The Hanover Insurance Group, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. The company’s continuing business is principally property and casualty insurance, reported in Commercial Lines, Personal Lines and Other. Chaucer is reported as discontinued operations following its sale.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net premiums earned | $1,111.0 | $1,058.2 | $2,206.1 | $2,100.7 |
| Total revenues | $1,198.6 | $1,133.4 | $2,418.1 | $2,224.9 |
| Income from continuing operations | $85.0 | $82.4 | $207.6 | $132.9 |
| Net income | $74.0 | $99.3 | $196.4 | $167.0 |
| Diluted earnings per share | $1.79 | $2.31 | $4.77 | $3.88 |
| Operating income before interest and taxes | $107.0 | $107.3 | $216.8 | $200.6 |
| Combined ratio | 96.1% | 95.5% | 95.9% | 96.1% |
- Growth and underwriting: First-half net premiums written increased 3.4% to $2,235.8. Commercial Lines grew 1.6% and Personal Lines 6.1%, with rate increases contributing to growth. First-half catastrophe losses were $99.0 pretax, down from $124.3. Prior-year reserves developed favorably by $20.6, compared with $6.7 favorable in 2018, mainly reflecting catastrophe reserve development. Commercial Lines’ first-half combined ratio improved to 94.8% from 95.5%; Personal Lines’ worsened to 97.6% from 96.7%.
- Quarterly results: Q2 net income fell, although continuing-operations income increased. Net income included a $9.9 after-tax loss related to the Chaucer sale and a $0.2 operating loss from the remaining Chaucer business. Continuing income benefited from stronger operating results and investment gains.
- Investment contribution: First-half net investment income rose to $139.8 from $131.6. Net realized and unrealized investment gains were $60.3, compared with losses of $19.2 in 2018, primarily due to fair-value changes in equity securities. These gains materially contributed to the increase in first-half net income.
- Cash flow and capital: First-half operating cash flow was $150.6, down from $179.5; investing cash outflow was $215.4 and financing cash outflow was $779.4. Cash and equivalents were $179.8 at June 30, versus $1,020.7 at year-end 2018. The decline reflected substantial shareholder distributions and debt repayment. The company paid a $192.6 special dividend, approximately $49.1 in quarterly dividends, repurchased $400.0 of shares through accelerated repurchase agreements, and repaid $125 of FHLB advances. Total debt was $653.1, down from $777.9; shareholders’ equity was $2,941.1.
- Liquidity and capital: Total cash and investments were $8,002.4, compared with $8,308.1 at year-end. Management reported $616.9 of fixed maturities and cash at the holding company, unused FHLB borrowing capacity of $91.7, and no borrowings under its new $200 revolving credit facility. U.S. insurance subsidiaries’ statutory surplus was $2,249.7; Hanover Insurance’s RBC ratio was 215% on the Company Action Level scale.
Material changes and unusual items
- First-half net income increased $29.4 year over year, aided by a $64.2 improvement in after-tax realized and unrealized investment results and higher operating income. The comparison was partly offset by reduced earnings from Chaucer following its sale.
- The company reduced estimated contingent proceeds from the 2018 Chaucer sale by $13.5 pretax after unfavorable development on Chaucer’s 2018 catastrophe losses, including Hurricane Michael and Typhoon Jebi. New U.S. Treasury tax regulations also resulted in a $5.6 tax charge in continuing operations, retroactive to January 1, 2018.
- Commercial Lines first-half underwriting income improved, but current accident-year underwriting profit excluding catastrophes declined, reflecting unusually high large losses in specialty industrial property and, to a lesser extent, inland marine. Personal Lines underwriting income also declined year over year, with higher catastrophe and non-catastrophe losses.
- Investment fair values increased: fixed maturities had $196.9 of net unrealized gains at June 30, compared with net unrealized losses at year-end. The company states it views fixed-maturity unrealized losses as temporary; that assessment depends on market and credit conditions.
Outlook, commentary and risks
No specific earnings or premium guidance is provided. Management describes a strategy of disciplined, profitable growth through agency partnerships, selective distribution, specialty capabilities and rate actions. It intends to pursue rate increases in both major lines, subject to competition and regulation, and notes that rate competition may constrain Commercial Lines growth and Personal Lines retention. Management expects operating cash flows to meet current cash needs, but actual results are not necessarily indicative of full-year performance.
- Michigan enacted no-fault auto reforms in May 2019, effective principally from July 2020. The law includes mandated PIP rate reductions and an eight-year rate freeze, changes to coverage limits and higher minimum bodily-injury liability limits. PIP represents about 28% of the company’s Michigan personal-auto premiums, excluding the MCCA assessment; management says it is unclear whether cost savings will offset mandated reductions.
- Key risks include catastrophe and weather losses, reserve-estimation uncertainty, claims severity and inflation, competition and the ability to achieve adequate rates, reinsurance availability and collectability, investment-market volatility and credit defaults, and regulatory, legal and residual-market exposures.
- Ordinary-course legal and regulatory matters are not expected to materially affect financial position, though an individual matter could materially affect results in a particular period. The filing reports no material off-balance-sheet arrangements and no material changes to market-risk disclosures.
Investor verification priorities
- Assess how much first-half earnings growth depends on equity-market gains versus recurring underwriting and investment income.
- Review reserve development by line, especially favorable catastrophe recoveries, automobile loss trends, and the run-off asbestos and environmental reserves.
- Track the final settlement of the June accelerated share repurchase, remaining repurchase authorization, and the effect of dividends and buybacks on liquidity and capital.
- Evaluate the financial impact of Michigan’s auto reforms, including mandated PIP pricing changes and potential changes in tort losses.
- Confirm the final Chaucer contingent-proceeds outcome and tax effects, and monitor investment portfolio credit quality and interest-rate sensitivity.