Hanover Insurance Group Inc (THG) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to The Hanover Insurance Group second-quarter earnings conference call. My name is Whitley and I will be your operator for today.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I will now turn the conference over to your host for today, Oksana Lukasheva, Vice President Investor Relations. Please proceed.

Thank you, Whitley. Good morning and thank you for joining us for our second-quarter conference call. We will begin today's call with prepared remarks from Joe Zubretsky, our President and Chief Executive Officer; and our interim Chief Financial Officer, Gene Bullis. Available to answer your questions after our prepared remarks are Dick Lavey, President of Personal Lines; Andrew Robinson, President of Specialty Lines; Jack Roche, President of Business Insurance; and Johan Slabbert, Chief Executive Officer of Chaucer.

Before I turn the call over to Joe, let me note that our earnings press release, financial supplement, and a complete slide presentation for today's call are available in the investor section of our website at www.Hanover.com. After the presentation, we will answer questions in the Q&A session.

Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements, including our 2016 outlook. There are certain factors that could cause actual results to differ materially from those anticipated by this press release, 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 statement section in our press release, slide 2 of the presentation deck, and our filings with the SEC.

Today's discussion will also reference certain non-GAAP financial measures, such as operating income and accident year loss and combined ratios, excluding catastrophes, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release or the financial supplement, which are posted on our website, as I mentioned earlier. With those comments, I will turn the call over to Joe.

Thank you, Oksana. Good morning and welcome to our second-quarter earnings call. I'd like to start by saying how pleased I am to have the opportunity to lead The Hanover. I have a deep appreciation for the work my predecessor and the entire team have done to build one of the most respected franchises in the independent agency space. The Company has developed a broad and innovative product portfolio, a disciplined underwriting acumen, and a reputation for responsive service that has driven improved earnings over time.

While certainly successful in the past, the organization also presents significant prospects for margin expansion, growth, and superior shareholder value creation. I look forward to working with all of you who have invested in our future.

This morning, I will provide the highlights of second-quarter results. Gene will review our financial performance and business results by segment. I will then offer my initial observations about our strategic position and value creation, and then our entire management team and I will take your questions. We reported net income of $2 million, or $0.05 per fully diluted share, which included a one-time charge for the debt retirement we announced in April. Operating income was $54 million, or $1.24 per fully diluted share, generating an operating return on equity of 8%.

Overall, net written premiums were flat, excluding the impact of the UK motor sale in June of last year. This reflected a very good growth in personal lines; moderate growth in commercial lines; and a decline at Chaucer, where we are taking advantage of reinsurance prices to proactively manage the risk profile of the book.

Our consolidated combined ratio of 97.3% reflects the impact of previously announced large losses and catastrophes in the current accident year at Chaucer, as well as unfavorable development in certain liability coverages in domestic commercial lines. These impacts were partially offset by lower property losses, including catastrophe activity in all of our domestic businesses, as well as favorable development of prior-year catastrophe losses at Chaucer. In addition, the volatility in the pound sterling surrounding the Brexit vote resulted in some foreign-exchange losses at Chaucer, which are not reflective of the long-term earnings power of this business.

While we are generally pleased with the underlying performance of our business, across most of the portfolio, there were a few areas in which our results did not meet our expectations. Let me now discuss the highlights of each of our businesses, starting with commercial lines.

Commercial lines posted a combined ratio of 98.9%, which reflected improved accident year results in property lines, partially offset by prior-year loss reserve development in certain areas within commercial liability coverages. The unfavorable development related to late reported claims and increased severity specifically related to activity in three litigious states in our middle-market multi-peril business, as well as in previously terminated business AIX. Our small commercial account business continues to perform well.

We believe our pricing of new and renewal business has captured the underlying trends we are experiencing, as we strive to stay ahead of the loss curve. As new information emerges, we include a conservative estimate of long-term cost trends in our pricing and loss picks.

The 2% commercial lines growth in net premiums written reflects the impact of pricing increases in our core middle market and small commercial businesses, which generally kept pace with our long-term loss cost assumptions and improved core retention. Commercial growth was offset somewhat by a slowdown in new business and lower premiums at AIX, as underwriting adjustments and pricing decisions were made prudently. We expect to continue to leverage our strong distribution partnerships and business consolidation expertise to generate profitable growth going forward.

Turning now to personal lines. This business posted a combined ratio of 91.3%, representing an approximately 4-point improvement over the prior-year quarter. This was driven by lower-than-usual catastrophe losses and lower weather losses in the homeowners line. Our combined ratio continues to benefit from the increased mix of total account in platinum business in the book, which tends to have better performance than monoline business over time.

The growth in net premiums written at 4.5% is attributed to rate increases, improved retention, and increased new business, which was up 16% compared to the second quarter of last year, as we drove significant growth in our account base platinum product. Account business now comprises 81% of our total book and 88% of new business.

Our commitment to being a bundled account provider continues to produce stronger customer retention, and ultimately, higher lifetime customer profitability. It also allows us to effectively address the needs of our agents and customers and to successfully compete with the ever-increasing number of new offerings available in the personal lines marketplace.

We are confident we can continue to grow this business, generating more revenue through our existing agency plan; expanding our market reach by entering new states, starting with Pennsylvania in December; and actively targeting the attractive $6 billion to $8 billion emerging affluent market in our current footprint.

Now turning to Chaucer. Chaucer's combined ratio at 103% was higher than planned and reflected elevated industrywide man-made large losses, catastrophe events, and lower favorable reserve development due to foreign-exchange movements. Given the nature of the Lloyd's business, we expect periods of elevated industry loss experience to impact our underwriting performance from time to time, as it did in the second quarter. Our losses were generally proportionate to our underwriting appetite and market share, and were appropriately reinsured.

Within our political risk business, the global collapse in commodity prices is projected to cause contract defaults in the trade credit line of business. In response, we have significantly reduced exposures in the affected commodity areas, countries, and regions. We also have imposed significant rate increases and more stringent terms and conditions while reducing risk retentions. Trade credit coverage is strategically important to the writing of political risk business, where we have been a leader for a long time.

Since The Hanover purchased Chaucer in 2011, it has consistently produced excellent results, a testament to the enduring strength of the business and sound risk management. We believe the long-term outlook for this business is very attractive, as we continued to leverage our underwriting intellectual capital, strong distribution partnerships, and durable reinsurance relationships.

Our underwriting and risk management philosophy was reflected in our second-quarter top-line results, as we reported gross premiums written, excluding the impact of the UK motor business, in line with the prior quarter, while net premiums written declined 8%, reflecting a more extensive use of reinsurance capital.

We believe the Brexit separation will have very little financial or strategic impact on our business, and it should not affect our ability to retain and attract talent. In addition to Lloyd's efforts to retain passporting rights to Europe, we are in the process of establishing direct access to the region through our own non-Lloyd's platform in Dublin. We have received preliminary agreement from the Central Bank of Ireland to proceed with the application.

We continue to maintain our longer-term combined ratio outlook of mid-90s for this business, and our commitment is to grow only as market conditions will allow us to do in a responsible way.

A few comments on investments in our capital position. Our investment portfolio is conservatively managed. The yield on the portfolio will continue to be pressured by the low interest-rate environment, which we anticipate to continue for some time. To partially offset this impact, we are selectively deploying alternative asset classes, including equities and commercial mortgages, without adding any duration risk.

Our capital position is strong. In the quarter, we executed a well-priced, oversubscribed debt refinancing and took advantage of general market volatility to repurchase approximately $19 million worth of common stock. Overall, we are very optimistic about our top-line trajectory and long-term earnings growth, despite some performance challenges in the quarter.

We are maintaining our original outlook for the second half of the year of a 95% to 96% combined ratio. However, we are revising our earnings-per-share guidance to $6 to $6.15, primarily to reflect first-half earnings and growth performance. Gene will provide further detail related to our guidance in his remarks. Gene?

Thank you, Joe and good morning, everyone. On a consolidated basis, second quarter of 2016 net income was $2 million, or $0.05 per diluted share, compared to $120.7 million, or $2.68 per diluted share in the second quarter of last year. Current quarter net income included a nonoperating charge of $56 million after tax associated with the redemption make-whole provisions of a 7.5% and 6.375% senior debt, which we refinanced in April.

Second-quarter 2015 net income included the $40 million realized gain on the sale of the UK motor business. So $96 million of the swing is attributable to these two unusual items.

Operating income was $54 million, or $1.24 per diluted share, compared to $70.4 million, or $1.56 per diluted share in the second quarter of last year. The overall combined ratio was 97% compared to 96% in the prior-year quarter.

I'll begin by providing financial color on our second-quarter underwriting results by business segment, starting with commercial lines. We realized over 2 points improvement in the current accident year loss ratio, excluding catastrophes, to 55%, which -- with contributions from all core lines of business. We remain focused on executing disciplined underwriting within our well-defined risk appetite and achieving targeted pricing.

Workers' compensation was a source of meaningful improvement, with consistent accident year loss ratio performance and favorable reserve releases. We continued to benefit from our focus of smaller policy sizes and business classes with lower risk profiles.

Moving on to commercial auto, the accident year loss ratio improved by 1 point in comparison to the prior-year quarter. Although improved, the lines still remain below our target profitability. Due to some continuing claim development in prior accident years, we added to prior-year bodily injury ultimate loss picks. As a whole, we remain encouraged by our recent progress and are confident in our ability to return this line to acceptable profit levels.

Commercial multi-peril benefited from unusually benign property loss activity, which resulted in the overall accident year loss ratio of 47%, down from 51% in the prior-year quarter. Our current accident year loss ratio selection for CMP liability coverages remain consistent with our pricing assumptions and reflected our updated view of loss trends.

We have increased our ultimate picks for prior accident years in response to unfavorable actual to expected experience in CMP liability. Similar to prior quarters' activity, this reflects an elevated number of litigated cases associated with slip-and-fall claims, particularly in major metro areas, in states with higher rates of litigation, and slower reporting patterns.

We have implemented more stringent underwriting and claims management guidelines over the past several quarters related to these coverages, and we will continue to carefully monitor trends. Despite the unfavorable liability activity, we expect CMP to remain one of our most profitable lines of business.

The underlying loss ratio at other commercial lines was over 2 points lower than in the prior-year quarter, driven by unusually low incidence of property losses in the quarter. Nevertheless, we saw continued unfavorable loss development in previously terminated business at AIX, primarily in accident years 2013 and prior. We remain confident with our most recent accident year performance.

While the unfavorable development in prior accident years results is disappointing, the activity came from lines we have been carefully monitoring and have been actively addressing through underwriting and claims initiatives. The expense ratio for the quarter was 36%, in line with the prior-year quarter. We are benefiting from growth leverage, as our operating platforms are scalable and do not require growth in operating expenses at the same rate as premium growth. Accordingly, we remain confident with our target of about 0.5 point of improvement for 2016.

In personal lines, the underlying loss ratio for the quarter was 61%, representing an approximately 2-point improvement over the second quarter of 2015, driven by favorable property loss experience in homeowners. Most of the improvement was associated with lower non-catastrophe weather losses compared to the elevated weather-related loss activity in 2015. In addition, we are seeing the impact of prior underwriting initiatives and favorable pricing across our book.

Our personal auto accident year loss ratio remained about flat compared to the second quarter of last year and improved year to date, reflecting stable frequency and proactive pricing actions. We continue to monitor bodily injury and collision severity trends, which we believe are appropriately reflected in our current auto pricing.

Second quarter 2016 personal lines expense ratio was 27%, 0.5 point lower than the second quarter of last year, as it benefited from a one-time premium tax adjustment. We continue to leverage our cost base with growth and make investments in product, platform, and market expansions to create further premium growth and efficiencies. Longer term, we expect our personal lines expense ratio to be approximately 28%.

Turning to our Lloyd's business, Chaucer's combined ratio was 103% for the quarter, up from 88% in the second quarter of 2015, excluding the impact of the UK motor business. Second-quarter catastrophes, including the Alberta wildfires, and earthquakes in Ecuador and Japan, together had a combined impact of approximately $26 million. This activity was partially offset by $12 million of releases of prior-year catastrophe losses, notably hurricanes Odile and Sandy, as well as the 2015 earthquake and floods in Chile.

We also experienced further loss activity in the trade credit class of business, which is within the marine line, and an increase in loss provisions for two notable large, man-made events that occurred in the first quarter. Mainly, the Jubilee Oil Field turret malfunction and the Brussels airport terrorist attack. Trends in [attritional] losses at Chaucer remain stable and the line with our expectations.

I would now like to review the impact of foreign-exchange movements on our second-quarter results. The weakening of the GBP among most of the currencies in the second quarter suppressed Chaucer's pretax earnings by approximately $9 million. Revaluation of loss reserves and certain currencies to pounds sterling, notably the euro, Swiss franc, Australian dollar, and Japanese yen had an adverse impact of $15 million, which mainly flowed through the reserve development line. This was partially offset by a positive revaluation of investments in overseas deposits in cash of $4 million, which reduced expenses, as well as an adjustment to premiums receivable of $2 million, which in turn, increased earned premiums in the quarter.

Additionally, we recorded unrealized foreign-exchange gains from euro-denominated investments of $3 million. These gains flow through ALCI within the equity line of the balance sheet. Net-net, the overall negative impact on foreign currency movements in the quarter, including the equity offset, was $6 million before tax and $4 million after tax.

While we actively manage our currency risk, endeavoring to match assets and liabilities, a certain level of net exposure persists, which in times of unusually wide foreign-exchange movements, as experienced with Brexit, can have an impact on earnings in any given quarter.

Our total net premiums written was flat with the prior-year quarter, putting the UK motor business sale aside. Personal lines grew 4.5%, maintaining strong rate increases in the 5% range, strong new business flow, and improved retention.

Commercial lines premiums increased 1.9%, as we continued to balance our new business appetite with the pursuit of profitable business mix and healthy pricing. Price increases in commercial lines were essentially in line with those experienced in the first quarter, with core commercial tracking at approximately 4%, while retention continued to improve to approximately 84%.

Chaucer's net premiums written reduced -- reduction of 29% over the prior-year quarter reflected the sale of the UK motor business. Adjusted for the UK motor impact, net premiums written declined 8%, while gross premiums written remain relatively flat with the second quarter of 2015.

Given the competitive market at Lloyd's, we actively use reinsurance to manage our risk appetite while retaining leadership and influence in our chosen specialty classes. The highly cyclical nature of Chaucer's business makes a continued focus on underwriting margins and profitability our primary objective.

Turning to investment results. Cash and invested assets were $8.5 billion at the end of the quarter, with fixed income securities and cash representing 88% of that total. Our fixed maturity investment portfolio has a duration of four years and is roughly 94% investment grade. The portfolio remains high-quality and well laddered.

Net investment income in the second quarter was $69 million, or $2 million lower than the prior-year quarter, but up sequentially, reflecting a lower average investment asset base due to the transfer of the UK motor business, prior capital management activity, and continuing pressure from lower new money yields. This impact will partially offset -- was partially offset by the investment of higher operational cash flows and additional income from prudently growing risk asset classes, such as commercial mortgage loan participations and yield-oriented equities.

Total portfolio pretax yield was 3.39% compared to 3.48% in the second quarter of last year. We expect continuing pressure from prevailing low interest rates likely for a prolonged period, which will have a slight impact on our overall outlook for 2016.

I will finish with a few comments on the strength of our capital position. Book value per share was $70.58, up 2% in the quarter and 7% year to date. Excluding unrealized gains on investments, book value was relatively unchanged as accretion from operating earnings was offset by the charge related to the debt refinancing, as well as dividends.

This refinancing action enabled us to increase the overall tenor of our debt capital and create a larger, more liquid, lower price benchmark going forward. At 21%, our debt to total capital leverage ratio is comfortably within our target range.

In the quarter, we repurchased approximately $19 million worth of free common equity. Our appetite for share repurchases continues to be influenced by our capital priorities, as well as prevailing trading multiples. Overall, we are confident in our current balance sheet strength and believe it will continue to provide a solid foundation on which to grow our business.

In regards to our guidance, our 95% to 96% combined ratio outlook for the second half of the year includes an aggregate 5 percentage points of catastrophe losses, with a split of 6% and 4% for the third and fourth quarters respectively. Based on the first two quarters of actual results, including the impact of lower-than-expected first-half written premium on full-year earned, and incorporating a slightly lower estimate for net investment income, we now expect earnings per share to be in the range of $6 to $6.15 for the full-year 2016. With that, I will turn the call back to Joe.

Thanks, Gene. Though it has only has been a few weeks, I would like to share my initial observations on our Company's strategic position and value-creation potential. We have a very strong operating platform, supported by loyal distribution relationships and talented professionals with knowledge of their markets.

There are ample opportunities to be harvested from this platform, focusing on three main areas in particular. First is the opportunity to further penetrate our existing 2,200 independent agents with our high-touch model and increase market share with them. Our relevance with these agents increased markedly over the last several years; however, many of these relationships are still sub-optimized. Gaining share and becoming a top three to five carrier on more agent's shelves would lead to higher quality growth and expense leverage, as a significant portion of the agency operating expense is fixed.

Second is the opportunity to more effectively and broadly leverage our existing domestic specialty products and evaluate adjacent capabilities. For instance, we have developed businesses in high-growth industries such as technology and healthcare, we have excess and surplus lines platforms to take advantage of the expanding and contracting nature of the admitted market, and we have yet to import any of Chaucer's vast capabilities to the US. We have considerable upside in these often higher-margin lines to generate above-average growth and to create additional expense leverage, while taking advantage of emerging industry demand in some of the highly technical underwriting classes.

Third are the opportunities embedded in the high intellectual capital platform represented by Chaucer. Its underwriting capability sets the business apart as a leader in some of the most complex risk classes in the London market. Looking forward, we can expand existing regional platforms and develop regional partnerships, such as our partnership with AXA in Africa, to get closer to distribution in targeted regions.

Additionally, we are already on the path of establishing a non-Lloyd's platform to increase underwriting flexibility and open additional avenues for growth. These are just a few examples of the substantial opportunities that exist in both domestic and international businesses, and I am optimistic about our prospects.

A few closing comments related to investments, capital management, and value creation. My investment philosophy is consistent with that with of our investment management team. We have an appropriately conservative investment portfolio, with durations reasonably aligned to liabilities; and a good balance of managing to total return and book yield. You should not expect any material changes to our investment approach, aside from a more active participation in the tax-exempt asset class, which will be triggered by changes in our tax status starting at the end of this year.

I believe the best use of capital is to invest in profitable business growth. As in the past, any excess capital should be moved to the parent Company, allowing for management flexibility. At the parent Company level, you can expect we will hold a cushion of liquidity. We will use a mix of dividends and share buyback programs on a targeted basis as a means to return capital to shareholders, with payout targets reevaluated from time to time.

The best measures of shareholder value creation are growth in book value per share and increasing our return on equity. We are committed to achieving this goal by increasing returns in our business without creating additional volatility. We are very much aware of the pressure caused by a prolonged low interest rate environment, and we will not attempt to compensate for this by lowering our underwriting standards.

We plan to capitalize on the multiple levers available to us, including gaining share of wallet with distribution partners, leveraging our expense base, and further developing underwriting intellectual capital in specialty, all while returning appropriate levels of capital to shareholders.

Over the next six months, together with the team, we will complete the strategic overview of the company and convert our learnings into specific business strategies to drive our company forward. We will plan to hold an investor day to bring all of you on board, likely in the first quarter of 2017.

At this time, operator, we would like to open the call for questions.

(Operator Instructions)

Charles Sebaski, BMO Capital Markets.

Thank you, and Joe, congratulations on first quarter here with Hanover.

Thank you very much.

The question and where I would like to focus is on the commercial business and the reserves. For having pretty good quarter along the way and accident year results, this is third quarter in a row where we've seen some true up on back years. Just hoping to get a little more clarity on helping investors get comfortable that there isn't leading up to a large charge.

When you see this happen, $20 million a quarter for a few in a row, and all of a sudden -- or maybe it does need to be done and there is $100 million charge or something. But in what you guys are going through and what you're seeing, if it's from different lines. Why we should not think of it that way or not?

Charles, let me start off by making some framing comments. Clearly, the all-in result was unfavorable development, but if you adjust for the 4X embedded in the Chaucer development, it is favorable quarter over quarter. We shouldn't ignore the $12 million of favorable development on Chaucer catastrophes as well.

The real issue that you're focusing on is the commercial line of business, both in CMP and other. I'm going to kick it to Jack in a minute to talk about the liability of component of CMP, which is causing the stress, which is slip-and-fall claims in three major metro areas, giving rise to soft tissue injuries, and attorney involvement. And it's causing some late reported claims and some increased estimates on existing case reserves.

We continue -- the CMP line of business is still very profitable. The property piece is performing very well, and it's the mainstay of our commercial product in the agency business. But these isolated areas really are causing the stress and I'm going to turn it to Jack to talk about from a pricing, underwriting, and claims management perspective, what we're doing about it.

Okay. Thanks, Joe. Chuck, as we said in the past, we're trying to address these claims trends early to avoid big surprises. And our philosophy has moved aggressively in that fashion over the last few years, as you know.

In terms of the news of the quarter, there really isn't anything new in terms of the type of claims or what we're seeing other than a slightly larger level. As we've said in the past, we had some isolated spikes and large losses that are resulting from slip-and-fall cases in the major metropolitan areas like New York City and Los Angeles.

The good news is we don't have outsized penetration in those areas, so we are addressing the performance gap relatively quickly. And as you've said, a few quarters ago, we saw something that looked like the duration of those claims was drawing out, it looked different than our development patterns had traditionally had been. So we went to work and started to recognizing some of that in our results and also getting more aggressive about some of our underwriting actions.

So we adjusted pricing and underwriting appetite in those geographies. We took steps in the claims department to better identify and monitor these claims and quickly moved specific claims into our major case unit for handling. In particular, we saw some labor law and sidewalk law-type claims in New York that were better served in that large claim unit earlier in the process. So we are doing so with the expectation that we'll get better outcomes into the future as we've gotten better at identifying those cases.

And then last but not least, we did have some specific larger accounts that, quite frankly, given the new trends, posed an opportunity to either retire or be more aggressive with regard to our pricing and underwriting actions. So net-net, we're pretty confident that we have our arms around this. And while we're disappointed that we had a little bit more activity in the quarter, we feel good about the fact that we can keep the CMP line performing as one of our top lines.

I want to address the last part of your question too about charges, et cetera. We have a lot of confidence in the strength of our balance sheet at June 30th. We obviously will be conducting our annual exhaustive bottoms-up reserve analysis either in the third or fourth quarter, depending on the arrival of a new CFO. It will be overseen and reviewed by an independent actuarial consultant. And of course, you can't speculate as to whether that is going to result in an increase, decrease, or a rebalancing of the reserve portfolio. We have to wait for the results of the study.

But that's an annual review; nothing special, but bottoms up, and it will be exhaustive and it will be overseen by a permanent CFO when he or she arrives.

All right. I appreciate all of that color. It's certainly helpful. Just two clarifying backups to that I would have is I think Gene mentioned that obviously the ultimates have been taken up. Can you give us an idea of what the mark is now and what it is adjusted from? I'm trying to at least get my head around the size of this move and what that means in actual expected ultimate loss for the pick. And then also, if the development was all case development or was there some IBNR development due to things you've learned in this true-up?

The activity that produces the difference between actual to expected is all case incurred, which flows into the reserve analysis. And as a result of that, we've responded to that in our picks for all of those accident years and the outcome of that is what you see reflected in the stat sub.

We feel confident that our reviews are thorough and that we're being responsive to all those changes. When we get down to actual loss picks for accident years, I'm not sure that I have that off the top of my head. But I would say all of them are responsive to the activity that we're seeing, and we are trying to stay ahead of it. And we think we are in pretty good shape.

Okay, but this is case adjustment on the development, right? As opposed to we've got a different view of exposure, and so we're going to increase IBNR in these back years because that is what's happening. That's what I'm trying to understand.

It [starts with] case and then that leads into your ultimate for the accident year. It's -- the activity that you see is driven by case, and then that affects your estimate of how much IBNR you need to hold, and that all blends into a full loss pick. An ultimate, only case incurred, but paid, all flows into your ultimate for that accident year.

Okay. I appreciate that. And just other, on the personal lines, obviously, a really strong quarter and fortunate in -- property events in the quarter. But otherwise, what the pricing is, any other commentary on the loss trend and pricing outside of the property event that obviously, turned out pretty well would appreciate.

I will make some framing comments on that. The personal lines did have a really, really good quarter everything sort of clicked. You saw premiums up 4.5% and a 91.3% combined. We were able to get rates at about 5% of the market, which are still above loss costs, and we focus on that a lot.

We had stable discounts that are now turned positive. We had retention increase by 100 basis points. We had benign weather affecting the property line, which came in positive, and of course, you can see the cat line as being favorable quarter over quarter.

So all things hit in the quarter; we're not saying this is a 91% business forever; it is probably a mid-90%s business. That is our target combined to produce a really good low teens ROE. So everything worked really well in the quarter. I will turn it to Dick to talk about specific pricing phenomenon he's seeing in the market.

Chuck, thanks, and I think we covered it well with those comments, but just a little more color. We're pleased that we're not seeing the frequency trends that our competition is seeing, as we -- I think we discussed in the past. It's really been flat for several quarters, down in some, really across all coverage parts in auto, collision, PD, and BI. And certainly some of that is driven by the mild winter that we had in the first quarter, but going back prior quarters we are seeing the same phenomenon.

So we are cautiously optimistic. There is nothing endemic in our book of that is going to pop that frequency; year-over-year comparisons, of course, next year could see slight increase. But we're really pleased. And we've talked before about what the drivers of that may be. Certainly, our quality mix of business, our account mix, we believe provides us some insulation to the employment and low gas price trends that you see that increase your miles driven.

But net-net, as Joe said, our pricing is covering our loss cost trend. Our severity is ticking up to low mid-single digits. But we explained that with the new model cars and the cost of technology and some large losses that we have seen in BI out of Michigan.

So we feel really good. We feel really good about our pricing and our ability to maintain those stable 5% rates. We're opportunistically looking for places where we can increase auto rates, and that may provide a bit of a headwind to our growth for the remaining part of the year. But net-net, all of the KPIs feel really solid to us.

Thanks a lot for all of the answers and good quarter in light of the challenging conditions.

Thanks.

Meyer Shields, KBW.

Thanks. Two broad questions. The first, in general, we're seeing modest deterioration in the commercial rate increases. Is that a function of improved performance or intense competition? Is there any way of teasing that out?

This is Jack. If I heard you correctly, you're talking about the market environment itself versus our results?

Yes.

I think what you've heard from some of our competitors is consistent with our belief that the market environment is somewhat stabilizing, but also a touch schizophrenic in that the larger account market still tends to be pretty aggressive and logically so, based on the returns that are probably being generated in that sector. And on the lower end of the scale, you see pretty substantial price stability, even though at least for us, the small commercial portfolio is performing well.

So there is somewhat of an overall stabilization in the pricing, but in any one line, for any one carrier, that can change. So you are seeing some bumping around.

Related to that, there is always stress on new business versus the renewal book. I would argue that the new business differential to renewals is still -- it's more stable than I predicted, and so we are enjoying some stability there also.

But I will say that part of our view is somewhat influenced by our strategy to stay in the small to midsize account range to work with select distributors to tighten that dialogue, and to leverage the product work we've done over the last five years to make our business more sticky. So I think we'll continue to show pretty favorable pricing in commercial lines based on those three major attributes of our strategy.

That is very helpful. Joe, you talked a little bit about importing underwriting skill sets from Chaucer into the US. And that seems to align with critically painful timing for specialty businesses. What time frame were you talking about?

We're in the very early stages of exploring how to leverage the intellectual capital of Chaucer here in the US, particularly through the excess and surplus lines market and the reverse flow business. The business that actually is generated from the US that ends up in the London market, Chaucer happens to get its market share, but why can't we work through our distribution system to not just let it happen but to channel it?

So Jack is actually working with Johan in a working group on looking for areas of potential where Chaucer can bring its underwriting capacity to the US market and capture some more of that reverse flow business. All part of the strategic plan we're embarking upon, and we have ideas on that. You'll hear about it at our investor day in early 2017.

Thank you very much.

Larry Greenberg, Janney.

Good morning and thank you. On the commercial lines accident year loss ratio, excluding cats being down, I don't know, I calculate about 3 points versus the average of the last four or five quarters. And that's in the face of this adverse development, two pieces that don't usually go together.

I hear you that the property losses are down, which explains the lower loss pick and CMP. And then the small case workers' comp doing well. But can you give us a break down in the commercial lines pricing change between pure price and exposure change, and what you think the peer price is doing relative to loss trend?

This is Jack. I will take the first shot at this and ask my colleagues to add in. We have been a little bit careful in the past talking about breaking down overall pricing. I would tell you now that across the core lines, while we are generating 4 points of what we call new money, which is that combination of rate and exposure, approximately half of the exposure, which is about 2.5 points of that, in the small commercial line is coming through as property insurance to value, a little less so in the middle market sector.

So all in, we take our rate plus insurance to value in the property side of the exposure, put that together to give ourselves the best estimate of what we're getting in terms of price versus exposure that may translate into additional loss cost. So we're still performing right at about our long-term, maybe slightly below our long-term loss trend in commercial lines for the core lines, and feel reasonably comfortable with that given where we are in the market.

Larry, this is Andrew. Just to maybe cover a bit on the specialty side. First, in terms of rate for this past quarter on a written basis, while we don't disclose the specifics, in aggregate, we're writing business, renewing our business right around where loss-cost trends are for the long term. And of course, on an earned basis, leading up to this quarter we have been seeing rate in excess of loss cost. So there's still some benefit that's going to flow through.

The other part of just connecting where we are with accident years relative to the adverse development, I think part of that is, just to remind you that at AIX and within our program business, the adverse development is coming from terminated programs 2013 and prior. And so there is a tad bit of discontinuity of our active book relative to where those adverse trends are emerging from.

And so, in addition to that, there was obviously a range of things that occurred since 2013 that helped give us a good deal of confidence in our more recent accident years. And so therein lies the connection between some of those other trends that you're seeing in this quarter.

Thank you, that is helpful.

Wayne Archambo, Monarch Partners.

Thank you. You alluded to considering acquisitions down the road. Could you give us some better sense of the framework for what you're looking for? What type of multiples you're willing to pay, level of accretion, geographies, new lines of business, bolt-ons? Can you just give us a little more details there?

Sure, obviously, M&A follows strategy and we're still developing our strategy, which will take a good six months. But I think you can remain confident that the cornerstone of our strategy will be highly leveraging the valuable agency plan that we already have.

There's a lot of headroom there. There's a huge amount of expense leverage. There's market-share gains to be had there. There's specialty penetration to take place there.

While we're not done with our strategic plan, I think you can remain confident that those will be tenants of our emerging strategy. So if you think about that, book of business purchases, renewal rights deals like the commercial -- the OneBeacon deal that we did a few years ago, agency partnerships and joint ventures. I would think broadly about business development and not just M&A.

It could take the place of buying, managing general agencies, not only for their own revenue flow but for the underwriting capacity of whoever is on the paper. So think about business development more broadly than just raw M&A. But it's going to follow strategy and our strategy surrounds the independent agency channel.

Do think you will have the strategic plan in place before the analyst day in the beginning of the year?

That would be the primary purpose of having the analyst day in early 2017 is to showcase the management team and our emerging strategy.

Great. Excellent. Thank you.

There are no further questions in queue. I will now turn the call back over to Oksana for closing.

Thank you all for your participation today, and we'll look forward to speaking with you next quarter.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.