Fred Eppinger - Chief Executive Officer
The Hanover Insurance Group, Inc. (THG) Bank of America Merrill Lynch 2014 Insurance Conference Call February 12, 2014 2:55 PM ET
Speaker present, you know that it comes with a lot of passion and enthusiasm for his business. We’ve got Fred Eppinger, who is CEO of Hanover. Fred joined the company as CEO in 2003. So a bit more than a decade and this company looks vastly different than it is then and it continues to change. So to talk about that development and where the company is going let me turn it over to Fred.
Good afternoon everybody. What I’d like to do is give you a little overview of the company, talk about where we are and what we’re doing. This has been a pretty big year for us. We’ve made a lot of improvements and frankly I think where our future is going to be became a lot clear and lot more exciting in the last 12 month.
So let me kind of take up through a little bit, who we are for those of you they don’t know the company at all. It is a call of THG it’s a New York Stock Exchange company. We happened to be one of the 40 oldest companies on New York Stock Exchange, 162 years, a little bit of tribute. But we are about $2.5 billion market cap we cross $5 billion for the first time this year in a gross written premium and it’s a broad-based book of business split with personal commercial and specialty.
If you look at a little bit about where our footprint is and our people, we have about 1.4 billion out of the country, about 800 folks state office. It’s really a [Lloyd] platform of one of the largest individual syndicate the Lloyd. And domestically we have about $4 billion of premium, about 4,300 employees and frankly one of the finest retail networks in the country with 41 office. And it really reached out the 2,000 of the best agents of the country. So it is a pretty broad institution.
Again those have seen me in the last 10.5 years that you’ve seen a version of this chart. This company is pretty forward. We set out to build a top quartile company, a company that could sustain top quartile returns through the cycle. We do that in a couple of ways. One is this focus on innovation and products that add value. We are very focused in every category we are in creating specialty business and flow business of a distinctive and adds value. We do that with partner agents. We are one of the smallest networks of agents in the country for our premium. We have very much in building franchise value and more exclusivity and aligning incentives through that. And then we have spent a lot of money on our retail distribution and distributed underwriting. We have invested in a lot of technology, we are very efficient. We have all the (inaudible) to everybody else does. We also spend a lot of money so that we can have remote professionals close to our distribution that allows us to take advantage of disruption and real quickly.
So it’s a pretty straight forward story. Now the company was a little different. I have been here 10 years. We were quite troubled 10 years ago; we were in the life business, variable annuity business, a lot of those businesses I exited. We were also a interesting first Personal Lines story to P&C Company. We were about 1.7 billion we are about 70% personalized and 70% in poor states.
So a big portion of what we did in the first part of the journey was fix it, make more money, get the portfolio right. But the most exciting part of the journey has been really since 2010 we got another set of upgrades in ‘09 and we were able to change our portfolio, because again what we are trying to do is have a portfolio that can sustain top quartile returns. And our portfolio that we had before was good when the weather was good. And so it wasn’t a terrific portfolio.
If you look at the best insurance companies of the country, the top quartile, the top five or six guy; what they do is a couple of thin. Yes, they execute, but they also have a portfolio that is more attractive both by states and line doing more businesses that have higher returns. And you got to execute also, you can't just have a portfolio, but we had the worst portfolio in the top 30 companies of the country. And now we have a portfolio that is good as the best three or four. So we have a very different portfolio of high margin business better spread geographically and enough robustness to it, so that we can really matter for the best agents in the country.
Where we are now in our journey though is why it’s pretty exciting. Most of that works behind us. This is the first 12 months that we were not integrating an acquisition or doing something significant on our portfolio. This has been about really leveraging that new portfolio and executing with our partner agents, since you saw a significant leverage of our earning this year and you will continue to see that over the next two or three years as we are able to leverage that strategic position with our agents and with the better portfolio as well as growth and capitalize on the disruption that we all see, right now that is going on in the market place.
So we are in a great position to continue to grow earnings in a very, very significant way over the next two or three years. If you look at our strategy this year, as I said it was a very good year, it was, we finished a lot of things off as far as talent and businesses really settled in and matured nicely. We also were able to like many other people in the industry get a really good handle on pricing and being able to really make strong size on pricing.
We also finished a lot of what I would say the work of getting rid of some of the volatility in our book and one of the [killing] fields of the company was that we were so concentrated in some states. So we had what I called micro concentrations with all this intense whether we’ve had in the industry over the last five years. That creative volatility. And we have exited roughly $350 million off in property oriented business, first lines oriented business in many cases that created micro concentrations that we have now eliminated. So, with the growth of the business, plus the elimination our portfolio is in a really good place. So, it's a good year and good year on earnings as well.
So, the numbers, from a growth point of view, even though we exited about $200 million worth of business in network I told you about. We still grew pretty nicely. Our book value grew and our equity grew, but more importantly you can see the growth in our earnings power, our ex-cat earnings growth. Like everybody else we made a lot more money this year, because the weather was better. But more importantly, we had a significant increase in our ex-cat earnings and that is going to continue, we talk about that. Because again all the levers are now in place, to build sustained rate to have retention increase and to be able to improve our mix, because we have a much better portfolio and terrific momentum in every business, virtually every single business we had improved margins and grew this year. So, it is a really nice place to be as a company as far as our position with our agent.
So, let me go to the results. Again as I said like everyone this was a pretty good year. So, we improved a lot because the weather outstanding with the year before, which is a place so we have quite a bit of business. But our underlying, we made about $100 million more in our domestic businesses. And as I said in each of our businesses, you saw nice improvement in the underlying earnings power, I go through a little bit.
This is an eye chart, I don't want to make a lot of points. But again going back to our goals, we're not all the way there, we still need to improve more to be at the returns we want. Where we are now is we pretty much consistently outperform the regional. And we are getting to the point particularly if you take out kind of reserved leases, our [action] years are right at the national, but we have more to go. We have more improvement, we have in the system and that we can make it happen and we need to.
Another unique thing about our business is that we have changed the mix dramatically and became a very balanced company over the last few years. So what I have here from ‘08 to now at the end of ‘13, what you see is a personalized oriented company with some commercial becoming essentially a well balanced specialty commercial personalized company that is now broad geographically, no longer concentrated in the few states.
And also important is this property casually mix, which again reflects the improvement of the underlying type of businesses we’re in. As I say, if you look at our portfolio and compared it by line and state, we have a very attractive mix. So now, it’s about execution and leveraging our strategy to make sure we get the most margins.
So what's more important actually than just playing mix, are you have clear distinctive position. And so each of our businesses, if you look at where we find ourselves, our strategy, our focus we’re in a great place. Our client oriented approach to personal lines, the way we do industry solutions in our commercial core flow business, our specialty business that goes directly to retail bypass the wholesale with our partners. Each of those businesses are quite distinctive in their right and allow us to think about a sustained growth.
And so if I start with business, insurance, we’re about $1.2 billion of half small, half middle. And again, we have a very interesting approach to that business. We have a distributed team and a really good network of underwriters close to the action. And so, what that brings to us is less than efficient, we have renewals in small that are centralized and we have all the straight through. But we are the only company of the major small commercial writers that have distributed new business underwrites close to the action.
What does that do? Well the most profitable part of small commercial is 25,000 50,000 the non-commodity. Our ability to react quickly to get the best business to help an agent understand their book and move their mature business to us is unprecedented. So, our operating models both know the agents better than anybody else and to have the expertise and the products to be able to do 50 and under really well is in a great position for the company right now.
Add to that, we are much more industry oriented. So we do a lot more around industry solution. So for instance, we have one of the fastest growing tech businesses in the industry in the small, because we just distributed underwriting in our products that we’re able to overserve that business.
So again, we have a very good small commercial present that business has gone from about $200 million in last three years to $633 million and we believe those agents consolidate their markets and buy other agency that’s going to be enormous growth engine for us.
The second business area is our middle market business, again no different philosophy. We tend to like [schmiddle] when I call schmiddle the lower end of middle so under 200,000 and it’s very much around solution, industry solutions why is that important?
Well in today’s world with the ability to put together data and do things a little bit more (inaudible) the ability to go and solve the problem for an industry is very powerful. When agents’ hit rate is better, then close rate is better the retention is better. And so an enormous part of our middle market is not generic, 84% of it is industry solutions. And we line up with our agency partners and proactively do that business, go after that business.
And we also, in their installed business we have technique called pipelining where we help them with the business they already have to move it to us so they can tell the coverage to that industry more effectively. So again, our ability to add value is very distinctive right now and both of these businesses are set up well to grow for us as we go forward.
Our U.S. specialty business again was an important part what we were trying to do to have some high margin business, but also to be relevant to the best data. So what you are seeing is a lot of retail agents are consolidating they are becoming more sophisticated. And what they want to do is do more themselves and bypass wholesales and have skills that they can add value directly in some of these areas.
So what we have done is created portfolio of specialty businesses that are relevant to the best agents in the country again fitting in our philosophy they tend to be smaller face value businesses. We have built a $700 million specialty business again growing very nicely in some very high margin areas. Let me take one as an example, which is panel for specialty industrial. It’s essentially an HPR business highly protected risk business for manufacturers where we go in and engineer their risk, help them with what their coverages are, bundle an environmental cover that we do to our third-party broker and solve the value, again provide a value added solution to a small manufacturer.
So that business is great for agents is a value added they were able to sell lots of value, the retention is extraordinary. And we have built a very high margin business that is now in the $50 million range. So we have a number of these specialty businesses again target at our franchise partners, value added and enables us to be very relevant to the better agents.
Personal line, again in personal line we have done a lot of work. We feel very strongly that there is a very attractive segment of value added in personal line. We spent a lot of time and attention and money to create the right demographic, the right products set for full account. Our people like in this room that have things that for umbrella and home and auto together is important. And we have a product called Platinum that we have introduced that allows agents to sell value and to create account from their installed base.
So we are very attractive. If you look at most of our agents have personal lines, most of their business is with them for long time and it’s account oriented, but it’s underserved. It’s not one company often, it doesn’t have the full umbrella, it doesn’t have the compliment of the coverages connected. And so what we are able to do is go in help them bring those together and sell value. Again, this is a business we worked hard to get to a nice strong position. And I feel very good about this going forward because more and more people are going to need this to efficiently serve the account market, so nice business for us going forward.
And then Chaucer, which is really our Llyod’s platform, again it’s a specially. They don’t have a lot of reinsurance, it’s most specialty and think about marine, aviation, energy. About 50% of it is denominated in dollars. We have been able to essentially acquired it add some teams and really build some best strength in some of the areas like casualty and a little bit in energy and marine. And so, we feel great about this business, it’s had a long track record and we’ve had lots of success in ‘12 and ‘13 since we bought it.
But it’s also again, Lloyd’s in our view is a consolidating business as well that the small syndicates are getting squeezed out and that the largest syndicate that lead are really in the driver seat, that’s what we’ve seen in January that’s what we can continue to see and we feel really good about our strategic position.
In addition, we are able to a lot of business; there is quite a business, the Lloyd’s business that originated from the U.S. in our partner agent. And so we've been able to fully, but surely connect like a direct linkage between our partner agents and our Lloyd’s platform and we’ve had probably $40 million $50 million we did this year, really good specialty business that originated in the U.S. and would become our own cover holder if you will. So, again more opportunity to be able to serve the best agents with a value add.
So, let me just step back from the product stuff and say just talk a little bit about the partner strategy. There are lot of ways you can think of us as the P&G of the insurance space. We know our distribution probably better than any other company. It's all about preferred shelf space with the right product and making sure that you have alignment of incentives and that's really what we're trying to do.
And so, if you look at the value proposition that we present to the best agents in the country, it's this notion of broad products that add value. So, we can be very relevant to you, we can write a pretty significant percentage of your business and we can give you all sense of weapons, because not only do we add value, we have franchise value.
So instead of many of my competitors that have 20,000 30,000 agents and they appoint every agent, we appoint very few agents. And so you're going to have something that other people don't have. And within some of our specialties, we're even more selective. So, we give very small number of people access. So again, you get something you get a franchise value with our appointment.
And then what we have is local professionals. They are close to you, they can act quickly, they can take advantage of opportunities that there is a disruption in the marketplace; they have the ability and the authority to act. And then finally, we build the tools to help agents improve their economics, thinking about fortifying their business, thinking about how to bypass the wholesale and come to us directly in retail.
And so that creates a linkage and an alignment that not only helps us grow, it protects us, because we have essentially most of our business with our partners. So if you look at the numbers, we have $4 billion of our business with the 1,000 partners.
And what does that do, not only is [having] doubled with some of the best agents in the country, we have tremendous alignment because we have so much business with each other. We are profit sharing arrangements of course retention arrangement and so that together we can deliver value and manage profitability quite nicely.
The other great thing about this is that if you look at $4 billion it’s terrific, but we’re still only about 4% share. So the headroom with these partners is enormous for us. And so as they see other opportunities, those opportunities come to us for us.
So again, I feel pretty good about the progress we've made. So as a company, we did lot of work to get to this point. And we are all the way there as I said. Top quartile we’re still 3.5 points away from where we need to be to be at the kind of return I want to sustain. We made a good step forward this year, I want to make another nice step for next year.
Why are we so confident in this leverage showing up? Well, on every dimension, we’re in great place. So pricing, in all our industry get pricing, but remember we have small face value, a value-added products, our ability to give price of inflation is much better than folks that play large accounts and go to broker business or do non-descript commodity flow through business.
Our ability to get rate, and so what you’ve seen is us give rate and have rate retention and most of our spot. And so if you look at the work we’ve done for instance on re-underwriting the business, not only have we got rate, we’ve gotten off of some business and got rid of some concentrations but in the same time we’ve been growing new business with our partners. And our retention has sustained. And even in Personal Lines where we’ve sold books of business, if you look at the non-books of business that we sold, even with all the rate we’ve done, we’re getting terrific retention and improving mix actually.
So again, our view is because have so much insight about our distributors, their business, the price sensitivity of their business, we can put together a predictive modeling and all that stuff that everybody in industry thinks so great. We can put that together with more local market insight than anybody else to really understand price sensitivity and make sure that we get the right price at the right time but from the right folks.
So again, we feel like this is a good thing and will enable us to sustain a momentum. As we go forward in ’14, the priorities aren’t that different. We have a little bit more work to do and some of the underwriting. We have about $8 million we’re going to get off of, and particularly Personal Lines property in New England we have to deals with other carriers where I am going to sale some of the property and continue to reduce our concentration. We’ve got a lot of work on pricing that we’ve continued to January which I said in our call January is right on track for all of that.
We also have a lot of growth opportunities right now that’s going on with our partner agent that we’re executing against, small commercial and then a couple of other businesses in particular. And again in general, our mix is getting better, right. It’s our broad mix of business with the higher margins, we’re growing the higher margin businesses. And so what you’re seeing is that we have leverage in price, we have leverage in mix, we have leverage in growth. And it’s pretty clear cut.
Now, as far as our philosophy with shareholders and capital, the other thing, we try to be thoughtful. This has been quite a journey. We have doubled the business in the last five years, we’ve changed the business dramatically over the last 10 years, we were the worst performing company in the segment at the beginning of the decade. So we had a lot of work to do. But one of our philosophies as we fix the company and investment company and build the balance sheet, we’ve always been thoughtful about returning money to shareholder too. And every step along the way goes through share buybacks and to dividends as we grow the earnings power of the company and we have been able to do something to the balance sheet, the portfolio to free up capital, we’ve been thoughtful.
Clearly we believe we can have continued growth, opportunities in high margin business that’s where a lot of our capital will go but we will always be thoughtful going forward about the way we returned money to capital to shareholders.
And so I think that this philosophy will not change. And if you look at, so what other thing I said today and I happy to answer question, how do I think about the company? Well there is no question, we are still getting better, we are still building. This has been a water shed year for us because I think people can see what we’ve done now, it’s clear, the strength of our relationships with agents is clear now, the portfolio strength is clear now, the ability to improve profitability is clear now. And so I think one of the thesis is that we are really good company that lot of people don’t know or they were waiting to get to this point. And so you know that our valuation is still really on a relative basis, we’re undervalued.
So not only that we have a good year this year with people started I think thinking about our stock as a good investment and we went up quite a bit, there is still a lot more to do and there is still lot more opportunity. And I think that because of the opportunity we have to grow the earnings of the business. And I think that we have a great story as of execution. And we just have to continue to execute.
So that’s all I really had. As I said, as a company we feel like we’re in the mode of executing. But I would also tell you that we are in that part of the cycle, where there is a lot of have and have not activity, what do I mean by that? The weaker companies aren’t really having problems. We all know names we can talk about it. And what’s fascinating, this is the private of the cycle where there is a little bit of a flight quality, we have the right kind of conversations and you add that to the fact that pricing in the industry for a lot of new businesses is good as it’s been in quite a while.
So the combination of being the person that people are coming to and an environment where price is pretty good and there is a lot of disruption in the marketplace in my view, create some opportunity for that couple of years for good company to both continue margin increase but also to see some growth. I think that’s where we are right now.
So with that I would look if there is any questions and be happy to answer any questions.
I’ve got a couple. I guess one question is this company has been, I don’t know what to call it, turnaround or building mode, because you’ve done a lot of work. And you’re just about where you need to be. The skills that the company needs to now grow this platform as opposed to the challenges you had before, do you have the right people in place for that?
Yes. So, what’s fascinating, again people say why do they get capital like this. In our business, there is a lot of stories of people when they call it turnaround, all they really mean by that is they get rid of the stuff and keep the good stuff. The problem with our company is we didn’t have enough of the good stuff that was sustainable, it was true focus. So we had to build these businesses. And again, in our business, you want to do it the hard way. You can go to the brokers into large accounts and go to wholesalers and then get killed, because it's so cyclical and price sensitive. We've done it the hard way by building the infrastructure, the operating model, the technology and most importantly, the people. We have 5,200 people, 4,400 have come since I started.
And we have the finest executive team in the industry, we have the most depth of talent if anybody our size. Because from day one, we've been building this company to take advantage of what's happening in the industry and be top quartile. So, one of the interesting things is that, we spend, I probably spend 35% of my time on talent acquisition, on talent development and getting really good people. Because again, if you think about what we do for a living, it's small face value, it’s distributed, it's execution, it's oriented to operational excellence. And so I feel great about it, but it's been why -- our expense ratio has been so high? I mean there was parts, remember three years ago I had quarters where my expense ratio was higher than my loss ratio, that's crazy. Not if you’re building a great business, not if you’re investing in a right way, not if you're not taking loss risk. We've taken expense risk and then we get troubled but that's because we built the team and we over invested.
So, we have some of the small businesses, I have senior people and we’re running businesses that have better competitors for four times the size the business they run here. So, it is one of our strengths and why I think we can grow right now without a lot of people increases, without a lot of leverage, because we have invested in the resources we're doing, the nice place to be actually right now.
The other question I had was your personalized business. I guess the business you focused on insulate you to some extent from the 15%, 15-minute type business, but it feels that the larger bigger companies over time do have an advantage given their size and scale, and may be where this business is going? How do you combat that over time?
Yes, I have been here for 16 years and done a lot of research on this particular point. The statistics are now what people think, and there is a price sensitive segment of this, there is no question. But the reality is that most direct platforms have failed to be able to cost effectively reach accounts, most haven’t penetrated umbrella, most haven’t penetrated home, most can’t handle for GAAPs and liability coverage.
And so what you see is actually a pretty significant stability in account business. And I’ll go step further, which is fascinating there is about $65 billion of account business with sub-scale regional companies that agents have had for a long time. And so for us not only we think there is an opportunity in the stable business and account business, we think there is a growth opportunity because we’ll be able to take that business from the regional companies that can’t services as well, they don’t the ability around self service, 24-hour service et cetera. And most of those companies are geographically concentrated so they have going to add more volatility from the weather that we’re experiencing. So I’m actually pretty bullish on it. Now there is others that go the other way, they say well, we should think about mono line auto, okay.
But that's not in my view where the most attractive segments are. Now we are not [shove] and we are not what Ace is doing at the higher end, but anybody that doesn’t live out of a car, needs umbrella, it doesn’t matter if you use technology and it’s not about age, it’s not about technology, the reality is the issues in the United States are not about property damage in personal line, it’s about casualty, liability coverage, on insurance motor risk, being sued because you have a passenger in your car. And again, that requires you to put together in account. And so we’re very bullish and all our research says that there is wonderful business here, it is the most profitable segment for most of the companies, even the companies that they want direct.
And if you look at that business, the independent agent, the good independent agent serves it well, serves it efficiently, keeps it. A lot of those are business owners that they have on the business side as well. So, we’re bullish on it, not easy. A lot of investment we’re making because you’re going to serve it efficiently, the full notion of 24 hour and self service is a big deal, we spend a ton of money on it. And we think it’s an exciting opportunity. Now again, at the very least, it’s a nice profitable business that’s going to be stable for us. But I am getting more bullish everyday as other people go the other way to create this opportunity. And there is sense of disruption in that industry as you know on last few weeks. And our ability to actually growth that’s coming from that is pretty significant I think it’s a tailwind to next year.
Fred, unfortunately that’s all the time we have, but join me in thinking Fred.
Thank you very much.