Ryan Specialty Holdings, Inc. (RYAN) Earnings Call Transcript & Summary

All right. I think we'll get started. So it's my pleasure to welcome the Ryan Specialty leadership team, including Pat Ryan, CEO; Jeremiah Bickham, CFO; Miles Wuller, CEO of Ryan Specialty Underwriting Managers and Tim Turner, President. So for those of you who may be not as familiar with the story, Ryan is a unique wholesale broker that has delivered double-digit organic growth for many years and is a leader in the excess and surplus lines market. So with that, I'd like to hand it over to Pat for some opening remarks about the business.

Thanks, Rob. So, we felt we had a solid third quarter with 13.7% organic revenue growth and the vital signs of the E&S market are really strong. Rates are hardening, continuing to harden and in most lines particularly in property and you all have read a lot about what's expected with the property lines with [ 1/1 ] renewals, reinsurance renewals was going to be a real imbalance of supply and demand. There's going to be a lot more demand than there is supply capital. Our property practice is really very strong practice, represents multiple lines within our property lines within that property practice. And that both multiple lines have been growing well over the last 12 years, but we look for some very significant tailwinds in the property market with 1/1 renewals. And so overall an answer to the question of how large is our property practice? We'd like to say that in reference of public documentation as to what industry represented that, approximately 30% of E&S market is reflected in property and that would be representative of our position as well. The tailwinds are going to be strong, but there will be this imbalance of supply and demand. So, as you watch for 1/1 renewals, you're going to see some people signing-up early because they're -- where they won't get enough capacity, others are waiting. So, it's very likely that most people will know how much capacity they have until shortly after 1/1 and some of the Pundits believe that it could be 15, 110 even up to 115 before it's all finalized. But it's going to be an important factor and a sizable part of our business. We feel we're well-positioned to get -- to retain the capital that we have in property expiring at 12/31. And that we will have significant new opportunities of people out are partnering with us in other lines who have fundamentally given us a commitment that they're going to provide more capital to us. But nobody knows exactly how much capital we're getting and more know until after 1/1. But very importantly, with E&S market have been as vital as it is our submission rates are strong. They continue to be strong across all lines. So when we talked about E&S slowdown, it was an inadvertent communication there. E&S market is very robust, but it bounces back-and-forth and we referenced one month period what I can do that again because it confuse people. But our founding thesis and our competitive position is strong as has ever been and we've had a unique beginning of our first 12 years. We've had double-digit organic growth through that 12-year period. For the year, there are quarters where you don't get that and certainly that is reflected in our guidance for the rest of the year. But the important thing is that we're providing real value-add to our retail brokers and it's never been stronger. We've had a lot of M&A activity that's been really, really beneficial to our overall growth. Secular drivers that were in the founding thesis, a panel consolidation, retail broking rollout, the growth in delegated authority underwriting admin and distribution are all very strong going into '23. So, what we say is, you can take a quarter and extrapolate it into a year. In our niche, you got to take the whole year, there will be some bouncing around by quarter. So I think that conclude my opening remarks, Rob and we'd welcome the Q&A.

Great. At the current pace, the E&S market is on-track to surpass $100 billion in annual premiums in 2022, marking the fifth consecutive year of double digit growth. Do you expect the market can sustain this level of growth and what do you see as the primary drivers?

Yes, I'd like to turn that over to Tim and Miles. Tim, like to start.

Sure. We do see that growth sustainable to go into '23. As we've talked about many times, there's -- while the overall growth continues there is niche firming phenomena continue to occur in North America, lot of it due to losses tied to social inflation and global warming cat property being the latest one. Most experts predict that cat property rates will go up 50% to 100% and that's on the existing book. So shifting flow into our channel will obviously drive growth even further. So we see lots of opportunity in '23.

Yes, on the delegated underwriting side in addition to the increasing landscape -- increased landscape, our track record in diverse portfolio continues to attract more capital from existing carriers and so that'll be a source of ongoing support and growth as we manage more carrier capital.

What do you view as the primary risk the E&S market growth? And could you give us an update on your view of some of the early signs of additional competition entering the market that you flagged earlier in the year?

Well, I'll start with the competition and then ask Miles and Tim. The competition is really ourselves just like playing golf. If we deliver retail broker needs, we are executing our competition. We have good competitors, [indiscernible] versus private companies are very formidable competitor. There is an imbalance -- non-imbalance, 3 large wholesale brokers and then third is the smaller one. The large it's called addition, large wholesale broker consolidation is pretty much [indiscernible] there are some smaller ones, medium-size I should say left. No, there's not opportunity to create a fourth through a roll-up. So it's really -- we enabled, solve the problem for the retail broker. And when we're on our A game, we do that. And if we don't solve that problem, I find I felt solve with themselves one-way or another. You guys want to pick-up the rest of it.

Sure. Most classes of business that we succeed in are loss leaders in the reinsurance world. So there is a direct tie to unprofitability and the standard market. The admitted markets have filed rates, terms and conditions and when they can't achieve that profitably, they have no choice but to dump the business and the non-renew it and that's the role we play. So that's continuing to happen across 8 or 10 practice group vertical in our industry, lots of shedding and dumping of business that's simply unprofitable in the admitted market, cat property being the latest one and the most obvious one, but it's happening in health care, it's happening in transportation, the number one loss leader in the reinsurance world. So we have big investments and that's in 3 segments and transportation is a further illustration not just trucking, but livery, shared economy, that business continues to just pour in, construction being a big one, especially in the infrastructure side of it. And I think Miles will give you a little more color on how that connectivity works in broking and underwriting. So in these high hazard niches that we broker and we build facilities to strengthen the trading relationship and more value-add in our trade with the retail brokers.

Well, and Rob, to pick up on I think your question is what what's driving increased competition by carrier in this space. So I think, we'll just address the phenomenon beside that, so D&O is one of those spaces where there was a class that was deeply -- the pricing was deeply suppressed 3 years, it achieved substantial rate over the last 3 years. It was a relatively benign Class Action lawsuit market over the last 3 years. And so those 3 years of hardening increased rate adequacy and broad capital market and it intersected with a slowdown of the capital markets where IPO's and [ SPACS ] closed down in Q1 of this year and that was a phenomenon we discussed it thoroughly at Q3 where you had increased capacity in this space and diminished opportunities. And so we thoroughly cover that, there's very few other examples we give, we remain in a cyclical hard market here, excuse me, structural hard market here where these spaces continue to come into the E&S space. On the cyber side, we just touched on that one, that is a space where again substantial growth in the last several years and rate and opportunity, the market doubled in size last year and that was met by 200% growth in the E&S space and only 20% growth in admitted space. So there is incremental capacity coming in, good risk management, loss control at the carrier at the corporate-level has improved loss results, but again it is a space that we see just early penetration much when only about 10% of cyber insured in the US today. So even though there might be modest pricing pressure over the next couple of years, the overall addressable market is substantial.

And I think you touched on pieces of it, but can you discuss the E&S pricing environment and how long you see that being sustained?

Sure. Well, obviously with the hard market, you've got both phenomenon, you have the dumping in the shedding of the business, so the volume itself is driving the market, but we're getting rate in almost every one of these high hazard niches and form tightening as well. We'll see that in property in '23, but, yes, absolutely we're getting rate and volume at the same time.

So your expectations have been for the company to grow double-digits annually on an organic basis, but as you guys have touched on, you've called out some headwinds affecting the business recently. Can you walk us through those headwinds and update us on where those are trending compared to the expectations you had laid out?

Definitely. So on our Q3 call, we spent a lot of time talking about a few headwinds for our organic growth that affected Q3 that we also expect to have a measurable impact in Q4. In order from least severe to most severe, we talked a lot about our construction practice, which primarily shows up in our wholesale brokerage specialty, we talked about M&A related risks that primarily shows up in our Underwriting Managers and then we talked about public D&O which is actually in wholesale brokerage and underwriting managers. What we witnessed in Q3 in the most significant headwind public D&O was a rapid deceleration of rate for reasons that Miles just mentioned and some of the business that was historically not in the wholesale channel, leaving the wholesale channel. And what we've assumed in Q4, is that all those headwinds either persist or get worse and no regrets by the way on the guidance that we gave in the implication for Q4 as we sit here today on December 5th, I think we're going to land spot on within that, within that guide range. And look I also think that, these headwinds are going to persist at least like D&O for example to through call it the first half of '23. But the important thing to remember is what Pat said earlier, don't look at a quarter and extrapolate it, certainly don't look at a quarter like Q4 and think that that's a new long-term trend. What we said on the Q3 call was that we're still all the long-term, the secular growth drivers that got us here and underpin this sort of baseline of double-digit organic growth all intact and while we are certainly going to have a bumpy Q4 of 2022, probably going to have some noise in H1 of '23, what we said about being a double-digit organic grower that still applies even to 2023.

And with respect to D&O, do you have a view on the rationality of these pricing decreases and how quickly if at all do you think the market can stabilize?

Miles, why don't you take that?

Yes, well the expectations, it will be a 4-quarter phenomenon. If you think of -- we probably -- the industry is probably unrivaled about a year of hardening so far, so it hardened for 3 years, its unrivaled about one year. We expect that there will be stability after 4 quarters. If you just look at the overall loss ratios at the industry, I think it's easy to surmise that, we're not quite at price adequacy in that space and if it's close, the carriers have several back that make up for. So we expect that the defined equilibrium less than 2 more quarters.

And if we could zone in on the property market now that it's been a few months in [indiscernible], what are you seeing in the market and how big of a tailwind because the property hardening proved to be fair, Ryan organic growth.

I would say that I'll start with that. Rates are higher -- rates were going to be higher than we expected in '23. The rate increases started to manifest them self in the third quarter. So that was going to trend up, by 1/1/, they're going to be significant. In many cases on loss, accounts, historical losses like besides 100% increases. So everybody is going to be scrambling for capacity. So there's going to be a need for insurance effect because self-insured retentions to possibly investment captive -- solve captive opportunities. There is just going to be a sharing of risk. There is also going to be a form chain that's quite dramatic because in the last several years most policies are all apparels. That's off the table now. It would be a big responsibility for brokers, retail and wholesale to make clear to the insurers that this is going to be specific apparel and coverage and that people do understand what it is that they're getting and what they're not getting. So it's just the beginning of a very, very hard market and a market that's going to be short on supply.

If we could talk about the delegated authority business, you've been particularly optimistic regarding the growth potential there. Could you walk us through the optimism?

Yes, well, so it's twofold. There is ongoing innovation and new lines of business, so as Tim laid off with, Ryan [ Turner ], the brokerage side of our house is structured in 8 main specialties. And the perfect outcome is in the delegated authority side where we can develop solutions that service their industry verticals. And so one example is publicly disclosed as we launched our excess casualty facility earlier this year, high-hazard excess, some primary and it meets the needs of that segment on a wholesale distributor basis. So new product innovation will be -- you'll continue to see that, but I also want to emphasize adding capacity to our incremental lines is a major source of growth. So similar to many of you in this room, we're delegated on our track record. We are managing carrier capital on an outsourced basis. And so as we develop that track record, several things are happening, people that have supported us on individual lines are now supporting broader portions of our portfolio, one was in the news earlier this year, so I'll reference it where one carrier went from supporting one line to adding 10 of our lines. I can't disclose the name, but there's a carrier out there that's done 5% of most of our lines. And so those are the extremes where it starts with people see our distinct underwriting value proposition. They now see the track record and that's attracting capital. So how does that flow into organic? Cyber is that example where we were able to double our capacity under management and we're able to increase the line sizes we can deploy by 50%. So that's one example of many that are going to drive organic across that platform.

And if we could switch over to the impacts of inflation, can you give us an updated view on how you see general inflation and social inflation impacting growth in 2023?

Talk about the impact on inflation from economic inflation and then Tim could pick up on the social inflation. But a lot of business was written in the last couple of years, assuming much lower interest rate. Now those claims are going to get paid out of a reserve that was established when they were written assuming a much higher fixed rate. Therefore, there's going to be the potential for under insurance. And so it's going to be very challenging to the carriers, to the brokers and to the insurers to make sure that they adjust for this inflation, both in the rates, but also the reserve development, but you'll be seeing carriers at year-end adjusting reserves to account for the fact that maybe the interest rate assumption is 1.5%, now it's mid-single digit or higher. And so those reserves are going to have to be picking up, which will be a balance sheet and an earnings hit. But very importantly, for the insurers is that they have to anticipate that their asset inflation needs to be covered on a go-forward basis because carriers will be very specific, they're going to be very demanding in what rates -- what values the insured and the broker are applying for and they're not going to cut any slack. If they understate the values, they're going to be under insure, they're going to have to claim problem. They're going to be very clear on that. So yes, people say inflation is good for the insurance industry. Yes, it is because premiums go up, our revenues go up, but it's not a clear -- it's not a straight line. There are disadvantages. There are carrier issues and then there are insured issues. It's become broker issues. So from a financial perspective, we're all going to get -- we and the commission business are going to get higher commissions because we have higher premiums. But we have greater responsibility. So you can't take it as it's just a free ride on the benefit of inflated assets that inflate the premium is a greater responsibility.

And then social inflation, without a doubt, the #1 driver of losses in the casualty and liability market and really causing a prolonged hard market in many classes of business. Today, states like Florida, most of us focus on the cat wind problem in Florida, the casualty problem in Florida could be as bad. Most carriers, most standard markets are pulling out of classes like habitational, so just any kind of sports and entertainment, higher education, social services and human services platforms being affected in states like Florida, New York, California, those are the leaders where social inflation has really had a severe impact on standard markets and their inability to price these risks accordingly, again, pushing more business into the non-admitted sector. We don't see that subsiding, we see that getting worse, unfortunately.

And regarding the cyber market, what are your expectations for the cyber market within E&S? And how do you see wholesale broker penetration in the cyber market at a time when we're also seeing retailers building cyber capabilities?

Why don't you start Miles and Tim can...

Yes, well, our facility -- our underwriting facility offers solutions to both. We have a facility that is open market, where the retailers can access it. And then additionally, as we did mention, we've built a proprietary wholesale facility to RT. And that allows -- it's twofold. We can provide a service to the overall industry. And then secondly, we can provide unique capacity to our wholesale partner, RT. The industry is speculated to actually rival the U.S. property and casualty market within the next 15 years. And so we saw it double last year and there may well be more doubling events. And so that's been a big focus of capital raising and we've secured a lot of capital the last 2 years.

On the brokerage side of cyber, a very technical product and requires expertise in the intermediary space. And so years ago, we started to build, recruit, train and develop cyber experts in anticipation of the market changing. And today, on the broker side of it alone at RT, we have over 100 cyber experts brokering our customers' business. The larger global retail brokers and national brokers don't need us as much. There's enough direct capacity for them. But there are some obvious difficult cyber risks that need capacity in a tower, a shared and layer basis and we still play a significant role there as you move away into the regional retail world and tens of thousands of regional brokers and agents around the country, they don't have that technical expertise in areas like cyber. So we play a critical role at being an extension of their marketing department. So we not only do we represent dozens of wholesale-only distribution companies, we bring that technical expertise to the table for them and their customer.

Ryan has reported better-than-expected EBITDA margin since becoming a public company. How do you think about the range for margins longer term? And what are the primary puts and takes as we go into 2023?

I'm glad you asked that, Rob, because if you would have asked me 1.5 years ago, where I thought margins for '22 would be, I would have guessed 29% and change, low 29s. But what's different from my expectation than versus what's actually happened. One, we've grown faster on an organic revenue basis. There's a correlation there with scaling and we've also got a little help from higher-than-expected fiduciary income because interest rates are obviously not where I expected them to be or most people expected them to be 1.5 year ago. Prior to the IPO, what we did was on a annual basis scale margins really every year even on a reported basis. On an underlying basis, if you look at '22 and '21 on a like-for-like basis in terms of cost and investments, we are scaling this year, but there's noise because we went public halfway through the year and T&E was artificially suppressed during the pandemic. We're not quite at a run rate cost basis, T&E is still not back to what I would consider a normal level and we've got a run rate impact of a record production class that we sought to onboard this year and fortunately we have. That being said, we think that where we land at the end of this year will be close enough. And so our goal and I'll confirm this when we initiate '23 formal '23 guidance in February of next year is that starting in '23, we can resume showing at least a little bit of scale on a reported basis. And fortunately, because we've got that baseline of double-digit organic growth, there is capacity to make the investments that facilitate long-term organic growth and show a little bit of scaling. Where the ceiling is in terms of margin, TBD, it will depend on business mix long term. It will depend on how fast we grow over the next several years, but we are certain that we're not at our ceiling. And when it makes sense, there's levers that we can deploy to further optimize margin ahead of our, call it, 30% floor roughly.

And touching on that producer class that you just mentioned, can you talk about the magnitude of investments you've made in talent this year and the impact on growth these hires could have in 2023?

Yes, I mean -- so from a -- and when I say production class, that includes pay code brokers, assistance, staff, new underwriters. We also made a healthy investment in de novo MGUs, which we've talked about on calls and they can double click on if you like. The ramp-up of producers, so wholesale and binding, that typically is about 2 years until they're breakeven. And when they're accretive, which is at sort of their target margin, that's sometimes 2 to 3 years. On the de novo MGU side, that depends on a number of factors, how quickly you can get capacity, the scale of the underwriting team. But what we -- how we view onboarding organic underwriting and broking talent as sort of an ongoing investment that we need to make because even though it doesn't show up in that year and in fact, it has a little bit of a margin suppression in the year you make that investment, over time that gives you stronger growth and as a result higher margin.

Got it. And maybe just on the M&A pipeline. How do you view the current M&A pipeline? And is the current market environment impacting your willingness to do M&A?

Yes, I would say that the M&A pipeline is strong. Our history in doing M&A is very consistent, has to be a strong cultural fit, has to be strategic, has to be accretive. We look for good companies. We don't buy distressed companies. We look for good companies who by virtue if they're joining us and our platform can become great companies. We've had several many examples of that, particularly All Risks, which is a last big acquisition, our largest acquisition in 2020. They had consistently done 15% to 18% organic growth for the 20 years before we got together. So they were a great company, but they have expanded their abilities, their brokers are getting significant productivity increases because they have our platform. They have access to a lot of retail brokers they didn't have before. They have access to capital providers they didn't have before. So we look for companies that we can bring that value to. Also, we courted them for 7 years. So a big part of our timing on acquisitions is when they're ready to sell. And so we just were patient with them, we keep in communication, we keep explaining ourselves and we try to keep our self front of mind with them and we have several of those going right now. I can't tell you that any of them will close, I can tell you that. We expect to be able to do and I can't say the timing. But certainly, once we're working what should be done in 2023, can't calibrate exactly when. But the nurturing of these opportunities is really the game. And we get ourselves and say we make our acquisitions in bunches like bananas, buy bananas in bunches. It just happens to come somehow or other like come 3, 4 at a time. So I think it was crossed.

All right. And maybe if I could just sneak one more in on the topic of industry consolidation, are you still seeing organic growth benefits from the narrowing of wholesale broker panels and the consolidation of retail brokers? Or was that largely a benefit in the past?

We do. Tim, why don't you pick up on that?

Sure. The RFP process really started in 2010 with the global retail brokers, the nationals and then the regionals and that's really cascaded through the top 100 over the last 10, 11 years and we benefited from that. Pat and I and our team here and all our local presidents knew retailers would buy differently from our space, driven by data analytics and the inefficiency cost that existed from using too many intermediaries. So big part of our success has been able to get on these panel consolidations on the brokerage side of the business. And so we've won or come in first or second with almost every RFP in the top 100. But today, going forward, there's more consolidation in brokerage left to be had, that will take place in Tier 2 and Tier 3 in brokerage. But more importantly, we're in the nascent stages of the consolidation of the use of delegated underwriting authority intermediaries, that's been much more difficult to set the stage for that. Retailers have the same problem in using too many intermediaries and delegated underwriting authority, but harder to solve on the product side. There's too much proprietary product woven into these facilities. So it's taken us every bit of 12 years to build a platform that's big enough and strong enough in all 3 segments of delegated underwriting authority, binding authority, which is the most elementary part of delegated underwriting authority, that's up underneath RT and that's created for a seamless experience for our clients on small, but tough commercial on the P&C side. And then moving up in terms of technical expertise, our program division, we strengthened it and doubled it with the acquisition of All Risks, we have a $1 billion platform there that is really poised to get a lot more market growth as retailers have too many intermediaries in the program business clearly. And then finally, Miles will go into more depth on this, on the MGU side, the MGA side, we've had to buy them, lot of M&A. We've had to create them with the de novo approach, our new relationship with nationwide allows us to use their paper and create reinsurance and even take risk at times, but create product faster in the delegated underwriting authority space. So today, we're in a great position to enter this new RFP era and capitalize on the consolidation of that business as well.

Yes and along that spectrum, I mean, the greatest update for consolidation remains in binding and programs or those are niches. As you work up to the MGU space, the optimal path there for us is to add talent to our teams and add incremental capacity, continue to service the market. But as you think about our offering across that platform, we bill ourselves as 24 MGUs, each of the unique specialty. The national specialty program union has 16 niches. The binding authority services billions of dollars of products and across those lines is over 200 lines of business offering solutions. And that's the roll-up opportunities, as Tim says, not just in acquisition suitors, but in providing single source market solutions to our retailers and wholesalers and that's going to be an ongoing theme because just as these gentlemen predicted the consolidation of wholesale panels among retailers 12 years ago, it is very intensive for retailers and wholesalers to have dozens or hundreds of sources for the same product and the expectations they're going to continue to consolidate with the service providers that can manage all of those lines of business.

And Rob, one last thing, just a clarification on taking risk that Tim mentioned related to the joint venture we have with Nationwide. We did make one discrete investment of $47 million in the joint venture that founded Geneva Re, that is our one and only risk-bearing investment. It sits on our balance sheet as an equity method investment, the changes in that value are below operating income. We do not intend to make other insurance risk-bearing investments going forward, just to clarify.

Actually, we're committed not to -- we've told our investors that we've told our Board that and that was when we were a private company it had tremendous collateral benefits for Ryan Specialty which we're reaping the benefit now.

All right. And with that, I think we're out of time. So thanks to the Ryan leadership team for being with us here today and for a great session.

Thank you, Ram.

Thank you.

Thank you.

Thank you.