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

And we're live. From the Bank of America Tower at One Bryant Park, New York City. This is the Bank of America U.S. Insurance Conference. If you're tuning in right now, you're tuning in for the Hanover Group's segment in the conference. On deck is principal financial here at Hanover, we are really pleased to have Jack Roche and Jeff Farber from Hanover, the CEO and CFO. I'm going to let them introduce themselves, and Grace Carter and I are going to ask some Q&A. I want to tell everybody that if you're dialing in and you're on the Veracast app, you should see a window where you can send me questions, and I am very happy to get your questions and ask them without attribution, unless you say, please attribute me. And I'm going to let Jack and Jeff talk about themselves a little bit, then we'll get to questions. So go ahead. Talk to us, guys.

All right. Thank you so much, Josh, and Grace, and really pleased to be here with you today. Again, I'm Jack Roche, President and CEO of the Hanover Insurance Group. And I've been with the firm about 15 years, in the CEO role for 3.5. And very excited to update you and share with you the progress we're making towards our transformation to be one of the top franchises for high-quality insurance agents in the U.S. We've spent the last 1.5 decades, frankly, transforming this company to a much more distinctive, more geographically spread out, more diverse franchise for our agents, and we're excited, as I said, to share the progress we're making and our optimism going forward. So with that, I'll allow Jeff to introduce himself.

Good morning, everybody. Great to be here. I'm Jeff Farber, and I'm the CFO of Hanover. Been with Hanover for about 4.5 years after a long career with a variety of financial services firms. And most recently, AIG, for the last 5 years as Deputy CFO and then the Chief Risk Officer of both businesses. Great to be here. Thanks.

Well, we're pleased to have you. And maybe a way to start out with is to talk about what makes Hanover different from other companies. We mostly use the term regional carriers, some people don't like that terminology, maybe you embrace it maybe you don't. But we talk about being a carrier of a size you are what it makes you different? What are the plans for expansion? And maybe always a pleasant question, how have things during the pandemic influenced who you are and what you're going to do going forward?

Yes. Thanks for that question. And on the categorization of regional care, we really do think of ourselves as kind of the one of the most distinctive emerging national carriers in the commercial line space, and we still are today, a regional carrier on the personal line space in 20 states. But whatever you call us, I hope what you think of us as a company that really has gone from being a more generic kind of agency-centric underwriting company to a much more specialized capable company that has dramatically improved its geographic footprint become increasingly specialized across our entire product set, but in -- particularly, in the commercial line space with all the specialty businesses that we've purchased and/or built. And our aim, as you know, is to be the best franchise for high-quality agents that are exclusively focused on the IA channel. And helping our agents, frankly, deal with the exciting changes that are coming upon our industry and transforming the way we do business, frankly, across the value chain. Josh, to your point, the pandemic and all that came across in 2020, clearly is going to accelerate the change in the industry. And we've already started to benefit from that and focus on that. We are proud of the fact that we were able to get all 4,300 employees up and running and servicing our agency customers, also building on the strong culture that we've worked so hard on. And frankly, driving every major initiative that we set out to do in 2020. As we reflect on the year, we did not really skip a beat on the major initiatives and priorities and investments that we would made. Last but not least, I think it's our distribution approach in addition to our specialized capabilities that makes us different, that we have a very unique select approach to appointing agents and to partnering with them, and we have built a series of analytical tools and consultative capabilities that I think are unmatched in the industry.

Grace, why don't you ask questions to follow?

Sure. Could we talk about the long-term ROE target of 13% and the key assumptions that underpin that and key upside and downside risk? In particular, this year, given the unique operating environment, how that might take out relative to the target?

Sure. Thanks, Grace. Let me just say a couple of quick comments kind of at the macro level, and I know Jeff will be happy to deal with the specific levers that we think will help us achieve those margin goals going forward. We do believe we come into 2021 very well positioned to deliver not only for 2021, but to continue our momentum that we built over the last 3 or 4 years to transform and translate all those strategic moves that we made into top quartile margins that we can deliver in a very consistent manner. And the reason why we have confidence is that our profitability that we delivered particularly in the last 3 years is very broad-based. It's not coming from one side of our business. All of our major businesses are delivering at our target ROE rates. And we think it's that broad-based profitability, frankly, that gives us the ability to continue to grow and prosper and achieve those top quartile returns. Jeff?

We have a lot of confidence in our ability to achieve the 13% ROE. And the biggest driver of that ends up being our ability to control our expense ratio and the leverage we get from the fixed costs. And then finally, the commercial lines margin expansion that we're anticipating really should offset the NII pressure that is put on the ROE. So again, a lot of confidence in our ability to achieve the long-term ratio of 13%.

So one thing I would point out on your confidence, I mean, if we go back in time, 2 years ago, maybe 10-year treasury was at 3%, maybe there at -- beginning of 2020, it's closer to 2%, now closer to 1%. I've always argued that there's some sort of relationship between ROE objectives and how much return you can get in excess of the risk-free rate. To what extent does your 13% ROE target change with changing interest rate environments? And how are you managing the investment portfolio, given the changes in the interest rates? And I guess when we say managing, we've really been managing, you're doing a lot of it in-house through your Opus business. Can you talk about how that is a competitive advantage compared to some of your competitors who might be outsourcing their investment management functions.

So there's a lot there, Josh, I'll try to cover it. Overall, we've had a consistent philosophy for a long period of time. And we have a team that manages outside money. So we've got a couple of billion dollars of outside money. And I think the combination of managing our $9 billion of inside money and also the experience of outside money, really gives us an opportunity to see more in the marketplace and to hire more talented people who find it interesting and exciting to manage outside money. To transition to the impact on ROE and how we think about our portfolio, we're not really anticipating any major changes in the investment allocation. As we think about the mix between underwriting risk and investment risk, I think we like that. We like that view of where the portfolio is structured, where we've got about 85% of the investment portfolio in fixed income and high-quality fixed income. Over time, as I said a moment ago, in the short run, at least, I think the commercial lines margin expansion will offset the impact of relatively flat NII, whereas interest rates are falling, but our cash flows are increasing, and it should help us there. Over the long run, it will really depend on which is more sustainable if the firm market in commercial lines is more sustainable versus the longer interest rates, 1 of those 2 would have a larger impact over the longer run.

All right. Grace, why don't you take the next question?

Sure. Could we shift gears and talk about technology a little bit and how that influences your opportunities for expansion, particularly when it comes to the Agency Insight tool?

Sure. Listen, we're quite proud as an institution that in addition to driving improved margins and delivering what we believe is top quartile returns, we've also been investing rigorously in our future. And I think we've been pretty consistent in kind of updating folks that, really, across the value chain, we are making targeted but significant investments. And we're doing that while we also increase our efficiencies and improve our expense position. But to your question, we are -- we have innovation on kind of the customer acquisition side, on the -- how we interact with agents and customers from a data efficiency standpoint. And certainly, in the claims side of the house, where there's really been significant progress and obviously aided by the pandemic environment of 2020. Inside of our innovation is this concept of advancing our partnerships with agents and building these analytical tools. Agency Insight is one of our proprietary tools that's part of that partnering approach. And what it allows us to do is to help agents take the information that is embedded in their agency management systems. And reassemble that data and information into a portfolio approach, one where the agency principles and the leaders of the agencies can see their book of business in a much more strategic way. And over time, we built a series of strategic views that allow them to understand how fragmented their business is by carrier, by line of business. There's a better understanding of where the improvement opportunities are to assemble accounts, to better serve their customers, frankly, to see where they've got some industry segment penetration that can start to get more programmized and more strategic in terms of their new business pursuits. So while we're proud of a lot of the innovation that we've done across the entire value chain, our proprietary analytics capability with agents, not only gives us an advantage in terms of partnering with the agent and generating good penetration, but it also gives us a tremendous strategic view of the business. We have insights across $75 billion worth of business because of the accumulation of that information that allows us to think about where we go next in terms of new industry sectors and building new products and capabilities.

Within the agencies that you're operating right now, I guess, on average for the targeted agencies, you're producing, I guess, about a 7% market share within those agencies in aggregate. It's higher at some, it's lower at some. Can we talk about your targets for how much is a ideal sort of contribution to individual agencies premium flow and your sort of plans for increasing your share in agency where you want a higher participation rate?

Yes. And that's a really particularly important question now as the distribution continues to consolidate. And so those market share statistics and targets are changing. What's not changing is that in the areas of the business that you are pursuing. If you're not a top-tier underwriter or market for those agents, you're not going to get the highest quality business. So being able to look at the data, understand where do I stand? What commitment level do I have the agent by segment, by sub-geography. And so the market share data that we share tends to be shaped by what industry sectors and lines of business are we focused on, how much penetration have we accomplished. And when we get to the agency lens, as you would imagine, on a smaller agent, that's predominantly a personal lines and small commercial relationship, we have expectations to be a top 3 player, get 10% to 15% market share. In places like Michigan, it can be well north of that. But as you get to the larger consolidating agents, you can be a very relevant top 10 player with 5% or 6% market share and be very focused on the sectors where you have capability because agents really aren't that worried about who's 1, 2 or 3 in their shop at that level. They're much more focused on the specific areas of pursuit and who can they rely on to be a consistent, high-quality provider in commercial lines in those subsectors. So that's what we're most proud of is that the agency insights data combined with the rest of the kind of partnering approach that we do with agents in the 3- to 5-year planning that we do allows us to set reasonable targets 1 agent at a time, 1 sector at a time, and we track it and make sure that we're on that path. And if we're not on that path, then we come back to the table and talk about what it is we need to do or whether those pursuits are realistic pursuits for our partnerships. But those numbers are changing, and we're -- what's not changing, like I said, is that we're increasingly penetrating our top partners, high-quality books of business, and we have sites to do more.

Jack, on that answer, I just want to -- I mean, look, can you be with a successful agency but there's not a lot of growth opportunity, and you'll want to say, look, we would rather nominate somebody else in your territory if we can't grow with you, is that what you're saying? And then someone else can become a Hanover representative? I mean, if someone is only swing you to 5% ceiling. That's kind of you're ceiling? Are you going to disengage with that agency?

Well, we -- there is definitely many examples of where either because an agent has decided that they've plateaued, and that's okay with them. Obviously, a lot of agents have decided to sell when they get to that stage of the game. But yes, our proposition only resonates when somebody is economically motivated and customer-centric. We spend a lot of time, energy and money building these specialized capabilities, and building our partnering approach. So if an agent is -- we're sitting at 2%, 3%, 4%, 5% market share and there's no aspirations for us to deepen those partnerships for the agency to grow, frankly, our franchise isn't that attractive. That's how we operate our business. But I would tell you that many agents are economically motivated, increasingly focused on bringing better value to their customers and that's what allows us to continue to grow and prosper. And maybe the last part of that is our points of distribution are getting enhanced by the consolidation. More and more agents are becoming part of companies like Marsh Agencies and Hub International and USI. And when that happens, our strong partnerships with those consolidators present new opportunities for us. But we use our disciplined approach 1 office at a time, and we don't appoint offices of even those big consolidators unless we have a real fit, and we have a commitment to drive towards that penetration.

So I have a question coming in from an investor. I'm going to ask the question their way then make a few changes. They want to know what the future is for personal lines at Hanover, given new entrants like Lemonade, price comparison websites, companies like Progressive entering homeowners and a trend towards disintermediation of the home auto bundle for people who can price auto much cheaper? Now you're really not competing with the broad category with your platinum product. I see your competitors are probably more like the Chubbs, the Pures, the AIGs, Sinsay Financial is the new program. But here's what I would say, to what extent -- how big is the market for the type of homeowner you want to insure? How competitive is that marketplace? How big of a share can Hanover effectively get with cap management as -- in the reamer for trying to get as much share in that market as possible? What is the long-term role for a Hanover in the personalized marketplace?