Good morning, and welcome, ladies and gentlemen, to the RLI Corp first quarter earnings teleconference. At this time, I would 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 question and answers after the presentation. Before we get started, let me remind everyone that through the course of this 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 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 first 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 Jacoby. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI earnings call for the first quarter of 2016. Joining me on today's call are Jon Michael, Chairman and CEO; Craig Kliethermes, President and Chief Operating Officer; and Thomas Brown, 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. I feel a bit like a broken record with these opening comments, which speaks to our consistency, but nonetheless, we are pleased to report a good start to the year with these first quarter results. Starting with the combined ratio, we achieved an 88 in the quarter, modestly better than last year. Underwriting income was positively impacted from favorable loss reserve development, in this case, $11 million coming out of the casualty segment. As a reminder, during the first quarter, we do not perform a full actuarial loss reserve study. Total gross written premiums was up 3% in the quarter. Casualty, our largest segment, turned in an impressive 9% growth rate on the strength of a number of different products, including some recent product launches. Surety was up 7%, continuing a very nice run of growth over the last several years.
Property, however, was down 13%. Excluding the discontinued crop and facultative reinsurance business that we previously reported, the segment was down 7%, which is attributable mostly to continued soft market conditions in catastrophe-exposed areas. Each segment turned in attractive combined ratios, casualty at a 92, property at an 84, and surety at an 80 combined ratio. Again, a pretty good result, leading to the aforementioned 88 overall combined ratio. Turning to investments, the first quarter was a good one with a 3.2% total return. Our equity portfolio was a strong contributor. It was up 5.7%, a result helped by our overweight in utility stocks. The bond portfolio also posted a positive total return, up 2.6% in the quarter.
Although pre-tax investment income was down a slight 1%, it was actually up 0.6% on an after-tax basis as our allocation to municipal bonds increased compared to the same period last year. With regard to our minority investments, Maui Jim turned in slightly lower earnings. While net sales continued to grow modestly, foreign exchange impacts and a ramp-up in marketing expenditures served to depress earnings slightly. Our other minority investment in Prime Insurance was basically flat in the quarter compared to first quarter of 2015. All in all, with strong underwriting and investment performance driving our results, book value per share was up 7% in the first quarter, inclusive of dividends. Now with that, I'll turn the call over to Craig Kliethermes. Craig?
Thanks, Tom, good morning, everyone. As Tom mentioned, we're off to a very solid start to 2016. Gross and net written premium growth both up 3%. Removing the impact of crop and the facultative reinsurance business that we exited last year, we were up 5%. Our core portfolio is on a good trajectory in a challenging market. At the same time, we were able to deliver another sub-90 combined ratio quarter. It is not getting easier, but there are still opportunities for the skilled fishermen who know where to cast their line. Let me provide some more detail by segment. In casualty, gross written premium was up 9% in the quarter and posted a 92 combined ratio. We continue to find opportunities both in our established products and within many that we have started in the last several years.
Our excess liability, transportation, and package businesses continue to grow at a double-digit pace. Transportation and excess liability continue to be a supply-side phenomenon, with many companies suffering very poor results and retrenching or pulling MGA contracts. Most of our package growth has come from expansion of distribution and share of wallet initiatives. The opportunities are not across the board. There are differences both geographically and within subclass. In this market, it takes seasoned underwriting and outstanding claim people to differentiate selection, pick the right spots, and weather the storm. We continue to invest in new people and new products across our casualty segment. We are working hard to get more products online and to scale. Rate increases are very difficult to come by. We see casualty rates as flat overall, we continue to see positive rate on most wheels-based business and in smaller account professional liability space.
We are having to give back a fair amount of rate in primary general liability and larger D&O risk to remain competitive. Our property segment was down 13% while reporting an 84 combined ratio. As Tom mentioned, after taking out the impact of exited products, we were still down 7%. A lot of this is price driven, as we see rates in cat-exposed businesses continue to slide at a double-digit pace. Rate levels are about 60% of what they were in 2013 for cat business. We've lost out on many accounts as rates we believe to be priced at or below expected loss cost. The margins in this business have gotten much thinner. Declining reinsurance rates and a better spread of risk have helped us take some of the pressure off our returns in the bottom line.
This is not a growth business for us until the underlying economics change. Meanwhile, we will continue to provide capacity to our best accounts and brokers where we still have an opportunity to make a profit. Also putting pressure on the top line for the quarter was marine and our recreational vehicle products. We have been able to achieve some positive rate in both of these businesses, but growth has been elusive as a result. The declining top line in property has caused some deterioration in the margins and resulted in higher expense ratios for this segment. Our surety segment continues to grow profitably. We were up 7% in premium and posted an 80 combined ratio. Our long-term presence, relationships, and consistent predictable risk appetite are a big advantage for us in this segment. Surety was led by our miscellaneous product, which grew at a double-digit pace.
These are typically very small bonds where ease of doing business is a critical differentiator. On the larger surety risks, we see an abundance of less refined competition. Although results have been good for the industry, we see storms on the horizon for those who view this as loss-free business. Surety is very specialized. Hope and luck are not a good long-term strategy. The odds will eventually catch up with those offering up loose credit and other terms. Our narrow and deep surety expertise and hallmark discipline should serve us well in the short and long term. Overall, we had a very solid quarter. I want to thank and congratulate the RLI associates for being different. Their drive, their discipline, and our diversified portfolio of products delivered again this quarter. I'll turn it back to Aaron, who will open it up for questions.
Thanks, Craig. We can now open the call 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 was received. Please stand by for your first question. Our first question comes from Arash Soleimani of KBW.
Thanks. Good morning. A couple of questions here. I know you said the growth within casualty, part of that was from some new products. Can you talk about did any of that growth come from new teams that you were able to bring on from any of the industry fallout?
Yes. This is Craig Kliethermes, Arash. We've added probably about a half a dozen products or so that have generated premium to date. A few of those have been smaller teams or smaller, mostly individuals, as opposed to teams that have started up products whether it be in healthcare, miscellaneous professional, in our D&O space. We've added quite a few in our E&S space, we really haven't gotten those products up online quite yet.
Okay. My next question, in terms of, you said you're getting rate in wheels-based business, which you've said in the past. Can you just clarify, are you getting more rate there than you think you would, I guess, actuarially need because the industry is in pain as raising rates, that kind of paves the way for you to get more than you would otherwise need? Is that a fair way to look at it?
I think it's both. I think there are some places where we are getting rate where it is needed, and I think that's probably true of a good part of the industry because I know the commercial auto and personal auto space, and particularly you guys all have seen results have not been that good. Some of that rate is needed, and then I think we've also found some opportunity where rate was, I'll say, just available or available to us in a specialized niche. I'd say that's probably more true of our transportation business for us in particular.
Okay. All right. Thanks for the answers and congrats on the quarter.
Thank you.
We'll go next to Randy Binner of FBR & Co..
Hey, thanks. I have a question about commercial auto and kind of how industry reserve trends are coming along. Our view, kind of statutory data, which isolates commercial auto as a class, is that it seems like reserve development continues to be poor through accident year 2014. I guess my question is commercial auto ever going to get better? This is a really long time to see a class have poor performance. I know you've done better, and I'm asking the question in a way to understand kind of how continuous this opportunity might be for you all. Are you feeling like rate adequacy is better in accident year 2013 and 2014 than it was in 2010 to 2012? Or is it just as bad now as it was before?
Randy, this is Craig again. I think that we would say, and our underwriters would say that, during 2011, 2012, 2013, maybe a lot of our competitors lost their way in regards to price.
Right.
They dropped price to either maintain market share or to grow market share. At that time, at least in the early part of those years, we were pretty steadfast in regards to what we were willing to charge for a given risk. We weren't growing much in the 2011, 2012 timeframe, and we have been able to take opportunity in 2013, 2014, 2015. In regards to current price adequacy, I think, again, it varies risk by risk, and I'll say class by class. In the classes that we particularly participate in transportation, we feel good about at least certainly the risks that are in our portfolio, that they're priced well. There's still a lot more room, we think, out there for pricing action in that space.
Do you think is competition more rational in kind of 2014, 2015 than they were in, call it 2011 to 2013?
Well, I think it's definitely more rational because we have people either exiting, leaving, pulling MGA contracts or getting substantial price. I think the people in the transportation space, particularly in public transportation space, a lot of people, their results have been very poor. I think they're not fooling themselves anymore, and they're getting significant price, probably double-digit increases, and they're willing to let the business walk away. Now they're letting the business walk away if they're not able to get the price.
Now we're in the kind of that pain trade, and this happens in the industry. What inning would you say that pain trade is in, where people are abandoning books or significantly increasing price? Where do you think that process is on an inning basis?
It's difficult for us to say. We hope it's going to continue for a while.
Okay.
Because it'll create an opportunity for us.
It just seems like the reserve data is not getting as better as I would've thought it was. On property, you mentioned significant competition, and I think I ask this question a lot on these calls. Can you characterize where that competition's coming from? Is it kind of new alternative providers, or is it more just your brand name guys just continuing to be more competitive on property?
A lot of it is the same competitors that we've had in the past. It's just that they've backed it with alternative capital, or they've backed it with reinsurers who are laying it off to alternative capital and willing to take a lower return. The one thing we have seen more recently, which is even more concerning, I think, is we've even started seeing some packaging within the E&S space of the cat risk and liability risk. We knew this was happening, and it happens quite frequently in the admitted space when we run into admitted competition. Now we've seen a few on the E&S side starting to package the liability and the cat risk as a package.
Wait, just to be clear there, they package?
Well, they're offering both coverages, yeah.
Package all that's in non-admitted, or is it someone who they
Yeah
a non-admitted piece with an admitted piece?
It's both. They're doing it through an MGA, the MGA might have admitted paper as well, but they're selling both products to the same customer base.
Basically, leakage into the non-admitted space is happening.
Right.
All right. Yeah, I'll leave it there. Thanks a lot for the answers.
We'll go next to Mark Dwelle of RBC Capital Markets.
Yeah, good morning. Thanks for your question. Not to make this into the transportation call, but that's kind of where I had my questions as well. Are you able to be a little bit more specific in terms of rate improvement across some of the different subcategories of wheels-based business, which to say trucking versus delivery versus taxis and limos, et cetera?
Well, we don't write a lot of that stuff, so ours is very specialized. We're seeing rate pretty much across the board in that space.
Just, I guess in terms of what size business do you guys typically write there? What sort of limits are kind of in the middle of your wheelhouse?
For transportation, typically, we prefer to write the million dollar primary, but we write excess as well, up to $5 million-$6 million, I believe, for a bus. Most trucks buy $2 million worth of coverage.
Right.
There's both a primary policy and usually some type of umbrella or excess policy attached to it.
Okay. When you were referring to, at the beginning, growth in both excess liability as well as transportation, when you put that growth together, is that both of those things together kind of in the same transportation category, or are you seeing growth in the excess business apart from transportation?
Apart from transportation. Obviously, we're seeing growth in the excess liability for the transportation segment as well as the primary, but we also sell an excess liability product in our E&S space that's mostly for contractors that continues to find opportunity.
Okay. I guess the last question in that. I mean, obviously, we know the number of the kind of higher profile exits from the transportation space. Are you seeing any new entrants that you've not seen as much in the past, or people with improved appetites, apart from yourselves, that are trying to take up some of the opportunity there? I'm not asking for names, I'm just asking for market color.
Right. We always see competition, and new people that come in that think they can be smarter than the last guy that lost money because they think the rates are a little better. I think you need to be a specialist in that space to make money across all markets. We see a lot of people that can fool themselves. I can't tell you why in wheels-based business, because it's not a particularly long tail line for casualty, so it comes back to bite people fairly quickly. For some reason, people continuously, they get burned, they get out for a brief period of time, and then their MGA finds a new market, or we'll find a new entrant to compete with, unfortunately.
Okay. I appreciate the color. Thank you.
That is star one for questions, and we'll go next to Mike Zaremski of Balyasny .
Hey, good morning. Just one question on the property segment's expense ratio. If I recall correctly, part of the step-up in the ratio last year was due to crop coming off the books. This quarter, it increased again, stepped up again to about 45%. You talked about the competitive environment. You also talked about some FAC that was not renewed. Just trying to get a sense if this is the appropriate near-term step-up in the ratio, or if you're taking some actions to offset it.
Mike, good morning. It's Tom Brown. Yeah, your memory's correct from last quarter. We still do have a carryover effect of crop. As we said earlier, between the crop and the FAC, that was about half of the decline in the premium for the quarter. Obviously, those had lower expense ratios. The other, I think as we said last meeting or consistent with last call, was we've kind of gotten entrenched. We like the business, we like our underwriters, and if and when that market turns, as Craig was talking about, we want to be in a vantage point where we can capitalize on that and maintain that. Said differently, you don't want to be going hiring underwriters to miss the opportunity.
Okay. Got it. The crop and FAC, will that stop impacting the year-over-year premium numbers next quarter? Because I thought the crop had ended. It was just a year-over-year.
As we said before, we thought we'd have $8 million-$10 million of crop, and we're currently at about $2 million into it in the first quarter.
Okay.
We'll see this running through the next couple of quarters. FAC will trickle in a little more evenly over that timeframe.
Okay. Thank you very much.
You're welcome.
We'll go next to Jeff Schmitt of William Blair.
Hi. Good morning, everyone.
Good morning.
It looks like other comprehensive income of around $22 million was driven by the equity returns. Did I hear that right? You had said that it was driven by utilities. What portion of the portfolio is that? Was there anything else that drove that?
Two things. Yeah, Jeff, you're right. Equities had a pretty significant uptick. Obviously, the first two months of the quarter were not so good, as we all know. March turned around for the quarter. As a component of that, it was the utility sector helped form that. Fixed income also had a pretty good run, with the decline in interest rates. All in, the two drivers would be the fixed income as well as the equity coupled with the earnings for the quarter.
Right. Okay. Could you maybe speak just kind of broadly to your philosophy around equity allocation? It looks like equities made up more than 50% of book value in 2013. That's ticked down to 45%. How do you think about it? Do you think about it relative to book or relative to total investments? Do you have a target over time?
Yeah, Jeff, we do. As we said before, it is relative to book. Like you said, it's in the neighborhood of about 50% of equity. If you look at the overall allocation of the investment portfolio, historically, it's been about 80% fixed income, 20% equities. That'll vary between mid to upper teens to low 20% for the equities. It is a very value-oriented strategy with a kind of a leaning towards dividend-paying positions. Obviously, with the value-oriented strategies being a little more in favor in Q1, certainly benefited.
Right. Okay. Thank you.
You're welcome.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you all for joining us this quarter. It was another good quarter for us. 88 combined, 3% top-line growth. In this market, I'd call that good. Our underwriters, as Craig said, they're good fishermen. We'll expect to continue to be disciplined as we move forward in this market. Thanks again. We'll talk to you again next quarter.
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