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THG Hanover Insurance

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission File Number 1-13754

 

THE HANOVER INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

04-3263626

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

440 Lincoln Street, Worcester, Massachusetts 01653

(Address of principal executive offices) (Zip Code)

(508) 855-1000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbols

 

Name of each exchange on which registered 

Common Stock, $.01 par value

 

THG

 

New York Stock Exchange

7 5/8% Senior Debentures due 2025

 

THG

 

New York Stock Exchange

6.35% Subordinated Debentures due 2053

 

THGA

 

New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months.    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

  

Smaller reporting company

 

 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The number of shares outstanding of the registrant’s common stock was 37,997,945 as of April 27, 2020.

 

 

 

 

 

 

 

 

 

 


TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

 

2

 

 

 

 

Item 1.

Financial Statements

 

2

 

Consolidated Statements of Income

 

2

 

Consolidated Statements of Comprehensive Income

 

3

 

Consolidated Balance Sheets

 

4

 

Consolidated Statements of Shareholders’ Equity

 

5

 

Consolidated Statements of Cash Flows

 

6

 

Notes to Interim Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

24

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

41

 

 

 

 

Item 4.

Controls and Procedures

 

41

 

 

 

 

PART II.

OTHER INFORMATION

 

42

 

 

 

 

Item 1.

Legal Proceedings

 

42

 

 

 

 

Item 1A.

Risk Factors

 

42

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

45

 

 

 

 

Item 6.

Exhibits

 

46

 

 

 

 

SIGNATURES

 

47

 

 

 

 


Table of Contents

 

 

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions, except per share data)

 

2020

 

 

2019

 

Revenues

 

 

 

 

 

 

 

 

Premiums

 

$

1,141.4

 

 

$

1,095.1

 

Net investment income

 

 

69.6

 

 

 

70.2

 

Net realized and unrealized investment gains (losses):

 

 

 

 

 

 

 

 

Net realized gains (losses) from sales and other

 

 

3.1

 

 

 

(0.4

)

Net change in fair value of equity securities

 

 

(136.2

)

 

 

48.6

 

Impairment losses on investments

 

 

(28.5

)

 

 

 

Total net realized and unrealized investment gains (losses)

 

 

(161.6

)

 

 

48.2

 

Fees and other income

 

 

6.8

 

 

 

6.0

 

Total revenues

 

 

1,056.2

 

 

 

1,219.5

 

Losses and expenses

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

728.2

 

 

 

699.6

 

Amortization of deferred acquisition costs

 

 

236.9

 

 

 

229.5

 

Interest expense

 

 

9.4

 

 

 

9.4

 

Other operating expenses

 

 

135.6

 

 

 

132.4

 

Total losses and expenses

 

 

1,110.1

 

 

 

1,070.9

 

Income (loss) from continuing operations before income taxes

 

 

(53.9

)

 

 

148.6

 

Income tax expense (benefit):

 

 

 

 

 

 

 

 

Current

 

 

21.3

 

 

 

12.2

 

Deferred

 

 

(36.5

)

 

 

13.8

 

Total income tax expense (benefit)

 

 

(15.2

)

 

 

26.0

 

Income (loss) from continuing operations

 

 

(38.7

)

 

 

122.6

 

Discontinued operations (net of taxes):

 

 

 

 

 

 

 

 

Sale of Chaucer business

 

 

 

 

 

0.9

 

Loss from Chaucer business

 

 

 

 

 

(0.3

)

Loss from discontinued life businesses

 

 

(1.3

)

 

 

(0.8

)

Net income (loss)

 

$

(40.0

)

 

$

122.4

 

Earnings per common share:

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(1.01

)

 

$

3.02

 

Discontinued operations (net of taxes):

 

 

 

 

 

 

 

 

Sale of Chaucer business

 

 

 

 

 

0.02

 

Loss from Chaucer business

 

 

 

 

 

(0.01

)

Loss from discontinued life businesses

 

 

(0.03

)

 

 

(0.02

)

Net income (loss) per share

 

$

(1.04

)

 

$

3.01

 

Weighted average shares outstanding

 

 

38.3

 

 

 

40.6

 

Diluted:

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(1.01

)

 

$

2.98

 

Discontinued operations (net of taxes):

 

 

 

 

 

 

 

 

Sale of Chaucer business

 

 

 

 

 

0.02

 

Loss from Chaucer business

 

 

 

 

 

(0.01

)

Loss from discontinued life businesses

 

 

(0.03

)

 

 

(0.02

)

Net income (loss) per share

 

$

(1.04

)

 

$

2.97

 

Weighted average shares outstanding

 

 

38.3

 

 

 

41.2

 

 

The accompanying notes are an integral part of these interim consolidated financial statements.

2


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2020

 

 

2019

 

Net income (loss)

 

$

(40.0

)

 

$

122.4

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

Net appreciation (depreciation) during the period

 

 

(83.2

)

 

 

115.0

 

Change in unrealized gains recognized in other comprehensive income

 

 

 

 

 

1.4

 

Total available-for-sale securities

 

 

(83.2

)

 

 

116.4

 

Pension and postretirement benefits:

 

 

 

 

 

 

 

 

Net change in net actuarial loss

 

 

1.2

 

 

 

2.3

 

Cumulative foreign currency translation adjustment:

 

 

 

 

 

 

 

 

Amount recognized as cumulative foreign currency

   translation during the period

 

 

 

 

 

0.1

 

Total other comprehensive income (loss), net of tax

 

 

(82.0

)

 

 

118.8

 

Comprehensive income (loss)

 

$

(122.0

)

 

$

241.2

 

 

The accompanying notes are an integral part of these interim consolidated financial statements.

3


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

 

March 31,

 

 

December 31,

 

(In millions, except share data)

 

2020

 

 

2019

 

Assets

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

Fixed maturities, at fair value (amortized cost of $6,493.7 and $6,452.2)

 

$

6,625.0

 

 

$

6,687.1

 

Equity securities, at fair value

 

 

447.0

 

 

 

575.7

 

Other investments

 

 

755.5

 

 

 

733.2

 

Total investments

 

 

7,827.5

 

 

 

7,996.0

 

Cash and cash equivalents

 

 

143.9

 

 

 

215.7

 

Accrued investment income

 

 

51.5

 

 

 

53.0

 

Premiums and accounts receivable, net

 

 

1,271.0

 

 

 

1,260.4

 

Reinsurance recoverable on paid and unpaid losses and unearned premiums

 

 

1,820.4

 

 

 

1,814.0

 

Deferred acquisition costs

 

 

465.7

 

 

 

467.4

 

Deferred income tax asset

 

 

3.2

 

 

 

 

Goodwill

 

 

178.8

 

 

 

178.8

 

Other assets

 

 

417.3

 

 

 

402.4

 

Assets of discontinued businesses

 

 

98.1

 

 

 

102.8

 

Total assets

 

$

12,277.4

 

 

$

12,490.5

 

Liabilities

 

 

 

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

5,724.9

 

 

$

5,654.4

 

Unearned premiums

 

 

2,421.0

 

 

 

2,416.7

 

Expenses and taxes payable

 

 

512.0

 

 

 

627.7

 

Deferred income tax liability

 

 

 

 

 

51.8

 

Reinsurance premiums payable

 

 

58.5

 

 

 

53.4

 

Debt

 

 

707.5

 

 

 

653.4

 

Liabilities of discontinued businesses

 

 

116.9

 

 

 

116.9

 

Total liabilities

 

 

9,540.8

 

 

 

9,574.3

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

 

 

 

Preferred stock, par value $0.01 per share; 20.0 million shares authorized; NaN issued

 

 

 

 

 

 

Common stock, par value $0.01 per share; 300.0 million shares authorized;

   60.5 million shares issued

 

 

0.6

 

 

 

0.6

 

Additional paid-in capital

 

 

1,861.6

 

 

 

1,837.3

 

Accumulated other comprehensive income

 

 

70.6

 

 

 

152.6

 

Retained earnings

 

 

2,344.9

 

 

 

2,410.9

 

Treasury stock at cost (22.5 million and 22.1 million shares)

 

 

(1,541.1

)

 

 

(1,485.2

)

Total shareholders’ equity

 

 

2,736.6

 

 

 

2,916.2

 

Total liabilities and shareholders’ equity

 

$

12,277.4

 

 

$

12,490.5

 

 

The accompanying notes are an integral part of these interim consolidated financial statements.

4


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2020

 

2019

 

Preferred Stock

 

 

 

 

 

 

 

Balance at beginning and end of period

 

$

 

$

 

Common Stock

 

 

 

 

 

 

 

Balance at beginning and end of period

 

 

0.6

 

 

0.6

 

Additional Paid-in Capital

 

 

 

 

 

 

 

Balance at beginning of period

 

 

1,837.3

 

 

1,871.8

 

Settlement and prepayment of accelerated share repurchases and other

 

 

24.3

 

 

(50.1

)

Balance at end of period

 

 

1,861.6

 

 

1,821.7

 

Accumulated Other Comprehensive Income, net of tax

��

 

 

 

 

 

 

Net Unrealized Appreciation (Depreciation) on Investments:

 

 

 

 

 

 

 

Balance at beginning of period

 

 

216.0

 

 

(27.2

)

Net appreciation (depreciation) on available-for-sale securities

 

 

(83.2

)

 

116.4

 

Adoption of Accounting Standards Updates (No. 2017-08 in 2019 )

 

 

 

 

1.5

 

Balance at end of period

 

 

132.8

 

 

90.7

 

Defined Benefit Pension and Postretirement Plans:

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(63.4

)

 

(88.6

)

Net amount recognized as net periodic benefit

 

 

1.2

 

 

2.3

 

Balance at end of period

 

 

(62.2

)

 

(86.3

)

Cumulative Foreign Currency Translation Adjustment:

 

 

 

 

 

 

 

Balance at beginning of period

 

 

 

 

(0.7

)

Amount recognized as cumulative foreign currency translation

   during the period

 

 

 

 

0.1

 

Balance at end of period

 

 

 

 

(0.6

)

Total accumulated other comprehensive income

 

 

70.6

 

 

3.8

 

Retained Earnings

 

 

 

 

 

 

 

Balance at beginning of period

 

 

2,410.9

 

 

2,182.3

 

Cumulative effect of accounting change, net of taxes

 

 

(0.9

)

 

(1.5

)

Balance at beginning of period, as adjusted

 

 

2,410.0

 

 

2,180.8

 

Net income (loss)

 

 

(40.0

)

 

122.4

 

Dividends to shareholders

 

 

(25.1

)

 

(24.5

)

Balance at end of period

 

 

2,344.9

 

 

2,278.7

 

Treasury Stock

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(1,485.2

)

 

(983.5

)

Shares purchased at cost

 

 

(59.2

)

 

(200.0

)

Net shares reissued at cost under employee stock-based

   compensation plans

 

 

3.3

 

 

5.7

 

Balance at end of period

 

 

(1,541.1

)

 

(1,177.8

)

Total shareholders’ equity

 

$

2,736.6

 

$

2,927.0

 

 

The accompanying notes are an integral part of these interim consolidated financial statements.

5


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In millions)

 

2020

 

 

2019

 

Cash Flows From Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

(40.0

)

 

$

122.4

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Net realized and unrealized investment (gains) losses

 

 

162.4

 

 

 

(48.4

)

Gain on sale of Chaucer-related Irish entity

 

 

 

 

(0.9

)

Net amortization and depreciation

 

 

5.1

 

 

 

6.9

 

Stock-based compensation expense

 

 

5.0

 

 

 

4.2

 

Amortization of defined benefit plan costs

 

 

1.5

 

 

 

2.8

 

Deferred income tax expense (benefit)

 

 

(36.7

)

 

 

13.8

 

Change in deferred acquisition costs

 

 

1.7

 

 

 

2.7

 

Change in premiums receivable, net of reinsurance premiums payable

 

 

(5.5

)

 

 

(4.3

)

Change in loss, loss adjustment expense and unearned premium reserves

 

 

75.0

 

 

 

99.2

 

Change in reinsurance recoverable

 

 

(6.4

)

 

 

(28.2

)

Change in expenses and taxes payable

 

 

(112.7

)

 

 

(88.0

)

Other, net

 

 

(12.8

)

 

 

(45.0

)

Net cash provided by operating activities

 

 

36.6

 

 

 

37.2

 

Cash Flows From Investing Activities

 

 

 

 

 

 

 

 

Proceeds from disposals and maturities of fixed maturities

 

 

316.3

 

 

 

193.1

 

Proceeds from disposals of equity securities and other investments

 

 

73.2

 

 

 

28.1

 

Purchase of fixed maturities

 

 

(376.5

)

 

 

(483.4

)

Purchase of equity securities and other investments

 

 

(109.7

)

 

 

(37.6

)

Capital expenditures

 

 

(3.2

)

 

 

(3.9

)

Net cash proceeds from sale of Chaucer-related Irish entity, partially

   offset by cash transferred

 

 

 

 

 

24.4

 

Net cash used in investing activities

 

 

(99.9

)

 

 

(279.3

)

Cash Flows From Financing Activities

 

 

 

 

 

 

 

 

Proceeds from exercise of employee stock options

 

 

3.0

 

 

 

5.0

 

Proceeds from short-term borrowings

 

 

54.0

 

 

 

 

Change in cash collateral related to securities lending program

 

 

 

 

 

6.7

 

Dividends paid to shareholders

 

 

(24.8

)

 

 

(217.0

)

Repurchases of common stock

 

 

(34.9

)

 

 

(250.0

)

Repayment of debt

 

 

 

 

 

(151.1

)

Other financing activities

 

 

(5.8

)

 

 

(4.2

)

Net cash used in financing activities

 

 

(8.5

)

 

 

(610.6

)

Net change in cash and cash equivalents

 

 

(71.8

)

 

 

(852.7

)

Net change in cash related to discontinued operations

 

 

 

 

0.5

 

Cash and cash equivalents, beginning of period

 

 

215.7

 

 

 

1,020.7

 

Cash and cash equivalents, end of period

 

$

143.9

 

 

$

168.5

 

 

The accompanying notes are an integral part of these interim consolidated financial statements.

 

 

6


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation and Principles of Consolidation

The accompanying unaudited consolidated financial statements of The Hanover Insurance Group, Inc. and its subsidiaries (“THG” or the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the requirements of Form 10-Q. Certain financial information that is provided in annual financial statements, but is not required in interim reports, has been omitted.

The interim consolidated financial statements of THG include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America, THG’s principal property and casualty companies; and other insurance and non-insurance subsidiaries. These legal entities conduct their operations through several business segments discussed in Note 9 – “Segment Information”. The interim consolidated financial statements also include the Company’s discontinued operations, consisting of the Company’s accident and health and former life insurance businesses, as well as the Company’s former Chaucer business. All intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with U.S. GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

In the opinion of the Company’s management, the accompanying interim consolidated financial statements reflect all adjustments, consisting of normal recurring items, necessary for a fair presentation of the financial position and results of operations. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 24, 2020.

2. New Accounting Pronouncements

Recently Implemented Standards

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASC Update No. 2016-13, (Topic 326) Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASC Update No. 2016-13”). This ASC update introduces new guidance for the accounting for credit losses on financial instruments within its scope. A new model, referred to as the current expected credit losses model, requires an entity to determine credit-related impairment losses for financial instruments held at amortized cost and to estimate these expected credit losses over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider both historical and current information, reasonable and supportable forecasts, as well as estimates of prepayments. The estimated credit losses and subsequent adjustment to such loss estimates, will be recorded through an allowance account which is deducted from the amortized cost of the financial instrument, with the offset recorded in current earnings. ASC Update No. 2016-13 also modifies the impairment model for available-for-sale debt securities. The new model will require an estimate of expected credit losses only when the fair value is below the amortized cost of the asset, thus the length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer affect the determination of whether a credit loss exists. In addition, credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. In November 2018, the FASB issued ASC Update No. 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, which explicitly states that receivables arising from operating leases are not within the scope of Subtopic 326-20.

In 2019 and 2020, the FASB has issued several updates to ASC Update No. 2016-13, including the issuance in April 2019, ASC Update 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, the issuance in May 2019, ASC Update 2019-05, Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief, the issuance in November 2019, ASC Update No. 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses and the issuance in February 2020, ASC Update 2020-02, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842) – Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). The Company implemented this guidance effective January 1, 2020 and it did not have a material impact on its financial position or results of operations.

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In August 2018, the FASB issued ASC Update No. 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASC update requires the capitalization of implementation costs incurred in a hosting arrangement that is a service contract consistent with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The guidance also requires an entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting agreement, and apply impairment guidance consistent with long-lived assets. ASC Update No. 2018-15 also provides specific guidelines related to the presentation of these capitalized implementation costs and related expenses in the financial statements. The updated guidance is effective for interim and annual periods beginning after December 15, 2019, and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted, including interim periods. The Company implemented this guidance prospectively, effective January 1, 2020, and it did not have a material impact on its financial position or results of operations.

In August 2018, the FASB issued ASC Update No. 2018-13 (Topic 820) Fair Value Measurement, Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The update removes the requirement for disclosure of the following: 1) the amount and reasons for transfers between level 1 and level 2 of the fair value hierarchy, 2) the policy for timing of transfers between levels, and 3) the valuation processes for level 3 fair value measurements. This update also added a requirement to disclose the changes in unrealized gains and losses for the period included in other comprehensive income for recurring level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop level 3 fair value measurements, in addition to other fair value disclosure modifications. The updated guidance is effective for interim and annual periods beginning after December 15, 2019, and should be applied prospectively for certain of the disclosure requirements and retrospectively to all periods presented upon the effective date for other disclosure requirements. An entity is permitted to early adopt any removed or modified disclosures upon issuance of the update and delay adoption of additional disclosures until periods beginning after December 15, 2019, the effective date of the standard. The Company implemented this guidance effective January 1, 2020 and it did not have an impact on the Company’s financial position or results of operations as the update is disclosure related.

In January 2017, the FASB issued ASC Update No. 2017-04, (Topic 350) Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment. This guidance eliminates step 2 from the goodwill impairment test. Instead, an entity should perform its goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, including any applicable income tax effects, and recognize an impairment for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for annual or interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company implemented this guidance effective January 1, 2020 and it did not have a material impact on its financial position or results of operations.

 

Recently Issued Standards

In January 2020, the FASB issued ASC Update No. 2020-01 Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). This ASC update clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting when using the measurement alternative under ASC 321.  It also clarifies the accounting for certain forward contracts and purchased options accounted for under ASC 815. The updated guidance is effective for annual and interim periods beginning after December 15, 2020. The Company does not expect the adoption of ASC Update No. 2020-01 to have a material impact on its financial position or results of operations.

In December 2019, the FASB issued ASC Update No. 2019-12 Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes. This ASC update removes certain exceptions to the general principles in ASC 740, Income Taxes, including intraperiod tax allocation when there is a loss from continuing operations, foreign subsidiary treatment under certain conditions and for calculating interim income taxes when the year-to-date loss exceeds the anticipated loss. This update also clarifies and amends existing guidance related to changes in tax laws, business combinations and employee stock plans, among others. The updated guidance is effective for interim and annual periods beginning after December 15, 2020. Early adoption is permitted, including interim periods. The Company does not expect the adoption of ASC Update No. 2019-12 to have a material effect on its financial position or results of operations.

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In August 2018, the FASB issued ASC Update No. 2018-14 (Topic 715-20) Compensation – Retirement Benefits – Defined Benefit Plans – General – Disclosure Framework – Changes to the Disclosure Requirements for the Defined Benefit Plans. This ASC update modifies disclosures related to defined benefit pension or other postretirement plans. This ASC update removes the disclosure of amounts in accumulated other comprehensive income expected to be recognized over the next fiscal year and the effects of a one percentage point change of health care cost trends on net periodic benefit costs and postretirement benefit obligations and clarifies the specific requirements of disclosures related to the project benefit obligation and accumulated benefit obligation. This ASC Update also adds disclosures related to weighted average crediting rates for cash balance plans and requires disclosure of an explanation of any significant gains and losses related to changes in benefit obligations for the period. The amendments in this ASC update are effective for fiscal years ending after December 15, 2020, and should be applied on a retrospective basis to all periods presented. Early adoption is permitted. Implementing this guidance is not expected to have an impact on the Company’s financial position or results of operations as the update is disclosure related.

3. Investments

A. Fixed maturities

The amortized cost and fair value of available-for-sale fixed maturities were as follows:

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

Amortized Cost,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance

 

 

net of Allowance

 

 

Gross

 

 

Gross

 

 

 

 

 

 

 

Amortized

 

 

for Credit

 

 

for Credit

 

 

Unrealized

 

 

Unrealized

 

 

 

 

 

(in millions)

 

Cost

 

 

Losses

 

 

Losses

 

 

Gains

 

 

Losses

 

 

Fair Value

 

U.S. Treasury and government agencies

 

$

265.9

 

 

$

 

 

$

265.9

 

 

$

20.3

 

 

$

 

 

$

286.2

 

Foreign government

 

 

4.2

 

 

 

 

 

 

4.2

 

 

 

0.3

 

 

 

 

 

 

4.5

 

Municipal

 

 

833.8

 

 

 

 

 

 

833.8

 

 

 

35.3

 

 

 

1.4

 

 

 

867.7

 

Corporate

 

 

3,749.0

 

 

 

6.2

 

 

 

3,742.8

 

 

 

81.5

 

 

 

60.0

 

 

 

3,764.3

 

Residential mortgage-backed

 

 

913.5

 

 

 

 

 

 

913.5

 

 

 

43.5

 

 

 

0.1

 

 

 

956.9

 

Commercial mortgage-backed

 

 

661.3

 

 

 

 

 

 

661.3

 

 

 

20.3

 

 

 

2.1

 

 

 

679.5

 

Asset-backed

 

 

66.0

 

 

 

 

 

 

66.0

 

 

 

0.4

 

 

 

0.5

 

 

 

65.9

 

Total fixed maturities

 

$

6,493.7

 

 

$

6.2

 

 

$

6,487.5

 

 

$

201.6

 

 

$

64.1

 

 

$

6,625.0

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

 

 

 

 

OTTI

 

 

 

Amortized

 

 

Unrealized

 

 

Unrealized

 

 

 

 

 

 

Unrealized

 

(in millions)

 

Cost

 

 

Gains

 

 

Losses

 

 

Fair Value

 

 

Losses

 

U.S. Treasury and government agencies

 

$

342.0

 

 

$

9.1

 

 

$

1.3

 

 

$

349.8

 

 

$

 

Foreign government

 

 

15.7

 

 

 

0.4

 

 

 

 

 

 

16.1

 

 

 

 

Municipal

 

 

807.1

 

 

 

27.6

 

 

 

1.2

 

 

 

833.5

 

 

 

 

Corporate

 

 

3,653.5

 

 

 

161.6

 

 

 

3.9

 

 

 

3,811.2

 

 

 

3.0

 

Residential mortgage-backed

 

 

905.4

 

 

 

17.1

 

 

 

1.1

 

 

 

921.4

 

 

 

 

Commercial mortgage-backed

 

 

666.4

 

 

 

25.6

 

 

 

0.1

 

 

 

691.9

 

 

 

 

Asset-backed

 

 

62.1

 

 

 

1.1

 

 

 

 

 

 

63.2

 

 

 

 

Total fixed maturities

 

$

6,452.2

 

 

$

242.5

 

 

$

7.6

 

 

$

6,687.1

 

 

$

3.0

 

 

As of December 31, 2019, other-than-temporary impairments (“OTTI”) unrealized losses in the table above represents OTTI recognized in accumulated other comprehensive income (“AOCI”). This amount excludes net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date of $4.2 million.  

The Company deposits funds with various state and governmental authorities. For a discussion of the Company’s deposits with state and governmental authorities, see also Note 3 – “Investments” of the Notes to Consolidated Financial Statements in the Company’s 2019 Annual Report on Form 10-K.  

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The amortized cost and fair value by maturity periods for fixed maturities are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or the Company may have the right to put or sell the obligations back to the issuers.

 

 

 

March 31, 2020

 

 

 

Amortized Cost, net

 

 

 

 

 

 

 

of Allowance for

 

 

Fair

 

(in millions)

 

Credit Losses

 

 

Value

 

Due in one year or less

 

$

354.0

 

 

$

355.8

 

Due after one year through five years

 

 

1,871.0

 

 

 

1,897.6

 

Due after five years through ten years

 

 

2,258.1

 

 

 

2,290.7

 

Due after ten years

 

 

363.6

 

 

 

378.6

 

 

 

 

4,846.7

 

 

 

4,922.7

 

Mortgage-backed and asset-backed securities

 

 

1,640.8

 

 

 

1,702.3

 

Total fixed maturities

 

$

6,487.5

 

 

$

6,625.0

 

 

B. Fixed maturity securities in an unrealized loss position

The following tables provide information about the Company’s available-for-sale fixed maturity securities that were in an unrealized loss position at March 31, 2020 and December 31, 2019 including the length of time the securities have been in an unrealized loss position:

 

 

 

March 31, 2020

 

 

 

12 months or less

 

 

Greater than 12 months

 

 

Total

 

 

 

Gross

 

 

 

 

 

 

Gross

 

 

 

 

 

 

Gross

 

 

 

 

 

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

(in millions)

 

Losses

 

 

Value

 

 

Losses

 

 

Value

 

 

Losses

 

 

Value

 

Investment grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

 

$

1.4

 

 

$

62.7

 

 

$

 

 

$

0.6

 

 

$

1.4

 

 

$

63.3

 

Corporate

 

 

49.0

 

 

 

1,145.7

 

 

 

 

 

 

 

 

 

49.0

 

 

 

1,145.7

 

Residential mortgage-backed

 

 

0.1

 

 

 

3.3

 

 

 

 

 

 

1.4

 

 

 

0.1

 

 

 

4.7

 

Commercial mortgage-backed

 

 

2.1

 

 

 

111.5

 

 

 

 

 

 

 

 

 

2.1

 

 

 

111.5

 

Asset-backed

 

 

0.5

 

 

 

21.3

 

 

 

 

 

 

 

 

 

0.5

 

 

 

21.3

 

Total investment grade

 

 

53.1

 

 

 

1,344.5

 

 

 

 

 

 

2.0

 

 

 

53.1

 

 

 

1,346.5

 

Below investment grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate

 

 

11.0

 

 

 

144.2

 

 

 

 

 

 

 

 

 

11.0

 

 

 

144.2

 

Total fixed maturities

 

$

64.1

 

 

$

1,488.7

 

 

$

 

 

$

2.0

 

 

$

64.1

 

 

$

1,490.7

 

 

 

 

December 31, 2019

 

 

 

12 months or less

 

 

Greater than 12 months

 

 

Total

 

 

 

Gross

 

 

 

 

 

 

Gross

 

 

 

 

 

 

Gross

 

 

 

 

 

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

(in millions)

 

Losses

 

 

Value

 

 

Losses

 

 

Value

 

 

Losses

 

 

Value

 

Investment grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and government agencies

 

$

1.3

 

 

$

73.0

 

 

$

 

 

$

9.3

 

 

$

1.3

 

 

$

82.3

 

Municipal

 

 

1.1

 

 

 

72.5

 

 

 

0.1

 

 

 

5.6

 

 

 

1.2

 

 

 

78.1

 

Corporate

 

 

0.7

 

 

 

86.5

 

 

 

0.1

 

 

 

4.7

 

 

 

0.8

 

 

 

91.2

 

Residential mortgage-backed

 

 

0.7

 

 

 

69.2

 

 

 

0.4

 

 

 

34.4

 

 

 

1.1

 

 

 

103.6

 

Commercial mortgage-backed

 

 

0.1

 

 

 

40.6

 

 

 

 

 

 

0.9

 

 

 

0.1

 

 

 

41.5

 

Asset-backed

 

 

 

 

 

 

 

 

 

 

 

1.7

 

 

 

 

 

 

1.7

 

Total investment grade

 

 

3.9

 

 

 

341.8

 

 

 

0.6

 

 

 

56.6

 

 

 

4.5

 

 

 

398.4

 

Below investment grade:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate

 

 

2.2

 

 

 

27.1

 

 

 

0.9

 

 

 

9.0

 

 

 

3.1

 

 

 

36.1

 

Total fixed maturities

 

$

6.1

 

 

$

368.9

 

 

$

1.5

 

 

$

65.6

 

 

$

7.6

 

 

$

434.5

 

 

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The Company views gross unrealized losses on fixed maturities as non-credit related and through its assessment of unrealized losses has determined that these securities will recover, allowing the Company to realize the anticipated long-term economic value. The Company currently does not intend to sell nor does it expect to be required to sell these securities before recovery of their amortized cost. The Company employs a systematic methodology to evaluate declines in fair value below amortized cost for fixed maturity securities. In determining impairments, the Company evaluates several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the  degree to which the fair value of an issuer’s securities is below the Company’s amortized cost. The Company also considers any factors that might raise doubt about the issuer’s ability to make contractual payments as they come due and whether the Company expects to recover the entire amortized cost basis of the security.

C. Proceeds from sales

The proceeds from sales of available-for-sale securities and gross realized gains and gross realized losses on those sales were as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

 

 

Proceeds from

 

 

Gross

 

 

Gross

 

 

Proceeds from

 

 

Gross

 

 

Gross

 

(in millions)

 

Sales

 

 

Gains

 

 

Losses

 

 

Sales

 

 

Gains

 

 

Losses

 

Fixed maturities, excluding held-for-sale (Chaucer)

 

$

66.0

 

 

$

2.7

 

 

$

0.4

 

 

$

60.1

 

 

$

1.0

 

 

$

1.5

 

Fixed maturities, held-for-sale

 

 

 

 

 

 

 

 

 

 

 

0.3

 

 

 

 

 

 

 

Total fixed maturities

 

$

66.0

 

 

$

2.7

 

 

$

0.4

 

 

$

60.4

 

 

$

1.0

 

 

$

1.5

 

 

D. Impairments

For the three months ended March 31, 2020, the Company recognized $28.5 million of impairments, consisting primarily of $22.2 million on fixed maturities and $4.8 million on mortgage loans. Impairments on fixed maturities included $16.0 million categorized as intend-to-sell and $6.2 million of credit-related losses. As such, the Company recorded an allowance for credit losses of $6.2 million on corporate fixed maturities at March 31, 2020. In addition, the Company increased its allowance for credit losses on mortgage loans by $4.8 million in the first quarter of 2020, to $6.1 million as of March 31, 2020. For the three months ended March 31, 2019, the Company recognized 0 impairments.

The methodology and significant inputs used to measure the amount of credit losses on fixed maturities in 2020 were as follows:

Corporate bonds – the Company utilized a financial model that derives expected cash flows based on probability-of-default factors by credit rating, asset duration and loss-given-default factors based on security type. These factors are based on historical data provided by an independent third-party rating agency. In addition, other market data relevant to the realizability of contractual cash flows may be considered, including current conditions and reasonable and supportable forecasts.

Mortgage loans – the Company utilized a model that estimates expected losses based on mortgage risk rating and risk factors based on property type, such as office, retail, lodging, multi-family and industrial.  Expected loss ratios are based on historical data provided by an independent third-party rating agency.  The risk factors, based on property characteristics and metrics including the geographic market, are predominantly driven by loan-to-value and debt service coverage ratios.   An adjustment to ratings may be made to reflect current conditions and to incorporate reasonable and supportable forecasts, such as volatility of cash flows and valuation.

 

E. Equity securities

Equity securities are carried at fair value and all increases or decreases in fair value are reported in net realized and unrealized investment gains (losses) on the Consolidated Statements of Income. The following table provides pre-tax net realized and unrealized gains (losses) on equity securities:

 

 

Three Months Ended March 31,

 

(in millions)

 

2020

 

 

 

2019

 

Net gains (losses) recognized during the period

$

(136.2

)

 

$

48.6

 

Less: net gains (losses) recognized on equity securities sold

   during the period

 

(0.6

)

 

 

1.1

 

Net unrealized gains (losses) recognized during the period on equity

   securities still held

$

(135.6

)

 

$

47.5

 

      

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4. Fair Value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, i.e., exit price, in an orderly transaction between market participants. The Company emphasizes the use of observable market data whenever available in determining fair value. Fair values presented for certain financial instruments are estimates which, in many cases, may differ significantly from the amounts that could be realized upon immediate liquidation. A hierarchy of the three broad levels of fair value is as follows, with the highest priority given to Level 1 as these are the most observable, and the lowest priority given to Level 3:

Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 – Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, including model-derived valuations.

Level 3 – Unobservable inputs that are supported by little or no market activity.

When more than one level of input is used to determine fair value, the financial instrument is classified as Level 2 or 3 according to the lowest level input that has a significant impact on the fair value measurement.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments and have not changed since last year.

Fixed Maturities

Level 1 securities generally include U.S. Treasury issues and other securities that are highly liquid and for which quoted market prices are available. Level 2 securities are valued using pricing for similar securities and pricing models that incorporate observable inputs including, but not limited to yield curves and issuer spreads. Level 3 securities include issues for which little observable data can be obtained, primarily due to the illiquid nature of the securities, and for which significant inputs used to determine fair value are based on the Company’s own assumptions.

The Company utilizes a third party pricing service for the valuation of the majority of its fixed maturity securities and receives one quote per security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value for those securities using pricing techniques based on a market approach. Inputs into the fair value pricing common to all asset classes include: benchmark U.S. Treasury security yield curves; reported trades of identical or similar fixed maturity securities; broker/dealer quotes of identical or similar fixed maturity securities and structural characteristics such as maturity date, coupon, mandatory principal payment dates, frequency of interest and principal payments, and optional redemption features. Inputs into the fair value applications that are unique by asset class include, but are not limited to:

 

U.S. government agencies – determination of direct versus indirect government support and whether any contingencies exist with respect to the timely payment of principal and interest.

 

Foreign government – estimates of appropriate market spread versus underlying related sovereign treasury curve(s) dependent on liquidity and direct or contingent support.

 

Municipals – overall credit quality, including assessments of the level and variability of: sources of payment such as income, sales or property taxes, levies or user fees; credit support such as insurance; state or local economic and political base; natural resource availability; and susceptibility to natural or man-made catastrophic events such as hurricanes, earthquakes or acts of terrorism.

 

Corporate fixed maturities – overall credit quality, including assessments of the level and variability of: economic sensitivity; liquidity; corporate financial policies; management quality; regulatory environment; competitive position; ownership; restrictive covenants; and security or collateral.

 

Residential mortgage-backed securities – estimates of prepayment speeds based upon: historical prepayment rate trends; underlying collateral interest rates; geographic concentration; vintage year; borrower credit quality characteristics; interest rate and yield curve forecasts; government or monetary authority support programs; tax policies; and delinquency/default trends.

 

Commercial mortgage-backed securities – overall credit quality, including assessments of the value and supply/demand characteristics of: collateral type such as office, retail, residential, lodging, or other; geographic concentration by region, state, metropolitan statistical area and locale; vintage year; historical collateral performance including defeasance, delinquency, default and special servicer trends; and capital structure support features.

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Asset-backed securities – overall credit quality, including assessments of the underlying collateral type such as credit card receivables, auto loan receivables and equipment lease receivables; geographic diversification; vintage year; historical collateral performance including delinquency, default and casualty trends; economic conditions influencing use rates and resale values; and contract structural support features.

Generally, all prices provided by the pricing service, except actively traded securities with quoted market prices, are reported as Level 2.

The Company holds privately placed fixed maturity securities and certain other fixed maturity securities that do not have an active market and for which the pricing service cannot provide fair values. The Company determines fair values for these securities using either matrix pricing utilizing the market approach or broker quotes. The Company will use observable market data as inputs into the fair value techniques, as discussed in the determination of Level 2 fair values, to the extent it is available, but is also required to use a certain amount of unobservable judgment due to the illiquid nature of the securities involved. Unobservable judgment reflected in the Company’s matrix model accounts for estimates of additional spread required by market participants for factors such as issue size, credit stress, structural complexity, high bond coupon or other unique features. These matrix-priced securities are reported as Level 2 or Level 3, depending on the significance of the impact of unobservable judgment on the security’s value. Additionally, the Company may obtain non-binding broker quotes which are reported as Level 3.

Equity Securities

Level 1 consists of publicly traded securities, including exchange traded funds, valued at quoted market prices. Level 2 includes securities that are valued using pricing for similar securities and pricing models that incorporate observable inputs. Level 3 consists of common or preferred stock of private companies for which observable inputs are not available.

The Company utilizes a third party pricing service for the valuation of the majority of its equity securities and receives one quote for each equity security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. The Company holds certain equity securities that have been issued by privately-held entities that do not have an active market and for which the pricing service cannot provide fair values. Generally, the Company estimates fair value for these securities based on the issuer’s book value and market multiples and reports them as Level 3. Additionally, the Company may obtain non-binding broker quotes which are reported as Level 3.

Other Investments

Other investments primarily include mortgage participations and limited partnerships not subject to the equity method of accounting. The fair values of limited partnerships not subject to the equity method of accounting are based on the net asset value (“NAV”) provided by the general partner adjusted for recent financial information and are excluded from the fair value hierarchy.

The estimated fair values of the financial instruments were as follows:

 

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

Carrying

 

 

Fair

 

 

Carrying

 

 

Fair

 

(in millions)

 

Value

 

 

Value

 

 

Value

 

 

Value

 

Financial Assets carried at:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value through AOCI:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$

6,625.0

 

 

$

6,625.0

 

 

$

6,687.1

 

 

$

6,687.1

 

Fair Value through Net Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

447.0

 

 

 

447.0

 

 

 

575.7

 

 

 

575.7

 

Other investments

 

 

185.6

 

 

 

185.6

 

 

 

187.1

 

 

 

187.1

 

Amortized Cost/Cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other investments

 

 

463.5

 

 

 

473.7

 

 

 

443.3

 

 

 

463.7

 

Cash and cash equivalents

 

 

143.9

 

 

 

143.9

 

 

 

215.7

 

 

 

215.7

 

Total financial instruments

 

$

7,865.0

 

 

$

7,875.2

 

 

$

8,108.9

 

 

$

8,129.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities carried at:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortized Cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

707.5

 

 

$

741.8

 

 

$

653.4

 

 

$

722.1

 

 

13


Table of Contents

 

The Company has processes designed to ensure that the values received from its third party pricing service are accurately recorded, that the data inputs and valuation approaches and techniques utilized are appropriate and consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. The Company performs a review of the fair value hierarchy classifications and of prices received from its pricing service on a quarterly basis. The Company reviews the pricing services’ policies describing its methodology, processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing, including a process for which securities with changes in prices that exceed a defined threshold are verified to independent sources, if available. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2020 and 2019, the Company did not adjust any prices received from its pricing service.

Changes in the observability of valuation inputs may result in a reclassification of certain financial assets or liabilities within the fair value hierarchy. As previously discussed, the Company utilizes a third-party pricing service for the valuation of the majority of its fixed maturities and equity securities. The pricing service has indicated that it will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Company will use observable market data to the extent it is available, but may also be required to make assumptions for market based inputs that are unavailable due to market conditions.

The following tables provide, for each hierarchy level, the Company’s investment assets that were measured at fair value on a recurring basis.

 

 

 

March 31, 2020

 

(in millions)

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and government agencies

 

$

286.2

 

 

$

151.2

 

 

$

135.0

 

 

$

 

Foreign government

 

 

4.5

 

 

 

 

 

 

4.5

 

 

 

 

Municipal

 

 

867.7

 

 

 

 

 

 

856.3

 

 

 

11.4

 

Corporate

 

 

3,764.3

 

 

 

 

 

 

3,763.8

 

 

 

0.5

 

Residential mortgage-backed

 

 

956.9

 

 

 

 

 

 

956.9

 

 

 

 

Commercial mortgage-backed

 

 

679.5

 

 

 

 

 

 

667.7

 

 

 

11.8

 

Asset-backed

 

 

65.9

 

 

 

 

 

 

65.9

 

 

 

 

Total fixed maturities

 

 

6,625.0

 

 

 

151.2

 

 

 

6,450.1

 

 

 

23.7

 

Equity securities

 

 

447.0

 

 

 

444.9

 

 

 

 

 

 

2.1

 

Other investments

 

 

3.5

 

 

 

 

 

 

 

 

 

3.5

 

Total investment assets at fair value

 

$

7,075.5

 

 

$

596.1

 

 

$

6,450.1

 

 

$

29.3

 

 

 

 

 

December 31, 2019

 

(in millions)

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and government agencies

 

$

349.8

 

 

$

157.9

 

 

$

191.9

 

 

$

 

Foreign government

 

 

16.1

 

 

 

 

 

 

16.1

 

 

 

 

Municipal

 

 

833.5

 

 

 

 

 

 

821.4

 

 

 

12.1

 

Corporate

 

 

3,811.2

 

 

 

 

 

 

3,810.6

 

 

 

0.6

 

Residential mortgage-backed

 

 

921.4

 

 

 

 

 

 

921.4

 

 

 

 

Commercial mortgage-backed

 

 

691.9

 

 

 

 

 

 

679.2

 

 

 

12.7

 

Asset-backed

 

 

63.2

 

 

 

 

 

 

63.2

 

 

 

 

Total fixed maturities

 

 

6,687.1

 

 

 

157.9

 

 

 

6,503.8

 

 

 

25.4

 

Equity securities

 

 

575.7

 

 

 

573.6

 

 

 

 

 

 

2.1

 

Other investments

 

 

3.5

 

 

 

 

 

 

 

 

 

3.5

 

Total investment assets at fair value

 

$

7,266.3

 

 

$

731.5

 

 

$

6,503.8

 

 

$

31.0

 

 

 

Limited partnerships measured at fair value using NAV based on an ownership interest in partners’ capital have not been included in the hierarchy tables. At March 31, 2020 and December 31, 2019, the fair values of these investments were $182.1 million and $183.6 million, respectively, approximately 2% of total investment assets.

14


Table of Contents

 

The following tables provide, for each hierarchy level, the Company’s estimated fair values of financial instruments that were not carried at fair value:

 

 

 

March 31, 2020

 

(in millions)

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

143.9

 

 

$

143.9

 

 

$

 

 

$

 

Other investments

 

 

473.7

 

 

 

 

 

 

4.1

 

 

 

469.6

 

Total financial instruments

 

$

617.6

 

 

$

143.9

 

 

$

4.1

 

 

$

469.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

741.8

 

 

$

 

 

$

741.8

 

 

$

 

 

 

 

December 31, 2019

 

(in millions)

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

215.7

 

 

$

215.7

 

 

$

 

 

$

 

Other investments

 

 

463.7

 

 

 

 

 

 

2.1

 

 

 

461.6

 

Total financial instruments

 

$

679.4

 

 

$

215.7

 

 

$

2.1

 

 

$

461.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

722.1

 

 

$

 

 

$

722.1

 

 

$

 

 

The tables below provide reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

 

 

Fixed Maturities

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

Municipal

 

 

Corporate

 

 

Commercial

mortgage-

backed

 

 

 

 

Total

 

 

 

 

Equity and

Other

 

 

Total

Assets

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance January 1, 2020

 

$

12.1

 

 

$

0.6

 

 

$

12.7

 

 

 

 

$

25.4

 

 

 

 

$

5.6

 

 

$

31.0

 

Total gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in other comprehensive income-net

   appreciation (depreciation) on available-for-sale securities

 

 

0.1

 

 

 

 

 

 

(0.4

)

 

 

 

 

(0.3

)

 

 

 

 

 

 

 

(0.3

)

Sales

 

 

(0.8

)

 

 

(0.1

)

 

 

(0.5

)

 

 

 

 

(1.4

)

 

 

 

 

 

 

 

(1.4

)

Balance March 31, 2020

 

$

11.4

 

 

$

0.5

 

 

$

11.8

 

 

 

 

$

23.7

 

 

 

 

$

5.6

 

 

$

29.3

 

Change in unrealized gains (losses) for the period

   included in other comprehensive income for

   assets held at the end of the period

 

$

0.1

 

 

$

 

 

$

(0.4

)

 

 

 

$

(0.3

)

 

 

 

$

 

 

$

(0.3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance January 1, 2019

 

$

21.1

 

 

$

0.8

 

 

$

13.1

 

 

 

 

$

35.0

 

 

 

 

$

4.6

 

 

$

39.6

 

Total gains:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in total net realized and unrealized

   investment gains

 

 

0.1

 

 

 

 

 

 

 

 

 

 

 

0.1

 

 

 

 

 

 

 

 

0.1

 

Included in other comprehensive income-net

   depreciation on available-for-sale securities

 

 

0.2

 

 

 

 

 

 

0.2

 

 

 

 

 

0.4

 

 

 

 

 

 

 

 

0.4

 

Sales:

 

 

(0.9

)

 

 

(0.1

)

 

 

(0.5

)

 

 

 

 

(1.5

)

 

 

 

 

 

 

 

(1.5

)

Balance March 31, 2019

 

$

20.5

 

 

$

0.7

 

 

$

12.8

 

 

 

 

$

34.0

 

 

 

 

$

4.6

 

 

$

38.6

 

 

There were no transfers between Level 2 and Level 3, and there were 0 Level 3 liabilities held by the Company for the three months ended March 31, 2020 and 2019.

15


Table of Contents

 

The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets. Where discounted cash flows were used in the valuation of fixed maturities, the internally-developed discount rate was adjusted by the significant unobservable inputs shown in the table.    

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

 

 

Valuation

 

Significant

 

 

Fair

 

 

Range

 

Fair

 

 

Range

(in millions)

 

Technique

 

Unobservable Inputs

 

 

Value

 

 

(Wtd Average)

 

Value

 

 

(Wtd Average)

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

 

Discounted

cash flow

 

Discount for:

   Small issue size

   Credit stress

   Above-market coupon

 

 

$

11.4

 

 

 

0.7 - 6.8% (4.4%)

0.6 - 3.4% (2.7%)

0.5% (0.5%)

 

$

12.1

 

 

 

0.7 - 6.8% (4.3%)

0.5% (0.5%)

Corporate

 

Discounted

cash flow

 

Discount for:

   Small issue size

   Above-market coupon

 

 

0.5

 

 

 

2.5% (2.5%)

0.3% (0.3%)

 

0.6

 

 

 

2.5% (2.5%)

0.3% (0.3%)

Commercial

   mortgage-backed

 

Discounted

cash flow

 

Discount for:

   Small issue size

   Credit stress

   Above-market coupon

   Lease structure

 

 

11.8

 

 

1.9 - 3.1% (2.7%)

1.7 - 6.0% (2.3%)

0.5% (0.5%)

0.3% (0.3%)

 

12.7

 

 

1.9 - 3.1% (2.7%)

0.5% (0.5%)

0.3% (0.3%)

Equity securities

 

Market

comparables

 

Net tangible asset

   market multiples

 

 

2.1

 

 

1.0X (1.0X)

 

 

2.1

 

 

1.0X (1.0X)

Other

 

Discounted

cash flow

 

Discount rate

 

 

3.5

 

 

18.0% (18.0%)

 

 

3.5

 

 

18.0% (18.0%)

 

The weighted average of the unobservable inputs was weighted by the relative fair value of the fixed maturity securities to which the inputs were applied. Each unobservable input is based on the Company’s subjective opinion and therefore inherently contains a degree of uncertainty. Significant increases (decreases) in any of the above inputs in isolation would result in a significantly lower (higher) fair value measurement. There were no interrelationships between these inputs which might magnify or mitigate the effect of changes in unobservable inputs on the fair value measurement.

5. Debt and Credit Arrangements

Debt consists of the following:

 

(in millions)

 

March 31, 2020

 

 

December 31, 2019

 

Senior debentures maturing April 15, 2026

 

$

375.0

 

 

$

375.0

 

Senior debentures maturing October 15, 2025

 

 

62.6

 

 

 

62.6

 

Subordinated debentures maturing March 30, 2053

 

 

175.0

 

 

 

175.0

 

Subordinated debentures maturing February 3, 2027

 

 

50.1

 

 

 

50.1

 

Short-term borrowings

 

 

54.0

 

 

 

Total principal debt

 

 

716.7

 

 

 

662.7

 

Unamortized debt issuance costs

 

 

(9.2

)

 

 

(9.3

)

Total

 

$

707.5

 

 

$

653.4

 

The Company had $54.0 million of short-term advances from the Federal Home Loan Bank (“FHLB”) outstanding at March 31, 2020, which will be repaid in the second quarter of 2020.

At March 31, 2020, the Company was in compliance with the covenants associated with its debt indentures and credit arrangements.

6. Income Taxes

Income tax expense for the three months ended March 31, 2020 and 2019 has been computed using estimated annual effective tax rates. These rates are revised, if necessary, at the end of each successive interim period to reflect current estimates of the annual effective tax rates.

The tax provision was comprised of a U.S. federal income tax benefit of $15.2 million and an expense of $26.0 million for the three months ended March 31, 2020 and 2019, respectively.

The Company or its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions, and have previously filed in foreign jurisdictions. The Company and its subsidiaries are subject to U.S. federal and state income tax examinations and foreign examinations for years after 2015.

16


Table of Contents

 

7. Pension Plans

The components of net periodic pension cost for the defined benefit pension plans included in the Company’s results of operations are as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

(in millions)

 

Pension Plans

 

Interest cost

 

$

4.6

 

 

$

5.3

 

Expected return on plan assets

 

 

(5.6

)

 

 

(5.8

)

Recognized net actuarial loss

 

 

1.5

 

 

 

2.8

 

Net periodic pension cost

 

$

0.5

 

 

$

2.3

 

 

8. Other Comprehensive Income (Loss)

The following tables provide changes in other comprehensive income (loss).

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

 

Benefit

 

 

Net of

 

 

 

 

 

 

Benefit

 

 

Net of

 

(in millions)

 

Pre-Tax

 

 

(Expense)

 

 

Tax

 

 

Pre-Tax

 

 

(Expense)

 

 

Tax

 

Unrealized gains (losses) on available-for-sale

   securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during period

 

$

(122.4

)

 

$

25.6

 

 

$

(96.8

)

 

$

152.0

 

 

$

(32.0

)

 

$

120.0

 

Amount of realized gains (losses) from sales

   and other

 

 

(3.1

)

 

 

(1.2

)

 

 

(4.3

)

 

 

0.3

 

 

 

(3.9

)

 

 

(3.6

)

Impairment losses on investments

 

 

22.7

 

 

 

(4.8

)

 

 

17.9

 

 

 

 

 

 

 

 

 

 

Net unrealized gains (losses)

 

 

(102.8

)

 

 

19.6

 

 

 

(83.2

)

 

 

152.3

 

 

 

(35.9

)

 

 

116.4

 

Pension and postretirement benefits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of net actuarial losses (gains) recognized as net periodic benefit cost

 

 

1.5

 

 

 

(0.3

)

 

 

1.2

 

 

 

2.9

 

 

 

(0.6

)

 

 

2.3

 

Cumulative foreign currency translation adjustment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation recognized during

   the period

 

 

 

 

 

 

 

 

 

 

 

0.1

 

 

 

 

 

 

0.1

 

Other comprehensive income (loss)

 

$

(101.3

)

 

$

19.3

 

 

$

(82.0

)

 

$

155.3

 

 

$

(36.5

)

 

$

118.8

 

 

Reclassifications out of accumulated other comprehensive income were as follows:

 

 

 

Three Months Ended

 

 

 

 

 

March 31,

 

 

 

(in millions)

 

2020

 

 

2019

 

 

 

 

 

Amount Reclassified from

 

 

 

Details about Accumulated Other

 

Accumulated Other

 

 

Affected Line Item in the Statement

Comprehensive Income Components

 

Comprehensive Income

 

 

Where Net Income (Loss) is Presented

Unrealized gains (losses) on available-for-

   sale securities

 

$

3.1

 

 

$

(0.3

)

 

Net realized gains (losses) from sales and other

 

 

 

(22.2

)

 

 

 

 

Impairment losses on investments

 

 

 

(19.1

)

 

 

(0.3

)

 

Total before tax

 

 

 

5.9

 

 

 

3.9

 

 

Tax benefit

 

 

 

(13.2

)

 

 

3.6

 

 

Continuing operations; net of tax

 

 

 

(0.4

)

 

 

 

 

Discontinued operations - life businesses

 

 

 

(13.6

)

 

 

3.6

 

 

Net of tax

Amortization of defined benefit pension

   and postretirement actuarial losses

 

 

(1.5

)

 

 

(2.9

)

 

Loss adjustment expenses and other operating

   expenses (1)

 

 

 

0.3

 

 

 

0.6

 

 

Tax benefit

 

 

 

(1.2

)

 

 

(2.3

)

 

Continuing operations; net of tax

Total reclassifications for the period

 

$

(14.8

)

 

$

1.3

 

 

Benefit (expense) reflected in income (loss),

   net of tax

17


Table of Contents

 

 

(1)

The amount reclassified from accumulated other comprehensive income for the pension and postretirement benefits was allocated  approximately 40% to loss adjustment expenses and 60% to other operating expenses for the three months ended March 31, 2020 and 2019.

9. Segment Information

The Company’s primary business operations include insurance products and services provided through 3 operating segments: Commercial Lines, Personal Lines and Other. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as management and professional liability, marine, Hanover Programs, specialty industrial and commercial property, monoline general liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Included in the Other segment are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to the Company’s former life insurance employees and agents; and, a run-off voluntary property and casualty pools business. The separate financial information is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

The Company reports interest expense related to debt separately from the earnings of its operating segments. This consists primarily of interest on the Company’s senior and subordinated debentures.

Management evaluates the results of the aforementioned segments based on operating income before taxes, excluding interest expense on debt. Operating income before taxes excludes certain items which are included in net income, such as net realized and unrealized investment gains and losses. Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income 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, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income before taxes may be important components in understanding and assessing the Company’s overall financial performance, management believes that the presentation of operating income before taxes enhances an investor’s understanding of the Company’s results of operations by highlighting net income attributable to the core operations of the business. However, operating income before taxes should not be construed as a substitute for income before income taxes or income from continuing operations, and operating income should not be construed as a substitute for net income.

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Summarized below is financial information with respect to the Company’s business segments.

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions)

 

2020

 

 

2019

 

Operating revenues:

 

 

 

 

 

 

 

 

Commercial Lines

 

$

724.7

 

 

$

698.7

 

Personal Lines

 

 

488.5

 

 

 

465.2

 

Other

 

 

4.6

 

 

 

7.4

 

Total

 

 

1,217.8

 

 

 

1,171.3

 

Net realized and unrealized investment gains (losses)

 

 

(161.6

)

 

 

48.2

 

Total revenues

 

$

1,056.2

 

 

$

1,219.5

 

Operating income (loss) before interest expense and income taxes:

 

 

 

 

 

 

 

 

Commercial Lines:

 

 

 

 

 

 

 

 

Underwriting income

 

$

10.4

 

 

$

36.7

 

Net investment income

 

 

46.4

 

 

 

44.3

 

Other expense

 

 

(2.2

)

 

 

(0.8

)

Commercial Lines operating income

 

 

54.6

 

 

 

80.2

 

Personal Lines:

 

 

 

 

 

 

 

 

Underwriting income

 

 

44.1

 

 

 

5.7

 

Net investment income

 

 

20.3

 

 

 

19.7

 

Other income

 

 

0.5

 

 

 

1.4

 

Personal Lines operating income

 

 

64.9

 

 

 

26.8

 

Other:

 

 

 

 

 

 

 

 

Underwriting loss

 

 

(3.3

)

 

 

(0.3

)

Net investment income

 

 

2.9

 

 

 

6.2

 

Other expense

 

 

(2.0

)

 

 

(3.1

)

Other operating income (loss)

 

 

(2.4

)

 

 

2.8

 

Operating income before interest expense and income taxes

 

 

117.1

 

 

 

109.8

 

Interest on debt

 

 

(9.4

)

 

 

(9.4

)

Operating income before income taxes

 

 

107.7

 

 

 

100.4

 

Non-operating items:

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains (losses)

 

 

(161.6

)

 

 

48.2

 

Income (loss) from continuing operations before income taxes

 

$

(53.9

)

 

$

148.6

 

 

The following table provides identifiable assets for the Company’s business segments and discontinued operations:

 

 

 

March 31, 2020

 

 

December 31, 2019

 

(in millions)

 

Identifiable Assets

 

Property and Casualty Companies

 

$

12,179.3

 

 

$

12,387.7

 

Assets of discontinued businesses

 

 

98.1

 

 

 

102.8

 

Total

 

$

12,277.4

 

 

$

12,490.5

 

 

 

The Company reviews the assets of its Property and Casualty Companies collectively and does not allocate them between the Commercial Lines, Personal Lines and Other segments.

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10. Stock-based Compensation

As of March 31, 2020, there were 2,761,668 shares and 2,352,110 shares available for grant under The Hanover Insurance Group 2014 Long-Term Incentive Plan and The Hanover Insurance Group 2014 Employee Stock Purchase Plan, respectively.

Compensation cost for the Company’s stock-based awards and the related tax benefits were as follows:

 

 

 

Three Months Ended March 31,

 

(in millions)

 

2020

 

 

2019

 

Stock-based compensation expense

 

$

5.0

 

 

$

4.2

 

Tax benefit

 

 

(1.1

)

 

 

(0.9

)

Stock-based compensation expense, net of taxes

 

$

3.9

 

 

$

3.3

 

Stock Options

Information on the Company’s stock option activity for the three months ended March 31, 2020 and 2019 is summarized below.

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

(in whole shares and dollars)

 

Shares

 

 

Weighted Average

Exercise Price

 

 

Shares

 

 

Weighted Average

Exercise Price

 

Outstanding, beginning of period

 

 

1,121,559

 

 

$

87.88

 

 

 

1,099,076

 

 

$

85.75

 

Granted

 

 

240,705

 

 

 

118.54

 

 

 

232,568

 

 

 

95.05

 

Exercised

 

 

(35,918

)

 

 

79.40

 

 

 

(64,017

)

 

 

75.98

 

Forfeited or cancelled

 

 

 

 

 

 

(3,141

)

 

 

95.39

 

Outstanding, end of period

 

 

1,326,346

 

 

 

93.67

 

 

 

1,264,486

 

 

 

87.93

 

 

Restricted Stock Units

The Company currently issues time-based, market-based and performance-based restricted stock units to eligible employees, all of which generally vest after 3 years of continued employment.

The following tables summarize activity information about employee restricted stock units: 

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

(in whole shares and dollars)

 

Shares

 

 

Weighted Average

Grant Date

Fair Value

 

 

Shares

 

 

Weighted Average

Grant Date

Fair Value

 

Time-based restricted stock units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding, beginning of period

 

 

335,166

 

 

$

109.55

 

 

 

332,481

 

 

$

97.28

 

Granted

 

 

136,634

 

 

 

118.60

 

 

 

144,072

 

 

 

117.51

 

Vested

 

 

(78,773

)

 

 

85.44

 

 

 

(99,855

)

 

 

83.25

 

Forfeited

 

 

(2,861

)

 

 

112.24

 

 

 

(8,687

)

 

 

97.14

 

Outstanding, end of period

 

 

390,166

 

 

 

117.56

 

 

 

368,011

 

 

 

109.01

 

Performance-based and market-based restricted stock units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding, beginning of period

 

 

86,252

 

 

$

110.70

 

 

 

69,838

 

 

$

95.58

 

Granted

 

 

54,415

 

 

 

105.10

 

 

 

42,119

 

 

 

117.68

 

Vested

 

 

(36,499

)

 

 

80.26

 

 

 

(10,089

)

 

 

82.74

 

Forfeited

 

 

 

 

 

 

 

 

 

 

Outstanding, end of period

 

 

104,168

 

 

 

118.45

 

 

 

101,868

 

 

 

105.99

 

 

In the first three months of 2020 and 2019, the Company granted market-based awards totaling 34,911 and 23,924, respectively, to certain members of senior management, which are included in the table above as performance and market-based restricted stock activity. The vesting of these stock units is based on the relative total shareholder return (“TSR”) of the Company. This metric is generally based on relative TSR for a three-year period as compared to a pre-selected group of property and casualty companies. The fair value of market-based awards was estimated at the date of grant using a valuation model. These units have the potential to range from 0% to 150% of the shares disclosed. Included in the amount granted above in 2020 and 2019 are 13,532 shares and 5,820 shares, respectively, related to market-based awards that achieved a payout in excess of 100%. These awards vested in the first quarters of 2020 and 2019, respectively.

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The Company also granted performance-based restricted stock units in 2020 and 2019, totaling 19,504 and 18,195, respectively, which are based upon the Company’s achievement of return on equity objectives. These units have the potential to range from 0% to 150% of the shares disclosed, which varies based on grant year and individual participation level. Increases above the 100% target level are reflected as granted in the period in which performance-based stock unit goals are achieved. Decreases below the 100% target level are reflected as forfeited. There were 0 performance-based awards that vested in 2020 or 2019. 

11. Earnings Per Share and Shareholders’ Equity Transactions

The following table provides weighted average share information used in the calculation of the Company’s basic and diluted earnings per share:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions, except per share data)

 

2020

 

 

2019

 

Basic shares used in the calculation of earnings per share

 

 

38.3

 

 

 

40.6

 

Dilutive effect of securities (1):

 

 

 

 

 

 

 

 

Employee stock options

 

 

 

 

 

0.3

 

Non-vested stock grants

 

 

 

 

 

0.3

 

Diluted shares used in the calculation of earnings per share

 

 

38.3

 

 

 

41.2

 

Per share effect of dilutive securities on income (loss) from

   continuing operations and net income (loss)

 

$

 

 

$

(0.04

)

 

 

(1)

Excludes 0.6 million shares due to antidilution that resulted from the Company having losses from continuing operations and net losses for the quarter ended March 31, 2020.

Diluted earnings per share for the three months ended March 31, 2020 and 2019 excludes 0.4 million and 0.2 million, respectively, of common shares issuable under the Company’s stock compensation plans because their effect would be antidilutive.

The Board of Directors authorized a stock repurchase program which provides for aggregate repurchases of up to $900 million, including a $300 million increase to the program that was authorized on December 5, 2019. Under the repurchase authorization, the Company may repurchase, from time to time, common stock in amounts, at prices and at such times as the Company deems appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. The Company is not required to purchase any specific number of shares or to make purchases by any certain date under this program. On December 9, 2019, pursuant to the terms of an accelerated share repurchase (“ASR”) agreement (the “December 2019 ASR”) the Company paid $150.0 million in exchange for an initial delivery of approximately 0.9 million shares of common stock. On February 26, 2020, the Company received approximately 0.2 million of its common stock shares as final settlement of shares repurchased under the December 2019 ASR.

 

12. Liabilities for Outstanding Claims, Losses and Loss Adjustment Expenses

Reserve Rollforward and Prior Year Development

The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in results of operations as adjustments to losses and loss adjustment expenses (“LAE”). Often these adjustments are recognized in periods subsequent to the period in which the underlying policy was written and loss event occurred. These types of subsequent adjustments are described as “prior years’ loss reserves”. Such development can be either favorable or unfavorable to the Company’s financial results and may vary by line of business. In this section, all amounts presented include catastrophe losses and LAE, unless otherwise indicated.

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The table below provides a reconciliation of the gross beginning and ending reserve for unpaid losses and loss adjustment expenses.

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions)

 

2020

 

 

2019

 

Gross loss and LAE reserves, beginning of period

 

$

5,654.4

 

 

$

5,304.1

 

Reinsurance recoverable on unpaid losses

 

 

1,574.8

 

 

 

1,472.6

 

Net loss and LAE reserves, beginning of period

 

 

4,079.6

 

 

 

3,831.5

 

Net incurred losses and LAE in respect of losses occurring in:

 

 

 

 

 

 

 

 

Current year

 

 

730.2

 

 

 

712.8

 

Prior years

 

 

(2.0

)

 

 

(13.2

)

Total incurred losses and LAE

 

 

728.2

 

 

 

699.6

 

Net payments of losses and LAE in respect of losses occurring in:

 

 

 

 

 

 

 

 

Current year

 

 

174.6

 

 

 

175.3

 

Prior years

 

 

484.4

 

 

 

459.1

 

Total payments

 

 

659.0

 

 

 

634.4

 

Net reserve for losses and LAE, end of period

 

 

4,148.8

 

 

 

3,896.7

 

Reinsurance recoverable on unpaid losses

 

 

1,576.1

 

 

 

1,484.9

 

Gross reserve for losses and LAE, end of period

 

$

5,724.9

 

 

$

5,381.6

 

 

As a result of continuing trends in the Company’s business, reserves including catastrophes have been re-estimated for all prior accident years and were decreased by $2.0 million and $13.2 million in 2020 and 2019, respectively.

2020

For the three months ended March 31, 2020, net favorable loss and LAE development was $2.0 million. Lower than expected losses in the workers’ compensation line, other commercial lines and homeowners line were partially offset by higher than expected losses in the commercial and personal automobile lines, commercial multiple peril line, and in the Company’s run-off voluntary assumed property and casualty reinsurance pools business. Within other commercial lines, lower than expected losses in the Company’s marine line and specialty industrial and commercial property lines were partially offset by higher than expected losses in the general liability lines. The higher than expected losses in the Company’s run-off voluntary assumed property and casualty reinsurance pools business was based on an updated third-party actuarial study received in the first quarter of 2020 for the legacy Excess and Casualty Reinsurance Association (“ECRA”) pool that primarily consists of asbestos and environmental exposures.

2019

For the three months ended March 31, 2019, net favorable loss and LAE development was $13.2 million, primarily as a result of favorable catastrophe development due to the sale of subrogation rights on certain 2017 and 2018 California wildfires. In addition, higher than expected losses in the Company’s personal and commercial automobile lines were substantially offset by lower than expected losses in the Company’s workers’ compensation and commercial multiple peril lines.

 

13. Commitments and Contingencies

Legal Proceedings

The Company has been named a defendant in various legal proceedings arising in the normal course of business. In addition, the Company is involved, from time to time, in examinations, investigations and proceedings by governmental and self-regulatory agencies. The potential outcome of any such action or regulatory proceedings in which the Company has been named a defendant or the subject of an inquiry or investigation, and its ultimate liability, if any, from such action or regulatory proceedings, is difficult to predict at this time. The ultimate resolutions of such proceedings are not expected to have a material effect on its financial position, although they could have a material effect on the results of operations for a particular quarterly or annual period.

Residual Markets

The Company is required to participate in residual markets in various states, which generally pertain to high risk insureds, disrupted markets or lines of business or geographic areas where rates are regarded as excessive. The results of the residual markets are not subject to the predictability associated with the Company’s own managed business, and are significant to both the personal and commercial automobile lines of business.

 

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14. Subsequent Events

On April 10, 2020, the Company announced that it will return 15% of April and May personal automobile premiums to its eligible Personal Lines customers in all of THG’s markets, providing financial relief during the outbreak of the novel coronavirus, also known as COVID-19, and subsequent global pandemic. The Company’s decision to return a portion of premium payments to its customers is a recognition of the impact of government-mandated stay-at-home measures, which are reducing the number of vehicles on the roads and miles driven, and consequently, the number of claims filed. The Company estimates that this premium refund will be approximately $30 million, which will be recognized in the second quarter of 2020. Pending regulatory approvals, the Company will credit April in-force policies in May, and May in-force policies in June.

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PART I

ITEM 2

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

TABLE OF CONTENTS

 

 

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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 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 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 24, 2020.

Results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), our principal property and casualty companies; and other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting of our accident and health and former life insurance businesses, as well as our former Chaucer business.

Executive Overview

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

Our strategy, which focuses on the independent agency distribution channel, reinforces THG’s commitment to our agency partners. It is designed to generate profitable growth by leveraging the strengths of our distribution approach, including expansion of our agency footprint in underpenetrated geographies, as warranted. As part of that strategy, we have increased our capabilities in specialty markets and made investments designed to develop growth solutions for our agency distribution channel. Our goal is to grow responsibly in all of our businesses, while managing volatility.

The outbreak of the novel coronavirus, also known as COVID-19, and subsequent global pandemic (“Pandemic”) began significantly impacting the U.S. and global financial markets and economies during the quarter ended March 31, 2020.  Circumstances relating to the Pandemic are unprecedented in scope, are changing rapidly, and are complex and uncertain.  Our investment portfolio was adversely affected by the deterioration in investment markets during the quarter. We experienced minimal adverse effects from the Pandemic on our underwriting results and operations, as well as our financial condition, through March 31, 2020, and we believe that the Pandemic’s economic impacts on our 2020 results should be manageable. However the severity, duration and long-term impacts of the Pandemic, including continued declines in general economic conditions, adverse impacts to our investment portfolio and uncertainty around possible and actual governmental responses to the crisis, may significantly affect the property and casualty insurance industry, our business, and our financial results over the intermediate and long-term.  (See “Contingencies and Regulatory Matters” and “Item 1A – Risk Factors” for further discussion).

During the three months ended March 31, 2020, our results reflected a net loss of $40.0 million, compared to net income of $122.4 million for the three months ended March 31, 2019, a decrease of $162.4 million, primarily due to a decrease in fair value of equity securities, as well as impairment losses on fixed income securities.

Operating income before interest expense and income taxes (a non-GAAP financial measure; see also “Results of Operations – Consolidated – Non-GAAP Financial Measures”) was $117.1 million for the three months ended March 31, 2020, compared to $109.8 million for the three months ended March 31, 2019, an increase of $7.3 million. This increase was primarily due to lower expenses and earned premium growth, partially offset by higher non-catastrophe current accident year losses, primarily within our commercial multiple peril line.

Pre-tax catastrophe losses were $37.9 million for the three months ended March 31, 2020, compared to $39.4 million during the same period of 2019. Net favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”) was $2.0 million for the three months ended March 31, 2020, compared to net unfavorable development of $0.3 million in 2019.

Commercial Lines

Our account-focused 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. We continue to pursue our core strategy of developing strong partnerships with agents, enhanced franchise value through selective distribution, distinctive products and coverages, and continued investment in industry segmentation. Commercial Lines net premiums written grew by 4.5% in the first three months of 2020, compared to the same period in 2019, primarily due to growth in our commercial multiple peril, commercial automobile, professional liability and marine lines.

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Underwriting results declined in the first three months of 2020, primarily due to higher non-catastrophe current accident year large loss activity and catastrophe losses, partially offset by lower expenses. Additionally, the Commercial Lines current accident year losses and LAE also reflected an initial reserve provision for COVID-19 related exposures. 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. Due to the Pandemic and the resulting economic downturn affecting our Commercial Lines businesses, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability.

Personal Lines

Personal Lines focuses on partnering with high quality, value-oriented agencies that deliver consultative selling to customers and stress the importance of account rounding (the conversion of single policy customers to accounts with multiple policies and additional coverages, to address customers’ broader objectives). Approximately 85% of our policies in force have been issued to customers with multiple policies and/or coverages with us. We are focused on seeking profitable growth opportunities, building a distinctive position in the market in order to meet our customers’ needs and diversifying geographically. We continue to seek appropriate rate increases that meet or exceed underlying loss cost trends, subject to regulatory and competitive considerations. Due to the Pandemic and the resulting economic downturn affecting our Personal Lines businesses, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability.

Net premiums written grew by 2.1% in the first three months of 2020, compared to the same period in 2019, primarily due to higher renewal premium driven by rate increases. Underwriting results improved in the first three months of 2020, primarily due to lower catastrophe losses, lower non-catastrophe current accident year losses and net favorable change in prior year reserve development.

On April 10, 2020, we announced that THG will return 15% of April and May personal automobile premiums to our eligible Personal Lines customers in all our markets, providing financial relief during the Pandemic. Our decision to return a portion of premium payments to our customers is a recognition of the impact of government-mandated stay-at-home measures, which are reducing the number of vehicles on the roads and miles driven, and consequently, the number of claims filed. We estimate that this premium refund will be approximately $30 million, which will be recognized in the second quarter of 2020. Pending regulatory approvals, we will credit April in-force policies in May, and May in-force policies in June.

Description of Operating Segments

Primary business operations include insurance products and services currently provided through three operating segments: Commercial Lines, Personal Lines, and Other. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as management and professional liability, marine, Hanover Programs, specialty industrial and commercial property, monoline general liability and surety. Personal Lines includes personal automobile, homeowners, and other personal coverages, such as umbrella. Included in the “Other” segment are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds, and other organizations; earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to our former life insurance employees and agents; and a run-off voluntary property and casualty pools business. 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 primarily of interest on our senior and subordinated debentures.

Results of Operations – Consolidated

Consolidated net loss for the three months ended March 31, 2020 was $40.0 million, compared to consolidated net income of $122.4 million for the three months ended March 31, 2019, a decrease of $162.4 million. This decrease is primarily a result of after-tax net realized and unrealized investment losses of $125.5 million in the first quarter of 2020, as compared to after-tax net realized and unrealized investment gains of $41.9 million in the first quarter of 2019. Partially offsetting this decrease was higher operating income before interest expense and income taxes for the three months ended March 31, 2020. Operating income before interest expense and income taxes increased $7.3 million primarily due to lower expenses and earned premium growth, partially offset by higher non-catastrophe current accident year losses.

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Table of Contents

 

The following table reflects operating income before interest expense and income taxes for each operating segment and a reconciliation to consolidated net income from operating income before interest expense and income taxes (a non-GAAP measure).

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions)

 

2020

 

 

2019

 

Operating income (loss) before interest expense and income taxes:

 

 

 

 

 

 

 

 

Commercial Lines

 

$

54.6

 

 

$

80.2

 

Personal Lines

 

 

64.9

 

 

 

26.8

 

Other

 

 

(2.4

)

 

 

2.8

 

Operating income before interest expense and income taxes

 

 

117.1

 

 

 

109.8

 

Interest expense on debt

 

 

(9.4

)

 

 

(9.4

)

Operating income before income taxes

 

 

107.7

 

 

 

100.4

 

Income tax expense on operating income

 

 

(20.9

)

 

 

(19.7

)

Operating income

 

 

86.8

 

 

 

80.7

 

Non-operating items:

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains (losses)

 

 

(161.6

)

 

 

48.2

 

Income tax benefit (expense) on non-operating items

 

 

36.1

 

 

 

(6.3

)

Income (loss) from continuing operations, net of taxes

 

 

(38.7

)

 

 

122.6

 

Discontinued operations (net of taxes):

 

 

 

 

 

 

 

 

Sale of Chaucer business

 

 

 

 

 

0.9

 

Loss from Chaucer business

 

 

 

 

 

(0.3

)

Loss from discontinued life businesses

 

 

(1.3

)

 

 

(0.8

)

Net income (loss)

 

$

(40.0

)

 

$

122.4

 

Non-GAAP Financial Measures

In addition to consolidated net income, discussed above, we assess our financial performance based upon pre-tax “operating income,” and we assess the operating performance of each of our three operating segments based upon the pre-tax operating income (loss) generated by each segment. As reflected in the table above, operating income 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 and unrealized investment gains and losses. Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income 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, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income before taxes are 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 attributable to the core operations of the business. However, operating income before taxes, which is a non-GAAP measure, should not be construed as a substitute for income before income taxes or income from continuing operations, and operating income should not be construed as a substitute for net income.

 

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. References to “current accident year underwriting results” exclude prior accident year reserve development, and may also be presented “excluding catastrophes.” Prior years’ reserve development and catastrophes are not predictable as to timing or the amount that will affect the results of our operations and have an effect on each year’s operating and net income. 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. Discussion of catastrophe losses in this Management’s Discussion and Analysis includes development on prior years’ catastrophe reserves and, unless otherwise indicated, such development is excluded from discussions of prior year loss and LAE reserve development.

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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, as well as unrealized gains and losses on equity securities, and the results of discontinued operations.

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

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions)

 

2020

 

 

2019

 

Operating revenues

 

 

 

 

 

 

 

 

Net premiums written

 

$

1,136.9

 

 

$

1,098.0

 

Net premiums earned

 

$

1,141.4

 

 

$

1,095.1

 

Net investment income

 

 

69.6

 

 

 

70.2

 

Other income

 

 

6.8

 

 

 

6.0

 

Total operating revenues

 

 

1,217.8

 

 

 

1,171.3

 

Losses and operating expenses

 

 

 

 

 

 

 

 

Losses and LAE

 

 

728.2

 

 

 

699.6

 

Amortization of deferred acquisition costs

 

 

236.9

 

 

 

229.5

 

Other operating expenses

 

 

135.6

 

 

 

132.4

 

Total losses and operating expenses

 

 

1,100.7

 

 

 

1,061.5

 

Operating income before interest expense and income taxes

 

$

117.1

 

 

$

109.8

 

 

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019  

Operating income before interest expense and income taxes was $117.1 million in the three months ended March 31, 2020, compared to $109.8 million for the three months ended March 31, 2019, an increase of $7.3 million. This increase was primarily due to lower expenses and earned premium growth, partially offset by higher non-catastrophe current accident year losses, primarily within our commercial multiple peril line.

Net premiums written increased by $38.9 million in the three months ended March 31, 2020, compared to the three months ended March 31, 2019, due to growth in both our Commercial and Personal Lines segments.

Production and Underwriting Results

The following tables summarize premiums written on a gross and net basis, net premiums earned and loss (including catastrophe losses), LAE, expense and combined ratios for the Commercial Lines and Personal Lines 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 March 31, 2020

 

(dollars in millions)

 

Gross

Premiums

Written

 

 

Net

Premiums

Written

 

 

Net

Premiums

Earned

 

 

Catastrophe

Loss Ratios

 

 

Loss & LAE

Ratios

 

 

Expense

Ratios

 

 

Combined

Ratios

 

Commercial Lines

 

$

830.5

 

 

$

707.6

 

 

$

675.9

 

 

 

3.5

 

 

 

64.2

 

 

 

34.0

 

 

 

98.2

 

Personal Lines

 

 

458.4

 

 

 

429.3

 

 

 

465.5

 

 

 

3.0

 

 

 

62.5

 

 

 

27.5

 

 

 

90.0

 

Total

 

$

1,288.9

 

 

$

1,136.9

 

 

$

1,141.4

 

 

 

3.3

 

 

 

63.8

 

 

 

31.4

 

 

 

95.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2019

 

(dollars in millions)

 

Gross

Premiums

Written

 

 

Net

Premiums

Written

 

 

Net

Premiums

Earned

 

 

Catastrophe

Loss Ratios

 

 

Loss & LAE

Ratios

 

 

Expense

Ratios

 

 

Combined

Ratios

 

Commercial Lines

 

$

779.5

 

 

$

677.4

 

 

$

652.4

 

 

 

1.6

 

 

 

59.3

 

 

 

34.9

 

 

 

94.2

 

Personal Lines

 

 

446.8

 

 

 

420.6

 

 

 

442.7

 

 

 

6.6

 

 

 

70.6

 

 

 

27.6

 

 

 

98.2

 

Total

 

$

1,226.3

 

 

$

1,098.0

 

 

$

1,095.1

 

 

 

3.6

 

 

 

63.9

 

 

 

31.9

 

 

 

95.8

 

 

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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 March 31,

 

 

 

2020

 

 

2019

 

(dollars in millions)

 

Net

Premiums

Written

 

 

Loss & LAE

Ratios

 

 

Catastrophe

Loss Ratios

 

 

Net

Premiums

Written

 

 

Loss & LAE

Ratios

 

 

Catastrophe

Loss Ratios

 

Commercial Lines:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

234.9

 

 

 

74.0

 

 

 

6.4

 

 

$

223.6

 

 

 

58.4

 

 

 

4.3

 

Commercial automobile

 

 

89.9

 

 

 

72.0

 

 

 

0.2

 

 

 

85.8

 

 

 

72.6

 

 

 

0.1

 

Workers’ compensation

 

 

96.9

 

 

 

54.7

 

 

 

 

 

 

93.1

 

 

 

54.0

 

 

 

 

Other commercial

 

 

285.9

 

 

 

56.6

 

 

 

3.2

 

 

 

274.9

 

 

 

57.4

 

 

 

0.3

 

Total Commercial Lines

 

$

707.6

 

 

 

64.2

 

 

 

3.5

 

 

$

677.4

 

 

 

59.3

 

 

 

1.6

 

Personal Lines:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Personal automobile

 

$

279.4

 

 

 

68.6

 

 

 

0.6

 

 

$

276.7

 

 

 

73.1

 

 

 

0.3

 

Homeowners

 

 

137.6

 

 

 

54.2

 

 

 

7.7

 

 

 

133.6

 

 

 

67.1

 

 

 

18.4

 

Other personal

 

 

12.3

 

 

 

27.7

 

 

 

1.5

 

 

 

10.3

 

 

 

54.6

 

 

 

1.9

 

Total Personal Lines

 

$

429.3

 

 

 

62.5

 

 

 

3.0

 

 

$

420.6

 

 

 

70.6

 

 

 

6.6

 

 

The following table summarizes GAAP underwriting results for the Commercial Lines, Personal Lines and Other segments and reconciles them to operating income (loss) before interest expense and income taxes.  

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

(in millions)

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Total

 

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Total

 

Underwriting profit, excluding

   prior year reserve development

   and catastrophes

 

$

30.5

 

 

$

56.6

 

 

$

 

 

$

87.1

 

 

$

39.6

 

 

$

42.2

 

 

$

 

 

$

81.8

 

Prior year favorable (unfavorable)

   loss and LAE reserve development

   on non-catastrophe losses

 

 

3.7

 

 

 

1.6

 

 

 

(3.3

)

 

 

2.0

 

 

 

7.5

 

 

 

(7.5

)

 

 

(0.3

)

 

 

(0.3

)

Prior year favorable (unfavorable)

   catastrophe development

 

 

3.3

 

 

 

(3.3

)

 

 

 

 

 

 

 

 

13.5

 

 

 

 

 

 

 

 

 

13.5

 

Current year catastrophe losses

 

 

(27.1

)

 

 

(10.8

)

 

 

 

 

 

(37.9

)

 

 

(23.9

)

 

 

(29.0

)

 

 

 

 

 

(52.9

)

Underwriting profit (loss)

 

 

10.4

 

 

 

44.1

 

 

 

(3.3

)

 

 

51.2

 

 

 

36.7

 

 

 

5.7

 

 

 

(0.3

)

 

 

42.1

 

Net investment income

 

 

46.4

 

 

 

20.3

 

 

 

2.9

 

 

 

69.6

 

 

 

44.3

 

 

 

19.7

 

 

 

6.2

 

 

 

70.2

 

Fees and other income

 

 

2.4

 

 

 

2.7

 

 

 

1.7

 

 

 

6.8

 

 

 

2.0

 

 

 

2.8

 

 

 

1.2

 

 

 

6.0

 

Other operating expenses

 

 

(4.6

)

 

 

(2.2

)

 

 

(3.7

)

 

 

(10.5

)

 

 

(2.8

)

 

 

(1.4

)

 

 

(4.3

)

 

 

(8.5

)

Operating income (loss) before

   interest expense and income taxes

 

$

54.6

 

 

$

64.9

 

 

$

(2.4

)

 

$

117.1

 

 

$

80.2

 

 

$

26.8

 

 

$

2.8

 

 

$

109.8

 

 

Commercial Lines

Commercial Lines net premiums written were $707.6 million in the three months ended March 31, 2020, compared to $677.4 million in the three months ended March 31, 2019. This $30.2 million increase was primarily driven by pricing increases and strong retention.

Commercial Lines underwriting profit for the three months ended March 31, 2020 was $10.4 million, compared to $36.7 million for the three months ended March 31, 2019, a decrease of $26.3 million. Catastrophe-related losses for the three months ended March 31, 2020 were $23.8 million, compared to $10.4 million for the three months ended March 31, 2019, an increase of $13.4 million. Prior year favorable catastrophe development for the three months ended March 31, 2019 included $13.3 million for the sale of subrogation rights on certain California wildfire losses. Favorable development on prior years’ loss reserves for the three months ended March 31, 2020 was $3.7 million, compared to $7.5 million for the three months ended March 31, 2019, a decrease of $3.8 million.

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Commercial Lines current accident year underwriting profit, excluding catastrophes, was $30.5 million for the three months ended March 31, 2020, compared to $39.6 million for the three months ended March 31, 2019. This $9.1 million decrease was primarily driven by a $12.6 million large property loss in our commercial multiple peril line, partially offset by lower expenses. Our property per risk excess of loss reinsurance treaty includes a $10 million annual aggregate deductible for the $10 million excess of $10 million layer. As this loss was the first to impact this layer of coverage in the treaty year, we retained $10 million of this large commercial multiple peril property loss to satisfy this deductible for the layer. Additionally, the Commercial Lines current accident year losses and LAE also reflected an initial reserve provision for COVID-19 related exposures.  

We are continuing to manage underwriting performance through increased rates, pricing segmentation, specific underwriting actions and targeted new business growth. Our ability to achieve overall rate increases is affected by many factors, including regulatory activity and the current competitive pricing environment, particularly within the workers’ compensation line. Due to the Pandemic and the resulting economic downturn affecting our Commercial Lines segment, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in a moderation in claims volumes due to a substantial reduction in business activity, for example, less traffic and congestion on the roads may result in fewer accidents involving our insureds in our commercial automobile line. In addition, a sharp reduction in our insured's underlying business activity, as well as the inability of certain businesses to restart operations and recover from the economic impacts of the prolonged stay-at-home orders, may result in a significant reduction in our future commercial multiple peril, workers' compensation and general liability premium levels.

Personal Lines

Personal Lines net premiums written were $429.3 million in the three months ended March 31, 2020, compared to $420.6 million in the three months ended March 31, 2019, an increase of $8.7 million. This was primarily due to higher renewal premium driven by rate increases.

Net premiums written in the personal automobile line of business for the three months ended March 31, 2020 were $279.4 million, compared to $276.7 million for the three months ended March 31, 2019, an increase of $2.7 million. This was primarily due to an increase in policies in force of 0.7%. Net premiums written in the homeowners line of business for the three months ended March 31, 2020 were $137.6 million, compared to $133.6 million for the three months ended March 31, 2019, an increase of $4.0 million. This is attributable to rate increases and an increase in policies in force of 1.6%.

Personal Lines underwriting profit for the three months ended March 31, 2020 was $44.1 million, compared to $5.7 million for the three months ended March 31, 2019, an increase of $38.4 million. Catastrophe losses for the three months ended March 31, 2020 were $14.1 million, compared to $29.0 million for the three months ended March 31, 2019, a decrease of $14.9 million. Favorable development on prior years’ loss reserves for the three months ended March 31, 2020 was $1.6 million, compared to unfavorable development of $7.5 million for the three months ended March 31, 2019, a favorable change of $9.1 million.

Personal Lines current accident year underwriting profit, excluding catastrophes, was $56.6 million for the three months ended March 31, 2020, compared to $42.2 million for the three months ended March 31, 2019. This $14.4 million increase was primarily due to lower current accident year property losses in our personal automobile line, partially due to a decrease in estimated miles driven in the month of March due to the Pandemic, and earned premium growth.

We have been able to obtain rate increases in our Personal Lines markets and believe that our ability to obtain increases will continue over the long term. Our ability to maintain Personal Lines net premiums written may be affected, however, by price competition, and regulatory and legal activity and developments. See “Contingencies and Regulatory Matters.” Additionally, these factors along with weather-related loss volatility may also affect our ability to maintain and improve underwriting results. We monitor these trends and consider them in our rate actions. Due to the Pandemic and the resulting economic downturn affecting our Personal Lines segment, there is an increased level of uncertainty in our ability to retain or grow our business and maintain or improve our underwriting profitability. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in a moderation in claims volumes due to a substantial reduction in customer activity, for example, lower miles driven by the insureds in our personal automobile line.

On April 10, 2020, we announced that THG will return 15% of April and May personal automobile premiums to our eligible Personal Lines customers in all our markets, providing financial relief during the Pandemic. Our decision to return a portion of premium payments to our customers is a recognition of the impact of government-mandated stay-at-home measures, which are reducing the number of vehicles on the roads and miles driven, and consequently, the number of claims filed. We estimate that this premium refund will be approximately $30 million, which will be recognized in the second quarter of 2020. Pending regulatory approvals, we will credit April in-force policies in May, and May in-force policies in June.

In addition, and as discussed under “Risk Factors – Michigan PIP Reform” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019, Michigan enacted major reforms of its current system governing personal and commercial automobile insurance in 2019. Michigan business represents 47% of our total personal automobile net premiums written. As of March 31, 2020, the net impact of these reforms is not significant to our total net premiums written and underwriting income.

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Table of Contents

 

Other

Our Other Segment had an operating loss of $2.4 million for the three months ended March 31, 2020, compared to operating income of $2.8 million for the three months ended March 31, 2019, a decline of $5.2 million. The decline was primarily due to lower net investment income as a result of the deployment of proceeds from the sale of our former Chaucer business. In addition, we recorded adverse prior year reserve development in our run-off voluntary assumed property and casualty reinsurance pools business. This $3.3 million reserve increase was based on an updated third-party actuarial study received in the first quarter of 2020 for the legacy Excess and Casualty Reinsurance Association (“ECRA”) pool.

Reserve for Losses and Loss Adjustment Expenses

The table below provides a reconciliation of the gross beginning and ending reserve for unpaid losses and loss adjustment expenses.

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in millions)

 

2020

 

 

2019

 

Gross loss and LAE reserves, beginning of period

 

$

5,654.4

 

 

$

5,304.1

 

Reinsurance recoverable on unpaid losses

 

 

1,574.8

 

 

 

1,472.6

 

Net loss and LAE reserves, beginning of period

 

 

4,079.6

 

 

 

3,831.5

 

Net incurred losses and LAE in respect of losses occurring in:

 

 

 

 

 

 

 

 

Current year

 

 

730.2

 

 

 

712.8

 

Prior year non-catastrophe loss development

 

 

(2.0

)

 

 

0.3

 

Prior year catastrophe development

 

 

 

 

(13.5

)

Total incurred losses and LAE

 

 

728.2

 

 

 

699.6

 

Net payments of losses and LAE in respect of losses occurring in:

 

 

 

 

 

 

 

 

Current year

 

 

174.6

 

 

 

175.3

 

Prior years

 

 

484.4

 

 

 

459.1

 

Total payments

 

 

659.0

 

 

 

634.4

 

Net reserve for losses and LAE, end of period

 

 

4,148.8

 

 

 

3,896.7

 

Reinsurance recoverable on unpaid losses

 

 

1,576.1

 

 

 

1,484.9

 

Gross reserve for losses and LAE, end of period

 

$

5,724.9

 

 

$

5,381.6

 

 

The table below summarizes the gross reserve for losses and LAE by line of business.

 

 

 

March 31,

 

 

December 31,

 

(in millions)

 

2020

 

 

2019

 

Commercial multiple peril

 

$

1,156.5

 

 

$

1,122.0

 

Workers’ compensation

 

 

704.8

 

 

 

698.2

 

Commercial automobile

 

 

427.8

 

 

 

427.0

 

Other commercial lines:

 

 

 

 

 

 

 

 

Hanover Programs

 

 

513.1

 

 

 

512.9

 

Management and professional liability

 

 

298.8

 

 

 

281.5

 

Monoline general liability

 

 

268.7

 

 

 

265.5

 

Umbrella

 

 

193.1

 

 

 

197.9

 

Marine

 

 

96.9

 

 

 

95.9

 

Surety

 

 

79.1

 

 

 

76.9

 

Specialty industrial and commercial property

 

 

77.8

 

 

 

71.1

 

Other lines

 

 

28.3

 

 

 

28.4

 

Total other commercial lines

 

 

1,555.8

 

 

 

1,530.1

 

Total Commercial Lines

 

 

3,844.9

 

 

 

3,777.3

 

Personal automobile

 

 

1,640.3

 

 

 

1,645.1

 

Homeowners and other personal

 

 

199.2

 

 

 

194.3

 

Total Personal Lines

 

 

1,839.5

 

 

 

1,839.4

 

Total Other Segment

 

 

40.5

 

 

 

37.7

 

Total loss and LAE reserves

 

$

5,724.9

 

 

$

5,654.4

 

 

“Other commercial lines – Other lines” in the table above is primarily comprised of fidelity and crime lines of business. Loss and LAE reserves in our “Total Other Segment” relate to our run-off voluntary assumed property and casualty reinsurance pools business.

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Table of Contents

 

The following table summarizes prior year unfavorable (favorable) development for the periods indicated:

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

(in millions)

 

Loss & LAE

 

 

Catastrophe

 

 

Total

 

 

Loss & LAE

 

 

Catastrophe

 

 

Total

 

Commercial Lines

 

$

(3.7

)

 

$

(3.3

)

 

$

(7.0

)

 

$

(7.5

)

 

$

(13.5

)

 

$

(21.0

)

Personal Lines

 

 

(1.6

)

 

 

3.3

 

 

 

1.7

 

 

 

7.5

 

 

 

 

 

7.5

 

Other Segment

 

 

3.3

 

 

 

 

 

3.3

 

 

 

0.3

 

 

 

 

 

0.3

 

Total prior year unfavorable (favorable) development

 

$

(2.0

)

 

$

 

 

$

(2.0

)

 

$

0.3

 

 

$

(13.5

)

 

$

(13.2

)

 

It is not possible to know whether the factors that affected loss reserves in the first three months of 2020 will also occur in future periods. We encourage you to read our 2019 Annual Report on Form 10-K for more information about our reserving process and the judgments, uncertainties and risks associated therewith.

Catastrophe Loss Development

In the three months ended March 31, 2020 and 2019, favorable catastrophe development was zero and $13.5 million, respectively. The favorable catastrophe development during the three months ended March 31, 2019 was primarily due to lower than expected losses related to the 2017 and 2018 California wildfires, including the sale of subrogation rights on certain California wildfire losses.

2020 Loss and LAE Development, excluding catastrophes

For the three months ended March 31, 2020, net favorable loss and LAE development, excluding catastrophes, was $2.0 million. Lower than expected losses in the workers’ compensation line, primarily in accident years 2016, 2018 and 2019, and other commercial and homeowners lines were partially offset by higher than expected losses in the commercial and personal automobile and commercial multiple peril lines. Within other commercial lines, lower than expected losses in our marine line, primarily in accident years 2018 and 2019, and specialty industrial and commercial property lines were partially offset by higher than expected losses in the general liability lines. The adverse prior year development for our Other Segment was due to our run-off voluntary assumed property and casualty reinsurance pools business. This $3.3 million reserve increase was based on an updated third-party actuarial study received in the first quarter of 2020 for the legacy ECRA pool that primarily consists of asbestos and environmental exposures.

2019 Loss and LAE Development, excluding catastrophes

For the three months ended March 31, 2019, net unfavorable loss and LAE development, excluding catastrophes, was $0.3 million. Higher than expected losses in the personal and commercial automobile lines were substantially offset by lower than expected losses in the workers’ compensation and commercial multiple peril lines. In addition, Other Segment unfavorable development of $0.3 million was due to adverse loss trends in our run-off voluntary assumed property and casualty reinsurance pools business which includes asbestos and environmental reserves.

Investments

Investment Results

Net investment income before income taxes was as follows:

 

 

 

Three Months Ended March 31,

 

(dollars in millions)

 

2020

 

 

 

2019

 

Fixed maturities

 

$

56.2

 

 

 

$

58.0

 

Limited partnerships

 

 

6.6

 

 

 

 

4.5

 

Mortgage loans

 

 

4.3

 

 

 

 

3.9

 

Equity securities

 

 

3.8

 

 

 

 

3.6

 

Other investments

 

 

0.9

 

 

 

 

2.1

 

Investment expenses

 

 

(2.2

)

 

 

 

(1.9

)

Net investment income

 

$

69.6

 

 

 

$

70.2

 

Earned yield, fixed maturities

 

 

3.45

%

 

 

 

3.61

%

Earned yield, total portfolio

 

 

3.60

%

 

 

 

3.65

%

 

The decrease in net investment income for the three months ended March 31, 2020 was primarily due to the deployment of Chaucer proceeds during 2019 for accelerated share repurchases and special dividends, as well as the impact of lower new money yields. These decreases were partially offset by the continued investment of operational cash flows and higher limited partnership income. We expect average fixed income yields to continue to decline as new money rates remain lower than embedded book yield.

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Investment Portfolio

We held cash and investment assets diversified across several asset classes, as follows:

 

 

 

March 31, 2020

 

 

 

December 31, 2019

 

 

(dollars in millions)

 

Carrying

Value

 

 

% of Total

Carrying Value

 

 

 

Carrying

Value

 

 

% of Total

Carrying Value

 

 

Fixed maturities, at fair value

 

$

6,625.0

 

 

 

83.1

 

%

 

$

6,687.1

 

 

 

81.4

 

%

Equity securities, at fair value

 

 

447.0

 

 

 

5.6

 

 

 

 

575.7

 

 

 

7.0

 

 

Mortgage and other loans

 

 

459.4

 

 

 

5.8

 

 

 

 

441.2

 

 

 

5.4

 

 

Other investments

 

 

296.1

 

 

 

3.7

 

 

 

 

292.0

 

 

 

3.6

 

 

Cash and cash equivalents

 

 

143.9

 

 

 

1.8

 

 

 

 

215.7

 

 

 

2.6

 

 

Total cash and investments

 

$

7,971.4

 

 

 

100.0

 

%

 

$

8,211.7

 

 

 

100.0

 

%

 

Cash and Investments

Total cash and investments decreased $240.3 million, or 2.9%, for the three months ended March 31, 2020, as compared to December 31, 2019, primarily due to market value depreciation.

The following table provides information about the investment types of our fixed maturities portfolio:

 

 

 

March 31, 2020

 

(in millions)

Investment Type

 

Amortized Cost, net of Allowance for Credit Losses

 

 

Fair Value

 

 

Net Unrealized

Gains (Losses)

 

 

Change in Net

Unrealized

For the Year

 

U.S. Treasury and government agencies

 

$

265.9

 

 

$

286.2

 

 

$

20.3

 

 

$

12.5

 

Foreign government

 

 

4.2

 

 

 

4.5

 

 

 

0.3

 

 

 

(0.1

)

Municipals:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

788.1

 

 

 

821.2

 

 

 

33.1

 

 

 

7.9

 

Tax-exempt

 

 

45.7

 

 

 

46.5

 

 

 

0.8

 

 

 

(0.4

)

Corporate

 

 

3,742.8

 

 

 

3,764.3

 

 

 

21.5

 

 

 

(136.2

)

Asset-backed:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed

 

 

913.5

 

 

 

956.9

 

 

 

43.4

 

 

 

27.4

 

Commercial mortgage-backed

 

 

661.3

 

 

 

679.5

 

 

 

18.2

 

 

 

(7.3

)

Asset-backed

 

 

66.0

 

 

 

65.9

 

 

 

(0.1

)

 

 

(1.2

)

Total fixed maturities

 

$

6,487.5

 

 

$

6,625.0

 

 

$

137.5

 

 

$

(97.4

)

 

The decrease in net unrealized gains on fixed maturities was primarily due to wider credit spreads.

 

Amortized cost and fair value by rating category were as follows:

 

 

 

 

 

March 31, 2020

 

 

 

December 31, 2019

 

 

(dollars in millions)

NAIC Designation

 

Rating Agency

Equivalent Designation

 

Amortized Cost, net of Allowance for Credit Losses

Fair

Value

 

 

% of Total

Fair Value

 

 

 

Amortized

Cost

 

 

Fair

Value

 

 

% of Total

Fair Value

 

 

1

 

Aaa/Aa/A

 

$

4,295.3

 

 

$

4,453.4

 

 

 

67.2

 

%

 

$

4,373.0

 

 

$

4,522.7

 

 

 

67.6

 

%

2

 

Baa

 

 

1,910.0

 

 

 

1,897.5

 

 

 

28.7

 

 

 

 

1,785.2

 

 

 

1,857.6

 

 

 

27.8

 

 

3

 

Ba

 

 

156.1

 

 

 

152.2

 

 

 

2.3

 

 

 

 

160.2

 

 

 

167.6

 

 

 

2.6

 

 

4

 

B

 

 

117.6

 

 

 

113.3

 

 

 

1.7

 

 

 

 

130.2

 

 

 

135.2

 

 

 

2.0

 

 

5

 

Caa and lower

 

 

7.3

 

 

 

7.3

 

 

 

0.1

 

 

 

 

2.0

 

 

 

2.2

 

 

 

 

 

6

 

In or near default

 

 

1.2

 

 

 

1.3

 

 

 

 

 

 

 

1.6

 

 

 

1.8

 

 

 

 

 

Total fixed maturities

 

$

6,487.5

 

 

$

6,625.0

 

 

 

100.0

 

%

 

$

6,452.2

 

 

$

6,687.1

 

 

 

100.0

 

%

 

Based on ratings by the National Association of Insurance Commissioners (“NAIC”), approximately 96% and 95% of the fixed maturity portfolio consisted of investment grade securities at March 31, 2020 and December 31, 2019, respectively. The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security, issuer diversification and yield curve position.

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Our investment portfolio primarily consists of fixed maturity securities whose fair value is susceptible to market risk, including interest rate changes. See also “Quantitative and Qualitative Disclosures about Market Risk” included in Management’s Discussion and Analysis contained in our 2019 Annual Report on Form 10-K. Duration is a measurement used to quantify our inherent interest rate risk and analyze invested assets relative to our reserve liabilities.

The duration of our fixed maturity portfolio was as follows:

 

 

 

March 31, 2020

 

 

 

December 31, 2019

 

 

(dollars in millions)

Duration

 

Amortized Cost, net of Allowance for Credit Losses

Fair Value

 

 

% of Total

Fair Value

 

 

 

Amortized

Cost

 

 

Fair Value

 

 

% of Total

Fair Value

 

 

0-2 years

 

$

1,414.0

 

 

$

1,436.9

 

 

 

21.7

 

%

 

$

1,253.1

 

 

$

1,276.0

 

 

 

19.1

 

%

2-4 years

 

 

1,811.6

 

 

 

1,857.5

 

 

 

28.0

 

 

 

 

1,811.9

 

 

 

1,872.9

 

 

 

28.0

 

 

4-6 years

 

 

1,631.9

 

 

 

1,664.5

 

 

 

25.1

 

 

 

 

1,841.2

 

 

 

1,917.0

 

 

 

28.7

 

 

6-8 years

 

 

1,090.4

 

 

 

1,123.0

 

 

 

17.0

 

 

 

 

1,113.9

 

 

 

1,177.2

 

 

 

17.6

 

 

8-10 years

 

 

416.9

 

 

 

410.0

 

 

 

6.2

 

 

 

 

316.2

 

 

 

322.2

 

 

 

4.8

 

 

10+ years

 

 

122.7

 

 

 

133.1

 

 

 

2.0

 

 

 

 

115.9

 

 

 

121.8

 

 

 

1.8

 

 

Total fixed maturities

$

6,487.5

 

 

$

6,625.0

 

 

 

100.0

 

%

 

$

6,452.2

 

 

$

6,687.1

 

 

 

100.0

 

%

Weighted average duration

 

 

 

 

 

4.2

 

 

 

 

 

 

 

 

 

 

 

4.3

 

 

 

 

 

 

 

Our fixed maturity and equity securities are carried at fair value. Financial instruments whose value was determined using significant management judgment or estimation constituted less than 1% of the total assets we measured at fair value. See also Note 4 – “Fair Value” in the Notes to Interim Consolidated Financial Statements.

Equity securities primarily consist of U.S. income-oriented large capitalization common stocks and developed market equity index exchange-traded funds.

Mortgage and other loans consist primarily of commercial mortgage loan participations which represent our interest in commercial mortgage loans originated by a third party. We share, on a pro-rata basis, in all related cash flows of the underlying mortgage loans, which are investment-grade quality and diversified by geographic area and property type.

Other investments consist primarily of our interest in corporate middle market and real estate limited partnerships. Corporate middle market limited partnerships may invest in senior or subordinated debt, preferred or common equity or a combination thereof, of middle market businesses. Real estate limited partnerships hold equity ownership positions in real properties and invest in debt secured by real properties. Our limited partnerships are generally accounted for under the equity method, with financial information provided by the investee on a two or three month lag. Accordingly, the adverse impact of the recent disruption in global financial markets associated with the Pandemic on our net investment income from these investments was not reflected in our results for the first quarter of 2020.

Although we expect to invest new funds primarily in investment grade fixed maturities, we have invested, and expect to continue to invest, a portion of funds in limited partnerships, common equity securities, below investment grade fixed maturities and other investment assets.

Impairments

For the three months ended March 31, 2020, we recognized $28.5 million of impairments, consisting primarily of $22.2 million on fixed maturities and $4.8 million on mortgage loans. Impairments on fixed maturities included $16.0 million categorized as intend-to-sell and $6.2 million of credit-related losses, primarily in the energy sector, and to a lesser degree, consumer cyclical and transportation sectors. For the three months ended March 31, 2019, we did not recognize any other-than-temporary impairments on our investment portfolio.

The carrying values of fixed maturity securities on non-accrual status at March 31, 2020 and December 31, 2019 were not material. The effects of non-accruals for the three months ended March 31, 2020 and 2019, compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities, were also not material. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income.

Unrealized Losses  

Gross unrealized losses on fixed maturities at March 31, 2020 were $64.1 million, an increase of $56.5 million compared to December 31, 2019, primarily attributable to wider credit spreads. At March 31, 2020, gross unrealized losses consisted primarily of $60.0 million on corporate fixed maturities.  See Note 3 – “Investments” in the Notes to Interim Consolidated Financial Statements.

We view gross unrealized losses on fixed maturities as non-credit related since it is our assessment that these securities will recover, allowing us to realize their anticipated long-term economic value. Further, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also “Liquidity and Capital

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Resources”). Inherent in our assessment are the risks that market factors may differ from our expectations; the global forecasted economic downturn resulting from the Pandemic is longer and more severe than current expectations; we may decide to subsequently sell a security for unforeseen business needs; or changes in the credit assessment from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, an impairment would be recognized as a realized loss. Although unrealized losses on fixed maturities are not reflected in the results of financial operations until they are realized, the fair value of the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets.

The following table sets forth gross unrealized losses for fixed maturities by maturity period at March 31, 2020 and December 31, 2019.  Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers.

 

 

 

March 31,

 

 

December 31,

 

(in millions)

 

2020

 

 

2019

 

Due in one year or less

 

$

0.6

 

 

$

 

Due after one year through five years

 

 

18.9

 

 

 

1.1

 

Due after five years through ten years

 

 

38.1

 

 

 

3.3

 

Due after ten years

 

 

3.8

 

 

 

2.0

 

 

 

 

61.4

 

 

 

6.4

 

Mortgage-backed and asset-backed securities

 

 

2.7

 

 

 

1.2

 

Total fixed maturities

 

$

64.1

 

 

$

7.6

 

 

Our investment portfolio and shareholders’ equity can be significantly impacted by changes in market values of our securities. Market volatility could increase and defaults on fixed income securities could occur. As a result, we could incur additional realized and unrealized losses in future periods, which could have a material adverse impact on our results of operations and/or financial position.

In the first quarter of 2020, the Pandemic resulted in significant economic disruption due to various government-mandated emergency orders, consumer and business uncertainty, and forced business closures. Stock and bond markets plunged, unemployment rolls expanded significantly, and many non-essential businesses were required to close in the U.S. and around the globe for an uncertain amount of time.  While the U.S. government and its agencies have taken extraordinary measures to stabilize the economy, it is unclear whether such actions will be sufficient to avoid economic recession in the near and intermediate term, and what effect such unprecedented events will ultimately have on our investment portfolio.  

Due to the Pandemic, global monetary policies have become extremely accommodative in support of financial market stability. Major central banks have lowered interest rates, relaxed collateral requirements and instituted various asset purchase programs to stabilize financial markets and support economic growth. In the U.S., for example, the Federal Reserve (the “Fed”) reduced its federal funds target range to 0% to 0.25% in March. The Fed has also offered support for the flow of credit to households and businesses. In April, the Fed announced it will provide up to $2.3 trillion in loans to support the economy and assist households and employers, and bolster state and local governments to deliver critical services during the Pandemic.

Fiscal stimulus by major market economies has also been enacted.  The U.S. has declared a national emergency and earmarked approximately $50 billion in emergency funding, Congress has passed the $2.2 trillion stimulus package to support households and businesses and the U.S. will give individuals and small businesses a three-month tax deferral, among other measures.

Fundamental conditions in certain corporate sectors are particularly tenuous, however, especially in the energy sector where the Russia/Saudi Arabia oil dispute and the decline in global demand have driven meaningful declines in our holdings of related fixed maturities.  Further, the lodging, restaurant and transportation services subsectors are severely impacted by the Pandemic. While we may experience defaults on fixed income securities, particularly with respect to non-investment grade debt securities, it is difficult to foresee which issuers, industries or markets will be most affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate, and we could incur additional realized and unrealized losses in future periods.  

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Other Items

Net income also included the following items:

 

 

 

Three Months Ended March 31,

 

(in millions)

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Discontinued

Operations

 

 

Total

 

2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains (losses)

 

$

(113.8

)

 

$

(47.9

)

 

$

0.1

 

 

$

 

 

$

(161.6

)

Discontinued life businesses

 

 

 

 

 

 

 

 

 

 

 

(1.3

)

 

 

(1.3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains (losses)

 

$

34.0

 

 

$

15.1

 

 

$

(0.9

)

 

$

 

 

$

48.2

 

Discontinued operations - Chaucer business, including

   gain on sale, net of taxes

 

 

 

 

 

 

 

 

 

 

 

0.6

 

 

 

0.6

 

Discontinued life businesses

 

 

 

 

 

 

 

 

 

 

 

(0.8

)

 

 

(0.8

)

  

We manage investment assets for our Commercial Lines, Personal Lines, and Other segments based on the requirements of our combined property and casualty companies. We allocate the investment income, expenses and realized gains and losses to our Commercial Lines, Personal Lines and Other segments based on actuarial information related to the underlying businesses. We managed investment assets separately for our former Chaucer business.

Net realized and unrealized losses on investment were $161.6 million for the three months ended March 31, 2020, compared to net realized and unrealized gains of $48.2 million for the three months ended March 31, 2019. For the three months ended March 31, 2020, net realized and unrealized gains (losses) were primarily due to changes in the fair value of equity securities, and to a lesser extent, from impairment losses on investments. For the three months ended March 31, 2019, net realized and unrealized gains (losses) were primarily due to changes in the fair value of equity securities.

Discontinued operations include our discontinued accident and health and life businesses. Losses of $1.3 million and $0.8 million for the three months ended March 31, 2020 and 2019, respectively, primarily reflect adverse loss trends related to the long-term care pool.

Income Taxes

We are subject to the tax laws and regulations of the U.S. and foreign countries in which we operate. We file a consolidated U.S. federal income tax return that includes our holding company and its U.S. subsidiaries. Generally, taxes are accrued at the U.S. statutory tax rate of 21% for income from U.S. operations. We accrue taxes on certain non-U.S. income that is subject to U.S. tax at the enacted U.S. tax rate. Foreign tax credits, where available, are utilized to offset U.S. tax as permitted.

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

The provision for income taxes from continuing operations was a benefit of $15.2 million and an expense of $26.0 million for the three months ended March 31, 2020 and 2019, respectively. These provisions resulted in consolidated effective federal tax rates of 28.2% and 17.5% for the three months ended March 31, 2020 and 2019, respectively. These provisions reflect benefits related to tax planning strategies implemented in prior years of $1.9 million and $3.8 million for the three months ended March 31, 2020 and 2019, respectively. In addition, these provisions also included excess tax benefits related to stock-based compensation of $1.9 million and $1.5 million for the three months ended March 31, 2020 and 2019, respectively. Absent these items, the provision for income taxes would have been a benefit of $11.4 million, or 21.2%, and an expense of $31.3 million, or 21.1%, for the three months ended March 31, 2020 and 2019, respectively.

The income tax provision on operating income was an expense of $20.9 million and $19.7 million for the three months ended March 31, 2020 and 2019, respectively. These provisions resulted in effective tax rates for operating income of 19.4% and 19.6% for the three months ended March 31, 2020 and 2019, respectively. These provisions included excess tax benefits related to stock-based compensation of $1.9 million and $1.5 million for the three months ended March 31, 2020 and 2019, respectively. Absent this item, the provision for income taxes would have been an expense of $22.8 million, or 21.2%, and $21.2 million, or 21.1%, for the three months ended March 31, 2020 and 2019, respectively.

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Table of Contents

 

Critical Accounting Estimates

Interim consolidated financial statements have been prepared in conformity with U.S. GAAP and include certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. While we believe that the amounts included in our consolidated financial statements reflect our best judgment, the use of different assumptions could produce materially different accounting estimates. As disclosed in our 2019 Annual Report on Form 10-K, we believe the following accounting estimates are critical to our operations and require the most subjective and complex judgment:

 

Reserve for losses and loss expenses

 

Reinsurance recoverable balances

 

Pension benefit obligations

 

Deferred taxes

For a more detailed discussion of these critical accounting estimates, see our 2019 Annual Report on Form 10-K.

Additionally, as a result of the recent economic disruption to the financial markets and overall challenges to economic conditions worldwide as a result of the Pandemic, we are experiencing a higher level of impairments in the first quarter of 2020 than in recent years.  Accordingly, the following critical accounting estimate has been added.  

INVESTMENT CREDIT LOSSES

We employ a systematic methodology to evaluate declines in fair values below amortized cost for all fixed maturity investments. The methodology utilizes a quantitative and qualitative process that seeks to ensure that available evidence concerning the declines in fair value below amortized cost is evaluated in a disciplined manner. In determining whether a decline in fair value below amortized cost should be recorded as an impairment, we evaluate several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the degree to which the fair value of an issuer’s securities is below our cost. We consider factors that might raise doubt about the issuer’s ability to make contractual payments as they become due and whether we expect to recover the entire amortized cost basis of the security.

We monitor corporate fixed maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit deterioration, as evidenced by ratings downgrades, unexpected price variances, and/or company or industry specific concerns. We apply consistent standards of credit analysis which includes determining whether the issuer is current on its contractual payments, and we consider past events, current conditions and reasonable and supportable forecasts to evaluate whether we expect to recover the entire amortized cost basis of the security. We utilize valuation declines as a potential indicator of credit deterioration and apply additional levels of scrutiny in our analysis as the severity of the decline increases.

For our impairment review of asset-backed fixed maturity securities, we forecast our best estimate of the prospective future cash flows of the security to determine if we expect to recover the entire amortized cost basis of the security. Our analysis includes estimates of underlying collateral default rates based on historical and projected delinquency rates and estimates of the amount and timing of potential recovery. We consider available information relevant to the collectability of cash flows, including information about the payment terms of the security, prepayment speeds, the financial condition of the underlying borrowers, collateral trustee reports, credit ratings analysis and other market data when developing our estimate of the expected cash flows.

When an impairment of a fixed maturity security occurs, and we intend to sell or more likely than not will be required to sell the investment before recovery of its amortized cost basis, the amortized cost of the security is reduced to its fair value, with a corresponding charge to earnings, which reduces net income and earnings per share. If we do not intend to sell the fixed maturity investment or more likely than not will not be required to sell it, we separate the impairment into the amount we estimate represents the credit loss and the amount related to all other factors. The amount of the estimated loss attributable to credit is recognized in earnings, which reduces net income and earnings per share.

We estimate the amount of the credit impairment by comparing the amortized cost of the fixed maturity security with the net present value of the fixed maturity security’s projected future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment.

Declines in market value which are not credit loss related are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce accumulated other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide assurance that the impairments will be adequate to cover future losses or that we will not have substantial additional impairments in the future. See Note 3 — “Investments” in the Notes to Interim Consolidated Financial Statements for further discussion regarding impairments and securities in an unrealized loss position.

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Statutory Surplus of Insurance Subsidiaries

The following table reflects statutory surplus for our insurance subsidiaries:

 

 

 

March 31,

 

 

December 31,

 

(in millions)

 

2020

 

 

2019

 

Total Statutory Capital and Surplus

 

$

2,420.2

 

 

$

2,470.2

 

 

The statutory capital and surplus for our insurance subsidiaries decreased by $50.0 million during the first three months of 2020. This decrease was primarily due to net realized and unrealized investment losses, primarily due to changes in the fair value of equity securities, and to a lesser extent, from impairment losses on investments. This decrease was partially offset by underwriting profits and changes in deferred taxes.

The NAIC prescribes an annual calculation regarding risk based capital (“RBC”). RBC ratios for regulatory purposes are expressed as a percentage of the capital required to be above the Authorized Control Level (the “Regulatory Scale”); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios for Hanover Insurance (which includes Citizens and other insurance subsidiaries), as of March 31, 2020, expressed both on the Industry Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level):

 

(dollars in millions)

 

Company

Action Level

 

 

Authorized

Control Level

 

 

RBC Ratio

Industry Scale

 

 

RBC Ratio

Regulatory Scale

 

The Hanover Insurance Company

 

$

1,074.3

 

 

$

537.2

 

 

 

225

%

 

 

449

%

 

Liquidity and Capital Resources

Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our insurance subsidiaries are subject to limitations imposed by regulators, such as prior notice periods and the requirement that dividends in excess of a specified percentage of statutory surplus or prior year’s statutory earnings receive prior approval (so called “extraordinary dividends”). During the first quarter of 2020, Hanover Insurance did not pay dividends to the holding company.

Sources of cash for our insurance subsidiaries primarily consist of premiums collected, investment income and maturing investments. Primary cash outflows are payments for losses and loss adjustment expenses, policy and contract acquisition expenses, other underwriting expenses, and investment purchases. Cash outflows related to losses and loss adjustment expenses can be variable because of uncertainties surrounding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. We periodically adjust our investment policy to respond to changes in short-term and long-term cash requirements.

Net cash provided by operating activities was $36.6 million during the first three months of 2020, as compared to $37.2 million during the first three months of 2019. During 2020, the $0.6 million decrease in cash provided was primarily the result of higher loss payments, partially offset by an increase in premiums collected.

Net cash used in investing activities was $99.9 million during the first three months of 2020, as compared to $279.3 million during the first three months of 2019. During 2020 and 2019, cash used in investing activities primarily related to net purchases of fixed maturities, and to a lesser extent, equity securities and other investments. In 2019, these decreases in cash were partially offset by net proceeds received from the sale of the Chaucer-related Irish entity.

Net cash used in financing activities was $8.5 million during the first three months of 2020, as compared to $610.6 million during the first three months of 2019. During 2020, cash was used in financing activities for the repurchase of common stock and for the quarterly dividend payment to our shareholders.  These payments were partially offset by short-term borrowings.  During 2019, cash used in financing activities primarily resulted from repurchases of common stock through an accelerated share repurchase (“ASR”) agreement, the payments of a special dividend and a quarterly dividend to shareholders, and the repayment of the FHLB advances.

Dividends to common shareholders are subject to quarterly board approval and declaration. During the first three months of 2020, as declared by the Board, we paid a quarterly dividend of $0.65 per share to our shareholders totaling approximately $25 million. We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them.

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At March 31, 2020, THG, as a holding company, held approximately $309.2 million of fixed maturities and cash. We believe our holding company assets will be sufficient to meet our current year obligations, which we expect to consist primarily of quarterly dividends to our shareholders (as and to the extent declared), interest on our senior and subordinated debentures, certain costs associated with benefits due to our former life employees and agents, and, to the extent required, payments related to indemnification of liabilities associated with the sale of various subsidiaries. As discussed below, we have, and opportunistically may continue to, repurchase our common stock. Additionally, from time to time, we may also repurchase our debt on an opportunistic basis. We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 2020 holding company obligations; however, we may decide to do so.

We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan. The ultimate payment amounts for our benefit plan is based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes, both positive and negative, to our current funding status and ultimately our obligations in future periods are likely.

Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. We believe that the quality of the assets we hold will allow us to realize the long-term economic value of our portfolio, including securities that are currently in an unrealized loss position. We do not anticipate the need to sell these securities to meet our insurance subsidiaries’ cash requirements since we expect our insurance subsidiaries to generate sufficient operating cash to meet all short-term and long-term cash requirements relating to current operations. However, there can be no assurance that unforeseen business needs or other items, including any effects of the Pandemic or associated legislative, judicial or regulatory actions on our liquidity and investment portfolio, will not occur causing us to have to sell those securities in a loss position before their values fully recover, thereby causing us to recognize impairment charges in that time period.

The Board of Directors authorized a stock repurchase program which provides for aggregate repurchases of our common stock of up to $900 million, including a $300 million increase to the program that was authorized on December 5, 2019. Under the repurchase authorization, we may repurchase, from time to time, common stock in amounts, at prices and at such times as we deem appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. On December 9, 2019, pursuant to the terms of an ASR agreement (the “December 2019 ASR”) we paid $150.0 million in exchange for shares of our common stock. Under the terms of the December 2019 ASR, we received an initial delivery of approximately 0.9 million shares of our common stock. On February 26, 2020, we received approximately 0.2 million shares of our common stock as final settlement of shares repurchased under the December 2019 ASR. In addition to the shares repurchased under the December 2019 ASR, during the first three months of 2020 we repurchased approximately 0.3 million shares at an aggregate cost of $34.9 million. As of March 31, 2020, we have repurchased 4.8 million shares under this $900 million program and have approximately $300 million available for additional repurchases.

We maintain our membership in FHLB which provides us with access to additional liquidity based on our stock holdings and pledged collateral. At March 31, 2020, we had borrowing capacity of $96.5 million. There were $54.0 million of outstanding borrowings under this short-term facility at March 31, 2020, which is included in debt on our Consolidated Balance Sheet. We may continue to borrow, from time to time, through this facility to provide short-term liquidity.

On April 30, 2019, we entered into a new credit agreement that provides for a five-year unsecured revolving credit facility not to exceed $200.0 million at any one time outstanding, with the option to increase the facility up to $300.0 million (assuming no default and satisfaction of other specified conditions, including the receipt of additional lender commitments). The agreement also includes an uncommitted subfacility of $50.0 million for standby letters of credit.  Borrowings, if any, under this new agreement are unsecured and incur interest at a rate per annum equal to, at our election, either (i) the greater of, (a) the prime commercial lending rate of the administrative agent, (b) the NYFRB Rate plus half a percent, or (c) the one month Adjusted LIBOR plus one percent and a margin that ranges from 0.25% to 0.625% depending on our debt rating, or (ii) Adjusted LIBOR for the applicable interest period, plus a margin that ranges from 1.25% to 1.625% depending on our debt rating. The agreement also contains certain financial covenants such as maintenance of specified levels of consolidated equity and leverage ratios, and requires that certain of our subsidiaries maintain minimum RBC ratios.  Concurrent with our entry into this agreement, we voluntarily terminated our then existing $200.0 million credit agreement, dated November 12, 2013.  We currently have no borrowings under this agreement and had no borrowings under this agreement during the first three months of 2020. The LIBOR rate, upon which Adjusted LIBOR is based, is expected to be discontinued by the end of 2021.  Our credit agreement permits us to agree with the Administrative Agent for the credit facility on a replacement to Adjusted LIBOR subject to the satisfaction of certain conditions.

At March 31, 2020, we were in compliance with the covenants of our debt and credit agreements.

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Off-Balance Sheet Arrangements

We currently do not have any material off-balance sheet arrangements that are reasonably likely to have an effect on our financial position, revenues, expenses, results of operations, liquidity, capital expenditures, or capital resources.

Contingencies and Regulatory Matters

REGULATORY AND INDUSTRY DEVELOPMENTS

In response to the Pandemic, regulators in many of the states in which we operate have issued orders or guidance pertaining to, among other things, (a) premium refunds, credits or reductions for personal automobile insurance premiums and premiums for other insurance lines that are expected to be impacted by the Pandemic, including certain commercial lines, for the periods currently impacted by stay-at-home orders and other governmental restrictions, with premium adjustments based on factors such as the ongoing frequency and severity of claims, inflation, repair costs and reinsurance pricing, among others; (b) premium payment grace periods, moratoriums on policy non-renewals and cancellations, and other measures that are similar to actions historically implemented in regions heavily impacted by catastrophes, which we anticipate to be manageable, depending on the duration of the regulatory orders and the degree to which policyholder payment patterns vary as a result; and (c) a reassessment of rates in light of current exposures, loss experience and economic conditions.  Regulatory restrictions on rate increases, underwriting and the ability to non-renew business may, depending on their duration, limit the Company’s ability to manage our mix of business and any potential exposures that emerge in our lines of business in the near term.

Draft legislation has been proposed in several state legislatures and in the United States Congress that seeks to require insurers to retroactively pay unfunded Pandemic business interruption claims that insurance policies do not currently cover, and/or to mandate prospective pandemic coverage.  The impact of such legislation, were it to be adopted, would, according to a statement of the NAIC on March 25, 2020, “create substantial solvency risks” for the property and casualty insurance sector, “significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.”  Industry trade groups further assert that any such legislation would be violative of basic contract law and well-founded principles of constitutional law.  Federal stimulus plans such as the CARES Act providing financial support individuals and businesses during the Pandemic may mitigate the political pressure to continue advancing such proposed legislation.

Proposals are also being considered at the federal level to establish government-funded pandemic insurance programs, possibly similar to the federal flood program.  Details on such proposals are too preliminary to estimate their potential impact on our business.

Information regarding litigation, legal contingencies and regulatory matters appears in Part I – Note 13 “Commitments and Contingencies” in the Notes to Interim Consolidated Financial Statements.

Risks and Forward-Looking Statements

Information regarding risk factors and forward-looking information appears in Part II – Item 1A of this Quarterly Report on Form 10-Q and in Part I – Item 1A of our 2019 Annual Report on Form 10-K. This Management’s Discussion and Analysis should be read and interpreted in light of such factors.

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ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

Our market risks, the ways we manage them, and sensitivity to changes in interest rates, and equity price risk are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2019,  included in our Annual Report on Form 10-K for the year ended December 31, 2019.  There have been no material changes in the first three months of 2020 to these risks or our management of them.

ITEM 4

CONTROLS AND PROCEDURES

Disclosure Controls and Procedures Evaluation

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our “disclosure controls and procedures”, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Limitations on the Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Based on our controls evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) material information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting, as required by Rule 13a-15(d) of the Exchange Act, to determine whether any changes occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that there were no such changes during the quarter ended March 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II – OTHER INFORMATION

 

The Company has been named a defendant in various legal proceedings arising in the normal course of business. In addition, the Company is involved, from time to time, in examinations, investigations and proceedings by governmental and self-regulatory agencies. The potential outcome of any such action or regulatory proceedings in which the Company has been named a defendant or the subject of an inquiry or investigation, and its ultimate liability, if any, from such action or regulatory proceedings, is difficult to predict at this time. The ultimate resolutions of such proceedings are not expected to have a material effect on the Company’s financial position, although they could have a material effect on the results of operations for a particular quarterly or annual period.

ITEM 1A – RISK FACTORS

This document contains, and management may make, certain “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, may be forward-looking statements. When used in our Management’s Discussion and Analysis, words such as: “believes,” “anticipates,” “expects,” “projections,” “outlook,” “should,” “could,” “plan,” “guidance,” “likely,” “on track to,” “potential,” “continue,” “targeted,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. We caution readers that accuracy with respect to forward-looking projections is difficult and risks and uncertainties, in some cases, have affected, and in the future could affect, our actual results and could cause our actual results for the remainder of 2020 and beyond to differ materially from historical results and from those expressed in any of our forward-looking statements. We operate in a business environment that is continually changing, and as such, new risk factors may emerge over time. Additionally, our business is conducted in competitive markets and, therefore, involves a higher degree of risk. We cannot predict these new risk factors nor can we assess the impact, if any, that they may have on our business in the future.

The Company is providing the following risk factor to supplement the risk factors contained in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019.

The impact of the COVID-19 Pandemic and related general economic conditions could have a material adverse effect on our results of operations, financial condition or cash flows.

The Pandemic began significantly impacting the U.S. and global financial markets and economies during the quarter ended March 31, 2020.  Circumstances relating to the Pandemic are unprecedented in scope, are changing rapidly, and are complex and uncertain. A prolonged economic downturn or recession could impact the ability of our insureds to remain solvent, affect their ability to pay premiums or renew their existing insurance policies, or result in customers reducing or eliminating coverages. Prolonged disruptions related to the Pandemic may also affect our agent partners and their ability to operate their businesses and place business with us. Significant agent disruption could also lead consumers to choose our competitors that offer direct-to-consumer or other solutions. These changes may materially and adversely affect our ability to profitably grow our business, particularly if these conditions exist for a significant amount of time.

As a result of the Pandemic and related economic conditions, our investment portfolio has become volatile, impairments have increased and yields on our fixed income investments have declined. The severity and length of the Pandemic may continue to have a negative impact on our investment portfolio and investment income, liquidity and capital position, which impact could be material.  

Due to government-mandated social distancing, lockdown and various stay-at-home and similar orders, the vast majority of our workforce is currently working remotely.  The duration of this remote work environment may adversely impact our ability to perform in-person tasks like inspections and investigations for our underwriting and claims functions. Furthermore, if a significant percentage of our workforce is unable to work, whether because of illness, quarantine, limitations on travel or other government restrictions in connection with the Pandemic, or other disruptions, the quality or timeliness of our services and operations may be negatively impacted. In addition, with a large percentage of our workforce working remotely, we are highly reliant on the effective functioning of our business continuity plans and technological applications, and we are subject to ongoing cyber threats and vulnerabilities.  We also outsource a variety of functions to third parties, including certain of our administrative operations. As a result, we rely upon the successful implementation and execution of the business continuity planning of such entities in the current environment. While we closely monitor the business continuity activities of these third parties, successful implementation and execution of their business continuity strategies are largely outside our control. If one or more of the third parties to whom we outsource certain critical business activities experience operational impacts, some of which could be significant, from the spread of COVID-19 and governmental reactions thereto, or claim that they cannot perform due to a force majeure, it could adversely impact our business, results of operations or financial condition.

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While we believe that our in-force commercial lines policies in large part do not cover business interruption losses related to the Pandemic, legislation has been discussed and introduced in various states and in the U.S. Congress to retroactively amend insurance contracts to provide business interruption coverage or limit policy exclusions for losses allegedly related to the Pandemic. While we believe that any such retroactive legislation changing the terms of an insurance contract would be unconstitutional and otherwise violative of well-established law, if such changes were to be enacted and upheld, we would be exposed to a significant unfunded liability. On the Federal level, there is also uncertainty around legislation to address insurance coverages for pandemics prospectively. State regulators may also continue to impose premium refund orders similar to those issued to date that call for premium refunds or credits across multiple lines of business, including Commercial Lines, mandate rate reductions for lines such as personal automobile and commercial automobile coverages due to a decrease in claims frequency as a result of less driving during the Pandemic, or mandate presumptions of compensability in workers’ compensation coverages.  The uncertainties related to these various legislative and regulatory matters, and the potential that other such uncertainties will arise in reaction to the Pandemic, could adversely impact our ability to sustain adequate returns in certain lines of business or in some cases operate lines profitably.

Additional factors that could cause actual results to differ include, but are not limited to, the following:

 

changes in the demand for our products;

 

risks and uncertainties with respect to our ability to retain profitable policies in force and attract profitable policies and to increase rates commensurate with, or in excess of, loss trends;

 

adverse claims experience or changes in our estimates of loss and loss adjustment expense reserves, including with respect to catastrophes, which may result in lower current year underwriting income or adverse loss development, and could impact our carried reserves;  

 

uncertainties with respect to the long-term profitability of our products, including with respect to new products such as our Hanover Platinum Personal Lines, excess and surplus lines, or longer-tail products covering casualty losses;

 

disruption in our distribution channels, including the loss or disruption of our independent agency channel, including the impact of competition and consolidation in the industry and among agents and brokers;

 

changes in frequency and loss severity trends;

 

changes in regulation, legislation, economic, market and political conditions, particularly with respect to rates, payment flexibility, and regions where we have geographical concentrations;

 

volatile and unpredictable developments, including severe weather and other natural physical events, catastrophes, pandemics and terrorist actions, and the uncertainty in estimating the resulting losses;

 

changes in weather patterns, whether as a result of global climate change, or otherwise, causing a higher level of losses from weather events to persist;

 

the availability of sufficient information to accurately estimate a loss at a point in time and the limitations and assumptions used to model property and casualty losses in general;

 

risks and uncertainties with respect to our ability to collect all amounts due from reinsurers and to maintain current levels of reinsurance in the future at commercially reasonable rates, or at all;

 

heightened volatility, fluctuations in interest rates (which have a significant impact on the market value of our investment portfolio and thus our book value), inflationary pressures, default rates and other factors that affect investment returns from our investment portfolio;

 

risks and uncertainties associated with our participation in shared market mechanisms, mandatory reinsurance programs and mandatory and voluntary pooling arrangements, including the Michigan Catastrophic Claims Association;

 

an increase in mandatory assessments by state guaranty funds;

 

risks and uncertainties associated with the Michigan legislation taking effect on July 2, 2020 that will reform the existing requirements that all personal and commercial automobile polices issued in the state include no-fault personal injury protection coverage without a cap on maximum benefits allowed and the resulting increase in litigation challenging or associated with this reform;

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actions by our competitors, many of which are larger or have greater financial resources than we do;

 

loss, prolonged illness or retirement of key employees;

 

operating difficulties and other unintended consequences from the introduction of new products and related technology changes and applications, as well as new operating models;

 

changes in our claims-paying and financial strength ratings;

 

negative changes in our level of statutory surplus;

 

risks and uncertainties with respect to our growth or operating strategies, or with respect to our expense and strategic initiatives;

 

our ability to declare and pay dividends;

 

changes in accounting principles and related financial reporting requirements;

 

errors or omissions in connection with the administration of any of our products;

 

risks and uncertainties with our operations and technology, including cloud-based data information storage, data security, cyber-security attacks, remote working capabilities, and/or outsourcing relationships and third-party operations and data security that may negatively impact our ability to conduct business;

 

an inability to be compliant with recently implemented regulations or existing regulation such as those relating to Sarbanes-Oxley;

 

unfavorable developments as a result of the implementation of recently enacted legislation in Michigan described above, or litigation matters, social inflation and the possibility of adverse judicial decisions, including those which expand policy coverage beyond its intended scope or award “bad faith” or other non-contractual damages; and

 

other factors described in such forward-looking statements.

In addition, historical and future reported financial results include estimates with respect to premiums written and earned, reinsurance recoverables, current accident year “picks,” loss and loss adjustment reserves and development, fair values of certain investments, other assets and liabilities, tax, contingent and other liabilities, and other items. These estimates are subject to change as more information becomes available.

Readers should not place undue reliance on forward-looking statements, which speak only as of the date they are made. We do not undertake any responsibility to update or revise our forward-looking statements, except as required by law.

For a more detailed discussion of our risks and uncertainties, see also Item 1A – Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019.     

 

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ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

Shares purchased in the first quarter of 2020 are as follows:  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Number of

 

 

Approximate Dollar Value of

 

 

 

 

 

 

 

 

 

 

 

Shares Purchased as

 

 

Shares That May Yet

 

 

 

 

 

 

 

 

 

 

 

Part of Publicly

 

 

be Purchased Under the

 

 

 

Total Number of

 

 

Average Price

 

 

Announced Plans or

 

 

Plans or Programs

 

Period

 

Shares Purchased(1)

 

 

Paid per Share

 

 

Programs

 

 

(in millions)

 

January 1 - 31, 2020

 

 

 

 

 

 

 

 

 

 

$

336

 

February 1 - 29, 2020 (2)

 

 

224,817

 

 

 

131.08

 

 

 

186,713

 

 

 

336

 

March 1 - 31, 2020

 

 

350,189

 

 

 

99.70

 

 

 

349,710

 

 

 

302

 

Total

 

 

575,006

 

 

$

111.97

 

 

 

536,423

 

 

$

302

 

 

(1)

Includes 38,104 shares and 479 shares withheld to satisfy tax withholding amounts due from employees related to the receipt of stock which resulted from the exercise or vesting of equity awards for the months ended February 29 and March 31, 2020, respectively.

(2)

Includes 186,713 shares of common stock received as final settlement of the December 2019 ASR.

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ITEM 6 – EXHIBITS

 

EX – 10.1+

Transition Services Agreement dated March 26, 2020, by and between the Registrant and J. Kendall Huber, previously filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on March 27, 2020 and incorporated herein by reference.

 

 

EX – 31.1

Certification of the Chief Executive Officer, pursuant to 15 U.S.C. 78m, 78o(d), as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

 

EX – 31.2

Certification of the Chief Financial Officer, pursuant to 15 U.S.C. 78m, 78o(d), as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

 

EX – 32.1

Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

 

EX – 32.2

Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

 

EX – 101

The following materials from The Hanover Insurance Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 formatted in Inline eXtensible Business Reporting Language (“iXBRL”): (i) Consolidated Statements of Income for the three months ended March 31, 2020 and 2019; (ii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019; (iii) Consolidated Balance Sheets at March 31, 2020 and December 31, 2019; (iv) Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2020 and 2019; (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019, and (vi) related notes to these financial statements.

 

 

EX – 104

The cover page from The Hanover Insurance Group Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in iXBRL (embedded within EX – 101).

 

+

Management contract or compensatory plan or arrangement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

The Hanover Insurance Group, Inc.

 

 

Registrant

 

 

 

April 29, 2020

 

/s/ John C. Roche

Date

 

John C. Roche

 

 

President, Chief Executive Officer and Director

 

 

 

 

 

 

April 29, 2020

 

/s/ Jeffrey M. Farber

Date

 

Jeffrey M. Farber

 

 

Executive Vice President and Chief Financial Officer

 

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