TRAVELERS COMPANIES, INC. annual report, FY2014

Travelers Companies, Inc. — FY 2014 Form 10-K

Business and reporting period. Travelers is a property-and-casualty insurer serving commercial and personal markets. This annual report covers the year ended December 31, 2014; quarterly figures below refer to Q4 2014. Following a July 2014 management realignment, reportable segments were Business and International Insurance, Bond & Specialty Insurance, and Personal Insurance. Prior periods were reclassified for comparison. Dominion, acquired in November 2013, materially contributed to year-over-year growth.

Financial results and condition

Metric	2014	2013
Total revenue	$27.16 billion	$26.19 billion
Net income	$3.69 billion	$3.67 billion
Diluted EPS	$10.70	$9.74
Net earned premiums	$23.71 billion	$22.64 billion
Net investment income	$2.79 billion	$2.72 billion
Combined ratio	89.0%	89.8%
Operating cash flow	$3.69 billion	$3.82 billion
Total debt	$6.35 billion	$6.35 billion
Shareholders’ equity	$24.84 billion	$24.80 billion

2014 pretax income was $5.09 billion and income tax expense was $1.40 billion; the effective tax rate was 27% versus 26% in 2013.
Catastrophe losses were $709 million, up from $591 million. Favorable prior-year reserve development was $941 million, versus $840 million. Both materially affected reported underwriting results.
Underlying underwriting margins improved as earned pricing exceeded loss-cost trends and reinsurance costs fell; increased non-catastrophe weather losses and large losses partly offset those gains.
At year-end, total assets were $103.08 billion and claims reserves were $49.85 billion. Investments totaled $73.26 billion, 93% in fixed maturities and short-term securities; the fixed-maturity portfolio’s average credit quality was Aa2.
Debt-to-total-capital was 20.4%, or 21.7% excluding after-tax unrealized investment gains. Holding-company liquidity was $1.59 billion, above its approximately $1.1 billion minimum target. The $1.0 billion revolving credit facility expires in 2018; $100 million of the $800 million commercial-paper program was outstanding.
Travelers repurchased 35.1 million shares for $3.28 billion and paid $729 million in common dividends. Year-end book value per share was $77.08.

Q4 2014 snapshot

Revenue was $6.78 billion, compared with $6.74 billion in Q4 2013; net income was $1.04 billion, compared with $988 million. Diluted EPS was $3.11 versus $2.70. Quarterly results are affected by catastrophe losses, reserve estimates, and investment gains or losses.

Material changes versus 2013

Revenue rose 4% and earned premiums rose 5%, primarily reflecting Dominion; net written premiums increased 5%. Personal Insurance earned premiums declined 3%, while Business and International increased 9% and Bond & Specialty increased 5%.
Net income increased only slightly, while diluted EPS rose 10%, largely reflecting share repurchases and fewer weighted-average shares.
The combined ratio improved by 0.8 percentage points to 89.0%; the underlying loss ratio improved by 0.5 points. Higher catastrophe losses partly offset better underlying performance.
Operating cash flow declined to $3.69 billion from $3.82 billion, reflecting higher claims, operating and commission payments, and income taxes, partly offset by higher premium collections.
Net investment income increased 3% overall, but fixed-maturity income fell $66 million as reinvestment yields declined; stronger private-equity and real-estate partnership returns more than offset that decline.
Net unrealized investment gains after tax increased to $1.97 billion from $1.32 billion, mainly as interest rates fell. This lifted book value but is market-sensitive.

Outlook, commentary, risks and unusual items

2015 outlook: Management expected strong retention. Renewal premium changes were expected to remain positive but generally below 2014 levels in Business and International and Personal Insurance; Bond & Specialty was expected to be broadly consistent with 2014. Underlying margins were expected to be modestly higher in Business and International, broadly consistent in Bond & Specialty, and lower in Personal Insurance.
Travelers estimated lower fixed-income reinvestment yields could reduce after-tax fixed-maturity investment income by about $25 million per quarter in 2015 versus corresponding 2014 quarters; non-fixed-maturity investment income was also expected to be lower than in 2014.
Cost actions in Personal Insurance were expected to reduce 2015 pretax expenses by $140 million annually versus pre-implementation levels. Quantum Auto 2.0 was available in about 90% of planned states at year-end 2014, with rollout to all planned states expected by year-end 2015. Direct-to-consumer premiums remained modest and the channel was expected to remain unprofitable for several years.
Catastrophe exposure, changing weather patterns, model uncertainty, inflation and long-tail claims could materially affect results. Reinsurance does not remove Travelers’ primary obligation to policyholders; collectability and coverage disputes remain risks.
Asbestos and environmental reserves were approximately $2.70 billion net of reinsurance at year-end. In 2014, the company added $250 million to net asbestos reserves and $87 million to environmental reserves. Management cautioned that ultimate liabilities remain uncertain and could differ materially from reserves.
A court order required a $579 million payment related to asbestos direct-action settlements; Travelers paid it in January 2015. A separate disputed reinsurance claim included $238 million recoverable plus $250 million of unrecognized interest at year-end; trial on remaining issues was scheduled for 2015.
Other notable exposures include the $1.63 billion of unfunded private-equity and real-estate partnership commitments, a $150 million maximum quantifiable guarantee related to certain investments and loans, and substantial pension sensitivity to discount rates. The qualified pension plan was 96% funded at year-end; the updated mortality assumptions increased its projected benefit obligation by $150 million.
The filing reports unqualified audit opinions on the consolidated financial statements and internal control over financial reporting. Management reported effective disclosure controls and no material weaknesses in internal control.

Important facts for investors to verify

Whether favorable prior-year reserve development remains substantial, and the sensitivity of asbestos, environmental and other long-tail reserves to future claims and litigation outcomes.
Whether 2015 pricing, retention and underlying margin expectations were achieved, particularly in Personal Insurance and after normalizing weather-related losses.
Whether Dominion integration, premium growth and cost reductions translate into durable underwriting returns rather than volume growth alone.
Whether investment income declines as forecast and how interest-rate movements affect investment values, book value and pension obligations.
Capital returns and liquidity: sustainability of repurchases and dividends, holding-company cash needs, subsidiary dividend restrictions, and the $400 million of debt principal due in 2015.
Reinsurance recoverability and the outcomes of the pending Munich Re dispute, asbestos-related proceedings and other significant contingencies.