Hanover Insurance Group, Inc. — Q3 2015 Form 10-Q
Business context and period. The company reports consolidated U.S. GAAP results for the quarter and nine months ended September 30, 2015, compared with the same 2014 periods. Its principal operations are Commercial Lines, Personal Lines, Chaucer (specialty insurance through Lloyd’s) and Other. Amounts below are in millions of dollars except per-share data and ratios.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenues | $1,233.5 | $1,265.6 | $3,829.3 | $3,782.5 |
| Net premiums earned | $1,150.1 | $1,184.0 | $3,566.9 | $3,521.7 |
| Net premiums written | $1,199.6 | $1,244.8 | $3,570.7 | $3,693.3 |
| Operating income before interest and tax | $122.5 | $86.4 | $342.1 | $273.6 |
| Income from continuing operations | $77.2 | $55.0 | $253.0 | $192.2 |
| Net income | $78.3 | $54.9 | $253.9 | $192.1 |
| Diluted earnings per share | $1.74 | $1.22 | $5.64 | $4.28 |
- Q3 combined ratio was 94.9%, versus 98.2%; nine-month ratio was 95.9%, versus 97.7%. Lower catastrophe losses were a key contributor. The nine-month expense ratio improved to 34.0% from 34.4%.
- Q3 catastrophe losses were $45.8, compared with $88.1; nine-month losses were $154.6, compared with $201.7. Favorable prior-year reserve development was $22.4 in Q3 and $76.2 year to date, versus $21.9 and $70.8, respectively.
- By segment, nine-month operating income before interest and tax increased in Commercial Lines to $126.5 from $103.4 and Personal Lines to $91.6 from $51.0; Chaucer rose to $132.4 from $126.7. Chaucer’s result included substantial favorable reserve development.
- Net investment income increased to $68.3 in Q3 from $67.5 and to $209.1 for nine months from $201.5. Average fixed-maturity yields declined year over year; management expects them to keep declining as new-money yields remain below embedded book yields.
Financial position, cash flow and capital
- At September 30, total assets were $14,041.0, shareholders’ equity $2,877.5 and debt $812.8, compared with $13,759.7, $2,844.0 and $903.5 at December 31, 2014. Cash and cash equivalents were $385.1, versus $373.3.
- Nine-month operating cash flow was $354.4, down from $408.1; investing cash use was $111.8, versus $347.2; financing cash use was $229.2, versus $35.9. Financing outflows included $114.3 of debt repurchases, $85.3 of share repurchases and $54.3 of dividends.
- Total cash and investments were $8,355.6, down 3.1% from year-end, primarily reflecting the U.K. motor business transfer. Fixed maturities were $7,084.9 at fair value. Approximately 94% were investment grade. Gross unrealized losses on fixed maturities and equities rose to $104.4 from $47.0 at year-end, mainly attributed to wider credit spreads.
- U.S. insurance subsidiaries’ statutory capital and surplus was $2,129.4, up from $2,057.1. Hanover Insurance’s reported risk-based capital ratios were 283% on the industry scale and 567% on the regulatory scale. The company reported compliance with debt and credit covenants.
- The holding company had $142.9 of fixed maturities and cash. Chaucer paid $86.0 in dividends to the holding company during 2015; no dividends were paid by Hanover Insurance to the holding company in the first nine months. Management said holding-company assets should be sufficient for expected obligations. A $200 credit agreement was undrawn, with $44 of additional FHLBB borrowing capacity reported.
Material changes, outlook and risks
- U.K. motor disposal: Effective June 30, 2015, the company transferred the business through a 100% reinsurance arrangement and sale of two subsidiaries. It recognized a $40.3 after-tax gain. The transaction reduced reported Chaucer premiums; excluding U.K. motor, nine-month net written premiums increased $114.8 year over year company-wide. Chaucer’s net written premiums fell, while its comparable business excluding U.K. motor declined 2.1% year to date.
- Debt repurchases: The company repurchased senior debentures with a net carrying value of $90.2 for $114.3, recording a $24.1 loss. Debt fell by $90.7 from year-end.
- Investment marks and impairments: Nine-month other comprehensive loss was $102.4, largely reflecting unrealized depreciation on available-for-sale securities and derivatives. The company recognized $8.8 of investment impairment losses in earnings for the first nine months, including estimated credit losses and securities it intended to sell. It assessed most unrealized losses as temporary, but noted that adverse market or credit developments could result in future impairments.
- Management commentary: Pricing remained favorable in U.S. Commercial and Personal Lines, and management continued rate and underwriting actions. Chaucer faced competitive rate pressure amid high capacity and limited major industry losses; large energy losses weighed on its current-year underwriting performance. Personal auto and homeowners policies in force declined 2.5% and 1.8%, respectively, over the cited year-over-year period as exposure management and lower new business offset rate increases.
- Guidance: The filing provides no specific earnings or revenue guidance. Management expects sufficient operating cash flow to meet requirements and expects fixed-maturity yields to continue declining. Results for the first nine months are not necessarily indicative of full-year results.
- Contingencies: In the Durand ERISA pension litigation, the company said it could not reasonably estimate the potential liability if the outcome is unfavorable. Other proceedings and regulatory inquiries were not expected to materially affect financial position, though they could materially affect a particular period’s results. Participation in residual insurance markets is also subject to less predictable results.
- Other risks: Catastrophe frequency and severity, reserve-estimation uncertainty, reinsurance collection and availability, investment-market volatility and defaults, competitive pricing, regulatory changes, foreign exchange, and legal developments could affect results. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much of earnings growth reflects lower catastrophe losses, favorable reserve development and the non-recurring U.K. disposal gain, versus underlying current-year underwriting performance.
- Whether reserve development remains favorable and whether the rise in reinsurance recoverables and reserves changes exposure to collection or estimation risk.
- Whether investment unrealized losses, credit impairments and declining reinvestment yields affect book value and future investment income.
- How the U.K. motor exit, Chaucer’s rate environment and U.S. policy-count declines affect premium growth and underwriting margins.
- Developments in the Durand litigation, capital and liquidity needs, and the pace and price of share repurchases under the expanded authorization.