Hanover Insurance Group, Inc. Q1 FY2023 Earnings Call

Good day, and welcome to the Hanover Insurance Group’s First Quarter Earnings Conference Call. My name is Jason, and I will be your operator for today’s call. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

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 Jeffrey Farber, our Chief Financial Officer. Available to answer your questions after our prepared remarks are Dick Lavey, President of Agency Markets; and Bryan Salvatore, President of Specialty Lines. 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 at www.hanover.com. After the presentation, we will answer questions in the Q&A session. Our prepared remarks in response to your questions today, other than statements of historical fact, include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements can relate to, among other things, our outlook, catastrophe load economic conditions and related effects including inflation, supply chain disruption, potential recessionary impacts and evolving insurance behavior. These statements can also relate to other risks and uncertainties such as severe weather and catastrophes 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, 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 ratio, 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, as I mentioned earlier. With those comments, I will turn the call over to Jack.

Thank you, Oksana, and good morning, everyone. I will begin with an overview of our first quarter results, a discussion of the accelerated steps we are taking to address the risks posed by extreme weather events as well as an update on the progress we are making towards our margin recapture plan. I will conclude my remarks with an update on our agency relationships and key takeaways from our recent annual agency conference. Our first quarter results, excluding catastrophes, were strong, consistent with our expectations and supported by the progress we’ve made to advance the margin recapture plan we established last year. We are executing price increases slightly above expectations in Personal Lines, while also meaningfully advancing pricing and underwriting measures across the board in commercial property. Throughout the quarter, however, Hanover and the industry experienced heightened catastrophe activity, stemming from severe freeze events and several storms with widespread wind and tornado activity, which turned what was a very solid quarter for our company into essentially breakeven operating results. I first want to take a moment to recognize the efforts of our exceptional catastrophe response team. Our catastrophe team members are working tirelessly to settle claims as swiftly and effectively as possible for our valued customers. The team once again stepped up to do what they do best, providing responsive service to our customers in their time of need and helping them recover from these storms as quickly as possible. Given the continuing pressure related to changing weather patterns and elevated catastrophe activity, I want to provide more insight into the actions we are taking to address its effects. On our fourth quarter call, we highlighted our past success in managing traditional catastrophe risks by combining disciplined underwriting, data, analytic tools and technology to reduce our micro concentrations and coastal exposures and enhance our pricing for the catastrophe perils. These actions have resulted in lower exposures to hurricanes and coastal risks over the last 10 years, reduced vulnerability to storms along tornado alley, and helped build a significantly more diversified book of business. Across our industry, however, it’s abundantly clear that the increasing severity of claims from changing weather patterns, including winter storms, necessitates even more aggressive strategies. While we have significantly reduced our catastrophe concentrations in many geographic markets across our portfolio over the past several years, we are acting with a heightened sense of urgency given the recent events. With that in mind, we are pursuing three key areas of action to respond to these new weather patterns. These actions include property underwriting enhancements, pricing acceleration and more proactive and assertive loss control and risk prevention measures. On the underwriting side, we are implementing new and revised underwriting guidelines, including even more stringent coastal and wildfire guidelines. Additionally, we are seeking to reduce exposure in specific sectors and geographies, non-renewing risks that lack appropriate winter weather controls and utilizing higher deductibles for certain types of losses with particular emphasis on water damage. We are also requiring temperature and water sensors on risks with higher property limits in specific industry classes, particularly those with prior losses. And we are leveraging our property segmentation tools, which allow us to model weather perils at specific locations and identify underfunded properties for significant price increases or nonrenewal. This will help reduce portfolio volatility and should drive expected catastrophe ratio improvement. We are also significantly increasing the use of technology to assist with large property assessments. Infrared thermography, advanced AI risk evaluation tools and drone programs are helping us better recognize and minimize potential hazards and vulnerability to weather-related storms. With respect to pricing, we are leaning into the hard market to push for even more rate and greater exposure increases, which should help offset elevated catastrophe losses and the anticipated increase in reinsurance costs. Both our personal and core commercial businesses are achieving their highest premium exposure increases in many years. In the first quarter, core commercial property renewal increases were 11.4%, property-focused specialty lines achieved an average increase of 16.8%, while our homeowners line achieved an average increase of 18.9%. Additionally, as of March, automated insurance-to-value adjustments in small commercial are set between 6% and 8% on top of the rate, which will push overall future renewal price change even higher. As part of our focus on loss control and risk prevention, we doubled down on water and temperature sensor installation in 2022, resulting in an increase in avoided property damage and business interruption. Customer adoption of this technology has grown significantly following Winter Storm Elliott, allowing us to increase the number of protected buildings by 25% over the last few months. While penetration of this technology is still low relative to our overall property portfolio, we are encouraged to see customer adoption continuing to gain momentum, and we have plans to drive greater utilization where exposures to winter weather are most severe. One of the key learnings we’ve taken away from our analysis of Winter Storm Elliott is that a limited number of properties drove a large portion of total losses. In response to these findings, we are strategically prioritizing larger, more complex risks for sensor installation, which will ultimately generate higher, more significant save rates. Working in partnership with one of the recognized leaders of risk prevention technology, we have the infrastructure to scale our existing risk prevention platform and are mobilizing quickly. Furthermore, we are supplementing these risk prevention initiatives with active agency management and customer education tools and programs. We are also enhancing our robust database of risk managers, building engineers and facility personnel at our larger insured locations, so we can deliver more timely, directed and targeted communications to help our customers prevent losses and/or mitigate damage when losses occur. Turning to our margin recapture plan, which primarily targets property lines and amplifies the effects of our catastrophe management initiatives, I will note the following: our first quarter ex-cat results underscore the strong progress we’ve made in all three segments of our business. In Personal Lines, our overall average price increase was nearly 13% across the account, driving premium growth of 10.1% in the quarter. Renewal price increases were slightly above expectations with acceleration in both home and auto. Retention remains strong, and we believe that there is additional room and market support for further price increases. In addition, new business pricing continues to be very robust, and we will be very disciplined to ensure that our profitability objectives are not compromised in any way. An increasing number of personal lines carriers, both public and mutual, are taking significant rate increases on both renewals and new business, resulting in an even stronger hard market in personal lines. Regulators in most states are more understanding of rate need. We revised our personal lines filings and pricing expectations upward relative to our view we shared in January. In auto, we now expect to achieve 13% to 14% renewal price increases in the second half of the year, which is about two points above our original expectations. Home renewal price should be around 20% for the remainder of the year, which is 2 to 3 points higher compared to what we originally planned. As a result of these actions, we remain committed to delivering meaningful loss ratio improvement in personal lines in 2023 and bringing this business back to target profitability in the latter part of 2024. In core commercial, we continue to execute on a combination of rate and exposure increases as well as targeted underwriting actions during the quarter. Price increases averaged 11.5%, reflecting an uptick from the fourth quarter. Retention is at target levels, providing room for even higher price increases going forward. We remain focused on further differentiating our approach to pricing by leveraging granular segmentation tools to push additional price increases in the areas we need it most, with emphasis on property. We are pleased to see our pricing and underwriting actions starting to earn into the book and show itself in our results, as demonstrated by the solid underlying first quarter performance in core commercial. We are off to a strong start for the year in specialty, as demonstrated by our excellent first quarter results. Price increases remained healthy, coming in at nearly 13% for the first quarter, led by property lines. The pricing environment in specialty remains firm in the majority of our markets, with increases in the quarter supported by strong exposure growth. Specialty delivered an ex-cat combined ratio of 83% and growth of 7.1% despite some ongoing segmentation and underwriting actions. The diversified nature of this book with nine different businesses in over 20 product areas continues to be helpful in acting as a buffer to property and catastrophe exposure. At the same time, we continue to execute on our specialty strategic objectives. During the quarter, we further enhanced our offerings with the launch of a new product for miscellaneous professional liability in the E&S market. This product is focused on providing E&O coverage for small to midsized firms that we had previously not been positioned to rate and will significantly enhance our ability to align with our distribution partners on a larger portion of their NPL business. Our top-notch team has decades of related experience, and we are looking forward to the opportunity to drive profitable growth in this segment, as we provide this valued and sought-after offering to our agents. We also continue to leverage and actively market our newer capabilities such as retail E&S, cyber, and specialty general liability. At the same time, we are further promoting our industry specialization, primarily by identifying areas of superior strength in specific regions and distribution points and leveraging them for growth in key sectors. The outstanding agency partnerships we have cultivated over many years are serving us exceptionally well, as we execute on our underwriting and pricing imperatives. It’s more critical than ever to have an experienced and capable distribution network to address and overcome challenges and attract the right opportunities. Last week, we held our Annual President’s Club Conference, a gathering of over 120 of our largest, most critical and successful agent partners. We conducted important executive meetings focusing on our capabilities, industry trends and pricing needs and how we can help our agent partners more effectively serve their customers during this very dynamic time. We came away from these meetings extremely encouraged about our prospects and with several key takeaways. First, it is clear that agent partners are more keenly focused than ever on improving their efficiency through more effective operating models, staff optimization and the use of advanced analytics and technology, seeking to enhance EBITDA margins. And we are incredibly well positioned to partner with them on their journey. Second, in light of increasing catastrophe losses industry-wide and the impact of inflation, our agents understand the need for increased pricing, more focus on risk prevention, and enhanced customer education and communication. Agents fully recognize the critical role they play in our efforts to advance customer adoption of risk prevention and mitigation tools. They are committed to partnering with us to make this important mindset shift and execute on risk control initiatives. Third, our differentiated personal lines, core commercial, and specialty offerings continue to be in high demand among the best agents in the country, as they acquire midsize and smaller agencies that have considerable amounts of this business and also look to continue developing areas of specialization. Our partner agents are particularly invigorated by the broad and expanding product capabilities in our specialty portfolio, enabling them to strengthen the depth of their customer and Hanover relationships, as they write more lines of business with us. Additionally, our TAP Sales platform offering, combined with our robust product capabilities and specialized industry verticals, sets us apart from many competitors and enables continued growth opportunities. Ultimately, we came away from the event with more conviction that our agent partnering approach represents a greater competitive advantage than ever, and that our strategy is further resonating with them, which positions us exceptionally well going forward to drive strong, sustained profitability and deliver outstanding value for our shareholders and other stakeholders. We began 2023 with the benefit of several quarters of strong price increases that will continue to earn into our book of business as we move throughout the year. We are working hard to mitigate our exposure to changing weather patterns and extreme weather events that are elevating catastrophe losses across the P&C industry. We are confident that the actions we are taking will generate positive results. We are making excellent progress on our margin recapture plan with a solid positive trajectory in 2023 and further gains expected in 2024. With that, I will turn the call over to Jeff.

Thank you, Jack. And good morning everyone. Our consolidated results for the first quarter reflected elevated catastrophe losses, which led us to exceed our catastrophe assumption by approximately $112 million or about eight points. First quarter catastrophe losses stem from over 20 events, including severe freeze events in February and the beginning of March, as well as widespread wind and tornado activity, particularly in mid-to-late March. According to preliminary industry estimates, this first quarter was one of the highest for catastrophe losses over the last 10 years. Excluding catastrophes, we performed in line with our expectations, registering an ex-cat combined ratio of 91.7%. Our expense ratio for the first quarter of 2023 was 30.7%, compared with 31.1% in the prior year quarter, keeping us on track to achieve our expense ratio target of 30.8% for the full year 2023. Prior year reserve development was favorable in the quarter by $3 million primarily attributable to specialty as well as workers compensation in core commercial lines, partially offset by unfavorable development in personal lines and commercial auto. Turning to a discussion of our underwriting results by segments starting with core commercial. Our combined ratio excluding catastrophes was 92.1% in the first quarter of 2023, above the prior year quarter, but in line with our expectations. Core commercial current accident year loss ratio excluding catastrophes was 58.5%, 1.1 points higher than the year earlier period driven by higher property loss severity in commercial auto. The underlying loss ratio in core commercial was in line with our expectations in the quarter. We were also pleased to see the frequency of large losses in our CMP business come down from elevated levels seen in the second half of 2022. Performance of other major lines within core commercial was also in line to slightly better than the prior year quarter results. Turning to specialty our combined ratio excluding catastrophes decreased two points from the prior quarter to 83% driven by favorable prior year reserve development and underlying loss ratio improvement. Specialty favorable development stemmed primarily from claims made management liability business and to a lesser extent, healthcare and surety businesses. The specialty current accident year loss ratio excluding catastrophes improved by about a point from the first quarter of last year, primarily reflecting lower than expected losses in marine as well as the benefit of increased rates earning. Turning to Personal Lines. The ex-cat combined ratio was 96.2% and primarily reflected higher prior and current accident year auto losses. Personal auto unfavorable prior year development of $7.9 million or 2.4 points was impacted by loss activity primarily in the third and fourth quarters of last year due in part to delayed reporting of third party claims in our property damage coverage. Home and other unfavorable prior development of $3.7 million or 1.6 points was primarily related to liability and reflected additional new information received on a couple of larger claims and a large unfavorable court verdict pertaining to a 2020 fatality claim. Personal Lines current accident year loss ratio, excluding catastrophes was 68%, primarily reflecting continued inflationary pressures on auto property and homeowners. Relative to our expectations, the underlying ratio in the quarter was about one point higher. Personal auto current accident year loss ratio excluding catastrophes of 75.8% was slightly above our expectations with higher severity, mostly offset by lower accident frequency in the quarter. The increased severity stem from the effect of continued inflation on repair parts and labor rates and increased car rental costs stemming from extended cycle times. In Home, some large fire loss activity drove the loss ratio to 56.9% which was slightly above our expectations. While the cost of lumber has come down and some other material costs have flattened over the past several quarters, labor costs continue to be elevated. As a result, we are continuing to lean into the use of rate and non-rate tools, such as home evaluations and insurance-to-value increases in our pricing. We remain pleased with the execution of our margin recapture plan in personal lines. We continue to achieve exposures and rates slightly above our expectations and are capitalizing on strong retention and a hardening market to push rates higher. Now, moving on to a discussion of our investments. Net investment income came in at $78.7 million, $1.8 million higher than the prior year quarter, helped by higher bond and reinvestment rates and growing operational cash flows, partially offset by partnership income, which was approximately $10 million lower than the prior year quarter. Partnership returns can fluctuate from quarter to quarter. Partnerships produced $5 million versus $15 million a year ago and our expectations of roughly $7 million per quarter in 2023. What’s important, however, is that for the vast majority of our portfolio, the current higher interest rate environment continues to provide an accumulating benefit to net investment income and allows us to reinvest at attractive market yields without compromising the credit quality of the portfolio. Our investment portfolio is high quality, diversified and thoughtfully built with robust growing yields. The portfolio is well-laddered with modest allocation to risk asset classes and benefits from significant issuer diversification. Given the recent attention on the global banking industry and investments related to commercial real estate, I would like to cover the composition of our investment portfolio and our limited exposure to these two areas. The banking sector represents approximately 10% of our total invested assets with an average rating of A minus. The portfolio includes a mix of U.S. money centers, U.S. regionals, and foreign banks, with no single issuer representing greater than 0.4% of total invested assets. We have limited investment exposure to Silicon Valley Bank, which represented $20.8 million in fair value at year-end 2022 and $14.8 million in fair value on March 31. Additionally, we do not have any investment exposure to Signature Bank or any other distressed banks. We own $835 million of commercial mortgage-backed securities. The portfolio is very high quality, supported by an average overall rating of AAA. Within the portfolio, approximately 91% is rated AAA and 5% is rated AA, underscoring our confidence in the quality and strength of these investment holdings. Our holdings are diversified by property type, geography, and vintage. Additionally, the CMBS investments have significant credit enhancements of 30% or more, which allows the securitization to withstand substantial underlying defaults with no losses to our tranche. Commercial mortgage loans represent approximately 4% of total investment assets. The loan-to-value ratio on average across our entire commercial mortgage loan portfolio is 58%, demonstrating an ability to withstand downside from price declines in commercial real estate. We recognize that, in general, the level of uncertainty related to investments is currently higher than much of the last decade, and investor concerns may continue to migrate from one asset class to another. However, our investment portfolio has proven to be very resilient. We have a relatively predictable stream of cash inflows and outflows and generally hold most assets to maturity. Overall, we feel very comfortable with the investment risks and confident in the quality of our portfolio. Looking at our equity and capital position, our book value increased approximately 2% on a sequential basis to $66.89 in the first quarter. We remain disciplined and balanced on our capital management priorities and committed to being strong stewards of our capital. I’ll conclude my prepared remarks by saying that despite the industry-wide challenges we face, I am confident the actions we are taking put us on a strong trajectory to deliver solid financial and operational performance in 2023, with the expectation for excellent performance in 2024 and beyond. Our planned catastrophe load for the second quarter of 2023 is 6.0%. We are aggressively focused on executing our catastrophe management initiatives and are pushing harder on our margin recapture plan to continue to drive superior returns for our shareholders. The underlying fundamentals of our business are strong. Our team is exceptional, and we are well-positioned to continue executing against our ambitious strategic priorities. With that, we will now open the line for questions.

Thank you. We will now begin the question and answer session. Our first question comes from Matt Carletti from JMP. Please go ahead.

Hey, thanks. Good morning. Jack, you spent a good amount of time there talking about a lot of the things you’re doing to tackle the elevated weather and catastrophe losses. Elliott was kind of a very different issue than what we saw this quarter. I was just wondering if you view kind of winter weather or spring weather as being equal things you need to tackle? Or do you think one is maybe more persistent and more of an issue than the other? Is it less of an issue on year-end and more of just catastrophe happen when they happen and not in a straight line?

Yes. Thanks, Matt. There’s no doubt, as we said in our prepared remarks, that the type of winter storms that we encountered, starting with Elliott, but also to a lesser degree in the first quarter are different in that they’re not as responsive to the property aggregation work we’ve done and the elimination of some micro concentrations. And so in that regard, that rises to the top of our list of areas that we really want to improve upon fast. Stating the obvious, all of that was accentuated by and exacerbated by the inflation and supply chain issues that continue. So it’s a bit of a perfect storm in terms of the cost that we have to incur. As we said, we’re going hard at this. We had momentum, frankly, in some of the areas of risk mitigation versus just loss reimbursement. I think in a lot of ways, Elliott and the subsequent storms give us an opportunity to advance those more quickly. And if you look back at Elliott, roughly 250 commercial customers made up an outsized proportion of our losses, which allows us, I think, to be even more surgical about how we go after that versus the broader catastrophe terrain. So we’ll continue to work very, very hard on the broader catastrophe management, including pricing and terms and conditions, but we are definitely putting winter storms at the top of our list to go at very surgically.

Great. You mentioned risk mitigation and working with your agents to get your insureds on board. What does that look like? Are there policy discounts if they install certain measures? Do they need to install it to avoid non-renewal? Will Hanover cover the costs or provide funding for the installation? How do you encourage your customers to adopt these measures?

Yes. Our strategy will encompass all of that. It begins with understanding what we learned about the types of customers and why they were unable to respond to a widely communicated freeze that affected nearly every state. We have been clear about which customers we believe were not adequately responsive from a risk management perspective. Some sectors, such as educational institutions and specific real estate accounts, are inherently more vulnerable to such events. Therefore, we are evaluating where we might reduce our portfolio concentration and where we can aggressively implement incentives. For instance, if customers adopt certain controls, we may offer pricing considerations, which currently means smaller increases rather than decreases. We will also assess the appropriate deductible for water damage based on customer responsiveness. Looking ahead, we are making a concerted effort to maximize pricing, especially where elevated limits are not fully addressed given the new severity. Even after inflation begins to ease, we are focused on ensuring we have the right insurance to value and pricing in line with the existing severity.

That’s great. I’d like to shift topics to discuss Personal Auto and ask a high-level question. Considering the various factors influencing cost pressures that we’ve addressed in previous calls, I’m curious about the impact of longer repair times and the increasing presence of electric vehicles. I assume your portfolio has a reasonable mix of higher-end vehicles. Does this mix change as the industry shifts towards more electric vehicles on the road? Is this contributing to the issue, or is it a minor factor?

Matt, this is Jeff. So that latter point, it really is not a material issue to us at that point. There’s certainly elevated costs for some of those types of vehicles. It’s just really not that big a part of our portfolio, frankly. And so I wouldn’t say that’s the center of our bull’s eye. I’ll let Dick comment on the PL trends real briefly. What I would say in the macro is the industry, as you see, is trying to get their arms around the impact of inflation and supply chain and, frankly, labor shortages that are dragging out some of these claims and making inflation a little bit more stubborn than maybe it otherwise would be. I think we and most of the industry have just had enough time now to get their arms around all the moving parts that contribute to getting your loss trend analysis right. So Dick, maybe you could just add to your point.

Yes. Before I continue, regarding electric vehicles, we are closely monitoring the situation. Although it's not fully evident yet, we recognize that repair costs, especially for batteries and materials, are currently high. This is something we will keep an eye on as it could influence future pricing. Generally, the loss trends remain consistent. While we are seeing some decrease in the average cash value of both used and new cars, this has not yet affected retail pricing, which remains elevated but is trending down. The main cost pressures are on the repair side, as mentioned by Jack; the labor costs are particularly persistent. Even with a drop in parts and supply chain costs, labor expenses are likely to remain constant. We are carefully analyzing our losses to understand their variations, which will inform us about future developments. Overall, the pricing we're establishing indicates we anticipate being above the loss trend in the second half of the year, which gives us confidence in our ability to manage it.

Right, thank you both for the answers. Very much appreciated.

Thank you.

Our next question comes from Paul Newsome from Piper Sandler. Please go ahead.

Good morning. Can you share some thoughts on how the efforts to reduce catastrophes will impact revenue? Are we expecting a significant change in certain business lines from a policy perspective? Also, could you provide some insights on the potential scale of the non-renewals?

I think we have been actively streamlining certain subsectors of our business, especially in the middle market, so I do not expect a significant decline in our growth trajectory. In the middle market, our growth is largely driven by pricing rather than expanding new exposures, while in small commercial and specialty, we aim to grow our business beyond just market pricing. This is a substantial step we are taking, and the marketplace is becoming firmer, allowing us to achieve our goals without significantly removing business from the system. I am optimistic that some of these subsectors will adopt and comply with our strategies more effectively. However, if that does not happen, we are willing to forgo a small amount of growth to achieve the improvements we seek.

I’m curious about the personal line side. How much of the changes we’re seeing is due to a shift in geographic mix versus other initiatives? Is this primarily about reducing concentrations, or is it more focused on simplification?

Well, I don’t think you’re oversimplifying it, but I think that, as you know, we’re in 20 states today, and we’re pretty substantially driven by Michigan and Massachusetts, despite all the diversification we’ve done in those other states. We outperform in those states. We’re closer to target returns in those states. When we look at the catastrophe experience, we have not been outsized in those states vis-à-vis our writings or at least in our estimate of lost share to market share. So I think in the present tense, Paul, you won’t see us do anything dramatic from a geographic shift. Our diversification as a business allows us to think more broadly than just our personal lines footprint, right? Heavy emphasis on growing specialty and specialty casualty and small commercial. I think that buffers the fact that we can continue to diversify the firm without doing something dramatic with our personal lines footprint in the short term.

Great. Thank you. Always appreciate your help very much.

Thank you.

Our next question comes from Mike Zaremski from BMO. Please go ahead.

Good morning. There's been a lot of great discussion, particularly regarding inflation. I believe that on the property side of the portfolio, investors seem to be comfortable that pricing is heading in the right direction, and you're implementing many corrective actions which will take time. I'm curious if you have any insights on the liability side, especially in commercial lines. Is the loss cost trend increasing, or are things stable or even better than anticipated? It appears that reserve releases in the commercial segment have been a bit light, but that might also be related to the property side. Thank you.

Hey, Mike, this is Jack again. I think that’s a really appropriate question at this stage of where we are in the business because there’s obviously a lot of appropriate focus right now on property, catastrophe, and non-catastrophe based on the volatility that we’ve experienced. That is really always at the top of our list in terms of priorities. But as we think about our growth into the future, we’re also being very mindful of what is happening kind of behind the scenes in liability trends. It varies across the portfolio, and I won’t go too far with this. But there are some areas in specialty, for example, where you know that as things mature, management liability in some of those areas, the results have been a little better than we expected, and we’ve been able to recognize that. There are other areas and probably commercial auto and to a lesser degree personal lines or liability where you’re starting to see some inching up of those liability trends pretty consistent with what our expectations were, but there’s evidence that as the courts kind of fully reopen as the cases make their way through the system, there is clear evidence to us and I think the industry that litigation trends and social inflation will emerge to be something that the industry has to reckon with. So what I’m really proud of is our team is all over these trends, and while you can’t be perfect, they’re much more focused on anticipating where things are going based on some metrics that we’ve established in each of these areas that are about where the litigation is manifesting itself and how that’s turning into severity trends versus just reflecting on past trends. To some degree, they're hard to analyze coming out of the pandemic and the most recent environment. Overall, liability trends are creeping up, I think, for the industry, and it’s something that certainly we’re watching very closely.

Okay. That’s helpful. My final question is about reinsurance, and I understand that the renewal period is approaching, so you might not want to share your exact thoughts. However, since Hanover’s reinsurance program has been more profitable for reinsurers compared to the average, do you expect the reinsurance renewal to affect the income statement as we model things out? Is there anything specific we should consider, or is it likely to be a non-event?

As you mentioned, Mike, our property renewal stands at 7.1%, which includes both the per risk and the cat program. We have had a fortunate situation for a couple of reasons. First, we increased our purchasing of cat risk, including both the cat bond and larger portions at the higher end. We renewed at 7.1% last year based on a three-year cycle, and we haven't utilized that treaty since 2005, which has worked out well for the reinsurers. Additionally, we had clear visibility for the upcoming renewal, which allowed us to incorporate significant increases into both the cat and property programs when establishing our plans and guidance. We are optimistic about renewing at the same levels, as we have factored in a substantial increase that we believe is attainable.

Thank you.

My pleasure.

The next question comes from Grace Carter from Bank of America. Please go ahead.

Hi, everyone.

Good morning.

You have mentioned over the past couple of quarters already some re-underwriting actions in certain middle market accounts like you just mentioned. I was curious to which the same account sort have driven the pressure and attritional losses have also driven pressure in catastrophe losses, like if there should already be any sort of benefit coming through the portfolio on the catastrophe loss side just given the underwriting actions you’ve already started to take over the past several months?

Yes, Grace, this is Jack. I'll share a few thoughts, and I'm sure Dick will want to add to this. There is often a connection when you're reducing your limits on the larger side of your business in relation to catastrophes. Catastrophes can occur in various ways, and having higher limits increases the chances of incurring significant losses when these events take place. I can't specify exactly which accounts we exited and how those might have led to losses. Additionally, not renewing some of these accounts does not automatically reduce our vulnerability. However, from a modeling standpoint, there is clear overlap in the Average Annual Losses we observe in our models based on the actions we've taken in the middle market.

Yes, exactly. Grace, I would just say in certain geographies that is your statement. is more true? Some pockets of the Midwest and some of the Northeast territories where we took some action to re-underwrite some property-centric, real estate centric classes food manufacturers, some schools those are some of the same classes that potentially have been hit on the catastrophe side. So it varies by geography this way, I would add some color to.

Okay, thank you. And in specialty lines, it seems like the gap between pricing and premiums written growth grew a little bit this quarter. I know you all mentioned some risk segmenting and underwriting actions in the prepared remarks. I was just curious if you could give us a little bit more color on those and where growth might go for the rest of the year?

Yes, I’m sure Bryan will want to chime in here. Overall, as we said in our prepared remarks, we really are quite happy with the way specialty is developing, not only in terms of the results in our ability to continue to grow and diversify the firm, but the impact that it’s having on our agents and value proposition that we present. But inherent in all of that, as you’re seeing, I think, with some of our competitors, you have to have a good healthy offense and defense in your game plan. Specialty can bring additional volatility. We’re on top of both where we’re offensive and where we’re more defensive based on where the market is guiding us. So Bryan, maybe you can chime in there.

We are pleased with the performance of Specialty in terms of profitability and growth. I’m also happy with the new business results from the first quarter, which exceeded our expectations. We are concentrating on areas that are both profitable and have stable pricing. While property-oriented segments are leading in growth, not all areas are the same. Pricing remains robust, and we are experiencing significant growth in those sectors. If we encounter any rate declines, especially in professional and executive lines like publicly traded D&O, we will be cautious. We will reassess and strive to maintain our pricing in line with trends, even if it means sacrificing some market share. Overall, our business has grown, particularly in the most promising sectors.

Thank you.

Thanks Grace.

Our next question comes from Bob Farnam from Janney. Please go ahead.

Yes, good morning. I have a question regarding the margin of the capture plan and personal lines. Both Jack and Dick mentioned that rates for auto and homeowners are increasing possibly a few points faster than anticipated for the second half of the year, and it seems they are ahead of loss cost trends. I'm wondering if you anticipate the margin improvement will occur more rapidly due to the higher rates, or if it just takes time to realize those earnings, meaning that by the end of 2024, the overall margin improvement could exceed your expectations because of these rate changes. I'd like to hear your thoughts on this.

Bob, this is Jack. I think at the highest level, so much of that depends on where the inflation and supply chain issues take us, right. They are more stubborn than I think anybody expected. Eventually, I think we all know that should come down and that should start to be part of the margin improvement. But we frankly, can’t depend on it. If we’ve learned anything over the last three or four quarters is that we have to price as if these are the costs that we have to incur. In that scenario, I think that the increased pricing we’re experiencing at least covers any gaps that might have been created by the inflation being more stubborn. Our hope is that by the back half of the year, we’re getting more priced than we originally planned for. And the trends themselves start to calm and come back the other way. To be any more precise than that is probably to sound like we have a better crystal ball than we do.

Right, right. Okay. Good enough. Thanks.

Thank you, Bob.

The next question comes from Meyer Shields from KBW. Hi Meyer, is your line muted?

We can’t hear you.

Am I coming through?

Yes. Here we go.

Are you able to hear me now?

Yes.

Sorry. So a quick question for Jeff to start with. So the second quarter catastrophe load or anticipation is still down year-over-year. I’m just hoping you could break that down between sort of the external loss trends of weather and inflation and the internal exposure and rate components.

You’re referring to the second quarter 6% load?

Yes. Versus last year, 6.9%.

Yes, we utilize our best-in-class models. There was a decline in the second quarter. Overall, the catastrophe load has increased from 5% to 5.1%. I will need to review what caused the decrease in last year's second quarter compared to this year's second quarter. However, this is related to specific perils modeled and does not necessarily reflect the rate versus loss trend.

Okay. Understood. And then a question for Jack. I’m not in any way questioning the margin focus. But in the medium term, is Hanover interested in building a specialty property underwriting capability so that it can address what seems to be a growing need among the agents?

Meyer, honestly, I believe we have various opportunities to grow our firm while diversifying further. Among the top 25 companies, we likely have a heavier property mix than many others. I think it's wise to optimize our current portfolio in relation to the property market and fully leverage the ongoing reset. This motivates us to explore growth opportunities that will improve our overall mix and reduce our property focus over time. We're not really one of those markets. In our specialty business, we maintain a significant and profitable marine segment, which is primarily property-oriented. Our Hanover business is entirely property-focused and targets the lower end of the market. I don't see us heavily investing in the layered property market, though we do have a portion of our E&S business in the property sector. Thus, we are participating in some aspects of that firming market.

And those areas for us have performed quite well over the last year or so. Those areas do continue to grow for us. So while we’re trying to be very balanced about where growth comes from and have that mix evolve, the areas that are profitable for us, like the ones that Jack mentioned, are continuing to grow for us.

Okay. No, that’s perfect. I just wanted to understand how you’re thinking about it. Thank you so much.

Thank you.

Thank you, Meyer.

This concludes our question-and-answer session. I would like to turn the conference back over to Oksana Lukasheva for any closing remarks.

Thank you very much, everybody for a very good discussion today. Looking forward to talking to you next quarter. Goodbye.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.