Good morning. Welcome to The Hanover Insurance Group conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your touch-tone phone. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.
Thank you, operator. Good morning. Thank you for joining us today. Participating in today's call are Fred Eppinger, our President and Chief Executive Officer, David Greenfield, our Executive Vice President and CFO, and participating from London is Andrew Robinson, Executive Vice President, Corporate Development and Risk Management. Before I turn the call over to Fred for a discussion of this proposed acquisition, let me note that the webcast with a complete slide presentation for today's call is available in the investors section of our website at www.hanover.com. After our prepared remarks, we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today, other than statements of historical facts, include forward-looking statements. These include statements regarding our expectations of the potential benefits from the proposed acquisition of Chaucer, including with respect to future accretion, improved business mix, distribution opportunities, and other benefits.
Forward-looking statements also include estimates of first-quarter catastrophe losses and segment income after tax per share, as well as statements regarding guidance and other projections for 2011 or beyond. There are certain factors that could cause actual results to differ materially from those anticipated by our press release, slide presentation, and this conference call. We caution you with respect to reliance on forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release, slides two and three of the presentation deck, and our filings with the SEC and Chaucer's public filings, which are available at www.hanover.com and www.chaucerplc.com respectively. The proposed transaction is subject to a number of conditions, and there can be no assurances that it will be completed or that we will achieve the benefits anticipated.
This is not an offer to sell any securities of The Hanover or a solicitation of any vote or approval of the transaction by holders of Chaucer shares. Today's discussion will also reference certain non-GAAP financial measures. Please see slide three with respect to such measures. With those comments, I will turn the call over to Fred.
Thank you. Thank you for joining us and making time for our call on such short notice. Early this morning, we issued a news release announcing terms of our offer to acquire Chaucer Holdings plc. We are excited about this tremendous opportunity for our company and our shareholders. This transaction would bring together two strong and complementary organizations with similar cultures and business philosophies. It will accelerate our journey to create a world-class P&C franchise by creating a more diversified, balanced company with greater scale, broader expertise and product portfolio, and greater earnings power. It will significantly advance our specialty strategy and should significantly improve our business mix and strengthen our position with some of our most sophisticated and successful partners.
The financial implications are also attractive, as we are able to deploy our excess capital to an opportunity that we expect will be accretive to shareholders and, more importantly, is a strategic transaction that should build long-term shareholder value by improving the distinctiveness of our company and enhancing our long-term returns and book value. We've been considering opportunities such as this for about a year. We have been looking at Chaucer in particular for quite some time. During this time, we got to know the company very well, and we could not be more excited about their talent and their approach to the business. Before David discusses some of the more specific aspects of the financial arrangements, I would like to review key points about this opportunity. First, I would like to share how we see this transaction enhancing our current long-term strategic priorities.
Second, I want to give you an overview of Chaucer, a company with broad product capabilities and which we regard as having one of the strongest underwriting teams at Lloyd's, and discuss some of the strategic benefits of the transaction. Third, I will share with you how I will align our organization after the transaction. Fourth, I want to give you my view of the financial strength and improved profitability prospects for the combined company. We expect the acquisition of Chaucer to provide numerous strategic benefits that will accelerate our current long-term strategy. As you know, early in our journey, we set a goal of building a world-class property and casualty franchise with top-quartile returns through the cycle, 11%-13% ROE.
After the early work of reestablishing profitability, strengthening our balance sheet, and shedding the life company and other runoff businesses, we have been intensely focused on fulfilling this vision. To achieve this vision, we have focused on three things: improving our financial strength and earnings power, enhancing the quality and distinctiveness of our product mix, and strengthening our position in shelf space with winning agents and brokers. Slide five illustrates the company vision that has driven our activities. While more work has to be done, we have made great progress on our journey. We are a completely different company than where we started the journey. In the era of financial strength, we have gone from a financially strained company in 2004 to a company that has generated significant earnings and capital growth.
This improvement has led to rating upgrades, a significant reduction in our cost of capital, enabled us to return over $700 million in capital to shareholders in the form of share buybacks and dividends, and has created the current capital flexibility to capitalize on an opportunity like this without diluting our shareholders. We have also made significant progress on building a distinctive product portfolio. Our product portfolio has improved dramatically from a $2 billion company with two-thirds of our premium in personal lines and 70% of its business in four states to a company with a more balanced and attractive portfolio. Today, we are a $3 billion company with a geographically balanced mix, with an equal balance of personal and commercial lines, and a much more distinctive portfolio, with over $700 million in annual premium in specialty and niche business compared to $70 million in 2004.
This shift has come from our successful efforts in both building businesses and buying businesses. We have successfully integrated five specialty acquisitions into our organization over the last three years, and have done so by maintaining a disciplined approach to underwriting, as demonstrated by improving reported underlying loss ratio results. The attractive portfolio Chaucer brings is another significant step to improve our mix. We have also built a very strong position with winning agents. Because of our expanded capabilities and investments in our field network, our position with many of the country's best retail agents is very strong and growing stronger. We now have a national network of partner agents where we have preferred shelf space and tremendous momentum for growth. Many of our better agents are increasing their focus on industry solutions and more specialty lines, and our enhanced portfolio is positioned to capitalize on this shift.
The addition of Chaucer is a logical step in building on this foundation and will help in all three areas of value. Obviously, its strong financial track record and quality of their portfolio and people should continue to strengthen our mix and earnings power. A number of their businesses, like energy, marine, aviation, and other segments, will enable us to grow and enhance our position with an important subset of our partners. Let me talk more specifically about Chaucer and why we believe it is such an attractive opportunity for The Hanover. On slide seven, there's a snapshot of Chaucer's business. With a tradition in insurance going back to 1922, Chaucer today has the capital capacity to write over GBP 700 million or $1.1 billion of premium and is one of the 10 largest managing agents at Lloyd's.
In the years since its formation as Chaucer Holdings in 1998, the company's management has built a very strong and respected Lloyd's underwriting franchise. A part of Chaucer's business has the traditional syndicated business that you routinely see at Lloyd's. More importantly, Chaucer has been successfully developing positions in many regional markets, including in the U.S. In its new strategic vision, which the company rolled out in 2010, Chaucer's management focused its attention on getting closer to local distribution and aims to build stronger broker and coverholder relationships and an international network to secure chosen global business. This similarity in strategic focus is one of the reasons we believe that Chaucer is such a good fit in our organization. Chaucer's lead syndicate is Syndicate 1084. This is a multi-line syndicate writing energy, marine, and other specialty businesses.
It also writes reinsurance and U.K. motor business, which includes commercial fleet as well as personal auto. The diversity at the heart of Chaucer's underwriting portfolio is one of the key strengths of the business. One of Chaucer's most valuable competencies lies in the energy sector, where they are regarded as one of the leading markets in Lloyd's. Chaucer is making good progress on the implementation of its new global energy practice, which they announced in November in 2010. The new practice incorporates Chaucer's current energy and engineering expertise to provide a fully integrated underwriting capability for broker and client requirements. This is an area of great interest and opportunity for us as we go forward together. Chaucer's marine business is made up of ocean, cargo, hull, and marine liability coverage for modern blue water risks, as well as protection against political risk and political violence.
For us, one of the most attractive parts of Chaucer's marine business is related to political risk support for U.S. businesses with some cross-border operations. Aviation is yet another attractive area for us, with a focus on the small general aviation sector. Chaucer's product portfolio is balanced with motor business. While this market has been difficult over the last couple of years, Chaucer has achieved rate increases of 17% in this business in 2010 and plans for additional positive rate action in 2011. This should allow them to outpace the loss cost trend and show improvement in underwriting results in this line in 2011. About 19% of Chaucer's business is written in reinsurance. It's split between property and casualty classes, which we view as an effective earnings and risk diversifier.
Syndicate 1176, Chaucer's second in-house syndicate, is a monoline syndicate providing coverage to the nuclear industry, which is one of the most sought-after capacities at Lloyd's. This syndicate is consistently one of the most profitable syndicates at Lloyd's. Finally, Chaucer has a turnkey solution. As new entrants come to Lloyd's market and provide capacity, turnkey Lloyd's entities ensure underwriting oversight, all the actual framework, technology, and everything else that supports the ability to write business through Lloyd's. Within Lloyd's structure, Chaucer has achieved this designation because of its quality of management, infrastructure, systems, people, and process. The performance of Chaucer has been very strong, as demonstrated by Chaucer's five-year average combined ratio of 90.6. Solid underwriting results delivered an average ROE of 16%. While they have somewhat lower returns in more recent years as a result of catastrophes, the underlying quality of their business is strong.
We assess Chaucer's balance sheet as extremely strong. Its investment portfolio is very high quality. They hold about half of their investments in cash and cash-like instruments. On the liability side, their balance sheet is also strong. Chaucer's management takes a prudent approach to reserving, as we do. Enterprise risk management is a very powerful driver of why we were interested in Chaucer. Our due diligence confirmed that they have a very high ERM standards and an advanced risk management culture. Chaucer's risk appetite is clearly defined in terms of limit and the volatility they are willing to accept. While the individual risks they write are frequently higher, Chaucer's aggregations are well-distributed and very transparent. Although Chaucer writes larger accounts than what we usually write, its net retentions are strictly limited and well-diversified. We intend to support and develop this longstanding and risk-savvy underwriting team.
Overall, Chaucer has a very diversified product portfolio, well-managed risks, and an extremely well-respected management team. Putting all these strengths together, we believe you have a business that, while not the largest among Lloyd's, is one of the best-run franchises in London. The expertise and insight the management team brings to the table are clearly among the most important points in our rationale to acquire Chaucer. I would now like to move to a discussion of other strategic benefits of this transaction. Clearly, this acquisition would bring immediate and beneficial risk diversification for us. On slide 10, there's a snapshot of what our combined business mix would look like. Referring back to my earlier comments, you can see how this translates into a more diversified portfolio. We frequently talk about our target portfolio being one-third personal, one-third commercial, and one-third specialty.
The Hanover's business at the end of 2010 was about 50/50 personal and commercial lines, with about 18% coming from specialty lines. Our portfolio more evenly spread among property and casualty, which recently has moderated volatility in our results. With this transaction, the combined mix would bring the percentage of specialty business to 28%, closer to our strategic goal, and the proportion of U.S. personal lines would decrease to 38% of the overall mix. With the addition of casualty in some categories, our portfolio would be more balanced, which would be extremely helpful in terms of risk and earnings diversification. A combination of Chaucer would bring a segment of reinsurance business to our portfolio. Reinsurance is an attractive diversifier for us, and we would manage it appropriately as part of the overall business mix.
Additionally, U.K. motor business, while not relevant for our U.S. distribution, would provide added diversification benefit to our overall business and geographic mix. In summary, each of Chaucer's business segments is important for us in their diversifying aspects. Slide 11 illustrates the added benefits of greater geographic reach and scale that Chaucer would bring to us. The combined company would write $4 billion in premium and would have over $12 billion of assets on the balance sheet. In the upper right-hand corner of the slide, you can see Chaucer's geographic mix. The largest portion, 38%, is attributed to worldwide exposure, capturing all risks which have an international component to them. A portion of these risks originate in the U.S. or are U.S.-centric.
Among our goals for this acquisition is to enhance our partnership strategy with winning agents and brokers and complementing our distinctive product capabilities with those provided by Chaucer and Lloyd's. The benefit of our distribution network are meaningful, and they come from specialty expertise that Chaucer brings in the areas of energy, aviation, political and trade credit risks, among others. In energy, the company writes business at all stages of the production cycle, including exploration, distribution, and energy construction. Their onshore exposures come from renewable energy contractors, and pipeline services. Given the growing nature of this business, we believe that The Hanover's strong and established distribution platform will provide Chaucer with additional market opportunities and give us a strong position with many significant agents and brokers. Another example of an interesting opportunity for our companies is associated with Chaucer's expertise in political risk and trade credit.
Many of our distributor's clients move manufacturing offshore and trade internationally. We are seeing demand for ensuring payment for export trade transactions or for political risk coverage, which insures assets in emerging markets. Many of our more sophisticated middle-market agents would like to have more direct access to a carrier who could provide these capabilities. Our view of potential distribution synergies between the two companies is consistent with how Chaucer views its future strategy as well. As I mentioned earlier, Chaucer's management has been focused on ways to get closer to regional markets, especially in the U.S., which is the largest insurance market in the world. Chaucer recognizes the potential for developing a strong distribution network through our relationships with agents and brokers. Chaucer's management is highly motivated by the alignment of our long-term business strategies. We also believe there's a strategic benefit to being part of Lloyd's.
Moving on to slide 13. As I mentioned earlier, Chaucer, as a member of Lloyd's, offers numerous benefits and attractive opportunities. The Lloyd's market, which produced over $35 billion of gross written premium in 2010, is a highly diversified and well-regarded insurance marketplace. It is known for its ability to provide innovative, tailored coverage and capacity for unique risks. Lloyd's is largely a subscription market, which means the loss exposures brought into the market are typically insured by several and often many insurance companies or Lloyd's syndicates. This allows for a very high level of risk diversification and provides a strong and efficient capital platform. Lloyd's carries an A excellent rating from AM Best, which is important because all members of Lloyd's underwrite business backed by Lloyd's financial strength. They enjoy a highly efficient capital model due to the mutuality and the layers of Lloyd's capital security.
In addition to capital-related benefits, Lloyd's also offers strategic opportunities for product and geographic expansion, which translates into significant growth opportunities for us going forward. Many of these benefits can be achieved in the near term, but there are also tremendous strategic flexibility and array of business opportunities for us in the long term. I would like to now touch on the organizational structure and combined leadership team. The degree to which any company succeeds over time is a reflection of the quality of its people. We place great value on the expertise of Chaucer's team will bring to our organization. Bob Stuchbery would continue to lead the Chaucer team. Bob was the Chief Underwriting Officer at Chaucer for many years before he was appointed to the Chief Executive Officer position in 2009. He brings over 30 years of Lloyd's underwriting experience.
He is also Deputy Chairman of the Underwriting Committee of the Lloyd's Market Association Board, the organization that facilitates adoption of best underwriting practices and is known as a valuable source of industry insight. Bruce Bartell, Chief Underwriting Officer, joined Chaucer in 1988 as active underwriter of Lloyd's Syndicate 1084, and was appointed Director of Chaucer Holdings plc in June of 2009. His main responsibilities include managing all underwriting functions within Chaucer. The depth and expertise of all the divisional heads who work under Bruce's supervision are also very impressive. Chaucer supports underwriting with a highly qualified and professional claims team, which has extensive Lloyd's marine and non-marine claims management experience. While Bob runs Chaucer's business, Marita Zuraitis will continue to lead Hanover's property and casualty business in the U.S. Marita, as you know, has been president of our property and casualty company for six years now.
We expect the integration challenges of this opportunity to be minimal. The Hanover and Chaucer's businesses are complementary to each other, and we anticipate little overlap in operations. The businesses would continue to be managed locally at the business unit level as they are currently. Obviously, we will coordinate some of the distribution initiatives to develop and capture some of the opportunities we see developing in the future, but that is something we do well with all our specialty businesses today. The combined organization would be supported by centralized corporate functions, and we have the right leadership already in place to fill these roles. Before David goes into the details of financial arrangement, I would like to give you my view on the financial opportunity. This is a very attractive financial opportunity for The Hanover.
Through the quality of their business mix, the financial performance, and very efficient capital model, we expect the combination to improve our current and future returns. In addition, our combined size and capital access should allow us to capture additional opportunities. This opportunity is particularly important given where we are in the cycle in some of their businesses. The more important benefit comes from improving our competitive position. This is another significant step in significantly enhancing our product mix, advancing our specialty strategy, and strengthening our position with many of our distinctive partners. With this transaction, we expect to have a portfolio mix that will enhance our ability to achieve attractive returns throughout the cycle, and combined with our distribution strength, should create significant profitable growth opportunities. With that, I will turn it over to David for a discussion of financial aspects of the transaction.
Thank you, Fred, and good morning, everyone. Fred has already laid out a compelling case for why this acquisition makes sense for us, including its attractive financial profile. I'll just take a few more minutes to run through the transaction details and touch on our view of the expected profitability and accretive nature of the transaction. I'll also add some commentary on the strength of the combined balance sheet. On slide 14. I'm on slide 14. Our offer is to acquire all of the outstanding common shares of Chaucer for cash. Chaucer stockholders will receive GBP 0.56 per share, including the GBP 0.027 per share dividend announced by Chaucer on March 7, 2011, for an aggregate transaction value of approximately GBP 313 million, or $510 million when converted at yesterday's closing sterling rate.
This price represents a 1.26x multiple of Chaucer's tangible book value per share at year-end 2010, adjusted for Chaucer's recently announced estimated catastrophe loss activity. The purchase price will be funded with a combination of cash on hand of approximately $235 million, as well as $250 million of new senior unsecured debt that we expect to issue prior to closing. You may recall we had excess funds available at the holding company at year-end. The cash on hand component of this transaction will come from assets currently held at the holding company, including a $99 million ordinary dividend we received from our operating company earlier this month. Under the U.K. Takeover Code, buyers are required to be in a fund certain position at the time of deal announcement.
We have also put in place a bank financing facility and foreign exchange forward that will provide certainty today that we have the funds available to close the transaction. Following the completion of this transaction, we still expect to maintain a comfortable cushion over applicable rating agency standards for capital and liquidity. We have engaged in discussions with each of our rating agencies about this transaction and expect that they will all affirm our current ratings with stable outlooks. In fact, one of the agencies has already released an announcement this morning and favorably commented on this transaction. The U.K. Takeover Code will largely govern the sequence of events and amount of time until closing.
We have already begun the process to request court approval for the scheme of arrangement in the U.K., which also requires approval from the Chaucer shareholders, Lloyd's, and regulators in the U.K. and U.S., and certain court approvals in the U.K. In order for the offer to be approved by Chaucer's shareholders, a meeting must be held and a majority of number of shareholders who represent 75% of the Chaucer shares voted at the meeting, in person or by proxy, need to vote in favor of the transaction. I am pleased to note that as of this morning, certain of Chaucer's shareholders, who collectively own 23% of the outstanding voting shares of Chaucer, have provided what are referred to in the U.K. as irrevocable commitments to vote in favor of our offer at Chaucer's shareholders meeting.
We are working to complete the transaction as soon as possible and currently estimate we would close early in the third quarter, subject to all the aforementioned approvals. In addition to all of the positives that Fred talked about, a combination with Chaucer is an attractive proposition in terms of potential financial outcomes going forward. We currently estimate that the transaction should take our EPS and ROE approximately 10% higher in 2012. Chaucer had achieved an average 90.6% combined ratio over the last five years, despite some significant catastrophe losses incurred by the insurance industry in 2009 and 2010. Chaucer's profitable underwriting is expected to improve over our pro forma combined ratio. The resulting organization would strengthen its risk management platform through a combination of capital modeling capabilities and sophisticated underwriting. We also expect to see important benefits to come from a more diversified earning stream of the combined entity.
The higher proportion of Chaucer's casualty risks would be complementary to the Hanover's property orientation. Additionally, the transaction will allow us to further optimize our capital structure and deploy a substantial portion of excess capital, which in turn should improve our ROE going forward. Finally, in the longer term, we plan to take advantage of the capital efficiency of Lloyd's by having the capability to write some of the Hanover products through Chaucer. We believe we can achieve scale benefits through growth in energy, marine, and aviation, as well as other specialty lines with our larger partner agents, as well as realize additional strategic and financial benefits that access to the Lloyd's market provides us.
Considering the magnitude and timing of the Japan earthquake, I'd like to provide more context on our assessment of Chaucer's expected losses for valuation purposes, and more importantly, Chaucer's strong underwriting and risk management practices, which we believe were validated by recent catastrophic events. Before the earthquake occurred on March 11th, we conducted extensive due diligence with Chaucer and developed a very favorable point of view on their risk management and underwriting expertise. After the Japan earthquake occurred, we expanded our diligence efforts to be sure we were comfortable with the resulting loss estimate, as well as to validate that this real-life event was consistent with what we learned in the due diligence process. We were more than satisfied with the outcome of our work in both of these areas. We continue to believe that Chaucer has an outstanding risk management and underwriting team.
We are also comfortable with Chaucer's Japan loss estimate that was announced a couple of days ago, including its conclusion that it does not expect any significant insured loss to arise in respect of Nuclear Syndicate 1176. Overall, we are confident that we've offered a fair and reasonable valuation for the company. In addition to improving our overall underwriting prospects and providing better diversification of risk, the combined company would benefit from a strong conservative and liquid investment portfolio. Turning to slide 14. Over the last couple of years, Chaucer's investment goals were to maintain capital and ensure the company meets liquidity needs at all times. Cash and equivalents made up 49% of the portfolio at the end of 2010, and the rest is essentially allocated to investment-grade fixed maturities.
The average credit rating of the portfolio is double A, and the allocation to sub-investment-grade securities was less than 1% of the portfolio. Chaucer has negligible exposures to peripheral European sovereign debt. About half of the portfolio is invested in the U.S. market, which closely mirrors Chaucer's proportion of premiums denominated in U.S. dollars. Their overall portfolio is rated double A, and the duration is 1.4 years. The combined portfolio on a pro forma basis would have high quality, well-laddered characteristics. Fixed income would represent 80% of the mix and would have an average rating of double A minus. Cash and equivalents would constitute 18% of the portfolio, and only 2% would be allocated to equities and other investments. Moving on to slide 15. I'd like to make a few points on the pro forma capitalization of the company.
As I mentioned earlier, the acquisition will be funded by cash on hand and anticipated new senior debt. As a result of a senior debt issuance, our financial leverage ratio would increase to about 27%, which we believe is an acceptable level within our industry. Over a reasonable period of time, we expect to manage this ratio down into the mid-20s as we continue to build book value through earnings. All coverage and capital adequacy ratios are well within the rating agency requirements for our current ratings. To summarize, we believe the acquisition of Chaucer is financially attractive for us. It should be neutral to modestly accretive to our earnings in 2011 and have a more meaningful impact on our earnings and ROE in 2012. Additionally, the combined organization should benefit from earnings diversification and strong growth opportunities.
It would have a solid balance sheet with a strong and liquid investment portfolio and added flexibility going into the rising interest rate environment. The capital levels of each of the statutory underwriting entities in the U.S. and in the U.K. are expected to remain very strong. Before I turn the call back to Fred, I want to take a minute to provide some information and context about our full year 2011 results in light of our first quarter earnings pre-announcement from last night. We are currently expecting our first quarter segment income after tax to be in the range of $0.48-$0.53 per share, which is somewhat lower than our original expectations, primarily due to higher catastrophe and non-catastrophe weather activity in the quarter. To a lesser extent, our results were also impacted by certain transaction expenses related to the Chaucer acquisition.
Considering our first quarter results as well as the completion of the Chaucer acquisition early in the third quarter, we believe the guidance we provided in February is still appropriate for 2011. I also want to emphasize that we continue to expect our weighted average shares outstanding to be approximately 46 million shares in 2011. For scheduling purposes, we now expect to release results after the close of the markets on May 2nd and hold our conference call on the morning of May 3rd, which is a few days earlier than we announced two weeks ago. With that, I'd like to now turn the call back to Fred.
Thanks, David. Just to reiterate, we are very excited about this transaction. It represents yet another important step in our journey. I expect this opportunity would create significant value for both companies, our shareholders, agents, and employees for both the near and the long term. The strategic rationale behind this transaction is very strong. Together, we should have a more diversified, balanced company with greater scale, broader expertise and product portfolio, and greater earnings power, which should significantly advance our specialty strategy, improve our business mix and strengthen our position with many of our most successful partners. In a minute, I will open the call for questions.
Before that, I'd like to take a moment to thank Chaucer CEO Bob Stuchbery, Chief Underwriting Officer Bruce Bartell, and the entire team at Chaucer and the Hanover team, who have put in a great amount of effort to advance the progress of this transaction. Through this process, it has already become very clear that together we make a great team. I look forward to continuing the great work we've been doing in the coming months. With that, we'd like to open it up for questions.
Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Cliff Gallant of KBW.
Morning, Cliff.
Morning, Cliff.
Morning, Cliff.
Can you talk a little bit about the process of bringing Chaucer on and what changes might be made at the Chaucer operation, and are there any expense cuts that you would expect to be able to make?
Cliff, as you think about this transaction, this is really not about expense reduction. It's really about complementary capabilities and growth opportunities. As I mentioned, obviously the entities will remain separate, and we'll run them that way. We will consolidate the support functions, as I mentioned in the script. I don't see a significant expense reduction as part of the opportunity here. As far as their mix, if you look at their strategic framework that they put out last year, we're very supportive of that framework, and we believe that the focus that they've put out, the changes they've made over the last, and refinements over the last five years, we're very supportive and frankly, I like the portfolio that they bring, and I'm supportive of their strategic direction.
Again, I think the biggest opportunity here is really around growth and our ability to, in those categories, the many categories that are relevant to our top 500 or so agent partners To really capture those opportunities directly with those partners. I like the portfolio quite well.
In terms of lines of business that you mentioned, like U.K. Motor, where there's probably less of that growth for you, will you plan to run that as it is, or will you be paring back that business? How will you approach lines?
Yeah, I think it's early to say on that. Again, we like the business. It's a good diversifier for us. I think what they've done has been very effective in the rate actions that they've taken. Right now, I would say I like the business the way it is run, and I like what they're doing with it right now.
Have you had any reaction yet from your partner agents here in the U.S.?
A great.
Other specific product lines that you expect will be sort of early or the early sellers?
Yeah. It's a very interesting point. I've gotten probably 30 emails this morning from many of our partner agents. The U.S. market's the largest insurance market. Lloyd's supports the U.S. market. Obviously, it does other things. Most of our significant partner agents have some participation in Lloyd's in various different ways. This whole best of both or the national company with a regional approach that we like to talk about, this ability to provide some distinctive products to those that have the expertise, retail agents that have the expertise, has really kind of got people's attention. They look at things like marine, a number of areas of marine, and get very excited about the capabilities that Chaucer provide. Obviously energy, particularly alternative energy, et cetera, there's a lot of our partners have specialty operations focused on categories like that. There's a number of these.
There's a lot of work to be done to do that well and to align it appropriately and get together with them. I think instinctively, our distributors that are sophisticated look at this as another set of portfolio that moves them in a direction that says we're a very important partner for them. Again, not every single thing will fit every single partner. I don't think that's the point, but I think there are a number of these guys. These are categories like aviation and marine that are broad categories where distinctiveness matters.
One of the things I mentioned in my script, one of the big trends is if you look at the, say, the top 1,000 agents in the country, the movement towards industry expertise and knowledge and insight at the distributor has gone way up, and therefore they want to partner with people that have that kind of expertise. I would argue that what we're going to do is continue to look for ways to build a portfolio of those kind of areas of expertise to provide to them. Obviously, Chaucer has a very successful business today, we're going to be thoughtful about how we build those. We just think there's a wonderful opportunity in many of these categories going forward. I'll give you a small example in fine arts, where they are very expert in fine arts. Obviously, we have a very successful marine business.
Fine arts has been traditionally often a place where it comes out of Lloyd's. You know that there's going to be a number of agents that are going to look to us to say, together, what kind of opportunity can there be? Again, we're very excited about this as an opportunity to advance what we have with some of these terrific partners.
Very much.
Thanks. I appreciate it.
Our next question comes from Sarah DeWitt of Barclays Capital.
Hi, Sarah. Good morning.
Hi. Good morning. I wanted to know if you could give us your sense and your thoughts on the strategic fit and the execution risk associated with the acquisition, given its high severity, it's international, and lines like political risk and reinsurance are somewhat outside your core competency of personal lines and commercial lines. Thanks.
Yeah. Let's first go with our sense of the quality of the business. One of the things that we've got to be very clear, this is not a broken company. This is a company with a 10-year track record that is outstanding. It's a company with a longstanding track record in these areas. They also have a very good track record of managing their risk and managing the way they manage that kind of volatility you're talking about. Obviously, that's a lot of why we looked at this company and we're comfortable with this company. I start with that premise, which is this is somebody that does what they do very well. Therefore, we believe that we are bringing capabilities to complement our capabilities. That said, let's talk about both things, both risk and reward.
For us, so much, we've spent a year looking at categories like this because we've always felt that a Lloyd's platform would be very complementary to what we're doing for a lot of reasons. We think the counterparty quality of that is very high and important to our agent partners. We spent a lot of time assessing how we fit, their philosophy about risk, how they assess risk, how they manage risk, how they do risk management. We feel very comfortable that there's a real consistency in all of that. I think part of that fit makes us feel very comfortable. Also, there isn't a lot of smashing together. This isn't about integration or cost reduction, where a lot of the risk comes in transactions is that kind of activity.
Because of the complementary nature of this, we believe actually the integration risk is quite modest. We do believe that we have the insights from the long period of discussions and due diligence to very much have confidence in both the way they do underwriting and their balance sheet. I guess the other point I would make is that people that have followed us understand what we've tried to do. In the last seven years, we've essentially changed this company dramatically. If you've seen this level of senior expertise that I've brought into this company in actuarial underwriting, IT, finance, our skill set is much deeper and broader than a company of our size. It was always with the mind of what we were trying to accomplish.
If you look at what we've done in growing our specialty business very thoughtfully, very targetedly, we have a nice track record of doing that well, taking expense risk, not loss risk, and creating book value growth. I think this is just a continuation of that. I'm very comfortable with the risk-reward trade-off of this transaction, and I think it's going to be a great fit for both their shareholders and our shareholders. It's a benefit to both.
Okay, great. Thanks.
Thank you.
Could you update us on your target of a low double-digit ROE?
Sure
when you expect to get there, given, I think you said the acquisition is 10% accretive to your current ROE.
Sure. We'll spend a lot more time on our earnings call as we go through the details. What I've been saying is that obviously, in the last 18 to 24 months, we made a number of investments as our investors all know, once we got the next upgrade from Best. We had made a number of investments. We did the renewal rights of OneBeacon. We did a number of specialty transactions. We did the national network investment over the last 24 months. We have had a little bit of an expense drag. If you look at our ROE over the last three years, I think it's about 8%. The notion is those investments are coming to the point where they're going to start continually improving our earnings stream as we've indicated. I'm very confident in that.
The leverage on the expense side, the quality of the mix, the rate that we're getting in small commercial and personal lines is good. As we go to earnings call, I'll talk about it. Again, we believe over the next four to six quarters, you're going to see constant improvement and you're going to see a march towards that range. As I said, as we have the earnings call, I'll have more specifics from the numbers that we can talk about it. I'm focused on that. I'm confident in that, and we're going to continue to move in that direction, which is a little counter to the industry, as you know, which, in the cycle, we've seen asset gears improve, and we've seen our combined ratios improve underlying because of this leverage of expense and its improvement in mix.
We believe that will continue over the next four to six quarters. Okay?
Great. If I could just get in one numbers question, do you have first quarter book value?
No, we haven't disclosed that point yet, so you'll have to give that a few more days.
Okay. Thank you very much.
Our next question comes from Mariza Costa of Stifel Nicolaus.
Hi. Good morning, everybody.
Good morning.
Good morning.
I guess David can't get away from reinsurance, huh?
Yeah. Not for very long or longer.
On that note, about the reinsurance business, I know it'll be very small for you, but what plans do you have for that business?
I look at their strategic direction and what they've articulated about how they think about their portfolio, and I'm very supportive of it. It is a smaller position of this business, but their approach to it and how they've balanced it, the property and casualty, I like very well, and I'm very supportive of their stated strategy. This transaction, we didn't buy a reinsurance company. We bought a broad portfolio of specialty capabilities, and we very much support their direction.
Some of the lines that included in this acquisition are obviously new for you guys and kind of following up on Sarah's question. I'm thinking that most of the key people will probably stay in place since this is going to be something new for you guys on the Lloyd's side.
Yeah. Obviously, this has been a very collaborative approach to get to this point in the transaction. We've spent a lot of time together, got to know those, and we are confident. Bob, I think, has already said today in his talking points that he is staying. We are confident that the team is going to be excited about joining us, and we believe that the skills will come and stay based on our conversations and discussions through this whole process. Again, I would articulate this as a collaborative process between the organizations getting to this point, and we are very comfortable about people being excited about this and the opportunities together. It is important, right? Again, as I said earlier, I would think very differently. This is not buying a broken company or a company that needs a lot of fixing.
It was important for us, and we think we're incredibly fortunate the value we're getting here by getting an organization that's successful, that combined because of our capital and size, there'll be more opportunity. This is a company that we believe brings a lot of capabilities that will stay with us.
Okay. On the trade and credit side, do they disclose what geographic areas they're in, or what kind of risks are they insuring there?
I'd rather not comment on their specifics. Obviously, you can look at their annual report. You can look at all their material. There is a number of disclosures about exactly what their businesses are, and it's more appropriate, I think, for you to get that from them.
From them. Sure.
It is a well-managed, and as I commented on the risk management, it is a very effective risk management, is the way they manage the distribution of that and the spread of that.
Okay. Just one last one on the agents. Should I ask this question? Is there any overlap or?
Some, absolutely some. You could imagine, they have coverholders that are some of our larger agent partners, for sure. It is somewhat limited because of the narrowness of their distribution in the U.S. There is some overlap. It's interesting, I've gotten a couple of calls already from folks that work with them today that are sharing their excitement. There is absolutely some overlap, and we're very supportive of their distribution partners, absolutely. We feel good about it. Again, U.S. is the largest market in the world, and it's going to be some natural overlap because of that, and we're very excited about that, actually.
Okay. Thank you. Congratulations.
Thank you.
Our next question comes from Ian Gutterman of Adage Capital.
Hi, good morning.
Good morning.
My first question is, I normally think of companies accessing, agents, I'm saying, accessing Lloyd's or the wholesale market. Does this mean you're going to ask them to essentially skip the wholesale broker and go directly through you?
No, what has happened, a lot of the cover holders, as you know, are experts in their field. There are those that are building that expertise, that are broader than they can reach to, and we will be developing those relationships to people that have that expertise. Again, I think we're not commenting whether it's wholesale or not wholesale. It really is about the expertise that those have and accessing those with expertise.
Okay. Really, I don't know if you would know this off the top of your head, but if you can give me maybe a ballpark. How much of your typical partner agent's business today is personal versus traditional commercial versus specialty?
It's a great question. If you look at our partners, we do a ton of research with our partners, actually. What you see is that in the last 5 years, that percentage of specialty has gone up dramatically. If you look broadly on our average agent, it's +35%. If you go up to let's say the top 200, that number gets closer to 40%-45%. Again, you could argue, what exactly is specialty? You're talking industry specific or specialty lines as the industry kind of broadly defines it. You're seeing that percentage essentially grow. How come? A lot of these agents have bought specialist distributors and assembled them together. Part of them have invested in industry specialization. Again, it's one of the things that we see. You know our strategy, but what's happening is that is even going down to small businesses.
If you look in our small business, why we're investing so much in launching small niches, you're seeing that notion of specialization in industry really pushing down so that they're more knowledgeable and more comprehensive, if you will, in the solutions around industries. This is a very, in my view, big trend. One of the fascinating things is that our industry has gone the other way historically. They've unbundled these coverages and unbundled which companies handle with pieces of these risks from the old days. One of that creates a lot of complexity, particularly in the average policy size of some of these businesses. Our view is that this is not only a growing trend, something that we've hit well. This is something that we feel comfortable in with this notion of more industry-focused knowledge and insight, more specialty business.
Again, it's not for everybody. What this is agents will start picking their specialization and areas of expertise more and more and more, and we will align appropriately with them as they do that. Again, this is something we watch very carefully. Again, I would tell folks that if you recall our investor day 3 years ago, a little over 3 years ago, I laid out this notion of specialization, this notion of a third, a third, a third. This is not something we just did. This is something that's been a conscious effort at moving in this direction. Again, my view is that the power of this kind of expertise and specialization is going to be very distinctive.
If you can combine it with great relationships with broad-based agents that have expertise in these areas, it is a much better thing than just going to a large market and being a commodity approach to capacity, which is what some people do at the large end. We are very confident that this is a step in that direction.
Can you clarify that last part? I guess, I don't know Chaucer specifically as well as I should. Are they a traditional Lloyd's player where they're taking a piece of a slip, or are they actually writing business where they sort of write the whole program?
Yeah. Again, I don't want to comment too much about what they are outside of what we've said, the view is what I said in my script. They have that subscription market. That's clearly part of what they do. A big part of their strategy has been reaching out to more distributors. They've laid it out pretty effectively, what they call regional approaches around the world, so that they can provide their expertise to more distributors, we very much support that. In energy, as an example, they've really brought together an industry solution that is very parallel to the way we think about the world, to provide that solution to some of these regional players. Again, we're very much committed to that. It is a combination, right?
Okay.
Again, you can see it in the annual report and our material as well.
Okay. Yeah, that part of the business makes strategic sense to me when I think about your agents. I guess the subscription part, I'm not sure how your agents participate in that once they do more business with Lloyd's overall and hope toss rates up on the slip. You know what I mean?
Yeah. Some of that business, again, some of that business is just done that way.
Okay.
Because of the need to spread the risk, right? In some of the people that are in those businesses, that's just the best efficient way to do that kind of business. By the way, that's why if you look at, again, some of the best companies in the industry, you look at the who's who or the top quartile, most of them have either increased or entered Lloyd's in one way or another. Because people see that there's a lot of risk that goes through Lloyd's that are naturally important categories, that Lloyd's is a great way for that business to be placed and the risk to be distributed. In addition, again, this diversification point is important to us because, again, for us, there is a value for the financial stability through the cycle to get a little bit higher margin businesses and some diversification.
It provides both of those things, though. There is some connection to our strategy as well.
Okay, great. Thanks. Good luck.
Thank you very much.
Our next question comes from Wayne Archambo of Monarch Partners.
Yes, just on the expense drag that you mentioned earlier, how long do you envision that going on, and does this deal in any way just sort of continue the expense drag that we've been seeing here for some time?
Again, Wayne, one of the wonderful things about what we've done is we've not taken any loss risk. We've taken expense risk, which is really not an issue in our business, if you essentially build the capabilities to grow profitably. As I've articulated in many of our earnings calls, what you see from the OneBeacon because of the earn-in, a lot of those things are almost mechanical. You're going to see significant improvement in commercial lines in particular through the next few quarters. Most of the fronting will be completed. We've transitioned from fronting to conversion in the June timeframe, so you can think about the four quarters after that, where that re-premium is being earned in, and the leverage of that is coming through.
You've also seen the improvements in the last couple of quarters on the commercial side because of the specialty businesses becoming more significant in scale and size. We're very confident that you'll continue to see that over the next four, five, six quarters. Again, one of the interesting things is we don't think by building these distinctive positions, we're not a commodity player. We believe that it's enhancing our margins as well. I'm very confident that we'll continue to see it come out as you've seen it in the last couple quarters, and you'll see it for the next four, five, six quarters.
You're sticking with the ROE targets of 13%?
Yeah. What I've said is 11 to 13 through the cycle. Obviously, our cost of capital as a business has dramatically decreased as I've refinanced our debt and taken down our risk, and our beta has come down as much as anybody in the industry in the last four years. Those targets are well above our cost of capital. Yes, that's where I'm focusing for the company. As you know, we also focus very much on building the book value of this institution. Last year, we ended up with the largest book value we've ever had. We continue to create value in the enterprise. Again, I believe that it's very important that through the cycle, we hit those kind of returns so that we can continue to profitably grow and warrant capital from the marketplace.
The nice thing about our company, obviously, is that we haven't had to go get shareholder capital since I've been here. We've essentially given it back, and we've been able to fix the company, and reinstate dividends and give back share buybacks. I think it's prudent and appropriate for us to have a return through the cycle that is in that range because I want to be one of the top quartile companies in the industry because I think we can do that and be distinctive and continue to grow.
Finally, how do you envision splitting your time now between the domestic business, the business overseas, and helping rebuild Worcester?
Everything's good. We obviously believe very strongly in creating a world-class company. As part of building a world-class company, as we all know, is having a place that your employees are proud to be part of. We're proud that we were voted as one of the best places to work for by Business Insurance. Part of that is our employees and a little bit of me contributes to our communities as well. Obviously, the 100 hours a week I work on this institution is not shortchanged. It's always an interesting question.
Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Fred Eppinger for any closing remarks.
I want to thank everybody for participating. I know it was very short notice. I want to reiterate how excited we are. We have a journey to become a world-class institution with returns 11 and 13. We are singularly focused on creating that kind of company. I believe this is an exciting step in that direction, and we will continue to move forward to improve the performance of this institution and really make it a place that the best agents want to work with and the best employees want to work for. I feel this is a very nice step in that direction. Thank you very much for your time.