3Q 2022 Earnings Conference Call Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

SIGI.OQ - Q3 2022 Selective Insurance Group Inc Earnings Call

EVENT DATE/TIME: NOVEMBER 03, 2022 / 2:00PM GMT

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NOVEMBER 03, 2022 / 2:00PM, SIGI.OQ - Q3 2022 Selective Insurance Group Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

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

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

Rohan Pai Selective Insurance Group, Inc. - Senior VP of IR & Treasurer

C O N F E R E N C E C A L L P A R T I C I P A N T S

Grace Helen Carter BofA Securities, Research Division - Research Analyst

James Inglis Philo Smith & Co. - MD and Partner

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

Meyer Shields Keefe, Bruyette, & Woods, Inc., Research Division - MD

Michael Wayne Phillips Morgan Stanley, Research Division - Equity Analyst

Michael Zaremski

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

P R E S E N T A T I O N

Operator

Good day, everyone, and welcome to Selective Insurance Group's Third Quarter 2022 Earnings Call. At this time, for opening remarks and introductions, I would like to tuthe call over to Senior Vice President, Investor Relations and Treasurer, Rohan Pai.

Rohan Pai - Selective Insurance Group, Inc. - Senior VP of IR & Treasurer

Good morning, everyone. We're simulcasting this call on our website, selective.com. The replay is available until December 4. We use 3 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 accumulation -- in accumulated other comprehensive income. And 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're 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, and we undertake no obligation to update or revise any forward-looking statement.

Now I'll tuthe call over to John Marchioni, our Chairperson of the Board, President and Chief Executive Officer, who will be followed by Mark Wilcox, our EVP and Chief Financial Officer. John?

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NOVEMBER 03, 2022 / 2:00PM, SIGI.OQ - Q3 2022 Selective Insurance Group Inc Earnings Call

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

Thank you, Rohan. Good morning, and thank you for joining us today. Before getting into the details of our performance for the third quarter and year-to-date, I think it's important to put these results in the proper context. We are operating in a very challenging environment defined by historically high levels of economic inflation, elevated catastrophe losses and capital market volatility. Despite this challenging backdrop, Selective continues to deliver consistently strong top and bottom line results. Through the first 9 months, net premiums written were up 11% and our non-GAAP operating ROE was 11.6%. Based on our updated 2022 guidance, we expect to produce a full year operating ROE of 12%, marking our ninth consecutive year of double-digit ROEs for our shareholders.

While pleased with our overall results, our underlying combined ratio has been under pressure due to higher severities in the property and auto physical damage lines of business. We remain disciplined in addressing this through a combination of pure price and exposure increases. On the flip side, higher inflation is also the impetus for the higher interest rate environment. This has allowed us to pick up significant book yield in our investment portfolio and boost overall returns now and into the future.

Moving on to results in the quarter. Growth in net premiums written of 11% was driven by strong renewal pricing in Standard Commercial Lines and Excess and Surplus Lines, strong retention rates and new business growth in Standard Commercial and Personal Lines and positive exposure change. Our combined ratio was 96.8% in the third quarter and 95.2% for the first 9 months. Catastrophe losses accounted for 4 points during the quarter, which was in line with our expectations and included a $10 million estimate for the ultimate net loss related to Hurricane Ian.

However, non-catastrophe property losses were 3.3 points above our expectations. For the first 9 months of the year, non-cat property losses were

1.8 points above our initial expectations, with approximately 60% of the excess losses attributable to the auto physical damage lines. While we've been highlighting this the past few quarters, this increase primarily relates to economic inflationary pressures.

Across all property lines, current year severities were up approximately 12.5% year-to-date. While frequencies were up slightly in the third quarter, they are generally in line with our expectations for the year-to-date. We continue to be diligent about adjusting building and contents values to reflect these higher repair and replacement costs. Year-to-date renewal premium change was 12% for our commercial property book and 10% for our E&S property and homeowners portfolios.

For the commercial auto physical damage line, loss severities continue to reflect inflationary pressures for factors such as repair parts, used vehicles and labor. Our efforts to address the ongoing profitability challenge in the commercial auto line have centered on price increases, which averaged 8.7% in the third quarter and 8% for the first 9 months of the year.

On the casualty side, we remain confident in our current year loss ratio selections, which included a 5.5% assumed loss trend. In addition, we continue to see favorable casualty emergence from the prior accident years. In the current accident year, reported casualty claim frequencies continue to emerge better than expected and remain below pre-pandemic levels.

Renewal pure price increases for the Commercial Lines segment averaged 5.8% in the third quarter, which was 100 basis points higher than the first quarter and 50 basis points above the second quarter. Our retention rate of 86% remains strong. Exposure growth during the third quarter was 3.8%, and total premium change in our Commercial Lines renewal book was approximately 10%.

We intend to remain disciplined and consistent in seeking price increases that, over time, match our forward loss trend expectations. This long-term approach to obtaining the appropriate price across the market cycle has defined our strategy for the past decade. As we look towards 2023, we expect the commercial lines pricing environment to remain constructive as industry-wide loss trends remain elevated and the reinsurance market continues to firm.

I also want to share a few thoughts on catastrophe losses, which have been well above expectations for the industry over the past 5 years. While Hurricane Ian was not a significant loss event for Selective, this catastrophic loss of life and property reinforced the importance of understanding and managing exposure to large events. Over the past 20 years, our actual catastrophe losses have been below the industry average as measured by points on the combined ratio.

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NOVEMBER 03, 2022 / 2:00PM, SIGI.OQ - Q3 2022 Selective Insurance Group Inc Earnings Call

Our catastrophe risk management efforts are centered on being disciplined around modeling catastrophe losses on both expected and extreme event bases, establishing clear guidelines around underwriting coastal properties, aggressively managing our aggregate limits exposed in markets that present the highest exposure and prudently purchasing reinsurance to protect the balance sheet.

Turning to investments. The higher interest rates so far this year have negatively impacted the value of our investment portfolio and reported GAAP book value. However, we have managed the portfolio to take advantage of the higher rates and enhance investment portfolio yield. As of September 30, yield on the fixed income and short-term investment portfolio was approximately 80 basis points higher than at the start of the year. With a 3.4x investments to equity ratio, every 100 basis points of higher retuon the investment portfolio translates to over 260 basis points of additional ROE.

We are an underwriting company, first and foremost. We view an increase in investment ROE contribution as an opportunity to exceed our ROE targets, not as an opportunity to forfeit underwriting margins.

I'll close with a few quick business updates. We continue to execute on our major strategic priorities. Our commercial lines geographic expansion plans discussed on recent calls remain well on track. Geographic expansion is a lower-risk way of leveraging our skills and infrastructure to grow the business in lines that we understand well. In October, we began writing new commercial lines business in Alabama and Idaho. We have previously opened Vermont in the second quarter. We will continue to open additional states over the next few years.

While our personal lines results were again marked by catastrophe losses, we continue to make solid progress in migrating our business towards the mass affluent market. Our new business growth in this segment largely reflects the ongoing migration. Heading into 2023, we expect to obtain additional rate and exposure changes to further offset higher loss severities. Filed rate increases in the third quarter averaged 6%.

Our E&S business remains a strong contributor to our financial results. It is a segment that continues to offer attractive business flow opportunities and margins. Although we are seeing heightened competition for casualty-driven classes such as construction, we are well positioned to deliver our continued growth in this segment. However, we will not do so at the expense of profitability.

As I look to the remainder of the year and into 2023, we are well positioned to navigate this challenging environment and continue to produce the strong and consistent results we have delivered over the past several years.

With that, I will tuthe call over to Mark.

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

Thank you, John, and good morning. I will review our consolidated results for the quarter and for the first 9 months of the year, and we'll discuss our operating performance and financial position. I will then finish with our updated guidance for 2022.

For the third quarter, we reported net income available to common stockholders per diluted share of $0.66, a non-GAAP operating EPS of $0.99. Despite a high level of attritional non-cat property losses and a small loss from our allocation to alternative investments this quarter, we reported an annualized non-GAAP operating ROE of 10.5%. Based on our full year guidance, we are positioned to deliver solid results for the year with a 12% operating ROE, which is above our 11% target. Given a higher expected cost of capital going into 2023, we expect to increase our operating ROE target for next year.

Turning to our consolidated underwriting results. We reported 11% growth in net premiums written for the quarter and year-to-date, driven by strong growth in each of our segments. We reported a consolidated combined ratio of 96.8% for the third quarter, down from 98.6% in the year ago period. The combined ratio included $34 million of catastrophe losses, or 4 points, and $16 million of net favorable prior year casualty reserve development, accounting for 1.9 points. We booked $10 million in ultimate net losses for Hurricane Ian related primarily to losses for the second landfall in South Carolina as we do not have a meaningful property exposure in the state of Florida.

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NOVEMBER 03, 2022 / 2:00PM, SIGI.OQ - Q3 2022 Selective Insurance Group Inc Earnings Call

In addition, we reported $1.9 million in estimated claims handling fees from Hurricane Ian from our participation with FEMA's National Flood Insurance Program. On an underlying basis or excluding catastrophes and prior year casualty reserve development, the third quarter combined ratio was 94.7%. This was 4.3 percentage points higher than the year ago period, driven principally by higher non-cat property losses.

For the third quarter, non-cat property losses accounted for 19.6 points on the combined ratio, which was 3.5 points higher than in the year ago period. The higher losses were primarily due to elevated auto physical damage and commercial property severities and were driven by the economic inflationary factors that John mentioned. We also experienced a somewhat higher level of frequency to the third quarter compared to the first half of the year. As a reminder, attritional property losses do experience a level of volatility from period to period.

Also impacting the underlying combined ratio in the quarter was the recognition of $9.3 million of ceded earned casualty reinstatement premium related to development on 3 losses for the 2018 and 2020 treaty years. While these losses are fully reinsured under our casualty treaty, the reinstatement premium added approximately 0.8 points to the consolidated combined ratio this quarter. We've otherwise stayed on our casualty loss picks for the 2022 accident year.

For the first 9 months, we reported a 95.2% combined ratio or 93.1% on an underlying basis. Catastrophe losses accounted for 4 points on the 9-month combined ratio, which is better than expected for this year-to-date period. The non-cat property loss ratio of 18.3% is running about 1.8 points above expectations year-to-date. This is the principal reason why our underlying combined ratio is projected to be higher than expected in 2022.

Moving to expenses. Our expense ratio was 32.6% for the third quarter, which was in line with the prior year period. For the first 9 months, the expense ratio of 32.4% was also in line with our expectations for the year. While we are focused on further reducing our expense ratio, the impact of economic inflation and the potential for higher reinsurance costs may collectively put some upward pressure on our expense ratio in 2023. Corporate expenses, which are principally comprised of holding company costs and long-term stock compensation, totaled $5.5 million in the quarter compared to $4.3 million in the year ago period.

Turning to our segments. Standard Commercial Lines net premiums written increased 11% in the quarter, driven by renewal pure price increases averaging 5.8%, excellent retention of 86%, new business growth of 5% and exposure growth of approximately 3.8%. The Commercial Lines combined ratio was 96.8% for the quarter and included 2.6 points of catastrophe losses and $16 million or 2.3 points of net favorable prior year casualty reserve development. The favorable prior year casualty reserve development was driven by $20 million from workers compensation for accident year 2019 and prior; $8 million from the business owner's policy line also for accident years 2019 and prior; and $3 million from bonds for accident year 2020.

These reserve releases were offset in part by $15 million of net prior year unfavorable reserve development in the commercial auto line driven by higher severities with $11 million attributable to the 2021 accident year. While frequencies continue to remain below expectations for the 2021 year, we now expect higher ultimate severities in this line and took action in the quarter.

Commercial Lines underlying combined ratio was elevated to 96.5% for the quarter. The 5.1 percentage point increase from the year ago period was principally driven by 4.2 percentage points of higher non-cat property losses. In addition, the ceded casualty earned reinstatement premium added 0.9 points to the combined ratio and elevated our current accident year loss ratios for the general liability and workers compensation lines, in particular. Commercial auto physical damage severities, which we highlighted last quarter, remained at elevated levels, and non-cat commercial property losses were also higher than expected for the quarter.

In our personal lines segment, net premiums written increased 11% relative to the prior year period. Renewal pure price increases averaged 0.5%, retention was up from a year ago at 85%, and new business growth was strong. These metrics reflect the successful execution of our mass affluent strategy as much of the growth was within our target market. The combined ratio, however, was elevated at 101.8% as a result of 14.9 points of catastrophe losses. The underlying combined ratio of 86.9% was 1.6 points lower than the prior year period.

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