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

Hi, everybody. My name is Michael Zaremski. I'm pleased to introduce Jack Roche, CEO of Hanover Group; and Jeff Farber, Chief Financial Officer. I had the pleasure of initiating coverage on The Hanover last year. And I'm telling you that, because in my conversations with investors, I've sensed that Hanover's been somewhat under covered and, therefore, underappreciated by certain investors. So we decided it would be best for Jack and Jeff to start off today with a presentation and then they'll give you a little -- they'll tell you about their secret sauce, why their book value plus dividends have grown, on average, a CAGR about 12% since Jack took the helm as CEO in 2017, and then we'll move into Q&A. So with that, I'll turn the mic over to you, Joe (sic) [ John ].

Thanks, Mike. Really appreciate that. And we very much appreciate being part of this prestigious conference. So I will spend the next 20 minutes or so providing an update on the progress that we've made, elevating The Hanover to a more consistent, top-performing and more distinctive carrier in the property and casualty sector. And then Jeff will add some thoughts regarding our financial trajectory and health, as well as our investor proposition. And then, as Mike suggested, we'll come back and take some questions. So let me just start off real quickly. As Mike alluded to, I've been CEO at the firm for the last 3.5 years. I've been with the company for 15, I've been in the P&C sector for 35. And I can promise you, this is the most dynamic time in our industry in my 3.5 decades. And I say that with enthusiasm and excitement. I believe this is an opportunity for the better companies and, frankly, the better agents to increase their share and to really blossom at a time when our customers are expecting more of us. And frankly, the technology and the data and the analytics are allowing us to really transform the way we do business. So I'll start off first with -- and reference some slides that you have here. And I'll start with just a basic overview of our company. We're roughly $4.2 billion, $4.3 billion in market cap, $4.6 billion in net written premium last year, another top quartile ROE performance in 2020 and really the best financial strength we've had as an organization with an A rating from AM Best. I'd give you a sense for the evolution of what we've done over the last 15 years since I've been here. When I got here 15 years ago, this was a company that was pretty well-respected for being a good underwriting company, but it was very much a regional company and dominated in 5 or 6 states. And it was personal lines and small commercial-centric, not a lot of distinctive products, certainly not on specialization. And what you can see on the right-hand side is through a series of acquisitions, and organic build-outs and some geographic expansion, we've fundamentally diversified the company and made it much more attractive in the eyes of the independent agents as well as investors. We now sit here today with roughly 40% of our business in Personal Lines and about 40% in our core Commercial business and a little over 20% in our Specialty business. But as I'll show you later on, all of our businesses are specialized in some form. And I want to give you a little bit of an insight inside of each of those businesses on why we're different and why we try to avoid the commoditized sectors of our business. And then from a geographic standpoint, we still have a pretty good concentration in Michigan. 1 of the 2 regional companies that made this company what it is, had a huge presence in Michigan, the Citizens Company. And we don't apologize for that concentration because, frankly, we outperformed the industry in Michigan consistently and generate terrific returns. But we have worked diligently to diversify the firm both from a geographic standpoint, from a sector standpoint and from a distribution standpoint. And I'd love to share more about that. But first, let me just give you my high-level view of our investor proposition and then Jeff will come back to that later. And I do think we bring a differentiated strategy and product offering. And hopefully, I make that case at a high level for you today. We believe we're well positioned for above industry growth. We were on that trajectory before the pandemic came across us. We intend to get back to it. And we've more than doubled the firm since I've been here, and that's even after consideration for buying and selling our Lloyd's Syndicate Chaucer, which was a great financial transaction, but it frankly wasn't where we wanted to go for the long term. So if you added that in there, we have a track record of substantial growth and financial performance that we want to build on. And then last but not least, well before it became fashionable, we were delivering value to all of our stakeholders. And we are a company with a terrific culture, with -- that employees are highly engaged in, that our communities are excited about, our participation and support. But our focus clearly is on driving shareholder value and taking this company to the next level. So we're doing that with a vision. And our vision is, frankly, to -- and as ambitious as it sounds, is to be the premier P&C franchise in the independent agency channel. And given the dynamic environment and the change that is coming upon us, we want to help agents transform the way customers value and experience insurance solutions, and we have a lot of exciting things to share in that regard. The tenets of our strategy are that we have a partnership model where we try to be the agency carrier of choice for the products and services that we build and represent and increasingly use technology and data analytics to grow our business but also transform our business and operate it quite differently. Below that, you see some enablers, and that speaks to our culture, our financial discipline, our desire to be a top performer and to execute in a way in which our agents and our customers can rely on us. We're building a brand and we think we're well down that path, but we're determined to be one of the best brands in the P&C business. So let me talk about those levers at a high level, and I'll start with our unique agency distribution approach. Those that follow us know that when we rebuilt this company 1.5 decade ago and we started down this journey, we not only started to make it a more sophisticated and more specialized business, but we targeted the best agents in the country. And we did that across the different size sectors. We don't do business in any meaningful way with the top 3 brokers because we focus on small to midsized accounts in the commercial line space. We're not a national account player. We're not a public directors and officers players. So because of that, our product set doesn't lend itself to playing with the global brokers. That said, when you come one octave below that, we are a meaningful partner and market for the likes of Marsh agencies, USI, Hub International, the big, big national agents that have been consolidating the business over the last 1.5 decade. But we have real sincere partnerships across the various different size sectors. And our proposition is more about identifying the top-quality agents that have a business fit with us, as well as a philosophical and financial fit with us. And I'll come back to that in more detail. We combine that unique distribution approach with our broad and relevant product and underwriting expertise and the deep insights that we've created in our unique model, and we really have a great value proposition for the best agents in the country. So let me talk a little bit about these leading specialized capabilities. And I want to talk about it broader than just our Specialty business. In each of our major businesses, our mandate to the business is that they have to be different. We have to be able to answer the question of "Why Hanover?" In our core Commercial business, that means that we have a series of industry specialized segments and offerings, both from a coverage, proprietary pricing and service perspective that we -- in small commercial, we have both a small account offering through our point-of-sale systems as well as for the more complex accounts, we have a more sophisticated underwriting model, which makes us unique. Many of the large companies are predominantly a point-of-sale type offering and many of the regional carriers are a nonpoint-of-sale or kind of packaged account writer. So in Small Commercial, we are anything but a commodity. We are a fulsome, small commercial market for the best agents. In Specialty, we have spent the last decade plus building this $1 billion-plus specialty business that complements our core commercial offering. And today, the returns of that business are terrific. It took a while through a series of acquisitions and business builds by hiring talent from some of the better companies to stand up a series of 9 specialized businesses. But collectively, we are one of the most active specialty writers for the retail agents direct. And that makes us unique. Many of our specialty brethren generate a lot of their revenue through wholesalers, which is not, in and of itself, there's anything wrong with that. We do some business with some wholesalers, but we're very unique in that the vast majority of our Specialty business comes direct from the retailers through our operating models and our capabilities. And last but not least, our Personal Lines business is anything but a commodity. And I'll talk about this really in more depth in a few minutes. But it's $2 billion business for us, generating terrific returns, and it's an account strategy with the top agents that are consolidating their books of business over time, and we're very excited about the prospects in that line of business. So I think what I wanted to pause and talk about beyond just the sectors and the lines of business is, in our business, in my opinion, the industry has been a little bit too internal focused over the last decade. Much of what's happened is carrier strategies have driven a fracturing of the business, a fragmentation of the business, even in Small Commercial, and you saw it in Personal Lines. People got infatuated with multi-variant pricing algorithms and products, and everybody was trying to out-GEICO GEICO. And what we've tried to do is help agents kind of restore their real value proposition. And that is what is the customer looking for out of their insurance program and how do we help them get that? And so in Personal Lines, we were one of the biggest markets to kind of reassemble accounts, and 85% of our business now is in account, and we're trying to do the same thing in commercial lines, not holistically because there's still going to be a fragmentation in some of the specialized areas, but to help agents see the value that they can provide by bringing more lines of business together with 1 carrier for 1 customer, so we can be more efficient, be more focused on their needs. And as the business gets more digitized, we can actually visualize how we can do that in an effective way. Really hard to create a digital experience for a customer when you have 5 lines of business going through 3 different carriers. And so we see this as kind of a preface to the new way of doing business is becoming more account-oriented and driving that into the distribution. So I'm going to take a fast drive then through our -- the rest of the slides here and tell you that we feel like we're well positioned for growth and for continued top quartile profitability. We have transparency to how we can further penetrate our agents with our product set. We'll continue to add some agents. We'll continue to add some products, but we have plenty of headroom in the products that we have today in the territories that we are. We're going to continue to expand some of the business unit capabilities, and we're definitely going to continue to innovate, and I'll talk about that in a minute. So going to the next slide. We'll talk about briefly the core commercial -- I'm sorry, this agency growth strategy just reinforces that point that we can get the vast majority of our growth over the next 5 years by penetrating our existing agents and then selectively adding some new appointments and driving ourselves like we have over the last several years to a much broader and deep partnership with those agents. Our Commercial Lines business, as I suggested, is diversified across a number of sectors. This includes our small and middle market business. And on the right side of the slide, you'll see that we are -- we do focus mostly on the small to lower end of middle market, which helps us maintain a proper level of volatility of our earnings, but also allows us to focus on operating model and really transforming those operating models and keeps us from playing in the more -- what we believe is the more commoditized portion of the business where the margins aren't as great. In our Specialty business, you'll see what we've done over the last 10 years in terms of building out and penetrating these specialty areas in E&S, health care, surety, our Specialty Industrial Property business, our executive protection business. This has been done, as I said earlier, through a series of small acquisitions and organic build-outs and is really one of our biggest success over the last decade. In our Personal Lines business, what you'll see as you learn more about our businesses, while we're a regional carrier in the personal lines business in 20 states, we are distinctive and we focus on the upper middle market and below the high net worth and have delivered an account strategy that frankly puts us in a very, very, very distinctive place. 70% of the Personal Lines in the IA channel is -- 70% of the business is with regional carriers, not national carriers. And we're perceived as one of the top regionals with a real distinctive capability in this business. So I'll finish with just some highlights, if you will, of how we're innovating and how we're using the new technology capabilities and data and analytics to transform the business over time. And when you think about this in the 3 major kind of pieces of the value chain, there's the customer acquisition stage where we're working with a number of insured tech firms and vendors to help agents go after programmatic-type small specialty business in a more digital and seamless way. That will take time, but there's a lot of good work being done and we're very actively involved to that with some of the firms that we're showing on this slide. In the middle of the value chain is this whole idea of data exchange and reducing some of the rituals of our business and frankly, asking less questions because we can get the data somewhere else, or asking less questions because they weren't really that potent to the underwriting pricing process to begin with. A lot going on in this space, very actively involved in that transformation and finding great efficiencies and progress there. And last but not least, on the servicing side, we had invested ahead of the pandemic and thank God, we did. Because we were able to use things like camera and video apps and downloads and other new methods to settle claims and settle them with little to no leakage and providing customers with an experience where we didn't have to get together physically in order to help them resolve their claim issues. So I'll leave you kind of with that final thought, that we are -- while we continue to deliver great financial results and improved expense ratios, we're not doing that at the expense of the future. We're investing heavily in the right types of things to modernize the company and position us for success in the future. So with that, I'm going to turn the floor over to Jeff, and he can take it from there.

Thank you, Jack, and good afternoon, everybody. I'm glad we switched the slide past my picture because it's always unsettling to look at yourself in front of a large group of people. Great to be here. Sorry that we can't be in Key Biscayne, I think that's where we were last year. But certainly hope next year that we'll all be able to be together and spend a little time together, right? That was a lot of fun last year. I've been with The Hanover coming up on 5 years as the CFO. And before that, spent 30 years or so in a variety of financial services firms, the last 5 was with AIG in a number of different capacities. So delighted with where we are. On the slide in front of you, this really shows a journey that we've been on to enhance the financial performance and create consistent profitability. 2010, we were in the bottom quartile from an ROE perspective with a depressed ROE. And all of the work that the team did and that Jack talked about over time to modify the portfolio really has shown itself. So by '15, we were up in the second quartile. And as we sit in 2020, it's 13.1% in the top quartile. And 2020 is not an aberration, '17, '18, '19 and '20 were all relatively strong, all top quartile, all roughly 12-plus percent ROE. And how did we do it? Well, if you look at the right side of the page, the darker orange is the loss ratio, the lighter orange is the expense ratio. And 2005 is a little bit different in that we were largely a personal lines company. So the mix of spend between loss and expense is different. But if you look from 2010 forward, you'll see a steady decline in both loss ratio and expense ratio, which has really been the driver, not surprisingly, of our enhanced performance. Page 18 here is our cat performance. And again, we go back to 2005. And so the first 10 years or so, the darker orange again is Hanover, and the lighter orange is the industry. And if you scan from left to right, you'll see the first 10 years or so, our performance was heavier in terms of actual cat performance relative to the industry. So we spent a good part of the last 10 years evaluating the risk and managing the property aggregation really thoughtfully to address the volatility that we were seeing. And if you look from '16 to 2020, generally speaking, Hanover was represented less in cat than the industry. And in fact, I think the math shows us that we were 4 points below the industry cat. So I believe that is really helpful, notwithstanding our heavy property footprint generally relative to some. We've been able to navigate and manage that really carefully by being away from the coast, being out of certain states that are cat prone and spreading the risk appropriately. Moving to the next slide, if we would. We've talked a lot about our aspirational goals of getting to a 13-plus percent target operating ROE. And where we are today is somewhere in the 12-plus percent range, and we've been consistently performing at that level, give or take, up or down in the 12s from '17 to '19 and a little higher than that in '20, aided by some frequency benefit, of course. But the model to get another 1% or so to get us well above 13% is targeted profitable growth, and mid-single digits consistently will do that and either stable or improving loss ratio. And if you think about it, the original model was stable loss ratio benefit from expense management and an ordinary, if you will, or consistent environment for NII based on an interest rate environment. As the interest rate environment has been more challenging and interest rates have fallen, notwithstanding the last month or so, not surprisingly and consistently, the margin of rate above loss trend has improved. So one way or the other, either in my opinion, we will have improved margin on the commercial lines loss ratio or the interest rate environment will improve. But we're very comfortable with being able to manage the concept of underwriting margin in NII as a unit. And then finally, the expense benefits we get from the growth are quite substantial. We have fixed expenses and we have marginal or variable expenses. And as we grow, we can easily achieve 20 basis points expense improvement on our expense ratio from growing at mid-single digits. When you do that, the 20 basis points converts to almost 30 basis points of ROE. So over a 3-year period, you basically pick up 1 point of ROE just from the growth and the leverage we get in expenses. And then finally, because we're focused on both the numerator and the denominator of the ROE quotient, thoughtful and attentive capital management and capital allocation will be a major part of this. Next slide, please. So how do we do all this? We have always been, or at least since 2016, a financially disciplined and focused firm around rigor. Around the financial discipline and rigor. So our investment portfolio, which I'll show you in a couple of minutes, is a very conservative portfolio, largely focused on fixed income. No plans to change that, but that provides the ballast for the results of the firm. We have been very disciplined with our loss picks and our reserves and our balance sheet, and we leave 2020 with a stronger balance sheet as we've ever had. The prudent financial leverage that we exercise is maintaining a very strong balance sheet while being thoughtfully focused on the amount of capital that we need and the amount of capital that we return to shareholders, given the ROE desires that we have. And finally, when we think about reinsurance, we focus on protecting the balance sheet and the capital of the firm, maintaining limited volatility in the earnings and then also opportunistically taking advantage of pricing arbitrages when they show themselves from time to time. So as you think about the investment portfolio, we have a $9 billion portfolio at the end of December. It's really constructed in 2 main components. The first is the fixed income portfolio, about $7.5 billion. And the remainder are cash, equities, mortgage loans, limited partnerships, et cetera, for about $1.5 billion. And given that we have about $3 billion of equity or a little bit more, you have -- and the high 40% range of that portfolio -- of the equity is risk assets. The fixed income portfolio is 96% investment-grade, has a weighted average rating of A+ and a duration of almost 5 years. And the risk portfolio is still a relatively conservative portfolio in that it has a manageable level of limited partnerships, which tend to be mezzanine-type partnerships. We have some marketable securities and some exchange-traded funds and then we have commercial mortgage loans, which have a low loan-to-value ratio. So the portfolio is constructed very conservatively and has performed very well over time. Next slide, please. So as we think about capital, we're very thoughtful capital allocators, where we feed businesses that we think have attractive opportunities, and we will scarcely give capital or start businesses that are struggling to allocate the capital where it can be best used. And as we think about any excess capital we have, we first want to bolster our balance sheet, make sure it's quite strong. Secondly, we use it for organic growth. And then we have a strong track record of returning capital to shareholders over time through both dividends and share repurchases. The chart on the right shows the dark orange or the dividends, the lighter orange are the repurchases. And I would share with you, this entire chart excludes $850 million of capital return to shareholders in 2018 and 2019 combined, which consisted of about 60% stock buyback at about 40% special dividends. But that's excluded from this chart. So if you look at this, we've done fairly active both dividends, and we've had a good track record of growing that dividend and maintaining a roughly 30% payout ratio and finding opportune times to buy back our stock, and we will continue to do that. Next slide, please. So we have a long track record of being very focused on ESG. And probably the early days for a very long period of time, governance has always been a focus. And our Board is very diverse. We happen to, at the moment, have a chair, a Board chair, that happens to be female. And we have best-in-class, best in practice, pay practices and very strong governance. On the environmental side, both attention to climate change and focus and also sustainability have been important hallmarks of how we try to drive the firm. And then finally, social. For all the time that I've been at the firm, we've been a very inclusive firm, very focused on inclusion and also diversity. Again, we have a diverse senior management team, a diverse Board, and have been focused on business resource groups and a variety of things. And certainly, that hasn't slowed down in the last year. If anything, we have ramped up our attention to diversity and inclusion and feel very, very good about that as we go forward. Next slide, please. So as we think about valuation, I think most in the industry have a little -- have been a little disappointed that the P&C companies have not performed as well as others in financial services. I think the banks in the last month or 2 have recovered nicely. I think we're making a slower recovery, perhaps the BI issue maybe providing a little bit of an overhang in that. But as I think about Hanover, we're trading really at a discount. So if you look on an earnings basis relative to our peers, and we have national peers, regional peers, specialty peers, median peers, our earnings just continue to deliver and our valuation has lagged behind. In terms of annualized total return, over a 5-year period, the stock has performed very nicely. Over a 3-year period, the stock has performed nicely. The last year has lagged a little bit, and we're looking to restore ourselves to outsized performance relative to our peer set. And the reason I think it's so important and the reason it's demonstrated is, if you look at value creation, which is the bottom of the chart, and again, the darker orange is Hanover and the peer median is the lighter orange. But whether you want to look at a 5-year, a 3-year or a 1-year basis, value creation we've defined as book value share growth plus dividends in the period, the value creation for shareholders has been very, very strong. So sooner or later, the actual valuation of the stock will follow the valuation creation, I believe. And to finish the -- Jack mentioned the investor value proposition in his opening remarks. We are truly a differentiated strategy and product offered company. The combination of how we face off with the independent agent channel and the products we offer and the locations we offer them, very differentiated. We are well positioned with that offering to have above industry growth, and we expect to get back to that in 2021 as we've guided to, and to consistently have top quartile profitability. And doing those things will deliver value to our stakeholders, shareholders and then other stakeholders as well. So we feel terrific about the company. And with that, we'll pass it back to you, Mike, and we're all yours to fill some questions.

Great. And that was a very thoughtful and thorough presentation. Now I need to pick and choose now because we only have about 5 minutes left. So let's move to something that I feel, I sense, differentiates The Hanover. And I think you, Jack, you touched on it on some of the slides. You mentioned the word partnership model. Data analytics is a sexy word, by the way, a lot of people use. But you have this Agency Insights platform. Maybe you can kind of talk about whether it really is a differentiator or is this something that -- a lot of us followers and other people can mimic? What is it helping you do in terms of your strategy?

Sure. And I'll be as brief as I can, given the time we have. But the short answer is it's very distinctive. There is no other company in the property casualty sector that has built trust and a capability where agents, big and small, have shared their customer data for us to give them a consultative package about how they can transform their portfolios, how they can better serve their customers over time. The agency management systems are built for transactional excellence. They do not give agency principles the ability to look at their portfolios like an investor would want to do on their portfolio. So the short answer is, if you talk to the largest agents in the land all the way down to the small agents in the land, they would tell you that not only are we the only company that has this consultative capability, but also we are -- because of what we do, are actively involved in helping them consolidate business and to transform the way they market their business and even where they go for from a new business standpoint. And last but not least, we have over $80 billion worth of customer level data that helps us inform our strategic direction. So it's a very, very distinctive capability. It helps us kind of be the company we are, and it shows the authenticity, frankly, of our partnership strategy.

I think this will be the last question, but it's one that a number of investors have asked and growth is something that investors seem to care about more so now than ever. So if there was a small knock on your excellent 4Q results, it was that growth was a little bit lower than expectations. So maybe you can kind of talk through where there some actions that were taken, maybe tough comps? And why you feel good about kind of growth getting back to pre-pandemic levels?

Sure. And that's the way to say it, Mike, is that we were on that trajectory. And so in third and fourth quarter of last year, we clearly were on a great path. And we did make some decisions in 2020 that curbed our growth, and we think will benefit in the long run by making sure that our profit was on the right path. But the short answer is, we definitely anticipate a good bounce back in exposures, particularly in Commercial Lines. The rate environment in Commercial Lines is going to continue to help us. The market consolidation work we did shows us that we have growth in the making, finished up in December, got out of the gates well this year. And last but not least, we did change the dials in Personal Lines a bit so that we could get our retention levels back to eventually the mid-80s, and that's a meaningful delta in terms of our ability to grow in 2021.