The Hanover Insurance Group, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2017. Hanover is a property and casualty insurer operating through Commercial Lines, Personal Lines, Chaucer (international specialty insurance) and Other. Comparisons below are with the corresponding 2016 periods; financial amounts are in millions of U.S. dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenues | $1,266.1 | $1,222.0 | $2,527.0 | $2,449.6 |
| Net premiums written | $1,275.7 | $1,221.6 | $2,462.5 | $2,365.9 |
| Net income | $78.4 | $2.0 | $123.6 | $80.2 |
| Diluted EPS | $1.83 | $0.05 | $2.88 | $1.84 |
| Operating income before interest and taxes (non-GAAP) | $118.9 | $94.7 | $188.0 | $215.1 |
| Combined ratio | 95.6% | 97.3% | 97.5% | 96.2% |
| Net cash provided by operating activities | — | — | $249.8 | $233.9 |
Q2 operating income after tax was $72.3 million versus $54.0 million; first-half operating income after tax was $113.1 million versus $125.5 million. The Q2 2016 comparison was significantly affected by an $86.1 million pre-tax debt repayment loss ($56.0 million after tax) that did not recur in 2017. First-half catastrophe losses were $141.2 million versus $82.2 million. Favorable prior-year reserve development totaled $24.5 million in 2017, compared with $15.0 million in 2016.
For the first half, Commercial Lines net premiums written rose 2.8% and Personal Lines rose 8.2%. Chaucer underwriting improved, while domestic catastrophe losses weighed on results. The first-half combined ratio deteriorated to 97.5% from 96.2%; Q2 improved to 95.6% from 97.3%. Net investment income was $143.4 million, up from $137.4 million, while management expects average investment yields to decline as new-money yields remain below embedded book yields.
At June 30, 2017, total assets were $14,792.7 million, shareholders’ equity $2,972.5 million, cash and cash equivalents $317.8 million, and debt $786.7 million. Debt’s estimated fair value was $873.6 million. Total cash and investments were $9,037.3 million. Operating cash flow increased year over year; investing activities used $145.9 million and financing activities used $66.5 million during the first half.
Material changes, outlook and risks
- First-half net income increased, but underlying operating income before interest and taxes declined $27.1 million, mainly due to higher catastrophe losses, partly offset by improved prior-year reserve development. The 2016 debt repayment charge also makes reported net income comparisons unusually favorable to 2017.
- Management’s “Hanover 2021” strategy emphasizes agency-partner distribution, responsible growth, specialty-market capabilities and investment in growth solutions. The filing provides no quantified earnings or revenue guidance.
- Management reported $1.8 million of employee termination costs in Q2 and expects approximately $8 million of additional costs in the second half of 2017. On July 1, 2017, the company acquired an Australian managing general agent expected to provide access to approximately $25 million of specialty premium.
- U.S. insurance subsidiary statutory surplus was $2,006.3 million, down from $2,173.4 million at year-end, primarily after a $296.8 million dividend to the holding company, including $80.0 million of extraordinary dividends. Further domestic dividends to the holding company during the following 12 months require regulatory approval. Hanover Insurance’s RBC ratio was 214% on the industry scale.
- Management said it expects operating cash generation to meet cash needs and that holding-company assets of $360.6 million in fixed maturities and cash were sufficient for current-year obligations. The company had no borrowings under its $200 million credit agreement; it also reported $91.9 million of additional FHLBB borrowing capacity. Approximately $156 million remained under its share-repurchase authorization after $28.0 million of first-half repurchases.
- Key risks include severe weather and catastrophe volatility, reserve-estimation uncertainty, competitive pricing and rate adequacy, reinsurance availability and recoverability, investment-market and interest-rate changes, foreign-exchange movements, and Brexit-related licensing and market uncertainty. Management also notes that Chaucer faces competitive rate pressure.
- The Durand pension-plan class action remains unresolved; the company cannot reasonably estimate potential ultimate liability. Other legal and regulatory proceedings are not expected to materially affect financial position, but could materially affect results in an individual period. Residual-market participation also exposes the company to less predictable results.
Investor verification priorities
- Assess the sustainability of underwriting performance by segment, especially catastrophe experience, the 97.5% first-half combined ratio and the contribution from favorable reserve development.
- Separate recurring operating results from the prior-year debt repayment charge and other non-operating items; review the company’s non-GAAP operating-income reconciliation.
- Monitor reserve adequacy, particularly Chaucer’s favorable development and the evolution of domestic losses, including catastrophe losses and AIX-related reserves.
- Review statutory capital and dividend constraints after the $296.8 million subsidiary dividend, including regulatory approval needs and RBC levels.
- Track expected second-half termination costs, the Australian agency acquisition’s premium contribution, investment-yield trends, and the unresolved Durand litigation.