The Hanover Insurance Group, Inc. (THG) Earnings Call Transcript & Summary

Thanks, everyone, for sticking around. We're very pleased to have Jack Roche from Hanover as our next speaker. Jack was appointed CEO in November of 2017. I guess you're not so -- the new CEO anymore, it's -- you've been there a bit. He has been a senior leader at the company before that, since 2006. Jack helped lead a dramatic change at Hanover over the dozen years, he was there in a number of capacities, and he has already put his imprint on the company as CEO. And as always, we look forward to his comments. Jack?

All right. Thanks, Jay. All right. Good afternoon, everybody. And again, I'll echo Jay's thoughts on. Thanks for sticking around, those of you that are still here, and I will try to move along swiftly. So we're not causing you delay in the rest of your day. But I am excited to update you on our company and on my perspective on this really dynamic property and casualty market environment, that we believe will advantage our company, based on all the work we've done to enhance our capabilities and be a much stronger company going forward. So I'm going to swiftly move through a few slides that will update some of you that are less familiar with us. I'm going to move, if I can, real quickly because I'd really like to spend the majority of my time talking about the environment, and I think some of you are thirsty about what is all this change doing? And why does it feel more and more complex than it ever has? And as a 34-year underwriter, I think I have a decent view on what's happening and why the next 5 to 10 years are actually going to be quite different than the years that have preceded it. So let me start by just talking to you with the -- some of the key messages that we're going to -- that I'm going to leave you with today. I believe after a lot of hard work, we've developed a very diversified franchise, that today sits with pretty broad-based profitability. And I'll come back to this theme. But I think we've tried to elevate ourselves to a top-quartile financial performance, but do it in a way where we're not overdependent on one part of our business. And I think that makes us unique as we go forward. I think we're also unique because we have a very distinct partnership approach that we use with a subset of the high-quality agents that are out in the country. And I'm going to go through a little bit of detail on that aspect of our company. We combine that unique distribution approach with increasingly a distinct set of specialized capabilities, really across our portfolio. I think we're extremely well positioned to thrive in this dynamic environment, not only in terms of based on what we've been able to develop in terms of our financial performance and capabilities, but our ability as a company to anticipate what's coming at us, and both deal with some of the defensive issues that come with those new challenges, but also the ability to anticipate some of the opportunities that are going to emerge and how to capitalize on them. And lastly, we have an ambitious but achievable long-term target of 13-plus percent operating ROE. I think if we execute against that, we truly will be a sustainable top-quartile performer. Again, for those who are less familiar with us, we're -- today, we sit here about $5.3 billion in market cap, almost $5 billion in revenue, 12.8% operating ROE, adjusted for the capital and the remaining capital that was deployed for Chaucer and an A invest -- A rating. I think in terms of the diversified portfolio, we've worked hard to improve our geographic footprint. When I joined here 14 years ago, we were 2/3 Personal Lines and really concentrated primarily in 6 states. Today, we are a national player for Commercial Lines. We're in '18 states in Personal Lines. And I think from a property and casualty mix standpoint, we're much better off. And from a sector standpoint, we've been able to get some real distribution across Personal Lines, Core Commercial, which includes Small Commercial and middle market and Specialty business. And inside our middle market business, we have a number of industry-related niches that I think are every bit as specialized as our Specialty Commercial business. But we label our Specialty businesses when we have a separate operating model and a separate set of resources versus more of a hybrid model that we use with our specialized middle market niches. So at the end of the day, where our company and our strategy going forward is quite simple, we use a unique partnership approach with roughly 2,100 agents across the country. We leverage these specialized capabilities, that I'll talk a little bit more about, to try to make our distinctiveness and that franchise come alive. And then over time, as change is accelerating our industry, we are investing in innovation that will help us not only grow the business but grow our earnings, create more operational efficiency, create more customer retentiveness. And frankly, just modernize our company. And down below, these pillars of our strategy are very key enablers. I think what's probably under -- what's least known about our company is that we have brought together some of the best professionals from the better companies over the course of the last decade. And we have a very unique collaborative culture that I think is built to have more integrated thinking to better anticipate the challenges that are around the corner. With all these line of business changes, with all the geographic issues that are coming across, with all the weather patterns changing, I would argue, if you don't have a team of really skilled talent that likes to collaborate, that likes to kind of challenge each other in terms of what's going on in the marketplace, you're going to have a hard time keeping up and really taking advantage of the opportunities that will emerge. And I'll talk a little bit more about some of the unparalleled insights that we have, not only in terms of the data that we collect inside the company, but the unique approach we have with our agency plan through our Agency Insights tool, which is industry-leading. And last but not least, we have a commitment to form. We aren't -- we are -- we rebuilt this company to be a top-quartile performer. We want to be known as a high-quality brand, with customers that are looking for something more than cheap price. And to do that, you have to be a consistent performer and agents have to perceive you at a higher level. So quickly on a couple of these dimensions. From an agency distribution standpoint, I think there's an awful lot of people that use the word partnership in our business, but we think we have established ourselves as a very different type of company. First and foremost, most of the best product makers in our business over-distribute, not because they're bad companies, but because they're generally big companies, and they have to get access to a number of distribution points. And in doing so, they dilute their franchise. And so we rebuilt this company, understanding that vulnerability and being able to reposition ourselves as a midsized company with a lot of capabilities, but that we don't give our franchise to every agent. We do give our franchise to some of the big consolidators who are consolidating the business. But I think that scarcity of our distribution, combined with the capabilities we build make us very unique. We like to think we have underwriting expertise. Every business we win to -- whether we did it organically or inorganically, we've placed a high level of priority on making sure we had the right underwriting skills, the right claim skills and in some businesses, the right risk control skills. And we've done that in a way where it's a fairly distributed model, where we have a concentration of expertise where we need to. But wherever we can, we like to deploy our resources locally to be able to take advantage of the partnerships that we've built. And then last but not least, we have some deep business insights, again, inside of each business, but also across the agency plan. We have an Agency Insights tool that we don't have time to go into much detail here today, but we really are the only company in the U.S. that has created a consultative capability, where the vast majority of our agents upload their customer base and allow us to bring back to them a consultative package on how they can look at their business as a portfolio, how they can look for improvement opportunities to better serve those customers, to get better economics out of their business. Particularly consolidating agents that are buying up a lot of small- and midsized agents. They have more Small Commercial and Personal Lines business than they ever expected to have. They need help on how to take that very fragmented set of business and start to pull together and drive better efficiencies, better economics and to better serve those customers. If you get a little bit of detail on our distribution strategy here, what you'll see is that we're not in the national accounts business, we're not in the public D&O business, so we really aren't that relevant to the top 3: Aon, Willis and Marsh. But when I get done saying that, we are extremely significant to Marsh Agency, right? Because what they've done is build some -- they've bought some of the best midsized and now some of the smaller agents, and Dave Eslick and his team are very connected to our team. I think if you were to talk to them, they would see us as one of their most strategic markets because of the capabilities we've assembled, but also because of the way we interface with them and help them drive their strategies as opposed to just implement ours. So as you go down the size spectrum and the segmentation we've done here, what you see is we get increasingly selective. We are in a preponderance of the top 200 below that top 10, good midsized agents, they are -- they -- our product set appeals to them. We have a lot of local relationships with those folks. But as you go down the food chain, our distribution selectivity allows us to really create a franchise, that not every agent in town has us. And because if we deliver the distinctiveness that we have in our portfolio effectively, it really does create more of a franchise value than they can feel with some of our better -- bigger competitors. I want to talk a couple of minutes about innovation. And again, not enough time to go into great detail, but we have worked hard to not only elevate our financial performance but to reset our expense structure so we can be competitive. But also imposed an expense discipline inside the company that allows us to divest from previously important aspects of our infrastructure and allocate more and more of that capital to things that will be increasingly important to our future. And that goes across the value chain. We have investments and pilots on the customer acquisition side, all through the independent agency channel. We have investments that are kind of in the middle of the value chain. How we interface with agents, how those agents interface with their customers. And there is so much efficiency to be gained by working with companies like Indigo and Diaz and others that are trying to solve for how do we get rid of the unnecessary interactions of the redundancies between all of those parties? And then last but not least, on the customer service side, we are actually amazed at the take-up rate and the advances that are happening with things like digital camera and video capabilities that can be downloaded through apps and allow customers to service or handle small property and small physical damage claims, but a number of interactions. I think of one area, like our appraisals, we were struggling like many companies to find the next round of appraisals. And so out of necessity, we built a virtual appraisal capability for Personal Auto. And these digital capabilities, combined with a more centralized value, actually is improving the way the experience that the customer has and creating tremendous cost efficiencies. So it's a very exciting time. And what we have tried to do is to pace ourselves with the level of investment commensurate with where we see the change happening and how the insurtech firms can help us move faster. Again, looking at our specialized capabilities, it really is not just about Specialty Commercial. I think we've repositioned ourselves within Core Commercial to have industry verticals that matter; coverage differences; proprietary pricing; risk control, where it helps; even our Small Commercial business is a combination of package accounts and BOP accounts, with some coverage differentiation based on the industry you're in. So we are a unique player across this place. Personal Lines, I think many of you have seen, we went from being just another market that was trying to out-GEICO GEICO, to one of the premier account players. 85% of our portfolio is now accounts. We've built tiered product platforms to be able to appeal to the right type of customers. We, importantly, synced up the monoline algorithms in home and auto, so we could create some pricing stability for those customers without muting our margins. So across our platform, the question we always ask ourselves is, why Hanover? If we're in a sector, how can we be different? Can we generate appropriate margins? Will the agents give us preferred shelf space? And we think we're making progress across all those dimensions. I'm going to move swiftly here so I can get to the industry issues. But this is just to show you that in Core Commercial, we have a broad-based kind of industry segmentation. And so that helps us with our relevancy with agents, but it also helps us with the diversification of our portfolio. Specialty commercial, through acquisitions and through organic growth, we have over $1 billion of dedicated Specialty business, including Marine and Specialty Industrial Property and E&S, management liability, professional liability. So in the eyes of most midsized and small agents, we are a very distinctive specialized carrier that deals almost exclusively with the retail channel. We're not the 21st market trying to get in the wholesale market and get our piece of the pie. We go direct to the retailers, we present a distinctive offering, and increasingly, that's what's allowing us to feel more and more like a real distinct franchise. You'll see in Personal Lines, what I referred to earlier, is that over time, we have become more account-centric. Our operating models are unique. Our products are unique. The Prestige business that we built on top of our Platinum experience is allowing us to truly be perceived as a really top-notch market for the upper middle market, sitting below the high net worth. So again, a very, very distinctive business for us. What I'd like to spend a few minutes on today is my perspective on what's happening in the industry. And given the time frame we had to hear, I tried to make it as simplistic as possible. What this tries to depict is that over the last decade, you're starting to see, while the overall market is reasonably stable, right? We haven't had negative pricing in our industry over this period, we haven't had double-digit rate increases. So one could argue, certainly, in the time that I've been in this business, this is the most stable time if you look at the macro aggregate view. But once you peel that onion back one layer, you start to see a much different story. And many of you are familiar with that. You see specialization, proprietary pricing, dynamic loss trends are making the performance of individual carriers inside of that macro environment start to vary much more greatly than they have historically. And it makes sense. When you had a pricing cycle that was severe, everybody -- that was the most important dimension to a company's performance. Today, without those massive cycle turns, it's really more about how good are you at your trade? Are you fishing in the right ponds? Are you playing in the right market sectors? How cognizant are you of those loss trends? What kind of analytical capability you have? And it's our belief that over the next 2 or 3 years, you will see this gap widen. And I think you already are. The winners are going to be even more advantaged. And the losers are going to be engaging in some real severe turnarounds or they'll go out of business or be sold. One chart that we put together, again, to show this high-level view at a geographic -- from a geographic perspective, is that if you look at 2002, which was kind of the start of the hard market or the mini hard market after 9/11, but too early for that pricing to have earned in. Almost every state -- this is a Commercial Lines view, in aggregate, out of the stats. Every state in the union, except for one, was essentially in the red, had a combined ratio north of 100%. And in today's investment market -- investment environment, that is not acceptable. Fast forward 4 years later, because of the firming of the pricing that came out of that capacity in that market cycle, in 4 short years, almost every state in the union was profitable. So then move forward another 12 years to 2018, which was the easiest year for us to get the financials around, is that it's a mixed bag. And it's because it has a lot less to do with the pricing of the marketplace, like I said, and more to do with what's going on in that individual state. What's the economy inside a state? What jobs, what exposures are driving that? What's the legal environment? And so on and so forth. So what you're seeing is -- if you're in Southern California, it almost doesn't matter what you do, you're going to have a hell of a time making money. If you're in Maine, it's the opposite. And so it's this combination of looking at what sectors are you playing in? What's your account size? What's the line of business mix? What's the geographic mix? It's complex, but it's actually more -- it lends itself to the better underwriters, the better higher-quality companies. Some of you might have seen in our fourth quarter results, we tried to put -- and this is a partial piece of the slide that we put out, I think it was Slide 6 in our quarterly presentation. And we tried to show folks that, yes, we believe the environment is getting more challenged that not just in Commercial Auto and the broader liability trends, that the severity of the -- severity is moving out. We have more attorney involvement, we have higher jury awards, we have litigation financing that's allowing people to go further and take more and more cases into trial and not just solve -- settle on the courtroom steps. There's a variety of factors that is clearly moving the environment up from a loss trend perspective. But what I think we need to move away from, as an industry, is stop trying to figure it out by how much price we may or may not have over loss trend. And start figuring out who's going to be most exposed to these trends? And what have they already done to anticipate some of those trends and actually position them for success in the future? So this was some areas that we highlighted, again, in the fourth quarter. And we said, in our middle market book, we saw, a few years ago, some trends that concerned us around pushing out of duration of liability claims, predominantly but not exclusively in the metro -- major metropolitan areas, in slip-trip-and-type falls, right? So we saw almost -- the Commercial Auto phenomenon was contagious towards those types of GL claims. And so we took action on it. And we were quoted in our earnings calls as saying, "Listen, we saw some CMP liability, we put up some unfavorable prior year development. We shared that we reduced our writings in those areas." And I would argue that while the environment is getting worse, our portfolio reshaping is offsetting a good portion of that, and that's what's contributing to more stable liability trends for our book of business. We're not in denial of the environmental change, we're just trying to be explicit about what did we do? What did we see? And this also shows you that kind of from the -- from a geographic standpoint, what we did to try to move the needle. These are actual major cities, where we reduced our writings quite considerably. So when you -- when we get right down to it, I think what we like to do is to say it's great for somebody to describe their company and how they're more distinctive and how their distribution approach is better. But what we're most proud of is really over the last 3 years, we've been able to take all that hard work and show that the financial results are adding up to the efforts of the past. And so we believe we've emerged to a sustainable top-quartile position. We're determined to do that. Over the last 5 years, you see what kind of shareholder value we've been able to create. Again, last year at 12.8% operating ROE, after we have consideration for the remaining capital from the Chaucer sale. And so we head into 2020, frankly, optimistic about our future. We did -- so when we look back into '19 as a retrospective -- give me a second to catch up with my slides here. We believe we not only delivered top-quartile returns, but we did it in a pretty distributed way. We've got a Personal Lines business, a Core Commercial business, a Specialty business, generating terrific returns. We've had measured growth. Like my predecessor, we believe that while we know we can grow above industry over time, you need to understand when you need to take a step back, when you need to be patient about emerging opportunities. So what you'll see from us is that we believe we can grow above industry averages, but we're going to take some steps like we did in '19, to really do some additional portfolio management, when we think that will position us for success going into the future. We continue to expand our products and capabilities, entered into the sectors like financial institutions, retail, E&S, enhanced our cyber capabilities. So we're not just standing still, we're trying to build on our capabilities. We're going to further integrate those innovation solutions into our business models, Small Commercial is going to change, but it's not going to go direct overnight. In our view, what's going to happen is you better be working on the kind of Small Commercial that requires some level of underwriting and some level of trusted advice, and then be able to flex your operating models and leverage insurtech firms to create a new modern way to do that very profitable business. And we think we're on that path. I think we continue to build on our talent base. We're attracting more and more talent this past year. We brought in a Chief Digital Officer, a Chief Analytics and -- Data and Analytics Officer. So we are -- we're moving forward in trying to build on the talent that we attract to the firm and obviously, thoughtfully managing our shareholder capital. And so our quest, while ambitious, we think, is achievable, that we can achieve a 13% operating ROE or better. And we'll do that with targeted profitable growth, with stable and improving loss ratios. And as we outlined in the past, we have additional expense leverage in our business, but we're conscious of the fact that growing in this business can be challenging. So while we achieve that expense leverage, we need to be making sure that we don't back up on our loss ratios in order to take advantage of that. What we said here, we finished last year with a 31.5% expense ratio, but our marginal expense ratio, based on the investments we made in new geographies and new businesses, is substantially less than that. That's not true for many of our bigger competitors. In fact, some of them are actually backing up a little bit on their expense profile, either because of mix or because of investments. So I hope those of you that are watching us will see that we're committed to investing in the future, but getting those investment dollars out of our installed expense structure and not out of our earnings. And that growth, as long as we're growing the right way, is particularly helpful to our company. And so this shows you that really over a 10-year period, we'd gone from being a second-quartile player -- or excuse me, a third-quartile player to a top-quartile player. And it was done systematically, it was done thoughtfully. And we share our stat position, but we intend to stay there and to grow further. And so that brings us to where we are today. When you look back and say, in that during the last -- really from 2011 to 2018, we've returned about $1 billion worth of capital through share repurchases and regular dividends. And then in '19, we returned another $950 million through repurchases, special dividends and regular dividends. And it's our intent to continue to generate excess capital with our earnings and to deploy it into our profitable growth. But obviously, when we sold Chaucer, and it was a good financial trade, we were committed that if we could not find additional ways to either inorganically, organically grow that business, that we would rightfully share that back to you instead of earning minimal returns from a NII perspective. And so we'll finish here, in summary with, we believe we are extremely well positioned to thrive into this dynamic market. We're grounded in the reality that the change that's going on today is unique. There's a lot of complexity to what's going on in the market environment. But we believe we've assembled a team and our distribution approach, greatly advantage us to navigate those changes into the future. And again, that balanced portfolio that says when things don't go our way, we're not over-reliant on one sector of our business. And last but not least, when you combine the talent that we have and the insights that we're able to achieve from our distribution approach, from the Agency Insights tool that we've developed, we have over $60 billion in Commercial Lines alone in terms of market placement data and insights that no one else has that we compete against. It doesn't guarantee our success, but it certainly can enable our success in a data-driven world. So with that, I'll finish up here and see if we have a couple of minutes for some questions. And Jay will let me know if we ran out of time.

No, we're good. We got some time. Let me just throw out a question. First of all, the ROE improvement chart was pretty impressive, especially when you consider interest rates were falling during that entire time. So I've been looking at the stock for a long time, and you guys have been talking about this. And I think the combination is, you've been able to achieve what you had set out to do. Obviously, as an analyst, I'm always looking forward, so when it comes to growth, and it doesn't sound like you're putting the pedal to the metal here, but you want to grow the business. What's the likeliest source of that growth? Is it new products, new agents or deeper penetration into the agencies you're in?

Yes. Listen, we have plenty of headroom in the businesses we're in today. And there's nothing more accretive, particularly if you have a profitable base to grow into those existing businesses in those existing geographies. So that's job one. And it's not as sexy, but it is the most accretive growth that we can possibly consider. So we have all hands on deck, differentiating where our margins are, where we think they're sustainable. And we're pushing ourselves to not underwhelm those opportunities that are emerging, particularly as others have to make different portfolio changes. Simultaneously, we are investing in new things. And admittedly, in '19 we took a little bit of a break because we were doing some pretty major platform work. We had come off of our Personal Lines platform work. We're investing heavily in our Small Commercial platform work. We did a little bit more in the digitization world. But it is our quest to go back at sectors of the business that are important to our distribution and build that next set of capabilities. That's what makes us relevant. That's what allows us to diversify, so you can see that next wave of growth potential will go -- will take us there. Last but not least, I think -- and there's a little bit of that comes from additional agents in the newer geographies where we cannot dilute our franchise, but we can grow up as those margins have matured. I think one of the biggest swing factors for any company, but I think, particularly for our company is the skill set we have in our company can move up one octave in risk-taking when the margins are better. So when you think of what's going to happen in the eventual correction of the workers' comp pricing, right? Some people are going to get compressed by that. And they're going to have to move their pricing, and we should be able to capitalize on that. If we're as good as I think we are in anticipating liability trends, that's going to create opportunity for us, particularly in the middle market space. Another potential tailwind for us is that our true partnerships with the consolidators in the business are showing us that as they think about consolidating markets, in order to provide more efficiency and more effectiveness to their customers. We're one of very few companies that has the data and the operating capabilities to help them do market consolidation. It's the breadth of our appetite and our operating models that allow us to capitalize on that. If you talk to USI, Marsh Agency, Hub International, EPIC, the folks that are really moving the needle on market consolidation, I would be really surprised if we weren't considered a top 2 player in that space. At least in terms of helping them with their strategies, but eventually with that market consolidation. So I think there's -- we've tried not to oversell this because the environment has to continue to move. But as those distributors start to look and become more operational, we think we've positioned ourselves quite well to help them do what they're trying to do to improve their EBITDA and their margins, but also be able to grow our company at an accelerated pace.

That's great. Any other last minute questions? If not, Jack, thank you very much for the...

Thanks for having us.

And thanks to everyone for coming. Mark your calendars for next year, we'll be here.