Good day, and welcome to the Hanover Insurance Group’s first quarter earnings conference call. My name is Denise, and I’ll be your operator for today’s call. [Operator Instructions] Please note this event is being recorded. At this time, I would like to turn the conference over to Oksana Lukasheva. Please go ahead, ma’am.

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 our Chief Financial Officer, Jeff Farber. 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 supplements 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, including our guidance for 2019. There are certain factors that could 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, Slide two 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 Jack.

Thank you, Oksana. Good morning, everyone, and thank you for joining our call. This morning, I will provide an overview of our first quarter results as well as an update on the execution of our strategic initiatives. Jeff will review our financials in detail, and then we’ll open the line for your questions. Overall, we are pleased with the progress we have made in the first quarter and our ability to produce strong returns in a dynamic marketplace. Our businesses performed well, delivering overall results consistent with our expectations. Our performance further demonstrates the strength of our market position and strategy as we continue to build momentum in our businesses, expanding insurance solutions for our distribution partners and policyholders and actively managing our business mix to maintain and enhance superior shareholder returns over the long-term. In the quarter, we posted an operating earnings per share of $1.96, a combined ratio of 95.8% and operating return on equity of 11.6% and an adjusted operating return on equity of 13%. I would like to start with some highlights for the quarter. First, we generated consolidated growth of 2.7%. Growth in the quarter was tempered by the successful execution of our pricing and profit-enhancement initiatives, predominantly in our Commercial Lines portfolio, including commercial auto and our Program business. Excluding these specific actions, our overall premium growth was 4.3%. We continued to maintain growth momentum in our most profitable segments, such as Personal Lines, Small Commercial and most of our specialty businesses. We also expect our new business initiatives in Commercial Lines to increasingly contribute to growth in future quarters. As a result, we expect our net written premiums to gradually increase throughout the year as, importantly, we are satisfied with the stable rate environment and price increases we are achieving across the portfolio.…

Thank you, Jack. Good morning, everyone. For the first quarter, we generated net income of $122.4 million or $2.97 per fully diluted share compared with $67.7 million or $1.57 per share in the prior year first quarter. After-tax operating income was $80.7 million or $1.96 per diluted share compared with $66.1 million or $1.54 per diluted share in the prior year quarter. The difference between net income and operating income per share in the quarter primarily reflects the increase in the fair value of equity security investments. Our combined ratio was 95.8% compared with 96.6% in the prior year quarter. The improvement was primarily from catastrophe losses when compared to the more severe catastrophe weather experienced in the prior year quarter. Current accident year catastrophe losses totaled $52.9 million in the first quarter of 2019 or 4.8% of earned premium, slightly above our plan primarily related to severe winter storms in the Midwest and Northeast. Despite the northern industry cat footprint in the first quarter, our relatively moderate cat loss experience is a reflection of our past exposure management and portfolio diversification initiatives. We also recorded favorable prior year catastrophe reserve development of $13.5 million or 1.2% of earned premium, which brought our total cat ratio for the first quarter of 2019 to 3.6%. As Jack said, we reached an agreement to sell a meaningful portion of our 2017 and 2018 California reserve recoveries associated with the Atlas, Thomas, Camp and Woolsey wildfires for a pretax net benefit of $13 million. Considering the uncertainties associated with the recoveries, potential additional litigation cost and the timing of resolution, the ability to collect a meaningful portion of the subrogation claims now was very attractive. Excluding catastrophes, our overall prior year reserve development was immaterial in the quarter with Commercial Lines favorable development…

[Operator Instructions] And your first question will be from Bijan Moazami from Compass Point Research.

A couple of questions regarding the two lines of businesses that you’re shrinking. Program business is not a big chunk of what you guys do, but I’m trying to understand how many MGA relationships you have there. And when you decided to shrink it, did you target a particular program? Or did you target a particular MGA that was not performing? And how does that business overlap in terms of product with your core agency distribution?

Bijan, this is Jack Roche. Thank you for that question. As you know, we have been repositioning our Program business over the last few years, frankly, to move much more towards controlled, specialized programs, programmatic business in the retail channel, less MGA-centric, unless the MGA is embedded in a retail agent of which we have a high-quality relationship more broadly. So we are substantially more retail agency-focused programmatic business that we believe is in categories that we can underwrite, oftentimes, leveraging the expertise from more – some of our more specialized underwriting units and have moved the portfolio quite substantially in that direction. The other part of your question is, from a profitability standpoint, we went into the year as we always do with a border row of programs that are performing very well, some that are performing adequately and others that are on the fence. We hold a high bar on what we expect those programs to perform at. And so maybe I’ll just turn it over to Bryan to add a little bit more color about the discipline that we’re executing there.

Thanks, Jack. Yes, I think what I would add is that we do have 33 programs. And as Jack mentioned, most of those programs are performing quite well. Some of them are really not meeting our threshold. And so as we look at those, we do put pressure on the pricing, the terms and conditions, and in some instances, that means that some of those programs are non-renewed. But an important piece of what we’re doing is also increasing our fee-based business. And so our focus in the near term is building up that fee-based business so there’s a balance over time of fee-based business and our traditional Program business. And so as we are putting pressure on that small subset of our underperforming programs, we’re growing our new business in the fee business, and that doesn’t come through on the net written premium line. So the reduction you’re seeing is really due to, in large part, taking action on programs that are not meeting our expectations and then replacing that with new business that really doesn’t come through on the net written premium line.

Can you give me an example of the fee we generate from the program?

It’s – there’s a mix each time we sort of write one of these programs. At the top of my head, I don’t have it available to us. But it does absolutely have a nice contribution to us over time in terms of our income and the effective expense ratio as well.

Yes. Bijan, this is Jack again. As you go through the transition that’s going on in the Program space, again, with our bias towards agents that really control a broader subset of the business with us, there are agents that are willing to set up either captives or arrangements where somebody, a reinsurer is taking a bigger part of the capital. And we can manage the program, leverage the kind of industry-leading platform that we built a few years ago and, therefore, work with the program administrator to provide that chassis and allow the agent and/or customers to take the risk. And so that’s really a function of really the hardening of the program sector over the last few years and more and more that business kind of making its way into that model.

That makes sense. On Commercial Auto, obviously, you’re getting a lot of rate increase, 9%. What are you seeing in terms of frequency and severity in that trend? Are we getting to a point where the business might become profitable? Or is that dynamic that we’ve been experiencing for the past many years is continuing, which is more losses?

Yes. This is Jack. I’ll let Dick speak to some of those specifics, but I’ll remind you and others that with respect to Commercial Auto, we think of this as the fifth or sixth line of business in our account strategy. Most of what we’re doing in the Commercial Line space is trying to be an account writer in the sectors of the business where we think our agents can leverage our capabilities and produce returns for us. And so in that context, we’re trying to look at the Auto line and where the Auto line is being subsidized, if you will, by the rest of the account or the sector, then we try to manage it accordingly. Those lines or those sectors that are – tend to be more account or Auto-centric is where we are particularly forceful with rate and underwriting actions. And so Dick, if you want to build off of that?

Yes. Sure. So to your specific question, we continue to see frequency flat to declining, but mostly flat. But the severity is really still topping in the bodily injury coverage, and those trends frankly have remained the same, those external forces that we’ve seen. The economy remains strong. Distraction remain – distracted driving remains an issue. Telematics really hasn’t kicked in. And coupled with that, we still see attorney involvement. I think we’ve shared before that that’s been on the increase over the last five years, which then drives the indemnity costs up. So naturally, we’ve been driving rate. And we’ve been – as you commented, we’ve been increasing the rate that we’ve been getting on the book this quarter with that 9%. But if you look at the most recent months, we’re pushing that towards 10%, which we will continue to do. So it’s really the levers you pull are rate and underwriting, reducing our monoline auto on the book, shifting away from heavy auto classes, as Jack just suggested, the wholesaler class being one of those. But we’re really quite happy with the mix of our book. It continues to be a light truck and PPT-centric book, about 70% of it is light trucks and PPT. So we think about classes. We think about geographies. There are certain geographies where these trends are stronger, some of the New Jersey, New York metro areas. So we’re going to continue to stay disciplined on it, including in our new business pricing, right? Because we don’t want to work so hard to fix this book, this trend and then to put business on the books at below-standard pricing. So it’s a comprehensive approach. But we are – those trends continue, and I think we’re getting after it the right way.

Bijan, this is Jack. One last thing on this is, again, the industry is still performing in Commercial Auto in total north of 110 combined ratio. So I’m sure there are subsectors of that, that are repairing more quickly. But as I said at the onset, we’re really not targeting trucking- or transportation-oriented accounts. And so if we were and if that was a specialty area that we had, maybe we would start to think about where do we get a little more bit more offensive, but we think the industry is a little bit still away from being able to think of auto in a very offensive way.

And maybe just last point I’d add, we – Jack referenced this, but something we watch very closely is the retention on the other lines as we drive this line hard. And we’re really pleased that our retentions in the companion lines, they’re meeting our expectations with regards to retention.

Just one last clarification quickly. The $85.8 million of Commercial Auto that you mentioned in your press release, these are all monoline, correct?

No. Not necessarily. Some portion of that’s monoline, some of it is in these heavy kind of auto-centric classes.

Yes. Monoline is a smaller number.

A small portion of our...

It’s a much smaller number than that number you just mentioned.

The next question will be from Christopher Campbell of KBW.

Congrats on the quarter. All right, I guess behind – beyond like the $400 million from Chaucer, what would you estimate the total excess capital is? Because I don’t think you guys are at like target underwriting leverage, are you?

Chris, this is Jeff. We haven’t given out our excess capital. We obviously look at rating agencies. We look at our internal economic capital. We feel very comfortable with the capital that we have, and we’ve managed that in that framework for a long period of time. We’ve described the excess Chaucer capital, and I think in the short run, that’s what people should people think about the redeployment opportunity.

Okay. Got it. And then can you walk us through the math on the subro sale? Why was this attractive for Hanover right now?

So as you know, we don’t write Personal Lines in California. So being a Commercial Lines writer, these tended to be chunkier, clearer, more straightforward claims that were very attractive to financial institutions that wanted to buy these things. The – obviously, there are gross losses. And to some degree, reinsurers participated in providing us – sharing in those losses. We sold a variety, which we described earlier on the call, of the wildfires to a financial institution. There were – some of those proceeds have to go back to the reinsurers. We have some law firm proceeds to pay some other expenses, and then we net down to $13 million. We haven’t sold all of them. We’ve sold the majority of those rights. But for us, if you think about the amount of time that it will take to collect the uncertainty around potential bankruptcy filings, the additional costs associated with collecting, it just felt like a good trade for us to monetize that opportunity and get certainty at a reasonably high percentage.

Great. And then just switching to Personal Lines, looking at the retention trends. I mean rates are a little bit better but don’t seem super high, but, I mean, is competition increasing? Is that what’s driving your lower retention?

This is Jack. I think we noticed, as others have, as people get healthier and deal with some of their frequency challenges in the past that frankly we didn’t experience as much, they’re getting on top of their loss trends and they are starting to at least become less firm in their pricing. So it’s hard to say where all that’s going to go, but I’ll let Dick comment on the fact that we are pleased that we have some stability in our pricing despite the fact that we have a very profitable book of business, and some of the pricing in the market is starting to come at us a little bit.

Yes. So Chris, I’d start with the point that our retention in Personal Line this quarter has been consistent with what we saw in Q4. We’ve been really fairly consistent with the rate that we’ve been taking. We’ve been taking it up on the BI side nine points, but the overall rate of high 4s, 5s, has been pretty consistent. So we watch that balance carefully, what – where we can push rate and maintain an adequate level of retention, and we’re pleased with it. The book is performing really, really in a top-quartile position. And we think our account strategy and the kind of the commitment that we have at the desk level and the agency level is going to allow us to navigate through this as we push more rate. We are seeing certainly some competition in the marketplace, but what makes us feel really confident as we can see the finish line on the rollout of TAP Sales is the level of kind of commitment we’re feeling at the transactional desk level with the account manager. So our submission rates are up kind of mid-single digits, so we’re getting more swing at the bat. Our PIF is growing at 3%. So we have what we like to say as interest in the firm is up. So this – our account strategy, the value proposition that we offer, the quality of the products, the prestige, we have – we’re bringing a lot to the market, and that’s helping us navigate through what we think is kind of a standard kind of pricing level that we’ll consistently need to drive into the future.

Got it. And do you think like maybe you need to ease up on rates, I mean, if everybody else is getting healthier? Or is it just you guys are fine to shed PIF, if that make sense?

No. I think – we think this is the kind of the maintenance level of rate. Others, if you look where their starting point is, where they’re coming down to, and it’s kind of in a mix of business, you’ll have to parse through that. With the account-level strategy, we’re going to try to keep this at a maintenance level. But we’ll...

Okay. Great. And then Just one last one on workers' comp. So I mean I understand the reserve releases, but really surprised that the core loss ratios keep declining year-over-year. I think four out of last five quarters, you guys have declined year-over-year, especially if you think about like widespread reports of rate pressures and other competitors are increasing those loss picks. So I guess, just why aren’t these like leveling out or potentially rising in Hanover’s case?

Chris, this is Jack. As you would expect, we study this religiously because we’ve worked hard to put ourselves in a position where our workers' comp portfolio is very profitable, very complementary to the book of business that we write. And we like to believe because we’re more account-centric and we play in the low to lower end of middle market that our business is a little bit less maybe price-sensitive. And we’ve seen that in that some of the pricing in the market, we’re able to kind of not giving back quite as much because we’re talking about an account proposition. But at the end of the day, we are – we continue to be pleasantly surprised with something actually below benign loss trends. It’s unprecedented in our industry. We believe it’s not only a function of a stable economy but also because of some of the jobs that have been repositioned. We spent some time with NCCI and others to try to explore this and understand why the loss trends continue to be so favorable. And frankly, there’s a prevailing view that there’s some sustainability to the loss trend improvement because of the way jobs have changed over time and, to some degree, the economic stability we’re experiencing. So we’re pleased. Our results are what they are, and we – but we watch it like a hawk and make sure that if there’s any kind of change in trends, we stay on top of it.

Okay, wonderful. Thanks to answer call, and best of luck in the next quarter.

The next question will be from Amit Kumar of Buckingham. Please go ahead.

Thanks and good morning. A few follow-ups. The first question is going back to the discussion on Commercial Auto. On Page 9, the initial loss pick is 69.8%, it was 72.2% year-end 2018. And so what I was trying to reconcile is, on one side, your initial loss pick is lower, and on the other side, we’re seeing adverse development. And we’ve also trued up in the back half of the year. What exactly is the talk process? Why not remain conservative and maybe down the road take down the loss pick versus moving to somewhere around from year-end to Q1?

Yes. Amit, this is Jack. I certainly appreciate as you’re trying to follow the waterfall or the flow of the numbers. I think the better comparison, though, is to look at the full year as we reconcile loss trends each quarter and then compare that to our first quarter and look at the level of rate that we’ve been putting through the book of business in the last 18 months in particular. We feel like we’ve – we’re starting to see some improvement there that is worthy of acknowledging in our current accident year picks. I think all-in, though, we still feel like we’re being very prudent and not trying to overreact to underwriting actions or things that we’re doing. And as we showed you in this quarter, we are not – we are taking some fairly material actions on the underperforming part of our book that isn’t fully contemplated, frankly, in our picks.

So coming to Q3, you are very confident that we will not be looking at an uptick in the loss pick?

Listen, we’ve been humbled like everyone else in this line of business, Amit. So I think it would be inappropriate for us to make any guarantees, but I think we work hard at this to try to make sure that our picks are realistic, and we have some confidence in our overall picks at this point.

Got it. Switching to Personal Auto, you obviously gave good color. I’m curious, Progressive talked about it, the change in, I guess, I don’t if it’s outlook, talked about competition, how things are changing. We talked about it in detail on the Allstate call. Are you thinking about – especially as you deal with severity trends in BI, are you thinking about this line differently in Q1 versus how strong it was all over 2018 for the industry?

I’ll have Dick respond to that.

Yes. No, I think we manage this book as a portfolio, right? So we look at the Auto line and its performance and what our target returns are, which drives, of course, our pricing levels. And then, of course, we pair that with our Auto line and our umbrella line. And as we pointed out, this portfolio hits or exceeds our target returns expectations. So I wouldn’t say we’re thinking about the line differently. We’re cautious. We’ve been a consistent pricer, as I said, for over the past several quarters. And so on this BI emergence, I’d say our picks were relatively tight, and so we’re just adding more rate to that, the nine points. And we think in due time, that should make its way into the performance. But as we sit here today, when we look at our performance relative to the industry, the last couple of years, we’ve been between one to three points better than average. So it’s an important part of our value proposition. So we think of the lines in a combined passion.

Yes. And Amit, this is Jack. Again, I remind people, when we look at the Personal Lines marketplace, it really has changed over time. And you have, obviously, direct writers that have been working on low limits, monoline auto business and are now trying to figure out how they tweak their strategy. You actually have fewer national carriers that are focused on this sector and certainly fewer of those that have as robust account strategy as we do. And over the last few years, the regional carriers have actually stepped up market share against the national carriers in the non-direct space. And we stand out, frankly, as a real industry leader in terms of how our product comes to market and blending pricing sophistication and synchronizing those algorithms so that we have an account strategy. That’s a fairly complex thing to do. And once you’re there, you do put yourself in a somewhat defensive position.

Yes. Maybe the last point I’d make is, of course, we study this line in our book with some really important quality metrics in mind. We – over 90% of our book has auto liability limits of 100, 300, almost 60% are multicar accounts. So the quality mix to us is important. We think over the long term, it is going to drive a good result.

Got it. The only other question I had was on the subrogation fees. I would – is there any adjustment to the reinstatement premium included in that favorable development number or no?

No. That’s not a meaningful portion of the adjustment. It would be – that $13 million is net of all costs of reinstatement. So that’s not really a part of this particular area.

And this – the $13 million, I guess, two other pieces. I know that some of these claims are sold on, I don’t know, $0.35 on the dollar, et cetera. Can you maybe, first of all, talk about how should we think about, I don’t know, maybe the gross amount of subrogation proceeds you might have received? And also talk about how do the gross losses for all the fires you mentioned in your opening remarks, what is the pre and post subro gross loss?

Yes. We have not shared that. If you go back and read, which we did disclosures on 2017 and 2018, you know they weren’t outsized. Otherwise, they would have – we would have shared those. We didn’t have Personal Lines. If we exclude a Chaucer, obviously, there were some Commercial Lines losses. I think it would be misleading to give all of that information because of all the complexities. We certainly could give the gross loss, we could give the reinsurance, we could give the percentage, then we’d have to give whether there were any contingent payments to law firms and we’d have to show you the waterfall of how much went back to the reinsurer by claim. So what we chose to do is to share $13 million. That was net of all costs, all payments, all information, and we told you specifically which wildfires it relates to. There are a couple of other wildfires, largely Tubbs, that we have not solved. We’re hanging on to that. We’re evaluating that one closely. But I think it is the most effective information in terms of a disclosure just to really give you the net. Otherwise, it would be confusing to most.

Fair point. And then just finally and I’ll end here. On the capital management, I think maybe Chris was asking this question, in your opening remarks, you talked about opportunity versus additional deployment down the road. I’m curious, has there been any evolution in the thought process in terms of those opportunities versus when we talked about this in 2018, i.e., I know that at that time probably the thought process was that most of it would be returned, maybe a small portion gets reinvested in some sort of acquisition, which makes sense. Are you – just based on the direction of the marketplace and the pricing, has your thought process evolved where maybe the desire is to hold on to that – the remaining sale proceeds or not?

Amit, this is Jack. I’ll start, and certainly, Jeff can jump in. I would say that our thought process and the framework has not changed much at all. It’s a very dynamic time in our business. We never know when opportunities are going to present themselves. I think we were very disciplined out of the gate to say that we are not going to do something outsized that would – or certainly would come outside the criteria that we set that would make an inorganic opportunity be beneficial to us. So we’re playing out the strategy that we articulated. And so as we move through the second quarter and we finalize the results of the ASR outstanding, we’ll revisit where we are. We’ll certainly know what’s in the pipeline in terms of any opportunities, have a better sense of what our growth looks like in the second quarter, and we’ll move to the next phase.

And any – sorry, go ahead.

Go ahead. Do you want to finish the question, Amit?

Yes. Just one, and I’ll stop here. There hasn’t been any change in the time line, right? I mean we get through Q2, then we get through the wind season, and I know in the past we talked about potentially rethinking this year-end. This is not getting pushed into 2020 is, I guess, what I was trying to ask.

I would say there has been no change in our thinking in terms of time line. We haven’t been specific in time line. We’ve been giving you some indication without specificity. Again, we’ve delivered $450 million back to shareholders. There’s $400 million remaining to be redeployed. The nice thing about it is we’re finishing the ASR. We’ve been studying it very carefully and thinking about our options, and we get to wait and see how things are playing out, what opportunities there are before we actually pull the trigger and share that with you. But there has been no change in our timing, our thinking or our commitment to you to redeploy it in short order.

Perfect, thanks for all the answers and good luck for the future.

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to turn the conference back over to Oksana Lukasheva for her closing remarks.

Thank you, everybody, for your participation today, and we are looking forward to talking to you next quarter.

Thank you. Ladies and gentlemen, the conference has concluded. Thank you for attending today’s presentation. You may now disconnect your lines.