Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter 2011 earnings call for Cincinnati Financial. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during that time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. I'll now turn the call over to Dennis McDaniel, investor relations officer. Please go ahead.
Hello, this is Dennis McDaniel. Thank you for joining us for our fourth quarter and full year 2011 earnings conference call. Late yesterday, we issued a news release on our results along with our supplemental financial package. To find copies of any of these documents, please visit our investor website, www.cinfin.com/investors. The shortest route to all of the information is in the far right column via the quarterly results quick link. On this call, you'll first hear from Steve Johnston, President and Chief Executive Officer, and then Chief Financial Officer, Mike Sewell. After their prepared remarks, investors participating on the call may ask their questions.
At that time, some responses may be made by others in the room here with us, including Executive Committee Chairman, Jack Schiff Jr., Chairman of the Board, Ken Stecher, Executive Vice President, J.F. Scherer, Principal Accounting Officer, Eric Mathews, Chief Investment Officer, Marty Hollenbeck, and Chief Claims Officer, Marty Muller. Please note that some of the matters to be discussed today are forward-looking. These forward-looking statements involve certain risks and uncertainties. With respect to these risks and uncertainties, we direct your attention to our news release and to our various filings with the SEC. Also, a reconciliation of non-GAAP measures was provided with the news release. Statutory accounting data is prepared in accordance with statutory accounting rules, and therefore were not reconciled to GAAP. With that, I'll turn the call over to Steve.
Good morning. It's a pleasure to speak with you today from Murfreesboro, Tennessee, where we will meet with agents this afternoon. This is the fourth state among 22 in total that we are visiting during the first and second quarters. Our agents, with their optimism, their commitment to our partnership and shared goals, really energize us. After three straight quarters of heavy catastrophe losses, the fourth quarter was profitable, with commercial lines, personal lines, excess and surplus lines, life insurance, and investments all contributing to strong operating earnings. Essentially, all indicators of longer-term performance are moving in the right direction, and that bodes well for creating shareholder value. Various strategic initiatives are having a positive effect, and I'll highlight several key areas. As we discussed during our last quarterly conference call, better insurance pricing is a top priority.
We are experiencing improvement through a combination of our diligence plus somewhat more favorable conditions in several markets. Our pricing precision for each policy continues to improve as we gain more experience with our pricing models. More thinly priced risks are getting significantly higher prices. Fourth quarter increases in renewal pricing occurred for each property casualty segment and also for each major line of business within segments. As we pre-announced, commercial lines renewal pricing accelerated during the quarter, with average increases in the low to mid-single digit range. Just over 80% of our commercial lines renewed at flat or higher prices. For our excess and surplus line segment, renewal prices continue to increase and are solidly in the mid-single digit range. Pricing changes for that segment have been positive for the last 16 consecutive months.
For personal lines, we believe our 10% increase in 2011 renewal premiums is roughly half from higher rates and half from higher policy counts. Policy retention has remained fairly steady over the past two years, with fourth quarter retention in the high upper 80% range for commercial lines policies and in a low to mid 90% range for personal lines policies. Our agents are able to sell the value of our products and services. They continue to work with us to implement price increases where they are needed. The market remains competitive, particularly for new business. While agencies appointed since the beginning of 2010 drove our 6% new business premium increase for 2011, new business written premiums for agents appointed prior to 2010 decreased approximately 2%. We are seeing plenty of opportunities to grow profitably and are comfortable declining new business opportunities we believe are underpriced.
We also continue to gain confidence that our pricing analytics are helping us to distinguish the more attractive new business offerings from the less attractive ones. In 2011, we appointed 133 new agencies in areas we consider underserved, about a dozen more than we planned at the beginning of the year. During 2012, we plan to appoint around 130 agencies. It takes several years for a new agency to develop the double-digit market share we enjoy with agencies appointed for 10 years or longer. The accelerated pace of appointments in recent years, plus our commitment to serving all our agencies and their clients, put us on a path where we believe we can achieve $5 billion of direct written premium by 2015. Above all, our emphasis on premium growth is to do so profitably in order to raise the level of earnings and book value over the long term.
Our life insurance business also grew in 2011, with earned premiums up 4%. Term life, the largest product line, rose 9%. Although life insurance profits remain challenged by the low interest rate environment, our agencies value the ability to offer quality life products and services to their commercial and personal insurance clients. The year 2011 will be remembered by many for its violent weather and other natural catastrophes. From a financial perspective, our unprecedented catastrophe losses in 2011 were an earnings event rather than a capital event, as we ended the year with higher shareholders' equity than at the start of the year. An important risk management element for keeping our capital strong is an effective reinsurance program, and we have renewed all our primary reinsurance treaties for 2012. For our per-risk treaties, property rates were up approximately 10%, and casualty rates were down around 5%.
We chose to add $100 million more to our property catastrophe reinsurance coverage, raising it to $600 million per event, and we now retain the first $75 million of loss. For a $500 million event, our net retention is $115 million, compared with the $88 million in 2011 and $104 million in 2010. Assuming stable levels of facultative reinsurance, we estimate that our total 2012 premiums ceded to reinsurers will be approximately $181 million, down roughly 16% from 2011 and up about 8% from 2010. Another important aspect of 2011's high level of catastrophe activity was that it allowed us to showcase our expertise in providing claim service. I can hardly say enough about how well our claims staff performed and about how our claims response and other elements of our service play an integral role in our ability to profitably grow the company.
We aim to give policyholders consistent value and service through all these storms. We believe shareholders deserve consistency, too. The payment of our dividend to shareholders last October marked our 51st consecutive year of increasing dividends, and we are committed to efforts that will benefit shareholders and other stakeholders for years to come. For 2011, our value creation ratio was 6.0%. While that's below our target range for the annual average in any five-year period, we are encouraged that our book value per share increased despite a catastrophe loss ratio that was three times higher than the annual average for the prior 10 years. We remain confident that various initiatives to improve profitability and grow premiums will continue to bear fruit, driving stronger value creation over the coming year.
Our Chief Financial Officer, Mike Sewell, will further comment on results during the quarter and several points regarding our balance sheet.
Thank you, Steve. Thanks to all of you for joining us today. I'll start by highlighting important trends in our property casualty underwriting performance. While our full year 2011 combined ratio of 109.2% was disappointing compared to our history and targets, we see several reasons to be optimistic. On a calendar year basis, the combined ratio before catastrophes improved by seven-tenths of a percentage point. Factor out the effect of additional 2011 ceded premiums from reinstating our property catastrophe reinsurance treaty, that improvement was 2.0 percentage points. On an accident year basis before catastrophes, the combined ratio for accident year 2011 improved by 2.7 percentage points over accident year 2010 after factoring out the effect of reinstatement premiums. We remain confident about the strength of our loss reserves and development patterns. Our approach is consistent.
We aim to remain solidly in the upper half of the actuarially estimated range, knowing that is important for longer-term financial performance. Reserve development on prior accident years recognized during 2011 was fairly consistent with 2010, down nine-tenths of a point to a ratio of 9.4%. For favorable reserve development recognized during 2011, 63% was for accident year 2010, in line with 62% for accident year 2009 that was recognized during 2010. For both periods, the balance of favorable development was concentrated in the two next most recent accident years. Our updated loss and loss expense reserve estimates as of December 31st, 2011, show accident year 2010 developed favorably by about six points on a ratio basis, while accident years 2009 and 2008 developed favorably by approximately eight points over the years.
For both 2011 and 2010, our commercial casualty lines of business was the majority beneficiary of the favorable development. There is no absolute assurance that accident year 2011 will develop in a similar pattern, but we do aim to be consistent in our reserving practices. During the fourth quarter, we refined our allocation to line of business segment and accident year for loss expense payments in reserves known as Adjusting Other Expense or AOE. While the refinement had a zero effect on consolidated property casualty loss expense reserves in total, some lines of business experienced higher incurred loss expenses and some lower. This was a one-time refinement of reserves among the lines of businesses. The full-year 2011 ratio effect raised the personal line segment ratios by approximately three percentage points and lowered the commercial line segment ratios by about one point. Some lines of business had larger effects.
Turning to expense management, our insurance operations reflect a focus on improving service and efficiency. The total number of associates and contractors is down 4% since the end of 2009. That includes a 4% increase in field associates, offset by a 5% decrease in headquarter staff and a 30% decrease in contractors. Our 2011 property casualty underwriting expense ratio at 32.2% was 60 basis points lower than last year. We anticipate the expense ratio continuing to benefit from future premium growth and more efficiency in our processes. Investment income is an area where our trend continues to run counter to what the industry is experiencing. Ours rose 1% for the year 2011 on a pre-tax basis. The pre-tax yield on our bond portfolio for the year 2011 was 18 basis points lower than the prior year. Interest income continues to face a headwind.
The portfolio had an effective duration of 4.4 years at year end, down from 5.0 years at the end of 2010. Dividend income was the source of our investment income growth during 2011. Dividends from our equity portfolio were up 4% for the fourth quarter and up 5% for the year. Our equity portfolio also had a nice rebound in valuation during the fourth quarter. The portfolio's fair value ended the quarter up 13%, reversing the 12% decline during the third quarter. Pre-tax net unrealized gains for the total investment portfolio reached nearly $1.5 billion at the end of 2011, an increase of 19% from a year earlier. Our investment approach remains consistent. We think the long-term capital appreciation potential is important. Our capital remains strong, and we ended the year with over $1 billion in holding company cash and marketable securities.
We are well positioned for capital management purposes and for growing our insurance business. I'll conclude my prepared comments by summarizing the contributions during the fourth quarter to book value per share. Property casualty underwriting profit increased book value by $0.39. Life insurance operations added $0.04. Investment income, other than life insurance and reduced by non-insurance items, contributed $0.41. Shareholders' equity changes related to our pension fund lowered book value per share by $0.11, primarily due to the low interest rate environment. The change in unrealized gains at December 31st for the fixed income portfolio, net of realized capital gains and losses, increased book value per share by $0.07.
The change in unrealized gains at December 31st for the equity portfolio, net of realized capital gains and losses, increased book value by $1.22. We paid 40 and one quarter cents per share in dividends to shareholders. The net effect was a book value increase of $1.62 during the fourth quarter to $31.16 per share. Adding the dividend, our value creation ratio for the quarter was 6.8%. With that, I'll turn the call back over to Steve.
Thanks, Mike. We have in place a strong foundation, both financially and strategically. We will see better days ahead in terms of company performance. In addition to having the most dedicated associates in the business, we work with the most professional independent agencies in the business. We look forward to strengthening our partnership as we meet with agents at sales meetings across the country over the next four months. We also look forward to meeting in person with many investors and shareholders throughout this year. We appreciate your interest in Cincinnati Financial Corporation. With me today to further discuss our results and outlook are Jack Schiff Jr., Ken Stecher, J.F. Scherer , Eric J. Mathews, Marty Mullen, and Marty Hollenbeck. We are all available to respond. Steve, we're ready to open the call for questions.
At this time, I would like to remind everyone, if you'd like to ask a question, please press star, then the number 1 on your telephone keypad. Again, that's star, then the number 1 if you have a question. Your first question comes from the line of Matt Rohrmann from KBW. Your line is now open.
Morning, Matt.
Gentlemen, good morning. Excellent quarter. Two questions. First, on the development side, obviously, you had detailed in the pre-announcement about the favorable development on the property side.
Then the quarter came in with some excellent results on the casualty side. Just curious, what were the primary drivers of the favorable experience on the casualty side? Was there anything in there in terms of special settlements, or was that just overall trends?
Matt, I think it was overall trend. We tend to look at the full year and you're always going to have variation, but we think we have a very consistent practice. We think it's been consistent over time. We've got reasonable consistency if you look at full years across time. We think the benefits come from a lot of the hard work that our associates and agents are putting in terms of getting rate, knowing more about our risk, all sorts of underwriting initiatives, frontline underwriting by our agents. We think that's been the primary driver.
It seems like workers' comp is heading the way you wanted it, right, Steve?
It sure does. That's one that we're feeling particularly pleased about, and I don't know if J.F. would want to add any more comments because that's been a real team effort there.
Yeah, we've talked a lot about workers' comp in the last couple of years. Between a lot of help from predictive modeling and analytics on the pricing side, much more in the way of specialized loss control activity, and most especially, some of the specialized activity we've had in the claims handling area. We're frankly pretty proud of the improvement we've made this year. It appears that the industry is going to go in the opposite direction this year, and we're confident that we can improve it even beyond what we've done already.
Okay, great. Last question, as you guys travel around the country doing your meetings, I just want to get a sense of how balanced the strength in pricing is. Is it heavy in the Midwest post the storms, property obviously, but just wondering how broad-based that is as you guys meet with different folks across the board.
Matt, we feel it to be fairly broad-based. There's a lot of enthusiasm, a lot of optimism, I think amongst the agency forces, we talk to them. Obviously, every policy's different, every situation's different. We do things on a risk-by-risk basis. The tone I think has been pretty uniformly positive in terms of affirming.
Yeah, I guess I would add a little bit to that. We've only been in Charlotte, Atlanta, and Birmingham so far on our trip, so haven't been out West or in the Midwest, we travel a lot, talk to agencies. Many agencies visit Cincinnati as well. As Steve said, I think there is an acknowledgment universally that price increases are deliverable. Having said that, and you all have acknowledged that in many of your reports, that new business can still be pretty competitive. The, if you will, the finesse that's being used is to raise rates appropriately, particularly when you're dealing with a very good account, one that you do want to retain, you don't want to go to extremes because if it gets to the marketplace, it'll draw attention.
We're not getting at all from any agent you talk to, any sense of a lack of confidence on their part to be talking about rate increases with their policyholders.
Okay, great. Thanks very much, guys.
Hey, Matt, before we let you go, I want to give just a little bit of a refinement on the workers' comp answer, or just a clarification. We talked about it in the press release in terms of Mike and his opening comments about the all other expense reserve. For the year, again, while the calendar year was the same, unaffected in terms of allocating to lines, the workers' comp did benefit by about 11 points on the calendar year by that refinement.
Okay, great. Thanks, Steve.
Thanks, Matt.
Your next question comes from the line of Vincent D'Agostino from Stifel Nicolaus. Your line is now open.
Hi, good morning, thanks for taking my questions. In the press release commentary, you'd mentioned the possibility of writing as much as $5 billion in premiums by 2015. Just a few questions on that with the first thing, how much of that growth do you think could be driven by accepting business that Cincinnati is already quoting on, but just not meeting your profitability hurdles, versus how much of that do you think would need to come from new agents or geographies and accounts? Second, what net written premium to surplus ratio would you anticipate running at if you could reach that $5 billion target? I'm assuming that you could up the leverage a little bit, but just curious if you'd have something in mind.
Yeah. Let me just touch briefly on the elements of it. I think the key point is that we want to grow profitably. That's key. We want to get as much of that growth as from our same agents as we can. We also recognize that we're underserved in certain areas where we're appointing new agents. In terms of the capitalization, we could go up a bit. We're running about 0.8 to 1 in terms of our premium surplus ratio now. We feel confident that as we grow the book profitably, especially when you consider the capital of the holding company, we've got plenty of capital to support all the profitable business our agents can send us.
Okay. I know you just mentioned the impact from work comp on the refinement in the adjusting salaries, but I was curious if you could maybe call that out for personal auto, just because I think that the core underwriting results there looked a little abnormal.
Yeah, Matt, this is Mike Sewell. For the personal auto, the effect was that it increased 8.5 points for the quarter Or for the year, I'm sorry. Just for the year. We had the workers' comp was down. It benefited 11.5 for the year. Personal auto was up 8.5. I did comment that the personal lines, it was up 2.8, but the commercial lines was down 1.0. Overall, when you look at the AOE reserve in total, the net reserve from year to year, it's within $2 million between the two years. It really had a zero effect on total reserves, and it's really just between the lines.
All right. Thank you very much. It was very helpful.
Thanks, Vince.
Your next question comes from the line of Ray Cordella from Macquarie. Your line is now open.
Hey, good morning, guys. Quick question, I guess, on the number of agents you guys appointed during the fourth quarter, 32. How much of a premium do those agents write? I think you had put out a number for the first three quarters. Just curious if those were larger, smaller, relatively similar.
Well, just in the fourth quarter, those agencies would've not contributed a lot to the new business. They're just up and running. Agencies appointed in 2011 wrote $14.9 million. It ramps up two, three, four months after they get on board with us. There is a contribution there.
Okay. Maybe I'm asking the question a little incorrectly, but I think in your presentation, it's about $1.6 billion in the agents you had appointed during 2011 up in the first three quarters. I'm just curious, is that another $400 million of upside potential in premiums you guys could write from those new agencies, or have you not released that number yet?
Well, we do track not only the number of agencies we appoint, but the total standard commercial lines and personal lines premium those agencies write. We average right now about 22% of the personal lines premiums that our agencies write. When we make those appointments, we would think over a period of, let's say, 10 years, that just from those agencies, we could hit that type of mark. Same would be on the commercial line side. After 10 years, we write about 10% of the agency's volume. We would expect that the lift we'll get from making those appointments would be in that range. Nothing that's happened over the last, let's say, five years would discourage us from believing we couldn't have the same kind of penetration in agencies we've been appointing recently.
Okay. That's helpful. I guess, just talking, I think on the last conference call, you guys had talked about the delta between pricing for one-year policies and three-year policies, and how it had expanded a little bit. I'm just curious, one, does the commentary about pricing of low to mid-single digits, does that encompass both one-year and three-year policies? Two, could you guys comment on maybe where the delta is between the one and three-year policies right now or in the fourth quarter?
Well, yes, it does include the one and three-year policies in terms of our averages. We would typically charge somewhere in the range of five percentage points different between a one-year and a three-year policy. Something would be typical right now for a one-year policy would be in the mid-single digits, 4% or 5%. We would go up as high as 8% or 9%, maybe 10% on a three-year policy. The marketplace atmosphere right now is such that our three-year policy's always been a strength, and most especially at a time like this. We're being careful to make sure we're getting a premium for the three-year policy, and our agencies are finding it sellable and very attractive to be able to offer that.
Okay. That's helpful. I guess lastly, just thinking about capital. Obviously 0.8 net worth and premium to surplus, a lot of capital at the holding company, and I know over time, you guys have been able to grow book value given the size of the equity allocation. One, I guess, are you guys comfortable about 25% of equities for your total portfolio? Two, do you guys continue to believe you create more shareholder value by holding that extra capital in equities?
Yeah. Make sure by the end of this I've answered your question. I do believe that we feel comfortable with the 25% in equity. I think as we have growth patterns, as the what is excess capital? The definition may have changed a little bit as we went through the 2008, 2009 period, as we've seen the weather that we've seen. We think for a growing company, it's good to have strong capital. That's been a great thing about Cincinnati Financial over the 60-year history. We've never been constrained by capital to grow. We want to make sure that we have plenty of capital to grow. We want to balance that with returning capital to our shareholders, and we do that, we think, with the dividend. We've increased about for 51 consecutive years now. We repurchased shares in each of the last three quarters.
We're just going to balance it over that period of time and make sure we've got plenty of capital to grow, but also make sure that we're returning capital to our shareholders.
No, that's very thoughtful and helpful. Thank you. Last question, I guess, and I know you guys had talked about the loss adjustment expenses and the change in allocation there. I guess for the fourth quarter, it looked like the accident year loss ratio, excluding catastrophes, was quite a bit lower just for the business overall versus the first three quarters of the year. Your sort of a 930 year to date number. Just curious, was there a true-up with the 2011 accident year going on during the fourth quarter? Or maybe can you talk about some of the thought process in the lower accident year loss ratio?
Well, we think we're getting good improvement in the accident year loss ratio. We do feel we were benefited a little bit by doing the true-up of the AOE during the final calendar quarter. We think probably benefited the accident quarter by about six loss ratio points.
Okay. That's helpful. Thank you.
Thank you.
Your next question comes from the line of Scott Heleniak from RBC Capital Markets. Your line is now open.
Morning, Scott.
Hi, good morning. How are you?
Good.
Just a couple of questions. You gave the $5 billion premium target, and I'm just wondering what you foresee E&S premiums being as part of that $5 billion, and also personal lines roughly. Do you expect the mix to be sort of the same, personal lines versus commercial, and where do you see E&S fitting in there?
Scott, this is J.F. I'll give you a rundown on what we're projecting in the commercial lines area. We're looking at about $3.4 billion in personal lines, about $1.2 billion.
CSU, our excess surplus lines subsidiary, we're targeting about $160 million. In life insurance, $290 million. Those are our goals.
Great. That's helpful. The next question I had was just on, you guys have talked a lot this year, the past several quarters, about predictive modeling. I know you've put a lot of effort into that. Just wondering, is that completely rolled out fully to most of the lines that you want, or is there more room for that in 2012 in the next couple of years?
Well, on the workers' comp side, it's fully rolled out. We've been using it now for almost two years. On the commercial line side, it's in the process. In other words, our entire book of business has been modeled, but we're coming up on renewals for all of that. We still have a ways to go for all of our renewals to have received the contribution of the insight that the model is going to give us. It's in process right now. It's going, we think, very well. One indicator that we'd like to see is that, there was a question earlier about whether or not we can grow to these levels profitably, writing the new business that will be required. The model is showing that the new business that we're writing has drastically improved.
By virtue of having the model and running the prospective new business through the model, we're seeing that the projected loss ratios on new business are actually very good. In addition to agencies being particularly careful with us when they first put business with us after a recent appointment, we have the benefit of the model helping us in that particular area. In all areas, both renewal and in new business, we're seeing a tremendous benefit from the model. It will continue to be refined. We'll be coming out with the next generation of our workers' comp model. As you all know, it's a process. The model is not a stationary target, but it's worked out very well for us.
Scott, I might just add a little more about the personal lines as well, and that it has gone through three rate revisions, three annual rate revisions now. It's really gaining traction. We've got plans for a fourth. In addition to getting more rate, we feel we're getting on the personal line side as well as the commercial, the rate where it's needed. We feel pretty positive about the rate increase and really the shift in the mix of our book towards what we feel to be better risk characteristics.
Okay. Along those lines a little bit, as far as new business, what's the differential between the price increases you're seeing on renewal versus new? Is there any class, geography in particular, you're pulling back more because the pricing is a lot more competitive? I know you kind of alluded to workers' comp a little bit, but is that where most of that is coming from?
Scott, I'll address the question on the differential between new and renewal. As J.F. mentioned, we're getting rate adequacy in both areas, but we don't have a, at least with a, say, split between how much more adequate or inadequate new versus renewal might be. For that part of the question.
I would say in terms of where we are getting the new business, as was mentioned in the release, we are getting a lift from the new appointments that we have made. That is the reason why we are growing in new business. Agencies that were appointed 2009 and previous, they were actually down a bit. That is a commentary on the fact that new business still remains fairly competitive. Just by way of a description of the fourth quarter, on a direct basis, our casualty premiums were up 3.7%, our property premiums were up 4.3%, commercial auto was up 2.5%. This is all new business. Workers' comp was down nearly 30%. We do not view that as an alarming amount, but it is a reflection on the conservatism that we are approaching comp. I would say as much as anything, we are pretty satisfied with the flow of new business, the advances we are getting.
It is still competitive, but we are confident that how we are pricing what we end up writing is we are in a better position right now than we would have been a year ago.
Good details. Thanks.
As a reminder, if you would like to ask a question, please press star then the number 1 on your telephone keypad. Your next question comes from the line of Paul Newsome with Sandler O'Neill. Your line is now open.
Good morning, folks. I was hoping you might be able to help us get a better sense of the effective tax rate going forward. It's been jumping around a little bit. Anything you can do to help us there?
Yeah, I think Mike comment a bit, the main thing is just the mix between our underwriting profit and our investment income. We've got a variety of tax rates. Underwriting is taxed at 35%, our gains are taxed at 35%, with our dividends received deduction and municipal bonds, we've got varying tax rates there. Mike might have a little more color on that. I think it's the variation in where the earnings are coming from and what the tax rate is for that particular bucket.
You're exactly right, Steve. Paul, this is Mike Sewell. When you think about the effective tax rate, when we take our pre-tax, GAAP book income at 35%, with it being a little bit lower this year than the prior year, which was about $500 million versus $176 million this year. By the time you take the tax-exempt interest and your dividends received deduction out, it ends up bringing you down to a pretty low number. When you calculate that, we're at 5.61% effective tax rate in the current year compared to 24.7% in the prior year. Had our earnings from operations been higher, we would have ended up with a more consistent effective tax rate.
Should we be thinking about tax rate in the 24%-25%, 26% range that you historically have had?
If we're at the normal levels for our operating earnings, yes. Really, when you look at it, Paul Newsome, the two drivers that's going to drive that down is the tax-exempt interest and the dividends received deduction. It's your operating earnings that's really going to be driving at the 35% rate.
Terrific. Thank you.
Thank you, Paul Newsome.
Your next question comes from the line of Ian Gutterman from Adage Capital. Your line is now open.
Hi, good morning, guys. I guess first, can I get a little clarification on the AOE? I think I follow what's going on, but I'm not quite sure. For example, the 11-point improvement in workers' comp, was that a one-time catch-up and 2012 won't include that? Or will 2012 have a workers' comp combined ratio, all else equal, 11 points better than I would have thought a quarter ago?
Yeah, that was really a refinement that just occurred. That's not going to be reoccurring each and every year. That 11.5 was really just the one time. On a go-forward basis, things will look normal. The other, if I look at this commercial product, some of the other ones were a little smaller fluctuations. Commercial property was to the benefit of a 3.5. Commercial casualty was up 2% because of it. On the personal line side, homeowners got a benefit of 1.6%.
Great. That's very helpful. Thank you. Also, the reinsurance renewal, again, I want to clarify on that. You said your ceded premium will be less in 2012 than 2011. Was that because of the reinstatement paid in 2011, or was that apples to apples?
That's correct. That's because of the reinstatement premium. That's why we wanted to give two years. We're up about 8% from where we were two years ago. I think we did a good job. We looked at having had the largest two catastrophe losses in the history of the company. The new RMS 11 model has higher estimates for us. We thought it prudent and conservative to add another $100 million to the top of our layer. We also raised our retention up to $75 million. I think one of the positive is if you look at it, and I don't even like to talk about it, but if you would have a $600 million event, we estimate that would only be about 3% of our surplus with this new program where it would have been 4% of our surplus before.
We think we've strengthened our balance sheet, our risk profile by adding that extra $100 million. I think we'll pay about $10 million more for the expanded program.
Okay, great. It sounds like if I take out the extra limit you bought on a sort of rate online basis, your price actually didn't really move too much. It sounds like the 10% increase is essentially just for the extra limit.
That, we did touch that layer of 100X of 100, and we got some rate increase there. It's a layer we hadn't touched before, and we hit it last year with both events and in 2008 with Hurricane Ike. We did have rate increase on apples-to-apples on some of the existing limits.
Okay. Were there any changes in terms, any restrictions on what's covered?
No, I think we were very stable there.
Just my last one, I guess, is a request as much as a question, but you mentioned obviously trying to get to $5 billion and obviously get there in the right way. Maybe in a future call, you can give us a combined ratio target to go with that?
We tend to not be real granular in Guidance, but we think that we need to be in the 95%-100% combined ratio in terms of where we're going to be as we grow.
Right. I just want to make sure we're thinking below 100. That's all I wanted to hear. Thank you.
Definitely.
Your next question comes from the line of Joshua Shanker with Deutsche Bank. Your line is now open.
Good morning, everyone.
Good morning, Josh.
I want to know a little bit about individual lines and reserving policies. There's a lot of movements going on in the reserve depending on what segment I'm looking at. Maybe you can go into, is there a chief actuary directing it? Are there various independent actuaries in each segment? How are we getting so much movement in various directions going on?
Josh, this is Steve. We are consistent. This is actuarial best estimate recommendations. We think that there's been consistency across time in terms of the methodology and the way we go about our reserving. We have a reserve committee and definitely consistent over time. We have outside actuaries that also look at our reserves. I think what added the volatility here in the fourth quarter is this all other expense refinement that we made in this quarter. I think basically what drove it is, we saw some of the catastrophe losses where we would have a big reserve go up. As we looked at the way it was being allocated, and we talked to our claims people in terms of where they were actually spending the time, it was indicating that we needed to refine how we allocated the all other expense.
Our actuaries came up with a methodology that leans a little bit more on claim counts, also in terms of interviewing the claims people. That's the change. In total for the calendar year, it was not an impact at all, and again, we think we've got very consistent procedures and controls from our actuarial department.
Please interrupt me if I'm saying something incorrectly here. On property, because you reserve very heavily for the significant claims, and you found out claims count or claim severity was not as aggressive as you initially intended. There was a significant reserve release based on claims, offset slightly by allocating more AOE to those property lines?
Well-
That AOE was taken away from the casualty . I'm trying to figure out exactly how all the moving pieces are working there.
We understand. It's a little bit noisy here this quarter. You're right, we did have favorable development on the actual estimates of these catastrophe losses. That is also consistent with our history. As we sit here near Nashville, I remember the first estimate on the Nashville floods is getting close to 2 years ago now. I think we estimated about $35 million for that, and it came in mid-20s when it was finally settled. We are seeing favorable development. I think it's a strength or a tribute to our claims people, and that we settled over 31,000 claims with our own people. I think by getting boots on the ground, getting them out there and getting them settled quickly, we were able to bring them in under. That's kind of a separate issue.
We benefited the quarter by about three loss ratio points there. Totally separate issue had to do with just how we allocate the all other expense, and that was a refinement as Mike's described here in the fourth quarter.
Yeah. In a catastrophe-heavy year, why would the AOE rise in the casualty lines?
I don't think that the AOE necessarily did rise in the casualty lines. In other words, workers' comp, it actually went down some in this.
Yeah.
I think you've got it.
Josh, when you look at the AOE, the incurred for the calendar year ratio, there was no change between the two years. It was 6.3% for each year. Again, it's just the allocation between the individual lines.
Understood. Completely unrelated, in a rising stock market like we've been having for the last, say, 15 weeks, does this give you an opportunity to take some profits on certain high dividend yielding stocks to reallocate into some that didn't meet the threshold? What's going on in allocation among equities?
Josh, it's Marty Hollenbeck. We haven't dramatically changed. The big run-up in equities the last few months really has largely just offset the decline in the third quarter of last year. In our type of stocks, the high-quality dividend growers generally underperformed, certainly in 2009 and to a lesser degree in 2010. We think there's a little more room to run. We like, as Steve mentioned earlier, the allocation to equities and the type of stocks we buy, not just for the long-term growth potentials but as income vehicles in a low interest rate environment. Had we not had the allocation we have to the type of stocks we buy, we would have showed a decline in investment income, both for the quarter and the year. Certainly the dividend increases have carried the day for us on the income front and investment income front.
Okay. Thank you. Congratulations on the quarter. If I can suggest in the 10-Q or 10-K, please hold our hands through all these reserving changes. You always give us great information. I expect you to do so again.
Yeah, we will have that.
All right. Thank you very much.
Thanks, Josh.
Your next question comes from the line of Ray Cordella from Macquarie. Your line is now open.
My follow-up on the reinsurance program was asked, so thank you.
Okay. Thanks, Ray.
Your next question comes from the line of Fred Nelson from Crowell & Weedon. Your line is now open.
Hello, Fred.
Hey, guys. It's a great conference call. I feel like I was watching the Super Bowl when Clint Eastwood said, "The players are in their locker room. It's halftime, and when they come out, wake up America, because there's going to be some big changes with a positive coming." I really appreciate the greatness that you gentlemen and ladies do and all of the team effort to do this. The question that I keep having coming to me in my little business world is, if you're an insurance company and premiums are sold for checks and money comes in an interest rate environment of basically zero, what do you do with that money to protect so that you don't have a disaster with a money market fund or a bank failure?
Where does the money go in the short term, it doesn't bring one iota of income back?
Well, Fred, we, sort of like a lot of folks in the fall of 2008, took notice of what happened with the money markets. We're very cautious to spread that around and not have big concentrations. The fact that cash yields nothing is literally unavoidable these days. We have to be very careful, and we have not increased our risk profile in any attempt to chase yield or return. We're very cautious out there, and we do spread it around.
You can't increase your allocation to equities that pay 4% or 5% and do have the preset parameters. You're kind of meeting that parameter right now and the maximum?
I wouldn't term it that way, Fred. No, we've got some room.
Yeah. Good. That's important to hear because people ask me that. Thank you again, gentlemen.
Thank you, Fred. Thanks for your comments.
Yeah.
There are no further questions at this time. I'll turn it back over to Steve Johnston.
Thanks, Steve, thanks to all of you for joining us today, and we'll look forward to speaking to you again in the first quarter call.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.