Good morning, welcome, ladies and gentlemen, to the RLI Corp.'s second 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 up the conference 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 Securities and Exchange Commission that contains a press release announcing second 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 of Corporate Development, Mr. Aaron Diefenthaler. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI earnings call for the second quarter of 2017. 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?
Thank you, Aaron, good morning, everyone. Last night, we reported $0.61 of operating earnings per share on the strength of an 89.3% combined ratio. The theme for the quarter across each segment was one of excellent combined ratios, all well below 100%, with headwinds to the top line. The 4% decline in gross written premium reflects our disciplined underwriting culture, where we have curtailed or exited lines where performance has not measured up. Our casualty segment, which makes up two-thirds of our premium, turned in a 93% combined ratio. There are a couple of key stories in casualty. First, transportation was down meaningfully in terms of premium, off $15 million, or 40% versus the second quarter of 2016. This was driven by prudent underwriting decisions in the wake of recent industry challenges in commercial auto lines.
The rest of the casualty segment performed well, up 12% versus last year on the strength of both mature and newer products. In the quarter, we experienced net favorable development of $10 million across multiple product lines, notably including a small amount of net favorable development in transportation. Our property segment had similar dynamics as casualty, with premium down, yet producing an attractive combined ratio. In this case, the property segment's gross premium is off 10%, but this was primarily driven by the previously discussed withdrawals from the RV and treaty reinsurance business. Absent this impact, the property segment's gross premium would've been up 2% compared to last year, driven largely by our marine line. Property segment faced the quarter with a 92 combined ratio and stands at 83 for the first six months of the year. Lastly, our surety segment also followed the trends noted in casualty and property.
On the one hand, quarterly premium was off 9% due to continued competitive market conditions. On the other hand, the 73 combined ratio continues a long-term trend of outstanding underwriting results. Contributing to the combined ratio during the quarter was $2.5 million of favorable loss reserve development. Turning to investments, there were no major changes to the portfolio in the quarter. Allocations, duration, credit quality, and yield were all fairly stable. Notably, investment income was up slightly in the quarter by 1.5% after nine consecutive quarterly declines. This growth in income was enhanced by positive total returns in both our equity and bond portfolios on both a quarter and year-to-date basis. Additionally, our two equity method investees, Maui Jim and Prime, performed well with a combined 31% increase when compared to the second quarter of 2016.
Strong underwriting investment results drove book value growth of 8% inclusive of dividends for the first half of the year. One last item to point out. Our tax rate dipped down to 23% in the quarter. This decline was heavily influenced by the tax benefits on share-based plans, the accounting for which changed in 2017. The new treatment records this benefit as a reduction to tax expense rather than directly to equity in 2016 and prior. Higher than normal levels of share activity, most notably on deferred compensation distributions, reduced the quarterly estimated tax rate by eight percentage points and the year-to-date rate by five points. With that, I'll turn the call over to Craig for further discussion on the operating results. Craig?
Thanks, Tom. Good morning, everybody. As Tom mentioned, we posted an 89 combined ratio while top line was down 4%. Although the decline in revenue is not what we want, it is a good result given some of the headwinds we faced. RLI is synonymous with underwriting discipline, and that means you address underperforming areas decisively while growing and nurturing those niches that have the most promise. That's exactly what we have done. We began exiting our property treaty and recreational vehicle businesses at the beginning of the year and are taking a more conservative approach to our transportation business. That leads to some unfavorable year-over-year revenue comparisons. Excluding our discontinued businesses, top line is relatively flat for the quarter and the year.
If we look past the impact from transportation as well, the top line on our remaining portfolio is up mid-single digits for the year and the quarter. We are seeing pockets of opportunity and continue to deliver very good underwriting results while we prune and fix what needs mending. Let me provide some more detail by segment. In casualty, we were down 1% on the top line while reporting a 93 combined ratio. Excluding transportation, gross premium is up 12% for the quarter. That growth is being driven by both established and newer products. Our E&S casualty business grew 14% for the quarter and is up 5% for the year. We have expanded our specialty footprint by adding several new products in the last two years, including healthcare, energy liability, and binding authority businesses.
In addition, we continue to find ways to grow our core primary and excess liability products in this space. We are also seeing opportunities in our specialty admitted businesses with new products added in our management liability division, as well as the specialty package businesses we continue to invest in. One product that did not grow in casualty was transportation, where premium was off about 40% for the quarter. This decline is reflective of the repositioning and re-underwriting efforts in the commercial and public sectors. Our underwriters, who have retired from the worst-performing classes in the most challenging jurisdictions, are also aggressively pursuing rate increases, which are up over 10%. We continue to reprice the more marginal risks across the portfolio and separate ourselves from those that are beyond repair.
We believe we have momentum and have gained the confidence to retain the most desirable business while assertively getting an adequate price. This should drive improved performance in these sectors as premiums are earned. From a trucking standpoint, competition remains significant, which has led to the loss of some larger accounts to competitors. We are known for our consistent underwriting appetite and will continue to maintain discipline by focusing on our most profitable relationships and avoid risks that are clearly underpriced. Overall, casualty results are flat with the exception of transportation, non-medical professional liability, where we continue to get rate increases in excess of loss cost inflation. I'm pleased to report that all major casualty products, including transportation, reported an underwriting profit for the quarter. On to property, which was down 10% top line for the quarter while reporting a 92% combined ratio.
Excluding discontinued businesses of RV and treaty, we were up 2% for the quarter and flat year to date. Rates on catastrophe business continue to be down double digits. Overall, our E&S property business was down 3% for the quarter on the top line as we continue to focus on picking our spots and diversifying our portfolio further. The growth in our marine business has helped keep our core premium in this segment relatively flat, and they are still finding ways to get small positive rate increases. Despite some storm activity and a sizable fire loss this quarter, we posted positive underwriting earnings for the quarter while reporting an 83 combined ratio for the year. In surety, we reported a combined ratio of 73% for the quarter, while top line was down 9%.
Our premium is off 4% year to date, which is more in line with expectations in this market. The timing of bonding requests and releases, as well as the purposeful retirement from a few large accounts and programs, drove the bigger shortfall in the quarter. Meanwhile, we had very good underwriting results reported across all four major products in surety, which has led to a 68 combined ratio year to date. Competition in commercial surety is very challenging. Lower rates and less disciplined standards for extending credit and indemnification continue to be more commonplace. We are keeping our powder dry, waiting on a more rational market to reappear. Meanwhile, we are doubling down on our marketing efforts with existing and new relationships while we are investing in technology and ease of doing business. We think our cautious approach in this frothy market is the most prudent path.
Overall, we reported another solid quarter. We have added several new products that have momentum, and we continue to find ways to tap our unrealized potential and widen moats on our more established products. In a soft market, you must know your niches, and our knowledge is narrow and deeper than most. In our largely diversified product portfolio, we see both pockets of opportunity and also some places that require us to pause and take corrective action. We have a low tolerance for underperforming products, and we certainly have demonstrated this by addressing the few we have swiftly and without regard for top line, all the while singularly focused on maximizing underwriting profit. This underwriting discipline is what our investors have come to expect of us and is what we expect of ourselves as owners.
I want to thank all of our owner associates for their hard work and commitment to the long-term success of RLI, and I'll turn it back to Aaron, who I think will open up for questions.
Great. Thanks, Craig. Operator, we can now open the phone for questions.
Thank you, sir. The question and answer session will begin at this time. If you're 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's received. Please stand by for your first question, which comes from Randy Binner.
I have a couple just in casualty. I guess the first is, with transportation down 40%, I'm presuming that it's continued reaction to severe losses in commercial auto. If that is what's driving it, is that right? Any color you can give on that? Is it mostly trial bar driven, or what exactly is continuing to drive that experience?
Randy, this is Craig. As you know, the industry saw a spike in loss ratios. I'll say, if you go back all the way back to 2009 to 2011, I think the industry loss ratios spiked about 20 points. I think in retrospect, we would say that also happened to us, fortunately from a lower base. It was mostly severity driven. I think you were asking that question. For us, it was severity driven. I think other people saw frequency, and I think that was part of the reason it was a little longer delay for us to realize that, since severity is not quite as easy to see as claim count spiking. We've actually started re-underwriting effort long before third quarter of last year, probably the first part of last year, because we started seeing just a slight elevation in loss ratios.
We've been working at this for a little while. I'd say that the deepest part of it, we're probably entering the midway through the third quarter of this effort. We're looking hard at all of our business in realization of the higher severity that we saw.
Okay. It's got a decent amount of tail to it. On the E&S casualty comments, healthcare, energy, and some other areas, I guess, what is it that's making that part of the market work? Is it smaller case? Is it more sensitive to a better economy? What's making that piece of the market work for you all?
Sure. Yeah. It's a little bit of mix. One, we've added some new teams of people, and their relationships with some brokers. These tend to be a little smaller risks, in, I'll say, the energy and some of the other spaces. Some of it is rounding out our portfolio so that we have a broader product portfolio to offer to the same client. I'd say in the healthcare space that we're seeing opportunities is really, there has been some retrenchment in the healthcare space for facilities. We've seen less competition in that space.
That's great. Thanks a lot.
Our next question comes from the line of Arash Soleimani.
Thanks. Good morning. I just wanted to follow up a bit on the, I guess, some of the severity comments you were making. Last quarter, you had also mentioned that loss cost inflation is picking up slightly, you said, within the broader commercial casualty landscape. I wanted to know if you could, I guess, provide updated thoughts on that comment from last quarter.
Arash, this is Craig. We continue to see, I think, an increase in severity across casualty lines. I think it's much more pronounced in the transportation space. We have not seen it bleed over too much into the, let's say, general liability space. It's a much more active plaintiffs' bar. I think there's certain areas that they're always pretty good at finding spots, popping up cottage industries in certain places where they find weaknesses. I think it's a little more pronounced with maybe some juries that are a little more willing to listen to that side of the argument.
Okay. Would you say that the way you've been reserving them lately is a bit more cautious than it may have been a year ago at this time? Is that a fair statement, just given, I guess, what you're seeing with-
Well, Arash, again, we always are cautious, I would say. We're going to continue to be, some would say, conservative in the way that we approach reserves. Certainly, I'll say in the transportation space, in the auto related space, probably more there than other places. Where we see it, certainly we're going to take a conservative view.
Okay.
I believe we're. Go ahead.
You go. Sorry.
No, I had nothing really to add. Go ahead, Arash.
All right. Thanks. My other question was just on the core loss ratio. Those were up year-over-year in each of the three segments. I just wanted to get your comments around that and how we should be thinking about that metric across the book.
Yeah, Arash, it's Tom Brown. They are up slightly, to your point, if you compare it to the second quarter of last year. I think we're dealing with ±1%. It's hard to read a lot into that. I would say that our mix has changed slightly. Property's down considerably. We have, I think, Craig, you mentioned the one large claim that we had during the quarter as well. That has an impact on the current year.
Certainly on the casualty side, on the auto related products, we are taking a little more conservative view to where we're booking the accident year, which I think is prudent.
Right.
You mentioned, I think Tom also just mentioned the one large claim. Can you remind me what that was?
We had a large fire loss. It happened to be a recycler near the end of the quarter. It was large. For us, we don't have too many big losses. For on net basis, it's a couple million dollars.
Okay. That was in the property segment?
It was, yes.
All right. Perfect. All right. Thank you very much for the answers.
Thank you.
Our next question comes from Jeff Schmitt.
Hi. I think most of my questions were answered, but just on the tax rate, you'd mentioned the benefits here and how the change and how the share base plans are accounted for. What's the impact on that run rate going forward? Do you have a sense on an annual basis, let's say?
Jeff, it's Tom Brown. Thanks for the question. It's hard, as you recall, when this new accounting pronouncement was released, there was a lot written that this was going to create volatility in the effective tax rate. That's exactly what we have here. As I said earlier, it was 8% for the quarter, 5% for the first six months. It's going to be in the 1%-2% on a more normalized basis. Again, you could have these spikes just simply by the function of a stock option, say an outsized stock option exercise or the deferred compensation plans where somebody takes a distribution. I think it's pretty true to form with what was written about this new pronouncement when it came out.
Okay. You think 1-2 points lower going forward on an annual basis than what
Yeah.
What it was in the past.
I would go back to historically, we're in the 28%-31% range, give or take, where we are with underwriting profits, coupled with the mix of municipal tax-exempt bonds in the portfolio.
Having said that, you could get volatility on a more normalized basis of 1-2 points, depending again on how much is exercised or distributed. This was a pretty outsized distribution in the quarter.
Okay. I don't know if you touched on this, but the policy acquisition cost or that ratio was down, lowest it's been in a few years. Was there anything in particular that drove that?
I would just say mix on that, Jeff.
Okay. Thank you.
Thank you.
We'll go to Mark Dwelle.
Yeah, good morning. Most of my main questions have been covered, could you talk through the decline in surety premiums? That was definitely steeper. I know you've been kind of commenting of price competition there for a while, but that was a pretty sharp turnaround in the quarter.
Sure, Mark, this is Craig. I think I said in my remarks, but there is some timing between some particular larger bonds that we bound last year and also some releases on bonds. When those releases come, sometimes it comes with return premium. Also, I think we've taken a little more cautious approach, particularly in the commercial surety space, as I mentioned. I think it is very competitive there, and particularly in regards to rates, but also in regards to terms and conditions. I just think we're going to be a little more conservative there because I think that it's very competitive.
Okay.
We did lose a program. Go ahead. We'd also miscellaneous surety program as well, that was actually by our choice, that was actually another maybe $1 million of reduction in the top line for the quarter.
Okay. To the extent of the timing differences, is that something there's a portion of this that effectively should, I would suppose, get picked back up in the third quarter? Was the timing the other direction, which is to say it renewed in the first quarter instead of the second quarter? You see what I'm getting at?
Yeah. Obviously, I really can't speak to the future necessarily, what's going to happen next quarter or the quarter after that. I could just say that these would be outliers a little bit for this quarter per se.
Okay. That's fine. I think that's all my questions. Thank you.
We'll take a follow-up question from Arash Soleimani.
Thanks. I just wanted on the expense ratios, they were down in both casualty and surety by a decent amount. I just wanted to see if there was anything in particular driving that.
Let me break that down a bit, Arash. Casualty could be mix again. With surety, I think they've been focused on efficiencies. It's down about 2%, I think, year-over-year in the quarter. That also could be driven largely by the mix. The miscellaneous surety carries a much higher policy acquisition cost than the other three, the energy commercial contracts, so that can have an influence on it. I would give credit where credit's due, and they've done a good job of looking at some efficiency in their processes on that. Casualty, I guess I would probably attribute a little bit to the mix. You didn't ask about property. Property's up. We've talked about that in the past. It's up because of the top line has declined rather significantly.
While we've taken some efficiency measures, we're slow to let go of people because as you all know, once that market turns, it's hard to find those people in the market. We are hanging on to our talent for the time being.
Okay, great. Thank you so much.
You're welcome.
If there are no further questions, I would now turn the conference back over to Mr. Jonathan Michael.
Thank you all for attending. Another good quarter, 89+ combined ratio for the quarter. We're pleased with that. We're pleased with some of the underwriting decisions we've made on transportation and other lines. We do have some momentum on some of the newer things that we've put in place in the last couple of years. Thanks again for attending. We'll talk to you again next quarter.
Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 with an ID number of 9167582. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.