Keefe Bruyette & Woods 2018 Insurance Conference

Sep 6, 2018

Slides

Yes. Hi, good morning, everyone. Welcome to the Hanover Fireside Chat. Joining me today, to my left is CEO Jack Roche, and to his left is CFO Jeff Farber. Thank you, gentlemen, for joining us. We're happy to have you. Thank you. Jack, do you just want to give kind of an overview of Hanover, where you're at, just high level view of where it's going? Sure. We'll take just a couple of minutes, and thank you for the opportunity today, Christian. For those of you that are less familiar with us, we'll just take a couple of minutes to give you an overview of kind of who we are and where we're going. We'd love to engage in some dialogue. We like to believe we're a strong and growing franchise in the P&C sector of a little over $five billion in premium, a little over $five billion in market cap. Over the last decade, we've fully transformed a regional generic insurance company into a more national, particularly on the commercial line side, and more distinctive company. We've made a number of small acquisitions and renewal rights deals and organic build-outs, new geography expansion with the idea of diversifying this business and making it more attractive to the best retail agents in the country. When I joined the firm 12 years ago, it was a vision and maybe even a dream. I truly believe we're sitting here today in a fundamentally stronger position as a company. Over the last couple of years, what you've seen is the financial trajectory catching up to a lot of the strategic moves that we made, particularly over the last six or seven years as we've rebuilt this company. When you think about all the capabilities we've built, especially in our more specialized commercial lines areas, all aimed at the small to mid-size account range, as well as the progress we've made in becoming one of the most profitable and most kind of well thought of personal lines markets account player, aimed at kind of the middle market customer. The real distinctiveness in our firm comes within our distribution approach. What we saw over a decade ago is that the best product makers in our business were over-distributing, and that the smaller companies increasingly were becoming disadvantaged by specialization and by the sophistication of the business. That's why you've seen almost $50 billion of the market move from smaller companies to the bigger companies over time, beyond acquisition. At the end of the day, we'd love to engage with some dialogue around the fact that why are we different, why do some of the best retail agents in the country favor us, or at least put us in an enviable position. We have less than 2,500 agents. The limitation of who we give our contracts to is part of the franchise value, as well as the increasingly distinctive offering that we bring to those agents through our distribution approach. In doing so, over time, what we've also been able to do is to develop trust and an engagement level that is bringing us a fundamentally unique insight into the books of business of our agents. For those of you that have followed us know that we have leveraged some tools, particularly our Agency Insight tool, to develop a consultative capability with our agents that has allowed them or has enabled them to show us more about how their business is placed today, given us that transparency that not only helps us execute on building these partnerships, but also strategically knowing where the oligopolies and where the commoditization in our business are happening. With that, I'd love to just kind of turn it back, we really believe the progress that we're making across all of our strategic initiatives are showing up in our financial trajectory, we believe that we've positioned ourselves nicely in this dynamic time in our business. Great. Thanks, Jack. Just, I guess, starting off, can we get an update? A few years ago, Hanover laid out its Hanover 2021 strategy. Can we get an update on where you're at in that journey, then how are you thinking about how you're going to get there and Great. I'll start off maybe just talking strategically about what we set out to do, then maybe Jeff can complement that with some of the financial progress that we've made. I think what we said in Hanover 2021 and kind of really the next phase of our journey was that we had plenty of room to deepen the partnerships, the agency partnerships that we have to further penetrate the industry segments and the geographies that we are still relatively new. We have confidence in more and more of those businesses and those geographies that they will contribute to our profitable growth. This is not about getting bigger, this is about getting better. In our business, growth is hard unless you really have insight into how to access the profit pools. First and foremost, penetrating the existing businesses and footprint. We're well down that path. Continuing to build out our specialized commercial lines businesses, including niche business within mid-market, but even some of the broader specialty businesses. We've gone from $50 million when I got here to $1,000,000,001 in gross written premium. We believe we can continue to grow that business thoughtfully and aggressively over the next five to 10 years. Could be a bigger part of our company. We hired Bryan Salvatore a year ago to help us do that, and he's making tremendous progress. Last but not least, we also articulated a vision around innovation. Small I innovation, where we make our existing businesses better, more operationally efficient, improve the customer experience, improve turnaround times and claims, take advantage of the technology and the data that's available to make our existing capabilities stronger. Also, over time, some growth innovation. Looking at new and evolving operating models all through our distribution channel to bring a better customer experience, particularly in the more specialized smaller account size where we think the initial action is going to be. We're excited about our strategic movement here, and we're really right on path, maybe a little ahead of where we planned on being with Hanover 2021. Jack and I were extremely involved in building out the strategy that we announced to all our investors in February of 2017. Notwithstanding Jack's elevation to be the CEO coming up on a year ago, it's really more of the same. We're committed to very similar to that strategy that we put out there. If you recall, the financial elements of that strategy were growing net premiums at the time at 7%-9%, growing our earnings per share, growing book value per share, and probably most importantly, the operating ROE to 11%-12% on an old tax reform basis. What we said at the time, and what we still say, is that the net premium growth was means to the end, and that the other three were really what the drivers of the financial elements that we wanted to deliver. We haven't been getting 7%-9%, and we may or may not get 7%-9% over the next couple of years. Maybe we'll be getting 6%-7% growth. However, because we hadn't planned on taking expenses out specifically in our Hanover 2021 model, and we did actually reduce our expenses meaningfully in 2017, that gives us the additional value creation in terms of earnings and ROE to make up for any potential shortfall in the premium. We feel very comfortable with those targets, even on an old tax basis, particularly the ROE. At the appropriate time in the future, we will publish new targets on a tax basis that has a 20% or 21% rate versus a 33% or 35% rate. Economically, I would just add that one of the things that was really key when you looked at the financial trajectory that we were planning for, was using all of our diversification and our insight into these businesses to keep our loss ratios flat or maybe slightly better, but getting the growth, the expense leverage that one would expect from a firm that invested heavily in new capabilities and new geographies. Our math is a little bit different than some of our more mature or stagnant competitors in that we have some fixed costs or some heavy marginal costs that can get overwhelmed if we find the right kind of growth. That said, we're committed to making sure we grow the right way, but just understand that our delta, it gets substantially better through expense improvement over time based on those substantial investments over the last six, seven years. Mm-hmm. Great. Thank you for that high level overview. Now we'll go a little bit lower. Can we get an update on your Chaucer strategic review process? If Chaucer is indeed sold, what are your plans for the proceeds? All right. We'll follow the same rhythm. I'll talk a little bit strategically about reminding folks, or for those that are not as close, why we entered into this strategic alternative process with Goldman Sachs' help. We had active dialogue through our regular strategic work with John Fowle and the Chaucer team as we look into the future and try to think about where we can be advantaged, where we think the market dynamics will play to the strength of our firm, and also what the needs are going to be in each of the marketplaces. I think through that strategic dialogue, we mutually came to the conclusion that there is at least the possibility that Chaucer could be advantaged by potentially a bigger balance sheet or a different type of ownership. I think that was accentuated when we saw in the third quarter of 2017 that heavy storms could have a heavy impact on Lloyd's syndicates, as well as other companies that are in the catastrophe business. Simultaneously, we are really coming into our own in the U.S. We put those two things together, all with great dialogue with John and his team, that it was the right time, not just for our investors, but also for us to look at it and see if the timing was right to consider different ownership for Chaucer for our mutual benefit. The last part about that, I would say, is that we had a number of investors that influenced that by suggesting that they were more interested in a pure play type P&C company than they were a hybrid company. That's not why we did it, but certainly we saw that as another advantage to at least considering that option. If we were to find the right buyer with the right economics that was advantageous to our investors, we took that action, then we would share with investors more specifically what our capital plans would be. Obviously, Jack and I spend a lot of time thinking about that and working through that. As we discussed on both the first and second quarter earnings calls this year, we're rigorous capital allocators. We allocate our economic capital to all of our businesses, and we're very thoughtful about challenging the use of capital and this scarce resource. The high-class problem of having extra capital means we have the responsibility of needing to deal with it. In the hierarchy of usages, the first we would look at would be, do we have organic uses? Are there things, ways that we can grow and utilize that capital at acceptable above-target returns to use it? We did say when we put our strategy out there in February 2017, that our model had a fair amount of capital being generated and in fact, sufficient or excess capital being generated beyond what was needed for growth. Since that time, we have other ideas, other thoughts, other strategies that we've been thinking about, so there are potential to use some of it organically. Beyond that, there are inorganic type uses, and we have a long track record of being thoughtful, clever, creative, scrappy, however you want to describe it, about utilizing capital for full rights deals or selective hires or creative ways to do it that aren't large transformational type, dilutive types of transactions. Particularly where price to book multiples are today for public companies, I don't think you'll see that type of an opportunity to do something to utilize the capital. Then working our way down between stock buybacks, special dividends, possibly giving consideration to the appropriateness of ordinary dividends, perhaps even some debt takeout where we have some high coupon debt, use of reinsurance. There's a whole toolkit that we would go through. Upon a theoretical signing or an execution, we would give investors the transparency and visibility to what we would be thinking, and we would be working our way through that excess capital and be very clear about the status, the timing, and the approach. Great. Questions from the audience? Joe. We have a microphone too. Hi. Just going back to the Hanover 2021 plan, it sounds like you're kind of suggesting that premium growth won't be what it initially was guided to. Can there take away that as more of an industry issue? Is it just the business out there is just not as attractive as initially believed that it would be? What can be the read across there? The follow-up is on the expense side, where are we at as far as the continuum of how much more improvement can actually be squeezed out given where you are on the top line? Sure. Again, I would say that when we met in that February and talked with investors, we were very clear that embedded in that was both, I think we used the terminology aspirational growth, that we weren't just here to iterate, that also wasn't going to be a perfect waterfall chart. We still think of internally in the company as a company that should be able to deliver above-market growth in this market environment and through some organic and inorganic capabilities, be able to grow at a higher clip. That's not going to come out on an annual basis if those opportunities didn't present themselves. I think of it as more if you look out 5-7 years, this is a company that went from $2.5 billion when I got here to $5.3 billion today. We still believe we have that opportunity. We separated out what we think is kind of smart growth in the short term without some help from M&A or something that's more transformational. That over a period of time, you should expect that we're clever enough to figure out how to supplement that with something more than just strong organic growth based on the capabilities we have. We believe we can deliver it. We're just trying to clarify what's aspirational and more kind of mid-range view versus what you can expect to put in your models for 2019. The growth that we've been getting in the year and a half since we started the strategy has been above market growth of 6%-7%. I was just suggesting that if it's not 7%-9%, we can still achieve our other targets. It clearly won't be linear. There was a small but meaningful element of M&A, or inorganic growth that was built into the 7%-9%. As everybody knows, that doesn't happen linearly, it happens opportunistically and depending on market trends and cycles. To answer the second part of your question on expenses. We clearly, for a long period of time, had allowed the expense ratio up until 2016 to be constant. As our premiums were growing, as Jack said, from the $2.3 billion to nearly $5 billion, expenses were growing at the same pace because we were descaling the company by adding capabilities, geographies, lines, et cetera. We now have the scale where that's not the case, we've demonstrated an ability to hold those fixed costs over the last 18 months and forward relatively flat while making some investments. You're seeing the benefits of scale with premium growth on fixed costs. We took out about $65 million of cost in 2017. We allowed a little less than half of that to come through. I should say we reinvested a little less than half that on data, analytics, foundational capabilities, and more than half of that is really coming through and enuring to the earnings and the shareholders. Over time, there will be additional expense opportunities. Whether we decide that some of those expense savings can fall to the bottom line or it will fund the interesting and fruitful investments that need to be made over the future remains to be seen. The only other piece to that is the whole mix, right? When you've got a personal lines business that's running at a 28% and you've got a surety business on the other end of the extreme that's running at a 50%, consistent with a lot of the industry, what we're committed to do is being very transparent about where we're getting operational and growth leverage versus mix shift and not making that but for our accounting, right? We want to be really clear about because we're in the high ROE business, not in the low expense ratio business. One leads to the other if you're doing things right, but we want to be really clear about where the shifts happen and why, and then let you be the judge of whether that's good, smart growth and deploying capital appropriately. It won't always be perfect. We just got to be really transparent about what part of our business is growing and why. Do you have a mic? Going back to the Chaucer process, can you just elaborate on your thoughts on counterparty risk, certainty of closure versus price? Sure. It's all considered, right? I think we need to find a suitor if we decide to sell that meets a series of criteria. They have to be willing to pay what we believe is the right price for us and for our shareholders. We need to assess the execution risk and that surrounds the potential suitor, and we also need to understand how their ownership fits with Chaucer's management. We've been transparent from the very beginning that this process is not a foregone conclusion that we thought we could do this in a way that wouldn't impair the asset. We're seeing this through with those criteria, and they're all in good balance, right? To over prioritize one to the other is probably not realistic, frankly. They all have to come together in order for the right transaction to happen. There are natural protections that one would pursue in any environment where you thought you had additional execution risk. That would be part of any opportunity we'd consider. Great. We have one in the back as well. Thanks. Just curious on with the Hanover 2021 targets and the Chaucer potential sale, how those interact and how that might affect some of the targets that you've laid out. I would assume it would help organic growth given what Chaucer was doing, but just interested in maybe returns and EPS and how you think about that. Yeah, I think there's no doubt that if the process translated into a sale, not only would we have to be very articulate about use of proceeds, but also how the firm goes forward and how we reset, consistent with Hanover 2021, but how we give you the view of what the firm looks like sans Chaucer, and what the prospects look like going forward, what the ROE projections are. As you can imagine, as we move down this process with that being a possibility, we would plan to be very articulate about our profit and growth prospects in the U.S. I think what you can say is that Chaucer, while it's one of the top performing syndicates and really has benefited our firm tremendously, and we believe into the future can be an industry leader, the short term economics are pretty clear. We're generating better returns out of our U.S. domestic business. We're getting good growth on a net written premium basis predominantly in the U.S. What we're doing is being very thoughtful in London about leveraging appropriate reinsurance to make sure that any growth that we get there translates into the appropriate returns and gives us the balance between short term economics and long term relevancy in the Lloyd's market. I think John Fowle and his team have done a fabulous job, I think one can expect from us that we would be really clear about how those two firms separate what the economics look like that, then translate that into the going forward kind of Hanover 2021 structure. If a sale were in the cards, one could clearly come to the conclusion just based on growth rates that the domestic business has been growing a little more quickly than the net premium basis than the Chaucer business. If the ROE was performing higher if you adjust for the excess capital over a reasonable period of time, then we could be clearer about the ROE opportunities. When it came to book value per share or earnings per share, you'd have to think a little bit about how did the capital get deployed and what framework and what Timeframe in order to be able to project different growth rates or increases or decreases for book value per share, earnings per share over time. If a sale were to be in the cards, so to speak, then we would want to lay that out for investors so you can really be clear and have visibility into how that would behave. Great. Any other questions from the audience right now? Okay. All right. Oh, sorry. No, please. Go. Okay. Just moving on away from Chaucer in, into your personal line. Your strategy is built around steady rate increases, not these dramatic up and downs we see from some other carriers. Are you seeing any signs that increasing personal auto competition, I'm thinking like the very big carriers and profit rates, are you seeing any impact of that being able to execute your strategy? Yeah. I think you're right. Our strategy has been unique in that I think we are one of very few companies that gravitated half a dozen years ago around returning back to an account orientation and not trying to play the monoline multivariate auto game. I think folks that did that made two mistakes. A, they found themselves in a bit of an arms race around data and analytics and tools, but also worked away from the value proposition of an independent agent. One of the reasons why we're performing as well as we are is because we have figured out a way to take these relatively sophisticated multi-line, multivariate products from home and auto, and synchronize at the account level, which is easier said than done, and we've done that successfully. We feel advantaged by that. Because we're performing well, and because we've done that hard work of synchronizing those models, we are able to provide not only a more overall stable price, but also not let the individual lines get out of whack. Not compromise each other, but synergize at a customer level. We believe that attracts over time a different type of customer. We think they're less price sensitive, they're more value driven. We think that for that reason, we experience a slightly different loss cost pattern. When people were talking about real frequency in that, we didn't see a lot of it, frankly. We saw some severity uptick like everybody. I would tell you that we don't see, at least for now, any material change in the competitive landscape. We understand it's going on, but in our day-to-day activity, not much really has changed for us. Then kind of just shifting over to commercial lines, what are you seeing in terms of that book, in terms of rates and loss costs by product? I think clearly we are at a time in the evolution of the business where we're in a more muted cycle, right? When I started in the business in 1986, if you didn't get 35% price increases every month, you had to go see the general manager and explain why not. Of course, that was a capacity driven market, driven by the liability problems in the business. We saw that again after 2001. What we see today is because of excess capital and because of, I think, a smarter approach to the business and a little bit more discipline in the ownership structures of the company, that you're seeing a much more muted cycle. Inside of that more muted cycle, you are clearly seeing a more varied performance at the carrier level. It makes sense that since price alone is not dictating or is the major factor in carriers' performance, you actually have to be good at what you do. Specialization and pricing sophistication is a double-edged sword. If you do it well, you're greatly advantaged. If you do it poorly, you can destroy value pretty fast. We believe that even though that in aggregate, in our view, pricing in the sectors we play in is still slightly below long-term loss costs, we believe the mix improvement that we're creating and all the hard work we did to get into some more distinctive categories, the line of business work we do, addressing some of the profit problems that we had in our program and contract surety businesses, all of that clearly overwhelms the gap between what we think is contemporary pricing with long-term loss cost. Then last but not least, our expense leverage is our final lever that helps us generate the kind of returns that we think is acceptable. Mm-hmm. Great. Getting a little bit deeper just into workers' comp specifically. Some competitors have noted seeing higher first half 2018 frequencies. How does that align with Hanover's book? Then just one market in particular I'm curious about, I haven't heard much recently, is California, which is about a quarter of your book. Just thoughts on overall frequencies. Sure Just what you're seeing in California? Sure. I think people that have watched our firm as we've kind of rebuilt it over the last decade know that we're the most conservative workers' comp carrier in the top 25. When I got here, our workers' comp book was not very good, and frankly, we did a lot of defensive measures. What we've done is repositioned our book to be much more small commercial centric, and in sectors of the business where the workers' comp line generates better returns. The proportionality to our overall book is such that the pricing of the last two and a half, three years has been less problematic. Make no mistake, the industry's given back 10 points of price in that timeframe, and those that have a bigger portion of that in their book or play more in the mid-market space, where the loss frequency exists, are probably feeling pressure. We kind of snicker when we hear people talking about but for workers' comp pricing on their earnings calls, because workers' comp is a big part of the business, and therefore your pricing in that line should matter. The benign loss trends over the last two or three years have surprised folks, myself included. I was on the NCCI board for four years. I certainly am a student of the workers' compensation business. I too was surprised, and I think it makes sense in that if you look back, workers' comp benefits from a slow growth environment. It gets punished in a recessionary economic time, and it gets punished in a high growth time. I think what you're seeing in aggregate is a relatively stable time in the workers' comp business generated by a relatively stable time in the economy. That said, I suspect what you're starting to see is that as economy starts to pick up, particularly in certain sectors, you're starting to see the age-old problem of retraining workers and people putting people into jobs that are changing and/or requiring some additional employment and not having the benefit of the right training and the right orientation. Standards get compromised, and you're starting to see, and it makes sense if you look at what would happen if the economy starts to perk up. That's why I believe what sectors you play in is as important as your transactional underwriting excellence. I think that's one thing we did particularly well over the last decade was reposition the portfolio. Over time, I believe this will be a benefit to our firm. I believe as the workers' comp market have to react to that we can benefit as others make adjustments at the right time. The last part is California. California is a big state. Because we do a lot of things in the tech sector and we had a lot of success in small commercial, it did get a little bit bigger proportionally. It's been very profitable for us. That said, we're not going to get overheated in California workers' comp. We're right now not seeing that as a huge growth opportunity. We're much more excited about additional geographies and becoming a total account player in the right sectors. Great. Probably have a minute for one more question from the audience if anybody has them. All right, well, I'll ask one more then. Hanover recently entered Pennsylvania, which can be a tough state for her to go compete against an incumbent. So what are your early takeaways? How would you grade your efforts, and what's the opportunity for that? Yeah, you're right. We've been in Pennsylvania for half a dozen years on the commercial lines side, gotten tremendous traction there. Great leadership there, great agency following from some high quality agents. I started my career 32 years ago in Philly, so it's been a personal interest of mine. On the heels of that, we entered personal lines mainly as a petri dish for our new platform for personal lines. We have a very modern platform that allows us to take that synchronizing of home and auto to the next level and keep up with rate relativities and a state-of-the-art point-of-sale system that the agents have absolutely given us accolades on. Now that the efficacy of that build is out and we've hit our marks, we're rapidly deploying it to all of our existing states because we can get, we think, some additional pricing benefits by having that installed. The point-of-sale experience to the CSRs and to the account managers is outstanding. We actually accelerated the deployment of that, and we couldn't be more excited about that. It's not a new state proposition. It enables us someday when we want to consider new states, but it's really more of a agency experience and pricing efficacy play, and both are going quite well. Mm-hmm. Great. I think we're out of time. Thank you, Jack. Thank you, Jeff, for being here. Yeah. Thank you very much. Appreciate it. Appreciate it, buddy.