THG - NYSE

Good day, and welcome to The Hanover Insurance Group's First Quarter Earnings Conference Call. My name is Chuck, and I'll be your operator for today's call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

Thank you, Jack, and good morning, everyone. I'll begin with an overview of our first quarter results, discuss our segment financial highlights and investment performance and then mention our 2024 outlook. We are very pleased with our strong start for the year, posting a first quarter combined ratio of 95.5%. We delivered a combined ratio, excluding catastrophes, of 89.5%, a 2.2 point improvement over the prior year quarter. Our current accident year loss ratio, excluding catastrophes, improved 1.9 points to 59.3% reflecting the continued earning-in of price increases. Our results were highlighted by a year-over-year reduction in the underlying loss ratio in Personal Lines and Specialty. Strong and steady margins in Core Commercial also contributed to the excellent performance. The continued improvement in profitability validates the effectiveness of our margin recapture plan, and gives us confidence that we are on the right path to deliver on our long-term ROE target of 14% or higher. At 30.9%, our first quarter expense ratio was slightly above our full year target of 30.7%, primarily due to the timing of certain expenses. Relative to the first quarter of last year, the expense ratio is higher primarily driven by changes in variable compensation accruals between the two periods as well as increased investments in our Specialty business this year, consistent with our growth and market share gain strategy. We remain on track to deliver a full year expense ratio of 30.7% in 2024. Catastrophe activity was within our CAT assumption for the quarter, accounting for 6% of net earned premium. Northeast floods in January and hail events in February and March were the main contributors to CAT losses. Ex-CAT prior year development was approximately $10 million favorable in the quarter driven by overall favorability in Core Commercial and Specialty. Each of the main lines of business in our Core segment developed favorably. Personal Lines prior year development was immaterial overall. Favorable development in Auto was offset by some unfavorable development in Home and Other. As we noted in our year-end call, the industry is experiencing elevated auto-related umbrella losses, and we prudently increased our recent prior year loss expectations in response. Overall, a combination of reserving prudence and favorable liability mix characteristics in Commercial Lines continues to serve us well. Now I'll review underlying segment results beginning with Specialty. Our Specialty book continued its track record of profitability in the quarter, delivering an ex-CAT combined ratio of 85.4%, 2.4 points better than the prior year quarter. The underlying loss ratio of 48.7% marked an improvement of 4.8 points over the prior year quarter, primarily from lower-than-expected losses in our Specialty Property business. Our longer-term loss expectation for Specialty remains in the low 50s. From a top line perspective, we remain on track to accelerate Specialty growth to the upper single digits for the full 2024 year. Our Core Commercial segment delivered an ex-CAT combined ratio of 90.0% in the first quarter. a 2.1 point improvement year-over-year. The Core Commercial current accident year loss ratio, excluding catastrophes, was relatively in line with our expectations and the prior year quarter at 58.5%. At the same time, we are intently watching for liability trends, including social inflation pressures in Casualty Lines. Trends in our book of business so far remains stable and very manageable. Our litigated frequency per exposure has returned to normal levels in 2022 and '23 after unusually low frequency of litigation in 2020 and '21. Overall, general liability loss frequency continues to decline, while the mix of claims is shifting to more complex claims, contributing to an increased loss severity. Commercial auto liability frequency seems to have settled at a new normal somewhat below the pre-pandemic levels, while severity is elevated but manageable. Workers' compensation remains stable, with a slight increase in indemnity while medical inflation remains within our expectations. Of course, we continue to monitor trends closely. We are managing our liability profile very carefully, as Jack discussed. Importantly, we are maintaining a very disciplined approach to our prudent liability loss picks and prior year estimations, taking small adjustments if and when needed, and promptly incorporating our updated view of trends into pricing and terms and conditions. We established this approach back in 2016 when we materially added to our reserve position as a new leadership team, while at the same time, initiating a shift in liability mix. We also adhered to thoughtful prudence during low-frequency COVID periods. We continue to feel confident in our reserve position. Core Commercial Lines net written premiums grew 3% in the first quarter. Rates continue to hold firm in both property and most liability lines, while retention ticked down 1.7 points for the quarter due to targeted nonrenewals in middle market, in-keeping with our positive strategic decision to sacrifice some top line growth in exchange for improved margin. Now moving on to Personal Lines. This segment delivered an ex-CAT combined ratio of 91.1%, an improvement of 5.1 points over the first quarter of 2023. The Personal Lines current accident year loss ratio, excluding catastrophes, improved 2.4 points to 65.6%, with the accelerating benefit of prior and current rate increases earning-in, coupled with moderating collision and property loss costs, we expect meaningful improvement in our ex-CAT loss ratio to continue throughout 2024. Auto current accident year loss ratio, excluding catastrophes of 73.6% in the first quarter improved 2.2 points year-over-year, driven by the benefit of earned pricing increases. Additionally, our data indicates that collision loss severity is easing, in particular for used car prices. We are also experiencing some deceleration in the cost of parts as well as lower rental costs due to shorter repair cycle times. At the same time, we remain cautious about liability coverages in auto and therefore, reflected an elevated loss expectation in current accident year picks in bodily injury. Similar to Commercial Auto, bodily injury frequency seems to have settled at a level below pre-COVID, while severity is elevated due to a higher occurrence of catastrophic claims, including pedestrian, bicycle and motorcycle hits and crashes at high speeds. However, as the benefit of higher rate continues to earn-in and the property loss trends ease, we expect significant loss ratio improvement for Auto throughout 2024. Home and Other current accident year loss ratio, excluding catastrophes, improved 2.4 points to 54.5%, driven by rate and exposure adjustments earning in. Also within Home and Other, we prudently increased loss ratio expectation for umbrella coverage in response to prior year development and an increase in catastrophic auto accidents in the industry. Of course, umbrella rates are up meaningfully compared to historical levels and the market is reacting accordingly. Both Auto and Home Lines of business achieved strong pricing increases in the first quarter. Auto price was up 18.2%, and we expect it to continue to stay solid throughout the year. Home price was up 30.2% on average in the first quarter including 19.6 points of rate and 10.5 points of exposure increases. We expect Personal Lines pricing to remain robust for the remainder of the year. However, Home exposures will tick down starting in the second quarter as insurance to value inflation adjustments return to more normal levels. Additionally, all peril and wind and hail deductibles start being applied to the majority of our target renewals in April, effectively lowering our risk on every property where such deductibles are applied. Equally important, earned prices will continue to accelerate for some time, increasing underwriting margins. Looking ahead, we expect the benefit of strong earned Personal Lines pricing and more stable property loss trend to drive a meaningfully improved Personal Lines current accident year ex-CAT loss ratio throughout 2024. Furthermore, we anticipate some additional improvements as the result of increased home inspections and new business rigor implemented in 2023 in homeowners. We expect significant margin improvement in Auto and Home to pace a return to target profitability by the end of this year on a written basis and in 2025 on an earned basis. Moving on to investment performance. Net investment income increased $11 million or about 14% to $89.7 million in the first quarter 2024, primarily driven by strong fixed income results from higher bond yields. The current rate environment should continue to provide an accumulating benefit to net investment income in 2024 and subsequent years. Historically, much of our investment portfolio was internally managed. After an in-depth and thoughtful analysis, we have made the decision to transfer management of the investment-grade fixed maturity portion of our investment assets to an external manager. We believe the switch to an outsourced model will allow us to benefit from the expansive capabilities of a large-scale asset manager, including their market depth and knowledge among others. Longer term, we hope that the external asset manager will help us to further optimize our investment portfolio's contribution to The Hanover's bottom line. We expect to complete this transition before the end of the second quarter. Moving on to book value and capital position. Strong earnings in the first quarter were partially offset by an increase in the fixed income portfolio's unrealized loss position, marking a 1.9% sequential increase in GAAP book value per share to $70.22. Statutory surplus increased by about 5% to $2.8 billion. In this dynamic environment, we remain focused on ensuring we maintain ample financial flexibility to support our business. Although we refrained from making any share repurchases this quarter, returning capital to shareholders through regular quarterly dividends and share buybacks remain important elements of our long-term capital allocation strategy. For the second quarter of 2024 our planned CAT load is 8.5%. As we mentioned in February, we have intended to pick higher on the probability curve in establishing our full year 2024 CAT load of 7%, and that it should decline for 2025. Our CAT guidance does not yet reflect the ultimate impact of substantial terms and conditions changes in Personal Lines that are currently underway. In summary, we are off to a strong start in 2024. We are executing successfully on our margin recapture initiatives and disciplined growth strategies concentrated in our most profitable lines of business. Our financial and operational performance is underpinned by targeted underwriting, strong pricing and a commitment to provide the products and services our agent partners and customers value most. We will continue to focus on creating long-term growth and superior returns for our shareholders. With that, we will now open the line for questions. Operator?

[Operator Instructions] And the first question will come from Michael Phillips with Oppenheimer.

First question, Jeff, on your comments there on Core Commercial, specifically GL, frequency is still down. good news there. I guess, maybe a brief description of why you think that's still the case and how long that could continue? And then part of that, too, is you said more complex claims. Can you talk about what you're seeing to describe those complex claims?

Sure. In terms of the frequency, I think we're seeing some of our insureds there's less physical activity going into the premises. And in some cases, people aren't going into malls, people aren't going into restaurants quite as often, and that's creating a reduced frequency. That's been pretty dramatic. In terms of the complex claims, you're seeing less minor claims, so the overall proportion of claims is growing with respect to the complex claims or more severity that's having lawyer involvement and the like.

Yes, sure. So I'll just give a little bit of more detail there, right? So for example, we've been leaning into technology for our E&S business, right? This is a fast-growing, very profitable area. We built out a completely new system for them. As you may know, they also have a lot of submissions and quotes in the E&S space. So we will get a lot of efficiency and upside from that type of investment. We're also adding staff to that area. And it's not just in our E&S area. We're also investing in the platform for our Industrial Property business, and we're investing in staff for our Marine business and our Healthcare businesses. So a number of our areas that we see is quite profitable, growing and having a lot of opportunity we're investing in. And I do think to Jack's point, that will earn through the revenue -- will earn through and that will absolutely help us on the expense side.

Mike, notwithstanding investing heavily in our most profitable and ultimately fastest-growing business. We're still committed to the 30.7% expense ratio for the overall firm.

The next question will come from Michael

From a premium and insured perspective, you'll see some PIF shrink into 2025. But from a premium growth perspective, you'll start seeing some growth continuing to get larger from here on, from here forward.

And this is Dick Lavey, one last point to your question about the Midwest versus the Northeast. Yes, exactly as Jeff said, we're manufacturing the PIF reduction in the Midwest 3x to 4x the rate in other geographies. That's really where the confection storm issues have prevailed and the wind and hail deductibles are being in place. The Northeast doesn't have those perils. So our Northeast business retention is higher and PIF shrinkage is less.

And second question is on reserve development, which was healthy again this quarter. I was wondering if there's any change in your high-level view on loss expense trends? You talked about frequency trends normalizing for some Casualty Lines. But wondering if you're seeing any changes in severity. I'm just asking given that some other insurers have increased their loss inflation forecast recently?

Yes. So overall, we're very comfortable with our balance sheet and very prudent in how we set reserves. In Core Commercial, we -- every major line was favorable. So feeling really good about that. Overall, our Property Casualty mix, while a little bit challenging during the inflation in that period, serves us reasonably well as casualty trends spike up. And Specialty is also largely a claims-made policy construction, which will help us, Jack talked about the limit structure in his prepared remarks, where 93% is less than or equal to $1 million overall and 77% in Core. And we also talked about how comfortable we are and the approach we took around reserving both in 2016 and 2020. And then finally, the concentration or our geographic focus, we -- back in '17, '18, '19, we really wanted to deemphasize the major metropolitan cities. Think about L.A., Chicago, New York, and that has really, really served us well. So while frequency is down, severity is up dramatically, and I think we've been prudent at picking and preparing for that all the while bringing up our severity picks.

The next question will come from Meyer Shields with KBW.

Thank you. It's [ Jane ] on for Meyer. My first question is on the core loss ratio for commercial. It was flat year-over-year. Just curious what your expectation for here onward? Is the run rate that we should think about going forward?

We're getting rate meaningfully above loss trend. And so we feel optimistic about our ability to have some improvement in the loss ratio going forward. From time to time, you have particularly higher or lower individual losses for property. I think a year ago, we happened to have had some lower levels losses this particular quarter, a little bit higher. But I'm pleased with how that business is producing at 58.5%, but I think we have a little bit of opportunity to improve that going forward as the rate earns in.

Perfect. That's helpful. My second question is on Personal Auto. I saw like a slight reserve charge there. I know it's very small. Just wondering if you can add more color on that? Just want to make sure I'm not missing anything behind it.

Can you clarify the question? I think I missed a word or two. It was about Personal Auto and what was the concern on the slide?

It's not a concern, just there's a slight reserves charge on that?

So in Personal Lines, overall, we had no development. Auto was favorable and Home was slightly -- it was adverse. And in Home, it was actually the umbrella. And truth be told, it's actually Auto that's showing itself in the umbrella. And I think we talked in our prepared remarks about some of the catastrophic activities such as pedestrian hits and some of those things are driving us to increase our picks for both prior and current period for umbrella.

The next question will come from Grace Carter with Bank of America.

The next question is a follow-up from Michael Phillips with Oppenheimer.

You hit it well. I mean this business is one where ease of doing business wins the day, and I know that's an overused term, but that means all the elements of the operating model aligned from the people, the way you have them, the way you do new business, the way renewals are handled. And of course, the platform that you put on the agent's desktop for them to submit and issue business. So as you know, we've made significant investments going back 3, 4 years on that. Our first product BOP is now completely rolled out, and we're working hard to get more comp added to it. So other competitors haven't frankly made those levels of investments. There are some that we compete well against day-to-day, but we're absolutely thrilled with where this business is and looking into the future, now that the platform is nearing completion, we feel comfortable actually expanding distribution and finding other points of access.

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

Thank you, everybody, for your interest and participation. We are looking forward to talking to you next quarter.