Good morning, and welcome, ladies and gentlemen, to the RLI Corp. third quarter earnings teleconference. At this time, I'd like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors, which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including in the annual Form 10-K, which should be reviewed carefully. The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing third quarter results.
RLI management may make reference during the call to operating earnings and earnings per share from operations which are non-GAAP measures of financial results. RLI's operating earnings and earnings per share from operations consist of net earnings after the elimination of after-tax realized investment gains or losses. RLI's management believes this measure is useful in gauging core operating performance across reporting periods but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available at the company's website at www.rlicorp.com. I will now turn the conference over to RLI's Vice President, Corporate Development, Mr. Aaron Diefenthaler. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI earnings call for the third quarter of 2018. Joining me on today's call are Jonathan Michael, Chairman and CEO, Craig Kliethermes, President and Chief Operating Officer, and Tom Brown, Senior Vice President and Chief Financial Officer. I'm going to turn the call over to Tom first to give some brief opening comments on the quarter's financial results. Craig will talk about operations and market conditions. Next, we'll open the call to questions, and John will finish up with some closing comments. Tom?
Thanks, Aaron, and good morning, everyone. Last night we reported operating earnings of $0.46 per share. Other key figures were our top line growth of 8%, a combined ratio of 96, and investment income growth of 15%. I would like to highlight a few events and trends driving these numbers. First, from a top-line perspective, our growth was driven by products across our portfolio. Our casualty segment was up 9%, property was up 14%, and surety was roughly flat due to competitive pressures in energy and commercial. However, miscellaneous exhibited positive growth as a result of recent technology investments. We believe that our broad-based growth is a testament to our diversified business model. Craig will go into further detail on some products trends in a minute.
In the quarter, Hurricane Florence had a $6 million net impact, which was the equivalent of $0.11 per share or three combined ratio points on an overall basis. Hurricane Michael is obviously a fourth quarter event, it's too soon to discuss the financial impact. Also impacting the quarter was $10 million of net favorable reserve development on prior accident years, with each of our segments benefiting. Product contributions were fairly broad-based, with notable amounts from our umbrella products, general liability, professional liability, marine, as well as modest reductions to prior year catastrophe reserves. While the net reserve benefit was down on a quarter-only basis, from a year-to-date perspective, favorable development increased underwriting income by $35 million in 2018 compared to last year's $32 million benefit. Despite the Florence impact, our Property segment turned in a 93 combined ratio.
Surety continued to shine with a 76 combined ratio, our Casualty segment reported a 101.5 combined ratio. We have spoken quite a bit in the past about the cautious approach we apply in our reserving practices when it comes to newer products, as well as longer tail lines exhibiting sizable growth. This is noticeable in the Casualty segment, where we have realized double-digit growth during the past four quarters. Investment income remained a strong contributor to earnings in the quarter. It was up 15% in the quarter compared to the third quarter of 2017 on a pre-tax basis. Our healthy operating cash flow, which stands at $163 million year to date, and growing investment asset base allows us to continue putting new money to work in a higher yield environment without sacrificing credit quality.
Equity and earnings for Maui Jim and Prime were down modestly compared to the third quarter of 2017, but still a meaningful contributor to our overall operating earnings. Through three quarters this year, we stand at a 93 combined ratio with 11% top-line growth. These are numbers to be proud of and they signal the strength of our franchise. With that, I'll turn it over to Craig. Craig?
Thanks, Tom. Good morning, everyone. As Tom mentioned, we were able to report another quarter of profitable growth despite the impact of Hurricane Florence. Overall, we grew the top line 8.5%, slightly off the pace of more recent quarters. Growth continues to be driven by a combination of newer products gaining scale, underlying rate increases in select products, and organic growth in exposures. We have invested in technology to improve ease of doing business and increase sales and marketing efforts to broaden relationships and awareness of our products. This has paid off as we continue to see growth across most of the products in our portfolio. Our consistent underwriting appetite and deep knowledge in our chosen markets provide a safe harbor to our distribution partners and customers from the irrational behavior of many competitors in the marketplace. I will provide a little more detail by segment.
In casualty, we grew top line 9% for the quarter while reporting a small underwriting loss. The underwriting loss is largely driven by our prudent approach to booking faster-growing, newer, or long-tailed products. Many of the newer products that we have grown are in the casualty segment and include energy liabilities, small account binding authority, cyber liability, and our reinsurance relationship with Prime. Reported losses for these newer products have been at or below our loss expectations, but it is still too early to definitively declare success. These products make up about 15% of our casualty premium and about half of the growth year-to-date. Elsewhere in casualty, both our commercial and personal umbrella businesses continue to grow at double-digit rates for the quarter and the year while generating underwriting profits. We have achieved about 5% rate increase in these products for the year.
Our professional liability unit, which focuses on design and miscellaneous professionals, turned in very good underwriting results and continued to grow modestly, up 3% for the quarter. Top line for transportation, while up 8% year-to-date, was down 10% for the quarter, resulting from the loss of a couple of large accounts. We are still upbeat about the opportunities given our deep knowledge and long track record of success. We continue to achieve meaningful rate increases with rates up 8% in this business for the quarter. Our underwriters will remain disciplined and be selective as opportunities arise. In property, we grew 14% for the quarter and reported a 93 combined ratio despite a 16-point impact from Hurricane Florence. Growth continues across all of our major products in this segment.
New business submissions are up in excess of 10% and the market continues to come to us as a reaction to more recent catastrophe activity, as well as the pain being felt in the London market. Our wind rates were up about 6% for the quarter, while earthquake rates were closer to flat. From a rate level perspective, we expect that the devastating impact of last week's Hurricane Michael will keep a floor under the current pricing environment. From a focus perspective, our number one priority is to help our affected customers get back on their feet as quickly as possible, and those efforts are already underway. Our surety segment was effectively flat on the top line while reporting a 76 combined ratio for the quarter. We are still achieving some growth in our transactional surety businesses, while the larger account-driven business remains much more competitive.
The improved economy has moderately increased demand for bonds, but we are still challenged by the excess capacity being put to work in this segment. We are continuing to invest in technology, marketing, and the customer experience as ways to widen our moat and add even more value to the deep customer and distribution relationships we have in surety. Overall, a respectable quarter given a few headwinds. Market conditions remain relatively stable with a few pockets where we can get rate in excess of loss cost. On a year-to-date basis, premium is up 11% on a 93 combined ratio, a testament to our underwriting and the strength and diversification of our product portfolio. We will continue to stay focused on the things we can control and take advantage of the opportunities as they arise. Our standard for excellence is very high at RLI.
Our associates embrace the challenges we face because we are different, because we are disciplined, and because we are owners. RLI will remain focused on our founding principles of acquiring great talent, sharing rewards, empowering an underwriting culture, and providing exceptional customer service. Results will follow. Thank you. I'll now turn it back to Aaron, who will open up for questions.
Thanks, Craig. We can now open the call up for Q&A.
Thank you, sir. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your telephone. If you wish to withdraw your question, please press star two. Your question will be taken in the order that it is received. Please stand by for your first question. Our first question will come from Randy Binner with B. Riley FBR.
Hey, good morning. Thanks. I had a couple. The first is on casualty. Craig, you mentioned that you have some newer products in energy, some small account, and cyber among others, and that was half the year-to-date growth, and so you're being prudent there. Is that prudence what drove the underlying loss ratio or the accident year loss pick higher in that segment, in the casualty segment? On a linked quarter basis, it's up about 2.5%, which probably stands out to people. It's actually down year-over-year. Is it those activities that's doing it or is it more on the transportation side?
Randy, this is Craig. Transportation, I don't think we've changed our booking ratios for over about a year, it's not necessarily transportation. Yes, a lot of that growth is coming from those products that we tend to book a little higher starting out. We don't really have a track record in some of those. We do the best we can at looking at industry results and people's past track records to try to figure out where to set the initial booking ratio. A lot of that growth, as I mentioned, about half of our growth in casualty came out of those products.
As you look forward, would you kind of expect similar levels of growth in those areas?
I can't predict the future. They're not at scale yet, I would predict further growth. As with any growth trajectory, these products have not been around, they've been around for a couple of years, these aren't products we started this year. You're going to see a typical growth trajectory over the first two or three years where you grow at a pretty rapid pace, and then things start to plateau a bit. Not flat, but the rate of growth starts to slow. We would expect the rates of growth on some of these products to start to slow over the next couple of years, I would expect.
Jumping to just on transportation, you mentioned you're getting an 8% rate across the book. Is there any way for you to characterize the rate difference that the two accounts you lost got at their renewal versus what you had wanted?
I couldn't tell you the specifics of those. We would typically price every account at a level that we would be comfortable, someone clearly came in underneath us. Usually, we don't lose accounts, just so you know, by a small amount. Our customer service and our knowledge in that space, our claims handling, I think people were willing to pay a difference in that space for us. People are not beating us by 5%, 10%, even 15%. A lot of times, when we lose those accounts, we lose them by 20%, 25%.
All right.
It's not one carrier. It's multiple competition in that space.
All right. Thank you.
We'll now take our next question from C. Gregory Peters with KBW.
Yes. Hi, good morning, gentlemen.
Morning.
My first question's on the premium growth mix. How much of the property and casualty growth is rates versus exposure? Where are you seeing the largest opportunities in casualty right now?
Christopher, this is Craig. I would say, now this is overall, not just in casualty, but overall, probably about a quarter, 25% or so, 20%-25% is from rate increases. Overall, a third or so of the overall business is new products growth and new exposures in new products. The remaining part is growth in exposures of products we've been in for quite some time.
Okay. Got it. That's very helpful. I have a second question just on the interplay between your core loss ratio trends and reserve development year-over-year. If I look across each segment, core loss ratio is improving year-over-year, but then reserve releases are down. I get part of this can be mix, but I'm thinking if reserve redundancies are getting thinner because you're increasing your loss picks, then why wouldn't we see that in higher core loss ratio picks? All else equal.
Chris, I'll answer this question, then Tom might want to jump in. Our information would indicate our releases have been bigger than they have been year-to-date. Certainly for the quarter, it was a lower release than it was last year this quarter. In aggregate, I think we're ahead of where we were last year.
Chris, yeah, right. I think Craig talked at the tail end of it. For the year-to-date, it is up, as I mentioned earlier, at a $35 million year-to-date in 2018 compared to $32 million year-to-date last year. I do think, back to Craig's point, we are cautious on some of those newer products as well as the longer tail excess type products as well, as they've shown some growth.
Got it. Is that why we're seeing the lower core loss ratios year-over-year, is because you guys are switching the book more to excess? Like raising where you guys attach on the loss?
Christopher, I don't think that's necessarily true. We have seen some growth in our commercial and personal umbrella products, as I mentioned before. I don't think that growth is really necessarily outpacing our overall growth in casualty. There's no conscious effort to try to move to a higher attachment point or anything like that for our book of business.
Okay. Got it. Very helpful. Can we get some color on what's driving the large tax benefit this quarter, and then how should we think about that going forward?
Yeah, Chris, it's Tom Brown. The tax benefit obviously starts with the tax reform from last year, which brought it down to 21%. As we've had a little less underwriting income, that's going to have an effect because of some of the tax preference items.
We did have on the tax preference items, as you get a benefit from some of the exercise of options has reduced it. Really, comparatively speaking, we got about $0.01 of impact in the third quarter on results of tax reform. I think if I recall correctly, it's about $0.13 for the nine months year to date.
Okay. Great. Just one final one, if I may. As we go into the fourth quarter, how should we be thinking about a special dividend, especially given how strong you guys have been growing in property and casualty lines? Will the dividend be lower year-over-year because you guys are going to need more capital to capitalize on the opportunities that you're seeing in the market?
Like before, our preference is to use our capital. If we have excess capital that we can't deploy, we'll pay a special dividend, and that's all we're going to say about that at this time.
Okay, got it. Is there an underwriting leverage that you're targeting specifically, I guess, just as your mix shifts or-
It depends on the mix and what our expectations are. No. The answer is no.
Okay. Great. Well, thanks for all the answers. Best of luck the rest of the year.
Thank you.
We'll now take questions from Jeff Schmitt with William Blair.
Hi, good morning, everyone. Question on the commercial casualty underlying loss ratio. Looks to be about 70%. Other than last year, if you go historically, it looks to be under 65%. That just seems like a big increase just for what's going on with some of those newer products and the conservative approach there. Now, I know you'd spoken in the past about some negative legal trends. Is there any more you can say about that or anything you're seeing on that front?
Jeff, this is Craig. We are still seeing growth in aggregate or year to date in transportation, which is one we did obviously have a few challenges a couple of years back. We continue to be cautious there, in light of what we saw a couple of years ago. We think we're out in front of it. We've gotten a lot of rates since then. We've done a lot of re-underwriting. Trends have been good so far, we're more of a wait and see attitude in regards to that. The other product that I mentioned I think we grew, is our commercial umbrella and our personal umbrella. Those are excess businesses that I think someone asked previously about.
Those have longer tails, although early returns have been very favorable, given some of the trends we saw in transportation, not that we've seen those come to light in any of the other liability lines, we're going to be a little cautious there. We typically book those fairly conservatively or at least at a higher booking ratio.
Okay. On the transportation book, I know you'd said, I think in the past quarter or two, that it was pretty close to profitability. Rate increases continue at a pretty high rate. Is it achieved profitability yet, or what is your outlook for that?
Right now, we believe it's making a small underwriting profit. We're hopeful. I think our underwriters believe it's better than that. Like I said, we're going to take a wait and see attitude. If our underwriters didn't think they were making money, they have zero incentive to grow it, and they wouldn't. I think we have pretty good checks and balances there, I think we feel pretty good about where we're headed there. Certainly, the rate of 8%, we think that's ahead of loss cost trends there. Regardless of where the starting point is, there should be some improvement in whatever margin we have there.
Mm-hmm. Okay. Thank you.
Once again, it is star one to ask a question. We'll go next to Mark Dwelle with RBC Capital Markets.
Yeah, good morning. My esteemed colleagues have taken several pounds at this, but I'm going to ask a couple more on commercial casualty. Can you just clarify the loss ratio in the quarter? Was there anything in the quarter that was maybe top up of prior quarter loss picks or prior quarter reserving at all, or is it all confined to the loss picks you're taking just for this quarter?
Mark, this is Craig again. There's been no material change to any of those loss ratios over the quarter or even, I don't even think for the whole year. There's been some mix changes, obviously, because the products people grow where they see the opportunities, and those vary quarter-to-quarter and account by account. We have not made any substantial change to any of those ratios. A lot of that has to be explained by mix.
Okay. Appreciate that. Second question related to the reserve releases in the quarter. Obviously, they were favorable for all the lines on an aggregate basis. Were there any meaningful reserve additions embedded within any of those net releases?
Mark, it's Tom Brown. Every quarter, every year, we're going to have some ups and some downs, but nothing of a meaningful nature that was unfavorable.
Okay, thanks. I guess two other questions that are kind of catastrophe-ish related. First, I guess on Florence, how did the losses that you experienced there compare to maybe what you would have expected for a loss of that magnitude or nature? Were you a little better or a little worse? I felt like it was a little better, but I'm certainly interested in your view.
Well, Mark, storm by storm changes a lot. Each one is unique. We viewed that one as more of a rain and water event. The construction in North Carolina and South Carolina, as we knew, was not nearly the same construction as you get in Florida, so you had some roofs peel back and then the water get in and you had some water damage to the properties. The losses overall, I think they were where we thought and about of the size that we would expect given the size of that storm and how long it stalled out over the area.
Right. Okay. Obviously it's early on Hurricane Michael, but I guess I would be interested in your impression. We've seen a range of industry losses put out from $4 billion-$10 billion. Do you have any sense, across that sort of range, whether it's a little on the lower end or a little on the higher end, at least from your perspective?
Mark, it's very difficult for us to estimate an industry event when we're such a small player relative to the whole industry. I would hesitate to guess. We have had over 35 claims come in so far, but they are where we would expect. There's not really been any surprises. It was a very strong storm. I think some people view that as a remote area, but I think that on the west side of the storm, there was probably more damage than you would typically think because that's supposed to be the weaker side of the storm. That's where Panama City and Panama City Beach are, and there's a lot of resorts and hotels, condos, and things like that there. I think there's certainly some damage there.
Among the claims you've seen so far, are most of them primarily in coastal-ish areas, or are you getting much in the way of claims further inland up in Georgia, the Carolinas, Virginia?
I will tell you, we've had one in Georgia. That's as far north as one's been reported yet. That doesn't mean you're not going to have more. It's still early. It's only been eight days. It's very early.
I get it. I'm just trying to get a sense of what you've seen so far. I appreciate it. It's way too early for anybody to know.
Most have been coastal in the Panama City and Panama City Beach area so far. Mexico Beach was not a particularly large town, so commercially.
Okay. I appreciate the call. Thanks very much.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you again for joining us. Good quarter, 8.5% growth in the top line, combined ratio of 96, which included the effect of Florence. Florence and Michael are reminders of what we're in this business for and demonstrate the value of the insurance industry in getting businesses back in business and homeowners back in their homes. We're proud of the part that we play in supporting that effort, for sure. We've got people on the ground there in both areas, adjusting claims and getting people back in business and back in their homes. Thank you, and we'll talk to you again next quarter.
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