The Travelers Companies, Inc. — Q3 2014 Form 10-Q
Business context and period: Unaudited consolidated results for the quarter and nine months ended September 30, 2014, compared with the same 2013 periods. Travelers is a property-and-casualty insurer. Its reportable segments were realigned effective July 1, 2014: International Insurance joined Business Insurance as Business and International Insurance; Bond & Financial Products became Bond & Specialty Insurance; Personal Insurance was unchanged. Comparatives are presented using the revised segment structure.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenues | $6.89B | $6.45B | $20.38B | $19.45B |
| Earned premiums | $5.98B | $5.67B | $17.73B | $16.79B |
| Net income | $919M | $864M | $2.65B | $2.69B |
| Diluted EPS | $2.69 | $2.30 | $7.60 | $7.05 |
| Net investment income | $719M | $657M | $2.15B | $2.01B |
| Combined ratio | 90.0% | 88.9% | 90.3% | 90.6% |
| Operating cash flow | $1.84B | Not clearly provided for Q3 2013 | $3.17B | $2.89B |
Quarterly net income rose 6%, while diluted EPS rose 17%, with the larger per-share increase reflecting share repurchases. For the nine months, net income declined about 1% but diluted EPS increased 8%, also reflecting a lower share count. Premium growth was principally attributed to the 2013 Dominion acquisition. The nine-month effective tax rate was 27%, versus 25% in 2013; the prior-year period benefited from a $63M tax reduction from resolution of prior-year tax matters.
Balance sheet, capital and liquidity
- At September 30, 2014, total assets were $104.52B, total investments $74.19B, shareholders’ equity $25.32B and debt $6.35B. Debt was broadly unchanged from year-end 2013.
- Debt-to-total-capital was 20.0%, or 21.3% excluding after-tax unrealized investment gains; the latter was within management’s 15%–25% target range. Cash was $367M.
- Holding-company cash and short-term investments totaled $1.88B, above the stated approximately $1.1B minimum target. A $1.0B credit facility supports an $800M commercial-paper program; $100M of commercial paper was outstanding.
- Nine-month operating cash flow was $3.17B; investing activities used $402M and financing activities used $2.69B. Financing outflows principally reflected $2.28B of share repurchases and $549M of dividends.
- Fixed maturities and short-term securities represented 93% of investments. Fixed-maturity portfolio average credit quality was Aa2; below-investment-grade holdings were 3.1%. Book value per common share was $76.42.
Material changes and operating performance
- Q3 combined ratio worsened 1.1 points year over year, mainly as lower favorable prior-year reserve development and higher non-catastrophe weather losses outweighed lower catastrophe losses. Nine-month combined ratio improved 0.3 points.
- Q3 catastrophe losses were $83M, compared with $99M; nine-month catastrophe losses increased to $668M from $538M. Favorable prior-year reserve development was $113M in Q3 versus $158M, and $590M year to date versus $581M.
- Q3 net realized investment gains were $40M, versus a $22M loss in 2013; nine-month gains fell to $57M from $155M. Q3 included $35M of gains from selling substantially all of a real-estate joint-venture investment. The 2013 nine-month comparison included $115M of Treasury-futures gains.
- Segment operating income: Business and International Insurance was $552M in Q3 and $1.72B year to date, down 2% and 3%, respectively; Bond & Specialty Insurance was $165M and $511M, up 38% and 28%; Personal Insurance was $239M and $582M, down 9% and 3%.
- Personal Insurance earned premiums declined 2% in Q3 and 3% year to date. Business and International premium growth was substantially influenced by Dominion; Personal Insurance results also reflected higher catastrophe losses and lower favorable reserve development.
- Other revenues were lower than in 2013, which included a $20M gain from sale of National Flood Insurance Program renewal rights and a $91M legal-settlement gain in Q2.
Outlook, risks and unusual items
- Management expected positive renewal premium changes to continue into the remainder of 2014 and 2015, generally at a slower pace in Business and International and Personal Insurance than in the first nine months of 2014. It expected Bond & Specialty renewal changes broadly consistent with recent periods.
- Management projected Business and International underlying underwriting margins above the prior-year comparable period for the remainder of 2014 and broadly consistent into 2015; Bond & Specialty margins broadly consistent; and Personal Insurance margins slightly higher for the remainder of 2014 but lower in 2015 in some lines, assuming normalized or higher weather losses. These are forward-looking expectations, not guarantees.
- Lower reinvestment yields were estimated to reduce after-tax fixed-maturity investment income by about $20M per quarter versus corresponding quarters of 2013 and 2014; non-fixed-maturity investment income was expected to be lower. Management cautioned that market deterioration could reduce investment income or produce realized losses.
- Travelers expected approximately $140M of annual pretax savings by 2015 from its expense-reduction plan, principally affecting Agency Automobile. Quantum Auto 2.0 was being offered in about 80% of planned states, with approximately 90% targeted by year-end 2014. The direct-to-consumer business was expected to remain unprofitable for several years.
- Asbestos and environmental claims, reserve estimation, catastrophe losses, inflation and long-tail claims, reinsurance collectability and pricing, competition, economic conditions, interest rates, regulation and execution of acquisition and expense initiatives are significant risks. Management said additional asbestos or environmental liabilities could exceed reserves and result in material future-period charges.
- Following a July 2014 appellate decision reinstating asbestos direct-action settlements, Travelers recorded $579M, including $77M of prejudgment and post-judgment interest; a rehearing petition was pending. Asbestos reserves were increased by $250M in Q3, and net asbestos reserves were $2.45B at September 30. Environmental reserves were increased by $87M in Q2 and stood at $364M net.
- A disputed reinsurance claim totaled $482M including $244M interest at September 30; the $238M contractual recoverable was recorded, but interest remained an unrecognized gain contingency. Management also disclosed $1.57B of unfunded investment commitments.
- On October 21, 2014, the company declared a $0.55-per-share quarterly dividend payable December 31, 2014. Moody’s and Fitch affirmed ratings with stable outlooks during the quarter.
Important facts for investors to verify
- How much future underwriting results depend on favorable prior-year reserve development, and whether asbestos and environmental reserves prove adequate.
- Whether catastrophe and non-catastrophe weather losses, loss-cost trends and pricing changes develop as management assumed in its outlook.
- Whether Dominion integration and planned expense savings translate into sustainable margins, and the effect of Personal Insurance premium trends and Quantum Auto 2.0 growth.
- Whether investment income can withstand low reinvestment yields and market volatility, and how interest-rate changes affect unrealized gains and equity.
- The outcome and payment timing of the asbestos settlement litigation, and the recoverability and eventual resolution of the disputed reinsurance interest claim.
- Whether continued repurchases and dividends remain consistent with capital needs, insurance-subsidiary requirements and management’s stated capital-return approach.