The Hanover Insurance Group, Inc. (NYSE:THG) Q3 2023 Earnings Call Transcript
The Hanover Insurance Group, Inc. (NYSE:THG) Q3 2023 Earnings Call Transcript November 4, 2023
Operator: Good day, and welcome to the Hanover Insurance Group's Third Quarter Earnings Conference Call. My name is David, and I will be your operator for today's call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.
Oksana Lukasheva : Thank you, operator. Good morning, and thank you for joining us for our quarterly conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer; and Jeff Farber, our Chief Financial Officer. Available to answer your questions after our prepared remarks are Dick Lavey, President of Agency Markets; and Bryan Salvatore, President of Specialty Lines. Before I turn the call over to Jack, let me note that our earnings press release, financial supplement and a complete slide presentation for today's call are available in the Investors section of our website at www.hanover.com. After the presentation, we'll 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 as defined under the Private Securities Litigation Reform Act of 1995.
These statements can relate to, among other things, our outlook and guidance for 2023 economic conditions and related effects, including inflation, supply chain disruption, potential recessionary impact, evolving insurance behavior emerging from the pandemic, and other risks and uncertainties such as severe weather and catastrophes that could affect the company's performance and/or cause actual results to differ materially from those anticipated. We caution you with respect to reliance on forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release, 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, the slide presentation or the financial supplement, which are posted on our website, as I mentioned earlier. With those comments, I will turn the call over to Jack.
Jack Roche : Thank you, Oksana. Good morning, everyone, and thank you for joining us. I will begin today's call with my perspective on our third quarter results and a summary of the success we have achieved in our underlying margin recapture initiatives to date. A review of the actions we are taking to improve our catastrophe resiliency, including new initiatives we have underway. Jeff will review our financial and operating results in more detail, and then we will open the line for your questions. I'll begin by acknowledging the heavy impact of CATs on our third quarter results and the great sense of urgency with which we are executing on our CAT resiliency actions. I'll expand more on this topic shortly. Excluding catastrophes, we are very pleased with our third quarter performance.
I'm happy to report that our third quarter ex-CAT results were slightly better than our expectations, in part due to the continued strong execution of our margin recapture plan, which helped to drive meaningful underlying improvement in all 3 of our business segments. Our progress in the quarter reflects the inherent strengths of our company, including our distinctive strategy and business model, broad and innovative capabilities, strong well-managed balance sheet, experienced and committed team and deep mutually beneficial partnering relationships with many of the best agents in our business. The last of these are deep agency relationships is particularly important today as we and others are thoughtfully increasing prices, modifying terms and conditions and tightening underwriting requirements.
In keeping with our commitment to being a premier property casualty franchise in the independent agency channel, we are working closely with our agents and their teams to help them better respond to their customers and navigate today's challenges. At the same time, we are further leaning into one of the hardest markets we have seen in property, particularly in Personal Lines as we deliver on our margin improvement initiatives. Those factors, along with many others, give us a very high level of confidence in our ability to drive disciplined execution further and enhance profitability over time. Our third quarter ex-CAT results are a strong testament to the successful execution of our comprehensive margin recapture plan as well as the important work we are doing to get back to our expected performance levels.
We continue to be focused on 3 main levers: Price increases, property underwriting enhancements, and loss control and risk prevention measures. In Personal Lines, margin improvement is driven by robust and accelerating earned price increases. Earned pricing is outpacing loss trends helping drive a 1-point improvement in Personal Lines current accident year loss ratio in the third quarter compared to the second quarter this year, primarily driven by Personal Auto. Auto collision loss trends remain elevated but we are seeing an easing of inflationary pressures, while prior rate increases are beginning to help drive improvement in our overall loss ratio. Homeowners loss pressure is proving to be an ongoing challenge. Having said that, we are confident continued price increases, on top of current increased earned rate and valuations, will bend the curve starting next quarter.
Additionally, we are taking a more aggressive approach to homeowners non-renewals based on specific underwriting criteria, including quality of ROOF Score, prior loss experience and age of construction. Third quarter Personal Lines total price change in auto and home were up 14% and 23%, respectively. By the end of this year, we expect an average homeowners renewal price change upwards of 28%. Collectively, we expect Personal Lines to experience a dramatic profit recovery next year, and a return to our target profitability on a written basis at the end of 2024, based on a range of reasonable assumptions for loss trends. We also continue to execute on our profit improvement plan in Core Commercial property lines in the quarter across all 3 focus areas: Pricing, underwriting and risk prevention.
In terms of pricing, our core Commercial Property renewal price increased by 14.7% in the third quarter, up 2 points from 12.6% in the prior quarter. We've also made meaningful strides in addressing large loss volatility in middle market, completing non-renewals and policy limit adjustments that have lowered our total property risks by 17% in constant dollars compared to 12 months ago. We also engaged in a range of risk prevention and mitigation initiatives designed to reduce both CAT and non-CAT losses in Core Commercial. We are successfully expanding the number of accounts enrolled in our IoT sensor program. We have increased the number of protected accounts by approximately 40% over the last 3 months and 175% since the end of 2022. Additionally, through the end of September, 30% of the 600 targeted middle market accounts have been addressed through underwriting actions or sensor deployment, and we'll continue to address additional accounts through the fourth quarter.
These actions are now delivering results, reducing large loss volatility and improving our Core Commercial current year loss ratio by over 5 points compared to the third quarter last year. Turning to our Specialty business. We are very pleased with the performance across our portfolio, delivering a combined ratio of 83% for the quarter, ahead of our expectations. While market conditions in some of our segments are competitive, in particular for sectors like management liability. Our ability to deliver consistent profitability is a validation of our diversified specialty portfolio and disciplined underwriting and rate strategy. Our Specialty growth in the quarter was somewhat muted due to the temporary impact of non-renewals of a couple of underperforming programs.
Despite ongoing excellent performance in Specialty, we expect all segments to contribute to the enterprise margin recapture plan, and we are also being proactive on any lines and segments that are sensitive to social inflation. Excluding programs, Specialty growth was 7.4% in the third quarter. Longer term, however, Specialty continues to represent a robust growth opportunity for our company. This business provides important diversification for our overall portfolio, and consequently, reduces our property and CAT exposures, all while providing our agent partners with robust comprehensive product offerings, highly valued capabilities and additional growth prospects. We fully expect our Specialty portfolio to return to upper single-digit growth starting in the first quarter next year, as we benefit from increased market penetration in most segments and growth in newer product offerings, including Specialty, GL and E&S business.
We also expect additional lift from our newest initiatives, including expansion in the wholesale channel, which is already delivering solid growth. Now turning to our efforts to manage our catastrophe exposures more effectively in Personal Lines. We made important progress on the CAT exposure management actions we discussed on our second quarter call. These actions include increasing all peril deductibles to specific minimum levels determined by coverage A limits, implementing wind and hail deductibles in additional states, and transitioning to an actual cash value schedule for roofs in certain states and on specific risks for new business policies. As of September, the default for all payroll and wind and hail deductibles in the comparative raters for new business have been updated and our agents are supporting our efforts.
These changes will be introduced in our TAP sales platform as a requirement on transactional new business as soon as next week. We also are advancing the technology and regulatory processes that enable us to expand these product changes to policy renewals starting in February, with our key states starting with April effective dates. We expect we will roll most of our homeowners business into new terms by the end of 2024. In addition, we are planning to introduce actual cash value for roofs in the comparative raters, starting in 2024 for new business in certain geographies and types of risks, thereby further reducing claims costs for older roofs. We expect these actions will enable us to better share loss costs with insureds, which should support loss prevention, decrease claim severity and minimize our exposure to aggressive roofer actions.
We expect to see significant improvements in our CAT vulnerability and loss experience once these product changes are fully in place. At an individual risk level, we could realize upwards of 30% to 50% reduction in hail and roof claims payouts. For example, a wind and hail deductible on a $1 million coverage A, depending on the roof age, will range between $10,000 and $20,000 against an average roof claim cost of $35,000 to $40,000. At the same time, we expect to see the benefit of reduced claims frequency as the higher deductibles will ensure that only legitimate claims are filed. In addition to product and pricing changes, we are also reviewing our geographic exposures, and reevaluating our property micro concentrations. While we continue to believe some of the recent CAT losses for Personal Lines in the Midwest were aberrant, we are taking steps to reduce our property exposure in certain areas across these states, including but not limited to Michigan.
We have updated our models and are reassessing our property aggregations to ensure we are not overly exposed in specific geographic areas in light of the increased property valuations and changing weather patterns. Additionally, we are achieving substantial decreases in exposure beyond PIF reduction from the product changes and risk prevention actions we are implementing. Longer term, we will continue our diversification efforts to emphasize Personal Lines growth in lower-concentration states. We also expect small commercial and Specialty exposure and policy counts to grow much faster than Personal Lines, and ultimately, to reduce the relative share of Personal Lines business in our overall mix. As we look ahead, we believe we have what it takes to succeed in a rapidly changing and challenging marketplace.
We are very encouraged by our strong ex-CAT performance and the progress we have made on our margin recovery plan during the year. We look ahead with resolve and a high degree of conviction that we are executing the right set of initiatives to move our company forward. We have a proven strategy, 1 refined to meet the moment, 1 that will benefit our agent partners and customers, and 1 that positions our company to deliver sustainable, profitable growth and long-term value creation for our shareholders and other stakeholders. With that, I will turn the call over to Jeff.
Jeff Farber : Thank you, Jack, and good morning, everyone. I will start with a high-level overview of our third quarter results, then review our segments and investment performance in more detail, and finally, provide some thoughts on our outlook. We experienced elevated catastrophe losses of $196 million or 13.7%, resulting in an overall combined ratio of 104.4% for the quarter. Catastrophe losses in the quarter were primarily the result of severe convective storms concentrated in the Northern Midwest, primarily in Michigan, triggered by damaging hail, severe wind and heavy rain, approximately 75% of all losses occurred in Personal Lines. Outside of the Midwest, our cat experience was relatively benign across the rest of our geographies.
We are confident the broad range of pricing and underwriting actions we are taking will reduce our CAT exposure and optimize our portfolio in the long term. Our CAT experience in Q3 masked what was otherwise a very strong quarter for the Hanover. We delivered in improved combined ratio, excluding cats of 90.7%. That's slightly favorable to our expectations, 3.5 points better than the third quarter of 2022 and an improvement of 2 points sequentially. Current accident year loss ratio, excluding catastrophes, improved 1.7 points on a sequential basis, demonstrating the power of rate increases and underwriting actions underway in all 3 of our business segments. We posted an expense ratio of 30.2%, 20 basis points below 2022 third quarter and slightly better than our third quarter expectations.
Prior year development was slightly favorable overall and we continue to maintain a strong reserve position. Finally, net investment income was slightly ahead of expectations for the quarter and year-to-date periods as higher interest rates continued to fuel our earnings power. Turning now to our segment review, starting with Personal Lines. The ex-CAT combined ratio was 96.4% for the third quarter, improving 1.8 points over the third quarter last year. The third quarter of 2022 included some year-to-date reestimations to the loss ratio in Personal Lines, and therefore, is not a very useful comparison. Because there is a little less seasonality in the middle quarters of the year, we believe the more informative comparative is sequential, which saw approximately 3.6 points of improvement in Q3, driven by both the underwriting loss ratio improvement as well as lower expenses.
Auto current accident year loss ratio, excluding catastrophes, of 77.5% in the third quarter improved 1.6 points sequentially, driven by the benefit of earned rates. While loss severity in auto remained elevated, we are seeing some signs it is beginning to ease. We continue to be cognizant of potential severity increases in bodily injury coverages and are selecting our loss picks prudently. Homeowners' current accident year loss ratio, excluding catastrophes, was 63% in the third quarter, consistent with the second quarter as the benefit of earned pricing was offset by prudent ultimate severity assumptions due to the volatility of recent loss patterns in this line. Personal Lines generated net written premium growth of 9.5% in the third quarter, driven by accelerating pricing increases.
Renewal price change was 18% in the quarter, versus 15.9% in Q2, or an improvement of over 2 points. Customer retention remains strong at 84.6% despite the level of pricing increases. PIF shrank slightly on a sequential basis, primarily driven by a slowdown in new business. We expect PIF will continue to decline and retention will tick down slightly as we introduce even higher prices and increased deductibles. However, we fully expect our Personal Lines premiums to continue to increase due to the substantial pricing increases. Turning to our Core Commercial segment. We delivered an ex-CAT combined ratio of 90.1% in the third quarter, an improvement over the third quarter last year and an improvement compared to our expectations. The core commercial underlying current accident year loss ratio, excluding catastrophes, improved by 5.4 points year-over-year to 56.3%, and was consistent with the second quarter 2023, as large loss experience in middle market commercial multi-peril remained stable for the third consecutive quarter.
This segment performance was a direct result of our strong execution against our margin recapture plan, highlighting both accelerating pricing actions and effective underwriting actions in middle market property. Through the first 9 months of 2023, our Core Commercial current year ex-CAT loss ratio improved 1.8 points from the same period in 2022 with a reduction in CMP large losses in each of the last 3 quarters of this year. CMP loss ratio year-to-date reflected 4.5 points of improvement over the first 9-month period last year. On the top line, Core Commercial delivered net written premium growth of 4.2%, paced by small commercial, partially offset by lower growth in middle market, in line with our expectations, and the result of targeted property non-renewals.
Retention of 83.8% was down somewhat year-over-year, specifically as a result of middle market underwriting actions, while pricing increased to 11.8%, an increase of 50 basis points compared sequentially to Q2. We delivered outstanding third quarter results in our Specialty segment, generating an ex-CAT combined ratio of 81.3%. The underlying loss ratio improved 5.8 points year-over-year to 47.8%, which included the benefit of earned price changes above loss trends and lower large losses in our property business. We continue to target a low 50s loss ratio in the Specialty business. Specialty net written premium growth of 2.9% was right in line with our expectations. Our specialty businesses are prioritizing margin improvement over growth. Accordingly, while Specialty has been posting strong profits overall, we have areas of underperformance, where we are non-renewing specific programs, which impacted our growth for the quarter.
Retention across our Specialty portfolio is very healthy at 79.7%, considering deliberate non-renewal actions. Moving on to our investment performance. Net investment income was strong at $84.2 million for the third quarter, driven by higher bond yields. We expect that the interest rate environment will continue to provide an accumulating benefit to net investment income over the long term, allowing us to reinvest in high-quality fixed income assets at attractive yields. Looking at our equity and capital position. Book value per share decreased 5.4% on a sequential quarterly basis to $59.21 per share, reflecting an increase in unrealized losses and payment of a quarterly dividend. We have a strong insurance company capital position with $2.5 billion of statutory surplus at the end of the third quarter.
This dynamic operating environment requires us to prioritize our capital uses to provide financial flexibility, liquidity and the resources necessary to support business growth opportunities. With strong pricing and growth, continued volatility in interest rates and an active quarter for catastrophes, we remained on the sidelines for repurchases this quarter. However, we have a long history of returning capital to shareholders through dividends and opportunistic share repurchases. Our philosophy hasn't changed and both levers remain key tools for our future. Turning to outlook. Our full year 2023 guidance remains unchanged. We continue to expect our ex-CAT combined ratio to be at the higher end of our original guidance range of 91% to 92%. As I discussed on our Q2 call, we are deep in the process of conducting a comprehensive reevaluation of our modeled catastrophe losses, our historical experience and supplemental non-modeled risks.
This will augment the detailed modeling and risk analysis process we conduct each year. We will discuss the results of that effort with you early next year but we would like to share the following 3 observations at this point. First, each point of CAT load increase represents a much more substantial increase in catastrophe severity dollars. For example, with the expected level of personal and commercial property earned price increase next year of around 15%, each point of higher CAT load allows for an approximate 37% increase in CAT losses, or 37% implied loss trend. Second, given the pricing, underwriting and terms and conditions work underway, we fully expect our CAT load next year to be a high watermark, from which we expect to decline somewhat as our CAT resiliency actions are implemented.
Third, considering the current interest rate environment and resulting increase in net investment income, we can absorb a very substantial increase in planned CAT severity and continue to have full confidence in our ability to achieve our return on equity targets. In conclusion, we have made substantial and measurable strides in executing on our margin improvement plan across all segments of our business and we are seeing tangible improvements in our underlying performance as a result. We have a very solid foundation to build on for the future, supported by a well-diversified enterprise, strong market position and superior team, which will allow us to execute on our long-term strategies. Operator, please open the line for questions.
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