Hanover Insurance Group, Inc. Q2 FY2021 Earnings Call

Good day and welcome to The Hanover Insurance Group’s Second Quarter Earnings Conference Call. My name is Gary and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

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. Before I turn the call over to Jack, let me note that our earnings press release, financial supplement and a complete slide presentation for today's call are available in the Investors section of our website. 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 fact, include forward-looking statements regarding, among other things, our outlook and guidance for 2021, the ongoing impacts of the COVID-19 pandemic, economic conditions and other risks and uncertainties that could affect the Company’s performance and/or cause actual results to differ materially from those anticipated. We caution you with respect to reliance on forward-looking statements and in this respect, refer you to the forward-looking statements section in our press release, the presentation deck and our filings with the SEC. Today's discussion will also reference certain non-GAAP financial measures such as operating income 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, the slide presentation or the financial supplement, which are posted on our website. With those comments, I will turn the call over to Jack.

Thank you, Oksana. Good morning, everyone, and thank you for joining us. I will begin by discussing our second 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 during the quarter. Jeff will review our financial results in more detail and provide some thoughts on the quarters ahead. And then Bryan, Dick, Jeff and I will be happy to take your questions. We are very pleased to report outstanding second quarter results highlighted by strong growth with net written premium increases of 11.7% or 8.6% on an adjusted basis excluding the impact of 2020 premium returns driven by gains across all segments. Operating income of $104 million or $2.85 per share. Our strong underwriting results are a reflection of our ability to capitalize on evolving market opportunities while navigating the complexities of this dynamic underwriting environment. From my perspective, there are two key takeaways for the second quarter results. First, our growth has accelerated and exceeded pre-COVID-19 levels in all segments. And second, we continue to achieve broad-based profitability with strong underlying underwriting results in each of our businesses. I would like to briefly discuss each of these points in turn. With respect to growth, we delivered a meaningful step up in premium increases in each of our business segments compared to the first quarter of this year. All of our major segments now are exceeding pre-COVID-19 growth levels as a result of our disciplined and consistent pricing strategy, strong retention, and robust new business production metrics. Strong relationships with our agent partners provide an opportunity for solid growth potential going forward as we capitalize on our most profitable market sectors and leverage our state-of-the-art technology platform. Additionally, we continue to enhance the level of sophistication within our claims data and analytics, including our real-time driving pattern and inflation monitoring tools. I've never been more confident in our ability to grow profitably. In Personal Lines, we delivered growth of 11.6% in the quarter or 5%, excluding the effect of premium returns in the prior year period. Our continued strong growth momentum in this business is a reflection of sustained agent and customer interest in our attractive account offerings, targeted pricing actions, the strength of our market position and our ability to successfully adapt and navigate a competitive marketplace. We grew our commercial lines businesses by 11.7%, driven by the strong performance of our specialty portfolio, as well as our small commercial business, which benefited from the economic recovery as we begin to see the impact of the rollout of our new quote and issue platform Tap Sales. Overall, we are well positioned to continue driving growth in all segments, and we now expect to deliver mid-to-high single-digit growth for the remainder of the year. Regarding loss trends, we are still experiencing some remaining lower auto loss frequency in the quarter reflecting the fact that a meaningful portion of our customer base likely has the opportunity to utilize more flexible working arrangements. Additionally, in many areas of the country, our data indicates reduced traffic and less congested rush hours as potentially lingering consequences of the pandemic. We expect frequency will reach its new normal over the course of 2021, which may provide some persistent lower accident frequency in certain geographies, given our mix and customer profile. We believe this benefit will be partially offset by near-term increased severity from materials inflation and more severe accidents including elevated fatalities. We delivered strong commercial lines profitability in the quarter although we experienced some elevated property losses, including in other commercial, which we do not believe are necessarily recurring or indicative of a trend. We believe it is consistent with that of the market. Thus, we think that there is room for additional rate increases in the property lines moving ahead. And as always, we remain very prudent on our loss selections. We are mindful of the potential for increased social inflation, medical information and treatment delays, and other inflationary trends. We are watching the economic recovery and the acceleration of business activity closely as well as the full reopening and catch-up of the court system in many jurisdictions. While the impact and duration of inflation on our book of business is yet to be determined, we believe our comparatively short reserve duration positions are well to manage through that potential exposure. With that as background, I would now like to share some recent highlights by business beginning with personal lines. Our efforts to selectively apply rate adjustments where warranted have been very successful, as demonstrated by our sequential PIF growth of 1.8% in auto and 1.7% in home during the quarter. New business growth came in ahead of expectations and we are seeing significant sequential improvement in retention. Our preferred customer focus and our value-based approach represents significant competitive advantages particularly as agents become even more strategic with their Personal Lines operating models and carrier placement decisions. Account business represents over 85% of our overall book, leading to a high level of retention and business stability. Our Personal Lines retention improved by over 2 points in the second quarter compared to the first quarter demonstrating the agility of our approach and the success of our business strategy even in this very dynamic environment. In Personal Auto, we expect our claims auto frequency to gradually approach new normal levels as the year progresses. Though the pricing environment remains competitive, we are seeing clear indications that the rate deceleration has bottomed out and the industry is looking to increase rates. As a result, we have much less of a need to significantly increase rates in the near future. We continue to gain momentum with Hanover Prestige, our full account offering for customers with higher value homes and autos and more complex insurance needs. These customers represent a growing segment of the Personal Lines market, which further positions us as a strategic partner with agents. The contribution of this offering to our overall growth is increasing every quarter, with the second quarter benefiting new business growth by 3 points. Turning to Commercial Lines, we executed extremely well on our strategic priorities posting growth of 12% in specialty and 11% in core commercial driven by a pickup in new business, rate increases, and exposure growth. Strong top line growth in our core commercial business is expected to continue through the year driven by the reopening of the economy, continued rate increases and a successful launch of TAP Sales. Our small commercial quoting platform is proving to be a great addition to our already strong small commercial offering. The response to this offering has been incredibly positive with agents praising the product's ease of use and simplified quoting process. The investments we have made to modernize our infrastructure and enhance our capabilities across our business are being realized at a time when agents are consolidating and buying more agencies with substantial small commercial books of business. This is forcing them to become more strategic about the carriers they choose to do business with.

Thank you, Jack. Good morning, everyone. For the second quarter we reported net income of $128.5 million or $3.52 per diluted share compared with net income of $115.2 million or $3.01 per diluted share in the second quarter of 2020. After-tax operating income was $104 million or $2.85 per share compared with $62.7 million or $1.63 per share in the prior-year quarter. The difference between net and operating income is due to the increase in the fair value of equity securities. Book value per share increased 4.8% in the quarter, driven by earnings and to a lesser extent an increase in unrealized gains in our fixed-income portfolio. I would like to acknowledge that some of the comparisons to the prior year quarter need to be put in context with the very unusual nature of the second quarter of 2020. With the economy largely closed and most of the country placed under stay-at-home orders, many lines of business experienced historically low frequency of claims last year. As the economy continues to open up and individuals return to the roadways, we believe our more recent growth trajectory and loss experience are better barometers by which to assess our performance. We are pleased with our overall combined ratio of 94.4% in the second quarter 2021 compared to 96.2% in the prior year quarter, which a year ago reflected several large catastrophe events including losses from social unrest. We incurred catastrophe losses of $76.8 million or 6.5% of net earned premium, 40 basis points above our quarterly expectation, primarily reflecting severe wind and hail events throughout the Midwest in June. Additionally, we experienced some favorable catastrophe development in the quarter from prior years, which is a testament to our prudent reserving approach. We continued to be prudent in our reserving and Commercial Auto, where extension of loss patterns and prior bodily injury development warrant a cautious approach. We have placed a considerable amount of emphasis on strengthening our balance sheet and it is stronger than it has been in many years coming out of the second quarter. Claims activity related to COVID-19 exposures continues to be manageable and we are holding substantial IBNR in that area. Our expense ratio for the second quarter of 2021 was 31.2%. We are confident that we can deliver a 30 basis point expense ratio improvement for full year 2021. Overall, current accident year combined ratio ex-cat was 89% in the quarter. This very strong underwriting result reflects our diversified book of business, our earning in of rate increases and some lingering frequency benefit in auto lines. Looking at our underwriting results by segment, our commercial lines combined ratio excluding catastrophes was 89.5% up 2.7 points from the second quarter of last year primarily reflecting a comparison to an extraordinarily low level of losses in the second quarter of last year.

Hi, thanks. Good morning. Jack I caught your comments on some of the areas of growth within Specialty. And I was hoping that you or Bryan could expand on that a little bit. Specifically, one question I have is, as you look at the type of client or the relationships with growth within those lines, to what extent is it cross-sell? I remember you talked in the past about existing Hanover relationships where they buy a Specialty product somewhere else, and the opportunity to consolidate that relationship. Is that a big piece of the growth? Or is that something more yet to come?

Yes, thanks, Matt, for the question. One we're excited to update you on. I'll start with overall Specialty growth. I think that's a direct result of how well the performance of each of these businesses is in terms of the bottom line where that broad-based profitability within the Specialty business is really at its best. Specific to your point around cross-sell versus individual business growth, it's still very much driven by the individual businesses and lines of business. Although we are definitely seeing an increase in cross-sell or what we would consider coordinated lines of business sale to total accounts. We have mobilized around that particularly in the small commercial space, all the way into our service centers. So I think right now what you see is the majority of our Specialty growth is coming from specialized products into specialized agents. Very much from our franchise agents as well as some specialized agents. But increasingly, we anticipate that more and more of that will come from cross-sell or coordinated business.

Yes, sure. So, Matt, yes, thanks for the question, very much agree with what Jack said. What I would add is that what we've been really working towards for the last couple of years, is a strategy that we refer to as total Hanover. I view that as a really consistent process, where we connect at the local level with our agents across businesses. So Jacks said is point on it, we're just in a very good place and our ability to grow across our lines of business is generating better production from our agents that have great relationships with our core commercial. And a piece of that is cross-sell as well.

Matt, we've been going after Commercial Auto for at least three years now with double-digit rates. It's hard for anyone in the industry to say when we're there yet because we've all been focused on it for nearly a decade now in terms of getting it right. In 2020, there was a unique opportunity to be very, very prudent and comfortable with that particular year. And then in 2021, in the first two quarters, we've seen some continuing frequency benefit, not quite as much as Personal Auto, and it's been waning throughout the period. There was some unfavorable development in that particular line. We just want to make sure that we're conservative and have appropriate loss picks for all the years.

Good morning. Thanks. Just going back to your mid-to-high single-digit growth guide for the second half. Can you just talk about how much of that is exposure growth versus rates? The reason why I'm asking is that I saw that the commercial rate increases accelerated sequentially while retention drops, which I assume is partly due to non-renewals?

Overall, obviously, you can see a rate increase in the second quarter was relatively consistent with the first quarter and even slightly up. We're seeing exposures bounce back sequentially. And our assumption is retention will be relatively flat, where we'd like it to be about 85%. I know it looks like it has come down a little bit, but a lot of that is wind aided. I think all factors will contribute. It'll be strong retention, good new business, a fair bit of rate, and continuing bounce back on exposures.

Good morning, congratulations on the quarter. I was looking at your guide and apologies if my math is not the best, but it would suggest I think that the core combined ratio for the second half would be higher than the first half. Is there any reason for that? It wouldn't be the first time I think of your seasonality is being a little bit more of a second-quarter heavy weather kind of core issue. But maybe you could talk to that?

Yes, I have to look at that. Paul, I don't believe that's the case. There's nothing that we see going on in the second half that would cause the core commercial ratio to increase. If I were to get underneath it for you a bit. Over time, I expect Commercial Auto to go up a little bit as the remaining frequency benefit abates. So I would have to go back and check that maybe we're being conservative.

Hi, how are you all today? I was wondering if we could talk a little bit more about workers' comp. The core loss ratio was a little bit higher than the past couple of quarters. So I was just wondering how loss costs are progressing as reopening progresses, and where you see loss costs going from here and also pricing?

Overall, we are definitely seeing some frequency move back to more normal levels as expected and we're certainly also seeing pricing flatten off and flatten up. We think that's worked through the system. But the last thing I would say on this is that we still see this as more of an opportunity than a challenge given our relatively low percentage of workers' comp in our total portfolio. So if those trends start to become more normal, they'll impact this less severely. But it'll also drive a different pricing dynamic. We're kind of on our toes waiting for pricing trends to catch up eventually to what the longer-term loss trends will be.

Hey there and good morning. I've got a couple of questions on the TAP Sales platform. The first one is, I understand that benefits you're going to be getting from the top line as the agents direct more business your way but I was curious whether there's an underwriting component to that as well. Is there a bottom line improvement expected as well? And how does Hanover's product differentiate itself?

Yes. Thanks, Bob. This is Jack. I'm just going to really address the latter part of your question there and then ask Dick to talk to you about the first part of your question, which is, in absolute, yes. Our small commercial offering, along with the overall enterprise approach we use with agents is very distinctive. We have an underwriting risk appetite for BOP accounts, as well as package accounts. We are equipped with a world-class service center and have great proprietary pricing. We're really one of the best prepared markets to help agents when they consolidate markets. So I think it's important to say that we are really excited about the new TAP sales platform and experience that we're creating that is multifaceted and distinct.

To your specific question about improved underwriting results. Absolutely yes on multiple dimensions. One of the elements of this broad-based platform is the pricing efficacy that comes along with a new rollout, where we've moved to a much more refined pricing segmentation, upwards of hundreds of cells in which we can slot customers. There are improved underwriting knockout rules on the way in and on the renewal side. So we're confident this will improve the loss ratio.

Thank you everybody for your participation today. We're looking forward to talking to you in our Investor Day.