Executive Summary

On July, 23, 2019, Travelers Inc. (TRV) reported results for the second quarter of 2019. Quarterly net income grew by about 6% on a year over year basis to $557 million.

Stiff tariff increases led to 6% in premium gain; however, underwriting performance deteriorated 15% to $52 million. This underwriting was adversely affected by lower run-off gains and a deteriorating combined ratio, partially offset by less holdover losses from prior year events. Overall, underwriting losses were offset by higher investment income.

Source: Travelers’ Q2 2019 Financial Supplements

On a year-to-date level, underwriting gains are up a strong 26.9% to $359 million, thanks mainly to a lower combined ratio. The year-to-date combined ratio improved by 0.7 percentage points to 96.1%, benefiting from the 0.7 percentage point drop in the expense ratio, which ended at 29.9% for the first six months of 2019.

Benefiting from both higher underwriting gains and investment income, Travelers year-to-date post-tax profit grew by 13.4% to about $1.4 billion.

Furthermore, the company continued to redistribute significant amounts of excess capital to shareholders via notable stock buybacks ($750 million) and dividend payments ($419 million). In total, Travelers returned over $1.2 billion to shareholders for the first six months of 2019.

Although Travelers continues to be well-positioned to generated growing earnings supporting its dividend-oriented strategy, I’m not willing to pay more than 1.2 times the company’s book value.

Lower Underwriting Margin In Q2 2019, Improved Combined Ratio in H1 2019

In Q2 2019, net income grew by 6.2% to $557 million, largely due to net investment income growth. Underwriting margins deteriorated slightly due to a higher underlying combined ratio and lower run-off gains.

Source: Travelers’ Q2 2019 Report

On a year-to-date level, net income rose by more than 13% to $1.35 billion, benefiting from strong underwriting performance in Q1 and higher investment income in Q2. The post-tax profit growth was mainly driven by higher contribution from personal segment while both commercial and specialty segments recorded decreased segment income.

Source: Travelers’ Q2 2019 Report

Personal insurance: the personal insurance business enjoyed an improved combined ratio on both quarterly and year-to-date levels. Although the combined ratio was above 100%, it improved by 4.7 points in Q2 2019, benefiting from lower catastrophe losses.

Source: Travelers’ Q2 2019 Report

Furthermore, net written premiums of about $2.9 billion increased 6%, benefiting from tariff initiatives. Agency automobile’s net written premiums increased 3%, driven by renewal premium change of 5%. Agency homeowners’ net written premiums increased 11%, driven by renewal premium change of 7% and higher levels of new business. All in all, the underwriting loss was $28 million, or $113 million lower than in the same period a year ago.

For the first six months of 2019, the combined ratio ended at 95.2%, down by 6.1 percentage points on a year-to-year basis. The H1 2019 combined ratio benefited from lower catastrophe losses, higher run-off gains, partially offset by an unfavorable move in the underlying combined ratio.

Source: Travelers’ Q2 2019 Report

The personal segment recorded an underwriting gain of $198 million, vs. a $100 million loss in H1 2018 and a post-tax income of $366 million. This is a whopping 226% improvement over the same period last year. This significant increase in segment income reflected a combination of higher earned premiums (+4% to $5.1 billion) led by tariff increases partially offset by the new catastrophe reinsurance treaty, lower catastrophe losses, higher net favorable prior year reserve development and increased investment income.

Business insurance: The post-tax segment income declined to $351 million or an 8.8% quarter-over-quarter decline.

Source: Travelers’ Q2 2019 Report

The business insurance segment generated a $55 million underwriting loss, driven by a deteriorated combined ratio. The Q2 2019 combined ratio increased by 2.3 percentage points, adversely affected by higher catastrophe losses, higher underlying combined ratio and lower run-off gains.

The underlying combined ratio of 97.4% increased 0.9 points, primarily driven by higher loss estimates in several commercial lines (general liability products, excess coverages, and commercial automobile business), higher non-catastrophe weather-related losses and adverse impact from the new catastrophe reinsurance treaty. The underlying combined ratio worsening was partially offset by lower large losses, primarily fire-related and a lower expense ratio.

Source: Travelers’ Q2 2019 Presentation

On a year-to-date level, this segments income was $765 million after-tax, a decrease of $72 million.

Source: Travelers’ Q2 2019 Report

The drop in net income was primarily due to decreased underwriting gains, driven by lower net favorable prior year reserve development and the new reinsurance treaty resulting in a 0.5 point increase in the underlying combined ratio, partially offset by higher net investment income.

The $100 million drop in the run-off gains was largely due to $60 million increase to environmental reserves for accident years 2009 and prior, higher than expected loss experience in both domestic and international operations.

Bond & Specialty insurance: Segment income for Bond & Specialty Insurance was $174 million after-tax, a decrease of $30 million. The drop in segment income was primarily due to lower net favorable prior year reserve development, partially offset by the increase in the net premiums, with contributions from both management liability and surety.

Source: Travelers’ 2019 Q2 Report

Although the combined ratio worsened by 8.4 percentage points, the underwriting margins of the segment remained very strong, with a combined ratio below 75%.

On a year-to-date level, the segment income was $312 million after-tax, a decrease of $65 million. As for Q2 2019, the drop was primarily due to lower run-off gains, partially offset by lower catastrophe losses and a positive commercial development in both surety and management liability businesses.

Source: Travelers’ 2019 Q2 Report

Although the contribution of bond and specialty insurance to Travelers’ overall income was lower than last year in the same period, the segment remains highly profitable and generates solid recurring cash flows.

The Increased Contribution of The Investment Portfolio

As I have repeatedly written in many articles, P&C insurers need to focus more on underwriting excellence. Some years, bad things happen, and the investment portfolio is one of the tools insurers use to offset deteriorated underwriting gains. However, one can’t always count on investment portfolio profits to save the day.

In Q2 2019, Travelers’ net investment income increased 8% vs. Q2 2018 and offset the drop in the underwriting income. The investment income benefited from higher investment yield and increased investment base.

Source: Travelers’ 2019 Q2 Report

The fixed income portfolio was the main contributor to investment income, representing more than 84% of the total return. Insurance investments typically benefit from higher interest rates as a large portion of their float is either invested in short term bonds, or if longer term frequently done in a “bond ladder” profile so some rates are resetting every quarter.

Source: Travelers’ Q2 2019 Presentation

As you can see, Travelers’ portfolio is more of the latter.

Pre-tax net investment income from fixed maturity investments in the second quarter and first six months of 2019 was $514 million and $1.03 billion, respectively. $25 million and $55 million higher, respectively, than in the same period in 2018. The increases in both periods of 2019 primarily resulted from higher long-term reinvestment rates available in the market and a higher average level of fixed maturity investments.

Furthermore, the investment portfolio benefited from higher returns from private equity limited partnerships during the second quarter of 2019. On a year-to-date level however, the net pre-tax investment income generated by the private equity portfolio was $36 million lower than in the same period of 2018.

Source: Travelers’ Q2 2019 Presentation

Dividend & Share Repurchase

Travelers’ capital allocation strategy is straightforward, emphasizing redistribution of capital to shareholders. Over the years, the company has returned billions to shareholders via share buybacks and the dividend. It also enjoys a fairly low .6 correlation with the S&P 500.

Following the same strategy as the first quarter, Travelers repurchased 2.6 million shares in Q2 for a total cost of $375 million.

Source: Travelers’ Q2 2019 Report

In total, 5.5 million shares were repurchased during the first half of 2019 at a total cost of $750 million, with total outstanding shares declining to 260.3 million. A 62% reduction over the last 14 years.

Source: Travelers’ Financial Reports

In 2019, Travelers will likely spend $1.1 to $1.3 billion repurchasing shares. At the current market capitalization (about $39 billion), this represents a 3.1%-3.3% return to shareholders. In addition, Travelers Inc. pays a quarterly dividend of $0.82 per share, 2.2% forward yield with a low 30% payout ratio. Therefore, at current prices it’s reasonable to expect an ongoing 5% – 6.5% return from shares. While respectable, but not particularly compelling for new purchases. With a well-covered dividend, and a straightforward consistent plan favoring share buybacks, long-term-oriented shareholders are probably best off keeping their shares.

Debt Position

On March 4, 2019, the Company issued $500 million aggregate principal amount of 4.10% senior notes that will mature on March 4, 2049. The net proceeds were used to repay the Company’s $500 million, 5.90% senior notes on June 2, 2019. Hence, the debt level was flat

Source: Travelers’ Q2 2019 Report

With the increase in the company’s capitalization, the debt-to-capital ratio decreased slightly.

Source: Travelers’ Q2 2019 Report

Takeaways

Q2 2019 results were driven by the underwriting margin deterioration, offset by higher investment income. Rate increases initiated in 2019 should start to pay off more in the near future. Furthermore, a new reinsurance treaty will lower catastrophic costs, should an extreme event occur. Both the personal and commercial segment might be positively affected by changes made over the last year with the specialty business line also continuing to deliver steady results over the cycle.

Put simply, the company is well run and well-positioned to deliver growing results returning excess capital to shareholders via share reduction and dividend increases. However, with a book value per share of $97.26, and a tangible book value per common share of $73.79, the company trades at 1.5 – 2.0 times book. I would find it more attractive at 1.2x book.

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In my opinion, current pricing leads to a return conclusion which is inadequate to warrant long-term investment. However, the company to return to 1.2 times book or some short-term opportunity to present itself, I wouldn’t hesitate to invest in Travelers. This may end up a long wait, but that’s alright, Travelers is worth continuing to follow.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-08-09