The Hanover Insurance Group - Q2 2024

Transcript

Operator (participant)

Good day and welcome to The Hanover Insurance Group's Q2 earnings conference call. My name is Betsy and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

Oksana Lukasheva (SVP of Corporate Finance)

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 Jeff Farber, our Chief Financial Officer. 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 investor 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 as defined under the Private Securities Litigation Reform Act of 1995.

These statements can relate to, among other things, our outlook, reserve position, economic conditions and related effects, including economic inflation, potential recessionary impacts, as well as other risks and uncertainties such as severe weather, catastrophes and social inflation that could affect the company's performance and/or 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.

John Roche (President and CEO)

Thank you, Oksana. Good morning, everyone and thank you for joining our call. I'm pleased to report our Q2 results demonstrate the strength and diversification of our business, our financial discipline and our ability to execute in a dynamic market environment. Despite significant catastrophe activity, we delivered strong earnings with a 9% operating return on equity in the quarter and a 12% operating ROE through the H1 of this year. Our performance reflects strong execution on two critical priorities. First, ex-CAT margin enhancement. We significantly improved our underlying margins and personal lines and delivered consistent, strong profitability in core commercial and specialty in the quarter. This focus on profitability yielded outstanding results, as demonstrated by an ex-CAT combined ratio of 88.5% compared to 92.8% year-over-year and second, the progress in execution of our catastrophe mitigation actions.

Although severe convective storms in the Midwest and South Central US made the Q2 more challenging than anticipated, we continue to have a high level of confidence that our proactive approach to managing catastrophe exposure will clearly bear fruit. In personal lines, our actions to address convective storm exposure are well underway. We remain optimistic about the rapidly growing impact of increased all-peril deductibles and the introduction of wind and hail deductibles on our CAT claims intake and ultimately loss severity. As a reminder, these terms and conditions changes only began impacting renewals in April of this year. We expect as a higher proportion of the book of business is rolled under these terms, the impact will dramatically increase in each of the next few quarters.

Additionally, we are anticipating that close to two-thirds of our Homeowners business in the Midwest will have wind and hail deductibles applied to the policy by the end of 2024 and the vast majority of the book will have the desired deductibles, both all-peril and wind and hail, ahead of the spring storm season. The current effect of property and CAT actions in Core Commercial is more significant after several quarters of increasing deductibles and pricing, as well as risk-specific PML pricing and risk prevention initiatives. As a result, our modeled CAT loads are significantly reduced in middle market, especially in states exposed to convective storms. 75% of the most vulnerable middle market accounts have been addressed through underwriting actions or sensor deployment. Our Q2 results also reflect our commitment to balanced and thoughtful growth.

We grew written premiums by 5.1% in the Q2, up 2.8 points from the Q1 of this year and we expect growth to increase sequentially each quarter for the remainder of the year as we elevate our new business and renewal retention in areas where profitability is strongest and where we'll benefit from continued diversification. Now let's look at the Q2 performance of our business segments in more detail, starting with specialty. Specialty achieved top-line growth of 8.2%, 3.4 points higher than in the Q1 of the year, helped by strong retention and accelerated double-digit new business growth. Retention remained strong at 83%, with continued renewal pricing momentum of 11.7%, further reinforcing the specialty segment's integral role with our agents as a key element in our value proposition. The specialty market in our target markets remained strong.

We achieved double-digit growth across multiple lines, including surety, marine, industrial property, healthcare and management liability. Our excess and surplus lines business also grew double digits in the Q2. The E&S market remains very attractive as freedom of rate and form allows us to capture opportunities at good margins while helping us further diversify our portfolio with respect to catastrophe risk. In marine, we are pursuing growth initiatives by expanding our portfolio geographically and by class of business to further limit us from concentration-related CAT and market volatility. Across most of our specialty portfolio, we continue to expand distribution points, including substantially growing the wholesale channel to capture broader market opportunities.

In addition to broadening our portfolio of specialty offerings, we are accelerating key technology investments as well to ensure we are optimally positioned to compete in the evolving digital environment and help agents create efficiencies, particularly with their smaller specialty policies. These investments should result in significantly improved "turnaround times" and allow us to capture more of the robust new business opportunities in the market. More broadly, our technology investments have positively impacted all of our businesses. We deploy digital APIs to work with our distribution. We use advanced analytics for pricing sophistication and risk selection and we have targeted generative AI use cases to achieve operational efficiencies. Turning to Core Commercial, this segment also delivered strong performance this quarter, achieving solid net written premium growth of 5.5%, driven primarily by an 8.5% increase in small commercial.

We remain very optimistic about opportunities in small commercial, with accelerated new business growth to be driven by several key initiatives. These include the continued build-out of our TAP Sales Platform with the rollout of our Workers' Compensation product in the H1 of next year, the expansion of virtual sales capabilities across all states and deeper market share penetration with our best agents. Additionally, we are very pleased with the pricing, class, geographic mix and quality of new business and renewals as the TAP Sales Platform includes enhanced capabilities for pricing sophistication and product expansion. While focusing on small commercial growth, we are simultaneously implementing profitability and property improvement initiatives in middle market, including the catastrophe management work I referenced earlier. Although middle market growth remained low at 1%, it showed sequential improvement and we have executed very well on the key margin and CAT management initiatives.

As we near the end of our portfolio optimization, we expect to elevate our growth in middle market beginning in the Q4. Looking ahead, the commercial lines market is expected to remain firm and disciplined for the remainder of this year and into 2025, supported by challenging liability trends. While we continue to closely monitor liability trends and proactively work to manage through the environment, we remain highly confident in the strength of our reserves and disciplined in our loss ratio picks. Over the past several years, we have dedicated significant effort to analyzing the expected trajectory of liability severity and its potential impact on our operations. This proactive approach led us to adopt a more defensive posture, both in terms of strengthening our balance sheet and refining our underwriting practices.

From where we stand today, we believe our current liability profile is very well positioned to navigate social inflation challenges. Our strategy includes maintaining lower limits, reducing risk in large metro areas and difficult geographies, reducing premises liability exposure and refraining from writing standalone excess umbrella policies. Additionally, we have implemented rate increases above our prudent loss trend assumptions, maintain a low reinsurance attachment point and have a lower reserve duration, which is inherent in a small account size book of business. These tactical decisions have collectively enhanced our resilience in the face of evolving market conditions. As we look ahead, we remain committed to navigating the evolving liability environment with vigilance and agility. Turning to personal lines, we delivered tremendous year-over-year improvement of 7.6 points in our XCAT current accident-year loss ratio, reflecting the outstanding execution of our margin recapture initiatives.

Personal Lines net written premiums grew 3.3% in the quarter, in line with expectations. Although we continue to project segment growth in the low single digits in 2024, we expect to see the pace accelerate slightly in the H2 of this year. Higher all-peril deductibles and new wind and hail deductibles are being applied to new business and renewals in all targeted states judiciously and on schedule. We continue to operate in a hard market across our geographies, especially in homeowners and believe this will continue at least for the foreseeable future, as many of our peers continue to file for higher rate increases as well as terms and conditions changes. We are seeing a number of carriers starting to follow our actions, particularly in the Midwest and we have continued support from our agent partners.

The elevated catastrophe experience across the industry reinforces the importance of our terms and conditions changes, as well as the more aggressive approach based on specific underwriting metrics such as quality of roof score. In conclusion, our strong Q2 and year-to-date performance serves as compelling evidence that we are on the path to meaningfully improved financial outcomes. While the industry landscape remains dynamic, with increasing liability trends and more frequent severe weather events, we are confident in our ability to navigate these complexities. Our distinctive strategy is a key advantage, positioning us to capitalize on emerging opportunities in the current market. Our flexibility and agility allow us to pivot quickly in response to changing conditions and to maintain our competitive edge. With this formidable foundation in place, combined with our inherent strengths and talented team, we are exceptionally well positioned for future success.

With that, I'll turn the call over to Jeff.

Jeff Farber (CFO)

Thank you, jack and Good Morning, everyone. We are pleased to report strong performance in light of catastrophe losses while demonstrating significant enterprise-wide XCAT margin improvement. Notably, all three of our business segments achieved underlying loss ratio improvements year-over-year, surpassing our projections. We're observing stable property loss trends and maintaining discipline over liability activity, which positions us well for continued growth and improved profitability. Our combined ratio for the Q2 was 99.2%, which included 10.7 points of catastrophe losses, largely the result of severe convective storm activity in personal lines. It's worth noting that 10.7 points included 1.4 points of favorable catastrophe prior year development, much of it relating to commercial lines events that are at least 18 months old.

XDATE prior year development was favorable by $17.4 million in the quarter, paced by broad-based property favorability in Specialty, Personal lines and Core Commercial. In Core Commercial, all the major lines of business developed favorably. We experienced healthy favorability in most property coverages and we took the opportunity to position our reserves more defensively in liability lines in response to industry headlines, as well as our own experience in certain pockets of our Core Commercial business. Our financial discipline, reserve prudence and proactive risk selection and underwriting allow us to effectively manage liability trends. As Jack mentioned, our previous actions relating to geographic, industry, limit and other underwriting choices have significantly advantaged the portfolio. Our liability severity assumptions have been and continue to be very prudent, while we benefited from significant frequency reductions in recent years relative to pre-pandemic trends.

In Specialty, favorable prior year reserve development was $11.3 million or 3.4 points, primarily driven by lower-than-expected losses in our professional and executive lines claims-made business. In Personal Lines, overall prior year development was favorable by $4 million, with property favorability, primarily in Auto, offsetting unfavorability in the Umbrella line reported in Home and other. We continue to experience pressure related to elevated Personal Umbrella losses stemming from Auto bodily injury coverage, which we are addressing by increasing our prior year loss expectations, current year picks and achieving higher Personal Umbrella rates in virtually all states. Our team continues to prudently manage expenses. The expense ratio for the quarter totaled 30.8%, in line with our expectations. The year-over-year increase of 20 basis points primarily reflected talent and technology investments in our Specialty segment, as well as increased variable compensation.

We remain on track to achieve our expense ratio guidance of 30.7% for the full year. Now I'll turn to our segment XCAT underwriting ratios and loss trends, starting with Personal Lines. This business generated an excellent XCAT combined ratio of 89.5% for the Q2, a 10.5-point improvement from the prior year period. Margin recapture initiatives in both Auto and Homeowners and Other drove a 7.6-point improvement in the underlying current accident-year loss ratio. The Auto current accident-year loss ratio, excluding catastrophes, improved 9 points to 70.1%. The comparison was somewhat impacted by elevated loss picks in the Q2 last year, which subsequently developed favorably by 1.7 points. The vast majority of the improvement, however, is the result of earning in double-digit price increases and, to a lesser extent, lower-than-expected Auto loss frequency.

Collision loss severity has stabilized as costs have leveled for parts and used vehicles and labor cost inflation has reduced. Although bodily injury frequency remains well below pre-COVID levels, severity continues to be elevated due to a higher proportion of large catastrophic claims, including pedestrian, bicycle and motorcycle hits and also high-speed crashes. As of the Q2, we have achieved target returns on an earned basis in personal auto. Homeowners and other current accident-year loss ratio improved meaningfully in the quarter to 57.5%, reflecting earned rate increases well above contemporary loss trends, as well as normalization of large losses as compared to a higher-than-usual level of large losses in the Q2 of 2023. Our other initiatives, including more frequent home inspections and underwriting restrictions in specific pockets of our book of business, are also helping to improve our XCAT home results.

We continue to see the benefit of earned pricing substantially building in the homeowners' portfolio. We expect that trend, together with loss pressures normalizing, should help drive substantial margin improvement through the back half of this year, positioning us to return to target profitability in personal lines on an earned basis in 2025. On the top line, personal lines net written premiums improved sequentially to 3.3% in the q2 and we expect growth to modestly increase throughout the remainder of the year. As expected, renewal price increases for personal lines in the quarter moderated sequentially to 18.5% from 22.8% in the Q1 of this year.

As I noted on our Q1 call, we expected home exposure increases to begin ticking down in the Q2 as insurance-to-value inflation adjustments normalized and as we began to apply all-peril and wind and hail deductibles to the majority of our renewals. Nevertheless, we are achieving strong rate increases in both lines of business. We believe rates will remain robust and ahead of loss trends. Personal Lines retention improved by over 2 points to 82%. PIF count, a lagging indicator, was down as expected, with a year-over-year reduction of about 10% in the Midwest and 3% in other areas. Turning to Core Commercial lines, we delivered a Combined Ratio excluding catastrophes of 88.7%, 0.6 points better than the prior year period.

The underlying loss ratio improved to 55.7%, supported by the successful execution of our margin improvement plan, including strong pricing and effective property underwriting, particularly in middle market. We continue to capture the benefit of earned rate above loss trend in Core Commercial. Workers' Compensation liability trends remain stable, albeit with a slight increase in indemnity. Consistent with the NCCI reported trends, we are observing a slowdown in claims emergence, which merits caution as we think about current year loss selections. We were satisfied with the solid performance of Commercial Multi-Peril in the quarter, as continued strength in property was partially offset by our move to proactively increase current accident-year loss selections in liability. On the top line, Core Commercial delivered net written premium growth of 5.5% in the quarter, paced by small commercial. Renewal price change remained in the double digits, consistent with Q1.

The specialty segment's combined ratio excluding catastrophes increased 80 basis points to 86.4% compared to the prior year period, driven by higher expenses as noted before. The segment's underlying loss ratio of 53.1% aligned with our expectations and our target of a low 50s loss ratio. Property large loss activity remained within anticipated levels. We are monitoring select lines for inflationary indicators and maintaining a prudent approach in our current accident loss selections. Specialty net written premiums grew 8.2%, driven by robust performance across several business lines. Retention remained strong at 83%, while renewal pricing metrics ticked up again, with average renewal increase standing at 11.7% in the Q2. Turning to reinsurance, we completed a successful renewal of our property treaties on July 1st. We experienced very favorable market responses, which speak to the strength of our pricing, underwriting and data quality.

The market was especially complimentary of the underwriting work we have done with regard to commercial properties, as well as our continued work on CAT exposures. The key elements and highlights of our current property reinsurance program are as follows. We renewed both treaties, Property Per Risk and CAT Occurrence, maintaining a very consistent structure from expiring treaties. Pricing was significantly better than our expectations, helped by our property work, in particular in middle market and Specialty. We secured full capacity across our Catastrophe Occurrence program, maintaining our $200 million retention and we purchased an additional $150 million in the traditional reinsurance market at the top of the existing CAT Occurrence tower. Taken together, these changes have resulted in increased reinsurance limits in our CAT Occurrence program that exhaust at $1.9 billion compared to the previous $1.75 billion for our highest concentration states.

Overall, the success of these renewals provides third-party validation of our underwriting and catastrophe mitigation actions. Moving to investment performance, net investment income increased $2.8 million, or approximately 3%, to $90.4 million in the Q2 compared to the prior year quarter, as higher interest rates drove strong fixed maturity and short-term income. This was partially offset by a decrease in partnership income. Income from limited partnerships was subdued in the quarter, driven by underperformance in a handful of funds. Variability in quarterly results is inherent in private fund valuations and fully expected in this long-duration asset class. Adjusting for the non-recurring $6.8 million benefit in the Q2 of 2023, partnership results for the first six months of 2024 are only $1 million lower than the first six months of 2023. We remain comfortable with our partnership investments.

Excluding partnerships, net investment income was up approximately 20% in the Q2 of 2024 as compared to the year-ago quarter. During the quarter, we completed the previously announced transfer of our investment-grade fixed maturity portfolio to an external manager. We expect this move will broaden our asset class exposure and further optimize investment's contribution to overall results. In conjunction with this transfer and considering investment tax gains expiring this year, we repositioned sector exposures within investment-grade fixed income and realized approximately $30 million in pre-tax losses. From an asset allocation perspective, we reduced exposure to CMBS with reinvestment of proceeds into other high-quality subsectors of securitized product, including RMBS and CLOs. We also repositioned within corporate bonds to extend duration slightly and move out of less favored credits at attractive spread levels.

Looking ahead, we believe a more normalized partnership income expectation is approximately $7 million-$8 million per quarter, though we remain cognizant of the tendency for private fund returns to follow a lumpy pattern. The current rate environment should continue to provide an accumulating benefit to NII in 2024 and subsequent years. We expect overall growth in NII of at least 10% in 2024 compared to 2023. Moving on to book value and capital position, GAAP book value per share increased 1.1% sequentially to $70.96 per share, reflecting net income partially offset by shareholder dividends. Our capital management strategy continues to balance reinvestment in the business, maintaining strong financial ratings and providing returns to shareholders through consistent quarterly dividends and share buybacks when warranted. Our outlook for the H2 of 2024 remains consistent with our original expectations and our Q3 planned CAT load is 7.4%.

In summary, our margin recapture initiatives are yielding excellent results, while our disciplined growth strategies are effectively targeting our most profitable lines of business. Looking ahead to the next 12-18 months, we are confident our positive trajectory will continue. Underwriting margins should continue to improve as past and current rate increases earn in and we execute against our catastrophe exposure initiatives. Furthermore, we expect the current interest rate environment should continue to provide an accumulating benefit of higher investment yields. We couldn't be more excited about our prospects and remain committed to delivering value to our stakeholders through sustainable, profitable growth and top-tier performance. With that, we'll be happy to take your questions, Operator.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone.If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Michael Phillips with Oppenheimer. Please go ahead.

Michael Phillips (Analyst)

Thank you. Good morning, everybody. I'll start with the first question in personal lines, specifically homeowners, XCAT kind of question. Given your core margins are really doing well and expanding there, I guess, do you expect kind of you're right below 20% in rates? Does that accelerate from here? Is that there? Are we at a peak for that?

John Roche (President and CEO)

Mike, thanks for your question. I want to make sure I clarify. You're speaking specifically to homeowners' pricing?

Michael Phillips (Analyst)

Yes, You're just under, it looks like 20% for the quarter, right?

John Roche (President and CEO)

Right. I think as we said as we said in our prepared remarks, Mike, that we're obviously coming off of the peak of a combination of significant insurance-to-value enhancement as well as increased rate. We're very pleased, frankly, with our Personal Lines team's ability to meet the market and in some ways lead the market. We're now at a point where insurance-to-value is very adequate and we'll continue to look at that in terms of staying on top of that adequacy and maintaining strong rate consistent with what we think the market is enabling us to do. It's going to be, I think, pretty stable from here on out, but we'll continue to watch the weather and the overall patterns and stay disciplined in the market.

Jeff Farber (CFO)

Mike, I think it's also important to remember while written rate will be relatively consistent for a short period of time, earned rate will actually increase because of the higher written rate that we've gotten the last few quarters. So you'll start to see that impact in the financials.

Michael Phillips (Analyst)

Yep. Okay. Good. Thank you. Thanks for that. Second question, Jeff, you said something at first I didn't really catch and then so maybe I want to make sure I got it right and then expand upon it a little bit. You were talking comp and I think you said something about a slowdown in claims emergence. Did I get that right? And if so, what's driving that? And kind of maybe peel back a little bit on that one.

Jeff Farber (CFO)

I think it relates to the indemnity portion and what we're seeing is some people that originally were out for a period of time, that's getting extended a little bit. But it's important to remember that the offset to that is the increased payroll that we've gotten over the last few years. So I think we've been extraordinarily prudent with our workers' comp releases and workers' comp loss picks. So I'm feeling comfortable with that, Mike.

Michael Phillips (Analyst)

Was part of the payroll issue? I mean, workers' comp growth was a little bit higher than expected. Was that part of that just because of the payroll or anything else behind that 8% or so growth in the quarter?

John Roche (President and CEO)

This is Jack, Mike. I think, again, we have been very disciplined in the workers' comp market and watching both medical cost inflation and indemnity trends.I think the net-net of that is that the increase in payroll overall has been extremely helpful in making sure that we have pricing adequacy. But I think what we're sharing in our prepared remarks is that we're watching to make sure that particularly the indemnity side of it that isn't constrained by fee schedules like medical costs, that there isn't something going on there that would cause some margin compression. We're not seeing any dramatic changes there, but we're just signaling to folks that we're maintaining a level of discipline in our analysis and looking ahead.

Jeff Farber (CFO)

And I'll just add, Mike, that our work comp book as a percentage of our portfolio is less than 18% of our book. So it's Core Commercial. Thank you. We are targeting growth in work comp in the small commercial business, which performs very well. So our small commercial initiatives include rounding out accounts and writing more of that business.

Michael Phillips (Analyst)

Okay. Great. Thank you, guys. Appreciate it. I'll hop off for a second. Thank you.

Operator (participant)

The next question comes from Mike Zaremski with BMO. Please go ahead.

Mike Zaremski (Analyst)

Hey, thanks. Good morning. Trying to reread part of the transcript. Your prepared remarks are always great. I think it was said that in Core Commercial, there was kind of healthy maybe favorability, better than expected in property and you took that to be more defensive in casualty lines. I don't know if are you saying you added - am I understanding that correctly? - that you're saying you're kind of when the stat data comes out, I guess not until next year we'd see more IBNR, or what did you - if you want to unpack that comment.

John Roche (President and CEO)

Yes. So with the property favorability in Core was very useful.Some of that was recorded and some of it allowed us to be more prudent or defensive in the casualty lines across the book and at this point, it's generally IBNR as those claims haven't shown themselves. You're seeing those in prior years.

Mike Zaremski (Analyst)

Got it. okay and are you just staying with the theme on casualty lines since it's been a big topic of conversation for especially recently? I feel like you all have done a good job of explaining to us that over the last five-plus years, you have taken making proactive decisions to exit certain metros where there's higher social inflation, etc. Is there a way to unpack, or have you looked at data to try to help us triangulate whether your loss trend assumptions might be different than others, or are you just anything that you feel that you want to better unpack to give folks more confidence that the reserve trends we've been seeing for you all, which have been excellent are run ratable?

Jeff Farber (CFO)

Mike, during 2016 you may remember we strengthened our balance sheet with a large reserve charge. At that time, we became increasingly concerned with the liability and legal trends in major metropolitan cities and with certain industries being more prone to losses. We also removed any remaining monoline or unsupported umbrella. We were talking externally and demonstrating these underwriting actions in 2018 and 2019.

As a result of those geographic and industry portfolio choices, we're experiencing, as you reference a very substantial commercial liability frequency decline since pre-COVID to 2019 levels. For example, having a relatively small contractor book is serving us well. This overall frequency decline has generally offset our actions to consistently and meaningfully increase our casualty severity assumptions since 2019. This decline, along with more recent property line favorability, has allowed more prudent reserving and increases in loss picks. Loss trend severity is intense broadly in the industry, but we're relatively well positioned to navigate the challenges. It's hard to say whose loss picks might be higher, but our loss picks since 2019 have gone up consistently very dramatically.

Mike Zaremski (Analyst)

Okay. That's helpful and if this is a stat, you don't want to share you don't have, that's fine. But any way you can dimension what percentage of your reserves are umbrella? I'll just say many of your competitors don't want to disclose that, so it's not saying you need to, but curious if you could help us to mention that.

Jeff Farber (CFO)

I don't have that right in front of me, but that's something that we can get back to people if they're interested.

Mike Zaremski (Analyst)

Okay. Great. Just lastly, back to personal lines. In terms of kind of clearly the plan to redimension especially the homeowners portfolio well in action, can you remind us? I believe you glide past us to a CAT ratio that would eventually fall over time as kind of the actions took place. Is that kind of based on the trajectory of the portfolio repositioning over the last six months? Has anything changed at a high level in terms of kind of that glide path down over time in the CAT ratio, CAT catastrophe load ratio, sorry, over time?

John Roche (President and CEO)

Mike, this is Jack. I'll talk broadly. From an enterprise perspective, middle market has dramatically changed the profile of their CAT exposure over the last couple of years. As we looked at some profit improvement opportunities, we also looked at what types of classes and within which geographies could we reset our catastrophe exposure and, frankly, enable the enterprise to have some maneuvering relative to our property aggregations across the country. I think that's having a profound effect.

I also think that we can't state enough that when you combine dramatic price increase in our personal lines book, combined with the deductible implementation that we're well underway with and some PIF growth patterns that further enable a better diversification, all of that aids us in having confidence looking forward that our CAT loads will certainly start to move in a better direction. We'll continue to, frankly, monitor the weather patterns and make additional adjustments if that's required. But based on what we know today and based on the actions, we have the highest level of confidence we've ever had that we are addressing our CAT loads and further diversifying our portfolio.

Mike Zaremski (Analyst)

Thank you very much.

John Roche (President and CEO)

Thank you, Mike.

Operator (participant)

The next question comes from Paul Newsome with Piper Sandler. Please go ahead.

Paul Newsome (Analyst)

I guess a little bit of a follow-up on Mike's question about CAT. I mean, specifically looking at the terms and conditions being on the personal line side, is there any way to think about the quantification of those changes? Does it have an impact you can measure on PMLs or anything that you can tell us, or even maybe you can even describe what you've known internally as a description for that impact? Or we just kind of have to know a direction that's a good idea?

John Roche (President and CEO)

Listen, first of all, we understand the desire to be able to get more specific KPIs or more transparency to metrics.The reality is the way you kind of answered the question for us is exactly how we're trying to pursue it, is that we have to take our measured steps that we've taken, both in personal lines and more broadly and continuously model the business and look at where our AALs' micro concentrations are and how that affects ultimately the PML first for earnings volatility metrics driven by severe convective storms but also relative to our tail and I think we are more effective than we've ever been. We've added some additional resources to make sure that we're as proficient as we possibly can be in measuring the impact that we're making on the actions we're taking today and thinking about what else we could do if that's necessary.

But as I said earlier, we're really confident that we are moving our CAT loads in the right direction and also providing ourselves additional incentives to grow in other less concentrated areas because of the diversification credit that is more visible to us now as we use the enhanced models.

Jeff Farber (CFO)

Paul, the impact on the Q2 of additional deductibles was extremely limited because it only started going in April 1 for renewal business. But as you think about coming around to what we consider the severe convective storm primary season Q2 of next year, it's going to be a completely different story. We're very optimistic.

Paul Newsome (Analyst)

Second question, I want to ask maybe a broader question about the expense ratio and the target over time. At one point, you had a, I think it was 20 basis points per year goal that changed with the profit struggles that you had several years ago. Are we kind of back to that theme, or has the nature of the company changed such that that's not something that necessarily makes a lot of sense if we look forward over the long term?

Jeff Farber (CFO)

So I think the 30.7%, Paul, that we guided to and are still guiding to for this year's expense ratio is a consistent 20 basis points improvement. Now, from time to time, it's been 30 or 10, but over time, it's been pacing that way. Generally speaking, we're still committed to that and we should be able to drive that. Having said that, our mix could change and that could change the trajectory a little bit overall. Most importantly, we're looking for hundreds of basis points improvement in the combined ratio and in any given year, a little less focused on whether it's 10 basis points more or 10 basis points less of the expense ratio. I think there's more action right now in the loss ratio for us.

Paul Newsome (Analyst)

Appreciate the help as always.

Operator (participant)

The next question comes from Grace Carter with Bank of America. Please go ahead.

Grace Carter (Analyst)

Hi. Good morning, everybody. Morning. While we've listened to peer results this quarter, it sounds like everyone's concerned with social inflation, obviously, but the commentary has varied a bit from one peer to another, with some industry participants more concerned on general liability, some more with commercial auto. Some commentary is focused more on primary layers and others on excess. I guess I'm wondering, in your opinion, is there a particular area of commercial liability that deserves more attention than others these days, or is the potential pressure from social inflation pretty widespread in your view?

John Roche (President and CEO)

Grace, this is Jack. Thanks for the question. I think ultimately, social inflation and legal system abuse are just affecting the severity of the severity of liability trends and more broadly, you see, obviously, in auto accidents or in kind of business-to-consumer type of exposures, you have individuals being harmed that lend themselves to higher jury awards, higher litigation rates and the court system clearly has changed in that more cases are going further into duration and that's somewhat helped by litigation finance. So I think those are pretty broad-based.

Some of the differences I think you're observing are what kind of portfolio one has and how much of that is susceptible to those social inflationary trends, whether that be limits profile or kind of classes of business and to some degree geography that you play in. But also, I think, as Jeff has been articulating both in his prepared remarks and in his response to the previous question, it's what changes have you been making along the way that could be running against some of those liability severity trends? And in our case, we know that we have made some real portfolio actions, particularly in middle market, that are giving us some advantages and that frequency of severity improvement is offsetting the natural severity of the severity trend that's going up.

And then last but not least, the decision we made 8 years ago, starting 8 years ago, to really get out of the excess umbrella business, particularly over other companies, is proving to be very beneficial because we obviously know our book of business well and we know how to provide umbrella coverage above our own business. I think where some companies might be getting caught short is they don't do the primary underwriting and so they have an excess book of business that tends to be much more vulnerable and harder to understand where those trends are coming from.

Grace Carter (Analyst)

Thank you and we've also seen some of the pressure on casualty reserves kind of spilling out of the soft market years into more recent accident years over the past couple of quarters. I mean, I guess, could you talk about your observations from that standpoint? You mentioned some of the repositioning that you've done in your casualty portfolio starting maybe 2018, 2019 and if those actions have insulated you so far from some of the pressure that we've started to hear about and the experience from the past couple of years? Thanks.

John Roche (President and CEO)

Grace, I think the frequency benefits that were evident in the 2020 year during the COVID year, unrelated to what we were talking about a few minutes ago, have provided an opportunity to cushion those phenomena that you were just referring to. So we weren't really sure whether liability matters were delayed or whether they just didn't happen in 2020. So prudence with those picks in that year have proven to be quite useful as we roll forward and deal with, as you referred to, the softer market periods. So it really is the combination of all those things coming together and how thoughtful and conservative were you along the way with your picks and your reserving and that's where I think we want to share our confidence that, particularly on a relative basis, we think we have done extremely well.

Grace Carter (Analyst)

Thank you.

Operator (participant)

The next question comes from Meyer Shields with KBW. Please go ahead.

Meyer Shields (Analyst)

Great. Thanks. Good morning. Thanks for taking my questions. If we can go back to workers' compensation, two things. First, you mentioned an uptick in, I guess, indemnity-related severity and I'm wondering, didn't that be covered by the exposure unit growth in the line? Is that a reserve concern or an adequacy concern?

John Roche (President and CEO)

No, I don't believe it's a reserve concern. I think what we're making is more of an observation that we see some evidence that lost time cases, on average, have moved out a little bit further and that the increased payrolls that obviously are captured in our premium base are also showing up in the indemnity dollars. So we're not sending out any alarms. We're trying to address the fact that in the industry, everyone's trying to determine where are we in the workers' comp medical cost inflation and the broader workers' comp trends and we're trying to reinforce investors that we are on top of these trends. We're not being overly optimistic. We're, if anything, being conservative with our picks and I wouldn't read any more into it than that.

Meyer Shields (Analyst)

Okay. Perfect. Thanks for clarifying. Also, on workers' compensation, is anything happening on the medical side of things? I guess it goes beyond comp, but since you call that indemnity, I'm wondering about medical trends.

John Roche (President and CEO)

I think we still see relatively modest increases in medical costs, particularly related to workers' comp because of the fee schedule phenomenon and again, since almost two-thirds of the loss costs in comp are medical costs related, we get a real tailwind from the surge in payrolls that have come along for the ride that make their way into our premium base. So I think that's why you're seeing more stability than people predicted, is because you're getting both the premium side the premium side is getting aided by payrolls and medical costs on a relative basis are still relatively benign.

Meyer Shields (Analyst)

All right. Perfect. Thank you so much.

Operator (participant)

The next question comes from Bob Farnam with Janney. Please go ahead.

Bob Farnam (Analyst)

Hi there. Good morning. Unfortunately, one more question on casualty reserves. I don't know if you've actually given it explicitly, but what underlying severity trend assumption are you using for your current loss picks and how has that changed over the years? And I guess, how does that compare to pricing these days?

Jeff Farber (CFO)

Well, we haven't given an individual severity assumption over time and the reason is we just find it difficult to give one casualty severity assumption. The lines are so different. We look at it individually. However, it has gone up dramatically and it has gone up in our assumption, similarly to price along the way, if not even higher. So as I said before, our frequency benefit has allowed us to increase that severity assumption without having to increase the loss pick or the loss ratio as dramatically as it otherwise would have been.

Bob Farnam (Analyst)

Right. I think more importantly, I just wanted to make sure that the pricing these days was keeping up with the. It sounds like you increased your expectations this quarter, so I just want to make sure the pricing is still keeping pace.

Jeff Farber (CFO)

It is. So it is our belief that the core commercial rate of 9.3% and overall price change of 11.7% and when you deconstruct the casualty component under that, it is our belief that we are getting more price than loss trend at the moment.

John Roche (President and CEO)

Bob, maybe to even link it up to a previous question regarding umbrella and Dick, maybe you can speak to this. We have ratcheted up our pricing in the commercial lines umbrella line significantly over the last few years with the assumption that the severity trends were going to deteriorate even before we saw it in our results. So maybe you could comment on that.

Richard Lavey (EVP & President of Hanover Agency Markets)

I'll just put a number to it. I mean, over the last four years, we've seen our umbrella pricing upwards of almost 40%. So we've been getting ahead of it. We've been looking at the methodology of how we're rating and making the appropriate filings to make sure we're adequate.

John Roche (President and CEO)

And I think that's a big part of how, as you try to figure out how this is playing out in the industry, is what was your starting point in terms of loss trend assumptions? How much have you priced over loss trend and what underwriting actions have you taken that might prove beneficial as those social inflationary effects start to kick in? And I think on all three of those dimensions, we've been very proactive.

Bob Farnam (Analyst)

Great. Thanks for the additional color.

John Roche (President and CEO)

Thank you, Bob.

Operator (participant)

Again, if you have a question, please press star then one to enter the queue. The next question comes from Michael Phillips with Oppenheimer. Please go ahead.

Michael Phillips (Analyst)

Hey, thanks for the follow-up. Just a quick one. If you could spend a second, maybe you could of your specialty marine book. Can you just spend a second on kind of describing the general nature of that book first?

John Roche (President and CEO)

I think I heard you blip for a second there, but I think you said you wanted us to talk about the marine book within specialty.

Michael Phillips (Analyst)

Correct. Yes. Thank you.

John Roche (President and CEO)

Okay. Go ahead, Bryan.

Bryan Salvatore (EVP and President of Specialty)

Sure. So I think it's a great question because we list it pretty simply, right, as marine. But under marine, we have quite a number of product lines, right? Much of it is inland marine.

It's a mix of builder's risk business contractor's equipment business and things like that. But additionally, we have a lot of what you would call floaters for computers, musical equipment. So it's really diversified. I would say there's probably 20 different product segments that we're going after in marine. So that's one of the things we like about the book. It's very diversified both geographically and it's also got a real diverse mix of product that's in there. So I think for us and maybe you've seen this, that's really helped it to remain very profitable even throughout all this time of increased CATs etc., right? We've been able to manage through that and have a diversified book that absorbs that.

Michael Phillips (Analyst)

No, that's helpful. So still a follow-up. I imagine the answer is no, but I mean, I would imagine given your book is so different, but there's been a lot of buzz, obviously around marine more of the global accounts and stuff because of what's happening right here in my backyard in Baltimore. None of that trickles down to your none of that excitement, I guess, on the pricing that trickles down to your book, I imagine, right?

Bryan Salvatore (EVP and President of Specialty)

So I didn't completely hear. I think you were alluding to that, I'll call it a crash that took place in Baltimore. And so we have a little bit of what you might call ocean marine as well, but that's really more like docks and marinas and lobster boats and really kind of simple stuff relative to what you're talking about. We don't do the large hauls. We don't do that type of exposure that I think you're referring to.

John Roche (President and CEO)

And we certainly don't put up limits that support major infrastructure across the country. So that's not our bailout at all. It's predominantly an inland marine book of business that is very diversified, like you said and one of our most profitable businesses over a very long period of time.

Michael Phillips (Analyst)

Okay. Good. Thank you. Good stuff. Appreciate it.

Operator (participant)

This concludes our question and answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.