We're live from the Bank of America Tower at One Bryant Park, New York City. This is the Bank of America U.S. Insurance Conference. If you're tuning in right now, you're tuning in for The Hanover Group's segment in the conference. On deck is Principal Financial. Here at Hanover, we are really pleased to have Jack Roche and Jeff Farber from Hanover, the CEO and CFO. I'm going to let them introduce themselves, and Grace Card and I are going to ask some Q&A.
I want to tell everybody that if you're dialing in and you're on the {guess} webcast app, you should see a window where you can send me questions. I am very happy to get your questions and ask them, without attribution, unless you say, "Please attribute me." I'm going to let Jack and Jeff talk about themselves, and we'll let them know we're going to get to questions. Go ahead. Talk to us, guys.
All right. Thank you so much, Josh and Grace. Really pleased to be here with you today. Again, I'm Jack Roche, President CEO of The Hanover Insurance Group. I've been with the firm about 15 years, in the CEO role for three and a half, and very excited to update you and share with you the progress we're making towards our transformation to be one of the top franchises for high-quality insurance agents in the U.S. We've spent the last decade and a half, frankly, transforming this company to a much more distinctive, more geographically spread out, more diverse franchise for our agents. We're excited, as I said, to share the progress we're making and our optimism going forward. With that, I'll allow Jeff to introduce himself.
Good morning, everybody. Great to be here. I'm Jeff Farber. I'm the CFO of Hanover. Been with Hanover for about four and a half years after a long career with a variety of financial services firms. Most recently, AIG for the last five years as Deputy CFO and then the Chief Risk Officer at both businesses. Great to be here. Thanks.
Well, we're pleased to have you. Maybe a way to start out with is to talk about what makes Hanover different from other companies. We sometimes use the term regional carrier. Some people don't like that terminology. Maybe you embrace it, maybe you don't. Can we talk about being a carrier the size you are, what makes you different? What are the plans for expansion? Maybe always a present question, how have things during the pandemic influenced who you are and what you're going to do going forward?
Yes, thanks for that question. On the categorization of regional carrier, we really do think of ourselves as one of the most distinctive emerging national carriers in the commercial line space. We still are today a regional carrier on the personal line space in 20 states. Whatever you call us, I hope what you think of us as a company that really has gone from being a more generic kind of agency centric underwriting company to a much more specialized, capable company that has dramatically improved its geographic footprint, become increasingly specialized across our entire product set, but particularly in the commercial line space with all the specialty businesses that we've purchased and/or built.
Our aim, as you know, is to be the best franchise for high-quality agents that are exclusively focused on the IA channel and helping our agents, frankly, deal with the exciting changes that are coming upon our industry and transforming the way we do business, frankly, across the value chain. Josh, to your point, the pandemic, all that came across in 2020, clearly is going to accelerate the change in the industry, we've already started to benefit from that and focus on that. We are proud of the fact that we were able to get all 4,300 employees up and running and servicing our agents and customers. Also building on the strong culture that we've worked so hard on, frankly, driving every major initiative that we set out to do in 2020.
As we reflect on the year, we did not really skip a beat on the major initiatives and priorities and investments that we would made. Last but not least, I think it's our distribution approach, in addition to our specialized capabilities, that makes us different. We have a very unique, select approach to appointing agents and to partnering with them, we have built a series of analytical tools and consultative capabilities that I think are unmatched in the industry.
Grace, why don't you ask a question to follow up?
Sure. Could we talk about the long-term ROE target of 13% and the key assumptions that underpin that and the key upside and downside risks? In particular this year, given the unique operating environment, how that might shake out relative to the target.
Sure. Thanks, Grace. Let me just say a couple of quick comments, kind of at the macro level. I know Jeff will be happy to deal with the specific levers that we think will help us achieve those margin goals going forward. We do believe we come into 2021 very well-positioned to deliver not only for 2021 but to continue our momentum that we built over the last three or four years to transform and translate all those strategic moves that we made into top quartile margins that we can deliver in a very consistent manner. The reason why we have confidence is that our profitability that we delivered, particularly in the last three years, is very broad-based. It's not coming from one side of our business.
All of our major businesses are delivering at our target ROE rates, and we think it's that broad-based profitability, frankly, that gives us the ability to continue to grow and prosper and achieve those top quartile returns. Jeff?
We have a lot of confidence in our ability to achieve the 13% ROE, the biggest driver of that ends up being our ability to control our expense ratio and the leverage we get from the fixed costs. Finally, the commercial lines margin expansion that we're anticipating really should offset the NII pressure that is put on the ROE. Again, a lot of confidence in our ability to achieve a long-term ratio of 13%.
One thing I would point out on your confidence, if we go back in time two years ago, maybe 10-year Treasury yields were at 3%. They were there at beginning of 2020 at closer to two. Now we're closer to one. I've always argued that there's some sort of relationship between ROE objectives and how much return you can get in excess of the risk-free rate. To what extent does your 13% ROE target change with changing interest rate environments, and how are you managing the investment portfolio given the changes in the interest rates? I guess when we say managing, we really mean managing. You're doing a lot of it in-house through your Opus business. Can you talk about how that is a competitive advantage compared to some of your competitors who might be outsourcing part of their investment management functions?
There's a lot there, Josh. I'll try to cover it. Overall, we've had a consistent philosophy for a long period of time, we have a team that manages outside money, so we've got a couple of billion dollars of outside money. I think the combination of managing our $9 billion of inside money and also the experience of outside money really gives us an opportunity to see more in the marketplace and to hire more talented people who find it interesting and exciting to manage outside money. To transition to the impact on ROE and how we think about our portfolio, we're not really anticipating any major changes in the investment allocation. As we think about the mix between underwriting risk and investment risk, I think we like that.
We like that view of where the portfolio is structured, where we've got about 85% of the investment portfolio in fixed income and in high-quality fixed income. Over time, as I said a moment ago, in the short run, at least, I think the commercial lines margin expansion will offset the impact of relatively flat NII, whereas interest rates are falling, but our cash flows are increasing, and it should help us there. Over the long run, it will really depend on which is more sustainable. If the firm market in commercial lines is more sustainable versus the longer interest rates, one of those two would have a larger impact over the longer run.
All right. Grace Card, why don't you take the next question?
Sure. Could we shift gears and talk about technology a little bit and how that influences your opportunities for expansion, particularly when it comes to the Agency Insights tool?
Sure. Listen, we're quite proud as an institution that in addition to driving improved margins and delivering what we believe is top quartile returns, we've also been investing rigorously in our future. I think we've been pretty consistent in kind of updating folks that really across the value chain, we are making targeted but significant investments, we're doing that while we also increase our efficiencies and improve our expense position. To your question, we have innovation on kind of the customer acquisition side, on how we interact with agents and customers from a data efficiency standpoint, and certainly in the claims side of the house, where there's really been significant progress, and obviously aided by the pandemic environment of 2020.
Inside of our innovation is this concept of advancing our partnerships with agents and building these analytical tools. Agency Insights is one of our proprietary tools that's part of that partnering approach. What it allows us to do is to help agents take the information that is embedded in their agency management systems and reassemble that data and information into a portfolio approach, one where the agency principals and the leaders of the agencies can see their book of business in a much more strategic way. Over time, we've built a series of strategic views that allow them to understand how fragmented their business is by carrier, by line of business.
There's a better understanding of where the improvement opportunities are to assemble accounts to better serve their customers, frankly, to see where they've got some industry segment penetration that can start to get more programized and more strategic in terms of their new business pursuits. While we're proud of a lot of the innovation that we've done across the entire value chain, our proprietary analytics capability with agents not only gives us an advantage in terms of partnering with the agents and generating good penetration, but it also gives us a tremendous strategic view of the business. We have insights across $75 billion worth of business because of the accumulation of that information that allows us to think about where we go next in terms of new industry sectors and building new products and capabilities.
Within the agencies that you're operating right now, I guess on average for the targeted agencies, you're producing, I guess about a 7% market share within those agencies in aggregate. It's higher at some, it's lower at some. Can we talk about your targets for how much is an ideal sort of contribution to an individual agency's premium flow and your sort of plans for increasing your share within the agency where you want a higher participation rate?
Yes. That's a really particularly important question now, as the distribution continues to consolidate. Those market share statistics and targets are changing. What's not changing is that in the areas of the business that you are pursuing, if you're not a top-tier underwriter or market for those agents, you're not going to get the highest quality business. Being able to look at the data, understand where do I stand, what commitment level do I have the agent by segment, by sub-geography.
The market share data that we share tends to be shaped by what industry sectors and lines of business are we focused on, how much penetration have we accomplished, and when we get to the agency lens, as you would imagine, on a smaller agent that's predominantly a personal lines and small commercial relationship, we have expectations to be a top 3 player, get 10%-15% market share. In places like Michigan, it can be well north of that. As you get to the larger consolidating agents, you can be a very relevant top 10 player with 5%-6% market share and be very focused on the sectors where you have capability, because agents really aren't that worried about who's one, two or three in their shop at that level.
They're much more focused on the specific areas of pursuit and who can they rely on to be a consistent, high-quality provider in commercial lines and those sub-sectors. That's what we're most proud of, is that the Agency Insights data, combined with the rest of the kind of partnering approach that we do with agents and the three to five-year planning that we do, allows us to set reasonable targets, one agent at a time, one sector at a time, and we track it and make sure that we're on that path. If we're not on that path, we come back to the table and talk about what it is we need to do or whether those pursuits are realistic pursuits for our partnerships.
Those numbers are changing, and what's not changing, like I said, is that we're increasingly penetrating our top partners' high-quality books of business. We have sights to do more.
Jack, in that answer, I mean, look, can you be with a successful agency, but there's just not a lot of growth opportunity, and you'll want to say, "Look, we would rather nominate somebody else in your territory if we can't grow with you"? Is that what you're saying? Someone else can become a Hanover representative. I mean, if someone's only bringing you to 5% ceiling and that's your ceiling, are you going to disengage from that agency?
Well, there is definitely many examples of where, either because an agent has decided that they've plateaued and that's okay with them. Obviously, a lot of agents have decided to sell when they get to that stage of the game. Yeah, our proposition only resonates when somebody is economically motivated and customer-centric. We spend a lot of time, energy, and money building these specialized capabilities and building our partnering approach. If we're sitting at 2%, 3%, 4%, 5% market share, and there's no aspirations for us to deepen those partnerships or for the agency to grow, frankly, our franchise isn't that attractive. That's how we operate our business. I would tell you that many agents are economically motivated, increasingly focused on bringing better value to their customers, and that's what allows us to continue to grow and prosper.
Maybe the last part of that is our points of distribution are getting enhanced by the consolidation. More and more agents are becoming part of companies like Marsh Agencies and Hub International and USI. When that happens, our strong partnerships with those consolidators present new opportunities for us. We use our disciplined approach one office at a time, and we don't appoint offices of even those big consolidators unless we have a real fit and we have a commitment to drive towards that penetration.
I have a question coming in from an investor. I'm going to ask the question their way, then make a few changes. They want to know what the future is for personal lines at Hanover, given new entrants like Lemonade, price comparison websites, companies like Progressive entering homeowners, and a trend towards the disintermediation of the home auto bundle for people who can price auto much cheaper. You're really not competing with the broad categories with your platinum products. I'd say your competitors are probably more like the Chubbs, the PUREs, the AIGs. Cincinnati Financial has a new program. Here's what I would say. To what extent, how big is the market for the type of homeowner you want to insure? How competitive is that marketplace?
How big of a share can Hanover effectively get with cap management as in the rearview mirror for trying to get as much share in that market as possible? What is the long-term role for Hanover in the personal lines marketplace?
Obviously all terrific questions given all the dynamics that are going on in the personal lines space. You can imagine we are watching all of those kind of macro dynamics very closely. We segment the business, and we watch the segmentation of the business regularly. As you know, the personal lines space in total in the U.S. is somewhere between $330 billion-$350 billion. Roughly $100 billion of that resides in the IA channel. That's been relatively consistent for the last two-plus decades. Actually, the latest data, 2019, says that that market share actually picked up. You saw companies like Nationwide converting themselves into the IA channel. In the 20 states that we operate in, there's roughly $45 billion of available business.
We obviously segment that further and try to take the low limits, a monoline auto or renters business, we push that aside, and we look at what is the sweet spot of the middle market and upper middle market customer base that we think we can be advantaged in bundling, presenting an account approach. That to the point of competition, there's no doubt that it's a competitive business, always has been. If you look over the last two or three decades, what has been true is that the market in total has been reasonably rational in terms of how it prices the loss trend over time. Obviously, some companies make better margins than others.
The pandemic last year obviously throws a lot up in the air, and these new entrants and new business models have everyone reflecting and not getting too casual with their analysis here. I would tell you that inside of the sector we play in, the middle market sector, we're actually below the Chubbs and the AIGs. We sit in a white space that we don't think has been serviced particularly well. That is kind of the account business that's below the high net worth but still has plenty of assets, usually multi-car, some toys. The industry kind of got carried away with trying to out-GEICO GEICO with these algorithms and multivariate products. About seven or eight years ago, we disciplined ourselves to kind of restore ourselves into an account strategy.
That's why we believe we have a very big seat at the table with our agents on this kind of upper middle market business. Our most recent entrance into that is the Prestige product, which brings a little bit more product to the more complex risks in that upper middle market. As we said in our recent earnings call, that's the fastest-growing part of our portfolio. All in, we're watching these dynamics carefully, but we feel relatively insulated from some of the hyper-competition and some of the business models that are really aimed at the low limits auto business.
All right. I'll ask Grace to come in for a little bit.
Sure. If we could talk about, in the current pricing environment, how you're balancing growth compared to returning capital and when you think about opportunistic capital returns, how do you think about the opportunities for repurchases versus special dividends?
For The Hanover. Clearly, profitable growth is a big priority for The Hanover, and we create more capital in growing mid-single digits than we can redeploy in a year. We come into the year with some excess capital. We'll create more capital. We have a track record of being really financially disciplined on capital management. At the current environment where our stock sits, we think repurchases are a very attractive use of capital, and I suspect that they will play a very meaningful role of our capital allocation and capital management throughout the year.
I have another question from the investor group. They want to understand how your appetite for risk differs from the Cincinnati Financial's or Selectives. I would add, how do you coexist, or do you coexist in agencies, with those shingles as well? Is that a peaceful coexistence? Are you trying to get the same business overall? How does that work exactly?
Yeah. Listen, I'll start off by saying those are two very fine companies, very fine competitors. I think when people think about the P&C sector, and companies that have an agency-centric type strategy, Hanover, Selective, and Cincinnati rise to the top. We are quite different. I think what makes us, I think, different than those other two is that we have really organically and inorganically built a lot more specialized businesses. We have over a dozen specialty businesses within our Hanover Specialty division. We have another dozen niches and industry sectors within our middle market business. Even in our small commercial business, we're not just a BOP market. We write a lot more packaged business and BOP business.
I think if you talk to our distributors, what they would say is that Hanover is more of a kind of broad-based, specialized player that quarterbacks that franchise in a way that's quite impressive given the complexity of the set of capabilities that we bring to the market. Where we're similar is that I think these three companies respect agents and what they bring to the table. We don't try to go around them. We try to go to them and bring our capabilities and help them be successful. To your question about I think, we compete in the marketplace, there's no doubt. They're not our biggest competitors in terms of day-to-day.
We really focus more on the business that some of the nationals have that is more specialized, a little bit more sophisticated business, and frankly, have increased our penetration, in the small to lower first tier middle market business. Over time, I think the combination of our agent centricity and our specialized capabilities is what makes us a little different.
I don't like to name names too much, does that mean that you're really seeing the real competition as trying to take business from the Liberty Mutuals, the Travelers, the Hartfords, as opposed to trading places with the other regional carriers?
Listen, I think there's a variety of larger and mid-size companies that write high-quality business in the sectors that we pursue. Certainly, those three companies you mentioned are within the top five or six companies that we tend to write new business from. I'm sure they could share a list with you that says that they occasionally take some business from The Hanover. In general, yes, Josh, I think we are not really targeting regional carrier business. We write some of that business where they write some sophisticated business on a less sophisticated pricing platform or don't have all the coverages. Day in and day out, our new business generally is coming from the higher quality companies who, frankly, don't work the independent agency channel the same way that we do.
As a test case, can we talk about Michigan? You're not a big personal auto writer, but you're a big personal auto writer in Michigan. My hunch, it has to do with personal injury law over there, and maybe it's harder to write. That would be my guess. Can you talk about why you've been successful? Does that have any extrapolation to how you can be successful in other states in a line of business that maybe people don't associate Hanover with?
I think the short answer is yes. Remember, our penetration in Michigan is a historical one, right? Cincinnati, excuse me, the Citizens Insurance company that was one of the combinations along with Hanover under the Allmerica Financial Corporation, is part of our origin and part of how this company was built. We had huge penetration. We have a long track record there, and we've been building on that track record. I think we've modernized the product and the capabilities there. Michigan is one of those states that because of the PIP laws, and because of the lack of national company penetration, we are particularly effective. We've outperformed the industry by 8 to 10 points pretty consistently.
As you know, with the Michigan reforms coming in over the last year, something that we advocated for quite strongly over the last decade, we feel very well-positioned to help the Michigan marketplace become increasingly more rational in terms of how they deal with the PIP reform, and frankly, give some relief to the policyholders who pay entirely too much because of the medical inflation and the fraud that has been perpetuated by the prior PIP approach. It's our expectation that we will help agents and customers through this transition. The early returns on our performance with the reform are quite good, and our agency support has been outstanding. As we look to other states, that presents some challenges. Massachusetts, as you know, moved to managed competition a decade ago.
We were one of the most successful companies in helping move through that and creating a multivariate product that doesn't include credit. I think we have a track record of being able to deal with states that do have some regulatory challenges that present some complexity, and our team, frankly, thrives in those types of jurisdictions.
Grace, why don't you go with one more?
Sure. Given how elevated catastrophes were last year, in addition to having a pandemic, could we talk a bit about risk management protocols and how the unusual events of the past year might have impacted your protocols moving forward?
Overall, we have a very strong risk management protocol and discipline. The property aggregation work and the mix work that we've done over the last several years has really served us well. Our level of catastrophes relative to the industry, I think, has been undersized, et cetera. Also, the underwriting discipline and use of ISO-based forms, and particularly this year, not having trade insurance, trade credit, travel insurance, or event cancellation has proved to be very beneficial under COVID. From a reinsurance perspective, I don't anticipate any major changes, I think, either in cost or structure. There may be some opportunistic reinsurance that we have bought selectively where there's been a pricing arbitrage over the last couple of years, which may find itself going away, and we'll opportunistically pull that off as the pricing arbitrage is no longer there.
In terms of states that you're in, to what extent are you in catastrophe-prone states, and to what extent has changes in reinsurance pricing sort of caused a change, I guess, into how much you'll cede in the coming year?
We don't write personal lines insurance in Florida, Texas, California. We tend to do very limited insurance on the coasts. As I mentioned earlier, the cat aggregation work that we've done over the last decade really has served us well in particularly cat-prone areas. Again, I don't anticipate any real meaningful changes in our reinsurance appetite.
All right. Well, we have hit the time limit. I appreciate you spending time with us today. As I tend to say, of course, we wish you and your employees safety and speedy vaccination. I mean, it's going to be a while, but maybe the mere evidence is not as long as we think. We wish you the best. We'll be in touch soon, and I'll forward on any additional questions that I get from investors to you, and be well, and take care.
Thank you very much, Josh and Grace, and the opportunity. I hope for the investors out there, at the minimum, what we've shared is our confidence and excitement for 2021. Thanks, all, for your attention.
Thank you.
Thank you.