1Q 2023 Earnings Conference Call Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

Q1 2023 Selective Insurance Group Inc Earnings Call

EVENT DATE/TIME: MAY 04, 2023 / 2:00PM GMT

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MAY 04, 2023 / 2:00PM GMT, Q1 2023 Selective Insurance Group Inc Earnings Call

CORPORATE PARTICIPANTS

Haley Chrobock

John Joseph Marchioni Selective Insurance Group, Inc. - CEO, President & Chairman

Mark Alexander Wilcox Selective Insurance Group, Inc. - Executive VP & CFO

CONFERENCE CALL PARTICIPANTS

Grace Helen Carter BofA Securities, Research Division - Research Analyst

Jon Paul Newsome Piper Sandler & Co., Research Division - MD & Senior Research Analyst

Matthew John Carletti JMP Securities LLC, Research Division - MD & Equity Research Analyst

Michael David Zaremski BMO Capital Markets Equity Research - MD & Senior Equity Research Analyst

Derek Han KBW

PRESENTATION

Operator

Good day, everyone. Welcome to Selective Insurance Group's First Quarter 2023 Earnings Call. At this time, for opening remarks and introductions, I would like to tuthe call over to Investor Relations analyst, Haley Chrobock.

Haley Chrobock

Good morning. We are simulcasting this call on our website, selective.com. Replay is available until June 2. We use three measures to discuss our results and business operations. First, we use GAAP financial measures reported in our annual, quarterly and current reports filed with the SEC. Second, we use non-GAAP operating measures, which we believe make it easier for investors to evaluate our insurance business. Non-GAAP operating income is net income available to common stockholders, excluding the after-tax impact of net realized gains or losses on investments and unrealized gains or losses on equity securities.

Non-GAAP operating retuon common equity is non-GAAP operating income divided by average common stockholders' equity. Adjusted book value per common share differs from book value per common share by the exclusion of total after-tax unrealized gains and losses on investments included in accumulated other comprehensive loss. GAAP reconciliations to any referenced non-GAAP financial measures are in our supplemental investor package found on the Investors page of our website.

Third, we make statements and projections about our future performance. These are forward-looking statements under the Private Securities Litigation Reform Act of 1995. They are not guarantees of future performance and are subject to risks and uncertainties. We discuss these risks and uncertainties in detail in our annual, quarterly and current reports filed with the SEC. We undertake no obligation to update or revise any forward-looking statements. Now I'll tuthe call over to John Marchioni, our Chairman of the Board, President and Chief Executive Officer, who will be followed by Mark Wilcox, our Executive Vice President, Chief Financial Officer and Treasurer.

John Joseph Marchioni Selective Insurance Group, Inc. - CEO, President & Chairman

Thank you, Haley. Good morning and thank you for joining us. We've had an excellent start to the year. The headline for the quarter is that we continued to deliver strong earnings and remain very well positioned to effectively navigate the economic uncertainty and elevated loss trends that our industry faces. In the quarter, we had strong growth in all three insurance segments. Our all-in combined ratio was 95.7% despite higher-than-expected catastrophe losses. After-tax net investment income was up 25% over Q1 2022, driven by active management of our core fixed income portfolio over the past few quarters, and we produced a non-GAAP operating ROE of 14.6%, outperforming the 12% average we generated over the past nine years. Let me provide some additional color on our top line growth in the quarter. Net premiums written in our core business, Standard Commercial Lines grew 10%. New business in this segment was up 15% as we continued finding opportunities within our traditional risk profile and pricing expectations. Renewal premium change was a positive 12% as pure pricing increased by 7% and exposure was up 4.7%.

Our Standard Commercial Lines footprint has expanded by eight states over the past five years, and that expansion contributed two points of overall growth in the quarter. Our early success in these markets is driven by the unique operating model we employ and the strength of the new distribution partnerships we established. In addition to bolstering top line growth, this expansion also benefits the bottom line through greater geographic diversification. We are working towards opening an additional five states over the next two to

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MAY 04, 2023 / 2:00PM GMT, Q1 2023 Selective Insurance Group Inc Earnings Call

three years.

Net premiums written in our E&S segment grew 16% with new business growth of 9%, renewal pure rate of 7.4% and stable retention. Our mix of business has remained relatively stable in terms of limits profile and the lines of business and hazard mix. Net premiums written in our Standard Personal Lines segment grew 31% as we continued our transition to the mass affluent market. The mass affluent market now represents about half of our in-force book, and we expect that target business allocation to increase over the next several quarters.

I am particularly pleased with our profitability in the face of elevated catastrophe losses. In a quarter where industry losses were significantly above long-term averages. Our catastrophe losses were six points on the combined ratio or about one point above expected. Our combined ratio of 95.7% was only slightly above our 95% long-term target. Our underlying combined ratio was 91%.

Let me make some further comments about profitability. Standard Commercial Lines produced a 94.7% combined ratio and a 91.3% underlying combined ratio. Non-cat losses were about three points lower than last year and our budget, reversing the trend of increases we saw throughout 2022. Despite this favorable outcome, our view of overall loss trends remains in line with last quarter and continues to drive our pricing targets. Commercial Lines pricing moved meaningfully from 5.6% in Q4 2022 to 7% in the first quarter, driven by increases in the property and auto line. Retentions remained strong and stable.

Commercial property renewal pure rate was up 11.8% in the quarter and exposure increased 5.1%, producing a renewal premium change of 17.5%. We expect this pricing trend to continue. Commercial auto renewal pure rate was up 10% and exposure grew by 4.9%, resulting in a total premium change of 15.4%. E&S continued to deliver strong margins with a combined ratio of 85% and an underlying combined ratio of 84.3%. Like Standard Commercial Lines, non-cat property improved year-over-year and was better than expected for the quarter. The strong rate we've earned and underwriting improvements we've made over the past few years have favorably impacted E&S casualty loss ratios.

Standard Personal Lines profitability remains challenged. Excess cat losses largely drove the quarter's 116% combined ratio, but the 95.7% underlying combined ratio was about 10 points over target. Profitability improvement will be driven primarily by price increases as we continue to transition to the mass affluent market. In the quarter, 15 filed rate changes became effective across the auto and home lines, with an average increase of 9.4%. We expect this pace to continue over the next several months. While there is a lagged impact on renewal pricing, new business pricing was up over 5% in Q1 and over 7% in the month of April.

Investments was another bright spot in the quarter. The portfolio produced $73 million of after-tax income in the quarter, up 25% over Q1 2022. Our investment team has been actively positioning the portfolio to increase book yields, which is up by 137 basis points at the start of 2022 while also moving up in credit quality. To reiterate a point made last quarter, when investment returns exceed their long-term average, as we are currently experiencing, we expect to outperform our 12% operating ROE target, and we did that this quarter. While pleased with our strong start to 2023, we fully recognize that one quarter does not make a year. We continue to operate with great discipline in executing our growth and profitability initiatives. Our team of highly skilled and fully aligned employees, leveraging our sophisticated tools and technologies has positioned us as a market of choice for our top-notch distribution partners.

Our executive and regional management teams hosted six regional agency council meetings in March as we do each year. These sessions, each of which includes 12 to 15 agency principles, are a great opportunity to solicit feedback on our performance, understand the challenges they face in their local markets and align on opportunities for additional profitable growth. They routinely tell us that the strength of our talent, the uniqueness of our operating model and the consistent approach we take to managing growth and profitability are the primary reasons why they make us their market of choice.

In closing, we in the industry continue to face headwinds from economic and loss trend uncertainty. However, I am confident we have built the organizational muscle to successfully navigate through any potential economic and market challenges. Our long-term track record of consistent strong performance along with industry low volatility backs up that claim. Now let me tuthe call over to Mark.

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MAY 04, 2023 / 2:00PM GMT, Q1 2023 Selective Insurance Group Inc Earnings Call

Mark Alexander Wilcox Selective Insurance Group, Inc. - Executive VP & CFO

Thank you, John, and good morning. We reported a strong start to the year with $1.48 of fully diluted EPS in the first quarter and $1.44 of non-GAAP operating EPS. Our non-GAAP operating ROE of 14.6% came in nicely ahead of our 12% target. The strong performance was driven by solid underwriting results and significant growth in after-tax net investment income. Turning to our consolidated underwriting results. For the quarter, we reported $1 billion of net premiums written for a healthy 12% growth rate over the first quarter of 2022, with each of our three segments contributing to the growth.

We reported a profitable consolidated combined ratio of 95.7% despite another active catastrophe quarter in the U.S. There were 18 individual PCS events impacting our footprint in the first quarter resulting in $55.3 million of net catastrophe losses or a manageable 6.1 points on the combined ratio. The driver of the cat losses were two large storms in March and one in February, totaling $38.8 million or 70% of our first quarter cat losses. These losses were offset in part by $13 million or 1.4 points of net favorable prior year casualty reserve development. The favorable reserve development included $10 million in favorable claims emergence in our Workers' Compensation line of business and $5 million in E&S casualty. This was offset in part by $2 million of adverse development in personal auto. We have also adjusted up our personal auto liability loss pick for 2023 compared to our original plan for the year. The underlying combined ratio of 91% for the quarter was 2.1 points lower than in the prior year period, benefiting from lower non-cat property losses in our commercial property and E&S property lines of business. Non-cat property losses in total were 2.8 points better than expected, which drove underlying margin improvement compared to our expectations. Non-cat property auto physical damage losses for commercial and personal auto remain elevated and above expectations.

Moving to expenses. Our expense ratio of 32.6% was up 50 basis points versus the year ago. As noted last quarter, we expect modest upward pressure on the expense ratio in 2023 but have several cost containment initiatives in place. Over the medium and longer term, we remained focused on lowering the expense ratio through various initiatives while ensuring we are investing appropriately to support our longer-term strategic objectives. Corporate expenses, which principally include holding company costs and long-term stock compensation, totaled $12.1 million in the quarter.

Moving to investments. Our portfolio remains well positioned. As of March 31, 93% of our portfolio was in fixed income and short-term investments with an average credit rating of AA- and an effective duration of 4.1 years. Risk assets were approximately 9.9% of our portfolio as of March 31, in line with last quarter, but down from 11.8% a year ago as we have modestly derisked the portfolio against market expectations of a recession later this year.

For the quarter, after-tax net investment income was $73.1 million, up 25% relative to $58.5 million in the year ago period, driven by significant growth in investment income from our core fixed income portfolio. This was partially offset by a lower contribution from alternatives, which are reported on a one-quarter lag and generated $6.1 million of after-tax gains compared to $15.1 million a year ago. The strong growth in fixed income was driven by our active portfolio management last year, where we put $2.7 billion to work at high yields. The after-tax yield on the total portfolio was 3.7% for the first quarter, translating to a healthy 12.2 points of ROE contribution.

In anticipation of a potential decline in short-term interest rates later this year, we've been lowering our allocation to floating rate securities. Approximately 8.4% of our fixed income and short-term investment portfolio remains in floating rate securities, which is down from 10.4% at year-end and around 15% just over a year ago. As we have pared back our floaters, we have instead elected to lock in the current high new money rates for a longer period of time while managing our duration and credit quality targets. In addition, consistent with 2022, we continued our theme of active portfolio management in the quarter and put $1.1 billion of new money to work at a pretax yield of 5.5%. Our current book yield now stands at 4.33%, up 20 basis points in the quarter and 137 basis points since the start of 2022. As a reminder, every 100 basis points of high yield on our total investment portfolio translates to about 2.6 ROE points.

I'd also like to highlight the strength of our investment portfolio in light of the recent turmoil, particularly within the banking sector. We have no direct exposure to the securities of the particular banks that have recently been wound down. Our exposure to bonds of financial institutions is more diversified across sectors with a focus on large money center banks within banking. Given the recent focus on commercial real estate, I thought I'd also briefly highlight our exposure to this asset class. Commercial real estate represents about 11.8% of our investment portfolio and principally arises from our allocation to agency and non-agency commercial mortgage-backed securities,

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MAY 04, 2023 / 2:00PM GMT, Q1 2023 Selective Insurance Group Inc Earnings Call

which totals 8.1% of our portfolio. Just over 93% of these securities are invested in AAA and AA rated tranches and have a low likelihood of loss attachment in part driven by the strong level of subordination in these higher rated tranches. We also have a 1.8% allocation to commercial mortgage loans, which are all performing with an underwritten loan-to-value of 58% and debt service coverage ratio of 1.8x. Investment-grade real estate investment trust debt makes up 1.3% of the portfolio while real estate investment trust equity represents 0.3% and commercial real estate debt and equity within our alternative portfolio makes up the remaining 0.3%. Overall, we feel good about the credit quality and liquidity profile of our investment portfolio. However, we are closely monitoring credit and liquidity conditions in the market and have a general bias to remain underweight risk assets at this time and to stay up in terms of credit quality and to maintain a strong liquidity position.

Turning to capital. Our capital position remains extremely strong with $2.7 billion of GAAP equity and $2.5 billion of statutory capital and surplus as of quarter end. Book value per share increased 5.8% during the quarter. Adjusted book value per share was up 2.5% for the quarter or 3.1% adjusted for dividends. Our parent company cash and investment position stands at $497 million, which is above our longer-term target. Our net premiums written to surplus ratio of 1.46x is in the middle of our target range and our debt-to-capital ratio of 15.9% is on the low end of our target range. These metrics provide us with significant financial flexibility to support our growth and execute on our strategic initiatives. We did not repurchase any shares during the first quarter. We have $84.2 million of remaining capacity under our share repurchase authorization, which we plan to use opportunistically in 2023.

Finally, turning to our outlook. For 2023, our full year expectations remain unchanged from last quarter and are as follows: a GAAP combined ratio of 96.5% inclusive of 4.5 points of catastrophe losses. This assumes no additional prior accident year reserve development. While our first quarter combined ratio came in better than expected, it's too early to adjust our full year expectations. After-tax investment income of $300 million, including $30 million in after-tax gains from alternative investments, an overall effective tax rate of approximately 21%, which includes an effective tax rate of 20% for net investment income and 21% for all other items, and weighted average shares of 61 million on a diluted basis, which does not reflect any share repurchases we may make under our authorization. Overall, we are off to an excellent start to the year in terms of growth and profitability.

With that, I'll ask the operator to open up the call for questions.

QUESTIONS AND ANSWERS

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions.] Our first question comes from Mike Zaremski with BMO.

Michael David Zaremski BMO Capital Markets Equity Research - MD & Senior Equity Research Analyst

Maybe I might have missed this, I came on a few minutes late. Any color on the prior year development, the pluses and minuses? I did hear the commentary that I don't think your view of loss trend has changed meaningfully quarter-over-quarter, but I was just curious any color on PYD, which did come a little light versus, I guess, at least our expectations in commercial lines.

Mark Alexander Wilcox Selective Insurance Group, Inc. - Executive VP & CFO

Mike, it's Mark Wilcox. I'll start, and John might jump in as well. So PYD for Q1 2023 was $13 million net. And there are a couple of puts and takes in there. First off, really consistent with the year ago. We continue to see favorable claims emergence within the workers' compensation line of business, really driven by lower severities in years 2020 and prior. We also saw lower severities for accident years 2021 and prior within E&S casualty and saw about $5 million, or $5 million of favorable reserve development there. But then the one other item in the quarter that went in the other direction was some pressure within personal auto liability for the 2022 year, and that was to the tune of $2 million from an adverse development. So, $15 million favorable, $2 unfavorable, net $13, a 1.4% benefit on the combined ratio during the quarter.

And also, I mentioned in my prepared comments, which you may or may not have heard, was we did actually on the back of the increase

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