The Travelers Companies, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Travelers is a property-and-casualty insurer. The filing presents Business Insurance, Financial, Professional & International Insurance, and Personal Insurance under the segment structure in effect at quarter-end. The November 2013 Dominion acquisition materially affects year-over-year comparisons, particularly in international premiums.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Total revenue | $6.785 billion | $6.674 billion | $13.493 billion | $13.002 billion |
| Earned premiums | $5.928 billion | $5.603 billion | $11.751 billion | $11.120 billion |
| Net investment income | $695 million | $687 million | $1.431 billion | $1.357 billion |
| Net income | $683 million | $925 million | $1.735 billion | $1.821 billion |
| Diluted EPS | $1.95 | $2.41 | $4.91 | $4.75 |
| Combined ratio | 95.1% | 94.3% | 90.5% | 91.4% |
- Q2 net income fell 26% and diluted EPS fell 19%. Lower realized investment gains, lower other revenue, higher catastrophe losses, and slightly lower favorable reserve development weighed on results. Share repurchases reduced the per-share decline relative to the net-income decline.
- First-half net income declined 5%, while diluted EPS rose 3%, primarily reflecting fewer shares outstanding. The first-half combined ratio improved 0.9 percentage point; the Q2 ratio worsened 0.8 point.
- Catastrophe losses were $436 million in Q2 and $585 million in the first half, versus $340 million and $439 million in the comparable 2013 periods. Net favorable prior-year reserve development was $183 million in Q2 and $477 million year to date, compared with $192 million and $423 million in 2013.
- Underlying underwriting margins improved overall, with earned pricing exceeding loss-cost trends; management cited higher non-catastrophe weather losses as a partial offset. Q2 loss and LAE ratio was 63.6% and underwriting expense ratio 31.5%.
- Segment results were mixed: Q2 operating income was $409 million for Business Insurance (down 29%), $254 million for Financial, Professional & International (up 65%), and $75 million for Personal Insurance (down 47%). Dominion drove much of the international segment’s premium growth. Personal Insurance was affected by higher catastrophe losses and lower favorable reserve development.
Cash flow, balance sheet, and capital
- First-half operating cash flow was $1.328 billion, versus $1.252 billion in 2013. Investing activities provided $487 million; financing activities used $1.799 billion. Cash at June 30 was $311 million.
- Total assets were $104.811 billion and shareholders’ equity was $25.532 billion. Investments totaled $73.941 billion, including $64.583 billion of fixed maturities.
- Debt was $6.347 billion; debt-to-total capital was 19.9%, or 21.3% excluding after-tax unrealized investment gains. Holding-company cash and short-term invested assets were $1.83 billion, above the stated approximately $1.1 billion minimum target.
- Travelers repurchased 17.3 million shares for $1.525 billion in the first half, including 9.5 million shares for $875 million in Q2. Remaining authorization was $3.23 billion. First-half shareholder dividends were $365 million.
- Net cash flows from operations and the investment portfolio are the main liquidity sources for insurance subsidiaries. The company also reported a $1.0 billion credit facility, with $100 million outstanding under its commercial-paper program.
Outlook, risks, and unusual items
- No specific earnings or EPS guidance is provided. Management expected strong retention to continue, but forecast renewal premium changes in Business Insurance to ease somewhat and Personal Insurance renewal changes to decline while remaining positive. Competitive pricing, economic conditions, regulatory approvals, and weather could affect volumes and margins.
- Management estimated that lower fixed-maturity reinvestment yields could reduce after-tax investment income by approximately $20–$25 million per quarter for the remainder of 2014 and into 2015 versus comparable quarters, partly offset by about $5 million of quarterly Dominion investment income through November 2014. It also expected lower returns from non-fixed-maturity investments than in comparable prior periods.
- The company’s plan to reduce claim-adjustment and other insurance expenses, primarily in Agency Automobile, targeted approximately $140 million of annual pretax savings by 2015. Quantum Auto 2.0 was being introduced across planned states. Management cautioned that its direct-to-consumer business was expected to remain unprofitable for several years.
- Q2 2013 included a $91 million legal-settlement gain in other revenue and substantial realized gains on Treasury futures; those gains were not repeated in 2014. Q2 2013 also benefited from a $63 million reduction in tax expense from resolution of prior-year tax matters.
- Asbestos and environmental claims remain significant uncertainties. Net asbestos reserves were $2.25 billion at June 30; net environmental reserves were $382 million. The company increased environmental reserves by $87 million in Q2 and warned that future adverse developments could produce material charges, which cannot currently be reasonably estimated.
- A reinsurance dispute had a stated claim of $477 million, including $238 million of booked recoverable and $239 million of accrued interest treated as an unrecognized gain contingency. Investment commitments to private-equity and real-estate partnerships totaled $1.59 billion.
- Effective July 1, 2014, International Insurance was to move into a new Business & International segment, while Bond & Financial Products would become a separate segment. Prior periods were to be recast in later reporting.
Most important facts for investors to verify
- Whether favorable reserve development persists and whether asbestos and environmental reserves prove adequate.
- Actual catastrophe and non-catastrophe weather losses, and their effects on combined ratios and earnings.
- Whether pricing and expense actions offset competitive pressure, loss-cost trends, and lower investment reinvestment yields.
- Dominion’s contribution to growth and profitability, including integration progress and the planned segment recast.
- Share repurchase pace and capital returns relative to operating earnings, catastrophe exposure, and rating and regulatory capital needs.