Business context and reporting period
The Hanover Insurance Group, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. Its continuing business is primarily property and casualty insurance, reported in Personal Lines, Commercial Lines and Other Property and Casualty. Prior-period comparisons are to the corresponding 2009 periods.
Financial results and key metrics
Amounts are in millions of dollars except per-share data and ratios.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $804.0 | $708.5 | $2,318.9 | $2,103.8 |
| Net premiums earned | $728.0 | $637.4 | $2,092.3 | $1,899.4 |
| Net income | $52.3 | $49.7 | $96.4 | $139.9 |
| Diluted EPS | $1.15 | $0.97 | $2.08 | $2.72 |
| Net investment income | $61.3 | $62.1 | $184.2 | $188.3 |
| Net realized investment gains (losses) | $5.7 | $0.0 | $16.8 | $(9.7) |
| Property and casualty combined ratio | 97.0% | 97.6% | 100.9% | 98.4% |
- Q3 net income increased about 5% year over year; nine-month net income declined about 31%. Nine-month 2009 results included a $34.5 million pretax gain on debt retirement. The 2010 decline also reflected higher catastrophe losses and lower favorable prior-year reserve development.
- Property and casualty net premiums written were $803.7 million in Q3, up from $688.8 million, and $2,330.9 million for nine months, up from $1,981.8 million. Commercial Lines growth was substantially supported by the OneBeacon renewal-rights business and AIX program business. Personal Lines written premiums were nearly flat for the nine-month period.
- Q3 P&C segment income was $79.2 million versus $73.6 million. Nine-month segment income fell to $151.5 million from $199.8 million. Nine-month catastrophe losses rose to $143.5 million from $92.3 million; favorable prior-year reserve development fell to $87.4 million from $128.2 million.
- The Q3 combined ratio improved to 97.0%, indicating underwriting profit before investment income. The nine-month ratio worsened to 100.9%, indicating an underwriting loss. Nine-month Personal Lines and Commercial Lines ratios were 100.0% and 102.1%, respectively.
- Nine-month operating cash flow was negative $15.0 million, compared with positive $26.9 million in 2009; management attributed the decline primarily to a $100 million pension contribution. Investing cash flow was negative $53.4 million and financing cash flow positive $24.7 million. Cash and cash equivalents ended at $271.6 million, versus $316.5 million at year-end 2009.
- At September 30, total assets were $8,596.7 million, total liabilities $6,117.9 million, and shareholders’ equity $2,478.8 million. Investments totaled $5,071.5 million on the balance sheet. Long-term debt rose to $640.0 million from $433.9 million at year-end, including $200 million of 7.50% senior notes issued in February. Total statutory surplus of the combined P&C companies was $1,795.3 million; Hanover Insurance’s RBC ratio was 328% on the Industry Scale.
- The investment portfolio had $318.9 million of net unrealized gains on fixed maturities, while nine-month other-than-temporary impairment losses recognized in earnings were $7.5 million. The average pretax earned yield on fixed maturities was 5.5% for the nine months, versus 5.6% in 2009.
Material changes, outlook and risks
- Management cited heavier first-half catastrophe activity, reduced favorable reserve development and higher expenses as the main pressures on nine-month segment earnings. More favorable current accident-year loss results partly offset these factors. Management expects less favorable reserve development in future periods than in recent years.
- Commercial Lines expansion and specialty-business investments supported premium growth, but added expenses; Commercial Lines premiums exceeded Personal Lines premiums for the first nine months. The OneBeacon renewal conversion to Hanover forms was expected to continue into late 2011. No specific earnings or premium guidance was provided; management cautioned that interim results are not necessarily indicative of full-year results.
- Management said holding-company assets were sufficient for expected 2010 obligations and anticipated adequate operating cash flows. It considered the qualified pension plan essentially fully funded following the $100 million contribution and did not expect significant contributions for several years, subject to market returns and actuarial assumptions.
- Shareholders received three quarterly dividends of $0.25 per share during the first nine months. The board had authorized up to $500 million of repurchases through October; repurchases totaled 7.9 million shares costing $338.8 million as of September 30. The company also acquired Campania for approximately $24 million and planned a Worcester development with estimated costs of $65–70 million, partly financed by committed FHLBB borrowing.
- Key risks include reserve-estimation uncertainty, particularly in long-tail lines and newer specialty business; a Michigan court decision expected to increase certain auto claims; catastrophe exposure; competitive pricing and regulatory constraints in Michigan and Massachusetts; economic pressure on policyholders and commercial customers; and possible investment impairments or lower investment yields. Katrina-related litigation, a pension-plan class action, and indemnities from disposed businesses remain contingencies. Management said the Katrina reserves assume the company will prevail on key coverage issues; ultimate exposure is uncertain.
- State dividend restrictions affect cash transfers from insurance subsidiaries. FHLBB borrowings are collateralized and could require additional collateral or repayment if pledged asset values fall below specified levels. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether catastrophe claims, Michigan auto litigation and other loss trends cause adverse reserve development, and whether current reserves remain adequate.
- How much of Commercial Lines’ premium growth and future profitability is attributable to acquired or renewal-rights business, and the costs and risks of converting that business.
- Whether the nine-month combined ratio can return below 100% without relying on favorable prior-year reserve development.
- The effect of continued share repurchases, dividends, acquisitions and construction spending on cash, debt, capital and insurance-subsidiary dividend capacity.
- Whether investment yields, credit losses or market movements change realized earnings, unrealized gains, or the company’s ability to hold securities through recovery.