Skyward Specialty Insurance Group, Inc. (SKWD) Q4 2023 Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the Skyward's Specialty Insurance Group fourth quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Natalie Schoolcraft, Head of Investor Relations. Please go ahead.

Thank you, Shannon. Good morning, everyone, and welcome to our fourth quarter 2023 earnings conference call. Today, I am joined by our Chairman and Chief Executive Officer, Andrew Robinson, and Chief Financial Officer, Mark Haushill. We'll begin the call today with our prepared remarks, and then we will open the lines for questions. Our comments today may include forward-looking statements, which, by their nature, involve a number of risk factors and uncertainties, which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed in our press release as well as our 10-K that was previously filed with the Securities and Exchange Commission. Financial schedules containing reconciliations of certain non-GAAP measures, along with other supplemental financial information are included as part of our press release and available on our website, skywardinsurance.com, under the Investors section. With that, I will turn the call over to Andrew. Andrew?

Thank you, Natalie. Good morning, everyone, and thank you for joining us. We closed out 2023 strong, reporting adjusted operating income of $0.61 per diluted share. Gross written premiums grew 21% in the quarter, and our combined ratio of 90.7% for the quarter included less than half a point of catastrophe losses. While it was a quiet catastrophe quarter for the industry, we continue to be at the low end of our peer group, even though over 25% of our business is property. Operationally, rate, retention, and submission flow in the quarter continued to be strong. I will talk more about this later in the call. Altogether, the execution of our Rule Our Niche strategy continues to be excellent, and our aim to deliver top quartile financial returns is visible in our growth, underwriting profitability, shareholder returns, and balance sheet strength. With that, I'll turn the call over to Mark to discuss our financial results in greater detail. Mark?

Thank you, Andrew. For the quarter, we reported net income of $29.3 million or $0.74 per diluted share compared to $20.4 million or $0.63 per diluted share for the same period a year ago. On an adjusted operating basis, we reported net income of $24.3 million or $0.61 per diluted share compared to $11.6 million or $0.36 per diluted share for the same period a year ago. In the quarter, gross written premiums grew by approximately 21%, and our transactional E&S, captives, industry solutions, and professional lines divisions each grew over 20%. Only global property and agriculture did not grow in the quarter, which is expected given the seasonality of this business. We continue to see excellent opportunities for this division in 2024. Net written premiums grew by approximately 19% to $214 million in the quarter, compared to $180 million in the fourth quarter of 2022. Fourth quarter 2023 net premium retention was approximately 67% versus 68% in the fourth quarter of 2022. Year to date, net premium retention was approximately 62% versus 59% a year ago. The fourth quarter is when we renew our professional workers' compensation and excess reinsurance programs. All of these renewals were orderly, and we are satisfied with the terms and structures of these programs for 2024. Turning to our underwriting results. The fourth quarter combined ratio of 90.7% improved 1.7 points compared to the fourth quarter of 2022. A 2.3 point improvement in the current accident year non-cat loss ratio to 60.9% was principally driven by changing mix of business. During the quarter, catastrophe losses were minimal and accounted for less than 0.5 point on the combined ratio compared to the fourth quarter of 2022, which was impacted by 1.2 points of catastrophe losses from Winter Storm Elliot. Excluding the deferred benefit from the LPT, there was no net impact from prior year development. We continue to maintain a conservative position with respect to our loss reserves as our actuarial central estimate at the end of 2023 indicated that we are in a more redundant position than at the end of 2022. The expense ratio increased slightly compared to the fourth quarter of 2022. We've talked in prior quarters regarding our business mix shift and investing in the business, so this is in line with our expectations in a target of a sub-30 expense ratio. Turning to our investment results. Net investment income was $14 million in the quarter, an increase of $8.7 million compared to the same period of 2022. Consistent with our investment strategy to deploy all free cash flow to core fixed income, in the fourth quarter, we put $118 million to work at 6.5%. The net investment income from our core fixed income portfolio almost doubled to $10.7 million from $5.9 million in the prior year quarter driven by an improving portfolio yield and a significant increase in the invested asset base. Our embedded yield was 4.5% at December 31, 2023, versus 3.7% a year ago. Our core fixed income portfolio is now over $1 billion, a $410 million increase from a year ago. Net investment income in the fourth quarter 2023 and 2022 were impacted by negative equity mark-to-market adjustments in our opportunistic fixed income portfolio. Just a reminder that last quarter we provided a redemption notice on $42 million of the opportunistic fixed income portfolio. Given the actions that we've already taken, including that notice of the $172 million in the opportunistic fixed income portfolio at December 31, 68% was in redemption. We anticipate reinvesting the proceeds from this part of the portfolio into our core fixed income portfolio. At December 31, we had approximately $270 million in short-term and money market investments resulting from strong operating cash flow of over $335 million. During the quarter, our yield on short-term investments continued to be north of 5%. We will continue to deploy this liquidity into our core fixed income portfolio. During the quarter, we executed a successful upsized follow-on offering of 5 million shares of common stock. Skyward sold 2.2 million and Westaim sold approximately 2.8 million, reducing their ownership to approximately 17%. We continue to see strong interest from our existing and new shareholders, and we appreciate their support for our company and our strategy. In terms of how we look at 2024, we expect full year adjusted net income to grow over 30% to between $105 million and $110 million based on a combined ratio between 91% and 92% inclusive of 2 points to 2.5 points of catastrophe losses. With that, I'll turn the call back over to Andrew for concluding remarks.

Thank you, Mark. Our fourth quarter results capped off what was truly a defining year for Skyward Specialty. Operationally, we had another great quarter as we grew double digits in seven of our underwriting divisions. We continue to realize pure pricing increases in the high single digits, which is above our estimated loss cost trends. Our new business pricing was up again over our in-force book and retention also remains strong in the low 80s. All are strong indicators of the attractive underwriting margins that we are generating should continue. We also continue to see strong submission activity, which is up over 34% from the prior year, the largest year-over-year increase we have ever achieved. Our full year results are also notable, particularly in the context that it will lead up to our IPO. During that period, we communicated core metrics and committed to building a company that consistently delivers top quartile performance. Our 2023 results demonstrated our progress towards this commitment. For the year, we delivered record growth of 28%, a combined ratio of 90.7%, adjusted operating income of $80.8 million, and we achieved a return on equity of 15.9% and grew fully diluted book value per share by 24% from $12.87 to $15.96. The year marked a significant underwriting achievement for us as we now have all eight of our underwriting divisions producing more than $100 million as compared to five at the end of 2022. Each division is now at a scale that can substantially contribute to the company's earnings. The three divisions that reached $100 million this year were surety, transactional E&S, and professional liability. In just three years, we've grown these three businesses in aggregate from $44 million to $383 million, driven by significant investments in talent and technology. All three are generating outstanding returns and have added meaningfully to the diversification of our earnings. While each division is delivering at or above our minimum target returns on capital, we continue to capitalize on market opportunities to grow both top line and margins, and ensure that we shape our portfolio to those areas that offer the best risk-adjusted returns on capital. As such, we have ongoing investments in new underwriting areas, product adjacencies, teams, and of course, technology. As I reflect on the progress following what was a remarkable year for Skyward Specialty, I find myself energized and inspired by what we have accomplished in such a short period of time and also the possibilities for 2024 and beyond. And of course, we remain laser-focused on executing our Rule Our Niche strategy in our progression towards generating top quartile returns at all parts of the market cycle. Finally, I'd like to thank my 510 colleagues for their excellent performance in 2023 and their commitment and drive to achieving our shared goals for 2024. I'd now like to turn the call back over to the operator to open up for Q&A.

Our first question comes from Matthew Carletti with Citizens JMP.

Andrew, I was hoping I could kind of go 70,000 feet per second and if we rewind a year ago when you guys were out on the IPO roadshow, technology was a big theme about how you guys embrace it and use it to empower your underwriters, claims, and so on and so forth. I was hoping you might be able to kind of fast-forward a year and what has changed there? We hear a lot about AI and things like that. Is that something you're working on embracing? Just maybe a quick bring us up to speed on how big a role that plays in your organization and how that might have changed over the past year?

We are moving at a very rapid pace and accomplishing a lot quickly. Next week, during our Board meeting, we will focus on claims. Our data scientists will present how we can identify claims that are most likely to require reserve developments, allowing managers to monitor these more closely and distinguish the 20% of claims that could drive 80% of changes. This effort enhances the intelligence available to our claims professionals and underwriters. One significant change is our approach to telematics in auto insurance. Instead of waiting for the first notice of loss after a G-force event, we proactively contact the risk manager to check if an accident occurred, enabling us to respond quickly afterward. This approach radically changes our process, and there are many other examples across product and underwriting.

I have a question for Mark. You mentioned that at year-end, 68% of the $172 million of Westaim funds are in redemption. Can you walk us through the timeline for how long that usually takes? Is it typically a quarter or 90-day process, or will it take longer for those funds to be redeemed and reinvested?

Sure, Matt. No, it won't be a quarter. I'm expecting about 30% of it to be redeemed in 2024; time will tell. But that's what I'm anticipating; around 30% in 2024 and the rest in 2025. We'll keep you updated, but it will take some time.

And Matt, these are just loans that we're allowing to mature. They were reasonably well-laddered, but it’s not evenly distributed; it’s not 50% in the first year and 50% in the second year. The average duration was around two years, a little under two years.

Our next question comes from the line of Mark Hughes with Truist.

Mark, the guidance, the $105 million to $110 million, that's coming off of the 2023 base; it is at $81 million. Am I saying that properly?

Yeah. Yeah, sir. You are.

Okay. And that seems like a pretty strong result. Anything you can say in terms of the contribution from net investment income and the top line as you think about that guidance?

Do you want to tell?

Sure, Mark. This is Andrew. We'll let you all put your models together based on the guidance Mark provided about the combined ratio of 91% to 92%. Considering the catastrophe part, you know our gross to net ratio. That should remain fairly consistent. You can use our written premium from 2023 and your own premium projections for 2024 to fill in the details. Regarding growth, while we don’t want to provide specific guidance, we are internally planning for a 15% growth rate, which is based on current market conditions and our investments. We've mentioned before that during a functioning market, we aim to achieve growth that is double that of our competitors, which includes others in the public specialty insurance space and some primary insurance divisions of the diversified Bermudian companies. This year, we've consistently achieved 20% growth, more than double that of our peer group. We believe our aim for a 15% growth next year aligns with surpassing that peer group's growth. We'll leave the specifics to your models, but that's our strategy.

Understood. And then, Mark, anything on the net investment income that's relevant here?

Mark, we just talked about a $1 billion fixed-income portfolio with a yield of 4.5. You and I can do the math. I expect that to continue throughout '24. The other components can be a little bit more variable. So I'll leave it to you to model out the portfolio in terms of fixed income. As for the rest of it, time will tell. But we've done well on opportunistic investments; however, it has moved around a little bit, as you know, in '23.

You guys are asking me to do a lot of work.

I can help you with that. If you want to send us your models, we can fill them out for you. How about that?

Yeah, I know.

I am joking about that.

The global property market may not be experiencing a seasonally strong quarter, but even so, it has shown a slight decline compared to last year. Earlier in the year, we saw much more significant growth. Is there anything specific happening in the fourth quarter?

I genuinely believe you shouldn't take that into account. It would mislead you into thinking negatively if you do. It's a very light quarter for us. We may have let one account go and there's no premium written for agriculture in the fourth quarter. I can confidently say that the beginning of the year shows you shouldn't interpret this negatively. The property market seems to be at its peak or possibly past it. However, I feel optimistic about our position, both regarding profit and the growth opportunities that we have, considering our targeted focus in that area.

Our next question comes from the line of Andrew Anderson with Jefferies.

Looking at the GPW growth from professional lines and transactional E&S, can you help us think about the source of growth there and how much of that is retained net?

Yeah. Well, without knowing sort of the context of your question, I can only assume that given everything that's being talked about in the D&O market, particularly the public D&O market, that likely underlies it a little bit. First off, everything is claims-made rules into our professional underwriting division. So our main drive line there is our miscellaneous professional, which, quite honestly, is relatively small face value, less than $1.5 million average limit. All types of classes included as well as employed lawyers, tech E&O, our excess lawyers offering. As you saw, we also did a media liability offering, including the professional portfolio as well as our architects and engineers book of business. It also does include management liability, which I'll come to in a second. And really, what's been a significant growth line for us is in the healthcare professional market. Regarding management liability, just to maybe get in front of our conversation, look, I feel great about our management liability book. But I think it's probably noteworthy that almost all of that today is private company. Less than a quarter of that is public. Of that, 70% is side A and 30% is side ABC. It probably has a 50% retention rate. We've been letting it go. On the positive side of our management liability, we are successfully targeting specific areas. We've been very successful in areas like Web3, cannabis, and among others, which are true specialty risks where we have considerable expertise compared to the rest of the market. Our professional growth and our portfolio is very atypical compared to how it is when you compare us against others. Lastly, to your question, because our average limit is so low, we are principally keeping it net. It's not entirely net, but it's principally.

Very helpful. Thank you. And maybe thinking about casualty loss picks here, can you kind of give us some color on how accident years 16 to 19 are developing, both for business within the LPT and non-LPT business?

Sure, Andrew. Good question. Look, so I'm glad you brought it up. The industry is talking about the 19 in prior years. A good reminder: the LPT covered policy years 2017, which, of course, would include part of the 18 accident year. Before we went public, we took the LPT up to the co-participation limit. We're not seeing any surprises on inflation or loss costs. We've talked about that. Our rate increases have exceeded what we think our inflation and loss cost trends are. Andrew, we haven't pulled that through in terms of our income statement. We've been conservative. Meaning, with loss picks, we're not taking full credit for rate increases. Does that answer your question?

Our next question comes from the line of Meyer Shields with Keefe, Bruyette, & Woods.

I have a quick question regarding the catastrophe load. I see it's significantly lower compared to most of your competitors, but the upper range seems to be higher than what you’ve reported in tougher pricing conditions. Is this a deliberately conservative estimate, or is there a shift in the overall composition of cat exposure?

No, our catastrophe number is a combination of a 10-year history. We feel like we're giving appropriate recognition to the catastrophe that's in our book. And then it's our job to continue to successfully grow our property portfolio in a way that ensures that we're not adding a lot of concentrated aggregate. When you're talking about 2 points or 2.5 points of catastrophe exposure in total, that's where you can really get yourself messed up if you have a lot of agriculture in a small area, where some of that can happen, like convective storms or something else. We're really good at our aggregation management. I think, given our book of business, if you looked over five years, we'll probably be in that 2 point and 2.5 point range, which is a pretty solid outcome given the amount of property that we have in our overall portfolio.

Okay. That's very helpful. You also mentioned property growth. Does that include increasing exposure along with rate increases?

There is clearly growth in values due to inflation. There is growth in values tied to business interruption depending on the segment of our portfolio. This is true for our global property segment. In our transactional E&S business, we may limit business interruption coverage and are likely using actual cash value for the buildings. You may not be seeing much growth in exposure because of how we typically structure those policies. However, this does not mean we are not observing a potential price increase that should correspond to the exposure for those types of risks. Does that help?

It does. Yes. And one last question, if I can. We've been seeing a lot of reserve issues expressed in the industry. I'm wondering what that means for the possibility of talent becoming available at competitors or some competitors.

That's a really good question. I don't know if I can see a correlation to it, to be honest. Look, not that this is going to sound a little bit flippant, but I would believe that we probably would not want the talent to be flushed out of an organization due to adverse development.

Okay, great. Sometimes the reaction is a little imprecise, which is what I was asking about, but I completely get what you're saying.

Yeah. One thing I will say, though, which has been the case for about 3.5 years now, we've been very targeted and intentional with our recruiting. We tend to have a very good view of the people that we're recruiting, their track records, underwriting expertise, distribution following, etc. While we're not recruiting from a general pool, we're recruiting in a quite intentional way. The media liability announcement a few weeks back is a great example of that; this has been an area of focus for us for a long time, and we were only targeting one of three teams. When we were able to move on one of those teams, we could do it very quickly.

Our next question comes from the line of Paul Newsome with Piper Sandler.

Certainly. I have a couple of questions that I would like to link. First, I want to ask how you respond to concerns that the competitive environment has worsened significantly over the past year and perhaps even more recently. Second, can you discuss what you think is occurring from a rate versus inflation perspective? My understanding is that there is a fear in these specialty lines that the competitive environment has reached a point where the rates are essentially flat in relation to inflation, and there's concern that this situation may continue to deteriorate. What is your response to this, and what do you observe when considering how to expand your book beyond your current offerings?

Let me share a few observations about the industry. There doesn't seem to be a consistent theme emerging. At the start of earnings season, professional discussions were prominent, and then we saw an ongoing focus on the auto sector, followed by general liability. However, there isn't a clear trend. Many strong companies, including our competitors, have noted increasing loss costs for some time. It seems like the media and analysts have decided to emphasize various issues this quarter, and some companies achieved that. Many strong businesses have recognized the inflationary pressures impacting liability in their risk assessments and loss ratio bookings. As for us, while nothing is perfect, we have taken our LPT reserve position to the top with a very conservative approach and have not released any reserves since my arrival. We've consistently reported our pricing above the loss cost trend, which strengthens our balance sheet quarter over quarter. I find it perplexing how other companies have made decisions this quarter, with some seemingly throwing everything into their reports, but the competitive landscape appears rational overall. Some firms are making irrational choices, particularly among MGAs, leading to questionable decisions. I often ask my underwriters to share examples of this behavior where competitors are undercutting prices unnecessarily. Typically, I receive several examples weekly. Overall, the market has remained orderly and constructive, as seen by our 34% increase in submissions this quarter, partly due to the talent we've recruited. This suggests ample opportunity. Our 21% growth, in relation to submission flow, indicates that our underwriters excel in identifying opportunities that align with our terms. Thus, I consider the market to be rational and orderly as a whole. Nonetheless, patterns discussed over time and recent fourth-quarter actions suggest that some may have found a way out. Our goal is to maintain consistency and order in our strategy while holding onto our reserves, enabling us to observe how seasoning and redundancy evolve before we take any further steps.

Our next question comes from the line of Bill Carcache with Wolfe Research Securities.

Following up on your investment portfolio commentary, what's your latest thinking on the possibility of extending the duration of the core fixed income here ahead of the rate-cutting cycle that most expect to begin in the coming months?

We're not looking to extend duration at this time. Our duration is currently about 4 and has remained consistent for quite a while. Honestly, I’m not interested in extending it right now. We'll see how things develop, but for now, that's not the plan.

Understood. That's helpful. And separately, if I may, Andrew, at a high level, can you speak to how focused you are on the risk that some of the E&S business that you've written could ultimately see move back to the admitted markets over time? How much exposure do you think you have there?

It's challenging to break it down, and it also depends on your perspective. I attended an industry event last week, and it was a major discussion point. What I can share is that within our transactional E&S unit and our global property unit, and in most areas of our professional unit, we aren't focusing on what I would call E&S light. I believe the business we're encountering is quite stable in the E&S market, and I feel positive about that. However, the issue is not just whether it constitutes true E&S business; if there is a decrease in E&S opportunities, there will be more competition for the available business, which can have a ripple effect. I would be surprised if more than a small portion of our business eventually transitions back to the admitted market. I consider ourselves a genuine E&S writer. We are selective—I'll give you various examples. I'm focused on writing quality cases while being careful about where we stand in management liability. We're only engaging with private companies. If someone wants to cover a Web3 risk or a cannabis risk, that isn't going into the standardized markets anytime soon, as it typically requires specific expertise that is only available among a limited number of individuals; this is generally true across our industry.

Our next question comes from the line of Gregory Peters with Raymond James.

Hey, good morning. This is Sid on for Greg. When we look at your growth over the last two years, it looks like it's really been driven broadly, but more specifically in global property, transactional E&S, and professional lines. So just hoping you can comment on the outlook from here. Should we expect the growth to be more balanced across your book? Or do you still see some more attractive opportunities in certain underwriting divisions versus others?

We definitely believe in micro cycles. While the overall market appears orderly, there are areas where things just don't make sense. Regardless of our capabilities, we will face fewer opportunities in those areas. We have taken full advantage of the property market, and surety has also been a significant area of growth for us. Our plans for this year are broad-based and may not show dramatic fluctuations in specific areas. However, one of our strengths is our ability to reallocate resources and seize market opportunities as they arise. Although we have reasonable plans, I expect the year will unfold differently than anticipated. I foresee our execution delivering better growth than we expect in some sectors, while other areas will experience slower growth due to changes in the marketplace. Our execution has consistently been strong, largely influenced by market dynamics. I believe our growth will be more balanced and diversified, which is our working assumption for this year.

Our next question comes from the line of Michael Zaremski with BMO.

This is Jack on for Michael. My question's on reinsurance ceding levels. I know there were some gross to net premium lumpiness last quarter. I guess longer-term, is the current 35% plus ceding level the right percentage to think about? Would you expect those levels to fall over time?

Yes, this is Andrew. For 2023, I believe our gross to net number was around 62.7 for the quarter, or for the year; I could be wrong, but it’s right around that number. I think our expectations are that it's a good number to carry into next year; it’s an initial planning number. Given our outlook for 2024, when you calculate the numbers and allocate underwriting income and investment income, you'll find that it aligns with that kind of low 60s gross to net.

In considering 2024, can you discuss how the business mix is expected to influence the loss ratio? I understand that in 2023, a shift towards property affected your attritional loss ratio negatively. I'm curious about your insights for 2024.

Yes. So implied in our view is a relatively consistent loss ratio underlying. If you back out what we've said about expenses and then take out catastrophes and so forth, you'll find that we're broadly in line. From a mix perspective, we've definitely been shortening our portfolio. At this point, at the end of 2022, I believe that 49% of our business or thereabouts was what we call short duration, less than two-year liabilities. This year, it's 53%. I think that as we look forward to 2024, it might go up a little bit more towards shorter tail liabilities. But there's not much going on here in terms of mix driving our underlying accident year. There’s also not much going on in terms of recognition of rate over loss cost trend going in there as well. Our working assumptions are for something that's relatively consistent.

I would now like to hand the conference back over to Natalie Schoolcraft for closing remarks.

Thank you, everyone, for your questions, for participating in our conference call, and for your continued interest in and support of Skyward Specialty. I'm available after the call to answer any additional questions that you may have. We look forward to speaking with you again on our first quarter earnings call. Thank you and have a wonderful day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.