Good morning. I'm Alison Jacobowitz. I work with Jay at Bank of America. Our next speaker is Selective Insurance. We're very pleased to have them. It's Greg Murphy, Selective CEO, and Dale Thatcher, the company's CFO. They've been a team now, I think, for over 10 years in this capacity, and I think they've been in our conference every year. They've done a great job of demonstrating the relative uniqueness of the company, which includes very strong independent agent relationships. With that, I'm going to turn the podium over to Dale. Thank you.
Not the podium. I'll stand out here. I walk a little bit. It just works out better. We got a forward-looking statement for the lawyers. I won't read that to you, we got to put that in everything. We'll have some forward-looking statements over the course of our presentation. I'll tell you a little bit about Selective and who we are. Last year, 2012, we had $1.7 billion in written premium. About 76% of that comes from standard commercial lines business. It's mainstream, Main Street, average account size of about $9,000. We distribute our standard lines through independent agents. We have approximately 1,000 independent agents that represent us. You can see the map here. The United States of Selective, those 22 states is where we distribute our standard lines product.
We also, in 2011 to early 2012, started up an E&S operation through a couple of renewal rights deals that we did. That represented about $113 million, or 7%, of our overall premium volume for 2012. That's distributed in all 50 states through wholesale general agents. We've had a history of financial strength that we'll talk to you about over the course of our presentation. You can see a little bit more detail about our standard commercial and our personal lines. The commercial is in all 22 states that we write in for standard lines, the personal lines is a subset of those 22 states, 13 states that are chosen because we feel they have better regulatory legal environments that are more consistent for generating consistent underwriting profits.
You can see we have 1,100 independent agents that distribute the commercial lines, 620 of those agents also distribute personal lines. In those states where we do both personal and commercial lines, just because you have a commercial lines appointment does not automatically mean you get a personal lines appointment. We only want to do business with those agents that are professional on both sides of the house. We have what Greg likes to call the Ivy League of independent agents, but as a guy from the Midwest, we call them the Big Ten of independent agents. I don't know. It's the top quality, the kind of people that have good succession planning, good sales culture. Those are the style of agents that we do business with.
The E&S contract binding authority, you can see there, this is the small size or what our chief underwriting officer likes to call E&S light. You can see the average account size there is $2,600. These are the small commercial enterprises, a natural extension of the small commercial nature of our normal standard lines business. That gives us an extra opportunity to generate margin, which is why we got into that business. You can see here the distribution for 2012, 76% commercial, 17% personal, and 7% from the E&S. You can see what our expectation over the five-year kind of timeframe, just to give you a feel for how we think these various businesses fit in into the overall scheme of who Selective is and how we're going to generate both growth and profitability in the future.
Financial strength is a foundation of our success, and access to the capital markets is an indication of that. We just did this deal a week ago where we retired or at least called, haven't yet retired. It takes 30 days to actually retire it, we called $100 million of hybrid debt that we had out there, had a 7.5% coupon rate. Basically, it just got compelling to refinance that, just like all of us have done with mortgages in the past. We were able to issue debt at 5.78%. We actually borrowed 175 initially, and the greenshoe was exercised to upsize that to $185 million. Ultimately, we did $185 million at 5.78%. Gives us an opportunity to pay back the old debt and also fund the expected growth in this kind of a hard market.
If you look at Selective during the last hard market, we were able to double the company's size between 1999 and 2006. The time to step on the gas pedal is when pricing is good. That's the way that we operate as a company. You can also see with the nature of our business, the small commercial lines that we do and where we write in those 22 states, we have a lot less volatility than the industry. You can see here a combined ratio over time, standard deviation of only 3.7 compared to the industry at 4.1. Keep in mind, when you put the industry all together and average them out, that's going to naturally compress that standard deviation.
When you look at us compared to individual competitors, we have substantially less deviation in our results, which is one of the reasons why we're able to run the company at a higher leverage ratio. Impact of cats on the combined ratio. I don't know what normal is anymore in the way of catastrophe losses. If you look at Selective before 2000 or 2009 for the last 25 years before that, we had an average cat load of about one and a half points compared to an industry cat load of between three and four points. We've always had less volatility there. The last three years has been a little bit crazier. We've averaged six points over the last three years in terms of cat losses. Clearly, the industry is still above that. I don't know what the new norm is.
One of the reasons why we've changed the way we do our guidance is you guys can make your own guesses as to what you think a normal cat load is. What we've done is we've taken our old historic average and doubled that, so the 1.5 becomes 3 points, and that's what we embed within our budgeting process. 3 points is double the old average, but half what the last 3 years has been. I don't know what the right number is, but anyway, that's the way we calculate things. Managing those increased catastrophes, you can see here some of the details regarding Hurricane Sandy. It was the biggest single event in the company's history. We had gross losses of $136 million is the current estimate for that.
Clearly, those losses are going to take some time to fully develop, but we feel pretty good about that number. If you look at Irene, which is the one that hit the year before, at this point in time, we were at about a $48 million number, and that ultimately settled down to a $45 million number. We do feel pretty good about that 136 gross estimate. That boils down to a pre-tax net cat of $47 million. We've got a $40 million retention on our program, and then you've got co-participation that brings that to 47, reinsurance reinstatement premiums of $9 million. An important component of Selective that's not always understood is that we are the 6th-largest write-your-own carrier in the National Flood Program. We receive claims handling fees in the event of something like Sandy.
We end up having $16 million worth of income as a result of claims handling fees for Hurricane Sandy. That acts as a natural hedge to our overall losses, gets you down to that $40 million pre-tax or $0.46 per share after tax. That added 9.8 points to the fourth quarter, and also 2.5 points to the full year. We ended the year at a 103.5. Before Sandy hit, we were clearly on track to beat our 101.5 that we expected, though, to generate for the year. Here's the conservative reinsurance program. Our cat cover is now $585 million in excess of a $40 million retention. You can see what the 1% probability and the 0.4% probability losses generate in terms of percentage of equity at risk there.
The current program exhausts at about a one in 228-year event. The old program that we had in place exhausted about a one in 159-year event. We did add some extra cover up top, an extra $150 million layer that's substantially collateralized. Another thing about Selective is that we manage our reserves by doing a full ground-up reserve analysis each and every quarter. We're not one of those companies that makes an announcement that tells you guys that we're going to be looking at reserves, and in 3 quarters, we'll let you know what we determine. We look at it every quarter so that we can stay on top of it, and that's why you don't see the same kind of reserve volatility that you see more broadly in the industry.
You can see our development compared to the rest of the industry here, and you can see that we've had favorable development since 2006. We have a conservative investment portfolio at a double A-minus average rating. About 90% of that is in the bond portfolio. We're at a 3.6-year duration, so we maintain a little bit lower duration than what you see from some of the other people that are presenting at this conference. I'd say the industry right now tends to be at about four and a quarter to four and a half. As inflation, if and when it kicks in, that's going to have a more dramatic impact the longer your duration is. The other thing is we have, because we run at higher leverage, we have higher invested assets per dollar of stockholders' equity.
We think it makes more prudent sense to maintain a little bit shorter duration there. Gives us an opportunity to participate more quickly in a rising interest rate environment and also puts less of our equity at risk. Here you can see where we run in terms of underwriting leverage. We're at a 1.6 to 1 in 2012. With the new bond deal that we just did last week, we'll be able to downstream a little bit of the proceeds there to help out the surplus and make sure that we've got plenty of room for growth, relieve that, and bring that down a little bit. But you can see compared to the broad industry at 0.8 to 1. If you compare that to just primary carriers, they're at about 1.1 to 1.
Clearly, we use more leverage, but we've been able to over time, and that gives us an opportunity to really deliver better ROEs. You can see at this level of investment what it takes to get to a 12% ROE for Selective. That's about a 95. You can see here our investment leverage at about $4 per dollar of stockholders' equity, and the underwriting leverage at 1.6. The industry needs to be at about an 87 combined ratio to generate a 12% ROE. Every time you see that yield on the portfolio go down by another 20 to 30 basis points, which is what's occurring broadly in the industry, takes another point of ROE to make up or another point of combined ratio to make up that ROE. Those are the dynamics that are at play in the industry right now.
This is our combined ratio improvement plan between the 2011 through the end of 2014. Our expectation is to generate an ex cats combined ratio of 92. If you put in our three points of expected cats, that gets you to the 95 that we've talked about before. You can see the biggest trends here are on the loss trend side and also pricing. We're expecting to get between five and eight points of pure price increase over the course of that time. In 2012, we delivered about 6.3% overall, 6.2% in the commercial lines space. We came out in January of 2013, delivered a seven and a half% price increase already this year. Our expectation for the year is to be between seven and a half and 8%.
We're very much on track to be able to achieve this. Our guidance for the year 2013 is to deliver a 96 ex-catastrophe combined ratio, 99 with catastrophe combined ratio. With that, I'll turn it over to Greg. Hopefully, I left enough time for you.
Oh, absolutely. Thanks, Dale, and good morning. I want to take you through some of the strategic initiatives and what makes Selective so unique in the marketplace. I think the biggest thing that we have is a very empowered group of decision-makers. We do field underwriting, and they are the linchpin of our success. Over 300 of our people, whether it's claims underwriting or safety management people, live where our agents are. They call on our agents, and they're able to respond. That makes a big difference and a big builder in the overall relationship that we share with our agents, which is superior in terms of relationships.
When you think about where we are relative to our sophisticated underwriting tools, I'm going to show you some slides in a little bit that will demonstrate why we've been able to now, starting our 16th quarter of price increases. We're into this for quite a long period of time, and you may be sitting there saying, "Well, why have you been so successful at doing it?" I think you'll see that in a minute as we roll through the rest of the presentation. We've got a big initiative focused around customer experience. We've looked at every touch point within our organization that has a customer effect and how do we improve that? How do we make it different?
Now we're also now taking that out onto the agency side in terms of what do you need to do as an agency to make yourself a more customer-centric organization? That's a tough thing when you're dealing with 1,100 agents overall. You can imagine if you're dealing with thousands and thousands of agents, how much more even difficult that could be overall. We're focused on constant improvement. That's what we do, and that's what makes us successful. This is a little bit on our franchise. Dale referred to it. Yes, we do have the Ivy League of independent agents. We have about 1,100 independent agents that represent Selective overall. Just think about some of the things that we do and measure. We're showing to you our agency survey. We do it every year.
It's an 8.3 on a score. That's at a time when we were one of the few companies raising pricing in the marketplace. Our average premium volume per agent is about $1.4 million. We look at an agent and say, "Hey, we want to be number one, number two, or number three in your shop. How do we get our share of wallet inside your agency into that 15%, 16%, 17%, 18%, 19%, 20%?" That's where we want to be inside of an agency. We don't want to be a bottom-tier company inside an agency. Otherwise, we say, "Hey, that's not an agency built around long-term success and long-term franchise value." We do a lot with our agents, and that's the reason why we're so successful and why we've been able to raise rate in the marketplace.
If you think about Selective and also what makes us a little bit more unique is we do feel we have the capabilities of a national, whether it's underwriting sophistication, what we're doing in the claims area. We're able to couple that with the nimbleness of a regional in terms of the responsiveness, in terms of being able to turn around an account quickly, being able to have a claims person be able to go out with an agent or to see a prospect, to go out and close that prospect. That is a huge advantage in the marketplace. I think that nimbleness helps us be more effective and respond to what's happening in different parts of the country quickly overall.
When you think about one of the big things that we have, and we actually went through this debate with our inside underwriters because a couple of years ago, they were coming to us and saying, "I put a big price increase out on an account and it didn't stick, yet I don't get credit for that." We sat there and said, "You know what? We built this entire way to measure and monitor our inventory, and it's based on a holistic number of things that come into it. How does the account score? What kind of problems do we have in the segment? How profitable is the agent?
What are the issues that we have overall in the line of business relative to this?" Then we measure all of those things, and our inside underwriters can get credit for, hey, when they non-renew something or when they get price increases, they're able to see the effect on that. We actually measure that and give ourselves credit. Dale showed you on the combined ratios waterfall slide, one of those things was marked underwriting improvement. That underwriting improvement is latched back to this dynamic portfolio manager that we have and measure and monitor our performance going forward. This is one of the outputs of it. We measure accounts overall in terms of above average, below average, and we go through that. These aren't all equally weighted. As a matter of fact, the below average and low categories represent probably about 20% of our inventory overall.
The other two categories, the above average and average, represent approximately 80% of our inventory. When you look at this, look at how the pricing is so different across the continuum. On the above average accounts for last year, where Dale Thatcher talked to you, we got 6.20% rate overall on commercial lines, but our above average account renewed slightly above 4%. When you look at the low average, it was more in the 12.5% range. At point of renewal, look what our underwriters saw relative to retention, and their focus is: how do I keep the above average and average accounts, maximizing the rate, but also keeping a strong retention on that business? That's their focus, and they can see that account by account as they go through their inventory.
Versus on the lower end, how do I drive as much rate and non-renew accounts where I want to non-renew, but be able to stick behind that knitting to say, "Hey, I'm convinced this is what I could do on this account, I know if it walks, it's going to improve my profitability. I know at the end of the day, I'm going to get credit in my underwriting as a result of my action." I think that's an important part. We've been working on this for many years now, and it's taken us a while to get to where we are overall.
I want to say the success that we have in driving rate and keeping retention overall is a result of the tools that we have, and we're able to deploy this on an account-by-account basis so everybody can see their inventory that comes up. Here's pricing overall, and this is starting now, the 2013 period, as Dale Thatcher mentioned to you, out of the chute at a 7.50% rate. If I were to draw the same analogy to a year ago, we started 2012 at 4.5% rate in January, where approximately 10% of our business is written in January in commercial lines. Our biggest renewal months are January and July. 10% of our inventory came in in the month of January.
We started out last year at a 4.5% and ended at 6.20%, and this year we're starting out at a 7.50%, an indicating rate overall somewhere between 7.5% and 8%. That doesn't mean we're going to stop at 8. It's just that when you look at that waterfall chart, those are the kind of assumptions that we had in there. We're mindful of the marketplace. We're going to continue to maximize the amount of rate and commercial lines that we can achieve to generate the profitability that we want to get. That's a big part of our success in terms of what happens. Look at the retention. Very consistent over the past four or five quarters. Why? Because of the relationship we have with our agents. That's why that retention stays at that 82% level.
It did not drop in the last several quarters that happened in many of our competitors. When you think about what's happening on the personal lines, that is a tale of two different cities almost. We've got a strategy around home that's a little bit different than the strategy around auto. Home is going to be driven by rate increases, promotion of whole account underwriting in terms of we want the auto and the home coming together. On the auto side, that's more of a multi-year strategy about bringing our auto results down through price increases above trend, but also by looking at our mix of business and also the fact that we write our business and a lot of new business relative to that gives us a new business penalty that takes a little bit longer, several years to work off on the auto side.
We're looking at overall rate in the personal lines side of 7% in 2013. When you look at it by sector, that's why I said it's a tale of two different cities. On home, it's more around we're mad as hell and aren't going to take it anymore. We are continuing to drive rate, we're going to continue to drive deductibles, we're going to continue to do the things that we need to do. We're going to drive the home line into where it's generating in a normal catastrophe year an upper 80s combined ratio. That's what we looked at. When we have a 120, a 125 year, it's not wiping out multiple years of profitability. Maybe it's only wiping out one and a half or two years of profitability. That's what we're doing on the home side overall in terms of pricing.
2013 anticipated price of 8.5% overall. We move on to the auto side, different. Legging into it, pricing at 5.5 for 2013 expectation above trend, but continuing to work through the overall performance on the business. This will be more of a multi-year strategy of legging down the performance to where it needs to be more consistently. In terms of some of the other initiatives we have on the claims side, this is one of the bars that Dale had up on his multi-year chart. We're doing a lot to bring down our cost of goods sold. A lot of it's in medical cost containment. It's around directed care, it's around networks, it's around how do we get clients, customers into networks as quickly as possible.
Fraud, we've done a lot in that area, whether fraud recovery, litigation, driving our staff counsel offices where it makes sense to bring down overall litigation costs. We've been pretty aggressive in trying to make sure we're managing every dollar in terms of cost of goods sold down overall. When you think about Selective and the opportunities, Dale talked about our leverage, and I think one of the things that people realize is every one point of combined ratio for us is one point of return on equity.
You heard from other speakers in terms of the interest rate environment, where we are as an industry, when you look out into your lens, you would sit there and say, interest rates are going to stay low for a while, which means combined ratios for an extended period of time are going to have to be in that area where Dale talked to you about, in the upper 80s in terms of generating the right returns. We look at this as a huge opportunity for us in terms of performance and a competitive advantage as to where we need to be relative to the industry. Again, our ability to manage the cycle is clear. We have the tools to manage the cycle. We have the people that successfully have been deploying this now, starting on almost going into our 16th quarter as we move forward.
We grew at the right time. We were not pushing for growth in the last several years. Why? Because it was tough to grow. What you found in the marketplace is you had to spin rate down to levels that just didn't make sense if you were going to grow for the last couple of years. Obviously, the balance sheet is very strong, as Dale indicated, a very attractive dividend yield overall as well. When we sit down and go through our guidance, we looked at it, as Dale mentioned, we're talking about a 96 ex cats. We've got three points in our estimate for cats. You pick your number, but that's what we've built in, and we're trying to continue to move that performance to where it needs to be.
We've got after-tax investment income reflecting a lower interest rate environment, more at like today's rates at the $90 million-$95 million. We've got 56 million shares on a diluted basis outstanding. What I'd like to do now is open it up to questions that you might have in the audience about a regional carrier and how we are successful and what we do that's maybe different than most other folks. With that, we'll open up to questions.
Thank you.
Hey.
Thank you. I got to get out of the spotlight here.
Oh, all right. I'll let you pick up from there.
Go ahead. There you go. Sorry.
With what you all were talking about in homeowners, I get that you're trying to increase rates. A, what type of pushback do you get from clients, agents, and what type of persistence did you want to keep in the homeowners book? Two, what are some of the other things and techniques you're trying to do beyond rate to try to improve profitability in that business we even heard of it in the past?
I would say it's a multifaceted approach to improve the performance rate overall. It's something that we're just putting in. We're doing our rating now on home by peril. We look at eight different perils in the home product that we rate up and build into our rate level overall. We're starting to get at the points that are more painful, and we're driving rate on that business, and it's successfully sticking as our retentions on home have been very high. It has not been a resistance point overall. Relative to other initiatives, we're making sure that the homes are properly valued. We're looking at age of roof. We're looking at types of constructions relative to roof construction. We're focused a lot on that. We're raising our deductibles more across the board.
We're looking more at getting our all peril deductible a little bit higher as we saw what happened as a result of Hurricane Sandy, which was not deemed a hurricane, and therefore the hurricane deductibles were not applied. We're trying to make sure that we're protecting ourselves now with all peril deductibles. How do you get all perils up to where they need to be? Maybe how do you put more variance in your all peril deductibles, depending on the zone that the property's in? There's the insured to value. There are so many things that we're going into to look at the type of business that we write, the mix of business that we write to improve performance overall on the home book.
Just to follow up on what you mentioned regarding the roof. Thank you. Just concerning the roof, if someone wants to buy insurance, you all go out and inspect their home, would you tell them, "We'll write you a policy, but you've got to replace your entire roof and do it this way?" Or
Well, there are certain restrictions as to the age of roof and the type of deductible you need to take, there may be underwriting restrictions relative to the age of roof overall.
Thank you.
I thought there was another question somewhere.
Jay's got one.
I'm going to let you answer Jay's question.
All right. Go ahead, Jay. Fire away.
Yeah, just a question on workers' compensation.
Big line of business for you guys.
Difficult line of business for the industry. I guess two questions, really. What are you seeing from a claims standpoint, and are you taking more dramatic action in that line than we're hearing about with your commercial book in general?
If you look, again, back to the waterfall chart, the claims initiatives, a lot of those claims initiatives have a lot more bearing on the workers' comp line than on other lines. In terms of renegotiating medical cost management contracts, getting better fee schedules out there, changing the way we manage it so we have a greater degree of specialization in how the claims handling process works, you don't have a single adjuster handling it from cradle to grave. You've got specific individuals that have a greater skill set handling the different components of the overall claim. Again, a lot of those claims initiatives around the workers' comp. Clearly, workers' comp is getting larger price increases than any of our other lines of business, but also clearly in the commercial line space, workers' comp tends to be the most regulated line still.
It is a little bit more difficult to get price increases there than other lines of business, but we have been successful so far. If we could not write workers' comp tomorrow, that would be great, but you really can't do that without damaging the rest of your business. We have to be careful about how we write it, where we write it. One of the things that we've found is that we have a large contractor's book of business and have historically. The downside to that is you got a little bit heavier casualty load, you get a little bit higher impact from workers' comp. The upside to that is you don't have nearly the catastrophe exposure that you do because they don't have as much bricks and mortar out there. There are advantages to that also.
Generally, we're an account underwriter. We're writing a whole account, and we're not just writing comp out in the marketplace. We're an account underwriter.
Right. We don't write monoline comp.
Yeah. Hammering's happening on that side of the room. How about a question from over here? You guys.
Alison's got one.
I've got one if no one else does.
Yeah.
How do you feel about the hammering? No, I'm kidding.
No.
Oh, I love it.
For the E&S business, can you just talk some about how those results are coming along and how that fits into your goals going forward and how you see that trending?
Well, let me talk first before about what we think about the E&S opportunity, why we got into it. We look at it as a huge opportunity for us. Our agents have millions of dollars of E&S contract binding authority business that's placed today in a highly fragmented manner. Some of the agents that we talk to may have 6-12 relationships, and they get paid their normal commission for that. Outside of that, they get nothing. We sat there, and we've been looking at the E&S business as an opportunity to get into. Why? Because it generally outperforms the commercial line space by somewhere between six and eight points a year.
We sat there and said, "Here is an opportunity to get a bigger shelf space inside our agent's office by getting into the contract binding authority business, which is the lowest end of the hazard curve on E&S business." What we look forward to is three things happening in the E&S space. First of all, business is going to migrate out of the primary market into the E&S business as more and more companies go through their budgeting process and understand where the underperforming segments are, and those things start to move out. Then two is general rate increases in the E&S space. Then the third thing is garnering a bigger market share from our agents, our retail agents, up through the wholesale channel, that we're going to provide them certain incentives to do.
That's the opportunity, and the goal is to get that performance down so it performs more consistently, and then we'll let the top line go up and down as a result of the difference in the market conditions, but focus more around a consistent ROE.
If you look at the two books of business combined, before we purchased them, they totaled about $135 million in premium, roughly. 2012 clearly was a transition year for us as we closed the second transaction on December 31st of 2011. They closed the year with only $113 million in premium, and that was as a result of us exercising our underwriting disciplines and kind of bringing them along. You also had a much heavier expense load in 2012 because of some of that transition process. The expectation is for them to improve and get better. The one thing I'll say, I'll point out is on the waterfall chart, it's clear that it says standard lines performance. I will tell you that we have the exact same expectation that by 2014, our E&S businesses will be performing at a 95 combined ratio.
The reason they're not on that chart is it's a different path for them. It's going to require a little bit more price. It's going to require more in the way of underwriting and claims initiatives. We fully expect that that's going to get to the 95 combined ratio for 2014. Ultimately, we do expect them to perform better than our standard lines. If you look historically, contract binding authority has performed consistently about six points better than standard commercial lines. The whole reason we got into that line of business is to provide us with a greater margin opportunity.
Any other questions? No? Okay. Well, thank you very much. Appreciate it. Thank you.