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

Good day, and welcome to The Hanover Insurance Group's Third Quarter Earnings Conference Call. My name is Ranju Thomas, and I'll be your operator for today's call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva.

Good morning, and thank you for joining us for our quarterly conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer; Dick Lavey, our CEO-elect; and Jeff Farber, our Chief Financial Officer. Additionally, Bryan Salvatore, President of Specialty Lines, will be available to answer your questions after our prepared remarks. Before I turn the call over to Jack, let me note that our earnings press release, financial supplement, and a complete slide presentation for today's call are available in the Investors section of our website at hanover.com. After the presentation, we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements can relate to, among other things, our outlook, guidance, performance, profitability, growth, strategy, capital management, the implementation and use of new technologies, the impact of revised policy terms and conditions, and targeted property actions. Additionally, they can relate to factors that could impact the company's performance and/or cause actual results to differ materially from those anticipated, including changes in the demand for our products, economic and geopolitical conditions and related effects, including economic and social inflation, tariffs, as well as other risks and uncertainties such as severe weather and catastrophes. We caution you with respect to reliance on forward-looking statements and in this respect, refer you to the forward-looking statements section in our press release, the presentation deck, and our filings with the SEC. Today's discussion will also reference certain non-GAAP financial measures such as operating income and accident year loss and combined ratios, excluding catastrophes, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release, the slide presentation, or the financial supplement, which are posted on our website. With those comments, I will turn the call over to Jack.

Thank you, Oksana, and good morning, everyone. We're very pleased with our third quarter performance. Our results reflect continued momentum across the organization, strong execution in a dynamic market environment, and the strategic benefits of our diversified portfolio. Our portfolio is built around several structural advantages: Specialty Lines with broad product profitability, a preferred Personal Lines franchise concentrated in higher-value accounts, and a distinctive Core Commercial book anchored to small-sized businesses, a segment in which we excel. This diversified business mix gives us multiple levers for profitable growth regardless of where the cycle turns. Importantly, our commitment to investing and growing where returns are most attractive remains unchanged. Profitability is our top priority, and the company will continue to make underwriting, growth, and capital allocation decisions through that lens. Turning to results. Our third quarter operating EPS came in meaningfully ahead of our original expectations and improved from the prior year quarter. Operating ROE was robust at approximately 19%. Net written premium growth was 3.1%. Across the portfolio, we remain disciplined and only wrote business that meets our return thresholds. These are intentional choices, and the underlying loss ratio performance reinforces our strategy. Turning to our segment results. Specialty remains one of the strongest examples of the value created by our diversified business mix. The breadth of our portfolio allows us to navigate changing market conditions, maintain underwriting discipline, and pursue attractive opportunities across a wide range of products and markets. While conditions are competitive in certain property lines, we continue to see meaningful opportunities for profitable growth in an increasing number of our offerings. In the quarter, excluding Hanover Specialty Industrial, which is most exposed to competition in the larger property market, and Hanover Programs, which we continue to tightly manage and limit expansion, we generated strong growth of 6.7%. We are seeing particularly strong growth momentum in the markets where conditions remain favorable and margins are attractive. Surety grew 8.8%, extending its strong track record. E&S growth accelerated from 6.5% in the second quarter to 11.7% in the third quarter, supported by our AI-enabled submission intake and triage capabilities. Management liability posted strong growth of 15.5%, and both Marine and Hanover Professional Liability delivered accelerated growth compared to the second quarter. Retention for Specialty remained very strong, improving sequentially to 83.2%. Renewal price change also improved slightly to 4.3%, while rate held relatively consistent from the second quarter, with liability rate continuing to accelerate. We entered the fourth quarter with strong momentum across many lines within our Specialty book and significant confidence in the segment's ability to deliver sustained profitable growth. I couldn't be prouder of how the organization is performing or more optimistic about the path ahead. We have built a special culture, attracted outstanding talent, and developed a leadership team that will continue to drive our strategy and performance for years to come. I believe we are exceptionally well positioned to build on this momentum and deliver sustained success. As we discussed, our leadership transition is well underway, and it's fitting that Dick take you through the performance for Personal Lines and Core Commercial and update you on our exciting technology initiatives. Dick?

Thanks, Jack. At our Investor Day 6 weeks ago, we shared our perspective on the opportunities ahead and the strengths that position us for continued success. As we look at our third quarter results, they reinforce the strategy we had laid out. While our top line was influenced by a competitive environment in certain markets, the actions we are taking strengthen the foundation for durable growth and strong profitability over the long term. I'll begin with Personal Lines, where the portfolio today is fundamentally different from the one we were managing just three years ago. We have deliberately shifted the book toward bundled higher-value account customers, customers who value advice and specialized coverage, and accounts with higher average premiums and lower price elasticity. Overall growth was 1.7% in the third quarter, reflecting top line moderation as we make deliberate choices in dynamic market conditions. Importantly, growth in the higher-value customer segment with Coverage A limits above $500,000 continues to outpace the broader portfolio, reinforcing the success of our preferred customer strategy. In this area of Personal Lines, retention remained exceptionally strong at 86%, a couple of points above the rest of the book, while premium increased 4%, supported by positive policy in force growth year-over-year. Renewal pricing is approximately 1 point higher for these customers, while new business growth of 5% and a 21% increase in submission flow underscore the attractive opportunities we see going forward. Furthermore, within the higher-value cohort, momentum with our Prestige product is particularly strong with double-digit growth in both the third quarter and year-to-date. We believe these trends position us well to continue expanding our presence with preferred customers while maintaining our focus on profitability. Overall, Personal Lines renewal pricing remained very strong and continues to support attractive profitability for both auto and home business. Looking ahead, we continue to develop opportunities for future revenue growth. These include adding new agency appointments, primarily in diversification states, and deepening existing relationships in those same markets. Data-driven prospecting and increased consolidation activity continue to create attractive openings to strengthen and expand our agency partnerships. In addition, quote activity and pipeline trends remain encouraging indicators. Turning now to Core Commercial. The business continues to perform well, delivering net written premium growth of 4.6%, while maintaining relatively consistent renewal pricing change of 7.4%. Our disciplined focus on smaller-sized customers, combined with strong agency relationships and consistent underwriting execution, continues to position us to outperform across a range of operating environments. Small Commercial requires a unique blend of underwriting acumen and operational excellence, especially for more complex accounts that require underwriting judgment beyond automated platforms. We've built our product suite and operating model specifically around the full spectrum of needs of small business customers, which continue to set us apart in the marketplace. As we look ahead, Small Commercial distribution expansion, broad product offerings, and service enhancement remain strategic priorities. Our strong value proposition has earned us strategically important positions with the industry's consolidators while also expanding relationships with existing agents and appointing new ones. Our TAP Sales production continues to grow and straight-through processing is expanding. Workers' compensation TAP Sales completes its rollout in Q4, extending our automated underwriting advantage to additional states. Each of these enhances the economics of serving small business accounts in our favor: lower transaction cost, faster turnaround, better agent experience, and stronger retention fundamentals. In Middle Market, we are generating strong retention and new business as agents increasingly recognize our value proposition. Our underwriting expertise, disciplined risk selection, and service capabilities have positioned us as a preferred market for lower Middle Market accounts, supporting consistent growth while maintaining our profitability. Middle Market grew 6.7% in the quarter, supported by historically robust retention, improving more than 3 points year-over-year. Taken together, we believe our differentiated position in Small Commercial, continued momentum in Middle Market, and a diversified distribution footprint for both businesses provide a durable foundation for profitable above-industry growth across Core Commercial. Overall, we remain encouraged by the market position of this business, and we are confident in our ability to expand market share and capitalize on growth opportunities ahead. Now I'd like to spend a few minutes on our technology and AI investments. Our technology throughput continues to improve, allowing us to deploy new capabilities more quickly and embed AI more deeply across underwriting, claims, and customer service. Importantly, we remain focused on practical applications that drive measurable business outcomes. From AI-enabled underwriting and automated submission processing to real-time agency connectivity, these capabilities are making it easier and faster for agents and customers to do business with us. During the quarter, we advanced our claims transformation efforts with the launch of Adjuster Workbench, which equips claims professionals with better information and insights at the point of decision-making. The platform helps adjusters make faster, more informed decisions by bringing together structured data, decision support, and relevant claims context in a single workflow. Over time, we expect these capabilities to improve both customer experience and operational performance through lower loss adjustment expenses and better severity management. We also advanced our surety workflow and credit certification capabilities to improve efficiency and underwriting effectiveness. And in E&S, we further enhanced submission intake and triage capabilities, which is already helping support responsiveness and growth. Additionally, in Commercial Lines, we launched a new AI-enabled data exchange capability designed to make it easier and faster to transact business with our agents and brokers. The solution leapfrogs traditional point-to-point APIs by connecting directly with agency data environments, automating data extraction, appetite and eligibility review, and also rating to significantly accelerate quote turnaround. Developed from concept to production in just three months, it demonstrates how our approach can rapidly translate ideas into practical capabilities with measurable business impact. While we are still in the early stages of realizing the full opportunity from our initiatives, we are encouraged by both the pace and delivery and the growing business impact. In closing, our third quarter results reflect the consistent execution of our strategy and the dedication of our employees across the organization. I am very excited about the future and confident in our ability to build on our strengths. We will continue to innovate thoughtfully, deepening our agency partnerships, maintaining underwriting discipline while delivering for our customers, and driving sustainable long-term performance. With that, I'll turn it over to Jeff.

Good morning, everyone, and thank you for joining us. We had very strong performance in the third quarter with a combined ratio of 92.3% and our best-ever third quarter operating earnings per share of $5.15. These results reflect the high-quality earnings engine we've built and underscore the effectiveness of our strategy and the strength of our diversified book of business. Each of our business segments delivered excellent results, bolstered by another quarter of strong returns in our investment portfolio. Excluding catastrophes, our combined ratio was 85.5%, an impressive 2.6-point improvement from the prior year quarter. Our current accident year loss ratio, excluding catastrophes, was 55.7%, improving nearly 2 points from the prior year quarter, with year-over-year improvement in each major segment. Catastrophe losses were 6.8 points of the combined ratio, inclusive of 0.7 points of favorable prior year cat development. This was consistent with our modeled expectations for the third quarter and gives us further confidence that our past actions are leading to more consistent returns even with some impactful wind and rain events in the Midwest this quarter. The expense ratio for the quarter of 30.9% was somewhat higher than our original plan, primarily from higher variable compensation for agents in Personal Lines reflecting our meaningfully better-than-expected results to date, as well as some employee incentive costs given the much better-than-expected performance. We remain diligent in our expense management and committed to the long-term framework and targets we have set for the company. Third quarter favorable ex-cat prior year reserve development of $18.3 million included favorability across each segment. In Specialty, favorable prior year reserve development was $14.8 million or 4 points with widespread favorability across multiple coverages. In Core Commercial, favorable prior year reserve development was $3 million or 0.5 points. And in Personal Lines, prior year reserve development was modestly favorable in both homeowners and auto. Our reserve position remains very strong and aligned to the current uncertain environment, particularly in liability lines, where we continue to remain prudent with our reserving approach. Now I'll further discuss each segment's current accident year results, starting with Personal Lines. This business generated an excellent current accident year ex-cat combined ratio of 81.9% for the third quarter, a 3.9-point improvement from the prior year period, driven by the benefit of earned pricing and benign frequency. In homeowners, we delivered an outstanding ex-cat current accident year loss ratio of 40.6%, improving 6.6 points from the prior year quarter and very favorable to our original expectations. In addition to the benefit of earned pricing, we observed very favorable attritional loss frequency and lower-than-usual large losses. We continue to attribute some of the benefit we've seen in recent quarters to deductible changes, leading to fewer smaller claims in both cat and ex-cat results. In Personal Auto, our ex-cat current accident year loss ratio was 67.9%, an improvement of 1.2 points compared to the prior year quarter. Frequency remains favorable across multiple coverages, particularly in collision. Personal Lines grew 1.7% in the third quarter, decelerating modestly from the second quarter. Growth has been impacted by our prior actions to manage exposure in certain concentrations, which has led to slightly lower PIF year-over-year as well as a competitive market. Both auto and home achieved strong resilient renewal pricing increases in the third quarter that approximated second quarter pricing increases with auto up 7.1% and home up 10.9%. Umbrella pricing increases also continued to be strong. Now turning to our Core Commercial segment. We delivered a current accident year ex-cat combined ratio of 93.2%, improving 1.1 points from the prior year quarter. The current accident year loss ratio, excluding catastrophes, was 60.5%, a slight improvement from the prior year quarter, benefiting from an increasingly strong book of business as well as solid property performance. Seasonally, we tend to have slightly higher property losses in the third quarter and have built that into our expectations. We remain prudent in our liability picks, which reflect a disciplined and measured view of the operating environment, helping to ensure that the portfolio and our balance sheet remain well positioned. We continue to price business consistent with that view with rate levels remaining quite strong. Moving on to Specialty. This business continued to perform extremely well with a current accident year ex-cat combined ratio of 84.6% in the third quarter, improving 1.4 points from the prior year quarter. The current accident year loss ratio, excluding catastrophes, was 47.7%, favorable to both year-over-year and our expectations for the segment, helped by favorable property performance. We remain very pleased with the continued strong profitability of our Specialty book and the positioning of the business to capture attractive growth opportunities in our markets. We are focused on and have line of sight to further premium growth acceleration in Specialty. Turning to Investments. Our investment portfolio continues to perform very well and remains an important contributor to the durability of our earnings profile. Net investment income of $131.9 million in the third quarter increased 12.7%, benefiting from greater investable cash generated by strong underwriting results and elevated reinvestment rates. We are able to deploy that capital at attractive yields while maintaining our disciplined approach to duration and credit risk, allowing us to enhance returns while maintaining our very high-quality portfolio. Roughly 88% of our total invested assets are in cash and investment-grade fixed income, highlighting the high-quality composition of our portfolio and the relatively modest size of our other risk exposures. Our fixed maturity portfolio weighted average rating is A+ with 95% of holdings investment grade. Earned yields on the fixed maturity portfolio were 4.58% in the third quarter, up from 4.33% a year ago, and we continue to reinvest at higher yields than what is maturing. This positions us to continue building a resilient and growing NII stream that we expect will support earnings stability in the periods ahead. While rising interest rates resulted in higher unrealized losses during the quarter, we believe those marks are entirely rate driven and not reflective of credit spread moves. Much of the well-laddered fixed income portfolio is asset liability matched with our insurance reserves. Accordingly, the temporary move in book value driven by the unrealized depreciation in the fixed income portfolio is largely matched with the change in economic value of the undiscounted reserves, even though the balance sheet may not reflect that. Moving on to our equity and capital position. Excluding the impact of unrealized losses, book value per share increased 2.7% sequentially even after accounting for our dividend payment and significant share repurchases in the quarter. We continue to actively participate in share buybacks, repurchasing approximately 386,000 shares totaling $86 million in the third quarter. And year-to-date through October 26, we've repurchased over 1.3 million shares at an average price of approximately $197. We have approximately $546 million remaining in our current share repurchase authorization. We have substantial excess capital and should continue to generate meaningful excess capital given the current environment. We will continue to evaluate the most effective uses of capital and returning capital to shareholders through dividends and share repurchases remains an important component of our approach. Through three quarters of the year, our combined ratio has run a couple of points better than the trajectory we contemplated in our original combined ratio guidance, fueled by exceptional underwriting performance across the business. As we have mentioned all year, meaningfully outperforming on the combined ratio causes an increase in expenses for agent profit sharing and employee incentives. Including those expense increases, we expect the full year combined ratio to clearly beat our original guidance. Our fourth quarter cat load is 5.2%. To summarize, we are excited about our exceptional performance so far this year and have never been more optimistic about where our business is headed longer term. With that, we are ready to open the line for questions. Operator?

[Operator Instructions] The first question comes from the line of Michael Phillips with Oppenheimer.

I think you had a great quarter, so I'm going to maybe talk some high-level questions and not specific to the quarter, if I could. I'm sure you track this. I'm not sure you share it, but we'll see. If you were to take your agency partners and maybe rank them from small to largest, is there -- I'm wondering, is there any correlation to size of agency and profitability of agency? And I'm thinking maybe like I've looked at some histograms where they show in different buckets and if you overlay those buckets with loss ratios from the business they give you. Any correlation there at all?

Yes. Mike, this is Dick. Yes, of course, as you would expect with our strong agency strategy, we track performance by agency type and size very closely. It's a critical part of how we manage distribution. Broad observations: we see strong profitability across our different distribution segments. So various sized agents can perform well, of course, really driven by our strategy, the small accounts that we -- the space we play in, the diversification of our capabilities, just the strength of our partnerships. But certainly, increased size of book brings scale, right, which does enable an ability to absorb shock losses, cat losses, et cetera. But what we know beyond scale or depth or market share as we track it, breadth matters a lot as well. So diversification of the book. And together, the breadth and depth can bring better performance on a number of performance indicators. So that diversification or breadth, what we know is important, in particular, is access to Specialty business. So you -- when an agent has business with us across multiple segments, Specialty being one of them, performance is quite good, as you would expect from the nature of those -- of that business. So it's really both depth and breadth that we look at. And of course, our Agency Insight tool gives us a perfect knowledge, if you will, into that and helps us manage and monitor that.

Okay. I guess it sounds like in summary, it sounds like maybe larger is slightly better margins in terms of the book they give you, if I paraphrase all that. Another way to ask that, Dick, would be to say this, if I could go a little bit further on this one. If I'm a small mom-and-pop agency and on the smaller side, below average. And then suddenly, I got bought out by a big multinational broker, can you track my performance now 5 years later, is my loss ratio better than the book I'm giving you?

It can be, sure. Frankly, there's a lot of factors in there. What's the starting point, what does that look like? If it's a small mom-and-pop agency, they're going to tend to have more Personal Lines and Small Commercial business, maybe a house account in Middle Market. So as they -- which can have strong profitability, those businesses. As they fold into a larger agency, that depends on the operating model that's adopted by folding into that agency. In the early years, they keep them honestly more autonomous. But over time, we are seeing increase in better profitability and growth as those smaller agencies have access to bigger, better, broader capabilities. So I think that's a good question. We see net-net benefits as these smaller agencies are integrated into the larger entities.

Okay. Second question on Specialty for a second. I think we're at that part of the cycle where obviously in a softening market, kind of the peaks and troughs of the P&C cycle might get amplified in the non-admitted space as kind of the admitted players might get hungry for the stuff they're not used to writing. To what extent -- and I know your Specialty book is more skewed towards admitted, I think it's 80-20, admitted, non-admitted. But to what extent is your Specialty book maybe protected from that happening? So that as we look out at your 5-year plan, I think your Specialty book is kind of the leader of your growth target. So any protection there that should keep that happening from admitted players coming into your Specialty book?

Yes, Mike, this is Bryan Salvatore. Thanks for the question. I'd say a few things. And I think we touched on it. We are very much focused on that small to Middle Market space, and that cuts across most of our portfolio. And so with that, we do see a bit less competition. There's still competition, but a bit less. We see a bit more pricing power than we hear amongst our competitors. And we still see the ability to grow it. And I think the fact that we have a very diversified portfolio really helps that, right? So -- I think Jack touched on it. Many of our areas are still seeing good growth opportunities. And frankly, we've worked on the portfolio in a way that we like the composition of our book. So yes, we're dealing with price competition. We're very, very balanced in the way we manage that price competition. And we've been able to continue our growth trajectory. And we think as we move into '27 and '28, we expect that to hold up and frankly, in a number of cases, improve.

The next question comes from the line of Mike Zaremski with BMO.

Maybe a 2-part question on pricing power in both Personal Lines and Commercial Lines. It's great to see pricing hold up much better than kind of peers. I'm curious if you have any color, if I look kind of back longer term at Hanover's pricing power versus peers, it wasn't -- the relationship seems to have gapped out much more in your favor in terms of pricing holding up, which is great. Retentions don't actually look to be too different for you all versus longer term either. So just curious if you -- any thoughts on why your pricing power is holding up so well relative to the industry.

Mike, this is Jack. I'll just say a quick response to that at a high level, and then I'm sure Dick or Bryan can jump in. But I think the short answer to your question is yes. If we look back over time, we were at a different stage of our maturity. A lot of our businesses were still developing. Some of them were through acquisitions, some of those were build-outs. So we really are in a different place in terms of the maturation of the portfolio and obviously, the pricing comes along with that. And I think our relevancy with the best agents in the country is peaking such that we're less of a target, if you will, for moving business. There's a real reason for agents to want to keep their book of business with us. And combine that with the account size, I think we have an advantage, if you will, going to market and maybe getting an extra point or two based on all of those key attributes.

Yes. So let's maybe click down a little bit. First, Mike, thanks for calling that out. Our performance on these dimensions, I think it's continued evidence that our strategy is working over time. I couldn't be happier with our performance in Personal Lines and Core Commercial and Specialty. In Personal Lines, we continue to penetrate our target segment, right, which is this higher valued account, which is securely served in the IA channel. And the fact that we have 90% account, nearly 80% common effective date and even higher on new business secures that customer and I think does drive the pricing resiliency that you're experiencing in Personal Lines. We're growing that book above $500,000 in Prestige. I think we're quite unique in Personal Lines right now, and I think the envy of the industry. Core Commercial, it's a similar theme, diversified business, book of business, but importantly, advantaged by the customer segments we play in. So it's an account focus with these smaller sized accounts. And I think that advantages us and gives us that pricing resiliency. So similar theme in Specialty. I don't know that we need to go to Bryan with that. I think it's a common -- which is what gives us great confidence about our future, frankly.

That's great color. Maybe pivoting a bit to reserves and long-tail casualty. I feel like you guys continue to put up very good and consistent results relative to the industry. Just curious if you'd be willing or able to share whether you're adding IBNR levels. So the ratio of IBNR is moving higher throughout the year in some of those long-tail casualty lines to continue to build conservatism? Or maybe is that something you're willing to discuss? I know we'll see some stat information, obviously, but not until March of next year.

Mike, we are clearly adding IBNR to our reserves. So our percentage of IBNR to total reserves keeps increasing. I thought we had, in my portion, had shared a statistic on this in the Investor Day presentation, but perhaps it was left on the cutting room floor. But over time, we'll certainly show that. I think what's important is we've been adding prudence to our reserves for years now. We've shown consistent favorable development. We're establishing our reserves well above our actuarial central estimate, and that obviously has to be done through IBNR. And as you know, we've carefully grown thinking about geography as well as industry selections, and that's created a reduced frequency. So all of that gives us a lot of confidence in our reserves.

And Jeff, while I have you just sneaking one in, and I will check the Investor Day deck. I don't believe you mentioned the new money rate on the investment portfolio unless I missed it.

We did not mention that, but it is clearly well above expiring and it has been -- it is certainly above our earned yield. But you can imagine when 10-year Treasuries are 5% or greater, we're certainly having a pretty helpful new money rate. So it bodes well for the portfolio. The real question is how long will rates stay at this level. But we're optimistic about our fixed income portfolio for sure.

The next question comes from the line of Rowland Mayor with RBC Capital Markets.