Hanover Insurance Group, Inc. — 2011 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2011. Hanover provides U.S. commercial and personal property and casualty insurance, primarily through independent agents, and operates internationally through Chaucer, its Lloyd’s-focused subsidiary. Hanover acquired Chaucer on July 1, 2011; reported 2011 results include Chaucer only for the second half, limiting year-over-year comparability. The company also reports a run-off business and discontinued operations.
Financial performance and position
| Metric | 2011 | 2010 | Change or context |
|---|---|---|---|
| Total revenue | $3,931.6 million | $3,152.2 million | Increase largely reflects Chaucer and premium growth |
| Net premiums earned | $3,598.6 million | $2,841.0 million | Up 26.7% |
| Net premiums written | $3,593.4 million | $3,048.0 million | Up 17.9%; includes Chaucer |
| Income before taxes | $22.3 million | $211.1 million | Down $188.8 million |
| Net income | $37.1 million | $154.8 million | Down $117.7 million |
| Diluted earnings per share | $0.81 | $3.34 | 2011 includes $5.2 million gain from discontinued operations |
| Net investment income | $258.2 million | $247.2 million | Includes $16.9 million from Chaucer; U.S. fixed-maturity yields continued to decline |
| Operating cash flow | $221.7 million | $83.6 million | Improved partly because 2010 included a $100 million pension contribution |
| Total assets | $12,624.4 million | $8,569.9 million | Increase principally reflects Chaucer acquisition |
| Shareholders’ equity | $2,509.8 million | $2,460.5 million | Up $49.3 million |
| Debt | $911.1 million | $605.9 million | Includes $300 million of senior notes issued in 2011 |
Consolidated segment income before interest and taxes was $72.5 million, versus $227.7 million in 2010. Interest expense was $55.0 million, up from $44.3 million. The reported GAAP combined ratio was 104.6% in 2011 versus 100.1% in 2010; above 100% indicates underwriting losses before investment income. Commercial Lines’ ratio was 107.1%, Personal Lines’ 104.2%, and Chaucer’s 97.8% for the six months included.
Cash and investments totaled $7,541.7 million, including $820.4 million of cash and cash equivalents and $6,284.7 million of fixed maturities. Approximately 94% of fixed maturities were investment grade. Reinsurance recoverables were $2,262.2 million, including $816.7 million due from Michigan Catastrophic Claims Association (MCCA). Gross loss and LAE reserves were $5,760.3 million; net reserves were $3,828.5 million. U.S. insurance statutory surplus was $1,582.8 million, down from $1,747.3 million; the Hanover Insurance Company RBC ratio was 270% on the industry scale.
Material changes versus prior comparable period
- Net income fell to $37.1 million from $154.8 million. Management cited substantially higher catastrophe and other weather-related losses and lower favorable prior-year reserve development.
- Pre-tax catastrophe losses rose to $361.6 million from $160.3 million. Events included U.S. winter storms, tornadoes, hail, windstorms and Hurricane Irene, and international flooding and earthquakes affecting Chaucer.
- Favorable prior-year reserve development declined to $103.3 million from $111.1 million. The 2011 amount includes $35.5 million from Chaucer for the six months consolidated.
- Commercial Lines net written premiums grew 7.5%; Personal Lines net written premiums were essentially flat, at $1,461.2 million versus $1,462.9 million. Chaucer contributed $428.8 million of net written premiums for the second half.
- Reported reserves and reinsurance recoverables rose substantially, primarily because Chaucer was added. These balances should not be read as organic year-over-year deterioration without separating the acquisition effect.
Outlook, management commentary, risks and unusual items
- Management expected underwriting opportunities and pricing conditions to improve across most Chaucer markets in 2012, especially catastrophe-exposed property, marine and energy. It expected casualty and aviation to remain challenging and U.K. motor rate increases to be more modest. These are expectations, not guarantees.
- For U.S. lines, management sought further rate increases in property, including homeowners, and aimed to grow specialty Commercial Lines and diversify Personal Lines beyond core states. Commercial Lines net written premiums grew, while Personal Lines faced rate competition and policy-count pressure.
- 2011 included $16.4 million in acquired-business costs, an $11.3 million loss on the foreign-exchange contract associated with Chaucer’s purchase, and $6.7 million in net foreign-exchange gains. Net realized investment gains were $28.1 million; other-than-temporary impairment losses recognized in earnings were $6.9 million.
- Chaucer’s acquisition purchase price was approximately $481.6 million excluding transaction costs; total purchase price including transaction costs was $493.3 million. Integration, Lloyd’s capital requirements and foreign-exchange exposure are relevant considerations.
- Management identified reserve estimation as a significant uncertainty: a one-percentage-point change in the aggregate loss and LAE ratio was estimated to affect segment income by approximately $36 million. Long-tail casualty reserves, catastrophe claims and newly developed or acquired business add uncertainty.
- Other key exposures include catastrophe severity and frequency, inflation in medical, repair and construction costs, competitive and regulatory limits on rates or market exits, investment-market volatility, reinsurance collectability, and concentration in Michigan and the Northeast. Residual-market mechanisms generated a $13.1 million underwriting loss in 2011.
- The company reported $816.7 million of MCCA recoverables and noted the association’s deficit, while stating it believed collection exposure was not significant based on statutory assessment support and its collection history. Reinsurance does not relieve Hanover of its obligations to policyholders.
- The Durand pension-plan litigation and Louisiana Road Home/Hurricane Katrina litigation remain unresolved; the company said it could not reasonably estimate potential ultimate liability for either matter. Certain indemnities tied to former life-business sales also remain.
- Management expected comparable cash dividends to continue, subject to Board approval and subsidiary dividend restrictions. The 2011 declared dividend was $1.13 per share; $135.2 million remained under the authorized share repurchase program at year-end.
- The auditor issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting. Chaucer was excluded from management’s 2011 internal-control assessment and the auditor’s internal-control audit; it was expected to be included in the 2012 assessment.
Important facts for investors to verify
- Separate acquisition-driven growth from underlying premium, revenue and reserve trends; confirm Chaucer’s full-year contribution and integration progress in subsequent filings.
- Track catastrophe losses, renewal pricing, combined ratios and current accident-year underwriting results, particularly in homeowners, Commercial Lines and Chaucer’s catastrophe-exposed classes.
- Review reserve development and sensitivity disclosures, including long-tail liabilities and Chaucer’s Syndicate 4000 exposures, and assess whether favorable development continues.
- Assess the quality, concentration and collectability of reinsurance recoverables, especially the MCCA balance and recoverables associated with Chaucer and Flagstone Re.
- Monitor statutory surplus, RBC levels, debt and interest costs, Lloyd’s Funds at Lloyd’s, holding-company liquidity and restrictions on dividends from insurance subsidiaries.
- Follow the Durand and Road Home litigation, other indemnification obligations, and the effect of regulatory changes and residual-market assessments.