and the pure rate, renewal pure rate in our loss picks. So that’s the first point I would make. I can’t speak to whether other companies take the same approach that we do, but we maintain discipline on that. Now when you think about inflation and the impact on frequency and severity, I think it’s important to put it in context. And clearly, for everybody in the industry right now, evaluating frequency and severity trends is complicated by a few different factors. I mean, obviously, one is social inflation and social inflation is one that while it will impact your future loss trend expectations it’s also going to be seen in your historical loss trends. So when you look back at those prior accident years, what is actual change in frequency and severity versus what you thought it was and is that manifesting itself in higher average severity, is it manifesting itself in higher rates of litigation? And then how do you respond to that? And how does that influence your pick for the upcoming year? So that’s the first exceptional impact. Second exceptional impact, which a lot of time has been spent on is COVID-19. And I think there’s clearly been a lot of focus around the drop in frequency in 2020 and how that’s continued into 2021, albeit at a lower pace, but also the offsetting impact, in some cases, partially maybe more so of some increasing severity that has gone along with that. And that is another exceptional factor that needs to be factored into how companies evaluate. And then the third and more immediate is the economic inflation that everybody is seeing. Although when you break down the component parts of the CPI, you realize that it’s largely driven by lumber and used cars are the big outliers. So when you see a little bit of upward pressure in other areas. So there’s a number of different pieces there. I think the most immediate one and again, from our perspective, this is always in our line of sight. It’s always factored into how we evaluate loss trends and how we update loss trend assumptions. But in terms of the more immediate economic inflation, I think you always want to keep that in context. And when you think about auto physical damage and the severity impact on that particular subline of business, severities have been on the rise in auto physical damage for the industry for a while, previously, it was driven by the increased cost of repairing vehicles because of more technology in the vehicles and then when you think about the impact of used cars, it’s largely on total losses and total losses are a portion and not the overwhelming portion of loss sellers in auto physical damage, but you also want to think about that short-term impact to severity in the context of lower frequency. So that’s the first point. And then with regard to lumber and my apologies for going on a little bit longer, but there’s a complicated answer to your question. With regard to lumber, I think it’s important to also keep that in context. So clearly, that is now manifesting itself in average severity. And let me talk about home first because in the homeowners line, lumber is going to have a bigger impact than it is in Commercial Lines. But lumber is just a small portion of the loss seller. And when you think about the other big piece, the big driver in CPI relative to home, it’s going to be drywall. Drywall has only been up about 10% in the same time period. So when you put all the pieces together for Personal, for home, let’s say, the construction cost index is up about 17%. And then remember that about 20% of the average loss dollar is for nonbuilding related items, extra expense and contents and those sort of things. So it’s in there, but it’s not as bad as the headline would suggest. And also, at least for us, when you look at our frequency relative to non-cat property, that continues to run a little bit lower than anticipated. So there’s an offset there. And then on the Commercial property side, the actual construction cost index is probably closer to 5%, and you’ve got about 40% of the loss sellers in commercial property that are not building related. So I think that puts in important context around how the headline numbers work their way through. All that said, property is still aligned in the industry that is running combined ratios well above its risk-adjusted target. That’s a line that you never want to look at on an ex-cat basis, you want to look at it on a normalized cat basis. And the other area of discipline that we have, and I can’t speak to others, is with regard to insurance to value. So we are constantly updating our coverage A values on the home side and our building values on the property side with an eye towards inflationary costs, and those get factored in and allow you to stay upfront, at least in times of normal inflation. So we’re not going to prognosticate if this is transitory or not transitory and really focus more on the diligence and the process we’ve always had around embedding loss cost changes into our loss picks.

That’s great. Very insightful and really helpful. A quick follow-up, just a numbers answer probably for Mark. The cat losses in standard commercial, do you have those by line, I think you’ve given them in the past between property, commercial auto and BOP?

Sure, Matt. So in the quarter, in standard commercial lines, the catastrophe losses were $11.3 million or 1.9 percentage points on the combined ratio for the standard commercial lines, and that’s really spread across 3 lines of business. Within commercial property, it’s $9.2 million. In commercial auto, it’s about $500,000. And in the BOP line is $1.6 million for a total of $11.3 million or again 1.9 points on the combined ratio.

All right, great. Congrats on a really nice start to the year.

Thank you, Matt. Our next question comes from Paul Newsome from Piper Sandler.

Congratulations on the quarter. I want to ask you kind of a big picture question. You’re getting rate above what you think, knock on wood, to what the claims inflation is. What factors should we consider that might keep you from having underlying underwriting margin expansion in 2022 versus ‘21, just maybe you could think about the pieces that we should be thinking about that might offset or change that embedded underwriting improvements?

Yes. So Paul, it’s a great question. I do think, in part, it ties back to the discussion we just had relative to loss trend and the impacts on loss trends. And we’ve tried to stress this, and I know it gets complicated but when you think about a forward loss picks, I think about ‘21 into ‘22, it’s not just about what is the impact of expected loss trend and what is the impact of expected written rate? That certainly influences your loss pick for the upcoming year, but the equal influence, at least for those of us who have a fairly disciplined and rigorous process around it is looking back over the last 5 accident years and saying, okay, how with each passing quarter has my actual frequency and severity emerged? That’s your historical loss trend. So when you look back and bring all those prior accident years to a fully trended basis based on actual changes in frequency and severity and then bring them to present rates. So what was my earned rate in each of those years, that’s your starting point. That starting point could be influenced by social inflation. So to the extent social inflation hit the prior accident years, and therefore, your loss trend in those years is emerging a little worse than expected, either driven by frequency or severity, that is influencing up the pick for your upcoming year before you load on the expected future trend and expected written rate and I think that’s the one piece that we’re certainly diligent about. And fortunately, for us, when we look back, the actual trends have been fairly stable with what we’ve embedded in there, and we’ve been earning rate at a very consistent basis to offset that trend. For everybody in the industry, that will be a big influence when they do their planning for 2022 on the casualty lines. And I think that’s the one area and I’m not prognosticating for us or anybody else, but that is the one, I would say, unknown or the information you would probably would not have from a lot of the companies when you think about rolling forward from this year to next.

Our next question comes from James Bach from KBW.

I was wondering about pricing. Can you provide your outlook for the trajectory of pricing on the commercial side? I know it’s been 5%, 5.1%, and 5.7% last quarter. Can you give us an idea of whether that’s decelerating or where you see rate increases going from here?

Yes, our performance in the first two quarters has been relatively stable. While market dynamics affect our pricing management, we've approached our pricing targets thoughtfully, focusing on our profitability and trends rather than chasing short-term gains due to market conditions. Looking forward, we believe the current pricing environment is sustainable, driven by several factors. Firstly, the low interest rate environment remains uncertain and, although our alternative investment portfolio is performing well, it masks the challenges faced by core fixed income portfolios. Declining yields will pressure underwriting margins. Secondly, many companies are experiencing increased volatility in their non-catastrophe losses, but when examining the last few years, we've seen higher levels of both cat and non-cat property losses. Reinsurance pricing is firming up, which, while possibly underwhelming for reinsurers, still reflects an upward trend that needs to be considered. Loss trends, influenced by inflation and social inflation factors we noted before the pandemic, are also important. As the economy reopens, we anticipate these trends to resurface, supporting the pricing environment. Additionally, many firms require improvement in their starting margins despite reporting strong results. We emphasize underlying results without extraordinary catastrophe impacts when considering our starting point. The industry still needs to address some loss ratio improvements. Lastly, the declines in industry headline rates recently have primarily originated from high-rate lines such as excess umbrella and specialty lines, while we observe more stability in areas like commercial auto and general liability, which are significant to our portfolio.

Perfect. You mentioned some improvement in the expense ratio beyond the temporary savings from COVID. Can you outline the strategies for expense savings going forward?

Yes. Certainly. So when we went into 2021, we put forth our expectations for the full year after the combined ratio, which was a 91% underlying combined ratio. And embedded within that guidance, we talked about 40 basis points of expense ratio improvement. And that was off an adjusted 2020 expense ratio. As you know, 2020 had a number of COVID-19 items. It was 33.8% on a reported basis, but adjusted for the pluses and minuses, it was really a 33.4%. So our expectation going into 2021 was for a 33 expense ratio, 80 basis points of actual improvement or 40% on an underlying basis. Year-to-date, we’re at 32.4%, so about 60 basis points of improvement versus expectations. And really, a couple of drivers there. It really is our travel and entertainment. We had expected T&E to be a little bit lower-than-expected in the first half of the year than the run rate, but it’s actually come in less than expected. And then we have just some overall general and overhead items that have come in below expected. And that includes things like rent, stationary, supplies, consulting fees, audit fees and things like that, that benefited the expense ratio. We expect some of those items to perhaps revert back to more normal levels, so maybe a little bit of upward pressure on the expense ratio, getting us back to more at the expected level for the full year 2021. But going into 2022 and into 2023, we do have a plan in place, line of sight and a path to continue to be more efficient as a company. And that will be reflected in as an expense ratio that we expect to be able to bring down. We’ve talked in the past about an appropriate expense ratio for our company, for our mix of business as we stand today of around a 32%. And we think there’s a pathway to get there by the end of next year going into 2023. So that’s sort of how we’re thinking about the overall expense ratio.

Our next question comes from Grace Carter from Bank of America.

Thinking about the recent increases in severity in personal lines. I was wondering where the pricing outlook is today versus when you all originally started thinking about the transition towards the mass affluent book? And as we kind of wait to see how these current severity trends play out, if there’s any impact on your growth appetite or the expected speed of the rollout or uptake in the meantime?

Yes, I can provide some insight. Our perspective hasn’t really changed. When we examine our portfolio, we’ve noticed a decline in frequency in auto claims, which has been more pronounced in personal lines compared to commercial lines. Although severity has increased, it's been more significant in commercial auto. Our data does not indicate any major shift in severity for personal auto. Regarding the pricing environment, I was actually surprised by how drastic the pricing changes were during COVID. Instead of issuing auto credits, there was a move to significantly adjust base rates, anticipating a permanent change in frequency and severity, which caught some market participants off guard. We chose to maintain relatively flat auto pricing, which affected our competitive position in the short term. However, we expect recent results to start applying upward pressure on personal auto pricing, and we believe this will gradually permeate the market. We are approaching a business segment that should be less sensitive to price, and home insurance plays a significant role in decision-making alongside auto. We consider them as part of a package going forward.

Thanks. I have a quick question about standard commercial. Many of our peers have mentioned increased property losses this quarter. However, when I examine the non-catastrophic property losses in standard commercial, they seem consistent with previous quarters. I'm curious if you have observed this as well or if there is something specific about your portfolio that has helped you avoid such losses.

Our non-cat property relative to our own expectations has been a little bit better-than-expected for the first half of the year. When you compare it to the prior year, last year was an exceptionally light non-cat property year. But when we think about our normal run rate, we’re a little bit better-than-expected on non-cat properties from a frequency driven. And I mentioned earlier in the response to the question around inflationary impacts, some of those on the property side are impacting severity a little bit. But in our portfolio, there’s an offsetting frequency benefit. We put them all together, we’re a little bit better-than-expected on non-cat property.

Our next question comes from Scott Heleniak from RBC Capital Market.

Most of the questions have been answered, but I have a couple of quick ones. Can you quantify the impact of premium audit exposure units in the second quarter on growth compared to the previous quarters? I would assume that most of the benefit will be seen in the second half and into next year. Can you provide more detail on that?

Yes. So let me try to answer this for you. So generally speaking, from our perspective, the best way for us to think about exposure change because there are different pieces that will move around in there that some companies consider exposure or others might not. We just look at the difference between the total premium change on our renewal book and the pure rate change. And in the quarter, that was about 2.7 points - 2.7%. And then when you think about that in the overall portfolio. So that renewal business is about 81% of the premium in the quarter. So assume a little over 2 points of the growth in the quarter would have been attributable to exposure change.

Okay. That’s definitely helpful. And then I wanted to switch over to the share buybacks, you were active in share buybacks in Q1 and you weren’t in Q2. So I wonder if you could just provide just your thoughts on your appetite, how you’re thinking about buybacks at current levels? And obviously, the market is still attractive and you’re running a lot of business, but I’m just wondering how buybacks might be factored in and come into play as you look for the rest of the year?

Sure. Scott, this is Mark. We put the buyback program in place back in December. And as we mentioned, it’s an opportunistic share buyback program. We’re right now seeing very attractive opportunities to grow our business. And you’ve seen the growth rate is significantly above where we’ve been for the last number of years. And so for us, the strong profitability we’re generating the capital that we’re generating, the best use of capital is just to put it back into the business and grow our core operations because it’s very attractive returns for our shareholders. When we think about the buyback program, it is going to be opportunistic. We would like to deploy it over a period of time, but we’ll be patient and judicious and look for an opportunity to enter the market to execute the buyback program. We don’t have a budget per se or plan to execute over a set number of quarters. It really is opportunistic.

I wanted to ask about E&S. It seems like you had strong momentum and premium growth there, and that trend appears to be continuing into the second half of the year. You mentioned a new platform, so is part of this growth coming from expanding your distribution partnerships? Could you elaborate on how much of this growth is due to organic expansion through distribution? Additionally, how do you see this evolving into 2022?

Yes. It’s all organic through distribution. We occasionally add new distribution partners, but we've noticed a significant increase in submission activity in the E&S space, which is driving the growth. Regarding the automation platform, we've discussed the enhancement of small business platforms that we are currently rolling out. For E&S, we are introducing a comprehensive quote, rate, and bind system for small businesses, which we believe will enhance our competitive position with wholesalers as we continue this rollout throughout the year and into early next year. We are confident in our market position, and the market benefits from strong rates; our rate level in E&S was just under 7% this quarter, along with robust submission flow. The business we're writing closely resembles our existing portfolio, focusing on small binding authority business, casualty-driven accounts, smaller contractors, and habitational types of accounts.

Thank you, Scott. Speakers, we do not have any questions in queue.

Great. Well, thank you. If there’s no further questions, we appreciate all your time this morning. And as always, please follow up with Rohan with any additional questions. Thank you.

That concludes today’s conference. Thank you, everyone, for joining. You may now disconnect.