Good morning, and welcome, ladies and gentlemen, to the RLI Corp. Third 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 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 of 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 2014. Joining me on today's call are John Michael Chairman and CEO; Mike Stone, President and Chief Operating Officer; Tom Brown, Vice President and Chief Financial Officer; and Craig Kliethermes, Executive Vice President, Operations. I'm going to turn the call over to Tom first to give some brief opening comments on the quarter's financial results. Mike and 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. We are pleased to announce another good quarter on the strength of our underwriting results and continued growth in investment income. Starting with our most important metric, we posted an 83 combined ratio in the quarter, which is consistent with our year-to-date combined ratio of 84. Underwriting profits were strong in each segment, with the casualty and property segments both coming in at an 86 combined ratio, while Surety reported an impressive 67. Consistent with prior quarters, reserve releases had a positive impact stemming from both Casualty and Surety segments. Catastrophe results were nominal in the quarter, with the American Canyon earthquake impacting operating earnings per share by less than $0.01. Again, this quarter, the numbers attest to our underwriting discipline.
On the premium side, gross premium was up 3%, and net premium was up 8%, both growth rates consistent with year-to-date performance as well. Each of our segments experienced growth in the quarter, and we're particularly pleased to see 6% growth in Surety premium because it represents our lowest combined ratio segment and also one with continued competitive pressures. All in all, this quarter's growth was consistent with our expectations and market conditions as well as our ongoing emphasis on underwriting profitability. Craig and Mike will elaborate more on market conditions in a moment. Turning to investments, growth in investment income remains a positive contributor, up 4.4% in the quarter and 6.2% year to date. Although we have been able to maintain average yields on a larger invested asset base in recent quarters, we are acutely aware that we are faced with a challenging current yield environment.
On a total return basis, fixed income effectively earned its coupon in the quarter, returning 0.6%. Equities, however, were down over the quarter, posting a negative 1.1% return. Investee earnings contributed favorably to results in the quarter with $2.9 million of investee earnings, up 14% from last year. This increase is primarily attributable to our investment in Maui Jim. In total, the combination of underwriting and investment results drove operating earnings per share of $0.68 in the quarter, which when combined with the first two quarters, drove a strong 12% growth in book value year to date. I will now turn over the discussion to Mike Stone. Mike?
Tom, thank you. Good morning, everybody. Another excellent underwriting results again this quarter. It's a testament to our discipline, our underwriting discipline, and our product diversification. As Tom indicated, 83 combined ratio for the quarter, 84 year to date. Gross written premium up 3%, but net was up 8% due to better reinsurance terms that we've obtained throughout the year. In our casualty business, gross written premium was up 3%. Our professional liability and package business continues to grow out its footprint and now is up and admitted in all 50 states. Gross written premium up some 27% in this space. In our commercial umbrella business, gross written premium was up 8%, the growth rate is slowing, and some competition has reentered this space. We're still seeing a little bit of rate in this space as well. Transportation was down 27% due to competitive pressures.
We were up some 50% in the third quarter last year. Again, the industry has a short memory. Only a few quarters back, much pain was being felt in this space. We'll see what happens next. medical professional liability, also very competitive, with gross written premiums down 27% in the quarter. In our largest product, general liability, our primary liability surplus lines business was up some 2% for the quarter, and we're still seeing basically flat rates in this space. Overall, casualty rates basically flat overall, up some 1% in the quarter. Still a good story, but casualty becoming less robust.
In our property segment, gross written premium up 2%. In the catastrophe business, that's wind and quake. We're seeing burgeoning competition from standard companies, surplus lines companies, alternative capital, and we saw catastrophe wind rates down some 10% for the quarter and quake down some 6%. This space will continue to be challenging through year-end. With another benign, nearly non-existent U.S. catastrophe quarter, along with increased capital allocation to this space will continue to drive rates south. RLI has deep producer relationships, experienced innovative frontline underwriters, and long-time excellent reinsurance partners. We'll continue to perform well in this product arena. In our RV, recreational vehicle business, which is reflected in this segment, experienced an increase in physical damage claims throughout the year, resulting in an increase in reserves of some $2 million. We are actively raising rates and vigorously re-underwriting this product. Our marine business continues to improve.
While gross written premium was down some 13% year-to-date and 4% for the quarter, they were essentially break even. We'll take the applause now. We're still pushing rates some up 5% in the quarter. Our surety business, as Tom indicated, a good story here. Gross written premium up 6% in the quarter, 3% year-to-date. combined ratio 67 in the quarter and 70 year-to-date. Surety results reflect some 20% increase in gross written premium in our account-driven commercial surety, and both miscellaneous and our transactional surety business and contract surety business were up as well. While our energy business was down some 10% and some 15% year-to-date, we continue to see heightened competition in this space and significant new competition in energy surety arena. Just a word to the wise, we have 30-plus years of deep underwriting expertise in the energy surety area. It's not a space for generalists or neophytes.
Overall, another excellent underwriting quarter, a testament to our RLI associates who perform yeoman work in deteriorating insurance market environment. We're well-positioned with a diverse product portfolio, superior underwriting, and support talent to outperform the competition. Craig will now discuss our crop and reinsurance issues.
Thank you, Mike. I did want to hit on the ceded reinsurance. We don't actually place any significant treaties this quarter, in the third quarter. However, I did want to comment a little bit on the net written premium growth relative to the gross written premium. I've seen some notes and comments about what were the drivers, and I want to set that record straight. First and foremost, the risk-adjusted reinsurance prices have decreased 10%-20% across our entire portfolio, and that has been the main driver of the net premium growth. We've also had product mix changes. It continues to evolve for us with heavier weighting in the transactional space where we cede less because we need less capacity. We've also added about $7.5 million year-to-date premium from Prime Insurance, which we take all net.
Lastly, but it seems to be the lead, what I've seen and read is that we have taken in a few select spots, we've increased our retention, but that is not a major driver for us. We did take a little bit bigger retentions in places where we've reached scale, and the underwriting has warranted it. Overall, we're preparing for 2015 right now, where we still see an abundance of reinsurance capacity. On the crop front, year-over-year premium is relatively flat during the quarter. We did increase the loss ratio a couple points on MPCI to reflect lower commodity prices overall. We expect bountiful yields to offset lower prices, but we also expect the net impact of these movements to fall right about at a farmer's typical deductible. There will be some claims, and we felt that the loss ratio adjustment at this time is the correct cautionary move.
As you know, our partner ProAg Acuna announced a recent change in ownership. In late September, we were given notice of cancellation on the assumed crop program effective at year-end 2015. The provisions of our contract permit us to retain a 2% quota share on the ProAg portfolio for the 2015 crop year. Expectations should be that our gross written premium will be down approximately 80% on a gross basis and 70% on a net written premium basis in 2015. We've enjoyed the partnership with ProAg. HCC has acquired a very good team. As we feel we have learned a lot about the ag space over the last several years, we plan to continue to look for other opportunities in this space. I'll turn it back over to Aaron.
Thanks, Craig. Operator, we can now open the call up for questions.
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 was received. Please stand by for your first question. Our first question today comes from Arash Soleimani with KBW Investments.
Hi, thank you. Just a couple quick questions. First, given the increased competition that you're noting, that you're seeing, is it fair to say, or are you seeing specialty risk return to standard market again, or has that not played out?
This is Mike Stone. Yeah, we're seeing a little bit of that. There's considerable competition in the surplus line space, and at this stage in the cycle, we start to see a little bit of the standard lines companies come in. They're in there. It's just probably a little bit increase in this space at this time, particularly in the property area.
Okay, great. Can you just, in terms of the ProAg, I think you said it was at year-end 2015, the relationship ends. Can you just quantify that one more time in terms of the impact to your gross written?
We'd expect the gross written premium and net written premium to be $8 million-$10 million next year.
$8 million-$10 million down?
No, $8 million-$10 million gross and net to us.
Oh, okay.
That's about 80% down on a gross basis and about 70% down on a net basis.
Okay, perfect. Thank you.
Our next question comes from Randy Binner with FBR.
Hi. Good morning. Thank you. I think these questions are for Mike, but the first one is just in the excess & surplus lines area. You mentioned that you were up, I think, 2% on net, but the rates were flat. I assume competition's pretty stiff, but where are you seeing the macro economy for that segment? Meaning, we see E&S more usually impacted by a better economy, more small business formation, hiring, et cetera. What's your feel broadly in that segment, how that's driving premium, in addition to the impact of competition from other insurers?
I think we said that it's basically flat, and our net base is up a little bit for the E&S space. Certainly as the economy improves and we see more economic activity, and we are seeing that in the construction space, where we have quite a bit of our business through general liability and commercial umbrella. We see some improvement there, no question about that. The problems that we see are the standard lines companies packaging up business, and increased competition from other surplus lines players. Net-net, we're still holding our own. It's still a pretty good marketplace. It feels a little worse than it did a quarter ago and a little worse than two quarters ago. Trend is not in the right direction. It's still, like I said, still pretty good. We've got rate for the last couple of years.
If it stays flat for a while, that would be a good thing.
Great. On the energy piece of it, in particular, energy prices are dropping, the price of oil, I guess, most notably. Do you see an immediate impact in that when you're talking about, and I'm sorry, this is over to energy surety, but is that something that comes through immediately? Does that affect the kind of the demand for surety on new projects, or is that more of a lagging impact?
Well, yeah, it is in the surety arena. We're not in the energy property or energy liability business directly.
Right.
In the surety side, yeah, it has an impact. Certainly, it has an impact on one of the underwriting aspects of this is the assets. It's the oil in the ground. As that gets less valuable, we have less effective collateral. You'll see less drilling activity, which drives this business as well. Yeah, it has an impact. Our premiums are down there. That's one of the reasons, but a bigger reason is we see more competition in that space.
Okay. Just one other just detailed question on the recreational vehicle property damage claims. Is that an issue of kind of normal loss trend or typical loss trend versus too soft a price, or was there particular events that caused that?
Well, we would say both. Certainly, we believe in retrospect the pricing was inadequate, and we've actually already filed and obtained rate increases in almost all 50 states. We actually started that process about three or four months ago to get those. As you know, as admitted business, it takes a little while to go through the regulatory process, but we have approval in those states. It has been more of an increased frequency. We've had a few severe losses, one-off type things, not necessarily weather related, but arson related that were unusual. We've kind of pointed out a certain distribution channel that's been a problem for us. We're trying to address that by shutting off that volume.
Okay. Would the increased frequency just be attributed to a better economy and more baby boomers out on the road with their RVs? Is it just kind of more use and targets out there, or what do you think drove the frequency?
Yes. Also during the summer months, you always get an increase in frequency. Yes, we would attribute it to that.
Also, Randy, it's a fairly small book in our overall property segment. We just wanted to point out the fact that that was one of the reasons that maybe our combined ratio was a little bit higher than you would expect given what's happened in the catastrophe arena this year.
Oh, yeah. Understood. It wasn't an area that maybe I missed any RV stuff, but I just hadn't seen it. Even, obviously RVs drive more in the summer, but even on a seasonally adjusted basis, your frequency was higher, just to be clear on that, right?
Yes.
Okay, got it. All right. Thanks a lot, everyone. I appreciate it.
Our next question comes from Ken Billingsley with Compass Point.
Good morning. I wanted to ask two questions. One, get a confirmation. When you talked about the ceded reinsurance business, I believe you gave a number that pricing within reinsurance costs had declined 10%-20%, was that correct?
This is Craig. Yes, that's correct.
Now when I look at the retention ratio in general, it's the highest it's been in the last two, three years. You said that you didn't have any new treaties renew this quarter. Could you maybe just walk through why you're seeing a bigger benefit now than you have maybe in the prior quarters?
Well, if you think about that, if your retentions remain stable and the amount of premium you see drops by 10%-20%, that's going to lead to obviously a higher retention ratio. Then, as I had mentioned, products like Mike mentioned, our professional liability business, which is more transactional, we just don't need the capacity. We're only putting out million, $2 million dollar limits, so we don't buy as much reinsurance there. Those products are actually growing, okay? Some of our other products where we utilize reinsurance a little more heavily, our D&O business, our umbrella business, they're more flat for the year. You're getting a mix, kind of an underlying mix issue that's being driven by our products that use reinsurance less expensively.
This 10%-20% decline, though, that was still in place for the last two quarters then as well. It just didn't have as big of an impact.
Yes. Some of our treaties were placed during the second quarter, you wouldn't have started to see that come through till the end of the second quarter or maybe third quarter.
Okay. It was the second quarter event. Okay. The other question I have, just last one, was on pricing. Your premium on net basis obviously is growing. How is that growing in relation to rate versus expanded customers? From a customer base, is it new or existing customers that are maybe increasing exposure?
Ken, this is Craig again. Let's see. On the pricing part, on a net basis, overall the pricing is slightly up. As Mike said, say zero to +3% on average across our portfolio, it's less than it used to be, we are seeing some increase there. As far as new customer or expanding up share of wallet kind of concept of with selling more to the existing product base, that's happening as well, obviously, because a lot of our growth is coming in the professional liability segment where we're trying to offer a property and casualty package at the same time we offer a professional package. We're seeing an increased take-up rate on existing customers, and of course there are some new customers in there too, but it's probably a half and half, I would say, across our portfolio.
I have one more question, if you don't mind. I just want to talk about, I believe Mike had mentioned the benign cat season so far, which maybe it just reflects on you, but we've already seen two companies today or yesterday report surprising higher major and non-major cat losses. Can you talk about maybe what you're seeing maybe is a little different than maybe what's been experienced at, say, Allstate or Platinum?
That's Mike Stone again, Ken. I didn't listen to their calls. I didn't read their results, so I don't know what drove that. Certainly, we had next to nothing when it comes to the, call it the American Canyon earthquake, that thing in Napa. While we have a business in Hawaii, there was very little loss from that hurricane. We haven't seen any other events in this quarter. It's been, from our perspective, nearly non-existent.
Okay. The current hurricane that's headed towards Hawaii, any cause for concern on your book?
It's a hurricane that's headed to Hawaii, so we'll pay attention to it. Our book in Hawaii is not that large. We'll pay attention. We're prepared. Our retention is such, we'll be fine. Hawaii really hasn't been hit very hard for some 30 years, I think. It's a little bitty speck out in a very big ocean, by the way.
Sure. You have reinsurance coverage that would limit if it were to be impacted fully?
Yeah. We have reinsurance coverage, and we have catastrophe coverage that'd be part of that. If it's a large hurricane, we'll have a loss, but it's well within our expectations. Not a great big deal.
Great. Thank you for taking my questions.
Our next question comes from Mark Dwelle with RBC Capital Markets.
Yeah, good morning. A couple just kind of clarifications, really. In the surety segment, if I'm understanding your comments, essentially you described almost all of the lines being positive except for energy, which was negative. Is that a fair characterization?
Yeah. From a premium standpoint, yes.
Okay. How is that different from last quarter, where the tone of your comments seemed to be, I'll say, more generally negative across the entire book?
Well, I think the last quarter-
How is this quarter different?
Well, this quarter we had a really good premium quarter for commercial umbrella for our account driven license and permit business. That can be a little variable. It's not that big, so if we get on a few accounts or we get a few accounts that are actually using the capacity that we provide, our premium will jump up a bit. Certainly, the contract's been fairly flat, our miscellaneous business is fairly
It's just basically an annuity. It just kind of up a little bit each quarter as we grow out that business. The one that's been under pressure has been the energy surety business for the last nine months, for all of this year. It continues to be under a bit of pressure.
There's not really a major rate impact to the growth in the quarter.
No
It's really just straight business.
Yeah. Typically, surety business, the rate's fairly steady. Where you see the change is on terms and conditions around collateral and indemnities and that kind of stuff.
Okay. Same question. On the crop business, that's all recorded as premium within the Property Segment. Is that correct?
That's correct.
Okay. Then within the investment portfolio, any particular changes in where new money investment is heading there? Or do you continue to?
Mark, good morning. It's Tom Brown. Reinvestment's primarily gone into fixed income during the quarter. The allocation between fixed income and equities remains pretty consistent with the historic ratios of 80/20. 20% equities.
Any change in the mix heading towards municipals?
Municipals are down slightly from year-end in the mix. We did, I think, move a little bit into higher yield bank type loans. Small portfolio, about $40-plus million.
Okay.
Within the fixed income complement.
Okay. Thanks for that. Those are my questions then.
You're welcome. Thank you.
Our next question comes from Jeff Schmitt with William Blair.
Hi, good morning. Just on the investment yield, just a quick question on, could you speak a little bit about the duration of the fixed income portfolio and sort of how it's trended and where you see that going?
Sure. Happy to, Jeff. It's Tom Brown. The duration is still well within our historic ranges. It's probably ticked down a couple of percentage points from about 4.8 to 4.65 in the quarter. We really find ourselves a little more neutral on the yield curve.
Okay. Do you see that sort of maintaining that going forward? Is there thoughts of changing that?
No. Again, I think going back historically, we've stayed pretty consistent, somewhere four to six or five, in that historic range, I don't see it moving much.
Yep. Okay. Thank you.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you all for attending another excellent quarter, low 80s combined ratio. We'll take that any time. Our net premiums were up 8%, good cash flow, and 12% increase in book value per share so far this year. It's a tribute to our underwriters and all of our employees for delivering another great quarter like we're seeing here. Thank you, and we'll talk to you next quarter.
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