HANOVER INSURANCE GROUP, INC. quarterly report, Q3 FY2017

Business context and reporting period

The Hanover Insurance Group, Inc. is a property and casualty insurer with Commercial Lines, Personal Lines, international specialty insurer Chaucer, and Other segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017; comparisons are with the same 2016 periods. Amounts are in millions of dollars unless stated otherwise.

Financial performance and condition

Net investment income was $76.6 in Q3 and $220.0 for nine months, up from $67.8 and $205.2, respectively. Nine-month operating income was $117.8 versus $204.1. Nine-month favorable prior-year reserve development was $44.6, compared with $23.8 in 2016.

At September 30, 2017, total assets were $15,389.3, total liabilities $12,417.3, and shareholders’ equity $2,972.0. Cash and equivalents were $227.2; debt was $786.8 carrying value, with estimated fair value of $873.3. Nine-month investing cash outflow was $499.2 and financing cash outflow was $92.1. The company paid $63.8 in dividends and repurchased $37.2 of shares during the nine months.

Material changes versus the prior comparable period

• Premium growth continued: nine-month net premiums written rose 4.7%, with growth in domestic businesses and Chaucer. Personal Lines grew 8.0% and Commercial Lines 3.6% on a net-written-premium basis.
• Results were substantially affected by catastrophes. Management reported nine-month pre-tax catastrophe losses of $335.7, versus $109.1 in 2016, primarily from Hurricanes Harvey, Irma and Maria, Mexico earthquakes, and earlier wind and hail events. Q3 operating income before interest and taxes fell to $13.1 from $129.8.
• Chaucer reported a nine-month operating loss before interest and taxes of $19.2, compared with income of $87.6 in 2016; its Q3 underwriting loss was $87.7. Personal Lines operating income declined for the nine-month period to $117.5 from $136.2, while Commercial Lines declined to $108.8 from $129.2.
• The overall nine-month combined ratio worsened to 100.0% from 95.5%. Q3 ratios were 102.1% for Commercial Lines, 89.2% for Personal Lines, and 139.4% for Chaucer.
• Nine-month net income declined $33.9 despite the absence of the prior-year debt-repayment loss: 2016 included an $86.1 pre-tax loss ($56.0 after tax) on debt repayment. Nine-month 2017 operating income before interest and taxes was also lower, principally because of catastrophe losses.
• Cash from operations decreased $27.8, while cash and equivalents fell $55.4 from year-end 2016. Statutory surplus of U.S. insurance subsidiaries fell $111.5 to $2,061.9, primarily after a $296.8 dividend from Hanover Insurance to the holding company.

Outlook, commentary, risks and unusual items

• Management’s “Hanover 2021” strategy emphasizes agency partnerships, responsible growth, specialty-market capabilities, and investment in growth solutions. The filing provides no quantified earnings or premium guidance.
• Management expects average fixed-income yields to decline as new-money yields remain below embedded book yields. Competitive pricing, especially in Chaucer and larger Commercial Lines accounts, may constrain rate increases; the company continues to pursue pricing and underwriting actions.
• Management said it expects sufficient operating cash to meet short- and long-term needs. However, domestic subsidiary dividends are regulated; further domestic dividends to the holding company in the ensuing twelve months would require New Hampshire Insurance Commissioner approval. The company reported compliance with debt covenants and no borrowings under its $200 million revolving credit agreement at quarter-end.
• U.S. insurance subsidiaries’ RBC ratio was 220% on the industry scale (440% regulatory scale). Chaucer had $828.4 of assets and letters of credit pledged to Lloyd’s; access to some investment and overseas-deposit assets is restricted.
• On October 10, 2017, CEO Joseph M. Zubretsky announced his resignation, effective November 3; John C. Roche was named successor effective November 4. The filing also reports employee termination costs of $7.3 for the first nine months and expects about $3 of additional costs in Q4.
• The Durand ERISA class action concerns alleged underpayment of cash-balance pension lump sums. The company cannot reasonably estimate potential liability. Other legal and regulatory matters were not expected to materially affect financial position, though they could affect results in a particular period.
• Other risks include catastrophe severity and reserve estimation, reinsurance recoverability and cost, investment-market and interest-rate movements, foreign exchange, competition, regulation, and Brexit-related licensing and market uncertainty. Management noted that Chaucer’s favorable reserve development may not continue.
• Potential U.S. tax on $10.4 of non-U.S. income was not provided because those earnings were expected to remain indefinitely reinvested; the filing estimates $51.0 of tax could be payable if accumulated undistributed earnings were repatriated, assuming foreign tax credits are realized.

Important facts for investors to verify

• How final catastrophe estimates for the 2017 hurricanes and Mexico earthquakes compare with the reserves recorded in this quarter, and the related net reinsurance recoveries.
• Whether the elevated combined ratios—particularly Chaucer’s Q3 ratio—and underwriting trends improve, and whether rate increases keep pace with loss costs.
• The durability and accident-year mix of favorable reserve development, especially at Chaucer, and any adverse development in Commercial Lines or other legacy business.
• Capital and holding-company liquidity after the $296.8 subsidiary dividend, restricted Lloyd’s funds, dividend-approval constraints, and the renewed letter-of-credit facility.
• Updates on the Durand litigation, CEO transition, expense initiative, and any material change in investment yields, unrealized losses, or reinsurance terms.