Business context and reporting period
The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2014. The company operates Commercial Lines, Personal Lines, Chaucer (specialty insurance through Lloyd’s), and Other; consolidated results also include discontinued operations, primarily former life and accident and health businesses. Comparisons below are with the three months ended March 31, 2013 unless noted.
Financial and operating performance
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $1,243.9 million | $1,180.3 million; up 5.4% |
| Net premiums written | $1,172.3 million | $1,076.7 million; up 8.9% |
| Net income | $54.6 million | $66.2 million; down 17.5% |
| Diluted EPS | $1.22 | $1.46 |
| Operating income before interest and taxes | $85.0 million | $102.2 million |
| Net cash from operating activities | $62.9 million | $(17.5) million |
- Underwriting: The consolidated combined ratio was 98.3%, versus 96.1%. The loss and LAE ratio rose to 64.6% from 62.4%; the expense ratio was 33.7% in both periods.
- Catastrophes and reserves: Pre-tax catastrophe losses increased to $57.9 million from $21.7 million. Favorable prior-year reserve development was $19.7 million, versus $6.9 million.
- Segments: Commercial Lines operating income declined to $16.1 million from $33.0 million, with a $21.3 million underwriting loss. Personal Lines operating income declined to $21.6 million from $30.5 million. Chaucer operating income rose to $49.2 million from $40.9 million.
- Investments and taxes: Net investment income was $67.0 million, compared with $67.3 million; average fixed-maturity earned yield was 3.79%, down from 4.03%. Income tax expense was $17.4 million versus $22.5 million; the reported effective tax rate was 24.1% versus 25.3%.
- Balance sheet at March 31: Total assets were $13.643 billion and shareholders’ equity was $2.681 billion. Cash and equivalents were $476.3 million; investments totaled $7.744 billion. Debt was $903.9 million, unchanged from year-end 2013.
- Cash flow: Investing activities used $60.0 million and financing activities used $14.5 million. The quarter included $16.3 million of shareholder dividends and $6.3 million of common-stock repurchases.
Material changes, outlook, and risks
Premium growth was led by Commercial Lines and Chaucer; Personal Lines premiums written fell as the company reduced exposure and policies in force. Management attributed the decline in operating income mainly to higher catastrophe and non-catastrophe weather-related losses, partly offset by improved Commercial Lines current-year results and increased favorable reserve development. Management said commercial and personal pricing remained favorable overall and described continued rate increases and portfolio actions, while noting competitive and regulatory constraints. Chaucer reported expanded underwriting opportunities but continued downward pressure on many market rates.
Management expects investment yields to continue declining as new-money yields remain below embedded book yields. It anticipated marginally higher new-money yields and lower fixed-maturity market values during the remainder of 2014. The filing provides no numerical full-year earnings or revenue guidance. Management expected operating cash to meet obligations and stated it did not expect to need additional insurance-subsidiary dividends to fund 2014 holding-company obligations. U.S. insurance subsidiary statutory surplus was $1.900 billion, up from $1.834 billion at year-end; the filing reports Hanover Insurance’s RBC ratio at 262% on the industry scale. Chaucer was in compliance with Lloyd’s capital requirements.
- Key risks include severe weather and catastrophe losses, reserve-estimate uncertainty, pricing and competition, bodily-injury loss trends, reinsurance collectability, investment-market and interest-rate volatility, foreign exchange, and regulatory or legal changes.
- The Durand pension-plan class action continued. The company could not reasonably estimate potential ultimate liability; the court had certified classes for specified claims. Other ordinary-course legal and regulatory matters were not expected to materially affect financial position, though they could affect a particular reporting period.
- Unrealized investment losses totaled $56.9 million at quarter-end, down from $94.7 million at December 31, 2013. Management considered them temporary, but adverse market or credit changes could result in impairment losses. No OTTI was recognized in earnings in Q1 2014.
- The company reported no material off-balance-sheet arrangements, no material change in market-risk disclosures, and effective disclosure controls; management reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether catastrophe and other weather-related losses, and the near-100% combined ratio, persist or normalize.
- The quality and sustainability of favorable prior-year reserve development and the assumptions underlying loss reserves.
- Whether Commercial Lines and Chaucer premium growth can be maintained profitably, and whether Personal Lines exposure reductions and rate actions improve results.
- Investment portfolio credit quality, interest-rate sensitivity, unrealized losses, and future investment income.
- Potential exposure from the Durand litigation, reinsurance recoverables, regulatory capital requirements, and restrictions on subsidiary dividends.