The Travelers Companies, Inc. (TRV) Earnings Call Transcript & Summary

Hi. Good morning. I'm Tracy Benguigui, insurance analyst at Barclays. This is day 2 of Barclays Global Financial Services Conference. And I'm pleased this morning to conduct a fireside chat with Alan Schnitzer, CEO and Chairman of Travelers. Good morning, Alan.

Good morning, Tracy. Nice to be with you. Thanks for having me.

Likewise. Just a few housekeeping items. Just want to remind folks who've done this a few times or if your first time on board, on the left side of your screen, you have the opportunity to submit questions as well as take a part of our audience response system, which is basically polling questions. With that out of the way, Alan, maybe you could kick off with some high-level thoughts on what you see for Travelers in this dynamic environment.

Yes. Well, again, good morning. Thank you for having me. And thanks, everybody, for joining us this morning. It's nice to be here. And I'm sure your more pointed questions will get to all the issues that are on people's minds. But maybe I will share 3 things just to set a backdrop here for the conversation. First, in terms of pandemic losses, there's still plenty of uncertainty out there, but I think we've come a long way since March in getting a clearer picture of what the pandemic and COVID means for the industry and for us. At least through the second quarter, pandemic losses have been modest for us, which is a reflection of how we approach risk and reward, and we manage that carefully. And as we've shared, we've been thoughtful in developing loss estimates and cautious in recognizing the benefits from those lines that have had lower levels of claim volume. And I'll add that, this morning, in the U.K., we've got an opinion out on business interruption. With all the caveats, so it is a long opinion. It's hot off the press. The ink hasn't dried. We're still making our way through our assessment of it. I will say that, at first blush, there's nothing in that opinion that causes us to think differently about our exposure to business interruption in any material way. So again, I think this is going to play out over time. Still plenty of uncertainty. My guess is we'll get into that a little later. But I think there's a clear picture and path forward to date than certainly 6 months ago. Secondly, taking a step back, if you look at the 3 years or so pre-pandemic for Travelers, you can really see the success of the strategic initiatives we announced back in 2017 in terms of growth rates and a lower expense ratio, productivity and efficiency. Notwithstanding the state of the economy over these last 6 months, our top line has been resilient, I would say. And with the firming market and that productivity and efficiency that we've generated in the organization over those several years, we feel very well positioned for an improving economy. And then the last thing I'd add, just by way of backdrop, Tracy, is that thanks to a lot of committed and talented colleagues, we haven't missed a beat either operationally or in terms of staying on track on strategic initiatives. So unusual circumstances, for sure. But despite the unusual circumstances, we feel really good about the strength of the franchise, and we feel really good about where we're heading.

Great. I think your sentiment is a little bit similar to what we've heard in other sessions where it seems like most executives are cautious, but it doesn't look as ugly as the initial expectations, I think, where we were sitting back in March. And with that, maybe I could get a little bit more technical. If you could describe for us this new earnings path in the COVID-19 world. And I think I'm just going to play off some of your comments earlier about, I guess, coming up with the loss estimates. How should we be thinking about the tail risks on COVID-19 casualty claims? And in your view, are there limitations to book IBNR? Given what I heard from one the big 4 auditors that you need, for book reserves, both, I guess, a view that it's [ estimable ] as well as probable.

Okay. So there's a lot in that question. Let me get started, and if I forget some of it and don't respond, let me know. And I would say your comment that it was ugly back in March, I wouldn't say it was necessarily ugly. I would say there was a fair amount of uncertainty back in March. And I think, 6 months later, some amount of that uncertainty is starting to be resolved. But getting back to your question, the arc of the earnings path from here, I'd say there's, broadly speaking, 3 things to look at: one would be losses; two would be the top line; and three would be investment income. In the last 2 earnings calls, I've described the factors that we expect will impact COVID-19 losses, and both favorable and unfavorable, by the way, because there are unfavorable and favorable impacts. I haven't seen anything up to now that's caused me to think any differently about the factors that are going to drive losses positive or negative. I have cautioned that it is important not to paint all insurance companies with the same brush because not all of us are going to have the same experience with COVID losses. And we've seen that in the reported results so far. In terms of the top line, we ensure the output of the economy. So as the economy contracts, there's going to be a lower level of insured exposures out there. And that's going to impact everybody. As I said, our top line has been reasonably resilient, and we've been pleased with that. Also, a firming market, to one degree or another, will offset at least some degree of that lower level of insured exposures. And then in terms of investment income, we manage our portfolio with an eye towards managing through periods of significant volatility. We know -- we didn't foresee a pandemic, of course, not this pandemic anyway, but we know that we're going to be tested from time to time, and we manage our investment portfolio accordingly. In our first quarter earnings call, we put a lot of data out there on that. And so that certainly gives us a lot of comfort. Having said that, the 10-year treasury, I think, this morning was under 70 basis points. It's going to be lower for longer and that's going to affect fixed income NII. But I think that's, to a significant degree, one factor driving a firming market. To your question about tail on COVID losses, yes, there's going to be a tail on COVID losses. It's going to go on and play out for some time. I would expect the plaintiffs bar to be opportunistic about it. So I think we will see that. And then lastly, your point on IBNR, there's nothing at all new about this probable and estimable standard. That's, as far as I know, always been the standard for booking liabilities. Nothing new at all about that. And for an insurance company, there's also nothing new about recording IBNR under uncertainty. Of course, different liabilities, different circumstances, different levels of uncertainty, but we factored that uncertainty into our IBNR estimates, which is why we say that we've been thoughtful about booking the losses and cautious about recognizing the benefits. And that is to reflect that level of uncertainty.

Okay. Great. Maybe just piggybacking off one of the comments you made earlier in the U.K., and it has to do with policy language, just more broadly, let's try to tee up COVID-19 and changes in risk perception. And I'm wondering if Travelers will take advantage of this fluid environment to holistically revamp policy language everywhere from exclusions to coverage obscurity. And I'm not just talking about communicable disease, but across all facets.

Yes. Well, certainly, communicable diseases is front and center. But just taking a step back and thinking about it holistically the way you asked the question, we are always evaluating policy language. And so coverages, terms and conditions, exclusions, things like that, it's an ongoing process in light of change in circumstances. And to a degree, I think our discipline in doing that is why we're -- one reason why we are where we are in terms of having modest COVID losses so far. But to answer your question, yes, in light of these circumstances, we will continue with that process. I think the way to think about it is there's really 2 pieces to it: there's the insuring agreement. So think coverage grants. Think exclusions; and then there's program structure. So think limits, sublimits, deductibles, attachments -- attachment points, things like that. When you have changing circumstances, certainly, the program design is likely to change faster than the insuring agreement. And so we are seeing a pretty quick response in program design and a lot of coverages. But in terms of the insuring agreement, any time we're in a circumstance where we feel like we can't model the risk, we can't model the price or changing circumstances result in some ambiguity in the insuring agreement, we will make changes. And I think that's underway. Communicable diseases, as I said, is front and center, but I think we will look at all of those things.

Got it. And then, I mean, you made earlier comments about this, but where we stand today, how do you feel about the strength of exclusions, particularly with respect to communicable diseases?

That's a -- it's a pretty broad question, and I always think it's a mistake to underwrite a claim without an insurance policy in front of me and the facts of the claim. So it's hard to answer that on a broad-based basis. I -- if you look at business interruption, for example. And in the U.S., overwhelmingly, the court decisions we've seen so far have sided with the industry. And of course, we've got the virus exclusion that we continue to feel very strongly about. But it's hard to, I think, respond to that in -- without actually looking at a particular set of facts and circumstances.

Okay. Great. Maybe it's a good time to turn to the -- our audience response system, which is our polling questions. And to kick things off, how hard of a pricing cycle are we in? And what is your pricing momentum predictions over the next 12 months? So the options are over 30%, 20% to 30%, 10% to 20% or 5% to 10%. It seems -- or the last one that no one picked was short-lived reversion to low single digits. And I guess the most popular choice by a margin is the 20% to 10% range, followed by 30% to 20%. So I just wanted to get, I guess, your reaction, Alan, on those polling results and if you could share your crystal ball on the direction of pricing.

Yes, the crystal ball is perpetually hazy, but the -- I think the answer to that question is there have been forces out there that have been driving a firming market, and all of those forces are out there and alive and well. And what we're seeing now, I think, is broadly a response to the fact that, in many lines, we've got a rate inadequacy. So for years, we had prices that lagged loss trend, and so the industry lost ground. You've got social inflation out there. We've been talking about social inflation for a couple of years now. But if you -- if you're reading industry commentary and following the rhetoric, I think you see that there is a broader and wider acknowledgment and reaction to social inflation today than relative to a couple of years ago. And so I think that's going to continue to drive pricing. Weather volatility is on everyone's minds. I think, certainly, last quarter, this quarter, last couple of years. So I think there's some reaction to that. Reinsurance pricing feels like it's on the way up. And we're a gross line underwriter. We're, on a relative basis, under-reliant on reinsurance. So I think less of an issue for us as a company, but I think an issue for the market, and that will drive market pricing. Interest rates, we talked about that, lower for longer. And on top of all of that, we've got this pandemic that I think has introduced another level of uncertainty into the market psyche. So I guess my reaction is I'm not going to put a number on it, but I think this trend's got a way to run, and I think it will improve margins.

Okay. Yes, I guess what you're describing is perception of a loss-driven -- loss cost-driven hard market cycle versus what we've seen in prior cycles, which is actual replenishment of capital.

I do think it -- I don't think it's an issue of capital in the industry. I do think it's loss-driven. But I also think, for a variety of reasons, you've got a lot of markets that are just more disciplined about managing. Everybody's got better data and analytics. And so I just think there's a higher level of discipline around managing an insurance company and managing for an appropriate level of return.

Got it. And this, I guess, ties into the next audience response system question. On a top line perspective, will a drop in insurable exposures from an economic shutdown outweigh hardening pricing for Travelers? And the responses are either not likely, equilibrium, likely, with the overwhelming majority in the not likely count followed by equilibrium.

What's the not likely? I don't have it on my screen.

Oh, sure. Just basically the tug of war of pricing and, I guess, insurable exposures. And it seems like -- I guess there's some skepticism out there if pricing can overcome the drop in insurable exposures from economic conditions.

Yes. So I guess my view on that is I'm not going to make a prediction on whether one's going to be more significant than the other. You never like to see a weak economy. You never like to see lower exposures. And to some degree, that just feels like gravity to me. It's something that we all have to deal with. But when you take a step back, the price per unit of risk is improving. And so -- and from that perspective, margins are improving. I mentioned that we've had a resilient top line. And so I take a step back and I look at that, feels okay where we are, and it feels like we're well positioned for the economy as it improves, and it will improve at some rate.

Okay. And let's talk about cat so far with 13 named events. The quarter is shaping up to be active, not just number-wise, but dollar-wise. Can you share some -- or any early insights of your cat experience so far?

Yes. So I think we've got our third hurricane of the season making landfall today, which is a relatively high number. We've had a very significant straight-line windstorm this quarter. A very, very active wildfire season in California and Oregon. So I -- without putting a number on it, these things are still evolving. So I think it's too early to put a number on cats for the quarter. We got a couple of weeks left. I do think it's reasonable to expect a above-average cat quarter. And I think, going beyond that, I would expect probably -- I don't have the numbers in front of me, but it feels like probably an above-average -- at least on a gross basis, an above-average non-cat weather quarter. So very active from a weather perspective this quarter.

Okay. Maybe shifting gears to talk about capital management. I mean all the years that I've met with Travelers, even with your predecessors, I've always heard Travelers speak about being stewards of capital for shareholders. And as a steward of capital, how do you strike the balance between capital deployment through share buybacks versus alternative options such as M&A or assumption of more insurance risk?

Yes. So we've been very consistent in our approach to capital management over a very long period of time. And I don't think I would describe it as a balance. I think I would describe it as a prioritization. And so when we think about the capital that we generate, our first objective is always to invest that back in the business when we think we can do that and create a return for shareholders. So if we've got an opportunity to invest in growth, whether that's organic or inorganic or an opportunity to invest in talent or technology or other capabilities, we always want to do that. But as you said it, we are stewards for somebody else's capital. And so we are highly disciplined in making those assessments. And so when we're confident we can do it and meet our return expectations, we'll invest the capital. But when we can't, we're going to give that money back to the capital providers. And so less of a balance, more of a prioritization.

Okay. Maybe just to unpack that a bit. Travelers has suspended buyback activity until there's more clarity on the state of the economy. Can you share what factors you're considering to make this determination?

Yes. Just to clarify, we didn't announce that we were suspending. We announced that we would be taking the circumstances into account as we thought about it. And I'll unpack that, too. When we think about the capital we're going to give back, the foundation of that decision-making really is the proposition that we want to be a strong AA-rated company. And so we've got a view of the capital that we need to maintain that position. And then we evaluate that against known requirements for capital and also the risk of unanticipated requirements for capital. And so when you're in a circumstance like we're in now, and we're in somewhere in the middle of a pandemic that's going to run for a while, and we're still gaining clarity on that, when we're in hurricane season and wildfire season, when you have this level of uncertainty, you take a step back and you say -- at least we say, having a little bit more capital feels better than having a little bit less capital. And so we haven't bought back any shares, but we didn't say that we were suspending buybacks. We said that, as the rest of the year unfolds, we may buy back some or none depending on how we feel in that assessment that I just described.

Okay. And I guess just one clarification there. Do you hold capital buffers for downturn protection above the AA rating objective that ultimately play into the amount of capital available to fund buybacks?

Sure. Yes. And I think I described that when I said that we hold capital for unanticipated -- or I mean we hold capital back for unanticipated needs. So whether that's -- we don't know how the weather is going to turn out. We don't know what the wildfires are going to do for the rest of the quarter for the year. So I think we maintain that buffer by acknowledging that we don't know all the requirements for capital. And so we definitely take that into account.

Okay. Maybe shifting gears to the low interest rate environment. It's interesting because P&C insurers tend to take risk on the liability side versus the asset side. However, investment income significantly eclipse underlying underwriting income if you exclude cats and PYD. So given where we are with interest rates at unprecedented levels, do you think we'll get to the point where underwriting income becomes a more meaningful contributor to earnings?

Well, certainly, on a relative basis, it should become a more meaningful contributor. And if you're asking whether it's actually going to be higher than the investment income, I don't know exactly that relationship, but -- so we're agnostic about where the return comes from. We're agnostic about whether the return comes from underwriting or investments, but we are intent on meeting our return objectives. And so if we anticipate because of a lower interest rate environment that we're going to be getting less of the return from the investment side of the house, we do expect that we will make that up on the underwriting side of the house. And so interest rates are a factor in our insurance pricing model. So yes, I would expect, as the interest rate environment plays out, we will -- that will result in underlying underwriting income being a relatively greater contributor to earnings.

Got it. If you had to like put a number on it and say, I don't know, for every 100 bps drop in interest rates, how much would you have to make up on the points on the combined ratio to breakeven?

More math than I want to do in my head on a live webcast, but on a historical basis, it's probably derivable from the financial supplement that we put out. And maybe the answer is a little bit different going forward given the rate we've been achieving, but that -- I don't have the numbers off the top of my head.

Okay. Fair enough. And how does low interest rate reshape your asset allocation posture?