Ladies and gentlemen, welcome to the first quarter 2013, The Hanover Insurance Group, Inc. earnings conference call. My name is Gwen and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session. If at any time during the call you require operator assistance, please press star zero and we'll be happy to assist you. As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to your host today, Ms. Oksana Lukasheva. Please proceed.
Thank you, Gwen. Good morning, thank you for joining us for our first quarter conference call. We will begin today's call with prepared remarks from Fred Eppinger, our President and Chief Executive Officer, and David Greenfield, our Executive Vice President and CFO. Available to answer your questions after our prepared remarks are Andrew Robinson, President of Specialty Lines, and Bob Sedgwick, President of International Operations and Chief Executive Officer of Chaucer. Also participating on today's call and available for questions are Mark DeRosier, President of Personal Lines, and John C. Roche, President of Business Insurance. Before I turn the call over to Fred, let me note that our earnings press release, financial supplement, and a complete slide presentation for today's call are available in the investors section of our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session.
Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements. There are certain factors that could cause actual results to differ materially from those anticipated by this press release, slide two of the presentation deck, and our filings with the SEC. We caution you with respect to reliance on forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release, slide two of the presentation deck, and our filings with the SEC. Today's discussion will also reference certain non-GAAP financial measures, such as operating income, operating income per share, operating results excluding the impact of catastrophes and development, ex-CAT loss and combined ratios, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release or the financial supplement, which are posted on our website, as I mentioned earlier.
With those comments, I will turn the call over to Fred.
Good morning, everyone, thank you for joining our first quarter earnings call. Our results this quarter were strong and largely in line with our expectations, putting aside the incremental benefit of lower than expected CAT loss. We delivered operating earnings of $1.32 per share, which translates to an annualized operating ROE of 10%, representing a solid improvement. Our book value increased by 2% to $59.58 during the quarter. Most importantly, I'm extremely pleased with our execution this quarter. The strength of our results and trends we are seeing support the confidence we have in our ability to further expand our underwriting margins and firmly positions us for strong performance in 2014 and beyond. Over the last few years, we have completely changed our business portfolio and competitive position.
Entering 2013, our leadership team created a clear set of priorities focused on leveraging this portfolio and improving our underwriting margins, creating a plan that drives us toward top quartile performance. I am pleased to see that our results this quarter track to our expectations, we continue to make progress on our strategic initiatives. I will outline those for you shortly, first I would like David to review our financial results.
Thank you, Fred, good morning, everyone. I'm very pleased with the results we achieved this quarter that reflect the diversified and growing earnings power of our company. Net income for the quarter was $66.2 million, or $1.46 per diluted share, compared to $49.7 million, or $1.09 per diluted share in the prior year quarter. Our operating income this quarter was $59.9 million, or $1.32 per diluted share, compared to $46 million, or $1.01 per diluted share in the first quarter of last year. This represents our best quarterly performance since 2007, while lower catastrophe losses is a major factor in the earnings improvement, as Fred mentioned, we're also making important progress in our strategic priorities and have seen good results in the underlying trends. Our combined ratio this quarter was 96.1% compared to 98.1% in the prior year quarter.
Lower catastrophe losses was the primary driver of the improvement in both our domestic and international operations. Chaucer also had a lower incidence of large losses, while ex-CAT results in our domestic businesses were fundamentally in line with our expectations. Catastrophe losses contributed 2 points to our first quarter combined ratio compared to nearly 4 points in the same period last year. Virtually all reported catastrophes this quarter originated in domestic businesses and relate to a handful of weather events, including Winter Storm Nemo, the three-day mid-February blizzard that affected the Northeast. The benefit of lower than expected catastrophe losses this quarter was partially offset by higher non-catastrophe losses from winter weather events in the U.S. We usually anticipate a higher frequency and severity of weather in the first quarter given our geographic mix, this year was no exception.
During the comparable period last year, the winter weather was unusually mild, which makes the quarter-to-prior-quarter comparisons more challenging. Prior year reserve development for the quarter was favorable at $7 million, or 0.6 points of the combined ratio. Chaucer generated favorable reserve development of $13 million, which came mostly from property line in the 2012 accident year. It's worth noting that Chaucer's overall favorable development was somewhat reduced by the impact of foreign exchange movements this quarter. In our domestic reserves, we experienced some continuing, although abating, development in bodily injury in personal and commercial auto lines. We also noted some physical damage and specific property losses from December that carried over into the first quarter. Our loss experience in workers' compensation continues to be favorable.
The trends we observed are largely as expected, and we continue to be comfortable with the overall strength of our loss reserve position. Moving on to a discussion of accident year results, excluding catastrophe losses. We consider the quarter-over-quarter analysis in the domestic ratios, the comparisons are impacted by two factors. As I mentioned earlier, non-cat weather returned to a more normal level this year compared to the unusually mild winter last year. This most directly impacted our loss ratio in homeowners, CMP, and also auto, due to physical damage and comprehensive coverage loss experience. As you may recall, last year's first quarter accident year loss picks were subsequently re-estimated in certain lines, including personal and commercial auto, to reflect higher loss trends we observed during the balance of the year. We believe this makes the full year 2012 loss ratios much more relevant for analysis.
Keeping this in mind, the commercial lines current quarter accident year combined ratio was 98.9%, compared to 97.6% in the first quarter of 2012, is one point better than the 99.9% we experienced for the full year in 2012. In commercial auto, the current quarter accident year loss ratio was slightly higher than the full year 2012 result, driven by an increase in frequency, primarily in property coverages, partly attributable to weather, while BI trends were largely as expected. The accident year loss ratio in other commercial lines has improved from year-end, is in line with expectations, reflecting the effectiveness of our underwriting actions and our pricing strategy. Our CMP loss experience was largely as expected, as well, with some impact from non-catastrophe weather and slightly higher frequency of large losses, which can be lumpy from quarter to quarter.
We continue to generate a healthy margin in workers' compensation, which is benefiting from both rate increases and our focus on smaller accounts and lower risk classes. The commercial lines underwriting result also benefited from an improvement in the expense ratio, primarily due to earned premium growth and continued improvement in our operating efficiencies. We achieved an overall growth of 3% in commercial lines this quarter, driven by small commercial, we continue to execute on our mix management and pricing strategies. Adjusting for a renewal rights transaction we executed in Florida, the commercial lines growth would've been 5%. Importantly, better pricing trends and a continued shift to a more profitable mix provide us confidence in continued margin expansion in the long term. Our growth expectation for the year remains at mid-single digits for this segment.
Overall, although there is clearly more work to do in commercial lines, we are satisfied with the trends and the progress we've made. In personal lines, our accident year combined ratio, excluding catastrophes, was 91.8% in the current quarter, compared to 90.7% in the first quarter of 2012, and 92.8% for the year. In auto, we're seeing improvement in accident year loss ratios attributable to the rate and other actions we have taken. Our loss ratio in the homeowners line has improved over last year as well, reflecting the rate and non-rate actions we took. Although the effect was somewhat masked by a higher level of non-catastrophe winter weather in this year's quarter compared to the unusually mild winter last year. We continue to execute on our exposure management strategies in the current quarter, which resulted in lower PIF and net written premiums for the quarter.
We expect to see some fluctuations in the growth results quarter to quarter due to the timing of our actions, both this year and last. We still expect overall personal lines growth for the year to be roughly flat to a slight decline. At the same time, we've noted improved rate activity and stable retention in personal lines, which we expect will contribute to growth in our earnings power going forward. Chaucer once again produced a strong contribution, generating $41 million of operating income before tax this quarter. The combined ratio of 86.7% included $2.6 million, or one point related to catastrophe losses, which is much lower than our expected normal run rate. The ex-CAT accident year loss ratio improved by almost eight points compared to the prior year quarter, and compared to full year 2012, the ratio improved by two points as we had fewer large losses.
Chaucer's expense ratio of 34.7% picked up a sizable benefit from the weakening pound sterling against other currencies this quarter. Our expected long-term expense ratio run rate for this business remains in the range of 37%-38%. However, you've probably already noted the ratio can fluctuate from one quarter to the next. Chaucer's net written premiums were $252 million compared to $200 million in the prior year quarter, representing 26% growth, which is mostly attributed to higher retained business at Syndicate 1084, as we did not renew certain quota share arrangements effective January 1st. The increase in syndicate participation will continue to drive growth of net written premiums through the rest of the year. However, the earnings impact this year is expected to be marginal as we recognize the unwinding of this agreement over time. Moving on to a discussion of our investment portfolio.
Net investment income was $67 million for the first quarter of 2013 compared to $67 million earned in the prior year quarter. For the first quarter, the overall earned yield on our fixed maturity portfolio was 4.03% down from 4.38% for the same period of last year. As new money yields continue to put downward pressure on our overall investment returns, we are employing certain portfolio management strategies intended to augment our yield without meaningfully increasing the overall investment risk in the portfolio. Notably, this quarter, we benefited from a modest portfolio of investment-grade mortgage-backed securities that we acquired starting in the second quarter of 2012. We will continue to prudently seek additional yield opportunities. At the close of the first quarter, we held more than $8 billion in cash and invested assets, with fixed income securities and cash representing 92% of the total.
Roughly 95% of our fixed income securities are investment grade. The duration of our portfolio remains at approximately four years. The balance of the portfolio is invested in equity securities at 5% and 3% is primarily held in overseas deposits and partnerships. Before I comment on capital, I also want to point out that our effective tax rate on operating earnings was a bit lower this quarter by about one point. This benefit is driven by allocation of income derived locally in the U.K., we expect that this will carry through for the rest of the year. Our balance sheet remains strong, providing us with excellent financial flexibility. We ended the quarter with $2.6 billion in shareholders' equity. Our book value per share was $59.58, up 2% from $58.59 at year-end, up 3% from the $57.65 in the past 12 months.
During the quarter, we continued to pursue a diligent capital optimization strategy. As you recall, over the last three months of 2012 and into January, we opportunistically retired approximately $120 million in legacy debt assumed in various acquisitions and projects. In March, we issued $175 million of subordinated debentures with a coupon of 6.35% due in 2053. The debentures are a more efficient capital instrument for us. We were able to successfully issue these securities in the retail fixed income market, which was a market that we had not previously been able to access. During the quarter and through April 26th, we also took the opportunity to repurchase 904,000 shares for approximately $43 million at an average cost of $47.23 per share. We have plans to continue to opportunistically repurchase shares to offset the impact of the additional interest expense from the subordinated debentures on our earnings per share.
Our target spend for the year is approximately $70 million, including the repurchases we have already made. As a result of these actions, our unadjusted debt to total capital ratio increased to 27.2% at the end of the first quarter. However, the subordinated debentures are considered equity treatment by rating agencies. As a result, become a more efficient instrument in our capital structure. Our debt to capital ratio is well within our internal tolerances and rating agency thresholds for our current ratings. Holding company cash and investments were $295 million at March 31st, increased due to the cash raised from subordinated debentures in late March. We also continue to maintain a $200 million credit facility that provides additional flexibility. To sum up, we had a strong quarter that was within our expectations and aided by low catastrophe activity.
We feel good about our financial strength and our underlying indicators for financial performance. We are confident that we will be able to continue to leverage our position to deliver the projected earnings in 2013. With that, I'd like to turn the call back to Fred.
Thank you, David. Our results this quarter provide us with continued confidence in future margin expansion and our ability to execute on our strategic and financial goals for the year. Our confidence is supported by progress in four areas of focus, continuing pricing improvement in our domestic businesses, continuing portfolio management actions, improvement in our domestic Specialty businesses, and a strong diversifying effect of Chaucer. I will touch on each of these drivers and initiatives and how they manifested in the quarter, starting with pricing. Simply put, we continue to see an improved pricing environment in virtually all of our businesses. You've heard extensive commentary about this in the P&C sector over the last year or so, and although there was some concern in the industry about a slowdown in the trend, we continue to achieve meaningful increases in the first quarter of 2013.
In addition, we are optimistic that we will continue to see solid pricing increases as we move forward in 2013. In the first quarter, we achieved positive pricing momentum in all lines of our domestic book. We saw 9% increases in Personal Lines, 9% increases in core commercial, and 14% increases in our domestic Specialty business. In the current dynamic market and pricing environment, which has been disruptive to agents, it is important to stay focused and targeted when it comes to rate increases. Our sophisticated underwriting and pricing models, as well as our strong position with our partner agents, allows us to be very targeted in our pricing approach, managing the balance between pricing and retention. It also allows us to continue to improve our mix and the quality of our overall portfolio as we grow with our partners.
In addition to pricing, we made very good progress on improving our portfolio through some targeted mix management actions. As we previously discussed, we believe that we must assume that the more challenging weather conditions we have seen in recent history is a permanent condition, and we must respond with pricing and targeted portfolio actions. We continue to manage our book of business to improve the quality of our mix and reduce our volatility by lowering property concentrations in certain geographic areas and by exiting businesses where we felt we cannot get appropriate pricing for the risk we are taking. Last year, we began a very targeted effort shedding less attractive business. In 2012, we shed about $120 million in premium, much of it by eliminating non-partner legacy agents. This year, we are targeting an additional $175 million in premiums.
Although it will somewhat temper our top-line expansion this year, this is the right trade-off to make for improving our long-term returns. Notably, in the first quarter, we undertook the following initiatives. First, we executed a renewal rights transaction that moved a Florida-based book of commercial business. This book came with our AIX acquisition. Second, we continued to aggressively manage our Personal Lines exposures in targeted geographies. We made excellent progress reducing our micro concentrations in a number of areas, which will reduce our volatility over time and allow us to shift capacity to higher margin business with our partner agents. Third, we are actively executing about a half dozen targeted profit improvement initiatives in core commercial lines in order to reduce potential volatility from weather and driving less profitable business out of the book. All in, we have reduced premium by about $40 million in the first quarter.
These actions, combined with our pricing, give us confidence that we are building a very attractive, stable portfolio for delivering future financial returns. Outside of these targeted actions, we are seeing strong business momentum. Our retention rates are holding at desirable levels, and business submission flow continues to be very robust. Our value proposition is well understood and supported, and we are gaining market share and agency shelf space in very attractive areas with our partner agents. As we prepare for our annual agency partner meeting beginning tomorrow, I am especially pleased with the position we have built with the best and strongest distributors in the U.S. Our agents are impressed by the talent we have added to our already strong team, as well as our broad and relevant product portfolio. Another source of our confidence comes from our profitability and growth outlook in our domestic Specialty Lines.
As our businesses mature and we are making the necessary changes to our portfolio, we have visibility into a solid margin expansion in our newer specialty businesses going forward. Additionally, we believe we have substantially dealt with some legacy items in this book, notably surety, where we have improved performance and now have a more balanced and attractive book of business. Overall, we are pleased with the margin improvement embedded in our results and are confident that our overall portfolio will increasingly benefit from growth and higher margins that this business has the potential to deliver. Expense ratio improvement is another source of margin expansion in the domestic specialty businesses. While we will continue to make investments in our products and operating model, many of our larger infrastructure and technology investments from building out our portfolio are behind us.
Additionally, we are gaining operating model efficiencies and scale as we continue to grow these businesses. Of note, and related to all our segments, I should emphasize that we are on track with our expense targets for each of our businesses. We are committed to ensure that every investment we make improves our ability to sustain improved margins. Chaucer continues to be an important part of our improved portfolio, bringing strong underwriting performance in critical specialty areas. It is also an important component on our path to a more balanced book of business with an attractive mix. As last year proved, our international platform allows us to be more resilient to U.S. weather patterns and events. As David indicated, Chaucer had another quarter of strong earnings, contributing $41 million on a pre-tax basis. The absence of catastrophes, lower large losses benefited this quarter's results.
Chaucer has had strong performance over the past year, but our long-term expectations for this business continues to be around 94%-96% combined ratio. Overall, the trends we are observing in our results for the quarter and the progress we have made in our planned initiatives gives us continued confidence in meeting our 2013 full-year estimates and position us for additional improvement in 2014 and beyond. As far as 2013 guidance is concerned, given that we are just one quarter into the year, we believe it would be premature at this point to adjust our full-year outlook to reflect lower level of catastrophe losses we experienced this quarter. Before I open the call for questions, I want to emphasize that every member of our team is focused on improving our underwriting margins and establishing a business portfolio that ensures our improving financial and strategic position.
We are just as committed to efficiently managing investor capital as evidenced by actions David outlined earlier. Our focus over the next two years is to march toward top quartile returns and a strong strategic position. We are driven to provide products and services that add value to our clients while generating an acceptable return of capital for our shareholders. We have a sense of urgency to succeed at both, and we're pleased by the progress this quarter demonstrates. I want to close by taking a minute to wish our colleague, Rita Zuraitis, much success and some luck on her next venture as a CEO of a public insurance company. We are all excited for her.
Rita has been an important and valued member of our team as we have been on this journey together for the last nine years, she will be missed by all of us at The Hanover. Operator, we are ready to open the line for questions.
Hello?
We lost our operator.
Ladies and gentlemen, if you wish to ask a question, please press star one. If your question has been answered or you wish to withdraw your question, press star two. Questions will be taken in the order received. Our first question comes from the line of Jay Cohen with Barclays. Please proceed.
Hi, good morning.
Good morning, Sarah.
First, on the reserve strengthening that we saw in personal auto and commercial auto and other commercial, it clearly slowed versus the prior quarter, but could you elaborate on what's still driving that and when you think that'll ultimately be behind you?
Well, sure. I think, as you pointed out, it certainly has slowed down from what we've been discussing over the course of 2012. I think the amounts involved are relatively small or minor adjustments we typically make each quarter to reserves, so you can see pluses and minuses in lines. Particularly as it relates to auto, I think we've been pretty clear on all of our calls that there are still some industry issues that are working through the system. We're seeing on our book of business, obviously, very good rate movement, very good results in the underlying auto lines, both personal and commercial. Nevertheless, as we go through our quarterly reserve analysis, we'll find opportunities where we want to add some additional reserves. Again, I think these are very modest amounts compared to what we've talked about previously.
Really no change in trends or underlying expectations.
I would say a couple things. One, we feel terrific about where we are with our balance sheet and our assumptions. There's really been no surprises this quarter from what we're planning for as we look forward. I think we're in a very good position against our expectations and our plan for the year. Okay, great. Then just on the ROE, you've given that 11%-13% long-term guidance before. So can you just walk us through how you believe you can get there in terms of how much margin improvement we would need to see and share buybacks? I would assume those are your two major levers.
Again, we've worked hard to get the portfolio where we think it is very sustainable. We've got our mix of business over the last four years. We've changed the mix of business. Our position with our partner agents is the best it's ever been. What we're seeing is really good growth of the best business with the best agents and the ability to get price and retain the business. If you look at it, obviously, we need three or four points more out of our combined ratio. We think that we can get that through the mix and pricing work that we're doing, and that we think we're going to have good, solid advances in growth, again, in mid-single digits or so, as we've talked about.
I think combined, we think that we have lots of levers that are working in our favor to get to those extra points. Again, we worked hard in commercial, for example, on the expenses, and we feel good that we're going to continue to be able to get what we need. When you look at it, we really like where we are for this year's plan, and we really love where we're setting up for 2014. Everything has fallen in place nicely. As far as capital management activities, I think that's on the margin. I think we will continue, as David said, do some of that.
We believe right now that there's a lot of available business that is very attractive at the pricing levels, and that our ability to continue to position ourselves to be the lead player with a lot of these agents in these categories just sets up our ability to increase margins. I think we're in a very good place, and we just got to stay focused on it.
Okay, is there a time frame for that 11 to 13?
As I said, I think we're making great progress in 2013, we're going to be a lot better in 2014. We all know that yields are the headwind. I'm not smart enough to know how long this continues, but obviously, the yields are the headwind. What we will see is we'll see significant improvement this year and next year in our returns. I'm not going to set an exact date because of the yield change. Again, as I've said over and over again, I feel very good about where our returns are going to be in 2014 given what we're doing.
Okay, great. Thanks for the answers.
Thanks, Sarah.
Our next question comes from the line of Vincent DeAugustino with KBW. Please proceed.
Hi, good morning.
Good morning, Vincent.
Good morning, guys. Fred, just wanted to start off on the $175 million of business that you'd mentioned regarding just shedding that. Would you happen to have the loss ratio that that $175 million's been running at?
Yeah. Vincent, what you've got, again, it's a mixed bag a little bit, right? Part of it is because of our concentration and really the tail that it drives. The marginal cost of that business, because it's in the Northeast or in a ZIP code that's quite concentrated, it is kind of on the margin, not attractive, but a lot of that business, we make a marginal contribution. We think the trade-off is right because it reduces the volatility. There's a number of that business. If you remember last year toward the end of the year, just before the Sandy storm, we did a renewal rights in New Jersey, Connecticut with a number of legacy agents that we, and New York too, excuse me, that we shed. On the marginal basis, that business contributed.
If you took the total cost of capital and the way we think about the tail, it made a lot of sense to get rid of. About half of the business we're shedding has that as a characteristic. The other part of the business is that when I look at some of the business we're getting off, this is particularly true in commercial, our expectations for weather and the losses from weather, the volatility from weather, that was more attractive business than our view is today. Given our new estimates of what kind of non-cat wind related losses is going to be as part of our losses, we view that as going forward, very difficult to get the kind of pricing we need in some of those geographies, we're making the moves on that.
It's hard for me to pick an exact loss ratio, but what I can tell you is that in every case, we believe that over time, these were businesses that would not allow us to get to the 11%-13% return through the cycle. That by getting rid of these, it gives us less volatility and more certainty, as well as higher margins. Every business we looked at is a little bit of different. Some of it is for the tail, some of it is the short-term volatility, and then some of it is just chronically underpriced. The Florida business, as an example, we just felt we couldn't get the adequate price for that pool of business. It wasn't that it was too property centric or whatever.
It was just a pool of business, we felt given where the market was and that type of business, that we couldn't get to the margins. I apologize that it's not one thing, but it's a bag of things that allows us to believe that it significantly enhances our future margin, particularly for 2014 as you work through kind of a transition of expense, et cetera, that'll occur this year.
Okay, perfect. That color is actually really helpful. David, if we could maybe just talk about some of your comments on the year-over-year comparisons.
Sure.
If I could maybe frame some timelines around that. Just as we think about the strong rate increase over loss cost trend and the margin expansion that would imply as we roll forward into the next few quarters, should we, I guess, start to see much better margin expansion as we're making comparison to second half 2012 estimates, which I think at that point started to reflect some of the higher loss picks. All else equal, would that assumption just on the timing be roughly appropriate?
Yep. Yeah. I think, Vincent, that's exactly right. As I said in my comments, the first quarter comparisons are complicated because of those things. As we look out for the rest of the year, all of the things we've discussed, both Fred and I, and we've been talking about over the last several quarters, will play out and we'll see better ratios on a quarter-over-quarter comparison. Obviously, we upped our ratios in the second quarter last year, as you mentioned, and we did that also in the third and fourth quarters. As we look out the rest of 2013, when we look at those comparisons, they'll still be a little bit noisy, but they're going to be better overall across all the lines of businesses and across the segments.
Yeah.
You'll get a more standard. Again, the combination in that first quarter, we had one of those non-winter winters last year, which made all our property businesses look a lot better. As you know, our pick for 2011 in particular was too low at the early of the year, and we made the adjustment. Those comparisons year-over-year are going to start looking good starting next quarter, and you'll be able to see the improvements in the actually years in almost all the lines. I'm sure as David said, there might be some noise here or there, but the reality is that you're going to start seeing the improvement through. That's how we got, by the way, to our overall range and pick for the year.
Yeah. That's it. Perfect. Just to wrap up, I wanted to offer my congratulations to Marita and also inquire into whether we might be able to anticipate hearing a little bit more from Mark and Jack going forward on the conference calls and just a little more regularly.
Yeah, absolutely. I think as people know, we have organized around the businesses for a while, and what you will see going forward is their participation both in the calls and the outreach. We've started that this year. As far as the calls go, you will see it in the future is that they will be available and more active in the questions. Absolutely.
Okay, great. Thanks, guys, nice quarter.
Thanks, Vincent.
Our next question comes from the line of Matt Carletti with JMP Securities. Please proceed.
Hey, thanks. Good morning.
Good morning.
Congrats on nice start to the year. Just had a few questions. First, just a quick one. Has there been any change to your Sandy estimate, whether gross or net over the last quarter?
No. No change at all. We're tracking very well to our estimates. You'll recall we took a little bit of time before we announced our number last year, and we were very thoughtful and thorough in our analysis. I think we have a really good number for Sandy. Nothing occurred this quarter that
caused us to be concerned about the estimate we have. If anything, it gave us a lot more confidence in it. No adjustment whatsoever with the Sandy estimate.
Okay. Second question would be just if you could talk about the debt issuance a little bit. It seemed like the talk in subsequent quarters, and particularly last quarter, was a lot focused on debt to cap ratio declining. I was a little bit surprised to see the reissuance of debt, which took you well within your bounds, but back towards a couple points back towards where you had been. I understand there's an opportunity to buy back stock, but your guidance doesn't suggest that you're going to be maximizing it in that way. It seems a little bit of a course reversal. Is it more growth than you've expected, and therefore need the capital to support it, or could you just kind of talk us through that process a little bit?
Yeah, sure, Matt. I think you're right about the comments we made. Both Fred and I have said previously, we'd like to get our debt to cap ratio down in the mid-20s. What you can't see on the surface of this is a bit of the difference between the 27% debt to cap ratio that you can see on the financial statements with the fact that on a rating agency basis, I'm actually better today on my equity capital than I was previously. This instrument and the opportunity to issue this instrument was perfect for us. It added $175 million to equity capital from a ratings perspective to strengthen our underlying capital for that purpose. It gave us a 40-year maturity at a price that was very hard to ignore at 6.35 basis points. On all of those measures, it was a good trade to be done.
It also, as you now know, opened up the opportunity for us to buy more on our equity shares because of the equity credit that I get from a rating agency standpoint. From my perspective, on all sides, this was a perfect trade for us to execute, notwithstanding the comments we previously made about leverage. The last thing I'll say is, our leverage at 27% is well within all of our tolerances, well within industry levels, if you will. We're not at all worried whatsoever about that metric.
Okay. No, that makes sense. Then last question, just relating to Chaucer, and particularly, I know we saw strong growth with the non-renewal of the quota share, but specifically U.K. motor. Could you update us on your views on that line? I know it's a line that has had a lot of focus, kind of negative headwinds, if you will, of late. You guys have grown it pretty well, at least in this quarter. Could you update us on your view there and what might make Chaucer's book different than others?
Yeah. I'll have Bob comment, too. Obviously, as we said to you, it's kind of a specialty book for us. It's small, and it's got some specialty aspects to it, the way the tranches of business. We have had previous couple years, great rate action that has earned its way in. It has been very successful and profitable for us, and continues to show very good signs and performance. A lot of the growth we've had in that business has been the rate earning in from the previous couple of years of rate. We are very happy with the performance of the business and feel very good about it right now. There's also some interesting reform things that have happened in that market that give us some positive feelings. Bob, is there anything we should make sure we mention?
Just comparing to the same quarter last year, we had eased back a touch in that quarter until we saw some of those rate increases kick in. It's more reflective this quarter to what we've seen in the last couple of quarters. You're right, some of the legislation changes here, particularly around LASPO, which is a change to the legal aid in banning of referral fees. We expect that to impact favorably on loss ratios. Although we're seeing some underlying rate reductions from high peaks, it still looks like a good opportunity in that area.
Great. Thank you very much for the answers.
Thank you.
Our next question comes from the line of Dan Farrell with Sterne Agee. Please proceed.
Hi, good morning.
Good morning, Dan.
Good morning.
I was wondering if you could just update us a little bit more on Surety. I saw it in commercial other, where I think most, if not all of that business is in, there was some nice sequential improvement in the loss ratio. Where do you stand in that turnaround? I think you've talked about being able to get to underwriting profitability on that. Were you there this quarter, and is there further improvement that can be driven?
I think we feel very good about the progress we made. As we had said, there was a lot of noise in the last two quarters that we were getting behind us last year. It is in a much better place. I would also say, though, it'll be better in 2014 than 2013. We're still improving in that line, but we feel very good about the mix, and it's coming out just as we expected. We had a set of plans. We addressed the runoff business, and it's unfolding the way we expected. I don't know, Andrew, if there's anything additional we should make sure we comment on.
No, Fred, I think you got it. Dan, I would just say it is as Fred describes. It's largely unfolding as we expect, and much of what we're doing right now is very much around positioning us for 2014, which we feel very good about.
Yeah. It's good. There's no surprises. It's good.
That's great. I apologize if I missed this, but within Personal Lines, do you have the rate increases for auto and home?
They're about the same. They're about one point different, Mark, I thought.
Yeah, probably maybe one point higher in home and
One point less in Auto.
Yeah. We're getting good in both.
Yeah. Just about nine in both. One's a little lower, one's a little higher.
Yeah. We're feeling pretty good, and it's pretty consistent across the board.
Okay, great. Thank you very much, guys.
Thank you.
Thank you.
Our next question comes from the line of Ray Irizarry with Macquarie. Please proceed.
Thanks, good morning.
Good morning, Ray.
Good morning. I just wanted to maybe touch a little bit more on Chaucer. I know, David, you've spent a lot of time walking through sort of the non-cat weather on the domestic side, sort of throwing off the year-over-year comps. I know Chaucer benefited from some lower large losses, I guess, in the first quarter of this year. Is there anything else we should think about in terms of the year-over-year comparison, I guess, first quarter to first quarter? Is the right way to think about it 2012, the full year relative to the first quarter?
Let me start with first quarter to first quarter, there was a higher incident of losses last year, which I mentioned, and that has to factor in. Probably would say 2012 is more normal than 2013 in that regard, if you will. The other problem, I think 2012 for the year is worth looking at. Remember that 2012 for the year was also very positive for Chaucer in terms of low level of losses across the entire year. We've been cautious about this. Fred said our long-term expectations on this business is in around the 94-96 combined ratio, and that's what I would use as sort of your balancing point. Then each quarter, we'll try to be as clear as we can on what's happening in the underlying business.
Okay, that's helpful. I know you've worked sort of hard to optimize the capital structure over the past couple of quarters. Is there anything sort of left in terms of the way you're thinking about the capital structure that you guys feel like you can do? Is this going to be it, you think?
I like where we are today, but there's still more work to be done or can be done. There are some things in the debt structure that I would look at in terms of liability management, but nothing's imminent in my mind in terms of what we would do there. I think we'll be less active than we have been in the last few quarters. Nevertheless, we're very focused on obviously making sure our capital structure works for the organization we are today, and it provides the businesses sufficient capital to meet their needs as they grow.
Okay, that's helpful. Then maybe the $70 million, I guess, you threw out there is in terms of sort of the way you're thinking about budgeting the repurchases for 2013. What's sort of the governor there in terms of that number? Is it just offsetting the incremental interest expense, or is it other capital needs in terms of growth?
Well, a couple of different ways to look at it, Ray. First and foremost, I want to make the transaction neutral to our financials. We didn't issue the $175 million to be dilutive to our results. My first and foremost goal is to obviously neutralize the impact of that, which is what the $70 million represents from that standpoint. There might be a little extra in there for it. Effectively, that's my first goal. As I think about capital management going forward, the way we think about it is three different elements of how we're focused on it. We have a very good and strong dividend policy. We also want to make sure that we have sufficient capital to meet the needs of our businesses and the opportunities that they have to take advantage of it.
Then we have share repurchase in our toolkit to be able to utilize. I think the share repurchase, if you look at our recent history, has been muted by the fact that our earnings have been lower. I need to get more earnings into the results, in which case, then I can deploy the capital in the ways that I just described to you. We'll be more active as we have higher earnings in that front. Again, that'll be in concert with making sure we're supplying enough capital to our businesses for their growth plans.
Obviously, the other thing that the theme has been, what we did with the debt retirement before is we unlocked some debt that was buried in the insurance companies. We've given ourselves more flexible. We have equity credit. We have positioned ourselves to have some flexibility if growth unfolds the way it could, right? We are the disruption in the marketplace. We're being opportunistic. It's being balanced with these other portfolio changes. We have given ourselves more flexibility here as we look forward, depending on what the market opportunities and business opportunities that present themselves. The way I think about it is we've given ourselves flexibility. We'll continue to be opportunistic beyond that number.
Right
if it's the right thing to do, as we see the changing market environment. Right now, I really like the flexibility that we've created.
Okay. That's helpful. Lastly, maybe, Fred, for you, in terms of the exposure management actions, I guess, on the Personal Lines side, and then I guess a little bit on the Commercial Lines book with the program business in Florida. How are the agents responding sort of to your wanting to back off from some of these concentrations that you guys have? How are those conversations going with the agents?
What's great about our strategy, again what's happened in the last 4 years with this portfolio change and our success out west and our success with Chaucer, et cetera, is we've been able to just put our strategy a little bit on steroids. One of the things we're able to do is I still have some legacy agents that aren't real partners in the sense of the partners we have going forward. If you look at these actions, 80% of these actions to date have been essentially with legacy agents we're eliminating. What happens is we have more capacity to actually give to our partners. We're shifting our share and the mix to the folks that we have more success and more of a future with. It hasn't been that problematic. Now, there is 20% of it that's some tweaking.
We've done some LRO work and flat roof work in some geographies around the Midwest. We've done some work in Personal Lines and some monoline business. We work very carefully with agents. For instance, we're doing a monoline thing where we found another carrier, where we're doing a deal and we're moving that business to another carrier that the partners have accepted. So far so good. Because what people see is that we're committing capacity to them. There's lots of growth opportunity. The mix is better, and we're shifting it away from, in my view, some of the legacy positions that we still have remaining in the business that are essentially around Personal Lines, oriented smaller agents that don't have the same portfolio that we now have going forward.
I feel very good about it, and it's funny, we have our agency meeting the rest of this week. If you looked at the growth we have with our partner agents and their mix, it's just extraordinary. That's why we think we have a ton of momentum going forward, both in margin and growth as we go forward here, as we get some of these actions behind us. So far, so good.
Okay. I appreciate the comments.
Thanks, Ray.
Our last question comes from the line of Larry Greenberg with Langen McAlenney. Please proceed.
Good morning.
Good morning, Larry.
Morning, Larry.
Hi, I think you probably answered this one question ago when you were talking about Chaucer, but it really just relates to the fact that we've now had four quarters where underlying combined ratios at Chaucer really been in the low 90s, 90 to 92, 93, I would say. The question was, are you starting to believe that that's really more representative of a run rate.
Of course, the two quarters before we bought them, they didn't quite have that.
That's fair.
Yeah. I'm going to make a comment if Fred will jump in or Bob. We've said this before, Larry, and we believe it. Chaucer is a very good, strong underwriting organization. I think we're being very careful not to believe that this last four or five quarters of great loss experience is real and that it'll continue in perpetuity. You can go back to sort of 2006, 2007 when the industry had a very low level of losses in CATs. As Fred pointed out, you can go to a couple quarters and point to some bad outcomes. I think broadly speaking, the Chaucer portfolio is managed very well. It's a very good book of business, and we're quite proud of it, and we think it's great for our business.
We also don't want to set an expectation that we're going to hit 90% every quarter.
What we did, and as you know, Bob, we brought it into the family, too. What we did, obviously, has a track record of about a 94 over a 10-year period. We also took a lot of volatility out of it when we put the two companies together. We got out of some FAC reinsurance. We try to focus the effort and the portfolio on stuff that fit our combined companies a little bit better. We are very convinced that we will get the kind of returns that we're targeting over the cycle. I think it is not appropriate for us to assume the last couple, three quarters, or it could be sustained at this level, Bob. Bob, I don't know if there's any comments you want to make about the franchise.
No, I think you said it all. I think they've been good quarters, we're not getting too ahead of ourselves. We are in the risk business.
Bob, any thoughts on Berkshire's quota share through the Aon vehicle?
We're watching it very closely. It's an interesting transaction. I suppose we'd expect to see some impact on signings, I think that's probably going to be more noticeable for smaller syndicates in the market and those that don't have a strong leadership position, and therefore, don't have closer relationships with their insureds. All in all, we've got an excellent relationship with Aon, we're constantly continuing to look for ways of developing that relationship further. It might have an impact in a couple of classes, we're really watching what the development as it unwinds.
Great. Thank you.
Thanks, Larry.
I would now like to turn the call back over to Oksana for closing remarks.
Thank you all for your participation today. We are looking forward to speaking to you next quarter.
Ladies and gentlemen, this concludes the presentation. Thank you for your participation. You may now disconnect.