Hanover Insurance Group Inc (THG) 2006 Q1 法說會逐字稿

Good day, everyone and welcome to the Hanover Insurance Group first quarter 2006 earnings conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn call over to the VP of Investor Relations, Ms. Sujata Mutalik. Please go ahead.

Thank you, Operator. Good morning, and welcome to the Hanover Insurance group's first quarter earnings conference call. With me today are Fred Eppinger, our President and CEO, Ed Parry, our EVP and CFO, and Marita Zuraitis, President of property and casualty companies. Also here available for questions is Mark McGivney, CFO of our property and casualty business.

Before I turn the call over to Fred for a discussion of our results, let me go over a few routine points. Please note that our earnings [inaudible - background noise] form 8K were issues last night, our press release statistical supplement and a complete slide presentation for today's call are available in the investors section of our website at www. hanover.com. After the presentation, we will answer questions in a Q&A session. Our prepared remarks and responses to your questions today, other than statements of historical fact, may include forward-looking statements. There are certain factors that could cause actual results to differ materially from those anticipated by the press release, slide presentation and conference call. lease, slide presentation and conference call. 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 and slide two of the presentation deck.

Today's discussion will also reference certain non-GAAP financial measures, such as total segment income, segment results excluding the impact of catastrophes, and ex-GAAP loss ratio, among others. A reconciliation of these non-GAAP financial measures to the close of the GAAP measure on a historical basis can be found in both the press release and statistical supplement, which are posted on our website, as I mentioned earlier.

With those comments, I will turn the call over to Fred.

Good morning, and thank you for joining our first quarter earnings conference call. It's good to start the year strong, so I am very pleased with our solid results for the first quarter. Segment income after tax was 56 million compared to 33 million in the first quarter a year ago. Our pretax property and casualty earnings improved almost 50% to 92 million for the quarter, while our runoff life business performed better than expected, generating a moderate loss of of about 2 million. The growth in our property and casualty earnings was driven by strong improvements in loss performance in both person lines and commercial lines. Underlying loss trends remain solid, and cat losses were comparatively low for the quarter, enhancing loss margins.

Ed will review our financial results in more detail, and Marita will provide an update on the property and casualty operation shortly.

In my overview, I'd like to highlight a few key accomplishments for the quarter. The fundamentals of our business remain strong in both of our property and casualty business segments through the first quarter of 2006. Our pretax personal line segment earnings showed an improvement of 25% compared to the prior year quarter while commercial lines earnings improved by 90%. Our commercial line segment recorded over 9% growth in written premium for the quarter. We saw a strong contribution for the investments we made in both inland marine and our bond business, and at the same time, our traditional drive lines grew at over 2% country wide, despite our obvious disruptions in Louisiana, and a cautious approach to workers comp.

We tend to remain strong at over 80% in our small to midsized target market, with an overall retention in the high 70s, due primarily to some re-underwriting that our worker's compensation--- we've done with the worker'scomp in large account business. We continue to sustain our margins in this business segment as evidenced in our results through the first quarter with a combined ratio in commercial lines of 94%, one of the best results we've reported in the last three years.

Now, turning to personal lines. As promised, we have turned the corner in personal lines growth in the quarter, and thanks in large part to success of commercial auto, our personal lines premium grew at about 2% in the first quarter compared to the prior quarter. This is despite our continued conservative approach to Massachusetts as we reduced the number of unprofitable voluntary agents last year. Overall, our personal lines investments in service, operating model and product enhancements are really starting to take hold; new business production across our entire network is up over 100%, and our continued roll out of connections auto and our enhancements to our homeowner's and umbrella products will build on this growth momentum during the year.

As I review our progress in our target states, I am confident that our agent targeting, our total account approach is working, as we successfully repositioned our personal lines book and are building momentum in market share on the shelf space of winning agents. More over, as the conditions become more difficult for the sub scale players in this tightening market, our success should continue.

As in commercial lines, we continue to grow responsibly, sustaining our margins, our combined ratio of 94.6% for the first quarter represents a 2-point improvement over the prior year quarter, and we carefully manage our growth at an agent level to insure continued attractive margins.

To summarize, I feel very good about our performance, and I believe we've turned the corner strategically in our P&C business. Two and a half year ago, we started this journey to create a special Company that focuses on winning agents and delivers a package of products, service, and responsiveness tailored to meet their needs in a very distinctive way. As strength and continued reprovement in our underlying earnings power, as well as the success we've already had in repositioning the Company demonstrates the soundness and success of this strategy.

Over the last three or four months I've had the opportunity to go one and one with hundreds of our agents, and I am pleased with what I learned. I am more confident than ever that our best of both strategy is working. The strategy of combining the products, technology, and people quality of the best nationals, with the local presence and responsiveness of the best regionals is something that the best agents want and need. Obviously, success does not happen overnight, and we must continue to focus on the hard work of execution every day. But I believe we are in a position to help winning agents in a period of consolidation in our industry.

Before turning the call over to Ed for the review of the financials, I would also like to comment on a couple of things related to the disposal of our life and annuity business. First, the overall transition of the life business to Goldman Sachs is on track and is expected to be completed by the end of the year, as reported. Also during the quarter, we had an adjustment to discontinued operations that resulted in a net $15 million charge to the loss on sales. Ed will discuss this adjustment in more detail. Second, I would like to point out that we have effectively completed our share repurchase program at this time, well within the first half of the year time frame we had promised.

With that, I will turn the call over to Ed for a review of the financials.

Thank you, Fred, and good morning everyone. Thanks again for joining our call. As usual, I'm going to be using a slide presentation during my remarks which is available online and I trust you all have this. So please turn to slide 5 for review of our consolidated results for the quarter.

As you can see for the quarter, we reported net income of 41 million, or $0.75 per share, down from 47 million, or $0.86 per share in the first quarter of '05. Net income for 2006 includes a $20 million net loss related to discontinued operations which I'll discuss shortly. Net income from continuing operations was 60 million, or $1.12 per share for the first quarter of '06, up from 40 million, or $0.75 per share in the first quarter of last year.

Let's now turn to slide 6 for a discussion of our segment earnings. Segment income after taxes for the quarter was 56 million, up 33 million from the first quarter of last year. Our property and casualty segment generated 92 million in pretax segment income up from 62 million in the prior year quarter. This increase was driven primarily by favorable loss performance in both personal and commercial lines, partially offset by increased expenses. Our life companies posted a $2 million loss from continuing operations versus a loss of $9 million in the prior year quarter. This improvement is primarily due to lower expenses and decreased losses from our run off debt service.

Now let's turn to slide 7 for a review of our P&C results starting with the discussion of personal lines. The personal lines segment generated pretax segment income of 49 million in the current quarter, compared to 39 million a year ago. This $10 million increase in segment income is due to improved current and exited year loss performance, lower catastrophes, and higher net investment income partially offset by an increase in expenses.

The first item I would like to comment on is the improved car accident year performance. While the results show a relatively large improvement from the first quarter of '05, our first quarter '06 current action yield loss ratio is comparable to the full year '05 ratio. As you will recall, we experienced favorable loss trends in personal lines throughout each quarter of last year. We do not expect the same improvement as we progress throughout 2006.

Next, catastrophe losses were lower quarter-over-quarter by about $3 million. Additionally, the current period earnings benefited from an improvement in net investment income principally due to increased operating cash flows, and from improved underwriting results of certain and voluntary pools, primarily NASCAR.

And lastly, total O.U.E. and L.E.E. expenses were $7 million higher in the first quarter compared to a year ago. This is due to several factors, including the impact of new accounting for stock-based compensation, continued investments in technology, certain claim and employee related expenses, and to a lesser degree, an increase in the proportion of overhead expenses absorbed by this segment.

Now let's look at commercial lines results which are on slide 8. Commercial lines segment earnings were 39 million in the current quarter, up 18 million from the first quarter of last year. As you can see from the slide, this increase was driven by improved loss performance both in the development of prior year reserves and with the current action year, partially offset by higher expenses. The ex-cat loss ratio improved by 10 points to 41.6% for the quarter. The increase in favorable develop---the increase of favorable development of prior reserves contributed 6 points to the improvement of the loss ratio.

Prior year reserves developed favorably by $14 million in the current quarter, compared to only $2 million of favorable development a year ago, representing a $12 million increase driven primarily by commercial, [multiple tunnel], and worker's comp. In the CMP line, prior year reserves developed favorably by $10 million this year, compared to 3 million a year ago, primarily due to improved claim frequency trends in the '04 and '05 accident years. In the worker's compensation line, we saw adverse development in the first quarter of last year of about $5 million and in this year's first quarter, we saw a small amount of favorable development.

The current action year results for the quarter also improved relative to last year, reflecting continued favorable loss trends in the increased proportion of inland marine and bond business in our overall book. As you know, these two lines typically carry a lower loss ratio but a somewhat higher expense ratio. Catastrophe losses were also lower than last year, which contributed about $2 million to the increase in segment earnings.

Then lastly, the current year quarter benefited from an improvement in the underwriting results of certain involuntary pools, primarily related to worker's comp. Offsetting all of these favorable trends was an increase in expenses of approximately $8 million, due to the same factors that I just mentioned that impacted personal lines, as well as the impact related to our inland marine and bond businesses which I just mentioned.

Now, let's turn briefly to production which is on slide 9. Overall, net written premium was 574 million for the quarter, up 5% from last year. Commercial lines net premium written increased by about 9% for the quarter compared to last year while personal lines increased about 2%. Even more importantly, we believe, the new business net premium written increased significantly for both commercial lines and person lines, with the 39%---39% growth in commercial line and 156% in personal lines. Marita will discuss production in detail in her remarks in a moment.

With that discussion of the P&C business, now let's turn briefly to the life companies. As you will recall, we have a continuing runoff life business, which consists primarily of traditional life insurance and retirement businesses. Additionally, for 2006, we also have results from discontinued operations related to the variable life and annuity business we sold last year.

First, as I mentioned earlier, results for the quarter from continuing operations were a loss of $2 million. This is better than expected due to lower expenses and somewhat higher investment income. Second, results from discontinued operations for the quarter were an after tax loss of $20 million, consisting of two components: First, this loss includes a provision of $15 million for an estimated potential liability for certain contractual indemnities to Goldman Sachs relating to the pre-sale activities of the variable business we sold. All of this is under FAS interpretation number 45 which sets forth accounting for guarantees. This $15 million provision represents an estimate of our cost to remediate certainly tax reporting processing errors for a portion of our variable annuity business. Second, we recorded a net loss of $5 million related to the net expenses associated with transitioning the business to Goldman Sachs. These expenses consist primarily of transition service costs, conversion costs, severance expenses, and are in line with our 40 year guidance of an after tax loss of $15 million.

Let me update you on the status of our share repurchase program. As Fred said, as of April 27, we have essentially completed our share repurchase program, re purchasing just over 4 million shares at an average price of just under $50 mi---$50 per share at a total cost of $199.7 million.

Lastly, before turning the call over to Marita, I would like to update you on the guidance we discussed with you at our investor meeting at the end the February. As we've said, our P&C results we are generally tracking well against the guidance we provided at that meeting. We're delivering on our written premium growth with an expectation of mid to high single digits for both personal and commercial lines. Our earned premium is on track for low to mid single digits growth in both personal and commercial lines. Our earnings are consistent with our top core [trial] R.O.E. targets. Our accident yield margins are holding as expected. With respect to expenses, our O.U.E. and L.E.E. ratios were higher in the quarter and for personal lines were in line with expectations but are about 1 to 2 point higher in the quarter than what we expect for the full year in commercial lines. Net investment income is consistent with our guidance and consistent with '05 levels, and finally, our affected tax rate is consistent with our expectation for the year of about 30%.

Now, a brief comment on the life segment. First, life segment results from continuing operations as we said are above----consequently we are revising the guidance provided for the full year. We now expect to generate a lower pretax loss in the range of $8 million to $10 million for the full year, for continuing operations from our life business. Remaining guidance for the life companies, with respect to the continuing operation continue---- are as we discussed in late February.

Lastly, the loss on disposal of business that I just discussed is expected to be $15 million higher due to the charge for the quarter, bringing the total full year expected net loss from discontinued operations to $30 million.

With that, I'd like to turn the call over now to--to Marita.

Thanks, Ed. Good morning, and thanks for joining the call. I'm once again pleased with our performance in the P&C business for the quarter. We continue to improve our underlying earnings power, while gaining growth momentum in both our personal lines and commercial lines businesses. We're very pleased with our growth in both person lines and commercial lines. New business premium has been the primary driver of growth; in personal lines, the growth is from the continued success of our Connections Auto product, and in commercial lines, the growth is led by our inland marine and bond lines, as well as core product in the geographic markets where we've invested in the right local leadership as well as underwriting talent.

So let me discuss some of the details. As promised, our personal lines policies in force grew in the month of December, and has continued to grow each month throughout 2006. We added almost 7000 policies in the first quarter. Furthermore, personal lines net written premium grew by 2% in the quarter, from 336 million a year ago, to 342 million in the current quarter. This is despite our continued conservative approach to Massachusetts. We shrank policies enforced in Massachusetts primarily on profitable policies resulting from agency actions that we had taken last year. We are also impacted by the mandated 8.7% rate reduction. Excluding Massachusetts, our personal lines premium growth would have been about 6%. This growth comes primarily from our personal auto book.

The turnaround in personal lines is driven by strong new business growth and solid retention levels. New business written premiums increased over 150% since the first quarter of last year. Our retention also remains strong at 81.5% for the current quarter and that's up almost 2 points from a year ago. As we discussed last quarter, these results are directly linked to the success of our Connections Auto product which continues to produce the new business momentum that we expected; new business growth in the Connections Auto launch dates is up almost 156%, compared to the first quarter of of 2005. We launched Connections Auto in Connecticut and Louisiana late in the first quarter, with very good preliminary results. This brings the total number of launch dates to 10, with Georgia ready to go as soon as we obtain approval from the insurance department. We are on track to introduce our new product in New Hampshire and New Jersey in the third quarter, and we expect to get some good lift in production in both of those states as well.

Not only are we generating healthy new business growth, but we are also maintaining the quality of our business. We monitor the frequency and severity trends on our new business, and I want to assure you the new business quality is in line with the overall profitability of our existing book of business. This 2% quarter-over-quarter growth is a great start for us, and we feel confidence that the growth comparisons will ramp up throughout the year. We are still committed to deliver the mid to high single digit growth that we promised to you in the investor conference.

Turning now to the commercial lines segment, as Ed said, underlying margins remain strong and written premium grew by over 9%, while our specialty growth outpaced our core lines by design, we still saw solid growth in our traditional drive lines; production in the inland marine and bond lines continues to be a good story for us, and they grew by 57% compared to the first quarter of last year. Our traditional commercial drive lines reported solid growth as well, with over 4.5% growth in direct voluntary written premium excluding New Orleans, were a little over 2% countrywide as Ed pointed out. Written premium in New Orleans for the first quarter reflects the impact of short term renewals that were necessitated by regulatory conditions. This is depressing our growth comparisons for the quarter. As the environment stabilizes and we renew some of these policies for a full year, Louisiana growth will pick up somewhat during the later part of the year. In New Orleans as you know, the market is unsettled. Prior to Katrina, we had in place a strategy to reduce our coastal concentration in Louisiana, and we continue to follow that strategy to the extent allowed by regulators and filed in our renewal plan.

Strong commercial lines growth rates in our traditional lines have also been suppressed by our conscious decision to up price and to improve our mix of business in our worker's compensation line. We have consciously walked away from worker's compensation accounts that fall within our appetite when competition has forced what we would consider inadequate pricing. Our objective is to grow while sustaining margin, and we won't compromise that. Excluding worker's compensation, direct voluntary written premium in our traditional lines, outside of New Orleans grew by almost 8%, and we think this is a better indicator of our core commercial lines growth.

Our new business growth has been strong, at just under 40%, and as expected, has been driven by our inland marine and bond lines, which almost doubled, while the traditional lines new business premium also recorded a solid 17% growth over the prior period. Additionally, our basic strategy of developing deep partnerships with winning agents and developing leveragable specialties is working. Our written premium from our winning agents grew over 19% in the quarter. Our reported retention levels were just under 78% countrywide; however this was suppressed somewhat by activity in New Orleans. The retention level excluding New Orleans is about 80%. While this is lower than we'd like, it was as expected given the intentional strategic reductions we have made in certain underperforming segments of our business such as the larger worker's comp accounts I mentioned.

The investment we have made in our commercial lines operating model, inland marine and bond line of business, and our developing partnerships with winning agents is producing results. Generating strong new business growth and solid underlying margins. In summary, we are very encouraged by the progress we've made in both personal lines and commercial lines. In addition to the strong top line growth, we've also maintained solid margins with an overall combined ratio of 94.4%, and our accident year results remain strong. Overall, our results in personal lines and commercial lines show improved progress, and both businesses are well positioned to deliver on both the growth and margin commitments that we made to you at the investor conference earlier this year.

And with that, I'll turn the call back to Sujata.

[OPERATOR INSTRUCTIONS] We'll take our first question from Dan Farrell with Fox-Pitt, Kelton.

Good morning. Can you give us any update that you may have on your discussions with the rating agencies and how you view your potential for a ratings upgrade from them?

Sure, Dan, this is Ed. Let me tell you where we are on the calendar. I think as you know, we've discussed in the past, we---we get with [A-invest] invest first, and we've had our meetings with them in the latter part of last calendar year, spilling a little bit into the beginning part of this year. I'm not exactly sure what their timing is, but we believe they're going to be getting to committee relatively soon. We've not yet had our face to face meetings with Moodies and S & P, although those are coming up in the next several weeks. They each have the full complement of data that they typically get.

As you know, our desire is, from an [A-invest] standpoint, for the financial strength rating to move to an A rating. We continue to make the case with [A-invest] that we are deserving of that. With regard to S & P and Moodies, we are ultimately really focused on our investment grade rating, which is as you know in each case is one notch below---currently one notch below investment grade, and the---- I think that the trick to getting that upgrade is to get the financial strength rating for the P&C business up one notch for each of them, and we are very much focused on that for this year. Obviously, I can't predict where we come out, but we think our case for all of that is very strong.

I guess what I would say, we've done everything we believe that we said we would do in the last two and a half years, and we have a very good track record in our business now as far as underlying results, and as you know, we believe we have enough capital already for A, and in talking to, particularly [Best] felt comfortable doing the share buyback, so I don't think this is a capital issue, I think this is time and the question for them is when is the right time, but we feel very, very good in the case we made, and feel very good going forward that we're generating the kind of capital and returns that it's an A, at least an A Company, so I feel confident that we will get it, I just don't know the timing of it.

Okay. That's great, and then, just on the reserves, this is the fifth consecutive quarter where you've had reserve releases in commercial lines. Can you talk about how the development on the reserves is impacting your view of your initial accent your loss picks of the commerce lines business going forward? They are down a little bit from, say, a year ago, but not significantly. I think given the reserve leases that you've been showing.

I think the way it's sort of working, Dan, is that if you go back over the last couple of years, in those earlier accent years, we are now seeing in the calendar year results favorable development which obviously indicates the initial pick was a little high. And I think what we are going to see over time is sort of the actuaries as they're making them, seeing the successful or better results opposite for each of of them, say in the lsat two accent years, and I think what you're going to see is that they are picking for the most current accent years relatively speaking lower loss ratios, so I think we'll continue to see some favorable development through the remainder of this year, but over time as those picks, I think, get more accurate with the current underlying trends in the business, we will see less of that, and we will see it reflected more in the initial picks.

I would also add to that, considering the short tail nature of our business, I'm confident in everything that Ed just said as well.

Okay, great. And then, just in terms of the guidance you gave at the investor day, I think you had indicated you thought the reserve development would be less of a favorable impact in '06 versus '05, does that still stand, given what we saw in the first quarter?

Yes. I think that we'll know a lot better once we get into the mid part of the year, but we still believe that although we will have favorable development this year, it will be to a lesser degree than last year.

Okay. Great. Thank you, guys.

[OPERATOR INSTRUCTIONS] We do have a question from Cliff Gallant with Keefe, Bruyette & Woods.

Good morning. Great quarter.

Thanks, Cliff.

On the---any comment on---in terms of the buyback, whether or not there will be a new one, and also on the expense ratio, Ed, sounded like this quarter was a little bit higher than run rate, and we should be expecting something a little lower in the future quarter? Is that correct?

First on the buyback, is your question, Cliff, where we may go going forward?

Yes.

As you know, we were very aggressive in completing this year's program, right? We said it would take six months, we got through it in three. We're going to---we feel good about our capital base, as Fred and I just said, we talked about the rating agencies, we really need to get through this season with the rating agencies, and need to get towards the end of the year, I think before we think about whether we'll have another program or not.

With respect to expenses, we felt that our original guidance was a little bit low in commercial lines, so it will be a little bit higher than what we indicated in February but perhaps a little bit lower than where we are right now in our personal lines maintaining our original guidance which was up slightly from a year ago.

Thank you.

We do have another follow up question from Dan Farrell with Fox-Pitt, Kelton.

Hi, just actually one follow up on the expense ratio question there. You've said in the past that you think you are running, I think, two to three points higher than you normally would ultimately once you are able to build up to scale and some of the expenses on technology start to pare back. Given what we saw this quarter, when do you think some of that improvement will start to materialize going forward?

Yes, I mean as Ed said, we think this quarter is a little higher than what you are going to see the rest of the year, but my view as we said at our guidance at the kick-off, this year is still going to be high, but I think as you look forward beyond this year is when you will start to see it. You are already starting to see the growth, right, and in personal lines, you'll see it earn its way through; you're also going to see a ramp-down of incremental investments. The caveat to that is we are always constantly looking for opportunities like in marine and bond, and if we believe that growing teams in that is the right business decision, we would do something there, and it would effect our expense ratios, but I would see going forward in the 2007 time frame, you're going to start seeing that expense ratio improve.

Okay. Thanks again.

Thanks.

At this time, we are standing by with no other questions. I'd like to turn the conference back over to management for any additional or closing comments they may have.

I think that is all, thank you very much for joining the call, and we appreciate you being here. Thank you.

Thank you. Once again, ladies and gentlemen, that concludes today's call. Thank you for your participation, you may disconnect at this time.