Business context and reporting period
The Hanover Insurance Group, Inc. (NYSE: THG) filed this unaudited Form 10-Q for the quarter ended March 31, 2019. The insurer reports Commercial Lines, Personal Lines and Other; Chaucer and former life businesses are presented as discontinued operations. Comparisons are with the three months ended March 31, 2018 unless otherwise noted.
Financial results and key metrics
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Premiums earned | $1,095.1 million | $1,042.5 million |
| Net premiums written | $1,098.0 million | $1,068.7 million |
| Total revenue | $1,219.5 million | $1,091.5 million |
| Income from continuing operations | $122.6 million | $50.5 million |
| Net income | $122.4 million | $67.7 million |
| Diluted EPS | $2.97 | $1.57 |
| Operating income before interest and taxes (non-GAAP) | $109.8 million | $93.3 million |
| Net cash from operating activities | $37.2 million | $31.4 million |
- Revenue rose about 12%, while net premiums written increased about 3%. Net investment income was $70.2 million, up from $66.0 million.
- Net income benefited substantially from $48.6 million of gains on equity securities measured at fair value, versus a $22.9 million loss a year earlier. The investment result is market-sensitive and materially influenced the year-over-year earnings increase.
- Combined ratio improved to 95.8% from 96.6% overall. Commercial Lines improved to 94.2% from 97.2%; Personal Lines worsened to 98.2% from 95.8%. Ratios include catastrophe losses and prior-year reserve development.
- Pre-tax catastrophe losses, net of favorable catastrophe reserve development, were $39.4 million versus $65.5 million. Favorable prior-year reserve development totaled $13.2 million, mainly from expected subrogation recoveries on California wildfires; non-catastrophe prior-year development was slightly unfavorable overall.
- At March 31, total assets were $11.98 billion, shareholders’ equity $2.93 billion, and debt $653.0 million. Debt was $777.9 million at year-end 2018. Cash and cash equivalents fell to $168.5 million from $1.02 billion; total cash and investments were $7.91 billion versus $8.31 billion.
- Cash used in investing was $279.3 million and cash used in financing was $610.6 million. Financing outflows included $250 million for an accelerated share repurchase, $217.0 million of dividends, and debt repayments. The company paid a $4.75-per-share special dividend and a $0.60-per-share quarterly dividend.
- U.S. insurance subsidiaries’ statutory capital and surplus was $2.30 billion, up from $2.17 billion at year-end. Hanover Insurance’s RBC ratio was 222% on the industry scale and 444% on the regulatory scale.
Material changes, outlook and risks
- Commercial Lines operating income rose to $80.2 million from $61.4 million, mainly reflecting lower catastrophe losses and better prior-year development. Underlying current-year underwriting profit excluding catastrophes declined, with unusually high large losses in specialty industrial property.
- Personal Lines operating income fell to $26.8 million from $34.3 million. Premium growth from rate increases was offset by higher current-year losses and unfavorable prior-year development. Management cited rate adequacy, profitable growth and agency partnerships as priorities; it gave no specific numerical earnings or premium guidance.
- Management expects to continue seeking rate increases and pursuing disciplined underwriting and responsible growth. Results remain exposed to competition, regulatory constraints, changing loss costs, severe weather, reserve-estimation uncertainty and reinsurance availability and collectability.
- Chaucer’s main business was sold in December 2018; the related Irish entity was sold in February 2019 for $28 million and Australian entities were sold after quarter-end in April for $13 million. Q1 2019 Chaucer-related operations recorded a $0.3 million operating loss.
- The company repaid $125 million of 5.5% FHLB advances in January and recognized related $26 million prepayment fees in 2018. It reported $92.4 million of FHLB borrowing capacity and no outstanding borrowings under that facility at quarter-end. An unsecured five-year revolving facility of up to $200 million, expandable to $300 million, was entered into on April 30, 2019; it had no advances as of May 2.
- Fixed-maturity unrealized losses declined to $42.0 million from $134.2 million at year-end; management considers them temporary but warns that market deterioration or a need to sell could result in realized losses. Other disclosed risks include potential catastrophe losses, reserve changes, investment volatility, Michigan auto-market proposals, and contingent consideration tied to the Chaucer sale.
- The Durand pension litigation was settled and dismissed; the settlement was stated not to be material. Other legal and regulatory matters were not expected to materially affect financial position, though could affect results in a particular period. Management reported effective disclosure controls and no material change to internal control over financial reporting.
Important facts for investors to verify
- How much of the earnings and EPS increase reflects recurring underwriting and investment income versus the $48.6 million equity fair-value gain?
- Whether Personal Lines loss trends and the specialty industrial property large-loss activity improve, and whether rate increases keep pace with loss costs.
- The assumptions and subsequent experience supporting wildfire subrogation recoveries and favorable reserve development.
- Whether reduced cash balances after the special dividend, share repurchase and debt repayment remain adequate alongside insurance-company liquidity needs.
- Future investment portfolio performance, including interest-rate, credit-spread, equity-market and unrealized-loss risks.
- Completion and proceeds of the Australian Chaucer entity sale, and the effect of Chaucer-related contingent consideration.