Business context and reporting period
The Hanover Insurance Group, Inc. filed this Form 10-Q for the quarter ended September 30, 2019. Its continuing operations are principally property and casualty insurance, reported in Commercial Lines, Personal Lines and Other. Chaucer, sold to China Re in December 2018, and the related Irish and Australian entities sold in 2019 are reported as discontinued operations.
Financial performance and position
- Third quarter: Premiums were $1.124 billion, up 4.9% from $1.072 billion. Total revenue was $1.215 billion versus $1.167 billion. Income from continuing operations was $111.2 million, compared with $104.0 million; net income was $118.9 million versus $100.4 million. Diluted EPS was $2.96 versus $2.33.
- First nine months: Premiums were $3.330 billion, up 5.0%; total revenue was $3.633 billion versus $3.392 billion. Continuing-operations income was $318.8 million versus $236.9 million, and net income was $315.3 million versus $267.4 million. Diluted EPS was $7.71 versus $6.21.
- Underlying operating results: Pre-tax operating income before interest and taxes, a non-GAAP measure, rose to $126.3 million in Q3 from $112.8 million and to $343.1 million for nine months from $313.4 million. Nine-month Commercial Lines operating income increased to $227.1 million from $208.3 million; Personal Lines decreased to $108.7 million from $109.7 million.
- Underwriting: The combined ratio improved to 94.4% in Q3 from 95.1%, and to 95.4% year to date from 95.8% (below 100% generally indicates underwriting profit). Nine-month net catastrophe losses were $134.2 million, compared with $169.2 million. Net favorable prior-year reserve development was $20.3 million, versus $7.1 million; catastrophe development was favorable $20.5 million, while non-catastrophe development was slightly unfavorable at $0.2 million.
- Investments: Net investment income increased to $68.8 million in Q3 from $66.4 million and to $208.6 million for nine months from $198.0 million. Nine-month net realized and unrealized investment gains were $75.1 million versus $3.8 million, primarily reflecting equity-security fair-value changes. Total portfolio earned yield declined to 3.62% from 3.76% for the nine-month comparison.
- Cash flow: Nine-month operating cash flow was $423.9 million, down from $466.4 million. Investing activities used $505.2 million and financing activities used $785.1 million. Cash and equivalents fell to $157.6 million from $1.021 billion at year-end 2018.
- Balance sheet and capital: Total assets were $12.627 billion and shareholders’ equity was $3.087 billion at September 30, 2019. Debt was $667.8 million, down from $777.9 million at year-end. Total cash and investments were $8.397 billion, up 1.1% from year-end, although cash declined substantially. Insurance-subsidiary statutory capital and surplus increased to $2.348 billion from $2.173 billion.
Material changes versus the prior comparable period
- Premium growth continued in both major lines: nine-month net premiums written rose 2.9% in Commercial Lines and 6.1% in Personal Lines. Management attributed growth mainly to pricing, retention and, in Personal Lines, rate-driven renewal premiums.
- Lower catastrophe losses supported improved overall operating income and combined ratios. However, nine-month current-year underwriting performance excluding catastrophes weakened in Commercial Lines, mainly because of large losses in specialty industrial property and inland marine; Personal Lines also faced higher current-year auto and homeowners losses.
- Nine-month net income growth was affected by the sharp increase in investment gains and by higher continuing-operations income. Comparisons also reflect Chaucer’s disposal: 2018 included $30.5 million of nine-month Chaucer income, while 2019 includes only residual discontinued-operation results and sale-related adjustments.
- The company returned substantial capital: it paid a $192.6 million special dividend in January and repurchased $400 million of stock through two accelerated repurchase agreements during the first nine months. The second agreement’s final share settlement occurred in October; management reported approximately $200 million remained under the repurchase authorization as of October 30.
Outlook, management commentary, risks and unusual items
- No quantified earnings or premium guidance is provided in the filing. Management describes a strategy of responsible profitable growth, agency distribution, specialty-market development, disciplined underwriting and seeking rate increases aligned with loss trends.
- Management expected operating cash generation and holding-company assets to be sufficient for current obligations, including dividends if declared, debt interest and pension funding. It reported approximately $576.3 million of fixed maturities and cash at the holding company. The company stated it did not expect to need additional insurance-subsidiary dividends to fund 2019 holding-company obligations, though it could choose to do so.
- Chaucer sale proceeds were finalized: the company received $22.0 million of contingent proceeds in Q3 after earlier unfavorable catastrophe development reduced the estimate. Sales of the related Irish and Australian entities generated $28 million and $13 million, respectively. A retroactive tax-law change produced a $1.2 million nine-month charge in continuing operations; Q3 continuing-operations tax also included a $4.4 million benefit relating to the Chaucer sale, alongside other tax benefits.
- Michigan’s 2019 no-fault legislation introduces PIP coverage choices, mandated premium reductions and a premium freeze, with cost controls phased in from 2020 and 2021. Management said it was unclear whether projected savings would offset required reductions; PIP represents about 28% of Michigan personal-auto premiums excluding the MCCA assessment. A constitutional challenge to parts of the law was pending, with an uncertain outcome.
- Key risks include catastrophe and weather volatility, reserve-estimation uncertainty, auto loss trends, pricing competition and regulatory constraints, reinsurance collectability and availability, investment-market and interest-rate volatility, and the Michigan reforms. The filing says unrealized fixed-maturity losses were viewed as temporary; gross unrealized losses declined to $7.0 million from $134.2 million at year-end, but adverse market or credit developments could still cause losses.
- Ordinary-course litigation and regulatory proceedings are not expected to materially affect financial position, but could materially affect results in an individual period. The company reported no material off-balance-sheet arrangements, remained compliant with debt covenants, and stated disclosure controls were effective; no material change in internal control over financial reporting was identified.
Important facts for investors to verify
- Whether premium growth and rate actions are keeping pace with underlying claims inflation, especially in personal and commercial auto and catastrophe-exposed property lines.
- How reserve estimates develop, including the offsetting trends in personal auto, commercial auto, workers’ compensation and terminated Hanover Programs classes.
- How much reported earnings growth depends on equity-security fair-value gains, catastrophe experience and discontinued-operation or tax items, versus recurring underwriting and investment income.
- The earnings, cash and capital effects of Michigan’s no-fault changes and the pending constitutional litigation, including the adequacy of anticipated cost savings.
- Whether reduced cash balances after dividends, repurchases and debt repayment remain consistent with liquidity needs, regulatory capital requirements and the company’s stated capital-return plans.