The Travelers Companies, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated statements prepared under U.S. GAAP. Travelers is a property and casualty insurer with Business and International Insurance, Bond & Specialty Insurance, and Personal Insurance segments. Amounts below are in U.S. dollars; financial figures are in millions unless otherwise noted.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenues | $6,785 | $6,710 | $13,471 | $13,339 |
| Earned premiums | $6,067 | $5,931 | $12,048 | $11,819 |
| Net investment income | $549 | $632 | $1,093 | $1,224 |
| Income before taxes | $887 | $1,076 | $1,804 | $2,224 |
| Net income | $664 | $812 | $1,355 | $1,645 |
| Diluted earnings per share | $2.24 | $2.53 | $4.55 | $5.08 |
| Combined ratio | 93.1% | 90.8% | 92.7% | 89.9% |
- Cash flow: Six-month operating cash flow was $1,293, versus $875 a year earlier; investing activities used $91, versus providing $765; financing activities used $1,314, versus $1,693. Q2 operating cash flow was $443.
- Balance sheet at June 30: Assets were $102,446; investments $72,470; cash $265; claims reserves $47,953; debt $6,436; and shareholders’ equity $24,714. Holding-company liquidity was $1.75 billion, above its approximately $1.1 billion target.
- Leverage and capital returns: Debt-to-total-capital ratio was 20.7%, or 22.3% excluding after-tax unrealized investment gains, within the stated 15%–25% target range. Travelers repurchased 10.0 million shares for $1.10 billion in the first half and paid $375 million in dividends. It had $2.23 billion of repurchase authorization remaining at June 30.
- Net unrealized investment gains were $3.59 billion before tax ($2.34 billion after tax). Shareholders’ equity included a $1.12 billion increase in accumulated other comprehensive income during the first half, principally reflecting unrealized investment gains.
Changes versus comparable periods
- Q2 net income fell 18% and diluted EPS fell 11%; first-half net income fell 18% and diluted EPS fell 10%. Share repurchases moderated the per-share declines.
- Premiums grew: earned premiums rose 2% in both the quarter and first half. Net written premiums increased 3% in Q2 and 4% in the first half. Personal Insurance earned premiums grew 7% and 6%, respectively; Business and International was nearly flat year to date, and Bond & Specialty was nearly flat.
- Net investment income declined 13% in Q2 and 11% year to date. Management attributed the reduction to lower reinvestment rates and weaker returns from private equity, hedge funds, and real estate partnerships.
- The combined ratio deteriorated 2.3 points in Q2 and 2.8 points year to date. Higher catastrophe losses and underlying loss costs exceeding earned pricing weighed on results.
- Q2 segment operating income was $393 for Business and International (down 28%), $202 for Bond & Specialty (up 34%), and $116 for Personal Insurance (down 33%). First-half operating income was $869 (down 18%), $346 (up 26%), and $255 (down 40%), respectively.
Management outlook, risks, and unusual items
- Outlook: The filing gives directional expectations, not formal consolidated earnings guidance. Management expected strong retention overall and competitive insurance markets. It anticipated domestic Business and International renewal pricing to remain positive, Bond & Specialty management-liability pricing to remain positive but ease slightly, and Personal Auto renewal pricing to remain positive and slightly improve. It expected Personal Insurance underlying margins to be lower and its underlying combined ratio higher in the remainder of 2016 and into 2017.
- Based on the interest-rate environment, management estimated fixed-maturity reinvestment yields and a lower level of fixed-maturity investments could reduce after-tax investment income by approximately $20–$25 per quarter versus corresponding 2015 and 2016 quarters. Non-fixed-maturity investment returns remained uncertain.
- Underwriting drivers: Q2 catastrophe losses were $333 ($222 after tax), compared with $221 in Q2 2015. First-half catastrophe losses were $651, compared with $383. Net favorable prior-year reserve development was $288 in Q2 and $468 in the first half, versus $207 and $450 a year earlier. Management cited loss-cost trends exceeding earned pricing and elevated non-catastrophe weather losses.
- Asbestos and environmental exposure: Travelers paid $524 in Q2 to settle the PPG asbestos coverage matter, including $518 related to asbestos reserves. Net asbestos reserves were $1,234 at June 30. Net environmental reserves were $421; Travelers increased them by $82 in Q2, citing adverse development in a limited number of jurisdictions. Management warned that reserve uncertainty could lead to additional liabilities or material future-period charges, which it could not reasonably estimate.
- A separate reinsurance dispute included a $519 claim at June 30: $238 of recorded recoverable plus $281 of unrecognized interest. Interest accrues at 9% annually; litigation remained unresolved, and the interest is treated as a gain contingency.
- Travelers issued $500 of 3.75% senior notes due 2046 and repaid $400 of 6.25% notes at maturity. Investment commitments to private equity and real estate partnerships totaled $1.69 billion. The filing also describes quantified guarantees and indemnifications, including a maximum $391 related to sold businesses.
- Key risks include catastrophe severity, reserve adequacy and long-tail claims, asbestos/environmental litigation, inflation and loss costs, low interest rates and investment volatility, competitive pricing, reinsurance collection and availability, regulation, and foreign exchange exposure. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether premium-rate increases keep pace with loss-cost trends, especially in Personal Insurance and Business and International.
- Whether catastrophe activity and favorable prior-year reserve development normalize, and how underlying combined ratios develop excluding both items.
- Whether lower reinvestment yields and non-fixed-maturity returns pressure investment income as management anticipated.
- Developments in asbestos and environmental reserves, including the PPG settlement effects and the unresolved reinsurance dispute.
- Future buybacks and dividends relative to earnings, liquidity, debt, and insurance-subsidiary capital needs.