Hanover Insurance Group Inc (THG) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the third quarter 2007, The Hanover Insurance Group earnings conference call. My name is Maria and I will will be your audio coordinator for today. At this time, all participants are in a listen-only mode and we will be facilitating a question and answer session towards the end of today's conference. If at any time during today's call, you require assistance, please key star followed by 0 and an operator will be happy to assist you.

I would now like to turn today's presentation over to your host for today's conference, Ms. Sujata Mutalik, Vice-President Investor Relations. Please proceed, Ma'am.

Thank you. Good morning and thank you for joining our third quarter earnings conference call. Participating in today's call are Fred Eppinger, our President and Chief Executive Officer, Marita Zuraitis, President of Property and Casualty Companies, and Warren [Bondar], Acting Principal Accounting Officer. Before I turn the call over to Fred, for a discussion of our results, let me note that our earnings press release and a current report on form 8-K were issued last night. Our press release statistical supplement and complete slide presentation are available in the investor section of our website at www.hanover.com. After the presentation, we will answer questions in the Q and A session.

Our prepared remarks and responses to your questions today other than statement 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 a conference call. We caution you with respect to alliance on these forward-looking statements and in this respect, refer you to the forward-looking statement section in our press release and in slide 2 of the presentation deck. Today's discussion will also reference of non-GAAP financial measures such as total segment income, segment results excluding the impact of catastrophes, [ex-cats loss] ratios and accident year loss ratios 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, all the statistical supplement which are posted on our website as mentioned earlier. With those comments, I will turn the call over to Fred.

Good morning and thanks for joining our third quarter earnings call. We remain on track for another strong year. Earnings per share from continue operations were $1.01 per share, up from $0.56 per share in the third quarter of '06. -I've detect segment earnings for the third quarter was $53 million, and compares to $28 million in the third quarter of 2006. This increases is driven by our property and casualty business which generated $93 million in pretax earning compared to $53 million from the prior year. As you may recall, earnings for the third quarter in 2006 included about $52 million in additional reserves related to the 2005 Hurricane Katrina losses. Our current quarter results also include a Katrina adjustment in a more nominal amount of $17 million. As we get closer resolving and settling receipt major claims associated with Hurricane Katrina, we have a clear line of sight as to the extent of their remaining pay-out. Absent any dramatic changes in the Louisiana regulatory environment, we expect to manage any additional changes to Katrina loses in the normal reserve process.

Also contribute to the strength of our earnings were low catastrophe losses in the quarter. Catastrophes excluding Katrina were only $8 million in the quarter compared to $12 million in the prior year quarter. Additionally, prior year developmental reserves continued to be strongly favorable at $34 million compared to $39 million in the prior quarter. Along with strong earnings, we also reported an overall 3% written premium growth for the quarter and a solid combined ratio of 96%. Our book value grew from $42.34 per share up from $40.55 per share in June of 2007. The presentation deck we have used every quarter is posted on our website. We won't go through any of the - - in detail as we have in the past, but both Marita and I will discuss the material in our remarks. And if there's any questions regarding the material, we will be happy to address them in the Q and A session.

Clearly, as you can see from the performance, we have a lot of positive momentum in our business. We also face some challenges that we continue to remain focused on. So let me just briefly review the positive trends in our business, the challenges we face and the outlook that we seek for our business. The financial trends underlying results have remained consistent through the year. The factors affecting this quarter's results are no different from the prior quarter's and are consistent with our guidance. Once again, we had a healthy level of favorable reserve development relating to prior accident years. We continue to believe that our reserves remain strong, and is favorable development is reflective of the strength of our balance sheet, and the improvements we have made in the quality of our book over the past few years. We expect that the magnitude of this favorable development will start to reduce in 2008. However, as we said at the last quarter, we still expect a favorable development on prior year reserves in 2007 will be more in line with what we reported in 2006. Additionally, we continue to remain disciplined in our current accident year loss. And our accident year loss ratios remain in line with the guidance we provide for the last quarter, which was to come in about 3 points higher than our 2006 accident year. Given the high mix of new business in our portfolio brought in by new products in new state, this is not unexpected and a prude and expectation on our part. We also continue to deliver on our expense commitment. Our underwriting expense ratio improved in the quarter and I continue to remain confident we are on track to deliver on our commitment.

Turning next to growth in net written premium, we reported an overall growth of 3% for the quarter. While this is still within range of our expectation, it remains at the lower end of our range, impacted primarily by market conditions that have become competitive. However, despite market conditions, I can see momentum in our business, and a tough market just makes it even more imperative that we remain focused on the strategic drivers of our growth. I still believe that we are well positioned to achieve or growth objectives for the year of mid-single digit growth, and that we will continue to deliver above industry growth rates going forward.

Marita will discuss our growth trends in more detailed. But let me just reiterate that we remain on track to achieve profitable growth in both segments of our business. In personal lines as you know, our growth is affected by the macro trends in Michigan and in Massachusetts. The Michigan economy is very challenging. There remains an important state for us and we continue to devote time and resources to manage it prudently so we maximum our franchise value in the state. In Massachusetts, the mandated 12% rate decreased puts the pressure on top line. Growth outside of these two states remain strong at over 10%, as our growth efforts continue to gain traction. In total, our growth for the quarter is roughly 2.5%. As I had said last quarter, I am expecting our fourth quarter growth to be somewhat higher as it should start to reflect greater benefit from our growth initiatives that we have talked about before. Such as our profiling efforts in consolidating books of business and converting agents to partners, including Michigan and Massachusetts. Also, the launch of our connections home product early this year will provide some lift in production in the fourth quarter.

Similarly, our commercial line segment generated 4% growth for the quarter. And net of some actions we took in Louisiana with regard to expose management, our run rate of growth is about 6%. Here again, we are affected by market conditions, particularly in middle market segment where pricing and competitiveness continue to be difficult. Performance in our small commercial segment wax encouraging where we've been able to take positive pricing action and generate new business momentum. As you remember, we have also launched a significant upgrade to our small commercial model and platform at the end of the second quarter. With many enhancements that include sophisticated pricing and ease of doing business.

We believe this will give us an added impetus for growth as the adoption of this new model continues to increase with our existing and new partners. In addition, our specialty business growth continues to be robust, and now represents over 25% of our commercial lines business which gives us greater diversity of earnings and more stable margins. Furthermore, during the quarter, we closed on our acquisition of professionals direct to specialize provider of -- profession liability. This investment first expands our specialties capability, and enabled our aging partners to be more of their client needs and grow their business. Well now, reflected on our numbers yet, we see a significant opportunity to cross sell this product with our Hanover agents. Finally, in Michigan, were general condition of the crummy base growth very challenging, we have used our targeted niche programs to give us opportunities with target agents agent to provide for prompt able growth opportunity. As I review our progress, I remain convinced that our agent targeting and broad target approach is working. And we are building momentum in market share on the shelf space with the winning agent. At all times, we endeavor to carefully manage your growth at an agent level to insure continued attractive margins.

To summarize, I feel very good about our performance and I believe we continue to strategically position the company in the best possible way to become a top player market. We remain on track to meet our commitment to you for 2007. We are singularly focused on creating a top quartel company so we are working on all the critical levels to deliver top quartel returns. I remain convinced that the best of all strategy which combine the product, the technology and people quality are the [nationals] with the local presence and responsiveness of the regionals makes us a distinctive carrier for our partner agent. And should enable us to take advantage of the market opportunities as weaker companies struggle through the current difficult market conditions. We will continue to take focus on hard work to remain successful. But by doing so over time, we should continue to create significant value for our agents and shareholders throughout the cycle. Before I turn the call to Rita, let me just quickly comment on our life segment results and on capital management. The life segment reported the net loss of $4 million for the quarter. This loss is primarily due to that pension adjustment we reported in our press release and some large mortality losses and our tradition at life policies that are held in the close black that can be sporadic in nature. But now, let me turn to capital management. Because of our confidence in the strength of our financial condition and our conviction that we have created a company with the potential to generate future potential growth, we aren't able to increase our annual dividend by $0.10 per share to $0.40 per share and we also announced today, or last night, a $100 million share buy back somewhat ahead of schedule. Helped by the mild hurricane season and as a result of our generating solid earnings throughout the year.

We will continue to evaluate our capital position and consider other uses of capital that may be available to us and we will continue to make responsible decisions and will maximize the returns to our shareholders over the long term.

With that, I now turn the call over to Rita to review our business. Thank you.

Thanks, Fred. Good morning, everybody and thanks for joining the call. I'm going to discuss each of our business segments in a little more detail. Covering the financial results, the business trends and an outlook for each of our segments.

Let me start by saying that I'm pleased with our accomplishments for the quarter, which remain on track, and are consistent with the progress we have made through the whole year. We continue to maintain our strong underwriting discipline despite the market conditions. Pricing is competitive and the difference in new and renewal pricing is widening in the marketplace. However, we continue to hold rate and take the trade-off in growth. As we have always said, we are committed to writing profitable business and we won't compromise on that. And you can see that in our results. Both segments continue to deliver solid earnings and show steady advancement to establishing a defensible market position. Of course, I'm pleased with the results for the quarter. Generating strong T and C segment income of $93 million, while providing some additional Hurricane Katrina reserves. Let me provide some insight to the $17 million in additional Katrina reserves first. As you probably know, the extension of the one year limit on policyholder' ability to challenge the settlement of claims expired on August 30th. As you would expect, there was a flurry of litigation activity leading up to the expiration date, that included 150 new cases for us.

In analysis of these cases, led us to establish these additional reserves. These reserves were established in commercial lines and are expected to primarily cover higher litigation expenses. As Fred said, for us, this adjustment is pretty nominal, and one that as you can see is tailing down. The situation in Louisiana is slowly and surely becoming more orderly. The positive resolution of these two major litigation cases on the [leavy breach] and the value policies which were ruled in favor of the insurance companies by the circuit court is very significant. Barring any sweeping changes in the Louisiana regulatory environment, which if it were to occur would potentially affect the entire insurance industry. It is our expectation that any further adjustments to Katrina would not be material. Let me now turn to a review of each of our segments starting with Personal Lines. In Personal Lines, we recorded net written premium growth of 2.5% for the quarter and 4.1% year to date. This third quarter growth rate is consistent with the guidance we provided last quarter when we indicated that the third quarter growth rate would be in line with our second quarter reported growth, which was 2.8%. We also guided to an uptick in our fourth quarter growth rate, and we remain on track with this expectation and we still expect to end the year with an overall growth rate in the mid-single digits. Let me remind you briefly as to the factors that caused a drag on the personal lines growth these past two quarters and why despite the drag, we remain optimistic about our ability to generate some growth momentum in the fourth quarter and going forward.

Like we pointed out last quarter, we have a meaningful personal auto presence in Massachusetts, and our third quarter growth reflects the impact of a 12% mandated rate decrease in personal auto in Massachusetts. This was not a surprise to us, and was [baked] into our expectations for the year. But a drag to growth nonetheless. Additionally, Michigan continues to become a more challenging environment. The economy in Michigan is putting strong pressure on the insurance market and we have to continue to work hard to maintain our market share in this core state. We have stepped up our agency management efforts and we're working closely with our partner agents. Assisting them with book consolidations. We have made revisions to improve pricing in certain segments and that, we believe, will help both new and renewal business, and were making new agents appointments where it makes sense. We know this marketplace and we will deploy the tools necessary to remain a dominant writer with strong margins. Finally, our new business protection continues to be impacted by the corrective actions we've been taking to improve mix and pricing in our connections auto book of business.

As we discussed last quarter, given the aggressive role-out off our connects auto product and amount of new business we've brought in, it's not uncommon to need some adjustments. Upon review of the new business that was written. Seeing indications of some margin compression related to connections auto book at the end of last year, we took steps including pricing actions that would alter the flow of new business being brought to us by agents. These corrective measures were aimed to improve our new business mix, such as increasing the proportion of multicar policies, and driving whole account business which is consistent with our strategy. We are starting to see the above improvements in our mix of new business. For example, in September, we saw a 4-point shift in our new business mix, moving in favor of multi car policies versus single car policies. We also saw a 10 point shift in our new business mix in favorite of auto policies that also have a home with us compared with the same time period last year. While these actions will yield positive bottom line results, improving margin over time through better pricing and improved mix, you are seeing the impact of these corrective actions on growth.

At the same time, some of our positive levers designed to grow more profitable segments haven't been fully reflected and earned in our numbers. These positive levers include increased efforts in profiling books of business and converting agents to partners. I'm definitely starting to see some momentum on this front and I can see a pipeline for the fourth quarter. At the same time, I know we will need to put greater focus and resources to increase the inventory and flow. Additionally, our connections home product is now available in 16 states. This new product which primarily enhances the ease of doing business for our agents was well received, and should help us achieve our growth objective by enabling the agent to round out an account. We are already seeing an uptick in the hit rates and quotes for homeowner policies with our umbrella endorsement capability. All in, I see growth momentum in personal lines going into the fourth quarter. And despite the tough market conditions, we remain on target to meet the mid-single digit growth commitment in personal lines. The financial results in personal lines segment continue to remain solid. As detailed on slide 5 in the presentation deck, personal lines pre-tax segment income was $49 million in the quarter compared to $35 million in the prior year of quarter. However, normalizing for the pre-tax impact of catastrophes, which includes the reserve adjustment for Hurricane Katrina, Personal Lines pre-tax segment income was consistent with the prior year quarter.

We had $10 million in favorable development of prior year reserves, which was $4 million less than the prior year of quarter. Favorable development in the current quarter continues to come primarily from our personal auto line, and is driven by improved severity trends in our more recent accident years. Offsetting this is a compression of our current accident year margins. Driven by our homeowners line, we're our accident year loss ratios were higher this quarter, compared to the prior year quarter, due both to an unfavorable comparison, resulting from an unusually favorable loss trend last year and some increase in large losses predominantly in Indiana and Michigan. We remain focused on homeowners loss pricing and are confident that we will be able to take underwriting action to correct this trend as needed given its short tail nature and maintain our margins. On the positive side, our personal auto accident year margins improved to this quarter. Reflecting some of the improvement we have achieved through the corrective actions we are taking to improve pricing and mix, as I discussed earlier. Like others in the industry, we saw an uptick in our accident year loss ratio in the first quarter of this year. However, while some of our competitors have reported a reoccurrence of this trends in the third quarter, our personal auto loss trends continue to remain fairly stable so far. That being said, we are aware of the deteriorating loss trend in the industry, and we are watching it carefully in our book of business. But at this point, we have no cause to believe that we will not be able to maintain our personal auto margin into the fourth quarter. The other factors affecting the change in earnings quarter over quarter in Personal Lines are detailed on slide 5, and I'll be happy to address any follow-up questions you have on those items. Now, turning to commercial lines.

In commercial lines, we reported a 4.2% for the quarter in growth. This was a little on the low side of our expectation, but we have confidence that we can continue to grow profitably in the fourth quarter. Our commercial lines growth rate was once again impacted by the catastrophe management actions we are taking in Louisiana. Resulting in a reduction of 1.8 points on our country wide growth rate for the quarter. This is, however, much lower than the 3-point impact we had last quarter and consistent with our expectation that Louisiana impact would diminish over time. Growth in states outside of Louisiana was 6%, which continues to remain a very healthy and responsible growth rate and gives us confidence that we have the momentum to deliver on the profitable growth commitment that we've made.

As in previous quarters, most of our growth came from the specialty lines, that we have aggressively developed over the last couple of years. We reported strong growth in our inland marine and bond businesses, which grew 24% for the quarter. Our core growth remained flat compared to the prior year where the market remains competitive and pricing is tight. However, we are getting positive rate in the small commercial segment, and starting to see some new business. This momentum which we attribute to the launch of our small commercial model and I'll talk about shortly.

As the market continues to become more challenging, it is even more important to remain consistent and disciplined in our underwriting, and we believe, we continue to balance that trade-off between quality and pricing. At the same time, we continue to focus our strategy to grow profitably through strong partnerships with winning agents and by providing agents a distinctive value proposition by offering them superior service, easy to use technology and a broad [suite] of insurance products. With that in mind, during 2007, we made some important improvements to our small commercial platform. With this upgrade, we introduced new front end automation, allowing for account view capabilities, up front eligibility and automatic pre-fills for all lines of business for each quote. As I said earlier, we are starting to see positive momentum from this upgrade. Additionally, we also launched miscellaneous professional liability coverage for small commercial customers, and we improved our workers compensation appetite by increasing eligibility to about 80% of all small commercial [pluses].

This small commerce upgrade and the product enhancements were well received by our agent who can now more riddle quote an entire account for their customers. As we work with our partners helping them to adopt and integrate our small commercial platform into their every day work flow, we should start to see some meaningful improvement in our small commercial growth rate. Fred already talked about the future potential of Professionals Direct, and the cross selling opportunities that presents with our existing agents. But once again, we see strong interest here.

Turning now to the financial results in the commercial line segment., which continued to remain solid, as detailed on slide 6 of the present taste deck. Commercial lines, pretax segment income was $39 million in the quarter, compared to $8 million in the prior year quarter. However, normalizing for the pre-tax impact of catastrophes which includes the additional reserve for Hurricane Katrina, commercial lines pre-tax segment income was $59 million in the current quarter up $8 million from the prior year quarter. We had $25 million in favorable development of prior year reserves, which was more or less consistent with favorable development in the prior year quarter. Reserves, developed favorably across all lines, but most significantly in the commercial multi peril and workers compensation lines. At the same time, we continued to maintain our current accident year loss ratio of 48.5% for the quarter, which is consistent with the prior year quarter and in line with our guidance. The other factors affecting the change in earnings quarter over quarter are detailed on slide 6 and are the same items as in personal lines. To close, I remain confident the progress we are making. As I said earlier, we are being responsible, and remain disciplined underwriters, constantly managing the trade-off between margin and growth. Every day, we continue to improve our position in the market, and deliver solid results each quarter.

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

Thanks, Marita. Operator, we'll now open up for questions.

(OPERATOR INSTRUCTIONS) The first question comes from the line of Jay Gelb with Lehman Brothers. Please proceed.

Thanks and good morning.

Good morning, Jay.

Good morning.

I was hoping you could give us a little bit more insight, Fred, on the capital management initiatives in terms of how much of the - - in your view of excess capital, the $100 million authorization address and then how does that come into play with the rating agency views?

Sure.

And then if you can also update on the CFO search. Thanks.

Sure. Thanks, Jay. Two things, as I said at the last call, the way I think about capital management, we spend a lot of time, as you know, working with the rating agencies, 'cause I would like with positive outlook from all three, and as I've always said, I would like to get that upgrade. So we are actually quite thoughtful with them, given the changes that have happened in the capital requirements given the reinsurance changes that have occurred, et cetera, and the modeling changes. At the beginning of the year, as I said in the last quarter, the conversations I've had with the rating agencies is that our capital was not a deterrent for another upgrade at the beginning of the year. So my assumption is without having the conversations at the end of the year, that any excess capital we generate is truly excess capital to our objective of getting those upgrades.

And I completely believe that I should, at the end of the year, sit back and have the conversation assess the opportunities with the whole year behind us, as well as our review by the rating agencies, and determine if there's additional access. But the reason I moved quicker is that clearly, we're through the Cats season now. It's clear to me that we are going to have a very robust year. And I felt it was important to me to act now, but it doesn't mean I won't assess it again at the end of the year, looking at it, and as I said in the last quarter, all things being equal, whatever additional capital we generate during the year, will be accessed if in quote if you will, based on my conversations last year. So I believe that it could be. It's not the whole amount of the excess, I think there's additional given that assessment. I couldn't give you a number, but I would say that there's still additional that you could consider an amount that I will think about how to best think about it, deploy and use it. We're also obviously thinking about the growth opportunities in the market.

We built this company to take advantage of weak regional companies that provide a significant portion of our $150 billion of the market. and what you are seeing now is struggling. Regional companies are now starting to struggle. If you look at what we did on our balance sheet, we have been very aggressive over the last three and a half years to get our contractor percentage down, to get our workers comp percentage down, to get our portfolio really pristine and a lot of those regional companies actually went the opposite ways stretching as the market got more difficult over the last six quarters, and you are starting to see the ramifications of that which will result in my belief in the next 2 or 3 quarters, more re-underwriting and more repricing. By then which will create growth opportunity. So part of our challenge always is to make sure we have our powder dry, work very strong financially so we can capitalize on those opportunities like good margin. So we will do that assessment at the end of the year, but as I said, I moved quicker because I thought it was obvious that it made sense. Obviously, the volatility in our stock, also in my view, created some tremendous buying opportunities of our company over the last quarter, and I want to make sure I have that available to us.

On the CFO search, we are quite close. There are a number of very good candidates, two or three in particular that we are very close on. I would expect that relatively near future that we will take action on that, and so I feel very good about both of the quality, the candidates and the timing of that, and I would believe that before the next quarter call that we would be making an announcement so I'm very comfortable with that. Thank you.

Okay. And then, separately, if you can just update us on your view on M&A and consolidation within the small commercial and personal line space and how Hanover may address that?

There are a couple of categories of the M&A, since I've been here, we've hired in the last 30 months 2200 people. So I've been relative aggressive at getting robust professional team here, particularly in specialty areas, and places where I thought like in Personal Lines modeling and commercial lines product, get the kind of people that could create some distinctiveness here. So, we've always been relatively aggressive and looking for opportunities to get some distinctiveness in our portfolio. What you see in the acquisition front is two things. I think everybody is seeing that a lot of the specialty companies that thought they had an unique model that could grow through the cycle. They're coming to the realization they don't. And so a lot of the smaller especially companies are in my view being, looking for alternatives. And you will see a number of those as you did in the last market turn, and the question is, are any of those bring the kind of capabilities. You saw what we did with PDI. My questions is there are a number of small teams out there that would, might make some sense, so I constantly kind of try to assess, does it make sense? And for us, leverage is obvious, both in the reinsurance leverage, the capital leverage, as well as the leveraging of indoor product distribution. You can make those small deals quite quickly.

That's one category. I would say that we would be prudent, but there will be opportunities over the next couple of years in that area that we can't pay attention to if they make sense, the second category is the fill-in. Which is as you alluded to, a lot of Personal Lines companies are shrinking. Most of the regional companies that are kind of $100- $300 million. Their personal info books are shrinking. If you look at the industry [trans 05] to 2005, the strength was severe. But now that we are hitting the soft market, a lot of these folks are having adverse selection at book and they're shrinking.

My view on that is, they still, many of them really over value the value of those books. And so, while there's lots of conversations out there on books and Personal Lines business, I would say that most of them have a little bit of an inflated value, what I, the question is going to be as they get more deterioration, will you see renewal rights deal or potential outright buys for certain. I believe you will. The question is, will they be priced effectively and can you do in a renewal right setting? We will also pay attention to that particularly in the states. We care about the states we believe share will help us, but to this point, I don't feel the value was there. Again, people are shrinking, and they are worried about, but they think the value is still more than I think it is anyway. But I do think that will become available. To a lesser extent small commercial. I do think there'll be some small commercial. But where you stand for the people we compete again, the regional setting. They really stretch their appetite in a lot of cases towards high risk contractors. As you can imagine in this cyclical business, and in particularly a soft market, that's where you get the most prized compression, that kind of business. So what you've got is troubled businesses, that people are out talking about.

And again, in those cases, it always comes down to distraction to your core business. Does it make sense, is it something that is easy to do? So I'll tell you, just like it always happens, we are now entering about a year and a half to two year period where you are going to see a ton of conversations and talk about sub scale faltering companies and for us, we built a company to take advantage of that in the marketplace without having to buy, but if I thought we could get a team or two, or we thought we could do it, we would consider it, but with always the focus on being a creative, creative shareholder value and getting our standards, which is as you know, true to cycle over 12%. So, I do think it's going to happen. Again, I just, you can see it from the people's earnings, you can see it from the balance sheet movement and even the large players in personal lines, you'll start and see the results get a lot closer to the 95s, 96s than the 85s, which again, make them less aggressive and in my view, create real opportunities for us as the business turns that they put in price increases. So again, I think there's going to be lots of activity in this area.

Thanks very much for the update.

Yes, no problem. Thank you.

Your next question comes from the line of [Rohjan Pye] with Banc of America Securities. Please proceed.

Good morning.

Good morning, Rohjan.

Fred, I was wondering how you look at the specialty in other commercial lines businesses today, I think it's already based to reviewed as books and selling opportunities with your existing agency plan? Now there are pretty sizable portion of the overall business and the major driver of commercial lines growth and profitability. Is there a strategic change in how you view these operations?

That's a great question. To me, one of the issues, if you look at our book of business. In essence, we believe two very strong things. We believe that there is a consolidation of the distribution and dependent agents. And so what you've got is better stronger midsized agent control, and the way we play, we write to look at the regional company as the folks we go after. And so, we have two [prongs], if you will of our business. You have what we call the ballast, which is the flow small commercial which we've invested a lot in. Because if you look at the most stable profit pool that exists in our business, in the midsized agents, it's small commercial, kind of under 75,000, that typically has high retention [assess].

We've invested a lot there. At the low end of that business, it's a little bit more commodity like, but a lot of it is very good solid profitable business. What we try to do is to get more than our fair share of that with the midsized agents is give them something distinctive to play. So we've invested in niches. we've invested in specialty businesses as we said. It's over 25% of our business then. And so as we go to them, we say you can bypass the whole fields like a PDI. a lot of those midsized agents have that kind of [businesses]. You can imagine small world. They go through whole sales, we increase income overnight by letting them go direct to us. So we use that in our value proposition to get more of their small commercial to move, not based on price, but based on our overall franchise value, and there's no question that's been our focus, so if you look at what we've done in marine, and bond, on PDI, we are doing a little bit more in casualty now, we're leveraging the businesses.

As it becomes stronger, there's no question it looks more like a third leg of our stool. There's no question. But our whole focus we are never going to be in the national account game of swapping capacity with big players in the world. We'll always be going after the specialty business that are in the small commercial word -- It's hard to get in and out. Sort of stickier. It has a little bit more fixed cost and it may change it's margins retentions better. Now, do I believe over time that a greater percentage of our specialty will be stand alone business? Absolutely. If you look at the bond, that's the poster child. Big portion of the bond we use with our partner agents, but there's a lot of bond business that is just good, small bond we do well through specialty distribution, and so as we pick off the specialty, we pick off the team there will be a hybrid between the business that we will have at specialty businesses that originates in our kind of agents, usually, but it could pass through a wholesaler or MCU. So again, we believe that it is a little bit different than we were.

If you look at the overall business, what did we do since the beginning? We try to create more diversity in earnings pool, we were too concentrated in Personal Lines in three states. And what we've done now by growing our other states in personalize, we have more diversity is it overcome something like a Michigan economy, Andy versus find the commercial lines, and being very conservative about the nation of our business, I think what we've done is created the third leg of the stool in our investor day, and in spring, I'll talk more about it. It's obviously something we've been planning on, but it wasn't significant enough to talk about, but as we sit back and we talk about investor day this year, I will be more articulate about exactly where that's going and how it's doing. We built critical mass now, I mean we are bigger than knows specialty companies now.

We are absolutely a significant player in the specialties that we have chosen. And we will continue to be. Because those again will be the little niche companies that will fail because of the soft market, struggle with access and returns. So again, I think that there's a tremendous opportunity for us to continue down that road.

Thanks for the detailed answer. I have a question for Marita. It seems that your lowering your accident, your aspects for workers comp and as you alluded to, also personal auto in recent quarters. And how much of this has been to reflect the better than expected loss environment and how much has to do with maybe possibly growing in new markets outside of your major states?

I'm not really seeing any significant changes in the trends. Like we said, we saw an uptick in the loss trend in the first quarter in auto, and we haven't seen any additional deterioration there. In home, everything is pretty much as it has been for quite some time. A slight uptick in some large losses in Michigan and in Indiana. But a pretty lumpy statistic, so overall, both personal auto and home have pretty much remained consistent from both of frequency and severity standpoint for several quarters now so we are not seeing any significant changes.

What we've done in the personal auto line because of the amount of new business that we've had and the ability to see the early results on that line, we've been able to make some tweaks to the connections auto product. Like I said, in our remarks to improve mix of business, to improve pricing and sales where we needed to improve those, and we are seeing some benefit with those changes and will continue to make chances as the product develops.

I think our comp, we will just talk a little bit on the comp because your question on the comp. Comp is probably one of the really interesting stories of our company. When we started this journey, we had a lot of large comp that was very under performing. And on the comp side, what we've done is essentially, we shrunk it dramatically but we focused on small comp to round out our accounts in small commercial, and we are now in a great place with comp.

And I'm, by the way, I don't believe half of trends that you see in the market, you know, about, because I've always been, I have a cynicism towards medical costs, and I believe comp is worse than people expect, particularly in the large accounts. But what we've done in comp is now that we have focused 0 be small comp, we have a nice mix. And most of it is about rounding out our accounts. You will see us be able to grow a little bit in that line, and so our results have been really outstanding, from a transition from not so good results to actually quite good results.

Commercial side, workers comp is probably the place we've seen the largest change in the make-up of our book, both from a risk grade perspective, as well as the size of account perspective. The workers compensation book we have today doesn't nearly resemble the workers compensation book we had four years ago, it hasn't been a very dramatic shift as far as size and risk grade and like Fred said, one that more resembles a pretty benign small commercial book of workers compensation.

Great. Thank you for the answers and good results.

Thank you.

Your next question comes from the line of Heather Hunt with Citigroup. Please proceed.

Hi, Heather.

Good morning. How are you?

Good.

Thank you. I just wondered if you could give us an update on the Massachusetts market sort of - - you kind of mention that you're working on filings for prices and price changes? Can you tell us, what kind of, to what degree do you think you can get some price changes and how much that will help you competitively kind of regain market share there?

Yeah. [Mass] is a very good story. Obviously , we all know how difficult mass is, and but, I actually think this is for real. I think the governor has been incredibly clear that he is supporting the commissioner, we are moving forward. As you know, this spring we are moving forward toward managed competition. And I couldn't be more pleased with the thoughtfulness and deliberateness of this change. Again, what you are going to see is companies like ours, and there's a handful, four or five of us, that have this skills to differentiate our product, there are some variables that won't a-- It will allow a lot more variables than they do today. There is a handful of us that have [abdicate] the whole state. Lot of the state only companies don't, so what you will see is we will be introducing products that are more consumer oriented and more segmented, like you've seen us do in other places around the country, and I believe very strongly what you'll see is the couple of big state only, you're going to lose share, and folks like us that are more account oriented, and that have a more sophisticated consumer oriented product.

You can imagine things like accident, forgiveness and things like that. That really are tailored to consumers so you get higher value pricing for some segments so I think, in Massachusetts, you still are behind the rest of the country as far as we're seeing some frequency decreases because we were late in the game as far as going after fraud, et cetera. And so, I think you'll see some price decreases continue here, but I have the opportunity to actually differentiate a segment and product is pretty tremendous. I also would tell you that people say will there be a floodgate of competition? I think we will see some new companies, but because Massachusetts is still a place that many people are afraid of, I don't think there's a floodgate. I think you'll have two or three companies come, as they see it work but I am very confident of our ability to compete. As you guys don't know, we have very much taken our share down purposefully because I have uncertain about what was going to happen in Massachusetts. But we now make very good money in Massachusetts, and we did take our share down for the last two to three years. And we are now poised to be a competitive player and make good returns, and grow a little bit. So I'm optimistic about this.

The other thing that it does, people realize the notion of the assigned risk plan makes it more certain, because like every other state, instead of having the ERPs that are arbitrary, like you get from the residual market, we will move to an assigned risk plan, that creates tremendous transparency and more stability in your earnings, and it make people that are good add data better and as I said, two-thirds of the market, can't do a multi-vary product. So in my view, we are going to have a tremendous advantage to be more effective and more accurate if you will in pricing and growing our business. I think it's good for the Massachusetts consumer because it's a state where we've lagged behind the rest of the state as far as being kind of product, consumer centric. I think it's a good opportunity for

Great. Thank you. Can you give us a sense of the time frame? Which benefits will evolve after implements I think of the springtime?

Yes. A good question, as you know, it's a short amount of time to change your entire infrastructure and product, right? It's just kind of, got finalized in the last forgotten rules were within three weeks here, and we have, in March, I guess, to get the filings done. What you will see is you'll see phase 1, so I would guess what you'll get is a lot of folks will not go to the full product offering, I think all of us are investing in the infrastructure and products to get there, and then the change will occur over that first year. And again, I think that you won't see significant changes, I don't think, in most people's files this year, just because of the short time frame. I think most people won't have everything together to be able get it done.

I know we have a lot of investments to make. So I would say it will evolve over the first year. You'll see changes, but I think, again, Massachusetts is always difficult to really understand the regulatory environment, but I believe very strongly that by the end of the year, you're going to start seeing what's going to happen. I think the agents are going to have more transparency on the winners and losers by the end of the year. Now, there should be, there will be a couple of folks that will just be aggressive on price, and I think they will financially struggle and that might take a year or so to work its way through. But I think it's going to involve i more than jump [patch]. I think it's going to involve over the next 18 months.

You feel like the state having been somewhat supportive of agents and sort of the local employment base. Do you think the state has a desire to try to keep jobs in the state and protect income bids from outside forces?

Yeah, I mean again, I believe very strongly that the reason they were doing this is because we were getting down to such a few number of companies that it made it incredibly volatile is the connection with property. when you start getting down at 17 companies and you have so many companies that have weak balance sheets or small subscale companies, it makes it an enormous risk to having a 1938-like storm, and I think that the policy makers understand that. Not all of them, but I think the policies makers understand that. And I also would say to you that the cost of living in Massachusetts is difficult, and that's what hurts our employment base in Massachusetts. When something like this that can make us more competitive both in Personal Lines, I would argue small commercial, I think they understand that. I think they are going to stay with it.

Again, we have, this not something that happened overnight, this has been three years of study and assessment, and debate and discussion, and it feels like it's going to be given real trial, I mean, I really do, I believe that they are going -- And I believe it's going to be a positive. Once it saves a lot of money for a lot of consumers, I think it's going to take off. So we will see. And two of the bigger players that's the liberty, our head quarters here that are very successful. We'll just be more successful. I don't think the employment base insurance based company are going to change that dramatically, given who is the players.

Great, thank you very much.

Ladies and gentlemen, as a reminder, if you wish to ask a question, please key star followed by 1 on your touch tone telephone. And at this time, there are no further questions in the queue. I will return the call back over to Ms. Sujata Mutalik, Vice President Investor Relations.

Thank you, operator and thank you everyone for joining the call. If you have any further questions, you can always reach me. Talk to you soon. Bye, bye.

Thank you for your participation. All parties may now disconnect. Have a great day.