State Auto Financial Corporation (STFC) CEO Mike LaRocco on Q2 2018 Results - Earnings Call Transcript

State Auto Financial Corporation. (NASDAQ:STFC) Q2 2018 Results Earnings Conference Call August 6, 2018 11:00 AM ET

Executives

Tara Shull - IR and Finance Director

Mike LaRocco - Chairman, President and CEO

Steve English - SVP and CFO

Jason Berkey - SVP, Personal Lines

Kim Garland - SVP of Commercial Lines and Managing Director of State Auto Labs

Matt Mrozek - Chief Actuarial Officer

Scott Jones - Chief Investment Officer

Natalie Schoolcraft - New Investor Relations contact

Analysts

Christopher Campbell - KBW

Larry Greenberg - Janney

Operator

Welcome and thank you for standing by. At this time, all parties are in listen-only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Today's call is being recorded. If you have any objections, please disconnect at this time.

I would now like to turn the call over to State Auto Financial Corporation Investor Relations and Finance Director, Tara Shull.

Tara Shull

Thank you, Angela. Good morning, and welcome to our Second Quarter 2018 Earnings Conference Call. Today, I'm joined by our Chairman, President and CEO, Mike LaRocco; Senior Vice President and CFO, Steve English; Senior Vice President of Personal Lines, Jason Berkey; Senior Vice President of Commercial Lines and Managing Director of State Auto Labs, Kim Garland; Chief Actuarial Officer, Matt Mrozek; and Chief Investment Officer, Scott Jones. We also have Natalie Schoolcraft, our new investor relations contact joining us. After our prepared remarks, we'll open the lines for questions.

Our comments today may include forward-looking statements, which by their nature involve a number of risk factors and uncertainties, which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed at the end of our press release as well as in our annual and quarterly filings with the Securities and Exchange Commission. A financial packet containing reconciliations of certain non-GAAP measures, along with supplemental financial information, is available on our website, stateauto.com, under the Investors section as an attachment to the press release.

Now I'll turn the call over to STFC's Chairman, President and CEO, Mike LaRocco.

Mike LaRocco

Thank you Tara and good morning everyone. Our journey to profitable growth took another significant step for this quarter, and I could not be more proud. All the hard work to turn around State Auto, our new culture, becoming the true digital-only carrier, building new sophisticated products, reducing loss and underwriting leakage and returning to our core strength as personal commercial lines carriers are paying off. The clearest indication of our progress can be seen in our non-cap statutory combined ratio of 94.5% with specialty and, more importantly, 91.3% for ongoing lines of business, personal and commercial.

Another leading indicator is the performance of our personal lines. These were the first lines of business we focus on with our new digital platform and our product changes. In both auto and homeowners, we are now growing for the first time in many years.

Our bold decision to sell only as a digital carrier is working. New business has increased dramatically, but our retention is still too low. Of course, the most important achievement is that after years of poor performance, we are now profitable auto insurance for the first half of 2018.

Over the last year, we’ve been profitable in homeowners; the second quarter of course is typically a [higher cat] quarter for us. Our home trends are very good and we expect a profitable performance going forward.

Our single goal is profitable growth, and our personal lines results are trending towards this objective and we are confident that we are positioned well for success. Small commercial and commercial auto are also moving in the right direction. We expect to have the new platform, the new digital platform along with the new products launch in all states by the end of September.

In addition, we will launch commercial umbrella on the digital platform in September. Early results in the states where our digital platform and new products are in production are very encouraging with quotes and sales trending in a positive direction.

By design, we had commercial follow-up personal and we expect similar results regarding both growth and profitability across these lines. Our approach to selling and servicing commercial is unique, and will give us a chance to disrupt the segment of our business that desperately needs disruption.

Across commercial, we have also been aggressive in targeted in taking rate actions. These efforts along with improvements in claims and underwriting have our underline loss trends moving in the right direction. The launch of the new platform and products should be the final piece to accelerate the improving results.

I should also note that within commercial, the strong performance of workers compensation. As we have seen in the past after some moderate success, the industry is losing pricing discipline. We will remain vigilant in our efforts to get the right rate for the risk, even if the result is less growth.

Finally, I must mention a strong result of our farm and ranch product through the first half. Even in the face of a single large loss, the small, but growing segment of our business continues to perform very well.

While I am encouraged with where we are through the first half of 2018, do not interpret that as the view that we are anywhere close to satisfied. The State Auto team realizes there is much work to do. Our key challenge has become more efficient and to have that reflected in a more competitive expense ratio.

We always knew the expense ratio improvement would lag our gains in growth and profitability. Our commitment to digital product and talent improvement required investment. There is no shortcut. While we are through the heaviest part of our investment period in each of these areas, but not the end, because there is no end for transformational companies, we will begin to see the improvements flow through the expense ratio.

In addition to our expense ratio challenge, we have the challenge of becoming fully digital, accomplishing that goal will allow us to meet the emerging needs of the market across product, distribution and service. We see great opportunity beyond the traditional approach of the P&C Insurance.

Now that we are emerging from the turnaround phase of our work, our sights are set on significant goals and opportunities.

And with that, I'll turn it over to Mr. English.

Steve English

Thanks Mike and good morning. For the quarter, STFC reported $0.14 earnings per diluted share with an operating loss of a $0.08 per diluted share. This compares on a diluted per share basis to earnings of $0.21, with an operating loss of $0.04 for the second quarter of 2017.

On a six-month basis, STFC reported on a diluted per share basis, earnings of $0.09 and operating earnings of $0.08. On an operational basis, this is an improvement compared to the operating loss per diluted share of $0.24 for the first six months of 2017.

As a reminder, non-GAAP operating results exclude net of tax, net investment gain or loss, which beginning in 2018 reflects the impact of the new accounting pronouncement ASU 2016-1 which requires the change in unrealized gains and losses on equity securities to be reported in net income rather than in other comprehensive income.

For the quarter ended June 30, 2018 $9.5 million of net unrealized investment gain and for the six-month ended June 30, 2018 $5.8 million of net unrealized investment loss have been included in the income statement caption, net investment gain.

A quarterly GAAP combined ratio of 107 was slightly higher compared to 106.2 from the second quarter a year ago. However, for the first six months of 2018, the GAAP combined ratio of 104.8 improved 2.7 points over the same period in 2017, reflecting improved loss and LAE ratios, both cat and non-cat.

On a statutory basis, personal auto was profitable for the quarter, and year-to-date with combined ratios of 97.5 and 99.2 respectively. Homeowners reported a combined ratio of 114.2 in the quarter, compared to 106.8 a year ago, with 16.5 point higher cats.

On a six-month basis, the homeowner 103.6 combined ratios improved 7.8 points including 4.3 points of non-cat loss ratio improvement. Cat losses contributed 22.8 points for the six-months compared to 26.5 points a year ago.

The impact of Cats on our combined ratio should lessen as the year progresses, with the second quarter typically being impacted by spring and early summer, wind and hail storms. Commercial lines statutory combined ratio for the quarter was up 4.4 points at 1057 with 5.3 points of less favorable development of prior loss reserves than last year's second quarter.

On a six-month basis, commercial lines combined ratio was up 2.3 points with 1.8 points less favorable development. Commercial auto actually loss ratios continue to show improvement, workers compensation continues to show outstanding overall results, and along with farm and ranch reported six months statutory combined ratios less than a 100.

Our combined statutory results for personal commercial insurance, our ongoing lines of business improved over a year ago on both a quarterly and year-to-date basis. Our estimates of prior-year reserves continue to develop favorably overall in the quarter, 17.9 million was reported, compared to 15.7 million in the second quarter of 2017.

For the six months ended June 30, favorable development totaled $38.3 million for 2018, compared to $25.4 million a year ago. In the quarter, favorable prior development of non-cat loss and ALAE reserves amounted to $18.1 million or 5.9 loss ratio points. This compares to the second quarter 2017 which reported 14.8 million favorable prior developments for 4.6 loss ratio points.

Focusing on our current accident year non-cat loss and ALAE ratio for personal and commercial on a statutory basis, the second quarter of 2018 ratio of 57.6 improved 5.5 points from the second quarter of 2017.

On a year-to-date basis, the ratio was up 50 basis points compared to the first six months of 2017. For personal lines, the current year accident year selections for personal auto in the quarter and year-to-date improved from last year's second quarter and first six months.

Last quarter, we commented on our initial 2018 picks citing the level of new business and personal auto bodily injury liability, loss, cost trends. While we continue to focus on their impact, we believe we are beginning to see the benefit of our rate actions, pricing, segmentation and claim initiatives.

The homeowner current your action your pick improved in the second quarter compared to a year ago, but is up 2.3 points on a six-month basis. In commercial lines, commercial auto workers compensation and farm and ranch, all reported improved current accident year picks for both the quarter and the first six months.

Small commercial package and middle-market commercial picks were up in both the quarter and year-to-date reflecting the impact of non-cat weather and fire losses compared to last year. The GAAP expense ratio for the quarter was 36.2, and for the first six months, 35.7 compared to 34.3 and 34.7, respectively a year ago.

We have discussed over the past three years, the investments being made in technology and products and during 2018, we continue to build and rollout commercial line technology and products having already largely completed personal lines.

In addition, the exit of specialty is beginning to impact the ratios as specialty earned premium runs off. We have eliminated much of the fixed direct cost of specialty such as underwriting staff, space cost and other direct overhead costs. However, corporate overhead costs remain and will be a focus as we transition ultimately to an all-digital company.

Speaking specifically to the statutory expense ratio in the personal and commercial insurance segments, the second quarter ratio was up 1.8 points and for the first six months one point. These increases reflect allocating less corporate overhead cost to the runoff specialty segment in the current periods.

In addition, year-over-year increases in estimated agent contingent commissions, associate variable compensation and increased underwriting report ordering cost associated with the connect system impacted the expense ratios.

Some comments on specialty, whose operating ratios are not meaningful as the business winds down. Written premium has dropped off quickly, our policy has been to recognize ceded written premium on this basis -- on this business on an earned basis contributing to the negative written premium in E&S property and programs.

This will continue as the remainder, the earned premium is recognized, which we expect as follows. For E&S property, we expect earned premium for the third quarter to be $1 million with fourth quarter premium of $0.5 million.

For E&S casualty, the third quarter is expected to be 14 million, fourth quarter 9 million, and the first quarter of 2019, 4 million. For programs, we expect 2 million in the quarter, for the third quarter and 0.5 million in the fourth.

Finally, this past July 1, we completed the renewal of our reinsurance programs, which are placed on a group basis. The most significant change was to our property catastrophe tree where we reduced our limits by $200 million due to the runoff of the E&S property book.

Our group retention remains at 75 million, with limits of 125 million and a 5% co-participation. Popping out the program at 200 million aligns with our 1 and 100 PML. On a property per risk basis, we increased our retention from 3 million to 4 million but eliminated the 2 million annual aggregate deductible.

In a similar fashion, we adjusted our excess of loss casualty treaty increasing retention from 2 million to 3 million and eliminating the 2 million annual aggregate deductible.

And with that, I'll turn the call over to Jason.

Jason Berkey

Thanks, Steve, and good morning, everyone. While work still remains to fully restore our personal lines profitability, this quarter, we achieved an important milestone with the second quarter personal auto combined ratio between 100% for the first time in several quarters.

The personal lines in total, the loss and LAE ratio was 73.7% for the quarter with a statutory combined ratio of 104.3% compared to 80.1% and 108.6%, respectively, in the second quarter of '17. We continue to take targeted rate actions and press for claims operational improvement on our path to fully achieving our target combined ratios in each product.

Those rate actions have put continued pressure on our retention. While improving profitability is the highest priority, we continue to see promising signs of growth in written premium, which grew 23% and policies in force, which increased 7.6% compared to the same quarter a year ago for this segment.

The new business lift from the new digital product rollout continues to increase each month and will continue to help offset the pressure on PIF from the lower retention.

Turning now to personal auto results specifically. The statutory auto loss and LAE ratio was 68.0% for the quarter with a statutory combined ratio of 97.5% compared to a 82.8% and 109.5%, respectively, in the second quarter of 2017.

We continue to take targeted aggressive rate actions in personal auto and to press for claims operational improvements in our care organization. In 2017, we made 50 personal auto rate changes into our 28 states with an average rate increase of 13.6%.

In the first quarter of 2018, we made 28 rate changes with an average rate increase of 6.9%. In the second quarter of 2018, we made 28 rate changes with an average rate increase of 7.6% and are subject to Department of Insurance approval in various states we have 22 rate changes in the pipeline, with an average rate increase of 7.1% in the third quarter of 2018.

The result is that the average written premium per policy in June 2018 is 6.2% higher than June 2017 and the average earned premium per policy is 10.3% higher. To measure the improvement in our profitability, we closely watched the rate of increase in premium versus the rate of increase in loss, cost.

In the second quarter 2018, the change in 12-month rolling earned premium per vehicle of 16.1% was greater than the change in our annual loss cost of 14.5%. Therefore in the second quarter, 2018 progress was made towards restoring personal auto profitability. However, we expect further significant bodily injury rate actions will be necessary to address the high level of bodily injury, loss, cost trend due to elevated frequency.

Our loss ratio on both our connected digital product and our legacy auto product improved. The overall loss ratio improved less as a result of our increase in new business, that resulted in a higher, overall impact to our auto book from new business penalty.

Therefore, we expect the increase in new business to place pressure on our overall loss ratio improvement. At the same time, we continue to see growth in personal auto. Starting in September 2017, and continuing through the second quarter of 2018, personal auto policies in force have continued to increase.

In financial terms, our personal auto performance is as follows; second-quarter 2018 net written premium for personal auto is up 23.2% versus second quarter of 2017, the eight consecutive quarter personal auto net written premium growth; quotes are up 65% over second quarter of 2017; new business accounts are up over 150% over second 2017.

PIF increased 4.6% above the second quarter 2017 PIF level. Retention was 73.3% in June 2018, this is a 5.6 point in the retention versus 2017 as this retention continues to see pressure from our aggressive rate actions to restore our profitability.

Moving onto homeowners, policies in force increased with the second quarter 2018 homeowners PIF increasing by 10.5% over second quarter 2017. Homeowners are also experiencing a new business lift from the launch of our new digital product.

Homeowners quotes are up approximately 88% over second quarter 2017. New business accounts are up approximately 165% over second quarter 2017 while the June 2018 retention of 78.8% is down from the 81.2% observed in June 2017.

In financial terms, our homeowner’s performance is as follows; second quarter 2018 homeowners’ net written premium increased 20.9% versus second quarter of 2017. The second quarter 2018 in LAE ratio was 82.7% with a combined ratio of 114.2%.

The homeowners cat loss and ALAE ratio for second quarter 2018 was 36.9 points, which is 16.5 points higher than the second quarter of 2017 homeowners cat loss and ALAE ratio of 20.4%, primarily due to the severe weather experienced in Colorado and Texas in the second quarter.

The second quarter 2018 non-cat loss and ALAE ratio of 38.2% was 11 point 3 points lower than the 49.5% in the second quarter of 2017, reflecting rate increases we’ve taken in response to increased severity trend previously noted on non-weather claims.

In conclusion, our personal line, story line for the quarter can be summarized in three themes. The first, the personal auto combined ratio in the quarter was below 100% for the first time in several quarters due to the combined effect of prior period favorable development and continued profit restoration efforts, including significant rate actions and claims operational improvements to restore personal auto profitability.

The significant rate actions continued to renew into our book and those rate increases will place pressure on both auto and home retention for the next several quarters. Second theme, moderation in our auto loss severity trend was achieved as a result of our ongoing claims operational improvements.

At the same time, auto bodily injury, pure premium trend remains high due to ongoing frequency trend and our aggressive bodily injury rate actions will continue.

And third, new business accounts continue to increase at record levels, due to our new digital product. The higher level of new business has resulted in an increase in our personal lines PIF. At the same time, the improvement in our personal lines loss ratios will continue to face a headwind from the impact of additional new business penalty, in our overall book with the increase in new business.

With that, I'll turn the call over to Kim Garland to discuss commercial lines result.

Kim Garland

Thanks, Jason. The commercial business results are as follows. A 2Q 2018, combined ratio of 105.7 versus 101.3 in 2Q 2017 and 2Q 2018 written premium increase of 3.1% versus 2Q 2017. For the commercial business as a whole, the story is, the statutory non-cat loss and ALAE ratio was 1.8 point higher in 2Q 2018 versus 2Q 2017 driven by less favorable board reserve development this year, 8.3 points compared to 2Q 2017, 13.6 points and a large farm and ranch loss, which had a 1.6 point impact on the 2Q 2018 loss ratio.

The catastrophe loss in ALAE ratio was 0.6 points lower in 2Q 2018 versus 2Q 2017. While commercial loss ratios are generally where we need them to be, commercial expense ratios are not in our biggest inhibitor to overall profitability.

The 2Q 2018 statutory commercial expense ratio of 40.7% was 2.4 points higher than 2Q 2017 due to ongoing technology investments in connect and higher agency contingent commission estimates.

Commercial connect has launched in 24 states for BOP and commercial auto, and we continue to be on track to launch the remaining six states and add commercial umbrella by September. Here's an update on commercial connect, straight through processing ratios and unit cost per quote continue to look good. Our straight through processing percentages in commercial connect, auto and BOP continue to run around 75% compared with 0% in our legacy system. And our labor cost per quote is 90% less in commercial connect than our – in our legacy system.

The key to the commercial expense ratio reduction over time will be to get all of our commercial business on this more efficient platform. These percentages are increasing but there is still a long way to go.

Our percentage of new business written premium on commercial connect versus all commercial new business in first quarter was 3.1%, in 2Q 2018 it was 7.4%, and the percentage of total written premium on commercial connect versus all commercial written premium in first quarter 2018 was 0.6% and in the second quarter 2018 with 1.3%.

Like I said, we have a long way to go to put all of our business on this platform. The agency feedback on the system continues to be positive. Also, to date, our new business lift has been greater in commercial auto than in BOP.

Commercial auto and new business premium is up 48%, June year-to-date 2018, versus June year-to-date 2017. BOP new business premium is down 2%, June year-to-date 2018 versus June year-to-date 2017.

We launched an updated BOP pricing model with the May and July launch dates, and we have seen BOP closure ratios increase with the new model. The updated BOP pricing model will be implemented in the original 13 commercial connect launch states in 3Q 2018.

Our experience with the small commercial connect launches following our experience with the personalized connect launch, but the spike in new business production will likely ramp up on a slower trajectory than it did for personal lines.

The commercial business results by product line are as follows; our focus on the loss and LAE results for each product line as the acquisition and operating expense ratios for every product line are poor as previously noted.

Commercial auto; the commercial auto loss and LAE ratio in 2Q 2018 is 62.5%, which is a 1.5 point deterioration versus the 61% in 2Q 2017. This deterioration was primarily driven by the catastrophe loss ratio being 1.3 points higher in 2Q 2018 versus 2Q 2017. We continue to be pleased about the impact of our profitability actions over the last three years.

Commercial auto written premium in 2Q 2018 was up 7.5% versus 2Q 2017. There are three important things to note about our commercial auto business, small commercial auto less than 10 vehicles versus middle-market commercial auto 10 or more vehicles. Our small commercial auto rate need is currently flat while our middle market commercial auto rate need is more than 15%.

The commercial auto team is focused on addressing this middle market rate need. Growth from commercial connect, commercial auto new business year-to-date is up 48%. There are more states to launch and enhancement in the pipeline, which we anticipate increase the growth rate of this product line.

Expense ratio, this quarter’s 44% expense ratio for commercial auto is both a threat, the product line is now sustainable at this expense level and an opportunity, a much lower expense ratio creates a lot of opportunity for this product line.

On the small commercial package, the small commercial package statutory loss in LAE ratio in 2Q 2018 is 68.3, which is a 3.6 point improvement versus a 71.9 into 2Q 2017. While an improvement over 2Q 2017, it is still too high. There are four classes in our legacy BOP business that are creating issues. Auto service, carwashes, restaurants and convenience store grocery.

In our legacy BOP book, we are taking the necessary rate and underwriting actions. As an example, auto service and car washes are not eligible to Connect BOP and will only be written on CPP Connect when it launches. Connect rates for restaurants and C store and groceries are higher than our legacy BOP rates and we are in the process of adding more third-party data validation sources for these and other classes in Connect.

Small commercial package written premium in 2Q 2018 was down 0.6% versus 2Q, 2017. BOP new business volumes and Connect states are relatively flat which is driving the flat overall growth in small commercial package. The revised BOP model was implemented with the May launched states and we have seen increased closer ratios with this revised BOP model.

The revised BOP model will be implemented in the original 13 launched states in 3Q, 2018. Other actions such as the launch of our first commercial platform agents continued enhancements to the agent interface and adding commercial umbrella to the Connect platform are in the pipeline and are expected to increase BOP growth on Connect.

On to middle market; the middle-market statutory loss in LAE ratio in 2Q 2018 is 81.8 which is a 33.6 points higher than the 48.2% in 2Q 2017. This is driven by 7.6 points of adverse reserve development primarily driven by claims 2008 and prior in 2Q 2018 versus 23 points of favorable development into 2Q 2017, while middle-market loss ratios jump around from quarter-to-quarter, our profitability focus is on CPP general liability with the most recent indications increased to over 10%, our CPP property indications are in the negative 5% to 6% range.

Middle-market written premium in 2Q 2018 was up 5.6% versus 2Q 2017. The rollout of Connect in small commercial continues free up time for our commercial underwriters to focus on middle-market commercial. This transition can be seen in the fact that our middle-market new business year-to-date is up 24%.

Workers' compensation; the workers' compensation statutory loss and LAE ratio in 2Q 2018 is 52.5% which is 10.6 points lower than the 63.1 in 2Q 2017. We all continue to be proud of the high level of discipline and operational execution of our entire workers' compensation team that they continue to show during this phase of the market cycle.

Workers' compensation written premium in 2Q 2018 was down 10.2% versus 2Q 2017, this decrease was driven by a lower than typical production quarter for our debit mod business. New business production from debit mod can jump around from quarter to quarter so we are not overly concerned about this.

Farm and ranch; the 2Q 2018 headline for farm and ranch is an approximately $2 million net fire loss of a hog confinement risk during the quarter. A post-loss evaluation of our new business and renewal underwriting of the risk found that are underwriting of the risk was sound and appropriate.

With this loss the farm and ranch loss in LAE ratio in 2Q 2018 is 65.3% which is 26 points better than the 91.3 in 2Q 2017. The large fire loss added 18 points to the farm and ranch loss in LA ratio in 2Q 2018.

The large loss may mask the progress that we have made in this line. At the end of 2017 I told you that are poor profitability results in farm and ranch in 2017 were caused by self-inflicted wounds getting behind on rate and losing some intensity around underwriting.

I could not be prouder of the passion and urgency with which the farm and ranch team attack these issues. We are on track to put 8.3 points of rate into farm and ranch in 2018 and 36 points of rate into farm auto in 2018. The underwriting managers who also brought our farm and ranch underwriting back to it's historically high quality standards. These actions have slowed down the growth of farm and ranch, written premium in 2Q 2018 was up 10.4% versus 2Q 2017.

With that, we'll open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Christopher Campbell with KBW.

Christopher Campbell

Yes. Hi. Good morning.

Mike LaRocco

Good morning, Chris.

Christopher Campbell

I guess the first question is for Jason. I just wanted to confirm that I heard this right in this script, but did you mention higher BI frequencies? I'm just kind of curious on that one, since we've been seeing competitors have been seeing lower frequencies?

Jason Berkey

Yes. I did mention that. We are observing that. I mean part of that is going to be – the other comment that I made about the new business penalties, some of the new business that we're writing is going to absorb a higher frequency as well.

Christopher Campbell

Okay. So you think that's more new business-related or is it kind of equally distributed through like the new and your existing business?

Jason Berkey

We're seeing in on both, but part of the driver will be the additional new business and the new business penalty.

Christopher Campbell

Okay, great. Very helpful. And then just, I think another question on the expenses and you guys did a great job of explaining kind of the deleveraging and that's going to take time. And I just notice on the unallocated LAE ratio, is there anything special happening there like increased defense cost or anything that you're seeing there?

Steve English

No. Hey, Chris, this is Steve. Not really, I think especially start parsing at across products and segments. There's a lot of art there and we tends jump around. But all-in-all there is not anything that we're concerned about on the unallocated site which is quite frankly principally driven by people cost, right? That's primarily our in-house claim stuff.

Christopher Campbell

Now, is there any movement downward in number as specialty rolls off?

Steve English

I would say, not, the role of specialty in of itself won't drive that number down tremendously.

Christopher Campbell

Okay. How do you think maybe specialized claims staff and specialty and…

Steve English

Yes. We do, but its not a material number. Its not – we have a lot more folks dedicated towards standard line side or personal commercial then in specialty.

Christopher Campbell

Great. And then just a one final one; any color on the rate trends that you're seeing? And then how those were trending in July? I'm thinking like commercial auto, BOP, worker's comp, I mean, are you still continued weakness there or…?

Kim Garland

So, I think in commercial auto we continue to see sort of rates continue to go up. Workers' comp is probably on the other side of it that rates continue to go down and on sort of BOP and CPP we still see a mix of small ups and downs.

Christopher Campbell

And anything in there that's causing the change of rate plans or underwriting guidelines?

Kim Garland

No. I think probably for us on commercial auto probably this the sort of split that I talked about between the smaller fleets being rate adequate, and us needing more rate on middle-market commercial auto is probably the biggest sort of focus with x-ray intensity that we'll have going forward from the quarter. And like I said we're digging into understanding general liability in CPP that has popped up a little bit, so that's on our radar screen.

Mike LaRocco

And Chris, this is Mike. I think the other thing on commercial and to some degree personal as well is the -- this move to digital creates a lot of interesting opportunities across product particularly with sensor-based products. So high you'll see us continue to have I think a lot of success with telematics which has worked very well for us in a personal line side and we have very high expectations across commercial lines as well. Its one of the reasons I talked about the opportunity for us in commercial lines once we complete the digital rollout there's all kinds of interesting opportunities there that in that side of the business there hasn't been a lot of innovation and creativity and I think that we're going to be able to bring to the market whether it's water detection sensors and different things that are happening now as well as the telematics, there some distribution opportunities as well.

So, I think when you look at pricing and the product development there's -- you're probably going to see a lot of things evolve in terms of better segmentation and better matching of rate to risk across commercial lines. So we're pretty excited about that.

Christopher Campbell

Okay. And I just one final one, Kim, I think you had just mentioned something about taking a deeper [dive on GL] trends, like what are you seeing there that's causing you to kind of, want to relook at that?

Kim Garland

So we – that there's probably I guess two drivers. One is we see – we refresh our actuarial indications on a regular basis and we just -- the last indication flipped from being less than 10% to above 10% that always makes us want to dig further. And then we're getting better over time at focusing our efforts on sort of classes of business that are creating issues. And we've come across a couple classes and the biggest finding there is what we are seeing in commercial lines and I think this is as much an industry phenomena as our phenomenon is just getting more accurate information about each individual risk, making sure its classified, right? Making sure it's everything that makes it more or less risky is incorporated into the price. In many ways I think personal lines maybe a little more advanced in that area. So those are the two things were looking at there.

Christopher Campbell

Okay, great. Thanks for all the color and best of luck in the third quarter.

Kim Garland

Thanks, Chris.

Operator

[Operator Instructions] Your next question is from Larry Greenberg with Janney.

Larry Greenberg

Thank you and good morning. Just on commercial auto, looking at the loss ratio taking out cats and reserve development had a big improvement from the first quarter of the year. And we saw a similar trend last year first quarter to second quarter, but then the back half of the year jumped back up. And I'm just curious if there is anything seasonal in the first to second quarter comparison and how would you characterize where that underlying loss ratio stands now relative to what the outlook for it might?

Kim Garland

So, I think there are the couple of things. There's nothing inherently seasonal at least abnormally for us versus other carriers and what we see around commercial auto. I think one of the biggest challenges is our commercial auto book is smaller than our personal auto books, so things jump around a little bit more from that, so that something we deal with when we do the reserve analysis every quarter. And then like I said no small commercial auto which just primarily what we are writing to-date on Connect or whatever we're really comfortable about where the overall rate level is for that.

I think we still have rate action to take in middle-market and it may be double digit rate actions. So I don't know if that got -- exactly got to your question but that's some commercial auto color for you Larry.

Larry Greenberg

Yes. Thanks Kim. That was helpful. And then maybe for Steve, if you could just give us a little color on where on the investment portfolio new money rates might be versus roll-off rates?

Mike LaRocco

Hey, Larry, I mean, actually Scott Jones will respond to that.

Larry Greenberg

Okay.

Scott Jones

Hi, Larry, right now we're experiencing probably about a 3.5 on new money rates in the market, which is a tad better than what's rolling off. So we're seeing some improvements there as the Fed continues to raise rates and help us out on the new money side.

Larry Greenberg

And then we look at equities, I know there's been some seasonal -- seasonality in the past with dividends. Is that -- is the past a pretty good representation of what we should expect right now? I know the fourth quarter is a pretty good dividend quarter for you, guys. I think you have some kind of foreign fund or something like that?

Scott Jones

We do have a few funds that's pay annually in the fourth quarter and that causing some seasonality in that dividend income. We got a little bit of bump in the second quarter because we owned the higher percentage of MLP investments in the second quarter than we have in the past, which do carry higher yields than most equity securities.

Larry Greenberg

Great. Thanks. And then my last question, just on retention. Are you guys finding that its really just a function of the aggressive rates you're putting through? Or is there anything else beyond that? And might there be some remediation efforts that kind of supersedes just what's happening on price?

Mike LaRocco

Yes. I think there is probably three things, Larry, this is, Mike, that are addressing it and kind of in reverse order. There are -- when we made this transition and when you make the decision to go completely digital you're going to run into a handful of your distribution partners who just can't get there either their customers don't reflect that or they personally have a difficult time not taking cash or checks or not having paper. That was a fairly small impact, but there's some impact of agents who just didn't come with us on the digital journey.

The second piece of that is that within agents even that ones who are comfortable with it, when you start -- people understand that they're going to have to move the customer, the policyholder understand they have to move to the – to this other way of doing business you're going to again see some of those customers who see the writing on the wall, they know what's coming there, aware of that and even though it hasn't hit them yet on a renewal basis. They are already thinking about a different way of conducting business.

Those are truly the minor issues. The biggest issue is the rate action. And I want to be really clear about this because there's a lot of variance in our retention rate by states. There were some states there were basically dumpster fires for us where we had had really bad results over the years and we were very aggressive in getting ourselves out to a better place. I think states like Colorado and Georgia where we really had to move aggressively to get our rates were they needed to be and make sure that we did everything we could to get our profitability back in alignment.

So, by far the biggest impact on our movement, on retention was based on that. Now that's primarily in the personal line side. On the commercial line side I think there's a lot of really excellent underwriting actions that were taken. Kim's already mentioned that we're very comfortable and proud of our results in the small commercial space, small commercial auto space and we're now in a situation where we were again pretty aggressive in terms of identifying larger fleets and making sure we reduced our -- we reduced our writings of large fleet business through nonrenewal efforts on our side.

So there's a lot behind those numbers. I want to be again really careful. Rate action is the primary driver, but there's a lot of things we're doing on a by-state basis. There were things that we're doing with some individual agents that weren't performing. There were things we're doing on large commercial fleet business, stuff that we initiated from our standpoint that really impacted the retention. And again as we move forward and as we move our customers from these legacy systems onto the digital system once again we're going to work have to fight through that and that will create some retention challenges as well, but the importance of going from legacy onto the digital from an expense standpoint and from an overall efficiency standpoint is something were completely committed to.

So this challenge we face around retention is one that we're going to have for a while. But again, everything we're doing takes a big picture look at how we want to move this company forward.

Larry Greenberg

Thank you.

Operator

[Operator Instructions]

Tara Shull

Thank you for your question. We want to thank all of you for participating in our conference call and for your continued interest and support for State Auto Financial Corporation. We look forward to speaking with you again on our third quarter earnings call which is currently scheduled for Thursday, November 1, 2018. This is my last call of the Investor Relations contact, as I move into a new role here at State Auto. So the next call will be facilitated by Natalie Schoolcraft. Thank you and have a good day.

Mike LaRocco

Thanks everybody.

Operator

This does conclude today's conference. You may now disconnect.