Business context and reporting period
The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2018. Its four operating segments are Commercial Lines, Personal Lines, Chaucer (specialty insurance and reinsurance through Lloyd’s), and Other. Comparisons below are with the three months ended March 31, 2017, unless stated otherwise.
Financial performance and condition
| Metric | Q1 2018 | Q1 2017 or comparison |
|---|---|---|
| Premiums earned | $1,263.6 million | $1,181.3 million; up 7.0% |
| Total revenue | $1,330.9 million | $1,260.9 million; up 5.6% |
| Net investment income | $82.9 million | $71.1 million; up 16.6% |
| Income before tax | $80.6 million | $59.0 million |
| Net income | $67.7 million; diluted EPS $1.57 | $45.2 million; diluted EPS $1.05 |
| Operating income before interest and taxes | $116.6 million | $69.1 million; non-GAAP measure |
| Combined ratio | 96.9% | 99.5% |
| Cash from operating activities | $31.4 million | $54.2 million |
Management attributed the increase in operating income primarily to lower catastrophe losses, improved non-catastrophe underwriting, and higher investment income. Pre-tax catastrophe losses were $71.2 million versus $84.1 million. Net favorable prior-year reserve development was $17.9 million, compared with $7.4 million; $9.5 million of 2018 development related to catastrophe reserves.
Segment operating income before interest and taxes: Commercial Lines $61.5 million (prior year $37.4 million); Personal Lines $34.4 million ($9.9 million); Chaucer $22.9 million ($24.9 million); and Other loss $2.2 million ($3.1 million). Segment combined ratios were 97.2% for Commercial Lines, 95.8% for Personal Lines, and 97.2% for Chaucer. The company-wide combined ratio improved, though Chaucer’s operating income declined.
At March 31, 2018, total assets were $15.33 billion, shareholders’ equity $2.91 billion, cash and cash equivalents $258.0 million, and debt $787.0 million. Cash decreased from $376.4 million at December 31, 2017. Operating cash flow fell year over year, primarily because of higher loss payments, partly offset by increased premium collections. Investing activities used $144.4 million, mainly for net purchases of fixed maturities. The company paid $22.9 million in shareholder dividends and repurchased $13.6 million of stock during the quarter.
Fixed maturities were $7.76 billion at fair value; approximately 95% were investment grade. Gross unrealized fixed-maturity losses rose to $142.2 million from $54.3 million at year-end, mainly due to higher interest rates and wider credit spreads. U.S. insurance subsidiaries’ statutory surplus was $2.13 billion, up $49.4 million. Hanover Insurance’s reported RBC ratio was 210% on the industry scale. The filing states the company was in compliance with debt and credit covenants.
Material changes and unusual items
- Net realized and unrealized investment results shifted from a $1.9 million gain to a $23.4 million loss. The 2018 result included a $23.0 million fair-value loss on equity securities. Adoption of ASU 2016-01 moved equity-security fair-value changes into net income, reducing comparability with 2017.
- Other comprehensive loss was $228.0 million, versus income of $26.4 million a year earlier. This included investment-market depreciation and accounting-standard adoption effects; shareholders’ accumulated other comprehensive income moved from $107.6 million at year-end to a $120.4 million deficit.
- The company recorded a $97.8 million after-tax cumulative benefit to retained earnings on adoption of ASU 2016-01, principally reclassifying unrealized equity gains. Early adoption of ASU 2018-02 also reclassified tax effects within equity. These accounting changes did not represent operating cash flow.
- The U.S. federal corporate tax rate fell from 35% to 21% effective January 1, 2018. The effective tax rate on continuing operations was 15.9%, versus 23.4% in Q1 2017.
Outlook, management commentary, and risks
The company provided no specific earnings or premium guidance in the supplied filing text. Its “Hanover 2021” strategy emphasizes agency distribution, responsible growth, specialty capabilities, and investment in growth solutions. Management said it expects to generate sufficient operating cash to meet current short- and long-term requirements, while noting that investment yields may decline as new-money rates remain below embedded book yields.
On March 28, 2018, the company announced a review of strategic alternatives for Chaucer, including a possible sale. Chaucer faced competitive pricing, higher expenses and current-year losses; its net premiums written fell 1.8%, partly because of increased ceded reinsurance. Management cited competition, pricing discipline, weather and catastrophe volatility, reserve-estimation uncertainty, reinsurance availability and collectability, interest-rate and market risk, foreign exchange, and Brexit-related licensing and market uncertainty as risks.
A putative class action concerning lump-sum benefits under a former employee pension plan remains unresolved. The filing says the company cannot reasonably estimate the potential liability; an adverse outcome could affect plan assets and future company funding. Other legal and regulatory matters are not expected to materially affect financial position, though particular-period results could be affected. The company reported no material changes in market-risk exposures and no material changes to internal control over financial reporting during the quarter.
Investor facts to verify
- Whether improved underwriting and combined-ratio trends persist, and how catastrophe losses and reserve development evolve.
- How much of earnings growth reflects core underwriting and recurring investment income versus favorable prior-year development and tax-rate effects.
- The impact of equity fair-value accounting and market movements on reported earnings, OCI, and book value.
- The outcome and potential financial or operational effects of the Chaucer strategic review.
- Liquidity and capital flexibility, including cash-flow trends, restricted Lloyd’s funds, dividend capacity, and remaining share-repurchase authorization.
- Developments in the Durand litigation, reinsurance recoverables, and the company’s ability to manage rate, weather, and investment risks.