RLI Corp. (NYSE:RLI) Q4 2022 Earnings Call Transcript

RLI Corp. (NYSE:RLI) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Good morning and welcome to the RLI Corp Fourth Quarter Earnings Teleconference. After management’s prepared remarks, we’ll be opening the conference up for question-and-answer session. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may make comments that reflect their intentions, beliefs and expectations for the future. As always, these forward-looking statements are subject to certain factors and uncertainties which could cause actual results to differ materially. Please refer to the risk factors described in the company’s various SEC filings, including in the Annual Report on Form 10-K as supplemented in Forms 10-Q, all of which should be reviewed carefully.

The company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing third quarter results. During the call RLI management may refer to operating earnings and operating — and earnings per share from operations, which are non-GAAP measures of financial results. RLI’s operating earnings and earnings per share from operations consist of net earnings after the elimination of after tax realized gains or losses and after tax, unrealized gains or losses on equity securities. Additionally, operating earnings and operating EPS exclude equity and earnings of Maui Jim and related taxes due to the sales of RLI’s investment. RLI’s management believes these measures are useful in gauging core operating performance across reporting periods that may not be comparable to other companies’ definitions of operating earnings.

The Form 8-K contains a reconciliation between operating earnings and net earnings. The Form 8-K and press release are available on the company’s website at www.rlicorp.com. I’ll now turn the conference over to RLI’s Chief Investment Officer and Treasurer, Mr. Aaron Diefenthaler. Please go-ahead.

Aaron Diefenthaler: Thank you, Drew. Good morning, everyone. Thanks for joining us to close-out 2022 with RLI’s fourth quarter earnings call. Participating with me are Craig Kliethermes, President and CEO; Jen Klobnak, Chief Operating Officer; Todd Bryant, Chief Financial Officer. Todd, will kick things off with the financial results for the quarter. Craig and Jen will offer some commentary on current market conditions, our product portfolio and possibly reinsurance just to get there. After our prepared remarks, we’ll take your questions. Then Craig, will close with some final thoughts. Todd?

Todd Bryant: Thanks, Aaron. Good morning, everyone. Yesterday we reported fourth quarter operating earnings of $1.53 per share. With both underwriting and investments contributing. Overall, we posted a combined ratio of 82.1 for the quarter and experienced continued topline growth, which was up 14% in the quarter. On a full-year basis, gross premiums written increased 16% and we posted an 84.4 combined ratio, marking our 27th consecutive year of underwriting profitability. Investment income advanced nearly 60% in the quarter and closed the year at 25%. Reinvestment rates moved higher, as did our invested asset-base driven largely by funds received from the sale of Maui Jim. Operating cash-flow was negative for the quarter. As we paid $116 million in taxes on the gain from the sale of Maui Jim.

This amount is included as a reduction to operating cash-flow, while the cash proceeds received from the sale are reflected as cash-flow from investing in the third-quarter. Apart from this nuance, Operating cash-flow was very similar to last year on both a quarter and year-to-date basis. Realized losses of $3 million in the quarter were the result of adjustments to Maui Jim’s pre-close financials, which increased our equity in Maui earnings and correspondingly decreased on realized gain recorded on the sale. This adjustment had no impact on net earnings. For equity securities, change in unrealized gains and losses reflects a $34 million gain in the quarter as the market rallied in closing the year. As mentioned on prior calls, large movements in equity prices between periods can have a significant impact on-net earnings.

But you can see on the comparative quarterly and year-to-date results. Craig and Jim will talk more about the market and premium in a minute, but at a high-level, all three segments experienced growth as we continue to benefit from favorable market conditions and most areas of our business. From an underwriting income perspective, the quarter’s combined ratio was 82.1 compared to 80.7 a year-ago. Our loss ratio increased 2.6 points, due to higher weather-related losses. In the quarter, we incurred $8 million in storm losses. $7 million in property and $1 million in casualty from a number of named storms. At the same time, we reduced our estimate of net losses from Hurricane Ian by $2 million, which is now at the bottom of our initial range estimate.

Claim volume in severity has come in below initial expectations for the storm, which occurred very late in the third-quarter. From a prior year’s perspective, we continue to benefit from favorable reserve development. Casualty posted $40 million of favorable loss emergence with contributions from a number of product lines. Property posted $4 million in favorable emergence, these largely to reductions in reserves for prior year’s storms. In addition, we experienced improvements in the current year’s underlying loss ratios for both property and casualty. Year-to-date, property’s underlying loss ratio declined 4 points compared to last year, due lower attritional losses in both inland marine and commercial fired, while casualties declined one point aided by the shift in mix of — in business mix and overall rate increases.

Moving to expenses, compared to last year, our quarterly expense ratio decreased 1.2 points to 40.3. On a full-year basis, our expense ratio declined 0.8 points to 39.5. Both results are reflective of improved leverage on our expense base, as net premiums earned continued to grow. Turning to investments. Total return performance improved and came in at 2.3% during the fourth-quarter and minus 11.5% for the year. Without question, it was a difficult year for the markets. So as a long-term investor, we were encouraged by stabilizing equities and higher bond yields, which are accruing to investment income. In the quarter, we continue to invest in high-quality bonds with incremental cash-flow and net and have yet to pivot towards riskier assets.

Apart from a short-lived short-term portfolio associated with the Maui Jim proceeds, new money yields continue to exceed 4%. Moving to other investments. We recorded $7 million in investee earnings in the quarter, with Maui Jim contributing $3 million and Prime posting $4 million. The result for Maui was due to the true-up of pre-close financials, as I mentioned previously. This adjustment had no impact on-net earnings for the quarter as realized gains were reduced by equal amount. As noted in the press release, we have excluded earnings from Maui Jim from operating earnings. As such, this adjustment does not affect those earnings either. On a year-to-date basis, investee earnings are down significantly, due largely the transaction related expenses incurred by Maui Jim from a company sale.

As a reminder, we received $687 million in exchange for our shares in Maui Jim in the third quarter. Final proceeds remain subject to customary post-closing working capital and other adjustments. We expect most of that adjustment process to conclude during the first half of 2023 and could modestly increase this amount. For 2022, our net earnings with realized gains, investee earnings, taxes and other sales related amounts reflect $434 million or $9.49 per share from the sale of our minority investment. The combination of solid underwriting investment results took book value per share to $25.89, up 25% from year end 2021, inclusive of dividends. This growth benefited from a gain associated with the sale of Maui Jim, a portion of which was returned to shareholders nearly at $7 per share special dividend in December.

All-in all, a very good quarter and strong finish to the year. And with that, I’ll turn the call over to Craig. Craig?

Craig Kliethermes: Well, thank you, Aaron and Todd. Good morning, everyone. As Todd mentioned, we finished the year with continued momentum, reporting excellent underwriting results and double-digit growth for the quarter. 2022 marks our 27th consecutive year of underwriting profit on both a net and gross basis. Now benefited from back-to-back years of top-line growth in excess of 15% and another year of rate increases in excess of underlying loss trends across the property and casualty segments. This has result to the very good returns that we are pleased to report to our shareholders. Our underwriters have been able to grow almost all the products within our portfolio, but there are few pockets where we still face stiff competition.

And hard reboot in the reinsurance market continued multifaceted inflation and weakened balance sheets should provide a stronger backbone to the industry’s underwriting discipline and be supportive of more firming. Assuming the competitive environment response rationally, we anticipate rate increases and disruption that should create new opportunities for profitable growth. We’ve already seen additional improvement and price terms and conditions in the property market at the end of 2022. Over the last decade, we’ve been able to access low attaching earnings protection from high quality reinsurers at favorable prices. At each reinsurance renewal, we evaluate the risk reward equation carefully, using our actuarial team and reinsurance brokers to inform decision making.

Given our conservative balance sheet, diversified portfolio of specialty products and underlying profitability, we have always retained the optionality to take more net, where the expected reinsurance ceded margins exceed fair return. We believe the cost of property reinsurance increased beyond that point at one-one. As a result, we adjusted our retention and co-participations accordingly and are comfortable with our new reinsurance structured. We remain optimistic about the expected underlying profitability of our portfolio. We believe, we are in a strong position to capitalize on disruption that we expect too soon. I will turn it over to Jen, who will provide more detail on the quarterly results and the reinsurance placements made on Monday morning.

Jen Klobnak: Thank you, Craig. From a product portfolio standpoint, the property segment led our top and bottom-line for the quarter. Premium grew by 40%, while underwriting profit increased 61% with all major sub-products contributing. Premium in our E&S property book grew by 54% including material rate increases for all coverages. The hurricane rate increased from 29% for the quarter and has been accelerating throughout 2022. We believe this trend will continue given the disorderly market conditions, that are further supported by increased reinsurance costs. I’ll provide more detail on our reinsurance renewal towards the end of my comments. It’s worth noting that our E&S property division achieved both a gross and net underwriting profit for the year, notwithstanding our second-largest natural catastrophe loss in RLI’s history.

Copyright: sifotography / 123RF Stock Photo

Our Marine product groups also exhibited strong growth with premium of 17%, including a 6% rate change for the quarter. Marine is now a consistent contributor to our bottom-line and this quarter was no exception. They experienced very little loss activity in the quarter and their growth over-time that help to right size their expense ratio. Finally, our Hawaii Homeowners product grew premium by 17% due to our local underwriters efforts. The Hawaii team is committed to providing response of seven, which has helped us win new accounts. Overall, we are very pleased with the property segments 62 combined ratio for the quarter. Turning to the Surety segment, premium was up 5% in the quarter, which was split between contract and commercial surety.

Contract surety premium continues to experience a lift from inflation and the cost of construction project and increased public spending on infrastructure projects. We also won some new accounts through our active marketing efforts. Commercial Surety experienced growth by expanding both existing and new account relationships. Surety produced an underwriting profit with very little loss activity in the quarter. We continue to carefully pursue growth opportunities, while monitoring the financial results of our principles closely, given the evolving economic environment. The Casualty segment’s premium grew by 4% in the quarter, despite some headwinds. The public D&O market is under pressure, we exited accounts with unreasonable changes in terms and conditions and provided a 9% rate decrease on our renewal.

The exit from Cyber Liability and reps and warranties business also affected the quarter-over-quarter premium comparison. Excluding that premium reduction, and casting our executive products group, the casualty segment would have grown 10%. Energy Casualty is another area in which we are retrenching, specifically in excess layers. We wrote almost $14 million of excess energy liability business in the 2022 calendar year that will be run-off throughout 2023. Our Transportation business unit grew 13% in the fourth quarter, although we are seeing a lot of competition in the truck market. Rate increased 8% in the quarter driven by public and specialty commercial autos, which are experiencing more stable market conditions. Personal umbrella was up 16%, as we continue to collaborate with our production partners to improve our processes and better meet customer needs.

The personal umbrella market continues to be disruptive, as many of our competitors for standalone umbrella have significantly reduced their appetite or left the space altogether. D&S casualty grew premium by 7% with more opportunities available outside of the competitive New York City construction markets. Rate increases in excess liability business were 8% for the quarter. When looking at our bottom-line results, I also have to mention our professional services and small commercial group. This product group is in a fairly stable environment and has been quietly growing. Premium increased 9% for the quarter and they achieved a very good combined ratio. This group supports the construction industry on an admitted basis and covers classes of business ranging from architect to small to mid-sized contractors.

The expertise we have developed in underwriting and claim handling over-time, continues to meet the needs of our customers. Now I’ll turn your attention to our reinsurance purchased on January 1. We renewed about 2/3s of our reinsurance coverage this month. The reinsurance market changed their portfolio in the fourth quarter. Casualty treaty coverage renewed as expiring with rate change estimated at flat to up 15% on a risk-adjusted basis depending on the line of business. We increased co-participations marginally to balance the increased retention that I’ll talk about in our property business. I wouldn’t describe the casualty reinsurance market as orderly compared to the property and catastrophe revenue. As our property per risk treaty has done loss impacted over the last few years, we renewed it with an estimated 40% risk-adjusted rate increase, an increase to first dollar retention to $2 million.

We renewed our catastrophe treaty with a roughly 45% of risk-adjusted rate increase and an increase in first dollar retention from $25 million to $50 million. Coverage is similar to expiry, including renewing our expiring reinsurance treaty limits from coverage and adjusting our limits for earthquakes to match our exposure. We have the advantage of writing almost all clinical CAT risk on E&S papers, which means we can adjust rates and terms and conditions very quickly. Throughout the latter half of 2022, we had already been tightening terms and conditions, reducing commission and increasing our benchmark pricing of property CAT business, anticipating the increase in reinsurance costs. We have been writing catastrophe insurance for about 40 units.

The last-time we materially increased our catastrophe retention was in 2007. Since that time, our property segment’s premium has grown over 140%. Our consolidated premium has more than doubled and shareholders’ equity has grown over 50%. We maintained our retention, because the economics made sense. Our reinsurance strategy going-forward were primarily focus on buying traditional reinsurance from financially secure partner in supporting correct term and have a high regard for our business model and disciplined underwriting. We will supplement the support with additional capital sources to replace the reinsurers, but become less relevant and commoditize their role. We will continue to assess our reinsurance purchases to maintain a balance in the risk-reward economics.

Given the increase in cost at January 1, we anticipate further rate increases on our primary business and believe the E&S property market remains attractive. With that, I will turn the call-back over to Craig.

Craig Kliethermes: Well, thank you, Jen. A great quarter and another year of differentiating underwriting results. We believe, we are in-depth risk managers, the proof is ultimately determined by results. Each day, we seek better ways to be the most profitable, diversified portfolio of specialized products in our industry, while meeting the risk transfer needs of our customers. We do this by adapting and reoptimizing our portfolio and weighing opportunities subject to the constraints we control and those we operate within. We will continue to serve our customers’ needs with a focus on stability and consistency. We will work to grow our business that are profitable, invest in new and existing businesses that provide opportunity and from time-to-time rehabilitate or exit the key products that may be required.

Our ability to be agile and adapt to the market environment is reflected in the 27 consecutive years of underwriting profit we have delivered to shareholders. The engine of our success is founded in the 1,000 associate owners who show-up every day, focused on the long-term success of their company with a vested interest in delivering the best outcomes for our customers and our shareholders. I want to thank all our RLI’s associate owners for another tremendous effort in 2022 and for taking care of our customers with their specialized knowledge and expertise, outstanding service, stable appetite for risk transfer and deep relationships that are forged and reinforced over a long period of time. Now. I’ll turn it back to the operator to open it up for questions.

See also 15 Most Advanced Countries in Medicine and 10 Pro-Life Companies to Invest In.

Q&A Session

Operator: Our first question today comes from Greg Peters from Raymond James. Your line is now open.

Greg Peters: Well, good morning, everyone. Thanks for the comments. Can we go back to the discussion on the reinsurance renewal for 01/01/2023. I believe, I’m — the retention has moved up to $50 million. Can you give us a sense? I know things have changed, but how that would have affected with the higher retention. The reported CAT loss on a net basis for 2022 and 2021, have you had that higher retention?

Jen Klobnak: I’ll have a look back to ’21, this is Jen by the way, but I can tell you for Ian, it was probably $10 million to $25 million of additional net loss depending on which underlying treaties we’re treating, so that’s a rough estimate.

Craig Kliethermes: The other thing Greg, to note there and I think if you think we could just put a square number to it, but as Jen mentioned, we range it. Because, you don’t know, how some of those property per risk treaty will play. And the other thing to really, think about from a rate increase that we have gotten and are continuing to get. There’s a lot more dollars in that property bucket that play well as far as the total underwriting results there from this segment.

Greg Peters: I understand. That makes sense. Can we pivot just given the reserve development. I know you commented about prior year development. And your view on accident year loss ratios. So I’m just curious, some of the numbers you reported sort of counterintuitive, just because of all the inflationary pressures we’ve heard about. What’s your — when you think about specifically the casualty and property segment. What’s your view on sort of a loss pick – accident loss pick assumptions in ’23 versus where they were in ’22, et cetera.

Todd Bryant: This is Todd, Greg. I think really the items you mentioned whether we want to call it inflation or social inflation, what you read about out there. That certainly influences are actuarial view. I think you’ll see it really in 2022 and normally you’re going to see it in the year. I think we’ve talked about that Craig mentioned to from a loss cost trend standpoint. So we do believe it’s adequate in total and really in most areas. But I know we’ve talked before as well that our actuaries, they’re going to weigh all that in, they’re going to typically take the longer-term trends, but they are influenced in periods — shorter periods of uncertainty or inflation, other factors, over a short-term trends are a bit higher, that’s going to influence the initial booking ratio.

It can also influence how long we hold-on to those initial fix and potentially expand loss reporting period. So all those things factor into the view, whether it be on casualty, all our other segments, so that has an influence there.

Greg Peters: Okay. Thanks for that color. I guess — and just as a follow-up, my — well, another question that would be my last question, which is, now that your property cat program has renewed, what’s — is it changing sort of your strategy as it relates to growing your property business? Or does it reinforce the strategy you have in place? Or how does this — how does the reinsurance — the increased retentions change sort of the matrix of ROI as we think about ’23 and ’24? That’s my last question.

Jen Klobnak: Sure. Thanks, Greg. This is Jen. I would say that our catastrophe strategy is constantly evolving. So things that are in that space are happening all the time, whether there are events or no events can impact how you’re approaching that segment and the various costs driving that business and this range over time as well. So this latest chapter, we are revisiting and have revisited throughout 2022, as we anticipated some change in the reinsurance market. And Ian, of course, provided something to talk about. And so that also had us looking at what we need to do. Throughout 2022, we had been increasing rates throughout the year, and we anticipate that, that trend is likely to continue. We’ve honed in on terms and conditions, watching deductibles, co-insurers, things of that nature to make sure that we are properly covering the exposure, but also sharing the loss with our insurers where that makes sense, depending on all of the factors that drive the outcome.

So part of it is premium, but part of it is coverage as well. So you have to see how all that kind of comes together. So going forward, it’s going to be similar to before. We’re going to be very active if an event happens and helping our insurers during that time, put boots on the ground, which is what we’ve emphasized a lot in 2022. That gives us really the best sense of what’s needed in that market and how we need to continue to evolve. That’s really the best input, it’s from our insurers and also our producers to some extent as well. So I would say we’re not intending to grow exposure significantly in 2023. We’re looking more to optimize what we have on the books. And so that’s reflected in the fact that we did not buy additional reinsurance limit on January 1st.

So we’ll work within the capacity we have at this point in time and continue to have really attractive returns, hopefully, on that portfolio.

Greg Peters: That’s makes sense. Thank you.

Operator: Our next question today comes from Casey Alexander from Compass Point. Your line is now open.

Casey Alexander: Hi. Good morning, and thank you for taking my questions. I have two questions regarding the property. One is with the increased rates, but also the increased retention, is it reasonable to think of more seasonal volatility of your earnings stream with higher margins in non-cat quarters and obviously a little more impact in cat quarters? And then as a follow-up to that question, we’ve heard tell of potentially more capital coming back to the market in the June reinsurance renewal period. If some of that seems reasonable, does that provide you an opportunity at the June renewal period to add on some additional coverage that might cover some of the increased retention that you’ve taken down at this point in time?