Last presentation of the conference. It's a lot of insurance over the last two days, but we're closing with an excellent speaker, I must say, and a first-time speaker to our conference. We have Fred Eppinger, head of Hanover. Fred took over Hanover, I guess, about 10 years ago, and the amount of change in this organization over that time is really astounding. That change accelerated recently with the acquisition of Chaucer, making this a global company, or at least multinational anyway. Fred's got a great story to tell. I'm going to let him tell it. I'll turn it over to Fred.
The last presentation. This is fantastic. What I'd like to do is introduce our company. Let me see if this works here. Is it going here? There we go. There you go. As Jay said, we are a 161-year-old startup. What I mean by that is that Hanover, particularly over the last nine or so years, has embarked on a journey to build this world-class P&C company that could deliver core top performance through the cycle. Today, we find ourselves at about $5 billion in gross written premium. It's about a third, a third, a third Specialty, personal lines, and Core Commercial. If you look at the mix of the business now, domestically, we're about $3.8 billion gross, and about $1.4 billion is out of the Lloyd's platform. Quite a broad and diversified portfolio now.
Let me just give you a little bit of an overview of what I'm going to talk about today and kind of a little bit about the company. We are very well-positioned and unique institution. We have built a series of pretty distinct business positions across our businesses that have allowed us to have preferred shelf space with some of the best insurance agents in the country. We have positioned ourselves now to really enhance the profitability of each of those businesses now that we've built them out. As we sit at the end of the year, we have the best balance, if you will, both geographically and line of business, as well as operating model and position in each of those businesses as we've ever had. 2012 was a transition year for us.
We did finish the integration of Chaucer, which is a pretty significant step for us. On top of that, we had finished up about nine acquisitions and business launches since 2009 to really complete the portfolio. We entered 2012 with some work to still be done, I'm going to talk a little bit about how we end it. Where we find ourselves now is in a terrific position to capitalize on the disruption that's happening in the marketplace. This is not just a turn. This is, frankly, a real change in the market because it's the first turn that has been really driven, not just by the cycle of insurance. It's been driven by the economy, it's been driven by yields, it's been driven by the structural changes that's occurring, which is really threatening small companies and really creating consolidation to better companies.
We feel that we're very well-positioned in each of our businesses through pricing, through our ability to actually shift to higher margin businesses to really continue to leverage the investments we've made on our operating model to really take advantage of this to both grow top line and the bottom line of the business. From the beginning, we set out to be a very vision-based institution. I think people that follow this industry realize that the industry isn't very good. 25% of the companies make all the money. What's interesting about the industry is the folks that tend to be good, stay good. As a company, when we started, we were probably the one or two worst companies in the sector. We had a life operation that almost put the company under in the early 2000s because of guaranteed minimum death benefit.
We started with a portfolio that was quite weak and wanted to set forth on a journey that created a property and casualty company that had a distinctive ability to make returns through the cycle. It really created a series of four priorities. One is to make sure we had a differentiated product set and in the most attractive areas of the industry. I'm going to talk a little bit about that because the dirty little secret in our industry is that most of the sectors, even if you're outstanding, are hard to make money because there's a lot of parts of the business that underachieve over long periods of time. The second thing was to create within those businesses a distinctive position.
Instead of just doing what everybody else or opportunistically go after large accounts or national accounts, to create niches or segments that we attract with an operating model that allowed us to both make money but to sustain profitability through the cycle. The third was to create what we call a value proposition that gave us preferred shelf space with the distributors of this industry. There's a lot of things going on, but there are about 1,000 of the independent agents that are better than the others. They were able to sell value. They're more broad in their capabilities. They have more distinctiveness. The question is, how do you get preferred shelf space in a business that has a lot of excess capacity? We think we've done that.
Finally, what you want to be able to do is, every great company in our space takes advantage of the cycle. Have and have not separate during the transition. The weak companies shrink, they re-underwrite. The good companies are able to not only grow through price, they're able to cherry pick. The question is, do you have the financial strength when it occurs to capitalize on it? What we've done, we believe, is set ourselves up for each of those for the next two or three years. Again, our history is interesting only because it gives you a sense of what we've done. In the first four or five years of the journey, it was all about fixing it. We were about 12 hours from being taken over by the State of Massachusetts. We had been downgraded four notches.
We had a portfolio with about 12 runoff businesses. The first five years were really about getting rid of the runoff businesses and refocusing on the P&C business. We were the business we are, as I said, we're 161 years old. We're the 36th oldest company on the New York Stock Exchange. We have some history to us, but we had a very difficult decade. What we did is really refocus the business. In 2009, late 2009, we got upgrades, a second set of upgrades from all the rating agencies. I think we're the only financial service company in America that got upgrades by all the rating agencies during the financial crisis in 2008, 2009, actually. After that, we took some proceeds from the sales, the runoff businesses, and the new rating, and set forth on creating this portfolio.
Expanding beyond our portfolio to really enhancing the business portfolio. We went on a journey of buying nine companies, entering a couple of others through renewal rights deals and expansions, to be able to create a portfolio that was much more distinctive. That's really what we've been working on. Now, where we are in the journey is that we're pretty much settled in. What's great about being here where we are, this year, it's really about just creating financial leverage. We have all the businesses, we have the geography in place, we have the business operating models in place, and now what we're doing is working on the margin through the levers that are available to us. We are really in a quite good place, to be able to increase our margin and our value in a pretty significant way.
The three levers that we're working on, and we've been working on that really positions us well, is this better mix of business, both geography and line, more distinctive strategies within the business, and then finally, this value proposition that's quite unique to our company, and I'm going to talk a little bit about, and makes us probably the most talked about company in our space because of our position with some of the better agents in the country. Again, each one of those levers are important. Let me just talk about geography. When we started in 2003, the P&C business was 70% personal lines and 70% four states, and they happened to be the worst four states in America, Mass, New Jersey, N.Y., and Michigan. The fifth state was Louisiana, the sixth state was property in Florida. You cannot create a more difficult mix.
By 2008, we were still about 57% in our core four. We're now about a third. Our portfolio has now spread nicely. Our geography and spread is very even, and distributed appropriately to better positions as far as regulatory reform, but also in places that have upside both demographics and the mix of lines of business. This is probably the most important thing. Again, one of the things that people that follow the industry don't realize is that, yes, the industry in total, underperforms cost of capital through the cycle. But what's even more interesting is that many of the lines of business and many of the geographies are always worse than the cost of capital. If you looked at our entire industry, there's about 18% of the lines of business that make cost of capital over the cycle, and most don't. It's really quite interesting.
There's a lot of reasons for that. The excess capacity, mutuals dominate certain states and certain lines. If you look at the best companies, 40% of their mix are in the better categories. It's not enough. You just can't do that. There's a lot of people that do cruddy in the best lines. To be world-class, to be top quartile, it's hard to have the worst mix and outperform. Of the top 50 companies in the country in 2008, we had the worst mix. 15% of our lines of business were in the attractive. While we outperformed, like our Michigan personal lines, we outperformed seven points to the industry. We do it very well. If you're going to be top quartile through the cycle, it's hard to have that bad of a mix.
Where we find ourselves today is we're now the same as the top quartile. We have about 40% of those attractive, and frankly, given what we did this year with Chaucer, et cetera, we're about 43. We have an attractive mix of business. Again, I say this isn't enough. There's a lot of people that do poorly in good lines, and there's a lot of people that do well in poor lines. It was a very important part of what we tried to do. As you look at our mix today, from 2008, we went from a $2.5 billion company. We're about a $4.5 billion today net and about $5 billion growth with this broad portfolio. In addition, and probably most importantly, in each of these businesses, we've created a very distinctive approach to go to the market.
In Small Commercial, we have the most distinctive operating model. We're the only one of the top four. We're kind of top four, if you will, in Small Commercial right now. If you look at our operating model, we distribute new business underwriting that's tied to all our automation. Sure, we have all the straight-through stuff, and we have all the automation like everybody else does, but particularly for that 25-50, we distribute our new business underwriting for the stuff that's a little different, which gives us an enormous advantage of what's really Main Street America. We have the efficiency of the renewal centers and all the automation, but we've spent so much money on automation, we can have remote people that can get into an agent's office and take advantage instantly of opportunities. Every one of these segments, we have a little different.
In Middle Market, we're an industry-oriented player. Almost all our business is around industry solutions, niches, and segments. We have end-to-end solutions for things like fine arts or cultural institutions. It is a very value-added approach to that business. If you look at personal lines, we have an account-oriented value approach that's full account that is very different, kind of a near affluent approach to that $1.6 billion business for us. With each of these, we try to be a value-added player that picks some niches and goes after it. We're not only broader and in better lines of business, we're a little bit more distinctive. Our value proposition. One of the things that people don't quite understand in our business is the consolidation that has occurred to the better agents.
The better agents and brokers in this country have really done a lot of acquisitions, but also a lot of investment in how to deliver industry solutions. What the question for us was, is we had a lot of small agents. You could imagine as a personal lines company in four states, we didn't have those kind of relationships with the top thousand. One of the things we did is we created a very clear value proposition that gives them greater franchise value. We have fewer appointments than any company in the top 20 in the industry. We give much more franchise value locally. We do retail straight on things like Specialty. We don't go through wholesalers. We go directly and built operating models to go direct to folks to provide Specialty business to retail agents.
We are very big around this local responsiveness and quick turnaround. That value proposition has allowed us to double our position with the best agents in the country. Today, we have $3.5 billion with 800 of the best agents in the country. That alignment of incentives is everything because what happens is through profit sharing and alignment of incentives, when you're trying to get price increases like in today's environment, it is very dangerous because you can get price increases, but adverse selection if you push too hard. If you have your business aligned with agents where you have a lot, where you have profit sharing in your lines, they're with you on how to get the best mix as well as the price.
It's why what you've seen us do is we've been able to get more price and hold our retention than almost anybody during this transition. For us, this whole shift to the best is big. By the way, those are the folks that are buying people. What happens is as they buy other agents, they shift share to us. We have a built-in ability to grow because those same 800 that I have $3.5 billion with, we only have 3% share. Our headroom with their consolidation and their move forward allows us to think forward in an easy way to profitably grow. Again, this is a big part of who we've tried to become. Over the last 5 years, we've made good progress as far as our size and our earnings power and capital. We've had a very difficult couple of years.
The weather in 2011 and Hurricane Sandy has really done a number on us. We're very proud, and I'm going to talk a little bit about of how resilient we are with something like Hurricane Sandy, which is really a storm that hit our biggest concentrations by zip code. We still didn't even hit our reinsurance retention. It tells you we've done a lot around our spread of risk, but our mix has changed. Since the last 5 years, even with all this change and all this investment, we have consistently outperformed the kind of regional company and Small Commercial in the industry. We are not where we need to be in top quartile. What you see is we have shifted and outperformed the regionals, but we consistently not at the top quartile.
Given all this investment, given all this change, the number one thing we need to do now is make sure we're outperforming and moving towards the top quartile, which is why we built the portfolio we built. If you think about 2012 and the transition, a lot of things happened to us because of the Chaucer. We obviously grew, as Chaucer got integrated into the business, and we had momentum, very significant momentum in our commercial business as well with all the new businesses. We were able to increase our dividend and move forward. Sandy was the story in a lot of ways this year for the company. As I step back, one of the most important things that our strategy has allowed us to do is aggressively attack our mix.
What I mean by that is that in the industry today, most people will tell you that this weather is something that has to be addressed. The volatility and the intensity of what I call kitty cats, which is we've gone from just few hurricanes to micro storms that are very intense, have changed people's perspective. It requires that you think about your micro concentrations of business because your micro concentrations create a marginal cost of capacity that's quite high if you're overly concentrated, and it'll cause a lot of volatility. What you're seeing is a lot of people working on those micro concentrations. What we did this year is we got rid of about $175 million of business.
Because of our strategy and our partnership strategy, we're able to do that by shedding legacy agents and doing deals with people to do renewal rights and other things to sell that business or move that business off relatively rapidly. We've done a lot of work there. We feel very good about our portfolio. We did grow a lot this year, but we did get rid of $175 million at the same time, and we have about $75 million more I'd like to do. What this does, guys, is it emphasizes the importance of diversification spread of risk, and good pricing, because nobody knows where these events are. That's why you're seeing an interesting way. I think you're going to see sustained pricing because of this and yields. There will be sustained pricing in the system because people can see what's happening.
Sandy, again, we're very proud of Sandy. Hanover was named after Hanover Square. We were here for 120 years before we moved to Massachusetts. Those zip codes were some of our most significant zip codes in the country. The models would've had us at something like $350 million. We had about $170 million. What we've done is we've managed our aggregations very well. We've done a great job in underwriting. We had no large losses. We had a number of losses, but no large losses out of it. I think we had one $5 million loss out of the whole thing. For us, that tells me that our diversifications work, and we did not use our reinsurance even. This is the second worst storm in history that hits our hometown, right?
For me, that makes me feel good about the resiliency going forwards of our earnings and where we're going. The other issue in the industry that I just want to comment on, clearly there is a severity thing in auto. Again, what's interesting about it, I think there's a lot of people that will talk about deaths per thousand highway miles, et cetera. For me, the key here is making sure that you've got the right mix and you're getting rate. In this year of transition, while we had some issues like everybody else in the industry did on severity, we've got really good rate above inflation, and we're reacting very quickly on top of that. Again, as we look forward, we feel very good about our results. In 2013, it's very simple.
It's all about leveraging the position we've built to create a world-class return. We believe that's 11%-13% through the cycle. I know that yields are going down, but we believe that in our book of business, we have a little bit less tail than most and float than most. Their ability, given the positions we've built over the next two years by working at three things that we're working on. One is obviously the financial performance and leverage through pricing and a little bit of operating model work we've got because we've built so many businesses, we have some expense leverage that's still in front of us. It's continuing to look at the mix and improving our mix, both to get volatility down, but also to get more margin in the book by increasing our Specialty and unique niche position.
Finally, continuing to leverage this shelf space I talk about with the agents. The lead market that we compete against, you all know who they are, I won't name them, that's those same businesses where we have 3% with those agents, they have close to 15%-20%. Our headroom with those really good agents is significant. Continuing to build that shelf space as we build out the products is right in front of us. I mentioned pricing in 2013. The reason we're confident in what's happening in 2013, this is both our pricing and both our personal and Core Commercial, as well as our retention. What you can see is obviously the market's helping. What I like about it is that our average policy size is small, like in commercial. We're getting really solid and growing price increases.
December was better than October, January was better than December. We're getting very good solid price increases, and our retentions are holding beautifully, even with this notion that we shed some business to reduce the volatility. Again, we are in a very good position to continue to improve our mix and improve our pricing. On expense, as I said, when we did so much building and buying of companies, we took what I call an expense risk versus a loss risk. In our business, you don't want to get in businesses you don't understand. You want to invest in the capabilities, the people, the technology before you do it. We invested a lot, we really increased our expense ratio when we went through this process.
As we have moved forward, obviously that's come down dramatically, and I think over the next two years, we'll get another point half or two out of commercial because we are now digesting that investment, it was the right way to do it. We took an expense risk, and we didn't get in a situation where we were extending ourselves and the appetite before we knew what we were doing. I feel very, very good about that lever as well. If you look at our Specialty position, which we worked hard to build, we are now one of the significant Specialty players in the markets we're in. We're about $700 million with a good portfolio of professional lines, some special industrial HPR type business, some program business and liability areas, and Marine and Surety.
We built out a diverse Specialty book direct to retail agents, which is a really nice solid diversifier for us with high margin. Chaucer, again we worked hard. We believe very strongly that a Lloyd's platform with its efficiency of capital is a great add to us. It was a Specialty oriented company. This isn't really a reinsurance company. This is a Lloyd's Specialty company. There are 13 or so really very strong embedded skill sets, and it's about $1 billion. It's performed very well for us. We made this year $136 million pre-tax out of this portfolio. What we love about it is the skill sets are strong. They're applicable to our partner agents in a number of categories in the U.S. as well as out of the Lloyd's platform.
We're able to leverage this platform to really provide a distinctive opportunity for our agents in places like aviation and Marine, in particular energy. We are now one of the better energy providers in the country and in the world, frankly, in things like platform and some of the alternative energy. It gave us an additional set of capabilities that we're very excited about having in the portfolio. As we think about the balance sheet, again, my point is that during the cycle, during the transition, this is the time you want to take advantage of the opportunities, and you've got to come with a strong balance sheet. We feel terrific about it. We have mostly short-tail lines. We have a lot of liquidity, and our debt ratios are in a very good place, and we've always been very conservative on the investment portfolio.
We are not one of the companies. I don't try to believe I'm a Warren Buffett. Our portfolio is very boring, and we're glad it is. We believe that we have a nice set of embedded yields. Like everybody else, we've seen monies going down, not a lot of the portfolio turns every year, we feel like it has some stability to it, and we feel very, very good about our balance sheet right now. As I look forward, we are very excited about the next couple of years. We believe that we built something very lasting, very distinctive.
What our goal has to be is now to leverage that platform effectively, to make sure we're getting the pricing, that we're continuing to work the mix, that we continue to reduce the volatility in our mix by the combination of all those, and to make sure that despite the headwinds in our industry with the yields, that we are able to continue to move forward in top quartile on our yields. I think you've seen our outlook. We're very comfortable with our outlook as a significant improvement this year and a significant improvement the following year as we build on this momentum that we have in the business. Again, as far as any of the book value measures, we end the year at actually the highest book value we've had for sure in the 161 years of the history of the company, probably helped by the yields.
We feel like we're in a good place. We've obviously increased our dividend every year. When the company was troubled, they had reduced the dividends, and I've tried to reestablish those, and we feel very, very good. We think it's an important part of what we provide to the shareholders. Part of the turnaround, what we've done during this turnaround is we had, as I mentioned, a lot of runoff businesses that we either shut down or shut down and sold. We were able to take the proceeds of that every time that I felt that we had excess capital to give back. We've given back about $800 million to our shareholders during this turnaround in the form of either dividends or share buybacks.
We've tried all along the way, not just invest in the company, which was important, the most important thing, but to also, anytime we had the excess capital, to be able to make sure that we were being thoughtful in returning to shareholders during this time frame. Again, as I close as the last presenter of this conference, that's a lot of insurance, by the way. The investment thesis. What's interesting about our company, as I said, because we're 161 years old, you're going to think of us as old. We're actually young. We're new to a lot of people. We've made a lot of changes in a business that doesn't like a lot of changes.
What we've done in a very thoughtful way, in a very deliberate way, every day for nine years, is to build a platform and a portfolio that can sustain returns through the cycle. What we've been able to do, even through the financial crisis, even through the worst weather in history, is continue to move this company forward with a portfolio that allows us to say we're going to be able to do that. Over the next two, three years, we believe through this portfolio and this unique value proposition and distribution set up, that we're able to continually improve our returns and get to what we consider top quartile returns through the cycle. We believe we control the levers now.
Now that we have the portfolio, now that we have the position with the agents, now that we have the ability to get the price in the mix, we believe we're a good stock to hold. Obviously, our valuation, because of all the things we've done and the uncertainty that comes with that, is at a place that it is also very attractive as well. We think we're probably one of the most interesting stories in our industry for the next two, three, four years, and we think we're in a great place to move forward. With that, I just want to say thank you. I guess we can take questions.
I do have some questions.
Sure.
You talked about the agents and the quality agents' offices you're in and the selectivity.
with which you've chosen your agents. Where do you rank in those agencies? If I said, what percentage of your agencies are you top three or top five, where do you stand?
That notion is kind of a very important notion because as agents, as we all know, agents have to place most of their business. There's a pecking order of who's their partners and who's not your partners. It's why this has been such a deliberate strategy to do this from the top, from the principal down, and to make sure we position ourselves with the best in the country. Jay, the way I would answer that is if you went to all 1,000 of our top agents and you said, "Are we one of the most important 3 agents they have?" It would be 100%. If you ask them who their most important market was for the next 5 years, to those 1,000 guys, 95% would say we're the most important market.
If you asked if we're the biggest in a lot of those agents, say Barney & Barney. It's a $700 million agency. There is probably 3 other folks significantly better than us, who are now $30 million with us. Those other businesses they've had for 40 years to get to that level. With us, they've been with us for 7. We know more about their business, they know more about us, and the upside together is greater than their lead market. What I can tell you very confidently is that they think about us differently. If you look at that 1,000 agents, most of those agents, we do not only just planning with, we do multi-year planning with. If you look at my time, I have spent probably one day in 100 of those agents to present to all their employees.
We're a very unique animal, we don't just do it the way other people do it. We actually choose those partners to have franchise value with, and then have a whole strategy with them to get to the most important position in their market. Again, some of those will only do 3 of our businesses. They might only have Specialty, or they might only have personal. Each one has a different portfolio based on what they're good at. I can very confidently say where we are today with those. There is another 300 that are emerging. We've said to each other, we want to be franchise partners. We have a good start, but we're on the process. There's all these criteria to get there's all these touch points to get there.
Again, there is no company in America that knows their agents better than we do. We know their portfolio. We know what they're good at. We know what they're not good at. It's just a different approach. Most companies our size would have four to five times more agents than we do. It's a whole different kettle of fish than having a lot of agents. We have to know them well because we have fewer.
Right. The other question I had had to do with your reinsurance retention. Here's the Hurricane Sandy, one of the biggest storms to ever hit the U.S.-
Yeah
You don't even hit your retention.
Yeah.
Maybe your retention's a little too high.
Yeah. That's a great question. We are a unique company in that our concentration on what we buy our CAT treaty to is really the Northeast. Obviously, you worry about the top end as much as you worry at the bottom end. The Northeast, because of its infrequency, we retain up to $200. Now, when I say infrequency, I didn't realize that 30 years before I took this job, we hadn't had a New England hurricane. We've had two in the last two years, so maybe infrequency is not the same anymore. In any cost benefit, it would be very hard for us to buy down because it's so infrequent, right, to sort of pay for this. By the way, we hit it what? We did about $170 domestically. To buy down to $100, it would be very hard.
You'd have to have one every year to really make that cost effective. That makes us unique. If you were in Florida where you had a frequency, right, you'd think about that different, it's a very Northeast-centric issue for us.
My last question had to do with the Specialty business in general.
Yeah.
Do you have the Specialty products now that satisfy your agents' needs? Obviously, Charles River brought you more product capability.
Yeah.
I'm sure that it matched up perfectly with what your agents need, are you where you need to be?
That's a great question. Part of the reason I went out and bought some of these companies or built some of these is we did a profile of our partners of where they were investing and where they had dedicated resources, like whether it was LPL in architects and engineers. What we did in healthcare is very specific to what we saw from agents. There's obviously lots of other things we don't do, right? There's lots of things. What we wanted to do was the kind of Specialty we wanted was smaller face value, things that many of our agents had that we could go direct retail and provide it. What you see us do is smaller architects, engineers, smaller lawyers.
What we're doing in HPR, which is highly protected risk, industrial risks, with the industrial risks that were in that $100,000 range that all our agents had a lot of that and they needed it. Our Marine is more dedicated to the kind of business that you see kind of in these under the 5 brokers. We like what we have. We like with our portfolio. Is there other opportunities? Sure. We don't have as much Specialty auto, for instance, that we could easily have, but I don't feel we have the skill set to do that. I feel that's something that I'd need more capabilities in claims and driver education, et cetera, to do well. We think it's well-matched, but there's other things we could do, and we think the upside of it, just in the businesses we are in, is quite good.
For instance, in D&O, we don't do public D&O, we don't do Fortune 500 financial service or anything. We do private. We do not-for-profit, right? That's the kind of stuff we've specialized in. Our agents have lots of that. We've just chosen to not do the other. I like where we are, but there is other opportunities over time, I would say.
Right.
Okay. Any other questions?
Just a quick one on capital return. I noticed it was about $75 million in the last few years. As you're starting to get into this harvest phase now that you're talking about-
Right
We're going to see something consistent with that this year, or does that have a chance of moving higher this year?
Again, the way we think about capital, as I say, there's a combination, whether it's dividends or share buybacks or whatever. Obviously, the last two years, earnings were very reduced because of weather. Even though our share price was attractive to do that, obviously that option was less attractive to do more. As we go forward, we kind of look at three things. We look at the ability to deploy that capital to high return businesses and build our business. We look at returning, how would we return if we have excess capital to the shareholders? Within that, we say, what's the best way to do it? We always consider that as one of the options.
What has happened historically is when I've had a lot of excess, the share buyback has always made sense because of where our price was and what the alternatives were. As we look forward, I don't see a lot of significant increase in share buybacks until we get our earnings to a higher level. We obviously have lots of business opportunities that we're considering. It is part of the portfolio that we always look at, and we're going to constantly look at it. I don't think it's going to jump up a lot this year and change dramatically given where we are for earnings. Okay?
Great.
Thank you very much.