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THG > SEC Filings for THG > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for HANOVER INSURANCE GROUP, INC.

Form 10-Q for HANOVER INSURANCE GROUP, INC.


1-Aug-2014

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

TABLE OF CONTENTS

  Introduction                                          31
  Executive Overview                                    31
  Description of Operating Segments                     32
  Results of Operations - Consolidated                  33
  Results of Operations - Segments                      34
  Investments                                           44
  Other Items                                           48
  Income Taxes                                          49
  Critical Accounting Estimates                         50
  Statutory Surplus of U.S. Insurance Subsidiaries      50
  Lloyd's Capital Requirement                           51
  Liquidity and Capital Resources                       52
  Off - Balance Sheet Arrangements                      54
  Contingencies and Regulatory Matters                  54
  Risks and Forward - Looking Statements                54


Table of Contents

Introduction

The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist readers in understanding the interim 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 interim consolidated financial statements and related footnotes included elsewhere in this Quarterly Report on Form 10-Q and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2014.

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. Additionally, results of operations include our discontinued operations, consisting primarily of our former life insurance businesses and our accident and health business.

Executive Overview

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

Operating income before interest expense and income taxes was $187.2 million for the six months ended June 30, 2014, compared to $183.3 million in the same period in 2013, an increase of $3.9 million. This increase is due to higher favorable development on prior years' loss and loss adjustment expense ("LAE") reserves ("prior years' loss reserves") and improved Commercial Lines current accident year results, partially offset by higher catastrophe and non-catastrophe weather-related losses in the first six months of 2014. Favorable development on prior years' loss reserves was $48.9 million for the six months ended June 30, 2014, compared to favorable development of $33.8 million in the same period in 2013, an increase of $15.1 million. Pre-tax catastrophe losses were $113.6 million for the six months ended June 30, 2014, compared to $81.5 million in the same period in 2013, an increase of $32.1 million.

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 remains strong 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, including the expansion of our product offerings in these lines supported by prior acquisitions of specialized businesses.

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 7.5% in the first six months of 2014, driven by our core commercial businesses. This growth is primarily due to rate increases, increased retention and targeted new business expansion.

Underwriting results declined slightly in the first six months of 2014, as compared to the same period in 2013, due to higher catastrophe losses, partially offset by improved current accident year results excluding catastrophe losses. 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.


Table of Contents

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 76% 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 profit declined slightly in the first six months of 2014, as compared to the same period in 2013. Higher non-catastrophe weather related losses in the current accident year were partially offset by favorable 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. We also continue to seek rate increases in our homeowners lines as a result of the 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, 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 profits increased in the first six months of 2014, as compared to the same period in 2013, primarily due to higher favorable development on prior years' loss reserves, lower catastrophe related losses and higher earned premiums, partially offset by higher non-catastrophe losses. Chaucer net premiums written increased by 12.7% in the first six months of 2014 due to expanded underwriting capabilities in our casualty lines, specific underwriting opportunities in our marine markets and the decision to increase our economic interests in Syndicate 1084 to 100% for 2014, up from 98% in 2013 and 84% in 2012.

Chaucer has continued to experience overall downward pressure on rates during 2014. Rates in the marine and aviation, energy, property and casualty markets remained under pressure during the first half of 2014 due to high industry capacity, including new capital from a variety of sources, and a continued absence of major losses. U.K. motor market rates were modestly lower after two years of declines following significant increases in 2010 and 2011. In response to these challenging market conditions, we continue to actively manage Chaucer's underwriting portfolio, using our expertise, distinctive underwriting capabilities and market knowledge to target specific attractive underwriting opportunities.

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.


Table of Contents

Results of Operations - Consolidated

Consolidated net income for the three months ended June 30, 2014 was $82.6 million, compared to $53.4 million for the three months ended June 30, 2013. The increase of $29.2 million is primarily due to improved operating results after taxes, principally in Commercial Lines, and higher realized investment gains from the sale of securities. Additionally, net income in 2013 included $11.3 million of losses from the repayment of debt.

Consolidated net income for the six months ended June 30, 2014 was $137.2 million, compared to $119.6 million for the six months ended June 30, 2013. The increase of $17.6 million is primarily due to the absence in 2014 of $19.1 million of losses from the aforementioned repayment of debt and higher realized investment gains from the sale of securities.

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. 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 highlighting net income (loss) 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.

The following table reflects operating income for each operating segment and a reconciliation of operating income to consolidated net income.

                                                Three Months Ended         Six Months Ended
                                                     June 30,                  June 30,
(in millions)                                      2014         2013         2014        2013
Operating income before interest expense
and income taxes:
Commercial Lines                              $     44.2     $  26.2     $   60.3     $  59.2
Personal Lines                                      22.7        19.9         44.3        50.4
Chaucer                                             38.1        36.9         87.3        77.8
Other                                               (2.8)       (1.9)        (4.7)       (4.1)
Operating income before interest expense
and income taxes                                   102.2        81.1        187.2       183.3
Interest expense on debt                           (16.3)      (17.4)       (32.6)      (32.1)
Operating income before income taxes                85.9        63.7        154.6       151.2
Income tax expense on operating income             (27.5)      (16.9)       (49.2)      (44.5)
Operating income                                    58.4        46.8        105.4       106.7
Net realized investment gains                       22.2        13.7         26.6        21.8
Net loss from repayment of debt                         -      (11.3)            -      (19.1)
Net (costs) benefit related to acquired
businesses                                          (0.2)       (0.2)        (1.1)        0.2
Net foreign exchange (losses) gains                 (0.2)           -        (0.3)        0.7
Income tax benefit on non-operating items            2.3         4.1          6.6         9.2
Income from continuing operations, net of
taxes                                               82.5        53.1        137.2       119.5
Net gain from discontinued operations, net
of taxes                                             0.1         0.3             -        0.1
Net income                                    $     82.6     $  53.4     $  137.2     $ 119.6


Table of Contents

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.

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

                                                   Three Months Ended           Six Months Ended
                                                        June 30,                    June 30,
(in millions)                                      2014          2013          2014          2013
Operating revenues
Net premiums written                           $ 1,276.2     $ 1,242.6     $ 2,448.5     $ 2,319.3
Net premiums earned                              1,174.7       1,090.8       2,337.7       2,185.1
Net investment income                               67.0          67.9         134.0         135.2
Other income                                         9.1          10.2          18.6          20.8
Total operating revenues                         1,250.8       1,168.9       2,490.3       2,341.1
Losses and operating expenses
Losses and LAE                                     725.5         692.1       1,476.0       1,375.5
Amortization of deferred acquisition costs         259.6         232.7         513.3         475.2
Other operating expenses                           163.5         163.0         313.8         307.1
Total losses and operating expenses              1,148.6       1,087.8       2,303.1       2,157.8
Operating income before interest expense
and income taxes                               $   102.2     $    81.1     $   187.2     $   183.3

Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

Operating income before interest expense and income taxes was $102.2 million in the three months ended June 30, 2014, compared to $81.1 million for the three months ended June 30, 2013, an increase of $21.1 million. Catastrophe related activity in the quarter was $55.7 million, compared to $59.8 million in the same period of 2013, a decrease of $4.1 million. Excluding the impact of catastrophe related activity, segment earnings increased by $17.0 million. This increase was primarily due to improved Commercial Lines current accident year results, partially offset by higher non-catastrophe weather-related losses in our homeowners line. Favorable development on prior years' loss reserves was $29.2 million in the quarter, compared to favorable development of $26.9 million in the same period in 2013, an increase of $2.3 million.

Net premiums written grew by $33.6 million in the three months ended June 30, 2014, compared to the three months ended June 30, 2013, and net premiums earned grew by $83.9 million. Chaucer accounted for $13.9 million of the net premiums written increase and $68.5 million of the net premiums earned increase. Chaucer's net premiums earned increased primarily due to the aforementioned increase in economic interests in Syndicate 1084. Growth in net premiums written in our Commercial Lines was a result of rate increases, strong retention and targeted new business expansion.


Table of Contents

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.

                                                   Three Months Ended June 30, 2014
                           Gross         Net          Net
                          Premiums     Premiums     Premiums   Catastrophe   Loss & LAE   Expense   Combined
(dollars in millions)     Written      Written       Earned    Loss Ratios     Ratios     Ratios     Ratios
Commercial Lines        $   613.0    $   541.0    $   517.6           3.3         61.8      36.6       98.4
Personal Lines              395.2        370.8        350.3           7.8         69.9      28.4       98.3
Chaucer                     415.4        364.4        306.8           3.7         52.4      39.7       92.1
Total                   $ 1,423.6    $ 1,276.2    $ 1,174.7           4.7         61.8      35.0       96.8

                                                   Three Months Ended June 30, 2013
                           Gross         Net          Net
                          Premiums     Premiums     Premiums   Catastrophe   Loss & LAE   Expense   Combined
(dollars in millions)     Written      Written       Earned    Loss Ratios     Ratios     Ratios     Ratios
Commercial Lines        $   591.0    $   521.5    $   485.8           3.1         64.2      37.6      101.8
Personal Lines              397.8        370.6        366.7           8.8         72.0      27.3       99.3
Chaucer                     405.6        350.5        238.3           5.2         48.6      41.0       89.6
Total                   $ 1,394.4    $ 1,242.6    $ 1,090.8           5.5         63.4      35.0       98.4

The following table summarizes net premiums written, and loss and LAE and catastrophe loss ratios by line of business for the Commercial Lines and Personal Lines segments. Loss and LAE and catastrophe loss ratios include prior year reserve development.

                                                       Three Months Ended June 30,
                                              2014                                    2013
                                  Net                                     Net
                                Premiums   Loss & LAE   Catastrophe     Premiums   Loss & LAE   Catastrophe
(dollars in millions)           Written      Ratios     Loss Ratios     Written      Ratios     Loss Ratios
Commercial Lines:
Commercial multiple peril     $   171.7         56.0           7.4    $   163.2         59.9           7.0
Commercial automobile              76.4         77.9           0.3         76.8         77.1           0.1
Workers' compensation              58.6         70.6              -        57.1         62.8              -
Other commercial                  234.3         58.1           2.0        224.4         63.3           1.9
Total Commercial Lines        $   541.0         61.8           3.3    $   521.5         64.2           3.1
Personal Lines:
Personal automobile           $   227.3         69.2           0.6    $   227.9         74.6           1.1
Homeowners                        132.7         73.6          20.7        131.8         69.4          22.6
Other personal                     10.8         37.6           3.0         10.9         47.1           8.7
Total Personal Lines          $   370.8         69.9           7.8    $   370.6         72.0           8.8


Table of Contents

The following table summarizes premiums written on a gross and net basis and net premiums earned by line of business for the Chaucer segment.

                                                    Three Months Ended June 30,
                                          2014                                        2013
                            Gross          Net            Net          Gross          Net            Net
                           Premiums      Premiums      Premiums       Premiums      Premiums      Premiums
(in millions)              Written        Written       Earned        Written        Written       Earned
Chaucer:
Marine and aviation      $      82.4    $     69.9    $     69.3    $      83.9    $     67.3    $     58.2
U.K. motor                      95.2          94.6          82.4           86.5          87.0          69.7
Property                        68.1          59.0          48.1           93.7          78.3          40.5
Energy                          80.7          64.9          48.0           85.4          73.0          34.1
Casualty and other              89.0          76.0          59.0           56.1          44.9          35.8
Total Chaucer            $     415.4    $    364.4    $    306.8    $     405.6    $    350.5    $    238.3

The following table summarizes GAAP underwriting results for the Commercial Lines, Personal Lines, Chaucer and Other segments and reconciles it to operating income.

                                                                             Three Months Ended June 30,
                                                        2014                                                             2013
                                                Personal                                                         Personal
(in millions)               Commercial Lines      Lines     Chaucer     Other      Total     Commercial Lines      Lines     Chaucer     Other     Total
GAAP underwriting profit
(loss),
excluding prior year
reserve
development and
catastrophes               $            26.1    $   28.6    $   6.6    $ (0.5)   $  60.8    $             6.1    $   34.7    $   6.5    $ (0.5)   $  46.8
Prior year favorable
(unfavorable)
loss and LAE reserve
development                             (1.8)        2.2       29.2      (0.4)      29.2                 (0.5)       (2.8)      30.7      (0.5)      26.9
Pre-tax catastrophe
effect                                 (17.0)      (27.2)     (11.5)         -     (55.7)               (15.1)      (32.2)     (12.5)         -     (59.8)
GAAP underwriting profit
(loss)                                   7.3         3.6       24.3      (0.9)      34.3                 (9.5)       (0.3)      24.7      (1.0)      13.9
Net investment income                   37.2        18.0       10.7       1.1       67.0                 36.0        19.1       10.7       2.1       67.9
Fees and other income                    2.1         3.1        3.1       0.8        9.1                  1.9         3.1        4.5       0.7       10.2
Other operating expenses                (2.4)       (2.0)          -     (3.8)      (8.2)                (2.2)       (2.0)      (3.0)     (3.7)     (10.9)
Operating income (loss)
before
interest expense and
income taxes               $            44.2    $   22.7    $  38.1    $ (2.8)   $ 102.2    $            26.2    $   19.9    $  36.9    $ (1.9)   $  81.1


Table of Contents

Commercial Lines

Commercial Lines net premiums written were $541.0 million in the three months ended June 30, 2014, compared to $521.5 million in the three months ended June 30, 2013. This $19.5 million increase was primarily driven by rate increases, increased retention, and targeted new business expansion, partially offset by exposure and portfolio management actions that focus on reducing volatility from weather-related events and driving profit improvement.

Commercial Lines underwriting profit for the three months ended June 30, 2014 . . .

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