Business context and reporting period
The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Its four operating segments are Commercial Lines, Personal Lines, Chaucer, and Other Property and Casualty. The July 1, 2011 acquisition of Chaucer materially affects comparisons: 2012 results include Chaucer, while the corresponding 2011 reported periods do not.
Financial performance and position
Amounts are in millions of dollars except per-share data and ratios.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenues | $1,127.2 | $853.9 | $2,249.0 | $1,687.7 |
| Net premiums earned | $1,050.0 | $770.5 | $2,085.6 | $1,532.2 |
| Income (loss) before tax | $11.1 | $(60.2) | $81.9 | $(22.7) |
| Income (loss) from continuing operations | $9.8 | $(32.8) | $60.5 | $(4.9) |
| Net income (loss) | $20.8 | $(32.2) | $70.5 | $(2.9) |
| Diluted net income (loss) per share | $0.46 | $(0.71) | $1.55 | $(0.06) |
- Net income included a $10.9 million after-tax gain from the April 2012 sale of Citizens Management, Inc. (CMI). Approximate net income excluding that gain was $9.9 million for Q2 and $59.6 million for the first half.
- Six-month segment income before interest and income taxes was $116.7 million, versus $2.5 million a year earlier. After interest expense, segment income before tax was $84.6 million, versus a loss of $18.7 million.
- Six-month net premiums written were $2,214.4 million, up from $1,565.3 million; Chaucer contributed $530.0 million. Total six-month combined ratio was 100.6%, compared with 107.1% for the 2011 domestic segments; Chaucer was not included in the 2011 comparison. 2012 segment ratios were 105.1% for Commercial Lines, 100.0% for Personal Lines, and 92.8% for Chaucer.
- Net investment income was $68.5 million for Q2 and $137.3 million for six months, increases of 12.3% and 13.1%, respectively. Management attributed the increase mainly to Chaucer and investment mix, partly offset by lower new-money yields; it expected yields to continue declining.
- Six-month net cash provided by operating activities was $59.3 million, down from $102.7 million. Investing used $326.0 million and financing used $41.0 million. Cash and cash equivalents fell to $520.8 million at June 30 from $820.4 million at year-end.
- At June 30, total assets were $13,118.7 million, total liabilities $10,501.2 million, and shareholders’ equity $2,617.5 million. Debt was $917.4 million carrying value ($1,032.0 million estimated fair value). Cash plus investments totaled $7,652.2 million.
- U.S. insurance subsidiary statutory surplus was $1,655.1 million, up $72.3 million from year-end. Hanover Insurance’s risk-based capital ratio was 272% on the industry scale and 544% on the regulatory scale. The company reported compliance with Lloyd’s capital requirements and debt covenants.
Material changes versus prior comparable periods
- Reported revenue and premiums rose substantially, but the comparison is not like-for-like because Chaucer was acquired in July 2011. The company’s 2011 pro forma information, as if Chaucer had been included from January 1, 2011, showed revenue of $1,052.0 million and a net loss of $26.4 million for Q2 2011, and revenue of $2,119.5 million and a net loss of $51.9 million for the first half.
- Lower catastrophe losses helped results: first-half pre-tax catastrophe losses were $114.7 million, versus $206.4 million in 2011. Prior-year reserve development was neutral overall in 2012, compared with $43.8 million favorable development in 2011; $26.8 million favorable development at Chaucer was offset by $26.8 million unfavorable development in domestic operations.
- Personal Lines underwriting improved as catastrophe and non-catastrophe weather losses declined, while Commercial Lines also benefited from fewer catastrophe losses and premium growth. Domestic results were partly offset by adverse reserve development, including in surety, commercial auto liability, and personal auto liability.
- Cash declined as the company invested substantial Chaucer cash into fixed maturities and equity securities. Fixed maturities increased to $6,534.8 million; cash fell, while total cash and investments rose 1.5% from year-end.
Outlook, commentary, risks and unusual items
- No quantified full-year earnings or revenue guidance is provided. Management said Personal Lines exposure-management actions could result in modest premium declines in 2012; it was pursuing rate increases in domestic lines and expected rate increases in many Chaucer classes, but noted competitive and regulatory constraints.
- Management cited historically low reinvestment yields as a headwind. It described European economic and sovereign-debt uncertainty, but did not expect developments affecting its European debt exposure to materially affect financial condition, results, or liquidity. European sovereign exposure was $89.2 million, primarily U.K.; the company reported no sovereign debt in Greece, Ireland, Italy, Portugal, or Spain.
- Investment risks include market volatility, defaults, further realized or unrealized losses, and the possibility that business needs could force sales of securities before recovery. Fixed maturities were approximately 94% investment grade; gross unrealized losses on fixed maturities and equities were $39.6 million at June 30, down from $63.8 million at year-end.
- Other key risks include catastrophe severity and frequency, reserve-estimate changes, reinsurance collectability and availability, competition, regulatory and economic changes, acquisition integration, and foreign-exchange and investment risks. The Chaucer pension plan was approximately $30 million underfunded; the U.S. qualified defined-benefit plan was described as essentially fully funded.
- Two legal matters remain notable. In the Durand pension litigation, the company could not reasonably estimate potential liability. In the Louisiana Road Home litigation, the state identified about 1,000 properties, but the company said the data was insufficient to estimate potential liability; the class allegations had been dismissed, without barring possible policyholder claims based on assignments.
- Adoption of revised insurance acquisition-cost guidance reduced equity by $25.8 million after tax as of January 1, 2012; the company said the effect on operating results was not material. A tax transaction released valuation allowances, including a $24.4 million benefit recorded in other comprehensive income. The CMI disposal generated the $10.9 million after-tax gain.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing stated there were no material off-balance-sheet arrangements and no material changes in market-risk exposures during the first half.
Most important facts for investors to verify
- Separate organic growth and underwriting trends from the acquisition-driven increase in premiums and revenue; review Chaucer’s ongoing contribution and integration.
- Track reserve development by segment and line, particularly domestic unfavorable development, against the prior-year favorable releases.
- Assess the sustainability of underwriting improvement given catastrophe exposure, rate adequacy, competition, and combined ratios near or above 100% in domestic segments.
- Review operating cash generation, the decline in cash, investment liquidity, and the effect of low yields and market movements on investment income and capital.
- Monitor the unresolved Durand and Road Home litigation, the Chaucer pension deficit, regulatory capital, and the impact of restricted assets and Lloyd’s funding requirements.