Good morning, welcome, ladies and gentlemen, to the RLI Corp third 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 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. At the request of the company, we will open the conference up for questions and answers following the presentation.
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 2012. Joining me on today's call are Jon Michael, Chairman and CEO; Mike Stone, President and Chief Operating Officer; and Tom Brown, Vice President and Chief Financial Officer. I'm going to give some brief opening comments on the quarter, turn the call over to Mike to talk about operations and market conditions. We will open the call to questions, Jon will finish up with some closing comments. From our perspective, there were several things worth highlighting this quarter. An 88 combined ratio, 6% gross premium growth, continued favorable reserve development, and strong growth in book value per share, up 12.5% since year-end, all within the context of still improving market conditions.
Operating income was $1.02. As usual, there were a few items that influenced this quarter that are worth pointing out. First, we had $18.1 million of favorable development from prior year's loss reserves. As those of you who have followed RLI for a while know, reserve levels are subject to quarter-by-quarter adjustment based on our actuarial process, and there can be, and oftentimes have been, significant volatility in these levels from quarter to quarter. Second, Hurricane Isaac and other smaller cat events amounted to $5.6 million, similar to last year's Hurricane Irene impact. Also of note to some in the quarter, our crop reinsurance book posted a $3.2 million loss on the 2012 crop reinsurance year. This result represents the impact of moving the 2012 multi-peril loss ratio to 110 during the third quarter.
Premium growth was up 6% on a gross basis, with our casualty segment leading the way, up 14%. Although investment income continues to be a challenge for the industry, our portfolio's total return was admirable, not only in the quarter but also year-to-date, where it returned 7.1%. Bottom line, $1.02 of operating income on an 88 combined ratio and continued strong growth in book value of 12.5% year-to-date. All in all, another good quarter. With that, I'll turn the call over to Mike.
Thanks, Aaron. Good morning, everybody. I'll try to provide a little color and talk about the marketplace and what we're seeing. As Aaron said, a very good quarter. Positive underwriting results, 88 combined ratio, 6% gross written premium growth. Casualty growth 14% on an 84 combined ratio is very satisfying and provides reason for an upbeat view. We are cautiously optimistic as we proceed. Casualty rates up some 5%, more in some lines, particularly commercial umbrella. Economy showing some signs of life, and some geographies are better than others. For example, the Northeast seems to be performing better than the rest of the country, but we're seeing some life in California and certainly Texas, and some in the Southeast. Our GL, our primary liability product, our largest product, saw growth in gross written premium some 5% year-to-date. Our CBIC products acquired last year are performing well.
We're seeing a little bit of growth there, around 5% as well. Transportation showing some positive uptick. Gross written premium's up 15% in the quarter and 10% year-to-date. I like to talk about the canary. The canary is not dead, it's starting to look for the oxygen. Good signs for casualty, still fragile, still a surfeit of competition. Casualty feels better than any time recently. Not the halcyon days of the early to mid-2000s, we're on the right path. Property. Crop. Aaron spoke to the results of 110 loss ratio. We think this represents a 1 in 25, 1 in 50-year event. A bump, we still like the business. It's diversifying, and it's a good business over time. Our quota share agreement with ProAg renews on 1/1. We hope to renew on comparable terms.
Overall, property gross written premium was flat, combined ratio of 100. Not acceptable, but without cat and crop, a 90 combined ratio. Seeing positive rate overall, some 3% in the quarter. We're continuing to re-underwrite our marine business, and we're seeing some improvement. Not enough, but directionally it's positive. Our gross written premium in that product is flat for the quarter. E&S property, our surplus lines property business, overall flat gross written premium year to date. We're seeing positive rate on the wind, still driven by RMS 11. We're through a whole cycle of renewals on RMS 11, so the increases will begin to diminish in that line, particularly given the relatively benign cat season, certainly hurricane season. Surety, gross written premium up 8% year to date, down 2% for the quarter. The year to date number, it's driven mostly by CBIC.
Competition remains fierce in most of the surety products, with no less than some three new competitors entering this segment in the quarter. With the economy not growing significantly, there's not enough business to go around. Contract surety that we've been managing carefully over the past few quarters with the economy in a bit of trouble. We saw our gross written premium down some 9% in the quarter. Current economy demands disciplined underwriting approach. The public sector construction market, where most bonding occurs, continues to be weak. Overall surety combined ratio of 70, so excellent underwriting performance and a testament to our diversified product mix in this segment. The positive impact of the acquisition of CBIC in 2011. Overall, very positive underwriting performance, a testament to our dedicated, experienced underwriting claim and support staff. With that, I'll turn it back to Aaron.
Thanks, Mike. 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 and one on your telephone. If you wish to withdraw your question, please press the pound key. Your question will be taken in the order that it is received. Please stand by for your first question. Our first question comes from the site of Randy Binner. Your line is open. Please go ahead.
I had a question about just on property. I understand the comments on the underlying results still being good. We were surprised to see such a high loss related to Hurricane Isaac, and I don't think, based on what we've seen from some of the other carriers that have reported so far, that does not seem to have been an issue for them. I was wondering if there was kind of some unusual concentrations or unusually high losses associated with that storm, if you could provide color on that and kind of what claim type geographies those might have been in.
Yeah, Randy, it's Mike Stone. We're not as big as some others. We write surplus lines property, and sometimes we'll get, I would say, unlucky on some of these storms. We'll have an unusual number of severe losses, and I think we saw that in this hurricane. I would suspect if you look back over the past six or seven years to the hurricane events that you've seen, typically we've done better than the industry, and that doesn't always obtain. I don't think there's anything that we look at as we evaluate this to say there's something we did wrong from an underwriting perspective. It's just, I think we just got a bit unlucky in this storm, where we've probably gotten a bit lucky in some prior storms.
Okay. Just, was it wind? Was it kind of like the roof on a commercial business, or was there extra flooding, or was there kind of anything that stood out from that perspective?
No, I don't think there's anything unusual. It's mostly roofs from wind.
Yeah.
Nothing that we could point at that would be particularly interesting or different. We just happened to have too many buildings in the particular area that got hit.
Okay. That's helpful. Then just one real quick one. I guess I didn't, maybe I wasn't listening close enough, but was the canary comment kind of to suggest that a good spot in transportation underwriting might be passing? Is that what you meant by that?
No, these guys are always laughing at me about the canary, so I have to keep talking about the canary. The canary, when it dies, means something's changing, right?
Right. Yeah.
Something's bad. I do it kind of in reverse. For transportation, it's something good. It's the leader. Transportation tends to be the leader of a casualty turn. When transportation's starting to get better, that means that the whole segment's probably going to get a heck of a lot better.
Okay, good. Yeah. That's a better takeaway from my end, so that's helpful.
That's the analogy, as terrible as it is. If I didn't mention the canary, these guys wouldn't talk to me for the rest of the week.
Okay. Well, we wouldn't want that. Okay, thanks for the clarification.
We'll move next to the site of Arash Soleimani. Your line is open. Please go ahead.
Hi, good morning. Just had a couple quick questions. First, was the decline in the tax rate this quarter just attributable to the higher allocation to munis?
Yeah, this is Tom Brown. Arash. Yeah, that's correct. We allocate a little higher portion of our portfolio to tax-exempt securities and had a corresponding improvement in the effective rate.
Okay. I just wanted to get just another update this quarter on what you're seeing in terms of the standard carriers backing out of the specialty space. Is that continuing this quarter? Is it accelerating, decelerating? Just wanted to get your thoughts on that.
Yes, Mike Stone again. I think as you see the market start to improve, some of that is driven by the standard lines companies spending more time on their standard line business and leaving a bit of the surplus lines space. I think that is what we are seeing that. Is it accelerating? Probably a little bit. It is certainly not a mad rush to the exits.
Okay. Is it fair to say that improvement in exposure units and just economic improvement is what would, I guess, serve as a catalyst to sort of boost that a little bit more? Or are there other factors you think would also be important for that to happen?
Well, I think if results get worse and they do not seem to be, I saw where Travelers reported this morning, and they were speaking about pretty good results and significant rate increases. That would indicate to me that they are probably getting a lot of rate in their standard business, and are not straying as far as they would have a few quarters back.
Okay. I apologize if you mentioned this during your opening comments, the year-over-year NWP decline in property, what was that from?
That requirement.
Mix. Yeah.
This is Tom Brown. Maybe I can answer. It's largely mix. Slight decline in the crop reinsurance program in 2012 compared to 2011 is probably the driver in that.
Okay. Thank you so much for your time.
As a reminder, if you would like to ask a question, please press the star and one keys on your touchtone telephone. We'll move next to the side of Ray Iardella. Your line is open. Please go ahead.
Thanks, good morning, everyone. Quick question, I guess, following up on the crop reinsurance. Should we expect any incremental impact in fourth quarter from crop reinsurance, just as earned premiums kind of go through that in the fourth quarter?
Ray, this is Tom Brown again. Yeah, that's really hard to predict what's going to happen in the fourth quarter. With the spring crop, a lot of that's coming out of the fields in the past and as we speak. What I can tell you is last year, the actual written premium went down slightly, very modestly, $80,000. I don't know if I can read too much into that for the upcoming quarter. We get information kind of from the reinsurer, from ProAg, react accordingly.
Okay. I guess the earned premium will be similar to what it was in the fourth quarter of last year?
Yes.
Is that the right way to think about it?
Yeah, I can't remember. I think I would say slightly down because I can't recall offhand what the 2011 quarter was, but earned premium should be around $8 million- $8.5 million in the fourth quarter.
Okay. No, that's helpful. Then, maybe, I know overall on the surety book there was some favorable development, but any update you can give on the contract surety book piece of it?
Yeah, it's Mike Stone. Again, as we indicated, the contract surety is something that we're watching closely. Things we thought improved a bit in the quarter. We think we managed through quite a bit of the loss activity in the first half of the year, and feel like things are improving, but it's pretty fragile. The economy is not in a real upswing. Contract surety tends to be hurt a few quarters or a year or so after the economy starts to sink. We hope we're through it. We feel pretty good about our underwriting and the discipline as we've approached this, and we think we've worked through the claim activity that we encountered in late last year and early this year.
Okay. No, that's certainly helpful. I think earlier this week, there was another conference call that referenced habitational rates up pretty drastically around the country. Just curious, A, are you seeing that as well? There was another comment about the DIC book in California having increased demand. Are you seeing that, or are you still kind of cautious on rate adequacy in the DIC book?
On your first question on habitational, certainly, it needs rate, both on the property side and the casualty side. We are getting rate, and where we're not getting rate, we're exiting that business. That's been an underperforming part of both our GL book and our E&S property book over the past several years. It needs rate. On DIC, we're not seeing any increased demand to speak of. We're basically flat, probably down a little bit in exposure because rates are down a little bit to flat. All in all, we're comfortable with our DIC book, both from a standpoint of exposure and where we are in the marketplace. We're certainly not seeing any increased demand at this point in time.
Okay. Thanks again. I'll requeue.
We'll move next to the side of Mark Dwelle. Your line is open. Please go ahead.
Yeah, good morning. A couple of questions. First, circling back around to the crop business. How does it impact your ability to renew that when the government hasn't passed their Farm Bill yet, and there's really no way of knowing whether they'll even get that done before year-end? Is that going to just delay the renewal, or does it not have any effect?
It's Mike Stone. It's not really going to have any effect on our renewal. Obviously, it's less impact to reinsurers. We'll proceed with the renewal, with being able to manage those terms as we go through that renewal process.
I guess I'm a little curious how you can set a rate on the renewal if you don't know what the underlying will be.
Well, we would expect an incremental change. Nothing great. We've been through this in the past. It's a quota share deal, it's going to flow through, basically. We're not going to change our ceding terms.
Right
All in all, it's going to flow through.
Okay.
The industry's trying to manage this the best it can.
Right. Okay. Over the last couple of years, you've launched some new business lines of design professionals and some of the others. Can you just comment on how those are contributing to premiums at this point? I haven't heard an update on those in maybe a quarter or two.
Yeah. We're happy with the performance of our new products. Certainly design professionals, we're starting a recreational vehicle, we're starting security guards, neither of which provided any premium increase. All in all, some $25 million with CBIC.
Okay.
Percent in the quarter. Yeah. Fairly good impact from new products, including the acquisition.
Okay. Last question, just kind of a capital management question. I'm sure you expected to hear this. Just how are you thinking in terms of a special dividend? You've done that the last couple of years. The share buybacks have been a little bit lower this year. I know you're not going to give anything upfront, but just curious how you're thinking about it at this stage.
We'll evaluate it. We always evaluate it, Mark. It's Jon Michael, by the way. We will continue to evaluate capital management. As is always the case, if we can't use the capital, we'll give it back in one form or the other, either in a special dividend or through buybacks.
Kind of what I thought you'd say. I felt like I ought to ask. Thanks, guys. We'll talk to you soon.
We'll move next to the side of John Thomas, your line is open. Please go ahead. John, your line is open. Please check your mute function or access your handset.
Hi, everyone. Thanks. How much higher are the crop losses this year compared to last year or a normalized year for the amount of premium you're writing?
This is Tom Brown. Are you referring to the loss ratio on that, John?
I guess the loss ratio or the actual dollar amount.
The loss ratio is, I think Aaron mentioned earlier, was about 110% this year. We would say compared to historic standards, we've been in this program now, this is our third year, approximately 20 percentage points.
The last two years were 20 percentage point, 20%?
I would say this year is 20 points higher than the, I would say, the aggregation of the prior two years. Correct.
Okay, thanks. Just another question, kind of related to excess capital. With the changing business mix, how do you think about how much surplus you need to support your premiums? Are you finding that you need less surplus to support net written premiums, or is your leverage ratio lower than, say, four or five years ago?
Jon Michael. I don't think it's had that much of an impact on our leverage ratio, just slight. We haven't seen any appreciable change in that. Probably seen more change in decreasing that decreasing primary liability book over that period of time.
Okay, thanks.
Once again, if you would like to ask a question, please press the star and one keys now. We'll move next to the side of DeForest Hinman. Your line is open. Please go ahead.
Hi, everyone. Can you give us an update on your bond portfolio strategy? You touched on the muni bond exposure, but can you kind of give us some color about your reinvestment yields that you're seeing? Where is a good place to put that money to work, and where is your portfolio duration sitting at this point in time?
DeForest, yeah. This is Tom Brown speaking. Wish there was a better place to put it. We're in a historic low interest rate environment, and it's hard to predict the future, but I don't see any movement anytime soon. Having said that,
The mix has not changed. Let me start at the highest level. The mix between fixed income and equities hasn't changed substantially. It usually hovers around 80% fixed, 20% equities, and right now it's at about 78/22, so pretty consistent with historic levels. New money, we have seen a little bit of an increase going into municipal bonds, around 40%. That's changed the overall mix slightly, but to be real clear, it's 40% of the money that we have available for reinvestment, but not the current allocation for the entire portfolio, 30% munis, 40% corporates, et cetera. We see that new money at a yield of about 2.4%, duration around four years. Our overall duration has moved out slightly to about 4.86. I think at the last quarter we said it was about 4.65.
Okay, that's helpful. Can you update us on the acquisition opportunities and then also your ability to get underwriting teams? I think in the past, but I could be wrong, you had commented that it was easier to do acquisitions when the market was softer. It was easier to get underwriting teams when the market was softer. Are those opportunities still there as we see some firming in the market? If they are there, what type of multiples? Are the multiples really increasing by quite a bit that would make us not pull the trigger on any type of deal?
Jon Michael here. We continue to see opportunities. We certainly started a couple this year. We had the acquisition of CBIC last year. We started two new lines we mentioned earlier with RVs and security guards. We continue to be active, looking at different opportunities, and I haven't seen that slow down. I think I've seen a bit of a pickup in anticipation of a much more firmer market.
When we think about acquisitions, I guess in the past, we've historically used cash, I could be wrong. With the multiple that the stock trades at, have we ever discussed using the shares as a currency to do a transaction at all?
That's a great idea, and we certainly have, and we will use shares when that's the right thing to do. Whether our counterparty wants the shares or wants cash, it depends. We certainly have a strong cash position, and we've used that, and we used that for CBIC.
Thank you.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael. Please go ahead.
Thanks again for joining us. Another good quarter. A combined ratio of 87.7. Premium growth 6% during the quarter. We've had decent to good book value growth of 12.5% year to date to a book value per share of $42.15. We mentioned on the call that we are seeing slight market improvement across most of our lines of business, and we hope that continues. Our diversified portfolio is helping us through this period, and we look forward to talking to you again next quarter and having another good quarter. Thanks again. We'll talk to you next quarter.
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