Business context and reporting period
The Hanover Insurance Group, Inc. (THG) is a property and casualty insurer with Commercial Lines and Personal Lines operations, plus an Other segment. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Unless noted, amounts are in millions of dollars.
On September 13, 2018, THG agreed to sell Chaucer to China Re. Chaucer is reported as discontinued operations, with its assets and liabilities classified as held for sale. The sale was expected to close late in 2018 or in the first quarter of 2019, subject to approvals and customary conditions.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Premiums earned | $1,071.7 | $1,004.4 | $3,172.4 | $2,957.0 |
| Total revenue | $1,166.6 | $1,085.9 | $3,391.5 | $3,175.4 |
| Income from continuing operations | $104.0 | $59.5 | $236.9 | $144.2 |
| Net income | $100.4 | $11.1 | $267.4 | $134.7 |
| Diluted EPS | $2.33 | $0.26 | $6.21 | $3.14 |
| Operating income before interest and taxes (non-GAAP) | $112.8 | $86.2 | $313.4 | $218.3 |
- Premium growth: Nine-month net premiums written rose 6.8% to $3,340.1; earned premiums increased 7.3%. Net investment income grew to $198.0 from $181.3.
- Underwriting: The consolidated combined ratio improved to 95.8% for the first nine months from 98.1% in 2017, and to 95.1% in Q3 from 97.1%. Commercial Lines’ nine-month operating income before interest and taxes rose to $208.3 from $108.2; Personal Lines declined to $109.7 from $117.1.
- Losses and reserves: Nine-month catastrophe losses were $169.2 before tax, versus $209.8 in 2017. Continuing-business reserve development was $7.1 favorable overall: $7.8 favorable catastrophe development partly offset by $0.7 unfavorable non-catastrophe development. Personal Lines had $17.9 of unfavorable non-catastrophe development.
- Cash flow: Operating activities generated $466.4 for the first nine months, versus $532.2. Investing activities used $465.5 and financing activities used $123.5. Reported cash and cash equivalents were $117.9 at September 30, compared with $297.9 at year-end 2017.
- Debt and capital: Debt was $777.6, down from $786.9 at year-end; its estimated fair value was $823.9. Shareholders’ equity was $2,982.4 versus $2,997.7. U.S. insurance-subsidiary statutory surplus was $2,171.2, up from $2,077.1; Hanover Insurance’s RBC ratio was 210% on the industry scale.
- Investment and liquidity: Fixed maturities excluding Chaucer totaled $6,092.6 at fair value, with $158.9 of gross unrealized losses, primarily attributed to higher rates and wider credit spreads. THG said it did not expect to need to sell loss-position securities to meet operating cash needs. Holding-company fixed maturities and cash totaled $395.8. The company had $200 million of undrawn bank-credit capacity and $89.8 million of additional FHLBB borrowing capacity; $2.0 was outstanding under the FHLBB facility.
Material changes versus prior period
Nine-month net income increased $132.7, reflecting higher core operating income and improved Chaucer results, partly offset by lower investment gains. Core operating income improved by $95.1, principally from lower catastrophe losses, a favorable change in reinsurance reinstatement premiums, premium growth, higher investment income and lower expenses; higher non-catastrophe current-year losses partly offset these benefits. Q3 net income also benefited from a $43.6 improvement in Chaucer’s results versus Q3 2017.
Comparability is affected by the Chaucer disposal classification and adoption of accounting guidance that moved equity-security fair-value changes into net income. Q3 2018 included $23.6 of such gains; nine-month 2018 included $6.7. Nine-month other comprehensive loss was $196.7, largely reflecting a $197.8 after-tax decline in available-for-sale securities. The company also recorded accounting-adoption adjustments to retained earnings, including a $97.8 benefit from ASU 2016-01.
Outlook, risks, contingencies and unusual items
- Outlook: Management described a strategy of profitable, disciplined growth through agency relationships, targeted expansion and specialty capabilities. It intended to continue seeking rate increases, subject to market competition and regulation. No quantified earnings or revenue guidance was provided. Management expected positive operating cash flow to meet short- and long-term needs and said the U.S. qualified pension plan was essentially fully funded after a $40.0 contribution in September.
- Chaucer transaction: Consideration is up to $865, comprising $820 payable at closing and $45 contingent escrow subject to downward adjustment if 2018 catastrophe losses exceed a threshold. Including an $85 pre-signing dividend, management cited total proceeds of up to $950. The company anticipated a net gain, but the final amount depends on earnings, catastrophe losses, investment values and tax attributes. THG agreed to indemnify China Re for specified pre-closing liabilities and identified regulatory, closing and contingent-payment risks.
- Underwriting and market risks: Risks include catastrophe frequency and severity, reserve-estimate uncertainty, automobile severity trends, competitive pricing and ability to obtain adequate rates, reinsurance availability and recoverability, and residual-market exposures. Management cautioned that investment values and book value may be affected by interest rates, credit spreads, defaults, currency movements and market volatility.
- Legal and regulatory: In the Durand ERISA class action concerning cash-balance pension lump-sum calculations, the parties reached a settlement in principle on major terms, subject to final documentation and court approval; the company did not expect the settlement to be material if finalized substantially as agreed. Other ordinary-course proceedings were not expected to materially affect financial position, though they could affect a particular period’s results.
- Other notable items: THG repurchased approximately 0.4 million shares for $44.2 during the first nine months and paid $69.1 in dividends. It repurchased senior debentures at a $1.9 loss. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the Chaucer sale closed on the anticipated timetable, the final proceeds and gain, and any adjustment to contingent consideration or indemnity exposure.
- Whether Commercial Lines’ underwriting improvement persists and whether Personal Lines’ adverse reserve development and loss trends moderate.
- How catastrophe activity, reserve revisions and reinsurance recoveries affect future loss ratios, cash flows and capital.
- Whether investment-market declines or credit deterioration cause further realized losses, impairments or pressure on shareholders’ equity.
- Current holding-company liquidity, subsidiary dividend capacity, debt maturities and repurchase activity after the reporting date.