TRAVELERS COMPANIES, INC. annual report, FY2011

Business context and reporting period

The Travelers Companies, Inc. is a property-and-casualty insurer operating through Business Insurance; Financial, Professional & International Insurance; and Personal Insurance. This Form 10-K reports the fiscal year ended December 31, 2011; it is an annual report, not a standalone fourth-quarter filing. Financial statements were audited by KPMG, which issued unqualified opinions on the statements and internal control over financial reporting.

Financial performance and position

The 2011 combined ratio above 100% indicates an underwriting loss overall. Catastrophe losses were $2.56 billion ($1.67 billion after tax), versus $1.11 billion in 2010. Net favorable prior-year reserve development was $715 million, down from $1.25 billion. The 2011 effective tax rate was negative 5%, including a $104 million benefit from favorable resolution of prior-year tax matters.

At December 31, 2011, investments totaled $72.70 billion, 93% in fixed maturities and short-term securities. Fixed maturities had an average credit quality of Aa2; 3.1% were below investment grade. Holding-company liquidity was $2.39 billion. Debt-to-total-capital was 21.3%, or 23.4% excluding after-tax net unrealized investment gains. The company repurchased 51.0 million shares for $2.90 billion and paid $665 million in shareholder dividends.

Business segments

• Business Insurance: Operating income fell 41% to $1.35 billion; combined ratio worsened to 104.7% from 91.3%, reflecting higher catastrophe losses and reduced favorable reserve development. Net written premiums rose 4% to $11.34 billion.
• Financial, Professional & International: Operating income rose 4% to $647 million; combined ratio improved to 85.8% from 87.7%. Net written premiums fell 3% to $3.10 billion, including reduced Irish personal-lines business and underwriting actions.
• Personal Insurance: Operating loss was $332 million, versus $440 million of income; combined ratio increased to 113.6% from 98.3%. Catastrophe losses rose to $1.49 billion from $594 million. Net written premiums increased 2% to $7.75 billion.

Supplemental fourth-quarter data: revenue was $6.37 billion and net income was $618 million, compared with $6.33 billion and $894 million, respectively, in fourth-quarter 2010.

Material changes versus the prior comparable period

• Revenue increased 1.3%, while net income fell 56%; diluted EPS fell 49%, with share repurchases moderating the per-share decline.
• Catastrophe losses more than doubled, driven by tornadoes, wind and hail, severe winter storms, and Hurricane Irene. The consolidated loss ratio rose to 72.9% from 61.0%; the expense ratio was unchanged at 32.2%.
• Underlying underwriting margins weakened, reflecting earned pricing and loss-cost trends and higher non-catastrophe weather losses. Management reported a 2.9-point deterioration in the consolidated loss ratio excluding catastrophes and prior-year reserve development.
• Net investment income declined 6%, and realized investment gains fell substantially, partly because 2010 included a gain on the sale of Verisk shares.
• Net cash from operations declined by $885 million. Investing activities provided $1.15 billion; financing activities used $3.31 billion, largely reflecting repurchases and dividends.
• Book value per share increased to $62.32 from $58.47 despite lower total equity, reflecting share-count reduction and higher unrealized investment gains.

Outlook, risks and unusual items

• Management expected 2012 renewal price increases and stronger underlying underwriting margins in all three segments, with improvement expected to begin in the first half of the year. These expectations depend on weather, loss trends, competition, economic conditions and, for personal lines, regulatory approval of rates.
• Management expected fixed-maturity investment returns to be slightly lower in 2012 because of lower reinvestment yields, and non-fixed-maturity investment income to be lower than in 2011. It indicated that 2012 dividends plus share repurchases would likely not exceed operating income.
• Catastrophe frequency and severity are unpredictable. A revised third-party hurricane model led Travelers to raise its own modeled single-hurricane loss estimates by 10%–24%; the company estimated catastrophe-bond attachment points could rise by as much as 70% at the next reset.
• Asbestos and environmental reserves remain uncertain. The company increased net asbestos reserves by $175 million and net environmental reserves by $76 million in 2011. Year-end net reserves were $2.44 billion for asbestos and $341 million for environmental claims. Management said additional liabilities could be material but could not be reasonably estimated.
• A proposed PPG asbestos settlement remained subject to contingencies: Travelers could pay about $620 million over 20 years or elect a discounted payment estimated at $468 million as of March 31, 2012. Separate asbestos direct-action settlements, totaling up to $502 million, remained subject to litigation and other conditions.
• A court judgment for $251 million of disputed reinsurance principal was recorded as a recoverable; awarded interest, which brought the judgment to $467 million by January 24, 2012, was not recognized and remained subject to further appeal. A separate workers’ compensation pool settlement could yield Travelers about $90 million, also unrecognized pending appeal.
• Other key exposures include reserve-estimation risk, reinsurance collectability, policyholder and surety credit risk, low interest rates and investment-market volatility, municipal-bond credit risk, regulatory limits on rates and subsidiary dividends, and litigation or emerging coverage issues. The company reported all insurance subsidiaries above risk-based capital requirements and compliance with credit-facility covenants.

Important facts for investors to verify

• Whether rate increases and underwriting actions offset loss-cost inflation, catastrophe experience and competitive pressures—and whether reported 2012 margin improvement materialized.
• Reserve development by accident year and segment, particularly the 2010 accident year’s unfavorable development and asbestos/environmental reserve adequacy.
• Actual catastrophe reinsurance protection, attachment-point changes, recoveries and reinsurer credit quality.
• Investment-income trends, portfolio credit quality and sensitivity to interest rates; confirm the effect of municipal and mortgage exposures.
• Holding-company liquidity, subsidiary dividend capacity, near-term debt maturities, pension funding and the sustainability of repurchases and dividends.
• Status and accounting treatment of the PPG settlement, asbestos direct-action litigation, and the disputed reinsurance and workers’ compensation pool recoveries.