Oksana Lukasheva - IR
Fred Eppinger - President and CEO
David Greenfield - CFO
Marita Zuraitis - President, U.S. Property & Casualty Companies
Jack Roche - President, Business Insurance
Andrew Robinson - President, Specialty Lines
Bob Stuchbery - President, International Operations
Mark Desrochers - SVP and President, Personal Lines
Ann Tripp - VP and CIO
Mark Welzenbach - SVP and CCO
The Hanover Insurance Group, Inc. (THG) Investor Day November 17, 2011 8:30 AM ET
Good morning, and welcome to The Hanover Insurance Group’s 2011 Investor Day. For those of you who may did not get a chance to meet in person, I’m Oksana Lukasheva, EVP, Investor Relations at The Hanover. It is a pleasure to see so many familiar faces, investors, analysts, people who have supported us, [pulled us] and challenged us over the last several years; I’m also excited to see a number of new faces in the room. We have been very much looking forward to today, so we can present to you our position in the marketplace currently and what we believe, where we believe we are going in this difficult market environment. In that context, we really appreciate your being here.
We know you have business schedules and it is very difficult to get away from you this volatile environment, but we hope you will find this event and the information that we will share with you today useful and relevant.
Speaking today will be Fred Eppinger, our President and CEO; David Greenfield, our Chief Financial Officer; Marita Zuraitis, President of U.S. P&C Businesses; Jack Roche, President of Commercial Lines; Andrew Robinson, President of Specialty Insurance. We also have the pleasure to introduce to you today Bob Stuchbery, President of International Operations, who will discuss also.
In addition not in speaking function but also in the room today are Mark Desrochers, President of our Personal Lines; Ann Tripp, Chief Investment Officer; Mark Welzenbach, our Chief Claims Officer; as well as other members of our executive team.
Please feel free to check them out during break and between the presentation at around 10:30 a.m. and also join us for lunch at around 12:30 p.m. after the Q&A session is completed and after the formal section of the day is done. For lunch we will have a choice of entrée for sit down option, for those of you who do not have the time to stay here, we actually do or will have lunch is available as well.
Before I open the podium to Fred, I’d like to read to you our safe harbor statement, a message you are probably used to hear often as you hear about Fred’s parsing on. Our presentation and our comments today will include forward-looking statements and we will be also referencing non-GAAP measures. So, let me draw your attention to the left side of the investor folder where we have identified forward-looking statements and some of their risk and uncertainties related to our business. Here you can also find a reconciliation of certain non-GAAP measures to the GAAP measures as well as some definitions that clarify the terminology that we will be using in the slides today.
With that let me hand the floor over to our President and CEO, Fred Eppinger.
Thanks Oksana. Good morning everybody and thank you for being here. I will say also I want to say thank you for being here. This is quite important day for us, it's little bit of a coming out. We have been on this journey for now seven, eight years, and this is a real turning point for us. And what I want to do is talk to you today about where exactly we are and what the outlook is.
Our belief is pretty simple, we believe we are as well positioned as anybody that exist in the industry for the next three or four years. We believe we built the product portfolio to talent the position with the best agency, the brokerage that are very, very unique in the business. And really positions us for a lot of momentum and financial improvement over the next two or three years. And I’m going to walk through why I believe that is true.
But before that let me just go through quickly, we are going to hear from today, I’m going to set the stage, go to the overview of where we think we are going and what’s really our priorities. Then what I’d like to do is have Marita talk about how we are going to catch the opportunity in front of us in the U.S. We are going to introduce Bob to you and he is going to talk a little bit about where we see the opportunities are for Chaucer and some of our international opportunity. And then we are going to do a deep dive in couple of the businesses. I’m going to ask Andrew Robinson to dig into our Specialty businesses, we have built a really exciting broad portfolio and Specialty businesses that have ton of momentum, that we are going to show you a little bit why we believe we are going to win and our winning. And then we will also going to talk a little bit about both Small Commercial and Middle Market with Jack Roche, we have built a very interesting position in both of those businesses and small we are now one of the leaders in the industry, we have doubled that business and we have tremendous momentum and I think in the outlook for that is outstanding. And then in Middle Market we obviously have this industry solutions approach that is also taken off a little bit.
So, again that will give you good sense of the businesses and why we are confident and where we are, and how we are going to improve the position going forward. And then Dave he is going to come and talk about our financials. Give a little bit of an overview; talk a little bit about the balance sheet strength and also the outlook for ’12. We did a little bit of that in the earnings call, but we want to do a little bit more, so people have a sense of where we are right now.
So, let me step back and touch on four points, because we really do think it's a great period of opportunity for us. We worked really hard to get to this spot as a company. Over the last seven years as people would have thought us, we completely transformed this company. Every single dimension of this company has been changed, 80% of the people are new, the portfolio is completely different and the positioning is completely different. We now have one of the most attractive product portfolios in the industry. It's broad based, it's in the right lines of business, the attractive lines of business, but more importantly it has created distinctive positions in the marketplace. So, we have a portfolio that is very distinctive and can sustain returns.
And you can see from the earnings call we talked about it, probably 90% of our business are achieving rate increases now very different than most people in the industry. So, again a very strong product portfolio. In addition, we have created a very interesting unique value proposition. More franchise value, more value added, we don’t just go to the top of the house or the brokers, we actually have built relationships with a lot of the board distinctive regional and super regional brokers in Asian country and we go direct. We don’t go through wholesalers. So, that value proposition has allowed build economics to better, but it has also given us tremendous shelf space and momentum. And so we are going to talk a little bit about that.
The third point I want to make though is that this is a very unique time in our industry and we all have been through turns and people are talking about this as a turn. But this is a very unique one, for a lot of reasons. It's the first time in 60 years where the turn is at the heart of a very difficult economic environment and our business is so tied to certain aspects of our economy like construction etcetera. So, that cold dynamic is very different, we have had extraordinary weather experience over the last three years. What I’m going to call kitty cats, which has really effected the 130 billion or so that is in the regional company aspect of our industry and probably something that’s going to fundamentally change the industry forever, because many of those companies are going to have to shrink to adjust.
We also see again this whole notion and for those of you that were economic majors, it's a very odd notion where yields are down but our cost of capital is up because of our analysis Solvency II and a lot of other issues around capital. So, this whole notion of balance sheet strain is different than just the notion that you are running out of reserve releases. It's also caused by a change of cost of capital changed by a volatility profile the is different, so your marginal cost of capacity is different today than it would have been five, six years ago, particularly if you are a property oriented company.
So, all of that comes together and it creates turmoil, and disruption. And we believe that we are amazingly positioned to capitalize on that, because a lot of what we do are competition is going to have to change, it's going to have to downsize, it's going to have to change the portfolio. And our value proposition which is geared towards improving agent economics is more needed today than ever because all of these changes affect agent economics, they got to consolidate in the markets they have, they have to get more profit sharing, they have to get more revenue out of their per account, every account they have. All of that plays to our strength, because of what we have built.
So, again it's a very interesting situation for us, and I want to step back a little bit and start with the beginning of where we came from, because I think it just gives you a little bit of context of where we are and why we think [where we are]. To (inaudible) this point I cannot do a presentation without the product and on so while we will start here, but people think that this strategy has changed, it hasn’t changed at all. It evolved to where we are today. From the very beginning the core of what we try to do is create a portfolio and a business that could achieve top quartile returns through the cycle. And we had a company that wasn’t able to do that, because of their mix in capability.
And to do that we focused on four basic things; first, creating a more distinctive portfolio that was more attractive areas of the industry, because if you recall our business was personalized oriented in very difficult states. The second thing was could we create distinctive market positions, positions that were defensible and could we build the underwriting of risk management acumen to be differentiated from the marketplace. Third, could we build the value proposition that allowed us to get preferred shelf space with the best agents in the country, because again for us we work with the best agents and brokers in the country. We are only in really four, five, six states, and we were within folks that were personal lines oriented. We [root] with the most vibrant folks that sold value. W weren’t with the folks that were growing the most.
So, how do you create a value proposition and distinctiveness, so that you can get best business because traditionally in our business you will get a new business penalty, but we have changed over of the $2 billion we inherited. We probably changed over a billion of that. So, we have most of our business is relatively new over the last six years and we would be out of business if we had a new business penalty like the traditional approach in our business. So, we needed a value proposition that allowed us to get mature business.
And the finally, we needed the financial flexibility to go to an agent and broker in this country and represent outside parties and say, we deserve to get your best business and again those who us, know that we are very close to financial collapse in 2002. So the ability to build financial strength was the fourth and probably the most important one for us to go forward. So, this strategy of the better agents, better business, more distinctive positions has been with us from the beginning. And I think what you see is really good progress. So, let me just go and talk a little bit about this improvement.
And again I want to tie this into why we think top quartile is what it is, because again it's good to disperse a step back. As we talk about top quartile and a lot of people they don’t understand why we say what we say, so I want to make sure I’m clear on that. We started the decade as one of the poor performers, literally in the first three years of this decade we were the worst performer in the industry, the worst. Okay. So, we didn’t come from a position where we had a portfolio that we could just hunker down and execute better. And then secondly, we needed to and what we did in the last few months, few years, is we have to stabilize and improve our competitive position in almost every area, which is what we have done. But obviously this transition over the last 10 years took tremendous amount of investment and change, and so in the last five years, we have only achieved average returns. Not what we want, not what we will achieve. But that’s what we did, because of the investments, the transition, the improvement we are average, that’s where we did the last five years, but we are now positioned given where we find ourselves with the product portfolio and the skills and the business mix and the momentum with the best agents and brokers. We are now in a position to go to that next step, which is really to reach our goals of the top quartile returns in the industry and sustain it.
I tell people you can always get lucky in our business and in ’06, ’07 the weather was good, so you can be a property centric company in three states and do okay. But you can’t sustain it. There is nobody in the top quartile and for any period of time that looks like that. And so for us we needed this business mix and we needed the shelf space to get where we are today.
So, again let me just talk about stuff you know, but again it's worth repeating. We have a horrible industry in total. Over the last 20 years we returned about 7.7%, and so when people look at our industry, they don’t understand how this much capital can go to an industry that is always under returning, that was a couple things you guys will understand. There is a lot of mutual’s that have a different cost of capital that drags us down. And there was also this notion that you don’t know the cost of goods sold for three years, so lot of companies fool themselves. But in essence this has allowed the industry and we all know it, and so how do you talk about top quartile in an industry like this. Well first of all the public companies as we all know outperformed the rest pretty consistently. Okay. Part of that is not true 100% but it's pretty close to 100% true, part of that is because it's a forcing device and if you look at the top 40 companies from 2000 and you look at them today about 15 of them are gone.
The public companies have a forcing device, say if they don’t get the adequate returns they tend to disappear. So, what you have is not a very good industry, public companies tend to be able to perform a little bit better, but most importantly there is a group of companies that consistently outperform and do well. So, when you look at valuations that people put together and you look at performance, so this is a 10 year period. In my view that mark is about 12, that differentiates these folks that pretty much constantly we are in the top quartile. Some move around, but not many. And again people will say well it's 15, it's 16, well from economics books being more than a couple 100 basis points over cost of capital is pretty hard to do in any of the industry for a long period of time. And if you look at it, the 10 years, 20 years etcetera, this line is about right.
Now if cost of capital changes dramatically down, obviously it will change down, but the way we think about it is that there are people that do it, there are things to learn from people they do it, and there are ways to build the capability to get there, it's just hard to do. There is I think only one company in the last 15 years that have gone from the bottom half to the top quartile. It is not something that’s common. But there is a story here around top quartile.
Now in that mix we were horrible. And as I said this is a 10 year average we were at the bottom, if I [use] the five year average, we would essentially been the worst company in the industry. Because the life company situation partly because of under investment in the P&C business for a long period of time, partly because of the mix of business that the company had, this company underperformed on any dimension. Now what has happened in the last five years is we have moved dramatically more than anybody else in the industry, but we are still just averaged.
Again the average of the industry over the last five years is about 8.5 or so, we are tad little bit below that. So, we have moved a lot, but we are averaged. Now part of that is just the drag of all of the investments that we have made of the changes we have made and how the portfolio we changed out, the excess expenditures we have taken on. But the reality is that we are averaged. And so for us the story is more about now, the story is more about what kind of portfolio and what kind of opportunity do we have in front in us. And that’s what today is about, to give you a glimpse and what we have accomplished and what we have done, because are at in my view in the next page what I try to capture is we really had an inflection point.
And there is a lot of people that would say, maybe you could have done it faster, you could have done it differently, but it was every stage was thought through. The first stage was paying the bills, to get the financial stability to being there tomorrow. We had to sell lot of portfolio, we had to shrink a lot of the portfolio, we got about 3,000 personnel because of it, and it was really about stabilizing. The next stage was really about building core competence and it's really in every business, both commercial personal but more importantly in claims and in underwriting and loss control and every part of this business and risk management, in capital management, and we have done that, but there was a lot of work, was building our capital base up again to get the ratings back.
And then came all the upgrades, right, and as you know, with all of the upgrades, we felt that we could reinvest, we had the momentum to improve the portfolio in a relatively dramatic way which is exactly what we did. So, we went to a balanced between property and casualty and we went to more attractive lines of business, we went to more specialty businesses, and so we took the business from a core to a better broad portfolio. And again where we find ourselves now is we are done. We have the portfolio, we love our portfolio, there is always places you can improve but we now have the breadth, the mix, the attractiveness of one of the best. If you look at our new business it's some of the best in the industry right now across the Board.
So, we feel very good about where we are, but the question is can we leverage this to get the kind of returns that really meet our goals. And again I’d tell you that the other headwinds, but everybody has yields headwinds, we have yields that are tough, we have weather. We are better positioned in both anybody I see. So, again we believe that it's time for the next step. Again you know the facts we have doubled the business or so, but more importantly if you think about the 2.4 we inherited as I said we probably turned over somewhere around 70% of that. So, in essence this whole business, our entire business portfolio is new since ’04 on every dimension whether it's accident years, if you look at it, without the weather the underlying accident years are improved, our book value is improved, so about the highest it's been in the 160 years. We obviously got upgrades from everybody, and we have also on the statutory surplus totally changed the dynamic that we feel that our balance sheet strength is terrific and in the best position it's been, so we have lots of flexibility to do whatever we need to do to capitalize on the market.
So, I think our bottom line improvement is significant. Now one of the points I want to make. And this is something that people talk to me all of the time about how much we give back to shareholders and in what form. What I like to believe is that we have proven that we never spend money that we don’t think we can get good returns on. And our track record of saying yes, we have excess capital in ’05, ’06, because we sold some stuff, we were not ready to invest it. We weren’t good enough, so we gave it back.
We have done that every single time we have excess money. If we think we have an ability to improve the value of this company, and the long-term returns, we invest it, if we don’t we give it back. And that’s what happen many times along this journey. We needed some excess capital to get the upgrades, but we always step back. In ’06 I had all of this money we didn’t go out and buy stuff, we weren’t ready to buy stuff, we weren’t good enough to buy stuff. We were not ready for the next step in the journey. And so again I hope for those that are new investors, or those who have been here, you may disagree with some of the individual choices that we have made, but we believe that what we do is we think about creating value for this institution and investing in a way that creates the greatest value for shareholders long-term. And that’s what our patent is. You saw again our dividend, we have tried to take it up every year, we believe the earnings power of the company properly reflect in what we have done within dividend policy, David is going to talk a little bit about it. And we think it's a balanced way to return money to shareholders, but again for us this has not been one of those situations where we grew at all cost at all. I think it's been very tempered and we try to pick our spot and no where we can do it while we can’t.
Now let me go to this portfolio, again I want to spend a little time on it. Part of it is obvious that people follow the industry, but I don’t think it is as obvious as maybe we think. We have created a very attractive portfolio here and it means a couple of things. It means lines of business, I’m not going to talk about lines of business because it's not sufficient, you just can’t get in the better lines of business and be good. But there is nobody in the top quartile that has a bad mix by line of business. So, it's not sufficient, but it's necessary to have a better mix, because we have lines of businesses in this industry that are dominated by mutual’s, and then our certain states that you will never earn cost of capital. And so if you don’t fix that mix you are never going to get a shot, you might get a shot for year, but you are never going to get a shot for duration. So, again we needed to really attack that dimension. We also attack this dimension of saying we just can’t be me too. We can’t just be another writer of (inaudible).
What is the position you have that’s distinctive enough to sustain renewal pricing to get the margin you need over the long haul. Second, we have created a very unique position in the industry, we this whole notion of not going to wholesalers going direct to retail agents and doing value added things, about industry solutions, about rounding out personal lines account. What we try to do is create a portfolio and a value proposition that is very unique for the best agents and brokers of the country so that they want us to have preferred shelve space, that they give us more mature business and we discussed from time on this, but it's working. We have enviable position, we have grown by far faster with the best agents in the country than anybody else in the last three years because of this. And so our ability to capitalize on a changing environment is unprecedented, because they know what’s better, they like us better, they understand how we help their economics and so our ability to get things in chunks and share shift in a period of turmoil is quite strong in my belief.
And so as a result we have preferred shelf space and momentum, so we have a combination of a good product set with some nice momentum. And I think the two of those things give us confidence that we can get better every day and move towards our financial goals. So, again I want to touch first on portfolio, because I think this portfolio point again is quantifiable if you will. What we have achieved and is not easy because it's about getting out of stuff just like it's getting into stuff. We have re-underwritten and repositioned our portfolio constantly every step of the way, therefore, we don’t by the way have a lot of disruption left, where a lot of the people do. But it's a big part changing your mix from bad places to good places and too good lines by bad lines. And we have also established as I said I will go to each business really interesting value propositions that we can now leverage.
So, let me talk a little bit about our mix. And you have seen this I think when we did the acquisition, I think I did some version of this. But it's easy to just look at this and say so what. And in ’09 when I was in this venue when we were having our Investor Day, I said by 2014, I’d like to be a third personal specialty commercial and about 5 billion, because I said with that kind of balance I know that we would be able to position ourselves well.
Now we have done it faster than I thought, because we have some opportunities and some ways to get there. But this by itself means nothing, we can have a mix like this and be terrible. But my point is we try to create a portfolio that have more attractive lines. So, let me just dig down and just show you what I mean. The best companies, the best to top quartile do two things well; they have a better mix of business both line of business and geography and again not sufficient but necessary; and they have a distinctive position. And there are people that are in that lines of business that do well. The best example is obviously Chubb home owners, (inaudible).
Home owners is a very difficult line, they do extremely well. I’d argue it's not even the same business what they do, but it's possible, but as I said before, it is there isn’t one top quartile company that has a mix worst than the industry, not one. And so having a better mix was quite important to our journey and so let me just give you some facts. So, if you look at the attractive and the unattractive businesses, we have certain lines of businesses that are very challenging, now pick five years. These are some of the best use we have ever had if you remember we had great weather, a couple of these five years. So, even in five of the best years we have had in the last 20, there are lines of business that almost nobody makes target returns. And if I had done 10 years and 20 years, the answer on the first one would have been almost zero.
And so again it is very hard to overcome something where nobody makes target returns. Now the opposite is true, there are certain line of business that both people do. Now again this is in a bad five years, I picked an attractive, I could change this little bit over 20, but it's just generally true. So, when you look at our mix, okay, when we started out, sorry one other thing. There are global lines that are the same thing and I pick some [voids] lines and some lines that was attracted to, but I could have done the same thing from the global line, marine, aviation that are more global not just U.S. centric, they think about them as global markets. Same exact thing is good ones and bad ones.
So, you look at them and you say, over five years, 10 years, 20 years is attractive and unattractive. Now where we started we had the worst mix of the top 50 companies in the industry. We had 12% of our business in the most attractive lines and by the way we were horrible in those lines, surety.
Now it is so much different now, we have 40% (inaudible), now people say what does that mean, is 40 good is it bad? But the way I think about, I think about the industry and I think about top quartile. So, the industry is about 18%. So, it's better than we were, but in the industry in total is about 18% effective line, and if you look at the top quartile companies it's about 44. Now this top quartile companies is my picks, so these are companies that are not just one line of business, I picked Travelers, Berkley and Chubb, because I think over the last 25 years those three companies that have a diverse portfolio three of the best companies at risk.
And if you look at them, and again it's not just what they do, I’m not just saying that’s the only reason. I’m just saying if you look at all of the product portfolios that I have on that list of bubble chart, they all have some version of this, whether it's the international side, or it's on the domestic side, they have a little bit better book of business. And again it's not enough. I’m not saying it's enough, but what we have done to this company is we put us in a place where you can see consistent returns, because the portfolio lends itself to execution excellence. So, again we have changed the business from where we were and again why the regional companies a lot of regional companies under before, because they are in categories that chronically underperform and they don’t care, partly why pricing in those categories are so tough.
So, again for me this was a big point of what we did as a company, but it's not enough. The other thing we have done ruthlessly is improve our capabilities. So, for last five years we have improved our underwriting capability and outperformed the industry on a loss pick dramatically. And that what is happening is we are doing it in every single line of business except for surety where we have a run off business which is still not bad because surety is a better line, but it was because I didn’t run that off fast enough, so legacy business from [Nash] to Michigan.
But we have outperformed, gotten better and we have an outlook for the ability to be a little bit better. So, again we are in both places, we are getting better and doing it. And then probably the most important thing of all is we have created positions in these businesses that are much more distinctive than (inaudible). And so in each of these businesses, we have created a very thoughtful value proposition and business position that we talk to about in pieces, that allow us to get rates, have higher retention and get more mature business from the distribution. So, in personal lines which has not really been a growth model for us, it's really been a portfolio change where we have grown in better places, we have got rid of our concentration, we have moved to full account and a value added value proposition for the best client that agent has. And who is that, that’s the people that have the full accounts, they are under the Chubb’s and the higher end and it's what we call the [near fluent] and it dominates the best segment. And it also is stable segment, it is people that value, the service they value, the whole package, they want consistency and price, and we have built both our product and our offering to that. And that’s why we have been attracted rolling in the right places nicely, and have had great price increases and we will continue to have.
Clearly we will talk about weather in a little bit and say what does weather brings to this, because the weather has been so extraordinary in the last two or three years, that’s it cloud some of this, but this is a great business for us right now. It is a very stable and the question is, how big can it get for us as we have really nailed this segment well.
The second area is this (inaudible) area, that Bob will spend a lot of time, we are thrilled about it, it's something that we worked at for four years to try to get access to some of these categories that are very attractive more global markets. As I said before, lot of that is U.S. originated, but still they are very attractive segments and what we believe is we have found a company and a team with a track record, consistency and frankly opportunity, because some of the categories they are in, we are very excited about taking them to our franchise agents overtime and broadening our penetration and growth in that area. So, we are very excited about that and Bob will talk about the portfolio, but again it's a very attractive returns over the cycle, and something that we think we have good leverage with.
On commercial, Jack will take you through some of this. We are very excited about it, we believe our small commercial we will be one of the leaders in small commercial in this industry. We created a end-to-end value proposition not just the point of sale, but the affinity, the niche and the non-point of sale solution that is very attractive and is leading to some significant growth for us and I think that’s a business that will continue to consolidate because of the struggles of the regional companies and we believe we are in the (inaudible) for that business.
On middle market we have gone the industry solution route very aggressively as you know. More holistic approach to industry, there is some examples in the business that have done that. It is very distinctive and you combine that with our franchise less appointment value proposition to agents and it's really the hook that really attracts the best agents in the world to us. And again it's been a great success story for us. Now again we are not like the biggest, we don’t our quality policy size of middle market is in 200 like the big two or three, it's 90. So, we play the game right below the guys at the brokers and we play the game where it's a much higher retention game and a much more sustainable return games.
So, again we feel very, very good about that position and then the U.S. specialty business that Andrew will take us to is again very important because what has happened this portfolio we have built that gives direct access from the special stage and focus in this area, and the retail agents, that are more franchise oriented with us, is very important because as agents improve their economics, they are building these capabilities, the best agents are building these capabilities and taking the skill set back from the wholesaler bringing it in house and we are one of the few markets that can really match up with them here and it creates a tremendous growth opportunity for us as we look forward.
So, in each of those businesses and again you will hear today, you can think about it for your own, but we believe that these aren’t just (inaudible) or generic positions or something that we just bought companies and just assembled this stuff. We believe we have now built after 7, 8 years a really hard work, a really interesting portfolio that is now complete and in place. And frankly in place in time to take advantage of what’s about to happen.
So, let me just talk a little bit about Chaucer, to me one of the exciting things that completed the portfolio. Obviously we wanted these categories, we wanted something that had a track record, we wanted scale, because they wanted to do the organic thing like we did in some of the other areas I wanted to make sure that we had a platform that we could leverage quickly. We wanted it to be accretive right away.
We also picked Lloyd’s, Lloyd’s is a very efficient platform from a capital point of view an it's a very different place than people remember 20 years ago. And I’m going to talk a little bit about that. We believe it is a very important market for some of the best carriers of the world. And what you are seeing is the best carriers of the world are flocking to in this categories. It's a very changed environment because it is a good way to do that business, and we think one of the reasons it's a good way is because the efficiency of capital in the Lloyd’s model is very good. And again with Solvency II and all of the other dynamics that are happening in our world around capital efficiency, we think it's a great place to be for these categories. And so again we are excited about what we did. Again the couple of things Bob is going to go this detail, but one other things people tell me they confuse about what Lloyd’s is.
25 years ago, it was considered the wild west of insurance. A lot of what they call mains or individual investors that is completely changed. It is the place with the [best in the bride have gone]. So, if you look at the capacity, now it's 90% really corporate capacity and it's with the right guys and so, it is a market where a lot of the best companies in the world particularly the specialty oriented companies have been attracted because of the things that I mentioned before and again Bob will talk about a little bit.
Now that market also performs very well. So, Lloyd’s performs better than the U.S. market, it performs better than the U.S. reinsurance market, it performs better than the European market and it performs about as well as the Bermuda market with more liquidity.
So, again for me this was something we worked at for long time, we wanted to make sure we hit it when it was ready, but it completes our portfolio and if you think about the top 1000 or so agents in the world, particularly right out of the top three. This capacity and this capability is very valuable, and so again we are excited about it, but it wasn’t that we bought anybody at Lloyd’s, we were very thoughtful about why Chaucer. And again Bob will talk about some of the details.
Lloyd’s in general is higher reinsurance market than what Chaucer is, we are not a reinsurance oriented company that’s not what our strategy is, it's more about retail agents and primary business, and specialty business. So, obviously we picked the company that was much less reinsurance, more specialty oriented. We also wanted somebody with a track record, because I didn’t want to fix it. We have fixed a lot of things along the way, and our view was sure will this in tweaks in portfolio to make it fit us a little bit better and we did. But what we wanted was something that was ready for the turn and had a team and scale bring to us. And that’s exactly what they brought. I think the returns over the cycles between 15 and 17% ROE.
And then the areas of opportunity fit what we were looking for, where there is a handful of 13 or so areas where I’m very excited about the future potential to give them to franchise agent in various forms. And again whether it's year one or whatever. We think there is a lot of growth opportunity in some of these categories, we have people that we know well that are specializing in these areas.
So, again we like it today, we are going to like it more tomorrow. It is a very important part of our portfolio and again if you go back who we think of ourselves the best companies. This portfolio is much more similar now. Our total portfolio is much more similar to the folks that have the best companies than it's ever been including this. So, again we are excited about that.
Now, let’s talk about the world. And we talked about it in the earnings call, and I think it's important to talk about the earnings call. I think people have talked to round it, you got to reset a little bit. Yields are going to be down, and it will be down for a while that’s a headwind. Reinsurance costs are going to be tougher. Cost of capacity with Solvency II and RMS and all of that takes different forms, but there is a balance sheet strain even on the best sovereign debt with some of the European reinsurers. The world is a little tougher. But if you look at the last 60 years in our industry, what happens when the world is a little tougher, particularly in the last couple of years of a soft market first couple of years of our market, they haven’t have not separate, certain people create tremendous amounts of value and so this is a time of great opportunity. If you are positioned well, and you are not digging out of some legacy issues. And we believe we are very well positioned, so that environment we have the portfolio I keep talking about, the business mix, but we also have this momentum with the right folks. The 1000 or so, or the best agents that have to go reunderwrite their book, reposition their book, replace what’s going on in places like comp.
And so we go into that market being able to help them in their economics without legacy strains and frankly with a lot of financial flexibility. And so our ability to kind of cherry picking points towards areas of opportunity is very good. And again could create tremendous value for the company.
Now let me just go through a couple of things that you know. We are well into the soft market, we all talk about it all of the time, we probably talk about it too much. But we are in a point where most people would consider a place where it's straining a lot of companies, and I’m not one of those guys that think the market. The market is no longer the market. There are segments to the market that have already turned, there are parts of the market that have turned two years ago like personal lines. There are parts of the market like in small commercial that never got that bad. There are pockets, but I will tell you we are the point where a lot of turmoil is out there, a lot of transition. And part of it is because of the reduction in the amount of reserve releases that are available for lot of companies. So, obviously companies can get through difficult times and maybe place a little bit more aggressively than they should, because they have reserve releases. Again what’s unique about us as a company, I just tell people a lot of companies good and bad live off of right now in their earnings, the ’03, ’04 years. We were horrible in ’03 and ’04, we didn’t have any reserve releases, so we had to live with the accident years and more mechanical reserve releases from the beginning. We did not have a casualty oriented high margin book in ’03 and ’04. We didn’t have any margins in ’03 and ’04.
And so one of the things that prepares us well, is we don’t have a problem with reserve problem, we didn’t have any business, we didn’t have any business that we were living off of that now goes away. We have lived off of mechanical, yes we had a little bit reduction in reserve releases but of our releases are short tell line mechanical because of the way we price conservatively and put reserves up constantly.
So, again this is going to affect, it's going to create headwinds for a number of companies there is a lot being written by some of the people in this room about this. But we are right at that point but again there is a bigger which is that there is some underlying disruption underneath that is really interesting, that I want you to know that we are focused on. One is when you look at the returns and the results, there has been a lot of written and while the results aren’t quite as bad, so there more room, it's going to hang on longer. And maybe it will, and maybe in some of the large accounts, casualty lines, maybe it will, and maybe because we are in an economic downturn that there won’t be as much price increase available as it was. So, maybe there will be more reunderwriting which I think is probably true.
But the overall combined ratio does it really tell the story. Let me talk about couple of points. One is comp, comp is at the worst point we have had since the last turn, but it's worse than this. This is a great time of unknown and is so much lack of clarity around healthcare. And the problem with comp is comp is converted to a healthcare line in a lot of ways. And what’s happening is with the new healthcare reform and all of the cost that are driving people to try to cost shift to unmanaged care, where to care it's like [comparative] creates a lot of uncertainty. The coordination of benefits alone in price of care is uncertain. What’s going to happen with that, you have seen it's a best methods of billion dollars and shifted into the comp market.
So, again where we are is bad but it's also uncertain that’s why you have seen some major companies reduce their position dramatically, there is a couple of that reduced almost a billion or over billion dollars. Well, this is a big part of the industry. So, when you have that much business moving around, it creates a lot of turmoil. Couple of things, so the carrier side, the expense reduction initiative that you have been reading about why because when you reduce something this significantly it requires expense reduction, and by the way it doesn’t just affects your company in comp, it creates turmoil and your other specialty lines, it creates turmoil with your personnel, creates turmoil all over. And so you have seen that starting as people have shrunk pretty dramatically.
Second thing, for agent, again big part of their earnings. When you are moving this much business around, when you are moving 30% of your business around because people are getting off while we are pricing dramatically. It ties up all your personnel. What does that do, it reduces your earnings. And so they are looking most agents under pressure and they are saying how do I make more money without a lot of growth. That’s why you are seeing more consolidation in small commercial, that’s why you are seeing this how do I recapture the revenue from the wholesaler, that’s why you are looking to see come to people and say how much of my business is getting profit sharing.
So, carriers that are well positioned and the ability to help agents through that, but a lot of it coming from this dramatic change in some of these lines. And it's not just comp it's property too. So, let’s talk about properties.
So, property we all know from watching the newspapers, that the weather has been crazy. It's going to be probably the worst weather worldwide. So, it affected all of the reinsurance markets worldwide. But the U.S. has a little bit different dynamic, which is the growth of kitty cats, and what do I mean by that? Well in the last five years what you are seeing is a dramatic increase in these kind of more localized storm, tornadoes, hail storms, and frankly, it's not just catastrophes. In our data for instance what you see in the non-cat weather in the last three years is four points worse than the previous 10, which is consistent with this kind of pattern, which is more intense weather.
This has created a bunch of problems, right. Not only does it create more reinsurance cost at the top, for little companies, but even for the big companies where this is mostly been a primary things, it's not really been a reinsurance things. It creates tremendous volatility from concentration. So, you started here and companies talk about their concentration risk. The 100 mile radius where they have got to fin out.
Now remember we have been doing this for seven years this was our field, too much concentration. But there is a lot of folks that didn’t. And so what you have now is lot of folks fining out locations, now the unique thing about that is that the marginal cost of capacity for one company is not the same as the marginal cost of capacity for another. So, if you are concentrated in New Jersey and another one concentrated in Ohio, your cost of capital in the next piece of business is tremendously different. So, what you are seeing is people getting out, changing pricing and the stuff is shifting and spreading in a different way. And for us, why is this important, well $130 billion, this $450 billion market is in the 500 smallest companies, that typically we are in three states or less. They are in trouble. I mean if you think about you are in Alabama and you get hit this year. What do you do? You don’t have a spread of risk. And so what you are seeing is people shrink. Lots and lots of people are going through it, you are going to see it one as reinsurance prices influence them again. But you are seeing it everywhere. And again do we have 150 million of this, we are going to keep fining out and some of our zip codes, absolutely.
But we are growing like crazy in so many other attractive places and it creates so much opportunity via at the speed bump. But for a lot of people this is a big deal. This is a big deal, it's going to fundamentally change the Mid West for instance, which is dominated by regional companies. And so what you are seeing is a lot of pricing is going to get to better places, in these categories that are chronically underpriced and you are going to see some shift. So, again we look at this and say, yes it's a headwind. It's going to be headwind for everybody, if you can’t ignore it, I mean it good, you can well in the last three years it's not going to happen, but no good company is going to do that. They are all going to take the same tact we are taken which is assume last three years a real go. Assume higher reinsurance cost, assume more weather, price for it and manage your marginal business more aggressively.
And so again this is a little different than the last turn, it's not just based on the trends and pricing, it's based on some of these capital cost, balance sheet cost, yield oriented issues, that are going to create a movement of business.
And again a chance for some people to do very well. I mean the strongest companies will do very well, that are diversified. So, again all of these are coming together and what we see is a picture over the next two or three years and again I’m not saying that casualty large casualty lines are going to turn as fast as they did in the late 90s. I don’t know, I’m not in that business so I don’t pay attention to as much. What I do know is there is a lot of categories that are going through a lot of turmoil, and there is a lot of good business in those categories and there is a lot of other business that you are going to be able to capitalize on the disruption that are going to hurt some of these companies and strain agent economics.
Now again Marita is going to talk a little bit about what’s happening with some of our agents and our value proposition that make this little more real. Dave he is going to talk a little bit about what we do with risk management which we are very proud of. We have been after this for a long time, but we think we are well positioned for a period of turmoil like this.
Let me talk about agents for a second, because I think there is some confusion and as I said, Marita is going to do a little more on this. And I’m using (inaudible) as an example, but the segments are the same frankly in all of the developed countries. If you look at the United States, there is roughly 30,000 agents, and they are typically is these segments that I have up there. There are five segments. You got the small agents, where the people mom and pop typically personal lines oriented. Little bit of small commercial and habitational and categories like that, but essentially first line.
All of the action though in our space right now is above there, because that smaller segment is slowly dying. So, what you are seeing is the vibrancy is really mostly in the top three segments; the brokers, what I call super regional agencies, and then there is some very good enviable midsized agencies, particularly in certain geographies like Wisconsin and Upstate New York etcetera where the dynamic of those local market lend themselves to it. And so what you see is the concentration for instance like in small commercial is dominated now by the top 2000 agents of the country.
So, this consolidation, and you read it every day, the roll ups but it's not just that, it's the quite consolidation that occurs, because these are the most sophisticated agents, they are the ones that have invested in capabilities. They run more to specialty lines, they have more dedicated operating model to sell value in personal and commercial. They have separated. And when we started our journey because we were personal lines company, we were very skewed to the smallest type agents. And so part of the project, part of the work here along with the product capability was to position ourselves with a position of strength with the consolidators.
To be able to be getting preferred self space from the folks that are growing, that are really investing. And the blue circle is the number of partners we have in those categories now. And what’s fascinating because again of our value proposition where we don’t appoint everybody, because a lot of my competition appoints through aggregators everybody, all 30,000 or 20,000 through aggregators.
What we have done is we are going to be very selective, we are going to get particularly our niches and specialty to a subset of you and we are going to directly to you. And so what you have seen is a tremendous change in our penetration with the most vibrant segments. This is why we have so much interesting headroom. So we are probably the most successful and Marita is going to show some statistics that we are far and away the fastest growing player with the best segments and the best agents and the best segments, partly because of what we have done to help them with their economics, partly because of this broad product portfolio which they are trying to recapture, which they are trying to bring back home so they get more earnings, they are trying to be more industry solution oriented, so they have better retention. So, we are playing to the trends of the best distributors.
Now this is really expensive to do. Most of our major competition, most of the competition that comes from Europe, most of the competition that try to grow in the United States, they do it to the big brokers and wholesalers, because it's expensive to build relationships with 2000 individual agents across the country. It has taken a lot of time, a lot of money, significant distribution in the last seven years to do this. And we are one of the handful of folks in the industry that have it. You just can’t do this, you just can’t wake up one day and say I have direct contact interface efficiency with 2000 of the best agents in the country.
And this is a very big part of the defensible strategy. If somebody in Germany wakes up, come on says, I want to do social service which is a very high margin business in the United States. In the United States they either have to go to the brokers or wholesaler, or go to a handful of folks. They don’t have the ability to get to the most profitable business, so what do they do, they get to the large business that turn to us.
So, again our view is yes, we all know the names of the company that have good distribution. We know two-thirds of those guys are in the top quartile. So, again what we have built here is something that’s rare, and a regional companies will have it four states but very few people have this breadth of access established. And so what we have now again when you look at it, you say, I got a defensible position that’s expensive to get and I have a distinctive product set. So, that’s really what we have built. And so when you look at the next 24, 36 months and we look at why we are bullish on increased profitability on reaching our goal that we have set out from the beginning to be a top quartile players really the last goal left to get that additional return into this place.
We have three levers for us that are all things that we will focus on; first is this notion that’s traditional. We are pricing in almost all of our business right now, because in the segments we have picked, we are not in the largest accounts, we are not in the big wholesalers, we are not in the big brokers. We have consistent price increases against our entire portfolio. We also have a little bit of reunderwriting we can still do, particularly in concentrated areas and zip codes like in the Northeast and little bit of Mid West.
But more importantly we have these high margin businesses that we have built, we have additional headroom. We have lots of disruption in the marketplace. We see our growth coming from our higher margin niches, our specialty business and so we look at it and say we are priced and we have growth in the higher margin businesses.
And then finally, if you look at our returns in the last five years, they have been materially affected by eight acquisitions, thousands of hired people, lots of investments and hundreds and hundreds of new products, building an operating model, building connections with 2000 agents. Obviously we don’t have to keep doing that. So, for us there is tremendous leverage in growing our small commercial, we have invested, we now have a national footprint. We now have a people in place, we now have the operating model and so the leverage of growing that business is much higher margin than it was yesterday.
If you look at all of the specialty businesses, it's same thing. So, again for us there is leverage now because we built the operating model, we have built the product set and we don’t have as many investments. So, that’s why we are encouraged, even with a very difficult environment with headwinds and all of that. Our ability to go up to the next step and return, and the potential to do the top quartile in a sustainable way.
So, with that I’m going to introduce Marita. Again Marita is going to go through the U.S. and talk a little bit about the how and then we will to Bob, right, and then a break right. So, then Bob will talk about Chaucer and give you a little bit more in-depth overview and then we will take a break and then we will go into the deep dives. Okay. Thanks Marita.
Thanks Fred, and good morning. I’d like to spend some time as Fred said going through our U.S. P&C Business and why I feel as Fred does that we are really well positioned to capitalize on the opportunities that this changing market is providing us.
So, just quickly some takeaway that I want to leave you with this morning. First our U.S. business is very different today even compared to just a few years ago, and I want to demonstrate that for you, both our personal lines and our commercial lines is stronger, clearly more diversified and more distinctive. And our specialty businesses which were nearly non-existence just a few years ago have really been the primary driver of our growth, and they are clearly focused on the most profitable segments in the industry. Secondly, we have built a strong network of underwriting capabilities with a broad and distinctive product offering. Next that our distribution strategy with our partner agent is clearly distinctive and I think it's part of our competitive advantage. So, I want to break that down for you this morning as well. And we are really well positioned with some of the best agents in this country that drive some pretty distinctive profitable growth. And that our results with the best agents in this country are really impressive and that we already have a track record with those best agents.
So, starting with an overview of our U.S. business. We are vastly different company than we were seven years ago. In 2004 we were 66% personal lines, and most of our commercial lines was undifferentiated. What I want to demonstrate this morning is that today, we have a very strong personal lines account oriented business with much greater geographic spread. We have got a strong portfolio of commercial lines and those commercial lines businesses are focused on a broad set of as Fred said, accounted oriented industry solution with the development of our niches and the segmentation of our middle-market business. And Jack will spend a lot more time talking about that specifically.
And we have deployed national underwriting capabilities and talent in the market close to the point of sale which we really believe is a differentiating factor for us. We have built a strong broad set of specialty capabilities with the best partners and brokers in this country that also have that specialty expertise, so it's well aligned. And the majority of our business is with the best 1000 agents out there. We clearly have the right agents, I will show you some good traction and momentum with those agents, but most importantly we also have an also lot of head room with the best agents out there.
So, starting first with a look at personal lines. Our personal lines geographic mix has greatly improved from 2004 to where we find ourselves today. The portion of our business coming from the growth states has nearly doubled. And our big four that we have always talked about Michigan, Massachusetts, New York and New Jersey is less than two-thirds of our portfolio. As you know we exited Florida home owners and Rhode Island completely. And we significantly reduced our Louisiana presence. And that 4% that you see today, most of that is personal auto.
Bottom-line our personal lines business is about the same size, but we have a significantly better mix and that mix is still improving as we go forward. So, not only is the geographic mix much improved but our business mix has improved and our pricing momentum has really been consistent over an extended period of time.
From the beginning of 2008 to September of 2011, we have had a 13 point increase in the percentage of our PIF that is sitting in account business. Our single car monoline new business policies decreased from 27% at the beginning of 2008 to 20% in September of 2011. And our overall retention improved 2 points and that’s despite the exposure management actions I talked about in Louisiana and some other tactical reductions on some non-performing business. This better profile of business has obviously better underwriting profit as you can see on the graph. And the account oriented profile has allowed us to drive price not only in excess of trend, but we believe in excess of the market and these pricing trends continue for us. This obviously drive continued improvement in our overall results.
So, now turning to a look on commercial lines. We have also transformed our commercial lines during this period. Jack Roche who runs our U.S. commercial lines business will outline this transformation and obviously more detail. But just from a high level perspective, we have developed a suite of very distinctive products that are focused on segments of the business where not only we feel we can add value but we can actually extract the best margins in the business.
In small commercial through both segmentation and mix management and in middle market through account oriented industry solution. We have gained nice geographic spread and we have deployed top talent in local markets. We have entered and built a western presence that we have never had before and I can show you those slides in a minutes. And we have increased the penetration in geographies outside of those big four just like we did in personal lines. We have built a flexible and sustainable operating model which is obviously important to both our expense ratio and our scale as a business. And we have focused our distribution again towards those best 1000 agents and brokers where our capabilities really match their capabilities and where that focus is particularly relevant.
I wanted to spend a little bit of time talking about the OneBeacon transaction, because it clearly accelerated our distinctiveness in commercial lines. I think our strategic approach to the transaction really allowed us to maximize the benefits from it. Through this transaction we have broaden our product offering, bringing 11 new segments and niches to our middle-market portfolio. We were also able to add more than 10 new affinity programs in small commercial. It also allowed us to expand our geographic diversification. We wrote 26 million of new and 90 million of premium that we renewed in the west, so it gave us a good starting point in our western extension.
We advanced our distribution strategy. We appointed less than 300 new agents with a transaction and we walked away from a $100 million of premium that was spread across 1200 agents clearly demonstrating our commitment to limited distribution and sticking to our distribution strategy as a company. And our agents certainly took note of that and it was a big part of some of the new business we were able to drive and the transaction. We increased our scale and our capability with the transaction. We were able to renew 213 million of premium in our existing footprint and we were able to strategically add some talent in some new geographies and some new niche and segment capability as well. And we clearly improved our expense ratio by the transaction.
So, I think agency focus and strategic orientation that we took to the transaction allowed us to retain 79% of the business which is well above that what you see in historical renewal rates deals.
Now turning to our U.S. specialty business. Andrew will cover our specialty businesses in a lot more detail, but just high level. When we started in 2004, our specialty premium was predominantly legacy surety and legacy in the marine business. Today we have a specialty business that’s focused towards the more attractive segments. It's relevant to the most sophisticated agents and brokers in this country. It has heavy casualty orientation, certainly diversifies the property business that we currently have in both our personal lines and commercial lines portfolio. And the growth has been considerable but it's measured driven by the fact that we are bolting on some teams and a lot of the business growth has come to us through acquisition. When you add $200 million of niche premium that’s embedded within our business insurance portfolio, to $673 million of premium that we have built here. We have clearly $900 million of specialized premium and obviously the nice margin and earnings lift that comes with that.
Many of these specialty capabilities were enhanced through very successful acquisitions, and I wanted to spend some time briefly walking through a few examples of those acquisitions and the skills we have built both in execution as well as gaining the maximum benefit out of these. We have over the past four years done seven acquisitions both with and without balance sheet and we have been successful in meeting not only our business goals from those acquisitions but also our financial objectives.
Starting with HSI our specialty industrial business. It is currently fully integrated into the Hanover platform. We grew the premium from 18 million when we acquired it to 35 million in 2011 and it is clearly delivering outstanding profitability for us as an organization. I went through the OneBeacon renewal rights deal but both growth and retention exceeded our expectations clearly and profitability across the board is either in line or ahead quite frankly of the expectation we had for the transaction. And we are delivering tremendous momentum with both the existing partners that we had prior to the transaction as well as the limited amount of new partners that we added as part of that transaction.
Our architects and engineers business is fully integrated into specialty lines, and although it's a small business it is performing well within our growth expectations for it. AIX is also an excellent example of our integration capabilities. We are doing business with some of the best partners and brokers out there. It's has been central to many of our consolidation efforts with some of these best partners. We grew that premium from a 120 million add acquisition to over 250 million today. And it consistently deliver strong returns for us. So, we have built strong acquisition skills, in both the execution and in gaining the maximum strategic benefit and quite frankly earnings left from the acquisitions that we have done so far.
Our geographic mix as I mentioned before both in personal lines and in commercial lines is far better than it was when we started this journey in 2004. In 2004, we were highly concentrated with over 70% of our written premium in just four states. Today now it's less than 50% we have to built the western region that it in first year did over 200 million of premium. Some of that as I mentioned helped by the OneBeacon renewal rights acquisition today. We have over $300 million of premium in that territory, again a good example of starting with the right agents and doing it right.
So, in 2004 we had 23 agents, 230 underwriters distributed across the country and really no product capability in the western half of the country. And today we have got 31 offices, 450 distributed underwriters across the country and a very broad product portfolio in the west. So, bottom-line here I believe that we have really built a significant position in these U.S. businesses and we have a very nice competitive position.
In personal lines we are delivering on the best total accounts solutions for agents to help them not only write but protect and retain their best customers, while we are driving a very profitable mix and good geographic spread. In commercial lines with small commercial we built a distinctive product offering with a flexible and responsive operating model. In middle-market we have built a robust portfolio of industry solutions and significant value added services that come with that product differentiation.
And from a U.S. specialty standpoint we have built a portfolio that’s focused on some of the highest margin business out there. So, in total we believe that we have a portfolio that is very relevant to the best agents and brokers out there and at the end of the day our mix clearly matches their mix.
So, with that I’d like to turn the discussion around some of our best partner agents and our partner agent strategy. Not only does our partner agent strategy drives value for some of the best agents in the country. It also drives clear economic value for us. So, when we translate our value proposition to agents, we can break down the value that we bring to those agents.
So, in our value proposition our agents get direct access to a broad product offering. That clearly gives us the ability to capitalize on growing high margin specialty business and shelf space with some of the best agents out there. Our agents get real franchise value because of the limited appointments that we have in the marketplace and that gives us the opportunity to not only drive franchise value with the agents that are consolidating but it gives us the access to their profit pools and the higher margin mature business that those agents have in their portfolio.
Agents get local expertise and national capability and for that we get the ability to capitalize on a changing market and we are there when they need us when something changes quickly in the marketplace. Our agents get product and operating model that is geared towards their economics and we have built tools and support that allow us to access share shift of attractive mature business with those agents.
So, I mentioned briefly that we understand the levers that drive agent economics, and what his slide attempts to do for you across the bottom of the access, is we believe these are levers that agencies can pull to drive economic value, whether it's organic growth through growing specialty, expanding their industry capabilities, getting more specific about the capabilities that they bring to certain markets, improving their sales force effectiveness. Secondly, they can do agency acquisitions by acquiring teams or acquiring agencies. Third, they can enhance the value that they get from the current customers that they write by rounding out accounts and by doing less with wholesalers and writing more with direct markets who have that capability. They can increase the value of their carrier relationships by consolidating carriers, taking a strategic approach to the companies that they do business with and again reducing the amount of business they with wholesalers. And they can manage their expenses better by improving their retention, by reducing servicing cost, and by increasing the hit ratio on their existing business.
So, if we focus on these agent economics and then build tools, that help them maximize their revenue, we feel that that’s a very compelling value proposition for those agents. We can assist in growth, by having products and people at the point of sale that are good at those products. We have built tools that allow them to consolidate and take a strategic approach to their carriers more efficiently. We have built a value added service and that clearly helps improve their economics. So, clearly taking this approach to what they need, and then allowing our process and our capabilities and aligning it well to their leers is really something that we have spent a lot of time doing. And we think that that’s helped build our performance with some of the best agents in this country.
One of the first steps I wanted to show you is our business with the top U.S. agents in this country it's a [stats] it a little easier to get at, because many of them are publicly traded. With these top 100 agents with all of their carriers, their shrinking at a rate of about 2%. Our growth over three year period with that same group has been 49% for a total of $830 million. A little bit harder, but trying to break down some of the other segments in not just the largest and tough agents, we have looked at Reagan Consulting best practices agents, these are a group of agents that use Reagan Consulting that have been awarded the best practices certification and those carriers are doing a little bit better than the market instead of shrinking it 2%, they are growing it 2%. Our growth with that group of agents has been 14% over that time, that same time period.
And then lastly we took a look at the Assurex partners. This is many of the top privately owned independent agents in the country, and they are growing at that same 2%, many of these are also best practices agencies, but with that group we have an 88% growth rate over that same time period. And again clearly showing that we are driving some share shift with the best agents, but I clearly demonstrating we are just scratching the surface because there is a significant amount of head room with these agents as well.
Not only are we becoming more relevant to the agents, but we are getting a little bit of attention. So, I wanted to include in here just a little bit of external validation if you will from a couple of our best partners. RJF Agency in Minnesota is $130 million with a 150 employees. And I think his quote here clearly shows the value of limited distribution as well as local leadership.
Heffernan is $490 million operation with 400 employees and again our ability to align our skills with their skills is really demonstrated here in what they had to say about us recently in rough notes.
Today we also have a larger percentage of our commercial lines premium with more relevant partners. We measure those agencies with us that do over million dollars of premium, over $300 million in premium and combined in 2003 that group represented 52% of our premium. Today it's 82%. We clearly again have the right agents, we have got good traction and momentum, but the head room is clearly significant when you look at the average share that we have with those 800 agents, is only about 3%. So, we feel like we have an also lot of room here.
To wrap up, over the next 2 to 18 months, we think and know that we have the opportunity to drive significant value creation. First in personal lines through mix management both from a geographic and quality perspective, from our property management actions as we continue to look at scale and spread, book consolidations which we have proven that we are good at and share shift with our best agents. And have focused on the best account oriented profile in personal lines.
In our U.S. commercial business, and Jack will spend a lot more time getting details on this, driving mix improvement through segmentation and building our industry solutions, by improved pricing environment and we are clearly seeing that out there in the environment today, through gaining scale in our operating model and the benefits to our expense ratio, that brings us further penetration of the most vibrant agents in this country through book consolidation also in U.S. commercial.
In U.S. specialty business, scale in these newer businesses as we grow into the capabilities, that we have built over these last few years, by penetrating some of these new segments and taking advantage of the segments that we have like marine and growing our AIX program business, clearly through cross-sell of both the new accounts but also the existing accounts that we have in our portfolio. And clearly focused on and target on the highest margin segments in the industry today. We will drive scale, we will improve our expense ratio and we will continue to lower our loss ratio.
So, I thank you for your time and attention this morning, and with that I will turn it over to Bob Stuchbery, the Head of our International business. Thank you.
Good morning everybody. I’m Bob Stuchbery, and I’m the Chief Executive of the Chaucer business. Let’s look first at the values that we bring to The Hanover group. We are a strong specialty underwriting franchise. We have a capital model that’s very efficient. Our capital ratio stands at 46% which is less than with average and little bit more about (inaudible). We have got a diversified underwriting portfolio, it's well balanced and that’s diversified by class of business and also by territory. We provide access to Lloyd’s and I’m going to focus a little bit on that later to give you the benefits that we get there, but Lloyd’s can’t give you that global reach, and the rating that Lloyd’s has on a combined basis. And I also demonstrate that in 2012, we can now look for the business is very positive.
So starting with a little bit about the Chaucer business. It started in 1998 and that was a management buyout of three syndicates, which were managed at time by traditional managing agency who now built that to be a top 10 managing agency at Lloyd’s. We currently manage four syndicates and related two of those we regard as being in-house syndicates, and two of those we manage on behalf of third party capital.
And we got a headquarters in London, by the Lloyd’s Building, but we also have international offices which are in Buenos Aires, Copenhagen and Singapore, and we have a contact office in Houston and we have a contact office in Oslo. And the main operations for our UK business which is predominantly UK (inaudible) is outside of London in which (inaudible).
So, this is a business structure, Chaucer Syndicate is the managing agency, and Chaucer Syndicate is the FSI regulated company. So, that’s where we get our regulation direction and then Lloyd’s does a regulatory function as well as a subset of the FSI.
So, overall funds in the management or capacity which is really a proxy for income, $1.6 billion. This is where it splits into what we regard as being third party syndicates and in-house, just touching on third-party very quickly. We have no economic interest here, the two syndicates 4242 is backed by U.S. private equity syndicate especially the one is currently backed by Clal, the largest insurance company in Israel, and soon it's be transferred over to Torres. So, I’d like to focus on what we call the in-house syndicates which is 1.4 billion.
Backed 1176, we broke this down to our Nuclear syndicate. And then our flagship syndicate which is 1084. And 1084 has a capacity again proxy for income of about $1.4 billion. Important to note at this stage the difference between capacity and economic interest. And you will see that on 1176 we now hear them we have a share of 56%, the remainder of that capacity is with traditional names, and that’s part of our strategy to manage our risk appetite for that class of business, is we are comfortable with that share of the overall Nuclear accounts.
On 1084, we have a share of 84% and again the 84% is just a function of where we sit relative to the charge of capital we got supporting the syndicate. The important thing again to note with some of our peer group is that we own all of our Class D. And for you guys new to the Lloyd’s market that’s probably not a significant issue, but it means that we have complete control over the growth of that business and it also means that some signs backed capacity that we benefit rented out from a limited tendency could be bought back to us. 1084 the flagship, we then breakdown in separate divisions, and the energy, property, marine, aviation, casualty and the UK which subset is predominantly motor business.
So, looking at the team. Our Chief Underwriting Officer, Bruce Bartell. Bruce is actually over here with me, and will be available for some questions later. Bruce has got expensive experience within Lloyd’s and (inaudible) of Lloyd’s. And it's his role to manage the Class D allocation and look at the strategy and business planning process under the classes business. The two syndicates again these are Lloyd’s terms have what we call active underwriters and these are in fact the business leaders for those syndicates.
John Fowle, is our business leader in 1084, he has got a number of years insurance experience and he is being with us right here. So he is relatively a new addition in terms of our class underwriting etcetera to Chaucer. And Michael Dawson, who is the underwriter on the Nuclear syndicate, tons of insurance experience. And he is being with us for eight years as well.
But more importantly below these guys, we break these divisions down, the division heads have an average of 31 years industry experience, and 11 years experience with Chaucer. The team then grows into what we will call specific class underwriters, and that’s important because every class of business that we write, we have specialty underwriters to write this. And there are 100 underwriters deployed writing over 30 subclasses of business. And each of those underwriters has expensive insurance experience.
So, the underwriting franchise that we built, we have got underwriting strength and debt and that’s demonstrated by the team that we have just gone through. We got a long established book of business as well. And this book of business is being distilled over really the last 10 years for the merger of around 10 syndicates. So, we have a lot of opportunities to take in business accounts, (inaudible) that we like, business stuff that we don’t like and that’s a means of our distilling it down to where we are today. And where we are today is demonstrated really by a track record. So, here we have taken a cycle 2003 to 2010 and our average combine ratio over that period was 91.3%. And because of the capital efficiency that’s averaged in ROE of around 17%, and that’s inclusive within there in things like 2005 with Katrina, Wilma, Rita etcetera.
So, it's the performance that we (inaudible) will be proud of and can evidence much strongly. So, the addition of the business, that’s the specialty insurer, our vision is to be Lloyd’s specialty insurer of choice and our goal to deliver superior return on capital and build enduring value. And it's really that enduring value which we focused on which is a return of equity that’s going to be consistently best in the Lloyd’s sector, a reliable performance, the absence of shock losses and volatility. I will get into some of that diversification across classes as well. Also the fact that there is a lot transparency about what we do, you shouldn’t be surprised about what we are involved in. And we created a very valuable Lloyd’s franchise across those brand, and that’s across a number of classes of business as we develop them.
So, looking then at the key areas of our strategic focus and what we have done here is break it into two. So, starting with what we called London and UK divisions. We have here a strategy or strategic focus to be the top three underwriters. Now that’s not my size of account not by size but line. We use as a metric here, but it broke out the pace of business in the class of business that we underwrite. We would expect to be one of the three people that has to be on his list to visit. So, it's the expertise that we provide along with the line size capability and ability to rise in that territories.
So, it's not all about size, it's about the fact that we got our expertise to underwrite it. We have a disciplined allocation of capital and again part of Bruce’s role as Chief Underwriting Officer is to look at the accounts as we go through a year. We see those area where we are outperforming in line with full cost and adjust where we not, and adjust where we are not either because we are not getting underwriting levels that we expected. All our states our rate increase in excess of what we like. So, we do have within the Lloyd’s structure that ability, fundability of capital which we can (inaudible) back with a Hanover before we make those decisions.
We have strong broker and coverholder relationships, and yes this too tend to be with the larger brokers, that type of business that we want. But more and more recently we are trying to develop those relationship with a next year of brokers, smaller brokers we have got specialties that actually like. And then we put down here the strengthening position in the UK motor. We are a very small UK motor writer, we have less than 1% of the market in the UK, but we are a specialist writer, so that’s a combination private car but specialism within private and also some fleet business as well. So, it's a very specialty portfolio, what you would regard as been more non-standard to standard business.
The global energy practice is roughly something that we have developed with Lloyd’s written energy business, business over the last couple of years we have been more and more disappointed with the offering within the Lloyd’s market for energy underwriting. And what we are trying to do here is to build the leading energy insurer within the Lloyd’s market. And that means that we have to integrate all of our capabilities that the client and the broker needs. And that’s a combination of wordings expertise, pricing expertise, exposure management and also very, very important that he claims expertise that we will have. So, these are the areas that we are looking at from strategic focus.
I’d like to now just delve little bit into why Lloyd’s. Lloyd’s has a unique operation structure, and it is not a single insurance company, it's a group of specialty insurance players who come under that franchise umbrella. And franchise is a term that will come back to. The franchise has a role of monitoring the performance at the players within their. And Fred might have referenced earlier to the fact that Lloyd’s is a much different place than it was a number of years ago. And really the appointment of the performance director is currently (inaudible) has done a lot to improve that overall performance of the market. They look at outliers as regards performance and they address those issues. So, given that credibility and it's one of the things that really host together, the writings that we have and which I will talk about later.
Much of the business that we write within Lloyd’s is on a subscription basis, this is the function of the size of business, the complex nature of some of the business that we are writing. And a subscription market has become back in [vogue], there was a trend for it to go back to more single participations, the couple of the larger corporate players supporting risks. Now because of the problems that you saw over the banking practice and that consolidation of exposure that people saw at that time. The subscription market has become more popular and this is really four more business to Lloyd’s. And within Lloyd’s it spread that business amongst the syndicates. So, that’s important part of what we have seen in Lloyd’s at the moment.
Fred also mentioned the diversity of the capital that we bought now, very few individual names left in the market. It is now big corporate international players. And as regards capacity the 2010 market capacity was nearly 37 billion, and that’s written to 85 syndicates and 52 managing agencies, but the peak of the Lloyd’s market as regards number of syndicates, they are over 450. And again one of the jobs that has been done really to consolidate that down into larger units more specialist, most financially secured units within the Lloyd’s market.
And financial security if important, Lloyd’s carries an A+ rating from Fitch and Standard & Poor’s, and A excellent rating from Best. And that’s really to demonstrate the chain of securities we call it within Lloyd’s and that comprises that chain of security the premiums we see, the capital that’s put up for the players that underwriting within Lloyd’s, but then on top of that, we have the Lloyd’s central guarantee fund which is a [neutralized] protection for policyholders. That chain of security, the beginning of ’11 sort of $86.7 billion. So, one of the important things, not only is to have those writings because the consistency of those writing and we have enjoyed those writings now for number of years.
I mentioned earlier the capital efficiency of our model, and let’s just look at that in little bit detail. So, what do we do within Chaucer is we balance that marine, aviation, energy, property, UK motor which again is unusual for the Lloyd’s market, and Nuclear which we are the only Nuclear syndicate and the largest writer effect class of business. (inaudible) is a total underwriting interest of about 1.1 billion and capital requirement as I said earlier is 46%, and that compares with a capital requirement from the market of 59.4%. And that capital ratio could really be used and should be used proxy for volatility. It's because we got that diversification with their account, but it allows us to operate of that capital ratio.
The diversity is to demonstrate that internally with the capital allocation, we are undertaking capital to UK motor at around 20%, and on a standalone basis the Nuclear syndicate has a capital ratio of about 400%. So, you can see the advantage that we get of that plan to book.
The combined ratio I mentioned earlier 91.3% and that’s over a period of time which we regard is a pretty good demonstration of the cycle. Investments we have got good leverage on investment we currently portfolio about $2.4 billion as at the end of September. And that’s what really drives that return on equity that we have had of close to 17% from 2003 to 2010. So, it's a model that’s well tested and is proven to be successful.
A little bit more about the account and the breakdown of that account, it's diversified using that word. We started UK motor 23%, energy 19%, property 21%, marine and aviation 23%, and our casualty including our international liability around 14%. And in total on a GWP basis in dollars that’s about 1.3 billion.
So, looking at these little bit more in detail, energy as I said 19% of our portfolio. We look at up mid downstream energy assets, property liability, we also included within this division the Nuclear business, and you will see at the bottom here, we put indications of what we have seen as regard to writing environment in 2011, and what we are forecasting for 2012. And across the portfolio in 2012 we are looking about a 3% rate increase. And that’s really pretty steady most classes whether it would be liability or property first party.
The property account that we have got, Fred again mentioned earlier that we are not a heavy writer of property treaty reinsurance, 21% of the portfolio was property, and again we are seeing rate increases this year particularly on the international side, because of loss activity and that’s coming across both the facultative and the treaty excess of loss account.
On the North American size where we don’t write facultative and binders, we were expecting late increases in 2010 to be around 10%, and that’s really driven by the (inaudible) loss rates. And all of this could be influenced did more by the experience that we will see more recently. So, we would at the moment, these are probably particularly in the international side, regionally conservative.
So, looking at the marine account and aviation, we write all class of marine business so that’s across the hull, the cargo specie, PV, political risk and some excess of loss, rate increases this year will be about 7% increase, but that has been driven by some of the marine classes. For 2012, we are actually reducing back our excel writings and that’s deflate in the rate increases that we expect t see in ’12. But still we expect that to be around 3% over the portfolio.
So far it's good news. Now look at aviation, little bit about what we write in aviation, we tend to be a general aviation writer and not airlines and by airlines we are defining these as being the flag carriers we avoid the heavy liability limits that you get, with U.S. carriers, European carriers, Japanese carriers. So, that’s a lot of privately owned fixed [rotary] wing. The results of this have been very, very good but it's a tough market at the moment. And you will see that from ’11 we expect to end the year about 1 point down on rating, and for next year we expect that to be about 2 points down. But it is a small part of the overall portfolio.
On the casualty side, around 14% of the portfolio is casualty, and again there is a range of classes that we write. But really in summary if you look at the U.S. exposure that we would have, our U.S. exposures either claims made or losses discovered, or where we do right things on our currents basis, they tend to be cap driven. So, when you see workers compensation down here as a class that we regret, we write that on a cat basis and not within an individual life. So, it's very [short tail]. There is no products exposure within our casualty book which drives that tail.
In 2001 we saw rate increases of about 1% reduction. In 2012, we forecast 6%. Standing here today that’s probably the one I would say is the most optimistic. We expect rates to go up in this area. We think it’s necessary the rates to go up in this area and we’re planning accordingly, but really the time will tell, but we’re looking for that across the glasses.
Looking at Motor, finally, as I said that’s differentiator for us in Lloyd's. It’s a chunk of our account where we’re looking at Personal Lines. It’s something that we’ve had a lot of raising action over the last couple of years. We are predicting those rates increases in 2012 to still be above claims inflation. And the book is now back performing very well. It’s a long-standed specialist book. And as I said our market share is very, very low.
In recent years, we’ve taken advantage of some of the aggregates as the means of producing business and that our retention ratio has increased quite considerably. So you’ll see some growth in 2012 as well.
So looking forward to 2012, and the market environment we face ourselves, (inaudible) chart there shows that 93% of the classes that we underwrite, we expect to see rate increases. And I’ve broken those down, highlighted in there on this slide, 7%, we’re forecasting to see there a flattening of rates, particularly around nuclear and also on the aviation account, a slight reduction. But the portfolio is going to be sensitive. The property portfolio that we underwrite with the international exposure that we’ve got following the recent catastrophes, we’re expecting to see rate increases.
Energy has seen some losses, Deepwater Horizon the more recently the Gryphon loss, so we’re expecting the rates to go up in those areas. And again, that’s an area that we’re focusing upon and building a good team.
UK motor, a lot of works been done there. It’s now back into, what we’ve got is, healthy profits. And we’re looking for rates increases just to keep ahead of claims inflation. And as I said, whilst we have been positive about casualty, that’s probably the one that we’re looking to get to put out at this stage, and aviation market still got a long way to go. But I think the important take away from this is that this is a strong portfolio. It’s a diverse portfolio. And 93% of that portfolio, we’re expecting to see rate increases in 2012.
So the next area is really the opportunity that we see for distribution with the Hanover. I mean, we’ve got a lot of Lloyd's branded products and we expect to make those available to a number of the Hanover agency network. We’ve already looked that in 2012, where our planning process in some of those areas that we can get some quick winds. And we’ve mentioned here aviation, energy, marine, financial institution. This is specific areas of those classes of business where we think we can do something in 2012, which will impact our 2012 planning.
More importantly, I think in 2012 there’s going to be the opportunity for us to look at the opportunities that we’ve got, which will come to fruition in 2013. And that’s now a key part of our strategy is seeing those opportunities fulfilled.
So quickly in summary, and getting you back on track. It’s a well diversified portfolio. We’ve demonstrated, it’s capital efficient. And that diversification comes from product mix and also geographical mix. And it’s something because of that diversification does act as a natural hedge against volatility.
We’re looking at positive outcome in 2012, with 93% of the portfolio looking to see rate increases. The underwriting that we’ve got in place the underwritings we’ve got in place, the team, the capital we now have in place is all there at place for us to take advantage of those opportunities if they occur. And as I said, we’re expecting to see some those in ‘12.
We’ve got the products, is now a matter of us working with The Hanover to look at some of the distribution of those products back to their agency force. And that’s something we’re going to focus upon. So really we do think that is very complementary, the mix between Chaucer and Hanover. And this should give us a very strong platform for which to see some profitable growth.
There are some appendices in the handouts, which aren’t in the presentation, which go into a little bit more detail, which I thought you might like on the individual classes and areas of business that we underwrite. So you can read those at your leisure.
So I think now, on a room at the back, we are going to have a break for coffee. Should we say 10 minutes, because we all running a bit late. So if we make back here in 10 minutes of time is that a good idea, and we’ll kick-off again in 10 minutes. Thank you very much for your time.
I think we are ready to resume our event. In a moment, you will hear from Andrew, talking about our Specialty business, followed by Jack Roche, who will speak about our Commercial Lines. David will talk about our financials and then we will entertain your questions in the question-and-answer session. Andrew?
All right, welcome back. Good morning, everybody. So over the course of the next 30 minutes, I’m going to try to give you a broad overview of our U.S. specialty business. And I’ll also then spend a bit of time going into detail on three of those businesses. Hopefully, as a means to communicate you the many different things that we’re doing and all the good work that we put in place that positions us from this point forward.
There are five things I hope to communicate and have you take away from this conversation over the next 30 minutes. The first is that we are, as an organization, deeply committed to building a U.S. specialty business that really enhances the value of the Hanover to you as shareholders and prospectus shareholders, to our agents, obviously, and to our employees.
Certainly, that we are building a portfolio that we believe is good, not only in terms of just its diversification, but as Fred mentioned earlier, importantly, we have taken a good deal of time to understand where it is that we believe the greatest opportunities exist in the U.S. property and casualty market, where margin exists, where we are all suited to go after those segments. And that’s really where the focus of our specialty activities are leading us.
Third is that we have invested considerably in bringing we consider to be some of the very best leaders to run these businesses, supported by very strong people. We’ve invested in infrastructure and operations, market leading products. And we believe that it is those investments that have been the reason we’ve been successful. So far I’ll share some of the examples and some of the results, but also what really position us for the future.
Fourth, even though we’re relatively young in our development of specialty businesses, we believe that in each of those businesses we’ve established a one or more leadership positions in the places that we choose to compete. And then fifth and I will cover this in the end in some detail, which is that in each of our businesses while we’re very pleased and proud of the progress we’ve made and the results that we’ve achieved we see considerable upside. There’s a lot of opportunity for improved margin, even our margins are good and certainly wonderfully opportunity for us to continue to grow and develop this businesses.
So let me give you an overview of the business. Our specialty portfolio consists of seven businesses. AIX, which is our Specialty Program business, Marine, Surety, Management Professional Liability, Healthcare, which is professional liability for health professionals and specialty, industrial which is focused on property risk that are highly protected, manufacturing risk that require a good deal of engineering as part of the loss control and risk management. Together this businesses produce around $700 million of premium. I think we’re targeting about $680 million for this year, which is about a 13% growth over the prior year.
And the key feature of this business and I’ll give you the examples and I’m going focus on the three segments that are in blue, AIX, Professional and Management Liability and Surety, key feature of this businesses. It’s all about what we’re doing from a product, from a risk control, loss control and some of the surrounding services. And I’m going to take one example before I move on give you the specifics around each of those three segments and that’s our specialty industrial business.
Our specialty industrial business is very much focused on, as I mentioned, sort of the each pair market, but we operate far below the factory mutuals and some of the larger players. The big part of that is that when there is a fire oftentimes you’re using specialized chemicals to put off the fire. So the debris removal is oftentimes a challenge. You have contaminated potentially, some contaminated debris that needs to removed.
One example of why it is that we’re winning is build products and services focused towards that specific exposure, which is one of the most important exposures that those kinds of manufactures have. What’s interesting is that when we’re competing against some of the incumbent markets on those kinds of business, which oftentimes are standard lines markets, which oftentimes are the E&S markets, those kinds of covers are frequently excluded. And so agents, if they find themselves in a situation where they’re insured, where the customer has a loss, might actually have an E&O exposure. So we find is that that’s an example where we build product and loss control services that go directly to the heart of the matter, obviously, charge for that exposure. And that’s a reason that, in that particular business, we’ve been very successful.
So let me move on and talk about the first of the businesses I’m going to cover, which is AIX. AIX is, as I mentioned, a program business, about $250 million. We have about 34 programs. Those 34 programs are through 30 different program administrators. You can do the math, our average program is about $70 million. And the typical AIX program is a program that is very seasoned, sort of a long track record. Most of these programs are programs that we would describe as historically dormant. They don’t really get to market. They’ve been with many of our competitors for many, many years, so people oftentimes don’t know about them. They tend to be substantive in terms of the hooks, whether they’d be loss control, or whether they’d be certain types of hooks around the way the programs are marketed, some of the connections with associations. They tend to be casualty focused, small face value kinds of exposures.
And generally speaking, moderate hazard, certainly, not in the extreme hazard end, but still in the specialty markets. And because of that they tend to have a reinsurance following that are in place for a long time and support those programs even as some of those programs have moved to us.
So what’s different? It’s a $30 billion market for program business here in the United States. Why is that as we really describe? We’ve been able to grow this business from a little over $100 million when we acquired it three years ago towards a $250 million business today. So there’s a few fundamental pillars. So what we do first is that we don’t do start-up businesses. We’re only focusing on mature business, business that we can understand, business that has track record.
But, importantly, we’re working with program administrators and the guys that are prospective program administrators for this businesses to understand exposure in ways that they might not ordinarily have an opportunity to understand. It’s value that we’re adding to them. Frequently, you find that there’s risk participation, either on the part of the insured and association, sometimes on the part of the program administrator.
Fourth is that we tend to work with programs administrators who have one or very distinctive qualities from an operating perspective, from a frontline underwriting perspective and potentially from a risk and loss control perspective. And importantly on this is that, we are different than many who operate in this space, except for one program which is written on a BOP or Business Owner Policy, every single we retain underwriting control. We work the program administrator to do frontline underwriting, but we remain in control of all underwriting decisions.
So again, $30 billion market. We’ve grown the business very considerably. Why is it that we’ve been successful and growing the business considerably? Well, a big part of it is that we acquired AIX three years ago, fundamentally, they were building a great business, a wonderful management team with lots of experience, had been able to take that experience from their 20 plus years working in the segment and be able to build the business learning from those experience, heavy focus on technology, operations, the ability to have product in a product structure so that as new programs are added they can easily be brought to market, and even very successful in doing that. And over the course of the last three plus years, we certainly have helped then accelerated that starting point that they brought to us.
Secondly, a big focus towards trying to find the best of breed, in terms of claims and loss control. So when we’re working in some of these specialized segments, the ability to bring in experts, who can add value is something that we’re opened to doing that many other carrier markets want to hold control of those functions, despite the fact that they don’t necessarily have the expertise. Importantly and then we’ll talk a little bit more about this. There’s much that we’ve done in terms of creating tools that add value to our distributors. That’s built on sort of an experience base with the leadership at AIX and the things that they’ve sort of thought about over many years that we’ve been able to develop.
And finally and importantly, I’ll give you a couple of examples that we bring this to life; the franchise relationship has proved to be very important to our success. Many, many of the program administrators that we’re doing business with and most of the growth is with that top 100 that Fred talked about in the opening of his discussion and it’s with the top 100 who both have retail brokerage kind of business, but also have focused on building a program administration business and see that as being a big part of their growth.
So I’m going talk about three examples. The first is a company called Frenkel, which is the 41st largest broker in the United States. And this is a really interesting story. And that Frenkel is a company that has this long standing program in cosmetics manufacturing and distribution. In fact, they have the sponsorship of the ICMAD. And this program has been, historically, with two carriers, very stable, very consistent program and through the process that we went through with one beacon where we were bringing over the renewal rights, what, was a relationship that we had with Frenkel became much more significant.
And through that relationship had an opportunity to bring AIX in and it happened to be at the time that Frenkel was making a decision to take a meaningful step forward with this program. They really wanted to move it to an entirely different level and then feel the two existing two carriers that were supporting them on the program were able to that. And through that process concluded that AIX for many other reasons that I just talked about in the prior page, in fact, was well suited to help them bring the program to another level. And I’m going to come to after this page just some comments that came back unsolicited from the President of the part of Frenkel that’s responsible for the cosmetics program that’s driving profit.
Second example, Wells Fargo; the Wells Fargo relationship is considerable for the Hanover. And the program that we have with AIX is one of only two national programs for ski resorts, very, very specialized class of business. Wells Fargo in our opinion does this and has a understanding of this class than any other broker in the United States.
Again, here is a situation, where long-standing relationship with the Hanover, AIX actually had a long-standing relationship with Wells, although, not a commercial relationship. But as soon as we acquired AIX, with the financial strength the relationship that we had built with other parts of Wells, it became an easy decision to take a program that had been very stable, sitting with an existing panel of carriers divided up by line of business for a very long time, and over the course of about 20 months, be able to move that entire program to us again with great success.
What is interesting about this, and I think that both Bob and Bruce noticed, is that there is a 30 year consistent support in London for the reinsurance and the program which continued as the business transition to us.
Finally and a slightly different example is, a specialist called Cline Wood, whose focus is specifically on the agricultural segment. And within the agricultural segment they are retail producer of that business, but they’re also a program administrator effectively for a livestock program. And again, a situation where two very reputable national carriers supporting this program, Cline Wood choosing to try to take this program to an entirely different level, try to engage their existing carrier markets and supporting them in that regard, weren’t satisfied with what they were hearing back in from many of the reasons, again, that I exposed to you on the prior slide and relationship that I actually built when the opportunity came to step in and be the carrier for that program we were able to do so and again, with excellent success.
So long quo here, but very powerful, probably the best advertisement I’ve read for us in sometime, which is in preparing for this Investor Day, I asked for each of the three program administrators, who I talked about in the prior slide, to give us their thoughts and if they’re comfortable with us presenting. And in fact, unsolicited, this is what Ken Hegel over Frenkel came back with and you can read most, but I’ll hit on few parts, which is we wanted to find a true partner and a carrier that understood the program business, but a partner those committed to the industry and share the same goals that we did, which is around continued growth and success of the program. And it goes on to say that there’s a number of reasons that they have gone with AIX and Hanover, one of those is product, two is the team, the financial strength of the company, our responsive service, our knowledge of the program business, our infrastructure and the list goes on and on and on. And this is an unsolicited comment.
It is actually this kind of reputation that has been sort of the linchpin for us being so successful and really capitalizing on what has been a relatively disruptive period over the course of the last couple years in the program market.
I am going to transition into talking about the second of the two businesses I want to cover, our Management and Professional Liability business. The Management and Professional Liability business for the Hanover is a business that in exist just four years ago. Today, it’s about $100 million business. I believe we have a plant for just actually about $93 million for 2011. It consists of the Management Liability business consists of kind of four components. The first is D&O, and a D&O package product, which includes Fiduciary, Fidelity, Kidnap and Ransom, Employment Practices Liability for private companies.
The second is a similar kind of structure for not for profits. So a standalone D&O product, as well as a Management Liability package. Third is a standalone Employment Practices Liability product and the fourth is a Crime product. So that in exist. And I’ll sort of give you a view in a moment as to how it is that we develop that as part of our overall entrée into the Professional Liability market.
On the Professional Liability side, it’s really four areas. It’s Professional Liability for lawyers, for accounts, for architects and engineers and then something that we call miscellaneous, which effectively is 164 different classes of professionals that range from agricultural consultants to translators, so very, very broad swath of professionals for which there’s a liability exposure, for which we’re able to provide an expert solution.
So what happened in terms of the development of this business and this very speaks to some of the comments that Fred made at the outset, some of the comments that Marita had made about the investments that we’ve made and how well positioned we are. In 2007, we bought a small specialist called Professionals Direct, a specialist in the Professional Liability segment. It’s a very successful acquisition, but it form just the starting point for us in this segment.
Next then what we did is we hired a women named Helen Savaiano and a small team to lead our Management Liability business. We started by bringing a focus towards not for profits and Employment Practices Liability, two areas that we thought we could immediately capitalize on given what we are doing in our commercial business. So that brought us into Management Liability.
Next, we hired a long-standing veteran, a gentleman named Bob Drohan to start and oversee our miscellaneous professionals business. Again, that’s a segment that’s focused on those 164 different classes. And we hired gentlemen named Gerry Merritt, which prior to joining ran the largest Lawyers and accounts professional liability business in the U.S. Then we made a big investment in infrastructure. We built effectively what is an end to end very modern technology platform called PLUS, Professional Lines Underwriting System, and we implemented it for Employment Practices and not for profit. And then we started to build a private company management liability.
Next, we took our LPL business and our MPL and we started to transition that out to our regional model. That is characteristic of much of what we do, trying to put the expertise closer to our distribution. We bought Benchmark, which again Marita talked about when she gave an overview of some of the acquisitions. And then we built PLUS as well as web front end called Point of Sale for a miscellaneous professional liability effectively being able to deliver solutions that our agents could access online for the miscellaneous professional liability business.
Next, we implemented PLUS for private company and point of sale for EPLI and not for profit. And then, we implemented PLUS for A&E. We hired another leader for one of competitors to run our Lawyers business and to start on an accountants business. All that done in four years. What we have today is the staff of about a 100 people, majority of those people are underwriters, out in the field, close to our markets. And we’ve also through the process, as you get a sense, built market leading infrastructure, market leading operations and certainly market leading products, so a quite significant investment in building this business effectively from zero to about $100 million over the course of four years.
So what is the distribution look like? Well, we got a start by focusing on specialist who are very good in management liability and specialist who are very good in professional liability. And certainly, over the course of the last eighteen months, we’ve seen a migration where very much the franchise partners who have capabilities in these areas are now becoming a very important part of the access and distribution of this product.
And the reasons that we win, I don’t want to go over all of this, because it is many of the reasons that Marita talked about earlier as she was giving an overview of distribution. But very much at the heart of this is being able to give very good distributors something more to sell. And in some cases, adding to their expertise or if they’re reaching the placement of this business through wholesalers, the ability for them call back some of the commissions they forego. And ultimately, of you do that with a relatively limited distribution, we have found that that’s been a formula for success.
And I imagine at this point, if you’re thinking about, well, this business has been growing from zero to $100 million or near $100 million or a relatively short period of time over the course of four years in a relatively challenging market with the profit characteristics of this business, should we be concerned. And I’m listing some examples here, and apologies for those in the room, the small font that should give you a sense that what we’re not doing is we’re not competing for new business in the new business market.
So the first example is something called NLADA, which is a program that have been with one of competitors for many years, and dormant, stable, would never see light of day. When we bought this business, we developed a relationship through Wells with NLADA. And over a period of a couple of years, here is a program that has some those wonderful attributes, a multi-million dollar program that we were able to position ourselves to intimately have moved to us with the support of Wells as a key distribution partner.
Second example, one of our very good agent relationships out of Chicago at TMK, a company that we have a very broad relationship with from a franchise perspective, who had an association sponsorship for, believe it or not, lyricists, they’re like jingle writers. Program that is very profitable. They wanted to grow. Again, unsatisfied with their existing market that was supporting them. We brought (inaudible) to meet with them. And over the course of six months, together, constructed an approach that would support them both in the development of the program and moving that existing book of business.
And again, an example, believe or not, competing in the new business market to develop this business for finding very attractive segments that are entirely consistent with what we’re trying to build in terms of our mix and supported by our infrastructure.
I’ll touch on one more example, which is a wonderful distributor in Michigan called Cambridge. And Cambridge, just look at the comments, again, unsolicited; we love doing business with Hanover Management Liability. We generally gravitate towards underwriters who understand ease of doing business and our underwriter actually walks the talk, where coverage focus is a key point. We’re coverage focused agency and our local underwriters truly understands management practices coverages.
I won’t say what company most of this businesses come from at Cambridge, but we haven’t been competing in the new business market. This has been largely a book of business move from one of the two markets that I think most people who are familiar with the industry would say, is are the strongest markets in the private company management liability segment. And that has been an extraordinary accomplishment for us to be able to build a business and be able to achieve those kinds of results with a sophisticated distributor in such a short period of time.
I’m not going cover the last example. I’ll leave that to you to read during your free time. I’m going to move on, just give you a sense for what’s happening in the development of our Surety business, is the third area. Surety is made up of both contract surety as well as commercial surety, about two thirds contract surety, third commercial surety as an organization. We have strategically been trying to rebalance that portfolio, moving it more towards a 50/50 kind of mix. And we’re well on our way to doing that, very confident in our progress towards that.
Again, the business, about $100 million, just shy of $100 million with a heavy emphasis towards the middle-market and down. On the contract surety side, it’s what you would expect, we’re serving general contractors and a series of segments that are much more specialty contract focused. And on the commercial surety side, you can think of the commercial surety business as having both transactional, which is very small bond needs and more account business, larger bond needs, and we have both the technology and the operations to do the small bond needs very efficiently, system called bond direct, which allows sort of a point of sale access to us, as well as be able to serve the account needs, market as well which is larger bond limits, and categorized around some of those segments that are listed on the page manufacturing, service contractors, healthcare, et cetera.
In terms of surety distribution, interestingly heavily weighted in terms of numbers towards franchise wide distributors who happen to have strong surety capabilities which tends to work very well for us, and so as far as, we take a very sound offering, a middle market focused offering with people who are local to the markets with strong knowledge, strong product, strong customer service. And then, also be able to do the contract in the commercial and interestingly there really isn’t a lot of markets who do that set of things well. So, if you combine that with our distribution strategy, it’s proved to be a very positive formula for success.
Nonetheless, we are continuing to grow and invest in this business and I know that David and Fred talked a little bit on the earnings call about some of the things that we’re doing. I just wanted to put a little bit more color around that. Most recently, we’re very proud that we’ve hired two of the best executives that we can find in the industry to help lead our efforts. Bob Thomas, who came to us from Argo and prior to that spent a large portion of this carrier at HCC. Ted Martinez came in, as I mentioned with a heavy emphasis towards us building our commercial surety business to lead that charge.
I think many of you are aware that back in 2010, we acquired effectively what were the renewal rights for book of business from insurance companies of west which became the platform by which we built our western focused surety business and brought over a team with that and suddenly had a national business where along with some additional hires that we’ve made in specific regions has really given us the coverage and the footprint that we’re looking for.
Third is that, we are with our commercial surety business, with the leadership of Ted Martinez we’re clearly moving towards expanding the breath of the segments that we touch, focusing on again, theme around very, very high margin segments, in this case, we’re looking at energy, we’re looking at waste management, number of others as well, expect to see developments around those areas over the course of 2012.
And importantly, as I mentioned, Fred, I think touched upon this a little bit during the earnings call, our most recent earnings call which is that we have made considerable investments in building the analytics tools by supporting operations on our contract surety business. We’ve meaningfully upgraded our credit and risk management that supports that through that process. We obviously are very conscious of the tough economic backdrop, so we’re being more diligent about any of the contract surety business that we feel is not credit worthy to move of that business, put in run-off and reserve accordingly, some of which certainly came through in our recent quarter.
So to finish, let me just touch on a few things. We’re very, very proud of the success that we’ve had, very proud. Our specialty businesses are great contributors to our results, great contributors to our growth. But there still is a meaningful level of upside that we see both in the near term and the medium term.
For AIX, I’d point you a couple of things. The first is that, we have very, very strong positions with 30 program administrators who are very, very good at what they do. Examples like, frankly examples like Wells. And what we see is, we see with those program administrators, second and third program opportunities that are with other carrier markets. And now that we’ve established ourselves, we’re just going to continue to move horizontally. In fact, I believe that we’ll see over the course of the coming 12 months, is that much of our growth is coming from AIX; we’ll in fact see that. We’ll be moving to second and third programs with the guys that we already do business.
Secondly, we’ve made very considerable investment in building the infrastructure of AIX and that investment, well; valuable to this point is all about the potential for us to improve our financial return from this point forward. Very little marginal cost for us to be able to grow that business, there is a theme and I think you’ll see a couple of times here.
Management and professional liability, again, proud of our results, but a lot of opportunity, a lot of momentum in that business. The most obvious thing is just simply cross selling products like miscellaneous professional liability and our management liability to both what we’re doing on new business and commercial lines as well as our renewal book, and that’s an initiative and focus that certainly has been underway where we’re gaining a lot of traction we see a great deal of upside. And not unlike AIX, big investment as you saw with the developments over the course of four years in management and professional liability. We see a tremendous opportunity to leverage the investments that we’ve made to-date and fully expect to see improved returns in those businesses, simply because of the expense leverage that will get that business grow.
Surety, focus on rebalancing our portfolio as we’ve been doing towards that 50/50 mix of commercial and contract. And being very aware of the financial backdrop and continue to manage our existing contract portfolio and paying extra diligent attention to the sort of the credit worthiness of any new business that we’re bringing on to the books as part of our portfolio management process.
Marine, I think probably more than any other segment in the market we’re seeing just the tremendous amount of disruption now in marine. And with that, we see tremendous opportunity, not just on rate, but also our ability to be able to improve our mix and we see that both with our adjacencies, things that we’re attacking, such as fine arts and collectibles which are natural places for us to go. But also, just to even within our existing books opportunity to continue to improve our mix and improve rate on the book.
HSI, I can say that, there really isn’t anything we want to change. We’re so proud of the progress that we’ve made, Marita talked about this, this effectively has been a grand success where we just simply want to do more of what we’re doing. It’s a segment of the business; short tail, you could see the results very quickly and it’s been one of our strongest profit contributors and it’s also been one of the strongest growing segments, we just simply want to continue to do what we’re doing. Again, with a lot of the destruction happening in property classes, we see more considerable upside even for 2012.
And then, finally on healthcare, which if time would allow, I’d love to spend more time covering. But, we’ve made considerable investment in home healthcare, durable medical equipment, diagnostic, in podiatrist, and eldercare. And for us 2012 is very much a period in which we’re going to leverage those investments, so is a very specialist areas, we’ve tremendous access through our distribution to that business and we really seem to capitalize on that. And similarly, Jack, actually will cover an example in the Human Services segment in the next presentation. But there is considerable opportunity, considerably synergy that exist between our healthcare business and some of the professional liability exposure that we can address that corresponds very well with what we’re doing in human services.
So, I’m going to wrap up with a repeat of the five net takes that I opened with, which is, first and foremost, we really are genuinely committed to building the very finest specialty business. Specialty business is part of the Hanover. We believe it’s a tremendous opportunity for us to add value. We’re focusing on those segments that we believe have the greatest profit opportunity, the greatest margin opportunity for us and quite honestly in the broader P&C, the U.S. P&C market.
You can see from the examples, we’ve invested heavily, we’re proud of that investment; we think it was the right investment, it positions us well and it will accelerate our success, our growth in earnings. We’ve established positions and these are not businesses that I’ve not made their mark, competitors and certainly our agents and the insurers are taking note.
And finally, as I hopefully can weight it here, just in the last slide. We see considerable opportunity. Financially, we believe that it’s a wonderful time for our specialty businesses and we fully expect to see the improving contribution from those businesses to the overall Hanover franchise.
So, with that, I’ll stop. I’ll introduce Jack Roche, who will take us through the next presentation.
Thanks Andrew. Let me try to follow down the path that Andrew just took us with specialty and just give you a deeper dive into our small commercial and middle market businesses, and tell you why we think that we are poised for improved performance and further distinction in those marketplaces, in those businesses.
The key messages I want to convey today are that we have over the last several years, built some strong capabilities and deep relationships with our best agents and we believe that position just for tremendous opportunity particularly as the market cycle starts to turn here.
In our small commercial business, we’re delivering improved performance today through our business mix improvement, our improved scale that was greatly enhanced by the OneBeacon transaction and also a flexible and differentiated operating model that Marita highlighted earlier.
In middle market, we are swiftly moving towards a real distinctive portfolio of industry solution including some of our need service venues that I’ll describe to you and positioning ourselves in that first and second tier middle market space is really the go to market for many of the best agents in the country. And so, we believe that you’ll see from us increased momentum and improved financial results based on the key leverage that I’ll get into in more detail.
But, first is the quick snapshot of where we are with each of these businesses at a high level. Our small commercial business is roughly a $620 million business for us today, that is basically comprised of about $530 million of business in the current definition that we use for small commercial one to $25,000. But as the foot note says at the bottom, that’s part of our new operating model, we are taking the lower end of middle market and move and get into a new operating model in that $25,000 to $50,000 sector, particularly larger states. And we believe that we can underwrite and position that business more cost effectively by transitioning it into our small commercial business. So, with about $90 million of that middle market business transitioning small, we have a pretty substantial scale in that business.
And in our middle market business, that leaves us with about $580 million of business of pretty distinctive portfolio average account size, as Fred highlighted earlier, is around $90,000 which means we’re playing in that first tier middle market business predominantly that we think gives us a better opportunity for profit over time.
As most of you know, we’ve made significant investments over the last three years in this business, this platform and certainly the investment we made to bring in the OneBeacon business which all and including the new business brought about little over $350 million worth of business into small and middle market. We launched a number of programs in industry segments and niches that I’ll talk about and created I think a really exciting operating model going forward.
Before I dive into those businesses, a little bit deeper though, I wanted to highlight what we talked about before in terms of how this relates to our distribution strategy. And what this chart basically depicts is that, two-thirds of our small commercial new business and over 80% of our middle market new business today is coming through the top 1000 agents in the country. And as Fred highlighted, more and more of the business is aggregating if you will in the mid-size and larger agents as the agency side of business consolidates.
And from our perspective, because that’s where agents are starting to really push on the specialization, our value proposition resonates the most. If you think about how this business goes from 50,000 or 60,000 agents, just five or six years ago to 35,000 agents, to probably on their way to 20,000 agents over the next five years, right.
Agents are not doing business of the rotary club anymore. They each have to develop their own value proposition. They have to figure out, what it is that they’re going to do to differentiate themselves in front of the customer base, in the commercial line space, that’s about industry specialization.
And you won’t see them all go to extremes, but you’ll see over the next decade an increase march towards specializing and offering customer solutions that relates specific to their industry and ultimately to their individual businesses. We think in that regard as we anticipate that continuing specialization trend, we’ve positioned ourselves perfectly for that to come through. When you add a limited distribution approach to that, it makes what we built, we think very potent.
So, let me go a little bit deeper into the small commercial business and why we think we’re a unique offering. As the market has been difficult over the last several years, we’ve had to work hard to make sure we’re position not only for improved performance today, but well positioned for the future. We’ve seen a number of carriers quite frankly go down a very different path. Some of the industry leaders have gravitated towards an approach that’s quite than ours and I’m going to highlight that a little bit particularly in our operating model, but also in our underwriting focus. But we really truly believe we have a distinctive offering, that our operating model is superior to those that we’re competing against, that we are an underwriting first, and that we have not lost site of the fact that a black box cannot do the underwriting that a human being can. And so, we use the science and various operating model tools that we’ve build to aid in our underwriting, not to replace it.
And ultimately, our franchise value is a big part of our performance improvement, because at the end of the day, if you’ve a top three position with agents in this business, they’ll protect you and they’ll bring you the right opportunities. And our pay back for that value proposition if you will is that we expect and seek premium pricing in this space, because of the portfolio we’re building. Above average retentions which helps on all level, not only on pricing level, but your operating efficiency. We expect improved operating efficiency driven by our new found scale and our operating model that I’ll talk a little bit more. And I think we’ve gotten quite good over the last five or six years at improving our mix management and not over relying on the market cycles to drive margin improvement.
So, when you look at small commercial, and this is I think a really important for those of you that are following sectors, that over the last several years we think that some of the industry leaders are following two dramatic of an approach towards allowing the black box to kind of dictate where they go in this space. And so, if you look at the chart on the left, small commercial and our mind is made up of point-of-sale or BOP accounts that can be easily done by agent through a portal in their shop.
Then, if you look at the green box, non-point-of-sale accounts which don’t fit great into a slot rating, slot underwriting approach, so you actually have to have a human being actually ask a few questions to the agent and we call that non-point-of-sale, because we generally on that account as oppose to an agent doing it within their shop.
Then, we’ve developed a set of industry niches that I’ll talk about in more detail, that are quite distinctive. And then, on the far right, some affinity programs which is just another way to get that industry segmentation in the small commercial space.
Contrast this to many of our competitors have really tried to migrate to this blue box. And there’s two fundamental problems from my perspective over time by over bedding on that blue box. A, if you’ve paid attention to the personal line business, over relying on science, particularly on new business pricing hasn’t been particularly fruitful. And so, what you find is that in order to be able to underwrite in that point-of-sale environment and let the agent do most of the work is that you’ve to nail your focus and appetite over time and you have to really over rely on some of the predictive modeling and multi-variate pricing. And what we’re doing in this space is using some of those tools to supplement and aid our underwriting, not replace our underwriting and pricing.
And so, you’ll see, I think over time similar to what you saw on the early migration of personal lines in the multi-variate pricing as you’ll see a lot of pricing volatility on young renewals in the small commercial space. That company is riding that business at a cheaper rate than they have in the past, because they’re relying on that multi-variate pricing. And then, they have to hit that renewal book pretty fast early in its cycle in order to get it to profitability. And we think this diversity is going to be our strength in terms of how we approach the small commercial business.
So, let’s talk a little bit also about what we’ve done over the last several years to improve our profitability and our position. We’ve been working on our mix for several years in three major categories. We’ve improved our geography by reducing our concentration in the big four in a similar manner to personal lines, although our situation was not quite as dramatic. And we have really now today less than 40% of our business in those big four states. And we’ve done that, not only by our western expansion, but by penetrating some of the other territories in the southeast and the south central to diversify our book of business.
From a class of business standpoint, we’ve taken what I thought was already a very disciplined approach towards the industries like construction and real estate, where we knew the economy was not going to treat those sectors well and we not only remained disciplined in those areas, but we further reduced our concentration in some of the volatile classes in a bad economy. And at the same time, we increased our penetration in some of the classes like the service business which tend to be a little bit more casualty oriented and actually thrive a little bit in this type of an economy.
And last, but not least, from a line of business standpoint we have reduced our concentration both from an overall perspective in property, but also in terms of its concentration across the country and we’ve been doing that to a variety of levers to make sure that the last three years of weather doesn’t dictate our future in terms of future profitability. So, I think we’re quite proud of the positioning that we’ve done in small commercial and the existing book of business.
Let me talk in conjunction with repositioning our portfolio and what we built. Let me talk a little bit more in depth about the operating model that we think is part of our success going forward. When we brought in OneBeacon, they did something’s differently that really gave us a fresh look to how we would do business. And the fundamental thing that we decided to do with regard to small commercial is to separate out kind of a new business platform from the renewal platform. And this directly related to the chart I talked to you about the breadth of the appetite that we have.
By going to a more distributed underwriting approach in small commercial from a new business perspective, we can underwrite that business more local, we can understand it better. The effectiveness in new business is more about getting the write business at the right price; then it is about handling it cost effectively. The cost efficiency in small commercial is primarily in how you handle the renewal book of business and the subsequent transactions like endorsements and servicing that business.
And so, what we’ve done is repositioned ourselves, not only from a portfolio standpoint, but also from an operating model that in most states we have a local new business underwriter working with our sales force deciding on the right on the business in a very disciplined way and then, backing that up with the renewals, with three renewal centers that have made tremendous strides in terms of renewal bypass and straight-through advances, but not at the cost of underwriting business properly.
We have also looked at, because our renewal book is performing quite well. We’ve looked at the pricing elasticity and made sure that we get the leverage right on how we price that business, because what we see in the industry is, too many competitors trying to introduce too much pricing volatility and all that does is backup on your operational efficiency and we end up spending $2 to make a $1.
And ultimately, we do have different tracks for the real small business at zero to $25,000 versus the $25,000 to $50,000, that allow us to make sure we don’t miss the real underwriting attributes in that next of small commercial.
And last, but not least, we have the best customer service center in the business. So, if an agent wants to improve their economics by moving small commercial into our center, bar none we have the best commercial service center in the small commercial business.
So, ultimately, what we’ve been able to do is on an Ex-Cat basis, improve our accident year loss ratios quite dramatically in this business and we think we are incredibly well poised to use this, at this stage of the cycle to our advantage. We’ve improved our retentions. You’ll see here that the only difference in our 2011 estimate of our small commercial business is really the difference between that $90 million of business that were migrating in from our middle market business, which quite frankly performs at an equally impressive rate from a profitability perspective. Again, that gives us tremendous scale, good positioning for affirming markets.
Let me spend a few minutes now taking you through, why we’re so excited about the middle market space. Again, we think we have a distinctive offering for the best agents in this country. We build real industry niches that combine some complex underwriting characteristics into a neat integrated offering. We’ve kind of decommoditize the commodity in the some of the general classes with some industry segmentation. We build some appropriate value-added services and continue to leverage a very tight distribution to make that distinctive in the marketplace.
And our pay back for that strategy is that we believe that we will continue to see significant pricing improvement above average retentions, improved operating efficiencies and we’ll continue to leverage our ability to mix manage, to improve our loss ratios.
So, let me similarly to what I did with you in small commercial, let me take through kind of the space. And if you look at the dark blue and the light blue sectors here, what we’ve done in some of the more general classes of business is we built industry segmentation. And in the light blue section, we go a step further in some of those industries that require a little bit underwriting expertise, a little bit more dedicated approach, a little bit more loss control and claim coordination; and so, we call those industry niches. Andrew, already talked about how we’ve significantly improved our specialty offering, I talked a little about small commercial. I think most of you know really the only large accounts we do are house accounts with our partner agents and we do that well; but, we’re not enamored with the profit potential in that business long-term. So, we only do that very selectively for the right agents.
And the way we differentiate, quite frankly, the niches from our industry segments is really those classes of business, those industry sectors that require an integrated multiple complex product and underwriting competencies. And we’ll take you through, if you look back on the last slide, you think of things like educators, educational institutions that have educator’s legal and have some professional liability along with the package.
Human services, which I’ll go into in more detail that has a similar complexion. Limousine’s and moving and storage, is kind of a unique auto offering that you really have to know what you’re doing to play in those spaces. Manufacturing housing and sports and recon technology, all of these share a common characteristic in that, it is not just package underwriting, you’ve to know the professional liability associated with that and it’s bringing that together in an integrated way for the first and second tier middle market that makes us distinctive. Because much of that market comes to the distribution through either a wholesale opportunity or through a disaggregated, kind of disintegrated way and the agent has to pull that together and make that look seamless for the customer.
Industry segmentation is just a lesser degree of that, but we also look at what we’ve done in the middle market space to build that industry segmentation, that product offering, those underwriting tracts, those service capabilities as the potential incubator for the next set of niches. And so, we look at it that way as we’re building those through.
And then last, but not least, we don’t dislike general accounts, we just rely on them less and we know that that is really, over time if you’re not segmenting the middle market space, you’re left to a lot of what we think is more ignorant underwriting that happens with a wider community of carriers.
On the right-hand side here, all we’re showing you is that over the last several years, we’ve progressed quite nicely into further segmenting our book and our expectation is that next year we’ll get that business quite close to our goal of having our middle market book 80% segmented in a way from a kind of a general business platform.
So, let me just go a little bit step further with the niches, because I want to give you a flavor of, okay, that’s interesting; but, let me touch it a little bit. Let me see exactly what you guys are trying to do to differentiate yourself. In the industry niches that I showed you those industry sectors that we’re focused on; we do have a more dedicated underwriting model similar to the way, Andrew, described specialty as we always bring somebody in that has expertise in that industry. We do not try to have “Amateur Hour at the Improv”. Those are classes of business that really require expertise.
And then, we setup a suitable infrastructure that brings dedicated expertise, but ultimately, we try to bring it to our middle market underwriters and we’ve done a certification process to try to get our middle market underwriters onboard and into that and maintain that expertise. We really only work with partner agents that have expertise in those areas. We don’t try to bring specialization to a generalist. We built out our loss control and claims expertise, so we don’t leave that behind.
And then, well, I’m going to just kind of take you through a brief drill down on is what we’ve done in developing some industry portals which we think will further catapult us into a really distinctive position in some of these industry niches. So, the pay back for us in going into this more dedicated approach in the middle market space is improved loss ratios, above average retention and quite frankly, leverage for other business. When we go out to the distribution, one of the most distinctive things that we bring is these industry niches and by further limiting that distribution, we create a lot of leverage for personal lines, for small commercial and for even some of the specialty businesses based on bringing that unique capability to a small subset of even our existing agents.
And from an agents perspective, they get a distinctive product offering that has limited distribution in most states and many of these products there is only 6 or 7 or 8 agents that get his offering as appose to the 100 that get that product offering from other companies. They get higher client retention and clearly get substantial referral opportunities when we do this well.
So, let me take a couple of minutes to just highlight what we are doing in this industry portals because I think it is going to be the next wave of true specialization that we will bring to the marketplace.
What we did starting about a year ago, as we started with our human service niche and we started to say, what’s happening in each one of these industries that affects the way in which these clients are buying their insurance and the way in which agents are trying to serve them. And what we saw very clearly is that especially if you stay in that first and second tier of the middle market, you don’t go up to the high end is that they need risk management solutions that can be brought to them more efficiently than sending out (inaudible) and ask him 65 questions in their place of business.
And so we immediately saw the opportunity to start leveraging some of the new technology and really start to bring these risk management tool in a much more class effective way and a much more effective way for the small and mid-sized customers.
So, what we started to do is to take some of the training and the curriculum that we build not only for our own folks but for the work that were doing with customers and starting to build those into a portal, not just in terms of loss control and claims best practices but also some of the things that we are starting to affect the industry in total. And if you think of the human services industry, this is a great example, because what’s happening in this human services sector is that the lack of public funding for many of these human services agencies is creating a need to shift their focus towards private, more private sourcing of their funding, and that’s putting a lot of strain on relatively small agency that don’t have the resources to get the grant writing done properly to get to that private sources or even to meet some of the new regulatory and certification demands that are coming on them for their employees in order to be eligible for this new funding.
So, what we have been doing is building out these portals in a way that not only covers the risk management needs, but also starts to address some of their broader business needs in a cost effective way, and allows them to go into these portals and leverage that for even something beyond their insurance needs. And you can imagine if you are an independent agent trying to really go after this sector, working with a carrier that is going to go to this level of detail to understand the industry and to provide service and coverage to that industry, and limit the distribution to only a subset of the agents in the country, this is what we think makes us a very unique proposition.
It also sets up a platform quite frankly that we can start to build that out for the rest of our industries quite easily. And so what’s the payback and the what’s the experience that we are delivering in the niche world. We have built this business from virtually nothing to about $200 million over the last several years. One product at time, similar timeline approach that Andrew introduced, very thoughtfully bringing in the right level of expertise, building the right product, aligning the right distribution and building those businesses from the ground up.
We have already experienced tremendous operating efficiency by doing this. Our hit ratios in the niche business are 47% versus 29% for the general business which is kind of an industry average about 30%. And our retentions are already starting to reflect not only that distinctiveness but the approach that we have had with our agents that causes them who want to keep that business for this longer.
So, in summary, I think I hope I conveyed to you just that deeper dive on why we positioned ourselves in the small and middle-market business to be not only an improved performer, but also somebody to watch going forward. During this really important time in our cycle we believe this strong capabilities and our partnership strategy provide us tremendous upside. In small commercial you can expect improved performance coming from our accelerated penetration with our partner agents based on the product and the model we built. Our continued business mix and pricing improvement that is really starting to evidence itself in the marketplace, increase scale and operating efficiency with that already good sized $600 million small commercial business.
In middle-market, our performance improvement is going to be driven by the robust portfolio of industry solutions we have built and our agents yield a sell value at a critical time in the cycle, the above average retentions and pricing is clearly going to be assisted and is already starting to show up in the marketplace now, and then the improved operating efficiencies that also leverages the improved operating model we have in their market.
And last but not least we think that what we have built in business insurance in small and middle-market as I said before serves as a substantial catalyst for us to get additional momentum in the other areas of our business including specialty commercial and personal lines.
So with that I appreciate your time this morning. I’m going to turn it over to David Greenfield, our CFO.
Thank you, Jack, and good morning everyone. You heard quite a bit now already about what we have been doing in the last few years and I want to try to bring that together in terms of how we build this strong platform and how that has expanded our capabilities and translated to overall financial performance.
In particular I want to cover how our strategy is delivering on improved operating performance. I want to focus on the capital strength and the flexibility that we have in our financials and our balance sheet, and also including talking a little bit about the quality of the overall investment portfolio and a moment on reserving practices and philosophy t help you with that. And then finally I will spend some time on the lever we have. The very strong levers we have in improving our ROE and how we see those things building on what you heard already in terms of the businesses and the expansion that we have talked about.
At the conclusion, it should be very clear that we are well positioned to continue delivering improved financial performance and we are delivering on a promises we have in terms of our strategic progress.
I will start off with a few points on the improved operating performance. Many of you may remember mix we had about six, seven years ago and a couple of the speakers have already commented on that. We were predominantly a personal lines company with a very regional focus. During this past six years we worked very hard to diversify our capabilities and our footprint by expanding nationally and dramatically improving the business mix which is a key driver here.
You heard quite a lot about this in Jack’s presentation, you heard about it in Andrew’s presentation as well as Marita’s and earlier when Fred opened the session today. You can now see here on the upper left hand chart the growth in our specialty lines and the OneBeacon renewal rights, draw very good growth over the past few years. This allowed us to further expand our footprint into the west and over the period we maintained a very strong focus on a limited number of very strong partners that you heard Marita referred to earlier.
The mix improvement has been an important element in our improved operating performance. In 2011, Chaucer also added to our growth and geographic diversification and this will continue through the first half of 2012. We just reported the first quarter results with Chaucer and you can already see the positive contributions that they make to our overall business profile. It's clear that our expanded product capabilities and portfolio expansion will enable us to focus very much on the higher margin opportunities and continue to manage our portfolio in a very productive way by increasing margins.
Moving onto a couple of charts on segment income. Looking at performance over the past few years on an ex-cat basis. You can see how the product and geographic diversity is helping us delivering increased earnings power. However, the results have been impacted by investments we chose to make building out our platform following those rating agency upgrades in the midst of the financial crisis. And at the same time you have also seen pressure on the results of our unprecedented weather events over the past three years. You heard Fred talk about that earlier today, how we have been impacted by weather and it's just hard to ignore going forward. As a consequence we are building a higher level of weather activity into our 2012 plans and I will cover that in a few minutes.
I’d like to move on to our strong capital position and the flexibility we have in pursuing the best opportunities. You will see in this next series of charts a very compelling story. You will see we set out to optimize our capital structure over the past few years, and we have enhanced our flexibility and our overall liquidity. At the end of this past September, we had over $3.3 billion in total capital, we increased our debt leverages here mainly to raise funds to close the Chaucer acquisition, but also to establish a strong position in the debt capital market for future needs. Despite the challenging market conditions in June, we had an excellent response from investors to the $300 million of debt that we raised. We subsequently used those proceeds to close Chaucer in early July and we also continue to lower our cost of debt. Over the past three years we lowered the cost of debt by nearly 150 basis point to 6.6%, mainly through retiring higher coupon debt.
In Chaucer we also now have access to a very flexible and capital efficient market at Lloyd’s from which we can also grow our business. Finally, we also put in place in July a new $200 million credit facility that’s also available for liquidity needs or opportunities as they may arise.
One of the most important measures of our success is book value growth, as you can see here we have continued to drive our book value per share up in light of the business investments we have made and the growth that we have undertaken. In addition to improving on the ex-at operating performance, we have also been mindful of capital management through our dividend policy and through returning capital and share repurchases. In fact over the past seven years we have returned over $750 million to shareholders through an increasing annual dividend and opportunistic share repurchases.
We continue to be to have a thoughtful approach to our capital based on our business opportunities we see available as well as being mindful of the rating agency requirements and regulatory requirements. Fred already mentioned dividend policy earlier and I just want to comment that earlier this week our Board of Directors raised the quarterly dividend of $0.30 per share which is further supported to our strength of our earnings power and the growth in our business.
Ad beyond just looking at overall metrics, it's important to understand that our risk management capabilities have also been improving. Overtime we focused attention on building our capabilities so that we can refine our approach to allocating capital to the best opportunities. Our sophistication has improved over the past seven years quite dramatically. And it has triggered decisions to withdraw capacity from certain underperforming markets or products and allowed us to more quickly reassess opportunities to deploy the next cap dollar of capital for the best returns overall.
For example you can see on this chart, we took actions over the last several years to reposition capacity away from coastal markets, and we will also use this our tools to further refine our capital resources and make them more efficient. We are continuously improving our capital and risk management tools and it's always gratifying to be recognized as one of the leading organizations in the industry on this front.
I’d like to now turn attention to a couple of balance sheet and related performance areas. First, we will take a look at the investment portfolio and then loss reserves. Our investment portfolio has always been of a high quality and well diversified. This past quarter we added over $2 billion of assets to the portfolio related to Chaucer, and now we have more than $7.5 billion in cash and invested assets available to us. Our portfolio delivers a stable source of income and as you can see in the net investment income chart, we have had a very level income over the last four years. I’d add then in terms of stress financial markets such as the recent financial crisis, the portfolio has also continued to serve us well and continue to deliver very stable high quality returns.
Prior to the acquisition the Chaucer portfolio had a much shorter duration in Hanover’s portfolio, consequently we were active this past quarter in repositioning Chaucer’s portfolio to extend the duration and increase its underlying yield. The information on this chart shows you how the overall quality of our portfolio change with the addition of the Chaucer assets, for example, the average rating on our corporate bonds increased from BBB+ to A-, and you can also see their business slight uptick in the investment grade corporate category. Overall, the portfolio duration is now shorter by about a half a year, but we are continuing to reposition the Chaucer assets to optimize returns against our overall objectives.
I wouldn’t expect any significant changes in overall portfolio composition, but you may see some marginal changes in allocation in the coming quarters. Just looking at our fixed income portfolio breakdown, you can search engines a couple of points here. I just want to mention that we have the high quality nature of the fixed income portfolio is about 95% investment grade, and it's worth noting just in terms of industry dynamics, the percentage of our assets in tax (inaudible) securities is underway, and the reason for that is some prior tax losses that we are still working through that make those investments a little bit less attractive to us at this time.
More than half the portfolio is allocated to corporate bonds, this has been a consistent strategy for the company for quite some time and again it's served us very, very well in terms of delivering performance and returns on the portfolio.
In our quarterly release we provided some specific details on our exposure to European issuers. We have limited exposure to partner Europe that have been in the news recently, such as Greece, Italy and few others. By far the largest portion of our direct sovereign debt exposure is UK based and $126 million or about 1.7% of the portfolio. Most of our European exposure comes out of the Chaucer portfolio and we are closely managing this in light of developments and our overall investment philosophy. You can certainly find more information about these exposures in our third quarter materials which we released about two weeks ago.
Before I turn on to loss reserves I just want to spend a minute on our forecasted portfolio returns and our focus for 2012. We managed the portfolio to minimize turnover and to maintain the highest returns possible. In the Hanover portfolio we expect only about 10% of the fixed maturity portfolio will turnover each year, over the next few years, which will cause downward pressure on net investment income, about 30 basis points in the yield calculation each year. This will be somewhat offset by growth in the assets from Chaucer as we continue to reposition their portfolio and extend their duration in line with our risk appetite and the overall liability duration. We will also consider modest diversification away from fixed income in anticipation of a rising rate environment that we expect to begin to see sometime in 2013.
Just moving on to loss reserves, I’m only going to spend a couple of minutes on this topic today, but we have a very detailed approach to reserving that incorporates best practices in the industry, such as quarterly full actuarial reserve work and quarterly reporting to our Board of Directors. We react very quickly to emerging negative trends in our data and we cautiously react to positive trends. We have a pattern of favorable reserve development overtime, that supports this approach and you can search engines from the table on this current slide that our initial loss ratios have trended positively over the past 10 years when compared to our current loss ratios for each of their respective accident years.
I’d just add for Chaucer, their loss reserve approach is quite similar to The Hanover, and as we begin to bring this practices together as we are now doing, you will continue to see strong reserving practices from both parts of our business.
Moving onto my final topic, strong leer which improve our profitability and return on equity. you have heard quite a lot today about The Hanover and The Hanover we have built over the last several years, it's a strong platform and it's built to deliver top quartile performance. However, there are challenging test ahead particularly under the current market conditions. We have a number of levers that are available to us that we believe will help us achieve our objectives.
As you have heard today we have assembled the portfolio of products and capabilities that allow us to take advantage of the best market opportunities. Our business mix is continuing to improve and with our strong risk management practices we will continue to refine our mix to focus on the best diversifying returns. And we will pair back underperforming businesses, geographies or products as appropriate.
Our risk management approach has resulted in a greater focus on exposure fining. In our most concentrated in affected areas. We are actively reducing monoline property exposure that translates into higher tail risk for us, this business obviously requires a higher cost of capital and our actions will continue to support our improved results. Now there are headwinds that we are also facing along with the industry. The two most significant items are the highest incidence of weather, cat and non-cat activities that has caused us to adjust to a higher cat expectation in 2012.
We are adjusting our pricing models and we will factor this into our overall portfolio management going forward. It will take a while for pricing actions to earn into our results but we are confident that this will drive improved performance in time. So, you should see improvement in 2012 but perhaps even more improvement as we get into 2013.
On the investments fronts although we are managing for a persistently low interest environment by maintaining an appropriate duration and minimal underlying portfolio trading we are also considering modest moves into diversifying assets, such as the high dividend yielding activity securities. Offsetting this, the size of our portfolio will drive the higher earnings power for the company so as rates do stabilize, we will begin to see increasing investment income. Despite all of the headwinds we believe our mix improvement and pricing expectations should deliver improved returns in 2012 and beyond.
Finally, during our earnings call two weeks ago we provided you some high level metrics on our expectations for 2012. In particular, we are estimating segment income of $3.85 to $4.15 per share. And you can see on this current slide some additional factors that support the expectations that we provide in for 2012. You have heard a lot about our business today, and our growth aspects and our business mix changes. So, I won’t go through everything on this slide but on an overall basis we expect modest growth next year and you can see some of the overall assumptions that formed the guidance we provided. This should be helpful to you as you consider what we have talked about today and how to think about our performance going forward.
So, just to wrap up, we are aggressively driving our business forward to be a top quartile performer. We have most importantly improved our underlying operating performance over the past few years through mix shift and portfolio management although there is more to be done and there are strong industry headwinds to battle. Our capital position is strong and we built inflexibility to meet opportunities as they arise and our balance sheet is strong including a high quality investment portfolio and very strong reserving practices. And finally we have a number of levers that are available to us to continue to improve our ROE and to drive improving operating performance for 2012 and beyond.
With that I’d like to turn the floor back to Fred.
Thanks David. And thanks everybody, I just want to quickly summarize today I know it’s a lot of material. And I apologize for those that know us really well and maybe some of which we have done it. But I actually think it’s quite valuable to get some texture for all that we have done. Because our basic belief is very simple, the market is difficult, there is no question about it, there is some trends that are very difficult, but this is the time when they haven’t have not separate this is when a share is shifted, this is when the better companies actually make hay. We believe we reposition ourselves to really to take advantage of this and do some interesting things over the next couple three years.
And again it’s interesting to us that we’ve kind of got to this inflection point. We worked hard over the last seven years to get to this point before some of this turmoil occurred and we think we made it, we think our portfolio stable, we think we’ve made a significant amount of investments and we’re kind of done the big heavy lifting as far as investments and we’re ready to capitalize.
David had this slide, we believe that when you look at this what’s interesting about our returns next year when we gave you guidance and say that’s an 8% return and 8 isn’t the 12 that we want. It’s not exactly where we’re going to be in the future and we’re not satisfied that’s an ending point. But if you look at what others are going to happen in this industry others are coming down. It run an out of reserve leases they’ve got the headwinds of weather, we decided to be prudent way very aggressive about our assumption about weather and cats and reinsurance costs, but even with all of that because of our mix management, our ability to get pricing across our portfolio, the ability to have retention. If you look at our retention, how it’s continuing to increase even though we’re getting pricing leverage because we’re better, we’re more distinctive we’re the right folks, we have preferred platforms.
In addition you’ve seen our pick growth down a little bit why because we feel that it’s appropriate for us to do a little bit more fining, we’ve done fining every year, we’ll do a little more fining this year maybe 150 to $200 million of targeted business. Because of this change in a dynamic of cost to capital we believe that with yields down and what’s happening with RMS and these other models that are marginal cost of capacity and some zip codes is so high that we can’t get the kind of target returns top quartile returns we want. So we’re going to do little bit of fining, but even with all of that, we believe we’re going to have growth, we believe our margins are going to be as good as some of the best companies in the industry next year and our average returns can be right there with the best, because we don’t see the industry get into that level that top quartile we talk about either. And we think 13 is set up beautifully, so we think the value creation opportunity is real here, if we stay focused on the basics and do what we’ve been doing and executing against what we’re doing.
I showed this chart in 2009, and the reason I bring this back is that we believe this, we believe that our goal is very simple, to build a world class top quartile performing company we needed to enhance our product portfolio and our position with agents dramatically. And so what I try to do today is give you some reality of all of the things we did, does it sound like a lot, yes it's been a lot, yes, it’s been a lot.
We now have almost 6,000 people, we have hired most of these people and in the last seven years we have a different portfolio, we have a strong position, but the reason we do what is that we believe the best companies need you can’t just execute better you’ve got to have a better portfolio and a better position.
Somebody said to me that this game is execution, and this is a game of interest, but I said guys I can go to the Houston Astros and I can tell him to work really, really hard, but if they don’t build their [mining] system they don’t get better players and any 10 games series that is going to be Yankees 100% of the time. What we have done in last seven years is build our [mining] system, we put great talent on the field and created the situation where is good as anybody there is on the segments we’re in.
Now we have the returns yet, no. But we have more line of site to levers the most companies, because we’re not living on reserve releases, we’re leveraging our investments and we’re seeing price increases and we’re seeing mix improvement across the Board. So, our feeling is that this is still right and I said that we’d be have $5 billion by 2014 on a little ahead. We’re going to get there faster and we’ll probably going to get to the returns faster than 2014. But we still believe that this was important to say and to move in that direction and make the investments we made. And so my view is that we’re one of the most interesting investments in our space and one of the reasons we are one of the most investment space, is because our price is low. That most people have not yet recognized the levers we have, a lot of the best players in the industry have already priced and all the price increases even though it’s not clear they will get them all.
For us we’ve done all these things and we have a very differentiated position with improving retention, improving pricing, improving mix and improving expenses, and we can see improvement over the next 24 months. So, again we believe to the right investor this is a good investment that our value proposition to folks that hold us for the next two or three years are going to be rewarded just like folk that invested in the seven years ago have been rewarded.
So, for me when I look at us, again there are four things I think about; one, our new business is very attractive, when we’re bringing in is very attractive business at the right price we are earning in some of the weather of thing. We have decided in weather non-cat we’re baking in property line and in places that are relevant three more points of the non-cat weather, we’re baking in much higher cat estimates that we’ve given you. So it’s going to take us a while to get that rate but what you are seeing is we’re earning that rate in and we’re holding our retention because of our distinctiveness.
The second thing is that we don’t have a lot of stress line of business we don’t have any model line comp that’s mid-market above. I’m not going to have to reunderwrite a bunch of the business, there isn’t a lot of legacy issues that are dogging us, this is really about earning in rate, this is really about getting the leverage on our infrastructure. Yes, there is some fining I’d like to do but it’s marginal.
And then last couple of points is this notion of legacy issues a lot of our competitors live off and the problem with this cycle is when you price and you get pricing that’s great but if you have headwinds because you’re having reduced a reserve releases which goes the other way you have a problem, you can look at our balance sheet mostly short tail lines we don’t really have among of those legacy. So, we will be able to have more transparency of the improvement in performance.
And then finally and really importantly, I mean I believe that it will be very hard for somebody to duplicate except for the very best that are in our space the one or two that I think about. To build the kind of network we have built. When Andrew talked about our ability to get chunks of attractive business about every time we invest in something we get a little bit better, we get not only preferred shelf space, we get last look, we get a lot of their best business, we get a lot of their mature business. when I think about improving their economics, they talk to us first, when I figure about consolidating markets.
All of that as the price points get better, lead to a situation where we will get both scale and margin improvement over the next couple of years. So, again our view is that it's not easy, that I wish the weather was better, I wish the yields were better, but I believe we are going to go from that first chart I showed you. We are average, we don’t want to be average. But we are a lot better than we have been over the last five years, and if we have been averaged in the last five years, if you think about what we have got for (inaudible) now then next five years our ability to get much better returns and the average industry player is right in front of us. We just have to execute.
So, with that I’d love to answer any questions I have the whole team here, we also we are going to have some time here together to answer questions. Obviously, we have the group together for afterwards as well.
Just in terms of your catastrophe assumptions in non-cat weather obviously that had to go up. when you talk about addressing that, you are also talking about getting more rate, is there other component longer terms how are you thinking about managing cat either through better risk selection hoping along those lines. And you have done a lot with (inaudible).
So, let’s talk about that, that’s a big point. So, that’s why I go back to this 150 or 200 million of shrinkage. So, the way I feel about it is that in most cases the non-cat weather that extra three points or so property we will get it. It's a very I look at it, and I look at it broadly and I say the regional guys are in more deep trouble than we are, partly because remember they haven’t taken rate increases, we have had constant rate increases for the last three years. So, what happens is they get behind. So they have to get 14 if we have to get seven. So, their turn s going to be greater, so, we are going to get away with doing a price increase and improve retention, plus we have more account profile than many of the national players.
So, I’m not too worried about the fact getting that. Even on the reinsurance stuff, because we are not in a lot of volatile areas, I’m not that worried about catching. The place that I think your point is dead on is that if you think about what’s happened with cost of capital, there is two sides of it. There is the cat side of it which is the tail, right, but then there is the volatility of concentration. And what we have in my view is we have geographic zip codes. We have 30 zip codes across our network, where we have so much concentration that the volatility of that weather makes our marginal cost of capacity higher than the average competitor. So, I’m never going to get enough price, because somebody is going to able to price less for that next dollar capacity.
What we have done is we have done the science of saying here is 30 zip codes, where that’s true, and we are fining it out, so that our marginal cost (inaudible). Now what’s nice about us and our partner strategy is it's easier for us to do it than anybody else, we don’t have 20,000 agents. What we are going to do, is get rid of some of the marginal legacy agents in these territories and give our capacity to our partners. So, what you will see us do in some of these zip codes is shrink. Now again I we really but that’s not true in lot of places, where we can get the pricing, we will get the pricing. But again my view is when you do the signs and volatility at the bottom, because we have non-cat and cat weather.
That volatility is severe and what it's doing is it's creating people to think about spread of risk differently. So, the folks that are at the regional companies in two states they can’t do much about it. And then (inaudible) all the reinsurance they have to buy so they will shrink. But the bigger guys what you are going to see is the better bigger guys is they are going to change their spread. They are going to fin out some places and growing others. And what’s good about that by the way is that we are not overly concentrated in a lot of territories where some of my bigger competitors are. So, there is going to be plenty of margin to be able to read balance, but it's a great point, again I talked about in our quarterly call. I think it's a good hygiene for almost every company to step back now and say what’s really my cost of capital, I mean marginal cost of capital, because a lot of stuff happen, lot of stuffs happen on these models, a lot of stuffs happening in the weather.
Now let’s talk about the non-cat weather just for a second. So, this is the function of the last three years out of the 10. We decided to just assume it. well, there is a lot of our competitor that could say, three is not going to repeat this way, it's basically where your geography is, and let’s get half of it. We have decided not to. And that make us uncompetitive in some market fine, like we are all ready if you look at where we are in a place like Michigan. We outperform everybody seven points. And so part of that is because of our strategy we are able to hold retention and get a higher price and we have been more constant in our price increases. So, I’m not worried about our disruption, we are going to track it like crazy to see if the disruption increases, but our assumption is with a little less growth because we are sending out we will be able to hold onto the good business, get the pricing and earn it in.
But you are dead straight, I mean again I do think everybody should be thinking about this question of reunderwriting and the marginal cost. One last point (inaudible) insurance, in property there is inside property and outside property. And some peoples pricing models are not fine enough to pick that up. So, Jack talked about service business as part of the reason service business is a better (inaudible). They are most insight property, they are just flat roads. So, there is a also I think what’s happening is the science and we worked on this hard. The science of pricing property is not just about geography, it's type of product, it's what class of product and again we rebalance our entire portfolio in the last three years with this notion that property is becoming more dear.
Can you just talk about your expectation of modest premium growth for Chaucer in 2012 in the context of 90% plus of the business getting higher prices.
Chaucer is a little bit unfolding on us because of the dynamics of the worldwide pricing environment that Bob talked about. Our view was when we purchased it, and the way we think about this year is modest price because we are tweaking the portfolio, we are trying to take some of the volatility out of the portfolio, we are trying to take some of the mix that was more reinsurance oriented out of the portfolio. Offsetting that is this pricing. And as Bob said w are little bit suspicious about casualty and some of these other categories that we are being timid about growth. If the pricing environment changed dramatically, could that change, yes. But I’d say that’s still fair. The way we are thinking about it is, Chaucer contribution to you would be modest growth and about the same contribution we saw last quarter. You would see a pretty steady (inaudible) quarter-over-quarter, because they are not a (inaudible).
So, what I’d like to see is this steady diet about that. Bob is there anything else that we should ad on that.
Some of the opportunities we see in international property for example, we necessarily wouldn’t dive into that because it would unbalance the portfolio. So, tweaking to be done within the account, and that’s probably going to suppress not taking full advantage of those opportunities as they present it.
And for us what’s nice about it, Bob mentioned something else, if you think about ’13, the way I feel about it is I want to make sure that we deliver good earnings improvement for you to see what the mix does. What’s interesting though there is 13 couple of really interesting value levers, right. If pricing and margin gets very strong, we now use outside capital for part of those earnings stream which we could bring back in and if we were comfortable with it. and as well as the synergy in our franchise agents that we see, we are going to go slow, we are going to do it carefully, we are going to do it in a targeted way, but also in ’13 we see that as an opportunity. So, I think it's appropriate for us to really in all of our businesses manage the share for profitability and profitability improvement. Because we are in this uncertain time and those changing time, and so we are going to be quite careful to do it and I think that’s the way it's going to be for a whole portfolio.
So you are suggesting a 5 point cat load for the company for next year, which in the context of your comments on whether you have bumped it up a bit. So, with that suppose that Chaucer’s cat load is about consistent with.
We took the whole company up to, I think we were $225 million now in total for cat load. Here we went from a little under 4 to a little under 5 in North America. And Chaucer is about a half a point to 3.25 of a point more than that. And we took them up as well. And so the weighted average is that it's like 5.2 or 5.1 or something that 225 to be. So, what I did is I took both. Now the reason why it's more increasing, you think it is, because our mix is going to casualty like crazy. So, what’s happening is if you look at the underlying mix, what we have done is we have looked at the real experience of cat even though our casualty business has grown, we believe that the volatility has in the marketplace around cat has gone up a little bit and so we made the higher estimate.
And we think it's appropriate to do, I mean who tech knows. If you look at it, this has been driven by three big, what’s baffling about the cat market right unlike the non-cat weather which has been there steady increase. That cat market a lot of this has been primary what I call kitty cat, so it's hit us, but has not blown through the top. It's just it's his constant diet of these cat storms that are right below the limit and so when you look at that, we look at over 10 years, we look at weighted average over the last seven. We just thought it was prudent to take it to what it was and be explicit about it, that’s way we are managing it.
The other thing is it does by the way, it makes it less seasonal right. Because some of this is instead of a third quarter phenomena and some of these are spring, because the hail storms or whatever. So, you see a balancing in our timing of that percent as it works through the system to.
What are the major property exposures that Chaucer currently has. And I believe in Japan it was $100 million loss last spring, is that what you consider high water mark or what are your other large geographic split.
We are a diversified portfolio. We would say from an RDS point of view this is where Lloyd’s sets realistic disaster scenarios, the scenarios that we run which are probably the high RR U.S. based either being Gulf exposed or Californian earthquake. We have an international exposure. And we do model against those RDS, so that’s what we were trying to limit our underwriters growth in any of those territories. So, that was indicative of that type of return period event. So, I mean we published those RDS so that can be seen.
Just in terms of your growth in the U.S. and you are combining with Hanover and cross-selling the product into the distribution channel. Could you quantify at all that you think that potential opportunity is and is it a matter of selling a new product through these agents or is it replacing.
We said we are going to go it slow but you could imagine, think about who does the energy, aviation, marine. This is all in the top 200 folks and half of Lloyd’s business is U.S. based. Those top 200 folks. So, again a lot of 200 folks have lot of energy exposures they have a lot of marine, they have a lot of the aviation business. So, for the most part it is using those skills and those capabilities to go to the next tier with our capabilities versus them going to somebody else just like we have done in lot of these other specialty businesses. There is some cases though, where we would be a different products.
So, what do I mean by this, as Bob mentioned [fine arts]. We do a lot of marine in the United States, we have six partners that have a lot of it, they have an international network, they have some other skills, but they tend to do excess. Our ability to put our skills together to go after the [fine arts] market is slightly a different, it's a evolution of those skills into a targeted solution. But for the most part it would be just based on their capabilities, but again it's not, I don’t think of it as this overwhelming percent that we are going to change their product. It's just that’s it's easy to assume in those categories 2, $300 million of opportunity over the next two, three years, because of our distribution.
And our position with some of the folks that do a lot of this business, but again I think that really evolve as we are thoughtful about these. When we bought them, we looked at these categories of opportunity that we profiled our agents and said, who write these kind of things, and there was a portfolio of really interesting opportunities. Again for me it's more of 13 opportunity as we think about this together. The other thing to understand is in top 1000 guys, lot of these guys also have Lloyd’s brokerage. And they have so it also makes us more important to a number of these guys and their whole footprint as well. So, again we feel pretty good about the overlapping what kind of leverage we get, but it is something we are little bit more cautious about how quickly we do it, and where we do it and how we do it. And again Bob is there anything else that I should.
The way we are looking at really is more of a 2013 and 2014.
You talked a fair amount about the loss ratio and expense ratio benefits of moving to a smaller group of bigger agents. And I’m just wondering, inherent in that, you have given the agents a little bit more leverage with regard to you, both on loss ratio and the expense ratio side. I was hoping if you could talk about that a little.
Again that’s really you are talking about the reason why people, our industry one of the most interesting dynamic in our industry right now is the power of the big three in certain categories. You will hear that time and time, part of the reason we don’t like large accounts, particularly in certain categories, is that the power has gravitated to the top two or top three and has become more commoditize than what brokered. When we talk about it, we are taking about the top 2000 agents, showed you those first three categories, which is the most sophisticated. Now these guys are still when you get out of that top 10, their size drops.
So, the revenue base, yes, I have almost $2 billion of premium that’s a $200 billion company. That’s their revenue base. And then we will have 150 markets etcetera. And so what we think about when you get down into that category and frankly a bread and butter which is that 250 million of premium, $25 million of revenue agent. We have a metrics that we watch which is are we important to them and are they important to us, because that’s the sweet spot. That’s why you never want to be number 10 with one of these guys, you want to be one of the top three and whatever you focus and you want to be big enough to matter to their economics. So, that the balance is there, but to your point you don’t want them to control the entire market.
This is why we focus, we spent so much money on these 2000 agents which we have about 1000 of them. What you look at is that’s where you have in my view sophistication, professionalism, the ability to sell value, but you have a balance of power where we can align incentives. Now that doesn’t mean that we can’t do business with the top 10. If we are distinctive, if we have an areas very good and we can add value, we do very good. But the notion of doing with some of the brokers just being broker there on large accounts is a very your point is dead straight on which is there has to be a balance.
That’s why we don’t like the large account, we don’t like just a big broker, we don’t like the wholesaler, where the power shifts completely there. We like value added, we like stuff where retention is more important in new business, because that’s where when you start doing profit sharing, their incentive is to hold it, not to trade it. the biggest issue about when you get down to smaller account, is all of a sudden your incentives are completely aligned. If they traded to $90,000 account every year, they make no money. So, if you can do value added, it aligns incentives that’s why almost everything we do is geared to those kind of agents.
Now let’s say there is also a qualitative thing. We have fired a lot of folks in that top 2000, that we call (inaudible), because our strategy doesn’t work, if you turn the business too much. You can’t do the value added stuff Jack is talking about, if they don’t hold the accounts with us, if we don’t go into it to try to keep every single account. So, what we have been able to do if select folks we have operating model that support us. That’s why to me our economic spilled so much, because we can almost look at our retention and pretty much project it in every business we go into. But your point is really important and I’d say the difference between people say you can’t grow in our business and a lot of European and other folks small companies that have grown the business say they go to LPL, typically what people do is they got a 12 wholesalers and 3 big guys, they go to the large lawyers because it goes faster.
The issue is you have no power. You are not distinctive, you are just one of 25 and the chance of making money is very small. We do all of those things the opposite. We go to the next year down, we go with the operating model matters, we go to the average policy sizes, we go to the operating model through expense that makes their economics better and we put it to bed. That’s almost what we do every way. And in some of the specialty places though if you are really distinctive that’s fine, which is some of the global things that Bob does, we were one of three guys that really is good at this. Well then about the power is different. But we work hard at this, because the history of our industry is (inaudible) that grew too fast in places where they had no power distinction and it just comes back and hit some, but again and I’d tell you is you repeople, if you watch some of the best companies in our industry, when I look at 3 or 4 guys that I truly respect, they avoid all commodity business too because it's really hard to go the highest markets and just be one of 20.
Okay, well thank you so much for your time and attention. I really appreciated it, and there is lunch here for everybody. Thank you very much.
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