Travelers Companies, Inc. — Q3 2018 Form 10-Q
Business context and period. Travelers is a property-casualty insurer operating through Business Insurance, Bond & Specialty Insurance, and Personal Insurance. This unaudited filing covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted. Amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenues | $7.72B | $7.33B | $22.49B | $21.45B |
| Earned premiums | $6.88B | $6.52B | $20.11B | $19.06B |
| Net investment income | $646M | $588M | $1.84B | $1.80B |
| Income before taxes | $806M | $320M | $2.22B | $1.87B |
| Net income | $709M | $293M | $1.90B | $1.51B |
| Diluted earnings per share | $2.62 | $1.05 | $6.97 | $5.34 |
| Combined ratio | 96.6% | 103.2% | 96.8% | 98.7% |
| Operating cash flow | $1.73B | Not stated for quarter | $3.43B | $3.49B |
Q3 net income increased 142% and diluted EPS increased 150%. Management attributed the improvement chiefly to substantially lower catastrophe losses and higher investment income, partly offset by lower realized investment gains. Catastrophe losses were $264M in Q3 2018 versus $700M a year earlier. For the first nine months, catastrophe losses were $1.11B versus $1.45B.
Earned premiums grew 6% in both Q3 and year-to-date. Q3 segment income was $410M in Business Insurance, $196M in Bond & Specialty Insurance, and $153M in Personal Insurance. The consolidated combined ratio improved, but underlying combined ratios—excluding catastrophes and prior-year reserve development—were slightly higher year over year in Q3 and for the nine-month period.
Financial position, liquidity and capital
- At September 30, 2018, total assets were $104.39B, total investments $71.85B, total liabilities $81.93B, and shareholders’ equity $22.46B. Equity declined from $23.73B at year-end 2017, largely alongside a $1.66B increase in accumulated other comprehensive loss.
- Debt was $6.56B, broadly unchanged from $6.57B at year-end. Debt-to-total-capital was 22.6%, or 22.3% excluding after-tax unrealized investment gains and losses; management reported this adjusted measure was within its 15%–25% target range.
- Holding-company cash and short-term investments were $1.39B, above the company’s approximately $1.16B liquidity target. Cash on the consolidated balance sheet was $359M.
- Nine-month operating cash flow was $3.43B. Investing activities used $1.76B and financing activities used $1.65B. Financing included $1.10B of authorized share repurchases and $611M of shareholder dividends.
- The company repurchased 8.2M shares for $1.10B under its authorization during the first nine months; $3.46B of authorization remained at September 30. It declared a $0.77-per-share quarterly dividend on October 18, payable December 31, 2018.
- Net unrealized losses on investments were $560M after tax at September 30, versus net unrealized gains of $1.09B after tax at December 31, 2017, primarily reflecting rising interest rates. The fixed-maturity portfolio had an average credit quality of Aa2; below-investment-grade holdings were 2.5% of that portfolio.
Material changes and unusual items
- Q3 earnings benefited from lower catastrophe losses than in the hurricane-affected 2017 quarter. Q3 2018 catastrophe losses primarily reflected Hurricane Florence, U.S. wind and hail storms, and a California wildfire.
- Year-to-date prior-year reserve development was favorable by $350M, compared with $299M in 2017. However, Q3 included $56M of unfavorable Business Insurance development, including a $225M increase in asbestos reserves; favorable development in other segments offset this at the consolidated level.
- Net environmental reserves increased $55M in the first half of 2018. Management cited greater-than-anticipated development in existing claims and legal developments in a limited number of jurisdictions.
- Investment income rose 10% in Q3, with management citing higher average fixed-maturity investments, improved reinvestment rates, higher short-term rates, and stronger private-equity partnership returns. Nine-month investment income rose 3%.
- The effective tax rate was 12% for Q3 and 14% year to date, versus 8% and 20% in 2017, respectively. The 2018 rates reflected the lower federal corporate tax rate and, in part, a $200M voluntary pension contribution that received a 35% tax benefit rather than a 21% benefit.
- The company issued $500M of 4.05% senior notes due 2048 and repaid $500M of 5.80% notes that matured in May. It also entered a new five-year $1.0B revolving credit agreement; it reported compliance with its covenants.
- A real estate investment with a $53M carrying value was sold in October 2018, with an estimated $20M pretax gain expected in Q4.
Outlook, risks and contingencies
- Management expects strong retention by historical standards and continued competitive property-casualty markets. It expects renewal pricing to remain positive in several domestic lines, with segment-specific differences; it cautioned that economic conditions, competition, regulation, and exposure changes can affect premium growth.
- Management’s outlook anticipates higher underlying underwriting margins in Business and Personal Insurance in specified future periods, subject to assumptions including more normal large-loss activity. It expects Bond & Specialty underlying results to be broadly consistent into 2019. These are forward-looking expectations, not guarantees.
- Management expects after-tax fixed-maturity and short-term investment income to be approximately $60M–$65M higher in the remainder of 2018 than in the comparable 2017 quarter, and approximately $20M–$25M higher per quarter in 2019 than in comparable 2018 quarters.
- Asbestos and environmental claim outcomes remain difficult to estimate. The company warns that additional liabilities or reserve estimate changes could materially affect future-period results. Net asbestos reserves were $1.35B at September 30; net environmental reserves were $372M.
- Other risks include catastrophe and non-catastrophe weather losses, reserve uncertainty and inflation in claim costs, interest-rate and credit risk in investments, reinsurance collectability and availability, competition, regulation, foreign exchange, and technology and cybersecurity risks. The filing reports no material changes to the risk factors in the 2017 Form 10-K.
- Unfunded commitments to private-equity and real-estate partnerships totaled $1.60B. The company also disclosed quantifiable indemnification and investment-related guarantees; amounts and potential outcomes vary, and some obligations are indemnified by third parties.
Important facts for investors to verify
- Whether future catastrophe experience and underlying loss trends support the improved reported combined ratio, and how much results depend on favorable prior-year reserve development.
- Developments in asbestos and environmental claims, including the $225M asbestos reserve increase, the $55M environmental reserve increase, and the possibility of material future reserve revisions.
- Whether the investment-income outlook is achieved, and how interest-rate changes affect fixed-maturity values, equity, and investment returns.
- Capital-return plans and capacity in light of catastrophe exposure, subsidiary capital needs, pension funding, the $1.0B credit facility, and the company’s leverage and liquidity measures.
- Assumptions behind segment pricing, growth, and margin outlooks, including competitive conditions, rate approvals, inflation, and large-loss activity.