HANOVER INSURANCE GROUP, INC. annual report, FY2022

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Business context and reporting period

The Hanover Insurance Group, Inc. (NYSE: THG) filed this audited Form 10-K for the fiscal year ended December 31, 2022; it is an annual report, not a standalone fourth-quarter filing. The company is a U.S. property-and-casualty insurer that primarily distributes through independent agents and brokers. Its segments are Core Commercial, Specialty, Personal Lines and Other. The company reorganized its former Commercial Lines segment into Core Commercial and Specialty in 2022 and recast prior periods.

Key financial and operating metrics

  • Premiums and revenue: Net premiums written were $5.48 billion, up 9.7% from 2021; net premiums earned were $5.25 billion, up from $4.77 billion. Total operating revenues, a company-defined measure, were $5.58 billion. GAAP total revenues were $5.47 billion, including investment losses.
  • Earnings: Net income was $116.0 million ($3.21 diluted EPS), compared with $418.7 million ($11.49 diluted EPS) in 2021. Operating income before interest and income taxes, a non-GAAP measure, was $285.1 million versus $432.3 million. Continuing-operations income before tax was $144.0 million.
  • Underwriting and margins: The consolidated combined ratio was 99.8%, compared with 97.0% in 2021; below 100% generally indicates underwriting profit. Total underwriting loss was $9.4 million, versus $126.0 million of underwriting profit. Segment combined ratios were Core Commercial 101.2%, Specialty 89.3%, and Personal Lines 104.3%.
  • Claims and catastrophes: Losses and loss adjustment expenses were $3.62 billion. Pre-tax catastrophe losses were $402.6 million, equal to 2021; $165.0 million related to fourth-quarter Winter Storm Elliott. Prior-year reserve development was favorable by $32.6 million overall, including $20.6 million excluding catastrophes, compared with $71.1 million favorable development overall in 2021.
  • Investments: Net investment income was $296.3 million, down from $310.7 million. Net realized and unrealized investment losses were $106.5 million, versus gains of $123.0 million in 2021, largely reflecting equity-security fair-value changes. Cash and investments totaled $8.81 billion at year-end. Fixed maturities had $817.7 million of gross unrealized losses, primarily attributed by management to higher interest rates and wider credit spreads; management said it did not intend, and did not expect to be required, to sell the securities before recovery.
  • Cash flow and liquidity: Operating cash flow was $722.3 million, down from $823.7 million. Investing activities used $507.6 million and financing activities used $140.6 million. Cash and cash equivalents were $305.0 million. The holding company reported $333.5 million of fixed maturities and cash; insurance-subsidiary dividends are subject to regulatory limits.
  • Debt and capital: Debt was $782.4 million carrying value ($786.9 million principal). Principal includes $375.0 million due 2026, $300.0 million due 2030, $61.8 million due 2025 and $50.1 million of subordinated debentures due 2027. No borrowings were outstanding under the $200 million revolving credit facility or FHLB facility at year-end; FHLB borrowing capacity was $120.9 million. Insurance-subsidiary statutory capital and surplus was $2.69 billion, down $29.6 million; Hanover Insurance’s RBC ratio was 207% on the industry scale.

Material changes versus 2021

  • Net premiums written grew 9.7%, but operating income before interest and taxes fell $147.2 million, primarily from higher current-year claims and less favorable prior-year reserve development.
  • Higher claims severity, inflation and supply-chain disruption affected automobile and homeowners losses; personal-auto frequency also rose from unusually low 2021 levels.
  • Personal Lines operating income shifted from $158.5 million to an $8.8 million loss. Its combined ratio rose to 104.3% from 96.2%, despite premium growth.
  • Specialty operating income increased to $186.0 million from $131.9 million, with a lower combined ratio and lower catastrophe losses. Core Commercial operating income declined to $106.9 million from $138.0 million.
  • Shareholders’ equity declined to $2.33 billion from $3.14 billion, substantially reflecting $827.7 million of other comprehensive loss, principally investment-security depreciation. Cash and investments declined 6.1%.

Outlook, management commentary, risks and unusual items

  • Management cited continuing uncertainty over inflation, repair and construction costs, supply chains, driving patterns and delayed court proceedings. It is pursuing rate increases, underwriting actions and business diversification, but provided no specific numerical earnings or premium guidance.
  • Management expects operating cash generation to cover short- and long-term needs and does not expect to need additional insurance-subsidiary dividends for 2023 holding-company obligations. It said it currently expects quarterly dividends comparable to the $0.81 per-share fourth-quarter 2022 dividend, subject to Board approval and available funds.
  • The 2023 catastrophe reinsurance program was described as fundamentally similar to 2022, but coverage adequacy and future availability, pricing and terms are not assured. Reinsurance recoverables totaled $1.96 billion, including $883.0 million from Michigan’s MCCA; the company remains responsible to policyholders if reinsurers do not pay.
  • Michigan automobile reform creates uncertainty around PIP costs, rate restrictions and litigation. The company reported an $883.0 million MCCA recoverable and noted that the outcome of legal challenges could affect estimates and future results.
  • Key broader risks include catastrophe severity and geographic concentration, reserve-estimation uncertainty, social inflation and litigation, regulatory constraints on pricing or withdrawals, investment-market and interest-rate exposure, and cyber, privacy and third-party technology risks. Management stated that ordinary-course legal and regulatory proceedings were not expected to materially affect financial position, though a particular period’s results could be affected.
  • Unusual items included the $165.0 million Winter Storm Elliott loss, $106.5 million of investment losses, and substantial unrealized fixed-maturity losses recorded through other comprehensive income. The auditor issued an unqualified opinion and identified valuation of loss and LAE reserves as a critical audit matter; management and the auditor reported effective internal control over financial reporting.

Important facts for investors to verify

  • Whether rate increases and pricing keep pace with claims severity and inflation, especially in Personal Lines, and whether its combined ratio improves.
  • Whether reserve assumptions remain adequate: net loss reserves were $5.26 billion, and management estimated a one-percentage-point aggregate loss-ratio change could affect operating income by about $53 million.
  • How Michigan PIP reform, related litigation and MCCA recoverables develop, including whether statutory cost controls produce expected savings.
  • Whether catastrophe losses, reinsurance renewals and counterparty recoveries remain manageable, particularly given geographic concentrations and the absence of aggregate catastrophe coverage renewed effective July 2022.
  • Whether fixed-maturity unrealized losses recover without forced sales, and how higher rates, credit spreads and limited-partnership returns affect investment income, equity and liquidity.
  • Whether holding-company liquidity, regulated subsidiary dividend capacity, debt service, the dividend and potential share repurchases remain sustainable.