The Hanover Insurance Group, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing also reports unaudited fourth-quarter results; this is an annual report, not a quarterly filing. Amounts are U.S. dollars.
Business context
Hanover is a property and casualty insurer operating through Commercial Lines, Personal Lines, Chaucer (specialty insurance written through Lloyd’s), and Other. U.S. business is distributed mainly through independent agents; Chaucer writes internationally through Lloyd’s brokers.
Financial performance and position
| Metric | 2015 | 2014 |
|---|---|---|
| Total revenue | $5,034.0 million | $5,067.6 million |
| Net premiums earned | $4,704.8 million | $4,710.3 million |
| Net premiums written | $4,616.8 million | $4,810.1 million |
| Operating income before interest and taxes | $465.6 million | $406.2 million |
| Net income | $331.5 million | $282.0 million |
| Diluted earnings per share | $7.40 | $6.28 |
| Net cash provided by operating activities | $438.4 million | $564.7 million |
| Debt, carrying value | $812.8 million | $903.5 million |
| Total assets | $13,790.9 million | $13,759.7 million |
| Shareholders’ equity | $2,844.4 million | $2,844.0 million |
Net investment income was $279.1 million, up from $270.3 million; net realized investment gains were $19.5 million, down from $50.1 million. The consolidated combined ratio was 95.7%, compared with 96.9%; below 100% generally indicates underwriting profit before investment income. Segment combined ratios were 100.4% for Commercial Lines, 94.2% for Personal Lines, and 87.5% for Chaucer.
At year-end, cash and investments totaled $8,292.2 million, including $6,983.4 million of fixed maturities, $576.6 million of equities, and $338.8 million of cash and equivalents. Approximately 94% of fixed maturities were investment grade. Gross loss and LAE reserves were $6,574.4 million, with $2,280.8 million of reinsurance recoverables on unpaid losses; net reserves were $4,293.6 million. U.S. insurance subsidiaries reported statutory capital and surplus of $2,192.8 million.
Cash flow from operations fell to $438.4 million, with management citing higher federal tax payments, timing of reinsurance payments, and slightly lower premium collections, partly offset by lower claims payments. Cash used in investing activities was $171.5 million and cash used in financing activities was $294.7 million. The holding company reported $129.9 million of fixed maturities and cash. The filing says it expected holding-company assets to cover 2016 obligations; future subsidiary dividends remain subject to regulatory limits.
Changes versus the prior year
- Net income rose $49.5 million, and operating income before interest and taxes rose $59.4 million. Lower catastrophe losses, a lower expense ratio, and higher investment income helped; higher Chaucer large losses and less favorable prior-year reserve development partly offset these gains.
- Catastrophe losses declined to $181.3 million from $223.0 million. Favorable prior-year reserve development also decreased, to $94.3 million from $99.1 million.
- Net premiums written declined 4.0% overall, chiefly reflecting the transfer of U.K. motor business. Excluding that business, management reported a $112.7 million increase year over year.
- Commercial Lines net premiums written increased 5.8%; Personal Lines increased 1.6%. Chaucer net premiums written fell to $889.3 million from $1,231.4 million, primarily because of the U.K. motor transfer; excluding U.K. motor, Chaucer declined 3.9%.
- U.K. motor was transferred effective June 30, 2015 through a 100% reinsurance arrangement for prior claims and in-force policies, alongside the sale of two entities. The transaction generated a $40.6 million after-tax gain.
- Investment portfolio unrealized values weakened: other comprehensive income was a loss of $152.5 million, compared with income of $28.8 million in 2014. Other-than-temporary impairment losses recognized in earnings rose to $26.8 million from $5.5 million, largely related to energy-sector investments.
Outlook, management commentary, risks and unusual items
- Management gave no specific numerical earnings or premium guidance. It described domestic Commercial and Personal Lines pricing as favorable and continued to pursue rate increases, improved business mix, agency partnerships, and geographic diversification. Chaucer faced competitive rate pressure and high market capacity; management expected investment yields to continue declining as new-money yields remained below portfolio book yields.
- Reserve estimates are a major uncertainty. Management reported $53.7 million of unfavorable prior-year development in Other Commercial Lines, including AIX program business, and $23.4 million unfavorable development in commercial automobile, partly offset by favorable workers’ compensation development of $46.9 million. Management estimated that a one-percentage-point change in the aggregate loss and LAE ratio would affect operating income by approximately $47 million.
- Reinsurance recoverables totaled $2,635.0 million. The Michigan Catastrophic Claims Association accounted for $906.5 million; the filing cites statutory assessment support and no significant identified uncollectible balances, but the concentration is material. Private reinsurer nonpayment or disputes could increase losses.
- Risks include severe weather and catastrophe exposure, concentrated U.S. business (Michigan represented 19.8% of combined Commercial and Personal Lines net premiums written), pricing competition and regulation, inflation in medical, repair and construction costs, reserve deterioration, investment and interest-rate volatility, foreign exchange, and cyber and operational risks. Terrorism exposures and mandatory residual-market assessments are additional risks.
- The Durand pension litigation remained unresolved; the company said it could not reasonably estimate a potential liability range. The filing also discusses run-off accident and health and reinsurance-pool exposures, including $88.7 million of net claim reserves for assumed accident and health business.
- Capital returns included $74.2 million of shareholder dividends and $127.3 million of common-stock repurchases in 2015. The board authorized aggregate repurchases of up to $900 million; approximately $289 million remained available at year-end. Debt repurchases generated a $24.1 million loss.
- Leadership transition was ongoing: the company was searching for a CEO successor, and Eugene Bullis was interim CFO after David Greenfield’s death in October 2015. The auditor gave an unqualified opinion on the financial statements and reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether the favorable reserve development, particularly at Chaucer, persists, and whether adverse Commercial Lines development continues.
- The development and collectability of the $2.635 billion reinsurance recoverable, especially the $906.5 million MCCA balance and Lloyd’s-related recoverables.
- Underlying underwriting performance excluding catastrophe losses, prior-year reserve development, and the U.K. motor disposal gain.
- Investment portfolio performance, energy-sector credit exposure, impairment trends, and the effect of lower reinvestment yields.
- Holding-company liquidity and access to regulated subsidiary dividends, alongside debt service, repurchases, and declared dividends.
- The outcome and potential financial effect of the Durand litigation and remaining discontinued-business liabilities.