The Hanover Insurance Group, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context
Hanover is a property and casualty insurer operating through Commercial Lines, Personal Lines, Other Property and Casualty, and Chaucer. The company acquired U.K.-based specialist underwriter Chaucer on July 1, 2011; reported 2011 results include Chaucer only from that date, so comparisons with 2010 are not fully like-for-like.
Key financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenues | $1,108.0 | $804.0 | $2,795.7 | $2,318.9 |
| Net premiums earned | $1,018.6 | $728.0 | $2,550.8 | $2,092.3 |
| Net income (loss) | $(9.7) | $52.3 | $(12.2) | $96.4 |
| Diluted earnings (loss) per share | $(0.21) | $1.15 | $(0.27) | $2.08 |
| Net cash from operating activities | — | $286.3 | $(15.0) |
- Revenue and earned premiums rose substantially, reflecting the Chaucer acquisition and growth in Commercial Lines, including business added through the OneBeacon renewal-rights transaction and AIX programs.
- Pre-tax catastrophe losses were $99.6 million in Q3 and $306.0 million for the first nine months, versus $24.1 million and $143.5 million in the comparable 2010 periods. Drivers included Hurricane Irene, winter storms, tornadoes, hail and windstorms.
- Net investment income was $67.8 million in Q3 and $189.2 million year to date. Fixed-maturity earned yields declined to 4.49% from 5.46% in Q3 and to 4.99% from 5.48% for the nine-month period.
- Combined ratios, including prior-year reserve development, were 106.8% in Q3 and 107.0% year to date, compared with 97.0% and 100.9% in 2010. Ratios above 100% indicate underwriting losses. Chaucer is included in 2011 only.
- Operating cash flow improved to $286.3 million from a $15.0 million use of cash in 2010; management attributed the change partly to the absence of a $100 million pension contribution made in 2010 and higher premium collections.
Balance sheet, debt and liquidity
- At September 30, 2011, total assets were $12,684.5 million, total liabilities $10,229.6 million and shareholders’ equity $2,454.9 million. Year-end 2010 comparatives were $8,569.9 million, $6,109.4 million and $2,460.5 million, respectively; the acquisition materially affects the balance-sheet comparison.
- Cash and cash equivalents were $922.7 million, versus $290.4 million at year-end 2010. Some assets are restricted: approximately $392 million of fixed maturities and $99 million of cash supported Lloyd’s underwriting at quarter-end.
- Debt was $901.6 million, versus $605.9 million at year-end 2010. The company issued $300 million of 6.375% senior unsecured notes due 2021 and repurchased $69.5 million principal of junior debentures, among other debt repurchases.
- Operating cash flow was $286.3 million; investing and financing activities provided $231.2 million and $140.8 million, respectively, for the first nine months. Management said holding-company assets and expected operating cash flows were sufficient for anticipated obligations. The company reported no borrowings under its $200 million revolving credit facility.
- U.S. insurance subsidiaries’ statutory surplus was $1,538.5 million at September 30, down from $1,747.3 million at year-end 2010. Hanover Insurance’s risk-based capital ratio was 261% on the industry scale.
Material changes, outlook and risks
- Q3 segment results before tax were a $7.6 million loss, versus $79.2 million income a year earlier. Commercial Lines and Personal Lines recorded underwriting losses; Chaucer contributed $19.9 million of segment income for its first reported quarter.
- Management cited unusually high catastrophe and non-catastrophe weather losses and lower favorable reserve development as key causes of weaker results. Favorable prior-year reserve development was $72.6 million for the first nine months, down from $87.4 million in 2010; management cautioned that future development may be less favorable.
- Management was seeking further rate increases in Commercial property and Personal homeowners lines. For Chaucer, it expected average rate increases across many lines in 2012, particularly catastrophe-exposed property and energy, while noting continued pricing pressure in casualty and aviation. It expected U.K. motor rate increases to moderately exceed claims inflation. These are expectations, not quantified earnings guidance.
- The Chaucer acquisition’s reported consideration was $480.7 million, excluding $11.6 million of transaction costs; total purchase price including those costs was $492.3 million. Management highlighted integration, foreign-currency, underwriting, catastrophe, regulatory and capital risks associated with the acquisition.
- Other principal risks include reserve estimation and adverse development, reinsurance recoverability, weather and catastrophe exposure, investment-market volatility and credit losses, competition and regulatory changes. The company disclosed two significant proceedings—the Durand pension-plan litigation and Louisiana Road Home litigation—and could not reasonably estimate potential liability in either.
- Management expected adoption of the insurance-contract acquisition-cost standard in 2012 to reduce stockholders’ equity by approximately $25–$30 million after tax as of January 1, 2012; it did not expect a material effect on operating results.
- The company reported disclosure controls were effective at quarter-end and no material change in internal control over financial reporting during the quarter. Chaucer was expected to enter the company’s annual internal-control assessment for 2012.
Most important facts for investors to verify
- Separate the effect of Chaucer’s consolidation from underlying organic premium growth and profitability.
- Track catastrophe losses, combined ratios and the sustainability of favorable reserve development, including Chaucer’s acquired reserves.
- Review the quality, valuation and liquidity of investments, including unrealized losses and restricted Lloyd’s assets.
- Monitor debt, statutory surplus, capital requirements and the availability of dividends from regulated insurance subsidiaries.
- Follow Chaucer integration, expected pricing changes, foreign-currency exposure, and the status and potential outcomes of the disclosed litigation.