Good day, and welcome to The Hanover Insurance Group's Fourth Quarter 2019 Earnings Conference Call. My name is Gary, 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 quarterly conference call. We'll 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 2020. 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, 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'll begin with comments on our financial highlights for the year, our strategic accomplishments in 2019 and a high-level overview by business line. Jeff will provide an in-depth review of our financials and our outlook for 2020, and then we'll open the line for your questions. We are very pleased with our strong performance in 2019. We delivered an operating ROE of 12% and 12.8% after adjusting for the undeployed equity from the sale of Chaucer. We generated premium growth of 4.5% for the year, on the strength of our broad-based profitability across our portfolio and solid execution against our strategic imperatives. We continue to focus on our objective to be the premier property and casualty franchise in the independent agency channel, advancing our proven strategy, leveraging our position as an agency carrier of choice, our leading specialized capabilities and our commitment to innovation. We drive those distinctive elements of our strategy through our extraordinary talent and unique collaborative culture. During 2019, the property and casualty insurance industry environment exhibited even more complexity as profit pools, loss trends and rate movements continue to change more dynamically than ever before. Traditional market cycles have clearly given way to more sectoral and geographic forces that require more sophisticated and savvy approaches to underwriting, loss analysis and portfolio management. We demonstrated that we are developing an industry-leading ability to anticipate the market dynamics and react with agility and expertise in order to deliver strong results that foster continued momentum. We stayed focused on the ultimate goal delivering profitable growth and allocating capital and resources to our higher margin businesses. Turning to our financial highlights for the year. While the P&C industry is clearly experiencing higher overall loss trends,…

Thank you, Jack. Good morning, everyone. For the quarter, we reported net income of $109.8 million or $2.76 per diluted share compared with $123.6 million or $2.88 per diluted share in 2018. After-tax operating income for the quarter was $80.2 million or $2.01 per diluted share compared with $64.9 million or $1.51 per diluted share in the prior year quarter. For the year, net income was $425.1 million or $10.46 per diluted share compared with $391 million or $9.09 per diluted share in 2018. Operating income for the year was $331.6 million or $8.16 per diluted share compared with $292.1 million or $6.79 per diluted share in 2018. With the full year of results now behind us and some property variability by quarter in certain lines, it is more informative to primarily focus my comments on our full year 2019 results and to mention quarterly movements where relevant. Our full year earnings reflected a combined ratio of 95.6%, an improvement from 96.1% in the prior year, due to lower catastrophe losses in 2019 and an improvement in the expense ratio. Full year catastrophes totaled $169.3 million or 3.8% of earned premium, which was below our catastrophe load assumption of 4.6%. During the quarter, catastrophes totaled $35.1 million or 3.1% of earned premium, 50 basis points below our fourth quarter assumption. The largest driver of catastrophe losses were Dallas tornadoes in October. Excluding catastrophes, we delivered a full year combined ratio of 91.8%, toward the higher end of our original guidance of 91% to 92%. Overall, prior year reserve development in 2019 was immaterial, with puts and takes by line. We tend to react to emerging trends and other loss activity quickly to avoid large issues down the road. We feel very comfortable with our reserves overall. During the quarter, we…

[Operator Instructions]. Our first question comes from Matt Carletti with JMP.

I think, first, Jeff, just wanted to circle back on your NII guidance. I think I heard it a little differently in your NII comments versus guidance comments. Did -- is -- what I was supposed to hear that it's -- once you take out the $8 million of Chaucer, it should be flat year-over-year with cash flow offsetting yields?

That's correct, Matt. You have it right.

Okay. Perfect. Just want to clarify that. Then shifting to the operations. You always give your price, can you give us a little more granularity there and don't need to nail down numbers, but even just kind of rough the pieces. What -- how much is pure price versus exposure? Because I know both are in there. Is it fairly equal-weighted? Is it shifting now as the market changes that one is driving it more than the other?

Yes, Matt. This is Jack. I assume you're talking about Commercial Lines?

Yes. I'm most focused on that. Yes.

Okay. Yes. So overall, I think what we would tell you is that throughout the year, we saw the rate component of Commercial Lines pricing continue to notch up really incrementally throughout the year, consistent with really the trajectory in the prior year. So -- and we also said, I think in the script and I've said in the past that the exposure part of this does move around a bit from quarter-to-quarter. And so I think last quarter, it was probably a little below our normal trajectory in this quarter, probably a little bit above our normal trajectory. So if you look at that net total of that trajectory, and you see -- we haven't really disclosed the rate-rate component and the component that goes with exposure that we think continues into our pricing. But I think if you think of 2/3 of that is the trajectory of that core pricing below the level, that'll get you close.

Okay. Very helpful. And then just a couple more numbers questions. You talked a little bit about the programs and how you non-renewed a handful of them in '19 to kind of prove the underwriting results. Can you just help me a little bit with the timing of those? I'm just thinking it from a standpoint of when they might have went into effect across the course of '19? And then when we anniversary them in terms of apples -- getting back apples-to-apples in 2020.

Sure. I'll say a couple of comments and then turn it over to Bryan. I would remind you that we have constantly been kind of pruning and adjusting our program profile for really the last few years, increasingly moving the portfolio to be more programmatic business with our broad-based franchise partners as opposed to kind of a singular program with an MGA that doesn't have that broader relationship with the company. So -- and most recently, including, if you remember, at the end of last year, we targeted programs and the auto centric classes or portion of our middle market business as particular areas that we were going to prune as we look at the liability environment moving out a little bit. So I'll turn it over to Bryan to give you a little bit more specificity. But I want you to see this as kind of a continuation of making sure that the business that we have in the program sector is strategic and increasingly more profitable.

Yes. Thanks, Jack. Matt, what I would add is that -- an important comment Jack made is that this is a business that we view as increasingly strategic with our select agents. So we're very careful about how we manage that -- those exits from those programs, but we're also sort of very committed to doing that where we need to. As a result, each quarter, we took action on an increasing amount of the program business. It resulted in our shrinking that program business by 8.5%, and I think you'll see that continue through the first half of '20.

Okay. That's very helpful. And then one last quick numbers question for, I guess, Jeff. Just on the few lines that saw the more -- they weren't massive, but more significant prior-period movements. So Commercial -- or sorry, Personal Auto, the commercial programs, and then on the other side of the workers' comp. Can you just give us a little bit of color on which accident years drove the majority of that movement?

So Matt, thanks. Overall, we feel really comfortable with our level of reserves. And as we've said, we're going to react to these things when we see them. So we don't have bigger issues going forward. Overall for the year, the favorability offset unfavorability. For the most part, it was relatively spread across, let's say, the last 3 or 4 accident years. I think we've talked about the bodily injury in auto being -- '16 and '17 were the primary years. Workers' comp was sort of spread evenly with a number of years, some older and some getting closer to more recent. So it really varies by line, but it wasn't -- other than the bodily injury at Personal Auto, it wasn't any particular line or either really recent or really old.

Congrats on a nice year, and best of luck going forward.

Thanks, Matt.

Thank you.

The next question is from Amit Kumar with Buckingham Research.

A few questions. The first question is on the guidance, 91%, 92% for 2020. I think it was a similar level for 2019. Maybe starting with the Commercial Lines. When you look at the pricing actions, and then you look at the loss cost trends, how are we thinking about margin improvement from here, assuming normalized losses and non-cat activity?

So Amit, overall, in terms of our guidance, thinking about 2020 relative to '19, we do expect some margin improvement, again, from '19, with Personal Lines largely being flat. So we're seeing some elevated property and some auto BI that we feel we need to react to. And in the Commercial Lines, we're actually seeing improvement there. So Specialty, we expect to have somewhat reduced property losses. And in Core Commercial, it's really a combination of the property volatility returning slightly to a normal level. And also the Commercial Auto improvement taking full hold. So the combination of continuing to get double digit pricing, and the earn in fully of the underwriting action should give us a little bit of a lift. And overall, there's a margin improvement from '19 to '20.

Got it. That's helpful. Maybe just staying on the loss cost discussion and switching back to the PowerPoint Slide 6, which I think you've done a great job in outlining how the social inflation trends and your book interacts. The question I had is you mentioned the limits, et cetera, and I think you're highlighting how your limits are at $1 million -- 90% of your book is at or below $1 million limit, et cetera. There is a debate, which is emerging in this space, which is talking about how low limits might not insulate companies from social inflation. And in fact, social inflation, in some cases, has made its way down from the larger limits to the lower limits. Maybe you can talk about the broader trends and also about your specific experience over the last 12 months or so?

All right. Thank you for that, Amit. This is Jack. I'm going to kind of talk about it at a high level and then I think Dick has some few thoughts that he wants to share. As you look at Slide 6 in our presentation, we really thought it was appropriate to remind everybody that the increased severity that's in making its way into the liability lines, obviously, first in Commercial Auto in a pronounced way, is something that we've been wrestling with and the industry has been wrestling with for a number of years. But if people will recall, midway through 2018, we saw some elevated losses coming through, particularly in the auto area that caused us to make some adjustments and -- in our picks, in our pricing, in our underwriting. We also want to remind folks that, 3 or 4 years ago, we were maybe one of very few companies that was identifying some CMP liability claims patterns that looked challenging to us. At that time, if you remember, we talked about losses that were primarily slip, trip and fall type losses in the major metropolitan areas, although you could see some of it in some of the more challenging litigation environments. So all of this was a way for us to kind of say, how do we share with folks, what we've already told you about the improvements that we've made in the portfolio, and then some contemporary things that we're doing to address the mix of the business, both sector and geographically? The last point I would make just is about the issue around the limits profile of a company. I would tell you, in aggregate, mathematically, this problem exacerbates itself as you move up the limits profile. Is there some evidence that you're seeing more and more litigation and activity at lower levels of the business? I think the answer is yes. And we talked about that a little bit in our Personal Lines business that we're even seeing some evidence of some change there. But mathematically, from a loss ratio standpoint, it gets very much exacerbated if you're a higher limit player, if you have a huge umbrella book of business. And so Dick, do you want to provide some color on that?

Yes. I think I'll just add a few color commentary. You're absolutely right, Amit. The low -- our view is lower limit certainly helps insulate you from this trend. But certainly, we're seeing it in our business. But just as importantly, moving away from certain classes or geographies is going to help as well. So what our -- what we showed you here was that we've taken some action. And more importantly, the outcomes for the improvements that we pushed ourselves on in these areas, which we think further insulates us or mutes the effect of the social inflation into the future. So what we show you is GL premium in our middle market book and how we pushed ourselves away from certain classes of business where that was more prevalent. So slip trips and falls, you would tend to find more in real estate, retail, hospitality, restaurant. So you can see 25% reduction for us over a 3-year period. So class of businesses is one way to help insulate you, geographies is the other. So we don't spike out exactly what -- which these cities are, but major metropolitan areas which were more litigious in nature, we watch those patterns closely. And again, pushing our GL premium in middle market out of those geographies pretty significantly, 30% in one area and 55% in the other.

The other question I had was -- maybe switching gears to Personal Auto. I know you sort of briefly responded to the loss cost trends, the previous question. Maybe can you expand on the frequency and severity trends in BI and PD? And how should we expect them over 2020?

Sure. Yes. I can take that one. So a good question. We don't have a crystal ball, obviously. But a key question I think, remains about the future of the frequency trends. Because when you talk about this, I think we would say the severity is likely to continue in FISDAM. So collision and comp, the cost of repair on that FISDAM side, industry trend, similarly, we see that severity continuing, also on the bodily injury without severity continuing, the litigation costs, the medical cost that we've talked about. So I think it's appropriate to expect that to continue. The frequency has been benign, and in some cases, declining. And that access -- the counterbalance, of course, to that increase in severity. So where does that go? We blend those things together, we see a pretty fairly consistent sort of go-forward view of the loss cost.

And this is Jack. I think what's critical to and what we've highlighted before is in Personal Lines, you can react to this, I think, more swiftly, right, through pricing and through some of the deductibles that we're imposing upon the business. So that's why we're comfortable that while we see some of these trends coming forward, and we're paying attention, particularly to that frequency number that Dick is alluding to, we can continue to make material adjustments, particularly with our new platform in Personal Lines that allows us to adjust pricing more granularly and more quickly.

And to be prudent Amit, we've planned for those trends to continue. And if we can manage them a little better, then we'll certainly do our best.

That's a fair point. Last question. On the capital management, and I'm sure you missed my capital management excess capital question. Your comment was you'll be good stewards of capital, you look for profitable business growth and then return capital. When you look at the opportunities versus capital versus stock multiple. Is a special dividend or an increase in dividend down the road, is that maybe a better option versus a stock buyback here? Or how should we think about those sort of different buckets, one over the other?

Certainly, Amit, we look at all of those things. And our first priority would be to deploy it in the business and generate real strong returns. And if there was anything else we could do, even small, inorganic, we would do that. We'll figure it out in terms of what's the best for shareholders. But at different price points of valuation, certainly, stock buyback becomes more attractive or less attractive. So we're going to continue all the alternatives. I think having excess capital in a short-term nature, like Chaucer, that dictates a special dividend. It sort of feels appropriate. The difference -- as you think about ordinary dividend and special dividend, certainly out of operations, one has to think about that a little differently. So stay tuned, and we'll keep you posted as best we can.

The next question is from Freddie Sleiffer with KBW.

Firstly, just on workers' comp, how are rising medical inflation and rising wages impacting your workers' comp loss trend?.

Thank you. This is Jack. Appreciate your question, Freddie. Listen, we've been around the workers' comp line for a few decades now. And as I said in my earlier comments, these are really truly unprecedented times. When you think of loss trends in workers' comp, they've generally really followed the economy and over time, seeing kind of indemnity kind of pushback and medical payments really come to the forefront. And even though there is still medical inflation out there, what is getting challenging, I think, for the industry to understand and happen to be helpful, but not challenging in a negative way, is understanding the difference between the cost of medical procedures, and if you will, medical inflation, with the reduction, frankly, in incidents and types of claims. And we have done a lot of analysis inside to determine how much of the reduced loss trend, and frankly, negative loss trend in a couple of years was the function of a robust economy versus changes in jobs, changes in risk management or even claims management. So I think it's safe to say that the kind of environmental shift within the businesses are offsetting normal medical inflation that's coming through. And like every good company, we do a lot of analysis. But the -- you can get caught up in faults precision. Because the part that's the hardest to understand is, why are there less losses coming through the system than historically has been the case?

That's helpful. And then just following up on that, how are you incorporating any risk of social inflation spreading to workers' comp?

I'll have to think about that for a second. I don't know that we have specifically tried to align social inflation to the workers' comp line of the business. I'd have to kind of defer to some of the folks that are maybe kind of doing some of that more granular analysis, but nothing comes to mind that jumps out at me.

Okay. And then just moving on to Personal Auto. Just wondering if intensifying bodily injury severity is specific to any particular region? And how are you feeling about overall personal with your pricing in 2020?

Yes. I want to make sure I heard that question correctly. The bodily injury severity is not sort of attached to any particular geography. I'd say that's a fairly broad spread phenomenon. But I think your second question was around pricing. And yes, we would say, the market environment is certainly becoming increasingly competitive. We've seen our competition decelerate their rate increases. So still achieving positive increases. As you would expect, we track this very closely. We have terrific comparative rater information by state and so we've been holding steady on our rate. We -- our filed position both in auto and home is above the industry, and we're feeling a little bit of a pinch in the retention there. But we think that's a wise trade-off as you prioritize profitability over growth. So it is a competitive environment. We're seeing some potential evidence that these competitive pressures may actually not have that persistency over time. As we had talked earlier, the severity we're experiencing in the industry, both on the FISDAM, bodily injury is putting justifiable pressure on profit. So we think other carriers likely will respond. So I think that's a question of how long this competitive environment persists.

And as we said earlier, we're getting 5 points of rate for Personal Lines overall, but for bodily injury, specifically, we're getting meaningfully more than that.

That's right.

[Operator Instructions], The next question is from Paul Newsom with Piper Sandler.

Congrats on the quarter. Most of the detailed questions that I could ask, maybe I'll give you towards the end of softball here. Could you talk a little bit about sort of longer term, where you want to build out, more particularly? I mean as we -- not so much 2020, but as we think about it over a multiyear period? Is it just more of the same? Or are there specific areas that you'd like to see heavily overweighted with growth over the next several years?

Yes. Thanks for that, Paul. This is Jack, again. Listen, it's an interesting time for us as a company after spending quite a bit of time rebuilding this portfolio and creating more diversification, driving more specialization into really all of our businesses. So I would start off with -- what we're most proud of is that our -- we have really broad-based profitability today. Our Personal Lines business is generating terrific returns, our Core Commercial business is generating great returns, and most of our Specialty businesses are above hurdle rate or better. So it's a kind of a high-class problem to say, where do you want disproportional growth? We also know that we have to continue to work on our continued diversification. So we have a bias where we can to kind of casualty-oriented specialized business that allows us to continue to get the property to casualty mix, and to continue with our geographic expansion and diversification. But as you know, in our business, if you don't do that profitably then the diversification doesn't really help you that much. So I would say that we have options down the road, and options are to see if at the right time, it makes sense for us to expand our Personal Lines footprint. Don't need to, but have that opportunity. We have great momentum in our Small Commercial business. That continues, and I think you'll see us continue to prioritize that. The middle market business, I think if the environment plays out like we think, our specialized niches that are embedded in that business could have some real upside to them. But last but not least, and Bryan can speak to this. We have real momentum in getting our Specialty businesses with our franchise retail agents to really start thinking about building that portfolio more assertively with us. So Bryan, maybe you can build on that?

Yes. Sure. So I guess, a couple of comments. First, I would point out that when I look at the overall specialty portfolio and the growth that we've achieved, when I take out the actions that we're taking in the program business, the rest of the Specialty business grew by 7% in '19. And we're looking for similar growth like that going forward. And I would add that some of our most profitable, largely, casualty-driven areas such as our broad-based Professional Lines business, our E&S business, they're growing high single digit, double digit-type growth. And that, to me, is very powerful. Additionally, we do think quite a bit about what is important? What is valued by our agents? And so as we continue to push there and continue to build-out, right, I think Jack before mentioned some of our newer propositions such as our financial institutions business and the work that we're doing to really expand our E&S business in the retail space. But those are areas that we have put a lot of focus on, and we expect to see real contribution from them going forward as well.

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, everybody, for participating today. We are looking forward to talk to you next quarter.

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