To Our Shareholders
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| Frederick H. Eppinger President and Chief Executive Officer |
2004 was a critically important year for our company, as we completed the first phase in our journey to become a world class regional property and casualty organization.
I am very pleased to report that we made great progress on our journey during the year, strengthening our organization, building greater confidence among our key stakeholders, and positioning our institution for a bright and successful future.
Strengthening the Foundation
Much of the progress achieved in 2004 further strengthened the foundation on which we will grow our business.
We began the year with a ratings upgrade, as the A.M. Best Company restored our Property and Casualty financial strength ratings to the “Excellent” level, and we continued to build positive earnings momentum and strengthen our balance sheet throughout the year. Today, our company is in excellent financial condition and we are well positioned to grow our business and to deliver on our promises to our stakeholders.
We increased net income by 44 percent for the year, to $125 million, or $2.34 per share. This strong earnings growth was driven primarily by our Property and Casualty operation, which reported segment income of $198 million, up 68 percent.
The earnings improvement in our Property and Casualty business reflects our core earnings capability and a very positive growth trend, as Property and Casualty earnings in each quarter of 2004 surpassed those for the comparable periods in 2003. This trend is even more noteworthy in light of the $40 million increase in net catastrophe losses we sustained during 2004.
Our Life Companies also made a solid contribution in 2004, generating earnings of $11 million and segment income excluding certain non-cash items* of $119 million. Results in this area reflect our ongoing efforts to maximize the value of this closed block of business, as well as the solid performance of the equity market during the year.
With solid earnings, we significantly improved our capital position, increasing Property and Casualty statutory surplus by $97 million during the year, to $1.1 billion. Our levered Property and Casualty return on equity was 11 percent on a stand-alone basis at year-end, up four points over the prior year.
We also increased our Life Companies’ statutory capital by $104 million, and with the approval of the Massachusetts Division of Insurance, made a dividend of $75 million from our Life Companies to our holding company. Statutory capital increased by $29 million subsequent to the dividend, and generated a strong risk-based capital ratio of 472 percent.
In addition to improving our financial performance, we also took a number of steps to further strengthen our talent base and our culture of execution. We are committed to employing the very best people throughout our organization. Ours is an execution business. The quality of our people and their performance over the long term is what will distinguish us from our competitors.
With that in mind, we formed a senior leadership team over the course of the year that I believe is one of the very best in our industry. This team is comprised of many talented and committed people—some of whom were with us at the very beginning of our journey and many others who have joined us more recently because they believe, as I do, that we can create a very special company.
Building the Business
While strengthening our foundation, we also invested heavily in key business strategies and initiatives during 2004. We have listened closely to our agent partners, and we are committed to providing them with what they have told us they need most:
- Long-term partnerships
- Competitive product solutions
- Dedicated, responsive service
- Ease of doing business
- Local problem-solvers
Our company is uniquely positioned as a super regional, offering our independent agent partners and their customers the best attributes of both national and regional companies. Our objective going forward is to continue to improve our distinctive position in the marketplace, to ensure our ongoing success. As we do so, we are focused on improving our local market and agency management, our products, pricing and underwriting, and the efficiency and effectiveness of our service.
In an effort to build stronger, more mutually-beneficial partnerships, we continued during 2004 to develop long-term business plans with key agents. The development of these plans will enable us to identify the best marketing opportunities and to allocate our resources in a thoughtful way, to create a more profitable, more successful future for our company and our agent partners.
We made substantial investments in our products as well during 2004, enhancing our competitive position. In Personal Lines, we introduced an auto insurance score tiering product in our core states, improving rate adequacy and margins as we began developing our next generation auto product. We also applied greater focus in New Jersey and Massachusetts—two big and challenging markets—with very positive results. In Commercial Lines, we enhanced our businessowner’s policy, while significantly improving our inland marine, bond and umbrella capability. As a result, we are better able to meet our agents’ product needs.
We also upgraded our service operations, making our systems more responsive and making it easier for agents to do business with us. Our new agency portal—The Agency Place—provides our agent partners with centralized access to the information and tools they need, 24 hours a day, seven days a week. Enhancements to our point-of-sale system make it easier for agents to quote and issue business.
Most importantly, our new Commercial Lines operating model manages more routine processes through automated systems, enabling our frontline underwriters to work more closely with agents to retain key accounts and prospect new business.
These and other financial, organizational and operational gains made in 2004 set the stage for continued progress in 2005.
Creating a World Class Company
While we are at different stages of our journey in our Commercial Lines and Personal Lines businesses, we are confident that we ultimately will be able to achieve and sustain top-quartile performance in both.
Personal Lines—Building the Foundation for Growth
We significantly strengthened our Personal Lines operation in 2004, putting a new leadership team in place, making sure we had good business on the books, and achieving overall rate adequacy. We improved our combined ratio in this business by six points, to 99 percent, and generated strong profits.
In 2005, we are focused on making investments that will help us maintain solid profitability, build our distinctive position in the market and prepare Citizens and Hanover for profitable growth in 2006.
Citizens and Hanover today benefit from strong relationships with many of the best independent agents in our markets, and are among the top three preferred companies among many of those agents. We are actively seeking to write more business with our best agents, and to develop new relationships with other winning agents.
At the same time, we are making significant investments to strengthen our product offerings. The breadth of our Personal Lines product portfolio today represents a competitive advantage over the regional companies that do business in our markets—many of which tend to focus on a single line of business—and is on par with many national companies. Our goal is to extend that competitive advantage.
In 2005, we plan to continue to enhance our auto, homeowners, and umbrella products. The most important of these enhancements—our new multi-variate auto product—is expected to be introduced mid-year. This product will enable us to profitably write a broader spectrum of the market with greater underwriting precision and will support our efforts to boost penetration and expand into new markets.
We will roll out a new Personal Lines operating model in 2005 that will make our operations more efficient and improve the level and quality of service we provide to our agent partners. This new operating model leverages automation and workflow enhancements so that we respond to agent and customer inquiries and resolve business issues more quickly.
Commercial Lines—Executing for Profitable Growth
After two years of significant investments, we entered 2005 with a very clear
mission in Commercial Lines—to strengthen our position with winning
agents and generate profitable growth.
Over the past two years, we have made important improvements across this business, establishing a solid foundation on which to build. We have re-underwritten our book of business, assembled an outstanding support team in both the field and home office, and implemented a new operating model that will distinguish our company in our target markets.
During 2005, we will continue to invest in our Commercial Lines business, beginning with our relationships with winning agents. In particular, we will work closely with those agents who have developed long-term business plans with us, and identify other growing and profitable agents in each of our territories.
As in Personal Lines, our Commercial Lines product portfolio already represents a competitive advantage. In 2005, we plan to further develop our product portfolio as we target the first-tier middle market, which represents clients whose premiums are between $25,000 and $100,000. We will expand our businessowner’s policy to accommodate larger risks, and enhance our inland marine, bond and umbrella programs, which on average offer higher margins over time and enable us to deliver a complete response to our agents and policyholders in our target market.
We also will leverage our new Commercial Lines operating model to support our growth objectives, especially in the first-tier middle market. This new model will provide efficient, cost-effective underwriting, processing, billing, claims and loss control support. More importantly, it will enable our most experienced underwriters to work more closely with our agents to retain and write good business.
Life Companies—Maximizing Value
Our life operation is a $14 billion closed block of business through which we serve about 320,000 policyholders. Our goals for this business in 2005 are to provide strong segment income excluding certain non-cash items*, to improve statutory capital, and to maximize the value of the business. These goals translate into operational priorities involving improving margins, diligent risk and expense management, and strong service to retain our customers. Finally, we will continue to effectively manage the guaranteed minimum death benefit hedge program, which reduces the volatilityof statutory capital as a result of changes in the equity market since the inception of the program. This program has been very effective since its implementation in December of 2003.
Creating a Super Regional—The Best of Both
The competitive environment in the property and casualty business is more
challenging than ever before. Those companies that build a distinctive position
and sustain superior performance over the long term will be the most successful.
Many national companies benefit from the scale to invest in technology and broad product offerings, but lack local market knowledge and their product and service offerings tend to be less flexible.
Regional companies, on the other hand, tend to benefit from strong relationships with their agents and know their markets well, but are limited by their narrow geographic scope, basic product offerings, inefficient automation and limited capital.
As a super regional, Citizens and Hanover offer the best of both the national and regional company models to our agents and their customers. We have sufficient scale to invest in high-quality products, services and local market underwriting capabilities. We understand our markets well. We have strong relationships with our independent agent partners, and we have talented and committed professionals in the field who are accessible and responsive.
We have made great progress on our journey to become a world class regional property and casualty company. We have established a solid financial foundation on which to build our organization and we are creating a distinctive position in the marketplace.
We will continue to strengthen our market position going forward, achieving and sustaining top-quartile performance.
We are more confident today than ever that we can and will achieve our goal, building a brighter, more successful future for our company, our agent partners and their customers, and delivering significant value for our shareholders and all of our stakeholders.
Frederick H. Eppinger
President and Chief Executive Officer
*Segment income excluding certain non-cash items is a non-GAAP financial measure and is reconciled to GAAP Segment Income on page 41 of the attached Annual Report on Form 10-K.
