Good day, and welcome to The Hanover Insurance Group's Second Quarter Earnings Conference Call. My name is Keith, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note this call is being recorded. I'd now 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 impact evolving insurance behavior emerging from the pandemic and other risks and uncertainties such as severe weather and catastrophes that could affect 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, and good morning, everyone. Thank you for joining us for our second quarter call. Changing weather patterns and persistent inflationary pressures have had a significant impact on our financial results during the first half of the year, prompting us to further accelerate our margin recapture plan, including additional catastrophe underwriting actions. The competitive landscape is changing rapidly in response to more frequent and severe convective storms and the continued inflationary pressures. In response, we are leaning into the hardest market we have seen in property, particularly in Personal Lines as we execute on our margin recapture plan. We are determined to fully leverage our deep market knowledge, underwriting expertise, enhanced tools and strong agency partnerships to address the unprecedented loss volatility in Property Lines of business. Our progress to date, our strong market position and our capable team give me the utmost confidence in our ability to succeed and deliver on the targets we conveyed at our Investor Day in 2021. We have a long history of successfully navigating challenging environments, and we are confident in our ability to do so going forward. With that theme in mind, I'll begin today's call with my perspective on the current dynamic environment and the significant catastrophe losses we experienced in the quarter and a review of the actions we are taking to restore property profitability. As part of our margin recapture and CAT management plans, including new initiatives we have underway. Jeff will review our financial and operating results in more detail and provide an update on our 2023 outlook, and then we will open the line for your questions. The catastrophe losses we and the industry have experienced in the second quarter are extraordinary. In particular, the record-breaking hail storms that impacted the Midwest and Southwest. Hail damage…

Thank you, Jack, and good morning, everyone. Let me begin with a high-level overview of our results and then discuss the performance of each segment in more detail. Significantly higher-than-expected catastrophe losses, particularly impacting Personal Lines resulted in a combined ratio of 111.3% for the second quarter. As noted in our pre-announcement, catastrophe losses in the quarter totaled $262 million or 18.5% of net earned premium. Stemming from 19 convective storms across multiple states. Over 70% of the losses were driven by hail peril. Putting aside CATs, our earnings were in line overall with our expectations. Lingering inflationary pressure in Personal Lines was offset by higher net investment income and strong underlying performance in both Specialty and Core Commercial. Prior year reserve development was immaterial in the quarter with favorability in Specialty offsetting unfavorable development in Personal Lines. The Personal Lines environment has resulted in some pressure on liability coverages, particularly auto bodily injury and umbrella, which is reported in home and other. Umbrella is inherently volatile, and we are monitoring it closely. However, we continue to be very pleased with this product offering, which remains one of the most profitable in Personal Lines. In auto, we preemptively increased our current accident year loss selections for bodily injury in light of our recent experience and broader industry trends. In the same vein, we are also seeing slight pressure within Commercial Auto liability, which offsets the continued favorability in workers' compensation. Specialty experienced continued favorability in the quarter reflecting lower-than-expected losses in our professional and executive lines claims made business. Our team continues to do a very good job in managing expenses delivering an expense ratio of 30.6%, an improvement of 20 basis points from the prior year period. Our results in the first half of the year position us well…

[Operator Instructions] And the first question comes from Paul Newsome with Piper Sandler.

I guess any more details about -- that gives us increased confidence in that sequential improvement, particularly in the Personal Lines underlying would be very helpful. I get the rate and I get the effects, but I think we've seen a lot of folks not quite make it in terms of improvement because of all those inflationary factors. I guess -- confident -- more confident to come would be helpful. But also, could you talk about sort of like as we go through the quarter, are we still seeing sort of an acceleration overall of inflation? Or maybe you could just talk about your inflation [indiscernible] as well, particularly in Personal Lines.

Paul, this is Jack Roche. Thanks for your question. And obviously, the Personal Lines loss trajectory and our acceleration of pricing and terms and conditions are really a top priority for us in addition to our CAT management efforts. To answer your first question, I think that the loss trend environment has been difficult for the industry to fully capture coming out in the post-pandemic environment. We're all trying to understand how the frequency trends and the severity trends are presenting themselves. There's a lot of good work being done from a claims analytics standpoint to separate out the various different types of claims and not use the traditional frequency and severity methodologies as our exclusive way to get after that. So I think what you saw in this quarter is that we acknowledge that even after the reset in midway through 2022, we needed to acknowledge that there was some persistency in the inflationary trends. And so we made those adjustments. We're committed to making sure that we don't get behind and that we do the best we can to acknowledge the loss trends that are presenting themselves. We do expect that inflation is peaking or is going to peak here. There are some indications that, that's starting, but we're not going to count on that in terms of how we attack the profitability challenges that we have. And I guess the best thing that we can do that I think you're seeing us do is to accelerate pricing to the next level on both home and auto. And relative to the CAT exposure, get even more emphatic about the changes that we need to make in order to address that aspect of our Personal Lines profitability.

Well, given the increases in price that we're getting that are really accelerating and some of the anomalous nature of what happened in the second quarter with fire losses, it would be very hard to imagine a scenario where we're not seeing sequential improvement in Personal Lines.

Great. I'm sure other people will ask about your Personal Lines questions, so maybe I'll ask a Commercial Lines one. Obviously, results have held up there much, much better than Personal Lines. You are -- are you -- could you talk a little bit about sort of how you think of rate versus inflation in those businesses as well, not so much for the next quarter, but as we're looking out in the next year or past. Do we get some help on those businesses? Or is it all sort of about top line growth at that point?

This is Jack again. I'll say a couple of overarching comments and then let Dick speak to some of his perspective there. I think the headlines for us are that because we do have a lot of property in our Core Commercial mix. We've been challenged more than some in terms of the CAT and the overall property volatility. The upside of that is that we are able to really lean into a firm market on the Commercial Lines property side and make some meaningful adjustments, not only in pricing but also some underwriting and terms and conditions there. And so I do think that pricing is still the #1 lever that we have, but price over loss trend, we believe, is very much going in the right direction. Dick, do you want to follow up on that?

Just to amplify, I mean, Paul, we see the pricing environment as kind of remaining steady. We feel with the work we're doing and the portfolio we have, we'll be able to persist at the levels that we're currently experiencing. We're pricing ahead of loss trend, except for in workers' comp, which is an industry trend. And then as Jack has referenced, you layer on the underwriting actions that we are going to take, although we're mostly through that. we constantly scrub parts of our portfolio. So put all that together, and we feel like we can stay ahead of loss trend as we are right now.

And I guess maybe the last thing, this is Jack again. The actions that we took, particularly in middle market, but to a lesser degree, in Small Commercial are clearly working, right? The underwriting on some of the large loss volatility that we had, we addressed pretty emphatically over the last several quarters, and we believe that a good portion of what we experienced in the second quarter shows that underwriting still matters.

The next question comes from Mike Zaremski with BMO.

I guess first question on the ground-up study on your catastrophe, I guess, profile and kind of thinking through kind of your expectations in the future. Just curious like you did a good job. I thought of giving us some stats on this being an anomalous event, especially the Michigan stats. But I guess just stepping back, is there just a -- would Hanover have just more concentration in certain geographies that would -- that just inherently makes your CAT losses a bit less predictable given concentration? Is that something that makes sense in the relevance of the catastrophe study?

So Mike, thanks for that question. This is Jack again. I think we certainly are taking the current catastrophe trends very, very seriously. But we're thinking about it broadly. And to answer, one of your questions in there, the most recent storms have clearly found our portfolio in a disproportionate way. There's no denying that, whether it be winter storm Elliott and how it presented itself or these hail storms that were heavily in the Midwest and particularly in Michigan. I think the only fair way to answer the question is when you look at the broader catastrophe environment, perils, geography that we will certainly benefit when the storms start to hit some of the other areas that they traditionally hit. We've proven that we've done some really good work on the property aggregate management relative to the hurricane perils and even for some of the more traditional convective storms. We've done reasonably well when it comes to things like wildfire out West. And so -- that's why the ground-up analysis is so important is that we're not going to play whack-a-mole with the most recent storms. We're taking very deliberate actions towards how we can improve our vulnerabilities around winter storms as well as these most recent hail storms, but our work goes to more broadly looking at those CAT trends and expecting that the weather will continue to be challenging but not as challenging as it's presented to us in the last three quarters.

Just to add a thought there, Mike. Clearly, the model has produced an insufficient results, at least in recent times. And so I don't want to preempt the process, which is a very detailed process, but we're going to be supplementing the industry-leading models that we use, and we're going to be considering how we'd wait different time periods with that, whether we want to use the traditional backward looking or we want to weight some more current information to make sure that we're as contemporaneous as possible.

Understood. And I'm just curious, so depending on the outcome of this process, well, base case, it will help you produce kind of, I guess, expectations on catastrophe losses and profitability. But with this kind of preempt potential, I guess, portfolio changes on the margin? Or could it be bigger changes to the portfolio depending on the outcome of the study...

We're already...

Anything strategic other than just kind of fine-tuning. Could this mean like a bigger transaction or something like that?

Mike, we're already pricing for a CAT level that's meaningfully above what we had built into our plan. It just seems to necessitate that given the current environment. But as we go forward, we're really optimistic about our ex-CAT results. We're really optimistic about our NII and the growing impact that, that has. So even with a meaningfully higher CAT load, we still have a lot of confidence in our ability to hit the long-term targets. But surely, we'll look at the individual components of the portfolio and make some different decisions as to disaggregating or focusing capital in different directions from time to time.

Okay. And my follow-up is on specifically Core Commercial lines. Can you kind of maybe let us know how you guys are thinking about the profit recapture plan within this segment? It seems like there's been -- well, we can see there's been some improvement on an underlying loss ratio basis. And we heard your comments about the fire losses, too. But it looks like there's been some improvement, and it feels like maybe you're not pushing for as much price as well. So are we kind of in the later innings in Core Commercial in terms of the initiatives you've been taking over the past year?

I think the way I would answer that question is that we have executed extremely well against the initiatives that we put in place around looking at some of our kind of most CAT-exposed areas, particularly in middle market, we spoke about a $25 million group of property oriented business that we took pretty flawless action on. But we continue to go forward. And relative to pricing, we see some refirming in the property lines, and we are a beneficiary of that given our mix as I said earlier. So we are leaning into what we consider to be a very firm market in the Property Lines and continuing to diversify our portfolio and really laser in on types of exposures that present themselves more to the CAT peril. And I think we talked in the last call about educational institutions and some commercial real estate that are a little disproportionate in terms of their exposure to some of the CAT perils. And so we've taken particular action on some areas of our portfolio where we just think the risk/reward trade-off isn't as good as it's been historically.

And the next question comes from Bob Farnam with Janney.

A couple of questions, more on the competitive environment in Personal Lines. So we've seen some kind of well-publicized pullbacks from the larger players from California and Florida, where not -- I'm just curious, in your footprint, are you seeing anything like that of the larger players pulling back from certain types of risks? And is that presenting an opportunity?

Yes, this is Jack. I'll say a couple of things, and I know Dick has a lot more to say about this, but the short answer is yes. We see that in the territories that we -- the 20 states that we compete in, several of them are kind of a mutual kind of regional carrier dominated and others are more of a mixed bag of public and mutual companies. But we definitely see particularly some mutual companies ceasing new business, meaningfully changing their pricing not only in the renewal book, but their pricing acceptability. So our agents are clearly feeling a hard market across our footprint. And as we said earlier, we're leaning into it because we need to improve this part of our business.

Yes. Just to amplify that, I would say, almost every state we're in, we see some action from multiple competitors, both stock companies and mutual companies that could come in the form of tighter coastal controls, certainly pull back in new business and absolutely pushing tighter terms and conditions. So -- which is why we have a lot of confidence and the aggressiveness and speed with which we're going to be moving. And of course, we think this is where our strategy will help us with a narrow distribution and tight relationships with our agents. We do -- we do communication exceptionally well at the agent level and the customer level. So we're -- you're not going to see us just send out a broad-based memo. We'll be very thoughtful about the way we approach how we're changing our products.

Right. And the second question I had was -- you may have already answered part of it because my second question was addressing adverse selection. So if your rate increases are in excess of what maybe what others are charging or increasing? Are you losing some of your better customers because there's more advantageous to move to the better priced products, but it sounds like you may -- may not because the competitors may not be there to offer lower rates. So long-winded question is just basically how you're dealing with adverse selection when you raise [indiscernible] much as you are.

Yes. I can assure you that we evaluate regularly not only our renewal book in terms of what's leaving us, but have very tight controls and monitoring of our new business. And the short answer is that the quality of our renewal book is very strong. We are happy to -- with the trade-off of the renewal and pricing at this point and we're accelerating pricing, don't see any adverse selection in that process. And from a new business standpoint, as we said in our prepared remarks, we're tightening our underwriting guidelines and accelerating our pricing, in some cases, above our renewal book and the market is still flowing new business our way. So we can be very selective in the short, short term, we're just making sure we don't over ingest new business of any flavor until we have confidence that we're on the right financial path. So we're going to be very conservative, but the market is very much cooperating with us.

Yes. This is where highly segmented analytics play an important role, right? We look at our retention at a very granular level by customer type to make sure that we're not losing the kinds of customers that we know are high margin.

And the next question comes from Grace Carter with Bank of America.

You had mentioned in the presentation some upward tweaks to loss cost trends in certain Specialty liability lines. I was wondering if we could get some more color on which lines in particular were impacted and if there was any corresponding impact on the Core Commercial book?

Yes, Grace, thanks for the question. This is Jack. I know Bryan will chime in here quickly. I think overall, while we're dealing with a lot of property issues of late. We're also monitoring the liability trends very, very tightly. And in that context, Bryan and his team as well as the Core Commercial team are trying to make sure that we stay very prudent in our current accident year picks. So Bryan, you can kind of respond more specifically within the Casualty Lines within Specialty.

Yes, sure. And as Jack said and Jeff pointed out in his comments, right, we're just being very thoughtful about where there is a potential for increased liability development. And so in those lines, right, whether it could be in our management liability lines, it could be in some of our E&S lines, it behooves us to take a bit more conservative of a position, increase our loss selections somewhat. In the end, I would say that where it comes in for us in terms of pricing and in terms of the loss ratio is on plan. But I think it's thoughtful for us to at least make some adjustments in the environment.

And I guess going back to an earlier question about rate and pricing and Core Commercial. It looks like rate and pricing were relatively flattish this quarter relative to the first quarter. And we had seen quite a bit of acceleration at some peers. I was just curious if we should think about that as maybe a function of mix by line or geography or account size and just if we should expect some reacceleration going forward given the property component of that book.

Grace. As I suggested earlier, I believe that the property lines within commercial broadly are further firming. So I think the answer is, yes, going forward, we're certainly pushing more rate and we see the market following that. But time will tell as we go through the next couple of quarters. Dick, I don't know if you have any specific...

We haven't spoken specifically about Commercial Auto to the other line, which also continues to be hard and requires us to continue to lean in there. So our objective is to accelerate pricing in Commercial Auto as well. So I think if you put those two together and -- you're going to see certainly a step forward, not a step backwards.

I will remind you, though, that we have tended to be a little bit kind of ahead of the market and maybe a little bit more disciplined with our Core Commercial lines pricing. So I'd like to think that you're seeing some people kind of come back to us. And the question is, where does it go from here? We think it goes up.

And the next question comes from Matt Carletti with JMP.

I just want to ask a question on some of the actions you're taking on Personal Lines. I think the market and you guys as well have been pushing rate for a while, and I think we're pretty familiar with whether it be kind of regulators slow playing things and then how the written and earnings patterns work. So the question is around some of the nonrate actions you're taking. And can you just give us your thoughts on, kind of, how regulators might look at those differently. If it's an easier process or a tougher process in some of the larger states you're exposed to? And then kind of if they get into the book any more quickly because I know you got to write them in, but it seems like they -- once they're written in is not an earned period that you really have to wait for, they kind of take effect immediately.

Yes, the nonrate actions that we take, frankly, are within our control they generally don't require any kind of approval from the state. It really is tightening down your underwriting appetite. You might nonrenew more business, which is something we're doing when we see losses, we'll -- we can tighten the nozzle on the quality of business coming in through the comp raters and our top sales platform. So those are all within our control and frankly, can have a pretty quick impact. Deductibles is the other lever that we talked about in our prepared remarks. Those two can be shifted quite quickly. In fact, we have all peril deductibles already filed. We have the wind hail deductibles already filed and approved. So there's not that process in front of us. It's really about customer adoption. And making sure that your pricing is properly adjusted to accommodate those different deductibles. So yes, that gives us confidence that the actions we're taking, frankly, can hit the marketplace pretty quickly as we described.

And the next question comes from Meyer Shields with KBW.

I want to follow up on Matt's question. I think everything you're talking about on the property side makes perfect sense. Is there any agency resistance to that? In other words, is there any pushback from the distribution in terms of how aggressively you're adjusting the property closure?

Meyer, thanks for that question. Obviously, given our strategy, that's an important question that we are asking ourselves, but obviously talking very, very openly with our distribution partners. And the short answer is no. We feel like we've got a high level of support. People understand that we have had some substantial financial pressure based on the environment, both from an inflation standpoint and a catastrophe standpoint. They also believe that we're driving pricing in terms and conditions that may be on the front end of the market but are consistent with the market conditions, and in the true spirit of our partnerships, we feel a high level of support. We've had great discussions with our National Agency Council and our regional councils. And in some geographies, people are really anxious for us to push further because there is starting to be an availability issue as some of the markets start to shut down new business or really alter their new business appetite in a significant way. And so us making adjustments in our pricing and not overreacting on the underwriting side is considered to be very supportive by our agency partners.

Okay. That's fantastic. One other -- maybe this is a positive issue. But I was hoping you talked about submission flows to -- for E&S casualty business.

Yes, sure. So not surprising, I think, to us is that the volume of submissions both to our wholesale practice and our retail E&S business remain up. In fact, we are staffing more and more for it to keep up with the volume. And so I think it's an area for us that has really proven to perform well and to be delivering very strong double-digit growth for us. So yes, thanks for the question. I'm pleased with the volume of submissions we're getting and we just have to manage them because they're meaningful.

Okay. Is there any change, I guess, one competitor early in earnings season, mentioned that they were seeing an uptick in casualty submission polls. I'm just trying to see how broad-based that is?

I'm sorry, I didn't quite get that. Sorry?

Broad-based, I understand that there's a kind of property business moving to the non-admitted market. I'm just trying to get a sense in terms of whether that is increasing or decreasing in casualty lines.

Now we see growth across both our property and our casualty E&S business. And frankly, the PIF count in our casualty business far exceeds our property business. So it's -- I would call it broad-based, yes.

Yes. This is Jack. I think we're not only seeing the market continue to present more and more opportunities, but we're being very disciplined around our own mix, including when we do property E&S do it where it does not add to our CAT exposure, and it's more very targeted lower limit property business that fits nicely into our portfolio. So both the market is supporting that in terms of flow and our underwriting discipline is ensuring that we take advantage of the opportunities in the right way.

And the next question is the follow up from Mike Zaremski with BMO.

Great. Just a quick follow-up on the slight uptick you're seeing in some of the casualty liability and inflation levels and cognizant that you guys have been talking about this more than others in front of it and your reserve release levels to year-over-year better than the industry average. But just curious, is this kind of broad-based because I was looking at the transcript, it looks like you mentioned Commercial Auto in their prepared remarks. But then after Grace's question, you touched on other lines. So is it just -- is it coming kind of broad-based? Is it mostly on the severity side? Or is it certain vintages? Or just any other context you'd like to add?

I think it's a relatively minor issue, Mike. We're really just wanting to be prudent in the BI and some casualty coverages. For us, it's probably an undersized issue, but we're seeing some of it in some recent years and just wanting to really be prepared for it.

And this concludes the question-and-answer session. I would like to turn the conference over to Oksana for any closing comments.

Thank you, everyone, for a great dialogue today, and we are looking forward to talking to you next quarter.

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