The Hanover Insurance Group, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports fourth-quarter results. THG is a U.S. property and casualty insurer distributing primarily through independent agents. Its continuing operating segments are Commercial Lines, Personal Lines and Other; the former Chaucer business is reported as discontinued operations following its sale.
Financial performance and condition
| Metric | 2019 | 2018 |
|---|---|---|
| Total revenues | $4,890.7 million | $4,494.3 million |
| Net premiums earned | $4,474.5 million | $4,254.4 million |
| Net premiums written | $4,581.7 million | $4,384.8 million |
| Net investment income | $281.3 million | $267.4 million |
| Net income | $425.1 million | $391.0 million |
| Diluted earnings per share | $10.46 | $9.09 |
| Operating income before interest and taxes (non-GAAP) | $453.6 million | $406.5 million |
| Operating cash flow | $602.9 million | $551.3 million |
Total revenue includes $109.4 million of net realized and unrealized investment gains in 2019, compared with $50.7 million of losses in 2018. Continuing-operations income was $429.0 million, versus $239.0 million. Fourth-quarter 2019 net income was $109.8 million, compared with $123.6 million in fourth-quarter 2018; quarterly continuing-operations income was $110.2 million versus $2.1 million.
- Underwriting: The consolidated combined ratio improved to 95.6% from 96.1% (below 100% generally indicates underwriting profit before investment income). Commercial Lines’ ratio improved to 95.2% from 96.4%; Personal Lines’ rose to 96.3% from 95.5%.
- Segments: Commercial Lines net premiums written increased 3.7% to $2,707.2 million; operating income before interest and taxes rose to $300.1 million from $265.7 million. Personal Lines premiums written grew 5.7% to $1,874.5 million, while segment operating income declined to $144.9 million from $146.2 million.
- Losses and reserves: Catastrophe losses were $169.3 million, down from $219.2 million. Prior-year non-catastrophe reserve development was slightly favorable by $0.9 million; catastrophe reserve development was favorable by $27.5 million. Gross loss and LAE reserves were $5,654.4 million, including $4,079.6 million net of reinsurance. Management cautions that estimates are uncertain; a one-point change in the aggregate loss and LAE ratio was estimated to affect operating income by about $45 million.
- Investments and liquidity: Cash and investments totaled $8,211.7 million, down 1.2%; cash and cash equivalents fell to $215.7 million from $1,020.7 million. Operating cash flow was positive, but financing outflows were $1,099.3 million, mainly reflecting $563.6 million of share repurchases, $386.2 million of dividends and $151.1 million of debt repayment. The company reported $340.7 million of fixed maturities and cash at the holding company.
- Capital and debt: Total assets were $12,490.5 million and shareholders’ equity $2,916.2 million. Debt was $653.4 million carrying value ($662.7 million principal), down from $777.9 million; the $125 million FHLB advance was repaid in January 2019. Insurance-subsidiary statutory capital and surplus rose to $2,470.2 million from $2,172.5 million. Hanover Insurance’s RBC ratio was 231% on the industry scale.
Material changes and notable items
- Operating income before interest and taxes increased $47.1 million, supported by lower catastrophe losses, premium growth, lower expenses and higher investment income. Higher current-year large losses partly offset those gains. Net income growth also benefited from the reversal in equity-security fair value results; the 2018 comparison included a $131.9 million after-tax Chaucer sale gain.
- The Chaucer-related Irish and Australian entity sales were completed in 2019. THG received $22.0 million in final contingent proceeds, below its prior estimate, and recorded a $9.7 million reduction to that estimate.
- The company declared a $2.50-per-share special dividend in December 2019 and authorized total share repurchases of up to $900 million. It repurchased approximately 4.2 million shares for $563.6 million during the year; settlement of the December ASR was expected by March 25, 2020.
- Net investment income increased, although management expected average fixed-income yields to decline as new-money rates remained below portfolio book yields. Investment portfolio duration was approximately 4.3 years; 95% of fixed maturities were investment grade.
Outlook, risks and contingencies
The filing provides no quantified earnings or premium guidance. Management described a strategy of disciplined pricing and underwriting, profitable growth, deeper agency relationships, specialty-line development and geographic diversification. It planned to continue seeking rate increases, subject to competitive and regulatory conditions.
- Michigan auto reform: Michigan’s 2019 legislation changes personal injury protection (PIP) options, mandates premium reductions and freezes the PIP rate component for eight years; cost controls begin in 2021. Michigan represented 47% of THG’s personal-auto net premiums written, and the filing says the net impact is uncertain. THG’s estimated MCCA recoverable was about $1.0 billion and had not been reduced for expected future claim-cost savings. A lawsuit challenging aspects of the reforms names Citizens; THG said it would contest the claims.
- Concentration and catastrophes: Michigan accounted for 20.9% of total Commercial and Personal Lines premiums written, Massachusetts 9.5%, and California 12.0% of Commercial Lines premiums. Severe weather, wildfires and other catastrophes, as well as reinsurance availability, cost and recoverability, could materially affect results.
- Reserving and legacy exposures: Claims inflation, social inflation, litigation, long-tailed liability claims and uncertain loss development could require reserve increases. Discontinued accident and health business, particularly the long-term-care pool, remains exposed to changes in claims and actuarial assumptions. Net asbestos and environmental reserves were $37.9 million.
- Other risks: State regulation and residual-market assessments, investment-market and interest-rate changes, reinsurer credit risk, agency relationships, competition and cyber or privacy incidents are identified as material risks. Reinsurance recoverables totaled $1,814.0 million, including $1,023.7 million due from the Michigan Catastrophic Claims Association.
- Routine legal and regulatory matters were not expected to materially affect financial position, though outcomes could materially affect a particular period’s results. The auditor issued an unmodified opinion and identified valuation of loss and LAE reserves as a critical audit matter. Management and the auditor reported effective internal control over financial reporting.
Key facts for investors to verify
- Whether Personal Lines loss trends, especially auto bodily injury and PIP, stabilize and whether rate increases keep pace with loss costs.
- Developments in Michigan reform implementation, the related litigation, MCCA recoverables and the ultimate effect of PIP cost controls and rate restrictions.
- Subsequent loss-reserve development, catastrophe experience and adequacy of reinsurance protection and recoverables.
- Whether investment gains—particularly equity-security fair value changes—are recurring, and how lower reinvestment yields affect investment income.
- Cash and holding-company liquidity after substantial dividends and buybacks, and the remaining debt, capital and dividend capacity of regulated insurance subsidiaries.