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State Auto Financial Corp  (NASDAQ:STFC)
Q4 2018 Earnings Conference Call
Feb. 14, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome and thank you for standing by. At this time all parties are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Today's call is being recorded. If you have any objections, please disconnect at this time. I'd now like to turn the call over to State Auto Financial Corporation, Director of Investor Relations, Natalie Schoolcraft, please go ahead.

Natalie Schoolcraft -- Director of Investor Relations

Thank you, Regina. Good morning, everyone and welcome to our Fourth Quarter 2018 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 Lines, Jason Berkey; Senior Vice President of Commercial Lines and Managing Director of State Auto Labs, Kim Garland; 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 and available on our website stateauto.com under the Investors section.

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

Michael Edward LaRocco -- Chairman, President & CEO

Thank you. Natalie and Happy Valentine's Day everybody. I simply cannot not be more proud of our nearly 1,900 State Auto associates. Over the last three plus years, they worked with passion and a belief that we could transform a traditional regional insurance company into an innovative digital carrier that is built to win in a market that is rapidly changing.

Our 2018 results with our ongoing combined lines of personal and commercial insurance both profitable and growing is confirmation that their hard work has paid off. Over the last three plus years we made a number of bold, strategic decisions regarding technology, products, people and culture. While we made errors along the way as we implemented the changes, we were resilient and remain focused and committed. Today because of those decisions and our persistence, State Auto has a strong foundation that will give us the opportunity to profitably grow at levels that outpace our competition. What we accomplished in 2018 is just the start of our journey, much work remains to be completed.

Our 2018 results were driven primarily by personal insurance. After many years of poor performance, we're once again growing and profitable in personal auto. In homeowners, our recent stretch of strong quarters continued, this line is performing very well. While regional and mutual competitors are turning away from personal lines, we see great opportunity. Our improvement in personal lines was a result of many factors, and a lot of hard work, most impactful was our new digital platform. Products on that platform were completely rebuilt with new sophisticated pricing models and improved segmentation. We took targeted and aggressive rate action and our much improved claims organization significantly reduced loss leakage.

Of course, when I look at the results for personal lines, I still see a great deal of opportunity. We can improve our customer retention. Our aggressive rate action, while needed to get profitable, has impacted our renewals. In a majority of our states though, we feel our rates are adequate across personal insurance. So, we expect our customers will experienced less rate disruption over the year ahead. While our digital technology is clearly a positive differentiator in the market, we have room to get even better. We've built a new custom portal for agents and policyholders, which will make the issuance and service of our digital policies much more effective. This is already launched in four states and today, we released in additional five states. The remaining states will be released in the near future. Our focus on technology will not abate. We'll continue to invest in this area to make the customer experience more efficient and allow us to leverage innovation.

Finally, we'll continue to improve our competitiveness through an ongoing focus on our pricing models and segmentation. We've built a strong data and analytics foundation that will allow us to carefully monitor our profitability and growth. In addition, we've had strong success with our new telematics products and are seeing good growth in our smart home product. The digital platform allows for the efficient implementation of these and other emerging products. Of course, we'll monitor this area very closely.

Our commercial lines showed good improvement throughout the year. In workers' compensation, we remain disciplined and delivered a strong profit. Our farm and ranch line suffered a large single loss in 2018, which accounted for 4.3 points on the combined ratio, yet still performed well. Across the small and middle market commercial, we continue to make changes to our pricing and workflow that we believe will return us to profit in both lines. While we did not achieve a profit, we were able to show modest growth in commercial lines.

Most exciting is that we've completed the rollout of our digital platform, commercial auto and small commercial or BOP. The results are positive and we expect that this platform will achieve the same results we've seen in personal lines. Offering a digital option to agents and small business owners separates us from the competition and creates a true competitive advantage in these lines.

Our expectations are that we can grow small commercial and commercial auto rapidly this year, while also improving our efficiency. The same platform will launch for farm and ranch later this year and for middle market commercials by the end of 2019 or early 2020. The commitment to digital for all our products will give us the opportunity to grow efficiently across a single technology platform. Wanted to mention that our exit of specialty lines is nearly complete. This transition is proceeding efficiently and effectively. The result is that we are now in the lines of business that align with our technical and product strategy. Being a focused organization will give us a greater chance for long-term success.

Our expense ratio remains too high. However, for the most part, it is where we expected at this point in our journey. Personal lines is on the path to a competitive level of expenses as our investment in technology allows us to grow efficiently. Across commercial, we expect to see progress through a combination of growth and operational improvements. We are laser focused on the expense ratio and are confident in our ability to gain efficiency.

We know there is much work ahead. And the next part of our journey will be a challenge. Completing the turnaround has energized our team and empowered us to move forward. We still must achieve profitable growth across all lines of business and do it consistently. What we've achieved in 2018 is just a start. Our confidence comes from our culture. Over the last three years, we built a culture based on the foundation of trust and respect, one that encourages all members of our team to be open and candid to speak up when they see a problem or an opportunity for improvement.

We believe in radical transparency in a company where every voice counts. We honor diversity inclusion of all people and opinions, it's critical to our success. Getting the right technology products, data and analytics are essential, but real success comes when you marry that with the culture that allows your entire team to be part of the process.

With that, I'll turn the call over to Steve.

Steven Eugene English -- Senior VP & CFO

Thanks Mike, and good morning everyone. Our 2018 all in reported results do not tell the story of the progress we have made toward achieving our goal of profitable growth. For the quarter, we reported a $24.5 million net loss for the year $12.8 million of net income. Those results, however, are materially impacted by the new accounting standard relating to equity securities and to a lesser extent the impact of running off our specialty segment. For the quarter and year-to-date on a pre-tax basis net investment losses included $68.5 million and $57.4 million respectively of net unrealized losses. I believe everyone is aware of how the equity markets fell in the fourth quarter of 2018.

We have added a new schedule to the press release detailing net investment gains and losses to assist in understanding the impact on reported earnings of unrealized gains and losses. Net income from operations, as disclosed in our press release, excludes the impact of those unrealized losses as well as realized losses, net of tax and was $29.1 million and $52.1 million for the 2018 fourth quarter and year-to-date respectively. This compares to a year ago when for 2017 in the fourth quarter and year-to-date, we reported net losses from operations of $20.5 million and $53 million respectively.

As a reminder, last year's fourth quarter and year-to-date operating results included a tax charge of $36.4 million related to the enactment of the Tax Cuts and Jobs Act of 2017. The applicable per share amounts are disclosed in our release. The comparative impact of specialty on our results can be assessed by looking at the statutory combined ratios disclosed in our release. The statutory combined ratio for all segments was 95.6% in the quarter, compared to 101.9% in the fourth quarter of 2017. On a year-to-date basis, the statutory combined ratio was 101.2% compared to 107.2% a year ago. We saw substantial improvement in both the quarter and year-to-date results.

Net written premium on this basis was down 1.1% in the quarter and 4.7% for the year, due to the decision to exit specialty lines. Results of our ongoing businesses are better. Our personal and commercial insurance segments reported substantial improvement and statutory combined ratios, while growing net written premiums by 12.5% year-over-year. For the fourth quarter of 2018, the statutory combined ratio for these segments was 92.8% compared to 97.1% a year ago. On a year-to-date basis 2018 improved to 98.6% compared to 102.3% a year ago.

Jason and Kim will cover personal and commercial and greater operational details. So, let's review some of the main drivers of that improved performance. First, the cat loss ratio in the quarter was higher at 2.3 points compared to last year's 0.4 points, which was an extremely light quarter for cats. For the year, we finished at 6.2 points compared to 2017 year-to-date cat loss ratio of 6.8 points. Both of these results we would describe as expected, but keep in mind 2017's results included the impact of Harvey and Irma. We did not experience significant losses for named storms in 2018.

Overall, our non-cat loss ratio improved in 2018 on an accident year basis along with higher levels of favorable prior accident year loss reserve development. For the fourth quarter of 2018, the personal lines accident year non-count -- non-cat loss ratio was up 1.9 points versus fourth quarter of 2017 at 56.3 points. While in 2018, the year-to-date ratio improved by 0.9 points to finish at 57.1 points. For the year, personal auto led the improvement, reporting an accident year non-cat loss ratio of 66.1 points compared to 70.8 points a year ago.

Development of prior-year loss reserves and personal lines was more favorable in 2018 than 2017, both in the quarter and year-to-date. On a year-to-date basis 4.9 points of favorable development was reported compared to 0.3 points a year ago. Personal auto, our largest product line reported 4.8 points more favorable development in 2018, while homeowners reported 2.9 points of favorable development compared to 0.7 points of adverse development in 2017. For commercial lines, the fourth quarter 2018 accident year non-costs -- non-cat loss ratio improved over 10 points finishing at 52.2 points. For the year, improvement was 1.4 points. For the year accident year results improved across all product lines with the exception of middle market commercial. Commercial lines development for the quarter and year-to-date was more favorable than a year ago. Development for the year was favorable across all commercial products at levels reasonably consistent with 2017.

These improvements are the result of the rate, underwriting, product and claim actions undertaken by our personal business associates and reported you by Jason and Kim the past couple of years. While the GAAP expense ratio in the quarter was slightly down versus a year ago, it is up on a year-to-date basis. Variable compensation accruals to both agents and associates are up year-over-year due to the improved results. These plans are a function of profit and growth. We continued the rollout of State Auto Connect (inaudible) personal, small commercial and business auto, while building out the platform for middle market and farm and ranch. Offsetting these increases were reduced salaries and benefits with the exit of specialty and less consulting spend. Beyond our underwriting results, net investment income was up year-to-date from both fixed income and equity securities.

Finally, our specialty segment, as Mike mentioned, has continued to run off as expected. On previous calls, our guidance has been that in the first quarter of 2019 we expect less than $5 million of earned premium with little to none in future quarters and that guidance has not changed. We will continue to disclose the impact of specialty in a runoff segment as there will be some amount of modest expense as we run off reserves and complete the shutdown of systems for example. Having said that, we do not anticipate making detailed disclosures unless something of a material nature occurs.

And with that, I'll turn the call over to Jason.

Jason Earl Berkey -- SVP of Personal Lines

Thanks Steve and good morning everyone. The fourth quarter was another solidly profitable quarter for personal lines with a combined ratio of 94.7%. We are very proud of the efforts of our State Auto associates and our agency partners to deliver profitable growth in personal lines in 2018. Our profitable growth as a result of many important efforts such as the ongoing claims operational improvements, the earning of rate actions to improve profitability and the new business growth seen with the launch of our digital Connect product, all coupled with our favorable loss reserve development in the quarter and for the year.

In total the personal lines loss and LAE ratio was 61.1% for the quarter, with the statutory combined ratio of 94.7% compared to 58.2% and 91.6% respectively in fourth quarter of 2017. For the full year of 2018 personal lines in total had a loss and LAE ratio of 65.6% with a statutory combined ratio of 97% compared to 71.7% and 102.4% respectively in 2017. Our ongoing personal auto rate actions will be more targeted going forward, reflecting the moderating trends now being seen. As our prior aggressive rate actions renew into our book, they continue to put pressure on our retention and on our personal auto PIF growth.

The new business lift from our digital Connect product rollout has somewhat offset the pressure on PIF from the lower retention. At the same time, we continue to see double-digit personal lines premium growth with net written premium up 13.9% in fourth quarter '18 over fourth quarter '17. In January, with the launch of our digital Connect product in North Carolina, we have now launched in all 28 of the states where we currently write personal lines. This completes a tremendous multi-year effort to go digital. As we transform our business and thrive (ph) in an ever more digital world. As Mike mentioned, we've launched and we'll continue to roll out the next generation of our Connect agency portal, Portal 2.0, containing enhancements to improve the agency quoting experience that we believe will help maintain our new business momentum.

Turning now to personal auto. The statutory personal auto loss and LAE ratio in the quarter was 69.4% with a statutory combined ratio of 100.7%, compared to a 74% and a 105.5% respectively in fourth quarter '17. We closely watch the rate of increase in our premium versus the rate of increase of loss cost to measure the improvement in our profitability. In fourth quarter '18, the change in 12 month rolling earned premium per vehicle was greater than the change in our annual loss cost. In addition, on our legacy personal auto book of business, the bodily injury frequency trend continued to be favorable in the quarter.

The auto loss ratio on both our Connect digital product and our legacy product improved due to the earn in of rate actions, along with claims operational improvements in our care organization. In financial terms, our personal auto performance is as follows. Fourth quarter '18 net written premium for personal auto was up 8.3% versus fourth quarter of '17. Quotes in the quarter were up approximately 19%. New business counts for the quarter were down 5.6% over fourth quarter '17, as a result of a lower close rate due to the ongoing targeted rate actions in personal auto. PIF finished 1.6% above the fourth quarter '17 PIF level. Retention was 69.5% and continues to be pressured by the earn in of our aggressive rate actions to restore profitability.

Moving on to homeowners, where we continue to see good opportunity for profitable growth. Homeowners policies in force increased 13.5% over fourth quarter '17 with new business lift from the launch of our digital product. Quotes were up 38% in the quarter over fourth quarter '17. New business accounts in the quarter were up 24% over fourth quarter '17 and homeowners retention ended the year at roughly 77%. In financial terms, our homeowners performance is as follows. Fourth quarter '18 homeowners net written premium increased 18.8% versus fourth quarter '17. The fourth quarter '18 loss and LAE ratio was 47.2% with a combined ratio of 83.9% compared to 33.9% and 70.1% respectively in fourth quarter '17.

Homeowners cat loss and ALAE ratio for fourth quarter '18 was 4.8 points, which is 4.5 points higher than the fourth quarter '17 homeowners cat loss and ALAE ratio of 0.3%. 4 points of the fourth quarter '18 homeowners cat loss and ALAE ratio are from Hurricane Michael. The fourth quarter ' 18 non-cat loss and ALAE ratio of 36.9% was 9.6 points higher than the 27.3% in fourth quarter '17, reflecting additional weather related claims and large losses in the fourth quarter of '18 versus fourth quarter of '17.

In conclusion, our personals lines storyline for the quarter can be summarized as: one, our personal auto rate actions continue to renew into our book and place pressure on both auto and home retention. Secondly, moderation in our personal auto loss trends continues as a result of our ongoing claims operational improvements and then finally homeowners combined ratio for the quarter was impacted by higher cat and non-cat weather-related losses than in 2017, resulting in a combined ratio of 83.9%. Needless to say, I'm proud of the team for our fourth quarter and 2018 results. We realize we have much room to improve, but we enter 2019 with a strong foundation and great confidence.

With that, I'll turn the call over to the anchor of our relay team Kim Garland to discuss commercial lines results.

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

Thanks Jason. Hello everybody. The commercial results are as follows. 4Q '18 combined ratio of 90.4% versus 105.2% in 4Q '17 and a 4Q '18 written premium increase of 3.9% versus 4Q '17. For the commercial business as a whole, the story is the statutory non-cat loss and ALAE ratio was 15.7 points lower in 4Q '18 versus 4Q '17, mainly driven by the current accident year loss ratio improving by 10.7 points.

Commercial loss ratios continue to be where we generally need them to be and commercial expense ratios are not and this is our biggest inhibitor to overall profitability. The 4Q '18 statutory commercial expense ratio of 45.1% was 0.5 points higher than 4Q '17 due to the ongoing technology investment in Connect and higher incentive compensation estimates. Our continued improved performance by our middle market business, 4Q '18 written premium growth of 8.1% versus 4Q '17, driven by new business premium growth of 37% in 4Q '18 versus 4Q '17. This completes the second consecutive year of over 30% new business growth for our middle market business, early signs of Commercial Connect new business traction for BOP commercial auto and commercial umbrella and the continued build-out of the third and final wave of our Connect build, the build out of the core systems for farm and ranch, CPP and workers compensation.

To give you an update on Commercial Connect, Straight Through processing rates continue to improve each month. Small business new business production is increasing. Small business quotes from our personal lines agents are up around 150% for January 2019 versus January 2018 and they are up 78% for January 2019 (ph) versus December 2018. Small business quotes from our commercial lines agents are up 39% for January 2019 versus December 2018. And January 2019 was our first 1,000 new business policy month on Commercial Connect.

As discussed last quarter, the benefits of Commercial Connect with its no touch model needed to get an acceptable expense ratio and (inaudible) model needed to get consistently better loss ratios are so significant that it is worth fighting through the transition period. We are excited that we seem to be nearing the end of this transition period and are starting to see traction with Commercial Connect. The commercial business results by product line are as follows. I'll focus on the loss in LAE results for each product line as the acquisition and operating expense ratios for every product line are poor as previously noted.

Commercial auto; the commercial auto loss and LAE ratio in 4Q '18 is 55.4%, which is a 8.1 point improvement versus 4Q '17. This improvement is primarily driven by the current accident year loss ratio being 10.2 points lower than the same period last year. Commercial auto written premium in 4Q '18 was up 8.4% versus 4Q '17. We continue to be extremely pleased with our progress in commercial auto. The combined ratio of 107.7% for commercial auto includes 11.9 points of IT expense, reflecting the Connect spend an additional 5.2 points for the increase in the estimate of incentive compensation. The engine for commercial auto has been created and is working. Going forward, we just need to put more volume on the Connect platform and continue to be fanatical about continuing -- about continually improving our pricing models, our operations and the usability of our system.

Small commercial package; the small commercial package statutory loss in LAE ratio in 4Q '18 is 42.8%, which is a 10-point improvement versus 4Q '17 driven by the current accident year loss ratio being 11.3 points better this year. Small commercial package written premium in 4Q '18 was down 6.6% versus 4Q '17, lower BOP new business volumes in Connect drove the decline, but as discussed earlier, we are starting to see traction in Commercial Connect new business volumes.

Middle market commercial; the middle market statutory loss and LAE ratio in 4Q '18 is 37.9% which is 15.6 points lower than 4Q '17. Middle market written premium in 4Q '18 was up 8.1% versus 4Q '17. Finishing the rollout of Connect in small commercial for new business continues to free up time for our commercial underwriters to focus on middle market commercial. As discussed earlier, 2018 was our second consecutive year of above 30% new business growth in middle market.

Workers' compensation; the workers' compensation statutory loss in LAE ratio in 4Q '18 is 41.4%, which is 21.8 points lower than 4Q '17. This level of loss and LAE ratio produces a great combined ratio for this product line, 73.6% for the quarter. We are continuing to be proud of the high level of discipline and operational execution our entire workers' compensation team continues to show during this phase of the market cycle. Workers' compensation written premiums in 4Q '18 were up 4.1% versus 4Q '17.

Farm and ranch; the farm and ranch statutory loss in LAE ratio in 4Q '18 is 50.2% which is a 30.7 points lower than the 80.9% in 4Q '17. The main driver of this improvement was a 28.9 points lower current accident year loss ratio in 4Q' 18 versus 4Q '17. You will also see a 47.6% expense ratio for farm and ranch this quarter. This includes 10.5 expense ratio points of technology spend, which reflects the cost of the core buildout of farm and ranch Connect. In 2018, our farm and ranch team has absorbed both the large 2Q hog confinement loss and the elevated IT expense ratios for the Connect build and still managed to achieve a 2018 combined ratio of 100%. I continue to be incredibly proud of the team's grit and performance this year. Farm and ranch written premium in 4Q '18 was up 7.2% versus 4Q '17. Our rate and underwriting actions have slowed the growth rate of farm and ranch.

Commercial lines' raw (ph) numbers for 2018 of 3.6% written premium growth and 101.2 point combined ratio mask how important a good year it was for the commercial business at State Auto. We completed the rollout Commercial Connect in commercial auto with the exception of Virginia, which is pending DOI approval, BOP and commercial umbrella and absorb this technology expense without seeing the benefits of the additional volume that will come in future years. We have made it toward the end of the transition period for adoption of Commercial Connect and are starting to see traction with our agents.

Our middle market business continued to grow even before it gets to receive the benefits of Connect. Our workers' compensation business had a sub-90 combined ratio and grew in tough market conditions, also before it got the benefits of Connect. And our farm and ranch business absorbed the large hog confinement loss, higher expense ratios from the Connect build and we're still able to grow and hit a 100% combined ratio.

I am incredibly proud of the work of the commercial team in 2018. They laid a lot of the groundwork this year that we believe will pay off in future years.

And with that, we'll open the line for questions.

Questions and Answers:

Operator

(Operator Instructions) Our first question will come from the line of Paul Newsome with Sandler O'Neill. Please go ahead.

Paul Newsome -- Sandler O'Neill -- Analyst

Good morning, congratulations on the quarter and the year.

Michael Edward LaRocco -- Chairman, President & CEO

Thanks.

Paul Newsome -- Sandler O'Neill -- Analyst

Wanted to ask about the favorable reserve development, maybe just a few more details. It seems to have come back quite a lot both this quarter and for the year, and if there's just sort of any details you can tell us about -- it's just -- one of the things just sort of struck me in magnitude, it seems to be a fairly big number for a personal lines business where you don't typically see a lot of development one way or the other. Anything unusual in there? Anything -- and obviously the reserving is different, but maybe just any details you can give us, that'd great.

Steven Eugene English -- Senior VP & CFO

Sure, Paul. This is Steve. I think what's running through everyone's mind is the sustainability of that level of development. And certainly as you mentioned, if you follow us for many years at just the industry, we would characterize as the development that we had here in 2018 and this really also extends somewhat to commercial lines as well as being higher levels than what we had kind of historically experienced in our standard lines businesses.

I think what's important to understand is where this development is coming from and what's been going on operationally inside the Company. So for example in personal lines, a lot of that development is coming from more -- some of the more recent accident years primarily 2017. Commercial lines, it goes back a little bit further, it's a little bit longer-tail business. But what's really important here is starting three years ago the claims organization was being rebuilt and has made tremendous progress, but on the reserving side, as you might expect, we were cautious and so we're starting to see more confidence and what and how those numbers are rolling through the analysis and adjusting those prior picks accordingly.

I would also say, while we don't plan on a certain amount of development, we haven't changed our reserving philosophy, which is to be a little north of where our actuaries pick and with a reasonable expectation that we will report favorable development. But in the event something turns on as unexpected, we'll have that cushion there to protect the balance sheet.

Michael Edward LaRocco -- Chairman, President & CEO

Yeah, this is -- Paul, this is Mike, just to tag on to the observation Steve made and kind of put an explanation point on it. I think a couple of things about where we are today. We've been talking over the last couple of calls about reducing both underwriting leakage and loss leakage. When you talk about those things, it's very difficult and also risky to say it's going to get us back a point or 2 points or 5 points. We knew for certain that in both our underwriting area and in our claims area, there was a lot of opportunity to get our averages down to reduce our cycle times and that was going to come back and give us a benefit at some point, but you can't adjust reserves earlier until you actually see that happening. And as Steve said, we now have that confidence.

What's interesting for me going forward is that our -- as we look at reserves that we're making now, without the specialty lines there's -- we believe as we look at auto, home, small, middle market commercial with perhaps the exception of workers' comp, which can certainly have a bit of a longer tail that we think consistency will prove out over time. And whether that is a favorable development of lesser amount or not obviously we can't even begin to suggest that, but we're very confident with our -- with the approach that we take and the ability to consistently and conservatively reflect that in our reserve things.

My second question is about investment income, because you've got a lot of moving parts. Could you give a sense of sort of the outlook for investment income? We've got probably a little bit higher rates, we've got runoff business, which usually pulls cash flow down in a growing business. So, I'm just not certain which direction ultimately the cash flows will go especially in the current interest rate environment? Do you have any thoughts on that?

Scott Alan Jones -- Chief Investment Officer and Vice President

Yeah, Paul, this is Scott. I can tell you right now in the market what we're seeing on new money yields is in the range of 3.25 and 3.75, depending on which particular sector we might be looking at in the fixed income market, which of those yields are higher than our current book yields. So that's going to help to bring book yield up a little bit. In regard to your comments on the cash flows, also something we keep an eye on and I think Steve can add some color on that.

Steven Eugene English -- Senior VP & CFO

So Paul, one of the things -- you're right on some of your comments you made in regards to what's going on in our standard lines book. I think one of the things to keep in mind in terms of specialty. Shutting down specialty obviously shut off the flow of incoming premium and with longer-tail business. We are going to be in the mode of paying down those reserves. So in terms of -- Scott was kind of giving you the yield perspective in terms of the absolute base to apply that yield against. I think you just need to take a look at the components of the reserves and given that we don't give guidance on this make your own call as to the run-off of those, but certainly from a cash flow perspective, we'll be paying down those reserves and that will eat into the investment base somewhat.

Paul Newsome -- Sandler O'Neill -- Analyst

Thank you.

Operator

(Operator Instructions) Our next question will come from the line of Christopher Campbell with KBW. Please go ahead.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Hi, good morning. Congrats on the quarter.

Michael Edward LaRocco -- Chairman, President & CEO

Good morning Chris.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

I guess my first question is just. I'm trying to think of the expense ratio from looking at the overall (inaudible) number you guys are at a 36.7 versus 35.1 -- and these are the annual numbers versus a 35.1 last year. So 160 bps increase. Now I thought last year you guys paid a higher of two bonuses, which drove the expense ratio up last year, so I was kind of expecting that to kind of roll off this year. So I guess just what's driving it the other way?

Steven Eugene English -- Senior VP & CFO

Yeah, Chris, this is Steve. So you're exactly right. A year ago we discussed on our, what I'll call our broader agency contingent plan, we did make an election because we were in a transition year, going from the old to the new plan and you're exactly right on that.

In terms of this year on the new plan, with the growth and the underlying profit on a dollar basis though that new plan paid out roughly the same kind of dollars, but we also had some other contingent plans in place also that resulted in the some dollar expense as well. Now let's flip to the associate side, the associates -- the bonus plans are also a matrix function of growth and profit. And I don't have in my head, I'm looking around at anyone that might have in their head, but the accruals for that in 2018 was quite a bit larger than 2017, if you just look at the growth in the combined ratio. So those two are pushing it the other way.

Scott Alan Jones -- Chief Investment Officer and Vice President

Okay, that makes sense. And then I guess I just have a few on commercial, these are probably for Kim. First one is commercial auto, lots of competitors have been adding reserves and bumping up accident year '18 loss rates (ph). Your core loss ratio is down 600 bps and reserve releases are flat. I guess you guys are not seeing any pressure in terms of like higher medical cost and litigation in the commercial auto book?

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

I think it's probably two offsetting pressures is how I would describe it. I think the industry trends are the industry trends and so we're subject to those pressures. But I think a lot of -- two things on our own side, we went through this sort of three-year period of really intensely be underwriting and reshaping the book and I think those benefits are continuing to flow in.

And on the Commercial Connect side, our commercial auto pricing model was completely rebuilt and redesigned. And so I think those two things are sort of giving us positive pressure in the face of sort of industry upward pressure. We are bullish on commercial auto, we want to ride it. Again as I said before, we think we got the engine set up right. And we think that's a lot of pay-off from the work that had been done over the prior three to four years.

Michael Edward LaRocco -- Chairman, President & CEO

Yeah, Chris, this is Mike. Just again put a little emphasis on something. I think until you kind of see inside that the things that in terms of the commercial auto product and how significantly it's been rebuilt from a model and tiering standpoint versus what didn't exist prior to do a direct comparison of what we experienced in the commercial auto space versus our competitors. This could be true over the last couple of years in personal lines as well. It's difficult because the amount of action we took to clean up a pretty broken product kind of put us in a different place. So we are very excited about commercial auto.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Got it. And you're not seeing any like claims durations like extending or anything like that or just to kind of like increased like the short-term demands, where they were like the attorneys will just wait until last minute and then dump everything on you guys?

Michael Edward LaRocco -- Chairman, President & CEO

I think that there's always those types of potential pressures in the marketplace. But our claims organization again, the way that we've rebuilt that it's a much more aggressive organization in terms of taking action, stepping in on litigation and not just simply suddenly being willing to go to court. We even split our claims organization in terms of putting the right focus on the right people on commercial versus personal and property damage versus liability. And I think, again some of those fundamental things that were done has been important.

I do want to comment that when -- we do worry about and think a lot about just kind of general inflation that's coming to the market, whether it's medical inflation. I actually worry, at least in the short term more about property damage, paint materials, labor costs. I think there's a real inflationary trend coming through the states. So I think we have to watch that very carefully from a rate pick standpoint that we're very aware of that and we're not a late reactor to those types of trends.

So, I don't want our answer to suggest that we don't see or have concern around inflationary piece of what you're talking about. The reason we're not seeing it as much in these results I think is that there are a lot of fixes put in place, both operationally underwriting, pricing and in the claims organization that impact where we are versus the competition, but the worry about inflation is something that we all have to be careful about.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Got it. That makes sense. A question on small commercial. Net written premiums were down 7%, but the combined ratio was like an 89.6% or something like that. I guess my question is if you're getting at sub-90s combined ratio. Why not write more of it? Was kind of just 4Q a blip or I guess just thoughts around small commercial in general right now would be helpful.

Michael Edward LaRocco -- Chairman, President & CEO

And thus, Chris, the reason we call Kim the anchor, but we're all anxious to hear his answer.

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

I'm getting crushed in the room right now (inaudible) you guys on the phone. All right, we want to write a ton of small commercial. I think the phenomena that probably describes that is when we implemented Connect, we went from a model in pre-Connect agents and underwriters sort of touched and discussed every policy even the very small ones. In a Connect world 60 right now I think roughly two-thirds go straight through without being touched, a third of being touched. And it's -- the price is the price, right. So they don't go back and forth with the agents for credits and debits and those sorts of things. And so, of all the sort of changes that we have made, we have made -- this is as dramatic any one of them for getting a set of agents who are used to doing business with us a certain way, getting them used to doing business with us in a new way. So that's sort of -- that's taken some time and the new business accounts as we've discussed on prior quarters for Commercial Connect have gone down especially for BOP.

What we are seeing and that's why we're so excited about January is there's really two groups that are having to get used to it. So, more traditional personal lines agents didn't write a lot of commercial either in general or with us. And so, the system is familiar with them by entered data, it's automated and so they are writing business with us and so we're super -- the fact that their quote volumes are up 150% in January seems to be the month where sort of the switches flipped. And so for our sales team and our agents just 78% in January says, OK that's on an upward trajectory for that set of personal lines agents who commercial is just new to in general.

The second set of agents is commercial agents who were used to doing business with us a certain way. And so they were also up in January before and that was the base where we had our decline of most of our business came through those agents, and so we went down a little bit. And now we're starting to head back up because they're getting used to it. And so having everybody get used to that is going up. So not only the quotes are up and the new business volumes are up and that is sort of the starting point.

As I say every quarter, our expense ratio is our problem and the only -- one of the only pass for us and especially in BOP is to put a lot of volume on this platform that we invested a lot of money in. So we're super bullish that we're at the end of getting through that transition period with both groups of agents.

Michael Edward LaRocco -- Chairman, President & CEO

And remember we obviously kid him a little bit, but we always knew small commercial BOP and commercial are going to come a little late to the party because this issue of who you are in the marketplace really does matter. It's different as Kim has already laid out across different agents, but you will see us now some of our commercial auto, a reasonable amount of it is mono-line commercial auto, which we're completely fine with. We love the package business, but that is not something that State Auto would have -- our agents would have traditionally seen us as.

If you look at the BOP business, some of the BOP stuff we're writing together prior what didn't really look like BOP. So, we've now kind of built the platform, the platform is working the acceptance of it has been very good. And now this message of who we are in the marketplace that we really want the BOP and commercial auto, and we're committed to it consistently for the long term is the reason that we're, as Kim said, pretty excited about the future.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Great, well thanks for all of the answers. Best of luck in 2019.

Michael Edward LaRocco -- Chairman, President & CEO

Thanks, Chris.

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

Thank you.

Operator

(Operator Instructions) We have a question from the line of Christopher Campbell with KBW. Please go ahead.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Hi, I have to go again sorry I wanted to ask a few more, but I did want to take up all the time.

Michael Edward LaRocco -- Chairman, President & CEO

It's all right.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Okay, great. Just another one from Kim, sorry to fire on you today. Just I'm in the commercial frame of mind. Workers' comp, your annual core loss ratio was I guess like 260 bps lower year-over-year and I think you're with just you know mandatory rate declines in your states, loss picks would increase all else equal. I guess, can you just give us a color on rates and then loss or loss cost frequency and severity trends?

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

So I think we see kind of things exactly as you described. We -- there's really I think two things around workers' compensation that are worth talking about. One as sort of the loss costs go down, our team fights very hard so that the rates don't go down as much so that we don't sort of follow the world down into a bad spiral. So, we emphasize that with them. The second thing -- there's probably three things. We really believe that we have a sort of a claims advantage in workers' compensation and so as loss costs go down, the -- how good or not you are at claims matters more and more because the margin for error gets thinner and thinner. And so how we sort of recognize, how we actively manage them, we think is a -- we actually think we are in industry-leading in that space. So we think that's probably an advantage for us, that's the second part of it.

And the third part is we have historically not taken full advantage of putting sort of predictive models on top of these loss cost things just sort of more general tiering in trying to underwrite that and historically we have probably missed out on better quality workers' compensation business because our pricing was not as segmented as it probably could have been or should have been. And so that is in the pipeline to go in 2019.

So in some ways, these pressures can be concerning and they make it harder for everyone, but we kind of look at it a bit optimistically when those pressures make it harder for everyone. The competitors who are better at this stuff we think will thrive while other sort of experience pain. But to your sort of core question, I think we see the trends very similar to what everybody else is seeing.

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Okay, and so would that imply like you would be thinking about a higher loss pick in '18?

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

No, well, I'm looking around to see if I'm allowed to say. We are saying -- we -- the team's direction is to not let there be deterioration in the loss ratio, right. And how you do that -- how we believe to do that as (inaudible) on rates and risk selection and predictive models and all of that right. Whether they can execute it is probably a harder ask in 2019 and it wasn't 2018, but..

Michael Edward LaRocco -- Chairman, President & CEO

I'd be a little bit harsher critic of them of the industry, right, because what we're not going to do is follow some bad players down the rattle in terms of rate decreases. We just got

-- it's just not who we are. I think secondly, there's ways to win by retaining your discipline. Will we possibly miss some growth opportunities? Potentially. I think with the integration of workers' comp more closely into our small commercial space, I think you're going to see opportunities there, but in workers' compensation, we don't believe in sacrificing profitability for the growth that we see bad people do and we're just not going to go down that path.

Christopher Campbell -- KBW -- Analyst

Got it. It make a lot of sense. And then just one final one, if I may, just a quick numbers one. Why weren't there any investment expenses this quarter?

Steven Eugene English -- Senior VP & CFO

Yeah. is good catch there. That's a function of -- we did some reallocation that we caught up on here in the fourth quarter. So, on a go-forward basis, obviously, we had investment expenses, but when we cleaned that up, it netted out. So $1 million to $1.2 million of investment expenses on an annual basis is still the run rate.

Christopher Campbell -- KBW -- Analyst

Okay, great, well thanks. Thanks a lot for getting a second set of questions in and best of luck in '19.

Michael Edward LaRocco -- Chairman, President & CEO

Okay, thanks.

Operator

At this time there are no further questions, I will turn the conference back over to management for any further remarks.

Michael Edward LaRocco -- Chairman, President & CEO

Just real quick, Natalie. I want to thank everybody for your questions and participation today. We're really proud of where we're at and I'll let Natalie close it out.

Natalie Schoolcraft -- Director of Investor Relations

Thanks Mike, thanks everyone for your questions. We want to thank you all 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 first quarter earnings call, which is currently scheduled for Thursday, May 2, 2019. Thank you and have a wonderful day.

Operator

Ladies and gentlemen, this concludes today's call. Thank you all for joining and you may now disconnect.

Duration: 53 minutes

Call participants:

Natalie Schoolcraft -- Director of Investor Relations

Michael Edward LaRocco -- Chairman, President & CEO

Steven Eugene English -- Senior VP & CFO

Jason Earl Berkey -- SVP of Personal Lines

Kim Burton Garland -- Senior VP of Commercial Lines & MD of State Auto labs

Paul Newsome -- Sandler O'Neill -- Analyst

Scott Alan Jones -- Chief Investment Officer and Vice President

Christopher Campbell -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Christopher Campbell -- KBW -- Analyst

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