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

And we're live. Everyone, this is Josh Shanker. Again, it's the Bank of America Annual U.S. Insurance Conference. If you're tuning it now, we're on the Selective Insurance slate of the conference, and we're joined by my associate, Grace Carter. Also, of course, from Selective, we're very excited to have John Marchioni and Mark Wilcox, CEO and CFO of Selective, here with us right now broadcasting live, I think from Selective headquarters. I can't tell, it looks like, John, you have a real background on you, not a virtual one, but that's pretty good. And we're really happy to have you here. And before I begin, I'd like to say most of these meetings, we're very thankful that you're joining us and also your employees adapting to these very difficult times. Perhaps just wanted to introduce a little of what's going on at Selective during COVID, and then we'll get on with our Q&A.

Well, thanks, Josh. Good morning, and it's great to be here. Always appreciate the opportunity to present at this conference. And I appreciate you leading off with a question about employees. And we often say that our best, longest, most sustainable competitive advantage as an organization is the strength of our talent and the commitment of our employees and I would say throughout the last year, our employees have come together to continue to deliver great value for our customers, our distribution partners and our shareholders. And I think culture is so important in our business, and we've worked hard to build a highly engaged team. And I think throughout this time, as we quickly transition to a work-from-home environment for all of our employees last March and had the tools in place for them to do their jobs and do them effectively and continue to find ways to support employees as they've dealt with their own personal challenges, whether caring for school-aged children or elderly adults, we've tried to support them as much as possible and kept them engage. And I think that's been a great part of our success over the course of the last year. So we're proud of what we've done and continue to do -- to deliver great value for our customers.

As -- any investor who's on the line should know, you can ask questions through the Veracast app. All you have to do is type in, and I will be reading those questions. So please don't be shy and ask questions, and they'll be addressed. But on the top of COVID, now I look, we're unfortunately, in some ways, the end is the darkest part. And -- but there is a light at the end of the tunnel. Can we talk about what are your priorities? Our -- we'd love to assume that we're 4 months into the future, 50% to 60% of the country is vaccinated, including the most vulnerable part of the country, maybe a little bit optimistic, but what will be the priorities for Selective in that immersion period?

And I would say, Josh, for us, we went into this pandemic, knowing that we had a very unique business model that positions us well in any environment. And honestly, coming out of this I think we're going to emerge as strong organization. And like you, I think we were all hopeful that we're much closer to the end than we are at the beginning, and there is a light at the end of the tunnel. But I would say -- and I'll point to 3 specific areas that we really think set us apart and have really solidified our position in the market in the last year and really helped us deliver value for our customers. So first, is the strength of our distribution partnerships. And our ability to come together with our distribution partners to continue to grow collectively, but also to continue to deliver great value to our customers has only been solidified through this pandemic. And we're going to continue to make sure that we focus on supporting our distribution partners because they've been so supportive for us and our mutual customers throughout this pandemic. The second point, and I already covered this, but our team and having a highly engaged team has been a critical part of our success, and we're going to make sure we continue to invest and creating that highly engaged team, giving our employees the tools to do their jobs more effectively, given the opportunities to move up and take on more responsibility and continuing to build out a diverse and inclusive organizational culture. And then the third area I'll highlight, and I think this is also something we'll continue to invest in, not new, but we've laid a lot of the foundation, but it really came through in a significant way during the course of the pandemic was our efforts over the last several years to deliver an omnichannel customer experience, deliver a digital experience and a virtual experience for those customers who wanted it. And the ability to have those tools in place and have customers increasingly taking advantage of those, I think, really positions us well coming out of this environment. We've never lost focus on the mission and continuing to build for the future. So as we work so hard to service our customers through this challenging time, and also adding to the pandemic, a very, very high cat year, for us, 8 points of catastrophe losses in that 94.9% combined ratio is much higher than typical for us, and continuing to be able to service our claimants in a way that was very efficient and very effective. But despite all of those challenges, we made great progress on redesigning our small business system. Small business has always been a big portion of our business. We've invested in improving the technology. We're about half of the way through that rollout. We've started the repositioning of our personal lines organization. We've enhanced our E&S technology. So when we look at where we are now is starting with a very strong, profitable base in terms of our book of business and have only continued to invest and growing on a go-forward basis, starting to fire up our geographic expansion. So we -- the strategy we've had, had positioned us so well. I think we've been enhanced over the last year. And we think we're extremely well positioned in the emerging market.

All right. Well, Grace, why don't you ask the next question on your list.

Sure. Building on your comments about distribution and growth, could we talk a little bit about how the pandemic has impacted your plans for expanding geographically and increase agent count over the past year or so? And how your plans now might compare to your plans prior to the pandemic?

Yes, sure. Thanks, Grace. Let me hit the distribution side of it first, and I'll come back and hit on geo expansion. And I would say we've also -- this has been a long-standing strategy for us. Our long-term goal is to achieve a 3.5 -- 3% market share in our Commercial Lines for current footprint states. We're currently at about 1.5 points if you look at all 27 Commercial Lines states, and we focus on 2 levers that really help us drive towards that market share growth. And that additional 1.5% of market share is about a $3 billion opportunity. And we view that as the lowest risk opportunity for us to grow. It's with agents we know for the most part, with products we know and geographies we know. So the 2 levers are getting our distribution partners to represent about 25% of the available markets in our states. We're currently at about 22% across all of our 27 operating states. So there's some headroom there to strategically appoint agents. In 2020, and this goes to your question on how do the pandemic impact that. In 2020, we appointed on a net of termination basis, 90 new distribution partners, and granted. There was a lull in the spring, early summer with regard to making new appointments as agents were really focused on getting their operations up and running. So a lot of those appointments were in the second half of the year. And really benefit us moving into 2022. But that's a typical -- I'm sorry, '21 -- that's a typical year for us. So I would say we were able to continue to add agents strategically at the pace that we've done historically. And then the other lever is share of wallet. You hear us talk about this a lot. We think it's reasonable for us to achieve a 12% share of our agents commercialized business over time. We're currently at about 8 across all of our distribution partners. So we remained focused on that. We've talked about the MarketMax, automation tool that we rolled out late last year that really helps agents profile, their book of business and find opportunities to grow with us on both controlled accounts and accounts that are new to the agency. We run that in about 250 of our distribution partners. So there's a lot of upside with those partnerships that we still haven't realized, and we'll continue to roll it out more broadly. Geographic expansion, as you recall, we opened up 5 new states in 2017 and 2018, the primary focus being the Southwest region, and we've been extremely pleased with the progress there. But we continue to take a very deliberate approach. And candidly, in the last 1.5 years or 2, we've really shifted our focus to make sure that our small business technology platform and servicing platform was best-in-class, and we're in the process of completing the rollout of those enhancements, and now we're about to get back into geographic expansion cadence. We have talked about opening up and starting to work to open up 3 additional states, that will open in late '22, early '23. So about an 18-month process start to finish and have identified Alabama, Idaho and Vermont, which are adjacent to our current footprint, smaller premium opportunity to some of our more recent expansion states, but we think present great opportunities for us, and that work will begin in earnest in the latter half of this year.

Can we shift to the past year, think about what means for your risk management. Obviously, catastrophes, very large cat years for the last few years, at least some perceive it. I may argue that long-term trends are for elevated cats. You can sort of chip that both ways. What do you think that means for Selective? How are you changing reinsurance purchasing behaviors? Will there be lower volatility in results going forward or certainly your positioning similar to what it's been in the past?

Yes. Excellent question, Josh. And why don't I take that one, and John can jump in and provide some additional color and commentary as well. So I think let me just start with the fact that 2020 was a strong and profitable year for Selective. We generated a 10.5% operating ROE and a profitable 94.9% combined ratio. The underlying profitability of our insurance portfolio is very strong, and we have excellent pricing momentum going into 2021. That said, 2020 was close to a record year for us in terms of the 8-point impact of cat losses on our combined ratio. However, unlike in prior years, such as if you look at 2011 and 2012 for us, which were heavy cat years, and '17 and '18 for the industry that were headlined by major events, 2020 really witnessed a range of midsized events, including the winter storms, the midwest torrential, tornadoes, convective storms, wildfires, civil unrest and hurricanes, the list is pretty lengthy. It really was the frequency of these midsized events that impacted our results as they were all full retention losses. In fact, of the $215 million of cat losses we incurred in 2020, about 2/3 of that came from 6 events, while the remaining 1/3 came from over 50 individual PCS events. And that really kind of drives on the point of it really was the increased frequency of those mid-sized, call it, full retention events that really impacted our results in 2020. Just taking a step back for a minute, that there clearly has been a trend of elevated cat losses and non-cat losses in almost every quarter started in 2017. And in fact, the '17, '18 and '20 were all elevated from a cat loss perspective. We believe that climate change might be driving this, and it's an issue that the industry has to grapple with longer term and understand implications for underwriting and risk mitigation. From an underwriting and risk management standpoint, to answer your question, we did not see anything that materially surprised us in 2020. The events of last year were highly localized and impacted companies based on their geographic footprints. Over the last 15 years or so, the impact of cat losses in our combined ratio has averaged a very manageable 3.2 points versus 5.3 points for the industry as a whole. That said, going into 2021, we have increased our assumption for cat losses to 4 points on our combined ratio from our annual prior guidance of 3.5 points for the last number of years. From our perspective, we do look to manage the cat loss volatility in multiple ways, and we do have a lower volatility profile than many of our peers. And that starts with the type of business that we write. We really seek to write low to medium hazard accounts with a more of a casualty focus. Second, we have very strict underwriting guidelines that stipulate clearly our risk appetite. We largely avoid writing property risks in coastal areas and don't deploy our Commercial Lines capacity in some of the very heavy cat prone states like Florida, Texas and California. And that has really served us well over the years. Third, we are a prudent purchases of reinsurance. We limit our 1 and 250 peak single event PML exposure to about 4% of our GAAP equity. We have a cat excess of loss treaty that provides $785 million of coverage above a $40 million retention for single events, including a $5 million retention for our non footprint and recent expansion states. And we also have a per occurrence property treaty that covers us for $58 million of property losses over a $2 million retention and then for any exposure above the $60 million, we fac out 100% and therefore limit the net exposure for large losses to $2 million. And thinking about 2020, going into 2021, we did evaluate multiple different types of reinsurance structures for a 1/1 renewal, including looking at aggregate structures, but at the end of the day, we maintained our existing structure. It does and has served us very, very well in the past, but we did buy an additional $50 million at the top of the program. We do expect to pay a little bit more for reinsurance in 2021 given the market conditions. And that's about a 50 basis point headwind on our combined ratio, and that's factored into our 2021 guidance of an all-in combined ratio, including cats, but excluding prior year casualty reserve development of 95%. So hopefully, that provides you some perspective on the record level of cat losses in 2020 and how we think about risk management and reinsurance.

And the only thing I would add to that, I think, Mark, did a great job of explaining how we approach it and how we think about our portfolio. Our portfolio has been fairly stable in terms of what we write from our limits profile and where we write it. But I think, Josh, to the question, I think we should probably assume that the volatility we've seen, not just in cat losses, but in non-cat losses will continue, we think, about target combined ratios on a risk-adjusted basis, the property line is one with the volatility we're seeing on both the cat and non-cat basis that we think needs to be managed to a much lower combined ratio in an average year and that's why this is a line that we think we need to increase pricing. We saw pricing in 2020 and the property line at just under 7%, and we think we want to continue to try to manage that sort of rate level going forward because we have to assume that you're going to see some increased volatility as we've seen in the last couple of years.

Grace, why don't you to up next?

Sure. Can we talk about the pricing outlook for 2021 and how that might impact your expectations for growth and margins over the next year?

Sure. Great question. We've said this previously and continue to believe that the drivers of the pricing environment that we're currently in are not going to go away soon, and we think it will continue to be a tailwind through the balance of '21 and '22. And really, the primary drivers, and I think everybody probably knows this, but clearly, the lower for longer interest rate environment is one of the biggest drivers, and everybody needs to be looking out and understanding the potential impact on their investment income and making up the difference that they're going to lose from lower yields on investment income and lower combined ratio results. And that is not going to go away. That's an industry dynamic that everybody is going to continue to deal with. As I just -- we just talked about, elevated cat and non-cat property losses, we'll continue to push rate level higher. We do have a firming reinsurance market. You've seen that. And I think there's different views of whether it's firmed as much as people expected it to on the property side. But pricing is going higher and terms and conditions are becoming tighter. And we also have elevated loss trends. And I think we've all talked about that. We were talking about it in the first quarter of 2020 before the pandemic hit. And at some point, as the economy normalizes, we expect loss trends to come back to where they were pre-pandemic, and that needs to be accounted for in pricing. We have, in our disclosures, in the guidance, and Mark reconciled how we get from the '20 year to the '21 year, pricing is certainly a big part of that. With regard to the '21 year, however, a lot of that price is already written. So much of your earn rate for anybody in our business, much of the earn rate for '21 is largely banks and that it was written in 2020. So any shift in the market would likely be more of a '22 impact. But again, we think it's a sustainable pricing environment. And we think this goes to the second part of your question around how we think about growth and retention in this kind of an environment. If you look at our history, our track record over the last 10 or 11 years, we've been able to manage pure renewal pricing at or above expected loss trend for each of those years and done it in a way that didn't negatively impact retentions. And I think that really goes to 2 of our key focus areas. Number one, is having the tools to be very granular in our approach. So we're focused on account by account basis on projected loss experience going forward to provide very specific pricing guidance to our underwriters on individual accounts. That's also allowed us in this rising pricing environment to see retentions go higher. So our retentions in 2020 were up a full 200 basis points over the prior year. And we think that says a lot of how we administer our pricing philosophy. And then the second part of effectively managing that balance between rate and retention is the strategy of your distribution partner relationships, and we think that came through in 2020 as well. Now we have the same discipline in terms of how we think about pricing individual accounts for new business. And we did generate about 2 points of new business growth year-over-year in 2020, and we think we did that in a very disciplined way. So we think this is a great market for us. We've proven our ability to manage the pricing environment effectively and still grow the organization, and we think we're well positioned to continue to do that into '21.

I have a question coming in from investors. It's a bit of a pivot, but we would get to it anyway, I suppose. What does the future hold for the Personal Lines business for a company like Selective looking forward 10 years, with the likes of GEICO, Progressive, Allstate and State Farm as well as the [indiscernible] of Lemonade, Root, Metromile, et cetera, will the segment be a good use of capital?

We do still like the business. But I will say that -- I think there's a segment of the market that we're built to compete in, and there's a segment of the market that we're not built to compete in and don't plan The mass market personal auto business that's driven by comparative rating, either within agency distribution or direct-to-consumer platforms is not how we're built, it's not the business we're looking to pursue. We do think there's a segment of the marketplace. And specifically, when you think about the affluent and mass affluent markets, that price matters, but it's not the driving factor. The driving factor is more coverage and service and guidance from an agency distribution partner to make sure they're placed with the right company. What we're doing as we speak, is repositioning ourselves to be able to compete more effectively in that slice of the market. We think we have most of the product and service capabilities already. We think our distribution plant is largely positioned to grow that segment of the marketplace, and we're in the process of rolling that out. And by midyear '21, early third quarter, we'll have some additional product and service enhancements that we think well position us to serve that market. So the answer is, for that segment of the business, yes. For the very price sensitive, increasingly commoditized monoline personal auto business, where prices are determinate factor, that is not a business that we think is a good investment for us. And that's why we're repositioning our business in a different direction.

In terms of thinking about the ROE target for 2021, what are the greatest downside risks you achieving your target? And what would be the great upsides as well?