The Hanover Insurance Group, Inc.
Q1 2021 Earnings Call Transcript

Published: 30 Apr 2021

[Operator:]

Good day and welcome to The Hanover Insurance First Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

[Oksana Lukasheva:]

Thank you, operator. Good morning and thank you for joining us for our quarterly conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer; and Jeff Farber, our Chief Financial Officer. Available to answer your questions after our prepared remarks are Bryan Salvatore, President of Specialty Lines; and Dick Lavey, President of Agency Markets.

[Jack Roche:]

Thank you, Oksana. Good morning, everyone, and thank you for joining us this morning. I will begin by discussing our first quarter financial highlights in the context of the current business and economic environment. I'll then provide a strategic review of each of our segments and our accomplishments during the quarter. Jeff will review our financial results in more detail and provide some thoughts on the quarters ahead, and then we'll be happy to take your questions. Overall, we are very pleased with our strong financial performance in the quarter, especially in light of the unprecedented catastrophe and activity. We posted net written premium growth of 5.2% and a combined ratio excluding catastrophes that exceeded our original expectations, underscoring our ability to capitalize on market opportunities while prudently managing the complexities of an uncertain environment. In particular, I want to call your attention to three highlights for the first quarter. First, we are very excited about the increasing growth momentum in our businesses. Premium production exceeded our original expectations for the quarter, elevating back to pre-COVID levels, reflecting our strong market position and the effectiveness of our strategy.

[Jeff Farber:]

Thank you, Jack. Good morning, everyone. For the first quarter, we reported net income of $92.7 million or $2.51 per diluted share compared with a net loss of $40 million or $1.04 per basic share in the prior year first quarter. After-tax operating income was $61.4 million or $1.66 per diluted share compared with $86.8 million or $2.23 per diluted share in the first quarter of 2020. The difference between net and operating income in the first quarter of each year primarily reflects the increase in the fair value of equity securities in 2021 and the decline in the first quarter of 2020. Our combined ratio was 98.8% compared with 95.2% in the prior year quarter, reflecting the impact of elevated catastrophe losses. In the quarter, we incurred catastrophe losses of 11.5% of net earned premium, driven by large losses from the severe winter freeze events in the South. Texas was impacted particularly hard by the freezing temperatures, power outages and winter conditions, accounting for about 2/3 of the total cat losses in the quarter, mostly in the commercial multi-peril line, of which we hold about 2.9% market share in the state. We have worked tirelessly over the last decade on our property aggregation. And for most events over the last four to five years, we have been pleased with our losses relative to the specific industry concentration and position, and first quarter's events were not an exception. Prior year reserve development was favorable in the quarter by $8.2 million, primarily reflecting lower-than-expected losses in Personal Auto and continued favorability in workers' comp. These results and our prudent reserving actions reinforced our focus on building a strong balance sheet and highlight our successful efforts over the years. This being said, we continue to exercise prudence and thoughtfulness in making our loss picks, taking into consideration 2020 loss pattern changes, which were disrupted by the pandemic. We are also keeping an eye on reserving uncertainties as a result of court closures, potential delays in reporting medical procedures and other issues that may delay claims. Many of these factors are historical outliers and as such are less indicative of future trends. This presents reserving challenges, resulting in the need for appropriate conservatism. Claims activity related to the COVID-19 exposures continues to be in line with our expectations and is fully manageable. We did not change our COVID reserves in the quarter, which continue to have ample IBNR. Our position remains very solid given our use of ISO-based policy language. Our mix of business, which excludes travel, trade credit and event cancellation coverages as well as our use of ISO-based forms has served us well during the pandemic. Our expense ratio for the first quarter of 2021 was 31.6%, which was a bit lower than our expectation for the first quarter, but up slightly from the prior year quarter, primarily driven by higher agency compensation expenses. We have a clear line of sight to delivering at least a 30 basis point expense ratio improvement for the full year. Fixed cost leverage is expected to yield higher improvement in future quarters as our earned premium growth continues to accelerate throughout the year. I am very pleased with our underwriting performance, excluding catastrophes, as demonstrated by an ex cat combined ratio of 87.3%, which is a function of mix improvement, earning and of rate increases and the continuing benefit of lower loss frequency in auto. Looking at our underlying underwriting results by segment. Our Commercial Lines combined ratio, excluding catastrophes, was 89.8%, down from 94.7% in the first quarter of last year. This improvement is primarily a reflection of loss ratio decreases in our CMP and auto lines as compared to the first quarter of 2020. Our CMP current accident year loss ratio, excluding catastrophes, improved by 8.3 points to 57.5% due to the favorable comparison with the prior year quarter, which was affected by one large fire loss and the impact of an annual aggregate reinsurance deductible. We continue to watch property trends carefully but also remain appropriately conservative on the liability component of CMP. Our Commercial Auto current accident year loss ratio, excluding catastrophes, improved 6.9 points to 59.6% as we continued to experience frequency benefits throughout the quarter. Additionally, our current year first quarter loss ratio was impacted by favorable involuntary pools results versus the first quarter of 2020. We remain appropriately cautious and prudent as we set picks for Commercial Auto bodily injury liability in light of potential claims delays and social inflation concerns. We also continue to achieve strong rate increases to address the multiyear liability pressure in this line. Turning to workers' comp. The ex cat current accident year loss ratio improved 3.1 points to 60.3% compared to the prior year quarter. Frequency is starting to pick up in this line compared to mid-2020 lows, but underlying trends overall remained largely favorable. We are keeping an eye on the current rate environment and the potential new risks that can emerge as businesses begin to reopen their offices and facilities on a larger scale. In other commercial lines, the current accident year loss ratio, excluding catastrophes, improved 2.4 points to 52.9%, underscoring the benefits of the profit improvement actions we took in prior years, along with robust rate increases that are now earning in. Overall, Commercial Lines net written premiums grew 7% in the first quarter, with contributions from both our core and specialty businesses. Our core commercial retention at 87.3% increased two points sequentially from 85.3% while new business gained momentum. Specialty growth accelerated in the quarter as the business continues to gain traction in several attractive profitable lines. Turning now to Personal Lines. Our combined ratio, excluding catastrophes, was 83.9% for the first quarter, down from 87% in the same period last year. The continuing temporary frequency declines in auto and favorable underlying activity resulted in a seven-point improvement in the auto loss ratio to 60% compared to the first quarter of last year, which was only impacted by the COVID-related economic shutdown in the second half of March. As the first quarter progressed, we saw signs of driving patterns picking up in off-peak hours. However, auto accidents during peak commute times, which typically make up a large portion of losses, remain suppressed. With the reopening of the economy, we expect frequency to trend towards more normalized levels by the end of this year. Thus, managing the balance between growth, rate and profitability in the shorter term is critically important. The loss ratio in our homeowners line increased 5 points to 53.4%, primarily due to a higher incidence of large fire losses and an unfavorable comparison to low non-cat weather in the first quarter of 2020. Our homeowners book remains very profitable. However, elevated weather losses and increases in the prices of materials, particularly lumber, highlight the need for rate increases in this line in the marketplace. Fortunately, the short-tail nature of this line allows us to react quickly to adjust pricing on our book of business if needed. Personal Lines net written premiums increased 2.2% in the quarter, driven by new and renewal business. We are particularly pleased with the sequential improvement in retention, which was up 1.3 points from the fourth quarter of 2020, reflecting the effectiveness of our recent pricing actions and the strength of our Personal Lines offering. Moving to investment performance. Our net investment income was $76.8 million for the quarter, up 10.3% from the prior year period, on the strength of better-than-expected investment partnership performance. This performance was primarily driven by positive valuation changes in the fund's equity holdings and certain successful but nonrecurring transactions in underlying partnership investments. First quarter partnership results do not change our outlook for investment partnerships or overall net investment income for the rest of the year. We were pleased to see new money yields pick up during the first quarter. If this trend continues, it should be marginally helpful for our net investment income over the balance of the year. However, overall new money yields are still below earned yield levels and will continue to put pressure on our net investment income for future years. Cash generation from our underwriting operations remained strong, which should mitigate this impact. Cash and invested assets at the end of the quarter were $8.9 billion with fixed income securities and cash representing 84% of the total. Our fixed maturity investment portfolio has a duration of five years and is 96% investment grade. We have a high-quality portfolio with a weighted average of A+. Net unrealized gains on the fixed maturity portfolio at the end of the first quarter 2021 were $281 million before taxes, representing a decrease in fair value of $228 million since December 31, 2020, due to an increase in prevailing interest rates. Our portfolio is well laddered and diversified by industry and asset class, and we are certainly not cash constrained. We typically hold fixed income securities to maturity and are not concerned about the temporary movements in the market value of our portfolio. Moving on to our equity and capital position. Our book value per share of $84.21 reflects a decline of 4.3%, driven by the declines in net unrealized gains of our fixed income portfolio. Excluding these unrealized gains, our book value per share was $77.50, representing an approximate 2% improvement in the quarter. We remain strong stewards of our shareholders' capital. During the quarter, we repurchased approximately 358,000 shares of our stock, and we also paid a regular cash dividend of $26 million. Through April 27, 2021, we repurchased an additional $40 million of stock under our 10b5-1 repurchase plan, leaving $40 million under our existing stock repurchase authorization. We are planning to discuss a potential increase to the current authorization at the upcoming Board meeting in mid-May. Our capital priorities remain unchanged. First, we strive to maintain our strong capitalization and adequate liquidity. Second, we continue to prioritize improving organic growth for which we generate plenty of capital. And third, we continue to maintain our policy of returning excess capital to shareholders through cash dividends and share repurchases. We will continue to remain nimble and actively manage our capital with the best interest of shareholders in mind. Given the magnitude of catastrophe losses in the quarter, we are very pleased with the operating ROE of 8.8% that we delivered in the first quarter. Normalizing for catastrophe losses, our ROE would have been above our long-term target, underscoring the strength of our underlying earnings power. Looking ahead, we continue to expect overall net written premium growth in the mid-single digits or higher for 2021, with top line momentum accelerating throughout the year. The growth in the first quarter and the continuing momentum in April give us confidence in our growth trajectory for 2021. As noted earlier, we remain on track to reduce our expense ratio by at least 30 basis points in 2021 to 31.3%. And we expect our second quarter cat load, which is typically our highest, to be 6.1%. In closing, we are very pleased with our underlying performance and our ability to build on our positive momentum in the quarter. We are confident that we are well positioned to sustain our profitable growth momentum and top quartile profitability, delivering value for our customers, agents, shareholders and other stakeholders. With that, we will now open the line for questions. Operator?

[Operator:]

And ladies and gentlemen, our first question today comes from Meyer Shields with KBW.

[Meyer Shields:]

Great. So I want to start with a question for Jack, if I can. You talked about taking, I think, a very rational, more competitive posture in Small Commercial. Can you talk about what you're seeing from your competitors? In other words, does this improve your competitive position or hold it steady?

[Jack Roche:]

I think -- Meyer, first of all, thanks for the question. I think there are a number of factors that are allowing us to build on the momentum that we've worked so hard on in Small Commercial. Not only is the profitability of our current portfolio and all the hard work we do with our agents to position our products to be broad-based and to be a little bit more comprehensive than many of the competitors that we compete against. But I think probably one of the biggest factors that's causing us to feel even better than ever about our Small Commercial opportunity is that more and more agents are getting strategic around their flow businesses and in particular, are starting to work on their operating models and how they can concentrate their business with fewer and more strategic carriers, which we believe plays right into our business strategy and our capability set. So if you add all of that up, being profitably positioned, investing in our capabilities, including our new platform, that couldn't be coming at a better time. Frankly, it gives us a lot of reason to be optimistic about how we can further build on our Small Commercial momentum.

[Meyer Shields:]

Okay. Understood. Maybe a related question, And I think the growth opportunity seems fantastic. But I'm curious as to -- when you have new business coming from new agents, is that booked more conservatively than, I don't know, new business from existing agents?

[Jack Roche:]

Well, I think one of the things we've shared in the past is that, even with new appointments, we have a real transparent approach to envisioning what our future partnership would look like, what our underwriting appetite is and how that matches their current book of business, leveraging our Agent Insight tool. And then as we start the process of building momentum, we hold them to the same high standard that we hold all of our agents in terms of the quality of the mix, the pricing that we look at vis-à-vis our own renewal book and some of the statistics that we gather from our Agency Insight tool. So we're quite confident that new business from high-quality new agents is at least as disciplined, if you will, as the new business that we write with our existing agency plan.

[Operator:]

Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

[Oksana Lukasheva:]

Thank you, everybody, for your participation today, and we're looking forward to talking to you next quarter.

[Jack Roche:]

Thank you.

[Jeff Farber:]

Thanks, everybody.

[Operator:]

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.