The Hanover Insurance Group, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. The company writes property and casualty insurance through Commercial Lines, Personal Lines and Other Property and Casualty.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Total revenues | $853.9 | $768.3 | $1,687.7 | $1,514.9 |
| Net premiums earned | $770.5 | $697.8 | $1,532.2 | $1,364.3 |
| Net income (loss) | $(31.8) | $2.3 | $(2.5) | $44.1 |
| Net income (loss) per diluted share | $(0.70) | $0.05 | $(0.06) | $0.94 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $102.7 | $(92.5) |
| GAAP combined ratio | 113.3% | 106.1% | 107.1% | 103.0% |
- Q2 pretax loss was $59.7, versus pretax income of $3.1 a year earlier; first-half pretax loss was $22.2, versus income of $62.4. Continuing-operations net loss was $32.4 in Q2 and $4.5 for the first half.
- Net premiums written increased 1.7% in Q2 and 2.5% for the first half; earned premiums rose 10.4% and 12.3%, respectively. Growth in both periods was attributed to Commercial Lines.
- Catastrophe losses were $156.7 in Q2 and $206.4 for the first half, compared with $85.0 and $119.4 in 2010. Management cited winter storms, tornadoes, hail and windstorms. First-half favorable prior-year reserve development was $43.8, down from $61.5.
- Net investment income was $61.0 in Q2 and $121.4 for the first half, down from $61.8 and $122.9. Average fixed-maturity yields also declined: 5.35% versus 5.51% in Q2 and 5.32% versus 5.50% for the first half.
Balance sheet, debt and liquidity
- At June 30, total assets were $8,981.3, total liabilities $6,496.3 and shareholders’ equity $2,485.0. Cash and equivalents were $721.6, compared with $290.4 at year-end 2010; total investments were $4,906.1.
- Reported debt was $857.9, up from $605.9 at year-end. The increase included $300.0 of 6.375% senior notes due 2021, issued June 17; the company also repurchased $55.0 principal of junior debentures during the first half, for $57.2 cash.
- Operating cash flow was $102.7, investing cash flow $130.7 and financing cash flow $195.5 for the first half. Management attributed the operating cash-flow improvement from 2010 partly to the absence of a $100.0 pension contribution made in 2010 and higher premium collections.
- Combined P&C statutory surplus was $1,658.6, down $88.7 from year-end, primarily after a $99.0 ordinary dividend from Hanover Insurance to the holding company. Hanover Insurance’s reported RBC ratio was 284% on the industry scale.
Material changes and notable items
- Commercial Lines reported a Q2 segment loss of $24.7, versus income of $16.9 in 2010; Personal Lines lost $22.9, versus $3.5. First-half segment income fell to $3.0 from $72.3. Higher catastrophe claims and reduced favorable reserve development were major factors.
- Excluding catastrophe losses and prior-year reserve development, first-half underwriting profit improved to $46.5 from $9.5, which management attributed to earned-premium growth, expense-ratio improvement, better business mix and improved Personal Lines results.
- On July 1, 2011, after the reporting period, the company completed its acquisition of Chaucer Holdings PLC. The filing reports total transaction cost of $490.5 including acquisition expenses, and says $455.0 cash was paid July 14, with approximately $13.0 of loan notes payable over time. Chaucer’s results are not included in this quarter’s financial statements.
- The Chaucer-related foreign-exchange forward produced a $4.7 loss recognized through June 30; an additional $6.6 loss was expected to be recognized in Q3. Acquisition-related costs were $11.1 in Q2 and $13.8 for the first half.
Outlook, risks and contingencies
- No quantified earnings or premium guidance is provided. Management expected earned-premium growth to exceed written-premium growth through the remainder of 2011 as prior growth was earned. It also expected investment yields to continue declining if new-money rates remained low.
- Management said it was reviewing property-line pricing after weather losses and emphasized underwriting discipline amid competition. Personal Lines growth was being pursued in targeted states while the company reduced concentration in Louisiana and selectively managed core-state business.
- Risks include further severe weather and catastrophe losses, less favorable reserve development, competitive pricing, investment-market volatility and defaults, reinsurance collectability and Chaucer integration and international exposures. The company noted Chaucer’s exposure to currency movements, Lloyd’s and UK/EU regulation, and catastrophe and nuclear-related claims.
- Two significant lawsuits remain unresolved: the Durand cash-balance pension-plan case and Louisiana’s Road Home hurricane litigation. The company said it could not reasonably estimate potential liability for either matter. Other proceedings could materially affect results in a particular period, though management did not expect them to materially affect financial position.
- Management said holding-company resources were expected to cover 2011 obligations after the Chaucer payment, and that insurance subsidiaries were expected to generate sufficient operating cash. These expectations are subject to claims variability, investment conditions and other uncertainties.
Investor verification priorities
- Check catastrophe frequency and severity, and whether the elevated combined ratio and underwriting losses persist.
- Assess the quality and sustainability of favorable reserve development, including the adequacy of loss reserves and reinsurance recoverables.
- Track Chaucer integration, actual acquisition funding and costs, subsequent-period results, currency effects and international exposures.
- Monitor debt and interest costs, statutory surplus and RBC, holding-company liquidity, and the effect of dividends on insurance-subsidiary capital.
- Follow investment yields, credit quality and impairment risk, and developments in the Durand and Road Home litigation.