Good day, and welcome to The Hanover Insurance Group's Second Quarter Earnings Conference Call. My name is Anita, and I'll 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. Ms. 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 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 supplements, 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'll begin with comments on our consolidated financial highlights for the quarter, market dynamics in our Personal and Commercial Lines business and the continuing progress we've made on our strategic initiatives. Then Jeff will provide an in-depth review of our financials, and we'll open the line for your questions. We are pleased with our result in the quarter and with progress we continued to make across the organization, advancing our key priorities and strategic initiatives. Our performance is a reflection of our distinctive strategy as well as the inherent strength of our unique agency distribution capability, which supports our goal to generate superior shareholder returns over the long term. Starting with the overall highlights for the quarter first, our strong results are demonstrated by our adjusted operating return on equity of 12.2%. Second, we generated net written premium growth of 4% while making thoughtful underwriting decisions. Our improved growth demonstrates the strength of our market position and the successful agency partnerships that serve us so effectively. We are intently focused on strategically growing products and classes of business that meet or exceed our target returns. At the same time, we are vigilant in managing our broader portfolio. This year, we made some deliberate choices to pull back on some lower-performing business, including Commercial Auto and components of our Program business, as we maintained our focus on our goal to deliver top-quartile return on equity this year and going forward. Excluding these profit improvement actions, consolidated growth in the quarter was 5.7%, up from 4.3% on a similar basis in the first quarter. We expect to maintain this growth trajectory as we monitor this dynamic market environment. Third, we delivered a very strong underwriting performance. Overall,…

Thank you, Jack. Good morning, everyone. For the second quarter, we generated net income of $74 million or $1.79 per fully diluted share compared with $99.3 million or $2.31 per share in the second quarter last year. After-tax operating income was $77.7 million or $1.88 per diluted share compared with $76.2 million or $1.77 per diluted share in the prior year quarter. Our combined ratio was 96.1% in the second quarter of 2019 compared with 95.5% in the prior year quarter. Current accident year catastrophe losses totaled $66.6 million in the quarter or 6% of earned premium. This is a very solid outcome given an active catastrophe experience for the industry in the quarter. Our efforts to diversify and manage concentrations over the years are clearly demonstrating benefits. We also recorded favorable prior year catastrophe reserve development of $7 million. Excluding catastrophes, our combined ratio was 90.7% versus 89.9% in the prior year quarter. The increase was driven by higher current accident year losses, partially offset by lower expenses in the current quarter. The expense ratio improved 50 basis points to 31.5% from the prior year quarter as we continued to benefit from the leverage on our fixed expenses from premium growth and the timing of certain items. At the same time, we continued to fund investments in our businesses from expense reductions across our organization. We remain committed to deliver the expected expense ratio improvement of 20 basis points moving forward. I will review loss ratio drivers as part of the discussion of our two main businesses. As a reminder, we increased our loss selections in our auto businesses in the third and fourth quarters of last year. Therefore, the second quarter comparisons between years may not be as helpful this quarter. Our 2018 full year ratio may be…

[Operator Instructions] The first question today comes from Amit Kumar with Buckingham Research.

Perfect. Just a few questions. The first question is the discussion on capital deployment. I know you cannot comment on the trade press and the discussion on the CapSpecialty. But maybe can you just refresh the thought process, how you would look at external opportunities and maybe the size of them? I know, I think that you've given us a number in the past, which I thought was on the lower end of what CapSpecialty might have been. So maybe just refresh us on any bolt-on acquisitions, et cetera, what size they could be.

Yes, Amit. Thanks for that question. This is Jack. I think we continue to be active in terms of our corporate development activities. We have consistently had resources working with not only the banks but also provoking different ideas that we've had. It's been a big part of our success in the past in terms of bringing in some smaller inorganic opportunities into the portfolio and so we continue that pursuit. But as you're referencing, we have some pretty strict criteria related to any M&A pursuits that we make. And so that guides us, both in terms of the size of the opportunity and really the quality of the properties that we would look at. They include being accretive to ROE in a relatively short period of time, and that is somewhat shaped by the opportunity itself. Any opportunity that we would pursue has to have some relationship to our distribution strategy which distinguishes us in the market. And last but not least, any people that come with any acquisition have to have the opportunity to join our culture and really be part of the company that we worked so hard to build. So when you put those criteria on top of the real inventory that's out there, it limits us in an appropriate way towards high-quality properties. So we are active, but we are, I think, particularly excited about organic opportunities these days. I think the valuations that are out there for the better properties are still pretty robust. And frankly, the organic opportunities that are emerging as the market evolves are really got the vast majority of our attention.

Yes. So that's a good point. And so the $257 million remaining undeployed is it fair to say, based on your comment right now, maybe the focus is more on deploying it organically based on the pricing discussion changing from Q2 versus Q1? And maybe a much smaller piece on anything in organic, is there any way to think about those pieces?

Well, I can let Jeff comment on this additionally, but we're, as you know, if we continue to generate the type of returns that we are today, we generate a reasonable amount of capital for deploying it against our organic opportunities. So we're bullish on our growth and believe that, that will, the trajectory will improve in the second half of the year and certainly into 2020, but we're also conscious of the fact that we have plenty of capital to fund the organic activities that we have in front of us. So we go back to the framework and Jeff, that you can articulate for our analysts, investors.

So we've delivered about $600 million of the $850 million of deployable capital back to shareholders in a pretty short period of time. In fact, I think it's about 6 months. So I feel pretty good about honoring the commitments that we've made to shareholders, and we've done that really without identifying in advance of doing it what we were going to do specifically. So we're going to continue with that model. And -- but I will tell you that we will redeploy that capital in our framework. We'll look at organic opportunities. We will consider other alternatives to return capital, if and when necessary and available. So we'll finish this ASR. That'll be two to four months, and then we'll move on from there, Amit.

Do you get the sense that all the return would happen by year-end 2019? Or could some of it spill over into early 2020?

Amit, I know you're trying to build a model, so I can appreciate the sensitivity, but it's hard to say, for sure. I think it's certainly entirely possible that it completes in '19, and it's entirely possible that it spills into '20 depending upon how we see opportunities and where the stock trades and a whole variety of different cost-benefit analysis that we do for shareholders.

The only last question I have, and I'll stop, just going back to the discussion on Commercial Auto. I think you flagged bodily injury, and it's interesting. I feel like every other company has a slightly different take on this issue. Do you get the sense -- I think you mentioned some very strong pricing numbers. What is your outlook on Commercial Auto achieving underwriting profitability on its own?

Yes, Amit. This is Jack. We have worked hard on the Commercial Auto line of business in the context of our overall portfolio. And as you know, we've now elevated our pricing in the Commercial Auto line now to double digits. We believe that's well in excess of any even short-term loss trend that seemed to be exacerbated. We also have taken that next level of underwriting action to ensure that we bend the curve on Commercial Auto loss ratios. That's evidenced by our lower retentions in this line, while the other lines tend to be holding. So we're able to take action on auto-centric business or specific auto business without compromising the growth of the overall portfolio and drive meaningful rate against some of the loss trend that is evidencing itself. So we are really confident that we can move this line closer to profitability, but it's going to take a while given the overall industry results.

The next question comes from Paul Newsome with Sandler O'Neill.

Congratulations on the quarter. I want to ask a little bit more about how you do your Commercial Auto. How closely do you adhere to the ISO forms and the ISO pricing versus how much you use your own internal forms and pricing data?

This is Jack again. For the most part, we are an ISO-based company in the Commercial Auto line. Certainly, from a forms perspective, we have some modifications based on certain industry sectors that customize for the verticals. But from a rating perspective, we have a starting point with the ISO loss costs, but we also have a proprietary model that allows us to add in different factors and allow us to shape the pricing appropriately. So we've been, I think, in that model for somewhere around 7 or 8 years and have a blend of ISO and some proprietary pricing.

And then unrelated question. I was wondering if you could focus a little bit on your ongoing efforts on the expense line. The expense ratio has come down pretty consistently for the last couple of years and looks like it's maybe coming down again this year. How far do you think you can extend that given the progress you've already made?

So Paul, this is Jeff. We've committed to delivering 20 basis points per annum, largely out of the leverage on our fixed costs. And underneath that, we are actually taking out a lot more cost than that and making investments that we need to around data and analytics and tools to make our business even better and easier to do business with. This particular quarter, in fact, this particular year-to-date, we have had some things that have lowered that to 50 basis points lower than it was a year ago. I don't think that will turn around later in the years, but we're committed to get the additional 20 basis points. Over the longer run, we're committed to really be focused on expenses, and there are probably some businesses over, really, the longer term that we can really focus on -- more on expenses. But for now, I think 20 basis points is a good modeling pace going forward.

Yes. This is Jack. I -- the only thing I would add to that is that we are still growing into some relatively new businesses and new geographies. So on a relative basis to many of our competitors, we have a lower marginal expense ratio than we do in our current expense ratio. So that's the leverage that we keep trying to play to. Some of that has to be watched on a mix-adjusted basis. If we grow certain lines or classes of business, they bring with them a little different expense quotient. But that said, we are very confident that over the next few years, we can continue to scale this business and further lower that expense ratio.

[Operator instructions] The next question comes from Christopher Campbell with KBW.

I guess starting with the commercial rate increases, like is there any chance you can break down what you're seeing in like GL, Commercial Auto, Property and then workers' comp?

Well, I tell you what. Overall -- I'm going to let both Dick and Bryan speak a little bit about this because there is some improvement. And probably excitingly, we're seeing some real improvement in the specialty lines. But across the core lines, I think, as we said, we are really pushing hard on Commercial Auto, as the industry is, and we're making sure that we get at least our fair share there. But as you know, on the other side of the coin, workers' comp, generally driven by statutory rate changes, the pressure is going the other way. All in, we're very pleased with the levels we have. But, Dick, if you want to maybe build on those?

Yes. No. I think you answered that well. We were seeing low double-digit rate -- or pricing in auto line. As we've said, mid or low single negative pricing in work comp and low to mid-single-rate increases in the Property and GL lines. So on balance, we're pushing ourselves towards covering the loss cost.

Yes. So this is Bryan, Chris. What I think I would add to Dick's comments is we are also similarly focusing on driving rate where we need it most. Now I would say that some of the things and some of the themes we've seen in the large account market for specialty is being felt somewhat in the segment, the smaller account segment that we're in. So we are being able to and pushing on pricing in our liability lines, our D&O lines, our E&S lines and some of our property lines. And so I think, net-net, what you'd see is that we're really achieving price that would, I would say is at or even certainly better than trend.

Great. That's very helpful. Now just diving into workers' comp a little bit I was like looking back, and it looks like the core loss ratios have declined like quarterly, I think maybe only one quarter since, like, late 2016 or something like that. And then even this quarter, there was like a 63 bps year-over-year improvement. I guess just with rates declining, can you just give us color with rates declining, industry chatter about increased competitiveness. Why aren't your loss picks going up so what's happening under the hood in terms of like frequency and severity trends that gives you confidence in the current accident years are still developing favorably given the dynamics of the industry?

Chris, this is Jack. Listen, you've been consistent on this point, and it's a fair question to ask of anybody in this pretty dynamic environment. And I think the best way to explain it is that we are seeing unprecedented low and even negative loss trend in this line. As we explore and stress test our picks and our roll forwards, there's I think the two majors things that drive us towards the performance levels that you're seeing are that we have moved our portfolio meaningfully to small commercial, technology sector and other more advantaged sectors of the business over time. The frequency levels are really moving in a very favorable position. There's evidence that there's even some specific loss types that are meaningfully getting pulled out of the system, if you have the analytics to follow that and understand what exactly is happening kind of below the overall loss trend level. So it's really a combination of we think we are driving optimal mix and getting the benefit, frankly, of the shifts that we've made in the past that are taking favorable industry frequency numbers and making our book, I think, even further advantaged. All of that said, we are watching this very carefully because we are cognizant of the pricing trends, and we are making sure that we don't miss a turn here, either because of loss trends normalizing or because of the cumulative effect of pricing.

Chris, our current picks for the last two years are still meaningfully higher than our developed picks for the years before that. So we think we're still comfortably conservative with the level of picks in the last couple of years.

Okay. Got it. And then just in workers' comp, in general, I mean, what are the impact that you're seeing from like opioid and prescription drug? Like how big of a driver are those just in terms of your severity?

Yes. This is Dick. That's something we're watching closely in the -- our loss trends, and we haven't seen it specifically spiked out, so it's hard for us to put an exact number on it. But it's one, obviously, that as we look at medical cost and the management of that, we'll keep a close eye on it. We put in place an increasingly larger numbers of just cost management capabilities in our claims area, so it's one that will -- we've got an eye on.

Yes. This is Jack. If you were to get inside the company and understand the level of investment that we've made on the claims side of the house and particularly in workers' compensation, including nurse case management and a lot of the follow-through on prescription meds, we are as diligent as anybody to make sure that when prescriptions are being made liberally or there's an opportunity for opioid abuse. So I am really proud of the improvement we've made within our claim department to attack this really critical issue. But at the end of the day, this is another area where our mix helps us. We are substantially in the small commercial business and the tech sector, and we're not really in the middle-market, day-to-day manufacturing construction business where a lot of that is residing.

Okay. Great. And then just one last one. Jack, I think Jeff mentioned in the opening script, just in terms of like the amount of, like, proceeds that you guys have deployed from Chaucer. So I guess just -- I'll pick the other side of that. Like have you -- what investments have you made internally in the business with those proceeds that, like, we haven't seen because they haven't had a press release on it?

Yes. Thanks for the question. We clearly, as Jeff articulated earlier, have not only some expense reallocations that we've made, but we have a pretty good inventory of areas that involve accelerating any kind of legacy transformation work that needs to be done from a technology standpoint, any current software capabilities related to our platforms. I think we've been very transparent about the fact that we invested heavily in our Personal Lines platforms over the last couple of years. We're one year into a three year investment in our Small Commercial platform. These are tens of millions of dollars of investments that both improve our point-of-sale application to our agents but also modernize the infrastructure and allow us to be able to be much more contemporary with how we attach the APIs, bringing third-party data and set ourselves up for the future. On top of that, we're building in the specialty businesses a financial institutions practice, a retail E&S business. We are building on our cyber capabilities, not because we're trying to go on the offense, but because we're trying to make sure that we are aware of this line of business and are prepared for how it becomes, really, the sixth line of business and a package account over time. So we're making what I consider to be meaningful investments across the infrastructure of the company as well as the capabilities that allow us to grow and be increasingly relevant to our agents. And frankly, we're in the planning season right now, where we're asking our teams to bring forward the next round of those investments and push ourselves hard to not just spend more money but to not miss out on the opportunity to reallocate some costs and accelerate those investments.

And for full clarity, we're using existing capital expenditure budgets and repurposed expense budgets from cost saves versus allocating equity that was created from the sale of Chaucer for those investments and expenditures.

Yes. Maybe not to pile on here, but one last thing that we probably don't speak enough about is we are spending a lot of time building kind of the next generation of our Agency Insights tool. As you know, we have really a very unique partnering capability but also data and analytics capability that our agents have really grown to depend on, and we are working hard to build out an even more impressive set of benchmarking capabilities and triangulating with third-party data in order to bring them additional ways to serve their clients and improve their economics. So that's another area that we're heavily focused on going forward.

The next question comes from Larry Greenberg with Janney Montgomery and Scott. Please go ahead.

You just touched on part of what my question was, which was really just to provide a little bit of an update on some of the initiatives you've made in the Specialty space. And I guess I'm curious, given what we hear are some dislocations in the E&S marketplace, does that help you accelerate some of the movement you're looking to make there? Just if you could talk about current conditions and what the opportunities are there.

Yes. Let me tee this up for Bryan because he spent an awful lot of time on this topic. And I think there's 2 dynamics, Larry, that are affecting us. Obviously, there's some real disruption and change going on in the E&S sector and being able to segment that and understand what's moving and where the opportunities are is really important, and that's where our Agency Insights tool and our interactions with agents help us. But additionally, there is increasing evidence that retail agents, particularly consolidating ones, are determining what E&S business they plan to place directly versus through the wholesale channel. Wholesalers are not going away, but retail agents are building capabilities to place some of that business, particularly if it's attached to other lines of business. And so from that, Bryan can build on how we're really focused on this sector strategically to find out where our place is.

Yes. And so I think, Larry, what I would do is I would go back to what Jack just said, right? Our retail agents are getting increasingly determining when you want to come directly to us and use a wholesaler. And so whenever we build our Specialty products, the driver always is are we further differentiating, adding relevance to our retail agents on behalf of Hanover? And that is the driver of really all of our builds, so it's the driver of build in the financial institution segment, and it's the driver of our build in the retail E&S segment. We do see very positive feedback from what we're doing here, and I do think it's driven by some of that dislocation that you're mentioning. There is demand for this type of area from us. Now I will remind you that we are still very much focused on that medium to small segment. That's our sweet spot, but there is real demand there. And so we are building out on it, and we're getting good traction.

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

Thank you very much for your participation today, and we are looking forward to speaking to you next quarter.

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