Selective Insurance Group, Inc. (NASDAQ:SIGI)
Bank of America Merrill Lynch 2014 Insurance Conference Call
February 13, 2014 10:05 AM ET
Dale Thatcher – EVP and CFO
John Marchioni – President and COO
Those of you who haven’t met me yet, I am [Alison Chicaguetson] and I work with J Cowen on the property casualty side.
The next company presenting is Selective and it’s always a total pleasure to introduce some of their perennial company at our conference. However, this year we actually have a first time speaker from the company, John Marchioni, Selective’s President and CEO. He has been with the company for more than 15 years. Correct? So we’re getting an interesting new perspective and joining him is Dale Thatcher, most of you know him, he is the company’s CFO and Jennifer DiBerardino is sitting in the audience. So we’ve got a full house from the company. So with that, I’m going to turn it over to them to tell you about the story.
Thanks Alison. It’s tough getting in and out of these chairs and I am glad to see that we actually have some Selective slides and that will be good. I won’t go through the traditional here, but it is there, we will have the forward looking statements as we always do and you are encouraged to look at our 10-K and take a look at what the risk factors are relative to that.
We’re going to talk about our history of success as a super-regional carrier. We’re the 44th largest U.S. property and casualty carrier, we’ve got a history of financial strength. We have been A rated by A.M. Best for 80 plus years. We specialize in small commercial but we also do the personal lines and the newest piece of the puzzle is our E&S business. So we will talk a little bit about today and you will also hear about our unique field based operating model there aren’t too many carriers that have the kind of expertise that we do and the uniqueness of how we distribute our product.
So if you look here at our standard commercial line that’s the biggest part of who we are, you can see 76% of our business comes from standard commercial lines, you can see the 22 state footprint where we distribute that. So those 22 states account for about 52% of the population in the United States. These are main street accounts the average account size is approximately $10,000. So these are the electricians that you call to come over to your house this is the Bagel place that you stop there in the morning for a cup of coffee, that’s our bread and butter style of risk.
It doesn’t mean that we don’t have larger accounts we do that, but generally speaking we distribute guaranteed cost contracts. As soon as a company gets large enough that they want to get into the alternative risk transfer mechanism they tend to go elsewhere for their products. We distribute through about 1,100 independent agents. So we like to have a very deep penetration of that agency plan. So we want to be a very important player within their operations so that they provide us with our best business and often times an opportunity to take the last shot at a piece of business it’s very important in terms of being able to achieve the best pricing and the best profitability.
We also -- what’s one of the unique things about us is that we have approximately 100 field underwriters that work out of their home each of those underwriters has about a 10 agencies that they do all of the new business underwriting for that agency. So they are living in that same community they are driving past those insurance, they understand the book of business but also importantly they know all the producers within that agent’s office, they have got relationships with them to the extent that they can be there face to face and get their best business and we are able to get a deeper penetration as a result of that.
On the personal line side we can see that we do personal lines in a 13 state subset of those 22 states so the states within our normal standard line footprint that we’ve identified as higher quality states in terms of the legal regulatory or natural catastrophe environment that’s much more conducive to long-term consistent personal lines profits is where we are, we got about 690 of our agents in those 13 states to distribute the personal lines product and that represents about 17% of our overall premium written.
And then accessing surplus lines, we’ve made a couple of acquisitions in the 2011 time frame, you can see that, that represents about 7% of our overall premium written, this is the commercial binding authority segment of E&S, so it’s a very small or what our Chief Underwriting Officer likes to call E&S light, so the average account size here is about $2,400 so this is restaurant, bars and taverns and habitational risks that can’t obtain insurance in the standard lines market place.
So they go to the E&S market place where you traditionally have tighter coverage and higher prices therefore, better margins. This area of the E&S space has traditionally been 6 to 10 points more profitable than standard commercial lines business and one of the reasons why we added this to the overall mix was to improve our overall profit profile.
So we’ll talk about strong balance sheet, how it provides a foundation for success. You will see that we have much lower volatility in our business both in terms of the combined ratio performance and also in terms of loss reserves and how they perform which obviously have started to become more and more important and this phase of the market cycle as you start to see some companies have difficulties around that, you will see that we have substantially less volatility and much better track record in terms of staying on top of reserves.
I will talk about our effective cycle management and also talk about the path to 92 ex-cat combined that we laid out at the very beginning of 2012 and how we are very much on track for that in spite of the early skepticism from some folks who shall remain nameless in the audience around our ability to achieve that we have performed very well. So talking about that financial strength we’ve got a conservative investment portfolio you can see here $4.6 billion in invested assets 90% of that is in bonds with an average AA minus quality so it’s pretty plain vanilla pretty straight forward investment profile there.
The other thing I think is important you can see to the right there is our net operating cash flows as a percentage of net premium written very strong cash flow as a result of how we perform the leverage that we employ and you can see also in compared to the industry that we tend to be better there so very strong cash flow company. Our portfolio has about a 3.6 year duration so our duration is a little bit lighter than our peers but that is by design again because we deploy a little bit more leverage than our peers also and I will talk about that in a minute.
If you look at our reinsurance program we have a $685 million coverage in excess of our $40 million retention so our current program exhausts at a one-in-250 year event so a fairly conservative program the $40 million retention is generally on par maybe a little bit lower than some of our peers but we increased the top layer this past year added an additional $100 million of coverage there I felt that, that was the prudent way to balance the overall risk profile of the company. The average reinsurer rating is A plus you can see there. We also achieved I know a lot of people are wondering the reinsurance pricing in the market place, we did achieve a flat premium in spite of the addition of another $100 million worth of coverage.
So there is some competitiveness obviously in the reinsurance market place. If you look at capacities on our combined ratio, that’s been obviously a big piece of the puzzle over the last couple of years, we’ve had some of the worse years in the company’s history but also as you can see even in spite of that we still have lower cat losses on the combined ratio than the industry did. So even though, ’10, ’11 and ’12 were some pretty difficult years in terms of points on the combined ratio, you can see the 10 year average for the industry is still at a 5 and we’re at a 2.8.
If you go back before 2010 our 25 year average is only about 1.5 so I don’t know it’s global warming or natural randomness in the weather patterns but clearly we’re at least for now in a heavier cat time frame but we still in spite of that end up performing better than the peers. We also have lower volatility results if you look at the standard deviation of our combined ratio over the last 10 years compared to our peer group you can see on the reserve development and on the combined ratio basis, both has lower volatility. One of the reasons why the rating agencies tolerate us running at a higher degree of leverage is because of that lower volatility that run at that’s generated by number of things.
One is the lower cat losses that we just talked about also by the fact that we are writing those small commercial policies that tend to be more well behaved about 85% of our business had $1 million and below, so you don’t have large limits policies that add an extra degree of volatility into the overall mix and the other thing is, we do group up reserve analysis each and every quarter by our whole actuarial department, so we can stay on top of reserve trends and react accordingly.
Reserve problems are a lot like fish they don’t get any better with page, you need to address them quickly. Here is the last piece of the three year plan, we originally laid out this water fall chart as I said at the beginning of 2012 it articulated that we expected to get three years of price increases of between 5% and 8% we’ve delivered in the first two years of those price increases and this is the third year of that. That 4.5 just tells you what’s the earn rate impact on the combined ratio is, we’re still getting in excess of that 5% to 8% or in that range so that’s going well.
And in fact, our guidance for this year is that we will get between 6% and 7% price increases so we’re doing well along that scale you can see that 92 ex-cat combined ratio that we laid out at the beginning of this 2012 we still have that exact same guidance two years later, two plus years later so that is our expectation so 92 ex-cat we layer on our guidance of about 4 points of catastrophe losses and that generates the 96 combined ratio that we’re expecting to achieve this year.
This slide gives you what impact of the our higher leverage than our peers generates our underwriting leverage we run at 1.4 or 1.5 in that neck of the woods, premiums to surplus. The industry is at about 0.7, our peer group is right around 1:1 premiums to surplus. You can see what that band means in terms of investment leverage so we got $4 of invested assets for $1 of stockholders’ equity compared to the industry at $2.30 and our peer group at about $3 per $1 of stockholders’’ equity.
What all of that ends up translating to is at a 96 combined ratio Selective generates a 10.5% ROE and the industry generates an 8% ROE. So there is a definite ROE advantage to the leverage that we’re able to deploy the reason we’re able to deploy the leverage is because we have lower volatility in our results and manage the reserves more carefully.
With that I will turn it over to John.
Thank you Dale. Good morning, I am glad to be here I am just going to give a sense as to what our strategy is as an organization and I will talk to you a little bit about what’s happening in terms of our operating performance. Just in terms of who we are as a company, I think the best way to describe our strategy is to have the capabilities of a national insurance companies in terms of products and appetite in terms of underwriting and pricing sophistication and in terms of technology but more importantly to deliver those capabilities for very strong regional model.
So our regional model that’s based on relationships with the best agents in the business and it’s based on power decision making, so our view is we’re going to push decision making on the underwriting and the claims side as close to our customers and as close to our agency as we possibly can and the ability to put those two factors together really sets us according to market place.
You see a couple of other items reference up here other than ones I mentioned we’re also very focused on the customer experience so we recognize it as an independent agency company we provide a shared experience to our customers and on the commercial line side in particular there is a real opportunity for us to differentiate ourselves to our customers improving retention and improving word of mouth of marketing through a much better customer experience and then Dale showed the fact that we benefit from leverage, effectively managing leverage allowing us to generate a higher ROE at the same combined ratio level in the broad industry.
In terms of this cycle management, you’ve heard a couple of references to this already, this gives you a sense as to our growth throughout the different market cycles, so you can see back in the last hard market that period from 1998 to 2006 we effectively doubled the size of the company and then as things started we started to have some pre significant market and economic headwinds in the late 2000 it was really about managing our overall growth because the time to grow was not during that period.
So again managing the top line managing our profitability as effectively as we possibly can and then we started to see a little bit of a change in the market place and from 2011 through 2013 and looking forward we really think as an opportunity for us to continue to accelerate growth and you’re seeing that start to happen. In terms of the areas that we look at as growth drivers for us on go forward basis, Dale took you through the different segments that we look at our business and the newest being E&S so E&S we started to get into through a couple of acquisitions dating back about two or so years, it gives us great product diversification it also gives us great geographic diversification.
So unlike our 22 states standard operating footprint this gives us a 50 state footprint for the E&S lines. It gives us a lot of upside potential going forward and also in our view we have an opportunity to capitalize on our retail agency relationships in our standard operating footprint to drive business to our wholesale partners on the E&S side so that’s one big area. We also continue to make sure we build our product portfolio we wanted to make sure that our coverage and our products are as marketable as possible we continue to reevaluate them, make improvements, we roll out additional product but again we’re always staying very close to our netting in terms of underwriting.
We’re a conservative underwriting company, we know we do well we know the markets that we serve well and we continue to build out our capabilities but within those defined parameters we also continue to build out our agency plan so we’ve had a franchised value agency appointment strategy, our view is with 1,100 agents we want to do more business with fewer agency partners requiring us to occupy one of those top two or three spots in our agency partners. But despite that, there are still opportunities of our footprint to add agencies door front so we continue to do that and it gives us a lot of upside and then finally, if you look at our market share across our 22 state footprint or the 50 state footprint on the E&S side.
Generally speaking, in the standard operations, we’re about one share on average of our 22 operating space, so there is pretty significant upside for us within our existing footprint and looking at it two ways what’s the market share that our agency partners control and then how much of what our agencies write do they write with us or as we consider it to be share of wallet. Those two factors are what really drive our growth on a go forward basis.
Now a lot of companies will stand up here and probably tell you they have got the best agency relationships out there and we would certainly say that but I think we can stand behind it and if you’re looking for proof in terms of the strength of our relationships you can look no further than this, so this is our performance on the pricing side over the last 19 quarters and if you look at our performance relative to the industry it’s very strong so the pricing is part of it but the more important factor is to look at pricing at the same time, we’re looking at retention levels.
So what you see here is as we started to really improve our rate performance back in the second quarter of 2009 when most industry surveys still had the overall market as slightly negative, we started to really manage our portfolio and we managed it through relationships with our agents but also through a very, very targeted underwriting philosophy, segment our book and make sure we’re targeting the rate in the best areas. But the ability to actually maintain very strong retention levels despite the fact that we’re out in front of the market place and then over the last several quarters, you actually see retentions pick up from about 80 to about 82 and stay there.
There is no question that, that is clear evidence of our underwriting capabilities but more importantly our ability to work with agents who really believe in our partnership and I think that’s critically important. I also mentioned the underwriting and pricing sophistication this gives you a sense as to how our underwriters manage their renewal portfolio from the pricing and retention perspective, what you can see here, is our renewal inventory split into five different categories, based on our desired retention levels.
So on the far left, you see the above average category that’s the business that is our best performing accounts that we think are the best performing accounts on a go forward basis, it represents about 53% of our enforced inventory so the bulk of our business, our renewal policies are in those left two towers that you see there. That’s where you see we’re getting the least amount of rate because you want to maximize retention so we’re getting rates just about 6% or so but you see retention up closer to 90%.
On the far right hand side, the low and the very low categories are where we want to make sure we’re maximizing rate and in certain cases if we are not able to achieve our rate targets which you will see we’re achieving in the 13, 15 or 16 kind of range, that’s the business that you’re willing to lose if you can’t get your rate level. So again think back to what Dale showed you in terms of that waterfall chart in reference to underwriting improvement this is where in addition to getting rate over trend, you’re getting mix of business improvement. So you’re improving the mix of business by retaining your best accounts at a higher level and your lower quality accounts you are getting more rates and retaining on a lower level.
So this is where that underwriting improvement comes from. Now as good as we feel about our performance there are still opportunities to improve our performance this gives you a sense on the commercial line side and Dale showed you the profitability overall but you can see very, very good performance across our major commercial lines with the exception of workers’ comp so workers’ comp continues to be the line that we really need to make sure that we’re focused on. And you can see that for the performance there on a reported basis of about 120, adverse in the year is 114 so when you take out the impact of prior year adverse development that’s a 114 so spill performance that we need to make sure we improve and we’re focused on driving that improvement.
And there is really three categories so the first one being making sure we continue to drive rate and excessive trend that’s where you are getting that part of the improvement. Also as I showed you earlier with that distribution of the renewal inventory making sure that we’re aggressively managing that old inventory and really starting to drive up the rate and down the retention on the accounts that are the most troubling for us.
Now we also need to keep in mind that we are account underwriter, we don’t write very much model line workers’ comp so we also need to look at the overall performance of an account between the non-comp lines and the comp lines but there is clearly an opportunity to drive more improvement in that area and then finally, and a big piece of the improvement on workers’ comp going forward is in the claims area. And when you think about some of the investments we are making in the claims arena most of these across all lines but the first three you see up here really affect the workers’ comp line specifically.
So the first one is a creation of a strategic case unit, so creation of a group of folks who are highly skilled at managing the tougher comp claims that you have, the ones that are going to have more lost time and more medical cost attached to them. The second piece is very much related to that so it’s the ability through modeling techniques that we’re in the process of rolling out to identify very early in the claim life cycle those comp claims that are likely to really escalate overtime get those in the hands of these skill professionals very early in the life cycle and they are going to better manage that inventory over a period of time.
So those two pieces are relatively closely tied together and then finally driving better penetration into our network partners on the medical side and really managing medical costs overall. You also see what we have done on the… we talk about modeling on the underwriting side have been a lot of modeling and implementation of models on the claims side so both broad and identification of opportunities for recoveries those have been implemented we’re going to continue to see improvement across all lines of business there and then finally, on the litigation management and the complex claims side driving mostly improvement on liability and the auto side -- general liability and the auto side but again very similar to the strategic case unit in the workers’ comp arena.
So we think when you look out in terms of performance there are certain things you could do to out select and our price your competitors and we’re focused on those but also making sure that we’re managing our lost cost dollars as effectively as we possibly can. And then just to close where Dale opened in terms of why Selective make such a great investment, so first and foremost a very, very strong balance sheet. That’s the foundation of everything else that we talk to you about.
The lower volatility that we’ve been able to demonstrate in terms of our operating results allows us to deploy that additional leverage in terms of premiums to surplus and invested asset leverage which again allows us to perform at a higher ROE at the same combined ratio as the broad industry, effectively managing the cycle and again when you look at what we’ve been able to do in terms of the past cycle, it gives us confidence in terms of our ability to manage the cycle on the go forward basis and then finally, as you will look out in terms of what we have been able to accomplish, we laid out a very aggressive three year plan to get us to a 92 ex-catastrophe combined ratio we’re in the year three of that and very clear in terms of our performance and the track that we’re on relative to those expectations.
So those were the reasons why you should really invest in Selective. So with that, I would like to open it up for the questions, Dale and I are really certainly here and happy to take any questions that you may have.
I have got a couple of questions on the slide you showed where you got the best performing accounts and the worst performing accounts and the various price increases has the percent of business in your worst performing accounts come down one, with respect to you would have given the action you’re taking or has more business fallen into that bucket?
Yeah so it’s a great question when you think about the distribution of premium it certainly as you execute your strategies and you’re retaining your lowest expectation performance accounts to a lower retention target, your mix is dropping but keep in mind because of the factors that be in these models you’re recalibrating them on the regular basis so it’s whole relative to your entire inventory. So you’re going to see that bucket repopulate as everything turn its size left to right but in theory and in practice your combined ratio on that business as you recalibrate starts to come down overtime as well.
You redefined what lower bucket to some extent.
Correct, because part of what feeds that process is our predictive modeling. Predictive modeling is essentially looking at everything on a relative basis, so you do in fact start to recalibrate things down and again you’re -- the tip of your loss ration then starts to drop as that business improves, generally speaking roughly 10% of the business it is earmarked for those lower two buckets so as you chop off the bottom 3% then you grab 3% from the upper slide and take it back in the bucket. It is a simple way to think about it.
And then the other question on the E&S business so your standard commercial platform is geographically focused on number of states. Your E&S platform is nation-wide. Have you had a different experience with your agent because you’ve introduced the E&S platform, have you been able to sell them more and what has been your experience in E&S in the state you are already in versus the one that you’re not in?
Yeah so a couple of pieces there, with regards to our agents reaction as we went into the strategy we made a concerted effort to say based on the style of the business we’re going to write here, which is small highly automated in terms of how it's underwritten and we thought it made sense to stay with a wholesale distribution model across all of our states as opposed to a direct retail in our states in a wholesale model out of our states.
We think that serves us best what we’ve really started to invest in now because of our agents our retail agents in many cases have their E&S business scattered across a number of different wholesalers, we’re trying to get them to consolidate and pick a few or more bigger partner wholesalers and consolidate that business we expect to start to see that really gain traction in 2014.
With regards to the balance of the states when you think about E&S business you do have some bigger states in terms of E&S market relative to the standard that are outside of our footprint we have got some relationships there that came along with the two acquisitions that we did and we’re seeing pretty good growth in both territories. So we look at it as a selective footprint and non-footprint and we feel good about what’s happening in both of those territories.
The only thing I would add to that is that, so we’ve two acquisitions the one acquisition the – that was headquartered in Horsham, Pennsylvania the other was the Montpelier music operation headquartered in Scottsdale, Arizona each of them were 50 state operations but they tended to have a tilt towards the area of the country that they were located in the performance of the respective operations at this point is driven really more by the history as opposed to by whether it’s footprint or non-footprint. So that’s really kind of what we’re seeing still at the present time.
My only other question was what’s wrong with West Virginia the one hole in your map?
West Virginia is wonderful state but from an insurance regulatory perspective and from an asset type perspective when you look at what it is, it just doesn’t make sense for us.
We continue to evaluate all of our non-footprint states for standard operations but that’s always been more about regulatory and legal environment and our appetite is not matching up with what’s available in that space.
And one of the things that you see about the states that we select to participate in is that we’re looking for states that we feel have an environment that enable us to achieve underwriting profits and at the present time our analysis of West Virginia that’s not really achievable.
So given the importance underwriters in your whole business model, I wondered if you could talk a bit about; A, how you ensure consistency on what has to be very widely scattered force? And secondly, as these folks retire or want to scale back how you go about replacing, I don’t think I don’t want to take somebody from New York and put him in choke of the Ohio?
Great questions. So in terms of how we ensure consistency because our field model and we have, as Dale said, almost 100 folks out there with underwriting authority but I will say it’s in within a very defined set of guidelines so everybody who is in one of those roles has a clear set of underwriting authority that they operate within and then within our regional management structure those authorities progressively go higher. But I would say the other real important consideration for us is because we have these generalist underwriters out there managing our relationships we also have a corporate underwriting group that is structured with experts both by line of business and by segment of business.
So we have a contractors group a manufacturing group a social service and specialty group and they are the ones who are establishing the parameters around what can and cannot written and they are also the ones who do a lot of the quality insurance work to make that they are looking at what each individual underwriters are doing both on the new business side and the new renewal business side. So a lot of controls around that diversified field model. So that is your first question.
On the second question you make a great point and actually building bench and a bench strength that isn’t that geographically dispersed based on our model it’s critically – we continue to do a lot more in terms of college campus recruiting and building interim type and development type programs for our underwriters both of those within the regional offices but also those who would openly be deployed as AMSs or agency management specialist or field underwriters as we describe them because we want to have folks that have been trained and have some local knowledge about the agency in a given geography I think that is pretty important.
So what’s in terms of workers’ comp what do you think about $60 million there on underwriting basis what’s involved in getting that back the acceptable returns and what’s the time frame for that?
So in terms of what’s getting -- what the focus is clearly as I try to lay out in the presentation is making sure that as we look at our distribution of renewal premium and driving rate and retention that we have much more aggressive approach to that for the workers’ comp line specifically than we do for the packaged lines and I think that’s certainly a big part of it. But I would say equally the claims improvements that we have laid out relative to the strategic case unit and the escalation model are going to be big drivers of that.
Now we don’t put out guidance on a per line basis but we certainly feel like what we’ve laid out in terms of those three areas, pricing, underwriting improvement and claims we’ll significantly improve that line of business overtime.
The other thing I will point out and I realized in some ways it may ring hollow to an investor looking at it because there is always, can you just cut that off and not do that because it’s losing money, but the thing is, there is a lot of those other lines of business but you don’t get a chance to write if you don’t provide a workers’ comp policy in the overall.
So one of the things our predictive modeling does for the underwriter is it gives them the score for the line of business it gives them pricing guidance for the line of business but it also racks and stacks all the different policies for that particular customer so the underwriter can get a feel for even though I might not be able to get the workers’ comp policy price to where I want to get it because of market forces can I still achieve an overall ROE on this customer that makes sense and that’s how one of the major components to managing the process. Believe me, given how workers’ comp has run for the industry for the 30 years I have been in the industry if we could not write it tomorrow and still keep all the other stuff we would be there in a minute. The problem is that it doesn’t end up working that way.
Okay, we got to end it there. Great job guys. Thank you.
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