Business context and reporting period
The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2016. The insurer operates through Commercial Lines, Personal Lines, international specialty insurer Chaucer, and Other. Comparisons below are with the three or nine months ended September 30, 2015, as applicable. Dollar amounts are in millions except per-share data.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums earned | $1,160.9 | $1,150.1 | $3,457.7 | $3,566.9 |
| Total revenues | $1,241.2 | $1,233.5 | $3,690.8 | $3,829.3 |
| Income from continuing operations | $88.3 | $77.2 | $168.3 | $253.0 |
| Net income | $88.4 | $78.3 | $168.6 | $253.9 |
| Diluted EPS | $2.06 | $1.74 | $3.89 | $5.64 |
| Operating income after tax (non-GAAP) | $78.6 | $72.2 | $204.1 | $199.7 |
| Operating income before interest and taxes | $129.8 | $122.6 | $344.9 | $342.5 |
| Combined ratio | 94.2% | 94.9% | 95.5% | 95.9% |
- Underwriting: Nine-month segment combined ratios were 99.1% for Commercial Lines, 91.9% for Personal Lines, and 91.5% for Chaucer. Q3 ratios were 99.2%, 93.1%, and 81.3%, respectively. Ratios include prior-year reserve development.
- Cash flow: Nine-month operating cash flow was $558.1, versus $354.4 in 2015; investing cash outflow was $319.0, versus $111.8; financing cash outflow was $259.8, versus $229.2. Cash and equivalents ended at $315.9, down $22.9 from year-end 2015.
- Balance sheet and liquidity: Total assets were $14,363.7 and shareholders’ equity $3,045.7 at September 30, 2016. Investments totaled $8,496.1; total cash and investments were $8,812.0. Debt carrying value was $797.9, compared with $803.1 at year-end 2015. U.S. insurance subsidiaries had statutory capital and surplus of $2,218.5.
- Investment income: Nine-month net investment income was $205.2, down from $209.1. Management said lower new-money yields and lower investment assets weighed on income and expects fixed-maturity yields to continue declining as new-money rates remain below embedded book yields.
Material changes versus the prior comparable period
- Q3 net income increased $10.1, while nine-month net income declined $85.3. The nine-month comparison was affected by an $86.1 pretax debt-redemption loss in 2016, versus a $24.1 loss in 2015; a $40.3 after-tax gain on the 2015 U.K. motor-business disposal; and lower realized investment gains in 2016.
- Nine-month operating income before interest and taxes edged up $2.4. Lower catastrophe losses and lower current-year losses were largely offset by materially lower favorable development on prior-year reserves.
- Net premiums written rose to $3,616.8 from $3,570.7, driven by domestic growth, partly offset by increased ceded reinsurance and lower energy premiums at Chaucer. Net premiums earned fell, reflecting the prior-year U.K. motor business and lower Chaucer earned premiums.
- Nine-month catastrophe losses were $109.1, versus $154.6. Favorable prior-year reserve development excluding catastrophe reserves was $3.1, versus $76.2; catastrophe reserve development was favorable by $20.7 in 2016. Together, total prior-year development was favorable by $23.8, versus $92.5 in 2015.
- Personal Lines nine-month underwriting income improved to $81.2 from $34.3, helped by lower catastrophe losses and rate increases. Chaucer underwriting income fell to $53.8 from $92.7, reflecting higher current-year losses and lower favorable reserve development. Commercial Lines underwriting income was $12.4 versus $10.9, with unfavorable prior-year development a significant offset to better current-year results.
Outlook, commentary, risks and unusual items
- Management cited continued rate increases, retention, targeted new business, and portfolio adjustments as priorities in the domestic businesses. It noted competitive pricing, particularly in Commercial Lines middle markets, and competitive pressure and challenging underwriting conditions at Chaucer.
- Chaucer’s nine-month gross premiums written, excluding the transferred U.K. motor business, fell 2.8%; net premiums written declined 9.6%, including a planned increase in ceded reinsurance. Management cited low oil prices and weaker energy-line volumes. The filing identifies Brexit-related uncertainty, including potential effects on Chaucer’s European licensing, markets, and foreign exchange.
- The April 2016 issuance of $375.0 of 4.50% senior debentures due 2026 funded, with cash on hand, redemption of higher-coupon notes. The redemptions generated an $86.1 pretax loss. The company reported compliance with debt and credit covenants and no borrowings under its $200.0 credit agreement.
- The company repurchased 1.3 million shares for $105.2 during the first nine months and paid $59.2 in shareholder dividends. Approximately $184 remained authorized for repurchases at September 30. Dividends and capital distributions remain subject to board, regulatory, and capital requirements.
- Key risks include reserve-estimation uncertainty, catastrophe and claim-severity volatility, reinsurance availability and collectability, market and interest-rate changes, credit defaults, foreign-exchange movements, competitive pricing, and regulatory or Brexit developments. Management expected its fourth-quarter actuarial reserve review could change carried estimates.
- The Durand pension-plan class action remained unresolved; the company said it could not reasonably estimate the potential liability. Other proceedings were not expected to materially affect financial position, though they could affect results in a particular period. Residual-market participation also exposes the company to less predictable results.
- No quantitative full-year earnings or premium guidance is provided in the filing. Management cautioned that interim results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether the fourth-quarter actuarial review changes loss reserves, particularly in Commercial Lines and AIX programs, and whether favorable development persists.
- Whether domestic rate increases keep pace with claims trends and whether Chaucer’s pricing, energy exposure, and reinsurance strategy stabilize underwriting results.
- How much of reported earnings and book-value movement reflects recurring operations versus debt-redemption costs, investment marks, reserve development, catastrophes, and foreign exchange.
- Whether low investment yields, energy-sector credit conditions, or interest-rate movements cause further pressure on investment income or realized impairment losses.
- Developments in the Durand litigation, Brexit-related licensing and market exposure, and the company’s capacity to fund dividends and repurchases while maintaining insurance capital and liquidity.