The Travelers Companies, Inc. (NYSE:TRV) Q2 2023 Earnings Call Transcript July 20, 2023

The Travelers Companies, Inc. misses on earnings expectations. Reported EPS is $0.06 EPS, expectations were $2.08.

Operator: Good morning, ladies and gentlemen. Welcome to the Second Quarter Results Teleconference for Travelers. [Operator Instructions] As a reminder, this conference is being recorded on July 20, 2023. At this time. I would like to turn the conference over to Ms. Abbe Goldstein; Senior Vice-President of Investor Relations. Ms. Goldstein, you may begin.

Abbe Goldstein: Thank you. Good morning, and welcome to Travelers’ discussion of our second quarter 2023 results. We released our press release, financial supplement and webcast presentation earlier this morning. All of these materials can be found on our website at travelers.com under the Investors section. Speaking today will be Alan Schnitzer, Chairman and CEO; Dan Frey; CFO; and our three segment Presidents Greg Toczydlowski of Business Insurance; Jeff Klenk of Bond & Specialty Insurance; and Michael Klein of Personal Insurance. They will discuss the financial results of our business and the current market environment. They will refer to the webcast presentation as they go through prepared remarks and then we will take questions.

Before I turn the call over to Alan, I’d like to draw your attention to the explanatory note included at the end of the webcast presentation. Our presentation today includes forward-looking statements. The company cautions investors that any forward-looking statement involves risks and uncertainties, and is not a guarantee of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also in our remarks or responses to questions, we may mention some non-GAAP financial measures.

Reconciliations are included in our recent earnings press release, financial supplement and other materials available in the Investors section on our website. And now, I’d like to turn the call over to Alan.

Alan Schnitzer: Thank you, Abbe. Good morning, everyone, and thank you for joining us today In the face of an historic cat quarter, our top and bottom line results demonstrate the strength of our franchise and the resilience of our business model. This quarter, we reported strong underlying results and investment returns, as well as, net favorable prior-year reserve development, which were essentially offset by an historic level of industry-wide catastrophe losses. There were PCS designated catastrophe events taking place on 88 of the 91 days of the quarter. Despite pre-tax catastrophe losses of $1.5 billion, we generated slightly positive core income for the quarter. We are very pleased with the underlying fundamentals of our business.

Pre-tax underlying underwriting income of $781 million for the quarter was up nearly 40% driven by record net earned premiums of $9.2 billion, and a consolidated underlying combined ratio, which improved 1.7 points to an excellent 91.1%. Earned premiums were higher in all three of our business segments. Underlying profitability in our Business Insurance segment was particularly strong. The underlying combined ratio improved by 3 points to an excellent 89.4%. The underlying combined ratio in our Bond & Specialty business was higher year-over-year, but at 87.8%, still generated a very attractive return. In our Personal Insurance segment, the underlying combined ratio improved by 2 points, reflecting the actions we’ve taken to improve profitability.

Turning to investments, our high-quality investment portfolio generated net investment income of $594 million after-tax for the quarter, reflecting stronger and reliable returns from our fixed-income portfolio and solid returns from our non-fixed-income portfolio. Given our confidence in the strength of our business, we returned $633 million of excess capital to shareholders during the quarter, including $400 million of share repurchases. Turning to production. Thanks once again to excellent execution by our colleagues in the field, we grew net written premiums by $1.3 billion or 14% to a record $10.3 billion. In Business Insurance, we grew net written premiums by 18% to $5.2 billion. Renewal premium change in the segment was a record-high at 12.8%, driven by renewal rate change, which accelerated 2.5 points sequentially to 7.2%.

The renewal premium change we achieved this quarter was broad-based. RPC was double-digit or near double-digit in every line, other than workers’ compensation, and it was higher sequentially in every line, including workers’ compensation. Even with strong pricing retention, an important indicator of marketplace stability, remained very strong at 88%. New business increased 36% to $671 million, led by the property line. In Bond & Specialty Insurance, record net written premiums were about even with the prior-year quarter. Retention in our management liability business was an excellent 91%, and new business increased 11%. Surety net written premiums were also once again strong. Given the attractive returns, we are very pleased with the strong production results in both of our commercial business segments.

The growth we’re putting on the books is from geographies, products and distribution partners that we know well. In Personal Insurance, top line growth of 13% was driven by higher pricing. Renewal premium change was 19.2% in our Homeowners and Other business, and increased to a record high 16.1% in our auto business. Another quarter of terrific production across the board positions us well for the rest of the year and into 2024. You’ll hear more shortly from Greg, Jeff and Michael about our segment results. Before I turn the call over to Dan, I’d like to spend a few minutes on what Travelers is doing in an important area for us, artificial intelligence. We subscribe to the view that over time the impact of AI across the economy is going to be profound, so is the opportunity for Travelers.

With our performance transformed mindset and our disciplined framework for assessing our investment priorities, we’ve been focused for years on responsibly developing differentiating AI capabilities across our three innovation priorities, extending our lead in risk expertise, providing great experiences for our customers, agents, brokers, and employees, and optimizing productivity and efficiency. Between our colleagues who are dedicated to AI specifically and others in enabling disciplines, we have a very significant number of our employees engaged on the objective of making sure that we’re leading when it comes to AI. As we’ve shared before and as you can see on Slide 23 of the webcast presentation, for some time, we’ve been steadily increasing our technology spend.

This year, we’ll spend more than $1.5 billion on technology. As this slide demonstrates, we’ve also been improving the strategic mix of our tech spend. That includes a meaningful increase in investments to develop require cutting-edge AI capabilities built on modern cloud technology. Importantly, we’ve done all that while significantly improving our expense ratio. In no small part, thanks to the success of our technology investments. The quantity and quality of data are key differentiators when it comes to AI. For more than a decade, we’ve been investing in datasets, data quality and data accessibility. Between submissions in our commercial businesses and quotes in PI, we intake millions of business opportunities each year. We also take and adjust and adjudicate millions of claims.

As one of the largest risk control organizations in the industry, we provide risk mitigation to our commercial customers, completing more than 100,000 risk control consultations annually. We capture valuable data from virtually all of those interactions. Our data also include decades of curated institutional knowledge in the forms of policies, procedures, guidelines, forensic investigations and so on. All of that creates an excellent foundation for the next iteration of generative AI. In addition to our extensive proprietary data, we’ve been assembling actionable third-party data for years. In fact, we have more than 2,000 datasets from hundreds of third-parties. All-in, we believe that we have a significant and hard-to-replicate data advantage.

Given the competitive advantages that will come from deploying AI across the insurance value chain and the expertise, resources and data required to get there, scale will increasingly be a differentiator in our industry, as well the ability to execute complex initiatives effectively and efficiently. Expertise, resources, data, scale and execution excellence, all favor Travelers. The potential use cases for AI in our industry are many and varied. We pursue very focused opportunities that are consistent with our innovation priorities and will create meaningful and sustainable competitive advantages, all with an eye towards leveraging strategic capabilities across our organization. AI capabilities that we currently have in production span the spectrum from those driving efficiency through automation, to more advanced generative AI and large language models.

More advanced models augment various aspects of our underwriting, claim handling, service delivery and other work. We use intelligent process automation broadly throughout our business to handle hundreds of routine workflows. Automation and AI have been meaningful drivers of our expense ratio improvement over the past seven years or so. The key success driver in insurance is segmenting risk as finely as possible, to achieve pricing that is accurately calibrated to the risk. Deep learning models have significantly improved our ability to classify it in segment risk in our flow businesses. For example, in Personal Insurance, we leverage proprietary AI and aerial imagery to assess roof and other site-related conditions at the parcel level. Parcel level risk assessment at scale was practically unimaginable to several years ago.

And that type of information is very difficult to obtain from the insured with a reliable degree of accuracy. In our Select Accounts business, we estimate that AI has improved business classification, a critical underwriting input by more than 30%. In our Middle Market business, we’ve developed a suite of sophisticated AI models, which facilitate targeted cross-selling, supporting our effort to sell more products to more customers. We’re also using AI to better understand our customers and their needs. So this improved customer segmentation, we can better align new product development and generate insights that improve the customer experience. Enhancing our industry-leading analytics using machine learning models to deliver sophisticated actuarial insights into loss cost trends and development, which improve our already strong pricing and product monitoring capabilities.

On the most advanced end, we’re leveraging generative AI in large language models, and we’ve been doing so for several years. For example, in our Bond & Specialty business, our proprietary large language models have processed hundreds of thousands of broker submissions as we work toward improving intake time from hours to minutes. This will improve our responsiveness to our customers and distribution partners, and contribute to our productivity. In our claim organization, our proprietary large language model ingest legal complaints filed against our insureds and then highlights key liability and coverage issues, assists in routing the cases to the best-suited defense counsel, and provides risk-related insights that can be incorporated back into our underwriting process.

We’ve also developed and are piloting a Travelers claim knowledge assistant, a generative AI tool trained on many thousands of pages of proprietary technical source material that was previously only accessible to thousands of different documents. The model provides claim professionals with the ability to easily access accurate actionable information on technical and procedural claim matters, increasing speed, accuracy, and consistency in various workflows, including in interactions with our customers and distribution partners. So in terms of AI, we’re investing with speed and strategic direction, consistent with our stated objective of delivering industry-leading returns. I’ve only shared some of what’s in-flight, and the capabilities that we’ve developed are in various phases of adoption.

The full impact of the capabilities we’re developing, and others on our roadmap are still ahead of us. To sum things up, we are very confident in the outlook for our business. We have terrific underlying fundamentals in our commercial businesses, improving underlying results in our personal insurance business, and steadily rising investment returns in our fixed-income portfolio. As you’ve heard, we’re also investing in impactful new capabilities to advance our ambitious innovation agenda. With that momentum and the best talent in the industry, we are well-positioned to continue to deliver meaningful shareholder value over time. And with that, I’m pleased to turn the call over to Dan.

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Dan Frey: Thank you, Alan. We’re pleased to have generated record levels of earned premium this quarter, and an underlying combined ratio of 91.1%, a 170-basis point improvement from last year’s strong results. This led to a very strong underlying underwriting gain of $615 million after-tax, up $171 million or 39% from the prior-year quarter. The expense ratio for the second quarter improved 40 basis points from last year to 28.6%, once again, benefiting from the combination of our focus on productivity and efficiency coupled with strong top line growth. As Alan mentioned, the industry experienced a very active cat quarter and our second quarter results include $1.5 billion of pre-tax catastrophe losses, our second largest ever cat amount for a second quarter.

As disclosed in the significant events table and our 10-Q, we had six events surpass the $100 million mark in Q2, the most ever for a single quarter since we began disclosing the table in 2013. Turning to prior-year reserve development. We had total net favorable development of $60 million pre-tax. In Business Insurance, net unfavorable PYD of $101 million was the result of better-than-expected loss experienced in workers’ comp across a number of accident years being more than offset by an increase in some of our other casualty reserves, as well as, for run-off operations. In Bond & Specialty, net favorable PYD of $119 million was driven by better-than-expected results in management liability and surety. Personal Insurance at $42 million of net favorable PYD, driven by Homeowners and Other.

After-tax net investment income of $594 million was in line with the prior-year quarter. Fixed maturity NII was again higher than the prior year quarter, reflecting both the benefit of higher average yields, and higher invested assets. Returns in the non-fixed-income portfolio were solid, but as expected, we’re not as strong as the double-digit yield we experienced in the prior-year quarter. With interest rates having moved higher during the second quarter, we are raising our outlook for fixed income NII, including earnings from short-term securities by $35 million after tax for the back half of the year. We now expect approximately $570 million after tax in the third quarter and $595 million after tax in the fourth quarter. New money rates as of June 30th are about 140 basis points higher than what’s embedded in the portfolio, so fixed income NII should continue to improve as the portfolio gradually turns over and continues to grow.

Turning to capital management. Operating cash flows for the quarter of $1.5 billion were again very strong. All our capital ratios were at or better than target levels, and we ended the quarter with holding company liquidity of approximately $2 billion. In late May, we issued $750 million of 30-year debt in order to maintain a debt-to-capital ratio in line with our target range as our premium volume has continued to grow. Interest rates increased and spreads widened during the quarter, and as a result, our net unrealized investment loss increased from $3.9 billion after tax at March 31st to $4.6 billion after tax at June 30th. As we’ve discussed in prior quarters, the changes in unrealized investment gains and losses generally do not impact how we manage our investment portfolio.

We generally hold fixed-income investments to maturity. The quality of our fixed-income portfolio remains very high and changes in unrealized gains and losses have little impact on our cash flows, statutory surplus or regulatory capital requirements. Adjusted book value per share, which excludes net unrealized investment gains and losses, was $115.45 at quarter-end, up 1% from year-end and up 3% from a year ago. We returned $633 million of capital to our shareholders this quarter, comprising share repurchases of $400 million and dividends of $233 million. We have approximately $6.2 billion of capacity remaining under the share repurchase authorization from our Board of Directors. Since the significant level of cat losses in late June resulted in lower earnings for the quarter than we had anticipated, we expect the level of share repurchases over the back half of the year to be lower than the level of share repurchases in the first half of the year.

Turning to the topic of reinsurance, Page 20 of the webcast presentation shows a summary of our July 1st reinsurance placements. While we did see some meaningful price increases on our reinsurance renewals, those increases were broadly in line with the price increases we are obtaining on the direct property premiums we’re writing. So there’s little or no impact expected on margins. We take another moment to highlight a few items on Page 20. First, we renewed our main cat reinsurance program at terms that were generally consistent with the expiring program. Second, we increased the coverage under our Northeast Property treaty by fully placing the $850 million layer above the attachment point of $2.5 billion. A year ago, we placed $750 million of that $850 million layer and the attachment point was $2.25 billion.

This treaty remains pretty far out on the tail for us. Finally, as part of our ongoing management of tail risk exposure for the enterprise and in response to inflation-driven growth in insured values in our Personal Insurance property book, we added a new hurricane cat excess of loss reinsurance program, specific to Personal Insurance coastal exposure, providing 50% coverage for the $1 billion layer above an attachment point of $1.75 billion, again far out on the tail. Any margin impact from this new program will be de minimis, given both the size of our PI property book and the level of price increases we are obtaining on that book. To sum up the quarter, our ability to absorb $1.5 billion of pre-tax cat losses and still report slightly positive core income for the quarter is a testament to the overall strength of our franchise, and the underlying fundamentals of our business.

Q2 was another quarter of double-digit premium growth, improved underlying profitability, and further improvement in our outlook for fixed-income NII, all of which bodes well for our future returns. With that, I’ll turn the call over to Greg for a discussion of Business Insurance.

Greg Toczydlowski: Thanks, Dan. Business Insurance produced $402 million of segment income for the second quarter, down from the prior-year quarter, driven by prior-year reserve development and higher cats, as Dan mentioned. Underlying underwriting results continue to be exceptional, with the underlying underwriting income up more than 50% from the prior-year quarter. We’re once again particularly pleased with the quarter’s underlying combined ratio of 89.4%, which improved by three points from the prior-year quarter. The loss ratio benefited from property losses that were about a 1.5 points better than our expectations for the current year quarter. The loss ratio also improved due to earned pricing. The expense ratio remained strong at 30.1%.

Net written premiums increased 18% to a quarterly record of $5.2 billion, driven by renewal premium change of 12.8%, retention of 88% and new business of $671 million, all record highs. Underneath RPC, renewal rate change accelerated sequentially from the first quarter by 2.5 points to 7.2%. We’re thrilled with these production results and the superior execution by our field team in the marketplace. In terms of pricing, we’re pleased with our response to the persistent environmental headwinds in both the property and liability lines. In each of our product lines, renewal premium change was higher than the first quarter. And beyond pricing, we continue to improve terms and conditions to ensure we’re achieving an appropriate risk-reward trade-off on the business we write.

As we always say, we execute in a granular manner, deal-by-deal, class-by-class. Into that point, we’re thrilled with our execution. Demonstrated by record retention of 88% on our very-high quality book of business and rate that is thoughtfully segmented by return profile. New business, as a percentage of the book, returned to pre-pandemic levels, led by the property line. We’re pleased with new business dollars at an all-time high. And as always, when it comes to new business, we remain focused on risk selection, underwriting terms and conditions, and pricing. We’re also very pleased with the impact that our strategic investments are having on our production results. As for the individual businesses, in Select, renewal premium change was up 1 point from the first quarter to a strong 10.6%, while retention also remained historically high at 84%.

New business increased $30 million or 28% from the prior-year quarter, driven by the continued success of our BOP 2.0 product. In Middle Market, renewal premium change was up more than 2 points sequentially from the first quarter to a historically high 10.5% with renewal rate change increasing sequentially by 1.5 point to 5.9% and continued strong exposure growth. Retention was once again exceptional at 90%, while new business was up 32% from the prior-year quarter, with increases across all account sizes in most markets. To sum up, Business Insurance had another strong quarter and continued to execute on the fundamentals to drive profitable growth. With that, I’ll turn the call over to Jeff.

Jeff Klenk: Thanks, Greg. Bond & Specialty posted strong top and bottom line results for the quarter. Segment income of $230 million was up slightly from the very strong prior-year quarter. The combined ratio was a terrific 77.1%. The underlying combined ratio was a solid 87.8% for the quarter. A small number of surety losses drove the roughly 4 point increase in the underlying loss ratio year-over-year. As we’ve said before, surety losses can be a bit lumpy. Even with the incremental losses this quarter, our returns in the surety line remain excellent. Turning to the top line, we delivered record net written premiums this quarter. In domestic management liability, we are pleased that we drove record retention of 91% in the quarter, up 2 points sequentially and 3 points from the second quarter of 2022, while continuing to achieve solid renewal premium change.

This result reflects our team’s deliberate execution to retain our high-quality book of business in light of the very strong returns. We’re also pleased that we increased new business 11% from the prior-year quarter. That’s a reflection of the strong franchise value we offer to our customers and distribution partners, and a lot of hard work by our team in the field. Additionally, we are pleased to report record surety net written premiums in the quarter. So both top and bottom line results for Bond & Specialty were once again strong this quarter driven by our continued underwriting and risk management diligence, excellent execution by our field organization, and the benefits from our ongoing strategic investments to extend our market-leading competitive advantages.

And now, I will turn the call over to Michael.

Michael Klein: Thanks, Jeff, and good morning, everyone In Personal Insurance, the second quarter segment loss of $538 million and a combined ratio of 122% were significantly impacted by catastrophes. While it’s not unusual for us to have a loss in the second quarter given it’s typically the quarter with the highest weather-related losses, catastrophe losses this quarter for both us and the industry were significantly elevated compared to historical results. Net written premiums for the quarter grew 13%, driven by double-digit renewal premium change in both Domestic Automobile and Homeowners and Other. The underlying combined ratio of 94.1% improved 2 points from the prior-year quarter, reflecting an improvement in the underlying combined ratio in Homeowners and Other, partially offset by an increase in Automobile.

In Automobile, the second quarter combined ratio was 108.4% with an underlying combined ratio of 103.5%. The underlying combined ratio increased 1.7 points from the prior-year quarter due to higher severity, driven by increased vehicle replacement and repair costs and a mix-shift from collision-only claims for its claims with bodily injury and third-party property damage, which is more consistent with more cars on the road leading to more multi-car accidents. These increases were partially offset by the growing benefit of earned pricing and a lower expense ratio. While some of the inflationary pressures in auto are beginning to show signs of easing, they are not improving at the rate we expected. Consequently, we’re not yet achieving the written rate adequacy levels, we had anticipated.

While we continue to make progress and expect to get there in the coming quarters, exactly when will depend on a few things. For example, how quickly inflation comes down, how quickly we can get additional rate through the regulatory process and our actual loss experience. In Homeowners and Other, the second quarter combined ratio of 135.1%, increased 17.1 points, due to significantly higher catastrophe losses. The underlying combined ratio of 85.2% improved 5.1 points, primarily driven by non-cat weather losses that were lower than in the prior-year quarter. Non-cat weather losses in the quarter were also better than our expectation, as more events reached our catastrophe threshold. Turning to production, our results continue to demonstrate disciplined market execution of rate and non-rate actions in both lines as we remain focused on improving profitability and managing growth in response to continued inflationary pressures in the environment.

In Domestic Automobile, renewal premium change of 16.1% increased 2.1 points from the first quarter of 2023. We expect renewal premium change to continue to increase from current levels throughout the second half of this year. In Domestic Homeowners and Other, renewal premium change of 19.2% was broadly consistent with the first quarter. We expect renewal premium change to remain in the high-teens through the end of the year. Before I conclude, I just want to take a minute to thank our claim partners for responding to our customers when it matters most. Behind the aggregate statistics of catastrophe events occurring virtually every day of the quarter, our tens of thousands of individual customers whose homes and vehicles are damaged or destroyed and whose lives are disrupted.

In each case, our claim team is responding, helping those customers get their homes repaired and their cars back on the road, continuing to deliver high-quality customer service despite the high volume of clients. Both the loss environment and the personal insurance marketplace remain dynamic. We continue to respond to the changing environment with a steadfast focus on execution quickly addressing changes in loss experience with targeted pricing, underwriting and other non-rate actions, remaining disciplined in writing business that is consistent with our appetite and making thoughtful and impactful investments for the future. We’re confident that the actions we’ve taken and we’ll continue to take will improve profitability as we move through 2023 and beyond.

Now, I will turn the call back over to Abbe.

Abbe Goldstein: Thanks, Michael. We’re ready to open up for questions.

Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Greg Peters of Raymond James. Please go ahead.

Greg Peters: Well, good morning, everyone. I guess, notwithstanding on Michael’s comments, I – just curious about if there’s going to be any shift in the strategy on property considering what’s going on with catastrophe losses. And I’m also trying to triangulate or bridge the difference between personal lines, which clearly was a negative surprise, and I think, Greg, in your comments you said property actually was a better net gain for you guys relative to expectations. So any broad comments on your views on property in light of the cats and in the different segments too, please?

Michael Klein: Sure. So I can start on the property side, Greg. Certainly, the catastrophe experience in the quarter was significantly worse than prior year and n worse than our expectations. In terms of our shift in strategy, what I would say is we continue to execute a series of actions in the property line to manage growth and improve profitability. And again, first and foremost, you see that in the pricing and the production statistics that we shared with you on the webcast. But beyond that, we’re managing terms and conditions, think deductibles, think roof age eligibility, think coverage levels on roof replacement, and a variety of actions that we look at very granularly state by state, market by market, account by account.

And then one of the other things we’re really encouraged by, Alan had mentioned in his discussion around artificial intelligence, is our aerial imagery and artificial intelligence-enabled capability we have there to refine our underwriting and our risk selection. So less the shift in strategy and more a continuation of a really broad array of profit management and profit improvement efforts in the personal lines property space.

GregToczydlowski: Hi, Greg. This is Greg. Just to follow-up on the commercial side, and so many times the catastrophes – the split between personal and commercial can be – really depends on the concentration of where the catastrophes hit in terms of where commercial businesses are. In terms of your comment, I think you referenced in my prepared comments, when I was explaining the underlying combined ratio, and I mentioned that property was better than expectation, and that really was non-cat property.

Greg Peters: Got it. All right. Thank you for the answers. And then, I guess, I’ll pivot, Greg, also during your comments, you talked about reserve development. Maybe spend a minute – don’t really touch upon workers’ comp, but the adverse development in the other lines.

Dan Frey: Hi, Greg, it’s Dan Frey. I’ll take the PYD comments. So in the quarter for Business Insurance, as we said, overall unfavorable $101 million. Comp continues to be favorable. The comp favorable was very strong this quarter, more than $250 million of good news. So that leaves us with the other liability lines including run-off being unfavorable. And that’s really led by umbrella, which is sort of the poster child for perpetual core levels of inflation just compounding and pushing more claims up into the umbrella layer. But a couple of things to put – to put that in context, I guess, we’re making a relatively small adjustment to those liability lines, given the fact that there are more than $15 billion worth of reserves in those lines.

The returns in BI continue to remain excellent. And across the company, I’d just remind us, including the good news coming out of Bond & Specialty, which is also liability type coverage, we had a net favorable of $60 million for the quarter.

Greg Peters: Got it. Thanks for the answers.

Operator: Thank you. Your next question comes from the line of David Motemaden of Evercore ISI. Please go ahead.