The Hanover Insurance Group, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; balance-sheet figures are as of September 30, 2014. The company operates Commercial Lines, Personal Lines, Chaucer (specialty insurance through Lloyd’s), and Other.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $1,265.6m | $1,201.8m | $3,782.5m | $3,564.7m |
| Net income | $54.9m | $61.3m | $192.1m | $180.9m |
| Diluted EPS | $1.22 | $1.37 | $4.28 | $4.03 |
| Operating income before interest and taxes | $86.4m | $107.2m | $273.6m | $290.5m |
| Net premiums written | $1,244.8m | $1,181.9m | $3,693.3m | $3,501.2m |
Q3 net income declined primarily because catastrophe losses reduced operating income. Nine-month net income increased despite lower operating income, helped by higher realized investment gains and the absence of 2013 debt-repayment losses. Nine-month operating income before interest and taxes fell $16.9m, mainly due to higher catastrophe losses.
- Underwriting: The combined ratio was 98.2% in Q3 versus 96.0% a year earlier, and 97.7% for nine months versus 96.8%. A ratio below 100% indicates an underwriting profit before investment income and other items.
- Catastrophes and reserves: Pre-tax catastrophe losses were $88.1m in Q3 versus $30.6m, and $201.7m for nine months versus $112.1m. Favorable prior-year reserve development was $21.9m in Q3 and $70.8m year to date, compared with $23.6m and $57.4m, respectively, in 2013.
- Segments: Q3 operating income before interest and taxes was $43.1m Commercial Lines, $6.7m Personal Lines, and $39.4m Chaucer. Personal Lines results were particularly affected by Michigan flooding and other catastrophe losses. Nine-month Commercial Lines and Chaucer operating income improved, while Personal Lines declined.
- Investment income: Net investment income was $67.5m in Q3 and $201.5m year to date. Average fixed-maturity earned yields declined to 3.68% in Q3 and 3.73% for nine months, from 3.99% in each comparable 2013 period.
Financial position, cash flow, and liquidity
- Total assets were $13,960.2m, shareholders’ equity $2,771.9m, and debt $903.4m, compared with $13,378.7m, $2,594.5m, and $903.9m, respectively, at year-end 2013.
- Cash and cash equivalents were $509.6m, up from $486.2m at year-end. Cash from operating activities was $408.1m for the first nine months, versus $181.9m in 2013; investing activities used $347.2m and financing activities used $35.9m. Management attributed the operating cash flow increase primarily to higher premium collections.
- Total cash and investments were $8,533.2m. Approximately 94% of fixed maturities were investment grade. The portfolio had $48.9m of gross unrealized losses, down from $94.7m at year-end; management considered these losses temporary but noted market changes or forced sales could result in impairment charges.
- U.S. insurance subsidiaries’ statutory surplus was $1,998.6m, up from $1,834.3m at year-end. Hanover Insurance’s risk-based capital ratio was 272% on the industry scale and 543% on the regulatory scale.
- The company reported compliance with debt and credit-agreement covenants and Lloyd’s capital requirements. It had no borrowings under its $200m credit agreement during the first nine months. Chaucer paid $67.9m in dividends to the holding company in 2014; no dividend was paid by Hanover Insurance to the holding company in Q3.
Material changes, outlook, and risks
- Premium growth was led by Commercial Lines and Chaucer; Personal Lines premiums written declined year to date as the company reduced exposure, including policies in force down 6.1% in personal automobile and 8.2% in homeowners.
- Management said it would continue pursuing rate increases, business-mix improvements, and exposure management. It cited elevated weather-related losses, competitive pressures, and low interest rates; it expects investment yields to continue declining as new-money yields remain below portfolio book yields. No specific earnings or premium guidance was provided.
- Chaucer faced downward rate pressure in several specialty markets amid high capacity and an absence of major industry losses. The company also identified risks from severe weather, reserve-estimation uncertainty, reinsurance collectability and availability, investment-market volatility, interest rates, foreign exchange, regulation, and competition.
- The Durand pension-plan litigation remained pending, including an appeal. The company could not reasonably estimate potential liability. Other ordinary-course legal and regulatory matters were not expected to materially affect financial position, though they could affect results in a particular period.
- Q3 other comprehensive loss was $53.0m, primarily reflecting net depreciation on available-for-sale securities and derivatives and foreign currency translation. Management reported no material changes in market-risk exposures and said disclosure controls were effective; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether catastrophe activity and elevated weather losses persist, particularly in Personal Lines, and how rate actions affect retention and profitability.
- The quality and sustainability of favorable reserve development, including the concentration of nine-month favorable development in Chaucer and personal automobile.
- Whether Personal Lines exposure reductions and premium trends stabilize while improving underwriting results.
- The effect of falling investment yields, market-value movements, and any credit deterioration on earnings, equity, and liquidity.
- Developments in the Durand litigation and any resulting pension-plan funding or company obligations.