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

Thank you, Operator. Good morning and thank you for joining us for our quarterly conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer, and our Chief Financial Officer, Jeff Farber. Available to answer your questions after our prepared remarks are; Dick Lavey, President of Agency Markets and Bryan Salvatore, President of Specialty Lines. Before, I turn the call over to Jack. Let me note that our earnings press release, financial supplement and a complete slide presentation for today's call are available in the investors section of our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session. Our prepared remarks and responses to your questions today other than statements of historical fact include forward-looking statements, including our guidance for 2019. There a 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 statement 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. With those comments, I will turn the call over to Jack.

Thank you, Oksana. Good morning, everyone, and thank you for joining our call. This morning I will provide an overview of our strategic accomplishments in 2018, highlights by business, and our focus for 2019. Jeff will review our fourth quarter and full year results in detail and provide guidance for 2019, and then we will open the line for your questions. In many respects, 2018 was a defining year for our company, marked by solid results and important strategic accomplishments. By selling Chaucer, we intensified our focus on our distinctive domestic P&C business, building out capabilities for our agents and customers, while delivering strong returns to our shareholders. Overall, we are very satisfied with our 2018 financial results; we posted a full year operating EPS of $6.79, operating ROE of 9.9%, and importantly an adjusted ROE of 12.6%. Recall that operating income for the year does not include Chaucer earnings, but we still have excess capital from the sale. Our ex-cat consolidated combined ratio at 91%, was in line with our original guidance and consistent with our 2017 performance. Though we are satisfied with our 2018 results overall, we are not immune to our share of industry-wide challenges; first the industry sustained elevated catastrophe losses from several California wild fires, winter storms, hurricanes and other events. While the magnitude of these events was severe, we fared relatively well, a testament to our risk and underwriting practices. For the year, we reported a catastrophe ratio of 5.2%, approximately half a point above our domestic catastrophe expectation. Though this was not a significant variance, we continue to focus on exposure management and portfolio diversification given the elevated catastrophe activity in the industry. Second, loss trends in auto have continued to put pressure on industry profits, including ours, particularly in commercial lines where…

Thank you, Jack. Good morning everyone. For the quarter, we reported net income of 123.6 million or $2.88 per diluted share, compared to 51.5 million or $1.20 per diluted share in 2017. After tax operating income for the quarter was 64.9 million or $1.51 per diluted share, compared to 65.8 million or $1.53 per diluted share in the prior year quarter. As a reminder, we have restated our prior year results to remove Chaucer from operating results. The difference between net income and operating income per share in the quarter primarily reflects the gain on the Chaucer sale of $3.08 per diluted share, partially offset by declines in the fair value of our equity portfolio of $0.92 per share, as well as the loss from the early repayment of FHLB debt of $0.48 per share. For the year, net income was 391 million or $9.09 per diluted share, compared to 186.2 million or $4.33 per diluted share in 2017. For the year, operating income was 292.1 million or $6.79 per diluted share, compared to 192.6 million or $4.48 per diluted share in 2017. Our annual earnings reflected a combined ratio of 96.1%, an improvement from the 97.3% in the prior year due to lower catastrophe losses and expenses. The combined ratio for the quarter was 97.4%, compared to 95% in the prior year quarter. During the quarter, catastrophes totaled 50 million or 4.6% of earned premium, a point above our assumption. The largest drivers of catastrophe losses were the California wildfires and Hurricane Michael. Full year catastrophes totaled 219.2 million or 5.2% of earned premium, above our 4.6% assumption The magnitude of our catastrophe losses overall was consistent with or better than our market share would indicate, which is a testament to prior diversification and underwriting actions. Excluding catastrophes, we…

[Operator Instructions]. The first question will come from Matt Carletti with JMP Securities. Please go ahead.

Jeff, maybe if I can just pick up, where you left off on the guidance, can you help us take it one step further and there's been a lot of obviously changes in 2018, a lot of capital changes, Chaucer gone, lot of rating agency impact and otherwise. Can you help us kind of translate some of those changes into stable state all else equal, how should we think about capital changes and the impact on ROE? So if combined ratio were stable, would you expect ROE to be stable or would you see improved ROE, because you're getting better capital leverage post deal or post those changes?

First of all we wanted to raise our 2019 picks, based on the loss trends we were seeing and we wanted to be a little more conservative. I think it's also important when you look at the midpoint of the 91% to 92%, the ROE on that basis including the excess Chaucer equity and assuming that for this purpose only that we don't do any other capital management actions in 2019 other than that have been announced, and again that's just for this purpose only, the ROE would be 11%. If you adjust for the equity that's for the undeployed equity of $400 million, the ROE is nearly 13%. So I feel pretty comfortable with those results, I think nearly 13% even though we are raising our picks to be more conservative it's pretty darn solid.

You actually (inaudible) me to my next question, which was on the deployable capital, obviously with the ASR is active my understanding is that should wrap kind of four to six months in. Can you help us just with; kind of remind us of the timing and the kind of thought process as to that remaining 400 million or so when we get to that point and how you’ll address it?

Sure. So we've spent the last four months or so talking with investors and analysts about Chaucer sale, excess capital and the deployment, and upon day one of the closure of the Chaucer deal, we redeployed 450 million of 850 million of deployable excess capital. So I believe that's really a nice installment and really demonstrates that we're going to do what we say we're going to do. So the ASR itself will complete in May or June depending upon how quickly JPMorgan buys stocks. At some point in the second quarter the ASR will complete. The rest will be redeployed through investment and/or capital management in a very reasonable timeframe in the best interest of our investors, and we will communicate timely about our actions, but we want to maintain a little bit of flexibility at this point to give us the options to deal with that in short order.

The next question comes from Amit Kumar with Buckingham Research. Please go ahead.

Maybe I'll take these in reverse order, going back to Matt's question on capital management, you mentioned a reasonable timeframe, is it fair to say that the reasonable timeframe will translate into getting most of this or all of it done by let's say early 2020 or could some of it be spread over 2020?

Amit thanks for the question. I think it's early for us to conclude on that. It is certainly not out of the realm of possibilities that it's finished in '19 and it's not out of the realm of possibilities that it spills over into 2020. We understand what shareholders are interested in and they want us to use it in the best interest of the company and holders and we will do that. So as we finish the ASR in the second quarter, we will come back to investors and talk with you about our thoughts and our actions and the opportunities.

Amit, this is Jack, I would just say that as we go throughout the year the framework of that Jeff has outlined and the regular communication is our commitment that we will be transparent about what deployable capital is left, if we made any use of the capital, and we have no intentions of dragging out excess capital on our balance sheet with no use that is really accretive or would be helpful to building this company in a way that shareholders would appreciate it. So that is our complete commitment, what we don't know is what opportunities could emerge, and so we want to maintain a little bit of flexibility as Jeff stated.

And does that mean, I know in the past you’ve talked about how efficient an ASR or a buyback is. So, does that mean we should not we should not take off the possibility that there could be another special dividend or am I getting ahead of myself?

I think you should not take the possibility triple (inaudible) there. I think it is certainly possible that there could be a special dividend later in '19, but it is entirely possible that we have other more effective uses for the capital depending on what investments there are and depending on how we feel about buying back stock and those sorts of things. So we have flexibility to do either, but certainly not off the table.

Moving onto the commercial auto discussion and I know Matt asked this, in terms of the guidance and net-net all else equal, how much of that is what exactly would be the point translation from the commercial auto loss pick for the 2019 number? Is that 100 basis point or how should we think about that?

I don't think we have that detail in front of us at the moment on the specifics. Certainly commercial auto for us is not a large line right, it’s $300 million of premium. We believe it's improving in 2019, because we're getting such substantial amounts of rate, but Oksana can work with you after they give you some of the details on the triangle and the information there.

Yeah, this is Jack. I would tell you that what we are - I'm sorry Amit go head.

Please continue answering.

Sometimes it's hard to work through a roll forward for (inaudible) and then align with the loss trend is obviously moving. That said we had a point of view on how loss trend is developing and we've made some material adjustments in pricing. You saw that throughout the year heading into '19, we've made some additional adjustments to try to get on top of the BI severity in particular, and we have made some adjustments from an underwriting standpoint on business that tends to be a little bit auto centric or in the wrong geographies, which is why we qualified a little bit our commercial lines growth in the first half of the year, because we want to make certain that we are addressing this concerning loss trend in the business. As Jeff said, we're an account writer in specific sectors of the business. So auto in and of itself doesn't drive our results, but we realize we've got to get on top of this one as does the industry.

Last question, on slide 10 you talk about the pricing increases of 6% that I would imagine roughly half of that is real pricing and the remainder is account exposure. When you think toward 2019, are you assuming a flat level of pricing and loss cost trends on an underlying basis, may be just talk about that? Is it three versus three or ex-commercial auto the remainder (inaudible) or maybe just expand on that?

So this is Jack again. Overall I would characterize both our pricing view and loss trend view as reasonably flat. We're going to have to continue to watch that very carefully as we make some adjustments, and see if the improvement that we're anticipating shows up and that bends the curve if you will a little bit on loss trend for us. But we project into the year a relatively stable kind of situation with some slight (inaudible) year improvement in the commercial auto area in particular. That said we know that workers comp is continuing to drive through negative pricing for the industry. We've made some adjustments to minimize the effect of that on us, and so we're watching there's been discussion about frequency in that line of business that we haven't seen a lot of movement on. But overall the puts and takes put us in a pretty kind of stable environment.

The next question comes from Christopher Campbell with KBW. Please go ahead.

I guess my first questions are just on the guidance. I think just going through a few of the items, the net written premium seems like that's in line with last year at mid-single digits. And Jeff I think you mentioned in your opening script about focusing on the most profitable lines. Could you kind of rank that for us just in terms of how you're thinking about growth across personal, commercial and specialty lines, just where they're at in terms of excess return above your targets for each of those broader groups? And then how does the relative performance - now how does that feed into your view of if you want to use some of the Chaucer proceeds for accelerating growth in each of those segments?

The areas that we feel strongest about in terms of profitability and therefore growth are really personal lines overall on account business, small commercial and many areas of our specialty business.

This is Jack. I would build on that. What you're seeing is our portfolio was maturing and where we have frankly more opportunities to look across our business and look for where profitable growth can come through and balance that against some of the dynamics that are going in the market. Even as we talk a little bit more cautiously about the middle market business, we have sectors within our middle market portfolio that are producing returns as good as any other part of our portfolio. So, it is truly a portfolio management process for us inside the firm. And with that I'd love to just give Bryan Salvatore a minute here, because we probably haven't stated kind of our confidence in our momentum that's been building in the specialty commercial lines side enough. So Brian if you would, maybe you could give a flavor of that for your businesses.

Sure Jack. Thanks. I'd start by sharing that the specialty business that we've built is now in excess of $1 billion in premium, and it did perform quite well for us in '18. If you refer back to Jeff's comments on the other commercial lines accident year loss ratio ex-cat last year that was 52.6. That did achieve our target returns, it's over a point now better than the year before. And I use (inaudible) because it does meaningfully overlap with our specialty businesses. I would say that we have built out a pretty broad offering in the specialty space. That offering is very much connected to the needs in the books of our agents, and so we like the relevant that that brings to our agents. But as we’re driving growth, what I would really sort of call out is that what you'll see is that we’re going to be continuing to drive growth in what we would look at as our most profitable areas, our best performing areas including professional liability and healthcare, marine, our commercial (inaudible) these are areas that perform quite well for us, and I think those are the areas that will continue to continue to drive growth in, and I think that that really adds value for Hanover.

Just another question on the healthcare you had brought that up, and I know there was like an (inaudible) competitor that's kind of pulling out of healthcare. What's attractive about that line right now for Hanover?

So for us, I think it's important to remember, our book is a bit different right. We are focused on what our agents’ books of business and that really brings us to, they are smaller accounts, it's focused more on the allied space, you won't see us in the hospital the large healthcare system space, and so I think the way it performs is a bit different and we're very comfortable with it.

Yeah, this is Jack. I think that is the professional liability space both in healthcare and more broadly is a good area to spike out and suggest that there is quite a dichotomy. You can see on the higher end and particularly in certain sectors like medical, there's a bit of a hard market and there is some real challenges going on. On the low end of the spectrum, there is some terrific returns and so what we try to do is to segment that in terms of where we think the profitability is and where our agents are most advantaged and bring those together. But it's a portfolio management exercise within the broader portfolio management that we do as a firm. But that's a great example of - that's one of our most profitable areas in the company. But on the other end of the spectrum there are some folks that are having some real problems on the med mal side.

The only other thing I would add Jack is that, we're also achieving our pricing that we're achieving in that space is really in line with the trends so we feel good about that as well.

That's very helpful. And then another one for you Jeff, on the guidance, the expense ratio. I think you said that's going to improve year-over-year. It was 50 bps year-over-year last year just in terms of like the growth that you're forecasting, what's the potential for your expense ratio improvements in 2019?

So the way we think about expense is a company like us there are a number of investments that we need to make around data and analytics and claims and ease of use for customers and so we continue to make those investments and we are committed to funding those investments with expense savings. But we are not going to have expense savings of fixed costs beyond that, but what we do get is a leverage on our fixed cost as we grow. So I think on the order of 20 basis points it’s probably what you can expect on the expense ratio from the benefit of growth and levering those fixed costs a little bit better.

That's very helpful. And then my final one is more on auto, and some of my peers have asked about this one as well. I guess just in commercial auto, it sounds like you're accelerating your rate plan there and assuming it's basically constant. Just what gives you confidence, just in terms of the rate level you have, just given the problems we've seen across the industry about various competitors who have put in fairly aggressive commercial auto rates and then raised loss picks and done all of that, added reserves, and it's still an issue in terms of taking enough rate to get up with (inaudible) or to get ahead of an accelerating loss cost trend. Walk us through your process on that, and why we should be confident in the rate levels that you guys are taking?

Yes, this is Jack. I would tell you that you're spot on Chris. I think this is still a moving target for the industry, and so we are vigilant about watching this trend, looking at what the various contributors are. I think we have a stronger view as we've ever had about what's driving the severity increases, but I'll let Dick Lavey kind of talk to you more in more detail about what we're doing and really our confidence level that we can bend this curve and make sure that the profitability delivers.

Thanks Jack. So as stated we were looking at this very aggressively and dissecting it as best we can with a multi-disciplinary team with underwriting and claims and actuarial as you'd expect to really try to get underneath the loss trend. Our actions are pointed and specific and we think aggressive and we'll adjust should we need to - driving rate across the entire book of business, as you saw we ended the quarter at 9 points and we're going to push that 10 into 2019, and when we look at our retention of the book and what we see happening in the industry, we are highly confident that we actually can push more rate. Working hard at reducing mono-line auto, as was mentioned shifting away from some of those heavy auto classes, non-renewing some non-performing business, and Jack referenced this before too, but geography is a really important element for this. We study where the losses are coming through at a state level and we see certain states performing worse than others. So, we're throwing our bodies at it so to speak and we think we have as good a visibility as we can and will make adjustments with each passing month.

I think the last thing I would say about this Chris is that intuitively there will be a point in which the delays in medical information coming through, somewhat driven by some of the privacy laws that make it more and more difficult for adjusters to be able to obtain information about claims earlier in the process and understand which claims might erode on us. There’s new tools in place to help with that, but there's also a maturation to that whole claims development. So I think as an industry at some point in time, much of the change that's happened over the last five or six years hit some inflexion point, hopefully eventually starts coming back down. But I think the combination of some pretty substantial pricing that is going on in the marketplace and some maturation of those trends should give you confidence that eventually this thing flattens out and starts to go back the other way.

The next question will be from Paul Newsome with Sandler. Please go ahead.

Just a couple of follow-ups; one, if I missed it I apologize. Did you give any color on that sort of commercial lines renewal pickup in the first quarter and why that's something that's one-time in nature?

I am not sure, I understand the question.

I think you said something along the lines of net written premium.

In terms of actually some renewal retention drop in the first quarter that would affect our commercial lines growth, is that would you referring to?

Yes

That’s a couple of idiosyncratic things going on in the first quarter. The prior year had some reinsurance premium that is slipping the other way, there’s a couple of accounts, Dick mentioned the monoline accounts that are non-renewed. So as we think about the full year, the year-over-year growth for commercial lines specifically in core commercial would just be a little bit slower than it has been over the past or for the full year, that’s all we're just telegraphing nothing particular.

And then I'm just curious, is there much of a difference in the personal lines, medical cost inflation issues between PIF-states and non-PIF states in your book?

Well maybe start with the first part of your question. I think the first part of your question is that what is different about personal auto in total is that generally even for a book like ours that's more account-centric and tends to have some nice characteristics to it, the limits on the business still are considerably lower than you would see, for example, in commercial lines. And so it contains, if you will, some of the loss trend that we're seeing, but Dick I don’t know if you have a point of view specifically on PIF versus non-PIF states.

Yes, I would just add to that. In the PIF states, Michigan being the biggest one of them, the nature of the claims, the fatalities, the delayed medical, the legal and the lawyer involvement, I wouldn't say is dramatically different, but we do an excellent job as you know of managing our results in Michigan where we have a 10-point advantage over the industry. We just have scale and we have a lot of experience a lot of feet on the ground, so we've done a great job there. But in terms of the dynamic of the loss, I wouldn't say it's dramatically different, just shows up in a different line, or it shows up in PIF as opposed to bodily injury.

What is common, and this is Jack again. What is common is that the pushing out of the durations of some of these claims are part of the challenge right. We have seen a meaningful kind of push out of the duration of the severity based claims then whether that's a PIF claim that takes 18 months to 24 months to develop and come back into our claims portfolio or whether it's a BI claim that we're addressing that up. What we're seeing is a consistent pattern in either avenue, if you will, where that delay is causing us to have to reflect the different development pattern.

[Operator Instructions] The next question comes from Larry Greenberg with Janney Montgomery & Scott. Please go ahead.

Most of my questions were answered, but just one simple one, can you remind us in terms of your cat load whether commercial and personal we should assume kind of similar loads or is there a difference between the two?

Larry I don' think we've given that in terms of a cat load. I think if you look overtime and you see how the two have performed, you can probably guess at that a little bit. But we haven't shared that yet. I guess we'll give some thought to whether we ought to break that out for people, but overall 4.6% is the overall load.

Next question will be from Sam Hoffman with Lincoln Square. Please go ahead.

I'm just calling in to get a little bit more detail on the commercial auto. Can you give exactly what the loss trend is in that line for the full year of 2018, in the fourth quarter of '18, and then right now what the run rate is?

This is Jack. Unfortunately, we are not really at the liberty to kind of give by line loss trend particularly on a short-term basis, and I think the last couple of years have proven why that's not prudent, because nobody anticipated the auto trends to accelerate the way they did. But I think as we look over the long haul, we definitely see that commercial auto trends have ticked up maybe as much as a couple of points over the last few years in terms of people's view of that in the short to mid-range, but we've been adverse to try to put out specific loss trends by line of business and pretend like we have a crystal ball at that level.

Sam I think we are going at this hard and you can be sure that. We're getting price increases that Dick mentioned of 9% moving into 10%, we're looking at segmentation, the very small portion of our $300 million that happens to be monoline. We're revisiting that small piece and we're just not backing off these corrective actions.

What is the earned price increase at this point like on a run rate basis heading into 2019?

This is Dick. In the fourth quarter we saw nine points of rate.

That’s the written or the earned?

That’s written, that’s applied right. So it will take some time to earn that in. Because we've been getting close to 9% in the fourth quarter, close to 9% in the third quarter, the earned will not be substantially different than the written. But by the time you get to '19 it'll be a little bit slower in the first quarter and it'll pickup with intensity.

And I think we can safely say, this is Jack again, we can safely say that the price that we will drive in 2019 in commercial auto will be meaningfully above even a conservative estimate of loss trends.

Okay. So the loss trends in 2018 were in the high-single digits, it sounds like?

That's correct.

And then my follow-up is, is there any reason to believe that Hanover's commercial auto business book as a whole is better or worse in terms of loss ratio than comparable companies, comparably situated companies in the industry, given that the bulk of your business is account driven. How should we think about that as we look at benchmarking and thinking about what your loss ratio should be?

Yes thanks for that. This is Jack again. Well Dick why don't you go --.

Yeah I mean I think it speaks to the strategy we deployed in the marketplace with playing heavily in the small commercial segment and the lower end of middle market, where frankly the commercial auto fleets are smaller our classes tend to be more professional in nature. So I do think that there is an element of the nature of the mix of business we have, both size and class, you could argue is going to lead us to a better outcome than other companies that play in bigger spaces, bigger fleets, more complex classes of business.

And that's what we were alluding to earlier that when you think of manufacturing firms that have big fleets or wholesale companies that tend to be auto-centric, we've made some meaningful repositioning in those kinds of classes or those kinds of businesses, because frankly you just can't overcome the odds, the mix, the line of business mix dominates your ability to make profit. So that's where we've made some real meaningful adjustments, and I think our portfolio vis-a-vis the industry tends to be on the lower account size. And then lastly, the point I made earlier, the percentage of our book that's monoline auto is quite small and getting smaller, and so the monoline auto that we have remaining performs quite well, but that in the past has been the place where we needed to do some underwriting and manage the loss ratio.

Okay, and since you're focusing on smaller accounts, would you say that your expense ratio in that line would be higher than peers and therefore the combined ratio would be about the same or do you think overall your combined ratio should be somewhat better than the industry.

Yeah, I think it's hard to make a lot of comparisons because some of that can depend on, go to the other extreme where if you get into trucking businesses where the commissions tend to be lower and so the loss ratio profile. So it's hard to make a real general statement. I think the hypothesis of our firm is that by playing on the lower end of the commercial line space, we will have a slightly higher expense quotient and a lower loss ratio component in total. But again what we caution people over time is, as we get more specialized then the account size versus the complexion of how much of your business is specialty or specialized, can also work against that same kind of expense to loss ratio quotient. So, overall we're quite comfortable that the returns we're delivering show expense ratio improvement overtime and a good stable loss ratio.

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

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

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