Good morning, welcome, ladies and gentlemen, to the RLI fourth 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 today's teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including the annual Form 10-K, which should be reviewed carefully. The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing 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 gain or losses. RLI's management believes that this measure is useful in gauging core operating performances across reporting periods but may not be comparable to other companies' definitions of operating earnings. The Form 8-K contains a 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 Jacoby. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI Earnings Teleconference for the fourth quarter of 2011. 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, turn the call over to Mike to talk about our operations and market conditions. We will open the call to questions, John will finish with some closing comments. Operating income came in at $1.35 per share in the quarter, $5.58 for the year. Results for both periods were positively influenced by favorable development in prior year loss reserves, $11 million in the quarter and $92 million for the year, with our casualty segment being the primary driver.
The combined ratio for the quarter was an 82, which allowed us to finish the year with a 78 combined ratio. 2011 marks the 16th consecutive year that RLI has maintained a combined ratio below 100. Perhaps an equally impressive figure is the 87 combined ratio RLI has averaged over those same 16 years. Gross premium was up 12% in the quarter and 10% for the full year. This growth was driven by our acquisition of Contractors Bonding in April, as well as by organic growth in some of our newer product initiatives. Within the investment portfolio, investment income was down 2.6% for the quarter, an improvement relative to the annual decline of 4.7%. As we've noted before, our ability to deliver superior underwriting results is particularly important in today's low-interest rate environment. On a total return basis, our investment portfolio performed admirably in a tough and volatile year.
The portfolio returned 3.4% in the quarter and 7.3% for the year. Between the positive underwriting and investment returns in 2011, capital grew significantly, which allowed RLI to pay a $5 per share special dividend in December. Including this dividend, book value per share advanced 16% on the year. Over the last six years, RLI has returned over $700 million to shareholders in the form of dividends and share repurchases. With that, I will now turn the call over to Mike Stone. Mike?
Aaron, thank you, and good morning, everyone. A superior underwriting quarter and year, a testament to our underwriting expertise and discipline and a business model that rewards underwriting profits. I might add, in all markets and economic conditions. Again, a 78 combined ratio for the year when the industry's going to be north of 100. We probably outperformed the industry by some 25 combined ratio points this year, a stellar performance. We're particularly proud of being able to grow our premium by 12% in the quarter and 10% in the year while maintaining our underwriting performance. The market continues to improve. That is, rates are moving in the right direction, but it's uneven, somewhat product specific or geographic driven by particular issues. For example, property catastrophe wind is due in some large part to the model change to reinsurance costs and to cat activity.
I continue to watch for movement from our transportation division, a short-tail casualty line, which should be an early indicator of true firming in the marketplace. My observation is somewhat mixed. Rates remain fairly flat, but we're seeing more opportunities in that space, which is hopefully a precursor to better rate activity. Frankly, without some real improvement in the economy, that is exposure growth and construction activity, we will continue to encounter difficulty growing organically. Let's look at our segments. Casualty gross written premium up 10% in the quarter, 4% in the year, largely due to our CBIC acquisition and our Professional Services Group growth. Rates overall, basically flat. Some areas due to loss activity, for example, the general liability habitational risks, where rates are moving north, but really driven by significant loss activity in that space.
Geographic issues in our commercial umbrella space, where New York contractors are allowing us to get some double-digit rate increase in that space as well. Again, this quarter, this segment benefited from prior years' improvements. Much of our business is driven by construction activity, from general liability for contractors to architects and engineers, and we need the economy to pick up to enable us to grow in that space. Property continues to be a growth driver for us as pricing allows for reasonable returns in this space. We're up 10% in the quarter and 15% in the year, driven by RLI Re and our crop business, up some 90% and 30%, respectively, year to date. We did renew our reinsurance with our crop partner and continue to believe it's a good business long term and provides a nice diversification for us.
Rates in this space, as I indicated, catastrophe and wind is up some 15% year-to-date, DIC down, fire down some 8% and 3%, respectively. RMS 11 continues to drive rates in the cat wind space. Overall, not as firm as you would expect given all the loss in this market segment. Surety, gross written premium up 23% in the quarter, 21% year-to-date, driven by our acquisition of CBIC and modest growth in the RLI segments, except for construction contract surety, where we're actually down 11%. Surety's performing well with a combined ratio of 85% for the quarter, 78% for the year. Contract surety is coming under pressure due to very weak construction activity, placing significant hardship on contractors and their sureties. We are being vigilant and exhibiting underwriting discipline. It's a difficult part of the marketplace and market time for our contract surety.
We'll continue to be vigilant here. Our CBI surety business continues to perform as expected, and we expect less volatility here given the smaller size of the contractors and a lower net position in that business. On 1/1, we renewed a couple of our rather large treaties. Our property per risk and catastrophe treaty were renewed at rate increases of 5%-7%. Casualty rates, as we renewed our large combined casualty treaties, were up some 2%-3%, basically driven by some select spots, but transportation and commercial umbrella and personal umbrella. Overall, stellar quarter from an underwriting perspective and year. While I'm loathe to sound political, we need a more robust economy. Without a more robust economy and exposure growth, we're going to have difficulty growing and difficulty driving growth in the future.
We adapt under all circumstances, as can be seen by how we have moved our segments from a 70% casualty, 20% property, and 10% surety to now, where we feel better opportunities exist in other spaces. It's 46% casualty, 38% property, and 16% surety. Again, a good quarter, good year, and we look forward to 2012.
Great. Thanks, Mike. Operator, we can now open the call up for questions.
Thank you. If you'd like to ask a question, please signal by pressing the star key followed by the digit one on your touch tone telephone. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star one to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal. We'll take our first question from Randy Binner with FBR Capital Markets.
Great. Thank you very much. Just a couple clarification questions on pricing and kind of market dynamics. I guess first in surety, you mentioned that contract surety is lower, on commercial surety, just interested to get your take on the market dynamic there and if there's maybe more top-line production in that area.
We were up a bit in the quarter and for the year, a single-digit increase. That space has quite a bit of capacity and we're fairly cautious at this stage. Usually at this stage of the surety market cycle, we start seeing commercial surety underwriters do unusual things.
Right.
We haven't seen that yet, which is good. We're cautious here and wouldn't expect a whole lot of growth. We feel like we're in a good spot here.
I apologize if you break this down in the press release or somewhere else, but what's your rough breakdown of contract versus commercial?
Again, we've got basically four areas of surety that we operate under. We have contracts. We have what we call commercial surety, which is really account-driven miscellaneous surety, and then we have a miscellaneous surety, which is transactional with small accounts, and then we have oil and gas. They're all pre-CBIC, roughly 25%, a little bit larger on the miscellaneous side. With the addition of CBIC, it will increase our miscellaneous commercial business, that is the transaction business, and the contract business a bit. The split will be more like 30/30/20/20 going forward.
All right. That's helpful. I guess if contract is slow and commercial's crowded but not yet irrational, it seems like the outlook there would seemingly only get worse from a premium production perspective. Is that fair?
Did you say for contract? I'm sorry.
Well, for just surety in general. Contract and then commercial as well.
I think it's not completely across the board that way. I wouldn't look at it with just a broad brush like that. Certainly, I think our oil and gas business is doing well, growing a bit. I think our commercial business will grow a little bit. I think our miscellaneous business will hopefully grow even more significantly. Our contract business will be under pressure for a bit. We've been through these cycles before. It's time to be careful, certainly on the contract surety side, and we will be. I still hope and expect that 2012 will be a decent surety year.
That's helpful. Just real quick on property, I think you mentioned that RMS 11's driving rate higher, but not as much as you might think. Any quantification of kind of where rates coming in there versus where it should be relative to the losses of the last couple of years?
Well, relative to the losses the last couple of years should be up quite a bit higher. Certainly we haven't experienced that loss activity, but the industry has. The catastrophe wind rates for 2011 were up some 15%, driven more so in the second half as people started implementing RMS 11. Certainly, reinsurance renewals on 1/1 are up pretty well across the board, and we experienced a bit of uptick, probably a little less than the industry. Certainly reinsurers are starting to try to drive rates. There has been quite a bit of loss activity in this space. It's not fully recognized as the Thailand floods recently amongst other large international catastrophe events. The only thing you can say good about the property cat market is there wasn't a Florida event this year. I should say last year. I don't know about this year yet.
All right. Fair enough. Thank you.
We'll take our next question from Douglas Mewhirter with RBC Capital Markets.
Hi, good morning. I just had a specific question about the reserve releases and any other comments that you might be able to make in addition. I guess mostly came from casualty. What accident years roughly did it come from? Just what do you see the trends running in terms of loss costs and any kind of leading indicators of those kind of trends, severity, frequency, et cetera, in casualty?
Doug, it's Tom Brown. Thanks for the question. The casualty years where we're seeing the releases are primarily from 2006 through 2009, so the more recent accident years. We really don't like to comment much on what's going to happen in the future. It's really variable.
Okay. How about what kind of current frequency and severity trends are you seeing then from casualty?
David, do you want the microphone? It's Mike Stone. I'd be happy to try to give it to you. I think our frequency and severity trends are fairly benign. I think less than we would've expected. Probably one of the low single digits order of magnitude. I think that's one of the things that is continuing to keep rates more moderate than you would expect given what's happened over the last six or seven years with casualty rates and what's happened with the loss activity in the property space.
Okay, thanks very much. That's my only question.
We'll take our next question from Vincent DeAugustino with Stifel, Nicolaus.
Good morning. Thank you. I know the saying goes, if it's not broken, don't fix it, and RLI is clearly a well-run operation. I'm curious if there's anything on the radar in terms of new initiatives or potential acquisition areas or any areas that you think could be improved. Basically, just wondering if there's any new strategic goals on the horizon for 2012 or beyond.
Yeah. John Michael here. Thanks for the question. Well, we had a combined ratio of 78, I think we have a lot of improving to do from that. In terms of acquisitions, we are constantly looking for new products, product extensions, acquisitions. Of course, we don't have anything to announce. We're constantly looking, and we'll change just as we've changed in the past. As much as we change, things remain the same. We've had 16 years of combined ratios under 100. Thanks.
Great. I guess just one other question. Looking at your equity portfolio performance after incorporating the 12% return. If my math's right, it looks like there was something in the neighborhood of maybe an $18 million net new fund addition. Is there maybe any incremental bullishness going on there, or am I just reading too much into it?
Vince, could you repeat the question, please?
Sure. Looking at the equity portfolio performance after incorporating the 12% return from the quarter, it looks like if my math's right, there should be about an $18 million net new fund addition to the equity side. I was just curious if there was any incremental bullishness going on there.
I didn't catch the last piece. Yeah, you're right. We have increased our position in equities. It is about approximately 20% of the overall investment portfolio. There was a strong increase from 9/30 to 12/31 in prices, and it also is skewed somewhat to a high dividend yield investment equities, which throws off a pretty good return. I didn't catch the last part of your question.
Yep, no, that's perfect. If I may, just one follow-up from an earlier question on the casualty line reserve releases. Were there any adjustments to prior 2011 quarters, or is it just mostly the 2006 to 2009 accident years?
This is Tom Brown again. Thanks for the question. There is some relief for the full 10 years, again, as I said earlier, it's predominantly in the 2006 through 2009 accident years.
Okay, great. Thank you so much.
We'll go next to Adam Klauber with William Blair.
Good morning. Thanks. Could you talk a bit about the competitive environment? Have we seen any pullback from the standard players?
That's Mike Stone. That's kind of a bit of a mixed bag. We've seen a little bit of pullback in some areas. By and large, they're still probably, as we look at our competition, probably the toughest piece of our competition, the biggest piece of our competition that we've seen over the last five or six years as the market has traded downwards. We haven't seen a big pullback again, which would be a precursor of a real firming market. We think the standard guys are still there, but they haven't felt the pain quite yet. We're starting to see a little of it, but probably not enough of it to drive them completely out, like what has happened in the past.
To the extent they're pulling back, is it more on the property than the casualty side?
It depends on the geography as much as anything. We see some of it on the property side, certainly, and in some areas that I indicated, like in the Northeast on the casualty side.
Okay. As far as gross premium written, it was lower in the fourth quarter than in the prior three quarters. Is that just more of a quarterly fluctuation, or did something change in the fourth quarter?
It's almost no crop premium in the fourth quarter. That's probably the reason that if you look at quarter by quarter, that fourth quarter will be less.
Is that why the growth is less because some of the growth over the last two quarters has been crop?
Yes.
Okay. That makes sense. Finally, when I look at casualty accident combined ratio, it's running around 104, I think 105 for the last two years. How much rate do you think needs to be put in that book to get it back to your core profitability? Are you seeing any more discipline in the market that will let you get that rate?
I'll answer the second question first. We're not seeing as much discipline in the market as we would like. We're seeing a fairly flat rate environment, which is good compared to what we've seen in the recent past when rates are declining. Flattening out of rates is a good thing. As I think I've said before, I don't think rates stay in stasis. They move one direction or the other. They don't stay flat forever. We've been bumping along what we think is the bottom for a while. What's going to be interesting is if they actually do turn up, or as they have in the past, in the recent past, when we think things were going to firm, they actually go down. I do think we're at an inflection point.
We think we need 10%-20% rate increase to get us to the margins where we think we ought to be on a across-the-board basis in casualty.
Great. Thank you very much.
We'll take our next question from Court Dignan with Fidelity Investments.
Hi, guys. Thanks for taking the time to talk with us. Had a question on how we should be thinking about the balance sheet and premium leverage, given the sort of mix changes the company's had over the last couple of years, your organic growth expectations, and as well as sort of retaining flexibility for prospective acquisitions, which has obviously played a role in the company's history. I don't know if it's too simplistic to think about it within the context of premium to surplus, but I was wondering if you could just hit on that.
Yeah. This is John Michael. In terms of premium to surplus and how much leverage we can probably generate in terms of operating leverage and maintain ratings. We believe that number probably starts to get taxed at around 1.3 or thereabout. We really do have a long way to go before
We get to that kind of leverage.
In terms of acquisitions that I previously mentioned, we are constantly looking at new products, product extensions, acquisitions, and the like. Last year I think we did Contractors Bonding and Insurance Company, and we did several other product extensions.
We'll continue to do that.
Is the environment for acquisitions better or worse than six months ago, 12 months ago, 24 months ago? No difference?
No difference. Yeah. I'd say, given where our stock's trading, we're in a better position than others. I think what happens is that when you begin to look at acquisitions, the expectation of the acquired is quite a bit different than-
what we're thinking that we ought to pay.
Then on the premium to surplus of 1.3 times, the way to interpret that is everything firing, all hands on deck, you operate at 1.3, but in more normal course, is one times more a reasonable target? I'm just trying to make sure I. Obviously, where you were at .5 a year ago or so, that was obviously on the low end.
Yeah. I think we can easily operate at 1.3. What happens is the rating agencies just won't allow you to go beyond that and maintain an A+ rating.
It depends on the products.
that you're writing.
Mm-hmm. Last question I had was just on the investment portfolio. I think maybe six months ago, you guys were buying 7- to 10-year corporates, plus, I think, adding some longer dated GSE paper. Can you give us a sense for what you're looking at now, and what generically, for the fixed income portfolio, you're getting for a new money yield?
Yeah. I mean, I think it's Tom Brown. It's remained fairly consistent. With the exception of my previous comment, we have shifted a little more into the equities, seeing some better yield, dividend yield on the equities as opposed to the fixed income portfolio. We should also point out that we did have a press release earlier in the week that we just announced a new hiring of a CIO, Aaron Diefenthaler. Too early to comment on some of his thoughts and views on the portfolio moving forward.
Can you give me a sense for the fixed income portfolio, what you're getting for new money yield?
Offhand, it was 2.9%, I think. Roughly 2.9%.
Okay. Great. Thanks a lot, guys. Good luck.
Thank you.
As a reminder, if you'd like to ask a question or if you have a follow-up question, please press star one now to signal. We'll take our next question from Matthew Carletti with JMP Securities.
Hey, thanks. Just a couple questions on the crop book. One is directionally, what do you expect out of that book this year? Is it kind of growth flat or otherwise? Secondly, were there any material changes on the renewal in terms of terms and conditions?
Hi, this is Mike Stone. Hi, Matt. Again, we continue to like the crop business. Obviously premium is driven a bit by commodity prices. We would expect our crop premium probably to be down a bit. We did renew the reinsurance partnership. We would expect the premium to be down a little bit in 2012, but it's yet to be determined with the price and the overall conditions in that market.
Okay. In terms of the renewal, any material change to terms and conditions or the length of the renewal?
The renewal is on an annual basis. We went from a 6% quota share to a 4% quota share. Some of that was driven by them seeking better terms in 2011 crop year, if I got that right, being not as good as it was before. We felt like keeping our overall premium at around what we wanted to be to begin with, given the spike in prices, 4% gets us about where we want to be.
Got you. Thanks a lot.
We have no further questions in the queue. At this time, if you'd like to ask a question, please press star one. Mr. Jacoby, we have no further questions in the queue at this time.
Great. Now I'd like to turn the call over to John Michael.
Thank you, and thank you for attending. I want to thank all of our 900 associates for another fantastic year. 78 combined ratio of our volume was up even without the acquisition of CBIC. We have had a terrific year, and we look forward to delivering even better results next year. Thank you all for listening, and we'll talk to you next quarter.
That does conclude today's conference. Thank you for your participation.