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RLI, Inc. (NYSE:RLI)
Q3 2018 Earnings Conference Call
Oct. 18, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome, ladies and gentlemen, to the RLI Corp. Third Quarter Earnings Teleconference. At this time, I'd like to inform you that this conference is being recorded, and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. Before we get started, let me remind everyone that through the course of the teleconference, RLI management may make comments that reflect their intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors, which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including in the annual Form 10-K, which should be reviewed carefully.

The Company has filed a Form 8-K with the Securities and Exchange Commission that contains the press release announcing third quarter results. RLI management may make reference during the call to operating earnings and earnings per share from operations, which are non-GAAP measures of financial results. RLI's operating earnings and earnings per share from operations consist of net earnings after the elimination of after tax realized investment gains or losses. RLI's management believes this measure is useful in gauging core operating performance across reporting periods, but may not be comparable to other company's definitions of operating earnings. The Form 8-K contains reconciliation between operating earnings and net earnings. The Form 8-K and press release are available at the company's website at www.rlicorp.com.

I will now turn the conference over to RLI's Vice President, Corporate Development, Mr. Aaron Jacoby. Please go ahead, sir.

Aaron Jacoby -- Vice President, Corporate Development

Thank you. Good morning to everyone. Welcome to the RLI earnings call for the third quarter of 2018. Joining me on today's call are Jon Michael, Chairman and CEO; Craig Kliethermes, President and Chief Operating Officer; and Tom Brown, Senior Vice President and Chief Financial Officer.

I'm going to turn the call over to Tom first to give some brief opening comments on the quarter's financial results. Then, Craig will talk about operations and market conditions. Next, we'll open the call to questions, and Jon will finish up with some closing comments. Tom?

Tom Brown -- Senior Vice President and Chief Financial Officer

Thanks, Aaron, and good morning, everyone. Last night, we reported operating earnings of $0.46 per share. Other key figures were a topline growth of 8%, a combined ratio of 96, and investment income growth of 15%. I would like to highlight a few events and trends driving these numbers.

First, from a topline perspective, our growth was driven by products across our portfolio. Our casualty segment was up 9%, property was up 14%, and surety was roughly flat due to competitive pressures in energy and commercial. However, miscellaneous exhibited positive growth as a result of recent technology investments. We believe that our broad-based growth is a testament to our diversified business model. Craig will go into further detail on some products trends in a minute.

In the quarter, Hurricane Florence had a $6 million net impact, which is the equivalent of $0.11 per share, or three combined ratio points on an overall basis. Hurricane Michael's obviously a fourth quarter event, and it's too soon to discuss the financial impact. Also impacting the quarter was $10 million of net favorable reserve development on prior accident years, with each of our segments benefiting. Product contributions were fairly broad-based, with notable amounts from our umbrella products, general liability, professional liability, marine, as well as modest reductions to prior year catastrophe reserves. While the net reserve benefit was down on a quarter-only basis, from a year-to-date perspective, favorable development increased underwriting income by $35 million in 2018, compared to last year's $32 million benefit. Despite the Florence impact, our property segment turned in at a 93 combined ratio. Surety continued to shine with a 76 combined , and our casualty segment reported a 101.5 combined ratio.

We've spoken quite a bit in the past about the cautious approach we apply in our reserving practices when it comes to newer products, as well as longer tail lines exhibiting sizable growth. This is noticeable in the casualty segment, where we realized double-digit growth during the past four quarters.

Investment income remained a strong contributor to earnings in the quarter. It was up 15% in the quarter compared to the third quarter of 2017 on a pre-tax basis. Our healthy operating cash flow, which stands at $163 million year-to-date, and growing investment asset base allows us to continue putting new money to work in a higher yield environment without sacrificing credit quality.

Equity and earnings from Maui Jim and Prime were down modestly compared to the third quarter of 2017, but still a meaningful contributor to our overall operating earnings. Through three quarters this year, we stand at 93 combined ratio with 11% topline growth. These are numbers to be proud of and a signal of the strength of our franchise.

And with that, I'll turn it over to Craig. Craig?

Craig Kliethermes -- President and Chief Operating Officer

Thanks, Tom. Good morning, everyone. As Tom mentioned, we were able to report another quarter of profitable growth, despite the impact of Hurricane Florence. Overall, we grew the top line 8.5%, slightly off the pace of more recent quarters. Growth continues to be driven by a combination of newer products gaining scale, underlying rate increases in select products, and organic growth in exposures. We have invested in technology to improve the ease of doing business and increased sales and marketing efforts to broaden relationships and awareness of our products. This has paid off, as we continue to see growth across most of the products in our portfolio. Our consistent underwriting appetite and deep knowledge in our chosen markets provide a safe harbor to our distribution partners and customers from the irrational behavior of many competitors in the marketplace.

I will provide a little more detail by segment. In casualty, we grew topline 9% for the quarter while reporting a small underwriting loss. The underwriting loss is largely driven by our prudent approach to booking faster-growing, newer, or long-tail products. Many of the newer products that we have grown are in the casualty segment and include energy liability, small account binding authority, cyber liability, and our reinsurance relationship with Prime. Reported losses for these newer products have been at or below our loss expectations, but it is still too early to definitively declare success. These products make up about 15% of our casualty premium and about half of the growth year-to-date.

Elsewhere in casually, both our commercial and personal umbrella businesses continued to grow at double-digit rates for the quarter and the year while generating underwriting profits. We have achieved about 5% rate increase in these products for the year. Our professional liability unit, which focuses on design and miscellaneous professionals, turned in very good underwriting results and continued to grow modestly, up 3% for the quarter.

Finally, topline for transportation, while up 8% year-to-date, was down 10% for the quarter, resulting from the loss of a couple of large accounts. We are still upbeat about the opportunities, given our deep knowledge and long track record of success. We continue to achieve meaningful rate increases, with rates up 8% in this business for the quarter. Our underwriters will remain disciplined and be selective as opportunities arise.

In property, we grew 14% for the quarter and reported a 93 combined ratio, despite a 16-point impact from Hurricane Florence. Growth continues across all of our major products in this segment. New business submissions are up in excess of 10%, and the market continues to come to us as a reaction to more recent catastrophe activity, as well as the pain being felt in the London market.

Our wind rates were up about 6% for the quarter, while earthquake rates were closer to flat. From a rate level perspective, we expect that the devastating impact of last week's Hurricane Michael will keep a floor under the current pricing environment. From a focus perspective, our number one priority is to help our affected customers get back on their feet as quickly as possible, and those efforts are already under way.

Our surety segment was effectively flat on the topline while reporting a 76 combined ratio for the quarter. We are still achieving some growth in our transactional surety businesses, while the larger account-driven business remains much more competitive. The improved economy has moderately increased demand for bonds, but we are still challenged by the excess capacity being put to work in this segment. We are continuing to invest in technology, marketing, and the customer experience as ways to widen our moat and add even more value to the deep customer and distribution relationships we have in surety.

Overall, a respectable quarter, given a few headwinds. Market conditions remain relatively stable, with a few pockets where we can get rate in excess of loss cost. On a year-to-date basis, premium was up 11% on a 93 combined ratio, a testament to our underwriting and strength and diversification of our product portfolio. We will continue to stay focused on the things we can control, and take advantage of the opportunities as they arise. Our standard for excellence is very high at RLI. Our associates embrace the challenges we face because we are different, because we are disciplined, and because we are owners. RLI will remain focused on our founding principles of acquiring great talent, sharing rewards, empowering an underwriting culture, and providing exceptional customer service. Results will follow. Thank you.

I'll now turn it back to Aaron to open it up for questions. 

Aaron Jacoby -- Vice President, Corporate Development

Thanks, Craig. We can now open the call up for Q&A.

Questions and Answers:

Operator

Thank you, sir. The question and answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press *1 on your telephone. If you wish to withdraw your question, please press *2. Your question will be taken in the order that it is received. Please stand by for your first question.

Our first question will come from Randy Binner with B. Riley FBR.

Randy Binner -- B. Riley FBR -- Analyst

Hey, good morning. Thanks. I had a couple. The first is on casualty. So, Craig, you mentioned that you have some newer products in energy, some small account and cyber, among others, and that was half the year-to-date growth, and so, you're being prudent there. Is that prudence what drove the underlying loss ratio or the actual year loss take higher in that segment and the casualty segment? Because it's about -- on a linked quarter basis, it's up about 2.5%, which probably stands out to people. It's actually down year-over-year. But is it those activities that's doing it, or is it more on the transportation side?

Craig Kliethermes -- President and Chief Operating Officer

Randy, this is Craig. So, I mean, transportation, I don't think we've changed our booking ratios for over about a year. So, it's not necessarily transportation. But yes, a lot of that growth is coming from those products that we tend to book a little higher starting out. We don't really have a track record in some of those. We do the best we can looking at industry results and people's past track records to try to figure out where to set the initial booking ratio. And a lot of that growth -- as I mentioned, about half of our growth in casualty came out of those products.

Randy Binner -- B. Riley FBR -- Analyst

Okay. So, is that -- as you look forward, would you kind of expect similar levels of growth in those areas?

Craig Kliethermes -- President and Chief Operating Officer

Well, I mean, I can't predict the future. They're not at scale yet, so I would predict further growth. But, as with any growth trajectory, it's in the -- I mean, these products have not been around like -- I mean, they've been around for a couple years. So, these aren't like, products we started this year. So, you're gonna see a typical growth trajectory over the first two or three years where you grow at a pretty rapid pace, and then things start to plateau a bit. Not flat, but the rate of growth starts to slow. So, we would expect the rates of growth on some of these products to start to slow over the next couple years, I would expect.

Randy Binner -- B. Riley FBR -- Analyst

Okay. And then, jumping to -- just on transportation, you mentioned you're getting an 8% rate across the book. Is there any way for you to characterize the rate difference that the two accounts you lost got at their renewal versus what you had wanted?

Craig Kliethermes -- President and Chief Operating Officer

I couldn't tell you the specific of those. We would typically price every account at a level that we would be comfortable, and someone clearly came in underneath us. And usually, we don't lose accounts, just so you know, by a small amount. I mean, our customer service and our knowledge in that space, our claims handling, I think people were willing to pay a difference in that space for us. So, people are not beating us by 5%, 10%, even 15%. A lot of times when we lose those accounts, we lose them by 20%, 25%. And it's not one carrier. It's multiple competition in that space.

Randy Binner -- B. Riley FBR -- Analyst

All right, thank you.

Operator

We will now take our next question from Christopher Campbell with KBW.

Christopher Campbell -- KBW -- Analyst

Yes, hi. Good morning, gentlemen.

Craig Kliethermes -- President and Chief Operating Officer

Morning.

Christopher Campbell -- KBW -- Analyst

I guess my first question is kind of the premium growth mix. How much of the property and casualty growth is rates versus exposure? And then, I guess, kind of where are you seeing the largest opportunities in casualty right now?

Craig Kliethermes -- President and Chief Operating Officer

Christopher, this is Craig. I mean, I would say -- now this is overall, not just in casualty -- but overall, probably about a quarter, 25% or so, 20% to 25% is from rate increases. And then overall, a third or so of this overall business is new products, growth in new exposures and new products. And then the remaining part is growth in exposures of products we've been in for quite some time.

Christopher Campbell -- KBW -- Analyst

Okay, got it. That's very helpful. I guess the second question is just kind of on the interplay between your core loss ratio trends and reserve development year-over-year. So, if I look across each segment, the core loss ratio is improving year-over-year, but then reserve releases are down. I mean, I get part of this can be mix. But I'm thinking, if you're having -- if reserve redundancies are getting thinner because you're increasing your loss mix, then why wouldn't we see that in higher core loss ratio hits? I mean, all else equal.

Craig Kliethermes -- President and Chief Operating Officer

I mean, Chris, I'll answer this question, and Tom might want to jump in. But, the -- I mean, our information would indicate our releases have been down -- are bigger than they have been year-to-date. Certainly for the quarter, it was a lower release than it was last year this quarter. But in aggregate, I think we're ahead of where we were last year.

Tom Brown -- Senior Vice President and Chief Financial Officer

Chris is -- yeah, right. I think Craig caught the tail end of it. For the year-to-date, it is up, as I mentioned earlier. $35 million year-to-date in 2018 compared to $32 million year-to-date last year. And I do think, back to Craig's point, we are cautious on some of those newer products, as well as the longer tail excess type products as well, as they've shown some growth.

Christopher Campbell -- KBW -- Analyst

Got it. And is that why we're seeing the lower core loss ratios year-over-year, is because you guys are like switching the book more to excess? Like raising where you guys attach on the loss?

Craig Kliethermes -- President and Chief Operating Officer

Christopher, I don't think that's necessarily true. I mean, we have seen some growth in our commercial and personal umbrella products, as I mentioned before. But, I don't think that growth is really necessarily outpacing our overall growth in casualty. So, I don't think -- there's no conscious effort to try to move to a higher attachment point or anything like that for our book of business.

Christopher Campbell -- KBW -- Analyst

Okay, got it. Very helpful. And then, can we get some color on what's driving the large tax benefit this quarter, and then should we think about that going forward?

Tom Brown -- Senior Vice President and Chief Financial Officer

Yeah. Chris, it's Tom Brown. The tax benefit is kind of -- obviously starts with the tax reform from last year, which was down to 21%. And then, as we've had little less underwriting, and that's gonna have a little effect because some of the tax preferenced items. And we did have, on the tax preferenced items, as you get a benefit from some of the exercise of options has reduced it. So really, comparatively speaking, we have about $0.01 impact in the third quarter on results of tax reform. And I think if I recall correctly, it's about $0.13 for the nine months year-to-date.

Christopher Campbell -- KBW -- Analyst

Okay, great. And then, just one final one, if I may. So, as we go into the fourth quarter, how should we be thinking about the special dividend, especially given how strong you guys have been growing in property and casualty lines? And will the dividend be lower year-over-year because you guys are gonna need more capital to capitalize on the opportunities that you're seeing in the market?

Jon Michael

Like before, our preference is to use our capital. But if we have excess capital that we can't deploy, we'll pay a special dividend. And that's all we're going to say about that at this time. 

Christopher Campbell -- KBW -- Analyst

Okay. Got it. And is there like, an underwriting leverage that you're targeting, like specifically, I guess, just as your mix shifts, or --

Craig Kliethermes -- President and Chief Operating Officer

It depends on the mix and what our expectations are. So, no. The answer is no.

Christopher Campbell -- KBW -- Analyst

Okay. Well, great. Well, thanks for all the answers. Best of luck for the rest of the year.

Craig Kliethermes -- President and Chief Operating Officer

Thank you.

Operator

We will now take questions from Jeff Schmidt with William Blair.

Jeff Schmidt -- William Blair -- Analyst

Hi. Good morning, everyone. Question on the commercial casualty underlying loss ratio. It looks to be about 70%. And other than last year, if you go historically, it looks to be under 65%. That just seems like a big increase just for what's going on with some of those newer products and the conservative approach there. Is there -- now, I know you'd spoken in the past about kind of some negative legal trends. Is there any more you can say about that or anything you're seeing on that front?

Craig Kliethermes -- President and Chief Operating Officer

Jeff, this is Craig. I mean, again, we are still seeing growth in aggregate or year-to-date in transportation, which is when we did obviously have a few challenges couple of years back. We continue to be cautious there in light of what we saw a couple years ago. We think we're out in front of it, and we've gotten a lot of rates since then. We've done a lot of reunderwriting. Trends have been good so far. But we're more of a wait-and-see attitude in regards to that.

The other product that I mentioned I think we grew is our commercial umbrella and our personal umbrella. Those are excess businesses that I think someone asked previously about. And those have longer tails. And although early returns have been very favorable, given some of the trends we saw in transportation, not that we've seen those come to light in any of the other liability lines, but we're gonna be a little cautious there. And we typically book those fairly conservatively, or at least at a higher booking ratio, so.

Jeff Schmidt -- William Blair -- Analyst

Okay. And then on the transportation book, I know you'd said, I think, in the past quarter too that it was pretty close to profitability. Is it -- rate increases continue at a pretty high rate. Has it achieved profitability yet, or what is your outlook for that?

Craig Kliethermes -- President and Chief Operating Officer

I mean, right now, we believe it's making a small underwriting profit. I mean, we're hopeful -- I think our underwriters believe it's better than that. But like I said, we're gonna take a wait-and-see attitude. So, if our underwriters didn't think they were making money, they have zero incentive to grow it, and they wouldn't. So, I think we have pretty good checks and balances there, and I think we feel pretty good about where we're headed there. Certainly, the rate of 8%, we think that's ahead of loss cost trends there. So, regardless of where the starting point is, there should be some improvement in whatever margin we have there.

Jeff Schmidt -- William Blair -- Analyst

Mm-hmm. Okay, thank you.

Operator

Once again, it is *1 to ask a question. We'll go next to Mark Dwelle with RBC Capital Markets.

Mark Dwelle -- RBC Capital Markets -- Analyst

Yeah, good morning. My esteemed colleagues have taken several pounds at this, but I'm gonna ask a couple more on commercial casualty. Can you just clarify, the loss ratio in the quarter, was there anything in the quarter that was sort of maybe a top-up of prior quarter loss picks or of prior quarter reserving, or is it all confined to the loss picks you're taking just through this quarter? 

Craig Kliethermes -- President and Chief Operating Officer

Mark, this is Craig. Again, there's no -- there's been no material change to any of the loss ratios over the quarter, even, I don't even think, for the whole year. There's been some mix changes, obviously, because -- the products people grow or they see the opportunities, and those vary quarter to quarter and account by account, so. But we have not made any substantial change to any of those ratios. So, a lot of that has to be explained by mix.

Mark Dwelle -- RBC Capital Markets -- Analyst

Okay. I appreciate that. And then, second question, related to the reserve releases in the quarter, obviously they were favorable for all the lines on an aggregate basis. But were there any meaningful reserve additions embedded within any of those net releases?

Tom Brown -- Senior Vice President and Chief Financial Officer

Yeah, Mark, it's Tom Brown. Every quarter, every year, we're gonna have some ups and some downs, but nothing of a meaningful nature that was unfavorable.

Mark Dwelle -- RBC Capital Markets -- Analyst

Okay, thanks. Then, I guess, two other questions that are kind of catastrophe-ish related. First, I guess, on Florence. How did the losses that you experienced there, compare to maybe what you would have expected for a loss of that magnitude or nature? Were you a little better or a little worse? I thought like it was a little better, but certainly interested in your view.

Tom Brown -- Senior Vice President and Chief Financial Officer

Well, Mark, I mean, storm by storm changes a lot there, each one is unique. I mean, we kind of viewed that one as more of a rain and water event. But the construction in North Carolina and South Carolina, as we knew, was not nearly the same construction as you get in Florida. So, you had some roofs peel back, and then the water get in, and you had some water damage to the properties. But the losses overall, I think they were where we thought and about of the size that we would expect, given the size of that storm and how long it stalled out over the area, so.

Mark Dwelle -- RBC Capital Markets -- Analyst

All right. Okay. And then, obviously, it's early on on Michael. But I guess I would be interested in your impression. We've seen a range of industry losses put out, from $4 billion to $10 billion. Do you have any sense sort of across that sort of range, whether it's a little on the lower end or a little on the higher end, at least from your perspective?

Craig Kliethermes -- President and Chief Operating Officer

Mark, it's very difficult for us to estimate an industry event. We're such a small player relative to the whole industry. So, I would hesitate to guess. I mean, we have had over 35 claims come in so far, but they are where we would expect. There's not really been any surprises. I mean, it was a very strong storm. I think some people view that as a remote area, but I think that on the west side of the storm, there was probably more damage than you would typically think, because that's supposed to be the weaker side of the storm. But that's where Panama City and Panama City Beach are, and there's a lot of resorts and hotels, condos, and things like that there. So, I think there's certainly some damage there.

Mark Dwelle -- RBC Capital Markets -- Analyst

Among the claims you've seen so far, are most of them primarily in coastal-ish areas, or are you getting much in the way of claims further inland up in Georgia, the Carolinas, Virginia?

Craig Kliethermes -- President and Chief Operating Officer

This is -- I will tell you, we've had one in Georgia. That's as far north as one's been reported yet. That doesn't mean you're not going to have more, so. It's still early. It's only been eight days, so --

Mark Dwelle -- RBC Capital Markets -- Analyst

I get it. I'm just trying to get a sense of kind of what you've seen so far. I appreciate it. It would be too early for anybody to know.

Craig Kliethermes -- President and Chief Operating Officer

Most of them coastal in the Panama City and Panama City Beach area so far. I mean, Mexico City Beach was not a particularly large town, so. Commercially. 

Mark Dwelle -- RBC Capital Markets -- Analyst

I appreciate the color. Thanks very much.

Operator

And if there are no further questions, I'll now turn the conference back to Mr. Jonathan Michael. 

Jon Michael -- Chairman and Chief Executive Officer

Thank you again for joining us. Good quarter, 8.5% growth in the top line, combined ratio of 96, which included the effect of Florence. Florence and Michael are reminders of what we're in this business for, and demonstrate the value of the insurance industry and getting businesses back in business and homeowners back in their homes. We're proud of the part that we play in that -- supporting that effort for sure. We've got people on the ground there in both areas adjusting claims and getting people back in business and back in their homes. 

So, thank you, and we'll talk to you again next quarter. 

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112, with an ID number of 9217140. This concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect.

Duration: 28 minutes

Call participants:

Aaron Jacoby -- Vice President, Corporate Development

Tom Brown -- Senior Vice President and Chief Financial Officer

Craig Kliethermes -- President and Chief Operating Officer

Jon Michael -- Chairman and Chief Executive Officer

Randy Binner -- B. Riley FBR -- Analyst

Christopher Campbell -- KBW -- Analyst

Jeff Schmidt -- William Blair -- Analyst

Mark Dwelle -- RBC Capital Markets -- Analyst

More RLI analysis

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