The Hanover Insurance Group, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended September 30, 2013; comparisons are with the third quarter and first nine months of 2012. The property and casualty insurer reports Commercial Lines, Personal Lines, Chaucer (specialty underwriting through Lloyd’s) and Other. Results include discontinued operations, primarily former life and accident and health businesses.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $1,201.8 million | $1,157.7 million | $3,564.7 million | $3,406.7 million |
| Net income | $61.3 million | $40.4 million | $180.9 million | $110.9 million |
| Diluted EPS | $1.37 | $0.89 | $4.03 | $2.44 |
| Operating income before interest and taxes | $107.2 million | $62.9 million | $290.5 million | $179.6 million |
| Net premiums written | $1,181.9 million | $1,120.1 million | $3,501.2 million | $3,334.5 million |
| Net investment income | $65.7 million | $69.2 million | $200.9 million | $206.5 million |
Combined ratio was 96.0% in Q3 versus 100.2% a year earlier, and 96.8% for the nine months versus 100.5%. Ratios below 100% indicate underwriting profit. Nine-month catastrophe losses declined to $112.1 million from $166.6 million, while favorable prior-year reserve development rose to $57.4 million from $8.3 million. The 2013 earnings improvement therefore benefited materially from lower catastrophe losses and larger reserve releases.
At September 30, total assets were $13.46 billion, shareholders’ equity $2.54 billion, cash and equivalents $602.2 million, and investments $7.35 billion. Debt was $938.7 million, up from $849.4 million at year-end 2012. Nine-month operating cash flow was $181.9 million, down from $204.6 million; cash increased by $37.3 million to $602.2 million. U.S. insurance-subsidiary statutory surplus was $1.75 billion, up $227.9 million from year-end.
Material changes and management commentary
- Commercial Lines nine-month net premiums written rose 4.8%; underwriting results improved, though the segment still recorded a $9.8 million underwriting loss for the period.
- Personal Lines nine-month net premiums written fell to $1,085.1 million from $1,112.2 million, reflecting policy and exposure reductions; underwriting returned to profit at $27.8 million from a $14.6 million loss.
- Chaucer nine-month net premiums written increased 16.4% to $880.5 million, mainly because Hanover’s economic interest in Syndicate 1084 increased to 98% from 84%. Chaucer underwriting profit improved to $78.5 million, supported by stronger favorable reserve development.
- Investment income declined as new-money yields remained below embedded portfolio yields. Average fixed-maturity earned yield for the first nine months was 3.99%, versus 4.31% in 2012; management expected yields to continue declining.
- Net unrealized gains on fixed maturities declined $220.5 million during the first nine months, primarily due to higher interest rates. Management considered unrealized losses temporary, but acknowledged adverse market or credit changes could result in impairment losses.
Outlook, risks, contingencies and unusual items
No specific earnings or premium guidance is provided. Management described pricing as generally supportive in domestic lines and planned continued rate actions and underwriting discipline. It cautioned that Personal Lines exposure-management actions were expected to reduce premiums and policies in force. For Chaucer, management anticipated few rate increases in Q4 2013 amid excess market capacity, soft energy pricing, and continued pressure in aviation, casualty and U.K. motor.
- Unusual costs included a $19.1 million nine-month loss from debt repayment, comprising an $11.3 million loss on repurchased senior debentures and $7.8 million in FHLBB prepayment fees. The company issued $175 million of 6.35% subordinated debentures due 2053.
- A $4.7 million real-estate loss was recorded after the company planned to consolidate its Howell, Michigan operations and sell one building.
- The Durand pension-plan class action remains unresolved. A court dismissed claims for participants receiving distributions after 2003 and certified a class for remaining claims; the scope of the dismissal was disputed, and the company could not reasonably estimate potential liability.
- Key risks include catastrophe and weather losses, reserve-estimate uncertainty, bodily-injury severity, reinsurance availability and collectability, interest-rate and investment-market volatility, competition, regulatory changes, and foreign-exchange movements.
- Management reported compliance with debt covenants and Lloyd’s capital requirements, and no material off-balance-sheet arrangements or material changes in market-risk exposures.
Most important facts for investors to verify
- How much of earnings growth is sustainable without the lower catastrophe losses and substantial favorable reserve development.
- Whether underlying accident-year underwriting performance and pricing remain adequate, particularly in commercial auto, personal auto and Chaucer’s softer markets.
- Whether continued interest-rate or credit-market moves affect investment income, unrealized losses, capital and future impairment charges.
- The outcome and possible financial exposure of the Durand litigation, as well as changes in reserve estimates and reinsurance recoverables.
- Debt and holding-company liquidity, including the effect of debt transactions, share repurchases and dividends on capital flexibility.