Good morning, ladies and gentlemen, and welcome to the fourth quarter and full year results tel
conference for Travelers. We ask that you hold all questions until the completion of formal remarks, at which time you will be given instructions for the question and answer session. As a reminder, this conference is being recorded on Tuesday, January 24, 2012. At this time, I would like to turn the call over to Ms. Gabriella Nawi, Senior Vice President of Investor Relations. Ms. Nawi, you may begin.
Thank you, Carlos. Good morning and welcome to Travelers' discussion of our fourth quarter and 2011 results. Hopefully, all of you have seen our press release, financial supplement, and webcast presentation released earlier this morning. All of these materials can be found on our website at www.travelers.com under the investor section. Speaking today will be Jay Fishman, Chairman and Chief Executive Officer, Jay S. Benet, Chief Financial Officer, and Brian MacLean, President and Chief Operating Officer. Other members of senior management are also in the room available for the question and answer period. They will discuss the financial results of our business and the current market environment. They will refer to the webcast presentation as they go through prepared remarks. Then we will open it up for questions.
Before I turn it over to Jay, I would like to draw your attention to the explanatory note included at the end of the webcast. Our presentation today includes forward-looking statements. The company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee of future performance. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. These factors are described in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also, in our remarks or responses to questions, we may mention some non-GAAP financial measures. Reconciliations are included in our recent earnings press release, financial supplement, and other materials that are available in the investor section on our website. Now, Jay Fishman.
Thank you, Gabby. Good morning, everyone, and thank you for joining us today. We're pleased that we posted solid results in the fourth quarter with net income per share at $1.51 and return on equity of 10%. The story for the full year, of course, was the remarkable weather. Weather losses were far and away the worst in our history, and as a consequence, net earnings per share of $3.36 for the year were considerably lower than what we've become accustomed to. Nevertheless, we price our product for the long term, and of course, we don't control the weather. There will be years such as 2006 and 2007, in which weather losses are surprisingly low, and of course, there will be years, but hopefully not too many, in which losses will be high.
A less financially significant but nonetheless important piece of the 2011 story was the persistent low fixed income investment environment. A year and a half ago, in the middle of 2010, we made the important decision that we were going to actively take steps in terms of rate, terms, and conditions to improve future returns in light of the insurance pricing environment and our view that it was increasingly likely that we would be facing low fixed income yields for some time to come. We increased those efforts in the middle of 2011 in recognition of the possibility that weather patterns might be changing prospectively for the worse, particularly given the active weather we experienced in 2010 and into the first half of 2011. We've shared with you before that we are just not big believers in magic market cycles.
We understand that our business is about one underwriter and one agent discussing one account at a time. We believe that our franchise was strong enough, and we could seek improved profitability through improved rate, terms, and conditions without adverse effect to our business. 18 months later, we have proven that to be the case in most of our commercial businesses. We take these actions selectively where our analytics suggest they are warranted, and we try very hard never to be disruptive to our agents or insureds. In our judgment, the success we've experienced speaks to the value that we bring to agents and customers, and the success we've had positions the company very well going into 2012. In particular, Business Insurance, excluding national accounts, had a pure renewal rate gain of more than 6% for the quarter and 8% for December.
As a result, given our current view of loss trends, we anticipate widening of the underlying underwriting margins in Business Insurance in the first half of 2012. In Personal Insurance, the regulatory environment is such that while the progress we've made is important, the real evidence of success remains ahead of us as we continue to roll out the pricing and underwriting changes that we have decided to pursue. I want to emphasize that the steps we are taking are not limited to rate. There are a number of levers available to us in addition to rate as we pursue improved returns. They include underwriting actions, particularly with respect to risk selection and location, as well as changing underwriting standards with respect to roofs and loss history in Personal Insurance. We've always been attentive to our expense base, and we continue to be very thoughtful in that regard.
Our commitment to improving prospective returns in Personal Insurance is no less than that which we had in Business Insurance when we began this program 18 months ago. Every personal lines franchise is unique, every company's agent group is different, and importantly, the value proposition to the insureds is quite different company to company. We believe that we will be successful given our agents, our insureds, and the value that we bring. While the bottom line financial results this year were less than we would have hoped, we couldn't be more pleased or more proud of our people when we look at the progress we've made to achieve improved returns, particularly given the difficult environment that continues to confront the U.S. economy.
We have really demonstrated the value of the Travelers franchise to agents and insureds, as well as the strength and diversity of the business that has allowed us to achieve all that we have over the past 18 months. We run the business for the long term and focus on returns over time. We're also pleased and proud that since 2005, we've generated an average annual operating return on equity of 13%. With that, let me turn it over to Jay.
Thanks, Jay. Let me begin by stating that we have maintained our strong cash position, ending the year with holding company liquidity of $2.4 billion. Operating cash flow is $351 million for the quarter, which included unusually high claim payments that resulted from this year's severe weather, and a $150 million payment to our qualified pension plan that, even in this very low interest rate environment, kept our funding level close to 90%. Consistent with our ongoing capital management strategy, we continue to return excess capital to our shareholders. During the quarter, we repurchased $1.2 billion of our common stock, which was at the top of our previously announced range, and paid $166 million in dividends, bringing year-to-date common stock repurchases to $2.9 billion, and year-to-date dividends to $669 million.
As was the case this quarter, there have been many periods during the past several years in which our share repurchases and dividends significantly exceeded our earnings. We achieve this by diligently and systematically identifying opportunities to free up capital, returning that freed-up capital to our shareholders. After several years of working at it, the process of freeing up capital is now largely complete. We now expect that future common share repurchases will be driven more by future earnings levels, taking into account capital needed for business growth and corporate needs such as debt service and pension obligations. Having said that, we remain fully committed to identifying and returning excess capital to our shareholders, whatever the source. I'd also like to point out that all of our capital ratios remained at or better than target levels at the end of the year.
Net unrealized investment gains increased by $337 million during the quarter to $4.4 billion pre-tax, or almost $2.9 billion after tax, and book value per share rose to $62.32, a 7% increase since the beginning of the year. Now let me turn the microphone over to Brian to go through the results in more detail.
Thanks, Jay. I'll start with Business Insurance. The real news in the segment is that the rate on the business we are writing is up significantly in the last 6 months and is now meaningfully exceeding our current view of loss trend. Renewal premium change of 8% for the quarter included pure rate increases of over 6%. This marks the fourth consecutive quarter that Business Insurance has seen positive rate change on renewed accounts. As with recent quarters, rate increased across all product lines, with the largest increases in workers' comp and auto. We are very pleased that the months within the quarter continued to show sequential improvement in pricing, with December renewal premium change of 10% and pure rate increase of 8% for the segment. Based on our preliminary look at January business, pure rate gain looks pretty similar to what we achieved in December.
Net written premiums were up year-over-year, driven by pricing gains and positive audit premiums. Retention and new business levels were solid, though down somewhat from recent quarters. As we mentioned last quarter, execution on our pricing strategy may impact business volumes going forward. So far, we continue to remain very comfortable with the balance between improved pricing and volumes. Through 2011, this has been a very easy call. I want to emphasize here that when we speak about pricing strategy, our goal is not simply to increase the price on every account. It's a very granular approach based on analytics, where we're looking for the appropriate price for the individual risk or the class of business. It's never been a one-size-fits-all approach. Turning to losses, overall loss trend was relatively benign. In workers' comp, we saw some higher than expected frequency from 2010.
In commercial auto, 2009 and 2010 bodily injury and 2011 physical damage losses were above our initial expectations. Some movement in loss trend concentrated in the 2010 accident year. More than offset by increased prices. In summary, we feel extremely positive about the results in Business Insurance. At our current pricing levels, we believe that we will be generating underwriting margin expansion beginning in the first half of 2012. In the Financial, Professional & International Insurance segment, operating income of $152 million for the quarter was very strong and consistent with the prior year quarter. This caps a very good year for the segment, with full-year earnings up more than 4% over what was a good 2010 result. In surety, we continue to see strong margins and slightly less volume, driven by sluggishness in construction spending.
We could not be more pleased that we've been able to maintain our current position as the market leader in this business during a very challenging economic environment without a meaningful increase in losses. That we have done so speaks volumes about our ability to select risks, the credit quality of this business, and our approach of running this business for the long term. Looking at management liability, this remains a line of business where market pricing continues to be challenged. Less so at the smaller end, which is the source of most of our premium. While our pricing here has lagged most of our other businesses, we were able to achieve positive renewal premium change for the second quarter in a row. This is reflective of favorable production results in our private and nonprofit business. Is due in part to benefits from recent technology investments.
In international, net written premiums were down quarter-over-quarter, due primarily to the timing of a few small reinsurance transactions and our exit from the Personal Insurance business in Ireland. Over the past several years, we have increased our focus on our international operation, and we are pleased with the progress to date. The quarter-over-quarter improvement in the underlying loss ratio more than offset the increase in the expense ratio, which is a good sign that the investment is paying off. In Personal Insurance, looking at auto profitability, the story is essentially the same as discussed for commercial auto. We've seen a moderate increase from expectations in bodily injury severity for the most recent accident years, and a higher than anticipated level of claim frequency and severity in the physical damage coverages for the 2011 accident year.
The quarter-over-quarter impact of these items, both from prior year and 2011 prior quarters, was almost six combined ratio points. Because of this volatility and the normal seasonality in the quarter, we think a better way to focus on the run rate of the business is to look at the full year combined ratio, which after adjusting for CATs and prior year development, was 99.5. This includes one point directly attributable to higher non-CAT weather related losses, and so 98.5 is our view of the current run rate, which is only two to three points higher than the combined ratio required to get us back to our historical target return. As Jay mentioned, we are committed to improving returns in this product in 2012 by aggressively pursuing rate and implementing local underwriting strategies. In homeowners and other, profits were once again down in the quarter, due primarily to adverse weather.
Although the impact of the weather in the fourth quarter was dramatically less than in recent quarters, it was still slightly higher than expectations, driven by the unusual Northeast October snowstorm. In addition, we did have some increased claim activity in the non-CAT weather from earlier in the year. As we have said many times, we obviously don't know what the weather will be in 2012, but given the experience of the last several years, we are managing the business with the expectation that weather losses may continue to run above longer-term historical averages. Accordingly, we are taking a broad-based, assertive approach to managing the property product, which includes not only executing local pricing strategies, but also seeking to tighten underwriting standards and changes in terms and conditions.
As examples, we are underwriting for age and quality of roof, reassessing how we factor in the number and type of previous claims, and implementing higher minimum deductibles for weather and non-weather claims. Additionally, we are changing a small portion of our reinsurance program to create a structure that better responds to higher frequency, lower severity events. We are taking a lot of actions in homeowners and are confident that these actions will further enhance the long-term profitability of our industry-leading franchise. Turning to production for both agency auto and property, renewal premium change and retention remains strong, while new business continues to trend down slightly as we accelerate our pricing, underwriting, and terms and conditions actions. With that, I'll open it up to your questions.
Carlos, you can open it up for Q&A now.
Yes, ma'am. Ma'am, would you like me to read the Q&A instructions now?
No, it's okay. You can open it up to questions now. Thank you.
All right. Ladies and gentlemen, if you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift your handset before entering your request. Ma'am, would you like me to go to the first question?
Yes, please.
The first question comes from the line of Keith Walsh with Citi. Please go ahead.
Hey, good morning, everybody. Couple questions. First, Business Insurance. You alluded to in the press release, the underwriting margin looked like it would potentially improve in the first half of 2012. Is this more optimistic than what you guys talked about last quarter, where you seemed to be a lot more adamant that this would take time to earn in over the next 12 months? I've got a follow-up.
Well, Keith, this is Jay. The rate that we wrote in the fourth quarter was obviously at a higher level than that which we wrote in the third quarter. Going into 2012, as we look out into 2012 as it earns, we are not more optimistic because that implies an attitude. This is fact. The fact is, the rate in the fourth quarter was higher than the rate in the third. Wherever we were in the third quarter with respect to margins, we're better off today, and it will simply take the time to earn that written premium into earn. I'd say that it's not a matter of optimism, meaning feeling. It's really a matter of arithmetic and fact.
We're in a better position today than we were in at the end of that third quarter with respect to the speed with which those margins will expand, assuming that we continue to earn rate at this level, the effect that it will have in the margin arena.
Okay, just sticking with Business Insurance. Obviously the rates are good, let's focus on the other part of the game here. I guess the retention and new business, which are both down pretty sharply on the new business side especially. What are the dynamics of not just the accounts you're keeping, which we can see in the rate, but what about the accounts you're losing? What's really going on there? If you could talk about new business hit rate. Thanks.
First, I would disagree categorically with your characterization of it's down sharply. The retention in Business Insurance
For the fourth quarter, was it 81%?
79.
I'm sorry, 79. 79 was commercial, 79%. In the context of thinking about business long term, that's still an exceptionally high retention rate. We've gotten used to rates in those mid-80s that frankly, we'd never, ever seen before. You go back to the period in the late '90s and early 2000s in middle market retention, we struggled to get it above a number that started with a seven. What's happening on the Business Insurance side is just fine. This is an easy trade-off. The one segment of the business where retention has been lower than others has been in the larger end of Select. You may recall that we define Select as the smallest end, which is highly technological, and then there's Express Plus, which is the larger end of Select. That category remains a more challenging pricing environment.
It has to do with the way we think that regionals compete and how they view middle market pricing. They don't have the technology to really compete effectively at the low end of small commercial. They don't have the infrastructure to compete effectively at the true middle market business that we define. They tend to land in that larger end segment. We've established our own thresholds for return expectations, and to the extent that we can capture business that meets those return thresholds, we'll take it, and to the extent somebody else decides they want to take it away from us at a lower price, that's just fine. So far, this has gone better than I think any of us would have expected 18 months ago. The trade-off at this point between return gains and retention, as you describe it, as losses, is just fine.
What was the 81? The 81 was.
81 was commercial account.
Commercial accounts.
I think overall, this is Brian, overall in retention, x the high end of Select, we're right around 80%, a little bit north of 80%, and we feel great about that. On the new business front, we're going to look at business in the marketplace, if we can find stuff that meets our return thresholds, we're going to write it. In this environment, we're not going to search below that.
I'd make one other observation, it's more challenging for us to quantify it and demonstrate it, but we have indicators that will support what I'm about to say. New business pricing is also better than it was. It's harder to measure because you simply don't have the prior year expiring premium to compare it, but we are comparing new business pricing against a manual rate that we construct. When you look at that pattern, there are two things that are really encouraging. One is that there's clearly lift going on, and two, that the gap between, and I'm not speaking necessarily about this particular quarter, but looking at it over a longer period of time here, six, eight months, the gap between renewal and new has narrowed.
Both of those things give us a pretty good sense of confidence that the pricing for new business is lifting as well. Can't quite quantify it with the level of precision that we can renewal, but we feel awfully good about it.
The one last comment I'd make on new is that our flow is still very solid. If this was a matter of we weren't getting the opportunity to quote on business and we weren't quoting, we'd be a lot more concerned with that. We feel good about the flow. We feel good about our activity in the marketplace, and profitability levels will be where they will be.
All right. Thanks.
Our next question comes from the line of Jay Cohen with Bank of America Merrill Lynch. Please go ahead.
Thanks. Two questions, both related to pricing. Can you talk about your desire in 2012 to continue to push for rate on the commercial side? Because obviously you've achieved a certain amount of rate already. Is that desire still very much in place, or will you be satisfied now with the priced ROEs are, and you don't need to push as much? That's question number 1. Then secondly, if you could describe the dialogue you're having with agents and brokers. Obviously, your effort is to improve profitability, improve returns. Theirs is to do the best for their clients. How much pushback are you getting from the agents, and have you sensed a change in that pushback?
Jay, I'll take on the first one. Our strategy now remains as is. We're going to continue to do this selectively, thoughtfully targeted. We are going to continue. Our goal, we get asked all the time, what's the target? We don't have one. That's partially because some of the conditions that we're responding to are just not as clear to us as they might be. I'm speaking specifically about weather. I'm speaking about investment returns. We're going to try and drive our products and our returns back to the historical kind of broad-based targets. We still have a mid-teens ROE as a long term. We talk about it over time. We still very much have that as a long-term target. We are most certainly from an individual pricing basis, this is important now.
I'm not speaking about the return on equity in the whole place. I'm getting very granular with you and talking about the returns on allocated capital of individual products based upon the rate that we have in place today and our immediate view of loss trend. We are getting closer. We are making real progress in getting back to the levels that will ultimately convert to mid-teens ROE on a GAAP basis. We got some to go yet. We are encouraged. We're going to keep driving until we find whether we can or not get back to our historical kind of return thresholds. That's, I think, the answer with what does 2012 feel like from a strategic and tactical perspective. I'll ask Bill Cunningham to talk about the agent arena.
Good morning. I would say on an overall basis, we look at our agent relationships as very strong partnerships. As being a strong partner, not surprising them is critical. Being upfront early in the process with our agents in terms of what we're doing on an overall basis. More importantly, as Brian mentioned, this is not a one-size-fits-all. Every account, communicating to the agent as early in the process as possible, because our ultimate goal is together to be out with that client, explaining why we need a given rate increase on a given transaction. At the same time, we do from time to time, agents feel a need to test where we're coming from, to give them time to do that.
I would tell you, on an overall basis, it has been very positive in terms of the feedback we've received in terms of how we've handled it. Again, partnership early in the process, no surprises, together sitting down with a customer whenever possible, not putting them in a position where their back is against the wall is key to our partnership.
Great. Thank you. Our next question comes from the line of Mike Zaremski with Credit Suisse. Please go ahead. Mr. Mike Zaremski, your line is open. Please go ahead.
Can you go to the next caller, please?
Our next question call comes from the line of Brian Meredith, UBS. Please go ahead.
Yeah, good morning. A couple questions here for you. First, going back to the auto insurance results that you're seeing in the quarter, you talked about the 98.5 and need to get it down to a 96. I guess the question I have there is, one, what are you doing to get it down there? Is it just pure rate? Is the market kind of receptive of the type of rate that you need to get it back down to those 96 levels? Then I have one follow-up.
Hey, Brian, this is Greg Toczydlowski. In terms of the auto strategy, it's predominantly a rate strategy that we're focused on automobile. When Jay and Brian talked about all the other levers that we're looking at from an underwriting in terms and conditions, we're focused a little more on the property side of the house with that. We're monitoring our competitive position all the time, and given the regulatory environment that we live in, it takes a little bit of time before we can get that rate through. We're feeling that we're continuing to see good flow and good retention numbers, and we'll continue looking at that as we go forward with the business.
Obviously, if you're writing it at 98.5%, 99%, that's not your kind of an acceptable return level. You can't get a double-digit ROE off of that, right?
That is correct. We are shooting closer to that combined ratio that you threw out, the 96%, and we're going to be doing that through pricing.
Some of the dynamics, Brian, that we've been experiencing, we suspect are more broad-based. This is just one, but it's an unusual pattern that's developed with the slowdown of the new automobile business generally. Price of used cars has risen. As the price of used cars has risen, what's been interesting is the number of accidents that result in total losses where the car produces salvage have actually gone down. Car relative value up, auto repair costs much less, so more cars are being put back on the road. As a consequence, what we've seen of that is an increase in sheet metal costs. I'm not talking about new sheet metal, I'm speaking now about replacement parts. That's not unique to us. That's going to be a condition that's going to affect lots of people.
It may impact us a tad more because we tend to write more comprehensive coverage than some other carriers do. We may be on the more extreme side of that, but the kinds of things that we're seeing are not things that, this is very important, are not things that indicate problems with underwriting or risk selection. They are more episodic issues with respect to specific costs that are not, I would say, unique to us. Our hope is, and of course, we're going to find out, we are going to find out that we can go to the market and drive the kinds of rate increases that will bring this back, just like we did in Business Insurance. We started extremely slowly. We started 18 months ago asking fundamentally if our folks could get one point. That's what we said.
Let's see if we can get one point. We've built on that every month. We're going to take that same systematic, thoughtful, patient approach to auto insurance and homeowners and see what progress we can make.
Great. A question for Brian. When you mentioned pure rate also up 8%, can you define that? Is that just rate less loss cost inflation?
No. When we say pure rate, we're looking at the components of the premium change.
No exposure.
it's the rate charged per-
Got you.
Unit of exposure on the average renewal.
Got you. Then how would that compare to what loss cost inflation kind of looks like in the quarter?
We don't peg the exact number. We said we're meaningfully exceeding it.
Okay, great. Excellent. Then just lastly, interest rate assumption when you're talking about getting rate, getting close to your kind of historical kind of double-digit ROE targets, what are you thinking about the interest rate environment?
Mechanics on that are that all new money is discounted at the current yield curve, basically where we invest money today. The surplus embedded in the business in that calculation is a more historical element premised on the fact that we have surplus that rolls off from old products and then comes on to support new. Importantly, we're not kidding ourselves with investment return. That's all new money at the current yield curve today.
Thank you.
Our next question comes from the line of Vinay Misquith with Evercore Partners. Please go ahead.
Hi, good morning. The first question is on pricing. You've seen pricing in workers' compensation and commercial auto up sharply because of high loss cost trends. Curious about what are trends you're seeing in pricing in other lines that you're pushing this year versus last year?
Yeah. A couple of just clarifications on that. The comp and the auto, we had the strongest rate improvements. It's not because we're seeing sharp increases in loss costs there. Obviously, pricing always has something to do with the loss cost trends, but it's not a sharp increase. We saw a fairly significant increase of a couple points really on almost every single line of business we write. This isn't an example where comp is spiking up dramatically, auto's up a lot, and everything else is kind of flat. I would say every line in the commercial space is moving. Comp and auto more dramatically, but it's not completely out of pattern with everything else.
as Brian-
Rate. I'm talking about rate change. Yeah.
As Brian always reminds all of us, and you as well, in comp and in many of our lines of business, it's very much a state-by-state story. There tends to be this view that it's one national rate. It's not. There are states where either frequency or severity underlying trends are either more concerning or less concerning than others. Our reaction with respect to rate and what we're trying to accomplish is very much driven by the state environment specific to that particular risk.
Fair enough. That's helpful. As a follow-up, what is the impact of non-CAT weather for all the segments? I believe for the Personal Insurance, it was two years for the full year.
Non-cat weather. I'm looking at Greg. Non-cat weather in PI for the full year.
Yeah.
Do we disclose that level of granularity, I guess, is the question.
Do you want to just point first? It's not something that we've disclosed previously. We obviously have some view of it, but the substance of that answer is functionally dependent upon whether our assumption of normal weather is right or wrong for high or low. Rather than trying to get into a debate about how much was non-cat weather, it's internal, and I'm not sure the data is all that meaningful.
Okay, fair enough. Just one last thing, if I may. What amount of rate increase do you think on the personal auto line do you think will be necessary for you to get to your level of profitability that you're targeting?
Well, the arithmetic is actually pretty simple. In Personal Insurance, if we want to drive the combined ratio down by two points, we got to get about three points of rate above and beyond what we otherwise would, because we are obviously, in effect, I'll say always getting rate. That's not universally true. Fundamentally, it's a business where the renewal price change has always been positive. I can't recall that it ever went negative.
Two to three points. Yeah.
That's really the dynamic of kind of three points of rate above and beyond what we would otherwise get, and under the presumption that loss trend stays about where it is. There's an all other things being equal dynamic. The answer to that is it's not as far away as it might otherwise seem. Now, the marketplace will have to say whatever it wants to say, and we're obviously aware of that, and our influence, our market consequence, our breadth in Business Insurance is, I think, one of the attributes that's enabled us to accomplish what we did in BI. We'll see whether that same dynamic holds true in Personal in the same way, it's just not that far off.
Just jumping back to his first question, because we have answered part of this in the past. On the non-cat weather, we said last quarter in Business Insurance, and it's still probably about the right number, is there's one point in the combined ratio of variance above a normal non-cat weather number for the year. I said in the quarter, it was pretty flat in BI. For the year, it's still about one point. In auto, personal lines, I said there's one point of clearly identifiable non-cat weather. There might actually be more in auto.
Right.
The home number, I don't remember off the top of my head.
If you're going to go on the same basis for full year, property would be closer to two to three points.
Variance of higher non-cat weather.
From whatever
Again, coming back to the notion of
From whatever was
Our view of normal weather might have otherwise been.
Sure, that's very helpful. Thank you very much.
Our next question comes from the line of Jake Gall with Barclays Capital. Please go ahead.
Thanks. I had two questions for you. The first is on the share buyback pace for 2012. I just want to clarify, should we be thinking about buybacks being equal to net income, operating earnings, retained earnings? Can you just clarify?
What we were trying to say was it should be looked at based on earnings, so not retained earnings for sure. Net income versus operating income, they are both income, and they have tended to be relatively similar. We think mostly in terms of operating income, but if there were large realized gains or something, we would take that into account as well. That would be more episodic.
All right. Just wanted to confirm on that. What's the maximum comfort level on debt to capital ex the unrealized gains?
We've talked in the past about, for a AA company like us of being in a 15%-25% range. We're at a little over 23. Part of the 23 is actually driven by pre-funding $250 million of debt that's going to mature in 2012. That's worth about seven basis points in that calculation. Being within that range is a very comfortable place for us.
Got you. The final one is on the non-fixed income after-tax earnings. It was down in 4Q versus 3Q. I'm just trying to figure out what you feel would be a reasonable run rate heading into this year.
Jay, William Hannon. For what it's worth, the quarter came in just about exactly where we thought the quarter would come in on October 1 as we looked at the matrix of factors which affect returns in the non-fixed income portfolio. I suspect the best way to make predictions about the future is to look at the bar graph back a few years, try to draw a mean, and figure that's about what we'll make because if we couldn't make that, we probably wouldn't maintain the portfolio. For what it's worth, there were no real surprises in the fourth quarter. This was about what we expected.
Okay. If I look at that over the past couple of years, probably averaging around $50 million-$65 million a quarter?
I'd have to look at the bar graph. I think on the low side of that.
Okay, thanks.
This is Jay. It's one of those things that as you know, it's really difficult to forget.
Yeah.
Whatever you put in your model, there is a level of uncertainty.
Yeah.
We have great visibility into the fixed income part of the portfolio. This is going to be so dependent upon what the economy does.
Understood.
Our next question comes from the line of Greg Locraft with Morgan Stanley. Please go ahead. Mr. Locraft, your line is open. Please go ahead.
Hello, do you have me?
Yeah, we got you.
Okay, great. I wanted to dig into the workers' comp line for a bit, just get some color on the market. I guess more specifically, one of your competitors in The Hartford has had some emerging troubles through 2011 in that line. Some other cracks are appearing from other competition. I know you don't believe in the cycle, what are you seeing specifically in that line? How do they manage their books of business different, and why are you so confident that this won't begin to have some issues into 2012 and beyond?
Let me talk for a second about in a little more specific what we're seeing. I'm not going to comment on how other companies might be managing their business, we can talk certainly about how we manage ours. Just to be clear on workers' comp, what we saw this year, in the aggregate continues to be a pretty strong picture for us. If you look at the prior years, 2002 through 2009, every year continued to perform better than we had expected. Positive in every one of those years. In 2010, we did see.
In fact, Bill said to me yesterday, make sure you still believe this, that if you look back to 2002, the current expected loss outcome in each of the years 2002 through 2009 is currently lower than the original estimate at the time we made it.
Better than.
Better than. Let's say lower loss ratio, better result. Right.
That's correct.
Right. 2002 through 2009. In 2010, we did see some continuation of the increase in late reported claims that we discussed in the second quarter. We believe this is really a direct result of the impact of the Great Recession on workers' comp claim reporting patterns. The 2010 year was out of pattern. Overall, all years, including 2010, we continued to have positive development on our overall workers' comp book. The impact of all of that is fully reflected in not just 2010, but rolled into how we looked at 2011 and what we booked there. Most importantly, is completely rolled into how we're pricing the product today. Given the pricing improvements that we've gotten, we feel good about the returns and the profitability levels of the comp business we're writing today.
As Bill said before, it's a state-by-state game and very granularly managed.
A couple of other facts that I think will be helpful. First, the magnitude of the 2010, I'll call it excess claim activity, to put a number on it, was under $100 million after tax. That's the magnitude of that change. Again, what we see, everything that we see tells us that those were occurrence dates incidents in 2010 that didn't manifest themselves until 2011. That's an unusual dynamic and something we haven't seen before. Maybe it's a function of the economy and how people feel about job security and whether they raise their hands or not. Again, to Brian's point, we've rolled that forward into the 2011 loss estimate, booked that fully, and are currently incorporating that into our 2012 estimate for pricing and reserving.
I think it's important because it will again help quantify it Well, in the combination of the rate gains and the loss trends and the positives and the negative 10 and everything else, our estimate of that allocated return on capital measure that we use to measure the profitability of the products in workers' comp all in now is low double digits. It's low double digits. I think it's helpful to put a perspective on what we saw. Our view on that 2010 development is that it's more, I'll call it timing rather than a permanent change. Of course, we'll see whether that's the case or not. To get back to your other question about, and of course, you all know this, you're sophisticated analysts, you get it. The issue of how one company reports versus another.
The critical element in all this is what does the company originally assume? Whatever experience we have in the loss arena is sort of one thing, but what original assumptions were made is a critical element in determining the embedded health of the business. I'd come back to the 2002-2009 period as at least indicative of the way we view the line. Importantly, severity remains as expected. That's an important element. The actual inflation dynamic there is not an issue. Lastly, again, this just speaks to the mechanics of the business and I think the integrity of the process here, the delta, the change that we had assumed from the 2010 into the 2011 year, that turned out to be a good, at least so far, remains a good assumption.
The base year 2010 changed some, the delta into 2011 that we had anticipated turned out to be, at least so far, consistent. A tiny bit of a complicated story, you got all the news.
That's very helpful. Thank you.
Our next question comes from the line of Michael Nannizzi with Goldman Sachs. Please proceed with your question.
Thanks. Just a couple of questions here. One thing we haven't talked about for a little while is the direct initiative. You mentioned it looked like in the release, about 80 basis points on the combined ratio, which something about $0.30 a share, if my math is right. Clearly more significant than it was as a percentage of earnings when you launched it. Just kind of what do you look at in the development of that business to let you know that you're creating value and that you're hitting your objectives so that it eventually starts to bring in earnings as opposed to create that pressure? Just one follow-up. Thanks.
I'll let Doreen and Greg answer as well, I'd pick the one element that we continue to work on from an operational dynamic is we're getting pretty good at getting people through the quote process and getting quotes out. Our next step is to do better. Next step, the thing we're working on more than anything else right now is to do better in converting those quotes into actual sales. It's not immediately apparent to us that it's a function of price, although, it won't surprise any of you if you listen to all the ads, the comment is, those who switched saved whatever the number is, $400. No great shock if you quote someone $400 more than they're currently paying, the likelihood of them switching is actually pretty low. The comment price is not an insignificant element there.
We have a, I don't know exactly what to call it, but we have a conversion curve. We know relative to at least what the customer discloses to us their current price is. We know how far, either plus or minus to that mark, in a large number of accounts, how close we need to be to convert. We've got more work to do in the conversion process so that the dollars that we're spending in the media, and we're not spending nearly what anyone else in the big players are, but to maximize that investment is to get more of the quotes converted into sales. That's our dynamic. Some of it is, we suspect, I'll say reputational. I think there are other companies that have, as a result of doing this for years, earned a reputation for being less expensive.
Whether that's true or not is a whole other question, but they seem to have earned a reputation for it, and we have to continue to build a reputation dynamic around the value proposition that we give. We're never going to be great at selling a half a coverage sandwich. If a sandwich is $6, we're not comfortable selling a half a sandwich for $3.10. That's just sort of not who we are culturally. We're much more comfortable providing customers with the coverage they need rather than the dynamic of how much can you afford. That's just not us. We're going to keep working at this, and we got our fingers crossed, but we're well on our way.
Got it. Then just a little bit more on workers' comp. Just the premium line was pretty bumpy during the year. I'm just curious, is that a result of pure seasonality? Is that a result of maybe a change in the competitive dynamic or just the market itself or any strategic change on your end?
It's actually more just pricing and audit premium running through the numbers. A decent piece of that is movement of the underlying exposure of the accounts and what payrolls have been and how those have moved up and especially when compared to a year ago when many comp accounts had some fairly significant return premium dynamic. You're going from a return premium environment to an audit premium plus environment, and that's probably, Fred, the biggest single driver of the movements in that line.
From our perspective, that's a good thing.
Yeah. Oh, yeah. That's definitely a good thing.
It's not necessarily a policy count, it's more of a exposure per unit?
Yes.
Oh, got it. Okay, great. Thank you.
Payrolls up or down.
Yeah.
The initial premium is based on an estimate. We come in down the road. When the policy expires, we do an audit. If the actual payroll was less than had originally been disclosed to us, then we have a return of premium. If the payroll turns out to be more than was originally disclosed to us, we have an additional billing. During the sort of depths of that Great Recession, we were in the return of premium arena as customers shed payrolls far more aggressively than they had anticipated they would. Now they reached a stage where they were flattening out. That brought the auto premium back to zero. Now they're growing modestly. What we're seeing again is now a change into the build arena of auto premium.
Great. Any change in the competitive dynamic just over the year, just in the larger case market that you've noticed?
This is Bill Cunningham. Nothing discernible. In the large national account-
When you say large, let's make sure we're talking-
I'm talking large national account loss responsive business.
Like your commercial accounts business. Not the small, not the Select or Express Plus, not the small end of commercial, but kind of the down the middle commercial accounts business.
I would just say over the course of the last 12 months, some of the cracks that you've described, we have seen competitors pushing price and moving price in a northerly direction in a number of states that we compete with them in.
Great. Thank you.
The next question comes from the line of Josh Shanker, Deutsche Bank .
I'm sorry. Before you take that question, let me just, because Bill used words that we understand here internally. I think what he was saying, you should correct me if I'm wrong, but I think what you're saying is when you said cracks, what you're seeing is other competitors struggling with the workers' comp line and not an insignificant increase in rates by other competitors as well. We never deal with other competitors. We get anecdotal observations from agents. That's what Bill is speaking about. Particularly in the states that have been more challenging from a loss trend environment, where we see other, we understand, again, we never talk with other competitors about rates in any way. We see them reaching for rate as well in that competitive environment. That's what the comment was.
Okay, next question. Josh Shanker's question, please.
This is Mike Hall. Everyone, during the Goldman Sachs Financial Services Conference call, you dissuaded investors from taking a look at Schedule P. Obviously, we're going to look at that, but maybe you know more than we do, and if you can walk through the math on why our look at Schedule P will lead us to the wrong answers. Maybe you can talk about what your reserves are going to look like when we do that following the 2011 numbers.
First, I don't think we ever dissuaded anybody from looking at Schedule P. I just go back to that Goldman Sachs conference. We were talking about the complexity of making, I'll call it somewhat simplistic assumptions based upon kind of overall views. No, our Schedule P is going to reveal the things that Brian shared with you earlier. You're going to see that the 2010 accident year for workers' comp had more claim frequency than we originally anticipated. You're going to see in the auto liability line, particularly I guess not particularly, but commercial auto for sure, you're going to see 10, 9, and is it 9 and 10?
A tiny bit in 8, but mostly 9 and 10.
9 and 10. I think those are going to be the things that you'll see that's why we're providing the explanation here today so that people understand what it is they'll be looking at when they see it.
So far from what you're seeing, looking at the beginning of the year of 2011 to where you are today, those things you're seeing in 2010 have sort of reversed the mean and are not showing up this year?
Well, we booked the change into 2011, first of all. In other words, the base year, what we do when we develop loss estimates for a given year, we start out with the immediate preceding year. We make adjustments for frequency and severity that we anticipate. When 2010 had that $94 million after-tax increase in claim activity that I spoke about, we obviously rolled that forward into our 2011 loss estimate, and that's been booked and recorded. As we look at 2012, we obviously are starting out with a base. Again, now you're asking the complicated question. Of that $94 million in that year, how much is a timing difference that we see as just from one year to the next and how much is a permanent difference?
We certainly are going into 2012 eyes wide open with respect to the 2010 accident year and what its effect was. That gets me back to my comment earlier that the estimated return on allocated capital for comp, broadly speaking, I mean broadly meaning across the whole book, is at the moment in the low double-digit range. That's incorporating that 2010 development into that.
If I could add a couple of things. There is a storyline that you have to follow in our Qs where we are describing things that are taking place each quarter. Some of which, as Jay said, impact us as we look at the business going forward, and that is when we talk about base year movement and our adjustments for current year loss picks and ultimate results for a particular year. There are other things that take place that get reflected in Schedule P that do not impact the numbers going forward. If you look at some of the property lines as an example, what you will see is disclosure in our 10-Qs talking about some development that has taken place. One that comes to mind were the Arizona hailstorms that impacted us from 2010, where we made loss estimates associated with what we had been seeing.
Then in 2011, saw further development on those losses that get reflected on our property lines. Those are losses that are episodic and therefore, do not impact us when it comes to looking at loss picks. When we say it is complicated, those are the kinds of things that we are talking about. The granularity of information that we go through to make a determination. Number one, are our reserves fairly stated at the end of each quarter? Which are always at best estimate. Then two, what does this information tell us about the past as well as the future, and then trying to very granularly and thoughtfully build those into our ongoing analysis.
The important point I think we made amongst those, the important point we made back at the Goldman Sachs day was that there seems to be a view somehow that current year reserve adequacy is a function of rate. That concept is just foreign to us. We do not understand it, actually. We make estimates of losses, we make those estimates of losses, frequency, severity. The notion that we would not be making our best estimate because a couple of years ago, rate was more challenged relative to five years ago when it was less challenged, is just completely foreign to us. We do not get that. To us at least, and I am speaking just for Travelers, the way we establish loss reserves are independent of whatever the rate is that is being gained on it.
They are very granularly determined, they are constantly being reviewed by actuaries internally. You have heard us say, when we make readjustments to current year loss picks, current year loss picks, not prior year, it is because we are seeing activity either up or down that was different from what we had originally expected that loss activity to be. That was the comment. No, by all means, dig into Schedule P.
I appreciate it. Thank you. Very granular answers. Question. Brian went through the math on Personal Auto. What is the run rate for, at least you guys think for annual CATs per year in the loss ratio? Unnormalized.
In Auto?
You said you were targeting 96, you got to 98.5, That doesn't include any normalized CATs. I just wanted to also get that part. I think at least. Maybe it did.
No, that's. Go ahead, answer the question.
Yeah, Josh, it's really insignificant for the auto side.
Would be the normal expectation.
Right. Yeah.
Yeah.
Okay. Thank you.
Yep.
Our next question comes from the line of Matthew Heimermann with J.P. Morgan. Please go ahead.
Hi, a couple questions. One, just to start clarifying your 99.5 to 98.5 run rate, was that personal auto or Personal Insurance?
That was personal auto, the delta is the one point of pretty clearly identifiable weather-related activity above that pretty low normal activity.
Okay. That's fair. I just wanted to make sure I heard that right. Just within FPI, obviously, you've been exiting the personal lines business in Ireland, and you talked about that from a premium standpoint. Just curious whether or not that exit is having any positive impact on the loss ratio, and if so, how much?
I don't know the exact number. It should have a positive impact, but it'll be pretty small.
Then just kind of timing-wise. My sense is there might be one more quarter of kind of cycling through. Is that right in terms of timing?
Maybe two, I think the overall personal lines premium in 2011 was about $24 million-$25 million. It's pretty small and should tail off in the next couple of quarters.
Then, I guess a bigger question would just be how customers are adapting to the rate increases. Obviously, we know exposures are up on an underlying basis with the economy, which puts some price pressure, or at least dollar spend pressure on customers where you're raising rates on top of that. Are you seeing customers either change the limits they're buying? I recognize not all your customers may have the flexibility to do so, but are you seeing any change in buying behavior, their limits, deductibles, or other things clients are doing to try to mitigate the dollar impact on them?
This is Bill Cunningham. I would say we're not seeing any meaningful change in the commercial space on terms and conditions, including either limits or deductibles. Where we are seeing changes in deductibles would be on the larger property end in wind exposed areas, and that would be on the margin. I would say across the board, clients are opting more for a price increase than a deductible increase. Again, that's largely anecdotal, but the numbers would support that it's more about the price and less about the terms and conditions.
Okay. Can you just help on a written basis connect the dots between what you reported for rate increases, exposure increases in Business Insurance relevant to what we're actually seeing show up on the net line in terms of written premium increases? I get retention's down, it doesn't seem to be down relative to the positive push from those two things to explain the delta.
It's a retention and I would say new business dynamic. The new business
Being off a bit.
All right. Maybe I'll follow up on.
I'm not sure I got the question there, Matt. I'm sorry.
Well, based on your chart, it looks like you're saying Business Insurance prices are up 6%. It looks like based on your chart, you're showing exposure growth of somewhere between 2% and 4%, which would make the range 8%-10%. Retention's down 4%, that takes that to 4% to 6%. I get new business is down a little bit, that feels more like about 100 basis points. I would've net expected better growth.
Okay. You got audit premium. Fred, why don't you-
that was a positive year-on-year delta too, though.
Right. If you're trying to reconcile written premium year-over-year, you've got the rate as a big improvement on a full year basis, about five points. You got two and a half points of exposure. You got retention down five points. You've also got.
Retention. Retention of business.
Yeah. You've got the business, yeah.
The biggest-
The change in new business. Right.
The biggest driver offsetting the price gains is retention in new business, the quarter.
Right. Then you've got audit premium swinging from negative to a positive.
All right. Maybe I'll follow up offline because I'm not exactly following. Thank you.
Our next question comes from the line of Josh Stirling with Sanford Bernstein. Please go ahead.
Hey, good morning, thank you for taking the call. Appreciate obviously all the color and disclosures on the reserve issues, both in the change and your really substantial disclosures in your third quarter stat filings, which I think are better than a lot of your peers. The one question I'd have basically to follow up on Josh and his conversation and all of the sort of talking we've done about workers' comp and commercial and personal auto and the challenges there. Recent past couple of quarters have seen a lot of releases from Surety, as well as I think your disclosures in your third quarter regulatory filing suggested that the excess lines and the liability, so claims made and occurrence, are funding much of the recent reserve favorable development as well as potentially it sounded like there was maybe a ULAE reclassification.
I think we used the word episodic before. I'm curious, should investors be looking at these as the sorts of things that we should be plugging into our models for next year as favorable offsets to potentially sort of modest favorable development and going forward in the other lines where we're talking about potential challenges?
Hi, this is Jay Benet. We've answered this question a number of times in the past. We, as a management team, have these very robust processes each quarter to evaluate what our reserve changes look like and to come up with our best estimate of reserves. We have no guidance, we have no views that we would have either internally or to share externally as to how reserves are going to develop. I think you as an analyst can feel free to think of whatever patterns you've seen, whatever you're hearing from other companies. As Jay said, it's all dependent upon what a company's assumptions are, what the starting point is. What are the loss ratios that they have at this point in time and how things are going to develop. One company's development could look a lot different than another company's.
I think you see our history, you see what we've done in terms of putting up reserves in the past, how those reserves have developed. As I said, our view is we're always at best estimate, and you can come up with whatever view you think is appropriate.
Yeah, no, that's certainly fair and expected something like that. Just in the context of Surety is obviously sort of an episodic and a credit-related reserve. The commentary you guys had suggested around the excess coverages was this was related to favorable judicial environment over the past number of years, and I was just wondering if we should look at this as kind of a one-time thing, maybe you've already answered that.
We're always building in the current view as to how an environment has changed. If we had certain views of the tort environment, let's say, several years ago that was driving a certain level of reserves and that tort environment has improved to date, we'd look at, okay, where is it today? We'd have some view as to where we think it might go in the future. That would be the basis upon which we reserve. What we don't do is we don't say, "Gee, there's some continuum of improvement. Let's book a quarter of it now. We'll book a quarter next quarter, and we'll book and keep going." It's always based on facts and circumstances as they exist, and it's the best estimate at that point in time.
If you go back in time in our disclosures, what you'll see is that the description of what's generating positive development, it's changed. It's been this line or the other line or that year in property or liability. It's a very big business. We're making estimates for multi-billions of dollars of losses every given year, and things just work out somewhat differently than we had originally expected. It's not as if there's a pattern there that somehow is reliable. It's changed over the years, and different lines show up at different times. As we said at the Goldman Sachs day, our goal is to get it right.
I know it feels good when you have that favorable reserve development in the period that it's reported, but we're pricing product every day. If we're going to make the most of what we got, either growing our business or recognizing loss trend or adjusting, the only way we're going to make really thoughtful decisions, really good ones, is if we get it right. That's our goal. Our goal is to get it right. It's obviously better that everybody says, "Gee, favorable, better than unfavorable." Maybe that's true at the moment, but when we have favorable development, that means that we overcosted our product in the year in which for the year it relates to, and maybe we could have sold more if we had a different view of cost. We're very driven to try and get it right.
I think that's right. I personally grew up in the business always thinking that the right answer was the right answer, and that it could lead you to better decisions. I think you guys obviously sort of do a good job of explaining that we shouldn't count on these things going forward. I don't think there's any issues there. If I could just ask one final numbers question.
Mike, we'd like to move on to the next question. Thanks. We've kind of gave you your take.
Our last question comes from the line of Cliff Gallant with KBW. Please go ahead.
Thank you for squeezing me in. Just on the investment portfolio, do you anticipate any changes in strategy, and can you comment on the outlook for the non-fixed income portion of the portfolio, please?
Well, no changes in strategy. We have a strategy which we think accommodates a very wide range of conditions. In terms of the outlook for the portfolio, am I allowed to give an outlook?
Well, we sort of did. No. Someone else had asked about the non-fixed income.
Well, that was what could be expected on an ongoing basis. I think I'm being asked for an outlook for the quarter. The question is
Okay. That's fine. I appreciate the answer.
I guess, typically, we don't venture an outlook for the quarter.
Okay. Cliff, that was it?
Yes. Thank you.
Thank you. Okay. Well, thank you for joining the call. We appreciate the time, given that we went a bit over. If you have any further questions, please contact myself or Andrew Hersom in the investor-