Selective Insurance Group, Inc. (NASDAQ:SIGI) Q3 2023 Earnings Call Transcript
Selective Insurance Group, Inc. (NASDAQ:SIGI) Q3 2023 Earnings Call Transcript November 4, 2023
Operator: Good day, everyone. Welcome to Selective Insurance Group's Third Quarter 2023 Earnings 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, Brad Wilson.
Brad Wilson: Thanks, and good morning. We are simulcasting this call on our website, selective.com, and a replay will be available until December 1. 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 return on 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 excluding total after-tax unrealized gains and losses on investments included in accumulated other comprehensive loss or income. 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 statement.
Now I'll turn the call over to John Marchioni, our Chairman of the Board, President and Chief Executive Officer; Mark Wilcox, our Executive Vice President, Chief Financial Officer, will follow John.
John Marchioni: Good morning, and thank you for joining us. We delivered strong earnings in the third quarter with excellent topline growth. Our annualized non-GAAP operating ROE was 15%, bringing our year-to-date result to 13.2%. This puts us ahead of our 12% operating ROE target we strive to consistently meet or exceed. We continue to see a meaningful increase in ROE contribution from investment income and solid underwriting performance. With a quarter ago, we are well positioned to deliver our 10th consecutive year of double-digit operating ROEs. Since 2014, our average operating ROE is 12%, a few in our industry can match this track record. As we proved across pricing cycles over the past dozen years, we have consistently achieved renewal pure rate equal to or exceeding expected loss trends.
We are focused on ensuring this continues going forward as we manage our new and renewal portfolio. The ability to underwrite at a granular level enabled by sophisticated tools is a key reason for our strong and stable underwriting performance over time. We have highlighted the industry's elevated uncertainty of loss trends influenced by economic inflation, social inflation, the unusual frequency and severity patterns resulting from the pandemic and a heightened frequency of catastrophe losses. These factors have put pressure on loss costs, necessitating continued industry focus on adequate pricing. We achieved standard Commercial Lines renewal pure price increases of 7.1% in the quarter and 6.9% year-to-date versus our expected loss trend of 6.5% coming into 2023.
Our 2023 accident year loss estimates are generally holding up as expected, but pockets of pressure exists, particularly in personal and commercial auto liability. Mark will discuss some of the actions we have taken. Within general liability, we have been embedding higher severity picks in our initial estimates in recent years, and they have come to fruition. Lower frequency has largely offset the higher severities in the most recent accident years. If the favorable frequency trend moderates and severity has emerged higher than expected, we could see additional pressure on this line. We believe this is an industry-wide dynamic, and therefore, expect pricing to reflect these elevated trends. Despite the higher interest rates that are providing a meaningful tailwind to investment income, we are maintaining our long-term target combined ratio of 95%.
This reflects elevated uncertainty about emerging casualty loss trends, inflationary impacts in property and increased weather event frequency. Standard Commercial Lines and excess and surplus lines, representing approximately 90% of our business are running at this target or better due to our consistent efforts to achieve renewal pure price consistent with expected loss trends. As a result, we can avoid more draconian actions that some competitors may need to take to address profitability challenges, disrupting our customers and agents. The remaining 10% of our business, Standard Personal Lines, is clearly short of target profitability, which we are addressing through aggressive rate increases. These filed rate increases began to take effect on a written basis during the first quarter of 2023.
We expect our overall written renewal rate will be approximately 9% in the fourth quarter and in the range of 20% to 25% in 2024, subject to regulatory approvals. As we file these rate changes, we are also refining our pricing for both cat and non-cat perils, including severe convective storm. At the same time, we are seeking to further improve homeowners' performance through terms and conditions. We are introducing actual cash value rather than replacement costs on older roofs. And in states most exposed to severe convective storm, we are implementing mandatory wind and hail deductibles. We expect these and other coverage changes to take greater hold as the market continues to evolve. Finally, we are taking further actions to accelerate the migration of the portfolio to our target market, which presents greater potential for long-term profitability.
Overall, topline growth continues to be excellent. Our distribution partners appreciate our franchise value, open communication and consistent approach to managing rate and retention. In total, net premiums increased 17% in the quarter to $1.1 billion, and we are on our way to exceeding $4 billion in annual premiums for the first time in our nearly 100-year history. Across all our segments, renewal pure price was 7% for the quarter and new business grew 26%. New states since 2017 added approximately two points to premium growth in a quarter. In our flagship Standard Commercial Lines segment, net premiums written grew 15% in the quarter with 13% growth in new business. Notably, the Commercial Lines marketplace continues to be constructive as evidenced by our renewal pure price of 7.1% in the quarter and strong retention of 86%.
Manageable policy count growth of 2.5% also contributed to the topline. During the quarter, property renewal pure rate was up 12.3% with exposure increasing 4.7% and total renewal premium up 17.6%. In commercial auto, renewal pure rate was 9.6% with increased exposure of 4.3%, resulting in a 14.3% total renewal premium increase. Geographic expansion continues to provide us runway to expand our business and diversify our portfolio. Our deliberate approach to adding new states has manifested in a repeatable process and generated strong results. We are adding West Virginia and Maine to our Commercial Lines footprint in the coming months and are excited to announce we expect to launch Washington, Oregon and Nevada in late 2024. Ultimately, we plan to write standard commercial lines in most of the contiguous United States.
Excess and surplus lines continued to perform very well with 25% premium growth in the quarter and an excellent all-in combined ratio of 83.9% or 80.4% on an underlying basis. For the first nine months, premium growth was 21% with a combined ratio of 89.7% and underlying combined ratio of 82.5%. I'll now turn the call over to Mark to review our financial performance in more detail.
Mark Wilcox: Thank you, John, and good morning. We reported $1.42 of fully diluted EPS in the third quarter, up 115% from a year-ago and $1.51 of non-GAAP operating EPS, up 53%. Year-to-date, fully diluted EPS was $3.83, up 77% compared to the prior year period, and non-GAAP operating EPS was $3.95, up 11%. This quarter, significant growth in after-tax net investment income and stable underwriting margins drove our performance. Our consolidated combined ratio for the quarter was 96.8%. With after-tax net investment income up 56%, we generated a healthy 15 percentage points of operating ROE, up 4.5 points from a year ago when we reported the same 96.8% combined ratio. Despite our strong operating ROE driven by higher net investment income, our full year expected combined ratio of 96.5% is above our 95% longer-term target.
Therefore, we will remain disciplined as we work to achieve our longer-term underwriting margins. The third quarter was another frequency-driven catastrophe quarter with 23 designated cats impacting our results, bringing the year-to-date total to 60 events. Catastrophe losses were $65 million or 6.6 points on the quarter's combined ratio. No single storm was significant with the largest event resulted in ultimate net losses of $8 million. As a result of the higher-than-expected cat losses in the quarter, we have increased our full-year catastrophe loss ratio guidance from 6 points last quarter to 6.5 points. We did not report any net favorable prior year casualty reserve development in the quarter. While our workers' compensation line continue to show favorable claims emergence with $7 million of favorable prior year casualty reserve development.
This was offset by unfavorable development of $4 million in commercial auto and $3 million in personal auto. As John described, we are closely monitoring casualty lines and continuing our practice of full reserve reviews each quarter for all major lines of business to stay abreast of emerging trends. As it relates to the current accident year, we took action in our personal auto line in the quarter, increasing loss cost by $4.9 million or 5.2 points on the Personal Lines combined ratio. We also added $4 million in commercial auto, increasing the third quarter combined ratio of 0.5 point for standard commercial lines. We expect these higher loss picks in these lines to continue this year. The underlying combined ratio was a very profitable 90.2% for the quarter, 4.5 points lower than a year ago.
Non-cat property losses of 17.6 points were 2 points better than the 19.6 points in the third quarter of 2022 and a bit better than expected. Also a lower expense ratio contributed 1.7 points of improvement. While our fixed controllable expense dollars were right on budget for the quarter and year-to-date, our expense ratio continues to benefit from strong premium growth. Year-to-date, our expense ratio was 31.6%, 80 basis points below the same period in 2022 and in line with our longer-term target. Over the medium and longer term, we will continue to drive operating efficiencies and manage our expense ratio while ensuring we continue to make the significant investments necessary to support our strategic objectives. Regarding our insurance segments, I would highlight the strong underwriting performance in standard commercial lines, which had a 94.7% combined ratio and underlying combined ratio of 90.4% and 15% net premiums written growth.
Our E&S segment also had an excellent quarter with 83.9% combined ratio, an underlying combined ratio of 80.4%, and net premiums written growth of 25%. Personal Lines had another quarter of elevated catastrophe losses, higher-than-expected non-cat property losses, modest adverse prior year development and continued pressure on the current accident year in personal auto. As John discussed, we are addressing this with aggressive rate and underwriting actions. The bright spot was the expense ratio, which came in lower than the run rate due to our flood business. In our NFIP right your own flood business, we continue to grow and take market share due to our servicing and technology capabilities. And as a result, we received a healthy growth bonus, which was earned this quarter and benefited the expense ratio.
Turning to investments. After-tax net investment income for the quarter was $80.2 million, up 56% from a year ago. This reflects our work over the last 21 months to aggressively manage our fixed income portfolio and build book yield in a rapidly rising interest rate environment. Since the start of the rise in benchmark interest rates 21 months ago, we have put $4.8 billion to work in fixed income and our results are benefiting from these actions. The after-tax yield on the total portfolio was 3.9% for the third quarter, translating to a strong 13.1 points of investment ROE contribution, up from 8.9 points in the third quarter of 2022. Alternative investments reported on a one-quarter lag, generated $5.1 million of after-tax income, up $9.5 million from a year ago's $4.4 million loss.
Our portfolio remains very well positioned. As of September 30, 92% of the portfolio was in fixed income and short-term investments with an effective duration of 4.1 years. Risk assets were approximately 10.6% of the portfolio, up modestly from last quarter, but near the low end of our target range. During the quarter, the average credit rating of our fixed income and short-term investments declined marginally to A+ from AA-. The decrease in the average credit quality was driven by Fitch downgrading the United States long-term issuer default rating to AA+ from AAA in August. In the future, we expect our credit quality to remain in the A+ to AA- range. Importantly, our investment strategy and underlying credit quality is unchanged. We continue to find attractive opportunities to deploy new money into high-quality securities while increasing the portfolio's book yield.
During the quarter, we invested $443 million of new money at an average pretax yield of 6.4%, improving our book yield by 12 basis points to 4.58%. Our book yield has improved by approximately 160 basis points since the start of 2022. As a reminder, every 100 basis points of pretax yield on the entire investment portfolio equates to approximately 260 basis points of ROE. Our capital position remains extremely strong with $2.6 billion of GAAP equity and statutory capital and surplus as of quarter end. Book value per share is up 5% this year or 7% adjusted for dividends. Operating cash flow through September 30 increased 8% to $522 million compared to the first nine months of 2022. Our parent company's cash and investment position totaled $486 million on September 30, above our long-term target of $180 million, providing us with ample dry powder.
Net premiums written to surplus increased to 1.53x driven by strong premium growth while our target operating range for premium to surplus continues to be 1.35 to 1.55x, we'd be comfortable moving above 1.55x for a period of time, and we have the flexibility to downstream capital to our insurance subsidiaries to reduce this ratio if appropriate. Debt to capital was stable at 16%, and we have significant financial flexibility to support our strong growth and execute our strategic initiatives. We did not repurchase any shares during the quarter and have $84.2 million in remaining capacity under our share repurchase authorization. Our view remains at the most attractive opportunities to deploy capital towards organic growth within our insurance operations.
Reflecting our continued profitable growth as an organization, our Board of Directors declared a quarterly dividend of $0.35 per share, an increase of 17%. Shifting to our outlook. For 2023, our full-year expectations have improved modestly compared to last quarter and the start of the year. We continue to expect consistent underwriting margins with an all-in GAAP combined ratio expectation for the year of 96.5%. We are increasing our after-tax net investment income by $10 million to $310 million. Our GAAP combined ratio guidance of 96.5% now includes 6.5 points of catastrophe losses, up 0.5 point from our previous guidance of 6 points and up 2 points from the start of the year. Our guidance, as usual, assumes no additional prior accident year casualty reserve development.
Our after-tax net investment income guidance of $310 million includes an assumption of $20 million in after-tax gains from alternative investments. Although down from $30 million in after-tax gains assumed in last quarter's guidance, the expected income from our fixed income portfolio more than offsets the decline in our assumption for alternatives. Other elements of our guidance remain unchanged with an overall effective tax rate of approximately 21%, with an effective tax rate of 20% for net investment income and 21% for all other items, and weighted average diluted shares of $61 million, which does not reflect any share repurchases we may make under our authorization. Lastly, this is, of course, my last earnings call with Selective. Serving as Selective's CFO for the last seven years has been an honor and a privilege.
I'm very proud of what we have accomplished, notably the significant value we have created for our shareholders. I want to thank John for his extraordinary leadership and our excellent working relationship, leaving Selective is not easy. I also want to thank our Board of Directors, talented employees and tremendous distribution partners who I admire greatly. Thanks also to all of you who cover Selective. I've enjoyed interacting with you and look forward to being able to do the same in a not-too-distant future. Over the long-term, I believe Selective will continue delivering profitable growth, and I look forward to its continued success. Now I'll turn the call back to John.
John Marchioni: Thank you, Mark. Before we open the line for questions, I would like to briefly comment on our CFO transition. First, on behalf of the Board of Directors and our entire team, I want to thank Mark for his many contributions to Selective over the last seven years. Mark has been a trusted partner, and we're pleased he could assist us in a seamless transition, closing the quarter and participating in today's call. We wish Mark well. Tony Harnett, is currently our Chief Accounting Officer, and we are fortunate to have someone of his caliber step into the interim CFO role while we search for a permanent replacement. Importantly, as we stated in our announcement, we do not expect the transition will impact our performance or strategy.
I am confident that Tony and our strong finance team are equipped to support the continued execution of our financial priorities. Overall, Selective is well positioned with excellent prospects going forward. We have the capital strength to support attractive growth opportunities and the tools and organizational capabilities to effectively manage our business through various market cycles. With that, operator, please open the call for questions.
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