TRAVELERS COMPANIES, INC. annual report, FY2013

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Travelers Companies, Inc. — FY 2013 Form 10-K

Business context and reporting period. Travelers is a property-and-casualty insurance holding company operating through Business Insurance; Financial, Professional & International Insurance; and Personal Insurance. This 10-K covers the year ended December 31, 2013, with unaudited quarterly data included. Dominion of Canada was acquired on November 1, 2013; its results are included in the Financial, Professional & International segment from that date.

Financial performance and condition

  • FY 2013 results: Total revenue was $26.19 billion, up from $25.74 billion in 2012. Net income was $3.67 billion ($9.74 diluted EPS), versus $2.47 billion ($6.30) in 2012. Operating income, excluding after-tax realized investment gains, was $3.57 billion.
  • Underwriting: The consolidated GAAP combined ratio improved to 89.8% from 97.1%; below 100% generally indicates an underwriting profit. The loss and LAE ratio was 57.9%, including 2.6 points from catastrophe losses and a 3.7-point benefit from favorable prior-year reserve development. The expense ratio was 31.9%.
  • Premiums and investment income: Net earned premiums were $22.64 billion, up 1%; net written premiums were $22.77 billion, up 1%. Net investment income declined 6% to $2.72 billion; average pretax yield fell to 3.8% from 4.1%. Net realized investment gains were $166 million.
  • Cash flow and liquidity: Operating cash flow was $3.82 billion, versus $3.23 billion. Holding-company cash and short-term invested assets were $1.59 billion, above management’s approximately $1.1 billion minimum target. The company also had a $1.0 billion revolving credit facility through June 2018; $100 million of its $800 million commercial-paper program was outstanding at year-end.
  • Capital and debt: Total assets were $103.81 billion and shareholders’ equity $24.80 billion. Total debt was $6.35 billion; debt-to-total capital was 20.4% (21.3% excluding after-tax unrealized investment gains), within the stated 15%–25% target range. Book value per share was $70.15. Fixed maturities and short-term securities represented 93% of the $73.16 billion investment portfolio.
  • Shareholder returns: Travelers repurchased 28.4 million shares for $2.40 billion and paid $729 million in common dividends. It ended the year with $4.76 billion of authorized repurchase capacity; the annual dividend per share was $1.96.
  • FY 2013 versus 2012 by segment: Business Insurance operating income rose to $2.33 billion from $1.84 billion, with a 91.9% combined ratio versus 97.4%. Financial, Professional & International operating income was $648 million versus $642 million, with an 84.3% ratio versus 84.1%. Personal Insurance operating income increased to $838 million from $217 million, with an 88.9% ratio versus 101.9%.
  • 2013 fourth quarter: Unaudited revenue was $6.74 billion and net income $988 million, or $2.70 diluted EPS. In Q4 2012, revenue was $6.48 billion and net income $304 million, or $0.78 diluted EPS.

Material changes and unusual items

  • Catastrophe losses fell to $591 million from $1.86 billion in 2012, a major contributor to improved earnings; favorable prior-year reserve development was $840 million, down from $940 million.
  • Results included a $91 million pretax gain from a legal settlement, a $20 million gain on sale of National Flood Insurance Program renewal rights, and a $63 million benefit from resolution of prior-year tax matters. The $166 million of realized investment gains included $115 million related to Treasury futures.
  • The $1.034 billion Dominion acquisition added $2.62 billion of investments and $1.79 billion of net claims reserves. Its Canadian operations expanded international premiums; integration and acquired reserve estimates remain areas to monitor.
  • Interest-rate increases reduced the portfolio’s net unrealized investment gain after tax to $1.32 billion from $3.10 billion and reduced shareholders’ equity through other comprehensive income. The fixed-maturity unrealized gain declined from $4.56 billion to $1.76 billion.
  • Net asbestos and environmental reserves were approximately $2.69 billion at year-end. The company added $190 million to net asbestos reserves and $65 million to net environmental reserves in 2013. Management says ultimate liability remains uncertain and additional future charges could be material.

Outlook, risks and contingencies

  • Management expected 2014 renewal pricing, in aggregate, to exceed loss-cost trends, while anticipating strong retention. Business Insurance underlying margins were expected to improve; Financial, Professional & International margins were expected to be broadly consistent with 2013; and Personal Insurance margins were also expected to be broadly consistent.
  • For Agency Automobile, Travelers targeted $140 million of annual pretax savings by 2015 from expense reductions. It incurred $12 million of an expected $16 million restructuring charge in 2013. Quantum Auto 2.0 launched in 18 states by year-end 2013, with rollout planned to all but three states before the end of 2014. The direct-to-consumer initiative was expected to remain unprofitable for several years.
  • Management estimated lower reinvestment yields could reduce after-tax fixed-maturity investment income by about $25 million per quarter in 2014 versus corresponding prior-year quarters; income from non-fixed-maturity investments was also expected to be lower than in 2013.
  • Key risks include severe or multiple catastrophes, uncertain climate and catastrophe-model estimates, reserve-estimation variability, asbestos/environmental litigation, reinsurance recoverability and availability, investment and interest-rate risk, competitive pricing pressure, and regulatory limits on rates and insurer-subsidiary dividends. The federal terrorism program was authorized only through 2014; the estimated 2014 insurer deductible was $2.35 billion.
  • A pending asbestos direct-action settlement appeal and reinsurance disputes remain unresolved. The filing does not provide a clear estimate of potential additional asbestos/environmental liabilities; management states they cannot currently be reasonably estimated. Other quantified guarantees include up to $465 million for certain business-sale indemnifications and $153 million for certain investment and loan guarantees, subject to stated indemnification arrangements.

Most important facts for investors to verify

  • Whether underwriting improvement persists after adjusting for lower catastrophes and favorable reserve development, and whether 2014 pricing continues to outpace loss-cost trends.
  • Whether the $140 million auto-expense savings and Quantum Auto 2.0 rollout improve margins without materially weakening retention or new-business volume.
  • How Dominion performs after integration, including its loss ratio, reserve adequacy and contribution to international growth.
  • Whether favorable reserve development continues, and the evolution of asbestos/environmental reserves and related litigation.
  • Investment-income trends, sensitivity of book value to interest rates, and the collectability of reinsurance recoverables.
  • Capital returned through buybacks and dividends relative to catastrophe exposure, subsidiary capital needs and holding-company liquidity.

Audit: KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Dominion was excluded from the year-end internal-control assessment under the acquisition-year guidance.