Selective Insurance Group, Inc. (SIGI) Earnings Call Transcript & Summary

We are going to keep chugging along, getting to a lot of companies today. Up next is Selective Insurance. And presenting for the company will be John Marchioni, Selective's CEO, newly announced CEO; and Mark Wilcox, the company's CFO. John was just recently appointed CEO and was President and COO prior to his new role. He was COO since 2013. He'd been with the company for 20 years. So we -- obviously, you've seen John before here presenting. In fact, I would say the CEO transition was about as smooth as I've seen, very, very seamless. Mark had joined Selective in 2017 from Renaissance Tree where he was Controller and Chief Accounting Officer. Taught me a lot about accounting over the years, so thank you for that. It's always a good opportunity to speak with a new leader of a company, and we're excited to have both of you guys here today. So first, congratulations on your appointment.

Thank you. Thank you.

Probably, I'm sure I already e-mailed you on that. No one was surprised by it. Maybe you have a fresh -- not a fresh, but you have a look at the company as a CEO from a somewhat different lens. So I'm sure you come in and say, let's take a good fresh look at this company.

When you look at Selective, what do you see as the core strength? And how do you see the company positioned for not 2020, but the next 5 to 10 years?

Thank you, Jay. So it is, obviously, an enormous honor for me to assume this role. Selective is a very special company, and Selective is a company that has delivered very, very strong and consistent results. And while I might be a little bit biased, I have the ability to follow somebody who I think is among the best CEOs in this industry and who did the job at a high level for 20 years, and 40 years in total in the organization. So obviously, coming into an organization that is extremely well positioned. And our strategy as a company has been fairly consistent. And when we think about our unique competitive advantages, and we are a very unique company in this business, it starts with our operating model. And we have had a field-based underwriting model for 2.5 decades now, and it provides enormous opportunity for us and for our agency partners, for them to have somebody in their office working with them. And our field underwriters control about 10 to 15 agency relationships. It gives the agent somebody who can get things done, can get business ran, which is a great advantage in the eyes of the agency. But it's also a great advantage for us in that we have somebody who's local to that agency, who knows the producer who's on the other side of that transaction, and in many cases, will know the business because they're local to that business. So we think there's a real underwriting benefit there as well. So that's, I think, advantage number one. It continues to position us extremely well going forward. Number two would be, we've continued to have a limited distribution philosophy. We only have about 1,350 agents across our 27 commercial lines, footprint states, which means that all of our agents are significant relationships for us, and we are to them. So we're going to occupy 1 of the top 2 or 3, in many cases, #1 spot, in most of our agencies, which makes the relationship as important to them as it does to us, and that will continue to be a core of what we're all about. And then I would say the third distinct advantage that we've continued to deliver in the marketplace is our absolute focus on customer experience. And I think 20 years ago and 10 years ago, that was more about the human element of delivering a great experience to our distribution partners and to our customers. And of late, it's been our investments in making sure that we deliver what we would consider to be a superior omnichannel customer experience. So whether that customer or that distribution partner wants that human interaction, they're going to get that at a high level. Whether they want the real-time digital experience, 24-hour experience, self-service environment, fully mobile opportunities to service their accounts, then we give them that potential as well. So I would say that the change in the customer experience focus, to make it both about the human element and the digital experience, continues to be a core competitive advantage for us. With regard to how we're positioned for the future, we have made so many investments in customer experience. We've made so many investments in making sure that our underwriters have all of the tools to do their job as effectively as possible. It started 15, 20 years ago with the deployment of modeling capabilities, delivering individual underwriting and pricing guidance to underwriters at the point of decision. The last couple of years have been making sure that we use technology to improve their efficiency. So all of the work that used to be manual for an underwriter to go out and gather information about an account to make an underwriting and pricing decision, the ability to deliver that to them in an automated fashion so they could spend the majority of their time adding value and making that underwriting judgment and that pricing judgment. And that helps us create greater efficiencies and allows us to create more capacity for growth. And I think that continues to be a growth accelerator for us. We've invested in geographic expansion. We've added 5 new commercial line states in the last 2.5 to 3 years, which have been great accelerators of growth for us. But the other big focus for us is -- the least risky way for us to continue to generate good, strong growth in our core Commercial Lines business, is through growing market share in our current 27 state footprint. Our current commercialized market share is just over 1 point. It's about 1.3 percentage points. We think a reasonable expectation over time is for us to get to a 3% share. And we could do that without having to stretch our underwriting appetite, without having to change our risk profile. And we think that continues to fuel our growth and continued profitability in the coming years.

For someone who has been at a company, a senior leader at a company, and you take over as CEO, I really want to ask you, what will you do differently? And I know it won't be vastly different because you were so involved with setting the strategy before. But you are a new leader of a company, and you want to put your imprint on it. Are there things that you want to do a little differently?

Yes. I would say the biggest area, Jay, that I would highlight -- because you're exactly right. I have been heavily involved in developing this strategy and executing on it. I would say the biggest area of focus for me going forward is making sure that from a culture perspective, we become more of an innovative, more of an agile culture, around deploying -- building and deploying technology in a way that leads to better underwriting decisions, better customer experience and better operational efficiency. We're at a time where -- and we've always been an organization that prides our -- prided ourselves on having the best talent in the business and having a culture where employees feel like they're valued and feel like they have the opportunities to continue to get better as individuals and continue to take on more responsibility. And I want to make sure that, that continues to be the case, that we continue to be an attractive place for people to work as we get more and more into new disciplines for the future around data science and data analytics, making sure that we have the ability to attract and retain that top-notch culture in emerging areas like data science, making sure that we have a culture that is much more inclusive than historically. You hear a lot of companies talk about the importance of diversity and inclusion, and we certainly do as well. We're trying to make sure going forward that we have the most inclusive environment so that individuals who come in with different backgrounds and different viewpoints have an ability to actually have an impact on the direction of the organization and feel like they're fulfilled in this organization. So I would say that will be a big area of change going forward for us.

Culture change, by definition, is tough. It takes a bit of time. But it starts at the top, so.

Agreed. And it also -- it's important to make sure that you have a culture, an existing culture, and I think our culture is very healthy, that it embraces people of different views. And it's a culture that cares deeply about the success of the organization and the people in it. So I think change in a culture like that is a lot easier to achieve, but nonetheless difficult.

You had mentioned the geographic expansion. So looking forward, what is your strategy for entering new states? And do you have any targets as far as how many states you'd like to be in?

So we're currently at 27 states for Commercial Lines with those 5 recent expansions, the biggest part of that being the southwest expansion, which is a 4-state region including Arizona, New Mexico, Utah and Colorado. We've got about 5 states that we would consider on the short list for additional expansion. And we put them in the category of fully operational, meaning you're going to open those states up, you're going to appoint agents, you're going to hire underwriting claims and loss control staff on the ground in those states. And those states include the Pacific Northwestern states of Washington, Oregon. Texas is a state we're evaluating, haven't made a decision about whether or not we want to enter Texas fully. And then a couple of round out states adjacent to our current footprint, including Vermont and West Virginia. That would get us to about 32. But our longer-term vision is to have our product filed and automated in at least the 48 contiguous states. Not that we would be fully operational with appointed agents and field employees in every state, but we have the ability to write multi-state accounts by agents written out of our current footprint, which we think helps us expand our market share within our current 27-state footprint. That's a longer-term proposition. I think you're talking about a 7- to 10-year horizon for us to get to that full 48-state capability. And then those 5 states that I just mentioned will be more near term in terms of opening them up in the next several years.

Got it. And the strategy for doing it, that's been pretty consistent. No changes there?

No. It's been a tried-and-true approach of our unique operating model, a smaller distribution model in terms of number of agents. Just to give you a sense, we opened up the state of Arizona with about 15 agency partnerships across the entire state. That controlled about 20% of the market. Colorado and Utah to Mexico, we're in that 10 to 15 sort of range. So limited distribution model, same underwriting appetite and same field model. And that's worked for us, and it's a much more conservative, much more deliberate approach. It takes a little bit longer to do it that way, but we feel like we reduce the risk by taking that approach.

Can you guys speak to your margin guidance for 2020? And really, what are the drivers of the improvement?

Sure. Jay, let me walk you through that. And just as a reminder, we had an excellent year in 2019, so great growth. Top line, up 7%, a very profitable, 93.7% combined ratio. That's an all-in calendar year combined ratio, and a 13.3% operating ROE. So just to kind of walk you through the guidance for 2020, and I'll come back to and take you through the details of the underlying margin expansion. One is an expectation of an underlying combined ratio of a 91.5%, 3.5 points of CAT losses. So an all-in accident year combined ratio of 95%. We don't forecast or expect any prior year reserve development. $185 million of after-tax net investment income, which includes $14 million from the alternative portfolio. So a couple of points of growth in net investment income despite a decline in interest rate environment. 19.5% tax rate and $60.5 million of weighted average shares outstanding. So that was the guidance, the full year guidance across the book we laid out for 2020. If we come back to the underlying combined ratio guidance, and starting with 2019, the 93.7% that I mentioned on a calendar year basis, if you back out the CAT losses and the favorable reserve development, the underlying combined ratio, the starting point was a 92.9%. So to get to the 91.5%, there's 140 basis points of underlying margin improvement for the 2020 year. And there's a couple of different drivers of that. One is, clearly, loss trend, which is a headwind. And as we talked about on the year-end call a couple of weeks ago, we have just under 4 points of expected trend in our underlying combined ratio expectations for 2020, 3.8% to be precise. And then the impact to that on the combined ratio as it just hits the loss ratio is, call it, 2.3%. Now we also have an expectation of rate for 2020 on an earned basis, and that includes both the written rate that we generated in 2019 that will be earned in '20, as well as an expectation of written rate in '20 that will be earned in '20. And that expectation is, call it, 3.7%. And the impact to that on the combined ratio after you factor in the variable-based underwriting expenses is a benefit of 2.4 points. So rate impact, 2.4 points; trend impact, a headwind of 2.3. So a little bit of improvement in terms of rate versus trend when you put those 2 pieces together. We also believe we can drive the expense ratio down. We have some opportunities to -- over time, to drive that down, approaching a 32 expense ratio over the next couple of years. For 2020, underlying combined ratio guidance has an expectation of about 40 basis points of expense ratio improvement, taking it down from the 33.8 to a 33.4. We then have what we call underwriting mix and claim benefit improvement, which is about 80 basis points. And that number includes both the underwriting side of the equation as well as a benefit on the loss adjustment expenses. The underwriting benefit really comes from managing the book of business and retaining the higher profitability, the expected profitability accounts, and then having a lower retention ratio on the accounts that have a higher expected combined ratio or lower underwriting profitability. So between those 2 underwriting mix and claims, that's about 80 basis points. There's a little bit of a rounding difference of 10 basis points and that gets you from the 92.9 to a 91.5. Again, that's an accident year basis, so that doesn't assume any reserve development. And that's ex-CAT, you had the expectation of CAT losses of 3.5 points, and it gets you to an accident year combined ratio of 95% for 2020.

It's really not the tailwind of pricing. It's actions you guys are going to take to change the mix, retain better business, blocking and tackling.

That's exactly right. And I think for us, it is a good market environment. We did see an acceleration in pricing towards the back end of the year. We had our best pure renewal rate increases in Q4 and the highest growth in outstanding Commercial Lines book in Q4. But for us, part of it is the starting point. If you look back over the last 5 years, Selective has been able to generate about 16.5 points of pure renewal rate, and that compares to the industry of about 8 points. We're hitting our target margins. As I mentioned, the 13.3 operating ROE for 2019, a very profitable combined ratio. So for us, yes, we're going to look to generate as much on rate as we can. But we're starting from a very good place in terms of embedded profitability in the book of business, and that allows us to have a relatively prudent assumption from an earn rate perspective in the combined ratio guidance.

And Jay, just to add one additional point of emphasis to what Mark already described is, because this whole discussion around mix improvement above and beyond rate relative to loss trend is something that we've consistently been very transparent about and measured. It's not just this number that, hey, we're going to improve our mix of business by making better decisions. We disclose it every quarter in terms of the price and retention by cohort. It's in our investor slide presentation every quarter. So we -- because of the sophistication that we've built in terms of modeling and other capabilities, we provide our underwriters individual pricing guidance based on our outlook for performance on every individual account. And then we track very closely for that best business, and in our presentation, you see it labeled as above average business. That's got a projected combined ratio much lower than our average. And then there's about 11% of our premium that we consider in the low end, very low retention buckets that has projected combined ratios well above average. And then we show you the relative rate level and the relative retentions on those different cohorts. By managing that worst 11% to a higher rate level and a lower retention level, you are getting a mix of business improvement that's measurable and trackable that gives us confidence that, that's realizable improvement from a mix perspective.

Yes. I see a lot of analysts just look at pricing trend and -- but there's other stuff you can do as you guys have done. Let's talk about price, and really, how you go about obtaining price increases. You have very close relationship with your agents that other companies don't really have.

Yes. So I think that's definitely an important consideration. And I know every company will say, we've got great relationships with our distribution partners. I think if you want evidence of that, you want to look at the performance on rate and retention over a long period of time to see if that's backed up by fact. In terms of how we've done it, and this is now, for us, 10 years of getting rate level, pure price, net of exposure changes, no exposure change in there, pure price at around 3% or higher, which looking back, tracked our expectations for loss trend. And we do that primarily 2 ways. Number one, very granularly. So we don't -- if our rate target is, as Mark indicated, we expect to get about 3.7% this year of earned rate, it's not that every account gets 3.7%. There are accounts that, in many cases, are earning a rate reduction and will get a rate reduction. There are others that earn a rate increase or should earn a rate increase that is in the double digits, maybe approaching 20%. That granular guidance to our underwriters is one of the reasons we've been able to achieve the rate and retention that we have. But the other part is, we do have great communication and great relationships with our agents. Our underwriters on the Commercial Lines side are assigned to an individual set of agents. So they develop a good working relationship. They know who is working that account on the other side. And that agent, because we're occupying one of the top market positions in that office, has a vested interest in making sure that we're communicating well and protecting the business we want to protect and aggressively pursuing rate on the accounts that deserve to be increased substantially. And that's the other reason we've been able to achieve that kind of success.