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THG > SEC Filings for THG > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for HANOVER INSURANCE GROUP, INC.

Form 10-K for HANOVER INSURANCE GROUP, INC.


25-Feb-2014

Annual Report


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

TABLE OF CONTENTS



        Introduction                                                     44

        Executive Overview                                               44

        Description of Operating Segments                                45

        Results of Operations - Consolidated                             46

        Results of Operations - Segments                                 47

        Investments                                                      65

        Other Items                                                      71

        Quantitative and Qualitative Disclosures about Market Risk       72

        Discontinued Operations                                          74

        Income Taxes                                                     74

        Critical Accounting Estimates                                    75

        Statutory Surplus of U.S. Insurance Subsidiaries                 80

        Lloyd's Capital Requirement                                      80

        Liquidity and Capital Resources                                  81

        Off-Balance Sheet Arrangements                                   84

        Contingencies and Regulatory Matters                             84

        Rating Agencies                                                  85

        Risks and Forward-Looking Statements                             85

        Glossary of Selected Insurance Terms                             85

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INTRODUCTION

The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist readers in understanding the consolidated results of operations and financial condition of The Hanover Insurance Group, Inc. and its subsidiaries ("THG"). Consolidated results of operations and financial condition are prepared in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP"). This discussion should be read in conjunction with the Consolidated Financial Statements and related footnotes included elsewhere herein.

Results of operations include the accounts of The Hanover Insurance Company ("Hanover Insurance") and Citizens Insurance Company of America ("Citizens"), our principal U.S. domiciled property and casualty companies; Chaucer Holdings plc ("Chaucer"), our United Kingdom (U.K.) domiciled specialist insurance underwriting group which operates through the Society and Corporation of Lloyd's ("Lloyd's"); and certain other insurance and non-insurance subsidiaries. The acquisition of Chaucer on July 1, 2011, which has added meaningful business volumes to our results, has affected the comparability of our results of operations for the years ended December 31, 2013, 2012 and 2011. Results of operations for the years ended December 31, 2013 and 2012 include results from all of our business segments, while results of operations for the year ended December 31, 2011 include Chaucer's results for only the period from July 1, 2011 through December 31, 2011. Additionally, results of operations include our discontinued operations, consisting primarily of our former life insurance businesses, accident and health business and prior to April 30, 2012, our third party administration business.

EXECUTIVE OVERVIEW

Business operations consist of four operating segments: Commercial Lines, Personal Lines, Chaucer and Other.

Operating income (formally referred to as segment income) before interest expense and income taxes was $393.4 million in 2013 compared to $75.1 million in 2012, an increase of $318.3. This increase was primarily due to lower catastrophe and non-catastrophe related losses, and higher favorable development on prior years' loss and loss adjustment expense ("LAE") reserves ("prior years' loss reserves"). Pre-tax catastrophe losses were $140.0 million, compared to $369.9 million during 2012. Catastrophe losses in 2012 were primarily the result of $198.1 million of pre-tax losses related to Superstorm Sandy during the fourth quarter, and from several tornadoes during the first six months of the year. There was favorable development on prior years' loss reserves of $76.3 million in 2013, compared to $15.8 million in 2012.

Over recent years, weather-related catastrophe and non-catastrophe losses have been in excess of longer term averages. Pricing in our Commercial and Personal Lines remained strong throughout 2013 as the industry continues to respond to these increased weather-related losses, as well as to the earnings impact of reduced investment income as a result of low interest rates, and other factors. We are continuing efforts to improve our underwriting results in both our Commercial and Personal Lines, through rate increases and improvements to our mix of business.

Commercial Lines

We believe our unique approach to the small commercial market, distinctiveness in the middle market, and continued development of specialty lines provides us with a diversified portfolio of products and delivers significant value to agents and policyholders. The small commercial and middle market businesses are expected to contribute to premium growth in Commercial Lines over the next several years as we continue to pursue our core strategy of developing strong partnerships with agents, distinctive products, franchise value through limited distribution, and industry segmentation. Growth in our specialty lines continues to be an important part of our strategy, with the expansion of our product offerings in these lines supported by acquisitions of specialized business over the past several years.

We believe these efforts have driven, and will continue to drive, improvement in our overall mix of business and ultimately our underwriting profitability. Commercial Lines net premiums written grew by 5.5% in 2013, driven by our core commercial businesses. This growth is primarily due to rate increases, strong retention and targeted new business expansion.

Underwriting results improved in 2013, as compared to 2012, primarily due to lower catastrophe losses, improved non-catastrophe current accident year results and lower unfavorable development on prior years' loss reserves. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins and we continue to seek rate increases across our lines of business.

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Personal Lines

Personal Lines focuses on partnering with high quality, value-oriented agencies that deliver consultative selling and stress the importance of account rounding (the conversion of single policy customers to accounts with multiple policies and additional coverages). Approximately 75% of our policies in force are account business. We are focused on making investments that help maintain profitability, build a distinctive position in the market, help diversify us geographically from our historical core states of Michigan, Massachusetts, New York and New Jersey, and provide us with profitable growth opportunities.

Underwriting results improved in 2013, as compared to 2012, primarily due to lower catastrophe losses, improved non-catastrophe current accident year results and lower net unfavorable development on prior years' loss reserves. We continue to seek additional rate increases, subject to regulatory and competitive considerations, in our personal automobile line, particularly as a result of recent trends of higher loss severity in bodily injury and personal injury protection claims. We also continue to seek rate increases in our homeowners lines as a result of the catastrophe and non-catastrophe weather-related losses that the industry experienced in the past several years.

Chaucer

Chaucer deploys specialist underwriters in over 30 major insurance and reinsurance classes, including energy, marine and aviation, U.K. motor, property, and casualty and other coverages. We obtain business through Lloyd's, the leading international insurance and reinsurance market, which provides us with access to specialist business in over 200 countries and territories worldwide through its international licenses, brand reputation and strong security rating. Our underwriting strength, diverse portfolio and Lloyd's membership underpin our ability to actively manage the scale, composition and profitable development of this business.

Underwriting results improved in 2013, as compared to 2012, primarily due to higher favorable development on prior years' loss reserves and lower catastrophe losses, partially offset by higher non-catastrophe losses. Favorable development on prior years' loss reserves during 2013 was $94.6 million, compared to $72.6 million during 2012, a change of $22.0 million. Chaucer net premiums written grew by 12.8% in 2013, primarily due to an increase in Chaucer's economic interests in Syndicate 1084 to 98% for 2013, up from 84% in 2012. While we benefited from favorable rates in certain catastrophe-exposed marine and property lines following high levels of insured market losses in recent years, we experienced overall downward pressure on rates throughout 2013 because of new capital inflows and an absence of major market losses in the current year. Rates in the energy market remained under pressure throughout 2013 due to a continued absence of major market losses. Also, net premiums written in our energy line were lower due to a reduction of estimated premiums for both the exploration and production coverage class and the construction coverage class. The aviation and casualty markets continued to remain soft as a result of low loss activity and industry excess capacity. U.K. motor market rates continued their modest decline, following the significant increases in 2010 and 2011. In response, we continue to actively manage Chaucer's underwriting portfolio, using our expertise, distinctive underwriting capabilities and market knowledge to target specific attractive underwriting opportunities despite an uncertain international Lloyd's market environment.

DESCRIPTION OF OPERATING SEGMENTS

Primary business operations include insurance products and services currently provided through four operating segments. Our domestic operating segments are Commercial Lines, Personal Lines, and Other. Our international operating segment is Chaucer. Commercial Lines includes commercial multiple peril, commercial automobile, workers' compensation and other commercial coverages, such as specialty program business, inland marine, management and professional liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes marine and aviation, energy, property, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). Included in Other are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a voluntary pools business which is in run-off. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance.

We report interest expense on debt separately from the earnings of our operating segments. This consists of interest on our senior debentures, subordinated debentures, collateralized borrowings with the Federal Home Loan Bank of Boston ("FHLBB"), and letter of credit facility.

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RESULTS OF OPERATIONS - CONSOLIDATED

2013 Compared to 2012

Consolidated net income was $251.0 million in 2013, compared to $55.9 million in 2012. The $195.1 million increase is primarily due to improved operating results after taxes, which was principally attributable to a decrease in catastrophe losses, higher favorable development on prior years' loss reserves and an improvement in non-catastrophe current accident year results. In addition, net income increased in 2013 as a result of higher realized gains from the sale of securities, partially offset by losses resulting from the repayment of debt.

2012 Compared to 2011

Consolidated net income was $55.9 million in 2012, compared to $36.7 million in 2011. The $19.2 million increase is primarily due to income from our Chaucer segment and lower costs in 2012 related to the Chaucer acquisition. Additionally, we recognized a $10.8 million gain from the sale of our third party administration business, Citizens Management, Inc. ("CMI"), which was completed on April 30, 2012 (see also "Discontinued Operations"). These increases were partially offset by a decrease in operating results in our domestic operations.

In addition to consolidated net income, we assess our financial performance based upon pre-tax "operating income (loss)," and we assess the operating performance of each of our four operating segments based upon the pre-tax operating income (loss) generated by each segment. We formerly referred to these pre-tax measures as "segment income (loss)." Operating income (loss) before taxes excludes interest expense on debt and certain other items which we believe are not indicative of our core operations, such as net realized investment gains and losses (including net gains and losses on certain derivative instruments). Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income (loss) before taxes excludes net gains and losses on disposals of businesses, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, extraordinary items, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income (loss) before taxes may be important components in understanding and assessing our overall financial performance, we believe a discussion of operating income before taxes enhances an investor's understanding of our results of operations by segregating income attributable to the core operations of the business. However, operating income (loss) before taxes should not be construed as a substitute for income (loss) before income taxes and operating income (loss) should not be construed as a substitute for net income (loss).

Catastrophe losses and prior years' reserve development are significant components in understanding and assessing the financial performance of our business. Management reviews and evaluates catastrophes and prior years' reserve development separately from the other components of earnings. Catastrophes and prior years' reserve development are not predictable as to timing or the amount that will affect the results of our operations and have affected our results in the past few years. Management believes that providing certain financial metrics and trends excluding the effects of catastrophes and prior years' reserve development helps investors to understand the variability in periodic earnings and to evaluate the underlying performance of our operations.

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The following table reflects operating income and a reconciliation of total operating income to consolidated net income.

YEARS ENDED DECEMBER 31                                 2013           2012           2011
(in millions)
Operating income (loss) before interest expense
and income taxes:
Commercial Lines                                      $  132.4        $ (80.3 )      $  16.3
Personal Lines                                           118.6           25.5           23.1
Chaucer                                                  150.4          136.8           32.9
Other                                                     (8.0 )         (6.9 )         (0.5 )

Operating income before interest expense and
income taxes                                             393.4           75.1           71.8
Interest expense on debt                                 (65.3 )        (61.9 )        (55.0 )

Operating income before income taxes                     328.1           13.2           16.8
Income tax benefit (expense) on operating income        (100.9 )          1.9           (2.6 )
Net realized investment gains                             33.5           23.6           28.1
Loss on real estate                                       (4.7 )           -              -
Net loss from repayment of debt                          (27.7 )         (5.1 )         (2.3 )
Net costs related to acquired businesses                  (0.1 )         (2.6 )        (16.4 )
Loss on derivative instruments                              -              -           (11.3 )
Net foreign exchange gains (losses)                         -            (0.4 )          6.7
Income tax benefit on non-operating items                 17.5           15.5           12.5

Income from continuing operations, net of taxes          245.7           46.1           31.5
Net gain from discontinued operations, net of
taxes                                                      5.3            9.8            5.2

Net income                                            $  251.0        $  55.9        $  36.7

RESULTS OF OPERATIONS - SEGMENTS

The following is our discussion and analysis of the results of operations by business segment. The operating results are presented before interest expense, taxes and other items which management believes are not indicative of our core operations, including realized gains and losses. Results for Chaucer include activity since the July 1, 2011 acquisition.

The following table summarizes the results of operations for the periods indicated:

YEARS ENDED DECEMBER 31                                 2013            2012            2011
(in millions)
Operating revenues

Net premiums written                                  $ 4,552.7       $ 4,368.4       $ 3,593.4

Net premiums earned                                     4,450.5         4,239.1         3,598.6
Net investment income                                     269.0           276.3           258.2
Other income                                               40.7            58.2            51.9

Total operating revenues                                4,760.2         4,573.6         3,908.7

Losses and operating expenses
Losses and LAE                                          2,761.1         2,974.4         2,550.8
Amortization of deferred acquisition costs                971.0           938.1           778.9
Other operating expenses                                  634.7           586.0           507.2

Total losses and operating expenses                     4,366.8         4,498.5         3,836.9

Operating income before interest expense and
income taxes                                          $   393.4       $    75.1       $    71.8

2013 Compared to 2012

Operating income before interest expense and income taxes was $393.4 million for the year ended December 31, 2013, compared to $75.1 million for the year ended December 31, 2012, an increase of $318.3 million reflecting improvements in each of our insurance segments. This increase in operating income is primarily due to lower catastrophe and non-catastrophe related losses and higher favorable development.

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Our consolidated catastrophe related activity for the year ended December 31, 2013 was $140.0 million, compared to $369.9 million for the year ended December 31, 2012, a decrease of $229.9 million. Our 2012 catastrophe losses included $198.1 million of pre-tax losses related to Superstorm Sandy.

Favorable development on prior years' loss reserves was $76.3 million for the year ended December 31, 2013, compared to $15.8 million for the year ended December 31, 2012, an increase of $60.5 million. For 2013, $94.6 million of favorable development related to our Chaucer segment was partially offset by $18.3 million of unfavorable development related to our domestic operations. For the year ended December 31, 2012, $72.6 million of favorable development related to our Chaucer segment was partially offset by $56.8 million of unfavorable development related to our domestic operations.

Net premiums written grew by $184.3 million for the year ended December 31, 2013, compared to the year ended December 31, 2012, and net premiums earned grew by $211.4 million. Chaucer accounted for $127.0 million of the net premiums written increase and $71.1 million of the net premiums earned increase, primarily due to the aforementioned increase in Chaucer's economic interests in Syndicate 1084. Additionally, growth in our core commercial businesses, resulting from rate increases, strong retention and targeted new business expansion, was partially offset by a decrease in our Personal Lines net premiums written.

2012 Compared to 2011

Operating income before interest expense and income taxes was $75.1 million for the year ended December 31, 2012, compared to $71.8 million for the year ended December 31, 2011, an increase in earnings of $3.3 million. This increase is primarily due to a $103.9 million increase in Chaucer operating income, reflecting a full year of earnings for Chaucer compared to only six months in 2011 and lower loss activity in most Chaucer product classes, partially offset by a $96.6 million decrease in Commercial Lines earnings. The Commercial Lines earnings decrease was primarily due to unfavorable development on prior years' loss reserves and increased catastrophe losses.

Our consolidated catastrophe related activity for the year ended December 31, 2012 was $369.9 million, compared to $361.6 million for the year ended December 31, 2011, an increase of $8.3 million. Both our 2012 and 2011 results reflected significantly elevated levels of catastrophe losses compared to our historical averages. Catastrophe losses in 2012 were primarily the result of $198.1 million of pre-tax losses related to Superstorm Sandy during the fourth quarter, and from several tornadoes during the first six months of the year. Our 2011 catastrophe losses resulted principally from winter storms, tornado, hail and windstorm activity in the first half of the year, and from Hurricane Irene and floods in Thailand and Denmark during the second half of the year.

Favorable development on prior years' loss reserves was $15.8 million for the year ended December 31, 2012, compared to $103.3 million for the year ended December 31, 2011, a decrease of $87.5 million. For 2012, $72.6 million of favorable development related to our Chaucer segment was partially offset by $56.8 million of unfavorable development related to our domestic operations. For the year ended December 31, 2011, $67.8 million of favorable development was related to our domestic operations and $35.5 million was related to our Chaucer segment.

Net premiums written grew by $775.0 million for the year ended December 31, 2012, compared to the year ended December 31, 2011, and net premiums earned grew by $640.5 million, in each case primarily as a result of including a full year of Chaucer's net premiums in 2012 compared to only six months in 2011. Chaucer accounted for $561.7 million of the net premiums written increase and $460.5 million of the net premiums earned increase. The balance of the growth is primarily attributable to Commercial Lines, resulting from rate increases, strong retention and targeted new business expansion.

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PRODUCTION AND UNDERWRITING RESULTS

The following table summarizes premiums written on a gross and net basis, net premiums earned and loss, LAE, expense and combined ratios for the Commercial Lines, Personal Lines and Chaucer segments. Loss, LAE, catastrophe loss and combined ratios shown below include prior year reserve development. These items are not meaningful for our Other segment.

                                                                 YEAR ENDED DECEMBER 31, 2013
                          Gross
                        Premiums       Net Premiums       Net Premiums       Catastrophe      Loss & LAE       Expense       Combined
(dollars in millions)    Written         Written             Earned          Loss Ratios        Ratios         Ratios         Ratios
Commercial Lines        $ 2,295.9     $      2,007.2     $      1,958.4               2.0            62.4          38.0          100.4
Personal Lines            1,531.6            1,428.0            1,454.2               4.6            68.8          27.9           96.7
Chaucer                   1,374.2            1,117.5            1,037.9               3.3            51.8          37.8           89.6

Total                   $ 5,201.7     $      4,552.7     $      4,450.5               3.1            62.0          34.7           96.7

                                                                 YEAR ENDED DECEMBER 31, 2012
                          Gross
                        Premiums       Net Premiums       Net Premiums       Catastrophe      Loss & LAE       Expense       Combined
(dollars in millions)    Written         Written             Earned          Loss Ratios        Ratios         Ratios         Ratios
Commercial Lines        $ 2,182.4     $      1,902.0     $      1,811.5              10.7            74.5          37.7          112.2
Personal Lines            1,611.7            1,475.6            1,459.9               9.2            76.5          27.3          103.8
Chaucer                   1,409.8              990.5              966.8               4.3            52.4          37.9           90.3

Total                   $ 5,203.9     $      4,368.1     $      4,238.2               8.7            70.2          34.2          104.4

                                                                 YEAR ENDED DECEMBER 31, 2011
                          Gross
                        Premiums       Net Premiums       Net Premiums       Catastrophe      Loss & LAE       Expense       Combined
(dollars in millions)    Written         Written             Earned          Loss Ratios        Ratios         Ratios         Ratios
Commercial Lines        $ 1,938.0     $      1,703.1     $      1,641.7               9.0            68.2          39.0          107.2
Personal Lines            1,561.3            1,461.2            1,450.5              11.3            77.1          27.1          104.2
Chaucer                     559.6              428.8              506.3               9.8            61.9          35.7           97.6

Total                   $ 4,058.9     $      3,593.1     $      3,598.5              10.0            70.8          33.9          104.7

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