Good day, and welcome to The Hanover Insurance Group's Fourth Quarter Earnings Conference Call. My name is Anthony, and I'll be your operator for today's call. At this time, all participants are in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

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 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 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 impacts, 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.

Thank you, Oksana. Good morning, everyone, and thank you for joining us. Today, I'll begin with an overview of our performance, discuss winter storm Elliott and ways to address future impacts of winter storms, update you on progress we've made in the fourth quarter to recapture our top-tier underwriting margins, and I will conclude my remarks with a review of our 2022 strategic accomplishments and the important strides we made this past year, strengthening our competitive position and executing our winning strategy. Next, Jeff will review our financial and operating results by segment as well as our balance sheet and provide an update on our outlook and longer-term financial expectations. We'll then open the line for your questions. For the full year, we delivered operating income per share of $5.53 and an operating return on equity of 6.7%. Both reflections of the inflationary economic environment and the magnitude of the cat activity in the fourth quarter. From a growth standpoint, we generated net written premium increase of 9.7% for the year, with strong contributions across all segments. Our full year combined ratio, excluding catastrophes, was 92.1%, toward the lower end of the guidance we provided on our third quarter earnings call in November. Given the frequency and severity of catastrophes in recent years, including unusual atmospheric events like Elliot, I'd like to take a minute to highlight the work we've done in the past and most recently, in terms of the strategic management of our catastrophe risks. We've built a strong track record in addressing catastrophe risks, in particular, hurricanes and convective storms, employing disciplined underwriting strategies augmented by data, analytic tools and technology. As a result, our share of catastrophe losses over the last five years relative to the domestic P&C industry has declined significantly. Additionally, our catastrophe losses…

Thank you, Jack, and good morning, everyone. I will begin by reviewing our consolidated results and discussing our segment operating performance in more detail. Next, I will update you on our investment portfolio and capital position. And then, I'll close my prepared remarks by providing our guidance for 2023. In the fourth quarter, we incurred catastrophe losses of $190 million or 13.9 points. Winter storm Elliott accounted for approximately $165 million or 12.1 points of the total losses. Over 70% of the losses from Elliott were within our Core Commercial property book. Properties with the largest losses were likely unoccupied for an extended period of time during the holiday week, which we believe may have delayed the discovery and remediation of water damage that resulted from burst pipes. Catastrophe losses aside, the fundamentals of our business remained very strong, and loss trends were within our expectations as evidenced by our ability to deliver ex cat results in line with the guidance we provided on the prior quarter call. The enterprise combined ratio, excluding catastrophes, was 94.1% in the fourth quarter, bringing the full year ratio to 92.1%. For the full year, we recorded favorable prior year reserve development, excluding catastrophes, of $20.6 million or 0.4 points, driven by specialty lines and continued favorability in workers' comp. These results underscore the success we've had building a solid balance sheet over the past several years. We entered 2023 in a really strong position and with heightened vigilance in assessing liability trends. We delivered an expense ratio of 30.9% in the fourth quarter, which reflected a strong improvement from the prior year quarter. The full year expense ratio came in at 30.8%, an improvement of 50 basis points from 2021, primarily driven by the impact of fixed cost leverage from growth as well…

Hey, thanks. Good morning. My first question is on loss cost inflation, and I appreciate all the great commentary. Maybe you can kind of give us an update -- I think you did, but maybe elaborate a bit more about whether you're seeing a pickup, not just on the property side, but I heard medical inflation mentioned to bit and some peers have talked about liability inflation kind of moving up a bit as well. But just curious if you -- if there's anything -- any more color you can offer other than the property side, which I think we better understand and we're seeing rate accelerate there to get in front of that on the more property side? That's my first question.

Thanks, Mike. This is Jack. I appreciate the question. I think we are not seeing any material lift in medical inflation at this point, while we're watching it very carefully. We, obviously, look for that not only in the workers' comp line, but also in the liability lines to see if we're starting to see some eventual medical inflation, which we do expect to evidence itself eventually. On the liability trends more broadly, we continue to monitor and see some evidence of the litigation environment and elements of social inflation starting to show up, and we've tried to stay on top of that from a claims analytics standpoint. I think we've captured that, frankly, in our picks. So, we're not seeing anything that we haven't contemplated to date. But like any prudent underwriter, we're watching it like a hawk and making sure that we have the right analytics in place to see what's on the horizon now that the courts are really fully up and running, and those cases are making their way through.

As far as expectations are concerned or guidance for 2023, we've incorporated increased lawyer involvement and increases in some medical procedures and the costs there on into those picks.

On the property side, not taking into account reinsurance costs. I know you guys have -- sorry, the company has a rolling reinsurance program. But is there any changes in what you're seeing in terms of the property inflation side in terms of maybe a step down from what's been historically high levels trailing 12 months?

I don't think we've experienced a material step down as of yet. And so, we're not certainly reflecting that in our picks. We're watching and hoping for that to eventually show up in terms of something more than, say, the cost of lumber and things that have come down a bit, but not -- we haven't seen a material dip yet. I think overall, related to our property trends is we were glad to see some stabilization in some of our property large losses, particularly in CMP, which we anticipated after seeing a little volatility earlier in the year. But overall, we have a pretty robust pricing environment, and we've done a lot of things from an underwriting standpoint to try to get at some of the volatility we've seen and try to stay ahead of this as much as possible.

We're getting a lot more rate than we are in terms of loss trend across virtually all of the different segments. And the assumption that we've made through 2023 is inflation remains high and then it begins to -- the increase in pricing begins to soften a little bit as you get later in 2023.

Okay. My final follow-up is just thinking about the long term, I know this is long-term return on equity, I guess, targets that you put out about 1.5 years ago at the Investor Day of 14% and kind of being cognizant, we can see the '23 guidance, what it implies a lower level, and we know that the inflationary environment is somewhat elevated and you'll be getting in front of it. But just curious, one, has the world changed a lot in the last 1.5 years that maybe we should be thinking about a different long-term number puts and takes? And also, just curious, ultimately, when we and investors look at kind of the proxies and compensation targets for upper-level decision makers, should we expect a step-up in targets to given that the 14% ROE is higher than current expectations over time? Thanks.

So, Mike, we have a lot of confidence in the long-term trajectory and the drive over the period of time to the 14%-plus ROE. 2023 will be very solid results. And you're right, if you were to do the math, think something like the guidance would imply 11.5% to 12% ROE, and that's not where we wanted it to be, but it's solid. But as you think about the rate and how it earns in and if we think about 2024, for 2024, we are every bit as strong as we would have anticipated in the Investor Day, if not stronger, when you bake in investment income. So, we're still very, very optimistic about the trajectory. But clearly, 2022 and even into '23, are not exactly on that line, but I think we're perfectly fine with that.

Any comments on just will the firm -- the firm's compensation structure given we're 1.5 years in, does it reflect a step-up in ROE over time?

Well, remember that particularly for our senior executives, we're heavily influenced in our compensation by long-term stock. So, I would argue that our performance, meeting expectations of investors is heavily weighted in our compensation scheme. But I think our Compensation and Human Capital Committee regularly intersects with our -- with the management team to set appropriately aggressive goals and to adjust those as the environment starts to improve, and we have high expectations that we're going to achieve those longer-term targets like we said, and our goals will reflect that.

Okay. Understood. And maybe I'll sneak one last one in. Just in terms of kind of reappraising property values to reflect inflation over the last couple of years, is there -- I don't know if it's baseball inning analogy in terms of kind of reunderwriting on the property side of the portfolio, maybe on the commercial side that you could kind of give us some insights into? Is it kind of latter half baseball innings or still a lot of work to do there? Thanks.

Well, I'll just say a quick thing about this. This is Jack, and then maybe let Dick get his perspective on the table. But I would say we're pretty far along in our overall property re-underwriting and repricing, but the environment is dynamic. And if we've learned one thing over the last few years, including the pandemic implications as well as the inflationary and supply chain pressures, some of the weather dynamics going on is that our job is never done in terms of assessing those trends against our portfolio and making sure that our underwriting and our pricing reflects those changes. So, I'm confident that we know how to do that and that we're making all the right adjustments. But I think because of the dynamics, Mike, it's hard to say what inning in the game is. I think the game continues, and it may be more like a soccer match where you have to just keep going until the PKs are done. But Dick, do you want to build on that?

No, exactly. I would say we're leaning into the ITV increases throughout this entire next year, and we'll watch it closely, right, both on the building values, the contents, business income. So, we've meaningfully increased what sort of rolls on to each policy upon renewal. And so, we'll see that -- we're just going to continue to put that at a pretty high level and watch the actual loss cost. But then also, as Jack said, we took a hard look at where within our book, we might be -- there might be undervalued properties. And so, you get at that in sort of a one-time basis where you analyze where ITV may fall short and you make adjustments. So, we're pretty far along on that process. And just -- this is one that will be in front of us absolutely for the next 18 to 24 months.

Thank you for the insights.

Thank you, Mike.

Our next question will come from Bob Farnam with Janney. You may now go ahead.

Hi, there. Good morning. A couple of questions on the guidance. So, the first off is the cat loss ratio, 5.1%. That's kind of low relative to the past few years, probably low relative to the average over the last 10. So, I'm just kind of curious if that's just because of the actions you've been taking to kind of reduce the volatility in cats.

If you look at that over 10 years, that's definitely the case. So, we've deconcentrated properties in order to reduce that. So, the earlier periods in the 10 years, I think, had a little bit different mix of business. We've done our modeling. We've increased the load. We've increased the perils. We've done a lot of work on it, and I think we're comfortable with the 5.1%.

Okay. And on the premium growth, so it sounds like it's probably going to slow down a little bit relative to 2022. How do you see the growth in each segment? It sounds like from your comments, you're going to see maybe a little slower growth in Core Commercial because of underwriting actions. Is that the right way to think about it?

Hey, Bob, this is Jack. I think overall, we're trying to reflect our premium guidance, if you will, to make sure that we're emphasizing that margin recapture is more important than the last point of growth. That said, we're in a pretty dynamic environment. And if we can improve our pricing and get done what we want to do on the margin with some of our underwriting actions and the market stays as firm as it is, then the growth may surpass that. But I think, at the sector level, PL, we're making material changes in Personal Lines that may move our PIP growth down. Obviously, the pricing, we'll work against that from a growth standpoint and keep the growth from going down too low. But we're certainly going to see less growth in Personal Lines in 2023 than we saw in 2022. And I think you're right, within middle market in Core Commercial, because of the limits volatility that comes with that business, we're going to be particularly focused on adjusting our growth and making sure that the growth is appropriate until we get more confidence in some of the pricing over loss trend. I also would be remiss if I didn't say that there's a number of parts of our portfolio across the Specialty Lines, in Small Commercial and even sectors within middle market where we're very bullish. The combination of the pricing environment and our current profitability and our headroom with agents allows us to continue to stay on the offense in those parts of our portfolio. So, really, that mid-single-digit guidance is a combination of all that, but with an emphasis on the fact that margin improvement trumps the last point of price in terms of our goals.

All right. Okay. Thanks for that. And that brings up another question for Personal Lines, as the rates keep going up, you said your retention seems to be holding up pretty well. Is there a point where you maybe pull back a bit if the retention drops too low? I'm just trying to get -- curious if there's a certain level of retention that you would say, all right, maybe we pushed the rate too much?

Well, let me let Dick comment on that, because I think if you watched us over the last few years, we've managed this particularly well in a pretty dynamic pricing environment. And so being an account writer, I think that gives us a little bit more stability than those that are writing monoline home and monoline auto tends to stabilize retentions. But Dick, why don't you share a few things.

This is at the heart of our state management and actuarial science and what we spend every waking moment of the day looking at price, the price retention trade-off, by state, by customer segment. We have profit pools that we obviously know of and want to protect. So, we watch those retention metrics very closely, and we make our pricing increases appropriate such that we protect those. So, I wouldn't put a particular number on it per se. And as Jack referenced, we're proud of our capabilities in this regard back in the pandemic times when others were reducing rates, and we were sticking with our higher level rates, we did see retention start to drop a little bit and made adjustments and we think quite effectively. So, with our account strategy, we like retention in the -- certainly the mid- to high-80s. So that's certainly a barometer that we'll watch closely.

Right. Okay. Thanks for that. And probably one last numbers question for Jeff. Just -- you keep mentioning that the new money rates are in excess of expiring. So, can you just give us what the actual new money rate is these days?

We haven't shared that. I guess treasuries are moving around so quickly, but I would suspect it's somewhere in the 4.75% range, something like that or to 5%, somewhere in that range.

Okay. Great. Thanks for the questions -- thanks for the answers, guys.

Thank you.

Thank you, Bob.

Our next question will come from Paul Newsome with Piper Sandler. You may now go ahead.

Good morning, guys, and thanks for the call, all the help. I am getting a question from investors today that sort of surprises me, but I wanted to ask it is more of a philosophical question, maybe a little bit [indiscernible] question, which is -- it sounds like you folks are, what I would expect, focusing primarily on profitability improvements. I guess philosophical question is, philosophically, why do you think in this part of the cycle, you should be -- you shouldn't be focused more on top-line growth in the various businesses? I think this is mostly coming from people looking at Personal Lines where they think price increases are pretty heavy and maybe we're seeing a reduction in competition. But just philosophically, how do you guys think about that?

Well, Paul, I actually appreciate the question because I think that is the appropriate question given the business we're in. And I think of growth really over a multiyear basis. The best underwriters in our business are able to generate good returns and grow ahead of the market over a period of time. And that is our aspiration. You saw that in our September 2021 aspirational goals. I think this year, we have the proper humility coming out of 2022 that the combination of hyperinflation and a challenging storm in the last two weeks of the year caused us to want to be a little bit more cautious with regard to growth rates and make darn certain that we can get our margins back on track and be a top-tier performer like we've been accustomed to being. And we know we have plenty of headroom. So, I have complete confidence that as we see our margins improve and the environment play out the way we hope it will, that we have all the capability as a firm to elevate our growth back to where we were, and we can balance growth and profitability quite well as a firm.

Paul, we have a lot of confidence in our ability to deliver on the growth goals that we set out there over a five-year period. And just as an example, for the five quarters since the September 2021 Investor Day, we've averaged about 10% growth versus the 7%-plus that we put out there. So, if there's a period of time where we're slightly below the 7% to make sure our margins are great, we're perfectly fine with that, as Jack just said.

And maybe just a couple of additional thoughts on the broader competitive environment across your businesses. It isn't really clear to me that people are actually -- competitors are actually pulling back in material places. It looks kind of like it may be a pretty mixed environment that's just -- and basically at the same place with various lines may be a little bit less or a little bit more competitive. Is that a fair assessment? Or do you really think that given all the craziness and volatility of earnings and the big losses that there's some material areas where people are actually pulling back and just the competitive environment is getting better?

I think that overall, we are in a reasonably disciplined marketplace. I think we see -- and as we predicted, there will be many cycles based on lines of business and sectors of the business. I think you saw on the extreme and some of the tougher specialty areas, there was a real hard market and some of that starts to subside a little bit, but already signs that may be in areas like med mal that may reaffirm. Relative to our portfolio, I think we see the same thing. If you look at Specialty, we have areas of the Specialty business that are performing extremely well. but we're still getting pretty good pricing. And traditionally, what would happen is that you would see some hyper competition developed. To me, that means that there is the utmost respect for what could be around the horizon and acknowledging that liability trends are still evidencing themselves, particularly coming out of a pandemic. So, when I put all that together, Bryan, maybe -- I know you're on the line, maybe you could add in your two cents, but Specialty is probably the best example for me where the market is still pretty stable and firm despite some pretty good margins by some of the better companies.

Yes, Jack, glad to weigh in. Look, I would say, and I would agree with you that there's enough out there in terms of the potential for social inflation, the potential for rising and the rising insurance -- reinsurance costs that I think folks are paying attention to that. And that's the way we're thinking about it. So, I feel good that we were able to achieve the kind of growth that we did, right, 11.2% last year, while continuing to appropriately, is the way I would describe it, push on rate, whether it's on the casualty side or on the property side. We continue to push, monitor our results and adjust accordingly. So, on the property side, we continue to push and that is holding, and our retentions are holding quite nicely. On the casualty side, we continue to push as well. And so, we'll watch that throughout the year. But the -- our competition is not creating an environment for us where we feel like we have to deviate from that right now. And I guess the only other thing I would add is, our book composition is sort of an interesting one given that it skews towards middle and smaller risks with a lower limit profile. And so those attributes are also serving us well. So, I think we're in a space where we can continue to push, we can continue to watch, and we're in a position to adjust should we think it's appropriate given the rate on the year-on-year rate increases we've gotten.

Thanks. Appreciate the help as always. Very much appreciated.

Thank you.

Our next question will come from Grace Carter with Bank of America. You may now go ahead.

Hi. Considering the catastrophe loss guidance for this year, I was wondering how the outlook for midyear reinsurance renewal factors into the increase? And just kind of if we should expect a bigger step-up in the second half of the year compared to the first half?

Grace, we went through our casualty renewals, as we said, and that was unremarkable or uneventful. We did a lot of additional buying last year. We added to the cat tower. We also put in place a cat bond, which has a three-year program on it, assuming we don't hit it, which is highly unlikely to hit given it just at the very top. We have assumed a firm market based on what we see and what we read for [one-one] (ph). I suspect we'll be in good shape in getting it done since we've never impacted our treaty since Katrina. But we buy the program on a three-year rolling basis. So, we're always pushing out a third. So, we've been conservative in how we've set our assumptions, but I'm feeling pretty good about it.

Thank you. And one more quick one. As we consider, I guess, casualty loss cost trends being under more scrutiny, have you all noticed any difference in umbrella loss cost trends in the latter part of the year?

Well, I think umbrella, Grace is I think it's hard to look at those losses on a quarter or even a half year basis, because they're kind of the law of small numbers, very few claims obviously produce your umbrella losses. I can't say that we've seen any huge material changes. But like many in the industry, we are observing more cases going to trial or staying longer in the litigation process. We are seeing some awards that appear to be above traditional levels, some of which get resolved and appeal, others don't. So, we're clearly monitoring the true implications of social inflation, which we believe exists, but we're not seeing a tremendous delta, if you will, on that aspect of our portfolio yet.

Thank you.

Thanks, Grace.

[Operator Instructions] Our next question will come from Meyer Shields with KBW. You may now go ahead.

Great. Thank you very much. Two quick questions, I guess. One, we've got the expense ratio guidance, obviously. But I was wondering if you could talk about the impact of inflationary pressures on incentive compensation in 2022? And how we should think about that component changing in 2023, 2024?

Meyer, are you talking about employee incentive compensation or you talking about agent incentive compensation?

I guess both, because I assume that they are going to both be included in the expense ratio. But if I'm thinking about that incorrectly, please let me know.

Sure. So, with respect to 2022, one of the reasons that the expense ratio was 50 basis points better than it was the year earlier or 30 basis points better than the guidance was both of those elements were impacted by Elliott and were impacted by inflationary pressures in general. And they follow the fortunes of the underlying firm in both cases.

So, does the 30.8% anticipate normal levels of incentive comp?

Absolutely. So, obviously, everything gets re-planned and re-baselined based on the guidance that we have. And so, the 30.8%, while flat to 2022, is a 50 basis point improvement over a two-year period or a 30 basis point improvement over the 2022 guidance that we gave.

Okay. That was helpful.

On the agency compensation side, as we look at that every single year, there's puts and takes on the direct compensation as well as the profit sharing or bonus plan calculation. So, you'll see some ups and downs on that, but that's embedded in this expense ratio.

Okay. No, that's perfect. That's helpful. The second question, and I don't know if this is meaningful, but if we tease out the exposure unit growth from the pricing and rate changes in Core Commercial and Specialty, it seems like exposure unit growth is decelerating in Core Commercial and picking up in Specialty. Is that random? Is there something actually going on there? And should we expect that to continue going forward?

So great question, actually. If you look at our pricing overall in Core Commercial, we have made progress in terms of getting rate up and holding it stable. We expect that, that will continue. Exposures on the property side will continue to go up. We are ratcheting up insurance to value appropriately and making sure, as Dick said, that certain occupancies and business types get reflected more than just the general increases. The casualty exposures for many classes are driven by payroll and/or sales, and those will fluctuate, particularly if the economy hits different sectors in different ways. And we saw a little of that frankly, in 2022. So, we try to reflect that. We're focused mostly on rate in the casualty lines because of that, because when those exposures come down, generally loss costs tend to follow that. I think in the Specialty Lines, I think, for the most part, our exposures have been growing because there is some property also in our Specialty portfolio, but exposures aren't as sensitive to those payroll and sales. And so, I don't think you're going to see that same kind of up and down, if you will, on the casualty side of Specialty.

Okay. Should we infer that there's maybe more not property exposure but property premium coming into the mix in Specialty relative to Core Commercial?

No, I would not come to that conclusion. I think it's just less downside on some of the casualty exposure, particularly when you think of workers' comp or the sales on manufacturing and retail and wholesale, it just doesn't have that dynamic in it.

Okay. Perfect. Thank you so much. That's very helpful.

Thank you, Meyer.

This concludes our question-and-answer session. I would like to turn the conference back over to Oksana Lukasheva for any closing remarks.

Thank you all for all your questions today, and we're looking forward to talking to you next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.