Business context and reporting period
The Hanover Insurance Group, Inc. is a property and casualty insurer operating through Commercial Lines, Personal Lines, Chaucer (specialty insurance and reinsurance through Lloyd’s) and Other. This Form 10-K covers the fiscal year ended December 31, 2017; comparisons are primarily with 2016. The company distributes U.S. products mainly through independent agents and brokers.
Financial performance and condition
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $5,184.4 million | $4,945.8 million |
| Net premiums written | $4,958.2 million | $4,698.8 million |
| Net income | $186.2 million | $155.1 million |
| Diluted earnings per share | $4.33 | $3.59 |
| Operating income before interest and taxes (non-GAAP) | $336.3 million | $322.8 million |
| Net cash from operating activities | $704.6 million | $743.4 million |
- Revenue rose about 4.8% and net premiums written about 5.5%. Net investment income increased to $298.1 million from $279.4 million; the total portfolio earned yield was 3.34%, down from 3.38%.
- The consolidated combined ratio was 98.7%, versus 98.6%; underwriting was profitable overall before investment income, but results differed materially by segment: Commercial Lines 99.3% (105.1% in 2016), Personal Lines 94.1% (92.3%), and Chaucer 105.3% (90.4%).
- Pre-tax catastrophe losses were $382.6 million, up from $125.1 million, principally reflecting Hurricanes Harvey, Irma and Maria, California wildfires and other severe weather, as well as Mexico earthquakes. Prior-year reserve development was favorable by $32.9 million excluding catastrophe reserves and favorable by $58.4 million including catastrophe development; 2016 had unfavorable development of $140.3 million excluding catastrophe reserves.
- At year-end, total assets were $15.47 billion, shareholders’ equity $3.00 billion and debt carrying value $786.9 million (principal debt $797.3 million). Total cash and investments were $9.42 billion. Gross loss and LAE reserves were $7.75 billion, including $5.14 billion net of reinsurance.
- Operating cash flow exceeded investing outflows of $506.3 million and financing outflows of $111.7 million. Holding-company cash and fixed maturities were approximately $313.7 million. The $200 million revolving credit agreement had no borrowings; additional FHLB borrowing capacity was $81.3 million. The company reported compliance with debt covenants.
- U.S. insurance subsidiaries’ statutory surplus was $2.08 billion, down $96.3 million. Hanover Insurance’s RBC ratio was 207% on the industry scale, compared with 235% in 2016.
Material changes versus the prior comparable period
- Net income increased $31.1 million. The improvement reflected better prior-year reserve development, improved current-year underwriting and higher investment income, partly offset by substantially higher catastrophe losses. The 2016 comparison also included a $57.4 million after-tax debt repayment loss that did not recur.
- Commercial Lines net premiums written grew 4.3%; its underwriting result improved to a $12.7 million profit from a $122.0 million loss, largely due to the comparison with significant 2016 reserve strengthening.
- Personal Lines net premiums written grew 8.3%, but underwriting profit declined to $84.1 million from $103.8 million, primarily due to higher catastrophe losses.
- Chaucer net premiums written rose 4.0% (6.4% excluding a 2016 reinsurance-to-close transaction), while underwriting shifted to a $45.1 million loss from an $80.3 million profit, mainly due to catastrophe losses.
- 2017 net income included a $22.3 million tax expense from the Tax Cuts and Jobs Act, including deferred-tax remeasurement and tax on previously untaxed foreign earnings. The U.S. corporate tax rate fell to 21% effective in 2018; management expects lower future effective taxes, subject to other tax and competitive effects.
Outlook, commentary, risks and unusual items
- Management’s “Hanover 2021” strategy emphasizes agent relationships, disciplined underwriting, responsible growth, geographic diversification and investment in specialty products and distribution capabilities. The filing provides no specific quantitative earnings or premium guidance.
- Management said the 2018 Commercial and Personal Lines and Chaucer reinsurance programs were substantially consistent with 2017 designs, but acknowledged that some coverage remained to be placed and that pricing, terms and coverage adequacy were not assured.
- Discontinued operations recorded a $16.8 million after-tax loss in 2017. The company added $23.3 million, pre-tax, to reserves for its discontinued long-term-care pool after updated projections indicated higher claim costs; future morbidity, premium increases and other assumptions remain uncertain.
- Key risks include catastrophe frequency and severity, geographic concentration (Michigan represented 20.3% of U.S. Commercial and Personal Lines premiums written), reserve-estimation uncertainty, inflation in repair and medical costs, competition and rate regulation, reinsurance counterparty risk, investment and interest-rate volatility, foreign exchange and Lloyd’s/Brexit-related market access.
- Reinsurance recoverables totaled $3.06 billion, including $930.6 million from Michigan’s MCCA and $2.11 billion due from traditional reinsurers. Reinsurance does not release the company from obligations to policyholders. Management recorded a $9.7 million allowance for uncollectible reinsurance.
- The Durand pension-plan class action remains unresolved; the company could not reasonably estimate potential ultimate liability. It also reported a company-wide expense-savings initiative that included $10.2 million of employee termination costs. The independent auditor reported that the financial statements were fairly presented under U.S. GAAP and internal control over financial reporting was effective.
Important facts for investors to verify
- Whether reserve development remains favorable, especially in long-tail Commercial Lines and Chaucer liability business, and how the 2016 reserve actions compare with subsequent claim emergence.
- The ultimate net cost of 2017 catastrophes, adequacy and placement of 2018 reinsurance, and collectability of the $3.06 billion reinsurance recoverable balance.
- Further long-term-care pool deterioration, including whether future premium increases offset the projected claim-cost increase.
- Whether premium growth and rate actions sustain underwriting profitability, particularly given Personal Lines and Chaucer combined ratios and competitive or regulatory constraints.
- The outcome and potential financial effect of the Durand litigation, and the effect of tax reform and 2018 accounting changes on reported earnings and volatility.
- Liquidity and capital flexibility, including statutory surplus and RBC trends, holding-company resources, debt obligations and restrictions on dividends from insurance subsidiaries.