State Auto Financial Corporation (STFC) CEO Mike LaRocco on Q3 2018 Results - Earnings Call Transcript

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About: State Auto Financial Corporation (STFC)
by: SA Transcripts

State Auto Financial Corporation. (NASDAQ:STFC) Q3 2018 Results Earnings Conference Call November 1, 2018 11:00 AM ET

Executives

Natalie Schoolcraft - Investor Relations 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

Analysts

Lou Feldman - Wells Fargo Asset Management

Christopher Campbell - KBW

Larry Greenberg - Janney Montgomery and Scott

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 Investor Relations Director, Natalie Schoolcraft. Please go ahead.

Natalie Schoolcraft

Thank you, Angela. Good morning, and welcome to our Third 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. 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, are included as part of our press release and available on our website, stateauto.com, under the Investors section.

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

Mike LaRocco

Thank you Natalie. For the last three and a half years, the State Auto team has worked incredibly hard. We made a number of bold, strategic decisions. We completely changed our culture, we exited lines of business that were either unprofitable or not aligned strategically to our future, and we decided to become a digital only carrier.

In addition to those strategic calls, we also made a number of significant operational changes. We built new products for sophisticated pricing models. We increased our skills around data and analytics, we added sensor based products and we expanded our distribution force.

All that work was necessary, because we knew that based on our poor results and the change we saw coming to our industry, incremental change would not be enough to fix State Auto. We were in a turnaround situation and we had to be bold.

Over the last few quarters as trends across losses and growth improved, we knew we are on the right track. This quarter’s results are a clear indication that the turnaround phase of our journey is now complete.

I could not be more proud of our associates and agents. Their patience and passion over the last three years led us to this point. Their patience as we made plenty of mistakes while implementing all this change and their passion to return State Auto to relevance in the market place.

All that hard work has paid off. We are not a relevant and important competitor in the property and casualty market. Completing the turnaround is simply the first step on our journey. We know there is much hard work left ahead of us and we relish the challenge. We are not interested in modest improvements. Our ambition is provide transformational change which will allow us to profitably grow and outperform our competitors.

As we now move forward on the next phase of our journey, we’ll focus on the following challenges. We’ll complete the roll out of our remaining products on our digital platform, farm and ranch, middle market commercial and workers compensation. Kim will provide more details regarding the timing of that work.

Early on, I noted that of companies in our space wanted to survive and win, incremental change would not work. We can achieve competitive expense ratios and growth by trying to improve on our legacy systems and products. We knew our decision to go fully digital would challenge our expense ratio over the short term, but once we were implemented and growing we begin to see the benefit across both growth and expenses.

Our personal lines numbers have begun to reflect that and we hope to see similar results for commercial as we continue to roll out and leverage the new platform. Upcoming digital investments will include improving operational efficiency for State Auto and our agents. We’ve only scratched the surface of what we can provide with our digital platform, becoming more efficient, becoming easier to do business with and adding innovative products and processes are key to the next phase of our journey.

The investment cost and the pay back from this commitment at technology is much better. We and our agents will see the benefits from our operational effect and its focus as we implement. Again, completing the turnaround is a moment in time, a great deal of hard work lies ahead. We need to deliver on profitability across our small middle market commercial business. We must drive the expense ratio down to continued growth and efficiencies.

The difference today versus the last three years is that now we have the solid foundation on which we can build. We’re now positioned to become the transformational company we set out to become. There is no guarantee we’ll achieve that lofty goal. It will be very difficult and we still have many challenges to overcome, however, our team of associates and agents have proven that they have the talent and drive to achieve the extraordinary and we love the challenge in front of us.

With that, I’ll turn the call over to Steve.

Steve English

Thanks Mike and good morning. For the quarter, STFC reported diluted operating earnings per share of $0.44 compared to last years third quarter of $0.54 diluted operating loss per share. Through the nine months, STFC has now reported $0.53 of diluted operating earnings per share compared to a $0.78 diluted operating loss per share for the first nine months of 2017.

Improved underwriting results in both the quarter and year-to-date reflect operational improvements in the strategic decisions we have made over the past three and a half years. The quarterly GAAP combined ratio of 98.4 includes lower levels of catastrophe losses, improved overall accident year non-cat loss ratios as well as continued favorable development of prior accident year losses.

This is somewhat offset by higher expense ratio in 2018 which I will comment on further in a moment. Focusing on our personal and commercial segment results, net written premiums grew 10.6% with a statutory combined ratio of 96.4. On the same basis for the first nine months of 2018, growth was 13.4% for the statutory combined ratio of 100.8. This compares to a year ago, when in the third quarter personal and commercial growth was 5.1% for the statutory combined ratio of 99.2 and through nine months growth was 0.3% with a combined ratio of 104.

The drivers of improvement are the same as for the all in GAAP combined ratio with one exception. Our third quarter personal and commercial cat-losses were slightly higher in 2018, which includes $5.7 million for hurricane Florence.

A year ago, we experienced losses from hurricanes Harvey and Irma with a significant portion of those losses coming from our now runoff specialty segment. We continue to see consistent, favorable runoff of prior accident year loss and LAE reserves, across our ongoing lines of business. Jason and Kim will provide further product details.

Investment income was up in the quarter $2.1 million or 11.2% led by higher amounts of dividend income and our investment in tips. For the first nine months, these also contributed to the year-over-year increase as well as a shift from tax-exempt securities to taxable’s in fixed income.

We are now seeing fixed income new money yields of approximately 3.6%. As I mentioned earlier, our expense ratio is up almost a point on a GAAP basis for both the quarter and year-to-date. On a statutory basis, for personal and commercial lines, the expense ratio was up 1.6 points for the quarter and 1.2 points for the first nine months.

The primary areas of increase include agent associate incentive compensation due to better financial performance, increased underwriting report cost from higher levels of quotes on our connect platform and amortization of capitalized costs as we continue to deploy our new system throughout 2018, for both personal and commercial lines.

In addition, we are in the process of building our connect for commercial package, farm and ranch and workers compensation. Kim will provide further detail on the status of these efforts. I will close on specialty. We continue to see the runoff of earned premium and the non-renewal of business.

At this point, net written premiums reflects final audit premiums, endorsement activity and seated reinsurance and has become minimal. Premium continues to be earned out as expected. We don’t expect any material changes to the guidance given last quarter.

Fourth quarter E&S casualty earned premium will be just below $10 million with E&S property and programs each being less than $1 million. We do expect some modest amount of E&S casualty earned premium in the first quarter of 2019 of approximate $4 million.

As we complete 2018, and head into 2019, any remaining specialty activity will be reported as a runoff segment, and will primarily be development activity on reserves, final earned premium as I just mentioned and some final expenses including deck, final deck amortization.

With that, I’ll turn the call over to Jason.

Jason Berkey

Thanks Steve, and good morning everyone. This was another profitable quarter for personal lines, with our combined ratio below 100 for the second consecutive quarter. Our profitability as a result of many important efforts across State Auto including the ongoing claims operational improvement and the earn-in of aggressive rate actions on our personal auto business, as well as favorable loss reserve development.

In total, the loss and LAE ratio was 61.1% for the quarter, with the statutory combined ratio of 92% compared to 70.9% and 100.7% respectively in third quarter of 2017. We continue to take more targeted rate actions and press for claims operational improvement on our path of fully achieving our target combined ratios in each product.

Those rate actions continue to put pressure on our retention, and on our personal auto PIF growth. At the same time, we continue to see double-digit personal lines premium growth with net written premiums up 18% in the third quarter 2018 over third quarter 2017.

The new business list from our digital connect product rollout continues to increase each month and has somewhat offset the pressure on PIF from the lower retention.

While the personal lines expense ratio increased in third quarter 2018 to 30.9% up from 29.8% in third quarter 2017, our path to expense ratio improvement is clear, and is largely tied to increasing the percentage of our enforced book that is renewal, digital connect product.

The improvement to expense ratio will overtime from the following affects; lower, renewal commissions from our digital connect products, higher straight through processing rates and self-service options allow a lower cost of service, our digital connect products and will reduce the portion of premiums spent to service enforce business, and finally, premium growth at a faster rate than the growth rate in non-commissioned expenses with the normalization of our IT investment. The net effect is an ability to increase expense efficiency with our digital connect product.

Turning out to personal auto specifically. We have been updating you regularly for some time now on our ongoing actions along our journey to profitable growth in personal auto. Those actions included aggressive rate actions, the closing of underwriting leakage, driving for claims operational improvements, increased focus on loss reserving process to minimize the likelihood of unfavorable development and implementation of our new digital connect platform with enhanced pricing to sophistication and efficient scalability for growth.

We knew this would be a multi-quarter journey and that we would need to consistently apply these actions to turn personal auto into a profitable and growing product line. Today, those ongoing actions have brought us to the stage in our journey where personal auto is both profitable and growing in the quarter.

The statutory auto loss and LAE ratio improved in the quarter to 60.1% with the statutory combined ratio of 89.6% compared to 79.9% and 107.6% respectively in third quarter 2017. Going forward, we intend to take more targeted rate actions in personal auto and to continue to press for further claims operational improvements in our care organization.

To measure the improvement in our profitability, we closely watch the rate of increase in premium versus the rate of increase of loss cost. In the third quarter 2018, the change in 12 month rolling earned premium per vehicle was greater than the change in our annual loss cost.

In addition, on our legacy personal auto book of business, the bodily injury frequency trend turned favorable in the quarter. The auto loss ratio on both our connect digital product and our legacy product improved due to the ongoing rate actions and claims operational improvement.

On the other hand, the personal auto loss ratio improved less overall in the quarter, as we expect to increase new business will continue to place pressure on our overall auto loss ratio. In financial terms, our personal auto performances is as follows; net written premiums for personal auto is up 14.7% versus third quarter 2017, the ninth consecutive quarter of personal auto net written premium growth, are up 33.5%, new business accounts are up 40.3% and PIF increased 5.2% above the third quarter 2017 PIF level. Retention was 71.9% and continues to be pressured by the earn-in of our aggressive rate actions to restore our profitability.

Moving onto homeowners, policies in force increased with the homeowners PIF increasing by 13.9% over third quarter 2017. Homeowners is also experiencing a new business lift from the launch of our new digital product.

Homeowners quotes are up approximately 90% over third quarter 2017. New business accounts are up approximately 70% over third quarter 2017.

In financial terms, our homeowner’s performance is as follows; third quarter 2018 homeowners’ net written premium increased 19.5% versus third quarter of 2017. The third quarter 2018 loss in LAE ratio was 64.2% with a combined ratio of 96.8%.

The homeowners cat loss and ALAE ratio for third quarter 2018 was 17.4 points, which is 8.1 points higher than the third quarter of 2017 homeowners cat loss and ALAE ratio of 9.3%. 5.4 points of the third quarter 2018 homeowners cat loss and ALAE ratio are from hurricane Florence.

The third quarter 2018 non-cat loss and ALAE ratio of 40.9% was 3 point 2 points lower than the 44.1% in the third 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 as first, the personal auto combined ratio in the quarter was below 100% for the second consecutive quarter due to the combined effect of prior period favorable development and continued profit restoration efforts.

The significant personal auto rate actions continued to renew into our book and those rate increases place pressure on both auto and home retention. Second, new business accounts continued at a higher level than the prior year due to our new digital connect product resulting in an ongoing increase in our PIF, at the same time the improvement in our loss ratios will continue to face a headwind from additional new business penalty with the increase in new business. Third, moderation of our personal auto loss severity trend continues as a result of our ongoing claims operational improvements. And then, finally the personal auto bodily injury pure premium trend on our legacy book moderated in the quarter with a favorable frequency trend being observed in the quarter for the first time in many quarters.

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

Kim Garland

Thanks, Jason. The commercial business results are as follows. A 3Q 2018, combined ratio of 103.7 versus 97.9 in 3Q 2017 and a 3Q 2018 written premium increase of 0.4% versus 3Q 2017. For the commercial business as a whole, the story is, the statutory non-cat loss and ALAE ratio was 2.9 points higher in 3Q 2018 versus 3Q 2017. This was driven by the middle market, non-cat loss and ALAE ratio being 11 – 2 points higher this quarter compared to 3Q 2017.

Commercial loss ratios continue to be where we generally need them to be and commercial expense ratios are not where we need them to be and are our biggest inhibitor to overall profitability.

The 3Q 2018 statutory commercial expense ratio of 41.8% was 3.3 points higher than 3Q 2017 due to the ongoing technology investment in connect and higher incentive compensation estimates.

Commercial connect for BOP, commercial auto and commercial umbrella has launched in all of our states except for Virginia and Alabama waiting on DOI [ph] approvals and North Carolina commercial auto which requires specialized programming.

The third and final wave of our Connect build, the build out of the core systems for farm and ranch, CPP and workers compensation has started. Some updates on commercial connect. Our Straight Through Processing rates continue to look good. To date, on commercial connect, new business has increased in commercial auto and it has decreased in BOP.

For commercial auto, new business premium is up 51%, September year-to-date 2018, versus September year-to-date 2017. BOP new business premium is down 7%, September year-to-date 2018 versus September year-to-date 2017.

Last quarter, we discussed the fact that we had launched an updated BOP pricing model with the May launch dates, and that we had seen BOP closure ratios increase with the new model. This updated BOP pricing model has now been implemented in all of our states.

The driver of Bob new business premium being down is that our historical commercial agents have not yet adopted the benefits of the new platform. The Bob connect new business policy count from our historical personal lines agents are up 96% in BOP between 3Q 2018 versus 3Q 2017. Our historical group of commercial agents previously were accustomed to state auto touching their small commercial policies for them, and then being able to call their underwriter to get credits or debits on price on these policies.

This new straight through processing, the price is the price model is a departure from their historical small commercial experience with state auto. It is not surprising to us that it is taking longer to transition this group of agents from our historical model to our new model, but there are massive long-term benefits dividing through this transition,

We have to have a no touch model on small commercial to get an acceptable expense ratio and we have to have a no touch model on small commercial to be able to rapidly scale small commercial and operate operationally. And over time, a price is the price model will produce a better loss ratio than a credit debit model for small commercial.

So while this transition is difficult, we have to and will fight through it. Our all-in bet on the commercial expense ratios and the moving -- and the moving pieces to keep an eye on are the following; we have built a BOP commercial auto and commercial umb – we have built four BOP, commercial auto, commercial umbrella and will build for farm and ranch, CPP and workers compensation, a platform where the unit economics of writing and servicing a policy are low enough that it creates a much lower commercial expense ratio at some achievable level of scale, and that we can put enough volume on this platform to achieve this level of scale that creates a much lower commercial expense ratio.

We are one fourth of the way through this process. The platform has been built and rolled out for BOP commercial auto, commercial umbrella and we believe it has created unit economics that will work.

The moving pieces to keep an eye on are the following. Our Connect investment can be thought about in three waves. Wave 1 was the launch and rollout of personal lines, Wave 2 is the launch and rollout of BOP commercial auto and commercial umbrella, and Wave 3 is the launch and rollout of CPP, farm and ranch, and workers compensation.

Wave 2 is virtually done, and Wave 3 will generally cover 2018, the buildout of the core system and 2019 the finish of the core build out of the system and the rollout of the states. For commercial lines, the following expense ratio dynamics will happen -- will be happening over the next couple of years.

In 2019, for Wave 2 products, BOP commercial auto, commercial umbrella, we expect IT expense ratios to decrease and premium volume should increase with a greater percentage of the business each quarter on this more efficient platform, and so the total expense ratio for these products should be decreasing.

For our Wave 3 products, CPP, farm and ranch, and workers compensation, IT expense ratios should increase as it is the heaviest year of IT spend and yet volume will not have started increasing because the state rollout has not yet occurred. The overall expense ratio for commercial lines will include both of these phenomena.

In 2020, for Wave 2 products, we expect the IT expense ratios to decrease further and continued significant increases in premium volume should provide some benefits of scale to the expense ratio and the overall expense ratio for these products should continue to decline.

For Wave 3 products, the bulk of the IT spend should be done and premium volumes a better unit economics should be increasing because this platform has been implemented. And so the expense ratio of these products should start to decrease.

These two things should cause the overall expense ratio for commercial lines to decrease in 2020. The commercial business results by product line are as follows. I’ll focus on the loss and LAE results for each product line as the acquisition and operating expense ratios where every product line are poor as previously noted.

Commercial auto, the commercial auto loss and LAE ratio in 3Q, 2018 is 58.3% which is a 5.6 point improvement versus 3Q, 2017. This improvement is primarily driven by the current accident year loss ratio being 9.3 points lower the same period last year. Commercial auto written premiums in 3Q, 2018 were up 2.7% versus 3Q, 2017.

We continue to be extremely pleased with our progress in commercial auto. The combined ratio of 104.6 for commercial auto includes 8.8 points of IT expense, reflecting the connect spend and additional 2.6 points for the increase in the estimate of incentive compensation. Going forward for commercial auto, we just need to put more volume on the connect platform and continue to be fanatical about continually improving our pricing models, our operations and the usability of our system.

Small commercial package; small commercial package statutory loss and LAE ratio in 3Q 2018 is 67.3% which is 2.2 point deterioration versus 3Q 2017 driven by a lower level of favorable prior-year development this year.

Our lower loss – our loss ratio in small commercial package is too high. As we discussed last quarter, we continue to take the necessary rate and underwriting actions in the four classes that are creating issues; auto service, carwashes, restaurants and convenience store grocery.

Small commercial package written premium in 3Q 2018 was down 7.3% versus 3Q 2017. Declining bought new business volumes in Connect as discussed earlier are driving the decline in growth in small commercial package.

The key to growth in small commercial package will be to get our historical commercial agents to embrace our new approach to small commercial, middle-market commercial; the middle-market statutory loss and LAE ratio in 3Q 2018 to 65.7 which is a 13.6 points higher than 3Q 2017. This is being driven primarily by poor liability results in our hotel and restaurant classes.

Middle-market written premiums in 3Q 2018 were up 3.5% versus 3Q 2017 finishing the rollout of Connect in small commercial for new business continues to free up time for 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 27%. Worker's Compensation; Worker's Compensation statutory loss and LAE ratio in 3Q 2018 is 63.6% which is 2.7 points higher than 3Q 2017.

This level of loss and LAE ratio produces a good combined ratio for this product line, 94.1% for this quarter. We all continue to be proud of the high level of discipline and operational execution, our entire Worker's Compensation team continues to show during this phase of the market cycle.

Worker's compensation written premium in 3Q 2018 was down 4% versus 3Q 2017. Farm and ranch; farm and ranch statutory loss and LAE ratio in 3Q 2018 is 59.0% which is a 4.1 point improvement over the 63.1% in 3Q 2017.

The main driver of this improvement was a 4.4 point lower catastrophe loss ratio in 3Q 2018 versus 3Q 2017. As a reminder, the third quarter is generally the highest catastrophe quarter for the farm and ranch industry.

You also see a 51.5% expense ratio for farm and ranch this quarter. This includes 16 expense ratio points of technologies spend which reflect the cost of the core buildout of farm and ranch connect.

In 2018 our farm and ranch team and has absorbed both the large to -- second-quarter hog confinement loss and the elevated IT expense ratios for the connect build. And the 3Q 2018 year-to-date combined ratio of 100.8 is in shouting distance of breaking 100. I'm incredibly proud of the team’s grid and performance this year. Farm and ranch written premium in 3Q 2018 was up 5.9% versus 3Q 2017. Our rate and underwriting actions have slow down the growth rate of farm and ranch.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Lou Feldman with Wells Fargo Asset Management.

Lou Feldman

I apologize that was a mistake. Please go on. Nice quarter guys.

Mike LaRocco

Thank you.

Operator

Your next question is from Christopher Campbell with KBW.

Christopher Campbell

Yes. Hi. Good morning.

Mike LaRocco

Good morning, Chris.

Christopher Campbell

Congrats on the quarter.

Mike LaRocco

Thank you.

Christopher Campbell

I guess just a few. I mean, obviously a great quarter, so just kind of a few like just little things. I guess just what's driving the big sequential, like core loss ratio, uptick in workers' comp? It was like up 300 bps and then last quarter it was down 810. So I just trying to understand a little bit of the noise in those numbers?

Steve English

Couple of things. I think Worker's Compensation just bounces around a little bit. You don't have huge scale in that line. I do think there is overall some downward pressure on rates, so even the loss ratio popped up a bit the combined ratio is still where we wanted to be so we’re okay with that. But it will go up and down a bit. We do large debit mod workers' comp and that that has variability from quarter to quarter.

Christopher Campbell

Got it. And what trends are you seeing in the audit premiums in that line? I mean, I see premiums are down like 4% year-over-year. So I'm trying to get an idea how much of that is rate versus how much could be offset by the positive economic trends and then like the underwriting actions you guys are taking across the book?

Mike LaRocco

So, audit premiums we’ve increases in revenue from our audit premiums, probably I remember the big pop in that was first quarter if I remember accurately. But in general they are up. Your question on underwriting actions was that for workers’ comp specifically or just across the board in commercial?

Christopher Campbell

As workers’ comp get more competitive there maybe like they’re possibly non renewing some accounts or like losing some accounts to fierce competition or if competitors are incentivizing a lot of new business?

Steve English

I think the dynamic in that area that we saw specially this quarter is probably the more the new business volume go down, the retention was higher than we are probably guessing given that. And so I think that's a combination of our underwriters probably both fighting hard for the renewals, but also one of the things we’re proudest of and think as a distinguisher for us is our sort of claim handling, loss mitigation ability that we have an workers’ compensation. So we did see a couple of renewals where we were higher in price but based on sort of our loss management claims handling they stayed with us versus moving the business for a lower price.

Mike LaRocco

Yes. And Chris, this is Mike. Just at a high level its definitely getting more competitive out there and we’re seeing competition probably do unfortunate what they've done in the past which is start racing to the bottom, but we’re not going to do that and I agree with Kim that I think it's a credit to our team that we’ve been able to retain a good amount of business. But we are willing to walk away if somebody pushes us not downward too far.

Christopher Campbell

Okay. Very helpful. And I guess just on kind of a little bit higher levels, it's look like personal lines are going to be profitable in 2018, which is very impressive. So when do we get there with commercial lines?

Mike LaRocco

Yes. I’m glad you ask that question, Chris, because I'm asking Kim that a lot lately. I’ll give you – I’ll start off and I let him really answer it. I we’re – I think as Kim noted in his comments our loss ratios are ones that we believe probably from a competitive standpoint are generally where they need to be and of course we’re always trying to get better, so what to be careful how I say that. But in commercial lines for us this is much more significantly in expense ratio challenge. And I think Kim and his team have put together a really really appropriate action plan to get at that, but the one thing that has to happen in commercial, we’ve got to write more business.

And we build this digital platform not like we did in personal lines in and the scale piece of it we always are looking for ways to get more efficient and effective on the operational expense side, but scale is part of it. And I think that we’re very bullish on the fact that you know we can add a lot more business onto our platform in the BOP and commercial auto space and then ultimately we’ll see the same type of progress in middle-market commercial. And if I didn't give you an exact date that was by design, I’m not allowed to.

But I love the way we’re trending right now in commercial. So I’ll give that as an introductory and let Kim take it from there.

Kim Garland

Mike and I known each other 20 years, so he answers the questions pretty much the same way I would answer them. So you probably covered like 90%. Really the loss ratios in general are been never perfect and you're always tweaking segmentation and all that are generally where they need them to be. An expense ratio where the first numbers are four just is not sort of viable. And so to solve the -- to get to profitability in commercial it is about getting to expense ratio as lower and it is the same sort of playbook that you saw in personal lines, right? You spend the money to build the platform that creates more efficient unit economics and then you either do or don't put enough volume on that platform to have the majority of your business at that sort of more efficient unit economic level.

So the two cycles that you see in the that we are dealing with, right, so personal lines with first, so the platform has been out longer. But I talked about sort of the adoption of a BOP specifically from some of our more commercial focused agents. We have to get them over the hump and then we have to sort of start to scale up with all of them. And then as we get scale with that at the more -- on the more efficient platform we believe that the lower expense ratio will come, but at the same time we’ve ramped up and started the process of CPP farm and ranch and workers’ compensation making the investment there, so we probably get to cycles of investment on commercial lines where we had one in personal lines and that will be a headwind.

Mike LaRocco

And then last think I would say, Chris, just a reminder, you guys have heard me say this for many of you for many many years but we’re an underwriting company, so every line so every line has to be profitable. We don't subsidize lines. We don't say it's okay for profit as a company, but not profitable on commercial. So Kim is known around the office as the anchor right now because he's kind of taken us down, but other than that we’re little bit competitive as well.

Kim Garland

I appreciate that, Mike.

Christopher Campbell

Got it. Okay. And then just kind of one final one. So -- I mean, very impressive like if you look at the year-over-year like cat loss ratio. You had some of that Irma. But I guess now that you have the E&S property line that's in runoff so you're not going to get surprises there in earnings, how should we be thinking about like kind of a normalized cat loss ratio going forward with just the personal and commercial lines?

Steve English

Hi, Chris, this is Steve. I would say, you could kind of default back to where we use to run prior to specialty. I think somewhere in the six, seven point range, but as time marches on and we grow lot more of these lines of business that are not cat exposed. So auto example while you do get maybe a point, point and half of cap losses on that line. It doesn't contribute to the overall cat load to any great extent. So I would say, you could kind of start there, but it should trend downward from there.

Christopher Campbell

Okay. All right. Well, thanks for all the answers. Best of luck for the rest of the year.

Steve English

Thanks, Chris.

Operator

[Operator Instructions] your next question is from Larry Greenberg with Janney Montgomery and Scott.

Larry Greenberg

Good morning. And I’ll extend my congratulations too, and I’ll even include Kim in that even though he is the anchor. So, should be a little bit nervous about whether or not these agents will come around to commercial connect?

Steve English

I want to start and we’re always nervous about everything. I'm not overly nervous, no, for any number of reasons. First of all the platform itself is an adjustment for people. But the reality the platform versus the way we used to do business is so significantly better, so significantly different that it's very easy for folks inside of offices whether they are more traditional commercial agent or not to understand the benefit. Secondly, we have the momentum of what's happening quite frankly digitally across the country, so a lot of barriers are being taken down in terms of people's biases in terms of doing things digitally.

So while there will be some of those very traditional commercial agents who will be somewhat reluctant to enter that space. I think that many and I believe solidly that most well, that's number one. Number two as Kim's already pointed out we’re getting a huge pickup from our personal lines or more dominant personal lines agents who've always had on the periphery a reasonable amount of kind of commercialize business, so we’re getting. And the third piece of this that’s really important is that all of the innovation you saw on distribution around personal lines with non-traditional agents what we call platform agents is all coming to commercial lines. I mean, you know if agents think direct response has hit personal lines, it’s coming heavily in small commercial side and with that is going to come a number of these platform agents who are already making a lot of noise in this space and we are perfectly positioned to partner with some of them.

So while there is certainly worry, because that’s what we do, I’m very very confident that will overcome those type of potential objections.

Kim Garland

And you know to be precisely accurate, it’s a bit inaccurate and maybe a little bit unfair to just categorize them as a single large group. There are some traditional commercial agents who have really embraced and taken the platform and are going off with it. But as much as personal lines was a different experience on the platform with them, I can think of no other experience that we have internally that is more different than small commercial, because even and as one of the drivers of our high historical expense ratio there is if you have a $1500 commercial policy and you pick up the phone and you call an underwriter and you kind of go back and forth on it, and you get a 5% credit or a 10% debit or whatever. That was the way of life.

And so, that way of life is gone. There is no – there’s no back and forth on price on a $1500 policy. And so that is such it is the most dramatic difference and experience of our entire library of products there. I’d say one of the advantages that we probably have with this group is, this is the group of agents that we do middle market business with also, and so you’ll see our middle market business sort of going up. And that's as -- as Connect roll out or middle market underwriters have freed up to have more time to work on middle market risks and sort of the way that game is played is to the extent in the commercial agency you can help them more with middle market risks. You’ll get looks more ad small and more small commercial risks, but it’s also in those agencies we have the – on the middle stuff you got to call in, you got to talk to your underwriter. It’s that traditional way and so we are making them think of like two ways of life inside of a single agency which is a big change and hard and difficult also. So, I’m not worried that we will get there and I’m -- we recognize almost from day one that this would probably be the hardest transition to make.

Larry Greenberg

Great. Thanks. And then you know you’ve talked over the years about underwriting leakage and claims leakage. Are you where you want to be – I mean, what inning of that game are we in? Is it done, I mean you’ve got it where you need it?

Mike LaRocco

No, I mean, I think I’d put in maybe the sixth inning if I think about a nine inning game, I don’t want to think about that World Series game that went 18. Probably around six and the real the reason I say that is that some things I spoke about in terms of the next phase of the journey and how we are going to continue to invest in technology, not the same level of dollars and it’s a certain to be a different payback. But this next phase of technological investment will allow both claims and underwriting to get closer to the ninth inning and maybe even pitch is shut out because the digital path Larry that we are on, we are way in the early phase of that. We’ve gotten, we’ve proven and validated that the quote and issue piece of it and payment processing piece of it works, we can get better and we will – keep turning the crank and get better.

But the digital journey in terms of a claims experience, an underwriting experience, service experience, we’ve just on the cusp of that. And I think those things will do two very important, meet two very important criteria. One, it will lower our friction cost a lot whether that’s in the speed of care handling, the quality of the check they are writing, the speed of answer from a service professional or maybe even what the agent or customer can do directly should they want to sell, for what we can control I think our underwriting leakage and our claims leakage have really really come down. And then a big part of what you’re seeing in these results. We talk about better pricing and better models and just taking more rate, reducing your loss dollars through faster response times and being a more finely tuned claims organization has been a big part of this as well. But I would never say we are further than the sixth innings because the digital journey will get us further down the road.

Larry Greenberg

Great. Thanks.

Operator

[Operator Instructions] We have no further questions.

Natalie Schoolcraft

Thanks everyone 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 fourth quarter earnings call which is currently scheduled for Thursday, February 14, 2019. Thank you and have a wonderful day.

Operator

Thank you. That concludes today's third quarter 2018 earnings conference call. You may now disconnect.