The Hanover Insurance Group, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Amounts are in millions of U.S. dollars except per-share data and ratios. Hanover is a property and casualty insurer with Commercial Lines, Personal Lines, Chaucer, and Other Property and Casualty segments. Its July 1, 2011 acquisition of Chaucer materially affects year-over-year comparability: Q1 2012 includes Chaucer; Q1 2011 does not.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Total revenues | $1,121.8 | $833.8 |
| Net premiums written | $1,016.8 | $749.9 |
| Net investment income | $68.8 | $60.4 |
| Income before tax | $70.8 | $37.5 |
| Income from continuing operations | $50.7 | $27.9 |
| Net income | $49.7 | $29.3 |
| Diluted EPS | $1.09 | $0.64 |
| Operating cash flow | $12.7 | $24.2 |
| Cash and cash equivalents | $628.3 at March 31 | $820.4 at December 31, 2011 |
| Total assets | $12,913.4 at March 31 | $12,598.6 at December 31, 2011 |
| Debt | $918.1 carrying value | $911.1 at December 31, 2011 |
| Shareholders’ equity | $2,579.0 at March 31 | $2,484.0 at December 31, 2011 |
Revenue rose about 35% and net income about 70% year over year, with the acquired Chaucer business a major contributor. Net premiums earned increased to $1,035.6 from $761.7. Segment income before tax, before separately reported debt interest, was $85.7 versus $49.8; after $16.2 of interest expense, segment income before tax was $69.5. The consolidated income-before-tax figure also reflects items outside segment income.
The consolidated combined ratio was 98.1% in Q1 2012, versus 100.7% in Q1 2011, but the 2012 figure includes Chaucer and is not directly comparable. Q1 2012 combined ratios were 100.3% for Commercial Lines, 98.0% for Personal Lines, and 93.8% for Chaucer. Catastrophe losses were $40.6, down from $49.7; favorable prior-year reserve development was $17.2, down from $28.5.
Net cash used in investing activities was $211.1, primarily reflecting net investment purchases; financing activities used $13.8, including $13.5 of dividends. Cash declined by $192.1 during the quarter. The company paid a $0.30-per-share quarterly dividend. U.S. insurance subsidiaries’ statutory surplus was $1,681.1, up from $1,582.8 at year-end; Hanover Insurance’s risk-based capital ratio was 282% on the industry scale and 564% on the regulatory scale.
Material changes and segment results
- Chaucer: Contributed $251.7 of segment revenue and $25.5 of segment income before tax; net written premiums were $200.2. The acquisition is the principal comparability difference from Q1 2011.
- Commercial Lines: Net written premiums increased 14.8% to $468.9. Segment income rose to $33.9 from $18.2, while the underwriting result improved to a $2.5 loss from a $16.0 loss, aided by lower catastrophe and weather losses and rate increases.
- Personal Lines: Net written premiums increased 1.8% to $347.4, but segment income declined to $27.5 from $30.3. Prior-year reserve development shifted from $14.1 favorable to $3.8 unfavorable.
- Investments and comprehensive income: Net investment income increased 13.9%, primarily due to Chaucer. Other comprehensive income was $54.7 versus $8.3, mainly reflecting appreciation in available-for-sale securities and foreign currency translation.
- Accounting change: Retrospective adoption of the insurance acquisition-cost standard reduced opening 2012 equity after tax by $25.8, or about 1%; management said the impact on reported operating results was not material.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management expects investment yields to continue declining as new-money rates remain historically low. It expects rate increases in many Commercial Lines and Chaucer classes, while noting pricing pressure in casualty and aviation and limited expected growth in U.K. motor.
- Management said Personal Lines net written premiums could decline modestly in 2012 due to agency terminations and exposure-management actions. Rate increases and selective underwriting are intended to support profitability; results remain exposed to competition, weather losses, and regulatory or legal developments.
- Key risks include catastrophe and weather losses, reserve-estimate changes, reinsurance collectability and cost, investment-market volatility and defaults, European economic and sovereign-credit stress, acquisition integration, and regulatory, competitive, and operational risks. The company reported no material change in market-risk exposures during the quarter.
- Investment portfolio: approximately 94% of fixed maturities were investment grade. Unrealized losses on fixed maturities and equity securities declined to $37.6 from $63.8 at year-end. The company said it did not intend, and was not more likely than not required, to sell loss-position fixed maturities before recovery; adverse market or credit changes could nevertheless cause impairment or losses.
- Liquidity and capital: the holding company held approximately $194.8 of fixed maturities and cash and management expected this to cover 2012 holding-company obligations without additional subsidiary dividends. Chaucer’s pension plan was about $30 underfunded; the U.S. qualified defined-benefit plan was described as essentially fully funded. Lloyd’s required capital was $753.1, supported by pledged assets, letters of credit, and a reinsurance treaty.
- Contingencies: the Durand pension-plan litigation and Louisiana Road Home/Hurricane Katrina litigation remain unresolved; the company could not reasonably estimate potential liability in either matter. Other proceedings were not expected to materially affect financial position, though they could affect a particular period’s results.
- Subsequent event: On April 30, 2012, the company completed the sale of Citizens Management, Inc.; it expected an after-tax gain of approximately $11.
Important facts for investors to verify
- Separate organic growth and underwriting trends from Chaucer’s acquired contribution when comparing periods.
- Track reserve development by segment and accident year, catastrophe losses, and combined ratios; the favorable reserve release fell substantially year over year.
- Assess cash generation and liquidity alongside investment purchases, restricted Lloyd’s assets, subsidiary dividend limits, and debt obligations.
- Monitor investment credit quality, unrealized losses, European exposures, and whether market or credit changes lead to impairment charges.
- Follow the outcomes and potential financial effects of the Durand and Road Home litigation, the Chaucer pension shortfall, and the expected gain on the subsidiary sale.