Good day. Welcome to The Hanover Insurance Group first quarter conference call and webcast. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva, AVP, Investor Relations. Please go ahead.
Thank you, Andrew. Good morning. Thank you for joining us for our first quarter conference call. We'll 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. Also in the room and available to answer your questions after our prepared remarks are Marita Zuraitis, President, Property and Casualty Companies, Andrew Robinson, President of Specialty Lines, and Bob Stuchbery, President of International Operations and Chief Executive Officer of Chaucer. Before I turn the call over to Fred, let me note that our earnings press release, statistical supplement, and a complete slide presentation for today's call are available in the investor section of our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session.
Our prepared remarks and the responses to your questions today, other than statements of historical fact, include forward-looking statements such as our outlook for segment income per share for 2012. There are certain factors that could cause actual results to differ materially from those anticipated by this press release, slide presentation and conference call. 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 total segment income, after-tax earnings per share, ex-CAT loss and combined ratio, and accident year 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 statistical supplement, which are posted on our website, as I mentioned earlier. With those comments, I will turn the call over to Fred.
Thank you, Oksana, and good morning, everyone. Thank you for joining our call today. I am pleased with our results for the first quarter as we continue to see favorable trends in our businesses and overall results are in line with the outlook we shared with you earlier in the year. Net income per share for the quarter was $1.09, and operating EPS was $1.01, which translates into an annualized operating ROE of 8%. Our book value per share increased 3.6% during the quarter and 5.7% over the last 12 months after adjusting for the adoption of the accounting change for deferred acquisition costs. Before I comment on our results by segment, I would like to touch on our strategic priorities for 2012. This should be helpful as we review our quarterly results and evaluate our progress throughout the year.
As we discussed at Investor Day, we have accomplished a lot in the last several years to reposition the company for better long-term performance. We transformed our company from a regional insurance company with a challenging geographic and product mix into a national player with global reach and an attractive business mix and strong and growing position with some of the best distributors in the industry. While we have improved our performance from the early days of the journey, our goal is to build a company that can deliver 11%-13% ROE through the cycle. In 2012, we believe we are now well positioned to both capitalize on the current market opportunities and position our company for improving profitability and sustainable attractive returns. Each of our businesses is focused on three critical value levers to improve our performance in 2012 and set up continuing financial improvement in 2013.
The three levers are, first, improving the quality and attractiveness of our current mix through targeted underwriting activities and growing higher margin businesses. Second, further strengthening our position and alignment with winning agents. Third, improving our underwriting and financial performance through a disciplined focus on pricing and operating model efficiencies. Our first quarter results provide evidence that our focus on these three levers is working. In personal lines, our three main priorities translate into implementing rate and non-rate actions to improve profitability and refining our business mix by managing pockets of property concentration and reducing low return business. We continued to achieve rate increases during the quarter. The filed rate increases were over 4% in auto and over 7% in homeowners. We also achieved strong retention, which at 81% was a two-point improvement from prior year quarter.
At the same time, our strong market position and our account focus strategy enables us to successfully adjust our business mix without sacrificing retention or our position with the best partners. We expect rate increases to be greater in both lines of business in the second quarter. The relatively mild winter was a welcome change this year. However, a very early and unusual tornado season, which impacted many of the states and territories we do business in, including Michigan, Tennessee, and Indiana, offset some of the benefits of a benign winter. Catastrophe losses in personal lines were $23 million, substantially in line with our increased CAT assumptions this year, but still relatively high compared to our longer-term historical trends.
As we've mentioned on previous calls, we continue to actively mitigate property exposure in certain areas to ultimately improve returns in 2012 and beyond by changing policy terms and non-renewing certain business. These efforts are ongoing and had a slight negative impact on our personal lines growth. These activities will continue into the second quarter and the rest of the year. We remain satisfied with our underwriting profitability in personal lines. Non-catastrophe weather was clearly more favorable in the quarter, but we also saw an improvement in underlying loss trends, especially in our homeowners lines, which we attribute to our pricing and non-pricing actions over the last several quarters. Our outlook for auto is also positive, but we are reacting to higher severity trends in auto liability lines that recently emerged in our most recent prior accident year performance.
We are working on a number of levers, including accelerating rate increases in the affected areas. We believe these actions, coupled with other pricing and underwriting initiatives, will drive improved results in personal lines going forward. In commercial lines, the three priorities I mentioned earlier crystallize our focus on balanced rate increases, continued penetration, especially in higher margin lines, and our efforts to drive further efficiency and effectiveness in our operating model. This quarter, our 12% growth in small commercial and middle market was driven by price increases of approximately 6%, strong retention in the mid-80s, and notable new business growth. Pricing accelerated as the months progressed, with middle market pricing standing at 8% for March, and we expect to see continuing trend in the second quarter.
As writings in new geographies, the broader acceptance of our more recent product enhancements, and our strong momentum with partners drove a higher pace of submissions. We believe the quality of our new business we are putting on the books today is excellent. It is coming from our targeted industry classes and regions. The growth is also primarily generated by our leading partners who have aligned incentives and understand and share our focus on adequate pricing, quality, and profitability. Our partnership strategy allows us to take a select approach to the market and achieve pricing on new business that is in line with what we see on renewals, thus substantially improving profitability prospects for our book of business. We believe in 2012, the quality and pricing levels of our new business will lead to continued improvement in our margins.
In summary, we are very satisfied with the quality of growth we are seeing. Rates are good in both new business and renewals. Retention is strong, and mix of business continues to shift to more desirable classes. All of these factors are driving a better quality book. While our growth in commercial lines was strong during the first quarter, it was still lower than the 21% premium increase we achieved in our specialty lines this quarter. We continue to shift our business to a specialty mix, which historically is more profitable and balances our mix. Our program business continued to grow during the quarter, stemming from strong pricing and retention on our renewal programs, as well as from new programs for The Hanover, which are mature and well established in the industry.
With about $300 million in annual gross premiums, a strong technology platform, and a solid underwriting talent, AIX has become a market leader in the specialty program market. We also saw quality growth from our Hanover Professional Portfolio, as well as newer specialties, including management liability and non-public D&O. Most of our emerging businesses are now positive contributors to our bottom line. We continue to be satisfied with the quality and pace of growth in our domestic commercial lines. We remain very optimistic about our expectations for the full year. A couple of thoughts on Chaucer. Chaucer continued to be accretive to our earnings, producing a combined ratio of 94% and a pre-tax segment income of over $25 million. Catastrophes were below plan, although we did see some several large losses slightly above plan, which were reflected in our ex CAT accident year results.
The current underlying trends and prior loss trends of the business continued to be favorable in the quarter. Market conditions are improving in the majority of property lines, especially in areas affected by the last year's CATs. Additionally, as the market responds to recent losses in the energy and marine sectors, we are seeing prices and terms and conditions in these accounts improve as well. We are confident Chaucer will continue to add to our earnings power and strengthen our market position going forward. Before I turn the call over to David, I would like to provide some commentary on our capital management. We continue to strive for effective use of our capital, balancing the use of leverage, driving efficiencies from Chaucer's assets and capital. Eliminating pockets of capital inefficiencies in certain areas of our domestic operations.
I would like to reiterate that in 2012, we continue to focus our efforts on improving profitability and driving higher ROE using the profitability levers we discussed. We do not think this will be a year of large acquisitions. We are centering our attention on executing on our priorities, refining our portfolio, and enhancing margins for the capabilities and resources we have. Given the results for the quarter, we continue to be confident in our original outlook for 2012 we provided to you in February. While we saw some development activity in a couple of areas, we believe we have reacted quickly. They are offset by many of our other trends that are better than our plan.
More importantly, we are confident that our actions around the key levers position us well to improve our earnings power and lead to stronger returns in 2013, as we consider our momentum and favorable trends around pricing, retention, and mix for this quarter. Given our strong position with agents and brokers, the growth we've achieved in recent years, as well as additions we've made to our team, our products, and our business portfolios, we will continue to fully capitalize on the changing market and achieve our financial goals. With that, I'll turn the call over to Dave.
Thank you, Fred, good morning, everyone. I'm very pleased with our first quarter results, which reflect our diversified and growing earnings power, the strength of our franchise, and how well we are positioned for the future. We continue to move forward on our path to an 11%-13% ROE. Net income for the first quarter was $49.7 million, or $1.09 per diluted share, compared to $29.3 million or $0.64 per diluted share in the prior year quarter. Our segment income this quarter was $46 million, or $1.01 per diluted share, compared to $25.9 million or $0.56 per diluted share in the prior year quarter. On a year-over-year basis, the favorable comparison is driven by several factors. For the third consecutive quarter, Chaucer has provided a strong contribution to earnings.
In addition, we continue to achieve meaningful growth and margin expansion, resulting in higher earnings in our domestic business. Fred has already provided commentary about our top-line performance and the pricing environment, I'll focus my remarks on our segment results. Starting with commercial lines, the combined ratio was 100.3% for the quarter, compared to 103.7% last year. The 3.4 points of improvement over last year was primarily driven by a better current accident year loss ratio and lower catastrophe losses, which were partially offset by a decrease in favorable reserve development. I'd like to break this down a little further. The current accident year loss ratio improved by two points compared to the prior year quarter. Clearly, a more mild winter drove some of this improvement. More importantly, however, we also see an improvement in underlying loss ratios.
We attribute this to many factors, including the continued benefit of a shift in our mix of business, as well as diligent underwriting actions that drove better severity trends. Additionally, we noted improved rate activity and retention in commercial lines for several quarters, as well as positive pricing in new business. We believe all of these factors combined to contribute to growth in earnings power this quarter. In terms of reserve development, we saw favorable trends in our CMP and workers' compensation lines this quarter, and we added incrementally to reserves in the commercial auto and surety lines. In commercial auto, we noted an increase in severity of losses, primarily affecting the 2011 accident year. As a result, we adjusted our loss picks up slightly for 2011 and also factored in a modestly higher severity assumption in our 2012 loss picks.
Concurrently, we continue to actively implement rate increases and other underwriting actions in this line in order to offset any potential for adverse impact going forward. Our pricing in commercial auto was 5% this quarter, up sharply from only 1% increase in the first quarter of last year. In surety, we continue to experience some loss activity in our contract book, given little improvement in the overall economy and continuing pressures on the construction industry. We are continuing to focus on shifting the business mix to commercial surety while maintaining a focused underwriting process in contract surety. This should result in improved results in surety going forward. Our expense ratio in commercial lines continued to improve, lowering the combined ratio by almost a point this quarter. We attribute this to fixed cost leverage from continued earned premium expansion and the continued improvement of our operating model.
Overall, the level of profitability improvements in commercial lines is in line with our expectations. Perhaps as importantly, better pricing trends and a continued shift to a more profitable mix provide us confidence in continued margin expansion going forward. In personal lines, the combined ratio was 98% for the quarter, compared to 97.5% for the first quarter of 2011. Catastrophe losses this quarter, primarily from the late February and March tornadoes, were $23 million compared to $22 million in the prior year quarter. We had about $4 million or one point of adverse reserve development, primarily in auto liability in the current quarter, compared to four points of favorable reserve development in the prior year quarter. As we noted in previous comments, the trend in reserve releases overall has been declining over the past four quarters.
We reacted this quarter to modestly higher severity trends in auto liability that emerged in our most recent prior accident year. Together, these items resulted in a small amount of adverse reserve development this quarter. The accident year combined ratio, which excludes catastrophe losses and prior year reserve development, was 90.7% in the current quarter, compared to 95.2% in the first quarter of 2011. While part of the improvement is attributable to more favorable non-catastrophe weather losses in the current quarter, we are also seeing favorable trends in our underlying margins, especially in the homeowners line. We are pleased to see that recent rate and underwriting actions we've taken to improve personal lines profitability are translating into better loss ratios. Moving on to Chaucer. This business delivered its third profitable quarter since the acquisition, generating $25 million of segment income before taxes.
The combined ratio of 93.8% included $7 million related to catastrophe losses, approximately three points, which is somewhat lower than our normal expectations for the quarter. The ex-cat accident year loss ratio for the quarter is slightly higher than normal and includes higher than expected large loss events, which we do not classify as catastrophes, such as the Costa Concordia loss. The combined ratio also included nine points of prior year releases this quarter. The favorable development came mostly from the 2010 and 2011 accident years related to energy and property businesses, as well as favorable adjustments to marine reserves, primarily from the 2008 accident year. Chaucer's expense ratio was 36.2% this quarter, which is slightly lower than our expected long-term run rate of about 37%. Chaucer's gross written premiums were $382 million this quarter, and net written premiums were $200 million.
The quarter's net to gross ratio is lower than our full year expectation. The reason for this is that a large part of Chaucer's ceded excess and loss reinsurance program is booked in the first quarter, whereas the underlying business will be written throughout the year. This quarter's net written premium is not an indication of reduced premiums for the year, and you should anticipate a higher net to gross ratio for the remaining quarters. The underlying trends in Chaucer's business are favorable. We continue to be pleased with the disciplined underwriting and more positive market trends, and we believe Chaucer will continue to contribute to our earnings going forward. Moving on to a discussion of our investment portfolio. Net investment income was $69 million for the first quarter of 2012, up about 14% compared to the $60 million earned in the prior year quarter.
This increase was driven primarily by the increase in invested assets acquired with Chaucer last year. Our net investment income this quarter was also boosted in part by dividends on equity securities that won't necessarily be repeated in subsequent quarters. For the first quarter, the overall earned yield on our fixed maturity portfolio was 4.38%. The Hanover's fixed maturities yielded 5.2%, and the Chaucer investments delivered 2.2%. At March 31st, 2012, we held over $7.6 billion in cash and invested assets with fixed income securities representing 85% of the total. Roughly 94% of our fixed income securities are investment grade, and the average duration in the portfolio is four years. In the first quarter of 2012, we deployed a portion of Chaucer's cash and short-term assets into higher yielding securities, primarily in corporate bonds. As a result, the book yield in Chaucer's portfolio increased by about 15 basis points.
The duration grew slightly, while the quality of the portfolio remained very strong at double A minus. As it relates to the overall investment portfolio, we also invested approximately $75 million in stable, primarily large cap equities with attractive dividend yields during the first quarter. With only 4.4% of our total portfolio currently allocated to equity securities, we felt comfortable taking on incremental equity risk while benefiting from the additional diversification and dividend yield. Our balance sheet remains strong, providing excellent financial flexibility. We ended the quarter with $2.6 billion in shareholders' equity. Our book value per share at March 31st, 2012, was $57.65, up 3.6% from $55.67 at December 31st, 2011, and up 5.7% from $54.55 at March 31st, 2011. As we previously discussed, we adopted the new accounting guidance related to deferred acquisition costs or DAC, which we applied retroactively by restating prior periods.
As a point of reference, the new methodology reduced shareholders' equity by approximately 1% or $26 million. The adoption of this guidance did not have a material effect on underwriting income or earnings, nor do we believe it will have a material effect going forward. Our debt to total capital ratio was 26.3% at the end of the first quarter, which is well within rating agency thresholds for our current ratings. This compares to 26.8% at year-end. Holding company cash and investments was $196 million at March 31st, which is above our target level, and we continue to maintain a $200 million credit facility that provides additional flexibility. Before I open the line for questions, I'd like to provide a couple of comments on our full year outlook.
Our business trends and the market dynamics we've seen this past quarter clearly give us continued confidence in our 2012 earnings guidance of $3.85 to $4.15 Segment income per share. I have a few items related to the outlook that may be helpful to you. Since Hurricane Katrina in 2005, and as a result of our coastal management actions over the last several years, our catastrophe loss patterns have changed. Tornado and hail events that are usually more active in the second quarter have had a more meaningful impact on our earnings and cat loads in recent years. Accordingly, our 2012 plan has an expectation for the second quarter catastrophe loss ratio to be higher than the rest of the year. We continue to expect less favorable reserve development in 2012 as compared to 2011 on a full year basis.
Additionally, we continue to expect flat to slightly declining net written premium volumes in personal lines for the full year. Quarterly patterns may be affected as we continue to implement our agency and exposure management actions in certain states. We believe we will continue to see improved accident year ratios in our domestic businesses in the second half of the year as a result of robust retention, improved rates, and a continued shift in business mix. We continue to expect only a slight increase in net investment income for the full year 2012, as the addition of Chaucer's invested assets is expected to be partially offset by continued low new money yields. Finally, we continue to assume that weighted average shares outstanding for the year to be 45.5 million shares. Operator, we're ready now to open the line for Q&A.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been answered and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Vincent D'Agostino of Stifel Nicolaus. Please go ahead.
Hey, Vincent. Good morning.
Hi, good morning. Thank you. Just one real quick clarification question, then two short follow-ups, if I may. For Chaucer, sorry if I missed it, but what was the loss ratio impact from the abnormal large losses?
Yeah, we haven't disclosed that specifically. It's not something we've put out there. I mentioned the one loss, the Costa Concordia, was the largest in there. What I would say is that overall, the slightly higher large loss activity was nothing of significance, just a higher volume, if you will, frequency of events, but just slightly above what the plan is for the year. I think when you look at that in context with the CAT benefits, you're probably looking at an overall loss ratio around where we expected. Yeah.
Okay. Great. Then just the two follow-ups would be on auto. Real quick, I know you had mentioned some of the severity trends popping up. I was just curious if you could give us an update on Michigan or whether or not there was any geographic concentration of where those severity trends were popping up at.
Yeah. It was across our core states, essentially, that we saw it. There was nothing that made Michigan stand out in any of the trends. It was really just the core areas. Marie, is there anything-
No, the only thing I would say is the BI severity was clearly coming from New York, New Jersey, Connecticut. We saw it in the 2011 year and reacted to it, we have been and will continue to price accordingly.
Yeah.
Great. This is a forward-looking question, we've heard a lot about other auto players that are implementing usage-based insurance programs, namely Progressive. To my knowledge, most of them are doing it in-house or mostly in-house with some outside help. My question is, how long, if at all, do you think it is before some of the middle-sized players like yourself would need to implement UBI programs? How much longer do you have before you have to do that? When it comes time to get that done, does partnering with some sort of turnkey third-party provider that provides sensors and analytics, is that the route that you might go? I was just kind of curious of your thoughts looking out and maybe how you've been looking at how you'd go about doing such a thing.
We obviously are assessing that. We actually have a pilot going on right now in that we're trying to assess what the benefit would be and how it fits with our target customer group, which is more of a full account-based customer group, because obviously some of the experiments to date are really as a service, if you will, to the clients because they use it to monitor the quality of driving as well, as you know, some people are doing it. We are in the middle of a pilot. In my view, we'll be ready if we think that the market acceptance fits our customer segment. It is something that we're paying attention to. We don't see the broad benefits yet from it, but we are monitoring it or, as I said, we're actually piloting it.
Great. Would you say we're a few years or are we still 5, 10 years away from broad-
It really is hard to tell. Again, if it's purely for rate making, it obviously is a zero-sum game at some level. Depending on how it's used and where it's used, again, it gives you obviously some insights. For me, it's one of those things that because of privacy issues and a number of issues surrounding it's not crystal clear how broad adoption is going to be
Again, for us, what we think about, is it appropriate for our target segment, and how would it be used by our target segment? That's part of what we're trying to make sure we understand is the value for our target clients. To your point, this is something that if it happens, a lot of people have read about equipment costs and all that. If it happens, right, all that'll get taken out of play, because not only will there be third parties, but the cost of all that equipment will go way down, right? It's one of those things that a lot of people, as you know, are paying attention to. Right now, I'd still say it's quite uncertain.
Great. Thank you so much.
The next question comes from Dan Farrell of Sterne Agee. Please go ahead.
Hi, good morning.
Hey, Dan. Good morning. Good morning, Dan.
Could you talk about the pricing increases that you're getting maybe relative to the loss cost trends that you're observing? Then in the specific localized lines that you're seeing some adverse development trends, what's your confidence level that you're addressing it through rate and axing your picks? Particularly axing your picks, it does seem like the recent quarters in those specific areas have seen a lot higher loss pick than you have then. I'd just like to get your view on what kind of cushion or confidence level you have on that.
Again, what's interesting about our pattern, right, you know this. Our pattern's a little unique. A lot of pattern in our industry, there's been a lot of reserve releases from 2003, 2004, particularly in the casualty long tail line. Because of where we were in 2003 and 2004, because our mix is short tail, most of our patterns is very mechanical around our recent years. We obviously, to Marita's point, we've been watching some of the severity in some of the auto lines in particular, because that's really what we're talking about here, and we have adjusted along the way. Again, we don't see anything that significant. I mean, the numbers aren't great, but because we don't have outsized reserve releases, it does change the percentages to some extent. I feel very good about it. I mean, we're all over it. We're tracking it.
We know where it's from. Again, these are a little bit more controlled, if you will, than say, excess comp or something like that. I mean, these really are the auto lines, and we believe that we've adjusted it appropriately. It's really the only place we're seeing things.
Even within the quarter, that increased pattern continued with January pricing being at five, February being at six, and March being at seven. We even saw the increase in the pattern within the quarter.
Yeah.
That's helpful. Just on Chaucer, on the expense ratio. That's bounced around, and I think you've indicated it would in the early quarters as you work through some stuff. Is the 36% expense ratio maybe something more of a trend now, or how should we think of that going forward?
Dan, I think, again, as I said in my remarks, I like the number 37 as a long-term run rate for us.
I understand.
There's some timing. Yeah, there is some timing of items coming through there, which bounce it around a little bit, and there's also sometimes a little bit of FX that are going to come into it, but I think you should really kind of think about it at around a 37 on a long-term basis.
Okay. Thank you.
Thanks, Dan. Appreciate it.
The next question comes from Raymond Iardella of Macquarie. Please go ahead.
Thanks, good morning, everyone.
Morning, Ray.
Good morning, Ray.
Good morning. The first question, I guess, maybe for David, on Chaucer. What is the threshold as far as you guys breaking out catastrophe losses in that segment? Is there a dollar threshold, or is it varied by line of business? Can you maybe give us some color on that?
Yeah. A couple things there. We have a corporate CAT policy threshold, which you'll find in our annual report, typically it's about a $5 million event, if you will. One way you can look at a CAT definition for us is the difference between man-made or natural disaster. Certainly, natural disasters tend to always show up in the CAT line. Man-made disasters are going to be more about how widespread they are. Chaucer's business is just different than the domestic businesses. Because of the types of risks they insure and the programs they write, we could see a $5 million, $6 million, $7 million loss, which is what they consider large losses, but they're more attritional in a sense. The only thing that really happened this quarter was there were just a few extra that showed up in here.
It's hard to predict when a rig is going to require a control or a boat's going to sink, you might see a little bit of movement here. You really shouldn't over-anticipate that. I mean, that was just sort of an aberration this quarter.
Okay. That's helpful. Then maybe just sort of more broader question. I mean, Fred, can you maybe talk about some of the smaller acquisitions you guys have done over the past two or three years and how they are performing? I think we spent a lot of time looking at Chaucer because it's broken out as a different segment. Maybe, I know you touched on AIX in your prepared remarks, but maybe touch on some of the other acquisitions you guys have done and how they've been performing.
Yeah. We've been very fortunate. Essentially, they've all worked out very, very well. Our professional lines business, our LPL business, has created a nice core to our professional lines. It was the platform, if you will, that we've used not just for LPL. It's become the platform for the other professional lines as well. That business now is a nice contributor to us. Our business, our HSI, which is our HPR, a wonderful business for us. It has been a very good contributor and a high margin business. That's worked out as well. Our A&E business, which is a small business with our architects and engineers that is now within our professional lines, has worked out. Again, another one contributing to the bottom line right out of the get-go, has been a very good positive thing for us.
The OneBeacon, you saw the data we showed on the renewal rates on OneBeacon. We were able to beat all our assumptions as far as both profitability and on retention for that. We retained over $300 million. On the healthcare side, Compania is a little bit earlier days, also is a contributor now. We had some investments we've been making in that platform, it is now a positive contributor. What you've seen in all of these businesses, we've had quick accretion to the company because they were small. They're all small. It allowed us to acquire a team and in many cases, a platform that we were able to grow off of. We really haven't had any yet that have been disappointing to us in any of those small specialty businesses. As I commented, they're really all now contributing.
We believe in 2013, they're all going to be very significant contributors to the company.
Okay, that's helpful. Then, I guess last question, going back to sort of the surety book and maybe some of the adverse there. You guys had some adverse in the third quarter, I think the commentary was a couple of years ago, you started making that switch towards more commercial surety and away from the contract business. Just curious, how big is the surety business for you guys? Can you give us an idea of where the level of commercial surety was in the past and what percentage it represents of your book currently?
Let me just on the contract, what we said, I'll echo it, we shrunk that pretty aggressively in the last two or three years. It was the one specialty business that the company was in when we started all this eight years ago. Because of our downgrade, it was what I would say is a mixed bag as far as the book of business, highly concentrated between Michigan and Mass. That business now is down 50%. I like it quite well, what we have, what we're active with. We got a great team on the ground, we've had some development, particularly on what I call the runoff business, the stuff that we really are no longer on, we've had some activity because of the economy of it is a small business now.
The commercial surety, we started really focusing on that probably three, four years ago in earnest when we got the upgrade, went to full A, because that's a business where I didn't want to really do a lot of investment until we had the ratings. We feel very good about that business now. I think, Andrew, the magnitude of that business.
Yes, this is Andrew. This is about a third of our total surety business, which will be somewhere probably between $90 million, $95 million in direct written premium for the year. A third of that is commercial surety. I think it's probably also worth noting probably two other points. One is that we have systematically gone out and really upgraded our talent. We feel very good about the team. We have a commercial surety leader that we brought in last year, a very senior fellow from Zurich who we feel very strongly about. We continue to build that team. We recently brought in a person to drive the contract business for us from Arch on the underwriting side and feel very good about the team behind him.
I think that the last step here over the last six months is we did a top to bottom review of our portfolio, and that is sort of a measure of additional confidence for us in terms of understanding where we are with the contract business. All in, we're pleased with the position we're at in terms of mix and making sure that we're confident with the existing account portfolio that we have.
Okay, thanks. I'll requeue.
Thanks.
Thanks, Ray.
The next question comes from Larry Greenberg of Ladenburg Thalmann. Please go ahead.
Hi again. You talked about, with Chaucer pricing changes, and it sounded like, and you're not alone on this, that property in loss exposed areas is probably the most robust right now. I'm just wondering how you're thinking about the opportunities there versus managing your aggregates and, are you putting limits? Or just how you are managing that trade-off.
Yes. Bob Stuchbery. We made some adjustments to the property account at the 1st of January, particularly around some of the risk appetites that we wanted to improve. The flip side of that is the opportunities we saw in Japan. We took the opportunity to write a little bit more aggregate at that stage. Rates were up higher than we expected, particularly on those contracts that have been affected. I would say that there's sort of adjustments and tweaks to the portfolio that we've got in order to take advantage of, as you say, we're seeing some good, healthy rate increases, particularly in those areas that have been affected by losses.
Yeah, I guess in total, Larry, we feel very good. The portfolio, as we put in the package, a little bit of an overview where we feel like for most of the business, we're getting good rate increases. We're taking advantage of some areas that are better than that. I would go back to what Bob said, which is we purposely have taken some of the volatility out and some of the aggregations. We reduced their position in U.S. CAT, for instance, right out of the gate. Matter of fact, frankly, before we closed, we really started working the portfolio well. We're very excited about the potential here because a lot of the synergy we're seeing is going to be in the specialty lines that we go after together in some of the skill sets they have.
We feel very good about the choices we've made to date, and we like the outlook this year for the returns out of the business.
Great. Thank you.
Thank you, Larry.
Once again, if you'd like to ask a question, press star then one on a touch-tone phone. The next question comes from Vincent D'Agostino of Stifel Nicolaus. Please go ahead.
Hi. Thanks for taking the follow-up.
Sure.
Considering the strong commercial lines new business growth, especially on some of the longer tail lines, I'm just curious if you might be able to talk about some of the controls or, I guess, early indicators that you might be looking at just to see if the new accounts that you're picking up are performing as you would expect, just because maybe you're not as familiar with them sort of thing.
Either way.
Yeah. I mean, we feel good about the new business that we're writing in the core commercial lines. We have robust pricing tools. We're seeing increases in premium audit. When you take premium audit and rate out of the growth, it is not substantial, but we're comfortable with it. We like the underwriting tools. We like the pricing tools that we have, and we feel good about the new business that we're writing. Not only what it is and the mix it is, but who it's coming from.
Yeah, I'd say similarly on the specialty side, the longer tail, although they're not very long tail, management liability, professionals, some of the areas in healthcare. We're very diligent about looking at effectively our deviation to our manual pricing renewal versus new business. We really can see how we feel about all the pricing in the new business. Obviously, mix is something that we're very diligent about, whether it be area of practice to sort of gauge severity or state or any of the many attributes that we use. Those are the things that we're watching. In terms of early emergence, we're measuring effectively our incurred numbers against earned premium in any of the younger businesses. We're looking at that year-over-year to make sure that we're improving.
For example, in our NPL business, we're in our third year. We're able to measure how we're doing in our first quarter against where we were for our first quarter for 2011 and 2010. We're looking at those metrics for improvement. It's a combination of things.
Yeah. I think you all know this as you follow us. One of the things we've done very diligently is we don't want the large face value policies. We are really focused on the smaller policies. We also are with partner agents. We don't typically do the large brokers with a large panel. This is really mature business. For the most part, this has moved over to us in chunks from partners as we've introduced these products, whilst we help them bypass wholesalers in some cases to give us their mature business. We've had very good luck. I mean, if you look at all the specialty businesses we're in, we feel very good about the quality and the portfolio. The only place in specialty we've had really any noise at all has been the surety, which ironically is the one that we were in historically.
On the contract side.
Yeah. On everything else, we feel it's developed beautifully for us. Frankly, the pricing we're getting right now is excellent as well.
You also mentioned small face value. That also is true about our workers' comp book, where the majority of that growth is coming from small commercial, virtually all of it low risk grade and small commercial workers' comp business in coordination with our total account strategy and small business. We're seeing that on the comp side as well.
Yeah.
Perfect. Thanks so much.
Thank you.
Thanks.
The next question comes from Matthew Carletti of JMP Securities. Please go ahead.
Hi, Matt.
It's actually Christine.
Oh.
Good morning. I've got a quick numbers question if you have it available. I was wondering if you had both net and gross written premiums for Chaucer in the first quarter of 2011.
We don't have that disclosed because we won't have it on the same basis of accounting. We can talk about it offline, and I can see what we have out in the public domain that may be helpful to you.
Okay. Thank you.
The next question comes from Raymond Iardella of Macquarie. Please go ahead.
A couple follow-ups. Thanks again for taking these extra questions. I guess first, workers' comp, just to touch on the commentary before, the growth on the small side, I mean, is that basically what's driving retention down a little bit? I'm assuming pricing is moving higher. PIF growth is certainly moving much higher. Is that kind of the right way to think about that business and the dynamics there?
You just answered your own question. I think you nailed it. On the workers' comp side, we are seeing some increase in premium audit. We're getting a decent amount of real rate. When you look at the pricing in small, the pricing in middle market, the shift in the risk grades, you just nailed the answer to your own question. We did see some sequential quarter-over-quarter PIF growth. If you remember, some of that is coming from the OneBeacon policies now being counted as our policies. There's some shift in the numbers as we took on OneBeacon premium as our own premium. You remember in the first year we did a reinsurance arrangement. That eventually that PIF count as ours. You'll see that
increase as well. When you cut through all the numbers, at the end of the day, there's a relatively small amount of real growth. That real growth is all coming from small commercial.
Okay, that's helpful. Then maybe on the expense ratio in the commercial business, nice year-over-year improvement. Just curious, David, I don't believe you mentioned any change in sort of the guidance in mid-single-digit growth on the commercial side. If growth reverts back to that level, how much expense ratio leverage do you guys have in that business?
I think I'm going to stick with really kind of where our guidance is for the current year. I wouldn't anticipate a lot more leverage in the expense ratio. We've had quite a bit of improvement over the last year or so. You saw some this quarter. Overall, for the year, we don't anticipate that ratio is going to move much based on our growth expectations.
In all of these levers, your question is good about 2013, right? If you look at our whole game has been to solidify our position with these agents, be able to shift better business and get pricing. We believe we have the portfolio in place, it does set up 2013. If you look at the ramp up of earn rate, if you look at retention, which equivalent goes to growth, it does create leverage and expense in 2013 for these businesses, obviously. We grew, as you know, we expanded, for instance, in Small Commercial last year into 12, 13 additional states and set up the national network on the back end of some of the OneBeacon Insurance Group stuff. A lot of this stuff, while it's not a huge impact for 2012, is something that makes us feel good about the continued improvement.
You're right. You've seen what we said would happen has happened. It will pause for a minute here, probably the rest of the year. What's going to happen because of this additional growth from our plan, it's likely to help again in 2013. I think it's the right observation of what we're trying to do on these, on all our economic levers. We believe they're coming in place nicely for us.
Great. Thanks for taking all my follow-ups.
Thank you, Ray.
This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.
Thanks to all of you for your participation today, and we look forward to speaking to you next quarter.
Thank you.
The conference has now concluded. Thank you for attending today's presentation.