Hi, we're about to begin. Good morning, and welcome, ladies and gentlemen, to the RLI Corp. Second Quarter Earnings Teleconference. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including 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. 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 Teleconference for the second quarter of 2011. Joining me for today's call are Jonathan Michael, Chairman and CEO of RLI Corp; Joseph Dondanville, Senior Vice President and Chief Financial Officer; and Mike Stone, President and Chief Operating Officer of RLI Insurance Company. The format for the call is as follows: I'll give a brief review of the financial highlights, then Mike Stone will talk about the quarter's operations, and we will open the call to questions. Jonathan Michael will finish up with some closing comments. Operating income came in at $1.91, up from $1.52 last year. There were, however, a variety of items that impacted these results positively on balance. First, there was favorable development on prior year's loss reserves of $43 million, which more than offset spring storm losses of $12 million.
The favorable development spanned each of our segments but was most pronounced in casualty. Also of note during the quarter, we closed on our acquisition of CBIC. As a result, our top line increased by $10 million or two months' worth of premium. With the addition of CBIC, gross premium grew 10%. Since Mike will provide more detail on underwriting performance, I'll jump ahead quickly to investments. Here, we, like the rest of the industry, continued to be challenged by a low interest rate environment. There were no material changes to the asset allocation in the quarter other than the buildup of cash, which was temporary as we repositioned the CBIC portfolio we acquired to match the profile of our existing investments. The investment portfolio's total return in the quarter was 2%. Through six months, it was up 3.7%.
Add up all the moving pieces, book value per share came in at $41, up 9% from year end. I will now turn the call over to Mike Stone. Mike?
Thanks, Aaron. Good morning, everybody. I think a very good quarter. We continue to execute and thrive in this difficult insurance market and soft economic environment. In our casualty business, our gross written premium was flat for the quarter. Our combined ratio was 64. Our new products, the CBIC package policy that we provide to contractors, produced some $6 million of premium in the quarter. Our professional services product line, the architects and engineers professional liability, and now package policy provided some growth of some $2.5 million in the quarter. Our E&S business, our more cyclical businesses, our E&S GL and commercial umbrella business, off some 17% in the quarter or $5 million, our transportation product down some 12% or $1.5 million in the quarter. Pricing is basically flat in the casualty lines. I wish it was fat.
As we struggle with this soft insurance market, as I indicated, a difficult economic climate, we're not seeing business growth, we're not seeing new business opportunities, with everybody fighting for their renewals. Our management liability business, the D&O coverage is a different story. Pricing off some 15% year to date as too much capacity chases way too little demand. Overall, we're expanding our specialty admitted businesses, our professional services, the package policy there, our professional liability, our CBIC packages for contractors while our E&S is shrinking. This is how we're trying to manage through this cycle. So far, I think we're performing very well. Property. Gross written premium up 16% with a combined ratio of 80.
A pretty good performance in a very difficult environment with quite a bit of catastrophe loss and a version change in the model that we continue to work through. Our reinsurance business was up some 67%, about $4 million in the quarter, as we find more opportunities and grow out our footprint in that business. Our E&S property business is up 3%, about $1 million in the quarter. As I indicated, the version changes helped mitigate the cyclical deterioration in this business. We did have spring storm losses, as mentioned by Aaron, of some $12 million. These were offset by a takedown on the last remaining Northridge claim of some $6 million. By the way, that's a short tail line of business. We think we're done, that's 17 years later. Our crop business is up some 35% or $6 million in the quarter.
While that business is performing well from a top-line perspective, the profit picture is a little murky with the drought in the Southwest and the excessive moisture in the Midwest and Mississippi Valley causing us some issues on the profit side. We don't expect it to be as profitable as last year. We're still optimistic that it will produce a profit. Surety. Gross written premium up some 26% in the quarter or $5.7 million. CBIC contributed some $4.6 million of that in the quarter. Our contract, our RLI business in Contract, Commercial, Miscellaneous, Oil and Gas, grew slightly in the quarter. Surety is still performing well. 60 combined ratio. Still not seeing any adverse trends from the economic slowdown. On our CBIC integration, it's moving according to plan.
We've begun integrating the surety team and enhancing the product mix by offering CBIC products through the RLI agents and vice versa. The property casualty package product has been analyzed, some enhancements implemented, and the product will be offered through the RLI agents in the very near future. Overall, we see real upside on the surety and the package products over time with the integration of this business and being able to offer these products to the RLI agents. We're pleased with the speed and efficiency of the integration thus far. As I've said, a good quarter, a superior quarter with prior year consideration. We continue to outperform. We believe it's our business model. That's what makes us different. It's our underwriting culture and discipline, the underwriter compensation, and paying them a percentage of the underwriting profits paid out over the tail of the particular product.
It's a diversified product mix. We've shifted from in 2005, where we were about 70% casualty, to today, we're 43% casualty. The shorter tail lines, property and surety, that used to be 30%, they're now 57%. We grow by design. This is how we try to manage through the cycle. Organic growth where warranted, talent acquisitions, and acquisitions as they present themselves as opportunities, as the CBIC did. Overall, a very good quarter, a testament to our underwriters and our business model. With that, I'll send 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 one on your touch-tone telephone. If you wish to withdraw your question at any time, please press star two. Your question will be taken in the order that it is received. Please stand by for your first question. We will go first with Randy Binner with FBR Capital Markets.
Oh, thank you. I thought your comments on surety were interesting. Obviously, it seems to be a place where you're making a larger allocation of the business, and you commented that the results were good. You're not seeing an impact from the economic slowdown. Travelers also saw some favorable contract surety development in the quarter. I'd just like to get some color on the comfort level around that versus a soft patch in the economy. Is surety overall holding up well, or is it more what you're doing on the underwriting side there?
This is Mike Stone. It's what we're doing on the underwriting side. We think overall surety industry performance will be pretty good. I don't think we've seen adverse trends that you might expect through this economic downturn. We're very vigilant about this, particularly in the contract side and watching that business and how it's performed. We've been through difficult patches in surety in the past, both through economic times, but also through, we think, probably we performed not too well on the underwriting side. We've improved our underwriting markedly and think we're managing through this cycle very well. I do think as things continue to soften, that there's a risk in the commercial surety side as well. That's where things like Enron came in and provided a very difficult fixture for surety underwriters in the past.
We're vigilant in that area as well, and that's continuing to perform probably a little bit better than expected. Overall, obviously, we like the surety business. That's a big part of why we acquired CBIC.
Just to follow up there, because I think it's interesting, just on the contract side. I think, is the dynamic being that a lot of the contractors just were able to build up and maintain cash reserves across the economic patch better than they did last cycle? Again, intuitively, it just seems like it would be more of an issue, and it's not. Just wanted to flush that out a little bit more, and then I'll drop back in the queue. Thanks.
Actually, I think at least from our business standpoint, overall, I guess if the rest of the sureties are experiencing fairly favorable results, what you say is probably correct. Certainly, we've done a better job of making sure that the contractors that we provide bonds for are more financially secure. We do a better underwriting from the standpoint of the technical aspects, making sure where their cash reserves are and how well they're managed. At least our contractors have come through this, not without exception, but all in all, in pretty good shape. There's not much room for error in surety. It doesn't take many losses to turn what you think is a pretty good result into a not-so-good result.
Understood. Thanks for the comments.
We'll go next to Mike Grasher with Piper Jaffray.
Good morning. Congratulations on the quarter. Great quarter. A few questions here, I guess, around the property losses and the cat-exposed property. Has that resulted in any change in your expectation or anticipation on exposure and likelihood of driving through more rate?
Mike, this is Michael J. Stone. I think everybody thinks they're going to drive more rate. It doesn't look like that's really happening. We're getting a little bit of rate on the wind business, and actually a bit of rate deterioration on the DIC business. A lot of the storms, certainly the storms that we experienced, are spring storms that are a little less susceptible to modeling. Certainly, the RMS version changes has, I think, buoyed rates a bit. Maybe not as much as we first anticipated as people kind of try to figure out how to manage through that. All in all, I think we've done a deep analytical look at our cat business, and we do that on a very regular basis and feel comfortable with our exposures and how they're being managed.
We don't look at it just on a model basis, but we also look at it on an actual exposure basis and how much we have in various zones and how we manage that. All in all, I think we're comfortable with our catastrophe business and exposure. Also, I think rates, again, without some event, I'm not real optimistic that rates will move north.
Okay, fair enough. Just around casualty, I think you mentioned that pretty much flat here with the competition. Is the competition more standard lines or standard carriers coming in? Is it more pricing, or is it terms and conditions that maybe they're offering?
Again, it's Mike Stone. Certainly, there's no want of competition. The standard lines companies are obviously moving into what was the surplus lines space in the hard market. Just by the sheer dint of being an admitted product, their terms and conditions are more expansive than what we can provide as a surplus lines carrier. There's certainly plenty of competition from the surplus lines companies as well. I think what you see in our casualty business is we all are fighting for our renewals and are working hard to keep them. There's just not a whole lot of new business out there circulating for our underwriters.
Did you mention what it was on the renewals that you're seeing? Are you getting pushback for single-digit rate increases? Are you able to drive through the single-digit rate increases?
It's basically flat. It's been basically flat for the last couple of quarters. Five points here, five points there. It depends on what the renewal is. It depends on the quality of that individual renewal, but on an aggregate basis, it's been pretty flat.
Okay. Then final question would be just around the CBIC business. Is there any way we can gain some perspective on the products, the surety product, and then the CMP, how maybe they're different than what your existing product lineup looked like and what it means for the RLI agent force?
Again, it's Mike Stone. On the surety side, they really operated with smaller contractors. They had some products that are very marketable to smaller contractors, an SBA product, a product that went to contractors that were doing $500,000, $1 million single aggregate jobs. In other words, fairly small contractors that we're not really as good at. We're going to be able to offer those products into our agency force. We're going to be able to offer a larger limit product to the CBIC agents. There's really opportunity both ways. On the package policy, we don't have a package policy in the contractor space. This provides an opportunity for us to roll out the package policy to our surety agents, and we have a significantly larger number of contract bonds than just CBIC.
As we roll this out to additional geographies, we expect to gain some traction with that product.
Okay, that's very helpful. Have you taken a stab at what you're projecting for the cross-sale opportunity here with regard to the package product?
We see significant opportunity. As we go into new states, we'll start to assess what we think our opportunity is going to be. Right now, on an overall basis, we're trying to get the product enhancements in place and talk to our production sources, our agency groups, and get a sense of where we're headed. It's a little early for that.
Okay, fair enough. Thanks.
We'll go next to Matt Carletti with JMP.
Hey, good morning. Thanks. Just a couple of questions. One is on the casualty reserve releases in the quarter. Can you give a little more color? You guys have had strong releases for a while, but the level we saw in the quarter, even for you guys, was something we haven't seen in several years. Was there anything unique in the quarter, either we're looking at different accident years or kind of a one-time item that popped it up?
Matt, this is Joe Dondanville. The casualty releases really took place in the 2001-2003 and 2005-2009 years, with a large portion being closer to that 2009 year, where we had reacted pretty conservatively on some habitational problems that we saw in the GL book. After a couple of years of evaluating it, we have made some revisions down on those loss estimates.
Okay. That's very helpful.
On the other casualty lines, we've seen favorable developments pretty much across the board. Loss trends continue to be favorable.
Okay. Do you have the accident year loss pick for Q1 and Q2 handy? I can back off the development, but I know the profit contingent is kind of an expense item that gets in the number you report. Do you have the actual loss pick handy for casualty?
It's around 70%.
Okay.
It'd be fairly consistent between the first and second quarter.
Okay. Last question is on just the crop business. I know Mike commented on this year's view. If I recall, that was kind of a couple-year quota share you entered into, and it's, I think, coming up for renewals sometime in the near intermediate future. How pleased have you been with that, kind of entering into that line? Is that something we're likely to see you renew or something that didn't live up to expectations?
Well, we're in discussions on renewal now. Obviously, we need to get through a little bit more of this crop year, we think it's a good business long term. We'll continue to work on managing that relationship, we look at other opportunities as they come along on the crop business as well.
Okay, great. Thanks a lot.
We'll take our next question from Arash Soleimani with Stifel Nicolaus.
Hi. Just a couple quick questions. One, just on the expense ratio, I just wanted to make sure it had gone up a little higher than we had expected. Is that more related, do you think, to bonus accruals or perhaps just the CBIC transaction, or just wanted to get a little bit more color on that, please.
This is Joe Dondanville. It's both. The CBIC acquisition contributed $1.6 million of that increase for their home office expenses, and the other portion, $2.1 million, is bonus and profit-sharing related.
2.1, okay. Just the next question. I saw that your equity allocation had gone down a little bit this quarter. I just wanted to see, is 20% still your long-term target, or has that strategy changed at all?
No, that strategy has not changed. In part, it's the consolidation of the CBIC portfolio that helped or that contributed to the allocation going down. We will be looking at that CBIC portfolio over the next several months to reposition it to match what we're doing in our other lines.
Okay, great. That's all for me. Thank you so much.
We'll go next to Doug Neuberger with RBC Capital Markets.
Hi, good morning. Excuse me. Looking at your casualty line, assuming if you back out some of the CBIC contribution, it looks like there's a slight downtick in organic growth, which has sort of been the norm for the past five years or so, isn't anything unusual. You said prices were flat. Does that imply that you're still, I guess, booking on a written basis at least a downward trend in exposure units, or is there so much business mix shifting around that it's hard to look at it that way? Looking from an economic perspective.
This is Joseph Dondanville. Line by line, there are certain lines like GL, in which our exposure units are going down. They continue to go down. Then we have other lines, new product lines, like the architects and engineers design program. Those are actually going up. Because GL has been our largest line, the impact on the economy on that line still is lingering, and it has had a bigger impact on overall direction of the book of business. Exposure units are going down. We're seeing the increase. It's not a significant rate change that's driving that number.
Okay, thanks. I just had a question about your ag business. Could you go over again the seasonality with the business? I know that you book a large portion of your premiums sort of in the mid-year, but then they earn out in a specific time as well. Also, is there a point in time where you have to, I guess, true up the price and volume and maybe make a reserve adjustment associated with those contracts?
This is Joseph Dondanville again. On the crop, about 80% of the crop premium, written premium, is booked in the second quarter. The season is typically starting in April, late April, May, through October, November, through the whole growing season, primarily for corn and beans are the two biggest drivers there. As the ag puts out estimates, we react on those estimates on yield and then monitoring price that drives any changes that we see. At this point, the drought effect and some late planting effects has caused us to book crop at a slightly higher than their average, their historical average. I think just recently, we received the final crop numbers for 2010 crop year. It pretty much flushes itself out within a one-year period.
Okay, thanks. That's all my questions.
Once again, it's star one to ask a question. We'll go next to Adam Klauber with William Blair.
Good morning. Thank you. Could we maybe get some more color on the favorable reserve development? How big a factor was that, the release and the habitational? Would you say it's more than a third of the release, say?
It's probably in that third ballpark. It's one of the largest pieces.
Okay. Then, in addition to that, it sounds like you're seeing pretty good development in more recent years. Does that account for also some of the step-up in favorable reserve releases?
Well, we do have development going back to 2001 and 2004 on the casualty as well. It's not all the most recent years, but 2006 through 2009 also seen some favorable developments as well. It's kind of across the board in all years in that the loss trends have been favorable.
Okay. Just from a process standpoint, being mid-year, did you do more of a significant review? You obviously look at them on a quarterly basis, but did you do a bit more of a mid-year review on them?
Well, our process is to do detailed reviews starting in the second quarter, third and fourth, and we do not do a detailed review in the first quarter.
Okay. That helps out. Then on the property, which you've talked about a bit, could you be more specific where the growth opportunities in the property area are?
Yes, Mike. We certainly grew our RLI Re business.
We see opportunities as we build out that footprint there. Marine was up. Certainly, the crop business was up.
Is the Re business, is that more domestic or international?
No, it's domestic.
Domestic, okay. Do you see those opportunities in the Re and the Marine continuing go forward?
Again, I think our reinsurance business has some legs. It's got some opportunity to grow. We're fairly small. We're going to continue to be small overall, but we're going to be a specialty player. There's some opportunity there. Marine, we've spent a lot of time fixing the underwriting on that business. We think we're getting there. A modest amount of growth as we move forward. Certainly, we need a change in the market for us to see real, more significant growth.
Okay. Thank you very much.
If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you. Thank you all for joining us this morning. It was a great quarter with the reserve release, as Mike indicated, and a very good quarter even without that release. Premiums were up 10%, underwriting income, $46 million, combined ratio is 65, and it was 89 without the reserve development. Book value is up nearly 9% since year-end. The CBIC acquisition was completed, and integration is proceeding smoothly. We continue to be well-capitalized, and we're prepared to be opportunistic as the market allows. We had a good quarter, and I want to thank you for joining us, and we'll talk to you next quarter. Thank you.
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