Good day, and welcome to The Hanover Insurance Group's Third Quarter Earnings Conference Call. My name is Nicole, and I'll be your operator for today's call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us for our third quarter conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer; and our Chief Financial Officer, Jeff Farber. Available to answer your questions after our prepared remarks are Rick Lavey, President of Agency Markets; and Bryan Salvatore, President of Specialty Lines. Before I turn the call over to Jack, let me note that our earnings press release, financial supplement, and a complete slide presentation for today's call are available in the Investors section of our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements, including our guidance for 2018. There are certain factors that could cause actual results to differ materially from those anticipated. We caution you with respect to reliance on forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release, Slide 2 of the presentation deck and our filings with the SEC. Today's discussion will also reference certain non-GAAP financial measures, such as operating income and accident year loss and combined ratios, excluding catastrophes, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release, the slide presentation or the financial supplement, which are posted on our website, as I mentioned earlier. As a reminder, we are reporting operating results for our domestic business only. Given our plans to sell Chaucer to China Re, Chaucer's results have been reclassified to discontinued operations for all periods presented. With those comments, I will turn the call over to Jack.

Thank you, Oksana. Good morning, everyone. Thank you for joining our call. This morning, I will review the highlights of the quarter, results at a segment level and provide an update on several key strategic initiatives. Jeff will review our financials in detail, and then we'll open the line for questions. During the quarter, we further strengthened our market position, capitalizing on our clear strategic focus, distinctive business model, and strong relationships with a select group of independent agents. At the same time, our talented and committed team continued to create sustainable value for our shareholders, partners and customers. Today, we are more confident than ever that we are achieving our goal to be recognized as the premier property and casualty company in the independent agency channel. We are concentrating our efforts on our target market sectors, those in which we believe we can generate more attractive growth and profitability. We are excited to build on our momentum and further develop our relevancy and market share with the top agents and brokers in the U.S. Overall, we are satisfied with our financial performance during the quarter and pleased with the execution on our strategic priorities. For the quarter, we posted operating income of $84.9 million or $1.97 per fully diluted share, a combined ratio of 95.1%, a combined ratio, excluding catastrophes of 90.9%, and an operating ROE adjusted for Chaucer equity of 14.1% for the quarter and 13.1% year-to-date. Our third quarter results include several noteworthy items. First, this has been an active catastrophe season, with 19 declared catastrophe events, several of them very significant, including Hurricane Florence. In light of this activity, our book performed well, generating a catastrophe ratio for the period of 4.2%. This underscores the benefit of continued coastal risk exposure management, consistent underwriting practices and…

Thank you, Jack. Good morning, everyone. For the quarter, we reported net income of just over $100 million or $2.33 per diluted share, compared to $11.1 million or $0.26 per diluted share in 2017. After-tax operating income was $84.9 million or $1.97 per diluted share, compared to $52 million or $1.21 per diluted share in the prior year quarter. The operating income for the third quarter included a one-time tax benefit of $4.3 million or $0.10 per diluted share related to a pension plan contribution we made during the quarter, benefiting from a 35% tax deduction. The gap between net income and after-tax operating income is driven by the net increase in fair value of equity securities of $23.6 million or $0.54 per fully diluted share. Discontinued operations, which includes Chaucer's operations and deal-related costs, had a net loss after tax of $3.6 million. Chaucer's segment income before taxes of $3.8 million for the quarter was more than offset by transaction-related expenses of approximately $7 million. Our continuing operations posted a combined ratio of 95.1%, down from the 97.1% in the prior year quarter, due to a more normal catastrophe experience, partially offset by variability in the current accident year loss ratio, which I will discuss in the segment details. Overall, catastrophes during the quarter totaled $44.9 million or 4.2% of earned premium, slightly favorable to our cat budget. The largest driver of cat losses was Hurricane Florence in North Carolina and Virginia, which accounted for approximately $13 million or 30% of Q3 cat losses. Excluding catastrophes, we reported a combined ratio of 90.9%, an increase of 1.5 points from the prior year quarter, driven by an increase in current accident year losses, while expenses remained in line with 2017. Prior year development was nil overall, with some pluses and…

Thank you. [Operator Instructions] Our first question comes from Christopher Campbell of KBW. Please go ahead.

Yes. Hi, good morning.

Good morning.

Good morning.

I guess, kind of just first question is on the adverse real development. So, personal auto has been adverse the last four quarters. Same thing with commercial auto, except the numbers are kind of growing quarter by quarter. I know you raised the commercial auto current year loss picks, but do you need to raise the personal auto one as well?

Yes, Chris, this is Jack. Thanks for the question. As we've committed, really, over the last several quarters, we are determined to stay on top of line of business trends and to make sure that we address things along the way. So consistent with that, we have been on top of some anomalies and some small trends within Personal Lines that we've made some adjustments to. We've also looked at the overall profitability of the business and still feel terrific about the business. But to your question, as we look forward into 2018, we think the combination of the pricing that we've taken and the continued positive trends and our account strategy and overall book management that we feel quite confident about the current picks in our Personal Lines business. In commercial, we obviously came to a slightly different conclusion. The industry continues to show some elevated loss trend. We've continued to see some severity of the severity for many of the reasons we described in the past, but essentially, loss trend is a notch higher than even we were projecting. So, we decided to make not only adjustment in the prior development, but also to update the full year accident pick. And that's the conclusion we came to.

Right. That's very helpful. And just looking at the core losses overall, they were about 160 bps higher year-over-year. Now, I know a lot of that is non-cat weather, so I guess – and that's like ex Chaucer, so how much of that was attributable of that increase was non-cat versus just what you're seeing attritionally from things like raising the Commercial Auto loss pick?

Yes. I mean, I think, we've outlined in our results kind of where we made some adjustments in our picks versus had some variability in property losses and some other areas. So, I don't know if you're speaking to a specific sector or just overall.

Yes. I think, Chris, overall, if you were to look at the elevation from our expectation in the current quarter, about half of it is related to the Commercial Auto pick, and the rest of it are the non-cat weather and attritional losses increase there. In addition, we also had a particularly low property loss quarter in the third quarter of 2017. So, on a comparative basis, you have that sort of hurting the comparability.

Okay. Got it. So, it's really not 160 bps, right? So, it's like 80 bps essentially with the Commercial Auto, and then you kind of have like a favorable quarter last year. Yes, I got it.

Yes. And when you bring that – Chris, when you bring that pull forward, too, that's why we made references to our full year projections, right? We think that, obviously, we still feel like we're really kind of right on our original view of the full-year picture.

Okay. And then, just, I guess, a few questions on Chaucer. I know it's in discontinued. But are there any expense dis-synergies that you guys get from getting that off the book, things like reinsurance, et cetera? And then, just also kind of a follow-up on that. Is that – I know you guys have the $45 million catastrophe contingent part of the sale proceeds. So, I guess, how much of that – and you're still below it at 820 bps versus the 10%. So, I guess, how much more losses could you take before that would be at risk? Is there any reinsurance that you bought to kind of protect that? And then, what are Chaucer's estimated micro losses?

Okay. Chris, this is Jeff. So first, on the potential dis-synergies. There really aren't meaningful dis-synergies. As you know, we had struggled to find synergies, and we had largely left the Chaucer business separate from the Hanover business. So that really doesn't become an issue. With respect to reinsurance, those programs were bought separately. We looked at it a couple of times, as you know, but the way those programs are structured, it didn't necessarily make sense to combine them, so we kept those separate. So, I don't think we'll see dis-synergies either from an expense structure or from reinsurance. Moving to the contingent consideration, we had $86 million as sort of the hurdle, if you will, which was the 10% of net earned premium. Through the end of the third quarter, we had $53 million of cat, so that leaves $33 million. Obviously, there's Michael, but even after Michael, there will be plenty of room after that. We did opportunistically put on some reinsurance for Chaucer cats for the remainder of the year. And we put that on at an attractive cost to protect a meaningful portion of the contingent consideration. There are some differences between what we put on in terms of attachment points, the amount of cover and the definition of a cat versus a natural cat, but we feel pretty comfortable with what's left and the meaningful portion of the contingent consideration that we've reinsured.

Okay. Well, thanks for that color. Now, just one final one. Shares have been kind of weaker since the Chaucer announcement. So, I'm trying to think – it will be some time before you guys decide what the proceeds will be. And you did kind of buy back more shares this quarter than we thought, especially in kind of a typically higher cat quarter. So, I guess, how much excess capital do you have currently? And then, how much could you theoretically buy back? Because you were buying back at $119 per share. It's at $107 now. So, presumably, buybacks are even more attractive than they were this quarter at current levels.

So, we gave an estimate on the last call, which was the announcement of the Chaucer sale. And the estimate we gave upon the close of Chaucer was that the excess deployable capital was $825 million to $875 million. So that seems to be still a good estimate for excess deployable capital. With respect to how much stock could we buy back, that – your analysis is probably just as good as ours. Obviously, we've been doing that work and thinking about it. Clearly, one can go into the market and buy $850 million of stock back at the current price without substantially moving the market or doing a Dutch auction or something there. But I think you can probably estimate that as well. It will take some time to deploy all of that. And that's why we're committed to using a portfolio approach of capital management and capital deployment techniques. And we've outlined those on the last call. So, you should think about more than one particular technique.

Okay. Got it. And then, just before pre – like pre-Chaucer closing, like how much excess capital do you have now? And then, how much could you buy back before you get to that post-Chaucer period?

We haven't really shared that with you. And obviously, we could do that if we chose to, but upon it closing, we'll announce that. But I think you should think about it as business as usual until a closing.

Okay, very well. Thanks for all the answer. Best of luck for the rest of the year.

Thank you.

Thanks, Chris. And again, just a quick follow-up to Jeff's comments. I think, we've been very clear along the way that upon closing, we do have a lot of work that we put forth and intend to be very clear about immediate capital management actions, as well as what we can do over time that would be in the best interest of shareholders.

[Operator Instructions] Our next question comes from Paul Newsome of Sandler O'Neill. Please go ahead.

I was hoping you could kind of walk through your Commercial and your Personal Lines business and talk to us about kind of how you feel about where you are from a rate versus claim cost deflation perspective, as well as where you are from sort of – I know it's hard to figure out in Commercial, but sort of policy in force version of growth versus stuff that's coming through because of rate or even mix change?

Sure. Paul, this is Jeff. Thanks for the question. I'll kind of give you some high-level thoughts, and then Dick Lavey can give you some additional commentary. I think, overall, what we've said in the past about Commercial Lines is still true. And as you see, there's some moving parts that are going on. We continue to have, I think, overall, pretty good industry pricing based on our portfolio and our strategy. I think we're delivering slightly above market pricing overall. That said, we still think we're a touch below loss trend, particularly as our view of commercial auto loss trend ticks up a little bit. So, we made a little bit of progress in pricing. I think the environment has been reasonably stable, but the denominator moved a little bit, in our opinion. On the Personal Lines side, I think we have been slightly ahead of loss trend with our pricing. We've been pushing rate in all the states that we feel like we need to keep ahead of that loss trend. And so that may have kind of come together a little bit in the last couple of quarters, but I think we still feel like we're slightly ahead on pricing to loss trend in the Personal Lines business.

Yes. I think, Jack hit the headlines on that. In Personal Lines, we do believe in both home and auto were slightly ahead of loss trend, and we're watching that carefully. In Commercial, we're getting positive rate in all lines, but workers' comp. And we know the story there. So, we feel good that we can continue to see improvement by managing pricing segmentation and underwriting actions where we're not ahead of loss trend, but our uptick in new money this quarter showcases that we're sort of artfully working through and getting price on the right kinds of accounts. From a PIF perspective, we're seeing PIF growth in Personal Lines of 3.3% in the quarter. So, that feels good as we drive out our point-of-sale application, and we're seeing underlying momentum at the desk level with our account managers. A good portion, of course, of our growth is on the back of strong retention. So, we've got strong retentions in the mid-80s, 84% in Personal Lines this quarter, and strong pricing in Personal Lines, 4.5%. In Commercial, same, we have strong retention. In Small Commercial, our retention is close to 86%. And our PIF growth is strong there. We do – similar to Personal Lines, we feel really good about the underlying momentum at the desk level, which means our submissions, both our submissions are up and our overall – our submissions are up and our overall yield rates. And just to make a point on the commercial auto rate, we're pushing ourselves hardest on that line, as Jack commented earlier, about what we need to do on the line, aggressively pushing upwards of 8% of rate. And we believe that the market can – will absorb that and potentially more. So, we're being really thoughtful about what our future pricing strategy is for commercial auto line.

Yes, and I'll just include with that also, that my comment about our view of commercial auto loss trend ticking up prompted us to immediately go back to the dials on commercial auto across small commercial and middle market and to meaningfully push forward across the segmentation tiers and pricing. So, don't mistake my comments around trend moving up. We made meaningful adjustments on the pricing side to be commensurate with that.

That's great. My next question, a follow-up to Chris' asking about capital management. I'm sure you have a plan, but can you talk about sort of the communication of that new plan to tell investors right after the close? Do you think it's something you need to be discussing next time you report earnings after the close? Or have you thought about the messaging and the timing of the message?

Paul, as soon as we had a close, we would have a call and announce the close of the Chaucer sale. And our expectation is, on that call, to be announcing the plan and some specific actions to deal with the capital.

Thank you.

Thank you, Paul.

[Operator Instructions] Our next question comes from Matthew Carletti of JMP Securities. Please go ahead.

Hi, thanks, good morning.

Good morning.

Just a couple of questions. One, just following up on the commercial auto, just as I read kind of the description in the press release of both kind of the adverse development and the movement in the accident year, just to confirm, they're very much linked. It seems like the older years are where you saw kind of the changes in trend and that kind of because of that baseline change that led you to increase the current accident year, kind of the base that you went off of went up? Or are you also seeing it coming through in much more recent claims?

This is Jack. I'll get us started here. As you know, at the end of 2011 into early 2012, we were probably one of the companies that first cited some of the escalation severity. And so, we put in place, at that time, a pretty rigorous process to figure out where this trend was going because there were some environmental shifts going on that needed to be assessed on more than a one-time basis. So, as you look across that, we've made some movement along the time. We did get to a point, probably a year ago, where we thought things were flattening out based on some significant pricing that we had thrown at the line, as well as some material changes that we made from an underwriting and pricing segmentation standpoint. And we believe those had a meaningful effect. What we've observed is that the severity has pushed out a bit further. And so, I would think of this as more of a continuation and maybe an accentuation of a trend that's been underway for some time, but we feel like we've got our arms around it and that we're watching it carefully. And we'll continue to push hard and make sure we don't get behind here.

Just to add to that, what we were seeing in the earlier years really caused us to want to be more conservative and get after it in the current year. It wasn't what we're actually seeing in the current year that was driving it specifically.

Okay. Yes, that's what I was getting at with my questions. That's helpful. And then, just one other question going to – shifting gears to Chaucer. You mentioned that all the regulatory applications are in, and that you're, give or take, year-end, it sounds like you're expecting a close. Who are the most key kind of regulatory approvals that we're waiting for?

So, the PRA, which is the London regulator, they're an important approval party. Lloyd's is an important approval party. Obviously, the Chinese regulators. Those processes are well underway. Given that China Re is owned by the Chinese government in large part, you could expect that. And then, there are a whole host of smaller, won't call them less important, but smaller to the deal, whether it be Ireland, Australia, Dubai, a variety of those. And they're all well underway. We're very confident in a December or January close. At this point, things are well-scripted. And both parties are really focused on wanting to close as quickly as possible. And so, we don't see a lot of things getting in the way of that. Certainly, either December or January.

Okay. Great. And then, one more, if I could, just following up on the return of capital, kind of post-closing. Can you talk a little bit about timing in the sense that one should decide that ex capital, however much it is you would like to return to shareholders through various means, how important is the timing of that? How important it is to get it back very quickly and kind of get the capital rightsized and the ROEs kind of reflecting run rate versus spreading it out over several quarters? I guess, more of the technicals of being able to buy back stock, how quickly you might be able to in spreading it out versus your thoughts on Dutch auction or a special dividend or something that is a quicker means of getting the capital back to shareholders?

Matt, this is Jack. I'll just say a couple of things, and then, Jeff can follow up. But I think you're really articulating the answer, and that is there has to be a balance. We are very focused in making sure that a meaningful part of the capital gets returned to shareholders in the most efficient and effective way. And so that means that we can't have a static plan. We have to have a plan that says out of the gate, we have a commitment of deploying capital using the balanced approach that Jeff has articulated, and then an articulation from there on what our intentions are to do over time. And I think Jeff was very specific on our last call to say that we would like to set up not only a framework that articulates what – how we get as much of the capital back in the investors' hands soon and efficiently, but also how we set up a pro forma so that you know, as an investor, how much deployable capital remains and that we update against that pro forma so that you understand really what the ROAC is for the existing business and what the deployable capital and how we're utilizing it, how much of it got translated into some organic growth opportunities versus future capital management activities. So, we plan to be very explicit about this. And Jeff, if you want to build on that.

Yes. Just two very quick points to add to that, Jack. The first is, we recognize that holding excess capital for any period of time or a reasonable period of time at 3.5% or whatever we might earn in the fixed income market is obviously dilutive to the ROE and the return. And the second point, even presenting an adjusted ROE, I think, in short order, investors will begin to lose patience and sort of get frustrated with that framework. So, we recognize the importance of redeploying and returning the capital in a reasonably short period of time.

Right. Appreciate the answers and best of luck.

Thank you.

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

Thank you very much for everybody's participation today. We’re looking forward to talking to you next quarter.