Berkley W R Corp Q2 FY2021 Earnings Call

Good day, and welcome to W.R. Berkley Corporation's Second Quarter 2021 Earnings Call. Today's conference call is being recorded. The speakers' remarks may contain forward-looking statements. Some of the forward-looking statements can be identified by the use of forward-looking words, including, without limitation, believes, expects or estimates. We caution you that such forward-looking statements should not be regarded as a representation by us that the future plans, estimates or expectations contemplated by us will in fact be achieved. Please refer to our annual report on form 10-K, for the year ended December 31, 2020, and our other filings made with the SEC for a description of the business environment in which we operate, and the important factors that may materially affect our results. W.R. Berkley Corporation is not under any obligation and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. I would now like to turn the call over to Mr. Rob Berkley. Please go ahead, sir.

Susanne, thank you very much, and good afternoon everyone and again welcome to our Q2 call. Along with me co-hosting, we have our Executive Chairman, Bill Berkley; as well as Rich Baio, Group CFO. We're going to follow a similar agenda to what we've done in the past where in a moment or two I’m going to hand it over to Rich to walk us through the quarter and focus our attention on a few highlights. And once he is through, I’m going to offer a few sound bites and then we will open up for Q&A. Rich, so if you please.

Great. Thanks, Rob, and good afternoon, everyone. The positive momentum continues to build in our business as evidenced by our growth in premium and expansion in underwriting profits as rate improvements and additional premium associated with increased exposure earned through the income statement. We reported a consecutive quarterly record underwriting profit in the second quarter of 2021 along with strong net investment income, resulting in an annualized return on beginning of year equity of 15%. The company reported net income of $237 million, or $1.27 per share. The components include operating income of $219 million, or $1.17 per share, and after-tax net investment gains of $18 million, or $0.10 per share. Drilling down into our quarterly underwriting performance, you will note that gross premiums written grew by $529 million, or 24.8%, to almost $2.7 billion. Net premiums written grew $472 million, or 27.2%, to more than $2.2 billion recognizing an increase in both segments. Our overall session rate decreased in the quarter due to changes in certain underlying outward reinsurance arrangements, lower reinstatement premium and business mix. Moving into segment production of net premiums written, the Insurance segment grew 29.2% to almost $2 billion with an increase in all lines of business. Professional liability led this growth with 64.8% followed by commercial auto of 31%; other liability of 28.7%, short-tail lines of 21.2% and workers' compensation of 15.6%. The Reinsurance & Monoline Excess segment grew about 11% to $218 million, with an increase in Monoline Excess of 20.9% and Casualty Reinsurance of 17.5%, partially offset by a decrease in property reinsurance of 13.8%. Underwriting income benefited from the compounding rate improvement above loss cost trends, along with growth and exposure and lower claims frequency in certain lines of business. We did experience an above-average level of non-weather related property losses in the quarter that partially offset these benefits. In addition, our current accident year catastrophe losses decreased significantly quarter-over-quarter from $146 million, or 8.7 loss ratio points in the prior year to $44 million, or 2.2 loss ratio points in the current quarter. As a result, quarterly underwriting income increased almost 800% to a record $202 million. The reported loss ratio was 61% in the current quarter, compared with 67.7% in 2020. Prior year loss reserves developed favorably by about $0.5 million in the current quarter. Accordingly, our current accident year loss ratio excluding catastrophes was 58.8% compared with 59.2% for the prior year's quarter. The continued growth in net premiums earned has benefited the expense ratio, which was 28.7% in the current quarter, compared with 31% a year ago. Net premiums earned outpaced underwriting expenses by a margin of more than 8.5%. We also continue to benefit from reduced costs associated with travel and entertainment, but do anticipate some of this will be given back as the economy more fully reopens. Wrapping up the full picture, on the underwriting side, our current accident year combined ratio excluding catastrophes was 87.5% for the quarter, compared with 90.2% for the prior year quarter. On the investment front, net investment income increased 96.9% to $168 million driven by strong results in investment funds. The fixed maturity portfolio reflected a decline quarter-over-quarter due to the lower interest rate environment, although the quarterly gap is closing. We also continue to maintain an above-average level of cash and cash equivalents as of June 30, 2021 which has been decreasing over the past few quarters, where we see opportunities to invest at attractive risk-adjusted returns. Our duration remains flat at 2.4 years, while maintaining a high credit quality of AA minus. Pre-tax net investment gains in the quarter of $24 million is primarily comprised of realized gains on investments of $39 million, a reduction in unrealized gains on equity securities of $18 million, and a decrease in the allowance for expected credit losses of $3 million. The realized gain was largely driven by the sale of two real estate properties, which also resulted in the reduction in our debt that was supporting one of the real estate properties of approximately $102 million. Corporate expenses increased approximately $13 million due to debt extinguishment costs of $8 million relating to the redemption of hybrid securities on June 1, and higher incentive compensation costs as well. In addition, we announced the formation of a new operating unit in the second quarter, which you may recall that such expenses are reflected in corporate until the operation begins writing business and is then moved into the underwriting expense. Stockholders' equity increased by $164 million to approximately $6.6 billion in the quarter after regular and special dividends of $112 million. Book value per share increased 2.5% in the quarter, and book value per share before dividends increased 4.3%. And finally, cash flow from operations continued to be strong with approximately $700 million on a year-to-date basis. And with that, I'll pass it back to Rob. Thank you.

Rich, thank you very much. So let me just offer a couple of quick observations, and then we'll get to your Q&A and take the dialogue anywhere participants would like to. I think by virtually any measure, it was a great quarter for the company. And from my perspective, it's been in the making for some period of time. In addition to that, I think there's a growing amount of evidence that would support the idea that there is more to come, and it's just again, quite encouraging. As far as drilling down into the market a little bit more when we looked at the major product lines with the exception of workers' compensation, all of them continue to get rate increases that outpace our view of loss trend. And that is even as we have been factoring in a bit more for financial inflation. Regarding workers' compensation, they are again growing, but early signs that the level of erosion there is slowing. That having been said, we are also paying close attention to wage inflation and what that may mean for the comp economic model. Rich walked you through the top line. Obviously, the 27% growth plus is pretty healthy. A couple of observations there, though. One, please keep in mind, if you go back and look at 2020, we were not an organization here in Q2 of '20, our top line fell off a cliff. We were give or take flat. So this was not just a bounce back to a normal run rate. This was meaningful growth. In addition to that, Richard commented around the Excess and Reinsurance segment. You would have noted possibly in the release, and also again in Richard's comments, that it was the Reinsurance segment where particularly our domestic treaty business, where we backed away from a couple of deals where we just thought as though the rates were good; they weren't good enough for us to participate. If you unpack the 27% growth overall, give or take about a third of it is coming from rate. The balance on it is coming from exposure as you would have gathered from the rate increase coming in ex comp at just shy of 10%. I think it's important that people not lead too deeply into as I suspect some might as to the rate increase. And what does this mean relative to what the rate increase was last quarter or the same time in the prior year. The simple fact is that when we think about our economic model, it is multidimensional. We look at the margins that are available in the business, and as we become pleased with available margins, we start to think about possibly how we reprioritize exposure growth versus pushing further on rate. And again, as we have seen the margins in a meaningful part of our portfolio become particularly attractive, we're still pushing for rate, we're still getting rate by and large ex comp that outpaces trend. But again, growing exposure becomes even more of an opportunity that we are capitalizing on. A couple of other comments as it relates to the top line. I think it's a helpful data point, particularly our specialty businesses are getting flooded with submissions. It's a comp and in particular, is our E&S businesses. What's driving it? Two things. An opening economy, which clearly we are benefiting from across the board, and, of course, a standard market that continues to revisit its appetite. As far as the opening economy just bouncing back to workers' compensation as we have expressed in the past, we're concerned with that product line and where rates have gone. But you would have seen that product line growing in our release and that is really driven by payroll growth. And again, I think it just speaks to the health and wellbeing of the U.S economy as it continues to recover. Maybe pivoting over to the combined ratio, Rich got through a lot of this. Just a couple of observations from my perspective. On the expense front, coming in at a 28.7% from our perspective is a pretty good place with opportunity to improve from here. As Rich suggested, as our travel and entertainment picks back up, certainly some if not all of the approximately 50 basis points benefit that we've been getting as far as expenses due to COVID that is likely to erode and disappear. That having been said, if you look at the power of the earned premium coming through and how it is likely to build from here, and you can see that given the written leads the earned, there is likely more benefit to be had over time. Loss ratio pretty good at 61%. The ex-cat accident year, as Rich mentioned was a 58.8. He talked about non-cat property and loss activity. That added relative to where it was running last year, about a little over 2 points. So this was quite frankly, we have a rash of fires. Some would suggest it's bad luck; we tend to believe that oftentimes you make your own luck. So we're digging into that to ensure that this is not a new normal. And it was more of a one-time unfortunate series of events. Another data point on the loss ratio from the paid loss ratio came in at a very attractive 44.3. A couple of comments on the investment portfolio. Again, Rich commented on the duration of the 2.4 years. The book yield is running, coincidentally, at about 2.4 as well. We continue to be very focused on inflation. From our perspective, inflation is very much here. There are some people that talked about it being this transient; that may be true, I'm not quite sure. When people talk about transient, well, how long is transient? Regardless, the costs of things are up today. But even if you saw inflation return to 2.5% or 3% level, we continue to believe that a 10-year at 130 or less doesn't make a whole lot of sense for the long run. One other comment just related to the balance sheet and the capital structure. And we can get into this during the Q&A if people are interested. We've done a fair amount of work and restructuring certain things per one of Richard's comments around the prepayment or the calling of certain securities and the cost associated with that. But as you think about, again, the earnings power of the business later this year, but even more so for '22 and '23, there's very meaningful benefit that will be coming through again, savings around capital costs. So long story short, very good quarter. And I think what's more encouraging than even just the results is if you look at how the table is set for what is likely not just to be the next couple of quarters but quite frankly the next couple of years, this is an organization that is going to benefit greatly from the broader macro conditions. So, let me pause there and Suzanne, we'd like to open it up for questions now if we could please.

Hi. Thanks. Good afternoon as well. My first question, I wanted to drill down into some of what you said in the introductory comments. Rob, you said that you're factoring in a bit more for financial inflation. Can you just expand on that and what change in terms of your loss plans assumptions in the current quarter?

So we are constantly visiting and revisiting our loss picks and trying to refine them based on all the available information at any moment in time. I think from our perspective, it's pretty apparent that there is more financial inflation in the system today, if you will, than there was a year ago. And as we think about our loss costs, for example, in the property line, the costs of building materials, or the cost of auto parts or other things like that, one need to appropriately factor in the financial inflation and what that means and how that impacts.

Can you give us a sense of just the magnitude of the movement you guys saw in the quarter relative to your loss ...?

Generally speaking, at least we don't dissect our loss picks to that extent. But certainly, I can assure you that when we have factored it in, it has led us to raise some of our picks from what we have been using in the past.

Okay. My second question is about the expense ratio of 28.7 for the quarter. I know you mentioned that it was impacted by 50 basis points due to COVID. Given the potential leverage from top-line growth, could this expense ratio of 28.7 become a new baseline, especially as we continue to experience some pandemic savings and even as we manage the ongoing challenges of COVID? Can you help us understand what the run rate for the expense ratio might look like?

Sure. So what I would suggest you do is if you sort of add back in the 50 basis points for COVID, then you look at the momentum behind our earned premium in part by looking at our written and how that's going to come through. And while, yes, some of that expense is variable, commissions, boards, bureaus and so on, a meaningful amount of our expenses is somewhat fixed. And to Richard's point earlier, I think that will certainly offset and probably then some of the COVID component not being part of the business, hopefully going forward because everyone is back to a more traditional way of operating.

Thank you. Hey, Rob. Two questions. First question on the loss ratio ex-cat and the COVID. For this quarter, in insurance, it looks like it's flat compared to last year. And I think it's where I kind of want to get either reminder or clarification. I think last year you had some frequency benefits. So maybe this quarter actually did improve in insurance, and can you remind us or talk about that?

I'm sorry, Michael, could you repeat the question? You broke up a little bit.

Sure. Apologize. Yes, yes. So the Insurance segment of loss ratio ex-cat and COVID impacts, it looks like the loss ratio there back in that was flat year-over-year compared to 2Q '20. But I think that you had some frequency benefits also that made 2Q '20 a little bit tougher comp as you look at the whole numbers. So I want to see if that was the case and clarify that, so actually this quarter did improve in insurance.

Yes. I'll give you my two cents, and Rich may have some thoughts to add to it. I think the biggest piece was the comment that both Rich and I made around non-cat property-related losses being a bit more challenging in Q2, 2021 than what we saw last year. And I think that would be a leading factor. And again, that was primarily fire. Rich, do you have any further thoughts on that?

That's spot on, Rob. That's exactly right. So I don't have any additional thoughts.

Okay.

Okay. So I was getting to maybe there was something last year that kind of dropped that loss ratio, but maybe not. So it's more just elevated this year from what you said. So, okay, that's helpful. Second question, Rob, did you approach the, I guess, the way you set reserve the philosophy behind how you set reserves for 2020, given all that was going on last year, any differently than you otherwise do in the reserve setting?

Certainly all of us, we, as a team took note of the impact of COVID on multiple levels, some of it helpful, some of it not helpful. But it's by the big piece that perhaps you're referring to is frequency trend, and there were many product lines that benefited from COVID as it relates to frequency. And how we have thought about it, first off, we recognize that is not the new normal, and we're seeing frequency trend virtually across the board returning to a more traditional norm. And second of all, as far as what I would define is a unique situation in 2020 and some one-time benefits that came about on the frequency assumption. We have recognized some of that but, I think, as we mentioned last quarter, we're reluctant to declare an outcome prematurely because there are certain things you can include that are done. And there are other things, it's hard to know whether there's just a pinch point in the legal system, for example, and there will be a catch-up.

Okay. That’s helpful. I guess the reason I was asking, Rob, because I think it's no secret that there's probably some cushion in the industry numbers. I'm not going to ask you about yours, but industry numbers because of 2020 accident year performance. And I guess what I was getting at is, do you think there's any impact of that on the overall pricing cycle because of what needs to be more of a cushion because of COVID results?

I think that different organizations have chosen to recognize that cushion at a different pace. I think a lot of that cushion came through primarily in the shorter tail lines, which would have been recognized sooner rather than later. And fundamentally, I think a lot of the drivers that are pushing this market to continue to firm are coming about as a result of other things.

Okay. Thank you. I appreciate it.

Hi, Mike. Good afternoon.

Hey, good evening, Rob. I have a question about the strong growth. As we see this return and the shift towards growth, does that impact your view on the progression of the loss ratio over the next year compared to what you expected six months ago?

From our perspective, again, nobody knows exactly what tomorrow will bring, or there's always the unforeseen event. But when we look at the data points, you can see rates continuing to outpace our view on trends by and large. In addition to that, when you do the math, one needs to factor in the impact of terms and conditions, particularly in the E&S space as well as on the facultative front and even into this broader specialty space. So, when I think about it, I think that there's further opportunity from here for things to improve. And again, we have a view that our rate increases on a written basis and on an earned basis will continue for some period of time outpacing trend.

Got it. And then a follow-up on, I guess, just a little bit a reminder, obviously, Berkley has a lot of the individual underwriting entities and these are pretty decentralized generally. So it doesn't work in such a way that those entities are kind of reporting up loss ratios to you guys and you're kind of counting up the picks, or to what extent centrally are you guys able to kind of actually have control over the assumptions that go into like underlying loss ratios?

Yes, so at the heart of our model, it's not an us and them so to speak. A model is much more of a collaborative one. So things such as loss pick using that as an example, that is certainly something that is a collaborative effort amongst really driven very much by the colleagues in the field at the same time; it is collaborative with us here. And we work together and we try and make sure that we're looking at it, if you will, at a more local granular level. At the same time, we want to make sure that we're getting the benefit of the broader view of the group and beyond. So it's not one or the other. It is really a team effort from my perspective, and there's what I would define as a very healthy give and take.

Hi. Good afternoon, everybody.

Great. Thank you.

So please don't be upset, I have a difficult question, but I believe you will have a reasonable answer. I consider you all as a prime example of recognizing bad news quickly, while good news tends to be reflected in your results over time. I've been reviewing the numbers and it seems you have been releasing reserves in workers' compensation for quite a few years, and I'm sure there's a rationale for that. I know you usually maintain reserves and produce favorable results in a long-tail line for a number of years until you're confident to make a change. I hope you can provide some insight into how this process works.

So, Josh, let me say it back to you because the line isn't great. And I want to make sure that I understood your question. You're making an observation around how what our loss reserve development has been in the workers' comp line and philosophically how we think about that?

I was looking through the schedule of PIC recent accident years and workers' comp are throwing off favorable development. And I imagine you guys would long-tail on like workers' comp traditionally, you would sit on those reserves for a few years before making any changes.

Well, I think the answer to the question, and again, we're happy to get into a more granular discussion with you offline is that we are looking at our picks. And we're looking at the historical data and we are looking at low frequency and we're looking at severity, and we're trying to adjust appropriately. I think we tend to be particularly cautious early on out of the gates. And then of course, as it seasons, we will respond. But again, I don't have the details in front of me, so I'd be reluctant to try and get into a more granular discussion. But if you'd like to take it up offline, we would be pleased to do that with you or one of your colleagues, whatever would be most convenient for you all.

Happy to do that. And the other question I had was about the arbitrage market. You guys let that fund get bigger, sometimes gets smaller. What's your outlook right now given where the market is and the opportunities there is? Will you be allocating more capital or less capital in the future to that in your minds?

I think if we take it one day at a time, we have some extraordinarily skilled colleagues that run that business and we have no shortage of cash as you would see from our balance sheet. So while it's been pretty steady, if they see more opportunity, we are certainly in our position to provide them more capital to manage.

How are you, Rob? So two quick questions. I think if I understand your response to at least correctly, you're talking about tweaking up some loss picks because of higher financial inflation. But if we take out the non-cat weather in the quarter, it looks like the underlying equity and loss ratio was better than in the first quarter. So I feel like I'm missing something there.

Well, I think obviously, we're in an industry where you price your product before you fully know your cost of goods sold. And when we're thinking about the impacts of financial inflation, and what that may mean for our claims costs in the future, we're trying to make sure that we appropriately factor that in. I think if you're like me and you show up at Home Depot once a month, you'll notice that a lot of the stuff you buy there is considerably more expensive than it was a year ago. So we're just trying to make sure that we are appropriately adjusting for the shift in a lot of commodity pricing and the shift in a lot of costs that would come about with claims.

Okay. The examples you gave for the financial inflation all seem to focus on short-tail lines. Are you seeing similar worsening inflation on the liability of the longer-tail lines?

Not as visibly if the shorter-tail lines are using a broad approach; we will have to observe the impact over time. There can certainly be an effect on certain areas, but for us, the discussion tends to be more focused on social inflation in terms of liabilities.

Okay, perfect. And then one last question, if I can. I assume that some of the employment costs you have are fixed costs. Is inflation there getting any worse?

I think generally speaking, there is wage inflation throughout the country, and there's likely to be more of that for at least the short-term. We'll have to see what it means over time.

Hey, Brian.

Yes, it involved multiple losses rather than just a single one.

Yes.

And I would tell you, I don't have the numbers in front of me. Rich, I would say it's a little bit of both of what Brian referenced. I think last year was a little on the lighter side this year was particularly heavy and run rates probably somewhere in between the book end. So I think the 2.4 were last year, I'd say a .5 I put back in, what's your thought on that?

Yes, I think that's right. I would agree with that.

Perfect. That's helpful.

I think that it is going to prove over time that the margin in the business that we're writing is very attractive. Thanks for the question.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.