RLI Corp. (NYSE:RLI) Q4 2023 Earnings Call Transcript

RLI Corp. (NYSE:RLI) Q4 2023 Earnings Call Transcript January 25, 2024

RLI Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the RLI Corp. Fourth Quarter Earnings Teleconference. After management’s prepared remarks, we’ll open the conference up for questions and answers. 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 the 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 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, equity and earnings of Maui Jim and the related taxes were excluded from operating earnings and operating EPS for 2022 due to the sale of RLI’s investment in the third quarter of 2022. RLI’s management believes these measures are useful in gauging core operating performance across reporting periods but may not be comparable to other companies’ definitions of operating earnings.

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

Aaron Diefenthaler: Thanks, Lydia. Good morning from [indiscernible] Peoria. Welcome to RLI’s fourth quarter earnings call for 2023. Joining us are Craig Kliethermes, President and CEO; Jen Klobnak, Chief Operating Officer; and Todd Bryant, Chief Financial Officer. As usual, Craig will start with some preliminary highlights, Todd will run down the financials, and Jen will offer commentary on current market conditions and our product portfolio. Lydia will then open the line for questions, and Craig will close with some final thoughts. Craig?

Craig Kliethermes: Well, thank you, Aaron, and good morning, everyone. We ended this quarter and year with profitable growth across all segments. Notably, it is our 28th consecutive year of underwriting profit. We’ve been able to grow our top-line at a double-digit pace for the last three years, resulting in doubling of the size of our company over the last six. We believe disciplined underwriting is a core competency of our company, which has proven out in the consistency of our financial results, which we have delivered over time. Remaining profitable enables us to provide a stable and secure market to our customers and partners for the long haul. All in, we completed another successful year and are enthusiastic about our opportunities going forward. I will let Todd and Jen go into more detail on the financials in the market in general. Todd, it’s all yours.

Todd Bryant: Thanks, Craig. Good morning, everyone. Yesterday, we reported fourth quarter operating earnings of $1.54 per share, aided by both positive underwriting and investment income. Overall, we posted a combined ratio of 82.7% for the quarter and grew top-line 13%, which Jim will discuss further. On a full-year basis, gross premiums written increased 15%, and we managed an 86.6% combined ratio, marking our 28th consecutive year of underwriting profitability. Investment income advanced 40% on the year, as improved reinvestment rates and a larger invested asset base have been accretive. Operating cash flow remained strong at $464 million for the year and continued to support growth in invested assets. Net earnings per share were $2.49 for the quarter and $6.61 for the year.

The full year result was down from last year, which was heavily influenced by the realized gains achieved on the sale of our stake at Maui Jim in the third quarter of 2022. Fluctuating levels of unrealized gains and losses on the equity portfolio also impact the comparison of net earnings between periods. From an underwriting income perspective, the quarter’s 82.7% combined ratio compares to 82.1% reported last year. Both periods benefited from relatively benign catastrophe activity and reductions in losses from prior period events. Overall, our loss ratio was up 0.5 point, while our expense ratio advanced 0.1 points, which we will discuss further. In Property, we recorded $4 million in losses from current year storms and maintained a low loss ratio on non-catastrophe events.

With respect to prior period events, we reduced loss reserves a total of $3 million on prior year’s catastrophes and $2 million on other claims. In addition, based on currently available information, we reduced our net estimate of Maui wildfires to $61 million from the $66 million reported in the third quarter. The $5 million reduction is evenly split between losses and reinstatement premiums. Overall, the segment’s loss ratio was 19.5% in the quarter and 42.9% on a year-to-date basis. In 2023, net catastrophe losses were notably higher, influenced in part by higher first dollar retention on our reinsurance treaties. Despite this, the segment recorded a combined ratio of 78.5% on a year-to-date basis as earned premium growth from rates achieved over the trailing four quarters continued to moderate the net impact of storm losses.

From a prior year’s reserves perspective, Casualty drove the majority of the overall benefit recorded. Casualty posted $9 million of favorable loss emergence across a number of products. We continue to remain cautious on both current and prior years, particularly for auto-related exposures. For Surety, favorable reserve development was just under $1 million, driven by the commercial sector. Turning to expenses. Compared to last year, our expense ratio increased 0.1 points for the quarter and 0.4 points on a year-to-date basis, closing the year at 39.9%. As discussed on our third quarter call, reinsurance reinstatement premiums related to the Maui wildfires impact the comparison. These premiums are fully earned as recorded and result in lower net premiums earned from a trend perspective.

These elevated ceded premiums earned adversely impact the expense ratio comparisons and account for 0.3 points of the increase on a year-to-date basis. For the quarter, we recorded just over $2 million in non-recurring expense in our Surety division that is notable on a comparative basis to last year’s fourth quarter. In addition, all three segments include increased bonus and profit sharing amounts in the quarter. Amounts achieved are driven by continued strength of operating results and notable growth in comprehensive earnings and book value during the quarter. Overall, we continue to increase investments in people and technology to support them, improve the customer experience and drive long-term efficiencies. Moving to investment results, headwinds experienced in Q3 in terms of tailwinds in the fourth quarter as stocks and bonds moved higher, driving positive total portfolio returns of 6.4%.

Purchase activity remained in-line with prior quarters and focused on high-grade bonds where we continue to find opportunities to support investment income. Yields averaged over 5% during the quarter and a higher balance of cash equivalents offers flexibility without impacting income potential. Away from the traditional investment portfolio, investee earnings were down in the quarter as 2023 reflects only firm while last year included the final true-up of earnings from Maui Jim, which as I mentioned, was sold in the third quarter. As referenced in our press release, we have excluded Maui Jim’s impact on operating earnings, which offers a better comparison. From a balance sheet perspective, debt leverage remains well below historic levels as we paid down debt in the third quarter, and we will await a more favorable environment to contemplate issuance.

Strong year-to-date comprehensive earnings drove book value per share of 31% when adjusting for dividends to nearly $31 per share. Our capital management strategy again includes a special dividend of $2 per share paid in the fourth quarter in addition to our ordinary $0.27 quarterly dividend. Consistent financial performance and conservative capital stewardship has allowed RLI to return over $1.4 billion to our shareholders in the last 10 years. All in all, a very good quarter and a strong finish to the year. And with that, I’ll turn the call over to Jen.

Jen Klobnak: Thank you, Todd. I’ll jump right into our segment results. Premium in the Property segment grew 24% for the quarter on a 55 combined ratio. Consistent with prior periods, our E&S property group led the way with 29% growth, including a rate increase of 31%. Following the quiet hurricane season, the market is starting to loosen with competitors increasing their limits. As rates continue to climb, we have allowed our hurricane exposure to decline a bit while the competition picks up. It’s a bit early to provide insight on market behavior based on reinsurance renewals as those changes can take a while to filter down to the underwriter’s desk at some companies. We are allowing more flexibility for our underwriters, especially on renewals, so we can continue to navigate the market effectively and capitalize on this generational price level.

Our marine book grew by 15%, led by inland marine. The division posted a 6% rate increase in the quarter. The team has achieved consistent, profitable growth by providing solutions when our producers come across unique risks and by attaining rate over time. We appreciate the team’s commitment to our customers and their contribution to our bottom-line. Our Hawaii book grew the top-line 13% in the fourth quarter. The team continues to focus on supporting our insurers and our producers who were impacted by the Maui wildfires. Our timely response to their needs has once again strengthened relationships and differentiated our team in the market. The Property segment’s improvement from the fourth quarter a year ago is driven by increased rates. Total rate increase for the segment was 24%.

Earned premiums growth outpaced expenses, which caused a notable decline in the expense ratio. We believe the market will continue to provide opportunities in each of our property businesses in the near term. Surety premiums grew 11% in the quarter on an 85% combined ratio. All Surety products contributed to the growth. We have added a number of underwriters and support staff to the division over the last couple of years who have added to our underwriting and customer support capabilities to ensure we provide excellent service to our producers and principles. At the same time, we have transitioned also with several accounts where the principal financial condition has deteriorated. We are growing at a slower pace in the surety industry, and we believe that it is a prudent strategy during this period of inconsistent economic conditions and increased competition.

The segment’s combined ratio increased from the fourth quarter of 2022 due to the expense ratio. We continue to invest in this business through people and technology to support long-term growth. We believe slow and steady growth is the right strategy at this time in the cycle for our Surety business. Casualty segment premiums grew by 8% on a 99 combined ratio for the quarter. Growth was led by personal umbrella with premium up 32%. This includes a 7% rate increase for the quarter. We have received regulatory approvals that we expect will accelerate rate increases into 2024. As loss frequency for this product has returned, we are managing growth through updates to select underwriting guidelines. Our transportation product group also grew premium by 20%, including an 11% rate increase.

This is a diverse portfolio as we added several small products last year that contributed to the top-line. This group is in a challenging market with plenty of competition, consolidation of insurers in the public space, and pressure on rates by our competitors, despite the fact that there is plenty of loss activity that should cause rational underwriters to take pause. As we have in the past, we will continue to push on rate to cover loss trends and walk away from business that is underpriced. Within the Casualty segment, we have two areas where premiums decreased. Our executive products group premium declined by 5%, which included a 5% rate decrease. Brokers continue to push for notable rate decreases on public D&O in particular. We try to be accommodated, but we will not support business at an adequate rate, which have become more frequent during the softening market.

Finally, Energy Casualty now renewed $3 million of premium in the quarter. We closed this business in July of 2023. During the full calendar year, we wrote $2.2 million of premium, which creates a small gap in the top-line for 2024. The segment’s combined ratio increased from last year’s fourth quarter due to the loss ratio. This is a function of the change in mix of business as well as our continued prudent stance on loss estimates. Although we have achieved increased rates, we recognize loss trends are still relatively high. Our investments in claims and underwriting talent and relationships with producers should provide continued growth opportunities for this segment in the near term. Lastly, I’ll make a few comments on reinsurance renewals.

As has been widely discussed, we found the reinsurance market much more orderly this year. We renew about 60% of our reinsurance treaties effective January 1. Although there was a lot of posturing from reinsurers seeking material rate increases on Casualty business, our risk-adjusted rate increases on casualty coverages were 5% to 10% on largely the same structures and placement percentages. On Property coverages, we eliminated minor non-concurrencies that had been introduced last year. The estimated risk-adjusted rate change on Property coverages was flat to a slight decrease. We maintain retentions and structures as expiring. We were able to place more of our catastrophe later, while we marginally increased co-participations on our working property coverage treaty.

With all of the changes to retention over the last two renewals for Property, we expect to retain a little bit more of Property segment premiums in 2024 compared to 2023. The broad support from the reinsurance community demonstrates confidence in our approach to underwriting our business. While we are constantly working on improvements to our products and processes, we have a healthy, diverse product portfolio. Inevitably, there will be challenges that will arise in 2024. But like the Kansas City Chiefs’ Isiah Pacheco, “We might get tackled, but we’ll bounce right back up and keep going.” Kudos to our employee owners for serving our customers well, especially during this recent growth period and for producing a financial result that continues to make RLI a stable insurance partner in the market.

Now, I’ll turn the call back to Lydia for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Gregory Peters of Raymond James. Your line is open. Please go ahead.

Gregory Peters: Well, good morning, everyone. I’m going to start sort of based on some comments that were made in the presentation. First, on reinsurance, I think you mentioned that you’re getting more property coverage with this renewal than you had last year. Maybe you could give us some perspective. Is that just more in the risk remote areas? Or what did you mean by that comment?

Jen Klobnak: So, our catastrophe structure, we actually had purchased more reinsurance — June 1, excuse me, of 2023. And that’s why we do have a little bit higher ceded property premium in the second half of the year. But at this renewal, January 1, we did purchase a similar structure and we were just able to place a little bit more of those layers. So, we tend to take co-participations in layers where we might place — as an example, we might place 90% to 10%. That’s just an example. This year, we were able to place a little bit more of that percentage. And so that just brought a little bit more coverage. On the lower treaty, the property per risk, you actually received a little bit more of those similar examples, those same layers. We retained a couple more points of those coverages. So, overall, we’re kind of where we were before given the increase we made in June of ’23.

Gregory Peters: Okay. Thanks for that clarification. And then just sticking on the property count, the property business is a collective segment. I guess when I look at the results for the fourth quarter, you had a great year, but I guess probably coming in a little bit below when I thought you might be able to grow at. And maybe at this juncture, it’s mostly rate and you’re not getting a lot of policy count growth or growth in TIV. But maybe you could give us some perspective on — some additional perspective that is on what’s going inside of property as you think about the outlook for ’24.

Jen Klobnak: Sure. I’d be happy to. So, if you look at the fourth quarter and as we consider what’s going on in the marketplace, we do have competition started to creep in, in the fourth quarter. I think it’s going to accelerate into 2024. So, what happened most recently is that as we look at the opportunity in the marketplace, we’re balancing a lot of factors here. So, we have a risk tolerance. It includes a lot of different metrics in how we measure our exposure, whether it’s policy limits or modeled losses or even number of policies that could translate into the number of claims we can handle in a given event. And so, as you balance those different features, recognizing we had grown a fair amount in 2022 and into 2023 in terms of exposure, more recently, we’re balancing the growth in Property with the rest of our portfolio.

We have a very diverse portfolio between Property, Surety and Casualty. And that diversity has paid off in the past in terms of allowing us to achieve an overall underwriting profit, but it doesn’t need to maintain balance. So, we don’t want Property to grow too much relative to the other segments, although we do want to take advantage of the market. In addition to that, our view of risk evolves over time, particularly with regard to cat. So, whether it’s the cat model updates, whether it’s litigation trends, legislation changes, lessons that we learned from claims. And so, we take all that into account to kind of develop what our appetite is. So, at this point in the market, we’re still able to achieve rate, which is great. But we are allowing the exposure to go down a bit as we look to see how the market is going to react to the 2024 reinsurance renewal.

I can tell you that MGAs in this space are acting a lot differently than carriers, and they’re being a lot more aggressive. It seems that some of the discipline that was introduced a couple of years ago is leaving the market with regard to MGAs, and so we’re going to have to contemplate that going into this year. But we’re in an active market. The benefit that we have is that most of that business is on E&S paper, which means we can change what we’re doing pretty quickly. We’ve got a flat organization with a lot of reporting that goes out on a regular basis. And so, we adjust what we’re doing pretty quickly. So, we’ll continue to be a bit reactive to the market, but — and see how that plays out into this year. But we do think that, that marketplace continues to be attractive.

And I don’t mean to ignore marine or Hawaii. Those are both very strong, growing and profitable books of business for us. Obviously, we have the Maui wildfire event in ’23, but overall, that book continues to be very attractive to us as well.

Gregory Peters: Perfect. An interesting comment on the MGA side of the equation. I guess my last question, Todd, in your comments, you started going through the prior period reserve development and you called out, I think, $9 million in Casualty favorable development. Wondering if you could just unpack the development, whether it’s Casualty or Property just on an accident year basis? That’s my last question.

Todd Bryant: Sure. Yeah, it was — $9 million I mentioned was on Casualty. It was spread. There was some on the GL side. I mean it was the commercial excess, EPG, it really spread out. Obviously, at $9 million, nothing large from any one particular line, but it did cross over a number of accident years, too, and it was a little bit in ’16, a little bit in ’17 on the GL, even smaller amounts, but it’s spread up through some in 2021 and ’22. So, it was pretty broad as far as accident years go, but certainly, on a quarter-only basis, not large at $9 million.

Gregory Peters: Correct. Okay. Thanks for the answers.