Berkley W R Corp Q3 FY2021 Earnings Call

Good day. And welcome to W.R. Berkley Corporation’s Third Quarter 2021 Earnings Conference 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.

Emma, thank you very much, and good afternoon, everyone. Thanks for joining for our third quarter call. So in addition to me on this end of the phone, you also have Bill Berkley, our Executive Chair; as well as Rich Baio, Executive Vice President and Chief Financial Officer. We are going to follow our typical agenda where in a couple of moments, I am going to hand it over to Rich. He is going to walk us through the highlights from the quarter. I will follow him with a couple of brief sound bites or reflections and then in pretty short order, we will open it up for Q&A and happy to take the conversation in any direction where people would like to. But before I hand the mic to Rich, I did want to flag with folks, one sort of macro observation. We were chatting internally earlier and how it seems like the quarterly calls oftentimes turn into an every 90-day session talking about certain numbers, which oftentimes go out a certain number of basis points. And while those discussions are worthwhile and productive from our perspective, it’s also important that people not lose sight of the macro and it is something that we spend a lot of time every day thinking about and that is, what is the goal of the exercise, what we are trying to do, and clearly, one of the cornerstone goals is building book value. Building book value is an important thing for a whole host of reasons, including building book value allows the organization to live up to or meet the needs of the various stakeholders. When we think about building book value, we approach it with an idea that we will refer to as risk adjusted return that many of you have heard us talk about in the past. We take this approach and apply it to both our investing, as well as our underwriting activities. And while you probably hear more companies not in their own words talk about these concepts. I think one of the differentiating ways that we approach this idea is how we think about volatility as a component of risk. And again, this is something that we’ve discussed in the past, but I think it’s particularly timely, particularly relevant, when we have a quarter for the industry, for society, like we saw in Q3. This idea of volatility as a component of risk adjusted return, we certainly grapple with both on the investing and underwriting side of the business. You can see it on the investment side, for example, in how we have thought about duration and how we have been willing to keep our duration short and even though that comes at a cost, we do not think the risk adjusted return is there to justify going out on the curve and extending that duration. We do not believe you get paid enough for that potential risk. In addition to that, again, as it once again crystallized in the third quarter, when we think about underwriting activities and we think about volatility as a component of risk, clearly, the industry is feeling the challenges that come along with cat activity. From our perspective, cat activity is there on a regular basis and why people choose to back it out on a regular basis doesn’t make a whole lot of sense to us. Our view is that volatility is real. It is a real component of risk. When we think about running the business, it is of great priority to us and how we think about deploying capital. So I am going to pause there, but before I do, I guess, one last comment. I know that there are a lot of people that will look at our numbers and Rich will walk you through it and you will do the math, and you will come up with an ex-cat accident year loss ratio and what does that mean, it is on a combined ratio and that will probably get you to approximately an 86.9%. But from our perspective, if one chooses to slip off the rose-colored glasses for a moment, we generated a 90.4%. That is the reality from our perspective. But in spite of the cat and the impact, we did achieve a very healthy underwriting result, and in the process, we achieved a 16.6% return on equity. Ultimately, when one thinks about building book value, you can’t just think about the steps forward that you take, you need to think about how you avoid the steps backwards. And when you think about compounding book value over an extended period of time, when you think about value creation for shareholders, amongst other stakeholders, not taking those steps backwards is a big part of the puzzle. So, with that, Rich, I will hand it over to you if you would please walk us through.

Terrific, Rob. Thanks very much, and good afternoon, everyone. Operating income increased by more than 100% to $247 million or $1.32 per share, which is compared with $121 million or $0.65 per share. The increase is primarily attributable to strong underwriting results, net investment income, and foreign currency gains. The company built upon the strong first half of the year, with continued growth in premium and expansion in underwriting profits. From a production perspective, gross premiums written grew by $525 million or 23.2% to a record of almost $2.8 billion. Net premiums written grew by $446 million or 23.7% to another record of more than $2.3 billion. The session rate was fairly consistent at 16.6% in the current quarter. Breaking down the results further, the Insurance segment grew net premiums written by 23.3% to more than $2 billion, reflecting increases in all lines of business. Professional liability led this growth with 58.7%, followed by commercial auto of 28.1%, other liability of 25.3%, short-tail lines of 8.6% and workers compensation of 7.7%. The Reinsurance & Monoline Excess segment grew 26.7% to $318 million, with an increase in Casualty Reinsurance of 36% and Monoline Excess of 27.4%, partially offset by a small decline in Property Reinsurance of 1.4%. The increase in net premiums written on a year-to-date basis was more than 20%, resulting from growth and exposure and compounding rate improvements that will continue to earn through in the coming quarters. This was evident by the increase in net premiums earned of 19% in the current quarter. Included in the quarter were current accident year catastrophe losses of $74 million or 3.5 loss ratio points, compared with $73 million or 4.2 loss ratio points in the prior year. As a result, quarterly underwriting profits increased 80% to $200 million, slightly off the record quarterly underwriting results in the second quarter of this year. The reported loss ratio improved 1.3 loss ratio points to 62.4% from the prior year, primarily driven by rate improvement in the business mix, prior year loss reserves developed favorably by approximately $1.5 million in the current quarter. Expense ratio improved 2 points to 28% in large part due to the growth in net premiums earned, which is outpacing underwriting expenses by approximately 7.5%. This improvement is evident from an operating cost, as well as acquisition cost perspective. We continue to highlight the partial benefit from reduced travel and entertainment, which is slowly coming back. Closing out the underwriting performance, our current accident year combined ratio excluding catastrophes was 86.9% for the quarter, compared with 89.8% for the prior year quarter. Turning to investments. Net investment income increased 26.1% to $180 million, driven by strong results in investment funds. The significant contribution in investment funds represents three consecutive quarters of outperformance and we feel it’s important to highlight that the investment fund results are not necessarily representative of future earnings. Despite the ongoing growth in invested assets, the six-maturity portfolio represents 69% of the total invested assets and the associated investment income declined quarter-over-quarter due to the persistent low interest rate environment. Strong operating cash flows of more than $825 million in the quarter contributed to the increased cash and cash equivalents as of September 30th. This resulted in a slightly shorter duration of 2.3 years in the current quarter, compared with 2.4 years in the second quarter. The credit quality of the fixed maturity portfolio remains high at AA-. Pre-tax net investment gains in the quarter of $20 million is primarily comprised of realized gains on investments of $36 million, partially offset by a reduction in unrealized gains on equity securities of $19 million. The realized gains were largely driven by the sale of real estate properties in the Southeast. The effective tax rate was 19.6% in the quarter, which largely benefited from equity-based compensation that predominantly vests in August of each year. Overall, strong performance resulted in an annualized return on beginning of year equity of 16.6%, as Rob alluded to. Stockholders’ equity increased by $70 million to approximately $6.6 billion in the quarter after regular dividends of $23 million and share repurchases of $93 million. The company repurchased approximately 1.3 million shares at an average price of $72.03 per share in the quarter. Book value per share increased 1.5% in the quarter, and book value per share before dividends and share repurchases increased two and a half percent. And with that, I will turn it back to Rob.

Thank you, Rich. Your comments were very clear and helpful. I have a few thoughts in response. Overall, this quarter looks strong across multiple metrics, with top-line growth just below 24%. A significant portion of this growth—around 40%—is due to rate increases, while about 59% stems from various forms of exposure like new policies and auto premiums, with a small contribution from other sources. The P&C industry is in a good position, aside from some challenges in the workers compensation market, which continues to face headwinds. While the property sector experienced some difficulties this quarter, the overall market conditions remain attractive, and we don’t anticipate a change in this trend. It’s a favorable time for specialty writers, especially those focused on casualty, and even more so in the E&S market. We're seeing a steady influx of opportunities in both specialty and E&S, and we have no reason to think this trend will reverse soon, which is encouraging. Regarding losses, we are being careful as we’ve discussed before. Inflation is a real concern, including social inflation, which we've talked about in the past, and there are also significant pressures from financial inflation impacting loss costs, both of which we need to monitor closely. While we believe the rate increases in nearly all P&C lines, except for workers comp, are surpassing trends, we're vigilant about keeping an eye on those trends and remaining cautious. On expenses, Rich covered it well. I want to emphasize that our company has focused more on organic growth rather than acquisitions, having launched 47 out of our 54 operating units from the ground up. Some of these are still working toward critical mass, but favorable market conditions are helping them progress. This leverage on our expense ratio will grow as our earned premium increases, benefiting both our established businesses and our smaller operations that are now seizing new opportunities. As for the investment portfolio, the duration and book yield are both at 2.3, but maintaining this discipline may come with trade-offs. We acknowledge that inflation is present and likely here to stay for a while. I'll pause here, but I do want to mention that as we assess our results and look to the future, we don’t see anything that could disrupt our current momentum. While we know the cyclical nature of our business means this won’t last indefinitely, we are currently benefiting from positive momentum. I’ll stop here and see what questions the participants have.

Your first question comes from Elyse Greenspan with Wells Fargo. Your line is open.

Hi, Elyse. Good afternoon.

Hi. Thanks. Good afternoon as well. My first question on the rate and pricing side, your level of rate increases when we exclude workers comp, it did go up a little bit in the quarter, I am assuming maybe that was due to some kind of business mix between the Q2 and the Q3, but anything changing on what you are seeing on the pricing environment and any business lines in the quarter?

I think it, well, obviously, mix is always a bit of a component. I would tell you it has more to do with what the market will bear. And we are continuing to try and make sure that as we price our product that it is appropriately priced for our needs, and quite frankly, there was just more opportunity to push the rates.

Okay. That’s helpful. And then on the expense ratio side, so two questions, one on, you mentioned that the COVID benefit is diminishing. If you could just give us a sense of what it was in the quarter? And then the second question, I mean, you pointed to the leverage from the growing premium, the expense ratio continues to trend down, it’s pretty good leverage there every quarter. So can you just help us think about kind of a run rate basis given that strong like 28% in the quarter?

I believe that the impact of COVID on the expense ratio was around 40 to 50 basis points. As the situation improves and travel resumes, that figure has likely decreased to about 30 basis points, and it may continue to decline over time. However, our earned premium is still growing. When considering the future of the expense ratio and whether we can maintain it at 28%, it's important to remember that our business is cyclical. We strive to maximize current opportunities, but there may come a time when market conditions change. As a disciplined underwriting operation, we might see our topline shrink and the expense ratio increase. While I won't provide a specific number for you to use, I suggest that by examining our written premium, you can estimate the trajectory of our earned premium, which should help in forming expectations about expenses.

Okay. Thanks. Appreciate the color.

Thanks for the questions.

Your next question comes from the line of Mike Zaremski with Wolfe Research. Your line is open.

Hi, Mike. Good afternoon.

Hey, good afternoon, Rob. Going back to the expense ratio, it seems like not long ago it was in the low 30s, and it has improved significantly. Some investors might feel inclined to downplay the expense ratio benefit due to the business's cyclicality. However, you mentioned several structural factors that might provide long-term support for the expense ratio. At a high level, if we were to enter a softer market, would you anticipate a significant reversal, or how much of this improvement do you believe is sustainable beyond just considering the next year given that market conditions are currently strong?

Nobody knows for sure exactly how it’s going to pan out, but I think we have a lot of headroom between where we are now and going above 30. So from my perspective, we are going to continue to try and be diligent around efficiencies and costs, but I don’t think anyone has an expectation that the group is going to go back to the range that you had referenced from an expense ratio perspective.

That’s helpful. Maybe switching gears...

Hey. Mike, just in addition to that…

Okay.

…I do find it interesting, and quite frankly, a little bit bizarre that people discount expense ratio. Because quite frankly that is real, that is tangible. Loss ratios, we know that reality over time. But the idea that an expense ratio doesn’t count that this strikes me as a little bit odd. So I don’t know, whoever is suggesting that, you could tell them I respectfully disagree. I suspect those people probably back out cats to them.

Thank you. The expense leverage has certainly added significant value for shareholders. Shifting to the topic of loss expense inflation, there are various business lines to consider. On the Casualty side, we continue to observe a slowdown in the court system, with reports indicating fewer lawsuits and settlements that are not as substantial as previously anticipated. However, these may just be isolated examples. Are there any developments or changes in your perspective on the loss trend in the Casualty area?

I believe it’s important to be cautious when assessing loss trends. The current situation is quite unclear due to the inflationary environment we’re experiencing socially and financially, as well as the ongoing impact of COVID, which complicates things further. We don't really know how much of the decrease in frequency is genuine versus just a temporary delay, or how much of it might be permanent. No one can say for certain. There may be some who could be tempted to declare victory too soon, but we don't fully grasp how much uncertainty still exists. As an organization, we are being very deliberate in our approach. If we’re fortunate, we will find that our caution was warranted. However, if it turns out that there’s merely a temporary lull and a significant surge in claims is still on the horizon, we will be ready for that as well.

As a follow-up, do you have any insights on the property side? It seems like this year is producing higher property losses than anticipated for some companies due to changes in the marketplace. Are the current models and risk assessments potentially flawed, and are adjustments being made to the risk approach? Thank you.

I think I would assume the most market participants are looking at their loss costs particularly around property and should be actively thinking about, back to the comments earlier in the call, their risk adjusted return. And while it’s very easy to do the math and to back the cat out, I think when all of a sudden you start to really reflect on one of your points a moment ago, the frequency of cat activity, it’s not so clear that one should be backing them out. And when they think about how they price their business, what is an appropriate rate, I think they need to think about this frequency observation that you are referencing. I think it’s a really important point that you raised.

Your next question comes from the line of Ryan Tunis with Autonomous Research. Your line is open.

Good afternoon, Ryan.

Hey. How it’s going? First question, just following up, I guess, on what you just said, within short tail lines, Rob, would you anticipate, I guess, lowering your exposure to cat-exposed lines over the next 12 months or so? Is that your expectation even less cat risk?

No, not necessarily. I think I tried to hint at this earlier in the call. Our focus is on risk-adjusted returns, and we don't mind volatility as long as we feel adequately compensated for it. If we observe property rates rising to levels we consider suitable, we will be ready to significantly expand that area. For reference, Ryan, you may recall that there was a time when we were drastically reducing our Reinsurance business because the market didn't make sense to us. Now, as you can see, we are growing it substantially. We can dip our toes in and gauge the conditions, and if everything looks good, we can invest much more than just a toe. If property rates decline from here, you'll notice us writing less. Conversely, if property rates improve significantly, we will likely take on more.

Got it. And then follow up on capital management, this felt like the biggest buyback quarter we’ve seen in some time and I went back and looked at, it was the first half of 2020 when you guys were buying back stock in a material way. I mean can you just remind us what the thought process is on when you decide to manage capital more aggressively through share repurchase? What are your thinking in early 2020 and why it looks like, you said, it picked back up this quarter?

But let me leave that to my boss to answer. I might have a comment at the end, but let me leave that to him.

Hi, Ryan. It's really about assessing how much capital we generate and how much we'll utilize, while also comparing the enterprise value to the current stock price. Two years ago, a price of 72 may not have seemed appropriate based on our book value and return on equity, but that perspective shifts with changes in our book value and returns. It's a dynamic process, constantly adjusting the capital we generate in excess of our needs, and simultaneously evaluating the stock price relative to its future value. We believed the stock price's attractiveness at one point was significant, but these judgments are continually evolving. Our aim is to maintain the right amount of capital, adjusting through dividends and buybacks. We strive to make informed decisions regarding capital usage, although the results may not always be reflected optimally in reported figures. This is similar to how startups don't always report the best results but end up with tangible book value rather than intangible. So, for us, that’s acceptable.

Got it. That’s clear. Thanks, guys.

Thanks for the question, Ryan.

Your next question comes from the line of Brian Meredith with UBS. Your line is open.

Good afternoon, Brian.

Yeah. Thanks. Hey. Rob, how are you doing? I want to focus a little bit on the comp and the growth that you saw there. I guess the first question is that audit premiums coming through or is there kind of a change in your view of comp, because as I remember couple quarters ago, you were a little concerned that as the economy opened up we may see a pop in frequency and that could be problematic for comp?

We believe that the growth in compensation is primarily linked to payroll increases and the return of employees to the workforce. The market continues to be quite competitive overall. Our expectation that the compensation market would stabilize by the end of this year or early next year seems to be extending, and we anticipate it may take about 12 more months based on our assessment of current market conditions and our position in the economic cycle.

And what’s your view with respect to kind of loss trend in comp potentially? It doesn’t seem like it is the frequency situation. But could it be a problem here?

Yeah. We’ve been more concerned about the severity. I think the frequency is generally speaking been a friend of the industry. That having been said, clearly, frequency trend, the improvement that you saw as a result of COVID was that’s dissipating because people are back to work. The severity trend has been a bit more of our concern and it remains a point of sensitivity in how we think about the product line.

Great. And then one other just quick one, cyber, are you much of a player in that market and what are your thoughts there?

We are a player. We are very fortunate to have some exceptionally skilled people in the space and we think that it is a line of business that is heavily dependent on expertise. And there are a lot of people that deem to want to play the game without the expertise and it’s possible that could end in tears. But that is not our approach, and again, we do write it, but we have great people who control it very tightly. Thank you.

Your next question comes from the line of Meyer Shields with KBW. Your line is open.

Hi, Meyer. Good evening.

Rob, when you mentioned that workers compensation is becoming a growing challenge, were you referring to this pricing dynamic?

I think rates just can remain very competitive. That was I guess the overarching point and there is a moment in time. I think what Brian was referring to when we had thought that the market may shift direction later this year, early next year, and again, our thought is that that will happen, but it’s probably pushed out of the year.

Okay. That’s helpful. When you look across, I have noted here today that the most recent quarter, what are the things that’s been relatively moderate, so far has been medical inflation? Can you talk about what you are seeing with regard to actual paid claims? Is there any sign of inflection in medical inflation itself?

I think that medical inflation is a challenging area. I think that there is maybe a, perhaps, among some of false sense of comfort, I think, one of the things that happened during COVID is that people in general, whether it would be related to comp or other health needs, people were reluctant to go into health-related or medical-related venues. And as a result of that, people were not getting the care. I think it is certainly possible you are going to see an uptick. So if you forget about the insurance industry for a moment and you look at the parts of the healthcare industry, for example, the hospital industry, you will see that there are a huge surge in patients in hospitals and they are coming in worse condition than they were pre-COVID and a lot of that is not COVID-related directly per se. It’s because people were not getting care or they were postponing the care and they are sicker. So I would suggest to you whether it’s comp or healthcare in general, you saw, I think, there is medical inflation. I think pharma prices continue to climb. I think costs in general continue to climb, but you need to separate out actually the cost of care versus the volume.

Your next question comes from the line of Mark Dwelle with RBC Capital Markets. Your line is open.

Good afternoon.

Yeah. Good evening.

Hey, Mark.

My first question, are there any COVID charges embedded within the catastrophe number you have provided? That is a number that I would like to back out even if it’s classified as a catastrophe?

Well, Mark, we certainly are hoping that COVID is not an event that is recurring with the frequency that nat cats are. Rich, I can’t remember, was it $6 million or $7 million?

Yes. $6 million, Rob.

It was $6 million. So yes, it was there, but in the context of over 2 billion dollars of earned premium, it's definitely tapering off.

Yes. Agreed. The second question that I had is, again just kind of a market perception question is, are we still continuing to see a significant amount of business flow from the standard or admitted markets toward the E&S market or has that begun to slow down or neutralize at this point?

No. We are seeing it continue to accelerate. It’s certainly more robust now than it was, without a doubt, last year it’s more robust than it was in Q1, and like quite frankly, it’s notably more robust than it was in Q2. So we are seeing that continue to accelerate.

Are there specific lines or categories where this trend seems to be more common, or is it present across the board?

By and large, it’s across the gamut. I would tell you that maybe certain aspects ironically of property may have slowed a little bit, but the liability lines remain turbocharged. Thanks very much. Appreciate the color.

Your next question comes from the line of Josh Shanker with Bank of America. Your line is open.

Hi, Josh. Good evening.

Good evening or good afternoon. I was just curious to learn a little bit more about the Reinsurance & Monoline segment. The growth is very, very strong in the quarter and given that it’s some unusual items in there, maybe we can go into some detail about what’s packed in there?

Really, it’s primarily a reflection of the liability lines and the strength that we are seeing and the opportunities there on the treaty side. And then we are also seeing some opportunity on the fact side, but they are both liability and property to a certain extent.

And can we extrapolate anything of looking back a quarter, looking forward a quarter, can you strengthen that it could be stronger going forward…

I think actually…

…maybe like the…

I think we need to wait and see how things develop at the beginning of January, which will provide valuable insights into the future of the Reinsurance market. We mentioned in the second quarter that our treaty teams deserve recognition for their discipline in choosing to move away from certain treaties, which reflected in our earlier numbers. It's clear that we will need to observe how the Reinsurance market evolves around January 1st. On the property side, there has definitely been a wakeup call, and I expect there may be some challenges for the industry, especially for those who opted for significant growth from 2016 to 2018. They might be reevaluating their pricing strategies now.

And the Reinsurance market is very 1/1 dependent, but your Reinsurance & Monoline segment doesn’t seem to have that same kind of seasonality?

I apologize, Josh. Could you please repeat that? How has the Reinsurance market been? I’m sorry, what was that?

1/1 dependent. It’s obviously...

1/1 is obviously a big date for the industry in general and the Reinsurance market included. I think over the years that sort of gotten spread out a bit, but there continue to be certain dates that are big ex-dates. I would tell you that you got to remember that some of the growth comes through over time through bordereaux. So we have certain estimates, but the way it comes through is through bordereaux over time.

All right. Thanks very much for the clarifications.

Thanks for the question, Josh. Have a good evening.

You too.

Your next question comes from the line of Michael Phillips with Morgan Stanley. Your line is open.

Hi, Michael. Good evening.

Thank you. Good morning. Good evening, Rob. One more on Reinsurance quickly, are there any notable changes to either what you are accepting or demanding on just kind of the terms and conditions of the Casualty Reinsurance book in terms of the contracts that you have maybe today versus say a year ago, I think, worth noting.

I believe my colleagues have been very disciplined, and they continue to be so. They are not accepting anything today that they wouldn't have accepted yesterday, and vice versa. The market is aligning with the position and underwriting discipline my colleagues have maintained. They are active in the market every day in a way that they think is appropriate for the capital. The market fluctuates, sometimes moving away from them and at other times moving towards them. As the market moves closer, they can engage more significantly, which is evident in our Specialty and E&S businesses as well as across all our operations. We engage in the market daily based on what we believe makes sense, and currently, the market is shifting in our favor.

Okay. Thank you. I guess just curious to hear how you think about, you said, it’s obviously cyclical business. It’s not going to last forever. What do you look for in terms of things in advance to see for you to think that things might be turning at the time for you to start back in a way, what things do you look for there?

Well, I think that, first off, I would tell you that, through our lens, we don’t think that that’s something we are going to need to be overly preoccupied with for some period of time given the strength of the tailwind. That having been said, there are a whole host of things that we are looking at that lead us to have a view around rate adequacy, in fact how we think about terms and conditions, of course, we are looking at submission flow, we are looking at hit ratios. So, honestly, all of our businesses have a variety of different data points that they used to triangulate off of to form a view of market conditions. Thank you for the question. Have a good evening.

At this time, there are no further questions. I would like to turn the call back over to the presenters.

Great. Emma, thank you very much. And for those that may actually still be on the call, I would just tell you that this is clearly one of those moments where the planets and the stars from much of what we do are lined up. This is a moment where our expertise and our discipline is clearly paying off and the success that we have had to-date and we will continue to have is really a reflection of more than 6,500 people all working together on behalf of our various stakeholders, in particular, our shareholders. So we are very grateful for their efforts. That’s about it for us. We will look forward to updating you in 90 days. Thank you for joining this evening.

This concludes today’s conference call. You may now disconnect.