Hanover Insurance Group, Inc. — Q2 2018 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2018; comparisons are with the three and six months ended June 30, 2017. Hanover is a property and casualty insurer operating through Commercial Lines, Personal Lines, Chaucer (specialty underwriting through Lloyd’s), and Other. Results include discontinued operations, primarily former life and accident and health businesses.
Financial and operating performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $1,362.8m | $1,266.1m | $2,693.7m | $2,527.0m |
| Net income | $99.3m | $78.4m | $167.0m | $123.6m |
| Diluted EPS | $2.31 | $1.83 | $3.88 | $2.88 |
| Operating income before interest and tax (non-GAAP) | $129.8m | $118.9m | $246.4m | $188.0m |
| Net premiums written | $1,363.7m | $1,275.7m | $2,628.3m | $2,462.5m |
| Combined ratio | 95.5% | 95.6% | 96.2% | 97.5% |
Six-month operating income growth reflected higher investment income, premium growth, lower catastrophe losses and a favorable change in reinsurance reinstatement premiums. Six-month catastrophe losses were $134.8m, versus $141.2m. Prior-year reserves developed favorably by $34.1m, versus $24.5m; this includes $15.3m of favorable catastrophe-reserve development.
Segment results were mixed for the first half: Commercial Lines operating income rose to $143.5m from $80.6m; Personal Lines rose to $61.7m from $57.8m; Chaucer declined to $44.8m from $54.6m. Q2 Personal Lines underwriting income fell to $8.0m from $29.5m, mainly due to higher catastrophe losses and unfavorable prior-year development. Q2 Commercial Lines underwriting income improved to $37.7m from $2.3m.
Six-month net cash from operating activities was $179.5m, down from $249.8m; investing cash outflow was $234.2m and financing cash outflow was $76.0m. Cash and cash equivalents declined to $244.9m from $376.4m at year-end. At June 30, total investments were $9,020.7m, debt was $787.1m, total assets were $15,403.6m and shareholders’ equity was $2,939.8m. U.S. insurance subsidiaries reported statutory capital and surplus of $2,075.7m; Hanover Insurance’s RBC ratio was 202% on the industry scale.
Material changes versus prior period
- Six-month net income increased $43.4m, while operating income before interest and tax increased $58.4m.
- Net premiums written grew about 6.7% for the first half. Management cited rate increases, retention and targeted new business growth, with domestic lines driving much of the increase.
- The U.S. corporate tax rate reduction from 35% to 21% lowered the effective tax burden; six-month income tax expense declined to $33.5m from $46.4m.
- Adoption of accounting standards changed equity-security fair-value accounting: gains and losses are now recorded in net income. First-half equity fair-value changes contributed to $19.7m of net realized and unrealized investment losses. Fixed-maturity unrealized losses increased to $181.3m from $54.3m at year-end, primarily as interest rates and credit spreads rose.
- Accumulated other comprehensive loss was $169.1m, compared with income of $107.6m at year-end. The filing also corrected the presentation of first-quarter accounting-adoption effects in comprehensive income; management concluded the correction was not material to previously issued interim statements.
Outlook, commentary, risks and unusual items
- No specific numerical earnings or revenue guidance is provided. Management says it aims for responsible growth, underwriting discipline and rate increases that meet or exceed loss-cost trends, subject to competition and regulation.
- The company announced a strategic review of Chaucer, including a possible sale. Management cautions about potential distraction and business or employee retention concerns.
- On July 1, Hanover added a reinsurance feature providing $75m of coverage above $300m in aggregate domestic losses, or for a single extreme event above the prior treaty limit.
- Insurance results remain exposed to catastrophe severity and frequency, reserve-estimate changes, bodily-injury loss trends, reinsurance availability and collection, competitive pricing, interest rates, investment-market volatility, credit defaults, foreign exchange and regulatory or political developments, including Brexit.
- The Durand ERISA class action reached a settlement in principle on major terms, subject to final documentation and court approval. If completed substantially as contemplated and approved, the company does not expect the settlement to be material to financial position or results.
- Chaucer disclosed a 5% participation in an Iran-related aviation reinsurance arrangement permitted under then-applicable U.S. authorization. The agreement expired June 21, 2018, was not renewed, and no claims had been paid as of June 30. Estimated gross revenue was approximately $275,000.
- Hanover paid $45.9m in shareholder dividends and repurchased $25.3m of stock in the first half. Approximately $121m remained available under repurchase authorizations at June 30. Management reported compliance with debt covenants and sufficient expected operating cash to meet requirements, while noting insurance-subsidiary dividends are regulated.
Important facts for investors to verify
- Whether premium growth and improved combined ratios persist, particularly given Q2 Personal Lines catastrophe losses and Chaucer’s weaker underwriting results.
- Reserve adequacy and the sources and sustainability of favorable prior-year development, including Chaucer’s casualty and treaty exposures.
- Investment portfolio sensitivity: the effect of higher rates and wider spreads on unrealized losses, equity-related earnings volatility and potential impairment charges.
- Progress and consequences of the Chaucer strategic review, including a possible sale and any impact on capital, earnings or operations.
- Liquidity and capital flexibility after dividends, repurchases and regulated subsidiary distributions; also monitor reinsurance protection, statutory surplus and RBC levels.
- Final resolution and financial effect of the Durand litigation settlement, and any material developments in other legal or regulatory matters.