Move on to the next presentation. I'm Alison Jacobowitz, by the way, with Merrill Lynch. I work with Jay Cohen on the property casualty side. For, I think many of the introductions this morning, we heard the words perennial speaker and industry executives with a wide range and a long-term experience. Both of those descriptors would definitely apply to our next speakers. Up next, we have Selective Insurance Group. We've got Dale Thatcher, the CFO. He's been with the company since 2000, and Greg Murphy, CEO, and he's been in various positions at Selective since 1980 and CEO since 2000. They've watched the company and also played an integral role in seeing the company grow into a super regional. With that, I'm going to turn it over to Dale.
Okay. Thanks, Alison. I won't go through the forward-looking statement, but it's there. The lawyers always like us to put that up. Go forward a little bit here and talk about who Selective is. We wrote about $1.5 billion in premium last year. We're a super regional carrier. You can see here the map of Selective. The blue states represent where we write our standard lines business, a 22-state footprint for that. If you followed the company at all, you saw that we made 2 E&S acquisitions last year. E&S we offer in all 50 states. That is a new item for the company and something that we'll talk about a little bit today in our presentation. We write predominantly small to mid-size commercial risks. They are suburban and rural style, so we don't get into the inner cities, and we don't have extremely large-size risk.
80% of the company is standard commercial lines. Also have had a history of financial strength. We've been A+ rated by AM Best for 50 consecutive years, and we've been A or better for 75+ years. Our standard commercial lines, we have a 22-state footprint, as I said. We distribute this through a smaller number of independent agents than most of the other companies that you'll talk to. We have 1,000 independent agents. We look for a deeper penetration of that agency plant. We want to be number one or number two because we think that makes us a better underwriter when we get the first or second look at a piece of business as opposed to the fourth or fifth look at a piece of business. The average account size for our commercial business is about $9,000 in premiums.
This is not Fortune 1000 style accounts, obviously. It's the electrician that you might call to come over to your house. It's the donut shop that you stop off at in the morning. The florist. Those are the style of risks that make up our bread and butter, and that's 80% of our net premium written. You can also see the pie chart here. Our largest lines on the commercial lines side are commercial auto, workers' comp, and general liability. We also are an account underwriter. We strive to write the entire account and make that entire account profitable. Personal lines, you see here, our 13-state footprint. We do not write personal lines in every one of our commercial line states.
The 13-state footprint is a direct overlap in our 22-state commercial lines, and it's the same agents by and large that are writing our personal lines business. We have 580 agents here that write it. It's also, generally speaking, the Homeowners piece is one that we've really been pushing on. I know you've probably heard this from some of the other carriers that have been here. With the advent of the cat losses in the last couple of years, Homeowners is a big issue in the industry right now. People are pushing hard on price increases there. We have an expectation of 11.5% price increases in the coming year. We also have by-peril rating capabilities within our personal lines. That's something that not everybody has. A lot of people have the auto predictive modeling process.
We use predictive modeling also on the Homeowners side, and it rates it up by-peril so that you can have a more specific and granular price for that particular risk. Our flood is also, we are a write-your-own carrier for the federal flood program, and that had net income about $11 million last year. We don't take any flood risk on that particular program. That's all reinsured by the federal government. You can also see here the pie chart that you have there for the split between Homeowners and Private Passenger Auto. The way we look at personal lines is basically you need to write Homeowners in the mid-80s. You need to write personal auto in the low 90s to be able to make them profitable. All of our ideas, all of our initiatives are geared around reaching those kind of points.
As I said before, we purchased two E&S businesses last year. They are contract binding authority E&S, which our chief underwriting officer likes to call that E&S light. These are the very small businesses that are pushed into the E&S marketplace. You can see that the average account size is only $2,200. For E&S standards, this is lower hazard within that E&S space. Obviously higher hazard than our standard commercial lines, which is why they're in the E&S space, but lower hazard in general. It's a nice complement to the small business offerings that we have. It also provides an entrée into a much higher margin class of business for us. Traditionally, the E&S business performs at least six points better than standard commercial lines, and the contract binding authority business historically has performed even better than that. It's about 75% general liability and about 25% property.
Also another advantage is that there's no workers' comp business within this segment. We have a high-quality investment portfolio of $4.1 billion in invested assets, a duration of about 3.2 years. Average quality of the bond portfolio of a double A minus. Only 1% of the portfolio is double B or below. Very high quality, very well diversified. Not a lot of interesting stuff there, which is probably good in the overall scheme of things. We use underwriting leverage much greater than many of our peers. We're at 1.4 premiums to surplus leverage compared to the broad industry, including reinsurers of about 0.8. If you look at just primary insurance companies, that's at about 1 or 1.1. You can see we use a lot more leverage than others.
The reason that we're able to do that and maintain our A+ rating is because we have a lot less volatility in our overall underwriting results. Part of it is because the small commercial that we write, part of it is because we're less exposed to catastrophes than the broad industry is. Part of it is because the way we run our reserves, and we stay on top of them, doing a full actuarial analysis of reserves each and every quarter so that we can stay on top of reserve trends. One of the things that we've talked a lot about in the industry, obviously, everybody is subject to the declining interest rates. I think this is kind of an interesting way that we look at it, is take our leverage and take what the investment returns are and what does it take to get to a 12% ROE.
At our leverage, you can see it takes about a 95 combined ratio to get to a 12% ROE. The industry broadly, at their leverage ratios, that takes about an 87 combined ratio to get to a 12%. What we've done is we've recast that in the far side there of what does it look like if you take current yields that we're investing at today, and what does that mean in terms of combined ratio that you have to get to generate a 12% ROE? You can see for us, it's a 93, for the broad industry, it's an 84. I mean, those are substantially below where the industry is performing, obviously, and what really cries out for the fact that we need a lot of pricing discipline in the marketplace.
The way we've deployed our capital over the years, you can see Selective doubled in size between 1998 and 2006, the last hard market that we had. We grew when the time was right. We're able to grow because of our relationships at a lot faster clip than a lot of our competitors, and we're able to grow longer than them. After that timeframe, we had an opportunity to really deploy some of that excess capital by returning it to shareholders through share buybacks, and we felt that that was the appropriate way to do that at that time. Obviously, in the 2008, 2009 timeframe, when the financial markets were melting down, it was all a matter of preservation of capital and preservation of liquidity.
Since that time in 2011, we made two small E&S acquisitions to really enable us to expand our ability to generate returns for our shareholders. We think now with the market, I won't call it hard, I'll say that it's firming to a certain extent. I heard one analyst call it a day-old bread market. It's not as soft as it used to be, but it's not quite hard yet. It's definitely moving in the right direction, and we've seen some really favorable and encouraging things. Sorry, it wasn't you, Jay. The path to a 12% ROE, not that we want to stop at a 12% ROE, but it'd be great to get there for starters anyway.
It's really predicated on our expectation that we're going to be able to achieve a 5%-8% pure price increase in each of the next three years as the market hardens. That's not the kind of price increases you saw in the last hard market. I mean, you saw 19%, 20%, 25% price increases. The expectation is with this kind of an economy, it's going to be a lot harder to sell that high of a price increase, but our expectations are built on only about a 5%-8% per year. You take that along with all of our Commercial Lines underwriting improvements, our additional Personal Lines price increases in underwriting improvements, our claim improvements, and our expense management, that'll get us to that 12% ROE range in a three-year kind of timeframe. That's our expectation.
With that, I'll turn it over to Greg Murphy to talk about a strategic overview.
Thanks, Dale. Good afternoon. I hope Dale kind of gave you a little bit of insight in terms of the number of components that we're pushing on to improve our profitability, and also the fact that our leverage plays to our advantage as a regional carrier. Let me talk a little bit about the most asked question that I get is, what makes you different than most other companies? I will tell you it is the relationship, it is the franchise value that we share with our agents. I can best demonstrate that to you when you step back and think about, for 11 quarters, we've been getting rated Commercial Lines and our retention has hardly moved down at all. It's bounced around a little bit, but it's hardly moved down at all.
I say that's a testament to our agents and the relationship that we share with them. Part of it is because we distribute our product to 1,000 agents. Our average agent writes $1.5 million of business with us. It's our field model. It's the fact that we're out there talking to our agents consistently in road shows. We survey our agents every year. We figure out from a technology standpoint what it is we need to do. Our technological competitors are Travelers, Hartford, and Zurich. They're not other regional carriers, and we're the company that wins all the awards from both AMS and Applied. Still, the linchpin of our success is the field aspect of our model, and it really centers around our field marketing specialists. Some people call them AMSs, some people call them field marketing people, we'll use that generically.
Our AMSs are responsible for hiring and firing agents in their territory. They're responsible for profitable growth. On average, we expect them to generate about $2.5 million of new business, new middle market business per year. They have that direct relationship with that agency, the reason why they're successful is they're in their office twice a week, three times a week, or once or twice a month, depending on how big the agent is and how much we're ringing the cash register every time we go into that shop. We kind of supplement that field middle market strategy with what we call an FMS or a field marketing specialist. Their focus now is more of a marketing role and less of an underwriting role.
They're in that agency to see small business, they're in that agency to see personal lines, these are businesses that kind of flow through our templates. It's more of a marketing push, the sense is that if we're in that agency more often asking for that business versus the middle market kind of role, we will see a better flow of both those styles accounts. We also supplement that with a safety management person. We have about 70 of them, they're out there, they're brought on service calls. They're out there to assist in the sales process to demonstrate the value to a customer that we bring in the middle market area that makes us different than most other companies. In addition to that, we also handle our claims in a field-based model.
We're able to tell an agent that Greg Murphy's going to be your claim person. He's going to see almost most of all your claims with the exception of the comp side, he's going to be your go-to person, relative to your claims inventory. That means a lot to an agent because they can take a claims person out on a sales call and introduce them to the customer prospect, saying, "This is who's going to handle your claims if you come with Selective." That makes quite a bit of difference when you're out there talking about the service elements of differentiating yourself from the customers. The other part to think about the customer is what we're doing as a regional carrier and the customer-centric focus that we are. We did an entire audit of every customer touchpoint in our company.
We said, what were the highest touchpoints that we had that had the lowest quality in terms of the relative value of what that point was. We've done an entire review of what it is we need to do differently, it's about building more around the end customer as well as our agent. There's a whole bunch of initiatives that we have, the voice of the customer. We reorganized our bill. There's a whole bunch of other things that we're doing, some of the outcomes of that, we expect to get more loyal customers, which means a better retention, lower acquisition cost to us, improved profitability. The other thing you get out of it now is direct access into the customer. Maybe we can improve some of the things that we do on the claim handling.
In other words, reporting a claim instantly into us, which reduces the days that that claim could be sitting out there. Having direct access to the customer gives us an opportunity to differentiate ourselves. We know every vehicle, every power unit that one of our customers drives. If we could sit there and think about recall campaigns and actually communicate that out to our customers. Again, it just shows you the power of that connectivity and differentiating yourself in the market in terms of true services going forward. You think about our overall strategy for growth, and it is multifaceted. You have all of these things coming into play. At the bookends or the anchors, you have rate and retention, and that is something that we very closely monitor in the marketplace. You also have underwriting improvements that you need to deploy throughout your book of business.
You also have to look at the quality of the business coming in, both in terms of how is it priced and how do you believe it stacks up, relative to the quality you have in your existing inventory. You have to be pushing on every one of those threads to improve your profitability successfully. It isn't easy. When you think about from a commercial lines standpoint, we've gotten 11 quarters of commercial lines rate increases. The only company that can sit out there and tell you, we've been doing this successfully for 11 quarters, and it hasn't been easy. I will tell you, when we talk to our inside underwriters, they say it's easier. Just like Dale said, it's not a hard market, it's a firming market.
You got to remember, when you're the only one out there raising rate, that's a difficult story to deliver to an end customer and to an agency plant. We've been doing it now for 11 quarters, mostly because of the underwriting tools that we have. We like to say sophisticated underwriting and granular pricing, I'd like to draw a loop for you. Just picture yourself as an inside underwriter. You've got 3,000 accounts coming up this month. At some point you have to sit there, what am I going to do with these 3,000 accounts that I've got coming down? You sit down the next thing, you got all these underwriting goals. You got line of business people telling you, hey, this line's not profitable. This segment's not profitable. You're telling your regional managers telling you, hey, look, this agent's not profitable.
We need to drive this amount of rate on this kind of diamond business. This is where we are off manual. This is where we are relative to frequency on this account. You can imagine, if you're an inside underwriter, you got these things all over the place out there trying to figure out what you're going to do on your inventory. We have this dynamic, call it dynamic portfolio management tool that manages the inventory, that allows them to sift through all of those goals. They can go through and play what if analysis. What if I drive rate on this account more? What if I non-renew this account? What does it mean to me so I could sit there and get my underwriting action? I know I'm driving this amount of rate on this account. I know I'm non-renewing this account.
From that, they can actually see the output of their actions for that month and then say, this is how I've met my underwriting improvement goal. From our standpoint, part of our annual cash incentive plan is tied to specific underwriting improvements that every region has that builds up. Not only do you have a price target, but you've got an underwriting profitability improvement target built into it. It's only because of this tool that we have that our inside underwriters can manage 3,000 accounts every month, and you're doing that month in and month out, trying to churn out that level of increase. When you think about capacity for growth from our standpoint, I think Dale touched a little bit on this in terms of our footprint. We've got footprint expansion opportunities we're looking at long term.
Within our footprint, we write a 7 share of wallet, and we track that. I can tell you exactly what that is for every one of our agents. We sit there and say, a 7 share of wallet, we want to increase. What a 7 share of wallet means is we write about 7% of our agents' premium volume in the commercial line space. We are driving that now higher through our middle market, trying to get more of their middle market business, pushing more of that to us. Again, like Dale said, we weren't pushing growth for the last several years. We were actually shrinking as a company, and we were shrinking as a company because that was not the time to grow into that kind of the teeth of a highly competitive marketplace.
We've added on this new marketing role, what we call the field marketing specialist. Again, that's to write more of that small commercial, to write more of the personal lines. We've introduced more than 50 new and enhanced products in the last few years, and we have a pretty strong pipeline of newer products, and we're trying to find the higher margin, less commoditized segments that we're trying to push out. Our agents write, in total, about $2 billion of E&S business, and of that, approximately $300 million-$400 million of that is contract binding style of business.
Through some things that we're looking at to try and incent agents to move that business to us, we feel that we've got a very successful opportunity to go after that business that today is placed in a highly fragmented manner without any real relationship attached to it. That's a little bit about our capacity to grow. When you think about all the new things that we've added recently, the E&S operation that we've got, we're looking now, we are on second generation models, and we're looking at moving to third generation models on the commercial line side. That will involve more customer knowledge base that we'll get at as a result of our customer experience. There's a whole host of things that we're looking at relative to our next generation in commercial lines.
Now is not the time to be developing models for the first time in the commercial line space because this market is going to generally just run right over you. For companies that are socializing rate, and what I mean by that, they're just raising rate across the board, they're going to find themselves adversely selected upon by companies that can better granularly price and have some increased sophisticated underwriting. You go through all the tools that we have, we feel confident in the amount of new business that we write in terms of how we go through that, and we're very encouraged when we look at our renewal inventory, how our retention's improving, how the business of our insureds is improving relative to audit premium and endorsements. Our exposure base is increasing.
When rate increases and exposure base increase, we're not writing one piece of new business to get that growth, and you're trying to see that growth come more into the marketplace. That's a little bit about who we are and what makes us different. Now, we'd love to take questions from the audience.
I'll be happy to start with one because I've got a bunch.
Go ahead
I guess I want to focus on workers' comp. It's been a line of business that certainly has been a challenge for you for a number of years. Others are now feeling that pressure. Talk about what you see going forward, and are your efforts to improve profitability in that line getting easier because others are now feeling that same pressure?
Yeah. I would say that let's break the pressure down. I think that there's numerous things that we're doing to improve our book. The ones that are more internally focused are different underwriting initiatives relative to the book and better segmentation. There's things that we're doing to try to change the character of the book, move it a little bit more from a little less contracting into more four-wall type of exposure, less higher hazard business. Those are things are clearly in our control. On the claims side, I just can't sit here and recite all the initiatives that we have on the claim front to drive our cost of goods sold down. Those are all within our confines of what we're doing in terms of better networks, return to work.
All the different things that we're focused on that, I would say, are within our control to drive that improvement. Then the final thing that's more market centric is the monoline comp carriers that are out there and the ability to push rate, and that's where it becomes a little bit more difficult. You see a state like Pennsylvania took a 5.66% rate reduction down. It's hard to intellectually go through that from an actuarial standpoint and get to that kind of rate level. Those are things that become a little bit more difficult that we need to work around, and we're trying to do everything that we can to push rate in it. We told on the conference call, our rate was about 4.5% for the month of January of 2012, and comp was our lead line in terms of the largest increase in there.
We see things changing, and we see some of the monoline carriers starting to run into some more problems, which is helping us get more rate in the marketplace.
The second question I had, maybe for Dale. You talked about having more operating leverage and more investment leverage. All else being equal, you would expect the company then to show a higher ROE. It hasn't been worse than others, but it hasn't been better than others either. Obviously, it's that margin, I guess. Anything else besides just that profitability margin that you see holding back the ROE?
Well, ultimately, we're in a better position. If we achieve the same combined ratio as somebody else, we're going to end up generating a better ROE. One of the things, and it kind of actually feeds into your last question, too, is that our book of business has traditionally been heavier in contractors. One of the issues in this past economic downturn is that you had kind of the bottom of the insurance cycle hit at the same time that you had a really miserable economy hit. Those two things really hammered the contractors a lot harder than you saw other industries get hit. As a result of that, you saw workers' comp results deteriorate particularly strongly, and that's why we ended up giving up a few more points on the combined ratio than maybe you saw some of our larger competitors, particularly.
Just as an example, Travelers has probably about 17% of their book in contractors. We started this past cycle at about 35% of our book in contractors. That makes for a significant difference in terms of profitability. If you kind of even those things out and look at the relative performance of the other groups and use kind of a Travelers weighting to it, we come much closer to their kind of performance.
Question in the back? Thank you. We got one right here, too. Thanks.
Just had a question on personal lines rate activity. You're taking some pretty significant rate there, especially on homeowners. Is there any resistance, either for competitive reasons or regulators pushing back on the amount of rate that you're trying to take there?
Yeah, I'll separate that into its two pieces. From a competitor standpoint, I think you've seen competitors finally sit there and go on home. More and more people are saying, "We need to run that at an 85 level with normal cat loads." I think that pressure has started to sit there and say, "You know what? We're going to start pricing to that level, and if the business moves, it moves." I also think that you're starting to see a little bit of regulatory resistance relative to RMS 11. We don't write personal lines in Massachusetts, but you've got a situation going on in Massachusetts with respects to just RMS and wind models in general. Yes, you're starting to see a little more regulatory noise on that.
I think that would probably be more of a governor on the amount of rate and the velocity of rate versus the competitive. If I had to pick one of those over the other, that may be more of an impediment. I would say you may see more regulatory impediment than you would see competitive impediments. There was a question right there. Okay, hold on a sec.
Thanks. Greg, you talk about how in Pennsylvania, you folks have been raising rates on the comp side, yet the state wants you to decrease them. What type of pushback do you get from your agents and your customers in that type of scenario, and how do you try to combat that?
Yeah, we try to combat that with the fact that we've got to do what's right in the marketplace in terms of from a profitability standpoint. We have to combat that with doing other things in terms of structuring the rate to move around that 5.66% rate reduction I talked about. That's just a part of what you need to do. When we sit there and we look at this cycle, we sit there and say, "This cycle will probably be three years in the 5%-8% range because of how tough the economy is." Like Dale mentioned earlier, if you had a stronger economy, I think you'd be able to do more rate-wise, and I think you're going to see more on the commercial lines regulation side, regulators starting to step in on rate increases as we move forward.
We are trying to manage within the confines that we have, and we're also trying to manage more of our business into the level of profitability, because as we move down the path and IFRS comes down the line, and you've got new accounting rules relative to your lines of business, you want to make sure you've got your lines in a more profitable range. I think comp's going to be a line that you're going to see a lot of companies start to take a lot more aggressive action on, so they're not using it as a line of any kind of so-called cross-subsidization on an account basis. We're aware of all those issues.
We're mindful of our consumers. We're also mindful of the fact that we need to make an underwriting profit. We need to make sure we're doing it holistically. We need to make sure we're doing it right by state. We're also making sure we need to do it right by line of business.
If I can ask one on the E&S business. To the extent you can you talk maybe, give us some more detail on how the integration is going and maybe what you're seeing from the producers as far as the new business opportunities becoming reality, and maybe if you could put a little more around that?
Sure. The integration's going well. One of the things is, we're not integrating it into our standard lines operation, but we are taking the book that we purchased from Alterra and integrating that into the platform that we purchased from Montpelier, because that's an end-to-end IT solution that we purchased there. That is an integration that is occurring, and that's been going very well, and we're on track and on budget for all of that, so we feel really good about that. The thing I'd say in terms of production is we started writing the Alterra business for our own account on August 1st. Although traditionally, when you make an acquisition, you expect to see some fall-off in production, and we actually didn't see any fall-off in production. That's been very favorable in our minds in terms of the way that integration piece of it is working.
Yeah. I would just add to that. We look at three legs of growth coming into E&S operation. The first is the volumetric change of business that comes out of the primary market into the E&S space as carriers tighten down their underwriting. There's business that automatically flows in. The first two businesses you normally see are straight bars and taverns, and straight apartments, excuse me, will come through. You got rate increases that will happen as a result in that marketplace. The third thing is, as we get our entire agency plant locked up with the incentives that we want to provide them, I think we're going to have a good insight into the $300 million-$400 million that they write on a highly fragmented basis. We look at there's a lot of opportunity in that space for us.
Beyond that is, obviously, we think that this is the exact right time to get into the E&S business, is that when the market hardens is when E&S really has a lot of growth opportunities. I think in a lot of ways, we've timed this very well. I wouldn't say that we're seeing that just yet in terms of rapid expansion, but I think that we feel really good about our opportunity to profitably grow that business in a very nice way.
Again, as Dale mentioned, it's a higher margin business, and I think it's a business that will provide a little more buoyancy to our long-term performance as a company.
On that business, what's the split between property and casualty, roughly? Do you know?
It's 25% property, 75% casualty, and the casualty is basically almost all GL with a little bit of umbrella or excess GL in it. No workers' comp at all.
Got it. Question right behind.
Yeah, thanks.
I had a question about rates. As more and more carriers, commercial lines carriers sort of get on the bandwagon with respect to trying to get more rate, is it enabling you to push a little bit harder, call it this quarter as compared to the prior quarter, or the prior quarter compared to the third quarter? Is it enabling you to raise the bar a little higher?
Yeah, the answer to the question is yes.
Okay.
We saw that. You got to understand that we're out probably somewhere between 60 and 90 days in advance of renewal, so we're out that far, putting quotes on the street. We heard a lot about the noise, about some of our other carriers. We do road shows with our agents. It's a 15-stop road show in the month of November, doing the planning process for the 2012 year. We heard about it in November, then we obviously modified. You saw the fact that our rate level for the month of January of 2012, which is the biggest premium month for us, was up 4.5% versus the third quarter was up 3.4%. As we indicated on our conference call, we were driving rate, and we were driving rate back in 2009, 2010, and we were driving rate.
We had to modify our strategy in mid-2010 to a barbell strategy, which said focus on rate and the worst end of the business, non-renew and get rate on the worst end, focus on retention on the best end, and just let the premium kind of fall where it is. We had to do that for the second half of 2010 and pretty much all of 2011 because of competitive factors that didn't kick in like we thought they should have. We are moving more back onto a rate environment, and we've got rate targets set. We have five regional offices. They all have different rate targets, and they all know what they're pushing to, and we want to make sure we're maximizing rate retention, and we closely monitor that every month and where we need to get more.
What we tell our folks is, "Now's the time to fix any kind of underwriting issue you've got inside your shop," and that's what we're aggressively doing. We want to make sure we're taking the most advantage of the marketplace. You don't want to leave anything on the table this year.
Do you also expect retention to improve in the early part of 2012 as compared to late 2011?
I would say that as more of our competitors drive rate, it makes doing what we do easier and makes our retention more stable and maybe even provide a little bit of upswing. We're making no prognostication on that. When more people do what we're doing, we're less of an outlier, which means that retention has more stability, I would think, a higher degree of stability in it than it would when you're out there more of a lone ranger. I know we're over time.
If I may add to that, Ron, is that obviously, we look very closely at retention and how that plays with the price that we're achieving, and we see that that tells us when we've got an opportunity to push price harder. If retention's going up, then you know that you got a chance to get a little bit more price out of things. We definitely look at that and monitor it very carefully and closely.
Okay, that was great. Thank you very much.
Thank you.