Selective Insurance Group, Inc. (NASDAQ:SIGI) Q4 2018 Earnings Conference Call February 1, 2019 10:00 AM ET
Rohan Pai - Senior Vice President, Investor Relations and Treasurer
Gregory Murphy - Chairman and Chief Executive Officer
Mark Wilcox - Executive Vice President and Chief Financial Officer
John Marchioni - President and Chief Operating Officer
Conference Call Participants
Mike Zaremski - Credit Suisse
Christopher Campbell - Keefe, Bruyette & Woods, Inc.
Paul Newsome - Sandler O'Neill
Mark Dwelle - RBC Capital Markets
Good day, everyone. Welcome to Selective Insurance Group’s Fourth Quarter 2018 Earnings Call. At this time for opening remarks and introductions, I would like to turn the call over to Senior Vice President, Investor Relations and Treasurer, Rohan Pai.
Thank and good morning. This call is being simulcast on our website, and the replay will be available through March 1, 2019. A supplemental investor package, which includes GAAP reconciliations of non-GAAP financial measures referenced on this call, is available on the Investors page of our website, www.selective.com. Certain GAAP financial measures stated in today’s call are also included in our previously filed Annual Report on Form 10-K and Quarterly Form 10-Q reports. All numbers are GAAP unless otherwise indicated.
To analyze trends in our operations, we use non-GAAP operating income, which is net income excluding the after-tax impact of net realized gains or losses on investments and unrealized gains or losses on equity securities. And in the fourth quarter of 2017 the impact of write-down of our net deferred tax asset due to tax reform. We believe that providing this non-GAAP measure makes it easier for investors to evaluate our insurance business.
As a reminder, some of the statements and projections made during this call are forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. We refer you to Selective’s Annual Report on Form 10-K and any subsequent Form 10-Qs filed with the U.S. Securities and Exchange Commission for a detailed discussion of these risks and uncertainties. Please note that Selective undertakes no obligation to update or revise any forward-looking statements.
On today’s call are the following members of Selective’s executive management team: Greg Murphy, Chief Executive Officer; John Marchioni, President and Chief Operating Officer; and Mark Wilcox, Chief Financial Officer.
And with that, I’ll turn the call over to Greg.
Thank you, Rohan and good morning. I'll first make some introductory remarks focusing on some high level themes and discuss those that will continue to drive our performance and strategy. Mark then will discuss our financial results, and John will review our insurance operations in more detail providing additional color on key underwriting initiatives.
We are extremely proud of our excellent 2018 fourth quarter and year results. For the quarter, non-GAAP operating income established a record $72 million, or $1.20 per share and the annualized non-GAAP operating return on equity or ROE was superior at 16.3%. For the quarter, each of our underwriting segments contributed to the exceptional 92.7% combined ratio and produced an annualized ROE of 8.1 points. In addition, after tax net investment income was up 42% to $44 million, contributing 10 points of annualized ROE.
This exceptional quarter capped off an overall strong year of company financial performance. 2018 marks the fifth consecutive year that we reported double digit non-GAAP operating ROEs, placing us in among extremely select group of insurance companies that have achieved this level of elite performance. This is particularly impressive track record in the context of, one, material industry catastrophe losses over the past two-year period. Two, a very competitive commercial launch [ph] pricing environment; and three, a depressed interest rate environment.
The strong track record is also a testament to our ability to execute our strategy of disciplined growth. For the year, non-GAAP operating ROE was 12.5% and ahead of our 12% financial target. In addition, our combined ratio of 95 generated 5.5 points of ROE, while after-tax net investment income contributed 9.2 points. Verisk’s Property Claim Services estimates US industry catastrophe losses for 2018 at $46 billion or about 8 points on the industry's overall combined ratio. The year will likely go down as the third most costly for the US insurance industry from a standpoint of catastrophes losses, serving as another painful reminder of the risk of severe events.
The major catastrophic events that occurred during the year included Hurricanes Florence and Michael as well as the California wildfire. In addition, non-catastrophe losses also placed pressure on commercial property as well as the homeowner results. The fact that the industry has had to grapple with severe weather related losses in each of almost -- each in the past 10 quarters suggest a new elevated norm that must be addressed through underwriting actions and strong underwriting [ph] pricing rather than hoping for weather improvement.
Industry-wide commercial property results have been volatile. And commercial auto has been a consistent poor performer, which one coupled with ongoing pricing pressure within the workers' compensation line have led to an expected 2018 industry combined ratio of about 99 or an 8% ROE.
This level of performance barely matches the industry's cost of capital, an mprovement over 2017, however, nothing to write home about. As I have often said before, hope is not a strategy that will drive improved underwriting results. And when you look into 2019 and 2020 underwriting performance, the only thing that really matters is earned, renewal, pure rate that exceeds expected claim inflation or loss trend.
We’ve established a strong track record of pricing discipline and we strive to mitigate the risk of severe losses through high quality underwriting, product risk appetite, and prudent reinsurance purchases. In addition to our outstanding financial performance during the year, we've also executed successfully on a number strategic initiatives that will assist sustained outperformance. First, our standard commercial lines renewal underwriters achieved overall renewal pure price increases of 3.5% for the year, in line with our expected claim inflation levels.
Second, as we discussed last quarter, considerable improvement has been achieved in improving our overall customer experience strategy with goal toward adding value added services to make our product superior. The development of a 360 degree review of the customer that allows us to engage customers and manner of their choosing, our digital platform continues to gain traction across personal and commercial lines allowing for continued enhanced customer engagement. In addition, we are making available our Selective Drive Sensor and Mobile Technology to commercial fleet customers.
In addition to fleet management, we expect the adoption of this technology to influence driving behaviors and improve loss experience over the longer term. Third, we've been taking active steps over the past two-year period to address profitability in our E&S segment that include implementing meaningful targeted price increases, exiting challenged business segments, and improving claim processes. Fourthly, our geographic expansion remains well on track and added $26 million of new business for the year. Over the past two years, we've opened New Hampshire as well as the Southwest region presence in Arizona, Colorado, Utah, and Mexico. This brings our total commercial lines presence to 27 states.
Our expanded regional capability provides access to growth opportunities, as well as improving diversification of our business. Finally, our investment team has done a superior job in repositioning the portfolio to take advantage of the rise in short-term interest rates without increasing the overall risk profile. The excellent 35% growth for the year in after tax investment income reflects the benefit of a lower tax rate, higher alternative investment contributions, and tactical moves within the portfolio, taking advantage of the rising interest rates.
Our investment portfolio is conservatively positioned from a credit duration and liquidity standpoint. With an invested assets to equity ratio of 3.33x and an after tax yield of 2.8, investment performance was a strong contributor to our overall ROE for the year.
Initiatives for 2019. Looking forward to the next two-year period, there remain a number of areas that require laser-like focus in order to maintain our financial position. One, achieving standard commercial lines written renewal pure price increases that match or exceed expected loss inflation trends. Two, delivering on our strategy for continued disciplined growth driven by the addition of new agents, greater share of wallet, and geographic expansion. Three, continuing to enhance our customer experience strategy including value added technologies and services such as Selective Drive and others that will improve retention and hit ratios, creating a true differentiation in the marketplace.
Four, improving profitability in commercial auto and E&S via targeting underwriting and pricing actions. And five, actively managing the investment portfolio, enhanced after tax yield while managing credit risk and liquidity risk.
Turning to 2019 expectations, our guidance for the year is based on our current view of the marketplace and incorporates the following. One, a GAAP combined ratio, excluding catastrophe losses of 92. This excludes no prior year development. The catastrophe losses of 3.5 points, after tax investment income of $175 million which includes $8 million of after tax investment income from alternative investment and overall effective tax rate of approximately 19 which includes an effective tax rate of 18 for the investment reflecting tax rate of 5.25 on tax advantage municipal products. And a tax rate of 21% for all other items. Weighted average shares of 60 million on a diluted basis.
Now I'll turn the call over to Mark.
Thank you, Greg and good morning. For the quarter, we reported fully diluted earnings per share of $0.76 and record non-GAAP operating earnings per share of $1.20. Net income including $26 million of after tax net realized losses related to the sales from investment securities to optimize our after tax new money yields as well as unrealized losses from our public equities.
For the fourth quarter, our annualized ROE was 10.4% and the annualized non-GAAP operating ROE was a very strong 16.3%. For the year began on a challenging note with the first quarter's higher than expected non-CAT property losses. Results were extremely strong in a subsequent three quarters. For the year, our non-GAAP operating ROE of 12.5% exceeded our long-term financial target of 12% for 2018. We ended the year with record levels of capital liquidity and feel extremely positive about our financial position.
For 2019, we have established a non-GAAP operating ROE target of 12%, which we believe is appropriate return for our shareholders based on our current estimated weighted average cost to capital, the current interest rate environment, and P&C insurance market conditions. Consolidated net premiums written increased 5% in the fourth quarter, a rough 6% for the full year. Each of our segments contributed to the top line growth for 2019 including 6% growth in standing commercial lines, 4% growth in personal lines and 7% growth for E&S segment.
Continued strong written renewal, pure price increases and stable retention rates drove the growth in standard lines. We also enjoyed new business growth in standing commercial lines in the quarter and for the year. The consolidated combined ratio was a solid 92.7% in the fourth quarter. On an underlying basis or adjusting for capacity losses in prior year causality reserve development, our combined ratio was 93.1%.
For the year, our consolidated combined ratio was 95%. Our Ex -CAT combined ratio of 91.4% for the year was better than our most recent guidance of 92% but above our original guidance of 91% going into 2018.
For the quarter, catastrophe losses added 2.4 percentage points for the combined ratio. Losses from Hurricane Michael accounted for $10 million on a pretax basis or 1.6 percentage points on a combined ratio, which was in line with our prior guidance for that event. We also incurred about $2.5 million of losses related to the California wildfires which impacted our E&S operations in the quarter. For the year, catastrophe losses accounted for 3.6 percentage point from the combined ratio, which was in line with our longer -term expectations of 3.5 point.
We are pleased with this outcome given the relatively high level of insurance catastrophe loss activity in the US in 2018. Non-catastrophe property losses in the quarter equated to 13.3 from the combined ratio, in line with our expectations. For the year, non-GAAP property losses added 14.8 points for the combined ratio, which is 1.5 points higher than the comparative period in 2017, and elevated relative to expectations.
During the fourth quarter, we experienced $17.5 million of net favorable prior year causality reserve development, which reduced the quarter's combined ratio by 2.8 percentage point. For the year, net favorable casualty reserve development totaled $41.5 million and reduced the combined ratio by 1.7 percentage points.
Partially offsetting this was an increase in our current accident year casualty loss pick compared to expectations, which impacted the overall combined ratio by 2.2 points in the fourth quarter, or $13.5 million and 1.3 for the year, or $31 million, principally driven by our commercial auto line of business. Our expense ratio came in at 33.7% for the fourth quarter, which is up sequentially, but down 1 point compared with a year ago.
For the year, the expense ratio was 33.2% which is down 1.2 points from 2017, reflecting continued efforts to manage our expenses. The profit base portion of our expense ratio, which includes supplementary commissions and performance-based compensation, was about 3.4 points in 2018, compared to 3.8 points in 2017, driven by a higher combined ratio in 2018 compared to 2017, and expected reversal of that benefit in 2019 will put some modest upward pressure on our expense ratio this year.
We remain focused on seeking areas of efficiency and cost savings, while continuing to invest in our employees and in key initiatives around geographic expansion, enhancing our underwriting tools technology and the customer experience. These ongoing investments position us well for the future, as we build out our capabilities and strategic position at the marketplace. Corporate expenses, which are principally comprised of holding company costs and long-term stock compensation, totaled $3.4 million in the fourth quarter, which is down $6.2 million relative to the comparative quarter.
The primary reason for the reduction in the quarter was lower long-term stock compensation expense, resulting in part from the decline in our share price during the fourth quarter. Corporate expenses totaled $25.4 million for the year and down $10.9 million relative to 2017, exceeding our $10 million long-term savings which we highlighted in 2017. As with the profit-based component of our expense ratio, it was a non-recurring element, the corporate expense savings in 2018 that will put some modest upward pressure on corporate expenses in 2019.
That said, we expect the volatility long-term compensation to decline modestly over time as a result of the structural changes we made for this program in early 2017. Turning to investments. Fourth quarter net investment income after tax was excellent $44 million, up 42% from a year ago. Overall, the average after-tax yield of the fixed-income portfolio was 2.9% during the fourth quarter compared to 2.2% a year ago. The average new money yield on the fixed-income portfolio during the fourth quarter was a very strong 3.3% after tax.
The weighted average after-tax book yield on our fixed income portfolio of 3% at year-end positions us well going into 2019. During 2018, we're able to increase our after-tax pretax book yield on our core fixed income portfolio by 47 basis points. As we continue to tactically position the investment portfolio to take advantage of rising rates without increasing credit risk or expanding duration of the portfolio. As an example, approximately 16% of the fixed income portfolio is in floating rate securities, which reset principally on 90-day LIBOR.
The book yield on these securities is benefited from the 111 basis point increase in 90-day LIBOR at 2018 and drove 16 of the 47 basis point increase in our book yield in 2018. In addition, we have also been actively managing our core fixed income portfolio in sector and security level basis to increase the risk adjusted yield. We are particularly aggressive in the fourth quarter given the market volatility and resulted into good opportunities to raise our book yield, although it did result in a higher than normal level of realized losses, which we believe was a good trade-off.
Our average credit rating remains strong at AA minus and the effective duration of our fixed income and short-term investment portfolio was relatively unchanged at 3.6 years. Risk assets which principally include high-yield fixed income securities, public equities and alternative investment portfolio accounted for 7.2 percentage points of our total invested assets as of the end of the year, down from 7.9 points a year ago. We will be gradually diversifying our portfolio of risk assets and our longer-term target is up to a 10% allocation, although the timing will depend on market conditions and opportunities.
During 2018, we modestly de-risked the portfolio by trimming our allocations to public equities in high-yield. Our other investment portfolio, which primarily consists of limited partnerships and private equity private credit and real asset investment, and reports on a one quarter lag generated pretax income of $6.9 million for the quarter compared with $3.4 million in the year ago period. For the year, this portfolio generated $17.8 million in pretax income compared to $12.9 million in 2017.
During the year, we entered into agreements to sell some of our pre-2008 vintage alternative investments for a pretax loss of $2.7 million to better manage potential downside volatility in this portfolio and credit capacity for new commitments going forward. Recall that our alternative asset performance is reported on a one quarter lag, and then our first quarter 2019 results will reflect the asset performance for the fourth quarter of 2018, in which the total return on the S&P 500 Index was down about 14% and the Barclays High Yield index was down 4.5%.
An expectation of negative marks on the alternative portfolio for the fourth quarter is reflected in our 2019 after-tax net investment income forecast of $175 million. As it relates to taxes, we had a very low 12.3% effective tax rate in the fourth quarter, which help drive down our 2018 full-year effective tax rate of 15.5%. This was driven by some capital loss carry back items to prior periods. They carry the previous 35% statutory tax rate resulted in some permanent benefits in the tax line item in the fourth quarter. We consider this a one-off benefit, and as Greg mentioned, we are projecting a 19% effective tax rate in 2019.
This benefit was excluded from non-GAAP operating income. Turning to capital, our balance sheet remains very strong with $1.8 billion of GAAP equity at year-end. Despite rising interest rates that put pressure on the market value of our fixed income portfolio, our book value per share was driven by strong earnings and was up 6.4% for the year adjusted for dividends. We continue to adopt a conservative stance with respect to managing our underwriting risk appetite investment portfolio reserving processes, reinsurance buying, and catastrophe risk management.
Our debt to capital ratio of 19.7% at the end of the year is trending below our longer-term target of approximately 25%, providing us with the flexibility to increase financial up on leverage if opportunities arrive. We generated adequate capital to -- through our operating earnings to sustain the top line growth rate of approximately 9%, while maintaining our current leverage ratios. Our 1.4x premium to surplus ratio, it means that each point of underwriting margin equates to approximately 111 points of ROE. In addition, 3.33 x investment leverage implies that every 100 basis points of pretax yield from our investment portfolio results in 273 basis points of ROE.
As it relates to our reinsurance program, we enjoyed a successful renewal of our catastrophe reinsurance program at January 1st. We maintained our existing structure that keeps 100 net PML from a major catastrophe risk US hurricane at a very manageable 2% of GAAP equity, and our one in 250 net PML at 5% of GAAP equity. We modestly increased participation on the program to make room for new markets and our renewal pricing reflected the loss-free status of our program and our continued efforts to generate strong renewal pricing in our property portfolio and continued efforts to diversify our exposure.
With that, I'll turn the call over to John to discuss our insurance operations.
Thanks, Mark, and good morning. I'll begin with an overview of the results of our insurance operations by segment and then review our key strategic initiatives to position us for continued success. Our Standard Commercial Line segment, which represented 79% of premiums in 2018, generated 6% net premiums written growth for the quarter and for the year. Net premiums written growth for the year was driven by stable retention of 83%, and overall renewal pure price increases of 3.5%.
This segment generated a combined ratio of 92.9% for the fourth quarter and 94.3% for the year. For the fourth quarter, renewal pure price increases remains strong at 3.4% with retentions remaining stable at 83%. For the highest quality Standard Commercial Lines accounts based on future profitability expectations, we achieved renewal pure price increases of 2.2% for the year and point of renewal retention of 91%. This cohort represented 49% of our commercial lines premium.
On the lower quality accounts which represented 11% of premium for the year, we achieved renewal rate of 7.9%, while retaining 77% at point of renewal. This granular approach to administering our renewal pricing strategy allows us to achieve additional loss ratio improvement through a mix of business changes, while continuing to deliver rate increases that equal or exceed expected claims inflation. Drawing down from the results by line for Commercial Lines, our largest line of business, general liability, generated a combined ratio of 89.8% in the quarter and 88.6% for the year.
Excluding umbrella, we achieved renewal pure price increases of 1.6% for general liability during the fourth quarter, and 1.7% for the year. Reserve releases were modest at $1.5 million in the fourth quarter. Workers compensation combined ratio was 59% in the fourth quarter and 70.3% for the year. This line experienced $30 million of favorable prior year reserve development for the quarter, as a result of lower-than-expected severities for accident years 2017 and prior. Workers compensation renewal pure prices declined 1.3% in the fourth quarter and were down 0.2% for the year.
While reported profitability remains strong due to favorable emergence on prior year reserves, our current accident year results and knows of the industry do not support the significant reductions in pricing that we're seeing across the country. While pleased with our performance in this line, we are maintaining underwriting and pricing discipline in the face of an extremely competitive marketplace. Commercial auto results were disappointing and remain a challenge for us and the industry. Loss frequencies have remained elevated for recent years, resulting upward adjustments to our estimates for the prior and current accident year casualty reserves.
The commercial auto combined ratio was 123.8% in the fourth quarter, and 150.7% for the year. Results for the quarter included $12.5 million of unfavorable prior year casualty reserve development, due to higher claim severities, as well as elevated frequencies in accident years 2015 through 2017. In addition, we increased the current year loss estimate during the quarter by $13.5 million to take into account the elevated loss experience. We were taking a number of active steps to address profitability at commercial work, including renewal pure price increases that averaged 7% in the fourth quarter, which was in line with the level for the year.
This is on top of renewal price increases averaging 6.7% in 2017, and 4.9% in 2016. Most of the benefit of these changes has been offset by continued increase in loss frequencies and severance. As such the elevated loss trend should support additional rate in 2019. We also continue to taking more conservative underwriting and pricing expense on higher hazard classes resulting in a shift of mix towards lower and medium hazard accounts. Longer term, we expect the introduction of Selective Drive to improve the performance of active accounts in that program.
Our commercial property book generated a 92.8% combined ratio for the fourth quarter and 101% combined ratio for the year. Results in this line were negatively impacted by catastrophe and non-catastrophe weather losses incurred earlier during the year, as well as our heightened frequency of large fire losses. While industry pricing for this line appears to be picking up, we believe it remains inadequate on a risk adjusted basis, especially in the context with elevated losses over the past two years. Renewal pure price increases for our commercial property business excluding annual earnings averaged 4.6% in the fourth quarter and 4.1% for the year having trended up throughout 2018.
We expect industry-wide pressure in the line to result an additional pricing heading into 2019. Our Personal Lines segment, which represented 12% of premiums for the year, reported flat premium volume in the fourth quarter, and 4% growth for the year. The Personal Lines segment produced profitable combined ratios of 91.8% in the fourth quarter, and 95.8% for the year. We are pleased with the overall performance of this segment, which generated solid underwriting results, despite generally elevated weather-related losses for the year.
We have made significant progress in lowering the expense ratio for the segment, which was 31.8% for 2018, excluding the benefit of the flood operation compared with 34.9% for the prior year. The homeowner's line generated a combined ratio of 74.2% during the fourth quarter, benefiting from generally benign weather in our footprint. Results for the fourth quarter included $1.5 million of prior year unfavorable casualty reserve development, which added 4.7% points to the combined ratio.
For the year, the homeowners' line generating a 95.5% combined ratio. For the quarter and year net premiums written were approximately flat compared with the prior year period due to competitive pricing environment and efforts we've been taking to limit catastrophe exposure. In Personal auto, net premiums written increased 1% for the fourth quarter and 8% for the year. Top line growth rates have been declining as market competition has again picked up. Renewal pure price increases on our book averaged approximately 6.2% for the year. The combined ratio for personal auto was 116.1% in the fourth quarter, and 106.3% for the year.
Prior year adverse casualty reserve development totaling $3 million added 6.9 points to the combined ratio for the quarter and 1.8 points for the year. On an accident year basis, our combined ratio was approximately 105. We continue to focus on a plan to improve the performance through price increases, mix change and expense ratio improvements. As these actions work their way through to book, we expect to see further margin improvement and our 2019 combined ratio expectation for this line is approximately 102.
Our E&S segment, which represented 9% of total net premiums written for the full year generated 7% growth in the fourth quarter and for the year. We sacrifice growth during 2017 in the first half of 2018, as we addressed underwriting profitability and exited some unprofitable classes. We've begun to see improvement in profitability from these actions and plan to maintain our focus on this front, as we've started to see a return to reasonable growth rates.
The combined ratio was 92.9% for the fourth quarter and 100.3% for the year. Renewal pure price increases in E&S averaged 2.9% during the fourth quarter and 4.7% for the year with substantially higher price increases and targeted classes. While the relatively small size of the book could lead to some quarterly volatility, improved underwriting, pricing and claim outcomes have us on track to achieve our risk-adjusted profitability target for this segment by the end of next year.
I'll now switch to discuss some of our major strategic initiatives. We are always striving to make Selective a market leader, a truly unique company in our industry that can generate sustained operating and financial out performance. To position us for the future, we continue to invest in, and strengthen our sustainable competitive advantages, which are one, our franchise distribution model with ivy league agents; two, sophisticated tools and processes that allow our underwriters and claims adjusters to make better decisions faster; and three, an excellent customer experience delivered through top notch employees and technological advances.
First, our extremely strong relationships with our distribution partners are a core competitive strength for us. Our longer-term Commercial Lines target is to retain a 3% market share in the season which we operate by appointing partner relationships approximating 25% of the markets and seeking an average share of wallet of 12% across those relationships. This call represents an additional premium opportunity in excess of $2 billion in our existing footprint. During 2018, we appointed a 110 new distribution partners, including our newly opened geographic expansion states bringing the total to over 1,320 partners and approximately 2,200 store fronts.
Over the past two-year period, a regional hub in the south-west was established. Our franchise distribution model as a key element of our strategy in these new markets allowing us to gain access to substantial business through a limited number of partner appointments. By limiting our appointments to approximately 40 across these four states, we are positioned to grow profitably with a small group of top notch agencies. We are extremely pleased with the new business opportunities we are seeing at this early stage. Our focus in the coming years will be on building out our operations in the Southwest in a thoughtful and deliberate manner.
Second, we continue to deploy sophisticated underwriting and claims tools that enable our personnel to make better decisions faster, creating greater efficiencies and improving outcomes. Our underwriters receive real-time model driven underwriting and pricing guidance on every account, along with the tool to measure the impact of each decision on our overall portfolio. With process of deploying an underwriting workstation, that will improve the efficiency of our underwriting staff, allowing them to handle larger portfolios without sacrificing our underwriting or pricing discipline.
Our ability to clearly understand the risk return characteristics of the business on a granular basis and obtain the appropriate price is a differentiator in the market. Our success is best demonstrated by our 10-year track record on obtaining market leading renewal pure price increases while simultaneously maintaining and even improving retention rates. On the claims side, we continue to utilize modeling and advanced analytics to segment our incoming claims at inventory, resulting in improved outcomes and a better claims experience. We continue to invest in technologies that help us enhance overall customer experience and position us to increase retention rates and new business hit ratios over time.
Our digital platform allows customers to interact with us into 24 by 7 environments in the manner of their choosing. We've developed a 360 degree view of our customers, enhancing our ability to provide value-added services such as proactive messaging in relation to product recalls, potential loss activity or policy changes. We seek to partner with our agents on this customer experience journey, so that our customers will have a seamless experience, regardless of how they choose to interact with us. Our Selective Drive program was introduced to policyholders in the fourth quarter.
Leveraging connected telematic sensors, this platform helps commercial fleet owners with logistics management and improved safety by tracking and scoring individual drivers based on driving attributes, including phone usage, while the vehicle is in motion. This program is provided to customers free of charge. We continue to invest in leveraging sophisticated technologies to provide our agents and customers, which should over time, improve our retention rates and new business hit ratios.
Overall, we remain extremely pleased with our financial and strategic positioning heading into 2019, which we believe is the strongest in our history. We will maintain a steadfast focus on underwriting discipline as we execute on our various strategies to generate profitable growth. The investments we are making today in our franchise distribution model, sophisticated underwriting, claims, tools and technology, and enhancing the overall customer experience in omni-channel environment will position us as a leader in the coming years.
With that, we'll open the call up for questions, Operator?
Our first question is coming from the line of Mr. Mike Zaremski with Credit Suisse. Your line is now open.
Great. Good morning, gentlemen. Mark you mentioned I believe in the prepared remarks about some, looking at my notes, pressure on the expense ratio if I heard – upward pressure on expense ratio, if I heard correctly, if you could elaborate?
Yes. Mike, that's exactly right. When you look at our expense ratio, we have made some, what I would consider some durable benefit in terms of reducing the expense ratio over time. We sort of peaked at 35.5% in 2016, and brought that down 33.2, 230 basis points of expense ratio improvement over the last two years. What I was referring to was an element of profit based expense within the expense ratio and with a slightly higher combined ratio than expected in 2018 as we would hope to normalize back going into 2019, there will be modest upward pressure.
But we are talking sort of two tenths of a point there, it's not a material number and of course the ultimate expense ratio and the profit component will be a function of the loss ratio and our results in 2019. That's what I was referring to.
Mike, this is Greg. Yes, we are obviously making major investments for future growth opportunities. John touched a little bit of some of the things that we are doing in advanced analytics, decision management, the work station that we are rolling out. When you think about what we are doing at CX and compare that to the competition or the fact that we are building more runway in our geo, geo expansion, what we are doing in the areas of safety, safety management, whether it is to drive product or other essential technologies, we continue to roll out.
On the system side, we've got a lot going on, on that front that continues to reap fresh and make sure we have the best-in-class systems, so there are lots that we do as an organization, and obviously that's an numerator and on top of that is things, profit based things that Mark mentioned. But I want you know are we focused on expenses? Yes. Are we going to expense our way to success? No. And so we are very strategic and mindful about how we manage and invest for the future. I think we strike that tuning fork for the best efforts.
Okay, now understood and yes, you guys have done a great job improving that ratio over time. My next question was, Greg, in the prepared remarks you talked about an elevated – the industry is experiencing elevated levels of frequency of I think property losses. But you can correct me if I am wrong. Does that raise your expectation of non-catastrophe property loss ratio?
Yes. I would tell you that we've seen – obviously you could see our outlook separated CAT, non CAT property which is exactly your question. For us, that's why we've always disclosed our combined ratio ex-CAT, so you can put in your estimate. We are very disciplined. We follow PCS, so it's not a PCS event. It doesn't get included in our numbers. So our number’s pretty pure relative to what a PCS loss would be, and how it affects our results. But you are absolutely right, Mike. It's the weather related and also severe property-fire related pressure that we are seeing both on commercial property and home that have driven up the need for ongoing improved underwriting whether Whether it's hail, cosmetic damage deductibles.
Whatever you do in terms of cost sharing, roofs when it comes down to the home side, and where you’re replacing roof versus where you repair and what is the co-participation between us and the insured on some of that. These are all issues that seem like, again , and now we’re in the middle of another polar vortex which will be another issue possibly for the industry for the quarter. But it just doesn't seem that there is really any kind of significant diminishment of the weather related activity other than not going down and doing the hard work.
And if I just might add, the elevated level of non-catastrophe property losses that Greg mentioned has been factored into our expectations for the 92% underlying combined ratio for 2019. So it's a little bit of elevated loss cost trend going into 2019 versus expectations going into 2018 that’s factored in for the forecast for the year.
Okay, got it. And then my last question is on commercial auto. Thank you for the color again this quarter. Roughly for the full year 2018, what was the impact to the underlying commercial loss ratio, and how are you guys -- are you guys thinking things get a little bit better in 2019 within your forecast?
Mike, this is Mark again. Just very quickly on the numbers. When you look at the -- I think your reference was to the fourth quarter commercial auto results. We had both current and prior year pressure on the loss ratio. It was about 10 points related to the prior year and about just -- about 10.5 points related to the current year. So in total, call it $26 million of pressure on the commercial and auto cost line in the quarter adding call it just about 20.5 points on the overall combined ratio in the current period.
For the current year, how about for the full year 2018? I know it was -- it hurt the underlying by a couple, 2.5 points this quarter. Just curious about by the full year.
Yes. So the full year, from a prior year development perspective it was $37.5 million or about 7.6 points. So the current year it was -- we actually took some pretty significant action and more so than we did in the prior year. So $29.5 million in terms of dollars and about 6 points on the combined ratio is that you included in the underlying loss for the full year and $67 million of prior and current year action or about 13.6 points on the full year and that compares to the full year last year $48.5 million or about 10.9 points in terms of current and prior year action.
So, Mike, let me try to make sure we got a good thing. So let's just go by accident year. I think it's a lot easier to take sum of all the quarters of ins and outs. And right now roughly speaking our 2017 accident year for commercial auto is about 113, our 2018 actually year is about 108 and we would expect some trend downward improvement and because I should question what's going to happen in 2019.
We expect that to trend down? Is it going to be as John mentioned a huge step down, no? But we are seeing as John mentioned, some of they are -- we are seeing some leveling out of frequency. We still have some severity at very elevated levels in the 2017 and 2018 years on the commercial BI portion of that line. And John touched on a little bit. If we can get our dry product in more of our fleets, more wheels on the ground the better you are in terms of fleet management. And just do the hard on effect, people getting game scoring on their driving. Nowhere are they distracted driving is a huge issue on the road.
And between what we are doing on that front, ongoing rate, underwriting actions that we are doing relative to radius checks, there is a whole, John deal over like everything that we are doing a whole lot of other, I'll tell you there is numerous activities and this is just -- this is not our whole strategy, I tell you that, Mike.
Thank you for the color. Good luck in 2019.
Mike, even our actuaries would say Mike sometimes looks as a distribution. A highest account on look. I am in trouble. Sorry, just a look, little humor. Thank you though.
The next question is coming from the line of Christopher Campbell with KBW. Your line is now open.
Hi, good morning. I guess my first question, just the overall ex CAT combined ratio guidance; it's basically like flat year-over-year with the updated guidance. I guess just -- I mean how are -- how should we think about that just in terms of the pure rate that you guys are taking versus the loss cost trends? Is it kind of imbalanced and then that's why we would expect that to be flat. I guess just how should we think about that?
Chris, this is Mark. Let me start. You are absolutely right and what I would say is a typical rhythm is we have some investor conferences coming up in the next few weeks and we will lay out in a little bit more detail of waterfall chart, walking you through the -- call the underlying combined ratio in 2018 which was the 93.1 versus the expectation for 2019 which is the 92 flat. And give you little bit more color but we do have a little bit more loss trend are factored into the trends for 2019, call it close to 3-8 loss trend in total and that's largely offset by earned rate.
A little bit of output pressure on the expense ratio that I mentioned but that's call two tenths and point and then the remainder is drive the margin improvement call it 110 basis points of margin improvement year-on-year is really underwriting mix the John spoke about claims improvement outcomes as well.
Chris, this is John. The only thing I would add, Mark hit it exactly right is the risk of stating the obvious that upward pressure we built in a low bid in terms of trend expectation is driven by the property and the commercial auto lines on the commercial line side as we've seen past trends move that reflected and how we think about future trends. And that's why we built a little bit more conservative into our expected claim inflation going forward.
Okay. Got it. And then just kind of another -- I mean a little bit deeper on that. I think you mentioned in the commercial property. I guess -- and I think in the opening script, you mentioned like 10 consecutive quarters of higher core loss ratios in the property book. So I guess just -- I mean how you think about rates? And are you seeing competitor's kind of starting to take this little bit more seriously? Because it feels like it's hitting your core losses for 10 consecutive quarters is basically telling you you're under priced in my opinion.
Chris, this is John. I think it's important to talk about our performance versus the industry performance. You have seen elevated losses on both industry performance and ours. Ours has been more driven by non CAT property where the industry I think has seen a little bit of movement on both the non CAT and the CAT property side. We started this and you see it in our prepared comments we gave you some rate detail by major line of business.
And over the last few quarters you've seen commercial property rates for us start to tick up a little bit and are running just over 4%. The industry movement that we've seen based on the industry's pricing survey that we rely on has also been in the right direction. But it still below our rate level and just a couple of points but it is moving in the right direction. So I would say when you look at the actual performance for the industry and then overlay a risk adjusted combined ratio target because that's only really have the focus on, we would view property as a line that you need to run at a much lower than average combined ratio over the long term because you are going to have this volatility that we are talking about.
And because of the short tail nature of the line, you need to make sure your underwriting margins that are generating the ROE because you are not going to get a whole lot of lift out of your investment returns on that line. So we've got a low targeted combined ratio for that line that we are striving for. We continue to be package underwriter. So we can't just take a single view of that individual line. But we would say overall for us and for the industry there is more rate need than we are seeing in the marketplace right now.
Okay. Got it. And then I guess one follow on for Mark. I guess what's driving the larger net investment income guidance? I mean how much of this is just premium growth versus your interest rate assumptions? And then I guess how are you guys assuming interest rates move in 2019?
Yes. It's a good question, Chris. So the guidance for the next year is a $175 million of after tax and investment income and as Greg mentioned, that includes $8 million after tax related to the alternative portfolio which is down significantly from the $14 million of after tax net investment income we generated from all set in 2018. And that's principally reflect what would expect to be a choppy to down first quarter results in all space done what we saw from the fourth quarter equity and credit markets given the lag in reporting.
I did mention in my comments and we have in the press release, it's sort of not necessarily a new metric per se but we talked about the weighted average after tax book yield in the portfolio as of the end of the year. And that's right at 3% call it 2.97% and that's the core portfolio plus high yield. And that gives us a pretty good run rate and insight into expectations for net investment going into 2019. We have a pretty stable sort of cash flows that we can anticipate. We do have reinvestment range. There is quite a bit of runoff in terms of principal repayment and coupon interest that we reinvest.
So we have some reinvestment rights. We did talk a little bit about the big jump in LIBOR in 2018. We are not expecting to see a similar trend going into 2019. It always difficult to forecast where interest rate is going to go. And even things are different today, far different today than they were just 45 days ago. But our expectation is for relatively flat interest rate environment going into 2019. A lot of that investment income related to that book yield that we have increased 47 basis points flow --with the last year to increase that.
And then really the wildcard is the alternative investment income. It's a very strong year in 2018. We are projecting it to be down significantly in 2019 but there is quite a bit like CAT -op business quite a bit of volatility around now projecting alternative investment income.
So, Chris, Greg. When you think about 2019 which in our opinion is already done from an underwriting standpoint with the exception of whether activity and property losses, I mean your ability to actually improve maintain your results. I would say it's too late. Companies are now working on 2020 because any unless you already have your written rate, you run out of premium, you are not moving it. So to tie together all the commented that Mark touched on. So when you think about underwritten premium level at like 3.5 rating just for commercial lines, higher than that E&S similar to kind of that in the personal lines area.
And then when you think about a relatively, we love the straight environment. We like to keep it stay like this for extended period of time. Because it forces underwriting and we believe we are an excellent underwriting company and for every one point of combined ratio we get one point of return on equity. That’s more than 2x the industry. So our ability to outperform on a combined ratio basis is significant. But Mark touched on it; no difference and just kind walk you through the renewal inventory and where we are what Mark is telling you based on a product, the investment product that we got on the books on the core and high yield fixed income side. We are looking at an embedded yield that already free after tax.
And it's not fair but 3x 333 gives you an idea the ROE that's already in there and then what's going to push that one way or another is what happens to rates moving out in the rest of the year which we don't believe you are going to see a lot of movement. They are -- we've pruned some of our alternatives to reduce our volatility to improve profitability. Again we are coming into the year with -- and with a solid reserve position is something that we've always tried to manage and pride ourselves on as an organization.
So when you think about what's happening, cash flow at 18% of premium is an exceptional number. So our cash underwriting combined ratio is extremely strong. And those are the things that are going to performance in 2019 but 2019 true maturity; I don't want to say it's over. That's really started yet. Yes, just we started at February 1 but the -- our 2,300 employees who work very hard, they are best in class, our 1,300 ivy agents are focused on how we grow the organization this year in terms of new business, new business opportunities because pretty much all of the core work and improvement and profitability one way or another is always tuning around the edges. But it's more of 2020 event than it is a 2019 event.
The next question is from Mr. Paul Newsome of Sandler O'Neill. Your line is now open.
Congratulations on the quarter and the year. I was hoping I could through beat the dead horse of the commercial auto just one more time. And I just really kind of -- I want your thoughts on what you think is truly happening underneath the hood in terms of moving on trend? And I guess some of the concerns these folks have had not necessarily just for Selective but broadly speaking as to why some of the things like higher attorney usage wouldn't necessarily spread to other lines of insurance like general liability or workers comp.
Paul, this is John. I think it's a great question. It's -- social inflation generation is something we are very mindful of it and keep track of. I'll tell you that we are at this point yet to see a significant movement in any of our major liability lines of business relative to litigation rates. And to a lesser extent and it's a little bit harder to track as specifically just pure attorney involvement regardless of what if the file is in litigation or isn't in litigation yet. Do we believe that that's a trend that might shift going forward? We do think there is a risk of that but we've not seen that to this point.
Now remember for us we do tend to write the lower and medium hazard style of business across all of our lines. Do we write some higher hazard classes? Do we write some heavier in class vehicles? And heavier and classic exposure on the liability side. We do. But we are predominantly low and medium hazard writers. So as a result of that the types of losses that make up the majority of our liability inventory across all lines tend to be of a less hazard exposure base.
So doesn't mean that we would be immune from it by any stretch but that's a consideration. The other thing I'll say and it's been a big focus of our claims operation. Because we don't just focus on lowering outcome from a loss and loss adjustment expense perspective. We also focus on the claim and experience side of things. And a big part of that focus is early communication with claimants. And I will tell you there is nothing better to getting a claim resolved and a fair outcome for everybody involved by early and clear communication on a claim and in many cases litigation can be avoided which is everybody's benefit when you have good solid communication upfront. And that's been a great focus of our claims team and I think helps us on that front.
Do you expect some of these efforts on the technology side that you discussed impact the frequency more than the severity or are it evenly, I mean, I just kind of wondering how we might see the impact of some of this technology that's been putting in these trucks and such improved the claim process.
Yes. I mean for speaking space, I think more specifically around Selective Drive.
Yes. Our view is that should impact both frequency and severity. Frequency on the basis that drivers with sensors in their vehicles knowing that their management is scoring drivers that should certainly improve frequencies. People start to exhibit their driving behavior and are less likely to be working or falling when they are driving. But it also impact severity if you believe that in fact accident caused by distracted driving are going to have, probably than average higher severity too because you are going to have or more head on collision type accidents in lot of cases because of the distracted driving.
But again that's technology. That is in the very early stages. We rolled that out in the fourth quarter. We are in the process of seeing increased take up weights but that -- it's going to take some time before a significant portion of our book has that technology deployed. But we do think as customers start to see the benefit of that, it will improve performance. We also can't loose sight of the fact and I think you heard a little bit of this earlier in our response to other question relative to frequency and severity trends in commercial auto.
And I think this applies to personal auto as well. Even if all of these focused around distracted driving and better driving habits starts to favorably impact frequencies. You do still have pressure on the severity side partly on the liability front because of the social inflation aspect. But also because -- there is impact on the liability lines because of the cost of repairing vehicle being higher. It's certainly affects your physical damage more so, but it also we believe weigh into PD liability as well. So that could continue to put a little bit of above normal inflation pressure on severity going forward.
And so let me just -- and I believe that the drive in the organization, this really try effect and you kind of touched on, one of them is obviously lowering and improving loss cost, but also there is an element of hit ratio, we expect our hit ratio to go higher at point of sale offering this product versus company that doesn't have this product. And then as we build it in the inventory and customers get a better handle how it's helping them better manage their fleet, better manage fuel cost. In some cases some of our insurers are paying for this service through another third party. And we are offering it free as part of the Selective offering.
I think it will improve retention as well. So there is a -- it's almost like the try factor when you start to look at the -- how this will drive improvement but are we worried about driving, driving behavior, road, road and poor road condition and then stay on top of that for the ongoing increase of legalization of marijuana state to state in some cases. And what that does to add another element of problem on the road. Does that concern us? Yes. So we have to combine all of those factors as we move forward. When we think about pricing, we think about what we do to manage our exposure.
But we are in the business what we write at all about products principally written on account basis. So whether it's comp or auto or general liability where we are -- we try to be to our best efforts of full account underwriter.
The next question is coming from the line of Mark Dwelle of RBC Capital Markets. Your line is now open.
Yes, good morning, guys. Just a couple left here that hasn't already been thoroughly plowed fields.
I can always count on you, Mark.
The one -- first question I had and you've already covered a lot on the investment portfolio. But for the alternatives in the first quarter, is it right and appropriate to assume that's probably going to be a negative number in the first quarter?
Yes. Mark, that's right. It's a difficult one to estimate but our expectations are that there will be negative mark. There is not a lot of data out there. We have a diversified portfolio of about 60 funds across private equity, private credit, real assets which include energy, infrastructure and real estate. Clearly, public equity was down significantly in Q4. Energy also very, very tough fourth quarter and with the lag in reporting those trends will be reflected in Q1.
Just from -- there is not lot of data points but to Apollo and Blackstone released earnings last night. They provide a little bit insight into how their portfolio did from a fee perspective and both for them; both their private equity portfolio and credit strategies were down in the fourth quarter. So as Greg said, yes, we would expect a negative mark in Q1 related to the old.
And obviously that -- Mark, that shrink drops into the $8 million after tax order.
So we properly sized our expectation for the year, expecting a little bit bumpiness but lot of the -- and energy prices have snapped back. It was a good number, good print on Exxon this morning. And so things are -- there is some gas shortages throughout the country and some of our suppliers are mid stream and on the gas side and other. So those are all -- again, one quarter doesn't make a year.
Sure thing, yes. Yes, maybe second quarter will be snap back. The second question I had, Mark, somewhere in your comments, and I've kind of lost track of where, you referred to your flood business, was that -- there were a number of floods around the country in the fourth quarter, was that a meaningful impact to the expense ratio in the quarter?
Mark, the reference I think related to the benefit on the personal line expense ratio so you have -- which are more they kind of the durable benefit which they have commissioned so we generate fees. We general from flood. We do generate claim handling fees from flood. There weren't any material flood in Q4. The majority of the benefit that -- for the full year was in Q3 related to Florence. And now is about $1 million but it wasn't anything significant in the fourth quarter that drove the results.
Operator, are there any more other questions on the line?
End of Q&A
Because of miss time there are no further questions.
Great. I appreciate the level of dialogue. If you have any follow ups. Rohan is available. Mark is available. And thank you very much for your participation this morning.
Thank you. This concludes Selective Insurance Group's fourth quarter 2018 earnings call. Thank you for participating. You may now disconnect.