The Travelers Companies, Inc. — Q2 2012 Form 10-Q
Business context and reporting period. Travelers is a property-and-casualty insurer with Business Insurance, Financial, Professional & International Insurance, and Personal Insurance segments. This unaudited quarterly report covers the three and six months ended June 30, 2012; comparisons are with the same 2011 periods unless noted. Amounts are in U.S. dollars.
Financial performance and condition
- Second quarter: Total revenue was $6.36 billion, versus $6.39 billion. Net income was $499 million ($1.26 diluted EPS), compared with a $364 million net loss ($0.88 loss per diluted share). Premiums were $5.53 billion, up less than 1%; net investment income was $738 million, down 3%.
- First half: Total revenue was $12.75 billion, versus $12.67 billion. Net income was $1.305 billion ($3.29 diluted EPS), versus $475 million ($1.10 diluted EPS). Premiums rose 2% to $11.05 billion; net investment income declined 4% to $1.48 billion.
- Underwriting: The consolidated GAAP combined ratio improved to 100.5% for Q2 from 125.0%, and to 96.3% for the first half from 110.1%. Catastrophe losses were $549 million in Q2 and $717 million year to date, versus $1.67 billion and $1.85 billion, respectively, in 2011. Net favorable prior-year reserve development was $221 million in Q2 and $525 million year to date.
- Segments, Q2 operating income: Business Insurance earned $362 million (prior year $11 million); Financial, Professional & International earned $182 million (prior year $164 million); Personal Insurance earned $17 million, versus a $471 million loss.
- Cash flow: Operating cash flow was $1.265 billion for the first six months, versus $901 million. Investing activities used $81 million, versus providing $655 million; financing activities used $1.169 billion, versus $1.487 billion. Q2 operating cash flow was reported as $451 million.
- Balance sheet and leverage: At June 30, total assets were $104.33 billion, total investments $72.94 billion, shareholders’ equity $25.05 billion, and debt $6.35 billion. The debt-to-total-capital ratio was 20.2% (22.3% excluding after-tax unrealized investment gains). Company-wide cash was $230 million; holding-company cash and short-term investments were $1.98 billion.
- Capital returns: Travelers repurchased 11.6 million shares for about $700 million during the first half and paid $341 million in dividends. Remaining repurchase authorization was $2.91 billion at June 30. Book value per common share was $64.90, up 9% from June 30, 2011.
Material changes and management commentary
- The earnings recovery chiefly reflected far lower catastrophe losses, somewhat better underlying underwriting margins, and higher favorable reserve development. Management attributed underlying margin improvement in part to earned pricing exceeding loss-cost trends. The 2011 first-half comparison also included a $104 million benefit from resolution of prior-year tax matters.
- Investment income was pressured by lower reinvestment yields. Average pretax portfolio yield declined to 4.2% for both Q2 and the first half, from 4.3% and 4.4%, respectively.
- First-half earned premiums increased 3% in Business Insurance and 2% in Personal Insurance, while declining 5% in Financial, Professional & International. Management noted lower new-business levels in several markets and competitive conditions.
- Management expected renewal price increases to continue through the remainder of 2012 and into 2013, with underwriting margins expected to improve versus 2011 and the first half of 2012. It cautioned that pricing actions could reduce retention or new-business volumes, and that economic weakness could weigh on exposures and premiums. The direct-to-consumer Personal Insurance business was expected to remain unprofitable for several years as it grows.
- The company expected fixed-maturity investment returns to be slightly lower through the remainder of 2012 and into 2013 because of low reinvestment yields. It said it expected to return excess capital, but anticipated dividends and repurchases together would likely not exceed operating income during the remainder of 2012 and into 2013.
Risks, contingencies, and unusual items
- Reserve uncertainty: Gross claims reserves were $50.79 billion. Net asbestos reserves were $2.325 billion and net environmental reserves $387 million. Travelers increased environmental reserves by $90 million in Q2; management warned that further adverse development could produce material future-period charges, but said such additional amounts could not be reasonably estimated.
- Asbestos litigation: A district court ruled in March 2012 that conditions for specified TPC asbestos direct-action settlements had not been met and that TPC was not obligated to pay the settlements. Plaintiffs appealed; the appeal was pending at filing.
- Potential reinsurance recoveries: A court judgment in favor of a Travelers subsidiary totaled $484 million, including interest, at June 30, but the interest was not recognized as income because it was treated as a gain contingency; the reinsurers’ appeal was pending. Travelers also anticipated an approximately $90 million allocation from a separate class settlement if approval survived appeal; this was likewise unrecognized.
- Catastrophe and market exposure: Catastrophe losses are inherently unpredictable, and reinsurance recoveries depend on coverage terms and reinsurer performance. Low rates, market volatility, investment impairments, and interest-rate changes could affect investment income, asset values, and equity. The fixed-maturity portfolio had an average credit quality of Aa2; below-investment-grade holdings were 3.1%.
- Other exposures: The filing cites competitive pricing, economic uncertainty, asbestos/environmental claims, regulation, reinsurance availability, and potential ratings changes as risks. Moody’s, A.M. Best, and Fitch affirmed ratings during the period, with stable outlooks.
Important facts for investors to verify
- Whether catastrophe losses and favorable reserve development normalize, and how underlying combined ratios perform without those effects.
- Whether pricing increases translate into sustained premium growth without materially weakening retention or new-business volume.
- Development of asbestos and environmental reserves, including the environmental reserve increase and pending asbestos settlement appeal.
- Status and collectability of the disputed reinsurance judgment and the unrecognized class-settlement allocation.
- Investment-income trends, portfolio credit and duration exposures, and the company’s capacity to fund capital returns while maintaining insurer capital and liquidity.