The Hanover Insurance Group, Inc.
Q3 2014 Earnings Call Transcript

Published: 30 Oct 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the third quarter 2014 The Hanover Insurance Group Incorporated earnings conference call. My name is Denise and I’ll be the operator for today. At this time, all participants are in a listen–only mode. Later we will conduct a question–and–answer session. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I would now turn the conference over to Oksana Lukasheva, Vice President, Investor Relations. Please proceed.

[Oksana Lukasheva:]

Thank you, Denise. Good morning and thank you for joining us for our third quarter conference call. We will begin today’s call with prepared remarks from Fred Eppinger, our President and Chief Executive Officer; and David Greenfield, our Executive Vice President and CFO. Available to answer your questions after our prepared remarks are Andrew Robinson, President of Specialty Lines; Mark Desrochers, President of Personal Lines; Jack Roche, President of Business Insurance; and Bob Stuchbery, President of International Operations and Chief Executive Officer of Chaucer. Before I turn the call over to Fred, let me note that our earnings press release, financial supplements and a complete slide presentation for today’s call are available in the Investors section on our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today other than statements of historical facts include forward–looking statements, including our earnings guidance for 2014. There are certain factors that could cause actual results to differ materially from those anticipated by this press release, slide presentation and conference call. We caution you with respect to reliance on forward–looking statements and in this respect refer you to the forward–looking statement section in our press release, slide 2 of the presentation deck and our filings with the SEC. Today’s discussion will also reference certain non–GAAP financial measures such as operating income, operating results excluding the impact of catastrophes and accident year loss and combined ratios excluding catastrophes, among others. A reconciliation of these non–GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release or the financial supplements, which are posted on our website, as I mentioned earlier. With those comments, I will turn the call over to Fred.

[Fred Eppinger:]

Thank you, Oksana. Good morning, everybody, and thank you for joining our third quarter earnings call. We are very pleased with the third quarter results as well as the progress we are making with respect to our key strategic priorities and our improving results and market momentum is beginning to demonstrate the growing value of our differentiated market position. While we were challenged by some severe weather in one of our largest markets, we enjoyed improved accident year margins in each of our segments, good growth supported by solid pricing trends and increased retention. Net income per share was $1.22 for the quarter. We delivered operating income per share of $1.06, and annualized operating ROE of 8%, which withstood a substantial weather anomaly in Michigan along with other catastrophe events. On an ex-cat basis, operating income for the current quarter improved substantially by 27% compared to the third quarter of 2013. The main highlights of our quarter include building growth momentum and continuing underlying margin traction in Personal Lines, improving margin in Commercial Lines along with continued profitable growth and another strong quarter at Chaucer. With yearend approaching and as we finalize our planning for 2015, we feel very good about our improvements we’ve made and the positive trends we’ve established, which brings our goal to generate top quartile performance closer within reach. I will now turn the call over to David to review our financials. And after that, I will come back to discuss our position within the industry and provide a longer-term perspective of our performance and our outlook for the fourth quarter.

[David Greenfield:]

Thank you, Fred, and good morning, everyone. Our third quarter results were very strong despite experiencing unusually large catastrophe activity in Michigan. We are pleased with the ongoing improvement and underlying trends and our ability to deliver on financial goals and growth targets. Net income for the quarter was $55 million or $1.22 per diluted share compared to $61 million or $1.37 per diluted share in the prior-year quarter. Operating income was $48 million in the quarter or $1.06 per diluted share compared to $61 million or $1.36 per diluted share in the third quarter of last year. Turning to underwriting results, our combined ratio increased by 2 points this quarter to 98.2%, driven entirely by higher than expected catastrophe losses in the quarter. At 7.4% of net earned premiums, catastrophe losses were nearly 5 points higher than in the prior-year quarter, and higher than our normal expectations. The accident year combined ratio excluding catastrophes improved by 3 points, reflecting very strong underwriting performance in each of our business segments. Catastrophe losses in the quarter were $88 million, of which $72 million came from the domestic lines. More than half of our U.S. catastrophe losses stem from Michigan events, which primarily affected personal lines. We also experienced additional losses related to prior-quarter catastrophe events and Chaucer’s $16 million of catastrophe losses included weather events in the Mexico and Europe. The unusually high catastrophe activity in Michigan is an anomaly against a long track record of strong and consistent profitability with low weather volatility in that state. This loss effectively demonstrated how much more resilient our company is today and how much progress we’ve made in diversifying our footprint. Just a few years ago, this would have absorbed most of our quarterly earnings. Today, with the strength of our organization and growing earnings power, we were still able to deliver strong earnings. Moving on to accident year loss ratios excluding catastrophe losses; in our domestic business, the loss ratio improved by nearly 3 points to 59% in the third quarter of 2014. In Commercial Lines, the more than 2-point improvement resulted from far better loss experience in Other Commercial Lines and to a lesser expense in Commercial Auto. In Other Commercial Lines, which included our specialty businesses, the ratio improved by more than 6 points over the prior-year quarter. This was driven by previous and ongoing mix management and pricing actions. Specialty business maturation and organic growth should continue to drive margin accretion in this segment. In Commercial Auto, our continuing re-underwriting efforts and rate actions are helping, and although we are pleased with the lower losses in the current quarter, we are not yet satisfied that we are at our desired level of profitability in this line. There is still additional loss-reserve development coming from prior accident years, which warrants a continuous cautious approach to this line. We achieved 8 points of pricing increase in this quarter and continued to maintain a rigorous stance towards [auto heavy] (ph) and monoline accounts. This, along with other profitability actions in Commercial Lines, will continue to impact our growth next quarter. In Personal Lines, the ex-cat accident year loss ratio improved by approximately 3 points from the same period in 2013. This is in line with our expectations owing to our ongoing pricing and mix management initiatives. The Personal Auto underlying loss ratio improved by more than 2 points as a result of rate increases, continuing shift towards account business and underwriting refinements. The Homeowners line improved by 4 points over the prior-year quarter, driven by pricing and mix shift, but also reflected in a favorable comparison to a higher than usual incidence of large losses in the third quarter of 2013. Moving on, expenses in our domestic businesses were little changed compared to the prior-year quarter. We achieved a modest improvement in the Commercial Lines expense ratio. This was driven by increased premium volume and operating efficiencies. And while expenses can sometimes vary from quarter to quarter, we remain on track to achieve the target of 1 point improvement in Commercial Lines for 2014. While a lower earned premium base in Personal Lines continues to impact the expense ratio, our return to growth in this line should relieve that pressure and we continue to expect the full-year ratio to be fundamentally in line with 2013. Chaucer delivered a strong performance this quarter, resulting in a combined ratio of 92%, similar to the prior-year quarter, but with some underlying differences. The segment’s performance included a 4-point improvement in the ex-cat accident year loss ratio, driven by lower large losses in Marine. This was largely offset by lower prior-year favorable reserve development, an additional point of catastrophe losses. Chaucer’s expense ratio also was in line with the prior-year quarter. Chaucer continues to benefit from a low level of global loss events and we maintain our long-term combined ratio expectation of 85% for this segment. I’m sorry, 95%, pardon me. Turning now to the topline, net written premium increased 5% this quarter, and growth in all – with growth in all segments. In Commercial Lines growth was in high single digits, Personal Lines growth momentum improved to 2% driven by our Platinum initiative as well as a lessening impact of exposure management actions. Finally, Chaucer’s net written premium increased 4%, primarily reflecting increased new business writings in Casualty and other due to the new team that joined us in late 2013. As the market condition in Lloyd’s continues to be challenging our efforts are strongly based on balancing our conservative appetite with the need to maintain and enhance our underwriting leadership and relationships with brokers. Turning to investment results, net investment income this quarter was $68 million, $2 million higher than the prior-year quarter. The prolonged low-interest rate environment continues to put pressure on investment income, though we have countered that with positive operating cash flows and changes in the portfolio mix towards equities and other instruments. The earned yield on our fixed maturity portfolio was 3.68% in the quarter compared to 3.99% in the prior-year quarter and 3.74% in the second quarter of 2014. At September 30, 2014, cash in invested assets were $8.5 billion with fixed-income securities and cash representing 91% of the total. 94% of our fixed income portfolio is investment grade and the average duration of the portfolio is 4.2 years. We continue to prudently expand our portfolio mix into non-fixed maturity investments, including equities, participation in commercial mortgage originations and partnerships. This strategy helps diversify the portfolio from spread products as well as offset the continuing pressure on the fixed-income portfolio from continued low interest rates. We ended the quarter with a strong total capital position of $3.7 billion. Book value per share was $63.37, down 0.4% in the quarter and up 6.6% year-to-date. The slight decline for the quarter was due to the impact of rising interest rates and equity market fluctuations on net unrealized investment gains. Net unrealized investment gains were approximately $293 million at the end of the third quarter, as compared to $222 million at the beginning of the year, and $361 million at the end of the second quarter. It is a very fluid time in the market and we do expect some volatility in our net unrealized investments gains position going forward. As an example, although we saw a $68 million decline in the net unrealized gains during the third quarter, as of this week a substantial portion of that decline had recovered. Our total debt to total capital ratio of 24.6% remains well within our target range. In this quarter we repurchased approximately 226,000 common shares for $14 million. On a year-to-date basis, we repurchased approximately 347,000 common shares at a cost of $20 million. We continue to favor capital deployment options that profitably grow our business. The strength of our balance sheet and stable reserve positions support our ultimate goal which is to grow our business and achieve our financial goals. With that I’ll turn the call back to Fred.

[Fred Eppinger:]

Thank you, David. The third quarter highlighted our ability to continue to build on the business momentum we have seen in recent periods. We are in a strong competitive position as we advance ourselves both in the underwriting performance and our relationships partner agents and brokers. And we believe we are well positioned to continue to improve based on our strategic – our strong strategic position and business model in each of our segments. Let me talk to you on three factors that lead us to this conclusion. First, we are pleased with our Personal Lines account strategy and new Platinum Experience product, which positions us well in the value-oriented account market. Second, in Commercial Lines, we are well positioned in the middle to small account markets, supported by a unique operating model and a broad business portfolio including our specialty business and an effective distribution strategy that creates an opportunity to [accept] (ph) the most attractive segments. And finally the expertise and underwriting leadership position at Chaucer provides us with good options and strong leverage in navigating the current market challenges. So let’s look at each of these factors through the lens of recent results, starting with personal lines. This business continued to gain growth momentum delivering an increased premium of 2% in this quarter and at the same, we achieved price increases of 5% in Auto and 7% in Homeowners, relatively consistent with the last several quarters. We are confident our strong and improving retention in Personal Lines means that we will be able to maintain similar levels of rate increases in the future. Furthermore, our distinctive accounts solution in the Platinum brand has provided strong business growth which is up significantly from prior periods. We are very pleased with the successful launch of our Platinum product and its early metrics. The product is now live in 15 states, which represents about 85% of our countrywide personalized new business. Platinum is a robust platform that emphasizes our foundational strategic elements, account focus and a value added approach. We expect that we will continue to provide meaningful new business growth and early indications also support our expectation of increased retention going forward. Additionally in states where we have launched Platinum, we have achieved strong increases in new account business, umbrella penetration, coverage limits and other factors that collectively point to further mix improvement in our book going forward. We believe over time this will lead to better account persistency and attractive returns. Although we recognize peer company commentary about increased competition in the auto marketplace, we believe we have a strong strategic position in our target segment that provides ample opportunity to profitably grow and gain share with our partners. Our approach to the business and partnership with agents who sell value gives us access to a relatively large customer base where customers look for an effective accounts solution with responsive service and strong coverages. With the bulk of our exposure management actions coming to an end in 2014 and our increasing retention and new business lifts, we believe the Personal Lines growth momentum will continue in the fourth quarter and into 2015. At the same time the combination of pricing and mix improvements should result in continued margin accretion into next full year. In Commercial Lines, specifically Core Commercial, we continue to have market momentum, generating 8% growth, although this was partially offset by some target profit-proven actions primarily in the auto market. Pricing increases in Core Commercial for the quarter were approximately 7%, relatively unchanged from last quarter, driven by increases in all our businesses. Specialty lines have continue to improve profitability as these businesses mature. All production indicators remain strong, we are achieving rate in excess of loss trends and growing at a good pace while keeping strong retention. We are now seeing the benefits of the significant investments we have made over the last few years in talent and our unique operating model. Improving returns again this quarter support our confidence in these businesses will continue and provide consistent value to our franchise. While there are market challenges and we are not immune to them, we believe our strong strategic position and unique operating model sets us well to compete in the current environment for a couple of reasons. First, our focus on smaller accounts and value-added segments where business is stickier by nature, shields us from some of the excess market capacities that is flowing into the market primarily settling at the upper end of the account spectrum. Second our rigor in pricing segmentation and consistency in messaging with our partner agencies allowed us to focus on winning and retaining more attractive segments of the business. Despite headwinds in the Lloyds market, Chaucer, delivered yet another strong performance this quarter. There was some weather-related catastrophe activity this past quarter, particularly in Mexico and Europe, although it was offset to a degree by a more favorable non-catastrophe large loss experience. Over the years Chaucer has worked diligently to assemble a number of solid specialty positions and strong teams in energy green, casualty and other lines, and our leading position in these classes and our diversified portfolio will help us successfully navigate the challenges of the current environment. We will be cautious given the market conditions, but we will continue to write business and seek out attractive market opportunities in our focus class. Overall, our third quarter results are a very strong indication that our strategy and approach to the business are the right ones for us. As we had previously mentioned, we built our company to perform well at all stages of market cycle, which now puts us in a favorable position as we continue to capitalize on market disruption. We believe we will maintain momentum and profitability grow – excuse me, and profitably grow in most of our domestic businesses. And underlying margins will continue to improve driven by rate, profit management actions as well as an improving business mix. It is also important to note that going forward the persistency of our earnings is much stronger and although Chaucer’s future performance will reflect the challenging market conditions in producing more normalized combined ratio of 95% we think we have visibility and enough improvement in our overall business to produce another 1 to 2 point margin accretion in the future. Before we open the lines for questions, let me summarize our current position and outlook. Overall, we are pleased with our results of the quarter and the encouraging trends supporting this, underlying – including underlying loss improvement, expense improvement and premium growth across our franchise. And despite higher than expected catastrophe losses in the current quarter we hope we are maintaining our guidance at the lower end of our initial range and believe we can deliver earnings per share of approximately $4.80 for the full-year 2014. The estimate includes catastrophe assumptions of the fourth quarter of 4% and I would remind you about our usual winter weather seasonality. We also expect low to mid single digit net premium growth in the fourth quarter as we continue our target re

[Operator:]

Sure. (Operator Instructions) Our first question comes from Vincent DeAugustino with [KBM] (ph). Please proceed.

[Fred Eppinger:]

Good morning, Vincent.

[Vincent DeAugustino:]

Good morning, how are you guys doing today?

[Fred Eppinger:]

Good.

[David Greenfield:]

Very well, thank you.

[Vincent DeAugustino:]

Good. All right, so good quarter. Just some more strategic questions I suppose. So this morning Selective had talked about a similar product launch as your guys’ Platinum product that’s doing quite well, so just curious if you think that within some of your peers that are in that more agency focused Ivy League agent type segment, if that shelf space is getting a little bit crowded. I know it’s early.

[Fred Eppinger:]

Yeah, I talked a little bit about this at our agency meeting. What’s fascinating about it is we believe that the $90 billion agency business, $70 billion plus of that is this value added-segment, value added account oriented segment. Two-thirds of that is really dominated by the small regional companies that have in my view less sophisticated product, they don’t have the self-service attributes that we have, they don’t have the technology investments capability we have. So what’s interesting right now in my view is it’s a wide open market. A lot of people that talk about this segment are talking about really more of the Chubb segment, so this middle market segment what we see is for what we are trying to do is wide open right now. There may be like you mentioned this morning that are starting to invest in it but it’s a very nice market for us, because these are businesses or accounts if you will that agents have served for a long time, but in some ways they have been underserved because of the technology abilities of these regional companies or the features that they have, the ability to tailor if you will the solution for that mid-size account that has multiple things. So we’re pretty bullish on our ability to capture it. Our agents control across the country, not just in our current Personal Lines footprint, about $38 billion to $40 billion of that market. So for us there is a lot of opportunity there as we work with our partners to serve it better.

[Vincent DeAugustino:]

Okay, lot of a good color there. And just to switch over to Chaucer, so this probably has been talked about over the years at some point or another, but just with crude prices coming in a bit, if there was any slowdown in activity for that industry, has that to date or would you expect that to potentially impact the energy line at all?

[Bob Stuchbery:]

Sorry, Vincent, you can just repeat that? It was difficult for us because…

[Vincent DeAugustino:]

Yeah, absolutely. So just with crude pricing coming in, I was curious if that would potentially impact any economic activity for that industry and thereby potentially impact Chaucer’s topline for energy.

[Bob Stuchbery:]

Yeah, it will have some effects on some of the earnings we get through on business that we write that are adjustable. But also it gives us other opportunities to some of the developing lines that we are exploring, where they are – those are technologies that are new that would have – we are involved in as well and we are trying to lead that position as well. So I wouldn’t expect it to have too much of an effect on our particular sector and the areas that we participate in.

[Vincent DeAugustino:]

Okay, good to know. And then so I think aviation was one of those emerging – I know it’s small and still have a lot of opportunities for you guys but we’ve heard that the rate increase environment hasn’t quite been quite as robust as what some insurers were hoping for and so I was just curious if that’s what you are seeing as well.

[Bob Stuchbery:]

Yeah, I think that there’s two elements to this. One is what we call the general aviation and the airline business which following some losses we had expected to see more of a wholesale increase in this sector. The reality is that affected airlines are obviously being – seeing those increases but across the marketplace it’s pretty at the moment, we’re not seeing those signs come through. The other thing I talked about on the last quarter’s call was aviation war, where we would expect to see rates to be going up and this is the area that we started to underwrite from around the 1st of April this year. So our expectations of rates increasing in that sector have definitely been fulfilled but across the main aviation airline rates aren’t moving up much at all.

[Vincent DeAugustino:]

Okay, all right, thanks everyone.

[Fred Eppinger:]

Thanks Vincent.

[Operator:]

Our next questions from Dan Farrell with Sterne Agee. Please proceed.

[Fred Eppinger:]

Hi Dan.

[David Greenfield:]

Good morning.

[Dan Farrell:]

Morning guys. Fred, just let me ask you on personal lines. In the past you guys have wanted to focus on your existing state mix as you were managing exposure but with exposure management winding down or at least a big part of it and obviously this Platinum product performing well, any thoughts on potentially expanding the state footprint?

[Fred Eppinger:]

Yeah, Dan, it’s a great question and I mentioned it briefly at some of our meetings. We are assessing right now because of our partners coming to us some targeted, smaller targeted list of states that stick what their footprint is, so more to come on that. But again, you are absolutely right, we are – by the end of this year, most of our exposure management will be behind us. That was – primarily what was left was of the New England and New Jersey business. And now we’ve got a nice growth happening with essentially our partners broadly across our footprint and we are with them having conversations on some targeted areas. And so more to come I think in the next couple of quarters about what we – where we go with that. But it is – again, we’ve mentioned it in small commercial as well, there’s a combination of – we’re a little bit ahead of our product and packaging on this segment but also the agents as they consolidate it by other agencies, they are consolidating their markets just like they are in small commercial. And because we have the tools to do that effectively and we have been very successful with that, a lot of them are coming to us and saying could you participate in that with us more broadly, so more to come on that. But I – again as I said in our investor day, we’re not going to play in every segment in the business but we love our segment that we’re in and we think that there is some nice profitable growth for us to continue with.

[Dan Farrell:]

Great, thanks and then just a question on the commercial lines segment. There was very good year-over-year improvement in total but one area that was a little higher than a year ago was commercial multi-peril. Was that due to just a more difficult comparison or is there a little less rate there relative to some of the other segments or anything else just along that…

[Fred Eppinger:]

Jack? Yeah, Jack, why don’t you take that?

[Jack Roche:]

Yeah, predominantly a tough comparison. If you look at the third quarter of ‘13 we had our best quarter in two years, so that was a bit of a tough comparison. But also the CPT line tends to be bumpy and so even beyond the weather you’re going to have – as you have seen from some of our competitors you’re going to have some losses that show up in whatever quarter they show up on. But over the three-year period we like the trend in this line and we don’t expect this line to be anything but one of our contributors to our profitability.

[Fred Eppinger:]

And we’ve seen very good stable pricing, so we’re in a segment – this is one of those places where you’ve heard the market a little bit at the very high end and property coming under pressure, our segment we’re getting nice price increases in that line so don’t see any kind of trend that scares us at all on it.

[Dan Farrell:]

Okay, great, thanks guys.

[Jack Roche:]

Thanks Dan.

[Operator:]

(Operator Instructions) We now have a follow-up from Vincent DeAugustino with KBW. Please proceed, sir.

[Vincent DeAugustino:]

Hi, good morning again guys.

[Fred Eppinger:]

Hi Vincent.

[Vincent DeAugustino:]

Just two follow-ups. So a couple of years ago you guys started expanding into the lower hazard workers comp states and so I was just hoping to get an update to somehow that basis is going from the…

[Fred Eppinger:]

So I am going to let Jack follow up.

[Vincent DeAugustino:]

Perfect.

[Fred Eppinger:]

But what’s a little different for us right, we have never been a monoline comp player. What we have been doing is if you think about our small commercial strategy where we build a lot of capabilities with a full account including comp, that’s where a lot of our growth has come. And that will continue as we grow our small commercial we are very effective now at the account approach of that business and so the vast majority of our success I would say is that flavor. And Jack I don’t know if you want to

[Jack Roche:]

Yeah, no I think that continues to be our focus. I would say that as the workers comp environment has improved over time and you see relatively benign loss trends, we have been a little bit more active in some of the sectors like technology beyond small commercial where we believe the dynamics are such that we can improve our margins. So we are trying to become a little bit less conservative as the environment improves but I think as we’ve said before we’re still relatively cautious on this line of business and have maybe a more conservative long-term view that really we’ll continue to maintain

[Fred Eppinger:]

And as you know in middle [little] (ph) market, or what we call [schmiddle] (ph) (indiscernible) to middle our industry solutions like TAP have been very successful for us and those are very effective for us to write multiple lines because of those industry solutions so that’s been very successful and will continue to be for us I think.

[Jack Roche:]

And as Fred articulated earlier, we do see with the consolidation of business on the distribution side, increasingly some of the large and midsize agents are looking to the consolidate markets and clean up the efficiency of their business. That presents us some unique opportunities on an account basis to help bring some business together that was previously split by our competitors or even in some cases rounding out some accounts of our own. So that does tend to drive some of our workers’ comp growth.

[Vincent DeAugustino:]

Okay, good to hear and just one last one on my end. So David you had mentioned as far as the share repo just clearly the first preference being cap deployment in the business and the average price there was quite good. So was that just an opportunistic type deployment or is there any incremental thought change?

[David Greenfield:]

Yeah, no incremental thought change, absolutely as you said if you remember back in August the markets were extremely volatile just as they are today but we did see a drop in the price and we used the opportunity to do some open market purchases and again we – I always say we do have a minimum level of repurchase that we build into our plan each year and this is consistent with what our expectations were for the year.

[Vincent DeAugustino:]

Okay, so we should think about 400,000 as the maintenance level, around it?

[David Greenfield:]

Yeah, or dollar terms around 20 – to $20 million.

[Vincent DeAugustino:]

Okay, got you. All right, thank you.

[David Greenfield:]

Okay. Thank you Vincent.

[Operator:]

We have no further questions. I will now turn the call back over to Oksana Lukasheva for any closing remarks. Please proceed.

[Oksana Lukasheva:]

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

[Operator:]

This concludes today’s conference call. You may now disconnect.