State Auto Financial Corporation (STFC) 2021 Q1 法說會逐字稿

Welcome, and thank you for standing by. (Operator Instructions) Today's call is being recorded. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Natalie Schoolcraft, Controller and Investor Relations Director of State Auto Financial Corporation.

Thank you, Laurie. Good morning, everyone. Welcome to our first quarter 2021 earnings conference call. Today, I'm joined by our Chairman, President and CEO, Mike LaRocco; Senior Vice President and CFO, Steve English; Senior Vice President of Personal and Commercial Lines and Managing Director of State Auto Labs, Kim Garland; Senior Vice President of Data & Analytics, Jason Berkey; Chief Actuarial Officer, Matt Mrozek; and Chief Investment Officer, Scott Jones.

After our prepared remarks, we'll open the lines for questions. Our comments today may include forward-looking statements, which by their nature, involve a number of risk factors and uncertainties which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed at the end of our press release as well as in our annual and quarterly filings with the Securities and Exchange Commission.

Financial schedules containing reconciliations of certain non-GAAP measures, along with other supplemental financial information are included as part of our press release.

Additional material titled Monitoring Our Progress has been made available on our website, stateauto.com, and along with the press release, can be found under the Investors section.

Now, I'll turn the call over to STFC's Chairman, President and CEO, Mike LaRocco.

Thank you, Nat, and good morning, everyone. I hope you and your families continue to be safe and healthy as we navigate, what we all hope, is the final stretch of the pandemic.

We just completed a very solid first quarter, coming on the heels of an excellent fourth quarter. Obviously, the headline numbers do not look great, but we all know they do not tell the full story.

The freeze that primarily hit Texas was the event that drove those headline numbers. It was both unusual and due to Texas infrastructure weaknesses, worse than it should have been. Regardless, this catastrophe drove the overall combined ratio for the quarter, and unless one takes the time to pull back the covers, overshadow what was a strong quarter for State Auto.

Let's look under the covers. We've been telling you about our efforts to get auto back to profitability. Last quarter, I made it clear that we are optimistic that we had turned the corner and expected auto to be profitable in 2021.

I'm pleased that the first quarter results showed all of our hard work is delivering. To be clear, we saw much work ahead, and no one is declaring victory. But we are pleased with our progress to-date and remain confident auto will return to consistent profitability.

The Texas freeze was primarily a homeowners' event, and that can be seen in those results. While Kim will cover this in more detail, I remain happy with this business and the way we've designed the product and how we're leveraging technology with regard to risk evaluation and inspection. Homeowners insurance pricing and underwriting is changing rapidly with advancing technology, and we are built for those changes.

Commercial lines continue to perform exceptionally well in terms of both profitability and growth. The turnaround over the last 5 years has been remarkable, and we are only on the cusp of what we can achieve across these products. As a regional, it's critical to be as diverse as possible, both geographically and by product. We are beginning to deliver on both.

The product diversity can, once again, be seen in this quarter's commercial results. It's also important to note that every product line, except homeowners and BOP, were profitable in the first quarter. The only 2 lines that missed were disproportionately impacted by an unusually bad first quarter cat event.

Applying any average first quarter cat load over the last 5 or 10 years and using that lens to review results would show that we indeed did have a solid first quarter.

I'm also pleased with our continued efforts to drive down our expense ratio. We've taken out a lot of unnecessary expense over the last 6 years and continue to push process improvement, leveraging both technology and operational change. While these efforts are ongoing, we know that the biggest opportunity is achieving scale.

We now have all our products on our Connect platform, a truly amazing accomplishment in 5.5 year time period. In addition, we have rebuilt all of the products that were put on that platform. This work has resulted in an industry-leading digital platform and products that are supported by sophisticated pricing models and strong underwriting. Our solid non-cap loss ratios reflect these efforts.

While we will continue to get better with both platform and products, the key pieces are in place. Now it's about adding profitable volume, which will drive down the expense ratios. In the coming quarters and years, we are built to do just that.

The industry continues to receive primarily good news regarding COVID business interruption claims. While there have been no changes on our limited number of cases, the industry trends bolster our cautious optimism on these cases.

Now, a quick word on rising costs. We are clearly seeing inflationary pressure as we settle claims. There are rising prices across labor, parts and materials. As a result, we are reacting by staying ahead of these trends by taking appropriate rate. While I'm not raising an alarm, we do feel the trends are real and will impact pricing going forward.

Finally, I'm certain you've seen the news, both sad and happy, that Steve will be riding off into the sunset at the end of the year. I want to take just a moment on this call to thank him for all he has done for State Auto as our CFO. I know all of you have benefited from his knowledge, insight and unusual sense of humor.

For me, personally, he has been a trusted adviser and a friend. While he will be missed, I cannot be more happy for Steve and his wife [Didi]. They are looking forward to enjoy the next part of life's journey, and especially those grandbabies.

Let me turn it over to Steve.

Thanks, Mike, and good morning, everyone. I'm not sure who has the most unusual sense of humor, but thanks for the kind words. STFC reported $3.6 million of net income for the first quarter of 2021 compared to a loss of $114.6 million in the same quarter of 2020.

Of course, we all remember what happened to equity investment valuations a year ago. On an operating basis, we reported a loss of $26.6 million or $0.61 per diluted share compared to a loss of $7.8 million or $0.18 per diluted share in the same period a year ago.

Similar to last year, the first quarter of 2021 was significantly impacted by catastrophe losses. Catastrophes comprised 20.1 points of the 112.9% GAAP combined ratio and were driven by Winter Storm Uri and Viola, which were primarily personal lines events.

Approximately 75% of these claims are closed, which is a testament to the hard work of our care team, delivering the promise and service our policyholders deserve. 2020's first quarter cat loss ratio of 12.7% was impacted by the Nashville tornado, which was heavily commercial lines.

First quarter 2021 GAAP combined ratio was 5.7 points higher than 2020's first quarter ratio of 107.2. Cats were up 7.4 points, while the GAAP non-cat loss and loss adjustment expense ratio was down 9/10 of a point, and the GAAP expense ratio was also down 8/10 of point compared to the first quarter a year ago.

Our winter storm estimates did trigger estimated recoveries from our property cat treaty. As a reminder, our group retention is $90 million for the 5% co-participation with limits topping at $270 million. Including reinstatement premium and the co-participation, along with our retention, the winter storms added 17 points to the personal and commercial statutory combined ratio, leaving just shy of 4 points from other catastrophes. Last year in the first quarter on the same basis, the Nashville tornado contributed 8.3 points, leaving just over 4 points from other catastrophe losses.

Net favorable development of prior year non-cat loss and ALAE reserves in the first quarter of 2021 was $24.6 million compared to $10.5 million of net favorable development in the first quarter of 2020. The difference of $14.1 million relates to: one, personal auto, which was relatively flat in the first quarter of 2021, with favorable development of $800,000, compared to adverse development of $5.2 million in Q1 2020.

Two, homeowners, which developed favorably by $2.1 million in Q1 2021 compared to adverse development of $2.2 million in Q1 2020. And three, commercial lines developing favorably by $21.8 million in Q1 2021 compared to $16.8 million in Q1 2020. We continue to see consistent favorable development in commercial lines across the various product lines and, in particular, workers' compensation.

The personal and commercial statutory expense ratio for the quarter of 33.5% compares to 34.8% in Q1 2020, a 1.3 point improvement. While costs such as estimated variable comp for agents and associates, along with other expenses such as bad debt, can vary quarter-over-quarter, but we are beginning to see the benefit of our investment in Connect, as more premium is added to the platform and the amount of yearly spend on building and rolling out Connect wanes.

Overall, net written premium grew 3.7% for the quarter compared to Q1 2020. Personal lines declined 3.2%, driven by personal auto as well as property cat reinstatement premium and homeowners. Commercial lines grew 13%, led by commercial auto and farm & ranch.

First quarter equity and other invested asset valuations continue to be on the rise, while bond values fell due to rising interest rates. Net investment income for the quarter was lower than Q1 2020. It was this time last year, we announced our exit from MLPs and anticipated that asset class shift, along with persistent low interest rates, would put downward pressure on net investment income.

And finally, as Mike mentioned, there is not much to report on COVID business interruption since we spoke in February. We still have had 21 lawsuits filed, and we still have 14 currently pending.

And with that, I will turn the call over to Kim for more product color on first quarter results.

Thanks, Steve, and good morning, everyone. Overall, our personal lines and commercial lines statutory results are the following. The 1Q '21 combined ratio was 112.8% compared to 107.3% for 1Q '20. Cat loss and LAE related to Uri and Viola contributed 17 points to the overall personal and commercial lines combined ratio for the quarter. Written premium growth was 3.7% for 1Q '21 versus 1Q '20.

For the quarter, we continue to be thrilled with the performance of our commercial lines business. Commercial lines had written premium growth of 13% and a 93.6% combined ratio, which includes 7.8 points of cat loss and ALAE, a higher cat loss ratio than we typically see in the first quarter for commercial lines.

Our commercial lines 1Q '21 expense ratio of 36.8% is 3.3 points lower than 1Q '20. We are seeing the benefit of finishing the Connect investment and increased scale.

We've completed the state rollout of Middle Market Connect and workers' comp Connect State rollout is scheduled to be completed in August. I cannot say enough good things about the IT and business teams that have worked on building and launching all of our products on the Connect platform. Just a heroic effort by everyone involved.

We are continuing to take significant rate in our commercial auto, small commercial and middle market commercial product lines.

Commercial auto. Our commercial auto results continue to be terrific, with 1Q '21 results of a combined ratio of 98.8% and written premium growth of 40.9%. The commercial auto expense ratio continues to improve as we achieve scale in this product line with a 31.6% expense ratio in 1Q '21, representing a 3.4 point improvement over the first quarter of 2020.

Small commercial, 1Q '21 had a combined ratio of 112.3% with written premium growth of 9.7%, including 16.5 points of cat loss and the ALAE ratio, a higher amount of cat losses than we typically see for small commercial in the first quarter.

Growth continues to accelerate in our small commercial product line and the combination of accelerating growth and our more efficient platform produced a 1Q '21 expense ratio of 32.8%, representing a 4.2 point improvement over first quarter of 2020.

Middle market had a combined ratio for the quarter of 95% with written premium being flat year-over-year. 1Q '21 new business written premium was down over 50% versus first quarter of 2020.

Toward the end of the first quarter, we started to see increasing traction in CPP Connect on submissions, and we are optimistic that we are getting towards the end of the Connect learning curve for middle market, and we anticipate middle market new business picking up in the second quarter of this year.

Workers' compensation had a combined ratio for the quarter of 56.7% with 55.8 points of favorable prior year development and written premium growth of negative 15%. By the end of May, we will have launched workers' comp Connect in 24 states and will finish the workers' comp Connect State rollout in August.

Our early workers' comp Connect metrics around submissions, quote to submissions, ratios, straight-through processing ratios and closure ratios look very promising. After years of our workers' compensation product shrinking, we are all looking forward to getting back into growth mode.

Farm & ranch, first quarter of '21 had a combined ratio of 88.9% and written premium growth of 34.5%, an absolutely terrific quarter. Our Farm & ranch business is beginning to see the impact of the Connect investment starting to burn off and the benefit of increased scale as the 1Q '21 expense ratio of 39.9% is a 5.6 point improvement over first quarter of 2020.

For personal lines in the first quarter, we had a combined ratio of 125.9 and written premium growth of negative 3.2%. On a direct basis, our personal lines written premium growth was essentially flat.

Our first quarter for personal Lines was a tale of 2 stories. First, for personal auto, we had a very solid quarter of progress on our work of restoring profitability to our personal auto business, as our first quarter personal auto results were very close to what we expected.

Personal auto had a 1Q '21 combined ratio of 98.9% with written premium shrinkage of 14.8%. There was no personal auto prior year adverse reserve development this quarter. Our 1Q '21 loss and ALAE ratio of 59.2% is where it needs to be for us to hit our 96 personal auto target combined ratio. Our 1Q '21 expense ratio is down 0.5 point versus first quarter of 2020.

Nonstandard policies now make up around 12% of our total personal auto policies. This percentage is in line with where we think it should be. Our personal auto restoration plan is proceeding as expected, and it is now time to start to work on adding growth to this profitable foundation.

For homeowners, the story of the first quarter was the Texas winter storms and continuing to take rate. Our home product line had a first quarter '21 combined ratio of 149.3% and written premium growth of 5.6%, which was reduced by 4.3 points of reinsurance reinstatement premium. This included a cat loss and ALAE ratio of 54.4% compared to 13% in the first quarter of 2020.

We have launched Home Connect 3.0 and 11 states through the end of March and another 4 states so far in the second quarter. Through a combination of base rate increases, rating segmentation changes, policy aging and inflation factors on Connect.

On Connect 3.0, renewals through the end of March, we have seen full term renewing premiums on Connect 3.0, 30% higher than full term expiring premiums with the Texas and Michigan averages being higher than 30% and countrywide ex-Texas and Michigan being around 17%.

In first quarter '21, 6% of our homeowners earned written premium was on Connect 3.0, and 46% of our homeowners' written premium was on Connect 3.0 rates.

We are pleased with where the business is positioned. Commercial lines is consistently producing profitable growth. Our personal auto profit restoration plan is proceeding as expected, significant rate is flowing into the system across our homeowners, commercial auto, small commercial and middle market product lines and expense ratios are falling as we exit the Connect investment period and begin to capture these benefits in a lower organizational expense ratio.

With that, we'll open the line for questions.

(Operator Instructions) Our first question comes from the line of [Derek Han].

You talked a lot about inflationary pressures and how you're adjusting for those trends for pricing. Can you give us some quantification on how much you're adjusting your loss picks or maybe where the loss trends are running at? And is it -- are the adjustment being mostly made in the personal home business?

Yes. Let me start briefly and then turn it over to Kim to be a little more specific. We're definitely seeing, as I mentioned in my comments, there is definitely inflationary pressure. There's no doubt in our mind about that. We see it a lot in the property lines of business, obviously. But you'll also see it in auto in terms of repair costs and labor rates and so on and so forth. So this is a kind of an across the board issue.

Some of the largest increases are in materials that are used to rebuild homes and businesses. So that's kind of where we're seeing the most significant. So I'll let Kim kind of touch on how we're addressing that from a rating standpoint.

Sure. And I'll probably -- I'll try and give you a flavor by a few product lines on the sort of order of magnitude of what we're doing. And when I speak to it for the property lines, I'll probably take into account both rates we're taking, and we're also seeing Coverager amounts increase. And so we get rate through both of those.

In middle market, these days, we are probably taking to 13% to 15% in rate with more of that coming in property, less on liability. That's our middle market commercial business. In our small commercial business, we are having about 12 points of rate entering the system. Again, much -- these rate increases on the small commercial side, property is higher, liability is lower.

And in homeowners, I told you we are taking -- in Connect 3.0, we're seeing about 30% in premium increases. Now in a state like Texas, some of that's inflation, but some of that is we've increased cat and weather loads in Texas. As I said, outside of Texas and Michigan, it's about 17, 18 points of rate.

And for auto, we are seeing physical damage severity increases in the high single-digit range. And in commercial auto, these days, we're taking about 10 points of rates -- 10 or 11 points of rate overall. The personal lines changes are more muted given the miles driven drop, things going up. The sort of profitability actions that we're taking are pushing things in the other directions. So we're not taking as much overall rate there. But that's what we're seeing.

Okay. That's really helpful. And then my second question is about the auto Connect product. How many states has it rolled out in now? And really, with the New York Connect products that you have for both personal auto and home, how is it impacting your retention levels?

Go ahead, Kim.

Yes. And is this for auto -- is this more personal lines or commercial lines, you're asking...

For the personal lines.

So for the personal lines, oh, my gosh, we are in -- I think there's only a handful of straggler states for 2.1 that are hard to get approval in. So we're probably in 25-ish of our 28 states. So it's almost everywhere.

What we see is over the past year, our preferred Connect policies in force growth is around 35% to 40%. So we're seeing traction there. While our Connect nonstandard PIF has shrunk about 20%. So those are the impacts we're seeing.

(Operator Instructions) Your next question comes from the line of Paul Newsome.

My congratulations to Steve. Been a long time. Great having you help us out over the years and very much appreciate your sense of humor as well.

Thank you, Paul.

I wanted to ask about claim -- maybe just some more -- your thoughts on auto claim frequency given the pandemic. I think most people -- companies have seen a windfall. It's fairly significant, and that's helped profitability, but prospectively, we presume that driving will come back. And how should we think about that when we look at specifically State Auto's results? And just your thoughts in general on that topic.

Yes. I'll just very briefly start and say that we're as well as others seeing a significant drop in frequency. Again, Kim can add a little bit more color commentary there. And I think the thing that's unusual, Paul, about ours, is all the good work that Kim and [Lindsey] and the team have done in auto, has also created this seismic shift in our business to more preferred and much, much less nonstandard business. So you're also seeing the -- in addition to just the COVID effect, I think we're starting to now really start to see the difference in the mix of business that impacts both frequency and severity as well.

So we're pretty excited about that combination of events that are lining up and helping make us pretty bullish about this line of business. But Kim, you want to add -- and I'll come back to comment on Steve, Paul in just a second. But Kim, you want to add some color commentary there?

Sure. So there are a couple of moving pieces, Paul, and I'll try and talk through them to think about our personal auto results. So I think when you look at last year's results, I think, as we talked about last quarter, the biggest difference between us and the rest of the industry in sort of like combined ratio lowering was, we had a lot of adverse prior year development in our 2020 results. And so that's why this first quarter not seeing adverse development on prior years was sort of a win or a good guy for us that we like to see.

And then sort of going forward, I think, Mike touched on one of them. So there is this -- so there's this frequency drop that, I think, is just natural in the industry, and there are the severity increases both on physical damage and liability. So we see that with, like all the others. But I think if you look at our total auto book, we are probably seeing greater frequency declines than the average carrier, because as we shift out of nonstandard into preferred, preferred just has lower frequencies. So we have the benefit of the overall industry sort of phenomena. And then we add on that our mix shift.

Now, look, we don't manage our book of business as one big blob. We manage it as preferred standard, nonstandard. And so we're not letting that sort of extra frequency decline kind of [flush]. So that's sort of how to think about our moving pieces in personal auto.

And Paul, just you mentioned, Steve, and it reminded me that when I was growing up, I, of course, had come from an Italian family. And my Italian grandmother on my dad side only spoke Italian. And I remember when I was a little boy she used to sit me on her knee, and she would say, if you ever reach a position of authority that high hopes for me. You need to always have a good concierge by your side and a trusted adviser. And I think she would have been very proud that Steve helped fill that role for me over the last 6 years. So I just want to kind of toss that in there as well.

Operator, back to you.

(Operator Instructions) At this time, there are no further questions. I will now turn the call to Natalie Schoolcraft for closing remarks.

Thanks, everyone, for your questions, for participating in our conference call and for your continued interest in and support of State Auto Financial Corporation. We look forward to speaking with you again on our second quarter earnings call, which is currently scheduled for Thursday, August 5, 2021. Thank you, and have a wonderful day.

Thank you. That concludes today's first quarter 2021 earnings conference call. Thank you for participating. You may disconnect.