Good morning, and welcome, ladies and gentlemen, to the RLI Corp. fourth quarter earnings teleconference call. 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 for questions and answers after the presentation. Before we get started, let me remind everyone that in 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 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 the press release announcing fourth 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 performances across the 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 on the company's website at www.rlicorp.com. At the request of the company, we will open the conference for questions and answers following the presentation. 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 fourth quarter of 2012. Joining me on today's call are John Michael, Chairman and CEO; Mike Stone, President and Chief Operating Officer; and Tom Brown, Vice President and Chief Financial Officer. I am going to give some brief opening comments on the quarter, turn the call over to Mike to talk about our operations and market conditions. We'll open the call to questions, and John will finish up with some closing comments. From our perspective, a good quarter to end a good year. The combined ratio in the fourth quarter was 94.3. This in spite of Hurricane Sandy losses, which so far have come in at the bottom end of our previously announced range, or $13.2 million when considering the offsetting effects of bonus and profit-sharing items.
Also in the quarter, $7.5 million of favorable reserve development. From a premium perspective, we achieved growth of 11%, most of which came organically. Growth was achieved in each segment but was particularly robust in casualty, which was up 19%. All of this drove operating income of $0.89 per share in the quarter. As this wraps up the year, this is also a good opportunity to point out some annual highlights. These included an 89 combined ratio, the 17th consecutive year of underwriting profits, and 12% growth in premiums. From an investment perspective, we achieved a full-year total return of 7.5%, although investment income continues to trend down, mostly due to lower reinvestment yields. At year-end, our market yield stood at 2.1% and duration at 4.9 years.
We finished off the year paying the $5 per share special dividend, which returned $106 million to shareholders, in addition to the $26 million of ordinary dividends paid. Including these dividends, book value per share advanced 17%, a function of both strong underwriting and investment gains. All in all, another good year. With that, I'll turn the call over to Mike.
Thanks, Aaron. Good morning, everybody. I think a very good quarter under the circumstances and a good year in a difficult environment. Our underwriting results continue to outperform the industry in this prolonged soft market and tepid economy with weak demand, little or no exposure growth. We continue to outperform. We continue to find new opportunities and continue our underwriting performance. combined ratio of 89 for the year and 94 for the quarter even with Sandy, some $15 million of loss from Sandy, our second-largest net cat event in our history. We grew our premium, our gross written premium, by 11% in the quarter and 12% for the year. We are seeing our rates move up and seeing some momentum develop. We are cautiously optimistic as we go forward on the rate price front.
Our excess and surplus lines casualty business, primary liability, and umbrella and our marine business are experiencing high single-digit rate increases. We see some momentum there. Property rates are essentially flat, though we did get significant increases on the wind-exposed business in 2011, and we're retaining that as renewals come through. We've not seen much rate movement as a result of Sandy, except in the marine marketplace that experienced a very significant loss from Sandy. Transportation rates are moving up but more moderately, 5% or so. There's some sign of optimism here. Our product head was at his recent convention, the brokers actually bought. That's probably a better telltale sign of market change, market firming than all the precise rate change numbers that you receive from others. I think that bodes well for the casualty business going forward.
Our casualty business continues to grow nicely, up 19% in the quarter, 20% for the year, with excess and surplus lines casualty, professional transportation, and CBIC, our relatively recent acquisition leading the way. Good growth written premium growth and good momentum going into 2013. Our property business growth was more moderate at 4% for the year and 3% for the quarter. Our catastrophe business is basically flat as we continue to manage our exposures. As you saw in our experience with Sandy, demonstrates that we are very diligent at managing our cat. Surety business premium up 2% for the quarter, 7% for the year. combined ratio at 81 for the quarter and 75% for the year. Excellent performance by any measure. Our diversification in this segment has worked well as our miscellaneous commercial and energy offset the more difficult contract business.
Our new ventures, RV, recreational vehicles, security guards, Rockbridge, the medical malpractice business that we purchased late last year, are off to a good start, wrote some business in the fourth quarter. We expect growth from these endeavors in 2013. At 1/1, we renewed our major property and casualty treaties, reinsurance treaties. Property was basically flat, both price and terms. Casualty, we increased our retention by a little bit more than 5% and expect to retain an additional $25 million or so in premium in 2013. We have excellent momentum as we move into 2013. We are cautiously optimistic on pricing and expect nice gross written premium growth both organically and through our new initiatives. A good quarter, good year. That's all from me, Aaron.
Great. We can now open the call up for questions.
Thank you. Ladies and gentlemen, to queue up for a question or comment, please press *1 on your touchtone telephone at this time. If you're on a speakerphone, please pick up the handset. Make sure your mute function is turned off to allow your signal to reach our equipment. Once again, ladies and gentlemen, that's *1. We'll take our first question from Randy Binner with FBR.
Hey, thank you very much. I'm just kind of looking for some more commentary on E&S. I think you mentioned kind of that as one of the bullet points in the broadly more optimistic outlook on pricing. If you wouldn't mind kind of giving more color on what you're seeing out there, if you're seeing more kind of traditional admitted carriers migrating out of E&S, if small business creation is giving a tailwind there, kind of the better economy is giving a tailwind. Just kind of more interested in your look on E&S.
Randy, it's Mike Stone. I think Standard Lines companies aren't leaving the space. Certainly, some of them are pulling back a bit, which is beneficial to the traditional E&S players like us. We are seeing more opportunities. Our submission counts are up across those businesses. We're seeing some rate improvement. The economy, it's really kind of a mixed bag. Some places are doing better than others. I'd say the Northeast is a bit better, and will probably be a bit better given Hurricane Sandy with construction activity in 2013. The Southeast is still moribund. The West Coast is a little bit better. All in all, I'd say a mixed bag on the economy.
Rates are moving up, which help us, I'd say the Standard guys are very much occupied on the Standard Line business, they're not as active in our space, but they're still there. We got plenty of competition, Randy.
Right. I appreciate that. Then I guess just on the casualty, a little bit to segue from the E&S pricing getting better, in particular casualty. I guess my basic question is why do you think pricing's better? Is it discipline really around low interest rates? That's been a concept I've kind of had difficult time coming around to, that people would be that disciplined. Is it following higher loss trends? What do you think is driving the market to be a little bit more disciplined on casualty pricing?
Well, as Mike Stone again, I think some of you have seen some pain in the marketplace. Some companies have gotten in a bit of trouble. Certainly rates have gone down for a prolonged period of time, what, five, six years? People are starting to feel the effects of that. You're starting to see reserve releases to be certainly less robust than they have been in the recent past. You take all that together, people are able to push some rates.
All right, fair enough. Thanks.
Thank you. We'll take our next question from Ray Iardella with Macquarie.
Thanks, and good morning, everyone. Just wanted to maybe touch on some of the surety business and maybe talk about the trends you're seeing there just on the contract side. I know it's a little bit of unfavorable development in the quarter.
Yeah. Mike Stone again. Actually, we've been working hard on our contract business over the last 18 months to two years. Obviously in a difficult economy, the surety business is tough. It's better this year than it was last. We think we're making progress in that business, getting rid of the bad performing business, bad performing agents, and concentrating our capacity In the better performing areas. We've got good diversification. Contract makes up 25%, or a little bit less than that, of our overall surety business. The other businesses are less cyclical from an economic perspective, and tend to be lower loss ratio businesses, high expense ratio businesses, where our technology and our agency force and our time in the business give us a bit of a competitive advantage. We still like the contract business long term, but it's much more cyclical than the other.
Okay. No, that's certainly helpful. Anything you can quantify in terms of particular accident years? Is it the 2011 accident year that you saw a little bit of unfavorable on?
This is Tom Brown. It's the 2010, 2011 accident years of contract surety.
Okay.
It's a little unfavorable, about $2 million. It's offset approximately $1 million on miscellaneous and commercial.
Okay. No, that's helpful. Maybe, Mike, can you maybe touch on the ProAg, that treaty as I guess it renewed in one-one?
Yeah. It renewed in one-one. There's a few bits and pieces that need to be finalized, but basically, it's done. We're going to take a little bit additional risk in 2013. We'd expect our premium to be up a bit. Certainly, our net premium peak to be up a bit in 2013 as we add additional risk there. We expect ProAg to grow a bit. Overall, we would think our premium would be up in 2013.
Okay. That's helpful. Thanks a lot.
Thank you. As a reminder, that is star one. We'll go to Meyer Shields with Stifel Nicolaus.
Thanks. First, I need to clarify something because I'm not sure I understood it. When you talk about retaining about $25 million more of net casualty premiums, is that solely the impact of the reinsurance adjustments? Or is some of that just the growth that you had on a year-over-year basis on gross premiums?
Meyer, this is Mike Stone. That is just the reinsurance. To the extent that we grow, in addition to that, I am just kind of looking at last year's premium, 2012, and saying it came in the same, we would keep $25 million more premium. Give or take, depending on what the volume actually does and what the mix actually is, it is kind of hard to get a precise number. Just trying to give you some flavor there. It is about 5% more, if you will.
Yeah, that is perfectly helpful. Thank you very much. Let me start again. In the first quarter of 2012, you saw much stronger property gross written premium growth than in the rest of the year. Is that a function of the fact of this?
It is Mike Stone again. Some of it is probably crop, because that is where most of our crop business comes in the first quarter. Also, the rates were going up quite a bit last year, we were still getting a feel for that.
Okay. Last question, if I can. If we look at the annualized yields, not on a year-over-year basis, but sequentially, it got a little bit better in the fourth quarter compared to the third. Is the shift to munis and sort of that negative year-over-year impact, has that basically washed its way through?
Meyer, it's Tom Brown. You've seen throughout the year a slight increase in the allocation to municipals. That'll have an actual reduction on the yield, but on a pre-tax or an after-tax basis, it'll actually improve that slightly.
Is it still likely to be a downdraft in 2013? On a pre-tax basis, I mean.
I think you'll see a little bit of that again. Some of that'll be offset in the effective tax rate. The current market yield is about 2.1. Hard saying where the rates are going to go, but can't go too much lower in this environment. We do have around $150 million that will mature through the course of 2013.
Great. Thank you very much.
Thank you. We'll continue on to Cort Dingman with Fidelity.
Hi, how are you guys doing?
Good.
Good.
I was wondering if you could tell me or approximate the new money yield that you guys are getting in fixed income and whether we should expect sort of ongoing sort of 20% of the portfolio to be into equities.
The first part, I think, help me out. Was your first name Cort? I apologize, I didn't catch your name.
Just wondering the new money yield for the fixed income portfolio?
Yeah, the fixed income, the new money is about 2.4%.
Okay. On a pre-tax basis, right?
Pre-tax, yeah.
Should we expect incoming cash flow to be split roughly 80/20, with the 20 being equities?
Our longstanding policy has been about a split of 80% fixed income, 20% equities, and we would not anticipate that changing.
Okay, great. I just noticed I was just looking at it briefly. The accident year loss ratio looked like it deteriorated a little bit year-over-year. Is that just explained by the disproportionate growth in the casualty segments versus property line?
Sure. You might have to help us out. We thought it improved slightly. Are you looking at a specific segment?
I was looking at the overall accident year loss ratio in the quarter on a year-over-year basis. I did it quickly, so there's potential for my math to be off.
It'd be basically mixed.
The explanation is primarily mixed?
Yeah, it'd be basically mixed. Yes.
Yeah.
It's not that big a movement.
I guess the question is why wouldn't it have improved? I guess the answer is mixed. Is that reasonable?
Yeah. Cort, again, our view would be that it improved by about two percentage-
Okay
points overall from about 51 to 49.
Okay. I'll take a closer look.
Okay. We can take that offline.
Okay. On the ProAg crop stuff, I was just wondering, I guess confirm, that's 100% quota share, right? Business, there's no XOL component?
This is Mike Stone. That's correct.
Okay. Going into this year, we obviously know that current conditions are going to continue to be challenging. I guess in contrast to this time last year when the drought conditions were still developing. What can ProAg do to address that? My understanding of the crop business is the yield component is kind of computed using government tables, which are on a lag basis. There's not so much you can do from a pricing standpoint. Is there a reinsurance component that you can do to address potentially increasing the profitability of that book year-over-year? If drought conditions persist, is it kind of de facto that it would probably be another challenging year? Are there things that you can do to mitigate it?
This is Mike Stone. There's some things that you can do to mitigate it, but there's not a whole lot of tools. It's fund selection. You can put more of the business in the development fund, where the government takes more risk than you do.
Yeah.
The problem is the historically profitable states are the ones that were unprofitable last year, and they're the ones-
Yeah
that you typically would not want to feed more to the government. I think there's a mix. Last year, Texas was better than Indiana, and typically that's not the case. Those kind of bets you can make on the edges. I think most experienced crop people are going to say that it's not likely that you're going to have that kind of experience again in 2013. Nobody knows, right? On the edges, you can manage some of that by seeding more. You can adjust your mix by writing more business in other states that are less likely to be affected.
Do you or ProAg buy XOL cover on top in that book?
We do not.
Do you know if ProAg does?
The government provides that.
Right, on top of the government.
No.
No. Okay. I was just lastly wondering if we get some additional detail on the casualty growth in the quarter. Was it disproportionate in one area, like near contractors or something along those lines?
This is Mike Stone. We grew most of our products within our casualty business. Certainly we've written quite a bit of commercial umbrella over the past few quarters, in the Northeast. We grew our transportation, we grew our professional architects and engineers, we grew our GL, we grew our CBIC, and we grew our D&O. We have pretty widespread growth across our casualty book.
Okay. Great. Thank you very much.
Thank you. We'll take our next question from Mark Dwelle with RBC Capital Markets.
Yeah, good morning. I think between Cort and Meyer Shields, they covered most of mine. One other I just wanted to hit on. You mentioned, or the press release noted the $6.6 million dividend from Maui Jim. That all runs just through the balance sheet, right? That does not run through the P&L?
Yeah, Mark, this is Tom Brown. That's correct. You'll see in the income statement we pick up our 40% share of their income for the year, but the dividend is all balance sheet. It just reduces the carrying value of the assets offset by the cash we received.
The only income tax effect is just the tax benefit that you note there.
Yes
the quarterly earnings, whatever your quarterly pickup would be.
That's correct.
Okay. Just want to clarify that. Thanks.
Thank you. Again, that's star one. We'll go to Adam Klauber with William Blair.
Thanks. Good morning.
Morning, Adam.
Could you give us an idea on how exposure growth is faring? In particular, did it pick up in the last quarter or two compared to the first half, and in particular, how is it doing in transportation and construction?
Adam, it's Mike Stone. I think exposure grows up marginally in the second half of the year, less than 5%.
How about in construction, transportation? Is that around the same?
That'd be about the same, yeah. I don't have that precise figure in front of me. I could get it for you. Yeah, about the same. There's not been a lot of exposure growth other than, as I indicated before, in certain pockets of the country that have experienced more than others and some places have still not grown at all.
Okay. As far as favorable development, you had roughly 10% this year, 17% last year, 13% the year before. If I remember, last year, there were some big programs you had development in. Roughly how many points were those couple big programs account for?
This is Mike Stone. I'm not sure what programs you're talking about.
I think maybe they're habitational. I can't remember the exact ones.
We've had some development on our habitational book both on the property side and the casualty side over the years. Exactly how much it was last year, I don't recall.
Okay.
We can certainly get that for you.
Okay. Then when we're looking at development this year, the 10%, just on a ballpark basis, is that more toward the old years, 2007 and past? Or would you say it's more evenly spread throughout the last seven, eight years?
Adam, it's Tom Brown. It's actually going to differ by line. In total, it's about half property and half casualty. In the more recent years, marine, for example, is in the 2009 through 2011 accident years. Some of the casualty do dip back as far as 2005, 2007, predominantly, I would say the 2009 to 2011 accident years.
Okay. Finally just-
Just to clarify that's for the quarter.
Oh, for the quarter. Okay.
The most recent quarter. Correct.
Okay. Then just finally following up on the accident year. When we looked at the accident year loss ratio ex-cat for the fourth quarter, it was down compared to the rest of the year, and clearly that number is going to bounce around quarter-to-quarter. Would you expect that to continue to come down as we walk into 2013?
This is Mike Stone. Adam, certainly we hope so. I would suspect not. I would think it'd probably be relatively flat given trend, what we see. I wouldn't expect it'll trend downward too quickly.
Okay. It sounds like you think the rate increases are just keeping up with loss trend roughly. Is that correct?
Yeah, that's about correct. Yeah. Hopefully, it'll accelerate.
Okay. Thank you very much.
Thank you. Ron Bobman with Capital Returns has our next question.
Hi. Good morning, everybody.
Good morning.
I just had a question about new business and the challenges across your different lines. You mentioned the various growth in different casualty subsegments, if you could discuss that and your property book, the challenges in getting new business. Is there anything different about this sort of upswing in rate and the challenges or ease at winning new business? Thanks.
Mike Stone. That's a good question. We would never have got too many underwriters sitting around me that if I said it was easy, they would probably throw something at me. I think we're seeing more opportunities and more opportunities that are of business that we would be interested in writing. We're quoting more business, and we're able to bind a bit more business. I don't know if that's particularly responsive. We have a broader product mix today than we did a couple of years ago, we're seeing more diverse opportunities. I don't know that I'd say it's any easier. We can talk about the Standard Lines, companies pulling back. It seem like there's more competitors every day from various places in most of our businesses.
Thank you.
Thank you. Let's move on to Vinay Misquith with Evercore Partners.
Hi. Good morning. The first question is on the top-line growth in the casualty business that was up 19% on a gross basis this quarter versus 14% last quarter. Just curious how much of that came from pricing versus new opportunities that you're seeing in the market.
That's Mike Stone. About probably 35% of it came from pricing, all the rest of it's new business.
Okay, that's interesting. The second question is on pricing. Historically, we see the fourth quarter as typically the worst quarter in terms of pricing because people want to meet their targets. This time around, we've seen maybe a modest acceleration in pricing. Why do you think that happens, and where do you think we go from here, in terms of pricing?
It's Mike Stone again. That's a good question. I think you're leading me to say it's going to get better because the fourth quarter. I'm not sure that's correct. I'm not going to go there. I do think that there's some momentum, no question about it. We've seen a couple, three quarters of upward rate movement. Coming off a fairly prolonged soft cycle, economy's starting to pick up a bit. I think all those things bode well for price to continue to move in a positive direction. I would also say, as I've said in previous quarters, this market feels a bit fragile. There's not as much fear out there as you would usually need, and there's a considerable amount of capital chasing business. Like I said, I think I'm pretty cautiously optimistic as we move forward.
Yeah, I think the fourth quarter usually is the most difficult quarter.
Okay. That's helpful. Thank you.
Thank you. As a final reminder, ladies and gentlemen, that is star one for any additional questions or comments. We'll go to Raymond Iardella with Macquarie.
Thanks for taking the follow-up questions. Just one maybe to touch on Sandy. I know it came in kind of below your initial expectations. Anything sort of surprising to you guys in terms of the claims that have come in?
It's Mike Stone. Ray, it came in at the low end of our expectation, not the lowest. I don't think so. We probably had more marine losses than we would've kind of anticipated. We haven't been in the marine business, haven't gone through a hurricane of any consequence since we've really been in that business to speak of. I think that's maybe something peculiar to us. No, we haven't had the struggles with wind versus water that you hear about. We haven't had the business interruption or contingency business interruption issues that you hear about. All in all, we've got a bunch of marine losses and some other property losses, but nothing that I think that we would think would be unusual given the size and nature of the storm.
Okay. Maybe touch on the M&A environment, kind of what you guys are seeing, any opportunities out there? I know you guys are always looking, any update would be helpful. Thanks again for taking the follow-up.
Yeah, Ray, we continually look for potential opportunities both in acquiring teams of people and companies. As you know, we acquired Rockbridge Underwriting this past quarter, we'll continue to look for those. I wouldn't say there's any unusual uptick in the activity there, or downturn in the activity.
Thank you. We have no additional questions in the queue. I'll turn things over to Jonathan Michael for any additional or closing remarks.
Thank you all for your questions and comments. We appreciate it. It was a good quarter in spite of Sandy and a good year for RLI. I think this is our 17th consecutive year of an underwriting profit, and I think we've even been eight years or so below 90 combined. All in all, it's been a good run, and we look forward to that continuing. Our premiums were up 12% for the year, and book value's up 17%, including the dividend that we paid. Once again, thank you, and thanks to our underwriters and claims people who've worked really hard to make these things happen. Thank you.
Thank you. Ladies and gentlemen, that does conclude today's conference call. Thank you all for your participation, and have a good rest of your day.