The Hanover Insurance Group, Inc. — Q2 2013 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2013. Hanover operates Commercial Lines, Personal Lines, international specialist insurer Chaucer, and Other businesses. Figures are unaudited; dollar amounts are in millions unless noted.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenues | $1,182.6 | $1,127.2 | $2,362.9 | $2,249.0 |
| Net income | $53.4 | $20.8 | $119.6 | $70.5 |
| Diluted continuing-operations EPS | $1.19 | $0.22 | $2.65 | $1.33 |
| Operating income before interest and taxes | $81.1 | $31.0 | $183.3 | $116.7 |
| Net premiums written | $1,242.6 | $1,197.6 | $2,319.3 | $2,214.4 |
| Combined ratio | 98.4% | 103.1% | 97.3% | 100.6% |
- Revenue and earnings: Q2 revenue rose about 5% and net income increased $32.6; first-half revenue rose about 5% and net income increased $49.1. Growth in earnings chiefly reflected better underwriting results, including reserve releases and lower catastrophe losses. Q2 net realized investment gains were $13.7, while an $11.3 debt-repurchase loss partly offset results. First-half realized gains were $21.8 and debt-repayment losses totaled $19.1.
- Underwriting and margins: The combined ratio improved year over year in both periods. First-half favorable prior-year reserve development was $33.8, versus no net development in 2012; catastrophe losses were $81.5 versus $114.7. Segment operating income before interest and taxes for the first half was $59.2 Commercial Lines, $50.4 Personal Lines, and $77.8 Chaucer. Commercial Lines remained at an underwriting loss for the first half ($12.6); Personal Lines and Chaucer reported underwriting profits of $9.8 and $57.7, respectively.
- Investment income and comprehensive income: Net investment income declined 1.5% to $135.2 for the first half, as lower reinvestment yields outweighed some dividend and mortgage-security income. Average fixed-maturity earned yield fell to 4.00% from 4.35%. Q2 other comprehensive loss was $133.4 and first-half other comprehensive loss was $136.1, primarily reflecting lower market values of available-for-sale investments. First-half comprehensive loss was $16.5, compared with income of $163.2 in 2012.
- Cash flow and liquidity: First-half operating cash flow was $33.3, down from $59.3; investing activities provided $133.2, versus $326.0 used in 2012; financing used $34.8. Cash and cash equivalents ended at $690.4, up from $564.8 at year-end. Total cash and investments were $7,797.2, down 3.1% since year-end. Management said holding-company assets were sufficient for expected obligations and did not expect additional insurance-subsidiary dividends to be needed for 2013 holding-company needs.
- Balance sheet and debt: Total assets were $13,306.4 and shareholders’ equity $2,495.7, down from $13,484.9 and $2,595.4 at year-end. Debt carrying value rose to $938.6 from $849.4; principal debt was $940.9. The company issued $175.0 of 6.35% subordinated debentures due 2053, repurchased $39.2 carrying value of 2025 senior debentures for $50.5, and repaid $46.3 of FHLBB advances plus fees. It repurchased $72.3 of common stock and paid $29.3 in dividends during the half.
- Insurance capital: U.S. insurance-subsidiary statutory surplus was $1,639.5, up from $1,523.4 at year-end. Hanover Insurance’s RBC ratio was 243% of Company Action Level (486% of Authorized Control Level). Chaucer was reported in compliance with Lloyd’s capital requirements.
Material changes, outlook, and risks
- Commercial Lines first-half net premiums written grew 4.1%, supported by rate increases, retention, and targeted new business. Personal Lines premiums written declined modestly as exposure-management actions and lower policy counts offset rate increases. Chaucer premiums written rose 13.6%, primarily because its economic participation in Syndicate 1084 increased to 98% from 84%.
- Management expects continued pressure on investment yields while new-money rates remain low. It anticipates Personal Lines rate and exposure actions may produce a modest decline in premiums and policies in force during 2013. Chaucer sees limited overall rate increases, with better opportunities in catastrophe-exposed marine and property; energy pricing is weakening and aviation, casualty, and U.K. motor markets remain pressured. No specific consolidated earnings or revenue guidance is provided.
- Investment-market risk increased: gross unrealized losses on fixed maturities and equity securities were $72.8 at June 30, up from $24.8 at year-end, mainly due to higher interest rates and wider credit spreads. Management considered these losses temporary, but acknowledged that adverse markets, credit deterioration, or a need to sell could cause impairments or realized losses. About 94% of fixed maturities were investment grade, compared with 95% at year-end.
- Key operating risks include catastrophe and weather losses, reserve-estimation uncertainty, bodily-injury severity, pricing competition, reinsurance availability and collectability, foreign-exchange movements, low yields, and market or credit losses. Chaucer’s estimated premiums, particularly in energy, are also subject to revision.
- The Durand class-action litigation concerns lump-sum cash-balance pension calculations. The company could not reasonably estimate a potential liability range; an adverse outcome could affect plan assets and future company funding. Other legal or regulatory proceedings were not expected to materially affect financial position, but could affect a particular period’s results.
- Management reported no material change in market-risk exposures, no material change to internal control over financial reporting, and no material off-balance-sheet arrangements. Debt covenants were in compliance at June 30, 2013.
Important facts for investors to verify
- Whether reserve releases—especially Chaucer’s favorable development—and lower catastrophe losses persist; first-half results included $33.8 of favorable prior-year development.
- Underlying current-year underwriting trends by segment, including Commercial Lines’ underwriting loss and the reported combined-ratio improvement.
- How investment yields, interest-rate-driven unrealized losses, credit spreads, and potential forced sales affect investment income, equity, and capital.
- Debt and capital allocation after the new subordinated issuance, debt repurchases, share repurchases, and dividends; also monitor statutory capital and RBC levels.
- Developments in the Durand litigation and any changes in reinsurance recoverables, catastrophe exposure, or Chaucer premium estimates.