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The Hanover Insurance Group Inc  (NYSE:THG)
Q4 2018 Earnings Conference Call
Jan. 31, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, and welcome to The Hanover Insurance Group's Fourth Quarter Earnings Conference Call. My name is Chad, and I'll be your operator for today's call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Oksana Lukasheva. Please go ahead.

Oksana Lukasheva -- Investor Relations

Thank you, operator. Good morning, and thank you for joining us for our quarterly conference call. We will begin today's call with prepared remarks from Jack Roche, our President and Chief Executive Officer; and our Chief Financial Officer, Jeff Farber. Available to answer your questions after our prepared remarks are Dick Lavey, President of Agency Markets; and Bryan Salvatore, President of Specialty Lines.

Before I turn the call over to Jack, let me note that our earnings press release, financial supplement, and a complete slide presentation for today's call are available in the Investors section of our website at www.hanover.com. After the presentation, we will answer questions in the Q&A session.

Our prepared remarks and responses to your questions today, other than statements of historical fact, include forward-looking statements, including our guidance for 2019. There are certain factors that could cause actual results to differ materially from those anticipated. We caution you with respect to reliance on forward-looking statements, and in this respect, refer you to the forward-looking statements section in our press release, Slide 2 of the presentation deck and our filings with the SEC.

Today's discussion will also reference certain non-GAAP financial measures, such as operating income and accident year loss and combined ratios, excluding catastrophes, among others. A reconciliation of these non-GAAP financial measures to the closest GAAP measure on a historical basis can be found in the press release, the slide presentation or the financial supplement, which are posted on our website, as I mentioned earlier.

With those comments, I will turn the call over to Jack.

John C. Roche -- President and Chief Executive Officer

Thank you. Oksana. Good morning, everyone, and thank you for joining our call. This morning, I will provide an overview of our strategic accomplishments in 2018, highlights by business and our focus for 2019. Jeff will review our fourth quarter and full year results in detail and provide guidance for 2019, and then we will open the line for your questions.

In many respects 2018 was a defining year for our company marked by solid results and important strategic accomplishments. By selling Chaucer, we intensified our focus on our distinctive domestic P&C business building out capabilities for our agents and customers, while delivering strong returns to our shareholders.

Overall, we are very satisfied with our 2018 financial results. We posted a full year operating EPS of $6.79, operating ROE of 9.9%, and importantly, an adjusted ROE of 12.6%. Recall that operating income for the year does not include Chaucer earnings, but we still have excess capital from the sale.

Our ex-cat consolidated combined ratio at 91% was in line with our original guidance and consistent with our 2017 performance. Though we are satisfied with our 2018 results overall, we are not immune to our share of industrywide challenges. First, the industry sustained elevated catastrophe losses from several California wildfires, winter storms, hurricanes and other events.

While the magnitude of these events was severe, we fared relatively well, a testament to our risk and underwriting practices. For the year, we reported a catastrophe ratio of 5.2%, approximately half a point above our domestic catastrophe expectation.

Though, this was not a significant variance, we continue to focus on exposure management and portfolio diversification given the elevated catastrophe activity in the industry. Second, loss trends in auto have continued to put pressure on industry profits, including ours, particularly in commercial lines where we increased our current year loss ratio selections by 4 points in 2018 based solely on the prior year severity. Loss trends change in our business, and as we said before, our objective is to recognize these changes and react to the information we have as quickly as possible.

The auto bodily injury trends continue to have our full attention. We are taking additional actions to improve auto profitability and to help offset the increased severity, through price increases and various underwriting actions that Jeff will address in more detail. Strategically 2018 was a very important year for us. We focused our resources to build on our unique distribution platform, enhance the organization's technological and analytical capabilities, and capitalized on emerging market opportunities.

We had several noteworthy strategic accomplishments in 2018. First, we conducted a strategic review of our Chaucer segment, resulting in a very successful sale of this business. As I highlighted a few weeks ago, the transaction enables us to focus entirely on our differentiated domestic agency strategy, while simultaneously reducing our volatility and exposure to global catastrophe events.

The sale also provides us with additional capital flexibility as we seek to balance profitable and disciplined growth with capital return to our shareholders.

Second, we continued to build out our specialty business, enhancing our product offerings, further strengthening our market presence and making several key strategic hires throughout the year, including senior talent in cyber, financial institutions, and excess and surplus lines. We have established a strong market position with the top retail agents and brokers, and have set the stage to capitalize on attractive growth opportunities building out our position as a specialty leader in our chosen markets.

Third, we increased business investments across the enterprise, while maintaining our rigorous expense discipline. We actively explore new business models and added capabilities on the technology and digital landscape. For example, we deployed a new agency quoting platform across most of our personal lines footprint, giving us greater underwriting and rating flexibility, as well as the ability to improve our homeowners and Watercraft product offerings. We launched a new customer acquisition platform in micro, professional and general liability products for sole proprietors. We also leveraged telematics and personal auto, expanded the use of drones in the underwriting process and increased the use of robotics, analytics and automation in many of our back office functions. Most notably, we are self-funding these innovative solutions by maintaining expense rigor and reallocating resources and capital to attractive strategic opportunities.

Fourth, we strengthened our position as a carrier of choice for our agents across each of our business segments. Our product and service enhancements combined with our unique consultative approach to agency partnerships, enables us to gain additional shelf space with our agents. In fact, over the last couple of years, we saw 17% increase in the number of franchise agents who write over $5 million in premium with us. These agents combined now write approximately 57% of our overall premiums. The business they place with us is typically spread across two or three business units. For example, specialty, small commercial and personal lines, helping us and them gain efficiencies across the P&C product spectrum. We also strengthened our market presence in some under penetrated geographic markets with select new agency appointments. This year, we appointed approximately 200 new agency locations, many agents we already do business with, to build out some of our less concentrated states, notably in Texas, Pennsylvania, Ohio, Illinois, and Virginia. Finally, we appointed some additional high-quality specialty agents to our platform to expand distribution points for products such as professional liability, management liability and inland marine. These high profit margin products continue to make a meaningful contribution to our bottom line.

Moving on to highlights by business, starting with personal lines, our personal lines combined ratio for the year was 95.5% and 91% excluding catastrophes, despite the impact of higher-than-expected personal auto bodily injury losses and some elevated non-catastrophe property activity. Though above our original expectation, these results demonstrate the value of our balanced book of business, which continues to deliver above target returns.

Differentiation of our offering remains key to our personal lines strategy as we continue to build an increasingly strong brand in the account business segment. Account business now represents 84% of our personal lines book. In 2018, we built on this differentiation with several business initiatives. We expanded our successful agency quoting and service platform originally piloted in Pennsylvania to virtually all of our personal lines footprint. This platform features more pricing sophistication, improved ease of use and coverage enhancements to customers with more complex insurance needs. It also is reflective of our commitment to modernizing our infrastructure and investing in our agency partnerships. Additionally, with its launch in Massachusetts last quarter, our flagship Hanover Platinum product is now available in all states. We also have added telematics, an online coaching product, safe team (ph) in nine states and plan to roll it out across our entire footprint in 2019. Deeper agency relationships and very strong renewal metrics drove our 2018 personal lines growth to nearly 8%. New business growth was also strong, supported by our new personal lines initiatives with momentum coming from our account base platinum and prestige products driving PIF growth of 3.5% for the year.

Going forward, we will continue to balance rate and retention, pursuing higher rate increases in certain states, particularly in areas with elevated auto bodily injury severity. Bodily injury coverage rates are now tracking at 9% and we have plans to achieve higher increases going forward. Overall, we are pleased with the strategic progress made in personal lines and we have confidence in its ongoing profitability.

In commercial lines, we generated a combined ratio of 96.4% for the year, and 90.8% ex-cats, delivering a meaningful improvement over 2017. We grew our commercial lines book by 6% during the year, emphasizing highly profitable lines of business and industry segments. Our broad product offering in small commercial, industry specialization in middle market and continued investments in specialty capabilities allows our agents the flexibility to provide a wide array of insurance solutions to their customers.

Growth in our small commercial segment reflects the positive impact of both strong renewal metrics and new business. Specialty growth was strong throughout the year. This business is now hitting target returns. Many of our newer lines are gaining scale and are producing double digit profitable growth, in particular, professional and healthcare lines, which continue to contribute to our overall performance. Additionally, our specialty businesses continue to further leverage the strength of our agency facing capabilities, driving even more coordination at the agent and customer level. This helped us achieve our growth plan and adds to our relevance with agent partners. Middle market growth was tempered due to continued pricing challenges in lines like workers' compensation and profit actions taken in some underperforming risks including auto. We believe that strong underwriting execution and continued shift to more profitable industry segments will help us expand our profit margins in this business. Core commercial lines pricing improved throughout the year, reaching 6% in the fourth quarter, overall core renewal price increases were led by the rate we were achieving in auto, while workers compensation pricing was pressured based on low industry losses. We expect these pricing dynamics to continue in 2019 as we prioritize earnings over growth.

Overall, we enjoy a strong market position in our core commercial and specialty lines and have confidence in their continued performance. As we look forward, we believe our prospects are strong. We have what it takes to further distinguish our Company in the marketplace, positioning the Hanover as a premier property and casualty company in the independent agency channel. We have the right strategic focus to deliver on our promise to all of our stakeholders. We will continue to leverage the strengths of our agency distribution providing our partners with more capabilities and applying proprietary analytics and insights to enable us to grow profitably together. We will further expand our specialty capabilities and drive further specialization into our core lines of business.

We will achieve this through selective appetite expansion and continued product build out. Finally, we will continue to drive innovation across the firm and deliver new solutions to enhance customer acquisition opportunities for our agents and our company as well as enhance our data analytics and drive process efficiencies. We are determined to deliver consistent top quartile industry performance and to take advantage of these dynamic times in our business, leveraging our great talent, superior distribution model and unique culture, enabling us to deliver strong shareholder value overtime.

With that, I will now turn the call over to Jeff for review of our financials and 2019 guidance. Jeff.

Jeffrey M. Farber -- Chief Financial Officer

Thank you, Jack. Good morning, everyone. For the quarter, we reported net income of $123.6 million or $2.88 per diluted share compared to $51.5 million or $1.20 per diluted share in 2017. After-tax operating income for the quarter was $64.9 million or $1.51 per diluted share compared to $65.8 million or $1.53 per diluted share in the prior year quarter. As a reminder, we have restated our prior year results to remove Chaucer from operating results. The difference between net income and operating income per share in the quarter primarily reflects the gain on the Chaucer sale of $3.08 per diluted share, partially offset by declines in the fair value of our equity portfolio of $0.92 per share, as well as the loss from the early repayment of FHLB debt of $0.48 per share. For the year, net income was $391 million or $9.09 per diluted share compared to $186.2 million or $4.33 per diluted share in 2017.

For the year, operating income was $292.1 million or $6.79 per diluted share compared to $192.6 million or $4.48 per diluted share in 2017. Our annual earnings reflected a combined ratio of 96.1%, an improvement from the 97.3% in the prior year due to lower catastrophe losses and expenses. The combined ratio for the quarter was 97.4% compared to 95% in the prior year quarter. During the quarter, catastrophes totaled $50 million or 4.6% of earned premium, a point above our assumption.

The largest drivers of catastrophe losses were the California wildfires and Hurricane Michael. Full year catastrophes totaled $219.2 million or 5.2% of earned premium above our 4.6% assumption. The magnitude of our catastrophe losses overall was consistent with or better than our market share would indicate, which is a testament to prior diversification and underwriting actions.

Excluding catastrophes, we delivered a full-year combined ratio of 90.9% in the range of our original guidance of 90% to 91% and consistent with our 2017 ex-cat combined ratio of 90.9%. Our underwriting results in the quarter reflected both heavier current period property losses and reserve adjustments to position our full year liability loss selections making quarterly comparisons between periods more challenging. Taking this into consideration, I will largely focus my comments on full-year results mentioning quarterly movements were appropriate and relevant.

Based on our 2018 reserve reviews, we remain confident in our overall reserves. The cumulative impact of prior year development was zero. However, we continue to make reserve adjustments in specific areas for prior year to reflect our current judgments by line. I will review our underwriting results by business. Our personal lines business has continued to perform well posting a 95.5% combined ratio for the year. We delivered a full-year combined ratio, excluding catastrophes of 91%, up from the 89% posted last year. The increase for personal lines was driven by both unfavorable prior year development and to a lesser extent an increase in current accident year losses. During the quarter, we increased our personal lines prior year reserves by $15.4 million or 3.5 points of the combined ratio related to both homeowners and personal auto.

For homeowners, the increase was due primarily to a small number of large claims including umbrella endorsements reported in our homeowners' line of business, primarily from the 2017 accident year. Auto development reflected continued elevated severity of bodily injury losses in recent prior years, most notably in the 2016 accident year. We are seeing higher medical cost inflation and increased attorney involvement in this line. However, the impact of this trend is mitigated in personal auto by relatively low policy limits. Though early indications of 2018 personal auto accident year loss activity are actually favorable, we increased our 2018 full-year estimate in our bodily injury coverage as we are reacting early to trends seen in prior periods. This drove an increase in the 2018 current accident year loss ratio of 0.4 points for the year and 2.5 points for the fourth quarter.

Personal lines fourth quarter current accident year results were also affected by the impact of non-catastrophe weather in our homeowners' line. Non-cat weather was driven by frequent and heavy rain falls in the Northeast and in the Midwest. We do not believe that the spike in property claims activity in the second half of 2018 is a systemic issue, but we are watching our own trends and industry data intently for factors such as replacement cost inflation and we'll seek additional rate increases in 2019 if needed.

Our loss ratio for homeowners for the full year of 2018 was remarkably consistent with the last 5 years average. These factors led the personal lines full year current accident year loss ratio to increase by 0.8 points to 61.2% compared with the prior year. Personal lines net written premiums increased by 7.7% for the year and 7% for the quarter. This growth was driven by strong retention of 83.7% and rate of 4.6% in the quarter. Going forward, this growth may moderate as we continue to increase rates for BI coverages and closely monitor trends for all of personal lines. We will react with price and underwriting actions as needed. Overall, at a 95.5% all in full-year combined ratio and 89% on an ex-cat accident year basis, our personal lines business continues to perform well and delivers results above our target returns, although we may see a slight increase in our 2019 accident year loss ratio versus our 2018 results. We are confident this book will continue to exceed return targets.

Moving to commercial lines, we delivered an all-in combined ratio of 96.4% for 2018, compared with 99.3% for 2017. Excluding catastrophe's (ph), the combined ratio improved by 1.4 points, helped by favorable reserve development, lower expenses, and a stable underlying current accident year loss ratio, the commercial lines favorable development of $16 million or 2.5% for the quarter was primarily driven by reserve releases in workers comp and general and professional liability lines, partially offset by reserve additions in commercial auto. The continued emergence of adverse trends in our commercial auto book remains disappointing.

Industry commentary attributes this pervasive trend primarily to attorney involvement and increasing medical costs. Our experience confirms that medical costs are on the rise and lawyers are now involved in more cases increasing severity and the time to close for such cases. Consistent with our reserving philosophy, we raised our loss risk (ph) assumptions for prior accident years and aligned our current year selections to the (ph) updated view of these trends where appropriate. We continue to take aggressive actions, including obtaining rate increases, improving pricing segmentation and increasing deductibles. We achieved a 9% price increase in the fourth quarter in auto and we believe further increases are achievable.

It's important to note that the majority of our $300 million of commercial auto premium is account driven, with the overall account remaining profitable. However, we continue to aggressively manage our small remaining mono-line business, actively reunderwriting this book. Auto aside, the rest of our commercial lines businesses are performing well with strong profitability gains in other commercial lines. CMP also delivered a relatively strong loss ratio despite being somewhat elevated due to property volatility in the second half of 2018. We are particularly pleased with our profitability in our specialty businesses, as evidenced by our performance in other commercial lines. On a full year basis, our current accident year loss ratio improved 1.7 points, helped by mix and underwriting actions as well as the general maturation of the book. Overall, our specialty businesses now exceed our target returns.

Our workers' compensation portfolio continued its strong performance during the year, improving the accident year loss ratio by 0.7 points. We continue to watch for emerging trends in this economy with very high employment and rate declines, but we remain very pleased with the ongoing strong performance in this line. The commercial lines expense ratio improved by 0.7 points compared to the prior year, helped by earning in the benefit of the cost initiatives executed in 2017 and leverage on fixed expenses from growth. Commercial lines net written premium grew by 6% for the year. This growth was driven by strong retention of 84.5% and accelerating pricing increases throughout the year, which culminated in an increase of 6.1% for core commercial lines in the fourth quarter. Importantly, growth stem from higher margin businesses including small commercial lines, professional lines, marine and specialty property, increasing the quality of our portfolio mix and profitability. Overall, commercial lines performed well despite the market headwinds during the year. We are confident in our ability to grow this business responsibly while maintaining stable underwriting profits.

Onto our investment performance, net investment income was $69.4 million for the quarter and $267.4 million for the year, increases of 10.9% and 9.6% for the quarter and year respectively over 2017. The increase was primarily driven by higher operational cash flows and strong partnership income. Cash and invested assets were $8.3 billion at the end of the year with fixed income securities and cash representing 86% of the total. Our fixed maturity investment portfolio has a duration of 4.5 years and is 95% investment grade. The well-laddered and diversified portfolio remains high quality with a weighted average of A plus (ph).

The operating effective tax rate for the quarter was 20.8% largely in line with the statutory rate. We anticipate that the effective tax rate going forward will roughly equal the statutory rate of 21%.

Moving on to equity and the strength of our capital position, our book value per share was slightly down for the quarter on a reported basis, it increased by 5.9% giving consideration to the special dividend of $4.75 we declared at the end of December.

More specifically, book value per share for the quarter declined by $0.59. This was driven by dividends of $5.35 per share, both special and ordinary, partially offset by net income of $2.88 per share and the additional economic gain on the Chaucer sale of $1.39 per share.

The economic gain reflected the impact of Chaucer's historical unrealized losses, and other AOCI items that have previously been reflected in the book value. As a reminder, the $250 million accelerated share repurchase agreement that we announced in conjunction with the close of the Chaucer sale was executed on December 31st, 2018, but had a settlement date of January 2nd and will be accounted for in our first quarter results.

On January 2nd, we retired 1.8 million of outstanding shares which will bring the first quarter average share count down to approximately 41.5 million. The ASR will conclude in the second quarter with the remaining shares to be retired at that time. We remain committed to diligently deploying capital through either investment in profitable business opportunities or capital return to shareholders.

In the aggregate and including the accelerated share repurchase agreement in progress, the Hanover returned to shareholders approximately $600 million of capital in 2018 or 20% of the beginning equity for the period. Our current balance of Chaucer related deployable equity is approximately $400 million.

All in our operating return on equity was 9.9% for 2018. After adjusting for deployable equity related to Chaucer, operating return on equity for the year was 12.6%. Before opening the line for questions, we want to share with you our guidance for 2019. We anticipate overall net written premium growth in the mid-single digits, driven by growth in our most profitable businesses. NII should increase by mid-single digits, driven by both increased cash flows and the higher interest rate environment. Our domestic expense ratio should improve as we benefit from the fixed expense leverage with increased investments in our business funded through expense savings. Our combined ratio, excluding catastrophes, should be approximately 91% to 92% plus a catastrophe load of 4.6% for the year. The catastrophe load is consistent with our prior year domestic assumption. Again, we expect an effective tax rate of 21%. We would also like to remind you of the seasonality of our business, while our first quarter catastrophe load of 4.4% is in line with the full-year average, our more northern footprint tends to show higher non-catastrophe weather losses in the first quarter. In addition, first quarter commercial lines growth will be negatively impacted by specific non-renewals.

With that, we will now open the line for questions, operator.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question will come from Matt Carletti with JMP Securities. Please go ahead.

Matt Carletti -- JMP Securities -- Analyst

Hey, thanks. Good morning. Jeff, maybe if I could just pick up where you left off on the guidance, can you help us take it one step further and with -- there's been a lot of obviously changes in 2018, lot of capital changes, Chaucer gone, lot of rating agency impact and otherwise. Can you help us kind of translate some of those changes into kind of stable state all else (ph) equal, how should we think about capital changes and the impact on ROE. So if combined ratio were stable, would you expect ROE to be stable or would you see improved ROE because you're getting better capital leverage post deal or post those changes?

Jeffrey M. Farber -- Chief Financial Officer

So -- thank you, Matt. I appreciate it. So, first of all, we wanted to raise our 2019 (inaudible) based on the loss trends we were seeing and we wanted to be a little more conservative. I think it's also important when you look at the midpoint of the 91% to 92%, the ROE on that basis, including the excess Chaucer equity and assuming that for this purpose only that we don't do any other capital management actions in 2019 other than that have been announced and again that's just for this purpose only, the ROE would be 11%. If you adjust for the equity, that's for the un-deployed equity of $400 million, the ROE is nearly 13%. So, I feel pretty comfortable with those results. I think nearly 13% even though we are raising our (inaudible) to be more conservative, it's pretty darn solid.

Matt Carletti -- JMP Securities -- Analyst

Yes, absolutely. You actually lead me to my next question, which was on the deployable capital, obviously if the ASR is active, my understanding is that should wrap kind of four to six months in, can you help us just with -- kind of remind us of the timing and the kind of thought process as to that remaining $400 million or so when we get to that point and how you will address it?

Jeffrey M. Farber -- Chief Financial Officer

Sure. So we've spent the last four months or so talking with investors and analysts about Chaucer sale, excess capital in the deployment and upon day one of the closure of the Chaucer deal, we redeployed $450 million of $850 million of deployable excess capital. So I believe that's really a nice installment and really demonstrates that we're going to do what we say we're going to do. So the ASR itself will complete in May or June depending upon how quickly JPMorgan buy stocks. At some point in the second quarter, the ASR will complete. The rest will be redeployed through investment and/or capital management in a very reasonable timeframe in the best interest of our investors and we will communicate timely about our actions but we want to maintain a little bit of flexibility at this point to give us the options to deal with that in short order.

Great, thank you for the color and best of luck in 2019.

Thanks, Matt.

Operator

The next question comes from Amit Kumar with Buckingham Research. Please go ahead.

Amit Kumar -- Buckingham Research Group -- Analyst

Thanks and good morning. Maybe, I'll take these in reverse order. Going back to Matt's question on capital management, you mentioned a reasonable timeframe, is that, is it fair to say that the reasonable timeframe will translate into getting most of this or all of it done by let's say early 2020 or could some of it be spread over 2020?

Jeffrey M. Farber -- Chief Financial Officer

Amit, thanks for the question. I think it's early for us to conclude on that. It is certainly not out of the realm of possibilities that it's finished in '19 and it's not out of the realm of possibilities that it spills over into 2020. We understand what shareholders are interested in and they want us to use it in the best interest of the company and holders and we will do that. And so as we finish the ASR in the second quarter, we will come back to investors and talk with you about our thoughts and our actions and the opportunities.

John C. Roche -- President and Chief Executive Officer

Yes, this is Jack, I would just say that as we go throughout the year, the framework that Jeff has outlined in the regular communication is our commitment that we will be transparent about what deployable capital is left, if we made any use of the capital and we have no intentions of dragging out excess capital on our balance sheet with no use that is really accretive or would be helpful to building this company in a way that shareholders would appreciate it. So that is our complete commitment. What we don't know is what opportunities could emerge and so we want to maintain a little bit of flexibility as Jeff stated.

Amit Kumar -- Buckingham Research Group -- Analyst

And does that mean, I know in the past you have talked about how efficient an ASR buyback is. So, does that mean we should not we should not take off the possibility that there could be another special dividend or am I getting ahead of myself?

Jeffrey M. Farber -- Chief Financial Officer

I think you should not take the possibility -- triple-negative. I think it is certainly possible that there could be a special dividend later in '19, but it is entirely possible that we have other more effective uses for the capital, depending on what investments there are and depending on how we feel about buying back stock and those sorts of things. So, we have flexibility to do either, but certainly not off the table.

Amit Kumar -- Buckingham Research Group -- Analyst

Got it, but moving onto the commercial auto discussion, and I know Matt asked this, in terms of the guidance and net-net all else equal, how much of that is -- what exactly would be the point translation from the commercial auto loss pick for the 2019 number, is that 100 basis point or how should we think about that?

Jeffrey M. Farber -- Chief Financial Officer

I don't think we have that detail in front of us at the moment on the specifics; certainly commercial auto for us is not a large line, right, its $300 million of premium. We believe it's improving in 2019 because we're getting such substantial amounts of rate, but (inaudible) can work with (inaudible) after they go through some of the details on the triangle and the information there.

John C. Roche -- President and Chief Executive Officer

Yeah, this is Jack, I would tell you that what we are -- I'm sorry Amit, go head.

Amit Kumar -- Buckingham Research Group -- Analyst

(inaudible) continue answering, (inaudible).

Jack Roche -- President and Chief Executive Officer

Yeah. I think it's hard to -- sometimes it's hard to work through a roll forward for viewing it in a line where the loss trend is obviously moving. That said, we have a point of view on how loss trend is developing and we've made some material adjustments in pricing, you saw that throughout the year, heading into '19, we've made some additional adjustments to try to get on top of the BI severity in particular and we have made some adjustments from an underwriting standpoint on business that tends to be a little bit auto-centric or in the wrong geographies, which is why we qualified a little bit our commercial lines growth in the first half of the year because we want to make certain that we are addressing this concerning loss trend in the business.

That said -- as Jeff said, we're an account writer (ph) in specific sectors of the business, so auto in of itself doesn't drive our results, but we realize, we've got to get on top of this one as does the industry.

Amit Kumar -- Buckingham Research Group -- Analyst

That's fair. Last question, on Slide 10, you talk about the pricing increases of 6% that I would imagine half -- roughly half of that is real pricing and the remainder is account exposure. When you think toward 2019, are you assuming a flat level of pricing and loss cost trends on an underlying basis? Maybe just talk about that, is it 3 versus 3 or ex-commercial auto the remainder gets better. Just maybe just expand on that?

John C. Roche -- President and Chief Executive Officer

Yes, thanks. So, this is Jack again. Overall, I would characterize both our pricing view and loss trend view as reasonably flat. We're going to have to continue to watch that very carefully as we make some adjustments and see if the improvement that we're anticipating shows up and that bends the curve if you will a little bit on loss trend for us, but we project into the year a relatively stable kind of situation with some slight accident year improvement in the commercial auto area in particular.

That said, we know that workers comp is continuing to drive through negative pricing for the industry. We've made some adjustments to minimize the effect of that on us. And so, we're watching, there's been discussion about frequency in that line of business that we haven't seen a lot of movement on, but overall the puts and takes, put us in a pretty kind of stable environment.

Amit Kumar -- Buckingham Research Group -- Analyst

Got it. I will stop here. Thanks for the answers and good luck for the future.

John C. Roche -- President and Chief Executive Officer

Thank you.

Operator

The next question comes from Christopher Campbell with KBW. Please go ahead.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Yes, hi, good morning.

John C. Roche -- President and Chief Executive Officer

Good morning.

Jeffrey M. Farber -- Chief Financial Officer

Good morning.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

I guess my first questions are just on the guidance, I think just going through a few of the items, the net written premium seems like that's in line with last year at mid-single digits, and Jeff, I think you mentioned in your opening script about focusing on the most profitable lines, I guess, could you kind of rank that for us just in terms of how you're thinking about growth across personal, commercial, and specialty lines, just where they're at in terms of excess return above your targets for each of those broader groups, and then just, I guess, how does the relative performance now, how does that feed into your view of if you want to use some of the Chaucer proceeds for accelerating growth in each of those segments?

Jeffrey M. Farber -- Chief Financial Officer

Thank you, Chris. The areas that we feel strongest about in terms of profitability and therefore growth are really personal lines overall on account business, small commercial and many areas of our specialty business.

John C. Roche -- President and Chief Executive Officer

Yeah, this is Jack. I would build on that in that what you're seeing is our portfolio is maturing and where we have frankly more opportunities to look across our business and look for where profitable growth can come through and balance that against some of the dynamics that are going in the market. Even as we talk a little bit more cautiously about the middle market business, we have sectors within our middle market portfolio that are producing returns as good as any other part of our portfolio. So it is truly a portfolio management process for us inside the firm and with that, I'd love to just give Brian Salvatore a minute here because we probably haven't stated kind of our confidence in our momentum that's been building in the specialty commercial lines side enough, so Brian if you would, maybe you could give a flavor of that for your businesses.

Bryan J. Salvatore -- President, Specialty

Yeah, sure, Jack. Thanks. I'd like to start by sharing that the specialty business that we've built is now in excess of $1 billion in premium and it did perform quite well for us in '18. If you refer back to Jeff's comments on the other commercial lines accident year loss ratio ex-cat last year that was 52.6, that did achieve our target returns, it's over a point and a half better than the year before and I use the OCL because it does meaningfully overlap with our specialty businesses. I would say that we have -- we have built out a pretty broad offering in the specialty space. That offering is very much connected to the needs in the books of our agents and so we like the relevant set that brings to our agents but as we are driving growth, what I would really sort of call out is that what you'll see is that we are going to be continuing to drive growth in what we would look at as our most profitable areas -- our best performing areas including professional liability and healthcare, marine, our commercial surety, these are areas that perform quite well for us and I think those are the areas that we will continue to continue to drive growth in and I think that that really adds value for Hanover.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Just another question on the healthcare, you had brought that up, but I know there was like an E&S (ph) competitor that's kind of pulling out of healthcare. I guess, what's attractive about that line right now for Hanover?

Bryan J. Salvatore -- President, Specialty

Yeah, I'll start. So for us, I think it's important to remember our book is a bit different, right. We are focused on what our agents books of business, and that really brings us to -- they are smaller accounts, it's focused more on the allied space, you won't see us in the hospital, the large healthcare system space, and so I think the way it performs is a bit different and we're very comfortable with it.

John C. Roche -- President and Chief Executive Officer

Yeah, this is Jack. I think that is the professional liability space, both in healthcare and more broadly is a good area to spike (ph) out and suggest that there is quite a dichotomy, right, you can see on the higher end in particularly in certain sectors like medical, there's a bit of a hard market and there is some real challenges going on; on the low end of the spectrum, there is some terrific returns and so what we try to do is to segment that in terms of where we think the profitability is and where our agents are most advantaged and bring those together, but it is -- it's a portfolio management exercise within the broader portfolio management that we do as a firm, but that's a great example of -- that's one of our most profitable areas in the company. But on the other end of the spectrum, there are some folks that are having some real problems on the med-mal side.

Bryan J. Salvatore -- President, Specialty

The only other thing I would add Jack is that we're also achieving -- our pricing that we're achieving in that space is really in line with trends. So we feel good about that as well.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Got it. That's very helpful. And then, another one for you, Jeff. On the guidance, the expense ratio, I think you said that's going to improve year-over-year. I think it was 50 bps year-over-year last year, just in terms of like the growth that you're forecasting, what's the potential for your expense ratio improvements in 2019?

Jeffrey M. Farber -- Chief Financial Officer

So the way we think about expenses, a company like us, there are a number of investments that we need to make around data and analytics and claims and ease of use for customers and so we continue to make those investments and we are committed to funding those investments with expense savings but we are not going to have expense savings of fixed costs beyond that, but what we do get is a leverage on our fixed cost as we grow. So, I think, on the order of 20 basis points is probably what you can expect on the expense ratio from the benefit of growth and levering those fixed costs a little bit better.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Got it. That's very helpful. And then just kind of my final one is more on auto. I think some of my peers have asked about this one as well. I guess shift in commercial auto, it sounds like you're accelerating your rate plan there and assuming it's basically constant. Just what gives you confidence, just in terms of the rate level you have, just given the problems we've seen across the industry about various competitors who have put in fairly aggressive commercial auto rates and then raised (ph) loss picks and done all of that, added reserves, and it's still an issue in terms of taking enough rate to get up with -- or to get ahead of an accelerating loss cost trend. Walk us through your process on that and why we should be confident in the rate levels that you guys are taking?

John C. Roche -- President and Chief Executive Officer

Yes, this is Jack. I would tell you that you're spot on, Chris. I think this is still a moving target for the industry. And so, we are vigilant about watching this trend, looking at what the various contributors are. I think we have a stronger view as we've ever had about what's driving the severity increases. But I'll let Dick Lavey kind of talk to you more -- in more detail about what we're doing and really our confidence level that we can bend this curve and make sure that the profitability delivers.

Richard W. Lavey -- President, Hanover Agency Markets

Yeah. Thanks, Jack. Yeah, so as stated, we were looking at this very aggressively and dissecting it as best we can with a multi-disciplinary team with underwriting and claims and actuarial as you'd expect to really try to get underneath the loss trend. Our actions are pointed and specific and we think aggressive and we'll adjust should we need to -- driving rate across the entire book of business, as you saw, we ended the quarter at 9 points, we're going to push that 10 into 2019, and when we look at our retention of the book and what we see happening in the industry, we are highly confident that we actually can push more rate. Working hard at reducing mono-line auto as was mentioned, shifting away from some of those heavy auto classes, non-renewing some non-performing business and Jack references before too, but geography is a really important element to this, we study where the losses are coming through at a state level, and we see certain states performing worse than others. So, we're throwing our bodies at it, so to speak, and we think we have as good a visibility as we can and we will make adjustments with each passing month.

John C. Roche -- President and Chief Executive Officer

I think this is -- the last thing I would say about this Chris is that intuitively, there will be a point in which the delays in medical information coming through somewhat driven by some of the privacy laws that make it more and more difficult for adjusters (ph) to be able to obtain information about claims earlier in the process and understand which claims might erode on us. There are new tools in place to help with that, but there's also a maturation to that whole claims development. So I think as an industry, at some point in time much of the change that's happened over the last five or six years hit some inflection point, hopefully eventually starts coming back down, but I think the combination of some pretty substantial pricing that is going on in the marketplace and some maturation of those trends should give you confidence that eventually this thing flattens out and starts to go back the other way.

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Okay, great, well thanks for all the answers. Best of luck in 2019.

John C. Roche -- President and Chief Executive Officer

Thanks, Chris.

Operator

The next question will be from Paul Newsome with Sandler. Please go ahead.

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

Just a couple of follow-ups. One, if I missed it, I apologize. Did you give any color on that sort of a commercial lines renewal pickup in the first quarter and why that's something that's one-time in nature?

Jeffrey M. Farber -- Chief Financial Officer

I am not sure, I understand the question...

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

I think you said something along the lines of net written premium (multiple speakers).

Jeffrey M. Farber -- Chief Financial Officer

Oh, in terms of actually some renewal retention drop in the first quarter that would affect our commercial lines growth, is that would you referring to?

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

Yes.

Jeffrey M. Farber -- Chief Financial Officer

Just a couple of idiosyncratic things going on in the first quarter, the prior year had some reinsurance premium that is slipping (ph) the other way. There's a couple of accounts, Dick mentioned, the mono-line accounts that are non-renewed. So just as we think about the full year, the year-over-year growth for commercial lines, specifically in core commercial would just be a little bit slower than it has been over the past or for the full year. That's all we're just telegraphing, nothing particular.

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

And then I'm just curious, is there much of a difference in the personal lines medical cost inflation issues between TEP (ph) states and non-TEP states in your book?

Jeffrey M. Farber -- Chief Financial Officer

Well, maybe start with the first part of your question, I think the first part of your question is that what is different about personal auto in total is that generally even for a book like ours that's more account-centric and tends to have some nice characteristics to it, the limits on the business still are considerably lower than you would see for example in commercial lines and so it contains if you will some of the loss trend that we're seeing, but Dick (multiple speakers) point of view specifically on PIF versus non-PIF states.

Richard W. Lavey -- President, Hanover Agency Markets

I would just add to that in the TEP states, Michigan being the biggest one of them, we have -- the nature of the claims, the fatalities, the delayed medical, the legal -- the lawyer involvement, I wouldn't say is dramatically different, but we do an excellent job as you know of managing our results in Michigan where we have a 10-point advantage over the industry. We just have scale and we have a lot of experience, a lot of feet on the ground. So we've done a great job there, but in terms of the dynamic of the loss, I wouldn't say it's dramatically different, just shows up in a different line where it shows up in TEP as opposed to bodily injury.

John C. Roche -- President and Chief Executive Officer

Yeah, what is common -- this is Jack again. What is common is that the pushing out of the durations of some of these claims are part of the challenge right. We have seen a meaningful kind of push out of the duration of the severity based claims then whether that's a PIP claim that takes 18 months to 24 months to develop and come back into our claims portfolio or whether it's a BI claim that we're addressing that (ph) up. What we're seeing is a consistent pattern in either avenue, if you will, where that delay is causing us to have to reflect the different development pattern.

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

Thank you. That's great.

Operator

(Operator Instructions) The next question comes from Larry Greenberg with Janney Montgomery & Scott. Please go ahead.

Larry Greenberg -- Janney Montgomery Scott -- Analyst

Hi, thanks and good morning. Most of my questions were answered, but just one simple one, can you remind us in terms of your catastrophe load what the -- whether commercial and personal should -- we should assume kind of similar loads or is there a difference between the two?

Jeffrey M. Farber -- Chief Financial Officer

Larry, I don't think we've given that in terms of the catastrophe load, I think if you look over time and you see how the two have performed, you can probably guess at that a little bit, but we haven't shared that yet. I guess, we'll give some thought to whether we ought to break that out for people, but overall 4.6% is the overall load.

Larry Greenberg -- Janney Montgomery Scott -- Analyst

Right. Okay, thanks. That's all I had.

Jeffrey M. Farber -- Chief Financial Officer

Alright. Thanks, Larry.

Operator

Next question will be from Sam Hoffman with Lincoln Square. Please go ahead.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

Good morning. I'm just calling in to get a little bit more detail on the commercial auto. So can you give exactly what the loss trend is in that line for the full year 2018, in the fourth quarter of '18 and then right now what the run rate is?

John C. Roche -- President and Chief Executive Officer

Yeah, this is Jack, unfortunately, we are not really at the liberty to kind of give by line loss trend particularly on a short-term basis and I think the last couple of years have proven why that's not prudent because nobody anticipated the auto trends to accelerate the way they did. But I think as we look over the long haul, we definitely see that commercial auto trends have ticked up maybe as much as a couple of points over the last few years in terms of people's view of that in the mid -- the short to mid-range, but we've been adverse to try to put out specific loss trends by line of business and pretend like we have a crystal ball at that level.

Jeffrey M. Farber -- Chief Financial Officer

Sam, I think, we are going at this hard, you can be sure that we're getting price increases that Dick mentioned of nine moving into 10%, we're looking at segmentation, the very small portion of our $300 million that happens be mono-line, we're revisiting that small piece and we're just not backing off these corrective actions.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

What is the earned (ph) price increase at this point like on the run rate basis heading into 2019?

Richard W. Lavey -- President, Hanover Agency Markets

This is Dick. So we, in the fourth quarter, we saw nine points of rate...

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

That is the written or the earned?

Richard W. Lavey -- President, Hanover Agency Markets

That is written. That is applied right, so, it will take some time to earn that in. Yeah, because we've been getting close to 9% in the fourth quarter, close to 9% in the third quarter, the earned will not be substantially different than the written in. By the time you get to '19, it'll be a little bit slower in the first quarter and it'll pickup with intensity.

John C. Roche -- President and Chief Executive Officer

And I think we can safely say -- this is Jack again -- we can safely say that the price that we will drive in 2019 in commercial auto will be meaningfully above even a conservative estimate of loss trends.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

Okay for the loss trends in 2018 were in the high single digits. It sounds like ---

Jeffrey M. Farber -- Chief Financial Officer

That's correct.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

Yeah, OK, and then my followup is, is there any reason to believe that Hanover's commercial auto business book as a whole is better or worse in terms of loss ratio than comparable companies -- comparably situated companies in the industry given that the bulk of your business is account driven, how should we think about that as we look at benchmarking and thinking about what your loss ratio should be?

John C. Roche -- President and Chief Executive Officer

Yes, thanks for that. This is Jack again. Well Dick, why don't you go.

Richard W. Lavey -- President, Hanover Agency Markets

Yeah, I mean, I think it speaks to the strategy we deployed in the marketplace with playing heavily in the small commercial segment and the lower end of middle market where frankly the commercial auto fleets are smaller, our classes tend to be more professional in nature, so I do think that there is an element of -- the nature of the mix of business we have both size and class, you could argue is going to lead us to a better outcome than other companies that play in bigger spaces, bigger fleets, more complex classes of business.

John C. Roche -- President and Chief Executive Officer

And that's what we were alluding to earlier that when you think of manufacturing firms that have big fleets are wholesale companies that tend to be auto-centric, we've made some meaningful repositioning in those kinds of classes or those kinds of businesses, because frankly you just can't overcome the odds, the mix -- the line of business mix dominates your ability to make profit.

So we've -- that's where we've made some real meaningful adjustments and I think our portfolio vis-a-vis the industry tends to be on the lower account size and then lastly, a point I made earlier, the percentage of our book that's mono-line auto is quite small and getting smaller and so the mono-line auto that we have remaining performs quite well, but that in the past has been the place where we needed to do some underwriting and manage the loss ratio.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

Okay. And since you're focusing on smaller accounts, would you say that your expense ratio in that line would be higher than peers and therefore the combined ratio would be about the same or do you think overall your combined ratio should be somewhat better than the industry.

John C. Roche -- President and Chief Executive Officer

Yeah, I think it's hard to make a lot of comparisons because some of that can depend on -- go to the other extreme, where if you get into trucking businesses where the commissions tend to be lower and so the loss ratio profile. So it's hard to make a real general statement, I think, the hypothesis of our firm is that by playing on the lower end of the commercial line space, we will have a slightly higher expense quotient and a lower loss ration component in total but again what we caution people over time is as we get more specialized then the account size versus the complexion of how much of your business is specialty or specialized can also work against that same kind of expense to loss ratio quotient. So, overall, we're quite comfortable that the returns we're delivering show expense ratio improvement overtime and a good stable loss ratio.

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

Terrific, well thanks for taking my question.

John C. Roche -- President and Chief Executive Officer

Thanks, Sam.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Oksana Lukasheva for any closing remarks.

Oksana Lukasheva -- Investor Relations

Thank you all for your participation today. We're looking forward to talking to you next quarter.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 65 minutes

Call participants:

Oksana Lukasheva -- Investor Relations

John C. Roche -- President and Chief Executive Officer

Jeffrey M. Farber -- Chief Financial Officer

Matt Carletti -- JMP Securities -- Analyst

Amit Kumar -- Buckingham Research Group -- Analyst

Jack Roche -- President and Chief Executive Officer

Christopher Campbell -- Keefe Bruyette & Woods Inc -- Analyst

Bryan J. Salvatore -- President, Specialty

Richard W. Lavey -- President, Hanover Agency Markets

J Paul Newsome -- Sandler O'Neill Partners -- Analyst

Larry Greenberg -- Janney Montgomery Scott -- Analyst

Sam Hoffman -- Lincoln Square Capital Management LLC -- Analyst

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