Don't waste an hour listening to the latest Travelers Companies (NYSE:TRV) earnings call. Just read this instead.
1. All about returns
The company's objective is simple enough: to achieve mid-teens levels in operating return on equity for the long run. So far, the insurance giant is right on track, with the full-year and fourth-quarter operating ROE falling above the 15% mark.
But management takes the goal one step further, with its focus on getting the most out of each product it offers.
With the changes management instituted in 2013, Travelers' products shifted dramatically in terms of return tranches. While the majority of its products were in the lowest return tranche as of the first quarter of 2013, the estimates for the first quarter of 2014 show the majority has moved up to a 10%-20% return rate.
By focusing on the individual products and their respective returns, the management team can ensure the company is a well-oiled machine churning out a return that meets its long-term goal.
2. Price is right
One of the biggest pricing changes Travelers made was a new product within its personal auto insurance segment. By offering a new product lower in price, the insurer was aiming for a bigger slice of the overall market. But investors should be clear on one thing: It's not all about pricing.
CEO Jay Fishman made it clear in the conference call that the new auto product, Quantum 2.0, was indeed lower in price, but it's also a lower-commission product. That means Quantum 2.0 is a lower-cost product, allowing the company to bring in acceptable returns from the product -- in line with its overall goals.
By looking at each segment, analysts noticed a decline in renewal rate growth, with each segment showing a 1%-2% decline in charged rates. That caused some concern, since pricing growth is often a key to insurance success. But CEO Fishman had a different perspective:
...we believe that many industry observers are putting inappropriate significance on the absolute number of rate gain, particularly the headline number that is so often quoted. While the number is interesting, it is not nearly as revealing as many believe, as the rate and retention in a much more granular basis holds the real key to success.
The company has a retention rate across its product segments in the high 70s to 80s, so the small decline in rates is not a problem investors should consider a big deal for the insurer.
In fact, Fishman says that as the company continues to succeed in its goals for product returns, there will be a long-term trend of declining rates. With consistently produced high returns from each product, focus would transition to increasing retention at rates that sustain the steady margins.
3. Investing for the future
One of the main issues plaguing the insurance industry has been the effect of low interest rates on companies' investment portfolios. Keeping in line with previous quarters, Travelers provided an estimated schedule of the impact low interest rates would have in the future if they stay at current levels.
Much like he discussed in the second quarter, CFO Jay Benet stated that low interest rates would likely cause a $25 million adverse effect per quarter for 2014 because of the amount of maturing investments for the year. Both 2015 and 2016 would see smaller impacts because of fewer maturities, though the $90 million and $60 million annual adverse effects, respectively, are still substantial.
Rising rates would further reduce the headwinds faced by the entire insurance industry. But as the current rate environment looks to stay for the time being, management still won't take its eye off the ball and reach for yield at the expense of returns on equity.
Make the call
Although some investors didn't take CEO Fishman's advice and ignore the headline rate declines, knowing the method to the company's madness may help assuage your concerns about Travelers' earnings report.
Fool contributor Jessica Alling has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.