HANOVER INSURANCE GROUP, INC. quarterly report, Q2 FY2016

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Business context and reporting period

The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The property and casualty insurer reports Commercial Lines, Personal Lines, Chaucer and Other segments. Comparisons are with the corresponding 2015 periods; Chaucer comparisons are affected by the transfer of the U.K. motor business effective June 30, 2015.

Financial performance and position

Amounts are in millions of dollars except per-share data and ratios.

  • Revenue: Second-quarter total revenue was $1,222.0, down 5.8% from $1,297.1; first-half revenue was $2,449.6, down 5.6% from $2,595.8. First-half earned premiums fell to $2,296.8 from $2,416.8. Net investment income was $69.1 for the quarter and $137.4 for the half, down 2.3% and 2.4%, respectively.
  • Profit and EPS: Second-quarter net income was $2.0 ($0.05 diluted per share), versus $120.7 ($2.68). First-half net income was $80.2 ($1.84 diluted per share), versus $175.6 ($3.90). Management-defined non-GAAP operating income was $54.0 for the quarter versus $70.4, and $125.5 for the half versus $127.5.
  • Underwriting: Consolidated combined ratio was 97.3% for Q2 versus 95.7%; first-half ratio was 96.2% versus 96.4%. First-half Commercial and Personal Lines combined ratios were 99.0% and 91.3%; Chaucer’s was 96.3%. Chaucer’s Q2 combined ratio was 103.2%.
  • Cash flow: First-half operating cash flow was $231.6 versus $102.7; investing cash flow was $9.0 versus $243.1; financing cash used was $217.7 versus $137.2. Cash and cash equivalents ended June at $361.6, compared with $338.8 at year-end 2015.
  • Balance sheet and liquidity: At June 30, total assets were $14,163.6, total liabilities $11,153.9, and shareholders’ equity $3,009.7. Investments totaled $8,179.5. Debt carrying value was $797.8 (principal $809.3), compared with $803.1 at year-end. U.S. insurance subsidiaries’ statutory capital and surplus was $2,152.6, down from $2,192.8; Hanover Insurance’s RBC ratio was 282% on the industry scale. Management said holding-company assets were sufficient for current-year obligations and expected operating cash flows to meet requirements.

Material changes versus prior periods

  • Q2 results included an $86.1 pre-tax debt-repayment loss; the first half also included that loss. Management cited the Q2 after-tax effect as $56.0. The company issued $375.0 of 4.50% senior debentures due 2026 and used proceeds plus cash to redeem higher-coupon 7.50% and 6.375% notes. The refinancing materially reduced reported earnings despite largely stable first-half operating income.
  • Prior-year non-catastrophe reserve development shifted to $5.0 unfavorable in the first half of 2016 from $53.8 favorable in 2015; including catastrophe reserve development, reported development was $15.0 favorable versus $57.7 favorable. Catastrophe-related activity fell to $82.2 from $108.8.
  • Commercial Lines and Personal Lines first-half net premiums written rose 2.9% and 3.9%, respectively. Chaucer net premiums written fell 12.8%, reflecting increased ceded reinsurance and lower energy volumes. Overall first-half net premiums written were $2,365.9 versus $2,371.1.
  • First-half investment impairments recognized in earnings were $25.9 versus $4.6. First-half foreign-exchange transactions reduced pre-tax income by about $21.4, versus a $14.6 gain in 2015. Net unrealized appreciation on available-for-sale securities lifted first-half other comprehensive income by $173.5 after tax.
  • The company repurchased 0.8 million shares for $67.5 and paid $39.6 in dividends during the first half. Approximately $222 million remained under the $900 million repurchase authorization at June 30.

Outlook, commentary and risks

  • No quantified earnings or premium guidance was provided. Management said it continued to pursue rate increases and underwriting-mix improvements in domestic lines, while noting intensifying competition, particularly in Commercial Lines. It expected fixed-maturity yields to decline as new-money yields remained below portfolio yields.
  • Management attributed Chaucer pressures to competitive pricing, higher large losses in political risk and trade credit, energy-market weakness and reduced favorable reserve development. The Brexit referendum weakened sterling and contributed to foreign-exchange volatility; risks include possible effects on Chaucer’s EU licensing, market conditions and currencies.
  • Key exposures include reserve-estimation uncertainty, catastrophe and severe-weather losses, reinsurance collectability and pricing, investment-market and interest-rate changes, and credit stress in energy and metals and mining. The company warned that market or credit deterioration could cause further realized or unrealized investment losses.
  • The Durand ERISA class action concerns alleged underpayment of cash-balance pension lump sums. The company could not reasonably estimate potential liability; any adverse result could affect plan assets and future company funding. Other proceedings were not expected to materially affect financial position, though a particular period’s results could be affected.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It noted a CEO/CFO transition among the risks discussed in the filing.

Important facts for investors to verify

  1. Separate recurring underwriting and operating performance from the $86.1 debt-redemption charge, 2015 U.K. motor-sale gain, investment impairments and foreign-exchange effects.
  2. Review reserve development by segment and line, especially Commercial Lines liability and AIX program reserves, and assess how much favorable Chaucer development is repeatable.
  3. Track Chaucer’s premium trends, ceded reinsurance, large-loss experience, Brexit-related licensing and currency exposure.
  4. Confirm statutory capital, RBC, dividend capacity and liquidity, including restricted Lloyd’s assets and the terms and covenants of debt and credit facilities.
  5. Monitor investment impairments and energy-sector exposure, and the Durand litigation as additional information becomes available.