Welcome to the Hanover Insurance Group Second Quarter Earnings Conference Call. My name is Hilda and I will be your operator for today's call. [Operator Instructions]. Please note that this conference is being recorded. And I would now like to turn the call over to Ms. Oksana Lukasheva, Vice President of Investor Relations. Ms. Lukasheva, you may begin.

Thank you, Operator. 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 Chief Financial Officer Jeff Farber. Available to answer your questions after our prepared remarks are Jack Roche, President of Agency Markets; John Fowle, Chief Executive Officer of Chaucer, and Brian Salvatore, President of Specialty Lines. 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 investors 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. 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 statements 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, 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 Joe.

Thank you, Oksana. Welcome, everyone, and thank you for joining our call today. This morning I will provide an overview of our business performance and progress on our strategic initiatives in the quarter, Jeff will review our financial results in detail, and then we will open the line for questions. Our second quarter results were solid, in line with our expectations and consistent with our stated strategic position. And we can continue to grow while maintaining our margin profile and producing a double digit return on equity. In addition to delivering a solid financial performance in the quarter, we continued to make progress on our long term strategic initiative, Hanover 2021. In the quarter, we delivered operating income of $72.3 million, or $1.69 per fully diluted share, a consolidated combined ratio of 95.6%, a combined ratio excluding catastrophes of 90.8%, and an operating return on equity of 10.6%. Our second quarter results included several highlights. First, we delivered top line consolidated growth of 4.4%. This reflects our controlled and thoughtful approach to business expansion. We continued to capitalize on growth opportunities in lines and segments where we could achieve adequate pricing and target profitability, such as the personal lines account business, small commercial, and higher margin specialty businesses. We also maintained a thoughtful and measured approach to growth in two of the more challenging markets, the U.S. middle market and international specialty, where the competitive forces were more intense. Second, excluding catastrophes, our domestic and international businesses generated substantially improved performance quarter-over-quarter despite a large property loss in our commercial lines marine business. Our combined ratio improved 2 percentage points, from 92.8% in the second quarter of 2016 to 90.8% this quarter. Our consistent achievement of this low 90%'s combined ratio reflects our disciplined approach to underwriting and reserving as…

Thank you, Joe. Good morning, everyone. For the quarter, we reported net income of $78.4 million, or $1.83 per diluted share, compared to $2 million, or $0.05 per diluted share, in 2016. 2016 included a one-time non-operating charge of $56 million after-tax associated with debt refinancing in April of last year. After-tax operating income was $72.3 million, or $1.69 per diluted share, compared to $54 million, or $1.24 per diluted share, in the prior year quarter. Our second quarter combined ratio was 95.6% compared to 97.3% in the prior year quarter, including catastrophe loss ratios of 4.8% and 4.5% respectively. Excluding cats, we generated a combined ratio of 90.8%. This represented a 2 point improvement over the prior year quarter, with underlying contributions from all three segments. In personal lines, the second quarter accident year loss ratio, excluding catastrophes, improved 50 basis points to 60.2%. Over the last year, we have seen slightly elevated severity in bodily injury and physical damage coverages, which was fully contemplated in our pricing. Frequency continues to remain stable. The combination of consistent rate increases and a strong and improving business mix gives us confidence that our auto book will perform well. Results in homeowners and other personal lines made meaningful contributions to the above-target profitability of our personal lines business. The personal lines expense ratio increased approximately 1 point over the prior year quarter, entirely the result of the one-time premium tax benefit in the prior year quarter. Turning to commercial lines, we recorded no prior year development in the current quarter. Six months after our extensive reserve analysis conducted at the end of last year, our prior year loss trends are behaving as expected, and we believe our reserves remain appropriate. The current accident year loss ratio, excluding catastrophes, was 56.8% compared to…

[Operator Instructions]. We have a question from Matt Carletti from JMP Securities.

I guess maybe first, Joe, I wanted to follow up on the brief comments you had about the acquisition of SLE Holdings. Can you expand on that a little bit? Is the idea there that they have some expertise in terms of products that you can extract to other places in the world, vice versa, that Chaucer has some expertise that could be put through their distribution? And looking at Australia as a fairly mature large market, $25 million in premiums is pretty small. What do you see the potential there over time?

Sure, Matt. We like the acquisition of SLE a lot for a variety of reasons. One, it does give us access to underwriting expertise in a leisure and entertainment marketplace. Second, as we talked about our Investor Day, there are many ways to develop business. One could buy an insurance company and analyze the reserves and the book of business. In this case, we bought an MGA, paid for its fee stream, and the Chaucer team will set out to convert all of the business to Chaucer paper. So, you only really take what you want, which is a great way to acquire a business. So, pay for the fee stream, convert the business you want, get access to a different product line, and, in this new hub and spoke world that we're living in with all the business not coming to London directly, it gives Chaucer access to the Australian market, where before we had limited access to that marketplace.

And then maybe just a couple numbers questions for Jeff. I just want to follow up on the couple numbers you gave on the inland marine fire. I think I heard you right that it suppressed premium growth by 1.4 points and inflated combined ratio by 1.5. Is that just on the multi peril piece of commercial, or was that overall commercial you were referencing?

That was overall commercial.

Jeff, following up on your comments on expectations for the Chaucer expense ratio, am I understanding it right that -- I think you mentioned some investments going forward, kind of starting at the 42% we saw this quarter, expected to build as you make some investments towards 45%. And then I guess the follow on question is how long are those -- do you expect those investments to be made? Is 45% kind of the go-forward rate, or should we at some point in the future expect some retraction from that?

Well, I think -- yes, we at 42% in the current period. We expect some additional investments that were delayed a bit that'll be made in the last six months of the year. And that'll drive it a little closer to 45%. It's really hard to say. We talked about our expense program. Chaucer, obviously, is doing similar things there. There may be less opportunity there given the nature of their business and the mix of distribution costs versus G&A and overhead. So, there John and his team are focused on the expenses there, and we're hopeful that we can bring it down a little bit below 45%. But for now, that's a reasonable proxy.

Our next question comes from Christopher Campbell from KBW.

My first question is on the flat core loss ratio year-over-year, which is pretty impressive given what we're seeing at our peers. And it looks like Chaucer's year-over-year improvement, the big driver was some personal lines that was offsetting a little bit of commercial lines deterioration. Just want to think about how should we think about that core loss ratio going forward. How sustainable is the Chaucer improvement?

Well, I think, Chris, overall we're very happy with our combined ratio results in the quarter. It is very consistent with the long term outlook for margin performance that we articulated at our Investor Day, and I think if you think about the three main businesses, thinking about commercial in the mid 90%'s, ex-cat low 90%'s, personal lines in the mid to low 90%'s, all-in maybe closer to 90% or even high 80%'s ex-cat. And as we said, Chaucer's strategy is to be a top quartile underwriter and a second quartile grower. And so, we're targeting a 95% combined ratio or better over time. Obviously, this quarter, devoid of catastrophes, they did better. But we think that's a very reasonable and prudent long term outlook for the Chaucer business. So, you can factor all of that math into your model. But this performance we produced this quarter is very consistent with that outlook.

My next question is the expected expense ratio savings. So, where are these being realized, and then how do these end up being allocated back to the segments?

The process that we undertook was really one of deferred maintenance. The expense structure had not been looked at in a while. And so, targeted areas were enterprise overhead, indirect support services, spans and layers, under-scaled operations, combining functions, those types of activities. I will tell you that most of the expense we took out was at least two, perhaps even three steps away from the end customer and the agent, so this will not be felt by the field. $30 million of it, as we said, were personnel savings, and $20 million were really going in and opening up vendor contracts that hadn't been opened up in a while, and the ability to negotiate better unit costs on many of our vendor contracts. So, that's how we did it, and that's how much we believe we saved. Allocating it back to segments has not been done yet. And when we sort of give you guidance on a 2018 plan, we'll factor that into our expense ratio guidance by segment so you can prepare your model.

That would be very helpful. And then just how much -- it sounds like some of the $50 million might be reinvested back into the business. Is there an idea of how much of that savings would go back into investments?

We haven't made that call yet. If you recall, at our Investor Day we said that we needed to reinvest in the business through helping our agents innovate and create products and services that they don't have today, and that we would find expense savings to fund that. Obviously, we found more expense savings than we need to reinvest in the business. So, without giving you a number, because we haven't finalized our 2018 plan yet, I would say a modest amount of the savings will be poured back into the business to fund our innovation efforts.

So, following up on Matt's question but more on the domestic side, it seems like you have the leadership team in place and you're going after distribution. So, would Hanover be open to a Chaucer-like acquisition domestically to kind of accelerate that growth in the business?

The answer is yes. We've looked at many types of business development activities; converting and managing general agencies, meaning converting their underwriting activities to Hanover paper is certainly something that could be done; hiring underwriting teams. Brian will be looking at building out new products and services by hiring people. We just did a renewal rights deal in Massachusetts in our personal lines business that will yield $20 million of premium. So, there's lots of creative ways -- rather than paying full multiples of books value for an existing enterprise, there's lot of ways to develop business that are more capital efficient and very, very attractive. And we're looking at those constantly in the U.S. and internationally.

Thank you. We have no further questions at this time. I would like to turn the call back to Ms. Lukasheva for final remarks.

Thank you, everybody, for your participation today. And we are looking forward to speaking with you next quarter.