Good morning, 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 the Form 8-K with the Securities and Exchange Commission that contains a 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 management believes this measure is useful in gauging core operating performance across the reporting periods that 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 Treasurer and Chief Investment Officer, Mr. John Robertson. Please go ahead, sir.
Thank you. Good morning to everyone. Welcome to the RLI earnings teleconference for the third quarter of 2010. Joining me for today's call are Jonathan Michael, President 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 and discuss the investment portfolio. Mike Stone will talk about the quarter's operations, then we'll open the call to questions, and Jonathan Michael will finish up with some closing comments. Our third quarter operating earnings were $1.19 per share. Included in this quarter's earnings are $20 million in pre-tax favorable development and prior year's loss reserves, which came from all segments. The combined ratio for the third quarter was 83.1.
Gross written premiums were basically flat when compared to the third quarter of last year and flat through the first nine months of this year compared to last. We were able to offset the premium declines in our casualty lines, which are sensitive to economic conditions such as building and transportation industries, with our crop and other assumed property reinsurance risks. Comprehensive earnings were $58 million for the quarter and $115 million year to date. Through nine months, our book value per share has grown 11% to $43.54. Turning to the investment portfolio. As of September 30th, our overall allocation was 78% in fixed income securities, 15% in equities, and 7% in short-term investments. The total return on our investment portfolio was nearly 4% for the quarter. Our total return in the bond portfolio was 2.5%, while equities were up 11.4%.
Year to date, our total return in the portfolio is nearly 7%. Investment income was $16.8 million for the quarter, up 3% over the same period last year and flat through the first nine months of this year. Changes to asset allocation, reducing our muni holdings and going into taxable securities, along with a growing asset base, has helped offset the declining reinvestment rates. Continued weak economic indicators have sparked more speculation of further quantitative easing by the Fed and has led to an extended rally in Treasury yields. With the highest unemployment rate in over 25 years, consumer confidence and spending remain subdued. Leverage helped fuel the economy over the past 10 years, and as consumers de-leverage and increase their savings rates, this constrains their spending. This, combined with the Fed's open market actions, has helped keep rates low for an extended period.
While the yield curve remains very steep, given where rates are, we are not extending duration at this time and remain asset liability matched. Our duration is at 3.5 versus 5.1 last year at this time. We continue to look at more defensive securities, such as step ups and floating rate coupons, as we invest our cash flows. Equities continue to be volatile, with equities posting the best September return dating back to 1939 and pushing the indices into positive territory for the year. The gains came as a result of modestly improving economic data and a growing belief that the additional quantitative easing will prevent a double-dip recession. While we have allocated some funds into equities during the market decline, most of the increase in our allocation has come from appreciation. We focus on equities with lower volatility and dividend income.
We believe this provides better protection in a declining market while providing long-term book value growth to enhance shareholder value. While we continue to believe in the long-term benefits of equities, we think the economic headwinds are strong enough to warrant caution. We are dollar cost averaging small amounts into equities and will continue to do so over time as the economic recovery strengthens. On the municipal bond front, we have reduced our exposures to roughly 13% of our portfolio versus 23% this time last year. As you know, over the past year, we have weighed the risk versus the return in our muni bond portfolio and opted to reduce exposures where we see higher risks. While this increases our effective tax rate, we believe state and local governments continue to be fiscally strained, and this sector will continue to come under pressure with budgetary shortfalls.
The tax equivalent book yield on our fixed income portfolio is approximately 4.9%, and the book yield on our equity portfolio is 4%. The portfolio quality remains double A, and as I indicated before, the duration is 3.5, no change from the previous quarter. Finally, we had no securities that were deemed OTTI for the quarter. Turning to the share repurchase. During the quarter, we repurchased 35,000 shares at an average price of $56.39. Over the last five years, we have returned over $400 million in capital to shareholders in the form of dividends and share repurchases. As we have said many times, our first choice is to deploy our capital to create shareholder value. When we do not see opportunities to effectively use our excess capital, we return it to shareholders. We have roughly $94 million remaining on our current share buyback authorization.
For the operations highlights, I will now turn the call over to Mike Stone. Mike?
Thanks, John, and good morning, everybody. Another excellent quarter as we continue to benefit from benign loss cost inflation. combined ratio of 83 is excellent even by our standards. Our gross written premium, basically flat in a very difficult environment, both from a pricing standpoint and the continuing weak economy. In our casualty segment, gross written premium is down about 5% for the quarter, 9% year-to-date. Rates are basically flat for the quarter and down about 3% year-to-date. We post a 84 combined ratio in this segment. We continue to walk away from underpriced business in this segment, and we are actually raising rates in our general liability product line as the accident year results are north of 100 combined ratio.
This product is under considerable pressure from the standard lines companies packaging much of this business, which is usually in the surplus line space, as well as abundant E&S competition. We would expect our competitors are well above 100. Remember that we typically outperform the industry by some 10 combined ratio points. The economy and market softening is a double hit to our casualty business. Construction, which is a big part of this area, is not moving forward yet, so there is quite a bit of competition chasing less and less premium. We will continue to underwrite carefully in this space. In our property area, gross written premium up 5% for the quarter, 15% year-to-date. combined ratio of 89, growth driven by our crop business and RLI Re, our facultative reinsurance business. Our E&S property business is down a bit in the quarter and down a bit year-to-date.
Obviously, the benign cat year and prices are reflecting a lack of a major cat loss this year. Our marine business is down about 14% for the quarter and year-to-date as we continue to re-underwrite this business and competition remains intense in this space. Surety, an excellent quarter, 63 combined ratio. Gross written premium down a bit, but it's up a bit year-to-date. Our energy surety business is under pressure due to the drilling freeze in the Gulf. We'd expect that to pick back up as that starts to unfreeze, if you will, but licensing in there is very slow. We are very mindful of what a weak economy can do in surety, and we're being very careful as we underwrite this business. Overall, a very good quarter, as I said.
We continue to invest in new products and build out our portfolio. We are seeing meaningful production from those new products, for example, crop, Design Professionals, factory. While we shrink underpriced products, for example, our general liability, our transportation, we continue to deliver excellent results in a very difficult marketplace in a weak economy. John, that's it.
Thanks, Mike. We're now ready to open the call up to questions.
Thank you, sir. The question and answer session will begin at this time. If you're using a speakerphone, please pick up your handset before pressing any numbers. Should you have a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star two. Your question will be taken in the order that it is received. Please stand by for your first question. Your first question comes from the line of Ken Billingsley from BGB Securities.
Good morning. Congratulations on the quarter.
Morning, Ken. Thank you.
Thank you, Ken.
Just a few questions. You gave a little bit of insights on rates and exposure units being down. Could you talk about competition as it revolves around terms and conditions? Is there a magnifying impact to income statements in the future due to competitors not only lowering rates, but offering more coverage than maybe what you are comfortable offering?
Yeah, Ken, it's Mike Stone. As you would expect at this stage in the cycle, we're starting to see a little bit of that. Not nearly to the extent that I think we saw in the late 1990s, but we're starting to see a little bit on the casualty side with some of the typical exclusions that you would see, for example, lead, mold, those kind of things on habitational business being removed. On the property side, there's pressure on deductibles. Overall, we're not seeing a complete running away from terms and conditions that are important to our business. We're starting to see some of it. It's really kind of a pricing that's more difficult right now in the standard lines, guys.
If you want to call that reducing terms and conditions, because obviously they don't have a lot of the conditions and exclusions that surplus lines companies would have. That's where most of the competition is coming from.
Back in the end of 2008, early 2009, a lot of CEOs were talking about rates should go up, but they weren't raising rates themselves. That tune has changed. Can you just comment maybe what you're seeing regarding the fact that there's fewer people talking about maybe that rates are going to go up in the near term like they did 12 to 18 months ago, yet the combined ratios on an accident year basis are in the 103-108 range?
Well, obviously, we're bumping along the bottom. I think that's the point. There's not been any real impetus of catalysts for a broad strengthening. When you have the standard lines companies eating into the E&S space the way they are, it also has a lot of capital chasing not as much premium. I think results are going to have to get worse. Reported results are going to have to get worse. There needs to be some sort of catalyst. You're right. The industry can't operate in this investment environment at a 108, 110. It'll come home. It's just a matter of time.
On the financial D&O product, I heard earlier today that there's fewer writers out there. Is that creating an opportunity for you, or how are you addressing that line of business?
It's Mike Stone. We're not much of a player on financial institutions in the D&O space. We'll write a little bit of Side A for financial institutions. That is basically the bankruptcy protection. Financial institution pricing has been fairly robust in the D&O space for a while. We're not a competitor overall in that space.
Last question, then I'll turn it over so other people can ask their question, is your comment was made that there, we see this a lot at the end of the year, where underwriters are attempting to grab business before year-end, whether they admit to it or not. Are you expecting to see as strong of a push in competition as people are trying to lock in some premiums before year-end?
This is Mike Stone again. That's certainly our fear, that the fourth quarter is usually a tough quarter for us. It's a tough quarter for underwriting companies in a soft marketplace. In those companies that have premium budgets, those budgets are part of compensation plans, it's tough. We don't have those kinds of goals, objectives. They're not part of our compensation plan. It's harder for us in a soft market in the fourth quarter, typically.
Great. Thank you, congratulations on the quarter.
Thanks, Ken.
Your next question comes from the line of Caroline Sears from Macquarie.
Hi, everyone. Some of my questions have been answered, my first question is just on market opportunities. In your press release, you mentioned that you were looking at some niche opportunities now, I was wondering where you are seeing those opportunities, what lines of business, whether you're looking more towards acquiring teams or whether M&A is more up your alley? Thanks.
Okay. Jonathan Michael. Of course, we have, in the past, niche opportunities come our way in acquisition of teams, mainly. That's our preferred method of growth in terms of inorganic-type growth. At the same time, we look at acquisition opportunities in the form of companies. We haven't done one of those for a long time, I would not rule out that sort of activity for us because we have been and will continue to seek those types of opportunities. Our preferred method of growth inorganically is acquiring teams or startup operations.
Is there any particular segment that you're more interested in? Is it more the reinsurance segment? Sort of what's preventing some M&A from happening now? Because we haven't seen too much.
It's not the reinsurance segment. We had started up a facultative property reinsurance segment, and of course, we are now a participant on a crop reinsurance deal. That's not our preferred
Direction. We're looking at more specialty niche-type products, and they run across the board for that.
Okay, thanks. Just finally, did you mention what years the casualty development came from or what lines of business?
This is Joe Dondanville. The casualty development came from 2005 through 2010, some positive and some negative, as well as some older 1999 and prior adverse development. The lines, the adverse is the old discontinued reinsurance programs back prior to 1999 or prior to 1996. The casualty came in a variety of areas, including our D&O area, our personal umbrella, transportation, and GL with a mix of positive in the prior accident years and negative in the current accident years.
Okay, that's it. Thank you.
Your next question comes from the line of Raymond Iardella from Oppenheimer.
Thanks, good morning, everyone. First one, I guess for Mike Stone. I think you had made some comments last quarter that you were seeing some encouraging signs in the commercial trucking business from an exposure perspective. Can you talk about whether you're still seeing this trend, or I guess, are there any other favorable exposure comps in other lines of business?
Yeah. We continue to see on the trucking side a little bit of increased activity. Miles driven are up a bit, so receipts are up a bit. Last year at this time and in our prior quarters, we were having return premiums. We're not having that. That's not taking place today. Rates are still fairly soft. From that perspective, we're seeing some positive trajectory. We're encouraged there. Typically, I would say that's the industry's canary, if you will. Typically, we'll start to harden sooner than the rest of them because it's a short tail casualty line. That's the one positive. We're not seeing that broadly in that product line, though. That's broadly from the standpoint of rate increases or reduced competition. There's still a considerable amount of competition.
Got it. Thanks. That's very helpful. I guess from a loss perspective, I know you had mentioned on the casualty side, you were seeing an increase in the accident year loss ratio, I guess, in the general liability product, and you guys were kind of reacting to that by raising price. It looked like the property accident year loss ratio ticked up a little bit in the quarter as well. Is that just due to, I guess, a change in business mix with the crop and in the assumed property book, or is that something else that's driving that?
There's that. The crop is causing the loss ratio to go up on the property side. We've had some summer storm losses from some of the small cats that hit the Midwest during the year, during the second quarter. We had an uptick in actual losses on the fire and on the assumed reinsurance portion that are more seasonal.
Got it. Okay. I guess quick numbers question. How much do you have in cash and I guess short-term securities at the holding company? Do you have that number by chance?
Probably about $50 million. It's $50 million or less. It's not a significant amount of cash there, but it would be in short-term type investments.
Got it. Thanks, guys.
Thank you.
As a reminder, if you would like to ask a question, please press star one. We'll go to our next question from John Grimstad from Piper Jaffray.
Good morning, and thanks. I was wondering if you would just give a little bit of color on frequency trends within each line. Any signs that point to an uptick? Thoughts on the remainder of the year?
This is Mike Stone. I think obviously we've seen a bit of uptick on the GL side, on the frequency side. Transportation, a bit of an uptick. I think beyond that, it's nothing unusual. Those are the two that we're seeing a bit of an uptick.
The other lines, as you said, pretty much stable, no deviation either way?
Yeah. Surety is probably down a little bit. Yeah, the other lines are fairly stable.
Going forward, you expect this to kind of play through the remainder of the year as well?
Well, certainly on the GL side, we would expect that it's not going to come to a screeching halt. We're re-underwriting that and expect to have less of that as we move through the quarter to quarter. Transportation is fairly short tail. Hopefully, that'll reduce itself as well.
Great. Thanks a lot.
Our next question comes from the line of Dean Evans from KBW Investment Bank.
Yes. Thanks. Good morning. I guess we sort of addressed why the accident year was a bit higher on the property side. I was wondering if you could touch on the casualty side. That also seemed to be running a little above recent trend.
Yeah. Mike Stone. Yeah. Our general liability
By the way, our largest casualty product is performing less well than it has in the past. Obviously, there's a considerable amount of competition in that space. As I said earlier, the standard line guys are packaging up this business, leaving less business in the E&S space, being chased by abundant amount of competition. We are pulling back, we're raising rates, and obviously, we're shrinking as a result.
There's really no one-time items, just sort of the general toughness in the GL market.
I'd say so.
To touch back on the property side, do you have at hand the actual dollar value of cat losses in the quarter? You did mention there were some items that helped drive the loss ratio up.
It's approximately $2 million.
Okay.
Our next question comes from the line of Doug Morter from RBC Capital Markets.
Hi, good morning. First question revolves around surety. Looks like your loss trends seem to be very favorable, both on the favorable reserve development, but also your loss picks are actually coming down as well, if you look at year-to-date or the quarter compared with the quarter last year. I was wondering if you could comment on that, and especially regarding a worsening economy, and you have more contractors going out of business. Is some of it maybe a comparison when the economy was really scraping bottom, and that might be an indicator? Or is it change in mix or just better underwriting?
Let me just try this first, and I'll let Joe augment what I say. First off, I think we've been conservative. We're not unmindful of what a weak economy can do to surety. We're also not unmindful of what bad surety underwriting can do to us. We've been through that. We've been very careful about our underwriting. I think, like I said, we've been conservative about how we've looked at the loss picture. I think we're starting to see favorable results. We're starting to believe that our results are going to be better than we expected, and our underwriting better than we expected. Certainly, again, we're still not unmindful of what a weak economy can do in contract surety and commercial surety. We've also not seen commercial surety underwriting getting aggressive. Our competition doesn't seem to be getting very aggressive in that space either.
We are benefiting from that. In prior cycles, it's gotten very aggressive. We feel pretty good about our underwriting in this space right now.
Yeah. I'll talk a little bit about the releases. They're generated from the commercial surety and contract surety as Mike has spoken to the, I guess, a little bit more favorable outcomes than what we had thought were going to occur with the economic downturn. Those are coming from accident years 2007, '8, and '9, where we just haven't seen the losses develop. Although we're trending, that seems to be the direction we're headed. We still look at this as potential exposure going forward.
Okay, thanks. I just have two numbers, questions to follow up. First, do you have at hand the amount of ProAg premiums that you wrote or actually that you assumed in the quarter? Also the, I guess, the year-over-year premium, I would assume premium declines in your GL and your transportation books.
Okay. The ProAg was about $3.5 million in the quarter. Just to comment, our expectations on the crop premium starting out was about 10% higher than what's actually come in. It didn't meet our original expectations, and I think you'll see that not just for us, but for the whole crop industry, the premiums we expect to be down. In looking at the transportation for the quarter, it was flat. For GL, it was off by about a little over $4 million or about 17% for the quarter. I think Mike had spoken about the re-underwriting in the GL areas that occurred this quarter.
Okay, thanks. That's all my questions.
Our next question comes from the line of Meyer Shields from Stifel Nicolaus.
Thanks. Joe, if I can ask a couple more questions on the casualty loss development. If we take out that $0.52, let me ask it differently. Does that $0.52 include the strengthening you mentioned for earlier quarters in 2010?
No.
No.
Okay.
That's just prior year only.
All right. The year-to-date number would probably be a better read of about 105% accident year?
Yes.
Okay. Secondly, just looking forward in terms of transportation, we've got CSA 2010 coming up. Can you tell yet what the impact is likely to be on, I guess, exposure units and insurance competition?
I'm sorry, what was the first part of that question, Meyer?
When we look at the regulatory initiative, CSA 2010, in terms of monitoring truck driver safety records.
Yeah.
We've seen a lot of estimates saying that that's going to knock out, let's say, 10% of drivers right now, but it should make for safer drivers and therefore better risks. I'm wondering if you're seeing an impact yet in terms of how insurance buying behavior is changing.
Yes, Mike Stone. I don't put as much stock in that as some other people do. We're not seeing it yet. Obviously, our underwriting process already involves a very careful review of individual drivers, both from a licensing standpoint, prior accident standpoint. I think we're ahead of the curve when it comes to underwriting in this space anyway, so how much impact it will have overall, that's, I think, difficult to assess. Obviously, it should have some beneficial effect going forward, but being able to quantify that would be rather difficult right now.
Okay, thanks so much.
Your next question comes from the line of Bijan Moazami from FBR Capital Markets.
Good morning, everyone. A number of questions. First, I can probably back into the numbers, but what accident year loss ratio you're assuming the surety business now?
The accident loss ratio on surety, Bijan, for the year is, I think, around 21, 22.
How does that compare with the accident year loss ratio for previous years?
It's a little better.
It's better.
I think in prior years, it might have been closer to 25.
Okay, fully adjusted?
Yes.
What is the overall reserves that you carry for the surety business? IBNR and case.
That I do not have in-hand, Bijan. We'll have to get back to you.
Okay, great. In terms of property, you guys have been growing the property business. What's your appetite for DIC, and where are you growing at this point?
It's Mike Stone. Obviously, the growth in property is coming mostly from crop.
Okay.
Typically our DIC business, what we've said over the past several years, is only going to grow if rates grow. While we have a little bit of room within our internal appetite, we don't have a lot. Rates in DIC, earthquake we're talking about here, are off considerably in the quarter. There's been increased competition there. We're comfortable with where we are. We're probably not going to grow that by much. Rates come up, and we're able to be able to get more premium for that exposure, our premium will go up, but simply by a function of the rate. We're not going to add to the exposure in any meaningful amount.
Okay. In your prepared remarks, Mike, you were saying that the loss cost is relatively benign, and there were a couple of court cases in California on the work comp side that has pushed up the loss cost, at least on the indemnity. Have you guys seen other cases that would suggest that the courts are becoming a little bit more aggressive, or the jury's giving larger awards than before?
I think we've seen some cases. There's another California case on indemnification that affects the contracting business. We are starting to see some tort reforms unravel. I think it's a little early on the jury awards. I think we'll see that as we get new judiciary by the current administration and more liberal state governments as well. I think over time, we'll see an impact of that.
Thank you.
Okay, Bijan, the surety reserve number is approximately $20 million.
$20 million. Thanks.
Our next question comes from the line of Vinay Misquith from Credit Suisse.
Hi, good afternoon. Can you give us a sense of why the favorable reserve development has stayed so strong for so long? Would that be a function of market conditions in the sense that frequencies and severities have been lower than what you expected?
This is Joe Dondanville. That coupled with a relatively low inflation rate.
Do you think that that's a negative for pricing overall? Because this trend should also impact competitors, correct?
Correct. Yes, I think it bodes not well for increases in pricing.
Okay, fair enough. The second point was on GL. I believe you mentioned that there was an uptick in GL frequencies. If you could just elaborate on that, and was it just on certain parts of your portfolio, or do you think this is an industry issue?
It is on a selected portion of our GL book in which we are pushing rates in order to try to correct it, which rate and re-underwriting is causing the book to decline. It's not the largest portion of our GL book.
Okay, that's great. Thank you.
As a reminder, if you would like to ask a question, please press star, then the number one on your telephone keypad. We'll go to our next question from Court Dignan from Fidelity.
Hey, guys. Thanks for taking the time. I had a question on the balance sheet. You guys have a great track record in basically basic blocking, tackling, staying disciplined, and generating an underwriting return. You've hit on a lot of the headwinds in the market today in terms of the standard line creep and other factors. I just look, and your statutory surplus is up, I don't know, maybe 50% over the last four or five years, and you're writing, I think, less premium. You're at, I think, below a 0.6 premium to surplus. Obviously, you enjoy a premium multiple for a good reason. It just seems like you add all those things together and does it make sense to consider sort of a large one-time special dividend to return some of the capital that doesn't look like it's got maybe great uses right now?
You continue to generate capital at a healthy pace, and I don't think there's probably too many great reasons to think that anything in the cycle is going to change in the near term. Just wondering if you could comment on that.
Thanks, Court. It's Jonathan Michael. Of course, we have a dividend policy. Sure, we look at something like a special dividend, and we have a buyback program. Our preferred method of deployment of capital would be to use it ourselves to find new opportunities. In that search, we're going to be very careful, and we will look at the aforementioned uses of capital in terms of dividend policy, buyback, and special dividends. Obviously, we couldn't comment on really any of those things until they become fact.
I don't know what happens with tax rates, but I'd be willing to bet that they're not going to go lower. Does a factor like that factor into your thinking in terms of near-term capital management?
I think perhaps this year, but we always take that in mind when looking at our own dividend policy. Other than that, I can't say really anything more about it. I mean, it's just, yeah, we think like you.
It doesn't appear that tax rates are going to go down.
Right.
Nobody's talking about that from a political standpoint, so we have to take that into account.
Can you just remind me what the process would be at RLI? Would it be a board vote in order to execute something like a special dividend? When would be the next time the board
Yeah, if it doesn't go to the shareholders, it has to be anything of any size. Yeah. Dividends have to be approved by the board, right.
When's the next board meeting?
This quarter.
Okay. Thank you.
As a reminder, if you would like to ask a question, please press star one. We'll pause for just a moment. If there are no further questions, I will now turn the conference back to Mr. Jonathan Michael.
Thank you. We're pleased to report another good quarter. All of our segments reported positive results. Premiums are flat from last year. That's good considering the economy and the insurance marketplace that we're faced with. Our conservative underwriting approach has and will continue to serve us well. We talked about that we are looking for ways to find new niches, and we'll continue to do that. We've been successful over the past several years of, and this past year of startup operations and new niches, and we'll continue to look for ways to deploy our capital. Speaking of capital, we have plenty of it, and we're mindful of ways to deploy that capital. I thank you all for joining us this morning, and I look forward to talking to you at our year-end press conference. Thanks. Bye.
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