Selective Insurance Group Inc (SIGIP) 2013 Q1 法說會逐字稿

Good day, everyone. Welcome to the Selective Insurance Group's first quarter 2013 earnings release conference 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, Jennifer DiBerardino. Thank you. You may begin.

Thank you. Good morning and welcome to Selective Insurance Group's first quarter 2013 conference call. This call is being simulcast on our website and the replay will be available through May 25, 2013.

A supplemental investor package which includes GAAP reconciliations of non-GAAP financial measures referred to on this call is available on the investors page of our website www.selective.com.

Selective uses operating income, a non-GAAP measure, to analyze trends in operations. Operating income is net income excluding the after-tax impact of net realized investment gains or losses as well as the after-tax results of discontinued operations. 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 that will be 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.

Joining me today on the call are the following members of Selective's executive management team; Greg Murphy, CEO; Dale Thatcher, CFO; John Marchioni, EVP of Insurance Operations; and Ron Zalesky, Chief Actuary.

Now I'll turn the call over to Dale to review the first quarter results.

Thanks, Jen. Good morning. First quarter results exceeded our expectations with continued improving commercial and personal lines pricing and light catastrophe losses, resulting in an overall statutory combined ratio of 96.8%. Standard commercial, personal, and E&S lines all have statutory combined ratios under 100.

For the quarter we reported operating income per diluted share of $0.36 compared to $0.28 a year ago. Lower catastrophe losses drove the results offset by three items. One, a one-time holding company expense of $0.04 per share related to a charge-off for the capitalized issuance costs of our junior subordinated note that we redeemed in the first quarter; an additional $0.02 of interest expense; and an increase in our long-term employee compensation expense of $0.04 per share, compared to first quarter 2012, driven by the rise in stock price.

The first quarter statutory combined ratio of 96.8% was a 2.3 point improvement from a year-ago quarter. Catastrophe losses in the quarter were only $1.6 million, pre-tax, or 0.4 points, well below our annual expected budget of 3 points. Our Hurricane Sandy catastrophe losses have remained within our estimates and we have had no further development from that storm. We had favorable prior-year casualty development of $2 million or 0.4 points.

As announced earlier this month, we are freezing our pension plan effective March 31, 2016. Due to differences in pension accounting for GAAP and statutory, we have a statutory curtailment charge that affects the statutory combined ratio but it has no impact on GAAP earnings or the GAAP combined ratio. As a result, the statutory combined ratio this quarter includes a $5.8 million charge or 1.3 points from the curtailment of the plan. $4.5 million or 1.0 points of the curtailment charge is reflected in the statutory expense ratio in the quarter with the balance in allocated loss and loss-adjustment expenses.

Total statutory net premiums were up 7% in the quarter with standard commercial lines net premiums up 7% and E&S up 10%. Standard commercial lines renewal pure price was up 7.5% for the quarter and retention remained flat at 83% from a year ago.

The standard commercial lines statutory combined ratio was a strong 97.6% in the first quarter, including a 1.4 point pension charge. All standard commercial lines of business were under a 100% combined ratio in the quarter with the exception of workers' compensation. The statutory combined ratio for every line of business includes a charge of between 1.3 to 1.7 points related to the curtailment of the pension plan.

Results range from a 77% statutory combined in BOP to a 98% in commercial auto. BOP results included 16.2 points of favorable development. Commercial property had a good quarter at 86.6% despite a $2.1 million increase in non-cat property losses or 1.1 points.

Workers' compensation results of a 118.9% statutory combined ratio were driven by adverse development of $7 million or 11.1 points on the combined. More than half of the adverse development is the result of a single claim dating back to the 1980's that increased by $4 million with the balance driven by development in the 2012 accident year.

Personal lines net premium written grew 5% in the quarter to $69 million and the statutory combined ratio was a profitable 92.4% including the pension curtailment of 1.3 points. For personal lines, cat losses were only 0.7 points in the quarter compared to 4.4 points in 2012. Pricing continues to be strong in personal lines with renewal rate up 8.5% in the quarter and we're seeing the benefits of our pricing success in the results.

Net premium written for our E&S operations grew to $28 million in the first quarter, up 10% from a year ago. The statutory combined ratio improved substantially to 98.2% from 120.3% a year ago driven by earned premiums that now reflect the full operations of this business and the decrease in start-up costs that we had in the first quarter of 2012.

Also included in the E&S results this quarter is a 3.8 point benefit related to one-time reduction for the anticipated supplemental commission payments. Given the size of the E&S operations, the combined ratio could have some volatility in the short term.

Turning to investments, first quarter after-tax net investment income was essentially flat at $25 million compared to a year ago. The overriding factor affecting investment income is the pressure of sustained low interest rates on portfolio yield. Obviously this dynamic is not unique to Selective and we have resisted taking on more risk in the form of lower credit quality or extended duration. Year-over-year fixed-maturity income declined 4% while alternative investment income increased 85% reflecting the strong M&A activity in the second half of 2012.

While the majority of our alternative investments report on a one-quarter lag, equity market performance is not entirely predictive of the performance of our alternative portfolio. This is largely due to the mix and vintage of our investments which include energy, mezzanine debt, real estate, and private equity.

The after-tax yield on fixed-maturity securities was 2.3% for the quarter, down about 26 basis points from the year-ago period reflecting the continued low interest rate environment. Fixed-income new money rates averaged 1% after tax in the quarter reflecting a high average credit quality of AA minus and modest duration of new purchases.

As we have stated, for every 25 basis point drop in portfolio yield we lose 1 point of ROE which subsequently requires a 1 point improvement in the combined ratio to offset this decline.

Invested assets increased 6% from a year ago to $4.4 billion driven by increased operating cash flows and the net additional funds as a result of the $185 million senior note offering and subsequent redemption of the $100 million junior subordinated notes. Our overall fixed-income portfolio maintains a high credit quality of AA minus and duration of 3.4 years including short-term investments.

Compared to a year ago, the portfolio unrealized-gain position improved from $165 million to $185 million, pre-tax, at March 31, 2013. Also noteworthy is the quarter-end unrecognized-gain position in the fixed-income held-to-maturity portfolio of $36 million, pre-tax, or $0.41 per share after tax.

Surplus in stockholders' equity remains strong at March 31 at $1.2 and $1.1 billion respectively. Book value per share increased to $20.46 from $19.77 at December 2012 due to net income and an after-tax increase to equity as a result of the pension curtailment announced earlier this quarter. The curtailment created an after-tax increase to equity of approximately $29 million or $0.52 per share.

Our premium-to-surplus ratio declined slightly from last quarter to 1.5 to 1 from 1.6 to 1 mainly due to the $57 million in additional surplus we downstreamed to the insurance operations after the senior note issuance in February.

Now I'll turn the call over to John Marchioni to review the insurance operations.

Thanks, Dale. Good morning. We are very pleased with our first quarter results. I believe they are reflective of our underwriting and pricing efforts to successfully maneuver a hardening, but not traditionally hard, market.

We've invested in many tools for our underwriters and claims specialists over the past few years throughout the soft market cycle and their effectiveness is beginning to manifest itself, as expected, in improving underlying profitability. We provide our underwriters with specific policy-level guidance, allowing them to target the highest rate increases on the worst-performing accounts while protecting retention on our best accounts.

In the first quarter, for standard commercial lines we obtained 14% pure rate on our lowest-quality accounts and held point-of-renewal retention at 75%. We obtained a 6% pure rate increase on our highest-quality accounts while they were retained at 90%. The achievement of 7.5% standard commercial renewal pricing in the quarter, while retention remains strong, is a testament to our capabilities and our agency relationships.

New business continues to be challenging. Standard commercial lines new business was essentially flat in the quarter from a year ago at $69 million. We carefully monitor the mix of new business by a number of different risk and pricing characteristics. As such, we remain confident in the quality of our new business overall. While we do see quality accounts being pushed into the market by some unsophisticated competitors, the level of quality new business accounts continues to lag putting pressure on new business for the quarter.

The excess in surplus lines contract binding authority business is tracking in line with our expectations to achieve between a 100% and 102% combined ratio for 2013. As we apply our Selective underwriting tools and disciplines to this still relatively new book of business we expect to see continued improvement to the 95% combined ratio range in 2014.

Pricing in the E&S market improved in the first quarter and we achieved 8.5% renewal price increases. Personal lines results in the quarter were strong not only reflecting the lack of catastrophe losses but also our targeted profitability initiatives for both homeowners and auto. We achieved an overall 8.5% renewal price increase for personal lines in the quarter while retention remained high at 87%.

Growth was within our expectations in personal lines as we carefully push rate and work to improve our mix of business. We continue to drive profitability in our homeowners line as we increase rates across the book and make underwriting changes, including raising deductibles to increase cost sharing.

Additionally in 2013, we have significantly tightened our underwriting appetite for monoline homeowners. Our by-peril rating platform allows us to allocate reinsurance costs into our pricing structure in a very targeted fashion.

We are targeting a combined ratio in the high 80's in a normalized catastrophe year. For the first quarter our homeowners line produced a combined ratio of 87.7%, including a pension charge of 1.1 points, while achieving renewal price increases of 11.4%.

For personal auto we have been consistently getting price above loss-cost trend achieving 6.4% in the first quarter. We are increasing the geographic diversification of our auto book and have made progress on increasing the age of the book from 3 to 3.2 years outside of New Jersey. We believe that the continued rate action and ongoing improvement in the underwriting mix of business and maturity of the auto book will continue to drive improvement in this line for long-term success.

We feel very good about our progress in underwriting and claims and are on target to achieve our 2014 goals as we've previously disclosed.

Now, I'll turn the call over to Greg.

Thank you, John, and good morning. Market conditions improved in all areas of our insurance operations, led by 8.5% renewal price increases in both personal lines and E&S, while commercial lines renewal price reached 7.5%. Retention, another key indicator of market stability was solid.

Due to the current state of the economy, I believe the low interest rate environment will continue through 2014 and will lower after-tax yields most likely through 2016. Clearly, this calls for significant ongoing price increases.

I've been in the insurance business for 33 years and thinking about this low interest rate environment, one has to go all the way back to 1950 to find interest rates at comparable levels. The ongoing ratcheting down of investment yield is forcing companies to significantly improve their underwriting margins which can only be achieved through substantial industry-wide renewal price increases.

As an organization, Selective has successfully balanced price increases with retention for the last 16 quarters. Clearly, companies that try to socialize rate in this environment will only hurt their renewal business and play into the competitive advantage that we've created with our pricing and underwriting sophistication.

We have a long history of being an underwriting company and we have the best agents in the business. Our underwriting and claims personnel are using tools such as the Dynamic Portfolio Manager and Fraud Analytics but, most importantly, our agents understand and support their deployment. We recently met with 120 President's Club agents and they overwhelmingly applaud our renewal pricing strategy and they're working with us to find quality new business opportunities.

At the end of 2011, we deployed a three-year profit improvement plan to achieve a 92 combined ratio, excluding catastrophe losses, by year-end 2014. The biggest driver of the plan is to achieve renewal price increases of between 5% and 8%. For 2012, our renewal price target was 5.8% versus our actual achievement of 6.3%. For 2013, we believe we will meet our 7.6% commercial and 7% personal lines pricing targets. We're in a solid position to exceed our three-year pricing portion of our profit improvement plan.

Our loss trend is estimated to remain stable and our plan includes claims initiatives designed to lower the combined ratio. The most significant initiatives include medical cost containment through extensive network renegotiations, enhanced nurse case management, sophisticated fraud and recovery predictive models, panel legal fee claim management, as well as a complex claim unit. We expect these initiatives will have the greatest impact on our workers' compensation and general liability lines of business.

Given the current rate environment, we're not stretching for yield through excess risk in our investment portfolio. When so much liquidity is competing for yield, we feel markets do not adequately compensate investors for extending duration or reaching down in credit quality. As a result, new bonds issues are heavily over-subscribed and end up aggressively priced. Therefore, we will retain our investment discipline and focus on the high-quality fixed-income opportunities while maintaining our duration at around 3.5 years.

After one quarter, our expectations for the full year 2013 remain; a statutory combined ratio of 96, excluding catastrophe losses and no additional prior favorable or unfavorable development; a 3 point estimate for catastrophe losses; after-tax investment income of approximately $90 million to $95 million; and weighted-average shares of approximately $56 million.

Now, I'll turn the call over to the operator for your questions.

Thank you. (Operator Instructions). Vincent DeAugustino, KBW.

Hi, and good morning. Thanks for taking my questions. I just wanted to focus most of my questions on workers' comp. I guess we've heard from a number of insurers that they're focusing more on smaller worker comp accounts. I'm just curious if that sort of broad shift in account-size appetite in the market has changed your return expectations for small-account business or even if you're seeing more competition in that space or, as of right now, if it's just rhetoric.

This is John. We've certainly, and we've talked about this in the past, over the last year or so we've really changed our focus, from a new business perspective and even from a renewal perspective, to focus as well on lower-hazard smaller comp classes of business. I would say, clearly, when you look at the competition for that segment of the comp market there definitely is more competition. You still see some higher commission rates for that sort of business and you definitely see more price competition for that sort of business. I think that's where the margins have been.

When you look at the overall performance of the line being poor, certainly that part of the market has performed a little bit better over time which is why companies are pursuing it. Now it's just a matter of making sure that you don't get so aggressive to pursue that business and change your mix of business that you're going to hurt your profitability on that side of the book.

Overwhelming, I would say we're an account underwriter. We're not running after monoline comp. We make sure that the comp that we do, we're very disciplined in the underwriting side in terms of how grade states, how we look at different classes of business. I think we try to make sure we pick the right opportunities to do that. When we go into an account we're writing a whole account. That's how we look at the profitability of the business overall.

I know that the focus has a tendency to be on workers' comp. We understand that workers' compensation is running above where we would like to see it. There's a little bit of unusual activity in the quarter that's kind of pumped those numbers up a bit but we feel that a lot of our claim initiatives are directed at the comp line to bring the cost of goods sold down but also that there is an opportunity to write good comp in the marketplace as part of an account profile.

That's really helpful. To your point, understanding the volatility in the workers' comp is a pretty long-tailed line. But, I'm a little curious if you're seeing any near-term changes in frequency or severity in recent quarters, any early indicators that we may be seeing some favorable or adverse trends. Some of the data we're looking at may be pointing to slightly improving frequency trends.

We see that ongoing frequency drop. We see a little bit of severity spike but, quarter-to-quarter, it's just too -- you've got to look at these trends on a more stable basis. It is something that we are very closely monitoring, including the rate at which we dispose claims. I mean, there are a lot of things that we look at comp holistically to manage that inventory.

Perfect. One last one, if I could sneak it in. Just, John with your comments about new business growth, and you guys have clearly done a great job at leading the industry both in the timing of rate increases and the magnitude and understanding the net investment income pressure and the multi-year drain on ROEs that's going to drive -- even understanding that, at some point, just because of your rate trajectory above industry, at some point should we expect you to take your foot off the gas and see new business growth accelerate in maybe 2014 or any thoughts that you might have there?

It's a great question. While we feel good about our renewal pricing strategy and our ability to maintain strong retention levels, new business continues to be a little bit of a wildcard. We've prided ourselves on being disciplined new business underwriters and if you'll look over the last several years, as the market cycle started to change, you saw our new business performance kind of move directionally, based on the quality of accounts in the marketplace.

I think as companies are now getting into their second renewal cycle we do expect there to be more quality accounts getting pushed out into the marketplace that we could identify with our tools and price accordingly and start to acquire. So, yes, we do think new business presents a growing opportunity for us as we move deeper into this market cycle.

Perfect. Thanks so much.

Scott Heleniak, RBC Capital Markets.

Thanks. Good morning.

Good morning, Scott.

Just a couple quick questions. First, on E&S, just wondering if you could give us an update on what your expectations are for growth this year. You grew 10% and just wondering if you might be able to see kind of double digits for 2013. And then the other question on E&S was just related to the margins. You mentioned the benefit of supplemental commission. Just wondering if there's anything else at play where you were able to get the margin improvements so quickly, relative to last year.

On the growth front we don't provide specific projections for growth for any of our segments. Obviously we're pleased with the 10% growth that we were able to achieve in the first quarter. We do recognize that there is substantial opportunity in the E&S space, both strictly with our wholesalers in general but also with the idea of getting our retail agents to drive business through our new wholesale partners. All that, we think, provides plenty of opportunity. But, we don't have any specific projections on that.

Is there anything on the margins?

When we disclosed the results in the prior quarter, clearly we weren't satisfied with the profitability of the book and said we were taking some pretty aggressive actions and you're seeing that now start to come through the book when you look at the performance in the first quarter from a profitability perspective. Certainly, in the short term that does put pressure on the top-line growth. But to be able to see that kind of loss ratio improvement and also grow the book in the quarter by 10%, we're very happy with that.

Just to reinforce what Dale said, while not providing specific guidance on top-line growth, you've got three dynamics at work there. You've got business starting to migrate from the standard market, which is a real opportunity for us. You've got us building out our wholesale agency partners' plant across the footprint over the next year to two. Then we think there's a real opportunity, we're starting to see some real traction from the business flowing from our retail partners. Those three factors, we think really position us well, especially now that we've gotten the profitability of that book on a path to where we want it to be.

I would add to that. Obviously this was -- part of this strategy was to get into the market and this was to garner a good shelf space opportunity inside our retail agents as well as expand out the overall portfolio. We feel that long term this business, as we indicated to you, will not be a huge percentage of our overall inventory but will be a sizeable enough percentage that it will help provide some better buoyancy to our long-term performance which is another reason why we've entered this market at this opportunity.

Okay. Just on workers' comp. I was just wondering if you could touch on the one claim you mentioned, the older claim that dates back to the 1980's. Is that fully dealt with, you feel like now?

Yes it is. We can't provide any specifics to that particular claim but every once in a while you'll have something pop or some circumstances change in an older claim and that was the case with that.

Okay. So nothing else really unusual in comp?

No.

Okay. Then the other question I had was just on the loss reserves were down pretty significantly versus the quarter. Just wondering if you could talk about what drove that big decline there.

Basically the biggest thing is the National Flood Program. Remember we had about $900 million worth of reserves sitting on the books at the end of the year for Sandy. That's all 100% reinsured by the federal government but under GAAP rules you have to gross up your balance sheet to show both the flood reserve and the reinsurance recoverable. That's the big drop.

Got it. Okay, the flood then. The only other question I have was just you guys mentioned, I know you've mentioned this before too, the increase in the deductibles on the homeowners book. Just wondering what is the average deductible now and where was that a couple years ago? How much have you increased that? I'm assuming it's pretty much across the board.

This is John. We increased the deductibles to $1000 or $1500 depending on roof age. Generally speaking, the book prior to that was at a $500 deductible, on average. You probably still had some others that may have pushed it up or down depending on the state. But, we're still in the process of working through our renewal inventory with the new deductible structure so it's moving up generally from $500 on average to $1000.

If I can come back to your last question for a second too, focusing on GAAP on the reserve change. I think if you looked at the statutory reserves you get the benefit of washing that all out and the reserve ratio was a very healthy 9% this quarter. That's the ratio that we focus on, which is the change in reserves over earned premium.

I will add a little bit more too is the other way to look at that is if you look, again, back at the GAAP you'll see the exact same drop on the reinsurance recoverable line.

Yes, it was just the flood part of it that I was guess missing there. That's all I had, thanks.

Thank you.

Ray Iardella, Macquarie.

Good morning, Ray.

Good morning. This is actually Chris calling in for Ray. Thanks for taking the question. I was just curious; the increase in other expenses year-over-year was about $5 million. Is that where the debt retirement charge flowed through the income statement?

Right. You've got that going through there. You also have the fact that, in the first quarter, the increase in the stock price also impacted that because the long-term rewards are mark-to-market so they're long-term awards of stock or restricted stock units. That flows through there also.

Is it possible to quantify the breakdown in those two components or it's just --

The amortization of the debt expense was $2.2 million, after tax, compared to basically nothing the year before. So, that's about where the $0.04 comes in. The long-term compensation was about $5.7 million, after tax, in the first quarter of 2013 compared to $3.5 million in the first quarter of 2012.

Gotcha. That's really helpful. Thank you. Next question was on personal auto, noticed that the loss ratio improved nicely year-over-year. Was there anything driving that besides pricing?

Pretty much a combination of pricing and underwriting efforts. There was a small, small amount of favorable development in there but not that's what pushing. I think you're seeing the ongoing benefits of all of the efforts that we've been working on that we've been talking to you guys year after year about. The fact that the home story was more of a leg-in story over time and that the home would be a much more aggressive story relative to what we're doing in deductibles, pricing, and other initiatives. I think you're just starting to see some of the benefits of that.

Gotcha. Great. One last one. Did you guys quantify or give us an update relative to maybe the previous estimate you had had regarding the amount of revenues in your flood claims adjusting revenues from Sandy for the quarter?

We've not updated that, no. Basically all of our Sandy estimates are holding pretty strong.

Okay. You're not able to quantify what the contribution of Sandy-related flood claims adjusting revenues is though?

Sandy last year contributed $16 million for the 2012 year.

Okay. All right, that's it for me. Thanks very much.

(Operator Instructions). Ron Bobman, Capital.

Hi. Thanks a lot and nice to see the continued progress and improvement on a variety of fronts. I just had a couple questions. I haven't really talked much about Sandy but I'd be curious just to hear your thoughts on a variety of subjects surrounding Sandy, whether it be claims handling, rates of claims being closed, late submissions of claims put in. Just generally what you're experiencing maybe relative to what you thought in early days. Then I had some specific questions a little bit Sandy-related. I would imagine that your E&S opportunities could mushroom in size by virtue of Sandy. Is my intuitive thought right on that? Maybe I've got too many in.

Keep going.

My last one was when you do close this Sandy claim I'm wondering how often you actually get a release from the claimant. Is that typical, minority, majority of the cases? That's it for me. Thanks, everybody.

This is John. I'll try to take some of this and then Dale could certainly follow on. To me when you talk about the Sandy experience, the headline is what Dale already said, which is the estimates that we put out there at the end of the fourth quarter continue to hold strong which I think is a positive. I think it also would indicate that we've continued to work through the inventory of claims on both the flood and the P&C side in a very positive way and are comfortable with our disposal rates on those claims.

Honestly, I think we've gotten very positive feedback from our agency partners in terms of the service standards we've been able to maintain, despite the significant nature of that event right in our footprint.

In terms of the opportunity for E&S, I would say, no. Primarily why I say, no, is our E&S operations are not really a heavy property market and certainly not a property market for wind-exposed properties. So, we wouldn't view that as a real opportunity for us on the E&S side.

Okay. How about the release question?

We don't see a lot of re-open activity, if that's the question. As we close claims out on the cat side, we certainly monitor reopens but I don't think there's anything outstanding to report relative to re-opening of claims after they're closed out.

What percentage are you through the -- 75% closed? 25% closed? Do you have a ballpark? On the P&C side, not the flood.

Basically, we estimate that we're above 90% closed on both sides of that.

Wow, that's great. Thanks, Dale.

There is always the possibility for something to get re-opened as something gets determined but we're well on our way.

Great. All right, hope it continues. Thank you.

(Operator Instructions). I'm showing no further questions from the phone lines at this time.

Thank you very much for participating in this morning's call. If you have any follow-up matters, please contact Jennifer or Dale. Thank you very much.

That does conclude today's conference. Thank you for participating. You may disconnect at this time.