旅行家集團 (TRV) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the fourth quarter results teleconference for Travelers.

(Operator Instructions) As a reminder, this conference is being recorded on January 23, 2018.

At this time, I would like to turn the conference over to Ms. Gabriella Nawi, Senior Vice President of Investor Relations.

Ms. Nawi, you may begin.

Thank you.

Good morning, and welcome to Travelers' discussion of our fourth quarter and full year 2017 results.

Hopefully, all of you have seen our press release, financial supplement and webcast materials released earlier this morning.

All of these materials can be found on our website at www.travelers.com under the Investors section.

Speaking today will be Alan Schnitzer, Chairman and CEO; Jay Benet, Chief Financial Officer; and Brian MacLean, Chief Operating Officer.

They will discuss the financial results of our business in the current market environments, they will refer to the webcast presentation as they go through prepared remarks, and then we will take questions.

In addition, other members of senior management are in the room, including Bill Heyman, Chief Investment Officer; Michael Klein, President of Personal Insurance; Tom Kunkel, President of Bond & Specialty Insurance; and Greg Toczydlowski, President of Business Insurance.

Before I turn it over to Alan, I would like to draw your attention to the explanatory note included at the end of the webcast.

Our presentation today includes forward-looking statements.

The company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee of future performance.

Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors.

These factors are described in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC.

We do not undertake any obligation to update forward-looking statements.

Also, in our remarks or responses to questions, we may mention some non-GAAP financial measures.

Reconciliations are included in our recent earnings press release, financial supplement and other materials available in the Investors section on our website, travelers.com.

And now Alan Schnitzer.

Thank you, Gabby.

Good morning, everyone, and thank you for joining us today.

This morning, we reported fourth quarter core income of $633 million, generating a core return on equity of a little over 11%.

That brings our full year core income to $2,043,000,000 and full year core return on equity to 9%.

The fact that we were able to generate that level of profit and profitability given the extraordinary catastrophe losses for the industry this quarter and year, on top of a decade of historically low interest rates and several years of a relatively soft pricing environment, speaks to the earnings power of the franchise.

It's the value of our competitive advantages, starting with underwriting excellence and investment expertise.

For the year, catastrophe losses were manageable, and we generated an after-tax underlying underwriting gain in excess of $1.2 billion and after-tax net investment income of nearly $1.9 billion.

Our results and strong balance sheet enable us to grow adjusted book value per share by 4% during the year after returning $2.2 billion of excess capital to our shareholders.

And as I'll share in a minute, we're encouraged about the outlook for 2018.

Overall, we were pleased with our underlying combined ratio of 92.6% for the year, which was impacted by high levels of non-cat weather and non-cat fire-related losses relative to our expectations.

Underneath that, our commercial businesses continue to perform well.

For the year, Business Insurance delivered a strong underlying combined ratio of 94.9%.

Bond & Specialty insurance delivered an impressive underlying combined ratio of 83.2%, even after a charge in the fourth quarter for a single surety loss outside the United States.

In Personal Insurance, we were pleased with an underlying combined ratio in the quarter of 90.4%, bringing the full year to 91.5%.

Those results reflect continued success in our leading property business, loss trends in personal auto within expectations and the continued successful execution of the pricing and underwriting actions we've been taking in the auto business all year.

Notably, our consolidated expense ratio was down 80 basis points for the year as we grew earned premium by almost 5%, continued to invest in the strategic initiatives we discussed with you at our recent Investor Day and delivered on our objective of improving productivity and efficiency, which resulted in about flat G&A expense dollars.

Turning to the top line.

We were very pleased with the success of our marketplace execution, which resulted in full year net written premium growth of 5% to a record $26.2 billion.

Importantly, in domestic Business Insurance in the quarter, renewal rate change reached 1.4 points, doubling from the third quarter, and renewal premium change reached 4 points.

For both measures, that's the highest levels in about 3 years.

Brian will give you more texture on the execution underneath the headlines, including a view by line, but I'll note that we achieved renewal rate gains in the quarter more broadly across our product portfolio and our accounts compared to recent periods.

It's an acceleration of a trend and improved pricing we've achieved over the past 6 quarters as the market started reacting to 2 things: first, the hurricanes and wildfires in the back half of the year; and second and more significant in my view, declining margins generally as interest rates remain at historically low levels and loss trend has outpaced rate and exposure for a few years now.

As we've been doing all year and as I reiterated last quarter, we'll continue to seek rate thoughtfully and in close coordination with our agent and broker partners, with the belief that our customers are well served by a stable and predictable market that keeps pace with inflation as opposed to more dramatic price swings of the past.

Given our sense of the market and the fact that retentions remain at historic highs, we're encouraged.

Aside from the pricing environment, new business in domestic Business Insurance was up in the quarter and for the year.

We explained at our recent Investor Day that a number of the initiatives we have underway are designed to create more top line opportunities for us.

It's still early days, but what we can see so far is positive.

Our marketplace execution in both Bond & Specialty Insurance and Personal Insurance was equally successful.

In our Management Liability business, we maintained retention at an impressive 88% throughout the year, with stable renewal premium change and higher new business volume.

Surety premium was higher both in the quarter and for the year as a result of an increase in large bond activity.

Personal Insurance finished the year with another quarter of accomplishing our objectives of improving auto profitability while maintaining momentum in our leading homeowners business.

We achieved 11 points of renewal premium change in auto, enough to offset the bodily injury severity we identified in the second half of 2016 on a written basis, and delivered policy in-force growth throughout the year in our homeowners business.

As it relates to the market generally, there has been a lot of speculation about how corporate tax reform will impact pricing.

Stepping back, we price our product with return objectives in mind.

The tax rate is just one factor impacting the pricing we need to achieve in order to reach our return objectives.

Other factors, for example, include the adequacy of expiring prices, loss trend, expenses, the cost of reinsurance, the impact of claims initiatives and so on.

Speaking for us, tax reform will help shrink the gap between where returns are trending and where we'd like them to be trending, but it doesn't completely close the gap.

Also, not every participant in the marketplace will benefit from tax reform, and even among those who do, the extent of the benefit varies.

In short, for us, tax reform helps, but we still have ground to cover.

As I said a minute ago, we're encouraged about the outlook for 2018.

We're well positioned to benefit from continued improvement in the pricing environment, the opportunities afforded by a more level playing field for domestic insurers as a result of tax reform and the prospect of a strengthening economy.

With that wind at our backs and from a position of strength, we'll continue to invest in our competitive advantages, focusing on extending our lead in risk expertise, improving the experience for our customers, agents and brokers and enhancing productivity and efficiency.

We believe we're well positioned to continue to create shareholder value.

And with that, I'll turn it over to Jay.

Thanks, Alan.

Core income was $633 million, down from $919 million in the prior year quarter, while core ROE was 11.1%, down from 16.4%.

As has been the case all year, these reductions in core income and core ROE were not driven by changes in our underlying performance.

Our underlying performance remained strong and actually improved over the prior year quarter.

Rather, these reductions were reflective of a continued high level of cat activity and the inclusion of an $82 million after-tax benefit in the prior year quarter from the settlement of a reinsurance dispute.

The strength of our underlying underwriting results is evidenced by our consolidated underlying combined ratio of 92.4%, similar to the 92% we produced in the prior year quarter.

Cat losses were $324 million after tax compared to only $89 million in the prior year quarter.

This $235 million increase was driven by losses from the California wildfires of $426 million after tax, comprising $382 million after tax for the October wildfires in Northern California and $44 million after tax for the December wildfires in Southern California, partially offset by current year net favorable development of $102 million after tax for catastrophes that occurred earlier this year, almost all of which related to the third quarter Hurricanes Harvey, Irma and Maria.

For both Harvey and Irma, the benefits of our underwriting actions over many years, including management of overall exposure, limits and deductibles, resulted in more favorable claim outcomes than we had expected.

For Maria, given that the storm occurred late in the third quarter and access to the impacted areas was extremely limited, our estimate was based on an exposure analysis.

That initial estimate has come down due to our receiving fewer claims than we had expected.

Net favorable prior year reserve development, for which I'll provide more details shortly, was $192 million after tax, up from $172 million in the prior year quarter.

Net investment income of $467 million after tax, while continuing to be strong, was down $26 million from the prior year quarter.

Non-fixed income NII decreased by $19 million after tax due to lower private equity returns, which, although strong, were not as strong as in the prior year quarter.

Fixed income NII, as anticipated, was lower by $8 million after tax due to the continued low interest rate environment.

And taking into account long-term bonds that are scheduled to mature in 2018, growth in the size of our fixed income portfolio, higher short-term interest rates and the new U.S. tax law, we expect that after-tax fixed income NII for 2018 will be $25 million to $30 million higher quarter-over-quarter as compared to corresponding quarters in 2017, a significant improvement from recent years.

Relative to what several other companies have disclosed, the passage of the Tax Cuts and Jobs Act of 2017 had a relatively modest impact on our fourth quarter results, a $129 million charge reported as part of net income.

This charge resulted mostly from revaluing our net deferred tax asset as of the enactment date using the new 21% tax rate and, to a lesser extent, providing for taxes on the deemed repatriation of our foreign earnings.

I should also mention that we executed some tax-related actions in the fourth quarter that provided real economic benefits while having an insignificant impact on fourth quarter 2017 core and net income but slightly increasing our fourth quarter consolidated combined ratio, primarily through the expense ratio, by about 0.5 point.

Under the new tax law, muni bond investment income will continue to be taxed at 5.25% while all other U.S.-based income will be taxed at 21% rather than 35%.

So looking forward, you should update your models.

Consolidated net favorable prior year reserve development was $293 million pretax compared to $264 million in the prior year quarter.

Business Insurance's net favorable reserve development was $244 million pretax compared to $221 million in the prior year quarter, primarily driven by better-than-expected loss experience in domestic workers' comp and commercial multi-peril, partially offset by higher-than-expected loss experience in domestic commercial auto.

Bond & Specialty's net favorable development was $42 million pretax compared to $79 million in the prior quarter, primarily driven by better-than-expected loss experience in domestic Management Liability, while Personal Insurance had net favorable development of $7 million pretax compared to $36 million of net unfavorable development in the prior year quarter.

For full year 2017, we had consolidated net favorable development of $592 million pretax.

As in prior years, I'm providing you with some insight into what our combined 2017 Schedule P is expected to show when filed on May 1. Excluding A&E, on a combined stat Schedule P basis for all of our U.S. subs, all accident years across all product lines in the aggregate developed favorably.

And except for commercial auto liability, which developed unfavorably by $87 million pretax due to higher-than-expected bodily injury claims in recent accident years, all product lines across all accident years in the aggregate developed favorably or had de minimis unfavorable development.

Page 19 of the webcast sets forth information about our January 1 cat treaty renewal.

Our corporate cat aggregate XOL treaty continues to provide coverage for both single cat events and an accumulation of losses from multiple cat events with similar terms as in the prior year but at a slightly higher cost.

The treaty continues to provide $1.5 billion of coverage, part of $2 billion excess of $3 billion after a $100 million deductible per occurrence.

It keeps the same broad peril and geographic coverage and the same positioning of the coverage layer, providing a significant buffer between earnings and capital.

The treaty has a single limit with no reinstatement provisions.

And note that the total cost of this treaty and therefore the slight cost increase are quite small in relation to our core income.

Fourth quarter operating cash flows, which were impacted by the relatively high level of cat claim payments, were $538 million, bringing total operating cash flow to over $3.7 billion for the year.

We ended the year with holding company liquidity of almost $1.3 billion, and all of our capital ratios were at or better than their target levels.

Net unrealized investment gains were over $1.4 billion pretax or $1.1 billion after tax, up from $1.1 billion and $0.7 billion, respectively, at the beginning of the year, while book value per share of $87.46 and adjusted book value per share of $83.36 increased 5% and 4%, respectively, from the beginning of the year.

Consistent with our ongoing capital management strategy and despite the high level of cat losses, we were able to return $549 million of capital to our shareholders this quarter while maintaining our balance sheet strength, through dividends of $198 million and share repurchases of $351 million, bringing total capital returned to shareholders to over $2.2 billion in 2017.

And with that, let me turn the microphone over to Brian.

Thanks, Jay.

Starting with this quarter's results in Business Insurance, segment income was strong at $637 million, and the combined ratio for the quarter of 88.6% was flat to the prior year.

Income was down from the prior year due primarily to the settlement of a reinsurance dispute in the fourth quarter of 2016.

The underlying combined ratio for both the quarter and the full year was about 1 point higher than 2016.

In both cases, the increase was driven by the loss ratio, with loss cost trends that modestly exceeded earned pricing, while the full year variance also reflects an unusually high number of large non-cat fire losses in 2017.

The full year expense ratio of 31.9% was 0.5 point lower than the prior year.

As Jay mentioned, the fourth quarter included the impact of some tax-related actions, so the full year is a better indication of our expense run rate.

Net written premiums of $3.4 billion for the quarter were up about 5% year-over-year, with domestic net written premiums up about 4%, driven by continued strong production results in Middle Market.

International net written premiums were up 15% or 11% excluding the impact of a change in foreign currency rates.

The growth in international was driven by strong production results in Europe and Canada, along with some normal fluctuations in the Lloyd's volume.

Turning to domestic production.

We were very pleased with our results in the quarter.

Renewal rate change was 1.4%, and renewal premium change was 4% and, as Alan said, for both, the highest level in about 3 years.

Retention remains at a historically high level of 85%, and new business was strong for the quarter at $478 million, up 16% from the fourth quarter of 2016.

Looking at the individual businesses.

In Select, production remained strong, with renewal premium change for the quarter of over 5%, retention of 83% and new business premiums of $100 million, up 11% year-over-year.

In Middle Market, renewal rate change increased to 1.5%, up about 1 point year-over-year, and renewal premium change increased to 3.6%.

Retention remained at a historically high level of 87%, while new business premiums of $298 million were up 17% versus the prior year quarter.

In terms of new business, the technology tools and process changes we've been rolling out over the last several years and we discussed at our recent Investor Day have allowed us to be more active in our targeted industry segments.

In Select, we're generating more submissions and quotes and having success in closing those incremental opportunities.

In Middle Market, we've been successful in quoting more while also closing more large accounts than a year ago.

While the normal volatility in writing large accounts was a factor in this quarter's growth, we believe our initiatives are beginning to have an impact.

So the aggregate production results were very strong, but as we have said many times, the aggregate numbers alone don't tell the entire story.

The detail of where we are getting rate and what accounts we are retaining is key to evaluating the success of our execution.

And looking at the results below the headline numbers, we couldn't be more pleased.

For example, as you would expect, there was significant line-of-business texture below the headline production numbers.

In terms of pricing, workers' compensation, a line that has had strong returns in recent periods, had renewal premium change that was positive but lower than a year ago.

Conversely, commercial auto, which is a challenge from a return perspective line, had the highest positive price change in the quarter, well above loss trend.

What's also encouraging to us is that across all of the major -- other major product lines, property, GL, CMP and Umbrella, renewal premium change was positive and up both year-over-year and sequentially.

And importantly, we were able to achieve these pricing increases while maintaining strong retention and growing new business.

There was also significant texture based on individual account performance.

We continued to be pleased that we are retaining our best-performing business, as evidenced by retention rates in excess of 90% for our best-performing Middle Market accounts.

In addition, pricing in the quarter improved across the continuum of Middle Market book, most significantly in our poor-performing accounts where we achieved rate increases well in excess of loss trend.

Finally, in addition to what we're seeing in the numbers, we're also encouraged that there has been some tightening of terms and conditions for catastrophe-exposed risks.

So all in, a great quarter and end to the year.

We were very pleased with our execution in the marketplace and how we are positioned for continued success in 2018.

Before turning to Bond & Specialty, I want to comment on our outlook for operating margins, which we include in our quarterly filings.

Since our 10-K won't be filed for a few weeks, I would note that we expect underlying underwriting margins in 2018 will be higher than in 2017 and the underlying combined ratio will be slightly lower than in 2017, assuming lower and more normalized levels of non-catastrophe weather-related losses and other loss activity.

This is subject to the usual caveats and forward-looking statement disclaimers.

In Bond & Specialty Insurance, segment income for the quarter was $112 million, down from the prior year quarter due to the international surety charge that Alan mentioned as well as a lower level of net favorable prior year reserve development.

In Surety, losses are episodic, and we remain pleased with the quality of our book.

The underlying combined ratio increased from the prior year quarter to 91.1%, reflecting the impact of the surety charge.

Net written premiums for the quarter were up 5%, reflecting growth in both our domestic Surety and Management Liability businesses.

Surety growth was driven by a higher level of large bond activity in the quarter.

Turning to production.

In our domestic Management Liability businesses, we continue to execute our strategy of growing our profitable portfolio by retaining our best-performing accounts and writing new business in return-adequate product segments.

So we couldn't be more pleased that retention came in at a strong 88% for the quarter while new business was up 17% from the fourth quarter of last year.

Renewal premium change of 3.4% was up slightly from the third quarter.

So Bond & Specialty results were solid, and we continue to feel great about our market position.

In terms of outlook.

For 2018, we expect that underlying underwriting margins and the underlying combined ratio for the first 9 months of 2018 will be broadly consistent with the same period of 2017.

In the last quarter of 2018, we expect that underlying underwriting margins will be higher and the underlying combined ratio will be lower than in the same period of 2017.

Turning to Personal Insurance.

Net written premiums for the segment grew 8% in the quarter, driven by higher pricing primarily in auto and modest PIF growth primarily in homeowners.

Catastrophe losses in the quarter were approximately $200 million after tax, above both prior year and our normal expectations, resulting in a $50 million loss for the quarter and a combined ratio of 108.7%.

For the full year, despite pretax cat losses of more than $1 billion, Personal Insurance generated $128 million of income.

The underlying combined ratio in the fourth quarter of 90.4% improved by 3.2 points compared to last year's fourth quarter, and the full year underlying combined ratio of 91.5% was about 0.5 point higher than full year 2016.

For domestic Agency Auto, combined ratio for the quarter was 103%, including a 1.1-point benefit from catastrophe losses as we reduced our auto estimate related to Hurricane Harvey.

The underlying combined ratio of 104.1% improved by 8.1 points from the prior year.

As you can see on Page 15 of the webcast, 4.7 points of the decrease is due to last year's fourth quarter having been elevated as a result of the year-to-date impact of the bodily injury loss reestimation.

The remainder of the improvement is primarily the result of earned rate from filing actions we have taken over the past year now exceeding loss trend by several points, in line with the planned actions we outlined a year ago.

I would remind you that seasonality inflates the absolute value of the fourth quarter combined ratio.

As we have continued to take actions to improve profitability in the auto book, renewal premium change increased to 10.6% in the fourth quarter.

Retention declined modestly, as expected, giving the -- given the pricing actions, and PIF growth has leveled out, again, in line with our plans.

We were pleased with the level of written rate in 2017, and looking ahead, we expect that full year RPC for 2018 will be broadly consistent with the full year 2017 result as we look to continue to improve the profitability of the book.

Turning to Agency Homeowners & Other.

The fourth quarter combined ratio of 115.3% included over 45 points from cat losses, driven by the wildfires in California.

The underlying combined ratio of 70.2% for the quarter was consistent with the prior year quarter as higher non-cat weather losses were basically offset by an improvement in the expense ratio.

For the full year, the abnormally high cat result of 23.6 points drove the combined ratio up to 100.7%, while the underlying combined ratio of 77.1% was about 1.5 points above the prior year due primarily to higher non-cat weather losses.

Homeowners volume continued to exhibit momentum with healthy PIF growth throughout the year and finished up 5.5% compared to the prior year-end.

We're pleased that our focus on generating growth in this product line has enabled us to steadily increase property PIF count even as we have intentionally slowed the PIF growth in auto.

We're also pleased to have introduced our newest property product, Quantum Home 2.0, in 3 pilot states during the fourth quarter, with initial response from agents and customers in line with our expectations.

Overall, in Personal Insurance, while the headlines were all about the significant catastrophe losses, we feel great about having achieved the goals we had established entering 2017.

In addition, we continued our ongoing expense discipline, which resulted in slightly lower G&A expenses while delivering 9% growth in net written premiums for the segment, reducing the full year expense ratio by 1.5 points.

So for Personal Insurance in 2017, we were very pleased with the execution on the key elements needed to position this segment for success in 2018.

Finally, as it relates to our outlook for the Personal Insurance segment as a whole, we expect underlying underwriting margins in 2018 will be higher than in 2017 and the underlying combined ratio will be slightly lower than in 2017.

So stepping back to the enterprise, we generated over $2 billion in profits in a year that was dominated by the impact of weather and large losses.

So we feel good about the result but, more importantly, feel great about the execution across all our businesses and our market position entering 2018.

With that, let me turn it back over to Gabby.

Thank you.

Before we go to the Q&A portion, Alan has a few additional words.

Thanks, Gabby.

As bittersweet as it is, we have one last piece of business before we open it up for questions.

I just want to acknowledge and thank Brian MacLean, who will be retiring at the end of March after a spectacular 30-year career and, after today, something like 53 consecutive earnings calls.

He'd never take credit for it, but we owe so much of what we've accomplished over so many years to him.

He's been a great colleague to so many, and he's been an important partner and friend to me.

Thank you, Brian.

And with that, Thelma, let's open it up for questions.

(Operator Instructions) Our first question comes from the line of Kai Pan with Morgan Stanley.

First, congratulations to Brian for 3 decades at Travelers and best wishes for your retirement.

And that doesn't count as a question, so my first one is on pricing.

And so there's acceleration of BI pricing, and you mentioned that your outlook for 2018 in BI is a lower underlying combined ratio.

But the 1.4% increase is still lower your general loss cost trend of the 3% to 4%.

Just wondering what's -- sort of what's behind the scene.

Are you expecting sort of the pricing to accelerate?

Yes.

It's Alan.

Thanks for the question.

It's all the things that we talk to you about quarter-over-quarter in terms of our ability to pull levers and manage profitability.

And I'll remind you that exposure is a piece of that and that a significant portion of exposure contributes to it.

But so there's selection and mix in the way we segment, in the way we price the product.

Claims handling, risk control, like expense management, all of those things contribute to our outlook on the -- on profitability in the underlying combined ratio.

Okay.

Then my follow-up is on the tax rates.

What's your sort of overall exactly tax rate for the corporation in 2018?

And as I got from your comments, looks like most of the tax benefits will flow through the bottom line.

This is Jay Benet.

The reason I gave you the pieces is that the effective tax rate is always going to be a function of the relationship of the tax-exempt interest to the total interest.

So in whatever modeling you're doing, you need to come up with what you believe the tax-exempt interest is going to be, apply a 5.25% tax rate to that, and then everything else that's U.S. domestic will be at the 21% rate.

So the tax effect -- the effective tax rate is going to move, but again, it's just -- that's the way of calculating it.

Kai, just reflecting back on your other question, you were talking about the pricing outlook.

And I would just remind you that as Brian shared with you, that assumes that in BI, the non-cat weather and elevated fire losses and, for that matter, in PI, the non-cat weather will both return to normal levels by historical standards.

Obviously, weather and large losses are going to be what they're going to be, but the outlook reflects that as well.

And in terms of the benefit from tax reform and what's going to happen to it, we -- as I tried to express in my prepared remarks, it goes into the mix of everything else that we use to generate the prices we need.

So yes, I do think that it'll fall to the bottom line.

Continuing on, our next question comes from the line of Ryan Tunis with Crédit Suisse.

Just for Alan and a follow-up to Kai's question, just thinking about the fact that last quarter, we had a 2018 outlook for broadly consistent margins, and now 3 months later, the outlooks do improve.

I just wanted to drill down a little further on what it is you've seen over the last 3 months because I think your outlook on pricing then was also pretty positive.

But I guess over the last 3 months, what's given you more confidence to really think that margins will be better?

Yes.

We -- you got to remember that when we talk about underwriting margins, we're talking about dollars in the combined ratio, we're talking about combined ratio points.

And that's the function of the written volume, for example, and everything else that goes into the mix.

So it's a combination of all the things that impact margins in the combined ratio.

I'm not sure how else to express that.

Okay.

I guess just on auto then, I think what you said is you think that RPC will be a similar level to this year as it was last year.

And it seemed like this year were several points above loss trend.

If you could just talk a little bit about what you're seeing there because that sounds like a decent amount of rate.

I don't know if there's a severity uptick beyond what you expected or something along those lines.

It's Michael Klein.

Thanks for the question.

The short answer is no, it doesn't reflect anything beyond what we expected.

It's just the follow-on steps in our existing game plan.

And I think when you think about pricing, sort of think of it in 3 pieces, right?

So the written rate we're going to achieve in 2018 is partly based on the rate we have already filed in addition to the rate we'll file in '18.

And so that drives a lot of our rate outlook.

What I think you'll see as you look ahead to 2018 is the RPC in the first half of the year will be higher than the numbers you see on the page from the first half of 2017.

In the back half of the year, it will be lower than the numbers you see for the back half of '17.

Importantly, on an earned basis, since written rate has accelerated through '17, earned rates will actually rise in 2018 relative to 2017.

So that's sort of a way that we think about it, but no, the broadly consistent RPC outlook doesn't reflect anything unanticipated in our loss experience.

Our next question comes from the line of Amit Kumar from Buckingham Research Group.

Maybe just staying on personal auto with Michael Klein, you gave some good color on RPC.

How should we think about the PIF growth from here just based on the fact that majority of your book is 12 months?

When should we see some change in that number down the road?

Thanks, Amit.

Appreciate the question.

I think if you think about just sort of the broad beams on auto, what we talked about in 2017 is our objective was to improve profitability and manage growth, manage meaning being reduced, right?

As we think about our objective for '18, it's really to try to achieve more balance between growth and profitability in auto.

And I think you can certainly see, as we talked about last quarter, we felt like we turned the corner on auto profitability in the third quarter.

You're seeing, in the year-on-year adjusted underlying combined comparison, that improvement accelerating.

But again, consistent with our RPC outlook, still work to do there.

And so again, we're looking to achieve a balance between profitability and growth in '18.

And then as that profitability continues to improve, we'll look to resume growth.

But we're right now trying to sort of to level off and then move it forward.

That's actually helpful.

And my follow-up, switching back to, I guess, commercial lines, and I know there was some good texture on the pricing chain -- change.

I'm curious, if we were to step back and think about the active cat quarter for Q3 and Q4 and its impact on the marketplace, would you say that it's early days for, I guess, a broad-based firming of those small and middle commercial market?

Or is it more isolated near term?

Amit, it's Alan.

We tried to give you a perspective by line to really address that because putting workers' comp aside and that is its own story.

The price increases we were able to achieve in the quarter were broader than just the property lines.

And as I shared in my prepared remarks, I think the more significant factor driving the pricing is where margins were certainly for us, and that's probably true relative to the industry.

So I can't tell you exactly what the industry's going to do or what's going to happen, but I can tell you what we're going to do, and that's to, thoughtfully and in close coordination with our agent and broker partners, continue to push for rate where we need it to improve the outlook and trend of returns.

Our next question comes from the line of Elyse Greenspan with Wells Fargo.

My first question.

In terms of the margin outlook for Business Insurance for next year, can you quantify the impact that non-cat weather had this year, so we know kind of what to adjust for when thinking about '18?

And in your margin outlook, are you -- how are you thinking about the expense ratio versus the loss ratio as we think about you potentially earning in better rate next year?

It's Greg Toczydlowski from Business insurance.

In terms of your first question, think about a point in terms of where large losses and non-cat weather are relative to our longer-term expectations for 2017.

And that would be a good way to think about a going-forward perspective.

Yes.

And Elyse, on your question about expenses, we're going to try to resist the temptation to break out the go-forward perspective on the loss ratio versus the expense ratio.

We give you an outlook on the combined ratio, at least qualitatively, because you get into some judgments on the level of precision that is probably too -- further than we'd like to go, at least for an outlook perspective.

I -- Jay Benet did say in his opening remarks or maybe it was Brian that looking at the full year was probably a better perspective on the outlook.

And I will add, just following up on our comments at our recent Investor Day, that productivity and efficiency are important strategic initiatives for us.

We've seen the benefit of that this year.

We've got real production -- real productivity and efficiency enhancements on the shop floor right now.

And we think there's more to come.

And what that does for us, it's not necessarily that we're trying to dial in a much lower expense ratio.

What we're trying to do is create all the benefits that come from operating leverage.

So we can take those incremental dollars, and as I've said before, we can let them fall to the bottom line.

We can use it to invest in important strategic capabilities or we can put it into pricing.

And it really is that flexibility that we're looking for going forward.

But in terms of the outlook, we're going to stick with the broader commentary on overall margins.

Okay.

And then my second question.

In terms of the pricing environment, going back to Business Insurance again, you said in your opening remarks that you want rates to keep pace with inflation.

What do you peg inflation at right now within your commercial lines book?

And when you make that comment, I guess that's what we should compare when we think about the RPC going forward within Business Insurance.

Yes.

Elyse, we've said for a long time that our long-term outlook, and again, that's -- our long-term perspective for all of Business Insurance is about 4%, and really no change on that.

It -- there's some texture underneath by line, for example.

I'm not sure what your question was about RPC, but rate contributes to margin, and there's a portion of exposure that's obviously part of RPC that also contributes to it.

So I'm not sure if that's the texture and color you were looking for.

I guess what I was thinking about was your RPC was about 4% in the quarter.

And then you're saying that kind of inflation is about 4%, but then to your commentary, it seems like you are pushing for more price across your book of business from where we were at in the fourth quarter.

So I was just trying to tie those 2 comments together.

Yes.

So Elyse, I would say that of -- think of RPC as having 2 components: one, pure rate; two, exposure.

Of the piece that's exposure, a portion of that behaves like margin, and there's a portion of it that has real loss content in it and doesn't.

So RPC needs to be above the overall loss trend in order for us to consider margins to be expanding.

And I'd -- you could look at those numbers, and you'd say, at least on a written basis, we're getting close.

Although we do think -- I do think over time that insurance, like most other businesses, pricing ought to keep up with inflation.

But I would say that given where we are now in terms of the outlook and trend for returns, we're looking to do a little bit better than just to offset inflation.

We're looking to expand margins.

Our next question comes from the line of Yaron Kinar with Goldman Sachs.

I guess my first question is with regards to the rate increases in Business Insurance.

If I strip out commercial auto, I think, if my calculation is correct, I'd get to roughly flat rate for the rest of the business.

Am I thinking about that correctly?

Or are there maybe areas or lines where you are getting more rates outside of commercial auto?

Yes.

Yaron, yes, I don't think you're doing the math entirely correctly.

There's a lot of different pieces underneath the net written premium change, which I'm sure -- I think you're trying to back into.

So we're certainly, as Alan said earlier, very much focused on where some of the more distressed lines are, automobile and the catastrophic exposed areas of property, but we're also pushing ahead on all of the products.

So the math doesn't come out where we're flat on all the other product lines.

Yes.

And I would just direct you back to Brian's comments where he gave you a view of pricing by line.

So price is positive in every line and, outside of workers' comp, higher both sequentially and year-over-year.

So we can follow up with you and walk you through the math if that's helpful.

Yes, I will do that.

And then maybe one other question on tax reform.

So Alan, if I understand your comments correctly, basically, you're looking at the results of -- or you're targeting a certain return, and tax reform ends up helping that return.

Just trying to get a sense of, are you expecting any change in investment allocation that would further boost or decrease the effect of tax reform?

Yes.

Let me turn that over to Bill Heyman and ask him to respond to that.

I think it was possible there will be over time some reallocation.

The elimination of corporate AMT removed a ceiling in terms of the amount of municipals we can own, although that's very theoretical.

Every day, we look at what the market throws up in terms of assuming roughly equal credit quality, which is rarely the case, where is the highest after-tax return.

I think more -- going forward, that will more often, in certain segments of the curve, be in taxables rather than municipals.

It may even be that we buy taxables and sell municipals in certain parts of the curve.

And the reason for that is that for the first time I can remember, individual investors and corporate investors have very different utility functions.

So at many parts of the curve, the municipal is not worth as much to us as it used to be, but it's worth more to an individual investor than it is to us.

So there may be opportunities to pick up after-tax yield on advantageous terms, but obviously, I -- we can't guarantee them or quantify them.

But I'd just like if you look at the portfolio 3 years from now, the mix would have changed.

And our next question comes from the line of Paul Newsome with Sandler O'Neill.

I want to ask whether or not the outlook for M&A for Travelers has changed with tax reform.

Does it make it easier or more interesting to buy something outside the U.S. for Travelers?

Yes.

What I can tell you is that tax reform for us and others who are similarly situated obviously just makes us a more competitive buyer relative to a non-U.

S. taxpayer who previously had the benefit of some structural advantages -- structural tax advantages.

Those advantages have gone away, so that levels the playing field, and so relatively speaking, we're a more competitive buyer.

So that's changed for sure.

What hasn't changed, Paul, is either our lens or our propensity to do transactions.

And by that, I mean, we are always looking for opportunities, both organic and inorganic.

And when we can make them happen on terms that are attractive to us, we're going to try hard to do that.

And as I've said before and just to reiterate it, we're going to try to do deals when it improves our return profile, lowers our volatility or provides us with other important strategic benefits.

So the -- maybe our positioning relative to others changes, but our lens, our propensity doesn't.

And the other thing that won't change is our capital management strategy.

We will continue to think about and allocate capital the same way we have historically.

I guess, given tax reform and all other things being equal, that there's probably higher earnings and capital to put through that capital management filter, but our thought process around capital management doesn't change.

And our next question comes from the line of Jay Gelb with Barclays.

My first question is on capital deployment in 2018.

Should we still consider 100% of operating earnings as being deployable for share buybacks and dividends absent another opportunity emerging?

Yes.

It's Jay.

As Alan just said, the way we think about capital management hasn't changed.

So we're always going to try to fund growth.

We're always going to look for opportunities to create shareholder value.

And to the extent that we continue to create excess capital, we'll manage it the same way, returning it to shareholders through dividends and share repurchases.

And the driver of that is the earnings of the play.

So no change there, and what we've said in the 10-K and 10-Q all along with regard to that still holds.

I appreciate that.

And then if I can try one on tax.

As I -- using your supplement, if I look at the tax-free municipal income and apply the rate you mentioned, I guess I get kind of driven down to a 15.5% to 16% overall effective tax rate.

Am I in the neighborhood on that?

If the calculation you're doing is looking at the supplement, taking some view as to what the average asset base would be for the munis, applying the rate that we show in the supplement as the earnings rate on that, you'll get the pretax muni NII.

Apply 5.25% to that, and you'll have that component of the tax accrual, and then the rest, whatever you're assuming with regard to the non-muni income, not just NII but underwriting, apply the 21% to, and you'll get an effective tax rate.

And our next call is a question from Jay Cohen with Bank of America Merrill Lynch.

A couple of questions.

First is the surety premiums went up, and you said there was more activity.

I mean, do you see this being a function of the economy?

And should we expect the top line on the surety side to possibly expand, especially if we've got more infrastructure spending?

Jay, this is Tom Kunkel.

I think the way we're looking at the surety production in the month is it really can be episodic.

And those are some very well-performing businesses and accounts that we were doing that volume with.

But I wouldn't say that we in any way view it as indicative as an increase in activity for the type of work that drive surety bonding.

So as they say, a little lumpy.

Got it.

Other question.

On the commercial lines market, your effort to raise prices a bit more aggressively has been met with a retention that has stayed at a historical high level.

It suggests the rest of the market is coming along as well.

And I'm wondering if you could speak qualitatively about what you're hearing from agents and brokers regarding how your competitors are responding to the same pressures that you are.

Jay, it's Alan.

We don't talk a lot to our distribution partners about the way our competitors price.

That's a -- it's a competitive marketplace, and they do what they do, and we do what we do.

I will tell you that just in terms of our process, we do a lot of work, and we've got a lot of talent out there in the fields, and our underwriters are out talking to our distribution partners about accounts 90, 120 days out to make sure that we're working in partnership with them and making sure that we're sharing with our customers why we're doing what we're doing.

So we've got, I think, just a tremendous field organization.

I think they've done a great job.

Obviously, we do operate in a competitive marketplace.

And so I do think that what you see in our results is, to some degree, a reflection of the market.

I've always thought that there are probably 2 reasons that maybe we have a little bit of incremental pricing power.

One is just the franchise value we bring to the marketplace and product breadth and risk control and claims -- unbelievable claims organization.

And I think that our agent and broker partners are proud to sell that, and I think our customers see value in it.

And the other advantage I think we have to some degree is data and analytics.

It's about risk selection and pricing, and we've been a pioneer for a long time in not just data and analytics but delivering that data and analytics to the screen of the local underwriter at the point of sale.

So I do think those 2 things probably give us a little bit of an advantage, but certainly, there's a marketplace dynamic to what we're able to achieve.

Our next question comes from the line of Brian Meredith from UBS.

Two quick questions here for you.

The first one, just curious, could we parse a little bit Business Insurance as far as kind of what's going on from a rate perspective?

And just curious, once small commercial went out of rate, it just doesn't need it, more competitive pressures.

And then also, on the -- in your large-ticket property business, that's one that you had excluded a while from your rate calculation.

It's just so competitive.

How is that trending now and maybe relative to your expectations?

Then I have one follow-up.

Yes.

Brian, this is Greg.

I'll start with the small commercial one.

We've been focusing on the small commercial business for a number of years now and really trying to get the margins to a place where we feel very comfortable with them in.

And we are very much within our target thresholds of where we want to be from small commercial.

So we've had a deliberate set of execution around our rate plan there.

So that's the first element around why you see a smaller level of rate in small than middle.

The second one really is around our Express business, which is -- think of it as the straight-through processing of small commercial, really has a more prescriptive like flat rating environment.

And so when we see some of the pressures of rate reductions in workers' comp, given the extraordinary profitability on that line over time, we see that more immediately impact that business.

So those are the 2 reasons that are driving the small commercial.

And on the property -- large account property?

What was your question on the large property?

Because we didn't...

I guess how is that -- the large account property, how is that planning out from a rate perspective right now?

Is it you're getting the rate that you kind of need in that area or not?

Yes.

Given that the hurricanes were in the third quarter, we're very pleased with our agility 1 quarter in, in terms of what we've been trying to do on the national property side.

And as Alan said, we think franchise value matters, and we're seeing that inside our numbers where we've been able to push thoughtfully and, at the same time, retain the book of business.

Yes.

Brian, this is Brian.

Just one comment on top of that.

And looking back over significant cat events over the years, the impact in the large property book on rate is usually 2, 3, even sometimes 4 quarters out the peak of that.

So we're optimistic that there could be more to come, but that's just looking at the historical trend.

And we made good progress in the quarter.

Yes.

Great.

And then just on personal lines and just on tax, I appreciate the comments on how kind of it's going to fall to the bottom line.

But I guess my question more on the personal lines space is, as you look out, understanding you need more rate to get to the right returns that you really want in that business, but would you -- should we expect the kind of your combined ratios where you'd like them to get are going to be higher here going forward as a result of tax?

And specifically, related to these certain states have return on capital-type benchmarks that they look at, are they going to be pushed back from those regulators on returns here with tax reform?

Sure, Brian.

It's Michael.

Thanks for the question.

I would say where you started is probably where we start, which is we're not at target returns yet and we got work to do.

I think consistent with Alan's comments in the opening, a lower tax rate sort of helps us move us closer but doesn't get us all the way there.

And so when you think about it from a filed rate and a regulatory standpoint, we certainly see and actually have seen just this week news from some regulators on the fact that they're thinking about the tax rate and looking to apply it in some of those conversations.

But generally speaking, it doesn't change the direction we need to move rates, particularly in auto.

We still have work to do there to get to target returns, and we're going to continue down that path.

Right.

But just the magnitude you need going forward is probably less today than it would have been before tax reform?

I would say all else being equal.

But again, to Alan's point earlier, you've got expense, and you've got loss experience, you've got investment yield, the whole bunch of things that go into that mix, and it's just one factor that we need to consider.

And our next question comes from the line of Meyer Shields with Keefe, Bruyette & Woods.

I don't know if I'm overthinking this, but I guess I was surprised that the outlook for 2018 for Personal Insurance was only a slightly lower combined ratio, with auto earned rates likely to approach double digits.

Am I missing something there?

Meyer, this is Michael.

Thanks for the question, and appreciate it because Brian did give you the overall outlook for the segment.

There's a little bit of texture underneath.

So if you think about auto specifically when you see the 10-K outlook, what you're going to see is our commentary there is for improved margins and combined ratio.

The home outlook, on the other hand, is broadly consistent, both from a margin and a combined ratio standpoint, assuming more normalized levels of non-cat weather activity.

When you put those 2 pieces together, you get improved margins and a slightly improved combined ratio in the aggregate.

Part of that, I guess the other factor is as auto premium is growing more than home, and auto carries a higher combined ratio mix impacts the adjustment in the combined ratio.

Okay, that makes a lot of sense.

Second, I guess, is a broader question.

You talked a lot in the past about how some elements of exposure act like rate.

Are those elements more, I guess, reflective of the price of the exposure for the values that are being insured or of exposure unit growth or -- on a real basis?

I'm not totally sure I understand the question, but I think it's more of a value than it is unit, right?

You increase the value of a unit, and it's that increase in exposure that behaves more like rate.

When you actually add another unit of exposure, you have another unit of loss content.

So I think that's the right way to think about it.

And our next question comes from the line of Sarah DeWitt with JPMorgan.

Just wanted to try one more on the tax rate.

What would the pro forma tax rate have been this year under U.S. tax reform?

Actually, it's not something we actually calculated.

So I think we would do -- we would suggest you do the same thing.

Just look at what the NII was for the tax-exempt portfolio, and then for everything else, supply the 21% rate.

But we haven't done the calculation.

Okay.

Yes, I'm coming up with some slightly different numbers than in the previous questions.

So just -- I mean, if you wanted -- if you were willing to disclose that, I think that would be helpful.

And then...

Well, I'd -- just to add, the information's in the supplement, so maybe it's something Gabby can follow up with you on.

Okay, great.

And then secondly, just on the auto insurance underlying combined ratio, improved nicely this quarter, but it's still above 100%.

How long should we be thinking about it will take to get below 100%, given some of the pricing actions you're taking, offset by the new business penalty?

Sure.

Thanks, Sarah.

It's Michael.

Just I want to just put a point on Brian's comment earlier about reflecting seasonality to start with.

So if you're looking at Page 15 and you're looking at the 101% for the full year versus the 104% for the quarter, that is pretty consistent with the seasonality we would typically see in the quarter.

In terms of how long it takes, I think we're certainly optimistic.

And as we said last quarter, we feel good about the progress we're making towards our target combined ratio and see that continuing as we look ahead into '18 and '19.

I think with the outlook that we have given you for RPC, you can sort of make your own estimate of what the earned rate will be, apply loss trend and get to an earned combined ratio pretty quickly.

And I guess at this point, as we look at our experience, we don't see anything that would cause us to tell you to do it any differently.

Just as a follow-up to your tax question, in terms of the going-forward approach to calculating an effective tax rate, what I said is absolutely on point.

There is a little bit of foreign income that's taxed at a slightly different rate, but that shouldn't matter.

That will matter more this year than in the future because of today's 35% tax rate versus the future.

But one of the other things that we should point out, and you'll see it in the press release, we did have a favorable tax settlement earlier in the year that would have affected this year's effective tax rate.

So if you're going to do a pro forma for this year, you have to take that into account.

And then in addition to that, we mention -- I mentioned in my commentary that we did some tax planning initiatives in the year that had some impact on the effective tax rate as well.

So really, the calculation you want to do is not about this year; it's about going forward.

Our final question comes from the line of Larry Greenberg with Janney Montgomery Scott.

So going back to tax reform and a level playing field, aside from the benefits that might be there on the M&A side, from an operating standpoint and from a business line standpoint, where do you think the most concrete benefits might arise given the more level playing field?

I guess the way we think about that is the tax line is an expense line like any other expense line that we work into our pricing models.

And to the extent that we've got a level playing field and aren't at a disadvantage in that regard, I think, again, on a relative basis from a pricing perspective, that helps.

And I would say after M&A and maybe even before M&A, that's a significant factor in terms of a level playing field.

But in terms of business insurance, specific lines, there is none that necessarily jumped out more than others?

I think the same math applies to all of our pricing models for all of our products.

So I don't think I would make a distinction there.

Okay.

And then just with better economic growth perhaps on the horizon, do you think that all things equal, small commercial premium growth should maybe catch up to the Middle Market and maybe even grow faster in an improving economic environment?

I'm not really sure how to answer that question.

I do think across all of our businesses, we're pretty well leveraged and pretty well positioned to benefit from an improving economic environment.

And in terms of -- if you're asking about growth in GDP by small entities -- by small enterprise versus large, I don't know that I've got a better view on that than you or anyone else.

And if you're talking about our own market position, small versus large, there's so many things that go into growth, and we actually don't think about it that way.

We execute, as you've heard us say many times, at a very granular level.

So whether it's small or large, we're trying to keep our best business, improve the profitability on the business where we need to and do a lot of hustle and leveraging our competitive advantages, trying to generate new business.

And when that very granular strategy adds up to growth, we grow.

So that's the way I think about it, and we don't really think about the small differently than the large from that perspective.

I'll now turn the presentation back to Ms. Nawi.

Please proceed.

Excellent.

Thank you all for joining us today.

And as always, if you have any additional questions, we are available in Investor Relations.

Thank you, and have a great day.

Thank you.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you all for your participation and ask that you please disconnect your lines.

Thank you.

Have a great day.