Chris Campbell from KBW. I cover P&C names for the bank. Joining us for this fireside chat, we have the senior management team from The Hanover. Directly to my right is President and CEO Jack Roche. Further to the right, we have Jeff Farber, who is The Hanover's Chief Financial Officer. Thank you for joining us today, gentlemen.
Thanks for having us.
All right. Especially for Jack, since it is his birthday.
This is exactly how you want to spend your birthday.
This is how dedicated he is.
45.
Awesome. I guess just starting off, let's start off at a very high level. Could you just kind of remind us where we're at with Hanover 2021? How is the strategy progressing? Has anything changed since you've originally laid out the strategy?
Yeah. Thanks, Chris. In 2017, we had regathered as a team and put forth kind of the relaunch of a strategy that I think started some 13 or 14 years ago. I thought of Hanover 2021, frankly, as a way to build upon the momentum and the transformation of the company over the last decade plus. As you saw, we came out with some relatively ambitious top and bottom-line goals. We reinforced our commitment to the independent agency channel and our desire to build a premier franchise in the IA channel and to continue to build distinctive product and capabilities, drive that through a limited and select distribution model, and over time, start to leverage data and technology to really kind of modernize what we do, both for ourselves and to drive new models into the independent agency channel.
That was our commitment, I think, at the time. I think today we feel like we're meeting or exceeding a lot of the expectations that we set for ourselves. A few things have changed. As you might have noticed, we sold Chaucer, and originally when we were together in 2017, we talked about Chaucer as an extension of what we were doing in the specialty business and a way to diversify our earnings stream. As time went by, I think two things became obvious to us that caused us to sell Chaucer. A, the London market was changing and Chaucer was becoming more of a reinsurer than a specialty insurer, which made it less strategically aligned with us. Frankly, our U.S. business really was coming into its own.
When we just looked at it financially, it made more sense to double down on the U.S. franchise than to try to be a global insurer and play a different game. As we went forward, we look now, we've kind of elevated our top-line expectations of 13%-14% ROEs driven by some expense work that we did as a firm to further position ourselves for success, and then admittedly take advantage of the tax reform tailwinds. We're still committed to mid-single-digit growth, to double-digit ROEs as projected, and frankly, we feel better than ever about the momentum of the firm.
Right. It seems like you've maintained really strong momentum. Any ideas on when we would expect a strategic refresh, like Hanover 2025?
Yeah. Well, yeah, 2021 will come upon us pretty soon, and it will be kind of talking in arrears. No, I think we're talking actively about sometime next year, looking at an investor day maybe mid-year where we can maybe showcase a little bit more about what we've built with inside the firm and to extend further, we think, the ambitious goals that we have. I wouldn't look for us to change anything radically about our expectations. We would reinforce them and maybe put a different timeline on them. Probably the thing I am most anxious to showcase at the right time is that people know us today by our outsides, our distribution approach, our specialized capabilities. I think we're anxious to show people how much work we've done on the inside of the company to become a more sophisticated analytical company with a lot of horsepower.
We're kind of the United Nations of insurance professionals. We've brought together really talented people from the better companies, when you get inside our firm, you see really top-notch sophisticated professionals that are integrated and working closely together that I think allow us to navigate this very dynamic market that we're in.
Great. I guess going from high level to kind of more product specific and thinking about pricing, I guess, can you give us an update on what you're seeing in terms of the quarter to date pricing trends? What lines are you seeing the most momentum? Where are you seeing kind of a deceleration in rate increases? Where do you think rates still need to catch up to loss cost trends?
Yeah. I'll get us started. By all means, Jeff, jump in. I would say, A, we're optimistic about the current environment. I think the combination of some continued underwriting improvements along with the rates that are available today in the marketplace, we feel very good about at least the short-term trajectory of the firm. I would characterize the market in my mind as stable. Stable, certainly it's been gradually improving. I think that compared to when I grew up in the business in the mid-'80s, this is the least cyclical time in the business. There's a lot of moving parts, and depending on what your current portfolio looks like and what sectors you're playing in, there can be some movement. We're in the low to medium size account business In some pretty desirable sectors of the industry.
To be able to get mid-single-digit pricing in this environment based on our portfolio, that makes us feel quite bullish.
Just to add a couple of quick thoughts. As Jack said, we're getting good, solid, stable, increasing price, really across the book. Obviously, it depends on the particular lines. That coupled with the very detailed work that we do around customer segmentation, which is really terribly important, getting price in the right places for the right customer, really gives us a lot of confidence that we can hold our loss ratios constant.
To the second part of your question, too, I think obviously the industry and our firm is very focused on seeing the commercial auto trend through. We're optimistic that the pricing that we're seeing today, in conjunction with the actions we've taken in the past, will finally be able to bend the curve. The industry truly has struggled to figure out what the new normal is going to be in terms of loss trends. We're now, I think, more confident than ever that we're getting on top of that, both in terms of understanding loss trends, but also pricing above loss trends, which is essential. That's essential for us because we're really not in the line of business business, right? We're trying as much as we can to be an account player in the right industry verticals, in the right sectors of the business.
To some degree, the trends in workers' compensation that have been surprisingly good have in some ways offset some of the troubles in the commercial auto business. We don't want to be playing whack-a-mole on each line of business. We'd love to be able to be in a position where we have the right pricing across the portfolio in the lines and the sectors so that we don't have kind of gyrations going on and instability that we bring to our distributors and our customers. At the end of the day, I think the environment today is pretty dynamic and still people are sorting out where commercial auto is and when the pricing in workers' compensation is going to have an effect and start to create some headwinds.
Great. I want to open it up to the audience. Are there any questions that anybody would like to ask the gentlemen right there?
Yeah. Hi, thank you. I'm curious on the specialized products that you referenced. You're in middle market and what I consider a lot of plain vanilla businesses, which is great. I'm curious, what kind of differentiation can you bring the product? There's a lot of competition. A lot of features can be copied relatively easily. Could you just give your kind of philosophy on that and some examples?
Sure.
Thank you.
There's no doubt that we're on the low to medium risk profile business. I would suggest that over the last 10 years in particular, we've become quite specialized. In the middle market business, over 80% of our business is in industry verticals where we have some type of coverage differentiation and/or proprietary pricing that we leverage into that. We're not a generic insurance company. We built those industry verticals as a way to transform that business, and that's where many of the folks that we brought from the better companies helped us do that over the last decade. If you've been watching us, we also built on top of that roughly $1.3 billion in specialized commercial lines that are in dedicated specialty models.
There's nine businesses that make up that book of business, from the businesses that were here when I got here, a smaller Marine Insurance business and a surety business, all the way to management liability, three elements in the specialty professional lines business. We have a program sector. We have Hanover Specialty Industrial Property. We have a healthcare related professional business on the lower end. When you think about our company today, when I got here, we were two-thirds personal lines and fairly concentrated in a small subset of geographies. Today, we're a 50-state player in the commercial lines business. We're two-thirds commercial lines, and inside of that, probably two-thirds of that commercial lines business is specialized in some form or another.
Our operating model allows us to kind of bring those dedicated specialists to the agents, depending on the level of expertise of the account and the level of expertise requirement at the point of sale with the agent. We have kind of a hybrid model where we have an expert-to-expert experience when that's required based on either the account underwriting requirements or the agency interface, or on the lower end of the specialty business, where we differentiate ourselves is that we can bring a fairly specialized product through our middle market and small commercial field models, which I think just allows us to get to more agents more effectively than a specialty model enables.
Thank you.
Even maybe the last thing on personal lines, even then, if you look at our value proposition work, we kind of call it specialized capabilities, not specialty. Everything that we do has to differentiate itself in some manner, shape, or form. Even in personal lines, we're very different than most of the people we compete in that over 85% of our business is account, where we have at least the home and auto, oftentimes the umbrella, and we bring our product to the marketplace In a coordinated way where we synchronize the multivariate pricings so that we create less pricing volatility at a consumer level than this kind of multivariate world that we live in where a lot of our competitors play. We superimpose upon ourselves the expectation that if we're not different, then we're subscale.
Every business has to show us why it is we think we can win in that space, and how are we going to differentiate ourselves into the future.
Great. Now, given the differentiation approach that you're trying to achieve, what areas are the most attractive in terms of growing right now?
Yeah. Listen, I would tell you that in the history of the company since I've been here, we're in the best position we've ever been in that we have fairly well-distributed profitable growth. Almost all of our businesses and geographies are contributing to our margins. That said, we do have some areas that are particularly attractive to us. I would characterize them first and foremost as most of the specialty businesses that we either bought through acquisition or built organically are coming into their own, have tremendous scalability, and have plenty of headroom within our distribution. The consolidation inside the distribution system has created more and more retail opportunity. We see particularly the larger consolidating agents thinking about where they need wholesalers, and they do for certain sectors of the business.
Where they can increasingly create centers of excellence and more direct-to-retail experience, improve their margins, and eventually improve the customer value proposition. Whether that be professional liability or continuing to grow our Marine and Specialty Industrial businesses, our Allied Health business, our technology sector business. We grew that organically over the last six, seven years. It's our most profitable business within the firm. We have a number of businesses that are specialized, profitable, and have tremendous headroom into the future. Maybe lastly, we've been talking actively on our calls about some new capabilities that we decided to move into. We are building out a financial institutions practice where we can bring together the professional and the P&C lines together on the small to mid-size banks and asset managers.
We hired some real talent from some of our best competitors to build that capability within the firm. We're driving a retail E&S strategy. We're very impressed with what Cincinnati did there, and that's something that we think that we can add to our arsenal. I hired some talent to build that out, and we've got a number of initiatives with our agents on that sector. Last but not least, I think, less about short-term growth, but more about long-term capability, we invested in cyberspace. We brought a gentleman on board that is making sure that we have the right view and exposure and reinsurance relationships so that as the cyber goes from being a sixth line of business to maybe a peril within the package policy for a lot of our customers, that we can do that intelligently and make that part of our proposition.
Okay. Great. Switching to auto, especially commercial auto, you touched on it a little bit. It's been kind of a problematic area for a lot of folks, especially commercial auto. I guess just how are you approaching this? How are you approaching improving the commercial auto book?
Let me say a couple things, and then I think Jeff can kind of build on the drill that we have within the firm. I think of auto as again, an important part of our portfolio management, and we have auto in small commercial, middle market, to a lesser degree in our program business, and in our technology and healthcare businesses. We think of it as a line of business, but we also think of it within the sectors that we're trying to play. Over the last few years, we obviously improved price, took a lot of underwriting actions, particularly on the auto-centric parts of our portfolio. Like many in the industry thought we had started to make some real progress, and the loss trends continued to stretch out. Heavily driven by the litigation trends, as well as some of the other dynamics in the auto sector.
We continue to push hard on inside the firm with a line of business orientation. Our corporate underwriting areas are focused on line of businesses and making sure that across the platform, we've got price discipline, we've got underwriting actions, we're keeping tabs of competitor views on the line. In each business, we have folks showing us that the trends in the auto line are not going to run adverse to the overall sector. I say it that way because I'll pick on our technology business. We have a less than profitable auto experience within our technology business, but the combined ratio for the entire sector is low 80s, high 70s. It's not really a line of business issue that we're going to worry about in a sector where we're making a lot of money.
On the other end of the spectrum, if you're writing a bunch of wholesale business in your middle market business, and it's driven by auto exposures, then you can't just keep throwing rate at it and hope it's going to get better. We've taken material actions Both from an underwriting standpoint and a pricing segmentation standpoint, like what Jeff was articulating earlier, it's really been built into the portfolio management and the financial rigor of the firm. Jeff, I don't know if you want to speak to how we've morphed our regular quarterly business review and the financial rigor with and for the businesses.
Sure. We have a pretty active financial level of discipline in our organization, and we have an operating committee that is charged with delivering on the plan each year. It's all of the senior folks running the businesses, our claims head, our chief actuary, I chair it, and we meet twice a month. We're looking at all the relevant information, not just data, but actually information insights, and taking action quickly. One might ask, well, why does it take so long to deal with commercial auto if you're looking at it every two weeks? It's really hard to know. I think the important point is we're not waiting to see how things play out. We're reacting to it really quickly.
Just a point to add on commercial auto, while we haven't escaped the industry challenges over that period of time, A, our book is a little smaller than most, and B, it tends to be light trucking related to our businesses versus longer haul trucking. In fact, tends to be small trucks. It could be a plumber with a few trucks or in many cases, it's actually cars, which are commercial auto. It doesn't necessarily mean that we avoided the trend of lawyers and social inflation and medical costs and whatnot, but it makes it, we think, a little bit easier to tackle and deal with in the account structure.
Last but not least, we are driving historically high rates through that book of business today. Despite an account orientation, we're not compromising our ability to drive industry-leading rate increases in the line of business today.
Great. Are there any questions from the audience? Okay. All right. I'll keep going. Workers' compensation, let's switch to there. We'll switch to a much better performing line. Right. Workers' comp rates are showing no signs of declining. Right? What frequency and severity trends are you seeing quarter to date? And then how dependent is Hanover's strong results and reserve releases on declining frequency?
First, I don't think there's anything to share on a quarter-to-date basis, particularly for a line with that kind of long tail line or mid tail line. I would say that we are seeing unprecedented levels of low loss trend, and in fact, negative loss trend for one or two years. Having been around the workers' comp line for the three decades I've been in this business, having been on the NCCI board and spending a lot of time analyzing this line of business, I think all of us are as surprised about the workers' comp loss trends as we are the auto trends going the other way. For that, I think this industry would be having quite a different experience right now.
It's hard to imagine that seven years ago, commercial auto was the most profitable line of business, workers' comp was the anathema of the business. Today, workers' comp is literally propping up the profitability of the business. This, too, will change. We think the cumulative rate decreases in the line will take its toll eventually. The reason why I think the short-term profits haven't decayed is because, I think, two major factors. There is evidence that there's loss control that is systemically moving out of the line. With changing jobs, with real risk management that's been pushed in from carriers and from clients, there is evidence that there are losses that have moved out of the line permanently. There's also evidence that the economic conditions are almost perfect for the line of business.
When you have high level of activity, when you have a too robust of an economy, you start to see untrained labor come into the jobs, and you start to have some frequency and some severity. When you go into recession, obviously, you have folks that are trying to keep an income stream going, and you tend to have a different type of loss experience. I think over the last few years, we've been in an ideal economic environment. That said, depending on how this plays out, you are starting to hear, in the manufacturing sector in particular, people struggling to find good trained labor. It's hard to imagine we're going to sustain the current loss trends that we've seen, the cumulative pricing in workers' comp should start to bend the curve the other way, and it's just a matter of when.
We're watching it, as you would expect. We're not trying to be the eternal optimists in this line. We're trying to be our own biggest critics and see where that's coming. The last thing I would say about that is that workers' comp makes up roughly 7%-8% of our total premium, and maybe about 13% of our commercial lines premium. I see this as an opportunity for the firm. We're the most conservative workers' comp writer in the top 25 by market share or by percentage of the book. We're as capable as most of the people we compete against. We've brought people from the better companies. We've invested heavily in this line of business from a claims management standpoint, from a loss control perspective.
In some ways, we're waiting for this change to happen so that when some of our competitors that are more invested in the line of business start to react, we can selectively go on the offense. In the meantime, I think we're trying to be cautious and thoughtful and just be a good account player. Our average account size in the workers' comp arena is just north of $5,000. We're not in the heavy kind of loss frequency area in the line of business. That serves us well.
Great. All right, kind of switching more beyond just product level things. Let's talk about Insurtech. That's kind of a bigger topic these days. Where is Hanover engaging with Insurtech firms to improve claims, underwriting, customer experience? What capabilities are these firms bringing that it's easier to partner than it would be to build it out yourself?
Actually, we don't talk about it as much, but we're extremely excited about the innovation that's really starting to foster in our business across the value chain. We have explorations and partnerships on the customer acquisition side, on the kind of data exchange and operational efficiency within the businesses that we do today, on the back end in terms of claims and customer service. I won't go through all of that. I think part of what we'll display, if you remember a couple of years ago, Dick Lavey, who runs agency markets, spent the better part of a year building a team that was focused on that exploration.
That said, "Let's go see where the action's going to be and see where we can put some focused investment in trying to see where this could help our company, and in particular, where it could help us build on our agency proposition." We're not really focused on trying to figure out how to go around agents and build direct-to-consumer models. We are very focused on customer interface, customer preferences, and how we can build models that allow us to work very closely with agents as trusted advisors and modernize the way the business is done.
We have work that we're doing on kind of programmatic small commercial, leveraging some Insurtechs on a white label basis to build their platforms and to extend into the distribution system so they can go after a class of business that tends to be small face value and do it in a digital way. We have some work in the middle, like I said, with companies like Indio and Davies, that are getting at the really important work of data exchange between agents and customers and carriers, and trying to create a more efficient flow of information. We've got a ton of work, really, really good progress on the claims and the customer service side.
Video camera apps that are allowing small property claims, small auto claims to be resolved more efficiently, frankly, in a way that the customer feels much more in control of their own destiny. A number of things on the claims side, frankly, that are probably going to be where the industry moves the quickest, leveraging those platforms.
With respect to your thoughts on whether we were building it versus renting the capability, we've moved in a large way, Chris, from historically building things to really renting it. It just allows us to be more agile, flexible in the use of the technology rather than to rely on the models and the tools of others.
Great. Are there any questions from the audience? Right now? Okay. John.
I want to ask you about the $250 million of capital.
Let's do it. I'm on capital management. I'm getting there.
Bring it on. Maybe people on the phone. The question was about the $250 million of capital. Anything in specific?
No.
Can we bring it today or? Your question is timing. I think clearly when we announced the sale of Chaucer at the very tail end of 2018, we said we've got $850 million of equity that this deal creates. People were very interested in terms of what we were going to do with it or what we weren't going to do with it. For those that might be relatively new, we've returned about $600 million of that capital in the form of an initial $200 million special dividend, a $250 million ASR. That ASR completed in late June. Then we just announced and did $150 million ASR at the end of June. That will run its course over two to four months from June 30th.
Our view is we know we can't sit with the capital just earning 3.5% or whatever it is for a long period of time. We'll go through our normal framework as that ASR completes, and we'll look at business investments and opportunities first as we go through our annual planning cycle. Are there ways that we can redeploy that capital? Having said that, historically, we generate a lot of capital in our operations, so we've historically had sufficient capital generated
To redeploy into the growth at a mid-single digits or 6% growth rate. Borrowing any unforeseen catastrophes or things like that, we expect that to be true. We often, as Jack talked about our history earlier of some acquisitions, some small things, there might be some things along the way. In this environment, it has to meet three requirements. It has to be accretive in short order, has to be consistent with our distribution, and also has to be a really good cultural fit. It's really hard to meet all those requirements. Then we'll reconsider capital management. We think like shareholders because we are shareholders, and we have shareholders' best interests in mind. You'll be hearing from us as to what our plans are in short order.
I just want to clarify, the 13%-14% ROE that you referenced earlier, that net of take the 250 out?
It is.
Yeah.
Right. At the moment, we're generating a mid-11 sort of all-in ROE with the capital that we've had, and that's a mid-12 ROE for the first two quarters if you adjust for the excess capital, and we believe that we can get to 13%-14%, largely with the leverage we get from expenses. If we can get 20 basis points per annum over a five-year period, that's 100 basis points on the combined ratio, which is about 130 basis points on ROE. Even if you give back a little bit with some NII, if rates were to stay where they are today, we still feel very comfortable with a 13%-14% operating ROE on a long-term basis.
Perfect. Thank you.
Thank you.
All right, Dick. We have time for one more question from the audience, if anybody would like. Okay, great.
Yeah, maybe just if we could finish up. I would just say, for some of you know us and some of you are less familiar with us, I'd just encourage you to look at the way in which a midsize company that is increasingly more capable and more agile than some of our larger competitors can compete in this new dynamic world. I think what's becoming obvious to us, and I think to others that size is important, but it's less important as things change. What's so encouraging to us as we see the market moving and loss costs being more dynamic and innovation becoming more prevailing, it's not hard to imagine that a company that's assembled the talent that we have, that's built the portfolio that we have, and that works so collaboratively together can't be one flavor of a successful company in our industry.
That's what we're out to prove. That's what we do. One of the biggest levers we have from a talent acquisition standpoint is to be able to present that type of opportunity to some of the professionals that are underwhelmed with their current environment. That's what I think you'll see over the next couple of years in particular, is that this kind of talent acquisition model that we've built is going to serve us well to take the company to the next level.
Okay.
Thank you.
Great. Well, thank you, gentlemen.
Thank you.
Appreciate it.