Please stand by. Good morning, ladies and gentlemen, and welcome to the RLI Corp. second quarter earnings teleconference. At this time, I'd like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open 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 second quarter results. RLI management may make reference during the call to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI's operating earnings and earnings per share from operations consist of net earnings after the elimination of after-tax realized investment gains or losses. RLI's management believes this measure is useful in gauging core operating performance across reporting periods but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available at the company's website at www.rlicorp.com. 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 second 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'm going to give some brief opening comments on the quarter, then I'll 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, there were several things worth highlighting this quarter. First, an 85 combined ratio. Second, 9% gross premium growth. Third, continued favorable reserve development. Fourth, continued growth in book value per share, up 7.4% since year-end. Fifth, still improving market conditions.
Operating income was $1.17. As usual, there were a couple of items that influenced this quarter that are worth pointing out. First, $2 million of favorable development from prior years' 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 has been significant volatility in these levels from quarter to quarter. Second, spring storms amounted to $12 million of impact across a number of small events. Coincidentally, the same impact as last year's second quarter. Premium growth was up 9% on a gross basis, with our Casualty segment leading the way. Property premium was flat, while Surety was up 3%. Bottom line, $1.17 of operating income on an 85% combined ratio and 9% top-line growth, a respectable second quarter.
With that, I'll turn the call over to Mike.
Thanks, Aaron. Good morning, everybody. Kind of a newsflash. We had some rain here in central Illinois last night. That'll become relevant as we talk further. A brief update on the market and what we're seeing out there. As Aaron said, we're up 9% for the quarter, 15% gross written premium for the year, and that's 10% without the addition of CBIC. We're cautiously optimistic as we move forward. However, there's been no watershed moment yet. We are seeing some companies show deficiencies, considerable amount of CAT activity again this quarter. Maybe the market will really firm soon. I would say, though, that with the moribund economy, it's going to be tough to see a whole lot of growth. Everything is zero sum at this point in time. Let's talk about our segments. Casualty, good story.
Positive rate trend, growth in all our major products, gross written premium up 22% in the quarter, 25% year to date, and that's 19% without the addition of CBIC. General Liability, our primary E&S product, primary liability E&S, our largest product, gross written premium up 10% year to date. Rates improving on the order of magnitude about 5%. We're starting to see a bit of movement in what has been our growth product in the past. Our commercial umbrella product up around 100% year to date, and about 50% of that is written over our own GL. It's business that we already underwrite from a primary side, so we're adding exposure, but a well underwritten piece.
There is some geographic areas that are truly hard with companies exiting this line and underlying companies requiring, or umbrella companies requiring higher limits, higher underlying limits, which is providing opportunities for gap layers that we are able to provide. We are getting a significant rate, north of 10%, plus our submissions are up considerably. Transportation, my canary in the mine. Gross written premiums up 28% in the quarter, 9% year to date. A good story with nice growth. Rates are up, however, just nominally, probably a little bit less than 5% year to date. I would say the canary still lives. Maybe it is gagging a bit, and maybe we can put it to death in the next half of the year. However, our product guys in the field are saying it is still competitive.
One large MGA lost its market, and quite a bit of business came on the street, which was able to fuel our growth in the quarter. No inflection point, but moving in the right direction. Our professional services business, our architects and engineers, design professionals, miscellaneous professionals, also growing nicely, up 77% in the quarter, 63% year to date as we grow out this business and have added a package product for these professionals, and we are growing that business as well. End results will improve in this area as we gain more scale efficiencies. A nice growth story there as we grow that out. Our personal umbrella product continues to grow steadily, up some 3% in the quarter and year to date. It is a nice niche here for us as we continue to grow that out and add some product there as well.
Our CBIC package casualty products, gross written premium was up about 6% year to date, and loss trends are good in that line. Overall, good growth both with and without CBIC. Rates trending up, but we remain circumspect with some optimism. A boost in the construction activity and the overall economy rebound would be welcomed. Property area. As Aaron said, we are flat for the quarter on gross written premium, up 5% year to date. There is no CBIC premium in this segment. Our CAT wind rates are up quite a bit, some 25%, with the introduction of RMS v11 last year. We still think it is too competitive, need more rate to get us to increase our writings. We are well within our tolerances, so we have some room to grow if we could get additional rate here. Our DIC in earthquake, it is off 7% in the quarter, about flat year to date.
Rates are up nominally somewhere south of 5%. Again, you are not going to see gross written premium growth in our CAT DIC earthquake unless we see rate improvement. Marine, also in this segment. Gross written premium flattening out in that area is up about 3% for the quarter. Most of the growth is coming from our inland product. Our re-underwriting in the wet marine is taking hold with some favorable development in the quarter and year to date. We continue to move to a more niche-based approach, smaller accounts, more inland, better underwritten in our marine. We are cautiously optimistic here. Spring storm activity, again this year, $12 million. We are slow, but we are taking action. We are raising rates, tightening terms and conditions. For example, higher deductibles in these areas. Crop, that is C-R-O-P, by the way. You have been reading about drought. Clearly, we see it here in central Illinois.
We are closely monitoring this issue. A few RLI facts. We expect about $35 million in premium from our ProAg relationship, of which we keep approximately $25 million. Only about 25% of ProAg's book is in the severe drought states. Their top five states, not impacted by the severe drought, and a disproportionate amount of their premium is in non-Group 1 states. Too early for any definitive assessment. Obviously, corn's impacted. Soybeans, it's too early. Remember, this is a crop-by-crop, county-by-county matter. There will be losses, but whether there will be a loss is too early to tell. Surety. Gross written premium up 3% in the quarter, 15% year to date. Premium is flattening out as we are cautious with our contract book, both the CBIC side and the RLI side. We're seeing considerable competitive pressure in the commercial surety space.
We expect to continue to grow this segment over time. It's performing well, and we're seeing much improvement in our contract book as well this quarter. Overall, good underwriting quarter. We are optimistic going forward, it's still fragile. We need some economic improvement to see real growth over time. Thank you, Aaron.
Great. 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'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 questions will be taken in the order that they are received. Please stand by for your first question. The first question comes from Randy Binner from FBR.
Hey, thank you very much. I just wanted to follow up on the crop insurance comments real quick. It was $25 million retained of net premiums earned annually. Is that correct?
That's correct. That's Mike Stone. That's correct.
You said approximately how much of the book was in what you would call severe drought states?
25%.
Okay. Thank you. I guess, what's your sense of how much of the corn crop has been lost? I've read anything from a third, a quarter to a half of it in the Midwest. Does that seem right from what you guys are seeing?
It's Mike Stone again. It's awful hard to tell. It's early. It's county by county. If you go through Illinois, central Illinois, and I drive to Chicago back and forth, as does our CFO fairly frequently, some looks pretty good and some doesn't look very good. It's pretty hard to tell. Like I said, we did get some rain last night.
Okay. I guess, how does the timing work? When is the determination made that a crop is lost? Now it's July, I guess it would be a third quarter event, right?
Yeah. Harvest time, right? It's September, October, was when we'll start to know something much more definitively. We'll start getting crop reports in, planning and stuff as time goes on through the quarter. Like I said, it's still too early, but it'll start to firm up in the third quarter.
One more, if I can. As far as whatever loss comes through, it feels like it would all be primary layer, meaning you would take it. Do you have any reinsurance cover for an event like this big if X amount of the crop is lost or?
No. We cede $10 million, plus there's government stop loss, obviously.
Would that kick in on this event, the government stop loss?
If it's bad enough, it will.
Okay. Can you characterize for us what the rough economics of the government program are?
Well, the government, it depends on whether it's Group 1 or Group 3 states, so it's different by group. Group 1, that's typically referred to as the I states, about 190 the government kicks in. Group 2 and 3 states, at about 150 the government kicks in.
That 190 refers to?
Loss.
Okay.
Loss ratio. Yeah.
Okay. Loss ratio for each individual company.
Well, for each individual crop. Each individual state.
Okay. Understood. Then, real quick on E&S. I guess, maybe I missed that kind of particular view in the overall commentary, but just kind of wanted to get your views on if E&S is still kind of slowly starting to turn the corner. We talked about that in previous calls, are larger carriers leaving E&S a little bit more? Is a better economy helping? Is the economy better enough to help E&S? Just looking for more color there.
Yeah. It's Mike Stone. I think, again, if you separate property and casualty, I'll talk about casualty. Yeah, I think some of the standard companies are starting to pull back a bit. It's not 2001. Is that when it got hard? 2002. Certainly nothing like that. We're starting to see a gradual pullback. We feel, as I said, cautiously optimistic. I don't think the economy's helping much. Clearly in the Southeast, it continues to be very difficult, very little construction activity. We've seen a little bit of pickup in the Northeast, particularly the New York area, which the economy's a little better. California's probably improving a little bit, but that's pretty fragile. It's really, you've got to look at sort of segments of the country. You get a different feel by section.
All in all, we think things are improving, and the standard guys are pulling back, but it still is a bit of a zero sum. There's a little bit more business in the surplus line space than last quarter. Property's been okay. With RMS v11, rates are up in the CAT side. You get outside the non-CAT side, it's still not improving.
Just one more on E&S.
Yeah.
My assumption is that most of the CAT loss came from E&S property in the quarter?
Yes, that's correct.
Okay. Was there any kind of property type or geography that was more affected, or was it fairly diversified across where all the storms hit?
Well, we had losses in the Oklahoma, Kansas, I think that's 76 or 77 CAT, and Dallas, which was, I think, 78.
All right. That's helpful. Thanks.
We'll go to the next question from Adam Klauber from William Blair.
Thanks. Good morning.
Good morning.
It looked like the accident year loss ratio was up. We have it around 53. That's up compared to last quarter, compared to some of the quarters last year. In particular, it looked like the property accident ex catastrophe was up. Could you, I guess, explain why?
Yep. Good morning, Adam. This is Tom Brown. Welcome.
Hi, Tom.
Adam, I think it's trending pretty consistent, I think with the first quarter, and there's a lot of variables in that, ranging from price, mix. We take a longer-term view of loss cost trends-
That maybe what we're seeing in the near term, and I think that's having a little bit of the meaningful impact on the overall loss ratio and more specifically to the property lines.
Hmm. Okay. Could you go into that on the property? I guess, mix-wise, what products are pushing it up?
That would be principally marine.
Also another question on the property. Sounds like in some of the areas, rates are up, particularly, I think you mentioned CAT-prone areas are up, but growth was pretty flat. Could you, I guess, give us an idea why rates are up, but there's no growth?
Yeah, because we're cutting back on exposure. Also our marine business is down overall, relative to the growth rate, it's down last year. We're a little less business in the DIC, a little less business in the non-CAT-prone areas, so-called fire business.
It's still competitive in the property space, even with rates up. Certainly, the CAT wind, hurricane wind is still competitive. Everybody's using the model.
Yep.
When you say it, everybody's up by that level, but the exposure's probably up that high too.
Okay. That's helpful. As far as favorable prior development, the good size number on surety, was that from CBIC, or is that the non-CBIC book?
Yeah. Adam, again, it's Tom Brown. It's actually a little bit of both. It represents about 25% of the overall favorable development for the quarter. It covers the miscellaneous commercial oil and gas have been favorable, principally the more recent years 2009 through 2011.
Offset modestly, a little bit of unfavorable development of contract surety, which with respect to the economy in that sector, probably no surprise.
Right. Okay. As far as property, also you had some decent development. Was that disproportionate from some storms in prior years, or is it just spread across years?
It's spread across years. I wouldn't, for the current quarter, point to any particular storm. It's largely coming from our marine book in the more recent years, 2008 to 2010.
Okay. That's helpful. Then finally, just following up on the E&S comment, we've heard the market is just moving gradually again, to emphasize gradual pullback from some of the standard carriers. Would you say that the speed of the movement has increased a little in the last three, six months? Or is it just sort of a very gradual path?
Adam, terrific question. It's Mike Stone. It's like how many angels dance on the head of a pin. I think it's continuing to move, whether it's moving a little faster. It feels a little better, okay? That's about as good as I can get. It feels like it's getting a little better.
Okay. Great. Thank you very much.
Next question comes from Matthew Carletti from JMP Securities.
Yeah, thanks. Good morning. Mike, just was going to circle back on kind of the general liability and umbrella E&S commentary. Kind of asking Adam and Randy's questions a different way. When thinking about the economy and kind of contrasting that with just competition from kind of traditional standard lines markets, which one of those do you think has more ability to kind of move the needle going forward in improvement? Is it some sort of tangible economic improvement going to be more important to you? If some of the larger standard lines guys get a little religion that'll move the needle more?
Matt, it's John Michael. My view is that for all of us, if the economy improves, it should move the needle quite a bit. What will happen if the economy improves, in my view, it'll cause some of the standard lines carriers to retreat and go back to some of the standard lines that they write a lot better than E&S carriers do. That's what usually happens when you see economic improvement. That's my view anyway.
Great. Thanks a lot.
We'll move to Meyer Shields from Stifel, Nicolaus.
Thanks. I'm going to do a little pin dancing myself. Were there any areas in the markets that you participated in where you're actually seeing rate trends deteriorate from where we were at first quarter?
It's Mike Stone. Not really, no. No. If anything, the worst is we see something that's flat. By and large, flat is the new down.
Okay. On the casualty reserve development, I guess still very strong, but did decline a little bit or more than a little bit from last year. Can you talk about what's driving that? Is it a shift in accident years or products?
Yeah. Meyer, I think it's probably a consistent trend with what has been experienced in the industry as a whole, maybe at a lesser rate. It was about 50% of the overall release for the quarter. Again, more recent accident years 2006 to 2010 ranging from GL and pub to some transportation in terms of the lines.
Okay. No individual years that are really turning bad or anything like that?
No. I'd say there might be a slight negative here and there, but nothing to read into. Most of it's more recent accident years.
Okay, great. Thank you very much.
The next question comes from Mark Dwelle from RBC Capital Markets.
Yeah, good morning. These guys kind of beat up most of the questions I had. I had one other related to the property segment, though. The net-to-gross retention has continued to kind of decline. Is that a product of mix, or is there some change in the reinsurance program there?
No, it's Mike Stone. It's mix.
Okay. As you continue to shift, or I guess maybe downshift in the property segment, I would presume that's freeing up a fair amount of risk-based capital under your ratios. Is that right?
This is Tom Brown. Mark. It's probably too early to tell on that.
Okay.
We do look at our models periodically, risk-based capital as well as our CAT models, nothing of significance to note as of this point in time.
How does the crop figure into those types of calculations? Does it have a similar capital weighting to property-type risk?
This is Mike Stone. Less. It's fairly diversifying when it comes to that. It's less.
Okay. Those will be all my questions, thanks.
We'll move next to DeForest Tinman from Walthausen and Company.
Hi, everyone. Kind of a big picture question. Can you give us an update on your investment portfolio and how you're positioning it? Maybe some of your thoughts on the rumblings in the muni bond market, if you have any exposure there?
Yeah, DeForest. Tom Brown here. I think it's two questions. One, just from a weighting, we're consistent with Q1, moving money more into the municipals from a weighting about 60% municipals, 20% corporates, about 20% asset-backed. Kind of split evenly between, in the muni world, between general obligation bonds and essential services. The second part of that question, I should point out, that's also very high investment grade, AA or better. On the second part of that question, I think you said rumblings in the market, if I have the right word. Are you referring to some of the recent bankruptcies, like in California?
In California.
Yeah, we monitor that very closely. Have no exposure to the more recent municipalities, et cetera, that announced bankruptcy. We monitor that very regularly and particularly look at any time we see a dip or a downgrade in the investment grade. We take a pretty hard look and an action.
Can you talk about the portfolio duration?
Yeah. In the duration, particularly that we're moving out a little bit, approximately seven years on some of that to get a little more yield. The overall has not changed significantly from Q1. It's at about 4.7, which is where we were at Q1. It's slightly longer than where we were at the end of the year at about 3.5. Tenure horizon, that's pretty consistent where we've been, the 4.5 to 4.7 overall duration.
Okay. You talked about there's increased underwriting going on, and we do have capital. Can you kind of help us think about the capital allocation strategy going forward? It doesn't look like you mentioned any share repurchases in the quarter. If we continue to accumulate excess capital, will we be looking at doing another one-time dividend?
Jonathan Michael here. We continue to look at our capital requirements, risk-based capital. As I've said in the past hour, we would rather use it ourselves. I think our long-term history of producing excess returns to shareholders by using it ourselves is what we would intend to do with it. Again, if we do not see opportunities or cannot use the capital and do not see anything in the foreseeable future for it, we'll return it. Our return will either be in the form of share repurchases, which we've done in the past or special dividends. Those are our two preferred ways of returning the capital. I can't make any predictions on what we'll use. We do have quite a bit, what, $80 million, $80-plus million on our share repurchase left.
When we see opportunities, if we cannot use the capital, we'll purchase shares, and we'll make a decision on a special dividend at another time.
Okay. Thank you.
As a reminder, that is star one if you would like to ask a question. We'll move next to Ray Ardelli from Macquarie.
Thanks, good morning, everyone. Mike, maybe a question for you. I think last quarter you had mentioned, in a rising rate environment, the retention on the E&S side of your business actually improves. Are you seeing that in the results, or can you comment on the retention on the E&S side?
On policy premium retention, it's about the same. It's not deteriorating. It's about the same. As a leading indicator, it's not moving north, but it's not deteriorating.
Okay. That's helpful. Then, Tom, I think you had mentioned maybe a little bit of adverse on the contract surety business. Any more color in terms of magnitude or potential action years that you're feeling some of that headwind from?
Yeah. Ray, it's principally in the 2010 and 2011 accident years. I looked up here. It's a little over $1 million.
Okay. Can you remind us how big that book of business is, generally? The contract surety book.
About approximately $40 million.
Okay. Thanks. That's all I had.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Micheal. Please go ahead.
Thank you very much for joining us. It was another good quarter for RLI, 9% growth at 85 combined ratio. At the end of the quarter, our shareholders' equity up nearly 8% since year-end at $40.24 a share. We're very proud of our underwriters and their discipline. Our 85 combined ratio average over the last 10 years is testament to our underwriters being disciplined in their approach. Mike mentioned, and Aaron mentioned that the rate environment continues to improve modestly, pretty much across the board. Submission activity is up. That's always a good sign, especially for our E&S book.
Given the low interest rate environment, and the pesky CAT activity that we had this quarter, and an expectation that the industry's reserve releases will begin to lessen considerably, we expect the rate environment to continue to firm, although at a modest rate. We really need a good economy to help the industry. That would really help. Again, a good quarter. We are looking forward to talking to you next quarter. Thanks for joining us today.
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