Selective Insurance Group, Inc. (NASDAQ:SIGI) Q1 2024 Earnings Call Transcript

Selective Insurance Group, Inc. (NASDAQ:SIGI) Q1 2024 Earnings Call Transcript May 4, 2024

Selective Insurance Group, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Selective Insurance Group First Quarter 2024 Earnings Conference Call [Operator Instructions]. I would now like to turn the conference over to Brad Wilson, Senior Vice President, Investor Relations and Treasurer. Please go ahead.

Brad Wilson: Good morning, and thank you for joining Selective’s First Quarter 2024 Earnings Conference Call. Yesterday, we posted our earnings press release and financial supplement on the Investors section of our Web site, selective.com. A replay of this webcast will be posted there shortly after this call. Today, we will discuss our financial performance, market conditions and expectations for the next three quarters of 2024. John Marchioni, our Chairman of the Board, President and Chief Executive Officer; and Tony Harnett, our Senior Vice President, Chief Accounting Officer, and Interim Chief Financial Officer, will make remarks before we move to our question-and-answer session. Our commentary today references non-GAAP measures, which we believe make it easier for investors to evaluate our insurance business.

These non-GAAP measures include operating income, operating return on common equity and adjusted book value per common share. We include GAAP reconciliations to any referenced non-GAAP financial measures in the financial supplements posted on our Web site. We will also make statements and projections about our future performance. These are forward-looking statements under the Private Securities Litigation Reform Act of 1995, and not guarantees of future performance. They are subject to risks and uncertainties that we disclosed in our annual, quarterly and current reports filed with the SEC. We undertake no obligation to update or revise any forward-looking statements. With those introductory remarks, I’ll now turn the call to John.

John Marchioni: Thanks, Brad, and good morning, everyone. In the first quarter, we generated an operating ROE of 11.7% and grew net premiums written 16%. Our growth was driven by strong pricing, continued exposure increases and stable retention. The combined ratio was elevated at 98.2% and well above our 95% target due to the reserving actions we took in the quarter. We pride ourselves on maintaining a consistent and disciplined posture relative to planning, underwriting, pricing and reserving. When we see adverse trends emerge, we respond. We reported $35 million of net unfavorable prior year casualty reserve development during the quarter. The main driver was $50 million of unfavorable Standard Commercial Lines’ general liability development, partially offset by $15 million of favorable workers’ compensation development.

The net adverse development added 3.3 points to our overall combined ratio and 4.2 points to the Standard Commercial Lines’ combined ratio in the quarter. Consequently, our insurance segments produced a 2.2 points of operating ROE in the quarter, below our expectations. We previously discussed how we increased our expected casualty loss trend in recent years. Entering this year, our 2024 combined ratio guidance reflected an overall expected loss trend of approximately 7%, consisting of 4% for property and 8% for casualty. Excluding workers’ compensation, expected casualty loss trend was closer to 9% for 2024. For context, our forward casualty loss trend assumptions, excluding workers’ compensation, were approximately 5% for 2021, 6.5% for 2022 and 7% for 2023.

The ex-workers’ compensation number is approximately 0.5 point to 1 point higher than the expected loss trend we typically discuss for all casualty lines. Despite these higher underlying assumptions, we’ve strengthened our reserves in general liability for the years 2020 through 2023 in response to further emergence of average paid severities. We also increased our general liability loss ratio picked for the 2024 accident year by about 1 point. Our trend assumptions for the commercial auto and workers’ compensation lines held up well. Every quarter, we undertake an in-depth reserve review and book our best estimate. Our portfolio has remained relatively stable in terms of hazard mix, limits profile and industry segment, and pricing of our book relative to indicated levels has remained stable.

Therefore, we believe the increased severities relate to elevated social inflation, which we consider widespread and evidenced by a higher propensity for claimants to retain attorneys and litigate, longer settlement times and higher settlement values. Certain jurisdictions pose heightened challenges, evidenced by expanded liability theories and higher, sometimes extraordinarily higher, damage awards. We are closely monitoring these jurisdictions and the broader trends across our book. We think the social inflation and elevated loss trends we are seeing are industry-wide and will lead to an acceleration of rate increases in general liability. During the quarter, general liability and umbrella renewal pure price was 6.5%, up from 5.7% last quarter and 5.4% for full year 2023.

We expect our general liability pricing will accelerate further in the coming months. To understand the quality and pricing of our book, we regularly monitor our mix of business by industry classification, hazard grade, limits profile, jurisdiction and other individual risk attributes. Our sophisticated tools and highly talented employees allow us to identify the areas of our book most in need of action. With our unique operating model and strong distribution partner relationships, we have a proven track record of executing rate and underwriting actions in a disciplined and targeted manner. We remain comfortable with our ability to continue doing so in this dynamic environment. Consistently achieving our 95% combined ratio target across our three insurance segments remains our primary goal.

We continue to prioritize achieving renewal pure price that matches or exceeds our expected future loss trends. Overall renewal pure price was 8.1% in the quarter, up from 7.4% in fourth quarter 2023 and 6.8% for full year 2023. Renewal pure price for Standard Commercial Lines increased to 7.6%, accelerating each month within the quarter. Excluding workers’ compensation, commercial lines pricing increased 8.8%. Exposure growth added 4.2 points, contributing to total renewal premium change of 12.3%. At the line level, property renewal pure rate was up 13.3% with exposure increasing 4% and total renewal premium up 17.8%. In commercial auto, renewal pure rate was up 10.4%, with exposure increasing 5.1% and total renewal premium up 16%. Even with accelerating pricing, retention remains stable as our regional teams manage our renewal book in a targeted and granular fashion.

Excess and Surplus lines continued its excellent performance with 24% net premiums written growth and an 87.6% combined ratio. Despite strong underwriting results and prior year reserve stability, we increased our current year loss pick by approximately 1 point, based on the severity dynamics impacting recent prior accident years and Standard Lines’ general liability. The E&S market continues to present profitable growth opportunities and we expect to continue to grow this book. We are beginning to see signs of improved performance in Personal Lines as we continue our transition to the mass affluent market and execute profit improvement plans. The combined ratio in the quarter was 105.1%, a 10.9 point improvement from the first quarter 2023.

The underlying combined ratio improved in the quarter by 2 points to 93.7%. Personalized net premiums written increased 17% in the quarter due to strong rate increases and larger average policy size. Renewal pure pricing in the quarter was 14.3%. We continue to expect full year 2024 personalized renewal pure pricing to be in excess of 20%. As expected, retention decreased from these strategic profit improvement actions and was 83% at the end of the first quarter, approximately 4 points below last year’s run rate. Retention is higher for target business. New business premiums in Personal Lines declined 19% with new policy counts down 37% as we took deliberate steps to curtail production of non-target business. For the quarter, nearly 90% of new home business had Coverage A values of $500,000 or greater.

On the strategic front, we often speak of our competitive advantage of a unique field model that places empowered underwriting staff near our distribution partners and customers. We just wrapped up our annual agency council meetings. We continue to receive feedback that our operating model is a meaningful differentiator. Staying close to the market and having strong relationships with our distribution partners serves us well. Our customers and distribution partners value consistency, clarity and transparency in our communication as we navigate the challenging environment. Our methodical geographic expansion continues to represent an attractive long-term growth opportunity and further diversifies our portfolio. We have a repeatable process and successful approach that has allowed us to accelerate this important strategic initiative in recent years.

In April, we added Maine and West Virginia to our Standard Commercial Lines footprint, now covering 32 states. We expect to launch Oregon, Washington and Nevada later in 2024; and Kansas, Montana and Wyoming in 2025. Our revised guidance, which Tony will discuss in more detail, implies an ROE exceeding our 12% target for the full year. With that, I’ll turn the call over to Tony.

Tony Harnett: Thank you, John, and good morning, everyone. We’ve reported $1.31 of fully diluted EPS in the first quarter, down 11% from a year ago. Non-GAAP operating EPS was $1.33, down 8%. This translated to a return on equity of 11.5% and an operating return on equity of 11.7%. Our GAAP combined ratio was 98.2% in the quarter, up 2.5 points from a year ago. Catastrophe losses of 5.3 points were 0.8 points better than the first quarter of 2023, and we continue to see a lower expense ratio. Underlying performance, which I will return to later, continues to be strong. However, net adverse prior year casualty reserve development of $35 million or $0.45 per share impacted our results. This reduced our annualized operating ROE by 4 points and added 3.3 points to the combined ratio.

$50 million of general liability adverse development was partially offset by a $15 million of favorable development in workers’ compensation. As John described, preserving, strengthening in general liability was severity driven as we experienced increased paid loss emergence in the quarter. We attribute this mainly to the continued elevated impacts of social inflation. Frequencies continue to remain in line with, or somewhat better than expectations. In fourth quarter 2023, we strengthened general liability reserves by $55 million attributed to the 2015 through 2020 accident years. This quarter’s $50 million increase was spread mainly across accident years 2020 through 2023, with 80% attributed to accident years 2021 and forward. The reserve adjustment is 3% of our net reserves for general liability and represented approximately 1.5 points to 2 points on the combined ratio across each of the impacted accident years.

Workers’ compensation produced $15 million of favorable prior year reserve development in the quarter. This was primarily due to lower loss severities in accident years 2021 and prior. In Personal Lines, $5 million of adverse prior year auto reserve development offset $5 million of favorable prior year homeowners development. For the current accident year, we took action in General Liability and Excess and Surplus lines, impacting each line’s combined ratio by approximately 1 point. Severity dynamics in standard lines impacting recent prior accident years drove the adjustments. As a reminder, we have various reinsurance treaties in place to manage our net exposure to individual large losses and catastrophic events. In the context of social inflation and its impact on severity, our casualty excess of loss treaty, which renewed on July 1, 2023, covers 100% of $88 million in excess of our $2 million retention.

The treaty covers our Standard market and E&S business. The overall underlying combined ratio was a strong 89.6% for the quarter, 1.4 points better than the first quarter of 2023 and slightly better than approximately 90% run rate in recent quarters. Our expense ratio was better than our expectation and improved 1.7 points compared to the prior year period, benefiting from our disciplined expense management and an elevated top line growth. Additionally, non-catastrophe property losses were better than our expectation and 0.1 points lower than the first quarter of 2023 as we earned substantial rate increases in the property and commercial auto lines. After-tax net investment income was $86 million in the first quarter, up 17% from last year and contributing 12.3 points of ROE.

Alternative investments, which report on a one quarter lag, generated $5.4 million of after-tax income in the quarter, down slightly from $6.1 million a year ago. We invested $581 million of new money at an average pre-tax yield of 5.8% in the first quarter. The fixed-income portfolio’s overall pre-tax book yield increased modestly in the quarter, ending at approximately 4.8%. The meaningfully higher book yield embedded in our portfolio provides a durable source of income as we move forward. The portfolio remains conservatively positioned. The higher interest-rate environment allows us to deploy capital in investment-grade securities at attractive levels, raising the bar for investing in risk assets. Fixed-income and short-term investments represented 92% of the portfolio at March 31, with an average credit quality of A+ and a duration of four years.

Our capital position remained strong with GAAP equity exceeding $3 billion and statutory surplus of $2.8 billion. Book value and adjusted book value per share increased 2% from year-end, and our premium-to-surplus ratio ended the quarter at 1.55 times. This is at the top end of our internal operating target of 1.35 times to 1.55 times, although we are comfortable moving above that range if attractive growth opportunities persist. Debt-to-capital was 14.3% at the end of the quarter, well below our internal threshold of 25%. This ratio, together with our operating cash flows, provides us the financial flexibility to support organic growth and execute our strategic initiatives. We did not repurchase any shares during the quarter and had $84.2 million remaining under our share repurchase authorization.

We expect to take an opportunistic approach to share repurchases and view organic growth within our insurance operations as the most attractive opportunity to deploy capital. For 2024, we now expect our GAAP combined ratio to be 96.5%, up from our original guidance of 95.5%. The 1 point increase reflects the full year 80 basis point impact of the first quarter adverse prior year development. Current accident year bookings in general liability and E&S casualty in the first quarter drove the remainder of the increase. We assume no additional prior accident year reserve development. While our planning and monitoring process allow us to respond quickly to trends, we acknowledge the elevated uncertainty of the loss trend environment in which we are operating.

Other key estimates remain unchanged, with 5 points of catastrophes and after-tax net investment income of $316 million, including $32 million from alternative investments. Our guidance includes an overall effective tax rate of 21%, with a 20.5% effective tax rate on investments and 21% on all other items. Fully diluted weighted-average shares are estimated to be 61.5 million. This does not reflect any assumptions for share repurchases we may make under our existing authorization. I’ll now ask the operator to open our question-and-answer session.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from the line of Mike Zaremski with BMO Capital Markets.

Mike Zaremski: First question, and thanks for all the color you guys gave on kind of how you changed all the accident years on the reserves and whatnot and loss trend. But I’m trying to just — this is something we’ve seen in a lot of other carriers, and this isn’t a Selective thing I’m asking about. But if we look at the underlying inter-commercial loss ratio, it didn’t change much year-over-year despite all the commentary you’ve given us about kind of expecting a higher loss trend and what happened with reserves. So maybe I’m just focusing too much on the underlying loss ratio. But why would that be kind of stable-ish given what transpired over the course of the year-to-date?

John Marchioni: I’ll try to break it down into the pieces for you, and we’re focused on the current year and the current year underlying. So the first thing we want to do is separate out property and casualty. So property and specifically non-cat property came in better than expected in Q1. So I think let’s put that off to the side. So that drives some of the underlying stability. With regard to casualty and general liability in particular, and in Tony’s prepared comments, he talked about the impact on guidance. We did make an adjustment to the current year by — which, on an annualized basis, raises the current year for — on an all-in basis by 80 basis points. So you’ve got a couple of offsetting factors there, and I think that’s the primary driver.

But now let me just take it one step further, because I think if you look at that and tie it back to the loss trend commentary, so we’ve been giving you casualty loss trend assumptions or expected casualty loss trend assumptions very consistently year-over-year. And if you look at what we gave you for the ’24 year, we had an assumption of 8% casualty trend. And as we’ve disclosed in our prepared comments, if you exclude workers’ comp from that, which gets you to focus more on GL and auto liability, it was closer to 9%. Now while we don’t update our current year loss trend assumptions quarterly, we do that on an annual basis, the effective impact of that 1 point — roughly 1 point loss ratio move is about the equivalent of having moved your trend assumption by about 2 points.

So I think that’s — you’ve got the minus or the increase on the loss ratio underlying from the casualty adjustment we made, and you’ve got an offsetting impact from your non-cat property going in the other direction.

Tony Harnett: And Mike, just to clarify one point, the impact that we made change to the current accident year was 20 basis points within our guidance, the 80 basis points was the prior year development.

Mike Zaremski: My follow-up, I’ll be mindful of other people in the queue, it’s just, now that you’ve, I guess, just time has gone on and you’ve been upping your loss trend for a little while. Is it emanating out of, you think any certain classes of — like other than just business line, right, GL, and you said Umbrella, is it coming out of any, do you think, certain types of business? I know Selective has a very strong niche in construction, or is there kind of any macro portfolio trends you guys have been able to hone in on that you think this could be emanating from? And I guess lastly, you also break-out and talked about Umbrella a lot. What percentage of your reserves, if you’re able to tell us, is Umbrella, because I don’t think we can see that on a stat basis.

John Marchioni: So I’ll handle the first part of the question, and then I will come back to you with regard to the Umbrella question. But just with regard to where this might be emanating from, I would say, at the highest-level, we continue to view this as kind of a market-wide shift in average severities. Now I’ll go a little deeper on that because there’s no question, and I think this has always been the case, and I think this is also an industry dynamic. There are certain jurisdictions that have and have always had or at least in more recent memory, have had more tough legal environments. So think states like Georgia and South Carolina, New York, New Jersey, Pennsylvania, Illinois. And I think when you have social inflationary trends like we’re seeing, if you have more challenging legal environments and cases where you have either case law or statute that has expanded theories of liability, I think you do see a more outsized impact as these social inflationary factors hit.

But the states I just took you through are pretty large states and pretty consistently in most companies’ portfolio. So I think that’s point number one. There are certainly some geographic differences in the magnitude of the impacts. But I think that what we’re talking about in terms of social inflationary trends are pretty evident across the board. I think the other important point to highlight is, and I think this is where we gain confidence in viewing this as a social inflationary trend. In addition to the fact that it’s hit pretty consistently across all accident years, all open accident years over the last several years, if you look at our mix of business over the last decade and including the more recent years, the limit profile of our book has been very consistent over that time frame, in addition to the underlying limits profile, our reinsurance attachment point on casualty has remained at $2 million.

So, you’ve got stability there. From an industry classification perspective, percent contractors versus percent manufacturing and wholesaling or mercantile and service has also remained quite consistent. Our hazard grade distribution; low, medium, high hazard has remained very consistent. So there’s no shifts in the underlying portfolio. And the one shift, and honestly, it hasn’t been all that dramatic is, as we’ve expanded geographically, we’ve seen a little bit of a shift in our geographic footprint. But based on the states I just took you through that tend to be the hotter spots from a litigation environment perspective, you would generally view that geo expansion as a diversifier from that vantage point. So I think when you put all those pieces together, that kind of gives us the confidence to make the statements around the overall dynamics at play here.

And Tony, why don’t you just touch on the second question?

Tony Harnett: Yes, we can follow back up after the call. We don’t have the split right in front of us on the Umbrella versus GL. But as a total, I would just sit there and say our general liability reserves represent about 40% to 50% of our reserve position.

John Marchioni: And as I mentioned, that $2 million retention means that our umbrella exposure and as we review that quarterly in our reserve adjustment, is really that 1 time or one layer.

Operator: Your next question will come from the line of Michael Phillips with Oppenheimer.