The Hanover Insurance Group, Inc. — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. The filing was signed February 23, 2021. Hanover is a U.S. property and casualty insurer that distributes primarily through independent agents, with Commercial Lines and Personal Lines as its principal businesses. The filing reports full-year results; fourth-quarter results are also summarized below.
Financial performance
| Metric | 2020 | 2019 |
|---|---|---|
| Net premiums written | $4.599 billion | $4.582 billion |
| Premiums earned | $4.527 billion | $4.475 billion |
| Total revenues | $4.827 billion | $4.891 billion |
| Net income | $358.7 million | $425.1 million |
| Diluted net income per share | $9.42 | $10.46 |
| Operating income before interest and income taxes (non-GAAP) | $484.7 million | $453.6 million |
| Net investment income | $265.1 million | $281.3 million |
| Net cash provided by operating activities | $707.6 million | $602.9 million |
| Combined ratio | 94.4% | 95.6% |
Fourth-quarter 2020 revenue was $1.297 billion and net income was $164.6 million, or diluted EPS of $4.43, versus $1.258 billion, $109.8 million and $2.76, respectively, in fourth-quarter 2019.
Underwriting and segments: The 2020 combined ratio below 100% indicates an underwriting profit before investment income. Commercial Lines’ combined ratio was 95.8% (95.2% in 2019); Personal Lines’ was 92.4% (96.3% in 2019). Segment operating income before interest and taxes was $275.4 million for Commercial Lines, $212.5 million for Personal Lines and a $3.2 million loss for Other. Net premiums written rose 1.0% in Commercial Lines and declined 0.5% in Personal Lines; excluding about $30 million of personal-auto customer refunds, Personal Lines premiums written would have increased 1.1%.
Cash, investments and debt: Cash and investments totaled $8.967 billion at year-end, including $7.454 billion of fixed maturities and $120.6 million of cash and cash equivalents. Operating cash flow was $707.6 million; investing activities used $608.8 million and financing activities used $193.9 million. Debt was $780.8 million net of issuance costs ($786.9 million principal). Hanover issued $300 million of 2.50% senior debentures due 2030 and used part of the proceeds to redeem $175 million of 6.35% subordinated debentures, recording a $6.2 million debt-repayment loss. The holding company reported $396.9 million of fixed maturities and cash. Insurance-subsidiary statutory capital and surplus was $2.589 billion, and Hanover Insurance’s risk-based-capital ratio was 233% on the industry scale.
Material changes versus 2019
- Net income fell $66.4 million, largely because net realized and unrealized investment gains declined to $5.0 million from $109.4 million, principally reflecting smaller equity-security fair-value gains. Operating income before interest and taxes rose $31.1 million.
- Pre-tax catastrophe losses increased to $286.7 million from $169.3 million. The filing attributes the increase primarily to civil unrest and riots, Hurricane Isaias, West Coast wildfires, and wind and hailstorms.
- Non-catastrophe current-year claims were lower, particularly in personal and commercial auto, as reduced activity and fewer miles driven during the pandemic lowered claims. Prior-year reserve development was favorable by $32.6 million overall, including $15.5 million excluding catastrophes and $17.1 million on catastrophe reserves.
- Net investment income declined by $16.2 million, reflecting lower new-money yields and limited-partnership income, among other factors. Total cash and investments increased 9.2%.
- Statutory surplus increased $118.3 million, principally from underwriting profits, partly offset by a $245 million dividend from Hanover Insurance to its parent.
Outlook, risks and unusual items
- Management said pandemic impacts on near-term results should be manageable, but emphasized that the duration and longer-term effects remain uncertain. No quantified earnings or premium guidance is provided.
- The pandemic affected underwriting, investment markets and operations. Hanover recorded approximately $19 million of pandemic-related reserve provisions in Commercial Lines and returned about $30 million in personal-auto premiums. Management said it believed most in-force Commercial Lines policies did not cover pandemic business-interruption losses, while warning that retroactive legislation or other regulatory action could create significant unfunded liabilities.
- Michigan auto-insurance reform creates uncertainty around PIP pricing, medical-cost controls and litigation. Hanover’s estimated MCCA reinsurance recoverable was approximately $1.025 billion; its estimate had not been reduced for potential future cost savings. The filing describes litigation challenging parts of the reform.
- Loss reserves are a major estimation risk: gross loss and LAE reserves were $6.024 billion, including $4.382 billion net of reinsurance; approximately half of net reserves were IBNR. Management cautions that actual claims and reserve development could differ materially from estimates. A one-percentage-point change in the aggregate loss and LAE ratio was estimated to affect operating income by about $46 million.
- Reinsurance recoverables totaled $1.874 billion, including $1.035 billion from residual markets and pooling arrangements. Reinsurance does not release Hanover from obligations to policyholders; collectability, coverage disputes, catastrophe severity and renewal pricing remain risks. Pandemic exclusions appeared in some renewed reinsurance contracts.
- Investment and rate risks include lower reinvestment yields, credit deterioration and market volatility. Fixed maturities were 96% investment grade; investment impairment losses were $26.3 million in 2020 versus $2.0 million in 2019. The portfolio’s weighted-average fixed-maturity duration was 4.8 years.
- Other exposures include catastrophe concentration in the Northeast and Michigan, California wildfire exposure, inflation and social inflation, litigation, regulatory constraints, agent and technology risks, and run-off long-term-care and legacy reinsurance obligations. Ordinary-course legal proceedings were not expected to materially affect financial position, though a particular period’s results could be affected.
- The company paid $100.7 million in shareholder dividends during 2020 and repurchased shares. Approximately $124 million remained under its $900 million repurchase authorization at year-end. The board said it expected quarterly dividends comparable to the fourth-quarter $0.70 per share, subject to future board decisions and available funds.
Important facts for investors to verify
- Review the development and sensitivity of loss reserves, especially long-tail liability, auto bodily-injury, workers’ compensation and pandemic-related claims.
- Track Michigan PIP reform, the related litigation, future cost controls and the collectability and assumptions underlying the MCCA recoverable.
- Assess catastrophe exposure and the adequacy, cost and renewal terms of reinsurance, including pandemic exclusions and counterparty concentration.
- Monitor investment income, credit impairments, portfolio valuations and the effect of persistently low yields or renewed market stress.
- Compare reported net income with operating income: 2020 earnings included substantially lower investment gains than 2019, while operating income improved.
- Confirm the timing and funding of dividends and repurchases, debt maturities and holding-company liquidity, given regulatory limits on subsidiary dividends.
The independent auditor issued an unqualified opinion on the financial statements and concluded that internal control over financial reporting was effective. Reserve valuation was identified as a critical audit matter.