Good day, welcome to the Chubb Limited third quarter 2016 earnings conference call. Today's call is being recorded. If you would like to ask a question, please press the star key followed by the digit one. For opening remarks and introductions, I'd like to turn the conference over to Helen Wilson, Investor Relations. Please go ahead.
Thank you, welcome to our September 30th, 2016 third quarter earnings conference call. Our report today will contain forward-looking statements, including statements relating to company and investment portfolio performance, pricing and business mix, economic and insurance market conditions, and integration of acquisitions, including our acquisition of The Chubb Corporation and potential synergies, savings, and commercial and investment benefits we may realize. All of these statements are subject to risks and uncertainties. Actual results may differ materially. Please refer to our most recent SEC filings, as well as our earnings press release and financial supplement, which are available on our website at investors.chubb.com for more information on factors that could affect these matters. During today's report, our management will also refer to non-GAAP financial measures.
Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP measures and related information are provided in our third quarter 2016 earnings press release and financial supplement. I'd like to introduce our speakers. First, we have Evan Greenberg, Chairman and Chief Executive Officer, followed by Phil Bancroft, our Chief Financial Officer. We'll take your questions. Also with us to assist with your questions are several members of our management team. It's my pleasure to turn the call over to Evan.
Good morning. Chubb had an excellent quarter, with record operating earnings per share, excellent core underwriting results, and premium revenue growth in line with our expectations. After-tax operating income for the quarter was $1.4 billion, or $2.88 per share, compared to $2.74 per share prior year, again, demonstrating, in my judgment, the accretive nature of our merger. As I have done the last two quarters, when discussing our underwriting results and premium growth and to give you greater visibility into the health of the company, I will compare our results to the 2015 prior quarter, as if we were one company back then and exclude the effects of purchase accounting. Again, this is how, as a manager, I look at the company's performance. The P&C combined ratio for the quarter was a published 86, and excluding purchase accounting, 85.5.
That compares to an 85% last year, as if we were one company back then. There are three components to that. Catastrophe losses were up over prior year to $144 million pre-tax, versus an exceptionally low $101 million last year. Second, positive prior period reserve development of $349 million pre-tax was down $40 million versus the prior year. That leads to the P&C current accident year combined ratio, excluding cat losses of 88.4% versus 88.9% last year, benefiting in particular from a reduced expense ratio. Both our North American and international insurance operations had excellent calendar and current accident year results. Adjusted net investment income for the quarter was $830 million, a very good result, particularly given the record low interest rate environment. Investment income was at the top of the guidance we gave you.
We have made good progress repositioning our portfolio in ways we have discussed on past calls. This has in fact contributed to the quarter's results. Tim Boroughs, our Chief Investment Officer, is prepared to make a few comments on the portfolio, if you like. Just ask him. Book and tangible book value per share were up 2.4% and 5.5% respectively, and our annualized operating ROE for the quarter was 12%, a really good result. Phil will have more to say about tangible book, prior period reserve development, and cats. Turning to premium revenue, total P&C net premiums in the quarter on a constant dollar basis declined 3.5%. Foreign exchange had a 1 point impact. As I have discussed on our previous calls, when we were planning the merger, we contemplated underwriting actions in certain portfolios not meeting our standards or exceeding our risk appetite.
These actions, which include either canceling or reinsuring certain business, reduce our premium but improve our risk-reward profile. The impact from these actions will continue for the balance of this year and 2017, though at a reduced level, will dissipate as the year goes along. If we normalize for these underwriting actions, including the purchase of additional reinsurance, total P&C net premiums in the quarter grew over just 1% in constant dollars, a 4.5 point difference. The additional reinsurance accounts for 3.6 points of that 4.5 point difference, with business cancellations representing the balance. Keep in mind, the additional reinsurance had an outsized impact this quarter because of the one-time unearned premium transfer in personal lines. I want to say a few words about current commercial P&C insurance market conditions globally.
The pricing environment continued to grow more competitive in the quarter for our commercial P&C business, varied depending on the territory, line of business, and size of risk. As noted in prior quarters, large account business, particularly shared and layered, is more competitive than midsize, wholesale is more competitive than retail. Certain markets are noticeably more competitive than others. London, Bermuda, Australia, and Brazil, by example, are particularly competitive, while the U.S. and continental Europe competition is a little less ferocious and a bit more orderly, continuing to soften nonetheless. Globally, new business is harder to come by. It is a hungry market, competition is fierce for new business, both rate and increasingly terms and conditions, particularly when it comes to large account business. Retention of renewals is a high priority. Our renewal retentions are excellent, I will give you some details shortly.
Rate movement varied by territory and market segment, but in general fluctuated in a reasonably tight range. For example, renewal pricing for the business we wrote ranged from flat in our U.S. middle market business to down 2% in our U.S. major accounts business, to down 3% in our international retail commercial P&C operations. Globally, general and specialty casualty related pricing ranged from down 0.5% to down 2.5%. Financial lines pricing ranged from flat to down 3%, and property related pricing ranged from down 1% to down 5%. With all of that as context, let me give you some detail on our revenue results. In our North America Commercial P&C business, net premiums were down about 2.5%. Normalizing for the impact of the additional reinsurance we purchased and for the underwriting actions, net premiums were flat.
The renewal retention rate, as measured by premium, was quite good at just over 90%, and new business writings were up about 1.5%. In our North America Personal Lines business, net premiums written were down about 16%. The additional reinsurance we purchased had a 16.5 point impact, and the Fireman's Fund had a 3 point impact. Therefore, growth was over 3% for the combined Chubb and ACE portfolios. Overall, North America Personal Lines rates were up 1.5%, and exposure change added about 3%. Retention remained quite strong for the legacy Chubb and legacy ACE portfolios at 94% and 95%, respectively. For the legacy Fireman's Fund portfolio, as we continued to convert the business to Chubb paper, retention was 75%. The impact of the Fireman's Fund conversion is diminishing and will be virtually gone by first quarter. Net premiums for our agriculture business were up over 15% in the quarter.
Still early, from what we can see today, based on yield forecasts and commodity prices, this is shaping up to be a very good year for crop insurance results. Turning to our overseas general insurance operations, net premiums written for our international retail P&C business were down in the quarter 1% in constant dollar and up about 1.5% when normalized for the additional reinsurance and underwriting actions. In our London market-based E&S and surplus lines business, premiums were down 4%, or flat when normalized for underwriting actions. The renewal retention rate for our international commercial P&C business was 84% in the quarter, actually right in line with historic averages, and new business writings were down 2%. By line of business, commercial P&C net premiums declined 3% but were flat excluding the additional reinsurance and underwriting actions, while personal lines grew 3% on the same basis.
Our global A&H business net premiums written in constant dollars were flat in the quarter and up 1% adjusted for the underwriting related portfolio actions. We expect improved growth in our A&H business in the fourth quarter. Our combined insurance operations in North America grew 4% in the quarter. In sum, total company P&C net premiums in the quarter on a normalized basis grew just over 1% in constant dollar. Market conditions globally are competitive, I expect as we progress through future quarters and the impact of the merger continues to fade, given the compelling power and capabilities of the new Chubb, we will produce faster growth in the near future. In particular, we are building on the tremendous potential of our middle market businesses, both domestic and international, with both traditional core package and specialty product.
We also have greater growth potential in our A&H and Personal Lines business. For the large account and upper middle markets, the power of One Chubb is compelling as we combine product and expertise to bring total solutions to clients. It is a real differentiator and will provide more opportunity in spite of soft market conditions. We are already seeing evidence of this potential growth. We estimate that our efforts to promote new areas of coverage to mid-market and large account producers and account cross-selling in all of our businesses around the globe contributed about $88 million to our company's new business growth in the quarter. 16% of North America's new business and 5% of international's new business. We are also on the front foot with new products and digital distribution.
For example, we recently began to introduce our small commercial business owners package policy, the so-called BOP, during the quarter. What began as a small pilot with 12 agents in one state has now been rolled out methodically to several hundred agents, and we were approved to write business in 43 states. We are executing a disciplined plan and currently have capabilities to write some 500 industry classes of business, where we have proven and deep expertise. Our package includes broad coverage for property and liability exposures and is complemented by workers' comp, commercial auto, and financial lines products. Technology and data are a differentiator for us. Our business package can be quoted and issued by an agent online in as little as four minutes with minimal questions. We expect 80% of our package plans won't require underwriter intervention, with an eventual goal to be 90% plus.
We also recently launched a cyber risk product specifically designed for micro-businesses by a digital distribution through CoverHound as part of their new commercial insurance solutions for micro-sized small businesses. We will soon add to that a miscellaneous professional liability product and a business owner's P&C package, all featuring straight-through processing from quote to issue. A number of Chubb's existing micro insurance products are scheduled to be redesigned for digital distribution on the CoverHound platform and other web-based producers in the near future. Just stay tuned. John Keogh, John Lupica, Paul Krump, and Juan Andrade can provide further color on the quarter, including current market conditions and pricing trends, as well as examples of how our expanded capabilities are benefiting the company. Before I close, we are in good shape with our integration plans and activities.
We are ahead of schedule in terms of both realized and annualized savings, as you can see from the updated table in the press release. In fact, we have now increased the total annualized run rate savings we will achieve by the end of 2018 to $800 million, up from $750 million. Finally, our outstanding claims and risk engineering organization is performing at an especially high level, as tested recently with a number of cats, including Hurricane Matthew in the U.S. Let's remember, outstanding claims service is what this organization is all about. Speaking of Hurricane Matthew, while early days, and from everything we know, we project our cat losses from this event to be circa $200 million pre-tax. With that, I'll turn the call over to Phil, we're going to come back and take your questions.
Thank you, Evan. Our balance sheet and overall financial position remain strong. Our loss reserves remain conservative. We have a $102 billion portfolio of cash and high-quality investments that are well-rated and liquid, and we're generating substantial capital and positive cash flow. Operating cash flow for the quarter was $1.7 billion. We grew our tangible book value per share by 5.5% in the quarter. You'll remember that at the close of our merger, the initial dilution to our tangible book value per share was 29%. As of the end of the third quarter, our year-to-date dilution has been reduced to 16%, an improvement of 13 percentage points in three quarters. Of course, that includes five points of benefit in unrealized gains because of lower interest rates.
In the quarter, investment income of $830 million was at the top end of our estimated range and benefited from strong cash flow and from the changes we are making to the management of our portfolio. There are a number of factors that impact the variability in investment income, including the level of interest rates, prepayment speeds on our mortgages, corporate bond call activity, private equity distributions, and foreign exchange. Our expected quarterly investment income run rate remains at $820 million-$830 million. Net realized and unrealized gains for the quarter were $264 million pre-tax and include a $307 million gain from the investment portfolio, primarily from a narrowing of credit spreads, a $44 million mark-to-market gain on our VA portfolio, primarily from the improvement to equity markets, and a $95 million loss from FX. Our investments are in an unrealized gain position of $2.5 billion after tax.
Net loss reserves increased $315 million for the quarter. The paid to incurred ratio was 90%. We had positive prior period development of $349 million pre-tax, or $252 million after-tax, with about 20% from short tail lines and 80% from long tail lines, principally from accident years 2010 and prior. This included $52 million of adverse development for legacy environmental liability exposures, which are now included in our corporate segment. As a reminder, we conduct our environmental review in the third quarter and our asbestos review in the fourth. Our catastrophe losses in the third quarter net of reinsurance were $144 million pre-tax, or $107 million after tax, principally from U.S. weather related events. During the quarter, we purchased additional reinsurance that reduced our net written premiums by $260 million. $200 million related to personal lines, the remainder related principally to commercial lines.
The $200 million personal lines reinsurance premium included $128 million of one-time unearned premium reserve transfers, which impact net written premiums for the third quarter only. Excluding the one-time transfers, the annual impact to personal lines of this new treaty is expected to be approximately $280 million. As we've mentioned, we're increasing our estimate of integration related savings. There is no increase in our integration and merger related expenses. Our tax rate of 18.4% is slightly higher than our normal range due to a higher tax rate on our positive prior period development because of the jurisdictions in which the development occurred. I'll turn the call back over to Helen.
Thank you. At this point, we'll be happy to take your questions.
Again, to pose a question, please press the star key followed by the digit 1. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, star 1. We'll go first to Kai Pan, Morgan Stanley.
Good morning. Thank you. First question on the capital management. You generate in the first nine months, $3.5 billion operating income. You recover more than one third of the tangible book dilution. That leverage is towards low 20s. You purchase additional reinsurance. I would assume that would limit some of the earnings volatility. Also, you said market is more competitive. How do you think your current excess capital position and the potential buyback in 2017 and beyond?
Well, Kai, it's early days. We're pleased we're building our capital position. It's in line with our own expectations. Capital management, we pay an awfully good dividend. We understand the potential for share repurchase. That always fits into our overall thinking when we look at all of our options of what we'll do with our capital. Stay tuned. We're not in a hurry.
Okay, that's good. Thank you for all the details on the sort of new products. I just wonder, what's the reaction from your distribution networks, including the middle market, about these new products? If you're worried about sort of too much concentration in terms of like carriers more from the high net worth perspective. Thanks.
For the small commercial that we just launched, that's in line with our plans, as we told you from the very beginning, it's a book of business that we'll build over. It takes years to do. That's right in line, that goes through agents, we've just begun really rolling out in a real way, that will continue as our technology and product comes online into the middle of next year, where it'll be fully operational. As far as agent reactions, very good, I'm going to turn it over for a moment to Paul Krump, who will give you a little more sense of the feedback we're getting in the marketplace.
Sure, Evan. I'd say that the agent feedback has been very positive. The new organization really hasn't missed a beat in terms of service to both agents and clients. I think the agents have been extremely complimentary of how focused the team is on finding solutions for risk exposures. Just one quick example. We were all recently at the CIAB, we ran into an agent who had a Fortune 500 CEO, who had a personal lines risk, but it included both a cattle and a horse ranch. I would tell you that in the past, legacy Chubb would have absolutely struggled to figure out a solution to that. Today, we were able to put that together in a very seamless way, our new capabilities in that area are unmatched, they'll only become crisper and better as we go along. We're very excited about that.
As respects the piece about some concentration, yeah, I would suggest to you that some of the agents have been a little concerned about the concentration. We've seen that more so, if anything, in how they've moved some of the Fireman's Fund business. We expected that in the retention, that has shown up. You have to remember that that Fireman's Fund book was a conversion, we anticipated that there would be more price dislocation on the Fireman's Fund, that, as Evan said in his remarks, will dissipate as we go forward.
Kai, the market reaction to the small commercial has been very good as we've begun to roll that out. The legacy Chubb brand name with agency distribution and the relationships are so deep, as we bring additional product to market, the reception and the goodwill couldn't be better. I'd remind you on the dislocation question, sure, the concentration issue is an element with producers. Look at our renewal retention rate. We're holding the business, and we are in fact, writing new business. While that tension and that dynamic is there, as Paul started saying to you, our capabilities are beginning to improve. That we could do farm and ranch and do high net worth together starts opening up a whole other market dimension that others can't follow.
We have other product and technology plans on the drawing boards that over the next two years will roll out and continue to differentiate us.
That's great. Well, thank you so much.
You're welcome.
Ryan Tunis, Credit Suisse.
Hey, thanks. Good morning. I guess my first question is on the repositioning of the investment portfolio, and I guess if you guys could just talk a little bit more about the changes made there so far. Potentially if there's an opportunity to even do more there, I guess just looking at average yield on invested assets has been flat over the past few quarters. Thanks.
Yeah. Well, when you say that, I'm going to turn it over to Timothy Boroughs, but when you say that's in the face of a declining reinvestment yield.
Right.
Ryan, at this point, we've fully integrated the legacy Chubb portfolio with our investment process and operating platform. That's taken place. The assets have been placed with several of our managers with whom we share a long history of success. We've been working with these teams to implement strategic and tactical changes to the taxable, municipal, and our international portfolios to improve risk-adjusted returns. In addition, earlier this year, I think this is important, we shifted most of our equity portfolio into the upper tier of the BBB sector of the high-yield bond market, which had the impact of reducing overall portfolio volatility. This sector has returned over 14% this year versus a gain in stocks of about seven.
The result of all these adjustments have produced additional net investment income of over $120 million annually above what the portfolio's run rate would've been since the time of acquisition. This has been accomplished with a better balance to our asset allocation, overall reduction in portfolio volatility while we've maintained an average rating of AA.
Okay, that's helpful. I guess just to follow up on the additional reinsurance and the merger-related underwriting actions, I know Evan pointed out that most of the action, if not all the action so far has been taken on books that were planned at the beginning of the deal. I'm just curious how dynamic that process still is, and if whether or not you're still finding books in areas where there's sizable opportunities, I guess, to improve either the volatility profile or the loss ratio profile of the business. Thanks.
Thanks for the question. No, we've been through the portfolio and we, by the spring, so early in the second quarter, we had finished going through everything together. We understood exactly where it either wasn't meeting our return expectations or where we had individual risk accumulations that would exceed our guidelines and appetite, or we had aggregate risk accumulations, concentrations that would exceed our appetite. That's all done and we put in place our plans to either fix or get off of business, or secure additional reinsurance. Let me go a step further, though, because I think there is this question out there also of, well, risk-reward ratio and how do you think about that, and how do you as investors judge that? First of all, I don't believe you can judge that. We can judge that.
You can't, except that how our ultimate results turn out, I think we have a track record that speaks to pretty good underwriting, reinsurance is part of the underwriting process. We don't give away premium easily. Why would we do that? You ask yourself that question. We wouldn't. Reinsurance, in the way we look at things, is not an expense, but it's rather a risk management and a capital management tool. We have very well established views and guidelines and process to determine and manage our risk tolerances. Our appetite for individual per risk volatility is an example, our accumulations of how much we would take in any one geography among our various products as they clash from a single event that might occur. We have very sound capabilities to analyze the alternatives. Do we retain the risk? Do we reinsure it?
If we're going to reinsure it, what's the best reinsurance structure and the pricing alternatives? We can evaluate reinsurance pricing versus what we think a risk is worth. We can then track the results, gross and net, and adjust as facts and circumstance, both company and market, change over time. It's a very thoughtful process that we go through. Frankly, the question you ask yourself, if you're me in the very beginning when you do something, a merger like this is, do you worry about the optics of the premium revenue? Do you just do what you know is the right thing to do to manage the business to give the optimal return on a risk-adjusted basis? For me, it's a no-brainer. You just do that. Anyway, thank you for the question, and I answered more than you asked.
That's helpful. I guess just the one follow-up, Evan, is, clearly we've seen the cost in the NPW growth. When you look at the results thus far, to what extent are we seeing the benefit of this? Do you look at this and think that all the underwriting actions and the reinsurance you've done have improved results so far? Do you think that's largely just still on the come? In other words, the benefit hasn't really played out at all on what you purported.
Look, you can't measure with absolute precision, what I will tell you is this. The actions you take are on a written basis, and then that earns in over a period of time, generally a one-year period of time. The results of that will emerge over time. It ameliorates margin pressure you get from rate reduction and loss trend that occurs on your book of business. It ameliorates your results from a single catastrophe or a series of catastrophes when they occur. It ameliorates your results in frequency of large losses if you've limited your per-risk net because you don't think you're getting paid for that excess layer or have the spread of risk worth taking the volatility. You judge it over a period of time. I think you're liking our underwriting results, and it's all part of that.
All right. Thanks so much. That's more than I need.
You're welcome. I'll keep going with you until you say enough.
Thank you very much.
Elyse Greenspan, Wells Fargo.
Hi, good morning. First, a kind of high-level question. We have a specter of inflation taking off next year. We've seen some of your peers report thinning reserve releases. Evan, do you think that we'll reach a point where the industry should start potentially taking more prices to get ahead of what could potentially be a painful inflection point in terms of inflation?
Yeah, let me just clarify one thing. Did you say inflation is taking off next year?
I said there's a specter that maybe inflation could pick up when we get to next year.
Yeah, I think they just hang that ghost out there, and it just has hung there the last few years. Everybody looks at it and says, "Maybe it's coming." Look, it's not like there's no loss trend. There is inflation in claims. It varies by class, but it isn't like it has disappeared. It continues, and you see it in certain classes where it rears its head. Then in other classes, it's there, it just is a bit more benign. Pricing is flat or down. It's interesting to me the way I listen to people talk about the market because they'll say, "Well, see, the market is not softening because the rate of decline of prices has ameliorated." Well, that's mindless to me. The rate is still going down. It's just going down at a slower rate. Well, that's still softening.
Even if it's flat, it doesn't keep pace with loss cost trend. Eventually it's going to show up in results. When? I can't say with any specificity. At that point when it shows up, does that mean a market turns? There's a lot of capital, and there's a hunger for a rate of return. Even the insurance industry giving a mid-single digit ROE, which is miserable on a risk-adjusted basis to me. That is attractive to many, where there's $ trillions sitting in negative returns right now and just hungry for yield. If they can get absolute yield of 2%, 3%, 4%, 5% on an absolute, forget risk-adjusted basis, they're interested. You continue to see more capital coming into the business.
I'm not imagining, and I don't run our company, I can tell you, we don't build a strategy based on a market turn. We base it on the market we see.
That's helpful. Just a couple of numbers questions for Phil. How much of the integration savings came into the numbers in the third quarter?
Third quarter actual realized savings, from an accounting standpoint, were $102 million. That would bring, it was $28 million in the first quarter, you'll remember, $72 in the second quarter, and $102 in the third quarter, bringing the year-to-date total to $202.
Great. What was the FX impact on EPS in the quarter?
It was $10 million.
Okay, great. Thank you very much.
Did we take care of your worksheet?
Michael Nannizzi, Goldman Sachs.
Thanks so much. I guess you spoke a bit about developments on the commercial side in terms of the BOP policy and small commercial. Can you talk a little bit about investments that you've made on the personal line side and maybe either new products or new geographies or further integration of those previously three separate brands? Thanks.
Yeah. We are making investments in the area, and this is only a certain number of months, but they will roll out as we go along. Let me give you a little more color. We first of all, have reorganized ourselves between all the disciplines, between actuarial, underwriting, marketing, and sales, where we can, in a faster and more practical way, react to each region in the U.S., which each one behaves a little differently, or the states behave differently in terms of both competitive behavior and what we see from a financial profit and loss perspective on pricing.
Number two, we are right now in the middle of making investments and executing on actions around what will ultimately come out in the next, I'm not going to predict the month precisely, but we're going to start rolling out a digital experience around our high net worth business, where customers will be able to interact with us and procure service and actually manage coverage in a more digital way. Foundational technology, there is a need to make large investment to update and be state-of-the-art in our foundational technology around underwriting and claims. Claims, we've already done it, and we will be investing in the underwriting side, and plans are afoot to do that. In product, Paul began to tell you one of the initiatives that we're already engaged in and that will emerge, and that is the high net worth.
There is a large segment of that population that has farm and ranch exposure. You can't typically get it all from one carrier. We have the capability with our farm and ranch capabilities, as well as our high net worth capabilities. We're putting them together, and we've already been piloting where we'll be able to serve that segment, and that distinguishes us from anybody else, one-stop shop. Coverages around cyber liability, which on a personal basis, and particularly for high net worth, is a new exposure. We've rolled out product to address that area before anyone else in the market did. This is not something where you throw a switch. I said from the beginning, it'd take a couple of years, but we have a lot underway.
Great. Thanks. Then just maybe a quick one for Phil, just on the reserve development. We've seen some sort of divergent trends from other folks so far this year, particularly this earnings season on development. Just curious if we'll be able to get a little bit of color on whether the development came from legacy ACE or legacy Chubb, and if the trends have been different from the two legacy books, and how we should think about the standardization of those two as we go forward. Thanks.
Let me start with. I will. I'll turn it over to Paul in a second. Let me just start with, in general this cycle was primarily related to the casualty book. The most weight in our studies were casualty. We also had some personal lines development that I'll ask Paul to talk about.
Yeah. Thank you both. As Evan's mentioned on previous calls, we're integrating our actuarial process for all lines. In doing so, we're bringing together much more credible data than previously available in the personal lines space because we got the three big portfolios. That data just caused us to increase our expectations slightly on the legacy ACE personal lines book. In particular, the homeowners and personal excess lines were increased ever so slightly. Again, that's on the legacy ACE book. It's not in the personal auto. I suspect I know what you're pointing towards, and it's not the auto.
Remember, it's on a base of a couple of few billion dollars, actually. It's a $4.9 billion base.
Okay, good.
Thanks.
You're welcome.
Charles Sobeski, BMO Capital Markets.
Good morning. Thank you. I guess I'll follow up on the new initiatives with the BOP and the small cyber and commercial. If we're thinking a couple of years out, how large of a component of the book could this part of the business be? Can these small policy, small risk component be a material component of the overall commercial business?
Yes.
Okay. All right. Fair enough. We had another one on cross-sell, and how the cross-sell opportunity set is with these small policies and personal line and then the A&H business. I guess I'm thinking in the U.S. Is A&H a differentiator in the Chubb, the larger personal lines book that you have now? Are those pieces integrated, or am I thinking about that wrong?
No, you're thinking right. I'm going to start with an answer to you, and then I want to take your question even a little broader, and I'm going to ask Paul and John to talk a little bit about middle market, cross-selling, and what's going on in upper middle market. Let me take your A&H. By the way, on small commercial, when you ask, could it be material? I'm going to repeat to you one thing I've said before. First of all, it's about a $90 billion market in the United States. Number two, average premiums, though, keep in mind, a couple of thousand dollars. You got to write a lot of customers to build, to cast a real shadow.
In a number of years, in a few years, I expect that this will be a book of business with a V on the end of it. Okay? That's what I mean by significant. When you talk about A&H, it's in two pieces. First, in the combined, we do a work site marketing, and we have great technology, and we now have quietly built over $100 million of business that is growing quickly, where we're doing supplemental A&H products, not traditional health. Sort of like the same thing that you'd see Allstate or Aflac doing. We're competing very well in that business. We have now introduced it to the Chubb independent agency distribution system right alongside our P&C offerings.
Because most of the agents have an employee benefits division, and so we can come in where it is 50 to a couple of hundred lives, that's a sweet spot for us. With technology and enrollers offer supplemental health products such as accident insurance, dread disease, hospital cash, et cetera. That is a real initiative that we think has legs that over a number of years is going to grow a substantial business. Secondly, through our corporate A&H division as part of our major accounts and our middle market, traditional travel accident insurance and global business travel to corporations where they pay for the insurance for employees.
That is a real initiative for us. It is part of our cross-selling, along with a whole host of other products that I'm going to ask John to start talking about, Paul, just give you a better sense of that cross-selling.
Sure. Thanks, Evan. Charles, yes, to Evan's earlier point, we've really focused on our cross-selling into our existing customer base and agency books. Also what we call strength of the organization, where we've added resources and distribution. I will remind you that with the Chubb, we picked up 48 branch offices that are just terrific assets for us. Some of the things that we're selling is clearly the specialty product that ACE brought to the table. Things like environmental
Things like global programs, a broader excess appetite, deeper financial lines, cyber, international, construction, transactional risk. These are all specialty plays that our branch operation is just doing a wonderful job of distributing and getting to our relationships and adding that cross-sell. A couple of quick examples on the upper middle market side. We had a global digital company where the Chubb organization had a small specialty product. This client needed a worldwide program from domestic casualty to international casualty, to the new ACE product with the Chubb relationship and the Chubb team. This organization pulled together in excess of a $3 million deal. There's a number of those examples I can run you through, but it just brings to life one example where the organization has brought together additional capabilities.
I want to add one thing about that account, that was, it took the capabilities of both organizations. The product set that legacy Chubb brought and that legacy ACE brought, by themselves, each one was hardly enough to win the day. The two together, there was no one who stood up to us in the competition. It was fascinating. Paul?
Maybe just another quick example, because I think John did a great job outlining it. Going back to the strength of the organization, an agent, a friend of mine, told me a story where one of our clients in the personal lines world runs a business, it's in the healthcare industry, and this prospect of his was very anxious to get a Chubb quote. He explained to them that he didn't think that this risk was within Chubb's appetite, but he also admitted to the client, the prospect that, in fact, now that legacy Chubb has changed to new Chubb, that the appetite has shifted as well because legacy ACE was bringing on so many more capabilities and skills. He approached us, and he was shocked that within days we put together a very competitive program.
The underwriter that he knew helped guide his colleague through the relationship, and we wrote the account with $several hundred thousand. That in itself is just personally very satisfying for me, but what also is very satisfying is that this agent is really turned on to Chubb right now and their submission activity has increased nicely.
I really appreciate all the answers. I guess just one final, if I could ask, might be helpful for us is, on the personal lines business, I know there's a lot of work on re-underwriting, reinsurance. If possible, if we could get some PIF data, could potentially over time help us understand the trend of the book quarter-over-quarter would be appreciated.
We will note that.
Thank you.
You're welcome.
Sarah DeWitt, J.P. Morgan.
Hi, good morning. The 12% operating ROE in the quarter was very strong, and you still have about another point of expense savings to realize. Is a 13% ROE about the way to view the right run rate for the company, or was there lower than average losses this quarter or some seasonality in the business? Just trying to get a sense of the ROE profile for the new company.
Yeah, well, I think that's maybe a simplistic way. It's just a sterile mathematical way of looking at it. You got to figure all the other factors. You just loaded additional expense on top. Let's see what happens to rate and trend and losses and mix of business and all the rest. I'm not projecting. I don't give guidance.
Okay, thanks. Then the-
You're welcome
underlying combined ratio in the quarter remains steady despite your comments about market conditions. What's driving that, and do you view that as sustainable?
I'm not giving you guidance. On the other side of the coin, I feel pretty confident in our underwriting and our ability to produce superior results relative to the industry. Our mix of business, our underwriting discipline, our willingness to shed business, to reinsure business, not to grow where it doesn't make sense, and to grow where it does make sense. Our global reach and our balance of businesses by geography, by country, where we selectively determine to write each line of coverage, not mindlessly across the globe, but selectively decide which country to write which business in. Our mix between middle market, small and large commercial, our mix between specialty and traditional.
The fact in major accounts business where we have superior capabilities. It's not simply about the cheapest price for shared and layered, but that you bought the franchise. Therefore it's our ability in primary casualty to be able to pay your claims, to be able to issue the paper all around the globe, collect the money and move the cash flow, pay the taxes for you, and then write all the excess coverages. Our ability to write multiple coverages on you on a global basis and not simply one coverage. I think all that goes into those results, Sarah.
Okay, great. Thanks for the answers.
You're welcome.
Paul Newsome, Sandler O'Neill.
Good morning. I've got a couple of unrelated questions. The first one is, I cover a lot of regionals, which I guess is my problem. They're all telling me that they're going after the high net worth personal lines business. I think some of this may be they're not really going up, so really targeting near affluent as opposed to affluent, it's hard for me to tell exactly how far up the scale they're going towards Chubb's business. The question really is, are you seeing those folks, and are they indeed trying to take the incremental customer out of that truly high net worth marketplace?
We're seeing the competition in one or two in the mass affluent space creeping into the lower end of high net worth. It's a price play, offer a cheaper price, having the broad coverages and the service capability, that's what it's really about. If people are going to compete simply on price but not the same quality of product and service, and that's the game, that's fine. You'll always have that. As I've said from the beginning, we expect that with the merger, there would naturally be others who would come into the space. It makes sense. It ought to happen. That doesn't disturb us.
Your ability to actually become a true high net worth player requires a lot of investment, a lot of patience, and because you got to build a hell of a capability in service, and you got to be able to follow your customers where they have exposure. By the way, you got to have a balance sheet and an appetite for greater volatility or risk, because high net worth behaves like a commercial account, not a traditional personal lines account.
My other question, which is completely unrelated, we have the impact from the Department of Labor coming up in April of next year, and there are some folks I think are very smart, like the folks at Milliman, that think that essentially you're going to end up with very few 1035 exchanges, and then the retentions for in-force annuity books will just sort of skyrocket. You have a life reinsurance business. You haven't had an issue with it or seen much impact out of it lately, but if you saw a large increase in retentions in that in-force book, would that have a material impact, positive or negative, on your results?
This is variable annuity business, not fixed annuity business. You realize that?
Yeah. I think that the thought is actually the variable annuity business will also, because a lot of those features are in the money, will become untransferable because they'll have to explicitly estimate the value of those derivatives to the customer, and it's very hard to swap them into something else if they're in the money.
Yeah. We'll have to take that offline with you, but I would say this. We study the lapses and the annuitization rates on a regular basis. Every year, we react to the changes as we see them. You realize we write an XOL book, an excess of loss book, that has been in runoff since 2007. Our lapses have been running to date better. They've been running lower, in fact, than we originally imagined, and we watch those and annuitization rates pretty carefully.
Fantastic. Thank you very much.
You're welcome.
Meyer Shields, KBW.
Thanks. Good morning. Evan, one sort of big picture question in light of the quarter's reflection of pricing trends and sort of the overall economy. Are you more or less optimistic about the revenue synergies from the combination of ACE and Chubb than you were six or 12 months ago?
I'm the same about the revenue synergies between ACE and Chubb. Absolutely the same. What I can't speak about is, yes, the capabilities and our ability to bring those capabilities and differentiate whether new product, an absolute like small commercial, or bringing product to customer through in middle market or in large account. I'm absolutely right where I was about that. What I can't tell you is how much joy you get at any one moment for it, depending on market conditions. I expected a competitive market, and we certainly got one.
Okay. That's helpful.
Remember this, which is very interesting to me. I told you that really you can't be pollyannish about it, that in the beginning, we would take some actions that would have dyssynergies, hate the word, give me a better word, where we would cancel some business, we'd reinsure some business. You'd reduce some premium revenue, the growth initiatives would occur over a number of years, and I said a three-to-five-year period to show a meaningful difference. We're keeping track of it. At the same time, you're going to have on your basic book of business, you're going to have a certain lapse pattern and a certain new business pattern. If you're a disciplined underwriter, that pattern is going to vary depending on the market conditions. You add the two together, and there you go. There you go is your ultimate growth rate.
What I know is we can measure the power of the integration from a revenue point of view and be able to track how one plus one is better than the two by themselves in any market condition. You following me?
I do. Yeah, that's very helpful.
Okay, you're welcome. Did you have another question, Meyer?
Just a very quick one. In terms of the reinsurance purchasing, is there any, I don't know, guidance is the wrong word, but ballparking you can give in terms of how the ceding commissions compare to the acquisition expenses?
How the ceding commission compares to what?
The acquisition expenses on a gross basis.
Yeah, sure. The ceding commission is better than the acquisition expense. Otherwise, I didn't even cover my operating expense.
Okay.
Let alone are you giving me a margin for my good business I'm giving you.
Perfect. Thank you.
You're welcome.
Jay Cohen, Bank of America, Merrill Lynch.
Yes, thank you. Thinking about the environment and just as you are really emerging as this mammoth global company, two of your competitors are clearly pulling back, and I'm wondering if you're seeing that in the number of submissions you're getting.
We're not only seeing it in the number of submissions we're getting in that, particularly in that large account business, but we're seeing it in the writings. John Lupica.
Yeah, absolutely. Thank you.
Juan Andrade.
Yeah, Jay, there's no question in that global casualty business where we've invested a bunch of resource and time and people over the last 7 to 10 years delivering a terrific product and being consistent with our pricing and our offerings. We are absolutely seeing opportunity from a couple of our competitors stumbling a bit. We're seeing more submissions or seeing more new business come into the portfolio at adequate rates. Mind you, we compare our new business to our renewal business, and the adequacy is on par to our portfolio. That is one area when Evan noted our new business was up, that we're definitely seeing new business increase in. It's all, yeah, global casualty risk manager business. That would include lead layer umbrella, I would include global property fronts and lead layer financial lines in there as well.
On the international side, Jay, I would add the same thing. We're really seeing more opportunity here as some of our competitors stumble, particularly on the service side. We're seeing more risk managers coming to us via the large brokers, looking for essentially the franchise opportunities that Evan described, given our multinational capability. We see it in our pipeline, but we also see it in our new business, particularly in places like Continental Europe.
Jay, the ameliorating factor on the other side that stops us from writing, well, it depends on the market condition. They'll come to us, they want the service. Are you willing to pay us the price we want? An awful lot of instances, they're bringing in the risk, and it's at a price that the expiring price is at a discount to what we think it's worth. There you go. There's the bid-ask as to whether we're going to write it or not.
Got it. The other question on the auto side, obviously, there was some noise on the personal auto side. All the stocks seem to go down on some of those days. Our suspicion is that personal auto is a very small part of your business. Can you talk about how big that business is for you?
Yeah. Paul Krump is actually looking for his statistics at the moment as we speak. Yeah, our combined ratio is behaving pretty well. It's not a huge book for us. Paul?
Yeah, just a level set. Again, it is not a lead line for us in personal lines. We generally write automobile only along with our other coverages for our customers. In addition, our auto product really appeals to customers looking for much broader coverage and service, particularly when it comes to vehicle repair and especially around safety systems. I would tell you that we're just not the best source for confirming standard market auto trends. Our premium is much more skewed towards the homeowners, and we have far more cars typically than we have drivers.
We do see, we've seen for a while what some others in the market have seen, that is there is particularly an upward trend in severity. Look, the kinds of cars that our drivers drive, more valuable cars, the technology continues to evolve, both in the materials used to manufacture the cars and the computerization, the digitalization of automobiles, that drives severity. We have seen that severity increase. Over a period of time, we've been taking rate, we're making an underwriting profit in auto. By the way, the volumes, look at page seven of the supplement. You get the volumes on a global basis.
Got it. Which is my experience, because you write my house, you don't insure my crappy car.
Thank you.
You're a friend, I'll just withhold my comment, my retort to you.
No teenagers in the house. I don't want them.
Ian Gutterman, Balyasny.
Hi, thank you. I guess I have a comment first, maybe building off the last comment there is, I'm looking forward to the new digitization in high net worth because the current Chubb website for homeowners feels like something out of the '90s. I'm hoping for something more customer friendly. My first question is on the cost saves. It looked like the incremental $50 million, if I compare the chart to the old chart, pretty much all comes in 2016, it's basically already done or about to be done. A, is that accurate? B, can you give us a little color on sort of what's been done year to date and sort of where we see it? Is it expense ratio in the segments? Is it corporate? Is it LAE?
Is there a way for us to sort of identify it, I guess, in our models?
No. I'll make that part short. There's no way for you to identify it.
Okay.
You won't be able to. Number two, you'll identify it in the overall, as you watch the expense ratio.
Right.
We can also identify to you in the loss ratio what percentage change in LAE exists. We're tracking the savings. By the way, we track it in a very buttoned-up mathematical way. It comes through finance and accounting. It's got controls around it. It can be audited both externally and by internal audit. We don't put out these numbers without real governance and control around it all, and that's how we manage to it anyway. It's all for real. What you have on the other side is what counterbalances is any investments you have that you make that will increase expense, or normal inflation in expenses. We kind of track between the two pieces. Your question about the $50 million. No, it's not in 2016, it's in 2017 and 2018.
Okay, I'll have to go back and look at that again.
If you want, Phil, I think we're going to expand on that.
I was just going to say that's right. It was across the years, the $50 million increase, and you can just compare it to the first quarter disclosure, you'll see it.
I thought before you had. Now you have $310 million of actual achieved in 2016. Before, you had $270, $275. That's why I was saying it's mostly in 2016.
The realized was. I think the $800 is the annualized.
It's the annualized. Look at the annualized, Ian.
Okay. I'll follow up offline on that one.
We definitely did accelerate what we would have expected in 2016.
Okay.
You'll see that the additional 50 is spread across the years.
Got it. Just to follow up on the small commercial effort, I guess, Evan, can you help me understand what I'm struggling with there, right, is that business is obviously, as you said, it's very low ticket, very sticky, doesn't change carriers a lot, and it's very dependent on sort of the experience with the CSR almost as much or more so than with the customer. What's sort of your edge going to be? Is it going to be a new take on service centers? Is it going to be a new take on front-end quoting to make the CSRs want to do business with you instead of someone else? I mean, what's sort of the hook, I guess?
The hook is a couple. First of all, in the agency, they are predisposed to grow their business with Chubb.
Okay.
The market concentration of this business, when you think of the guys that you would think of are the ones who are leading brands in it. Well, in aggregate, they have 20% market share of a $90 billion market, it's incredibly spread. There's a lot of carriers in there that frankly, the agents, if you take the relationship with Chubb, they want to grow that relationship, and they have more confidence in that. You start with that. Number 2, our technology and our ability to quote, bind an issue, and a 4-minute to do it, and that you don't touch, that's something that is a great differentiator to CSRs.
Got it.
That we'll offer the total product package plus specialties wrapped around it that others don't have is a differentiator. I think when you add all three together over time, we will grind this out. Ian, this is not a passing game where you make a 50-yard gain in one play. This is a grind-it-out foot by foot, yard by yard.
Well, that's what I was actually going to ask next.
That's great. That's what we're in the business of. We're all not trying to get out of the business tomorrow. We're here for a long time building a company, and this is part of the effort. It's not something like, what's the update every quarter? How's it looking?
Yep.
Nah. Come on, you measure it over years.
Is it a by agency approach, meaning you're trying to win over agents and get book rolls one at a time? Or is it going as broad as you can to get-
You go agent by agent. You'd love book rolls, that's again like a short pass.
I'm wondering.
You know, I tend to go yard by yard.
Yeah.
sure, you'd love book rolls, and maybe you'll get some of those, but you take it policy by policy.
Got you. Very good. Perfect. All right. Thank you.
You're welcome.
We have time for just one more person to ask questions, please.
Remember, we don't have second careers around here. That's all we do. We got all day for this.
Brian Meredith, UBS.
Yes, thanks. Just a couple of quick ones here for you. Evan, just looking at the global reinsurance business, big decline in premiums. Is that all just market related, or are you seeing some customers shying away from you now that you're just a much bigger primary player? What is the outlook for that business for you guys?
No, there's nothing related to. We've been a big primary player for a long time. There's nothing related to that, Brian. It is truly market. Our reinsurance folks, we liberated them a long time ago from volume. You will do the right thing to earn an underwriting profit, or you'll walk away from the business.
Okay.
That's all that's a reflection of. Look, it's a little like the E&S business. In reinsurance, you have to be prepared in the way we run reinsurance. Everybody a little differently, where it has more volatility to it based on the market signature. You will have moments where you, there'll be moments when you may grow very quickly, and then you got to be willing and prepared that on the other side, there's volatility and you just shed like mad if you have to, if your intent is to earn an underwriting profit. Wholesale E&S is next like that. It expands, the market expands or shrinks, depending on market conditions.
Great. Then my next question for you, Evan, can you chat a little bit about what you're doing, efforts to roll out the Chubb brand, particularly in the personal line side and some of the emerging markets and the platforms that ACE used to have? Or ACAS, sorry.
Yeah. We're focused in just a couple of geographies around the world. We're focused in the U.K. There is a business, it has been a good business, and we are putting more effort and more investment into that U.K. business. Juan is exploring a couple of places on the continent, in a thoughtful way, where there is opportunity, we believe. Beyond that, we're in Australia, where we have a portfolio and are growing that. Other than that, it's where our customers emanating out of the U.S. or one of those markets may in fact have a property or an exposure in another country. We have a Lloyd's platform that is used to be able to quote and issue that alongside their U.S. policy because they have a home in Mexico, or they have a home in Colombia. We can service it on a global basis.
Got you.
The notion of expanding high net worth into a whole lot of countries, if you understand the market environment in those countries and the actual consumer behavior, as we know it, there is not a high net worth market to be pursued in most markets of the world. That's just a fact.
Got you. It is more just rolling out the Chubb brand in some of those emerging markets. Does that kind of carry weight in areas like China and some other areas?
Well, it does carry weight. We're pushing the, I would say this, the ACE brand was a bigger brand in China, as an example, than the Chubb brand. The conversion to the Chubb brand, it gets the halo of what was the ACE brand because it's based on personal relationship more namely. In the other markets of the world, the Chubb brand, ACE brand, we are promoting the brand and building it, and I think it's very well received. There's a tremendous brand equity in that Chubb name. It just has a distinguishing brand image in terms of service and claims like no other insurance company I know. That is an asset. That is an asset that we will promote, that we will burnish, that we are fiduciaries of, and will protect.
Great. Thank you.
You're welcome.
Thank you everyone for your time and attention this morning. We look forward to speaking with you again at the end of next quarter. Thank you and good day.
That concludes today's conference. Thank you for your participation. You may now disconnect.