Good day, everyone. Welcome to Selective Insurance Group's second quarter 2019 earnings call. At this time, for the opening remarks and introductions, I would like to turn the call over to Senior Vice President, Investor Relations, and Treasurer, Rohan Pai.
Good morning, everyone. This call is being simulcast on our website, and the replay will be available through September 3rd, 2019. A supplemental investor package, which includes GAAP reconciliations of non-GAAP financial measures referred to on this call, is available on the investor's page of our website, www.selective.com. Certain GAAP financial measures will be stated in the call that are also included in our previously filed annual report on Form 10-K and quarterly Form 10-Q reports. To analyze trends in our operations, we use non-GAAP operating income, which is net income excluding the after-tax impact of net realized gains or losses on investments, unrealized gains or losses on equity securities, and debt retirement costs related to our early redemption of our debt securities in the first quarter. We believe that providing this non-GAAP measure makes it easier for investors to evaluate our insurance business.
As a reminder, some of the statements and projections made during this call are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance and are subject to risk and uncertainties. We refer you to Selective Annual Report on Form 10-K and any subsequent Form 10-Qs filed with the U.S. Securities and Exchange Commission for a detailed discussion of these risks and uncertainties. Please note that Selective undertakes no obligation to update or revise any forward-looking statements. Joining today on the call are the following members of Selective's executive management team: Greg Murphy, Chief Executive Officer, John Marchioni, President and Chief Operating Officer, and Mark Wilcox, Chief Financial Officer. With that, I'll turn the call over to Greg.
Thank you, Rohan, and good morning. I'll first make some introductory remarks and then focus on some high-level themes and initiatives that enhance our strategy and position us for continued profitable growth. Mark then will discuss our financial results. John will review our insurance operations in more detail, providing additional color on key underwriting initiatives. Our second quarter results were excellent, reflecting ongoing superb underwriting results coupled with outstanding investment income performance. For the quarter, our combined ratio was 93.1, and after-tax net investment income was up 27% to $48 million that generated non-GAAP, fully diluted operating earnings per share of $1.16. For the first half of the year, we generated very strong annualized non-GAAP return on equity, or ROE, of 12.8%, which exceeded our full-year target of 12%.
Our ROE targets are established annually based on expected interest rate levels, our weighted average cost of capital, and excess margin over weighted average cost of capital, as well as the general property and casualty market conditions. The targeted ROE determines our insurance product pricing on a risk-adjusted basis by line of business and provides the baseline for the financial portion of our annual incentive compensation plan. For the quarter, all aspects of our underwriting operations performed remarkably with, one, overall net premium written growth of 7%; two, solid renewal pure price increases of 3.4%; three, strong retention; and four, new business that was up 7% to $146 million. We continue to execute on our initiatives around increasing our share of wallet within our Ivy League distribution partners, appointing new partners, as well as growing in our five recently opened states.
Based on the first six months, our insurance operations generated an annualized ROE of 6.4 points. We continue to maintain a leadership position in Commercial Lines renewal pure pricing that was up 3.1% in the quarter, 80 basis points over the Towers Watson CLIPS first quarter pricing print while maintaining stable retention. New business growth was strong, up 9% to $111 million. Our current view of the Commercial Lines marketplace is favorable both from a pricing and a pure premium standpoint. For the first six months of the year, our overall observed casualty claim frequency count for the current accident year have been reported below expected levels. In addition, favorable Commercial Lines prior year casualty reserve development improved that segment's loss and loss adjustment expense ratio by 2.7 points.
In addition, our ongoing efforts to enhance customer experience, or CX, through digital offerings and other value-added services are making a difference in overall customer satisfaction. For example, our continued diligence through targeted vehicle recall emails gained the attention of the National Highway Traffic Safety Administration. After seeing an article about our efforts through our public relation push, this Administration wants to partner with us on a multi-channel drip campaign where automobile manufacturers will provide us with a list of VINs of vehicles that still haven't had their Takata airbag repaired, which we then can match to our database. Collectively, we reach customers with the most dangerous do not drive warning. Vehicle recall notifications, coupled with our efforts to reduce distracted driving to our Selective Drive product, offered free of charge to Commercial Lines accounts, are a significant part of making our communities safer.
Our investment segment had excellent six-month results for the year, driven by, one, operating cash flow that was 12% of net premiums written. Two, $918 million in overall fixed income purchases at an after-tax yield of 2.9%. Three, partially offsetting that were reductions in LIBOR of 49 basis points, a decline in the US 10-year Treasury rate of 68 basis points, and lower spreads. For the first six months, after-tax investment income was up 21% at $89 million and produced a very strong annualized ROE of 9.2 points. Reflecting on the first half of the year, there are a few topics that I would like to comment on.
First, while the industry results have benefited from generally moderate catastrophe loss activity so far this year, it's important to remember that we're coming off a string of eight consecutive quarters between 2017 and 2018, during which catastrophe and non-cat property losses were elevated. Severe winters, hurricanes, tornadoes, wildfires, and severe convective storms were all extreme events that the industry must continue to anticipate in property experience. The recent earthquakes in California served as a further reminder of the potential of large tail events. In our opinion, the pricing and underwriting of the product lines do not fully reflect the financial volatility embedded exposure and needs more rate to meet its targeted risk-adjusted combined ratio. Second, it appears that the industry will need to continue to grapple with the prospect of a prolonged low-interest rate environment with the 10-year Treasury yield standing at about 2% at June 30, 2019.
Lower new money yields will place pressure on overall portfolio yields for the industry, requiring companies to drive further improvement in underwriting results. Our agile approach to pricing and underwriting, as well as claim improvements, is best demonstrated in the performance of our underwriting results. As we've often said in the past, we love a low interest rate environment as it compels companies to improve their underwriting, pricing, and risk segmentation. Our strong technical and underwriting capabilities, above average underwriting leverage at 1.4 to 1, and proven track record of effectively managing renewal price and retention positions us well. Third, there's been a lot of discussion in recent months about Commercial Lines pricing environment. Let me start by saying that the only pricing that matters is overall renewal pure price, and the level we require is determined by three factors.
One, the prior four-year on-level accident year combined ratio starting point. Two, expected loss trend. Three, expected ROE contributions from investments. Our combined ratio for the fiscal four-year period ending June 30, 2019, was an excellent 93, and the loss trend is anticipated to be in the area of 3%-4%. We expect Commercial Lines pure pricing in the 3.5% range and are excited about the potential growth opportunities that may arise as other companies move to address profitability in their books of business. Finally, we continue to make substantial strides in enhancing our customer experience capabilities, which is a true differentiator in the marketplace. This is a shared journey with our Ivy League distribution partners to deliver a superior experience with our collective insureds.
The investments we've been making in our digital strategy allow our customers to engage with us in the manner of their choosing, we've introduced value-added technologies and services such as, one, Selective Drive for our commercial automobile owner customers. Two, proactive messaging. Three, SWIFT claim fast-tracking. Four, EZ Claim Write, which is a mobile appraisal solution that facilitates claims estimates within hours based on uploaded photos. We believe these initiatives will improve retention and hit ratios over time. We feel confident in our ability to maintain attractive ROEs given the implied profitability embedded in our business, coupled with our renewal pure price increases versus the expected loss trend. With half the year behind us, our full-year expectations have been revised as follows. An improved GAAP combined ratio, excluding catastrophe losses, of 91, down from 92. This excludes any additional prior year loss development.
Catastrophe losses of 3.5 points. After-tax net investment income of $180 million, which includes $13 million of after-tax investment income from alternative investments. Overall after-tax investment income expectations remain unchanged due to lower anticipated after-tax new money yields on our core fixed income portfolio. An overall effective tax rate of approximately 19%, which includes an effective tax rate of 18% for net investment income, reflecting the tax rate of 5.25% on tax-advantaged municipal product, as well as a tax rate of 21% for all other items, and weighted average shares of 60 million on a fully diluted basis. I'll turn the call over to Mark to review the results for the quarter.
Great. Thank you, Greg, and good morning. For the quarter, we reported a record $1.21 of fully diluted earnings per share and $1.16 of non-GAAP operating earnings per share. We generated an annualized ROE of 14.5% and a non-GAAP operating ROE of 13.9%. Through the first six months, a non-GAAP operating ROE of 12.8% is above our 2019 12% ROE target. We are pleased with our track record of generating consistent double-digit ROEs for over five consecutive years. For the quarter, our high-quality underwriting results contributed 7.1 points of ROE, and investment income contributed a solid 9.6 points to the overall ROE. We enjoyed another strong quarter of growth, with consolidated net premiums written up 7%. Underwriting profitability was strong with a second quarter combined ratio of 93.1%. On an underlying basis or excluding catastrophe losses and prior year casualty reserve development, our combined ratio was 91.1%.
For the first half of the year, our reported combined ratio was a profitable 93.9%. Our underlying combined ratio was 92.1%, which represents 160 basis points of margin improvement over the first half of 2018. Our 90% ex-CAT combined ratio for the first six months is better than our original full-year guidance of 92% for 2019. As a result, we have updated our full-year ex-CAT combined ratio forecast to 91% for the year, assuming no additional prior year casualty reserve development. For the quarter, catastrophe losses added 4.6 points to the combined ratio, which was in line with our expectations, which are seasonally adjusted. Non-CAT property losses accounted for 14.4 percentage points on the combined ratio, which was slightly better than expected.
In addition, in the second quarter, we experienced $17 million of net favorable prior year casualty reserve development, driven by $12 million in the Workers' Compensation line and $5 million in the General Liability line, which improved the quarter's combined ratio by 2.6 percentage points. For the first half of the year, net favorable prior year casualty reserve development reduced the combined ratio by 2.1 percentage points, while catastrophe losses were 3.9 points. Unlike last year, where we had pressure on both the current and prior accident years in the Commercial Auto line that resulted in increased ultimate loss ratio picks, reported losses are coming in within expectations in the Commercial Auto line of business thus far this year. Non-CAT property losses accounted for 15.7 points on the combined ratio during the first half of the year, which is in line with our expectations.
Our expense ratio came in at 33.5% for the quarter, which is up 60 basis points from the comparative quarter, driven by higher employee bonus compensation as a result of the improved underwriting profitability. Our 33.4% expense ratio for the first half of the year was in line with the prior year period. Overall, we continue to seek areas of efficiency and cost savings while balancing these savings with investments in our operations for the company's long-term success, including investments in our people, technology, and key initiatives such as geo expansion and significantly expanding our customer experience capabilities. As we mentioned earlier this year, we expect our expense ratio to remain relatively flat this year, assuming we hit our targeted level of underwriting profitability.
If the strong year-to-date results continue through year-end, there'll be some modest upward pressure on the expense ratio due to profit-based expenses to agents and employees. Corporate expenses, which are principally comprised of holding company costs and long-term stock compensation, totaled $9.6 million, compared to $3.3 million in the comparative quarter. The primary reason for the increase in the quarter was high long-term stock compensation expense resulted from a strong appreciation in our share price during the period. For the first half of the year, corporate expenses totaled $22 million, compared with $15 million in the year-ago period, driven mainly by the 23% increase in our stock in the first half of 2019 versus the 6% decline in the first half of 2018, which increased our compensation expense related to the liability portion of our awards.
After-tax corporate and interest expenses reduced our annualized non-GAAP operating ROE by 2.8 points during the first six months of the year, compared to 2.4 points in the first half of 2018. Turning to investments. For the quarter, after-tax net investment income of $48 million was up $10 million or 27%. The excellent performance was primarily a result of the strong contribution from our alternative investment portfolio and high yields on the fixed income portfolio compared to a year-ago. The overall after-tax yield on the fixed income portfolio, including high yield, was 2.9% during the quarter, compared with 2.8% a year-ago. The average new money yield on the fixed income portfolio during the quarter was 2.7% after tax. Approximately 13% of the fixed income portfolio is invested in floating rate securities, which reset principally based on 90-day LIBOR.
We've been tactically managing the investment portfolio, seeking opportunities to optimize the after-tax book yield while maintaining high credit quality and managing duration risk. Our average credit rating remains strong at double A minus, and the effective duration of our fixed income and short-term investments portfolio is down modestly to 3.3 years. On a sequential basis, the pre-tax book yield on our core fixed income portfolio decreased two basis points in the quarter after increasing 47 basis points last year and four basis points in the first quarter, driven by the lower interest rate environment. On a go-forward basis, we expect pressure on our book yield given the significant reduction in rates since peaking early in the fourth quarter of last year.
Although, as Greg mentioned, we are reaffirming our full year 2019 forecast of $180 million for after-tax net investment income, which, as a reminder, is up from our original 2019 forecast of $175 million. Risk assets, which principally include high yield fixed income securities, public equities, and alternative investments portfolio, accounted for 7.9% of total invested assets as of the end of the second quarter, which is up modestly from year-end, mainly reflecting additions to private credit mandates. Our alternative investment portfolio, which includes limited partnerships in private equity, private credit, and real asset investments, and reports on a one-quarter lag, generated a strong pre-tax gain of $7 million for the quarter, compared with $2 million in the year ago period. Turning to capital, our balance sheet remains strong with $2.1 billion of GAAP equity as of June 30th, an increase of 15% so far this year.
Strong appreciation of the value of our fixed income portfolio resulted in net unrealized after-tax gains totaling $145 million on a year-to-date basis. Growth in tangible book value per share plus accumulated dividends was 7% in the quarter and is up 23% on a trailing four-quarter basis. Our premiums to surplus ratio is approximately 1.4x, and we've targeted a range of 1.4x-1.6x in recent years. So we're on the low end of our target, and this, combined with our $257 million of holding company liquidity, provides us with meaningful capacity to grow as market opportunities present themselves. We continue to adopt a conservative stance with respect to managing our underwriting risk appetite, investment portfolio, reserving processes, reinsurance buying, and catastrophe risk management.
At this higher operating leverage, each combined ratio point equates to about a point of ROE, which is about 2x that of the industry average. In addition, our 3.12x investment leverage means that each point of pre-tax book yield on our investment portfolio results in about 2.5 points of ROE. This model positions us well to generate superior returns in today's low interest rate environment. And with that, I'll turn the call over to John to discuss our insurance operations.
Thanks, Mark, and good morning. I'll begin with the results of our operations by segment and then provide an overview of some of our strategic initiatives. Our Standard Commercial Lines segment, which represents approximately 80% of premiums, generated net premiums written growth of 8% for the first half of the year, continuing its track record of strong profitability. For the six months, the segment generated new business growth of 10%, stable retention of 83%, renewal pure price increases of 3.2%, and an excellent combined ratio of 93.7%, or 92.7% on an underlying basis. Our highest quality Commercial Lines accounts, which represented 49% of Commercial Lines premium, we achieved renewal pure rate of 1.8% and point of renewal retention of 91%. On the lower quality accounts, which represented 11% of premium, we achieved renewal pure rate of 8% while retaining 78% at point of renewal.
Our ability to analyze the risk and return characteristics of each piece of business at an extremely granular level allows us to achieve additional loss ratio improvement through mix of business changes while maximizing overall retention. Drilling down to the results for the first half of the year by commercial line of business, our largest line, general liability, achieved an 87.8 combined ratio, which included favorable reserve development totaling $7 million, or 2.1 points. We achieved renewal pure price increases of 2.4% for this line. While loss trends have been generally benign in recent years, we are closely monitoring loss severities. Our workers' compensation line generated an 83.9 combined ratio for the first half of the year, aided by favorable reserve development totaling $20 million, accounting for 12.7 points on the combined ratio. This favorable development related primarily to lower than expected severities for accident years 2017 and prior.
Renewal pure pricing was down 2.8%, and we continue to take a cautious approach to underwriting this line, which on a current accident year basis is generating a combined ratio of 96.6. Workers' compensation pricing for the industry has come under sustained pressure, and loss cost filings by NCCI and other individual state bureaus continue to be negative. If loss trends were to increase or even flatten out, it would likely result in deteriorating combined ratios for the industry. Commercial auto remains an area of focus for us and the industry as results have been significantly worse than target levels. The combined ratio for this line was 106.5. There was no prior year development and liability claim frequencies remain in line with expectations for the current year. We continue to keep a close watch on claims trends in bodily injury from both a frequency and severity standpoint.
To improve profitability, we achieved price increases averaging 7.3% this year on top of similar price increases in each of the past two years. In addition, we've been actively managing new and renewal portfolios in target business segments and improving rating and classification inputs. Over the longer term, we expect accounts that adopt our recently introduced Selective Drive program will have greater insight to their commercial auto risks and have the potential to reduce their loss experience. Our commercial property book generated a 98.1 combined ratio. The results for this line have tended to be profitable but volatile due to elevated levels of non-cat losses driven by adverse weather and large fires. We have seen some signs of price firming in this class, but believe the industry needs to address profitability through additional pricing and underwriting actions to reflect the overall performance and embedded volatility in this business.
Our renewal pure price increases averaged 4.3%, and we are taking steps to address the drivers of the higher loss experience through business mix shifts and safety management efforts. Our Personal Lines segment, which represented 11% of first half premiums, reported flat premium volume driven by renewal pure price increases averaging 5.4%, retention of 83%, and a 25% decline in new business driven by an extremely competitive market for personal auto. This segment produced a combined ratio of 95 or 88.4 on an underlying basis. In personal auto, net premiums written volume was flat, and the combined ratio was 100.4, a substantial improvement relative to the 104 a year ago. Renewal pure price increases averaged 9.5% for personal auto liability and 5.1% for physical damage, leading to a continued profitability improvement with earn rate exceeding loss trend but putting pressure on new business.
The homeowners line reported a 1% premium decline relative to a year ago and a combined ratio of 97.4, including 15.6 points of catastrophe losses. Despite some expected volatility in quarterly results, profitability in this line has generally been strong in recent years, and renewal pure price increases averaged 2.6% for the first half of the year. Our E&S segment, which represented 9% of total premiums, generated 14% net premiums written growth, primarily reflecting the onboarding of new distribution relationships. This segment generated a 93.6 combined ratio, a meaningful improvement relative to a year ago, and renewal pure price increases averaged 4.5%. Over the past two years, we've undertook a number of deliberate steps to achieve price adequacy, improve the business mix, and centralize our claims handling processes, which are contributing to the improved combined ratio performance in this segment.
We are pleased with this performance and expect to generate more consistent profitability going forward. I'll switch now to some of our strategic initiatives, which are key to achieving our objective of generating best-in-class operating and financial performance over the long term. First, I'd like to highlight our continued investment in building out our franchise distribution model, which is the foundation of our ability to generate consistent profitable growth. Our distribution partners are the best in the industry, and our franchise model is enabled by our empowered field-based servicing capabilities, which remain a true differentiator in the marketplace. We've often spoken of our objective to obtain a 3% commercial lines market share over time in the states in which we operate. This is built around appointing partner relationships that control approximately 25% of their markets and seeking an average share of wallet of 12% across those relationships.
We believe that executing on this objective provides us a substantial runway for growth in coming years, allowing us to effectively double our premium volume without substantially altering our risk appetite. Our current agency market share stands at approximately 20%, and our share of wallet is approximately 8% in our legacy states. We've appointed a total of 52 new distribution partners in 2019, bringing the total to approximately 1,350 partners and 2,280 storefronts. Our goal for the year is to appoint 100 new distribution partners. Over the past two years, we embarked on a geographic expansion strategy, opening five new markets consisting of New Hampshire and a Southwest hub incorporating the states of Arizona, Colorado, Utah, and New Mexico.
Execution of this strategy has gone extremely well, and our operations in the new states are performing in line with our expectations, with current in-force premiums of $50 million from these new states. Another major strategic initiative have been our efforts around enhancing the overall customer experience. Our objective is to position Selective as a leader in this area, and we have built capabilities that allow customers to engage with us in a 24 by seven environment. Our self-service and digital service offerings continue to experience strong adoption rates, and our proactive communication initiative is receiving strong customer response. We see increased demand for our Selective Drive product for commercial lines customers with vehicle fleets. The product allows business owners to leverage features such as logistics management, improved safety guidelines, and telematics-based driver scoring.
In addition to improved driving behavior over time, we believe value-added services such as this will improve retention rates and new business hit ratios. Looking out to the remainder of 2019 and beyond, we are in extremely strong financial and strategic position.
We are investing in technologies, tools, and people that will position us for long-term success and are confident in our ability to generate superior financial results for our shareholders over time. With that, we will open the call up for questions. Operator?
Certainly. We will now begin the question and answer session. For participants over the phone, if you would like to ask a question, please press star followed by the number one. Please record your name slowly and clearly. Your name is required to introduce your question. To cancel the request, you may press star and then the number two. One moment please, for any questions. Our first question is coming from the line of Amit Kumar of Buckingham Research. Your line is open.
Good morning, Amit. Good morning?
Hey, can you hear me?
Yeah. Now we can. Thanks. Sorry.
Sorry about that.
Yeah, no, that's fine. Great. Good morning.
Feeling like Joe Biden here. Just very quickly.
Okay.
On commercial pricing. You talked about the industry facing the need to pursue pricing because of past issues. Would that translate into your pure pricing modestly declining going forward as you look at this market share, or could there be some pressure from the new business penalty for you?
Let me start, and John can certainly add in. As I went through our whole presentation, our pricing is one of the most disciplined processes that we go through. As I mentioned on the call, we're looking at the past 4-year on level. That's your baseline. Where do you start? What's in that noise? What level of noise is in that, and how do you expect trend to move forward? Where is your investment return? As I mentioned, the three factors right now, the one that we expect the most amount of pressure to be on is going to be on the investment performance due to, one, where we are on the 90-day LIBOR, where we are on the US 10-year Treasury, and the fact that spreads have narrowed in roughly in the 40 basis point range across many sectors.
That part of it is going to put additional pressure to put pricing at the right level for 2020 right out of the box.
I would tell you that what I had in my prepared remarks is that the favorable aspect that we view is, 1, the fact that our current observed levels of current accident year claim count for casualty is below what we expect. That is your early indicator of how your current accident year is going to move, because there's 2 things that affect your accident year. There's frequency and severity. If your frequency's off the mark early on, you know that you're going to have pressure on your pure premium calculations. We're not seeing that. The other part then that is relieving a little bit of pressure is the fact that we continue to see favorable development, and the favorable development is basically lowering that starting point that we're at.
Why we are kind of favorable on where we stand is we feel all those things line up well for us. The pressure is probably more applied on the investment income side than it maybe is anything underwriting specific.
Go ahead.
I think Greg covered a lot there. This is John. Let me just add a couple of additional points as clarification here. Because we're achieving our target margins, our focus from a pricing perspective and how we set our targets is focused on maintaining those current profit levels to the extent, as Greg indicated, investment returns come under increasing pressure as we look out to future quarters. That requires us to lower our combined ratio expectation to make up for the difference from an overall ROE perspective, and that's how we'll manage it going forward. As you heard from Greg's earlier comments, there is pressure in the market to improve underwriting results, and I think this was also part of your question. That does present opportunities for us.
Because our margins are strong and we have, and have used now for well over a decade, very sophisticated underwriting and pricing tools, as companies start to take more aggressive stance on rate, they wind up pushing some high-quality accounts into the market that present great opportunities for us to write new business. We do think that's a benefit to us in terms of how we're positioned. The other point I think worth noting is we also strive to make sure that all of our major lines of business are either achieving or approaching their target combined ratios. As you've seen in our results, in our prepared comments, we are still working to lower Commercial Auto, and part of that is through rate, part of that's through other underwriting mix and claims improvements.
Commercial Property, while generating a positive underwriting result, is running above where most companies would want it to because of the inherent volatility in that line. These lines of business for the industry are being masked somewhat by the very strong results in Workers' Comp. Workers' Comp now is in a negative rate situation, and when you look out to the future, that's got to be addressed. There's a number of pieces there, but it's certainly a dynamic marketplace.
If I step back, do you get the sense, on the commercial piece, and this is maybe a broader question, can you talk about what the loss trends might be running at in terms of some numerical values? I'm trying to figure out how much is pricing versus loss cost trend margin running at.
In our commentary, we had that we believe it's in the 3%-4% range. That's loss trend overall. Yeah, that's loss trend overall is what we feel we're running at today.
And I-
Again, just to get to the point, let's just make sure we make this point, because I know you guys are hearing a lot from our competition and all right. Let's just baseline for a minute, if we could.
Our pricing in Commercial Lines running in the 3.2, 3.3 area. If you looked at it all in and on a renewal basis, like many of our competitors are reporting, which I'm not a believer in, we're like 2x then. I just want to make sure that when you guys sit there and you start to compare, hey, Murphy told me lost trend was going to be in the 3 to fours. Renewal pricing is a 3.3. Hey, I've got a margin diminishment. All right. That's where we are in pure pricing. I just want to make sure that that is clear for you guys, one. Two, John has talked about this over and over again.
We drive and harness a lot out of our underwriting and claim improvement based on what we're doing in terms of the segmentation of our business and how we are kind of driving higher rate level or non-renewing some of the accounts at the poorest performing levels. That's how, and plus all the claim activity that we've done that has improved the cost of goods sold all work in as part of our overall improvement. Again, I don't want to sit here and tout, hey, we're up 6% in overall renewal pricing, because I don't believe in that. I just want to make sure that you guys have all of the moving parts when you start to compare Selective and Selective's performance for 2020 versus some of the comps you may be looking at. That's all.
Yeah. That's another very fair comment, because everyone has a different way to compute what the pricing number is, and it's not apples to apples in many cases.
Right. That's the point that I'm trying to make. You know what? Why don't we start reporting results ex comp?
Yep.
Compare the ex comp results to your rate level ex comp, and then tell me how those numbers stack up.
Yeah, no, that's a fair comment. The only other question, and I will stop after that is, it's interesting to listen to your comments on Commercial Auto. When you said it seemed that it was stable versus Q1, and I feel like Commercial Auto is that elephant and everyone has a slightly different take on it. Can you just talk about what changed Q2 versus Q1, and also maybe talk about the broader discussion as it relates to Commercial Auto and some other lines regarding the jury awards and the tort environment, and has your thought process changed on that or not? Thanks.
All right. Let me start, and then John, it's great. Let me start. First of all, there's no change in our view at Q2 versus Q1. Our current accident year is running at about 106%. It stays at about 106%. I think that the commentary that you're hearing is just more data accumulated. After the first quarter, we told you that overall observed trends were better than anticipated on the claim count casualty side, and that was for the overall book. I don't want to get down to such specificity by line, but that overall trend continues, and that's our view of Commercial Lines in totality. The Commercial Auto has our view at that six months versus three months is not different. What is the benefit is some of the pressure that we've seen on the prior accident years.
We're not seeing any of that yet today and view that we're comfortable with where we are reserve levels, where we have our severity picks for the 2018, 2019, and 2017 years. Feel good about that, and feel good about the rate level. I think where people got offline or a little bit off their budgets was just principally driven by claim frequency counts, and then followed by some elevated severity, which is what you're talking about. We have seen some pockets of higher severity in certain parts of the country. That's something that we are closely monitoring. It's not an overall trend, but we are very much tuned into what's happening on the severity side of the book. Let me turn it over to John to add some additional color to that.
Yeah. Let me just address the second part of your question relative to additional trends, social trends. We do monitor litigation rates and attorney involvement rates. Across all of our casualty lines, including auto, they have been very stable. Now, we certainly hear other market participants' public commentaries on that topic, and we're mindful of that. From our perspective, we have not seen any material change in litigation rates. As I've also referenced in the past, we really pride ourselves in our claims organization in early communication with claimants, and ongoing communication with claimants, which I think is the best way to give them a sense of how the claim's going to be adjudicated, and in many ways will reduce the likelihood for them to feel the need to involve an attorney in that claim adjudication.
Got it. That's very helpful.
Thanks for the color, and good luck for the future.
Thank you.
Thank you. Our next question comes from the line of Paul Newsome of Sandler O'Neill. Your line is open.
Good morning.
Good morning.
Good morning. Congratulations on the quarter. I just wanted to not really beat the Commercial Auto dead horse, but actually I want to ask a little question that maybe is picking your brain a little bit. I have a theory that there's a difference between folks that use ISO only policy forms and rates versus those that tend to use their own system and own pricing. My question is, does my theory sit with what you've experienced, and where do you fit on that spectrum of how you underwrite your Commercial Auto? Is it mostly your forms and data, or is it a lot of ISO and industry-level stuff?
Paul, this is John. Let me take a crack at this. We are largely an ISO-based company in terms of forms, rules, and rates. We do have our own proprietary endorsements and those are used to modify coverage, in many cases, to add coverages that are segment-specific for different industry classifications. I think the important point, and our sense is that's largely the case for most market participants. Whereas in Personal Auto, it's a little bit different, where some of the bigger companies are using their own underlying data and are less reliant on ISO. For Commercial Auto, it's predominantly ISO-driven. I think that's really just the underlying rate plan that starts the process in terms of pricing adequacy on an account-by-account basis. What's equally important is the accuracy of the information you have relative to vehicle type, vehicle radius, vehicle usage. That's an important consideration.
Also the underlying pricing models that we use. When you think about the ISO class plan, that's what underlies your base rate for the average risk by certain classification type. You modify that based on individual risk characteristics. In our case, using a multivariate predictive model that separates from a future profitability expectation, best from worse, and modifies or recommends to the underwriter how to modify that filed base rate, which is based on ISO loss costs. That's our approach. We think it gives us an advantage. We're not alone in taking that approach, there's a lot of companies in the market that are just relying 100% on the ISO class plan, and not using their own tools and models to modify it.
That's really helpful for me personally. Could you talk a little bit more about the E&S business turnaround? That was quite dramatic. What are your thoughts sort of perspectively now that you seem to have got that to a really decent level of profitability?
I'll start again, Paul. This is John. We're pleased with what we're seeing there. Again, it's been a few quarters in a row now, and we like that. We're not declaring victory by any stretch, but we think we're on a very good path. We have seen very strong property results that underlie the results that you're seeing over the last few quarters. That will have inherent volatility in it going forward, just like our core commercial lines business has underlying volatility on the property line of business. That's less than a quarter of our premium, or about a quarter of our premium E&S. We're predominantly a casualty writer. There's been no prior year development, unfavorable or favorable the last couple of quarters, which is also a positive. You're getting a sense of what the underlying casualty book is running, and you have seen improvement.
That improvement is driven by pricing actions that have been taken. It's been driven by underwriting actions, in particular, exiting a few smaller segments of the business that were not generating significant premiums, but were adding some volatility to the results. Also a lot of the claims changes that we made by migrating to our Selective claims operations have improved the performance of that portfolio as well. We feel good about where it is. We continue, though, to believe, and this has always been our philosophy getting into this business, is we expect to achieve our target margins for this business consistently, and we're willing to accept a little bit more volatility quarter to quarter, year to year with regard to premium growth based on market conditions. As we sit here today, we're getting solid growth.
We got solid margins coming through, and we're pleased with the path that we're on. To the extent the pricing starts to drop off or we don't feel like we can achieve our target margins, we'll let the top line flatten out if that's the case.
Paul, this is Greg. Just to add to that, we want to get the contracting binding business growing again. We'd like to see a little bit more discipline in the contract binding pricing, and that's where I would say that what we experience doesn't necessarily match up with the broader brokerage-based E&S trends that you're hearing about market-wise. Again, like John said, we feel good about where we are on the operation, and want to continue to maintain performance at this level. It is a small book of business, and the numbers can get pushed around by not that large events.
Great. Thank you very much, congrats on the quarter.
Thank you, Paul. Thank you.
Operator, next call. Next question.
Thank you. We have a question coming from the line of Christopher Campbell of KBW. Your line is open.
Hi. Good morning, gentlemen.
Morning.
Morning.
I guess first question is on personal auto. Rates accelerated and premiums were down year-over-year. I guess how would you just describe the competitive environment you're seeing in personal auto?
Chris, I think clearly what we've seen is a rapid shift down in rates. That doesn't necessarily mean negative, generally speaking, broadly across the market, what was a pretty strong rate environment, and based on the rate filings we see come through company by company, state by state, has quickly dropped down into the very low single digits. Again, I'm generalizing. Each company is going to be a little bit different, it has moved fairly quickly, and I think it's in reaction to some of the bigger companies that have seen improvement in their own underlying trends. That's really what happens. We've continued to have additional rate running through our book relative to the filings that we've made over the last couple of quarters, and that's really hurt our competitive positioning for new business based on the rapid change in the market environment.
Got it. What's your view, if you're thinking if competitors are going to low single digits, what's your view of loss cost inflation for the industry?
We don't view loss trend in Personal Auto really that different than overall. I'd put it in the 3%-4% category until you start to see miles driven or gas prices or other things really start to fluctuate. Right now with very low unemployment, there's a lot of people on the road. Let me just add one other comment, Chris, relative. We're trying to improve. We feel really good. We've always viewed Personal Lines as three different operations within that division. The home, as we've always told you, our goal in home is to get it into a low 90 in a normal CAT year. A normal CAT year in home's about 14 points. We're pretty much there when you look at it on a multi-year basis.
We have two states that we continue to focus on the home book that we need to make further improvement. Our flood operation improves our combined ratio by about 60 basis points, and it's the one hedge that we do have to adverse weather. That's a positive because we actually make additional funds based on how the claim reimbursement works in the FEMA program, and that's a positive. Then the auto, which is what John was touching on. You're stuck in the comparative raters. The question is, we need to make some fine-tuning improvements in our expense ratio, then, I think look at how we militate some of the increases in the auto overall and target some of our increases that we need to do very granularly so we improve our positioning in that comparative rater that's used in every agency.
Okay. Got it. Thanks for all the color. Then just one more on the Commercial Lines side. As these competitors retrench and start to raise rates, how does this impact your willingness to grow? I would think that your core combined ratios are pretty good, right? I don't think you guys really need to take a ton of rate. You're still at mid-single digit rating or premium increases. Can you get to double digits in Commercial Lines, if everybody starts raising rates?
As I said in my commentary, again, some of it depends on how the sophistication of the competition does it. I would say to you today, anybody that socialized rates is going to get hurt badly because if you don't have the sophistication that John walked you through just in Commercial Auto, therefore you're distributing rate more socialized across your segmentations, across your accounts, across your geo-locations, that's a huge opportunity because those accounts will enter the market, then we'll have an opportunity to run our very sophisticated modeling against and see where we price out at. I view that as a competitive advantage in this marketplace. This is the opportunity that we would want to grow. If we had the opportunity to post some outsized growth levels, we would be willing to do that.
It has to be at the right pricing in the marketplace.
Just to add to that, Chris, to Greg's point, to the extent we have opportunities to put our foot down and grow a little bit more rapidly. In the past, we've talked about the sustainable growth rate of being about 75% of the forward ROE given the dividend payout ratio. That's called around 9%. We've grown about 7% thus far year-to-date. We're at the low end of our range, as I mentioned in my prepared comments, in terms of a premium to surplus ratio, and we have adequate and ample capacity at the holdco to drop down into the insurance subs. From a capital position, from a leverage perspective, we have ample capacity to grow if market opportunities present themselves.
Okay, great. Well, thanks for all the colors. Best to luck in the third quarter.
Thank you, Chris.
Thank you. We also have a question from Michael Zaremski of Credit Suisse. Your line is open.
Morning, Mike.
Good morning, gentlemen. Greg, in your prepared remarks, you said you feel pricing for the industry commercial-wise should probably stay around current levels. You talked about lower interest rates. I also believe you talked about one of the reasons being some competitors seeking to improve their results. If I'm understanding you correctly, just trying to understand, do you feel that a number of your competitors are hurting? If so, is it Commercial Auto? Has something changed in the last quarter or two where you feel more confident about your views on pricing? Thanks.
Let me just start with the fact that our expectation is different than a lot of other companies. Let me just make sure we've got that clear. Our core baseline is we want to print
A number in excess of our weighted average cost of capital. That's where we feel we need to be. We told you last year that when we started 2019, our target was 12. We will recalculate that target for 2020, and we'll tell you what that target is, and that becomes the basis for what we need to get rate-wise, and it becomes the basis for our incentive compensation plan. Those are all very much aligned. Where the rest of the competition is, you can tell me, you look at the performance, it's all over the place. There are some very large Commercial Lines writers that are not printing margins even at their weighted average cost of capital. What I'm really referring to is the fact that, A, not a lot of companies are at the baseline they need to be at, number 1.
Number 2, as the low interest rate comes in, companies are going to have to make that up in improvements. The question is, if you thought you needed a certain amount of improvement, now you need more than that because of the lower yield environment. The question is, does the competition have the tools, agility, sophistication to be able to deploy that at a granular level? When they don't have that capability, we are very sophisticated now in our ability to go out and harvest that business to increase our share of wallet. These are the things that John's mentioning as we try to drive higher share of wallet.
We want to make sure that everything that we're doing on a CX basis, our customer experience, what we're doing is so unique that agents now are starting to better understand what we're driving to end customers, understand the value that it brings to a client to be able to do proactive communication to them on billing reminders, product recalls, vehicle recalls, what we're doing on our Selective Drive product. Now, most recently, we'll be entering the market for customers for our security vendor product, which is another tool that we'll be offering for producers to add additional value at point of sale. All of these things obviously should allow retention to go higher and should improve hit ratios at point of sale. When they're sitting there offering different carriers and they say, "Who has the best-in-class customer experience to my end customers?
Who's trying to maintain a 24/7 environment?" Which is the goal that we're driving ourselves to. We're like the only carrier out there that's really doing that, with the exception of maybe the captives that could have some of that capability. When you talk about an agency-company relationship, we are very far ahead. I don't know if you noticed that, but we recently got a five-star rating, and the only Commercial Lines carrier to get a five-star rating was Selective. Again, I know we're kind of going through a lot, but those are the things why an agent's going to want to have their best-in-class customer with Selective.
Okay, got it. That's helpful. You've talked a lot about telematics on the commercial side over the last couple of quarters or maybe more than that. Are you guys feel a first mover in telematics for Commercial Auto? Because I think only you guys and Progressive, I know, talk about it.
Yeah. We think we're a first mover in terms of how we've deployed it. Again, it's telematics based. We're not using it for rating purposes like you see on the personal line side. This is more a way to give a value-added offering to commercial business owners so they can better manage their fleets. At the same time, because of the telematics, you're creating greater awareness around driving behaviors of individual drivers in these fleets of vehicles, which we think improves experience overall and gives agents some additional service to offer their clients, which will help them win and keep more business. As far as we've seen, there's nobody else that's deployed a product like that, but it's not the same telematics-based rating platforms you've seen really permeate through the personal line side of the business. Mike, this is Greg.
When you think about it, obviously there's three things that we do as an industry. One, we're a form of capital. By an insured having insurance, they need less capital on their balance sheet. Two, we put lives back together after a claim. Three, we make our communities safer. One of the biggest things that our Selective Drive product does, and we are pushing it hard, is because it's not plugged into the computer of the vehicle, it works through other power sources. It actually works off the phone, and because it works off the phone, it can detect distracted driving, which is a huge issue in the marketplace. Distracted driving is something that we view as a major issue, something we want our trusted risk advisors, our agents, our producers pushing at point of sale.
That, look, we want to make you a safer account by having the Selective Drive product. Not only do you know where your vehicles are, not only do you get a scoring on every one of your drivers for every week, how well they're driving, but you also understand when they're distracted driving in addition to fleet maintenance, in addition to other things that you want to know as an owner. It's a valuable tool to an owner. Particularly, we write a lot of construction business for an owner of a construction account to know where all their people are, know where all their vehicles are. On a Friday afternoon at two o'clock, you want to know who's still on the job site versus who's not on the job site.
This is what you get from this product, and it's offered as part of just being a Selective customer. Again, it's a real value-added product that is very unique in the marketplace.
Yeah, I'm sold on the product, I'm not sure.
Why don't you sign up as a Commercial Lines account? I'll have a Drive account this afternoon. I'll personally deliver you, Mike.
Thanks, Greg. Last question might be for John. To the extent it's not proprietary, maybe you can give us a flavor of some of the strategies carriers like yourself use to help mitigate the Workers' Comp suggested rate decreases. I know a lot of times we see some of these headlines from certain states saying 10%, 18% rate decreases. I know some carriers like yourself talked of being able to mitigate some of that.
Let me just be clear on how we manage pricing. We price individual accounts based on the pricing tools that we have relative to the right price for the exposure presented. Loss cost filings do change. The headline number that you see relative to an individual state's loss cost change is the overall book in the state that it applies to. It affects each individual book differently based on your mix of industry classification, so it's not a straight comparison. There are individuals' credits and debits on individual accounts that are based on risk characteristics. Those will move on a renewal policy based on the underwriter's review of the change in characteristics, as well as the change in the underlying loss cost. That's how we administer pricing on an overall basis.
It has resulted in pricing, in our actual renewal portfolio that's different from what you see on the overall loss cost filing. It's still our focus is always on making sure that each account is priced appropriately based on the exposure presented.
If the industry's in a credit position, you can give them less credits.
Mechanically, that's how it works. Again, the underwriting documentation behind that needs to explain why that's appropriate for that individual account, that's what we really pride ourselves on.
Mike, we got a great claim operation on the comp side that's very focused in on pure premium or cost of goods sold, whatever words you want to use on it. They are really digging down in terms of tendencies. When we get a claim, how do we get it fast-tracked? Are we treating a claimant for a back injury or obesity or both? Then how do you manage the outcome on that claim? How do you escalate them to the right people? We're actually now looking at our cost of goods sold separated, our pure premium calculation separated into a very granular level, whether it's knees, back, shoulders. Okay, what's a knee cost? How many knees are you doing? What are we seeing in the trend in knees? Then how is that driving overall your cost higher? Because this is what John's talking about.
Right now, it almost seems like the NCCI calculations have frequency going to 0. That's not going to happen. You're going to see an uptick in frequency. I think at some point you have to be very mindful of severity in this line. When it turns, we think it's going to turn pretty severely, that's why we're very careful about it. That's why you see that we're very disciplined in what we're trying to do in the marketplace. We're running on an accident year basis, our comp at about a 96 right now. On an accident year basis, that's where we are, but that's not that far off what our target risk-adjusted performance should be. Is there a little bit of room in there? Yes. Part of it may be affected by prior years continuing to drop down.
Still, at the end of the day, a 96 versus your target, you don't have enormous amounts of room in that today.
Just one follow-up. You said NCCI has frequency going to 0. If I understand
That's a joke. I'm sorry.
Oh, okay.
Joke. They've got frequency in theory going to zero industry-wide. It's a joke. Sorry. I should have classified it as a joke, but frequency is not going to zero, Mike. Okay? I'm sorry.
The long-term trend in frequency is negative, right?
It has been declining, I would say more of the story in comp, particularly in all this favorable development you're seeing, has been severity focus and what your long-term inflationary embedded trends were in medical versus what you're actually experiencing. That's where a lot of the release. It's been a little bit of frequency, but it's been a lot of severity buried in these numbers. You know your frequency count in comp within 18 months. Our actuary is sitting across the table shaking his head. I won't tell you the percent confidence that he has, but I know what it is. Your frequency numbers really aren't moving around that much. It's the severity that's really changing, and it's changing versus what they've embedded in their diagonals that go way back to the beginning of time. If I could say it that way.
I want to clarify for everybody that zero frequency is a joke. Okay, Mike?
Appreciate the insights.
Thank you. At this time, we don't have any more questions on queue. Speakers, you may disconnect.
All right. Thank you very much. If anybody has any follow-up, please contact Mark or Rohan. Thank you very much for your participation in the call today. Thank you.
Thank you, everyone. That concludes today's conference. Thank you all for joining. You may now disconnect.