I'm very pleased to welcome our next presenters, Baldwin Insurance Group. We have Trevor Baldwin, who is CEO. It's a first-time presenter here. It's a newly public company. Company went public in October of last year. Is a fast-growing insurance broker focusing on a number of different segments of the property casualty and Medicare business. Trevor joined the company in 2009 after spending time in the private equity world, and he was appointed CEO in May of last year, and was BRP's president before that. One of the fun parts of this job is learning about new companies. Our deep dive into BRP last year revealed a company with a really unique culture, some serious growth aspirations. Kris Wiebeck is joining us here as well. He's the CFO and has been with the company since 2015.
Trevor, I think because it's a relatively new company and a lot of folks haven't seen you before, it might be helpful to start just discussing the history of the company and the history of the management team.
Absolutely. Yeah, thanks, Jay. First, thanks for having us, really excited to be here this morning. Baldwin Insurance Group was really officially founded in 2011 out of our predecessor organization, BKS Partners, which was formed by my father in 2006. I joined the firm, as Jay mentioned, in late 2009 and spent the next 12 months really focused on restructuring the organization to position ourselves to execute on a larger scale growth strategy. We launched in January 1 of 2011 with $5.5 million of commission revenue. Since then, we've been super focused on building really a unique organization in our industry that enables us to execute on our vision of delivering double-digit organic growth well into the future.
The question really is, that's helpful. Talk about just the management team, where they came from, because a lot of these guys didn't grow up in the insurance business.
Yeah, that's right. The first strategic hire we made was bringing on Kris Wiebeck, our CFO, in 2015, and he joined us with really terrific capital markets and investing experience. He had recently listed his prior firm, MMA Capital, not to be confused with Marsh & McLennan, on NASDAQ, and was head of U.S. investments for them before leaving at the end of the first quarter in 2015. We were fortunate to be able to recruit him onto the team a few months later. I'd known Kris for quite a while, both growing up in Tampa, and we knew to execute on the growth strategy and aspirations that we had as an organization, we were going to need someone with a high degree of sophistication around capital markets and investing. Kris really brought that to the team.
When he joined, we at that point launched our initial capital raise, bringing in capital from a family office, and that's what propelled our initial launch of our partnership strategy, which is the nomenclature we use for M&A, and really launching that in 2016, which has propelled us to where we are today. We've been successful in building out our broader executive leadership team with some really terrific talent. John Valentine is our Chief Partnership Officer, so he's responsible for M&A, as well as gets involved in strategy and execution. He joined us after a 17-year career in investment banking. I got to know John during a stint he had at a boutique investment bank based in Tampa while I was still in the private equity industry.
We had looked at a couple of opportunities together, and John went on to have a really successful career at Wells Fargo Securities, ultimately leading the Mid-Atlantic region for them before we were able to convince him to come join our nascent insurance brokerage platform. Dan Galbraith, who joined us last year as our Chief Operating Officer, brought a terrific combination of both sales and operational leadership skill sets. Most recently, he was the head of sales nationally for a company called Stericycle. The really unique background on Dan is that he got to Stericycle through acquisition. He started his career with Cintas in a combination of both operational and sales roles, and then was running sales for their document shredding business, which was spun out into a joint venture.
When it was spun out and merged with another company, he ultimately received the head sales role in that business. When that business was acquired into Stericycle, within a year, he was running sales for the entire Stericycle organization. He's been on the acquired side multiple times, and every time ended up in the top sales role. His ability to bring a real sales orientation to our operations was something we were super focused on, particularly with our bent towards organic growth.
Our Chief Accounting Officer, Brad Hale, he was head of SEC practice for CBIZ before joining us to really lead our accounting function and has been a terrific addition to the team. Chris Stephens, who joined us as General Counsel, had a great background, both as General Counsel with a large real estate brokerage business that has a lot of similar attributes and aspects to our organization as well as a great career as a partner in corporate and M&A law prior to that.
Instead of getting a bunch of insurance people, you got really good salespeople, really good M&A, great financial person. You're giving them what you take from other companies.
That's exactly right. We wanted to bring people that had unique vantage points, terrific expertise, and weren't going to be burdened with the past kind of views of what was possible in the industry. So far, that's really panned out well for us.
This is a tough question to answer in a short period of time. It's probably not so fair, but fair. Maybe if you can just do a quick summary, but when it comes right down to it, what makes BRP different than competitors?
I'd say there's really two things. From an investor perspective, it's we are relatively nascent in our development and our overall trajectory. We're a young organization. We're still relatively small organization, but there's a massive market opportunity in insurance brokerage, an industry that's consolidating at a relatively rapid rate. I'm sure as you'll continue to hear from me and Chris and others, we have what we believe to be a fairly differentiated approach to M&A, what we call partnership, and ultimately driving organic growth. When we're out there continuing to grow our organization, having conversations with potential firms that are going to join our platform, it's a very different dialogue in that they have the opportunity to really leave their imprint on what we're building and what we're scaling, versus many of our peers who are built out and fully at scale.
A potential partner firm joining BRP has the ability to be a platform in a region, to be a part of that leadership team, versus being somewhat dismantled and absorbed into an existing infrastructure, and potentially reporting into somebody that maybe they've been competing with in that market for the past 10, 15, 20 years. What we're finding is that the folks that are interested in our story and our strategy, and that we're having a lot of dialogue around becoming a part of our organization. It's not the folks that are looking to sell out and hit the beach in a couple of years, but it's the folks that are really looking to sell in and become part of a larger insurance platform story and have the ability to be a part of building the next great national brokerage platform.
Talk about where your revenues are now and what your long-term aspiration is for the company.
Why don't I start with our long-term aspiration, and I'll let Kris talk a little bit about where our revenues are today. We have a stated goal as an organization that we refer to as Top 10 in 10, which is we plan to build a top 10 brokerage firm in the U.S. over the next 10 years. If you look at the stats today, the number 10 firm is about $1.1 billion in revenue. If you look at where we are today on a pro forma LTM basis as of Q3, it's something slightly less than $150 million in revenue. That Top 10 in 10 strategy is something that we announced at our internal leadership summit in 2019, and it's something that our entire leadership team and organization is really focused on and is built around.
There's a lot of momentum around building towards that long-term goal. Kris?
Sure. As Trevor said, when he joined there about $5 million in revenue. I joined in 2015. We were, I think, just over $20 million in revenue. If you looked at our Q3, we were about $101 million of actual through Q3. On a pro forma basis, if you would bring in partners that had joined us, not were in our actuals for the full year, it'd be about $116 million. As you mentioned, most of the analysts have us for a year-end right around $150 million. We've seen pretty substantial growth on a percentage basis and feel we definitely have a long way to go to hit the goals.
Roughly $150 million to over $1 billion in 10 years is the goal.
Absolutely.
I think you're the only company here that has said that. That's that kind of growth, which I would expect. One thing that does make you unique, certainly relative to some of your local competitors, is your centralized service model. Can you talk about that, and do you need to still invest very heavily in that service capability?
Maybe the easiest way to frame this is how a lot of our local competitors are set up, which is traditionally an insurance sales professional or what the industry refers to as a producer. At scale, they tend to spend only about 20%-40% of their time focused on cultivating new client relationships or generating new sales because they have a mature book that they're spending so much of their time servicing and managing. We've been incredibly intentional as we've organized our structure in separating the sales and service function. That our sales professionals, who we refer to as risk advisors, they tend to spend 60%-80% of their time focused on cultivating new client relationships.
As a result, the productivity of our sales professionals is multiples of the industry average sales professional because we have enabled them to spend a lot more of their time focused on cultivating those new client relationships. Then our clients ultimately get a more seamless and consistent client experience because we have dedicated teams of service professionals who we deploy around that client relationship and are tasked with delivering on our client stewardship commitments. It's really been an effective model. As we look at that infrastructure and where it sits today and where it needs to be as we continue to scale the organization, the core infrastructure is established in there.
What we're doing at this point is really just scaling that infrastructure as the organization scales, and then continuing to identify and adopt technology and capabilities to enhance what we're doing and how we're doing it. Thinking about tools that can lead to business process efficiencies or using technology to drive automation into our business processes. I can give you an example of something we recently rolled out, which is a tool called BKS Compass. What that is in our middle market business, our clients during the renewal phase have to fill out physical PDF applications for the underwriting companies. We've partnered with a firm, an insurtech firm called Indio, that has helped to digitize the insurance application process, and it turns into an ongoing repository for that information that's seamlessly transmitted back and forth between agency management systems when fully integrated.
That, as an example, has brought a tremendous amount of efficiency into how we're able to interact with our clients during the renewal phase, and also has meaningfully improved the experience of our clients during that data gathering process.
Trevor, one thing that has distinguished your numbers relative to at least the public competitors is your organic growth. It's multiples of what we see from others. I know what drives it is somewhat different depending on the segment of your business we're talking about. Let's do a quick walk through your main segments and why you are growing faster in those businesses than the overall market.
We have four core reporting segments, and in each of those operating groups, as we refer to them, we have a unique way of going to market. As an example, in our middle market operating group, which is your traditional multi-line insurance brokerage operation focused on midsize to larger businesses and high net worth individuals and families, we have a trademarked client engagement process called our Risk Mapping process. That's a five-step sales process through which we engage with a prospective client to do a diagnostic assessment and review of their existing insurance program architecture. We're doing everything from benchmarking limits and pricing and deductibles. We're assessing the business risks and exposures emanating from their business operations and putting all of that into a report that we then come back and present to that organization.
That provides them perspective on what they're doing inside their existing insurance and risk management strategy, also is where we provide advice on how we think we could help them optimize what they're doing. When we take a prospective client through that process, we win them 90% of the time. That compares really favorably to the industry's average quote-to-bind ratio of roughly 10%. What we've done is we've turned the typical insurance sales process upside down, where in general, the typical industry approach is a sales professional or producer would come to a business owner or executive team and convince them that they should be allowed to quote the insurance.
They'd go back and they'd secure quotes from a number of different insurance company partners, come back, present those quotes to the business owner, who's then also going to compare those quotes to maybe what they received from their incumbent agent. Ultimately then, if that business executive is not an insurance professional or expert, they're going to boil the decision down to the lowest common denominator, which at the end of the day oftentimes becomes price. We've taken price out of the equation. We are hired by the client before we've even gone into the marketplace to receive quotes. What that also means is our insurance company trading partners, by the time we're out to market, they know it's a controlled opportunity.
Rather than them getting a submission from us and two other agents, and they don't really know the relationship dynamics, who controls the opportunity, when our underwriters receive a submission from our team, they know it's an opportunity we control. If they're delivering on the terms, conditions, and pricing that we're signaling are going to win the opportunity, they know that they have a really good chance of winning the business. It ensures more efficient trading relationships with the insurance companies. It ensures better outcomes for our clients and overall more strategic approach to how we're managing risk and insurance on behalf of our clients. It's a true win-win-win.
That's a great example. If we talked about, let's say, the Main Street business, what's your advantage there? Why are you growing faster than others?
In our Main Street business, this is where we're serving everyday Americans and small business entrepreneurs. This business is predominantly oriented toward personal insurance, with the majority of that being led with the homeowners product. Rather than go and compete head-on with the Progressive and State Farm of the world, who have billion-dollar advertising budgets that are geared towards driving inbound proactive insurance shoppers, we don't want to engage with those consumers who are proactively shopping insurance, because that's an individual that's predisposed to be more transactional in nature. Oftentimes, that shopping is triggered either by a desire to drive cost savings or by some sort of a risk-related event that makes that potentially a less favorable risk, in our view.
Rather, what we're looking to do is insert ourselves at a point in time in a primary transaction where we make ourselves the solution of convenience. What I mean by that is what we've done is we've partnered with real estate brokers and brokerage firms, mortgage originators, and other centers of influence that insert us as a value add, as an example, when someone is in the process of buying a new home or refinancing their home. At that point, what they're not focused on is proactively shopping their insurance, but ensuring that they have the right coverage at an adequate price to allow them to seamlessly close on that life event, whether it's closing on their new home and moving in, refinancing their house so that they can send their kid to college, whatever that objective may be.
What we have to deliver on is we have to have speed of execution. We have to deliver our ultimate client with an experience that gives them a comfort level that we've adequately shopped the marketplace on their behalf to give them the right coverage at a competitive price. If we do that, insurance becomes something that they're not thinking about, that they're relying on us to provide that advice and consultation. We're putting it to bed, and they're not revisiting it every year to shop it. They're getting embedded into the seven-touch-point client journey that we're in the process of launching in our Main Street operation, so that we're really institutionalizing those relationships and driving cross-sell opportunity, continue growing and expanding the market or the product set that we penetrate into that client relationship.
I do want to talk about the M&A strategy, but before that, I guess your fastest-growing segment is your specialty business, the MGA business. Maybe talk about that and why that's growing so quickly.
It's a really exciting part of our business. As part of our specialty segment, we have a business, MGA of the Future, this is a business we partnered with in April 2019, and it's an MGA platform that's built on a completely proprietary technology stack. The business was founded by two primary founders, a gentleman, Jim Roche, and Brian Schultz. Jim, he has a unique background in that he was a computer science graduate at Vanderbilt University, a Darden MBA, but then spent time in the insurance industry as a product manager at Progressive, and most recently, prior to founding the MGA business in late 2015, was the head of strategy for QBE North America's personal insurance operations. This technology stack is completely homegrown and proprietary, built by Jim and his team.
What it does is it enables the automation of the insurance company functionality. Everything from data intake, policy underwriting, policy issuance, policy billing, endorsement processing, and renewal processing is done seamlessly in an automated fashion through our technology stack. As a result of that, at the end of the third quarter on our MGA of the Future platform, we had roughly 355,000 policies in force, and we managed that entire book of business with a team of less than 20 people. That compares to an industry incumbent who would likely need north of 100 professionals to manage that same size book of business. That business today is built around a core renter's product, the distribution strategy is focused on what we call shelter distribution, where we've integrated with specialty renters, agencies, and software providers where we become the solution of convenience at point of lease.
Our technology is the integrated renter's insurance solution into a number of property management software providers, where when you're a renter, you come in, you're going through the renting leasing process, all of a sudden you hit a hard stop, and it says, "We need proof of insurance." At that point, you can either go out and you can get a quote from State Farm or Lemonade or whomever, or you can work through the integrated insurance workflow in the leasing software. In less than two minutes, you can have a bound renter's insurance policy, be getting your keys, and be moving into your apartment.
Our technology enables that seamless quote bind issue experience in less than two minutes, and what we're really excited about is that while we have significant velocity in our core product portfolio of renters, where there's a total addressable market of over 44 million units, and the software providers that we're integrated with today manage over 15 million units, we've only penetrated about 350,000 of that at the end of the third quarter. More exciting is our ability to, as a result of this technology platform build proprietary insurance products that we'll launch to be able to distribute through our owned retail and wholesale businesses. What I mentioned on our third quarter earnings call is the near-term product in our product pipeline is a Florida homeowners solution.
Many of you all may know that the Florida homeowners insurance marketplace is in a bit of disarray right now. If we're able to come to market with an AM Best rated solution, and again, we don't take any risk, we're simply the MGA, but that's a huge differentiator. If you look at the overall economics, when we're the MGA on a solution, we'll be able to receive, call it 23%, 24% commission when you're looking at a homeowners-type solution product, versus on the retail side today, we get an average commission of about 12%. For placing that same $ premium, you double the revenue and potentially double or triple the earnings for distributing that same $ of premium and deliver our client a better AM Best rated enhanced solution with a better, more seamless client experience.
Yeah, it sounds very interesting. To reach your goal, top 10 broker in 10 years, you clearly will have to make acquisitions. Let's talk about your partnership strategy, your M&A strategy. Maybe first discuss the overall trends in the industry driving consolidation among intermediaries.
A couple of data points. One, the insurance distribution industry is still incredibly fragmented. There's over, depending on who you listen to, north of 30,000 to 35,000 independent insurance agents and brokers operating in the U.S. This past year alone, in 2019, there were nearly 700 announced transactions in the industry. The pace of consolidation is significant, but despite that, there continues to be a tremendous amount of opportunity out there. When you look at the average age of an independent insurance agency today, the average age of an owner is about 57 years old. You have aging demographics, you have increasing valuations that are driving interest and transacting, and then you have this wave of consolidation.
The industry's largest firms are getting bigger and bigger, and what that affords them as far as the ability to make investments in technology, unique capabilities, and afford a bench strength of talent that has unique and differentiated expertise around particular industry segments and product segments. It continues to get harder and harder for the smaller independents to compete.
Discuss the kind of business you want to acquire. If there's this perfect deal out there for you, for Baldwin, what does it look like?
We have a lens that's focused on growth. As we talked about earlier, we're focused on building a platform that can sustain double-digit organic growth well into the future. We're focused on partnering with very high-quality businesses with high-quality teams that have a lot of gas left in the tank. What that means is we're not going to be the acquirer of choice for a principal that maybe is looking to cash out and hit the beach in two to three years.
While that could still be a highly accretive and attractive acquisition opportunity, we're looking to truly partner with entrepreneurs who have 20 years of gas left in the tank and are looking to sell in, not sell out, and become part of the next national brokerage platform, really being able to leave their imprint on how we continue to grow and scale a highly differentiated organization.
You're not alone in looking for deals, right? We see a lot of private equity. We see Gallagher, Brown & Brown, Marsh Agency. What has happened to prices for deals over the past five years?
Yeah, pricing has definitely come up. The way we think about it is where pricing sits today from mediocre to lower quality assets, it's too high. We still feel really good about where pricing is for high-quality businesses that have a demonstrated track record of delivering high single digits to double-digit organic growth, and that have really top-tier talent. Because at the end of the day, despite the impacts of technology and consolidation, this is a people business. Our ability to continue to execute on our outsized growth strategy is predicated on our ability to continue to cultivate our reputation as a destination employer in the industry.
We're very much focused on talent, on cultivating and building a culture that's recognized and celebrated for our success in attracting that high-end talent and being what we call a forever home for the industry's leading independent firms. What I mean by that is while private equity-backed firms have certainly been really active in the space, the lens through which they evaluate and look at potential transactions, I believe, is somewhat different than ours. They have a much more finite investment period, and so they're very much more focused on day one cash flow and very much less interested in growth. When we're evaluating a partnership opportunity, while what we pay for that business day one is super important, what's more important is what's our basis in that business in three years once the earn-out's settled?
What we're focused on is looking through that lens of investing in businesses that are growing and expanding, and that we can plug in our growth services platform to even accelerate and enhance what they're doing and make it a true win-win transaction.
I've got a bunch more questions, but I don't want to hog the mic. If there are questions for the Baldwin team, We have a question down here. Ron?
Hi. Thanks. I believe you have a Medicare Advantage brokerage-focused business. Could you describe where it sits in the distribution channel for that product and how big it is? Thanks.
Yes. Prior to the two recent deals we announced in the Medicare space, that was a relatively small part of our business. Where we sit in the Medicare distribution value chain is we're what's called an FMO. We have top-level contracts with the health plans that we are trading with. What that means is we're not going through another intermediary. We're contracting directly with the health plan. Unlike many of our peers, our model is very much focused on then going direct to the actual agent, boots-on-the-ground agent. We're focused on building density in the core markets that we want to be investing and growing in so that we can afford to have true boots-on-the-ground sales management and marketing support resources to enable the success of our 1099 agents.
We've completed a study of the U.S. on a county-by-county basis, identifying the top 25 markets that we want to be in based on a number of factors, including demographics, such as what are the population and agent demographics look like. Equally as important is what are the competitive dynamics of the Medicare Advantage plan marketplace? Because if it's a market that has great demographics, but there's only two plan options, an agent doesn't have a whole lot of utility. You can, as a consumer, make the choice between two plans on your own. If it's a marketplace that has, say, 15 different plan options, well, then there's a lot of utility to an agent and how they can help an individual navigate that very complex decision they're making. We are very bullish on the Medicare business.
We're excited to continue investing in it. Our two most recent announced partnerships were two Medicare deals, one in Texas and one in Washington. We're excited about what that growth opportunity looks like for years to come. I also think it's probably worth noting some nuances in our revenue recognition methodology in our Medicare business compared to maybe some of the peers you would be familiar with, like an eHealth or a TRANZACT that Willis recently acquired. Kris you want to cover that?
Yes. We did adopt 606 as part of the IPO process. We took an approach of fully constraining our Medicare revenue at point of sale to one year at a time. That's something we worked with PwC on. The standard practice in the Medicare industry is to book a lifetime value, which ends up having a pretty big difference between your cash flow in a given year and your GAAP revenue, and you hang up a large receivable. We were able to work with PwC, and constrain that to one year. So it's not apples to apples when you look at our revenue versus some of the others, like a TRANZACT or an eHealth.
What's the run rate size of the two deals? That's it for me. Thanks.
The two deals we announced were roughly $11 million of revenue.
We should probably wrap it up here. Trevor, it was great having you here, Kris as well, to tell the story. Thank you.
Thank you, Jay.
We are going to keep chugging along, get into a lot of companies today. Up next is Selective Insurance, and presenting for the company will be John Marchioni, Selective's CEO, newly announced CEO, and Mark Wilcox, the company's CFO. John was just recently appointed CEO and was President and COO prior to his new role. He was COO since 2013. He's been with the company for 20 years. Obviously, you've seen John before here presenting. In fact, I would say the CEO transition was about as smooth as I've seen. Very seamless. Mark joined Selective in 2017 from RenaissanceRe, where he was Controller and Chief Accounting Officer. Taught me a lot about accounting over the years, thank you for that. It's always a good opportunity to speak with a new leader of a company, and we're excited to have both of you guys here today.
First, congratulations on your appointment.
Thank you.
Probably, I'm sure I already emailed you on that. No one was surprised by it. Maybe you have a fresh, not a fresh, but you have a look at the company as a CEO from a somewhat different lens. I'm sure you come in and say, "Let's take a good, fresh look at this company." When you look at Selective, what do you see as the core strengths, and how do you see the company positioned for not 2020, but the next five to 10 years?
Thank you, Jay. It is obviously an enormous honor for me to assume this role. Selective is a very special company, and Selective is a company that has delivered very strong and consistent results. While I might be a little bit biased, I have the ability to follow somebody who I think is among the best CEOs in this industry and who did the job at a high level for 20 years and 40 years in total in the organization. Obviously, coming into an organization that is extremely well-positioned. Our strategy as a company has been fairly consistent, and when we think about our unique competitive advantages, and we are a very unique company in this business, it starts with our operating model.
We have had a field-based underwriting model for two and a half decades now, it provides enormous opportunity for us and for our agency partners, for them to have somebody in their office working with them, our field underwriters control about 10-15 agency relationships. It gives the agent somebody who can get things done, can get business written, which is a great advantage in the eyes of the agency. It's also a great advantage for us in that we have somebody who's local to that agency, who knows the producer, who's on the other side of that transaction, and in many cases will know the business because they're local to that business. We think there's a real underwriting benefit there as well. That's, I think, advantage number one and continues to position us extremely well going forward.
Number two would be we've continued to have a limited distribution philosophy. We only have about 1,350 agents across our 27 commercial lines footprint states, which means that all of our agents are significant relationships for us, and we are to them. We're going to occupy one of the top two or three, in many cases, number one spot in most of our agencies, which makes the relationship as important to them as it does to us, and that'll continue to be a core of what we're all about. I would say the third distinct advantage that we've continued to deliver in the marketplace is our absolute focus on customer experience. I think 20 years ago and 10 years ago, that was more about the human element of delivering a great experience to our distribution partners and to our customers.
Of late, it's been our investments in making sure that we deliver what we would consider to be a superior omni-channel customer experience. Whether that customer or that distribution partner wants that human interaction, they're going to get that at a high level, whether they want the real-time digital experience, 24-hour experience, self-service environment, fully mobile opportunities to service their accounts, that we give them that potential as well. I would say the change in the customer experience focus to make it both about the human element and the digital experience continues to be a core competitive advantage for us. With regard to how we're positioned for the future, we have made so many investments in customer experience. We've made so many investments in making sure that our underwriters have all of the tools to do their job as effectively as possible.
It started 15, 20 years ago with the deployment of modeling capabilities, delivering individual underwriting and pricing guidance to underwriters at the point of decision. The last couple of years have been making sure that we use technology to improve their efficiency. All of the work that used to be manual for an underwriter to go out and gather information about an account to make an underwriting and pricing decision, the ability to deliver that to them in an automated fashion so they could spend the majority of their time adding value and making that underwriting judgment and that pricing judgment. That helps us create greater efficiencies and allows us to create more capacity for growth, and I think that continues to be a growth accelerator for us. We've invested in geographic expansion.
We've added five new commercial line states in the last two and a half to three years, which have been great accelerators of growth for us. The other big focus for us is the least risky way for us to continue to generate good, strong growth in our core commercial lines business is through growing market share in our current 27-state footprint. Our current commercial lines market share is just over a point. It's about 1.3 percentage points. We think a reasonable expectation over time is for us to get to a 3% share, and we could do that without having to stretch our underwriting appetite, without having to change our risk profile, and we think that continues to fuel our growth, and continued profitability in the coming years.
For someone who has been at a company, a senior leader at a company, you take over as CEO, I really want to ask you, what will you do differently? I know it won't be vastly different because you were so involved with setting the strategy before, you are a new leader of a company, you want to put your imprint on it. Are there things that you want to do a little differently?
I would say the biggest area, Jay, that I would highlight, because you're exactly right. I have been heavily involved in developing this strategy and executing on it. I would say the biggest area of focus for me going forward is making sure that from a culture perspective, we become more of an innovative, more of an agile culture around building and deploying technology in a way that leads to better underwriting decisions, better customer experience, and better operational efficiency. We're at a time where, we've always been an organization that prided ourselves on having the best talent in the business and having a culture where employees feel like they're valued and feel like they have the opportunities to continue to get better as individuals and continue to take on more responsibility.
I want to make sure that continues to be the case, that we continue to be an attractive place for people to work as we get more and more into new disciplines for the future around data science and data analytics, making sure that we have the ability to attract and retain that top-notch culture in emerging areas like data science, making sure that we have a culture that is much more inclusive than historical. You hear a lot of companies talk about the importance of diversity and inclusion, we certainly do as well. We're trying to make sure going forward that we have the most inclusive environment so that individuals who come in with different backgrounds and different viewpoints have an ability to actually have an impact on the direction of the organization and feel like they're fulfilled in this organization.
I would say that'll be a big area of change going forward for us.
Culture change, by definition, is tough, takes a bit of time.
It-
It starts at the top.
Agreed. It also it's important to make sure that you have an existing culture, and I think our culture is very healthy, that it embraces people of different views, and it's a culture that cares deeply about the success of the organization and the people in it. I think change in a culture like that is a lot easier to achieve, but nonetheless difficult.
You had mentioned the geographic expansion. Looking forward, what is your strategy for entering new states, and do you have any targets as far as how many states you'd like to be in?
We're currently at 27 states for commercial lines with those five recent expansions, the biggest part of that being the four-state region including Arizona, New Mexico, Utah, and Colorado. We've got about five states that we would consider on the shortlist for additional expansion, and we put them in the category of fully operational, meaning you're going to open those states up, you're going to appoint agents, you're going to hire underwriting claims and loss control staff on the ground in those states. Those states include the Pacific Northwestern states of Washington and Oregon. Texas is a state we're evaluating, haven't made a decision about whether or not we want to enter Texas fully, a couple of round-out states adjacent to our current footprint, including Vermont and West Virginia. That would get us to about 32.
Our longer-term vision is to have our product filed and automated in at least the 48 contiguous states. Not that we would be fully operational with appointed agents and field employees in every state, but we have the ability to write multi-state accounts by agents written out of our current footprint, which we think helps us expand our market share within our current 27-state footprint. That's a longer-term proposition. I think you're talking about a seven to 10-year horizon for us to get to that full 48-state capability, those five states that I just mentioned will be more near-term in terms of opening them up in the next several years.
Got it. The strategy for doing it, that's been pretty consistent. No changes there.
No, it's been a tried and true approach of our unique operating model, a smaller distribution model in terms of number of agents. Just to give you a sense, we opened up the state of Arizona with about 15 agency partnerships across the entire state that controlled about 20% of the market. Colorado and Utah, New Mexico were in that 10-15 sort of range. Limited distribution model, same underwriting appetite, and same field model, and that's worked for us. It's a much more conservative, much more deliberate approach. Takes a little bit longer to do it that way, but we feel like we reduce the risk by taking that approach.
Can you guys speak to your margin guidance for 2020? Really, what are the drivers of the improvement?
Sure, Jay, let me walk you through that. Just as a reminder, we had an excellent year in 2019, great growth, top line up 7%, a very profitable 93.7% combined ratio. That's an all-in calendar year combined ratio, a 13.3% operating ROE. Just to kind of walk you through the guidance for 2020, I'll come back to and take you through the details of the underlying margin expansion. One is an expectation of an underlying combined ratio of a 91.5%, three and a half points of cat losses, so an all-in accident year combined ratio of 95%. We don't forecast or expect any prior year reserve development.
$185 million of after-tax net investment income, which includes $14 million from the alternative portfolio, a couple points of growth in net investment income despite a decline in interest rate environment, 19.5% tax rate 60.5 million of weighted average shares outstanding. That was the full-year guidance across the book we laid out for 2020. If we come back to the underlying combined ratio guidance starting with 2019, the 93.7% that I mentioned on a calendar year basis. If you back out the cat losses and the favorable reserve development, the underlying combined ratio, the starting point was a 92.9%. To get to the 91.5%, there's 140 basis points of underlying margin improvement for the 2020 year. There's a couple different drivers of that. One is clearly loss trend, which is a headwind.
As we talked about on the year-end call a couple weeks ago, we have just under 4 points of expected trend in our underlying combined ratio expectations for 2020, 3.8% to be precise. The impact of that on the combined ratio is it just hits the loss ratio is call it 2.3%. We also have an expectation of rate for 2020 on an earned basis, and that includes both the written rate that we generated in 2019 that will be earned in 2020 as well as an expectation of written rate in 2020 that will be earned in 2020. That expectation is, call it, 3.7%. The impact of that on the combined ratio after you factor in the variable-based underwriting expenses is a benefit of 2.4 points. Rate impact 2.4 points, trend impact, a headwind of 2.3.
It's a little bit of improvement in terms of rate versus trend when you put those two pieces together. We also believe we can drive the expense ratio down. We have some opportunities over time to drive that down, approaching a 32 expense ratio over the next couple of years. For 2020, underlying combined ratio guidance has an expectation of about 40 basis points of expense ratio improvement, taking it down from a 33.8 to a 33.4. We have what we call our underwriting mix and claim benefit improvement, which is about 80 basis points. That number includes both the underwriting side of the equation as well as a benefit on the loss adjustment expenses.
The underwriting benefit really comes from managing the book of business and retaining the higher expected profitability accounts, and then having a lower retention ratio on the accounts that have a higher expected combined ratio or lower underwriting profitability. Between those two, underwriting mix and claims, that's about 80 basis points. There's a little bit of a rounding difference of 10 basis points, that gets you from the 92.9 to a 91.5. Again, that's an accident year basis, so that doesn't assume any reserve development, and that's ex cat. You add the expectation of cat losses of three and a half points, and it gets you to an accident year combined ratio of 95% for 2020.
There's really not the tailwind of pricing. It's actions you guys are going to take to change the mix, retain better business, blocking and tackling.
That's exactly right. I think for us, it is a good market environment. We did see an acceleration in pricing towards the back end of the year. We had our best pure renewal rate increases in Q4, and the highest growth in our standing commercial lines book in Q4. For us, part of it is the starting point. If you look back over the last five years, Selective has been able to generate about 16.5 points of pure renewal rate, and that compares to the industry of about eight points. We're hitting our target margins. As I mentioned, the 13.3 operating ROE for 2019, a very profitable combined ratio. For us, yes, we're going to look to generate as much earned rate as we can.
We're starting from a very good place in terms of embedded profitability in the book of business, and that allows us to have a relatively prudent assumption from an earned rate perspective in the combined ratio guidance.
Jay, just to add one additional point of emphasis to what Mark already described is because this whole discussion around mix improvement above and beyond rate relative to loss trend is something that we've consistently been very transparent about and measured. It's not just this number that, hey, we're going to improve our mix of business by making better decisions. We disclose it every quarter in terms of the price and retention by cohort. It's in our investor slide presentation every quarter. Because of the sophistication that we've built in terms of modeling and other capabilities, we provide our underwriters individual pricing guidance based on our outlook for performance on every individual account. We track very closely for that best business. In our presentation, you see it labeled as above-average business. That's got a projected combined ratio much lower than our average.
There's about 11% of our premium that we consider in the low and very low retention buckets that has projected combined ratios well above average. We show you the relative rate level and the relative retentions on those different cohorts. By managing that worst 11% to a higher rate level and a lower retention level, you are getting a mix of business improvement that's measurable and trackable that gives us confidence that that's realizable improvement from a mix perspective.
A lot of analysts just look at price and trend. There's other stuff you can do.
Absolutely
As you guys have done. Let's talk about price and really how you go about obtaining price increases. You have a very close relationship with your agents that other companies don't really have.
I think that's definitely an important consideration. I know every company will say we've got great relationships with our distribution partners. I think if you want evidence of that, you want to look at the performance on rate and retention over a long period of time to see if that's backed up by fact. In terms of how we've done it, this is now for us 10 years of getting rate level pure price, net of exposure changes, no exposure change in there, pure price at around 3% or higher, which looking back, tracked our expectations for a loss trend. We do that primarily two ways. Number one, very granularly. If our rate target is, as Mark indicated, we expect to get about 3.7 this year of earned rate, it's not that every account gets 3.7.
There are accounts that in many cases are earning a rate reduction and will get a rate reduction. There are others that earn a rate increase or should earn a rate increase that is in the double digits, maybe approaching 20%. That granular guidance to our underwriters is one of the reasons we've been able to achieve the rate and retention that we have. The other part is, we do have great communication and great relationships with our agents. Our underwriters on the commercial line side are assigned to an individual set of agents. They develop a good working relationship. They know who is working that account on the other side.
That agent, because we're occupying one of the top market positions in that office, has a vested interest in making sure that we're communicating well and protecting the business we want to protect, aggressively pursuing rate on the accounts that deserve to be increased substantially. That's the other reason we've been able to achieve that kind of success.
Let's talk about the claims side. Obviously, with many of the P&C companies, we're hearing about rising liability costs. Can you guys talk about the trends you're seeing in the major lines of business as far as claims inflation goes?
I'll start and Mark can certainly fill in. I think at the highest level, Mark indicated this, our assumption for loss trend overall is 3.8% going into 2020. It was about that level for 2019. If you look back over a period of years, it was probably closer to 3%. This is an important consideration. We talk about claims trends as though it's a single number. In reality, when you talk about trend, you've got to talk about it in two pieces. First is historical trend. Look back over a number of accident years, what is the actual change in frequency and severity in your book of business that has happened? There could be different factors, might be economic, some might be environmental. What is the actual historical trend in your portfolio?
That's going to vary from company to company. What's your expectation for future trend? That really becomes the focal point. We just took you through the 2020 roll forward for guide. Every year for at least the last 10 years, we've always included an embedded expectations trend in our loss picks. We would start for all of our lines of business with a loss ratio selection that was five accident years, fully trended based on historical, brought to present rates. That would give you your starting point. You would take that starting point and inflate it by your view, and in many cases, they were tied closely to the components of CPI that impacted that line.
That would normally, historically, that number is now closer to 4%, but that's embedded in our loss ratio pick, and that's where you want to really understand a company's starting point. When you look at each one of the last several accident years, what was your embedded assumption for, and what was your earn rate level in that accident year, and that's how you lock down each of those accident years. Forward now, to the extent claims trends are starting to, by us increasing our overall trend from about three to closer to four, we are assuming in the claims environment, we're accounting for that in our loss ratio expectations, and we're accounting for it in our price. We track very closely attorney representation rates and litigation rates, two different things. Literally are known claims in litigation.
They have been fixed over a long period of time for each of the casualty lines. The other metric you want to keep close, harder to have accurate, consistent data is attorney rep rates, because you don't have a file in litigation. Claims adjuster happens to know that that claimant has, and help in that case. Those tend to be a little bit more volatile, but I would say relatively stable across all lines as well, continue to stay focused on. That's how, and I would say the trends for GL and for commercial auto liability, we fairly consistent order going forward because to the extent there's things happening in the environment relative to settlement values, it'll probably affect all the lines similarly.
Your business is so different than a Chubb or an AIG's experience is going to be somewhat different as well.
We do have a low limits profile, and we're not suggesting that file will make anybody immune from Well, I don't necessarily refer to it as social inflation. There are a number of things that could impact loss costs. Certainly isn't making almost 90% of our casualty limits at $1 million or less, but it would be more muted on the type of account that we write, which tends to be more business across a number of different commercial segments.
Your E&S business has improved quite a bit. What contributed to the turnaround, and what's the strategy for the acquisitions you made? Must've been five years ago?
Yeah, it was actually 12. We entered that business through a couple of what were effectively renewal rights transactions with two. You're right. We were happy with the improvement we've seen from a profitability in a number of quarters in a row now, pretty consistent and solid profitability. We do think pricing discipline. We also think as we got into those is we inherited different claims organizations that ultimately got brought into the overall Selective philosophy, the claims management tools, which we think helped.
We introduced a lot more actuarial knowledge in this portfolio and to set pricing targets. In the last year or so, we did have a couple of small segmentations in that business, specifically snowplow removal exposure, and a little bit of liquor liability that was attached to a restaurant book that we decided to exit because it was small volume, high volatility in order to the benefit of the results we've seen in recent times. We like the business. Now remember, our E&S is really small account size on E&S is $3,000. It's predominantly in the binding space, a little bit of brokerage business, but it's a small artisan contractors, habitational restaurant. We like the business. It's a wholesale business segment. We like the growth prospects going forward.
The headlines you hear about with regard to E&S in terms of pricing and rapid growth tends to be more of the high-
Right
property catastrophe exposed segments that really not where we play. I think what you see in dynamic in our E&S book is more akin to what we see on the standard small commercial line side.
To personalize. Before we do that, The investment portfolio, because your asset to equity leverage is a little higher. That generally is good, but when interest rates come down, could have a bigger effect on you. How do you expect the drop in interest rates to impact contribution?
Yeah, good question. It is a headwind. Going back to the leverage, it has come down a little bit over the last couple of years with strong growth in GAAP equity. At the end of the year, we finished with in terms of invested assets per dollar of shareholders, 3.05 times. That's considerably higher than the industry as a whole. For us, about a point of earned yield pre-tax, that are points of ROE. We don't need a lot of investment yield to ROE from the investment portfolio. We've put a lot of work and spent a lot of time and effort tuning the investments the couple of years, hiring some new core] redoing alternative strategy. It remains a very defensive, conservative investment partly because of the investment leverage.
It helps you on the upside, it obviously hurts you on the downside if you have negative rates going up. We did work very in 2018 in the rise in interest rate environment to really build the book yield on the investment portfolio, in 2018 and 2019, we generated over nine points of ROE from the investment portfolio. Despite the interest rate environment in 2019, we were able to grow after-tax net investment income by 13% and still generate just over nine points of ROE from the portfolios. Just being a little bit more judicious, not turning the portfolio and having built the book yield up, that paid dividends in 2019. As we look ahead to 2020 of $185 million of after-tax net investment income does assume about 2%. We finished 2019 with about just over $180 million investment income.
That really reflects an expectation of the credit spreads as we see them today. Pressure on the reinvestment rates as we have a weighted average life in the port of 5 years. On average, we have about, assume interest rates stay where they are, about new money we need to put to work each year between natural sales and maturities and coupons, plus the operating cash flow we generate to put to work in our 2020 guidance. The other thing that I'll mention is back to the cash flow, generating very strong cash flow from operations. We look ahead to 2020, the cash flow from operations builds, obviously more than offsets the decrease in the book yield. Net net, a little bit of growth in outcome in 2020. The core tenet of the portfolio, conservative, stay up in credit quality.
It's a AA-minus average credit quality across the core fixed, relatively low on the duration side. We're at 3.6 years, which is at the low end of our target duration, and we're underweight our risk assets. We have about an 8% allocation to what we call risk yield, public equities, and alternatives end of our target range given the fact that valuations are pretty high at the moment.
You, Jay, Mark explained it extremely well. We love this, and we love it because it requires companies to generate underwriting results, and that's what we're built to do. We're a great underwriting company, and we're able to thrive in an environment like this. Especially with higher operating leverage at a 1.4 to 1 premium to surplus. I think if you look at it from an underwriting perspective, we're generating about a point of ROE. Our ability to above average leverage relative to the rest of the market, but offset that with a very conservative and we continue to be a conservative buyer of reinsurance. We continue to have a very conservative philosophy and track record, and we write a lower hazard, lower volatility portfolio.
We see a lot less volatility in our combined ratio, and that's how we manage the overall risk profile of the organization.
Got it. I want to talk about personal lines. I also want to make sure I have any questions on the commercial lines business, the growth, the agency strategy. Just raise your hand. Let's do personal lines. What's the strategy here? I guess in your states, you have scale. Nationally, obviously, you're not a scale player. What's the longer-term strategy for personal lines?
Personal lines is still a business we like. It's not our core business. It will never be our core business. I would consider complimentary business for our overall. When you think about our distribution model and having a limited allows us to offer another product to our distribution partners. It helps us build that overall relationship cent of our premium. It's a line of business that we, or a segment of business we expect to run at consistables. By having that philosophy, specifically with personal auto in the last two years, it's been to grow. We have focused on improving our personal auto. We've seen some improvement on the loss ratio side. That's really hurt our competitive positioning, mostly on a multi-line basis.
We're putting together the auto and the home for one customer so that auto has hurt our ability to grow the home line. It's a nice business for us to round out the portfolio. It's a business we want to be in. We're going to make sure that we're filling our target margins. Our philosophy on home is to run that line at about a 90% combined ratio in a normal cat year for us for home is about 14 percentage points. Most of that for a few years, you see a little bit more volatility, and it's been a little bit above that target in the last two years. I was about more consistent improvement.
Unfortunately, in a comparative rating environment, which is what's become agency channel, it's just hard to compete if your rate level is coming in higher than where a lot of the peer in recent quarters, and has pressured our ability to grow that segment.
Since it's not your core business, and as you said, it won't be, is M&A scale here kind of off the table?
We certainly think about opportunities to expand the portfolio, to add product SKUs to partners. I wouldn't necessarily look at personal lines as a fit, as a segment that I would be any further from what we have. We like the business. We like the portfolio we have. Area that we'd be looking to expand through M&A.
Got it. In a minute 23, capital management, your philosophy, what do you think we'll see in the next year?
I mentioned earlier, we've had excellent growth in GAAP equity. We enter 2020, probably our strongest financial position we've ever been in, $2.2 billion of GAAP equity, $1.9 billion of statutory surplus.
Okay.
CEO. Strategically, the best we've ever been positioned, we feel very, very good about our future prospects. We delivered a 13.3 ROE last year. If you on the margin guidance that we gave you in terms of the underlying combined ratio caps and net investment income, you put that all equity base, we're looking at a very attractive ROE for 2020 as well. We believe our number was to put it back into the business and grow.
We have a great of affirming pricing environment heading to target margins, and that is the number one capital today. That said, from a growth perspective, the goal is to grow book value dividends at a clip higher than our peer group, which does entail being good stewards of our shareholders' capital. We have a number of tools in place that we could utilize if we ended up in a situation where we lay our capital back into the business. That could include special dividends, that could include buying or retiring debt, or that could include all of those at the present time, not kind of on the immediate future. Our goal is to deploy the capital back into the business, continue to focus on disciplined and profitable growth.
Perfect. Great summary, CEO.
Thank you.
Great session. Thank you.
Great to be here as always.