Travelers Companies, Inc. Q2 FY2021 Earnings Call

Good morning, ladies and gentlemen. Welcome to the Second Quarter Results Power Conference for Travelers. We ask that you hold all questions until the completion of formal remarks, at which time you will be given instructions for the question-and-answer session. As a reminder, this conference is being recorded on July 20, 2021. At this time, I would like to turn the conference over to Ms. Abby Goldstein, Senior Vice President of Investor Relations. Ms. Goldstein, you may begin.

Thank you. Good morning, and welcome to Travelers' discussion of our second quarter 2021 results. We released our press release, financial supplement, and webcast presentation earlier this morning. All of these materials can be found on our website at travelers.com under the Investors section. Speaking today will be Alan Schnitzer, Chairman and CEO; Dan Frey, Chief Financial Officer; and our three segment Presidents, Greg Toczydlowski of Business Insurance; Tom Kunkel of Bond & Specialty Insurance; and Michael Klein of Personal Insurance. They will discuss the financial results of our business and the current market environment. They will refer to the webcast presentation as they go through prepared remarks, and then we will take questions. Before I turn the call over to Alan, I would like to draw your attention to the explanatory note included at the end of the webcast presentation. Our presentation today includes forward-looking statements. The company cautions investors that any forward-looking statements involve risks and uncertainties and are not a guarantee of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also, in our remarks or responses to questions, we may mention some non-GAAP financial measures. Reconciliations are included in our recent earnings press release, financial supplements, and other materials available in the Investors section on our website. And now, I would like to turn the call over to Alan Schnitzer.

Thank you, Abby. Good morning, everyone, and thank you for joining us today. We are very pleased to report excellent underwriting and investment results for the second quarter and the first half of the year. Core income for the quarter was $879 million or $3.45 per diluted share, generating a total return on equity of 13.7%. In terms of underwriting results, higher underlying underwriting income and net favorable prior-year reserve development, as well as a lower level of catastrophe losses, all contributed to higher core income. Underlying underwriting income was 8% higher than in the prior quarter, driven by record net earned premiums of $7.6 billion and an excellent underlying combined ratio of 91.4%. We are particularly pleased with the continued strong underlying fundamentals of each of our three business segments. In Business Insurance, net earned premiums were higher and the underlying combined ratio improved by 3.7 points while both Specialty Insurance and Personal Insurance delivered meaningful increases in net earned premiums and continued strong margins. Turning to investments, our high-quality investment portfolio generated net investment income of $682 million after-tax, reflecting very strong returns on our non-fixed income portfolio. These excellent results together with our strong balance sheet enabled us to grow adjusted book value per share by 13% over the past year after making important investments for the future and returning significant excess capital to our shareholders. During the quarter, we returned $625 million of excess capital to shareholders, including $401 million of share repurchases. In Business Insurance, net written premiums grew by 5%, driven by retention, which ticked up almost a point in renewal premium change at a near record high of 9.5% and 9% growth in new business. The combination of strong pricing and high retention reflects continuing strength in the pricing environment. Inside of renewal premium change, pure renewal rate change was a strong 7.1%. Greg will share more details about the texture underneath renewal rate change in a few minutes. Renewal premium change also included the highest exposure growth we've seen in nine quarters, an encouraging sign of improvement in U.S. economic activity. We expect pricing to continue to outpace loss trends for some time. Furthermore, our excellent top and bottom line results this quarter for the first half of the year demonstrate the continued successful execution of our strategy to grow the top-line at attractive returns, as well as the effectiveness of our well-defined and consistent investment philosophy. We will continue to relentlessly pursue our priorities of extending our lead and risk expertise, providing great experiences to our customers, distribution partners and employees, and improving productivity and efficiency. With the momentum we have and the best talent in the industry, we are well-positioned to continue to create meaningful shareholder value over time. With that, I'm pleased to turn the call over to Dan.

Thank you, Alan. Core income for the second quarter was $879 million compared to a core loss of $50 million in the prior year quarter. The significant improvement was the result of positive factors across the business, including a lower level of catastrophe losses, improved results in our non-fixed income investment portfolio, more favorable prior year reserve development, and increased underwriting income. Our second quarter results include $475 million of pre-tax catastrophe losses compared to $854 million from last year's second quarter. This quarter's losses were somewhat below what we would have assumed for a typical second quarter, but year-to-date catastrophe losses are still above what we would have assumed, given the high level of losses in the first quarter. On a year-to-date basis, we have accumulated about $1.5 billion of qualifying losses toward the aggregate retention of $1.9 billion on a property aggregate catastrophe excess of loss treaty. The treaty provides $350 million of coverage on the first $500 million losses above aggregate retention in a month. Combining strong pricing and high retention illustrates the industry's clear view of the ongoing headwinds impacting returns to the industry, including weather volatility, low interest rates, and social inflation. Turning to capital management, operating cash flows for the quarter of $1.8 billion were again very strong. All our capital ratios were at or better than target levels, and we ended the quarter with holding company liquidity of approximately $2.4 billion. During the second quarter, we took advantage of favorable market conditions and raised $750 million to help fund future growth with a 30-year debt issuance at 3.05%, representing our second lowest 30-year coupon ever. Adjusted book value per share, which excludes net unrealized investment gains and losses was $103.88 at quarter end, up 4% since year-end and up 13% year-over-year. We returned $625 million of capital to our shareholders during the second quarter, with $24 million in dividends and $401 million in share repurchases. Coming back to reinsurance for a moment, let me direct your attention to Slide 20 of the webcast presentation for a summary of our July 1 renewals. The structure of our main catastrophe reinsurance program is generally consistent with the prior year. We've renewed our Northeast Cat Treaty back on July 01 on substantially similar terms and pricing that was up only slightly on an exposure adjusted basis. Before turning the call over to Greg, I'd like to make a few comments about inflation. We are relatively less leveraged to overall CPI type inflation as compared to say medical inflation and social inflation. We are experiencing a degree of elevated severity currently in the auto lines, but the relatively short tail periods limit the impact of that exposure. Additionally, it is important to remember that we have some natural hedges in our business that mitigate the effects of inflation. Higher inflation is often associated with stronger economic activity contributing to higher insurance exposures. With that, I'm pleased to turn the call over to Greg for a discussion of Business Insurance.

Thanks, Dan. Business Insurance had a great quarter with strong financial results and terrific execution in the marketplace. Segment income was $643 million for the quarter compared to a loss of $58 million in the prior year quarter. We're particularly pleased with the underlying combined ratio of 93.3%, which improved by 3.7 points from the second quarter of 2020. In terms of non-Cat weather, this quarter's result was about 1.5 better than what we assumed for the quarter. Turning to the top-line, net written premiums were up 5% benefiting from strong renewal premium change with an underlying renewal premium change at 9.5%. Our ability to achieve historically high pricing with improved retention speaks to the stability of pricing in the markets. We're very pleased with these aggregate production results, and our marketplace execution has generated written pricing that has been in excess of estimated loss trends resulting in significant improvement in profitability. As for the individual businesses, our national property business has achieved rate increases at 84% of the accounts renewed in the second quarter. Given persistent loss pressures and low fixed income yields, we will continue to seek rates to further improve our margins while focusing on all of the non-rate levers to improve risk profile and profitability across our portfolio. We will also continue to invest in the business for long-term profitable growth.

Thanks, Greg. Bond & Specialty posted excellent returns and growth in the quarter. Segment income was $187 million, considerably more than double the prior year quarter, driven by favorable prior-year reserve developments and significantly improved underlying underwriting margin and higher business volumes. Turning to the top-line, net written premiums grew an exceptional 16% in the quarter, with solid contributions from all our businesses. In management liability, renewal premium change was a record 12.7%, driven by near-record rates. Our Bond & Specialty results reflect our ability to successfully manage this business through a variety of business and economic cycles. So, Bond & Specialty results were excellent, and I will now turn it over to Michael for Personal Insurance.

Thanks Tom and good morning everyone. We're very pleased with our second quarter Personal Insurance results. Segment income of $121 million was up $111 million from the prior year quarter, benefiting from lower catastrophes, higher net investment income and higher net favorable prior year reserve development. Partially offsetting these improvements was a lower underlying underwriting gain. Our combined ratio improved from the prior year quarter by about 1.5 points to 99.7%. Net written premiums grew 16%, with domestic homeowners up 12% and domestic automobile up 4%. The current quarter results reflect the benefits of modestly lower claim frequency compared to pre-pandemic levels. We plan to begin filing for rate increases in selected states later this year as we continue to balance business volumes and profitability. In homeowners and other, the second quarter combined ratio of 108.3% was six points lower than the prior year quarter, driven by a reduction in catastrophe losses. However, there was an increase in underlying combined ratios reflecting elevated frequency and severity of fire and non-weather water losses, which we continue to actively monitor. Our strong current quarter profitability is attributed to increased severity driven by higher costs of used vehicles and parts, while we will continue to invest in solutions that meet customers' needs while working with our distribution partners to deliver profitable growth. Now I'll turn the call back over to Abbe.

Thanks, Michael. Before we open it up for Q&A, I'd like to turn the call back over to Alan for a moment.

Thanks, Abbe. As bittersweet as it is, we have one last piece of business this morning before we turn to Q&A. I want to acknowledge and thank our partner and friend, Tom Kunkel, who will be retiring in September after a spectacular 37-year career at Travelers. Tom, we're all going to miss you personally and professionally. And with that, we're happy to take your questions.

Thank you. We have our first question from the line of Michael Phillips from Morgan Stanley. Please go ahead.

Thank you, and good morning everyone. Michael, I want to focus on your comments about personal auto. Toward the end, you mentioned plans to file for some rate increases later this year. I'm curious about the timing of this frequency benefit you mentioned, which appears to be lasting longer than it is for some of your competitors. Is this possibly due to a mix of business in your portfolio that may be more favorable? Can you confirm that? If frequency is beginning to return to pre-pandemic levels and you anticipate that trend to continue, why not implement rate increases now? What is driving the need for these rate adjustments? Is it related to frequency, or is it more about severity? It's a two-part question regarding the timing of the rate increases and what is influencing that decision. Thank you.

Sure, Michael. Thanks for the question. Really, the timing is just a function of the process. We're actively putting together, filing packages, and engaged in conversations with State Insurance Departments as we speak. So, it's not a question of waiting to get rate; it's just about the process of working with regulators. Regarding frequency and severity, we're seeing frequency moving closer to pre-pandemic levels and we are seeing pressure in severity, particularly in collision and third-party physical damage claims driven primarily by higher costs of used vehicles and parts. So we're responding to both frequency and severity driving the need for rate. Additionally, we're taking a cautious approach with our pricing to ensure we maintain profitability.

Okay, that's helpful, Michael. Just to follow up on that, if the timing is more about the process, it seems you'd prefer to move forward sooner rather than later. Your margins in the second quarter were still better than those in the second quarter of 2019, which is pretty good, but you anticipate changes. Given that your margins are still strong, do you expect any resistance from state authorities, suggesting that your profits are sufficient and could hinder your ability to obtain the rates you desire despite decent returns?

Yes, Michael, I think it's a great observation and it's part of that process that I described, really a conversation with regulators about what the historical experience has been. But also pointing out that part of that favorable experience is due to the extraordinary event that was the pandemic. So we're in conversations with them about weighing historical experience versus prospective views of trend. Again, this varies state-by-state and our starting point varies by state as well.

Hey, thanks. Good morning. Can you guys hear me?

Yes.

Sorry about that, just got back to the office, so getting used to the old phone. So I just wanted to keep it on personal auto, when we think about where you're seeing some of the elevated loss trend, Michael, is it more geographic or is it preferred versus more standard? I mean, like what are kind of the variables that you're looking at the most to kind of think about? Where you're seeing loss trying to come back the most?

Yes, great question, Ryan and good morning. We are seeing it, there are variations across geographies. We look at things like return to normal indices and driving data by state and by geography. But broadly speaking, most areas of the country are seeing driving activity return again to close to pre-pandemic levels. As we exit the quarter, the frequency benefits we've seen over the past few months and quarters, have started to wane throughout the second quarter, which is a part of my comment about trends returning to pre-pandemic levels.

Hi, thanks. Good morning. I just wanted to just follow-up a bit more on the auto side. So maybe, Michael, I'm just wondering, I guess, obviously you're taking rate, but how are you thinking about balancing taking rate versus what could be maybe short-lived severity increases or is the view that these increases in severity that you're witnessing are not transitory and might be more sustainable?

Yes, it's a great question. And certainly, as we've talked about severity trend over time, we've often said that we take a long-run view of trend when we set our prices. If the starting point is elevated because we’ve seen an uptick in severity, the key question is whether the experience we're seeing is an anomaly or sustainable. We're effectively considering both frequency and severity as part of our ongoing pricing discussions. In any case, we continue to monitor those trends closely.

Yes, good morning, everyone. I'd like to address the many questions regarding personal auto. This has been the best month for growth in terms of new policies since 2016. Considering that you expect frequency to return, is there a risk for customers who joined due to competitive pricing during the pandemic, but may find those prices insufficient in the post-pandemic environment and potentially leave?

Yes, Josh. There’s always a risk and certainly there’s pressure on retention when you start to increase prices. That said, we feel comfortable with pricing levels that we’ve been putting on the books. Our focus remains on retention, conversion, and getting it right with our customers as we continue to grow in auto.

Hi, good morning. So first, just sort of a question on what you're seeing in the Workers Comp market in terms of pricing? I think there's been an expectation that things would begin to turn. Are you seeing that? And then I have a follow up.

Good morning, this is Greg. Yes, Workers Comp continues to bounce around. We thought that we were going to hit the bottom a couple of quarters back, but with the pandemic, there's clearly been some favorable frequency activity around Workers Comp and increased payrolls. As we continue to work with the bureaus regarding their loss cost recommendations, they are coming in less negative. Overall, we did not quite hit a positive rate number, but we do see improvement every quarter.

Hi Jimmy, it is Dan, I'll take that one. We have taken the view that social inflation has gone nowhere and that the elevated level of losses we saw pre-pandemic are going to persist, and that elevated loss trends even off of that higher level of losses are expected to continue. So that's what we've assumed as we continue to make our loss picks and assess our reserves.

Yes, thanks. We've expressed our views on inflation historically and we’re continuing to watch closely. Before we wrap up, we also note that our focus on data and analytics allows us to make informed decisions. Again, we are confident in our approach.

Thank you. Dan, you mentioned that Travelers is less leveraged to overall CPI type inflation. Are there better macroeconomic indicators we should be looking at if CPI is a lesser measure for long-tail lines? I have muscle memory from a formal role that there are other indices you look at that are more nuanced for your businesses to measure claims inflation?

Tom will start and Dan can fill in whatever I miss. We're not trying to forecast CPI or inflation generally. We're focusing on forecasting loss costs and analyzing data to make informed decisions. We incorporate forecasts from third parties for more granular loss cost analysis across various lines of business.

Hi, thanks. Good morning. Alan, I guess my first question is on the Fidelis investment as well. So just as we think about M&A, is this a shift in your stance on reinsurance?

There's nothing about this that signals any shift in our thinking about reinsurance. We are focused on being a primary writer with very limited interest in reinsurance. The investment is more about learning from an interesting business model with a strong management team.

Yes, thanks. Most of them have been asked. Just I'm curious, wildfires are kind of kicking up here in the West Coast. Maybe you can talk a little bit about what you've kind of been doing over the last couple of years to kind of manage your exposure to wildfires?

Sure, Brian. We're actively managing our exposure to wildfires across the business, with significant actions taken particularly in California. We've extended agreements with wildfire defense systems in multiple states, have launched new products and are currently converting existing California policies to these new pricing levels and eligibility requirements.

Thank you for accommodating me. One final question on personal auto: can you discuss the month-by-month frequency trends in the second quarter so we can evaluate the situation?

I don't have specifics for you month-by-month, but I can say that we observed frequency benefiting early in the quarter. As we exited the quarter, frequency was approaching pre-pandemic levels.

Thank you. There are no further questions at this time. Ms. Abbe Goldstein, please continue.

Thank you very much. I appreciate everyone's time and for joining us this morning, and as always, if there are any follow-up questions get in touch with Investor Relations and good day everyone.

This concludes today’s conference call. Thank you for participating. You may now disconnect.