The Hanover Insurance Group, Inc. — Q1 2017 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2017, compared with the same period in 2016. Hanover operates Commercial Lines, Personal Lines, international specialist insurer Chaucer, and Other; its business is primarily property and casualty insurance.
Key financial results
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total revenue | $1,260.9 million | $1,227.6 million |
| Net premiums written | $1,186.8 million | $1,144.3 million |
| Net income | $45.2 million | $78.2 million |
| Diluted EPS | $1.05 | $1.80 |
| Operating income before interest and taxes | $69.1 million | $120.4 million |
| Net cash provided by operating activities | $54.2 million | $82.0 million |
| Combined ratio | 99.5% | 95.0% |
Revenue rose 2.7%, but net income fell $33.0 million. Management attributed the decline primarily to higher catastrophe losses. Pretax catastrophe-related activity was $84.1 million, versus $31.2 million a year earlier. Net favorable prior-year reserve development was $7.4 million, compared with $18.7 million.
Net premiums earned were $1,181.3 million, up from $1,151.3 million. Net investment income increased to $71.1 million from $68.3 million; the total portfolio earned yield declined to 3.29% from 3.40%. Total losses and expenses were $1,201.9 million, versus $1,119.5 million. Income before taxes was $59.0 million, down from $108.1 million. The 2017 tax provision was $13.8 million and included a $2.3 million excess stock-compensation tax benefit following adoption of new accounting guidance.
Balance sheet, liquidity, and capital
- At March 31, 2017, total assets were $14.49 billion, total liabilities $11.58 billion, and shareholders’ equity $2.91 billion.
- Cash and cash equivalents were $257.0 million, down from $282.6 million at year-end 2016. Operating cash flow was positive, while investing and financing activities used $47.8 million and $32.1 million, respectively.
- Debt was $786.6 million; its estimated fair value was $865.1 million. The company reported no borrowings under its $200 million revolving credit agreement or its FHLB short-term facility and was in compliance with debt and credit covenants.
- U.S. insurance subsidiaries’ statutory capital and surplus was $2.23 billion. Hanover Insurance’s risk-based capital ratio was 241% on the industry scale and 482% on the regulatory scale. Chaucer was in compliance with Lloyd’s capital requirements.
- The company paid $21.4 million in shareholder dividends, or $0.50 per share, and repurchased approximately 51,000 shares for $4.6 million during the quarter. Approximately $179 million remained available under the repurchase authorization.
Material changes and segment performance
- Commercial Lines: Net premiums written rose 3.5% to $625.3 million. Segment operating income fell to $37.4 million from $42.7 million; underwriting reported a $2.7 million loss versus $3.7 million profit. Higher catastrophe losses and current-year claims weighed on results.
- Personal Lines: Net premiums written rose 7.4% to $362.1 million, supported by rate increases, new business, and retention. Segment operating income declined to $9.9 million from $47.1 million, and underwriting posted an $8.4 million loss versus $28.6 million profit, mainly reflecting higher catastrophe losses.
- Chaucer: Net premiums written declined 1.8% to $199.4 million, partly because Q1 2016 included a $17.7 million reinsurance-to-close transaction. Excluding that item, written premiums increased 7.6%. Segment operating income decreased to $24.9 million from $33.7 million, principally due to lower favorable reserve development and higher catastrophe losses.
- The consolidated combined ratio increased to 99.5% from 95.0%. Ratios were 100.2% for Commercial Lines, 101.6% for Personal Lines, and 93.5% for Chaucer.
Outlook, commentary, risks, and unusual items
- In February 2017, management announced “Hanover 2021,” a strategy emphasizing agency partnerships, responsible growth, investment in growth capabilities, and combining core commercial and personal lines into “Hanover Agency Markets.” No numerical earnings or premium guidance is provided in the filing.
- Management expects average investment yields to continue declining as new-money yields remain below embedded book yields. Chaucer faces competitive pricing pressure; management noted uncertainty about maintaining adequate rates. Domestic underwriting results may also be affected by competition, weather losses, and regulatory considerations.
- The quarter included $1.4 million of other-than-temporary investment impairment losses, primarily on other investments, compared with $20.9 million in Q1 2016. Approximately 94% of the fixed-maturity portfolio was investment grade; the filing warns that market volatility, defaults, or forced sales could produce future realized or unrealized losses.
- The company identifies catastrophe and weather exposure, reserve-estimation uncertainty, reinsurance recoverability and availability, investment-market and interest-rate risk, foreign-exchange movements, and Brexit-related effects on Chaucer’s licensing and markets as risks. Foreign-exchange losses reduced pretax operating income by approximately $1 million, versus approximately $12 million in Q1 2016.
- A putative class action concerning lump-sum benefits under a former employee cash-balance pension plan remains pending. The company cannot reasonably estimate potential ultimate liability. Other legal and regulatory matters are not expected to materially affect financial position, though a particular period’s results could be affected.
- Management reported no material change in market-risk exposures, no material change in internal control over financial reporting, and no material off-balance-sheet arrangements. The filing states that first-quarter results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether catastrophe claims and subsequent reserve development continue to pressure underwriting results, particularly in Personal Lines and Commercial Lines.
- Whether premium growth and rate increases translate into improved underwriting margins amid competition and regulatory constraints.
- Reserve adequacy, including the drivers of favorable development and exposure to long-tail claims and reinsurance recoverables.
- Investment portfolio sensitivity to rates, credit spreads, defaults, and any need to sell securities while unrealized losses persist.
- Liquidity and capital availability, including regulatory limits on insurer dividends, pension funding needs, and the unresolved pension-plan litigation.
- Execution of the Hanover 2021 strategy and Chaucer’s response to competitive market conditions and Brexit-related uncertainty.