RLI's (RLI) CEO Jonathan Michael on Q1 2016 Results - Earnings Call Transcript

| About: RLI Corp (RLI)

RLI Corp (NYSE:RLI)

Q1 2016 Earnings Conference Call

April 21, 2016 11:00 AM ET

Executives

Aaron Jacoby - VP and Corporate Development

Thomas Brown - VP, CFO and Treasurer

Craig Kliethermes - President and COO

Jonathan Michael - Chairman, President and CEO

Analysts

Arash Soleimani - KBW

Randy Binner - FBR Capital Markets

Mark Dwelle - RBC Capital Markets

Jeff Schmidt - William Blair

Operator

Good morning and welcome ladies and gentlemen to the RLI Corp’s First Quarter Earnings Teleconference. At this time, I would like to inform you that his conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for question-and-answer session after the presentation.

Before we get started, let me remind everyone that through the course of this teleconference, RLI management may make comments that reflect their intentions, beliefs and expectations for the future. As always, these forward-looking statements are subject to certain risk factor, which could cause actual results to differ materially. These risk factors are listed in the company’s various SEC filings, including the Annual Form 10-K, which should be reviewed carefully. The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing first quarter results.

RLI management may make reference during the call to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI’s operating earnings and earnings per share from operations consist of net earnings after the elimination of after-tax realized investment gains or losses. RLI’s management believes this measure is useful in gauging core operating performance across reporting periods, but may not be comparable to other companies’ definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available at the company’s website at www.rlicorp.com.

I will now turn the conference over to RLI’s Vice President, Corporate Development, Mr. Aaron Jacoby. Please go ahead, sir.

Aaron Jacoby

Thank you. Good morning to everyone. Welcome to the RLI earnings call for the first quarter of 2016. Joining me on today’s call are Jon Michael, Chairman and CEO; Craig Kliethermes, President and Chief Operating Officer and Tom Brown, Vice President and Chief Financial Officer.

I am going to turn the call over to Tom first to give some brief opening comments on the quarter’s financial results. Then Craig will talk about operations and market conditions. Next, we’ll open the call to questions, and Jon will finish up with some closing comments. Tom?

Thomas Brown

Thanks, Aaron and good morning, everyone. It feels a bit like broken record with these opening comments which speaks to our consistency. But nonetheless we are pleased to report a good start to year with these first quarter results.

Starting with the combing ratio, we achieved an 88 in the quarter modestly better than the last year. Underwriting income was positively impacted from favorable loss reserve development. In this case $11 million coming out of the Casualty segment. As a reminder, during the first quarter we do not perform a full actuarial loss reserve study.

Total gross written premiums was up 3% in the quarter. Casualty our largest segment turned in an impressive 9% growth rate on the strength of a number of different products, including some recent product launches. Surety was up 7% continue a very nice run of growth over the last several years.

Property however was down 13%. Excluding the discontinued crop and facultative reinsurance business that we previously reported the segment was down 7%, which is attributable mostly to continued soft market conditions in catastrophe expose areas. Each segment turned in attractive combined ratios, Casualty at a 92, property at an 84 and Surety at an 80 combining ratio. Again a pretty good result leading to the aforementioned 88 overall combined ratio.

Turning to investments. The first quarter was a good one with a 3.2 % total return. Our equity portfolio was a strong contributor, it was up 5.7% was all helped by our overweight utility stocks. Combined portfolio also posted a positive total return up 2.6% in the quarter. And although, pre-tax investment income was down a slight 1%, it was actually up 0.6% on an after tax basis as our allocation to municipal bonds increased compared to the same period last year.

With regard to our minority investments, Maui Jim turned in a slightly lower earnings, while net sales continue to grow modestly. Foreign exchange impacts and the ramp up in marketing expenditures served the depressed earnings slightly. Our other minority investment prime insurance was basically flat in the quarter compared to first quarter of 2015. All-in-all, the strong underwriting and investment performance driving our results. Book value per share was up 7% in the first quarter inclusive of dividends.

And now with that, I’ll turn the call over to Craig Kliethermes, Craig?

Craig Kliethermes

Thanks, Tom and good morning, everyone. As Tom mentioned, we’re off to a very solid start to 2016. Gross and net written premium growth both up 3%. Removing the impact of crop and the facultative reinsurance business that we exited last year were up 5%. So our core portfolio is on a good trajectory in a challenging market. At the same time, we’re able to deliver another sub-90 combined ratio quarter. It is not getting easier, but there is still opportunities for the skilled fisherman who know where to cast their line.

Let me provide some more detail by segment. in Casualty gross written premium was up 9% in the quarter and posted 92 combined ratio. We continue to find opportunities both in our established products and within many that we have started in the last several years. Our excess liability, transportation and packaged businesses continue to grow at a double-digit pace.

Transportation and excess liability continue to be a supply side phenomenon with many companies suffering very poor results and retrenching or pulling MGA contracts. Most of our package growth has come from expansion of distribution and share of wallet initiatives. The opportunities are not across the board. There are differences both geographically and within sub-class. In this market, it takes seasoned underwriting and outstanding claim people to differentiate selection, pick the right spots and weather the storm.

We continue to invest in new people and new products across our Casualty segment and we are working hard to get more products online and to scale. Rate increases are very difficult to come by, we see casualty rates as flat overall. So we continue to see positive rate on most wheels based business and in smaller account professional liability space.

However, we are having to give back a fair amount of rate in primary general liability and large D&O risk to remain competitive. Our Property segment was down 13% while reporting an 84 combined ratio. As Tom mentioned, after taking out the impact of exited products, we were still down 7%, a lot of this is price driven as we see rates in cat exposed businesses continue to slide at a double-digit pace.

Rate levels are at about 60% of what they were in 2013 for cat business. We’ve lost out on many accounts as rates we believe to be priced at or below expected loss cost. So the margins in this business have gotten much thinner. Declining reinsurance rates and a better spread of risks have helped us to take some of the pressure off our returns in the bottom-line. But this is not a growth business for us until the underlying economies change. Meanwhile we will continue to provide capacity to our best accounts and brokers where we still have an opportunity to make a profit.

Also putting pressure on the top-line for the quarter was marine and our recreational vehicle products. We have been able to achieve some positive rate in both of these businesses, but growth have been elusive as a result. The declining top-line and property has caused deterioration in the margins and resulted in higher expense ratios for this segment.

Our Surety segment continues to grow profitable. We were up 7% in premium and posted an 80 combined ratio. Our long-term presence, relationships, and consistent predictable risk appetite are a big advantage for us in this segment. Surety was led by our miscellaneous product which grew at a double-digit pace. These are typically very small bonds where ease of doing business is a critical differentiator. On the larger Surety risk, we see an abundance of less refined competition. Although results have been good for the industry. We see storms on the horizon for those who view this as loss free business.

Surety is very specialized. Hope and luck are not a good long-term strategy. The odds will eventually catch up with those offering up loose credit and other terms. Our narrow and deep Surety expertise and home art discipline should serve us well in the short and long-term. Overall we had a very solid quarter. I want to thank and congratulate the RLI associates for being different, their drive, their discipline and our diversified portfolio of products delivered again this quarter.

I’ll turn it back to Aaron to open it up for questions.

Aaron Jacoby

Thanks, Craig. We can now open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. The question-and-answer session will begin at this time. [Operator Instructions]. And our first question comes from Arash Soleimani of KBW.

Arash Soleimani

Thanks and good morning. Couple of questions here. So I know you said the growth within casualty part of that was from some new products. Can you talk about did any of that growth come from new teams that you were able to bring on from any of the industry fall outs?

Craig Kliethermes

Yes, so this is Craig Kliethermes Mr. Arash. We’ve added probably about half a dozen products or so that generated premium to-date and a few of those have been smaller teams or smaller mostly individuals as oppose to teams that have started that products whether it be in healthcare, miscellaneous professional, in our DNO space we’ve added quite a few in our E&S space, but we really haven’t gotten those products up online quite yet.

Arash Soleimani

Okay. My next question in terms of you said you are getting ray in wheels based business that you’ve said in the past. Can you just clarify are you getting more rate there than you think you would I guess actuarially meet because the industry is in pain, is raising rates that kind of paves the way for you to get more than you would otherwise need is that a fair way to look at it?

Craig Kliethermes

I think it’s both. I think there is some places where we are getting rate where it is needed and I think that’s probably through a good part of the industry because I know the commercial auto and personal auto space in particularly you guys all seen results have not been that good. So some of that rate is needed and then I think we’ve also found some opportunity where rate was I’ll say just available or available to us in a specialized niche. And today that’s probably more true on a transportation business for us in particular.

Arash Soleimani

Okay. Alright, thanks for the answers and congrats on the quarter.

Craig Kliethermes

Thank you.

Operator

And we’ll go next to Randy Binner of FBR Capital Markets.

Randy Binner

Hey, thanks. I had a question about commercial auto and kind of how industry reserve trends are coming along. Our view kind of statutory data which isolates commercial auto as a class is that it seems like reserve development is continue to be poor throughout [indiscernible] in 14. And so I guess my question is, is commercial auto ever going to get better? This is really long time to see a class have poor performance. I know you’ve done better and I’m asking the question in a way to understand kind of how continuous this opportunity might be for you all. But are you feeling like rate adequacy is better in accident years 2013 and 2014 than it was in 2010 to 2012 or is it just as bad now as it was before?

Craig Kliethermes

Randy this is Craig again. I think that we would say and our underwriters would say that during 2011-12, 2013 maybe a lot of our competitors lost their way in regards to price. They drop price to either maintain market share or to grow market share. At that time at least in early part of those years we were pretty steadfast in regards to what we were willing to charge for given risk.

So we weren’t growing much in the 2011-2012 time frame and we have been able take opportunity in 2013, 2014, 2015. In regards to current price adequacy I think again it varies risk by risk and I’ll say class by class. And the classes that we particularly participate in transportation we feel good about at least certainly the risk that are in our portfolio that they are priced well. But there is still lot more room we think out there for pricing action in that space.

Randy Binner

Do you think is competition more rational in kind of 2014-15 than they were in call it 2011 to 2013?

Craig Kliethermes

I think it’s definitely more rational because we have people either exiting, leaving, pulling MGA contracts or getting substantial price. I think people in the transportation space particularly public transportation space a lot of people have -- their results have been very, very poor and I think they are not fooling themselves anymore and they are getting significant price probably double-digit increases and they’re willing to let the business walk away now they are letting the business walk away if they’re not able to get the price.

Randy Binner

So now we’re in the pain kind of pain trade and this happens in the industry. So what inning would you say that pain trade is in where people are abandoning any books or significantly increasing price, where do you think that process is in the inning basis?

Craig Kliethermes

I mean it’s difficult for us to say. We hope it’s going to continue for a while; because it will create an opportunity for us.

Randy Binner

Yeah, I do just seems like the data, the reserve data is not getting as better as I would have thought it was. On property you mentioned significant competition and I think, I asked this question a lot in these calls. Is it -- can you characterize where that competition is coming from? Is it kind of new alternative providers or is it more just your brand name guys, just continue to be more competitive on property?

Craig Kliethermes

A lot of it is because same competitors that we’ve had in the past it’s just that they backed it with alternative capital or they’ve backed it with reinsurers who are laying it off to alternative capital willing to take a lower return. The one thing we have seen more recently, which is even more concerning I think is the we’ve started seeing some packaging within E&S space of the cat risk and liability. So we are well -- we knew this was happening, it happens quite quickly in the admitted space when we run into admitted competition, but now we’ve seen a few on the E&S side starting to package the liability in the cap risk as a package.

Randy Binner

So just to be clear there, so they package it’s a…

Craig Kliethermes

Well they are offering both coverages.

Randy Binner

Package all that’s non-admitted or is it someone who they package to non-admitted piece with admitted piece?

Craig Kliethermes

Indeed it’s both they are doing it through an MGA so the MGA might have admitted paper as well, but they are selling both products to the same customer base.

Randy Binner

So basically leakage into the non-admitted space certainly happening?

Craig Kliethermes

Right.

Randy Binner

All right, yeah, I will leave it there. Thanks a lot for the answers.

Operator

And we'll go next to Mark Dwelle of RBC Capital Markets.

Mark Dwelle

Yeah, good morning, thanks for the question. Not to make this and do the transportation call but that’s kind of where I had my questions as well. Are you able to be a little bit more specific in terms of rate improvement across some of the different sub-categories of wheels based business, which to say trucking versus delivery versus taxies and limos et cetera?

Craig Kliethermes

Well we don’t write a lot of that stuff, so ours is very specialized and I mean we are seeing rate pretty much across the board in that space.

Mark Dwelle

And just I guess in terms of what size business do you guys typically write there or what sort of limits are kind of you're in the middle of your wheel house?

Craig Kliethermes

For transportation, typically I mean we prefer to write the $1 million primarily, but we write excess as well up to $5 million, $6 million I believe for bus most trucks by $2 million worth of coverage. There is both a primary policy and usually some type of umbrella access policy attached to it.

Mark Dwelle

Okay. And so when you were referring at the beginning growth in both access liability as well as transportation when you put that growth together is that both of those things together kind of in the same transportation category or are you seeing excess -- growth in the excess business apart from transportation?

Craig Kliethermes

Apart from transportation, obviously we are seeing growth in the excess liability for the transportation segment as well the primary, but we also saw an excess liability product in our E&S space that mostly for contractors that continues to find opportunities.

Mark Dwelle

Okay. And I guess the last question, are you seeing any -- I mean obviously we know the number of the kind of higher profile exits from the transportation space. Are you seeing any new entrance that you have not seen as much in the past or people with improved appetites apart from yourselves that trying to take up some of the opportunity there? I am not asking for names I am just asking for market color.

Craig Kliethermes

I mean we always see competition. And new people that come in and think they could be smarter than the last guy that lost money because they think the rates are a little better. But as just I think you need to be a specialist in that space to make money across all markets. And we see a lot of people that can fool themselves I can’t tell you why in wheels based business because but it’s not a particularly long tail line for Casualty. So it comes back to bite people fairly quickly. But for some reason people continuously they get burned they get off for a brief period of time and then they find it -- then the MGA finds a new market or will find a new entrant to compete with unfortunately.

Mark Dwelle

Okay. Appreciate the color, thank you.

Operator

[Operator Instructions] And we'll go next to Mike Keremski of Volley [ph]

Unidentified Analyst

Hey, good morning. Just one question on the Property segment’s expense ratio. If I recall correctly, part of the step up in ratio last year was due to crop coming off the books. This quarter it increased again stepped up again to about 45% you’ve talked about the competitive environment. You also talked about some fact that was not renewed. Just trying to get a sense if this is the appropriate near-term step up in ratio are you taking some actions to offset it?

Thomas Brown

Mike good morning it’s Tom Brown. Your memory is correct from last quarter we still do have a carryover effect to crop, as we said earlier that was between crop and the factory that was about half of the decline in the premium for the quarter. And those had lower expense ratios. The other I think as we said last meeting just in last call was we’ve kind of gotten trenched. We like the business we like our underwriters. And if and when that market turns as Craig is talking about, we want to be in the advantage point where we can capitalize on that maintain that. Said differently you don’t want to be going hiring underwriters and miss the opportunity.

Unidentified Analyst

Okay, got it. So the crop and facul [ph] that stopped impacting the year-over-year premium numbers next quarter or I thought the crop that ended it was just a year-over-year…

Thomas Brown

Yeah as we’ve said before we thought we would have $8 million to $10 million of crop and we’re currently at about $2 million into it in the first quarter. So we’ll see this running through the next couple of quarters. In fact we’ll trickle in a little more seasonally over that time frame.

Unidentified Analyst

Okay, thank you very much.

Thomas Brown

Welcome.

Operator

And we'll go next Jeff Schmidt of William Blair.

Jeff Schmidt

Hi, good morning.

Thomas Brown

Good morning.

Jeff Schmidt

It looks like other comprehensive earning of around $22 million was driven by equity return. Did I hear that, you had said that it was driven by utilities. Is there -- what portion of the portfolio was that and was there anything else that drove that?

Thomas Brown

Two things Jeff you’re right. Equity had a pretty significant uptake. Obviously it was first two months of the quarter we’re not so good as we all known. March turned around for the quarter. As a component of that it was these sector, utility sector help pulling that. But the fixed income also had a pretty good run with the decline in the interest rates. So all in those were the two drivers would be the fixed income as well as the equity coupled with the earnings for the quarter.

Jeff Schmidt

Right okay. And could you maybe speak just kind of broadly to your philosophy around equity allocation, it’s around it looks like equities made up more than 50% of book value in 2013 that take down to 45%. But how do you think about -- do you think about it relative to book or relative to total investments? And do you have a target overtime?

Thomas Brown

Yeah Jeff we do. As we’ve said before, it’s really it is relative to book. Like I said it’s in the neighborhood of about 50% of equity. If you look at the overall allocation of the investment portfolio, historically it’s been about 80% fixed income 20% equities. And that will vary between mid to upper teens to low 20% for the equities. It is a very value oriented strategy with a kind of a leaning towards dividend paying positions. And obviously with the value oriented strategies being little more favorable in Q1 certainly benefited.

Jeff Schmidt

Alright. Okay, thank you.

Operator

There are no further questions. I will now turn the conference back to Mr. Jonathan Michael.

Jonathan Michael

Thank you all for joining us this quarter. It was another good quarter for us 88 combined 3% top-line growth in this market. I would call that good and our underwriters as Craig said they are good fishermen. So we’ll expect to continue to be disciplined as we move forward in this market. Thanks again and we’ll talk to you again next quarter.

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 with an ID number of 4967961. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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