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THG Hanover Insurance

Filed: 23 Feb 21, 7:00pm
0000944695 thg:CommercialMultiplePerilLineMember us-gaap:ShortdurationInsuranceContractsAccidentYear2016Member 2017-12-31

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

For the fiscal year ended December 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 Symbol

 

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

 

 

 

 

 

 

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

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes      No  

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 has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

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

Based on the closing sales price of June 30, 2020, the aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant was $3,814,120,782.

The number of shares outstanding of the registrant’s common stock, $0.01 par value, was 36,387,389 shares as of February 19, 2021.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of The Hanover Insurance Group, Inc.’s Proxy Statement to be filed pursuant to Regulation 14A relating to the 2021 Annual Meeting of Shareholders to be held May 11, 2021 are incorporated by reference in Part III.

 

 

 


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2020

TABLE OF CONTENTS

 

Item

 

Description

 

Page

 

 

 

 

 

Part I

 

 

 

 

 

 

 

 

 

1

 

Business

 

3

 

 

 

 

 

1A.

 

Risk Factors

 

17

 

 

 

 

 

1B.

 

Unresolved Staff Comments

 

32

 

 

 

 

 

2

 

Properties

 

32

 

 

 

 

 

3

 

Legal Proceedings

 

32

 

 

 

 

 

4

 

Mine Safety Disclosures

 

32

 

 

 

 

 

Part II

 

 

 

 

 

 

 

 

 

5

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities

 

33

 

 

 

 

 

6

 

Selected Financial Data

 

34

 

 

 

 

 

7

 

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

 

35

 

 

 

 

 

7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

70

 

 

 

 

 

8

 

Financial Statements and Supplementary Data

 

71

 

 

 

 

 

9

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

122

 

 

 

 

 

9A.

 

Controls and Procedures

 

122

 

 

 

 

 

9B.

 

Other Information

 

122

 

 

 

 

 

Part III

 

 

 

 

 

 

 

 

 

10

 

Directors, Executive Officers and Corporate Governance

 

123

 

 

 

 

 

11

 

Executive Compensation

 

125

 

 

 

 

 

12

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

125

 

 

 

 

 

13

 

Certain Relationships and Related Transactions, and Director Independence

 

125

 

 

 

 

 

14

 

Principal Accounting Fees and Services

 

125

 

 

 

 

 

Part IV

 

 

 

 

 

 

 

 

 

15

 

Exhibits, Financial Statement Schedules

 

126

 

 

 

 

 

 

 

Exhibits Index

 

127

 

 

 

 

 

16

 

Form 10-K Summary

 

130

 

 

 

 

 

 

 

Signatures

 

131

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Table of Contents

 

PART I

ITEM 1 — BUSINESS

ORGANIZATION

The Hanover Insurance Group, Inc. (“THG”) is a holding company organized as a Delaware corporation in 1995. We trace our roots to as early as 1852, when the Hanover Fire Insurance Company was founded. Our primary business operations are property and casualty insurance products and services. We market our products and services through independent agents and brokers in the United States (“U.S.”). Our consolidated financial statements include the accounts of THG; The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), which are our principal property and casualty subsidiaries; and other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting primarily of our former accident and health and life insurance businesses, as well as our former Chaucer international business.

INFORMATION ABOUT OPERATING SEGMENTS

We conduct our business operations through three operating segments. These segments are Commercial Lines, Personal Lines and Other. We report interest expense related to our corporate debt separately from the earnings of our operating segments.

Information with respect to each of our segments is included in “Results of Operations - Segments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations ("Management's Discussion and Analysis") and in Note 13 – “Segment Information” in the Notes to Consolidated Financial Statements.

The following is a discussion of our operating segments.

GENERAL

In our Commercial Lines and Personal Lines segments, we underwrite commercial and personal property and casualty insurance through Hanover Insurance, Citizens and other THG subsidiaries, through an independent agent and broker network concentrated in the Northeast, Midwest and Southeast U.S. We also continue to actively grow our Commercial Lines’ presence in the Western region of the U.S., particularly in California, which is our largest state for Commercial Lines as measured by net premiums written. Included in our Other segment are Opus Investment Management, Inc. (“Opus”), a wholly owned subsidiary of THG, which provides investment management services to our insurance and non-insurance companies, as well as to unaffiliated 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 former life insurance employees and agents; and a run-off voluntary property and casualty pools business.

Our business strategy focuses on providing our agents and customers with competitive insurance products delivered with clear and consistent underwriting and pricing expectations, while prudently growing and diversifying our product and geographical business mix. We conduct our business with an emphasis on disciplined underwriting, pricing, quality claim handling and customer service. In 2020, we wrote approximately $4.6 billion in net premiums. Agency relationships and active agency management are core to our strategy. Based on net premiums written, we rank among the top 25 property and casualty insurers in the United States.

RISKS

The industry’s and our profitability are significantly affected by numerous factors, including price; competition; volatile and unpredictable developments, such as weather conditions, catastrophes and other disasters; legal and regulatory developments affecting pricing, underwriting, policy coverage and other aspects of doing business, as well as insurer and insureds’ liability; extra-contractual liability; increased attorney involvement in claims matters; size of jury awards; acts of terrorism; fluctuations in interest rates and the value of investments; and other general economic conditions and trends, such as inflationary pressure or unemployment, that may affect the adequacy of reserves or the demand for insurance products. Our investment portfolio and its future returns are impacted by the capital markets and current economic conditions, which affect our liquidity, realized losses and impairments, credit default levels, our ability to hold such investments until recovery and other factors. Additionally, the economic conditions in geographic locations where we conduct business, especially those locations where our business is concentrated, affect the growth and profitability of our business. The regulatory environments in those locations, including any pricing, underwriting or product controls, shared market mechanisms or mandatory pooling arrangements, and other conditions, such as our agency relationships, affect the growth and profitability of our business. Our loss and loss adjustment expense (“LAE”) reserves are based on estimates, principally involving case assessments and actuarial projections, at a given time, of what we expect the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims frequency and severity and judicial theories of liability, costs of repairs and replacement, legislative activity and other factors. We regularly reassess our estimate of loss reserves and LAE, both for current and past years, and resulting changes have and will affect our reported profitability and financial position.

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The outbreak of the novel coronavirus, also known as COVID-19, and subsequent global pandemic (“Pandemic”) significantly impacted the U.S. and global financial markets and economies during 2020. Circumstances relating to the Pandemic are unprecedented in scope, continue to evolve, and are complex and uncertain. Our investment portfolio was affected by the deterioration in investment markets during March 2020, as well as their recovery in the subsequent months. In addition, we experienced both favorable and adverse effects from the Pandemic on our underwriting results and operations, as well as our financial condition, during March through December of 2020. However, we continue to believe that the Pandemic’s impacts on our results going forward should be manageable. 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.

Reference is also made to “Risk Factors” in Part I – Item 1A.

LINES OF BUSINESS

Commercial Lines

Our Commercial Lines segment generated $2.9 billion, or 59.5%, of consolidated operating revenues and $2.7 billion, or 59.4%, of net premiums written, for the year ended December 31, 2020.

The following table provides net premiums written by line of business for our Commercial Lines segment.

 

 

Net Premiums

 

 

 

 

 

YEAR ENDED DECEMBER 31, 2020

 

Written

 

 

% of Total

 

(in millions, except ratios)

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

921.7

 

 

 

33.7

%

Commercial automobile

 

 

336.0

 

 

 

12.3

 

Workers' compensation

 

 

320.3

 

 

 

11.7

 

Other commercial lines:

 

 

 

 

 

 

 

 

Management and professional liability

 

 

271.8

 

 

 

9.9

 

Marine

 

 

264.4

 

 

 

9.7

 

Hanover Programs

 

 

179.1

 

 

 

6.6

 

Specialty industrial and commercial property

 

 

166.0

 

 

 

6.1

 

Monoline general liability

 

 

91.3

 

 

 

3.3

 

Surety

 

 

61.1

 

 

 

2.2

 

Other

 

 

121.4

 

 

 

4.5

 

Total

 

$

2,733.1

 

 

 

100.0

%

Our Commercial Lines product suite provides agents and customers with products designed for small, middle and specialized markets.

Commercial Lines coverages include:

Commercial multiple peril coverage insures businesses against third-party general liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold. It also insures business property for damage, such as that caused by fire, wind, hail, water damage (which may include flood), theft and vandalism.

Commercial automobile coverage insures businesses against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured’s vehicle and property damage to other vehicles and property. Commercial automobile policies are often written in conjunction with other commercial policies.

Workers’ compensation coverage insures employers against employee medical and indemnity claims resulting from injuries related to work. Workers’ compensation policies are often written in conjunction with other commercial policies.

Other commercial lines is comprised of:

 

management and professional liability coverage is primarily composed of professional, management, and medical liability, which provides protection for directors, officers and other employees of companies that may be sued in connection with their performance, and errors and omissions protection to companies and individuals against negligence or bad faith, as well as protection for employment practices liability;

 

 

marine coverage includes inland and ocean marine and insures businesses against physical losses to property, such as contractor’s equipment, builders’ risk and goods in transit, and also covers jewelers block, fine art and other  valuables;

 

 

Hanover Programs (formerly referred to as “AIX”) provide coverage to markets where there are specialty coverage or risk management needs related to groups of similar businesses, including commercial multiple peril, commercial automobile, general liability, workers’ compensation, and other commercial coverages;

 

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specialty industrial and commercial property provides insurance to small and medium-sized chemical, paint, solvent and other manufacturing and distribution companies, and fire and allied lines coverages;

 

 

monoline general liability coverage includes bodily injury, property damage and personal injury arising from products sold, or accidents occurring on premises, or from operations;

 

 

surety provides businesses with contract surety coverage in the event of claims for non-performance or non-payment, and commercial surety coverage related to fiduciary or regulatory obligations; and

 

 

other commercial lines coverages include umbrella, and fidelity and crime.

 

Our strategy in Commercial Lines focuses on building deep relationships with partner independent agents through differentiated product offerings, industry segmentation, and franchise value through selective distribution. We continue to make enhancements to our products and technology platforms that are intended to drive more total account placements in our small commercial and middle market business, and to enhance underwriting margins in our specialty businesses. This aligns with our focus of delivering the capabilities that we believe will help expand the depth and breadth of our partnerships with a limited number of agents.

Our small commercial, middle market and specialty businesses each constitute approximately one-third of our total Commercial Lines business. Small commercial offerings, which generally include annual premiums of $50,000 or less, deliver value through product expertise, local presence and ease of doing business. Middle market accounts, with annual premiums generally in the range of $50,000 to $250,000, require greater underwriting and claim expertise, as well as a focus on industry segments where we can deliver differentiation in the market and value to agents and customers. Small and middle market accounts, which sometimes together are referred to as our “Core Commercial Lines” business, comprise approximately $1.7 billion of the Commercial Lines segment net premiums written. Our specialty lines of business include management and professional liability, marine, Hanover Programs, specialty industrial and commercial property, monoline general liability and surety.

In our small commercial and middle market businesses, we offer coverages and capabilities in several key industries including technology, schools and human services organizations, such as non-profit youth and community service organizations. We also provide further segmentation in our core middle market commercial products, including real estate, hospitality, manufacturing, contractors and wholesale distributors.

Part of our strategy is to expand our specialty lines offerings to provide our agents and policyholders with a broader product portfolio to address their needs and to increase our market share of our partner agents’ total business. We have over time acquired various specialized businesses aimed at further diversifying and growing our specialty lines. We used these acquisitions as platforms to expand our product offerings and grow within our existing agency and broker distribution network.

We believe our small commercial capabilities, distinctiveness in the middle market, and continued development of our specialty business offerings provide us with a diversified portfolio of products and enable us to deliver significant value to our agents and policyholders. We believe these efforts will enable us to continue to improve the overall mix of our business and ultimately our underwriting profitability.

Personal Lines

Our Personal Lines segment generated $1.9 billion, or 40.1%, of consolidated operating revenues and $1.9 billion, or 40.6%, of net premiums written, for the year ended December 31, 2020.

The following table provides net premiums written by line of business for our Personal Lines segment.

 

 

Net Premiums

 

 

 

 

 

YEAR ENDED DECEMBER 31, 2020

 

Written

 

 

% of Total

 

(in millions, except ratios)

 

 

 

 

 

 

 

 

Personal automobile

 

$

1,151.5

 

 

 

61.7

%

Homeowners

 

 

653.4

 

 

 

35.0

 

Other

 

 

60.5

 

 

 

3.3

 

Total

 

$

1,865.4

 

 

 

100.0

%

Personal Lines coverages include:

Personal automobile coverage insures individuals against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured’s vehicle and property damage to other vehicles and other property.

Homeowners coverage insures individuals for losses to their residences and personal property, such as those caused by fire, wind, hail, water damage (excluding flood), theft and vandalism, and against third-party liability claims.

Other personal lines are comprised of personal umbrella, inland marine (jewelry, art, etc.), fire, personal watercraft and other miscellaneous coverages.

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Our strategy in Personal Lines is to provide account–oriented business (i.e., writing both an insured’s automobile and homeowners insurance, along with other Personal Lines coverages, when applicable) through our partner agencies, with a focus on increasing geographic diversification. The market for our Personal Lines business is very competitive, with continued pressure on independent agents from direct writers, as well as from the increased usage of real time comparative rating tools and increasingly sophisticated rating and pricing tools. We maintain a focus on partnering with high quality, value-added agencies that stress the importance of consultative selling and account rounding (the conversion of single policy customers to accounts with multiple policies and/or additional coverages, to address customers’ broader objectives). We are focused on making business investments that are intended to help us maintain profitability, build a distinctive position in the market and provide us with profitable growth opportunities. We continue to refine our products and to work closely with these high potential agents to increase the percentage of business they place with us and to ensure that it is consistent with our preferred mix of business. Additionally, we remain focused on further diversifying our geographic mix beyond the largest historical core states of Michigan, Massachusetts and New York. We expect these efforts to decrease our risk concentrations and our dependency on these three states, as well as to contribute to improved profitability over time.

Other

The Other segment includes Opus, which provides investment advisory services to affiliates and also manages approximately $4.2 billion of assets for unaffiliated institutions, such as insurance companies, retirement plans and foundations, including $1.6 billion of funds managed at December 31, 2020, on behalf of China Reinsurance (Group) Corporation ("China Re") for our former Chaucer segment. The Other segment also includes earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to former life insurance employees and agents; and our run-off voluntary property and casualty pools business.

MARKETING AND DISTRIBUTION

We serve a variety of standard, specialty and targeted industry markets. Consistent with our objective to diversify our underwriting risks on a geographic and line of business basis, we currently have a split of approximately 40% Personal Lines, 40% Core Commercial Lines, and 20% specialty lines. Commercial Lines, including our small, middle market and specialty businesses, and Personal Lines segments distribute our products primarily through an independent agent network.

Commercial and Personal Lines

Our Commercial and Personal Lines independent agency distribution and field structure are designed to maintain a strong focus on local markets and the flexibility to respond to specific market conditions. During 2020, we wrote 21.0% of our Commercial and Personal Lines business in Michigan and 9.2% in Massachusetts. Our structure is a key factor in the establishment and maintenance of productive, long-term relationships with well-established independent agencies. We maintain 37 local offices across 25 states. The majority of processing support for these locations is provided from Worcester, Massachusetts; Howell, Michigan; Salem, Virginia; and Windsor, Connecticut.

Independent agents account for substantially all of the sales of our Commercial and Personal Lines property and casualty products. Agencies are appointed based on profitability, track record, financial stability, growth potential, professionalism and business strategy. Once appointed, we monitor their performance and, subject to legal and regulatory requirements, may take actions as necessary to change these business relationships, such as discontinuing the authority of the agent to underwrite certain products, or revising commissions or bonus opportunities. We compensate agents primarily through base commissions and bonus plans that are tied to an agency’s written premium, growth and profitability.

Our Hanover Programs business and some specialty business is also distributed through managing general agents or wholesale distributors who have expertise in the industries served or products offered.

We are licensed to sell property and casualty insurance in all fifty states in the U.S., as well as in the District of Columbia (“D.C.”). Throughout the U.S., we actively market Commercial Lines policies in 37 states and D.C. and Personal Lines policies in 20 states.

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The following table provides our top Commercial and Personal Lines geographical markets based on total net premiums written in the state in 2020.

YEAR ENDED

DECEMBER 31, 2020

 

Commercial Lines

 

 

Personal Lines

 

 

Total Commercial and

Personal Lines

 

(in millions, except ratios)

 

Net

Premiums

Written

 

 

% of Total

 

 

Net

Premiums

Written

 

 

% of Total

 

 

Net

Premiums

Written

 

 

% of Total

 

Michigan

 

$

145.5

 

 

 

5.3

%

 

$

821.8

 

 

 

44.1

%

 

$

967.3

 

 

 

21.0

%

Massachusetts

 

 

181.5

 

 

 

6.6

 

 

 

241.6

 

 

 

13.0

 

 

 

423.1

 

 

 

9.2

 

New York

 

 

217.5

 

 

 

8.0

 

 

 

116.9

 

 

 

6.3

 

 

 

334.4

 

 

 

7.3

 

California

 

 

316.6

 

 

 

11.6

 

 

 

 

 

 

 

 

 

316.6

 

 

 

6.9

 

Texas

 

 

232.9

 

 

 

8.5

 

 

 

 

 

 

 

 

 

232.9

 

 

 

5.1

 

Illinois

 

 

119.6

 

 

 

4.4

 

 

 

97.9

 

 

 

5.2

 

 

 

217.5

 

 

 

4.7

 

New Jersey

 

 

143.4

 

 

 

5.2

 

 

 

69.5

 

 

 

3.7

 

 

 

212.9

 

 

 

4.6

 

Connecticut

 

 

60.0

 

 

 

2.2

 

 

 

104.9

 

 

 

5.6

 

 

 

164.9

 

 

 

3.6

 

Georgia

 

 

85.2

 

 

 

3.1

 

 

 

55.6

 

 

 

3.0

 

 

 

140.8

 

 

 

3.1

 

Virginia

 

 

85.6

 

 

 

3.1

 

 

 

37.5

 

 

 

2.0

 

 

 

123.1

 

 

 

2.7

 

Maine

 

 

66.4

 

 

 

2.4

 

 

 

51.8

 

 

 

2.8

 

 

 

118.2

 

 

 

2.6

 

Wisconsin

 

 

51.2

 

 

 

1.9

 

 

 

43.2

 

 

 

2.3

 

 

 

94.4

 

 

 

2.1

 

Tennessee

 

 

53.7

 

 

 

2.0

 

 

 

36.4

 

 

 

2.0

 

 

 

90.1

 

 

 

2.0

 

Indiana

 

 

57.8

 

 

 

2.1

 

 

 

30.4

 

 

 

1.6

 

 

 

88.2

 

 

 

1.9

 

Pennsylvania

 

 

64.2

 

 

 

2.3

 

 

 

20.9

 

 

 

1.1

 

 

 

85.1

 

 

 

1.9

 

Minnesota

 

 

81.0

 

 

 

3.0

 

 

 

 

 

 

 

 

 

81.0

 

 

 

1.8

 

Florida

 

 

76.8

 

 

 

2.8

 

 

 

 

 

 

 

 

 

76.8

 

 

 

1.7

 

New Hampshire

 

 

42.6

 

 

 

1.6

 

 

 

33.1

 

 

 

1.8

 

 

 

75.7

 

 

 

1.6

 

North Carolina

 

 

71.8

 

 

 

2.6

 

 

 

1.2

 

 

 

0.1

 

 

 

73.0

 

 

 

1.6

 

Ohio

 

 

40.6

 

 

 

1.5

 

 

 

28.9

 

 

 

1.5

 

 

 

69.5

 

 

 

1.5

 

Other

 

 

539.2

 

 

 

19.8

 

 

 

73.8

 

 

 

3.9

 

 

 

613.0

 

 

 

13.1

 

Total

 

$

2,733.1

 

 

 

100.0

%

 

$

1,865.4

 

 

 

100.0

%

 

$

4,598.5

 

 

 

100.0

%

We manage our Commercial Lines portfolio, which includes our core and specialty businesses, with a focus on growth from the most profitable industry segments within our underwriting expertise. Our core business is generally comprised of several complementary commercial lines of business, consisting of small and middle market accounts, which include targeted industry segments. Additionally, we have multiple specialty lines of business. The Commercial Lines segment seeks to maintain strong agency relationships as an approach to secure and retain our agents’ best business. We monitor quality of business written through ongoing quality reviews, accountability for which is shared at the local, regional and corporate levels.

We manage Personal Lines business with a focus on acquiring and retaining preferred accounts. Currently, approximately 85% of our policies in force are account business. Approximately 57% of our Personal Lines net premium written is generated in the combined states of Michigan and Massachusetts. In Michigan, based upon direct premiums written for 2020, we underwrite approximately 7% of the state’s total market.

Approximately 66% of our Michigan Personal Lines net premium written is in the personal automobile line and 32% is in the homeowners line. Michigan business represents approximately 47% of our total personal automobile net premiums written and approximately 40% of our total homeowners net premiums written. In Michigan, we are a principal market for many of our appointed agencies, with approximately $2.2 million of total direct premiums written per agency in 2020.

In addition, in 2019, Michigan enacted major reforms of its current system governing personal and commercial automobile insurance, especially related to automobile Personal Injury Protection (“PIP”) coverage. We believe that we are effectively executing the transition to the reformed system and expect to navigate this market successfully. As of December 31, 2020, the net impact of these reforms was not significant to our total net premiums written and underwriting profit. For the full year 2020, net premiums written that were attributable to PIP coverage in Michigan were $144.3 million, or 3.1% of our total company full year 2020 net premiums written, while Michigan personal automobile net premiums written represented 11.7% of THG’s total company full year 2020 net premiums written. For more information, please refer to “Risk Factors” in Part I – Item 1A.

Approximately 66% of our Massachusetts Personal Lines net premium written is in the personal automobile line and 30% is in the homeowners line. Massachusetts business represents approximately 14% of our total personal automobile net premiums written and approximately 11% of our total homeowners net premiums written.

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We sponsor local and national agent advisory councils to gain the benefit of our agents’ insight and enhance our relationships. These councils provide market and operational feedback, input on the development of products and services, guidance on marketing efforts, and support for our strategies, and assist us in enhancing our local market presence.  

Other

With respect to our Other segment business, we market our third-party investment advisory services directly through Opus.

PRICING AND COMPETITION

The property and casualty insurance industry is a very competitive market. In the Commercial and Personal Lines segments, we market and distribute through independent agents and brokers, and compete for business on the basis of product, price, agency and customer service, local relationships, ratings and effective claims handling, among other things. Our competitors include national, international, regional and local companies that sell insurance through various distribution channels, including independent agencies, captive agency forces, brokers and direct to consumers through the internet or otherwise. They also include mutual insurance companies, reciprocals and exchanges. We believe that our emphasis on maintaining strong agency relationships and a local presence in our markets, coupled with investments in products, operating efficiency, technology and effective claims handling, enable us to differentiate ourselves and compete more effectively. Our broad product offerings in Commercial Lines and total account strategy in Personal Lines are instrumental to our ability to capitalize on these relationships and improve profitability.

We seek to achieve targeted combined ratios in each of our product lines. Targets vary by product and geography and change with market conditions. The targeted combined ratios reflect competitive market conditions, investment yield expectations, our loss payout patterns and target returns on equity. This approach is intended to enable us to achieve measured growth and consistent profitability.

For all major product lines in the Commercial and Personal Lines segments, we employ pricing teams that produce exposure and experience-based rating models to support underwriting and pricing decisions. In addition, we seek to utilize our understanding of local markets to achieve superior underwriting results. We rely on market information provided by our local agents and on the knowledge of staff in the local branch offices. Since we maintain a strong regional focus and a significant market share in a number of states, we can better apply our knowledge and experience in making underwriting and rate setting decisions. Also, we seek to gather objective and verifiable information at a policy level during the underwriting process, including prior loss experience, past driving records and, where permitted, credit histories.

CLAIMS MANAGEMENT

Claims management includes the receipt of initial loss notifications, generation of appropriate responses to claim reports, loss appraisals, identification and handling of coverage issues, determination of whether further investigation is required, retention of legal representation where appropriate, establishment of case reserves, approval of loss payments and notification to reinsurers. Part of our strategy focuses on efficient, timely and fair claim settlements to meet customer service expectations and maintain valuable independent agent relationships. Additionally, effective claims management is important to our business since claim payments and related loss adjustment expenses are our largest expenditures.

We utilize experienced claims adjusters, appraisers, medical specialists, managers and attorneys to manage our claims. Our property and casualty operations have field claims adjusters located throughout the states and regions in which we do business. Claims field staff members work closely with the independent agents who bound the policies under which coverage is claimed. Claims office adjusting staff is supported by general adjusters for large property and large casualty losses, by automobile and heavy equipment damage appraisers for automobile material damage losses, and by medical specialists whose principal concentration is on workers’ compensation and automobile injury cases. Additionally, the claims offices are supported by staff attorneys, both in the home office and in regional locations, who specialize in litigation defense and claim settlements. We have a catastrophe response team to assist policyholders impacted by severe weather events. This team mobilizes quickly to impacted regions, often in advance for a large tracked storm, to support our local claims adjusters and facilitate a timely response to resulting claims. We also maintain a special unit that investigates suspected insurance fraud and abuse. We utilize claims processing technology which allows most of the smaller and more routine Personal Lines claims to be processed at centralized locations.

CATASTROPHES

We are subject to claims arising out of catastrophes, which historically have had a significant impact on our results of operations and financial condition. Coverage for such events is a core part of our business, and we expect to experience catastrophe losses in the future, which could have a material adverse impact on our financial results and position. Catastrophes can be caused by various events, including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, severe winter weather, fire, explosions, riots, and terrorism. The incidence and severity of catastrophes are volatile and difficult to predict.

We endeavor to manage our catastrophe risks through underwriting procedures, including the use of deductibles and specific restrictions for flood and earthquake coverage, subject to regulatory restrictions and competitive pressures, and through geographic exposure management and reinsurance. Our catastrophe reinsurance program is structured to protect us on a per-occurrence and aggregate excess basis. We monitor geographic location and coverage concentrations with a view toward managing corporate exposure to catastrophic events. Although catastrophes can cause losses in a variety of property and casualty lines, commercial multiple peril and homeowners property coverages have, in the past, generated the majority of catastrophe-related claims.

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REINSURANCE

Reinsurance Program Overview

We maintain ceded reinsurance programs designed to protect against large or unusual loss and LAE activity. We utilize a variety of proportional and non-proportional reinsurance agreements, which are intended to control our individual policy and aggregate exposure to large property and casualty losses, stabilize earnings and protect capital resources. These programs include facultative reinsurance (to limit exposure on a specified policy); specific excess and proportional treaty reinsurance (to limit exposure on individual policies or risks within specified classes of business); and catastrophe excess of loss reinsurance (to limit exposure to any one event that might impact more than one individual policy). Our proportional reinsurance consists of quota share reinsurance agreements and our non-proportional reinsurance includes excess of loss and stop loss reinsurance agreements.

Catastrophe reinsurance protects us, as the ceding insurer, from significant losses arising from a single event including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, severe winter weather, fire, explosions, riots, flood and terrorism. We determine the appropriate amount of reinsurance based on our evaluation of the risks insured, exposure analyses prepared by advisors, our risk appetite and market conditions, including the availability and pricing of reinsurance. Although we believe our catastrophe reinsurance program, including our retention and co-participation amounts for 2021, is appropriate given our surplus level and the current reinsurance pricing environment, there can be no assurance that our reinsurance program will provide coverage levels that will prove adequate should we experience losses from one significant or several large catastrophes during 2021. Additionally, as a result of the current economic environment, as well as losses incurred by reinsurers in the past several years, the availability and pricing of appropriate reinsurance programs may be adversely affected in future renewal periods. We may not be able to pass these costs on to policyholders, or there may be a delay in passing these costs to policyholders, in the form of higher premiums or assessments.

We cede to reinsurers a portion of our risk based upon insurance policies subject to such reinsurance. Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to us. We believe that the terms of our reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Subsequent to the emergence of COVID-19 in March 2020, some of our reinsurance contract renewals contain varying forms of pandemic and other exclusions, which we believe are consistent with current reinsurance contract exclusions in the market generally. We believe our reinsurers are financially sound, based upon our ongoing review of the financial strength ratings assigned to them by rating agencies, their reputations in the reinsurance marketplace, our collections history, information and advice from third parties, and the analysis and guidance of our reinsurance advisors.

Reference is made to Note 14 — “Reinsurance” in the Notes to Consolidated Financial Statements. Reference is also made to “Involuntary Residual Markets” below.

Our 2021 reinsurance program for our Commercial Lines and Personal Lines segments is substantially consistent with our 2020 program design. The following discussion summarizes both our 2020 and 2021 reinsurance programs for our Commercial Lines and

Personal Lines segments (excluding coverage available under the U.S. federal terrorism program which is described below under “Terrorism”), but does not purport to be a complete description of the program or the various restrictions or limitations which may apply:

 

Our Commercial Lines and Personal Lines segments are primarily protected by a property catastrophe occurrence program, a property per risk excess of loss treaty, as well as a casualty excess of loss treaty, with retentions of $200 million, $2.5 million, and $2 million, respectively.

 

The property catastrophe occurrence program provides coverage, on an occurrence basis, up to $1.1 billion countrywide, less a $200 million retention, with no co-participation, for all defined perils. For occurrences from $1.1 billion to $1.3 billion, we have coverage for 33% of losses. Additionally, there is a program feature which provides coverage in excess of $300 million in aggregate catastrophe losses. This feature provides $75 million of coverage, subject to 24% co-participation, that may respond either to an event that exceeds $1.1 billion or to events in excess of $300 million in aggregate catastrophe losses. The catastrophe losses subject to the aggregate feature are limited only to those events that exceed $7.5 million of incurred losses per event and have a per occurrence limit of $200 million.

 

The property per risk excess of loss treaty provides coverage, on a per risk basis, up to $100 million, less a $2.5 million retention, with a co-participation for the second half of 2020 and the first half of 2021 of 37.25% for reinsurance placed in the $2.5 million to $3.5 million layer, 3.25% for $6.5 million in excess of the $3.5 million layer, 0.75% of the $10 million in excess of $10 million layer, and no co-participation for reinsurance placed in excess of the $20 million to $100 million layer. There is a $10 million annual aggregate deductible for the $10 million excess of $10 million layer. Accordingly, we retain $10 million of loss in excess of the $10 million attachment point before we can make a reinsurance recovery from the $10 million excess of $10 million layer.

 

In 2020, the casualty excess of loss treaty provides coverage, on a per occurrence basis for each loss, up to $75 million less a $2 million retention, with no co-participation.

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For 2020 and 2021, Commercial Lines segments are further protected by excess of loss treaty agreements for specific lines of business. For example, the surety and fidelity bond excess of loss treaty provides coverage, on a per principal basis, up to $40 million, less a $7.5 million retention, with no co-participation.

 

In addition to certain layers of coverage from our Commercial and Personal Lines segment reinsurance program as described above, Hanover Programs also includes surplus share, quota share, excess of loss, stop loss, facultative and other forms of reinsurance that cover the writings from Hanover specialty and proprietary programs. There are a variety of different programs, and the reinsurance structure is generally customized to fit the exposure profile for each program.

Our intention is to renew the surety and fidelity bond treaty, the property per risk excess of loss treaty and the property catastrophe treaty in July 2021 with the same or similar terms and conditions, but there can be no assurance that we will be able to maintain our current levels of reinsurance, pricing and terms and conditions. Our 2021 casualty excess of loss treaty is effective January 1, 2021.

Terrorism

As a result of the continuing threat of terrorist attacks, the insurance industry maintains a high level of focus with respect to the potential for losses caused by terrorist acts. Insured losses may encompass people, property and business operations covered under workers’ compensation, commercial multiple peril and other Commercial Lines policies, as well as Personal Lines policies. In certain cases, such as workers’ compensation, we are not able to exclude coverage for these losses, either because of regulatory requirements or competitive pressures. Losses caused by terrorist acts are not excluded from homeowners or personal automobile policies. We continually evaluate the potential effect of these low frequency, but potentially high severity events in our overall pricing and underwriting plans, especially for policies written in major metropolitan areas.

Although certain terrorism-related risks embedded in our Commercial and Personal Lines are covered under the existing Catastrophe, Property per Risk and Casualty Excess of Loss corporate reinsurance treaties (see “Reinsurance – Reinsurance Program Overview” above for additional information), private sector catastrophe reinsurance is limited or unavailable for losses attributed to acts of terrorism, particularly those involving nuclear, biological, chemical and/or radiological events. As a result, the industry’s primary reinsurance protection against large-scale terrorist attacks in the U.S. is provided through a federal program that provides compensation for insured losses resulting from acts of terrorism.

The Terrorism Risk Insurance Act of 2002 first established the Terrorism Risk Insurance Program (the “Program”). Coverage under the Program applies to workers’ compensation, commercial multiple peril and certain other Commercial Lines policies for direct written policies. The Program will expire in December 2027. All commercial property and casualty insurers are required to participate in the Program. Under the Program, a participating issuer, in exchange for making terrorism insurance available, may be entitled to be reimbursed by the Federal government for a portion of its aggregate losses. The Program does not cover losses in surety, Personal Lines or certain other lines of business.

As required by the Program, we offer policyholders in specific lines of commercial insurance the option to elect terrorism coverage. In order for a loss event to be reinsured under the Program, the loss event must meet aggregate industry loss minimums and must be the result of an act of terrorism as certified by the Secretary of the Treasury in consultation with the Secretary of Homeland Security and the U.S. Attorney General. Losses from events which do not qualify or are not so certified will not receive the benefit of the Program. Such losses may be deemed covered losses under the insured’s policy whether or not terrorism coverage was purchased. Further, under the Terrorism Risk Insurance Program Reauthorization Act of 2015, our share of U.S. domestic losses in 2020 from such events, if deemed certified terrorist events, would have been limited to 19% of losses in excess of an approximate $431 million deductible, which represented 19.8% of year-end 2019 statutory policyholder surplus of our insurers, and, under the 2020 re-authorization, is estimated to be $471.2 million in 2021, representing 18.2% of 2020 year-end statutory policyholder surplus, up to a combined annual aggregate limit for the federal government and all insurers of $100 billion.

Given the unpredictability of terrorism losses, future losses from acts of terrorism could be material to our operating results, financial position, and/or liquidity. We attempt to manage our exposures on an individual line of business basis and in the aggregate by one-half square mile grids in major metropolitan areas.

Reinsurance Recoverables

When we experience loss events that are subject to a reinsurance contract, reinsurance recoverables are recorded. The amount of the recorded reinsurance recoverable depends on the estimated size of the individual loss or the aggregate amount of all losses in a particular line, book of business or an aggregate amount associated with a particular accident year. The valuation of losses recoverable depends on whether the underlying loss is a reported loss, or an incurred but not reported loss. For reported losses, we value reinsurance recoverables at the time the underlying loss is recognized, in accordance with contract terms. For incurred but not reported losses, we estimate the amount of reinsurance recoverable based on the terms of the reinsurance contracts and historical reinsurance recovery information and apply that information to the gross loss reserve estimates. The most significant assumption we use is the average size of the individual losses that will exceed our reinsurance retentions for those claims that have occurred but have not yet been reported to us. The reinsurance recoverable is based on what we believe are reasonable estimates and is disclosed separately on the financial statements. However, the ultimate amount of the reinsurance recoverable is not known until all losses are settled.

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Other than our investment portfolio, the single largest asset class is our reinsurance recoverables, which consist of our estimate of amounts recoverable from reinsurers with respect to losses incurred to date (including losses incurred but not reported) and unearned premiums, net of amounts estimated to be uncollectible. These estimates are expected to be revised at each reporting period and such revisions, which could be material, affect our results of operations and financial position. Reinsurance recoverables include amounts due from state mandatory reinsurance or other involuntary risk sharing mechanisms, and private reinsurers to whom we have voluntarily ceded business.

We are subject to concentration of risk with respect to reinsurance ceded to various mandatory residual markets, facilities and pooling mechanisms. As a condition to conduct business in various states, we are required to participate in residual market mechanisms, facilities and pooling arrangements which usually are designed to provide insurance coverages to individuals or other entities that are otherwise unable to purchase such coverage voluntarily or at rates deemed reasonable. These market mechanisms, facilities and pooling arrangements comprise $1,035.0 million of our total reinsurance recoverables on paid and unpaid losses and unearned premiums at December 31, 2020, $1,024.7 million of which is attributable to the Michigan Catastrophic Claims Association (“MCCA”).

The MCCA is a mandatory reinsurance association that reinsures claims that arise under Michigan’s unlimited personal injury protection coverage, which, as of July 2, 2020, is one of the available coverage options under Michigan’s no-fault automobile insurance statute. The MCCA reinsures all such claims in excess of a statutorily established company retention, currently $580,000. Funding for the MCCA comes from assessments against automobile insurers based upon their share of insured automobiles in the state for which the policyholders have elected unlimited PIP benefits. Insurers are allowed to pass along this cost to Michigan automobile policyholders. This recoverable accounted for 61% and 62% of our total personal automobile gross reserves at December 31, 2020 and 2019, respectively. Because the MCCA is supported by assessments permitted by statute, and there have been no significant uncollectible balances from MCCA identified during the three years ending December 31, 2020, we believe that we have no significant exposure to uncollectible reinsurance balances from this entity. As discussed under “Risk Factors” in Part I – Item 1A, in June 2019, Michigan enacted major reforms to its prior system governing personal and commercial automobile insurance.  These changes, among other things, eliminated the requirement to purchase unlimited personal injury protection and allowed consumers to purchase a choice of coverage options. In addition, the reform legislation set forth cost savings measures for personal injury protection claims, including MCCA-reinsured claims, that are expected to take effect in July 2021. Our current estimate of MCCA reinsurance receivables has not been reduced for these potential future claim cost savings.

In addition to the reinsurance ceded to various residual market mechanisms, facilities and pooling arrangements, we have $839.3 million of reinsurance assets due from traditional reinsurers as of December 31, 2020. These amounts are due principally from highly-rated reinsurers, defined as rated A- or higher by A.M. Best or other equivalent rating agency. In certain instances, for example in our Hanover Programs business, we also require, from the reinsurer, a deposit of assets in trust, letters of credit or other acceptable collateral in order to support balances due from reinsurers that provide reinsurance only on a collateralized basis. The following table displays balances recoverable from our ten largest reinsurance groups at December 31, 2020, along with the A.M. Best rating for each group’s ultimate parent or lead rating unit, if an A.M. Best rating is available. Reinsurance recoverables are comprised of paid losses recoverable, outstanding losses recoverable, incurred but not reported losses recoverable, and ceded unearned premium.

REINSURERS

 

A.M.  Best

Rating

 

 

Reinsurance

Recoverable

 

 

(in millions)

 

 

 

 

 

 

 

 

HDI Group (Hannover Ruckversicherungs AG)

 

A

 

 

$

124.9

 

Lloyd's Syndicates

 

A

 

 

 

105.7

 

Swiss Re Ltd.

 

A+

 

 

 

86.9

 

Allegheny Corporation (Transatlantic Reinsurance Co.)

 

A+

 

 

 

74.1

 

Toa Reinsurance Company Ltd.

 

A

 

 

 

67.7

 

Munich Reinsurance Companies

 

A+

 

 

 

64.6

 

Siward I Reinsurance Company Ltd.

 

 

(1)

 

 

 

44.1

 

Axis Capital Holding Ltd.

 

A

 

 

 

27.8

 

Giovanni Agnelli B.V. (Partner Reinsurance Company of the U.S.)

 

A+

 

 

 

23.1

 

Berkshire Hathaway Inc. (General Reinsurance Corp)

 

A++

 

 

 

22.6

 

Subtotal

 

 

 

 

 

 

641.5

 

All other reinsurers

 

 

 

 

 

 

197.8

 

Residual markets, facilities, and pooling arrangements

 

 

 

 

 

 

1,035.0

 

Total

 

 

 

 

 

$

1,874.3

 

(1)

No A.M. Best rating available. Reinsurance recoverable fully collateralized by assets in trust.

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Reinsurance recoverable balances in the table above are shown before consideration of balances owed to reinsurers and any potential rights of offset, including collateral held by us, and are net of an allowance for uncollectible recoverables. Reinsurance treaties are generally purchased on an annual basis. Treaties typically contain provisions that allow us to demand that a reinsurer post letters of credit or assets as security if a reinsurer is an unauthorized reinsurer under applicable regulations or if its rating falls below a predetermined contractual level. In regards to reinsurance recoverables due from Lloyd’s Syndicates, as part of the Lloyd’s “chain of security” afforded to all of its policyholders, recourse is available to the Lloyd’s Central Fund in the event of the failure of an individual syndicate and its capital providers.

Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, ceded reinsurance arrangements do not eliminate our obligation to pay claims to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. Specifically, our reinsurers may not pay claims made by us on a timely basis, or they may not pay some or all of these claims. In addition, from time to time insurers and reinsurers may disagree on the scope of the reinsurance or on the underlying insured risks. Any of these events would increase our costs and could have a material adverse effect on our business.

We have established a reserve for uncollectible reinsurance of $6.6 million as of December 31, 2020, or 0.3% of the total reinsurance recoverable balance, which was determined by considering reinsurer specific default risk on paid and unpaid recoverables as indicated by their financial strength ratings, any ongoing solvency issues, any current risk of dispute on paid recoverables, and our past collection experience. There have been no significant balances determined to be uncollectible and thus no significant charges recorded during 2020 for uncollectible reinsurance recoverables.

Our exposure to credit risk from any one reinsurer is managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. When reinsurance for our Commercial and Personal Lines segments is placed, our standards of acceptability generally require that a reinsurer must have a minimum policyholder surplus of $500 million, a rating from A.M. Best and/or S&P of “A” or better, or an equivalent financial strength if not rated. In addition, for lower rated or non-rated reinsurers, we customize collateral and restrict participation to effectively manage counterparty risk, with review and approval required by the counterparty credit committee.

REGULATION

Our property and casualty insurance subsidiaries are subject to extensive regulation in the states in which they transact business and are supervised by the individual state insurance departments. Numerous aspects of our business are subject to regulation, including premium rates, mandatory covered risks, limitations on the ability to cancel, non-renew, reject business or limit writings in certain geographic areas, prohibited exclusions, licensing and appointment or termination of agents, restrictions on the size of risks that may be insured under a single policy, reserves and provisions for unearned premiums, losses and other obligations, deposits of securities for the benefit of policyholders, investments and capital, policy forms and coverages, advertising, and other conduct, including restrictions on the use of credit information and other factors in underwriting, as well as other underwriting and claims practices. These restrictions limit the ability of insurers to underwrite or price policies on the basis of available third-party information (such as “social media”) and “big data”. Insurers are also subject to state laws and regulations governing the protection of their data systems and the use and protection of personal information collected in the ordinary course of operations. States also regulate various aspects of the contractual relationships between insurers and independent agents.

Such laws, rules and regulations are usually overseen and enforced by the various state insurance departments, as well as through private rights of action and by state attorneys general. Such regulations or enforcement actions are often responsive to current consumer and political sensitivities, such as automobile and homeowners insurance rates and coverage forms, or which may arise after a major event. Such rules and regulations may result in rate suppression, limit our ability to manage our exposure to unprofitable or volatile risks, require expenditures to facilitate compliance, or lead to fines, premium refunds or other adverse consequences. The federal government also may regulate aspects of our businesses, such as the use of insurance (credit) scores or other information in underwriting and the protection of confidential information.

In addition, as a condition to writing business in certain states, insurers are required to participate in various pools or risk sharing mechanisms or to accept certain classes of risk, regardless of whether such risks meet their underwriting requirements for voluntary business. Some states also limit or impose restrictions on the ability of an insurer to withdraw from certain classes of business. For example, Massachusetts, New York and California each impose material restrictions on a company’s ability to materially reduce its exposures or to withdraw from certain lines of business in their respective states. The state insurance departments can impose significant charges on an insurer in connection with a market withdrawal or refuse to approve withdrawal plans on the grounds that they could lead to market disruption. Laws and regulations that limit cancellation and non-renewal of policies or that subject withdrawal plans to prior approval requirements may significantly restrict our ability to exit unprofitable markets. Such actions and related regulatory restrictions may limit our ability to reduce our potential exposure to hurricane and other catastrophe-related losses.

The insurance laws of many states subject property and casualty insurers doing business in those states to statutory property and casualty guaranty fund assessments. The purpose of a guaranty fund is to protect policyholders by requiring that solvent property and casualty insurers pay the insurance claims of insolvent insurers. These guaranty associations generally pay these claims by assessing solvent insurers proportionately based on each insurer’s share of voluntary premiums written in the state. While most guaranty associations provide for recovery of assessments through subsequent rate increases, surcharges or premium tax credits, there is no assurance that insurers will ultimately recover these assessments, which could be material, particularly following a large catastrophe or in markets which become disrupted.

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We are subject to periodic financial and market conduct examinations conducted by state insurance departments. We are also required to file annual and other reports with state insurance departments relating to the financial condition of our insurance subsidiaries and other matters. The National Association of Insurance Commissioners (“NAIC”) and the Federal Insurance Office are each actively engaged in reviewing and considering proposed insurer risk-based capital standards, risk analysis, solvency assessments and other regulatory initiatives.

Other aspects of our business are subject to regulation as well. For example, Opus is subject to state and federal securities law, including regulation by the Securities and Exchange Commission (“SEC”), pertaining to the marketing and provision of institutional investment management services.

INVOLUNTARY RESIDUAL MARKETS

As noted above, as a condition of our license to write business in various states, we are required to participate in mandatory property and casualty residual market mechanisms which provide insurance coverages where such coverage may not otherwise be available or at rates deemed reasonable. Such mechanisms provide coverage primarily for personal and commercial property, personal and commercial automobile, and workers’ compensation, and include assigned risk plans, reinsurance facilities and involuntary pools, joint underwriting associations, fair access to insurance requirements (“FAIR”) plans and commercial automobile insurance plans.

For example, since most states compel the purchase of a minimal level of automobile liability insurance, states have developed shared market mechanisms to provide the required coverages and in many cases, optional coverages, to those drivers who, because of their driving records or other factors, cannot find insurers who will insure them voluntarily. Also, FAIR plans and other similar property insurance shared market mechanisms increase the availability of property insurance in circumstances where homeowners are unable to obtain insurance at rates deemed reasonable, such as in coastal areas or in areas subject to other hazards. Licensed insurers writing business in such states are often required to pay assessments to cover reserve deficiencies generated by such plans.

With respect to FAIR plans and other similar property insurance shared market mechanisms that have significant exposures, it is difficult to accurately estimate our potential financial exposure for future events. Assessments following a large coastal event, particularly one affecting Massachusetts, Texas, New York or North Carolina, or a large wildfire event affecting California, could be material to our results of operations. Our participation in such shared markets or pooling mechanisms is generally proportional to our direct writings for the type of coverage written by the specific pooling mechanism in the applicable state or other jurisdiction. For example, we are subject to mandatory participation in the Michigan Assigned Claims (“MAC”) facility. MAC is an assigned claim plan covering people injured in uninsured motor vehicle accidents. Our participation in the MAC facility is based on our share of personal and commercial automobile direct written premium in the state and resulted in underwriting losses of $15.4 million in 2020. There were no other mandatory residual market mechanisms that were significant to our 2020 results of operations.

RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

Reference is made to “Results of Operations – Segments – Reserve for Losses and Loss Adjustment Expenses” of Management’s Discussion and Analysis for discussion of prior year development. Additionally, information regarding loss and LAE reserve development appears in Note 15 – “Liabilities for Outstanding Claims, Losses and Loss Adjustment Expenses” in the Notes to Consolidated Financial Statements.

The following table reconciles reserves determined in accordance with accounting practices prescribed or permitted by insurance statutory authorities (“Statutory”) to reserves determined in accordance with generally accepted accounting principles (“GAAP”). The primary difference between the Statutory reserves and our GAAP reserves is the requirement, on a GAAP basis, to present reinsurance recoverables as an asset, whereas Statutory guidance provides that reserves are reflected net of the corresponding reinsurance recoverables. We do not use discounting techniques in establishing GAAP reserves for property and casualty losses and LAE, nor have we participated in any loss portfolio transfers or other similar transactions.

DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Statutory reserve for losses and LAE

 

$

4,490.4

 

 

$

4,184.2

 

 

$

3,935.6

 

GAAP adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

Reinsurance recoverables on unpaid losses of our

   insurance subsidiaries

 

 

1,641.6

 

 

 

1,574.8

 

 

 

1,472.6

 

Statutory reserves for discontinued accident and health business

 

 

(116.2

)

 

 

(113.2

)

 

 

(112.4

)

Other

 

 

8.2

 

 

 

8.6

 

 

 

8.3

 

GAAP reserve for losses and LAE

 

$

6,024.0

 

 

$

5,654.4

 

 

$

5,304.1

 

Reserves for discontinued accident and health business of our insurance subsidiaries are included in liabilities of discontinued operations for GAAP and loss and loss adjustment expenses for Statutory reporting.

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DISCONTINUED OPERATIONS

Discontinued operations include our discontinued accident and health and life businesses and our former Chaucer operations.

Accident and Health and Life Businesses

The discontinued accident and health business includes interests in 24 accident and health reinsurance pools and arrangements that we retained subsequent to the sale of First Allmerica Financial Life Insurance Company (“FAFLIC”) in 2009. We ceased writing new premiums in this business in 1999, subject to certain contractual obligations. The reinsurance pool business consists primarily of long-term care, the medical and disability portions of workers’ compensation risks, assumed personal accident, individual medical, long-term disability, and special risk business. This business also includes residual health insurance policies. Total reserves for the assumed accident and health business were $117.4 million at December 31, 2020. The long-term care pool accounted for approximately 73% of these reserves as of December 31, 2020. Reserves for the long-term care pool, individual medical, and residual health insurance policies are discounted. Reserves for all other assumed accident and health business are undiscounted. Assets and liabilities related to the discontinued accident and health business are reflected as assets and liabilities of discontinued life businesses.

Loss estimates associated with substantially all of the discontinued accident and health business are provided by managers of each pool. We adopt reserve estimates for this business that consider this information, expected returns on assets assigned to this business and other facts. We update these reserves as new information becomes available and further events occur that may affect the ultimate resolution of unsettled claims. Based on information provided to us by the pool managers, we believe the reserves recorded related to this business are adequate. However, since reserve and claim cost estimates related to the discontinued accident and health business are dependent on several assumptions, including, but not limited to, morbidity, lapses, future premium rates, future health care costs, persistency of medical care inflation and investment performance, and these assumptions can be impacted by technical developments and advancements in the medical field, medical and long-term care inflation and other factors, there can be no assurance that the reserves established for this business will prove sufficient. Revisions to these reserves could have a material adverse effect on our results of operations for a particular quarterly or annual period or on our financial position.  See also “Risk Factors” in Part I – Item 1A.

Our long-term care pool accounts for the majority of our remaining reinsurance pool business. The potential risk and exposure of our long-term care pool is based upon expected estimated claims and payment patterns, using assumptions for, among other things, morbidity, lapses, future premium rates, and the interest rate used for discounting the future projected cash flows, as well as regulatory developments affecting the ceding insurers. The long-term exposure of this pool depends upon how our actual experience compares with these future cash flow projection assumptions.

Our former life insurance businesses, which are also included in discontinued operations, include activities that were not significant to our 2020 results, although we retain indemnification obligations with respect to these businesses.

Chaucer

In 2018 and 2019, we sold the components of our Chaucer segment to China Re. Prior to the sale, this business encompassed our international property and casualty insurance products sold principally by a wholly-owned United Kingdom-based subsidiary operating through the Society and Corporation of Lloyd’s (“Lloyd’s”), and other international insurance and non-insurance subsidiaries. Results from our former Chaucer segment were not significant in 2020, although we retain certain indemnification obligations with respect to this business.

See also the “Discontinued Chaucer Business” section in our Management’s Discussion and Analysis and Note 2 – “Discontinued Operations” in the Notes to Consolidated Financial Statements.

INVESTMENT PORTFOLIO

Our wholly-owned subsidiary, Opus, is responsible for managing our investment portfolio. Opus directly manages our entire fixed maturity and equity security portfolios, which together with cash, constitute approximately 91% of our investment portfolio. Opus is also responsible for the selection and monitoring of external asset managers for our commercial mortgage loan participations and limited partnership investments. We select and monitor external managers based on investment style, performance and corporate governance.

Our investments are generally of high quality and our fixed maturities and equities are broadly diversified across sectors of the fixed income and equity markets. Our overall investment strategy is intended to balance investment income with credit and interest rate risk, while maintaining sufficient liquidity and providing the opportunity for capital growth. The asset allocation process takes into consideration the types of business written and the level of surplus required to support our different businesses and the risk return profiles of the underlying asset classes. We look to balance the goals of capital preservation, net investment income stability, liquidity and total return.

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The majority of our assets are invested in the fixed income markets. Through fundamental research and credit analysis, with a focus on value investing, Opus seeks to identify a portfolio of stable income-producing higher quality U.S. government, foreign government, municipal, corporate, residential and commercial mortgage-backed securities and asset-backed securities. We have a general policy of diversifying investments, both within and across major investment and industry sectors, to mitigate credit and interest rate risk. We monitor the credit quality of our investments and our exposure to individual markets, borrowers, industries, sectors and, in the case of commercial mortgage-backed securities and commercial mortgage loan participations, property types and geographic locations. We recognize Environmental, Social and Governance (“ESG”) issues as important factors to include in our fundamental investment research process, because these factors can influence the sustainability of an investment, and its risk and return profile.

Investments held by our insurance subsidiaries are subject to diversification requirements under state insurance laws. Investment considerations include asset/liability profile, including duration, convexity and other characteristics within specified risk tolerances. The investment portfolio duration is approximately 4.8 years. We seek to maintain sufficient liquidity to support our cash flow requirements by monitoring the cash requirements associated with our insurance and corporate liabilities, laddering the maturities within the portfolio, closely monitoring our investment durations, holding high quality liquid public securities and managing the purchases and sales of assets.

Reference is made to “Investments” in Management’s Discussion and Analysis.

RATING AGENCIES

Insurance companies are rated by financial strength rating agencies to provide both industry participants and insurance consumers information on specific insurance companies. Higher ratings generally indicate the rating agencies’ opinion regarding financial stability and a stronger ability to pay claims.

Strong ratings are important factors in marketing our products to our agents and customers, since rating information is broadly disseminated and generally used throughout the industry. We believe that a rating of “A-” or higher from A.M. Best Co. is particularly important for our business. Insurance company financial strength ratings are assigned to an insurer based upon factors deemed by the rating agencies to be relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security.

EMPLOYEES AND HUMAN CAPITAL RESOURCES

As of December 31, 2020, we had approximately 4,300 employees, all of whom are located in the United States. We believe our relations with employees are positive, as evidenced by employee feedback received through employee surveys and other formal and informal channels.

In order to successfully operate our business, we rely on our corporate culture and on attracting, developing and retaining qualified employees to differentiate our company and deliver on our commitments to our independent agents, customers, investors and other stakeholders. The following is a description of the material human capital measures and objectives that management focuses on in managing the business.

Inclusion & Diversity

We strive to foster an environment of inclusion and diversity (“I&D”) that welcomes the unique perspectives, experiences and insights of individuals from all backgrounds and walks of life, because we believe that this will lead to greater engagement of our employees in pursuit of our business objectives. Our goal is to continue to develop an inclusive and diverse workforce that fosters innovation, respect and collaboration.

Management has focused on I&D within our workforce by developing a multi-year educational program around inclusion that is designed to impact each of our employees and by diversifying our sourcing practices to develop, advance and retain a diverse employee population. Additionally, we are investing in internal business resource groups to support our company’s cultural values, drive our business initiatives forward, meet the needs of both internal and external stakeholders, and foster our commitment to build an inclusive and diverse work environment. Management’s continued objectives in I&D include reinforcing inclusive behaviors at all levels of our organization, evaluating and mitigating bias in the talent lifecycle in an effort to recruit, hire, develop, and retain women, people of color, and other underrepresented groups, and continuing to focus on our internal business resource groups to promote belonging and the importance of allyship.

Accountability for I&D has been established by incorporating Board oversight of I&D, as part of our larger corporate culture, into the charter of the Compensation and Human Capital Committee of the Board of Directors (“CHCC”) and by including support of and progress on I&D initiatives as part of the incentive compensation evaluation process for our CEO and entire executive leadership team.

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Engagement and Alignment with Company Culture

We believe that an employee workforce that is engaged and aligned with our core cultural values of collaboration, accountability, respect and empowerment (our CARE values) is fundamental to delivering on our business commitments. Management focuses on maintaining a workforce that is engaged by providing transparent communications and soliciting employee feedback informally and through employee surveys and focus groups. To foster accountability, every employee, regardless of role, receives a formal evaluation and performance discussion annually, and the evaluation process is aligned to our CARE values. In addition, we expect that performance connections take place between manager and employee on an ongoing basis to discuss goals, overall performance, development opportunities, and demonstration of leadership and corporate values.  

Development and Succession Planning

We recognize the importance of employee development for our team members throughout their careers as an important driver of workforce engagement, retention, and succession planning. Management focuses on providing learning and development through multiple modalities, including utilizing a robust online learning management platform that accommodates various schedules and diverse learning styles, engaging in experiential learning through stretch assignments and special projects, using virtual and classroom workshops, providing reimbursement for tuition and education-related fees (including professional and industry designations), and through the course of our goal-setting and performance evaluation process.

We are committed to identifying and investing in the development of our future leaders and accomplish this through formal talent review and succession planning processes that are aligned to standard leadership capabilities and our critical roles. Our development focus may include 360 feedback assessments, formal leadership development programs, executive coaching and experiential development opportunities for many employees.

Incentivized Workforce

The emphasis on our overall performance is intended to align the employee’s financial interests with the interests of shareholders. Our compensation philosophy is based on a merit system where employees are paid for their performance and recognized for their talents and contributions. We are committed to fair and equitable total compensation that includes base pay and short- and long-term incentives that are competitive with others in our industry, while also ensuring internal equity across our organization. In addition, our benefits packages, including medical plan selections and other health and wellness offerings, are designed to maintain the physical, financial, mental and social well-being of our employees, their families and dependents. Most employees receive short-term incentive compensation based on annual goals with the funding and metrics approved by the CHCC. Additionally, our senior leaders receive long-term incentive compensation in the form of equity awards.

EXECUTIVE OFFICERS OF THE REGISTRANT

Reference is made to “Directors, Executive Officers and Corporate Governance” in Part III - Item 10.

AVAILABLE INFORMATION

We file our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our definitive proxy statement on Schedule 14A, and other required information with the SEC. Shareholders may obtain reports, proxy and information statements, and other information with respect to our filings, at the SEC’s website, https://www.sec.gov.

Our website address is https://www.hanover.com. We make available, free of charge, on or through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Code of Conduct is also available, free of charge, on our website. Additionally, our Corporate Governance Guidelines and the charters of our Audit Committee, Compensation and Human Capital Committee, Committee of Independent Directors and Nominating and Corporate Governance Committee, are available on our website. All documents are also available in print to any shareholder who requests them. Unless specifically incorporated by reference, information on our website is not part of this Annual Report on Form 10-K.

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ITEM 1A–RISK FACTORS

RISK FACTORS AND FORWARD-LOOKING STATEMENTS

We wish to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, our actual results and could cause our actual results to differ materially from historical results and from those expressed in any forward-looking statements made from time to time by us on the basis of our then-current expectations. The words “believes”, “anticipates”, “expects”, “projections”, “outlook”, “should”, “could”, “plan”, “guidance”, “likely”, “on track to”, “targeted” and similar expressions are intended to identify forward-looking statements. Our businesses are in rapidly changing and competitive markets and involve a high degree of risk and unpredictability. Forward-looking projections are subject to these risks and unpredictability.

Risks Related to Underwriting, Risk Aggregation and Risk Management

Our results may fluctuate as a result of cyclical or non-cyclical changes in the property and casualty insurance industry.

The property and casualty insurance industry historically has been subject to significant fluctuations and uncertainties. Our profitability is materially affected by the following items:

increases in costs, particularly increases occurring after the time our insurance products are priced, including construction, automobile repair, and medical and rehabilitation costs. This includes inflation, rises in the cost of products due to tariffs or other factors and “cost shifting” from health insurers to casualty and liability insurers (whether as a result of an increasing number of injured parties without health insurance, coverage changes in health policies to make such coverage secondary to casualty policies, the further implementation or the repeal of national healthcare legislation, lower reimbursement rates for the same procedures by health insurers or government-sponsored insurance, or the implementation of the Medicare Secondary Payer Act, which imposes reporting and other requirements with respect to medical and related claims paid for Medicare eligible individuals). As it relates to construction, there are often temporary increases in the cost of building supplies and construction labor after a significant event (for example, so called “demand surge” that causes the cost of labor, construction materials and other items to increase in a geographic area affected by a catastrophe). In addition, we are limited in our ability to negotiate and manage reimbursable expenses incurred by our policyholders;

competitive and regulatory pressures, which affect the prices of our products and the nature of the risks covered;

volatile and unpredictable developments, including severe weather, catastrophes, wildfires, civil unrest, pandemics and terrorist actions;

legal, regulatory and socio-economic developments, such as new theories of insured and insurer liability and related claims and extra-contractual awards such as punitive damages, financed litigation, where a third party unrelated to a lawsuit provides capital to a plaintiff in return for a portion of any financial recovery from the lawsuit, and “social inflation” or other increases in the costs of litigation, size of jury awards or changes in applicable laws and regulations (such as changes in the thresholds affecting “no fault” liability or when non-economic damages are recoverable for bodily injury claims or coverage requirements) that impact our claim payouts;

fluctuations in interest rates, as a result of a change in monetary policy or otherwise, inflationary pressures, default rates, commodity prices, foreign exchange rates and other factors that affect net income, including with respect to investment returns and operating results for certain of our lines of business; and

other general economic conditions and trends that may affect the adequacy of reserves.

The demand for property and casualty insurance can also vary significantly based on general economic conditions (either nationally or regionally), rising as the overall level of economic activity increases and falling as such activity decreases. Loss patterns also tend to vary inversely with local economic conditions, increasing during difficult or unstable economic times and moderating during economic upswings or periods of stability. The current Pandemic has introduced additional complexity to loss patterns. The fluctuations in demand and competition could produce unpredictable underwriting results.

Due to geographical concentration in our property and casualty business, changes in economic, regulatory and other conditions in the regions where we operate could have a significant negative impact on our business as a whole. Geographic concentrations also expose us to losses that are potentially disproportionate to our market share in the event of natural or other catastrophes.

We generate a significant portion of our property and casualty insurance net premiums written and earnings in Michigan, Massachusetts and other states in the Northeast, including New York. In addition, a significant amount of Commercial Lines’ net written premium is generated in California. For the year ended December 31, 2020, approximately 21.0% and 9.2% of our net premiums written in our property and casualty business were generated in the states of Michigan and Massachusetts, respectively, and 11.6% of our Commercial Lines’ net premiums written was generated in California. Many states in which we do business impose significant rate control and residual market charges and restrict an insurer’s ability to exit such markets (for example, the Insurance Commissioner in California has taken steps to limit non-renewal of property policies in geographic areas prone to wildfires). The revenues and profitability of our property and casualty insurance subsidiaries are subject to prevailing economic, regulatory, demographic and other conditions, including adverse weather in Michigan and the Northeast. Because of our geographic concentration

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in certain regions, our business, as a whole, could be significantly affected by changes in the economic, regulatory and other conditions in such areas.

Further, certain new catastrophe models assume an increase in frequency and severity of certain weather or other events, such as fires, whether as a result of global climate change or otherwise. Financial strength rating agencies emphasize capital and reinsurance adequacy for insurers with geographic concentrations of risk that may be subject to disproportionate risk of loss. These factors also may result in insurers seeking to diversify their geographic exposure, which could result in increased regulatory restrictions in those markets where insurers seek to exit or reduce coverage, as well as an increase in competitive pressures in less weather-exposed markets.

Our profitability may be adversely affected if our pricing models differ materially from actual results.

The profitability of our business depends on the extent to which our actual claims experience is consistent with the assumptions we use in pricing our policies. We price our business in a manner that is intended to be consistent, over time, with actual results and return objectives. Our estimates and models, and/or the assumptions behind them, may differ materially from actual results.

If we fail to appropriately price the risks we insure, fail to change or are slow to change our pricing model to appropriately reflect our current experience, or if our claims experience is more frequent or severe than our underlying risk assumptions, our profit margins will be negatively affected. If we underestimate the frequency and/or severity of extreme adverse events occurring, our financial condition may be adversely affected. If we overestimate the risks we are exposed to, we may overprice our products, and new business growth and retention of our existing business may be adversely affected.

Our business is dependent on our ability to manage risk, and the failure of the risk mitigation strategies we utilize could have a material adverse effect on our financial condition or results of operations.

Our business performance is highly dependent on our ability to manage operational risks that arise from a large number of day-to-day business activities, including insurance underwriting, claims processing, servicing, investment, financial and tax reporting, compliance with regulatory requirements and other activities. We utilize numerous strategies to mitigate our insurance risk exposure, including: underwriting; setting exposure limits, deductibles and exclusions to mitigate policy risk; updating and reviewing the terms and conditions of our policies; managing risk aggregation by product line, geography, industry type, credit exposure and other bases; and ceding insurance risk. We seek to monitor and control our exposure to risks arising out of these activities through an enterprise-wide risk management framework. However, there are inherent limitations in all of these tactics, and no assurance can be given that these processes and procedures will effectively control all known risks or effectively identify unforeseen risks or that an event or series of events will not result in loss levels in excess of our probable maximum loss models, which could have a material adverse effect on our financial condition or results of operations. It is also possible that losses could manifest themselves in ways that we do not anticipate and that our risk mitigation strategies are not designed to address. Such a manifestation of losses could have a material adverse effect on our financial condition or results of operations. These risks may be heightened during times of challenging macroeconomic conditions.

Risks Related to Reserves and Claims

Actual losses from claims against our property and casualty insurance subsidiaries may exceed their reserves for claims.

Our property and casualty insurance subsidiaries maintain reserves to cover their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability. Rather, reserves represent estimates, involving actuarial projections and judgments at a given time, of what we expect the ultimate settlement and administration of incurred claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims frequency and severity and judicial theories of liability, costs of repair and replacement, legislative activity and myriad other factors.

The inherent uncertainties of estimating reserves are greater for certain types of property and casualty insurance lines. These include automobile bodily injury liability, automobile personal injury protection, general liability, and workers’ compensation, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, environmental liability, where the technological, judicial and political climates involving these types of claims are continuously evolving, and casualty coverages such as professional liability. There is also greater uncertainty in establishing reserves with respect to new business, particularly new business that is generated with respect to newer product lines, such as our financial institutions and cyber-risk lines, by newly appointed agents, or in new geographies where we have less experience in conducting business. In these cases, there is less historical experience or knowledge and less data that the actuaries can rely on. Estimating reserves is further complicated by unexpected claims or unintended coverages that emerge due to changing conditions. These emerging issues may increase the size or number of claims beyond our underwriting intent and may not become apparent for many years after a policy is issued, such as was the case for the industry with respect to environmental, asbestos, and certain product liability claims. Similar concerns have emerged with what has been called “silent” cyber, or claims arising for cyber losses under traditional policies where such coverage is not contemplated. These losses are reflected as prior year reserve development. Although we undertake underwriting actions that are intended or designed to limit losses

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once emerging issues are identified, we remain subject to losses on policies issued during those years preceding the underwriting actions.

Additionally, the introduction of new Commercial Lines products and the development of new niche and specialty lines present new risks. Certain specialty products, such as the human services program, non-profit directors and officers liability and employment practices liability policies, lawyers and other professional liability policies, healthcare lines and directors and officers coverage may also require a longer period of time (the so-called “tail”) to determine the ultimate liability associated with the claims and may produce more volatility in our results and less certainty in our accident year reserves. Some lines of business, such as surety, are less susceptible to establishing reserves based on actuarial or historical experience and losses may be episodic, depending on economic and other factors. Changes in laws, such as so-called “reviver” statutes that retrospectively change the statutes of limitations for certain claims, such as sexual molestation claims, add further uncertainty to the adequacy of prior estimates.

We regularly review our reserving techniques, reinsurance and the overall adequacy of our reserves based upon, among other things:

 

our review of historical data, legislative enactments, judicial decisions, legal developments and trends in imposition of damages, changes in political attitudes and trends in general economic conditions;

 

our review of per claim information;

 

historical loss experience of our property and casualty insurance subsidiaries and the industry as a whole; and

 

the terms of our property and casualty insurance policies.

 

Underwriting results and operating income could be adversely affected by further changes in our net loss and LAE estimates related to significant events or emerging risks, such as risks related to attacks on or breaches of cloud-based data information storage or computer network systems (“cyber-risks”), privacy regulations or disruptions caused by major power grid failures or widespread electrical and electronic equipment failure due to aging infrastructure, natural factors like hurricanes, earthquakes, wildfires, solar flares and pandemic or man-made factors like terrorism and civil unrest.

Estimating losses following any major catastrophe or with respect to emerging claims is an inherently uncertain process. Factors that add to the complexity of estimating losses from these events include the legal and regulatory uncertainty, the complexity of factors contributing to the losses, delays in claim reporting, and with respect to areas with significant property damage, the impact of “demand surge” and a slower pace of recovery resulting from the extent of damage sustained in the affected areas due, in part, to the availability and cost of resources to effect repairs. Emerging claims issues may involve complex coverage, liability and other costs which could significantly affect LAE. As a result, there can be no assurance that our ultimate costs associated with these events or issues will not be substantially different from current estimates (for example, actual losses arising from an event could have varied widely depending on the interpretation of various policy provisions). Investors should consider the risks and uncertainties in our business that may affect net loss and LAE reserve estimates and future performance, including the difficulties in arriving at such estimates.

Anticipated losses associated with business interruption exposure, the impact of wind versus water as the cause of loss, disputes over the extent of damage caused by hail storms (particularly with respect to roof damage claims), supplemental payments on previously closed claims caused by the development of latent damages or new theories of liability and inflationary pressures leading to claims cost escalation could also have a negative impact on future loss reserve development. Many states permit insureds to simply sign-over their claims to contractors or others (so-called “assignment of benefits”), which frequently generate higher claim demands. Other states permit filing of suits without prior discussions, which has a similar effect and also increases loss adjustment costs.

Because of the inherent uncertainties involved in setting reserves and establishing current and prior-year “loss picks”, including those related to catastrophes, we cannot provide assurance that the existing reserves or future reserves established by our property and casualty insurance subsidiaries will prove adequate in light of subsequent events. Our results of operations and financial condition have in the past been, and in the future could be, materially affected by adverse loss development for events that we insured in prior periods.

Risks Related to Weather Events, Catastrophes and Climate Change

Limitations on the ability to predict the potential impact of weather events and catastrophes may impact our future profits and cash flows.

Our business is subject to claims arising out of catastrophes that may have a significant impact on our results of operations and financial condition. We have experienced, and in the future may experience, catastrophe losses that could have a material adverse impact on our business. Catastrophes can be caused by various events, including hurricanes, floods, earthquakes, tornadoes, wind, hail, fires, drought, severe winter weather, volcanic eruptions, tropical storms, tsunamis, sabotage, civil unrest, terrorist actions, explosions, nuclear accidents, solar flares, and power outages. The frequency and severity of catastrophes are inherently unpredictable.

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The extent of gross losses from a catastrophe is a function of the total amount of insured exposure in the area affected by the event and the severity of the event. The extent of net losses depends on the amount and collectability of reinsurance.

Additionally, the severity of certain catastrophes could be so significant that it restricts the ability of certain locations to recover their economic viability in the near term. And, repeated catastrophes or the threat of catastrophes could undermine the long-term economic viability of certain locations like coastal or wildfire-exposed communities, which could have a significant negative impact on our business.

Although catastrophes can cause losses in a variety of property and casualty lines, homeowners and commercial multiple peril property insurance have, in the past, generated the vast majority of our catastrophe-related claims. Our catastrophe losses have historically been principally weather-related, particularly from hurricanes and hail damage, as well as snow and ice damage from winter storms.

Although the insurance industry and rating agencies have developed various models intended to help estimate potential insured losses under thousands of scenarios, there is no reliable way of predicting the probability of such events or the magnitude of such losses before a specific event occurs. We utilize various models and other techniques in an attempt to measure and manage potential catastrophe losses within various income and capital risk appetites. However, such models and techniques have many limitations. In addition, due to historical concentrations of business, regulatory restrictions and other factors, our ability to manage such concentrations is limited, particularly in the Northeast and in the state of Michigan.

We purchase catastrophe reinsurance as protection against catastrophe losses. Reinsurance is subject to the adequacy and counterparty reinsurance risks described below. Should we experience losses from one significant or several large catastrophes, there can be no assurance that our reinsurance program will provide adequate coverage levels.

Climate change may adversely impact our results of operations and/or our financial position.

Global climate change from rising planet temperatures over the last several decades has been linked to a number of factors that contribute to the increased unpredictability, frequency, duration and severity of weather events, including: changing weather patterns, a rise in ocean temperatures, and sea level rise. Further increases or persistence in these conditions would lead to higher overall losses, which we may not be able to recoup, particularly in a highly regulated and competitive environment, and higher reinsurance costs. Certain catastrophe models assume an increase in frequency and severity of certain weather or other events, which could result in a disproportionate impact on insurers with certain geographic concentrations of risk. This would also likely increase the risks of writing property insurance in coastal areas or areas susceptible to wildfires or flooding, particularly in jurisdictions that restrict pricing and underwriting flexibility. The threat of rising seas or other catastrophe losses as a result of global climate change may also cause property values in coastal or such other communities to decrease, reducing the total amount of insurance coverage that is required.

In addition, global climate change could impact assets that we invest in, resulting in realized and unrealized losses in future periods that could have a material adverse impact on our results of operations and/or financial position. It is not possible to foresee which, if any, assets, industries or markets will be materially and adversely affected, nor is it possible to foresee the magnitude of such effect.

Risks Related to Reinsurance

We cannot guarantee the adequacy of or ability to maintain our current level of reinsurance coverage.

Similar to insurance companies, reinsurance companies can also be adversely impacted when catastrophes occur. In setting our retention levels and coverage limits, we consider our level of statutory surplus and exposures, as well as the current reinsurance pricing environment, but there can be no assurance that we adequately set these levels or limits or that we will be able to maintain our current or desired levels of reinsurance coverage. In particular, and as discussed under “Reinsurance Program Overview” in Information About Operating Segments - Reinsurance, not all of our 2021 reinsurance programs for the Commercial and Personal Lines are fully placed. Reinsurance is a significant factor in our overall cost of providing primary insurance. However, unlike primary insurers, reinsurers are not subject to rate or other restrictions requiring them to continue availability of reinsurance or limiting cost increases or mandating coverage forms. An individual insurer’s reinsurance expense is correlated to the level of losses experienced by its reinsurers. Future catastrophic events and other changes in the reinsurance marketplace, including as a result of investment losses or disruptions due to challenges in the financial markets that have occurred or could occur in the future, may adversely affect our ability to obtain such coverages, as well as adversely affect the cost of obtaining that coverage.

Additionally, the availability, scope of coverage, cost, and creditworthiness of reinsurance could continue to be adversely affected  as a result of not only new catastrophes, but also terrorist attacks and the perceived risks associated with future terrorist activities, global conflicts, including the threat of nuclear conflict, and the changing legal and regulatory environment (including changes which could create new insured risks). Federal reinsurance for terrorism risks coverage offered by insurers is available under the federal terrorism risk insurance program, but it only applies to certified events of terrorism (as defined in the legislation) and contains certain caps and deductibles. Although the federal terrorism risk insurance program coverage is in effect through December 31, 2027, should this program be modified unfavorably by the government in the future, private reinsurance for events of terrorism may not be available to us or available at reasonable or acceptable rates.

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Although we monitor their financial soundness, we cannot be sure that our reinsurers will pay in a timely fashion, if at all.

We purchase reinsurance by transferring (known as ceding) part of the risk that we have assumed to reinsurance companies in exchange for part of the premium we receive in connection with the risk. As of December 31, 2020, our reinsurance receivable (including from the MCCA) amounted to approximately $1.9 billion. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us (the reinsured) of our liability to our policyholders. Accordingly, we bear counterparty risk with respect to our reinsurers, including risks resulting from over-concentration of exposures within the industry. Although we monitor the financial strength ratings assigned to them by rating agencies, their reputations in the reinsurance marketplace, our collections history with them, the credit quality of our reinsurers, and the analysis and guidance of our reinsurance advisors, and we believe that the financial condition of our reinsurers is sound, we cannot be sure that they will pay the reinsurance recoverables owed to us currently or in the future or that they will pay such recoverables on a timely basis. The contractual obligations under reinsurance agreements are typically with individual subsidiaries of the reinsurance group and are not typically guaranteed by other group members. In certain circumstances, with “unauthorized” reinsurers or those with lower financial strength ratings, we may require collateral equal to 100% of estimated reinsurance recoverables. The collateral can serve to mitigate credit risk.  In the event of losses, we may look to “draw down” on this collateral to satisfy reinsurance recoveries due to us, but if the collateral held is insufficient to meet those recoveries, we will be exposed to losses.

Risks Related to Regulation, Mandatory Market Mechanisms and Mandatory Assessments

Our businesses are heavily regulated, and changes in regulation may reduce our profitability.

Our insurance businesses are subject to supervision and regulation by the state insurance authority in each state where we transact business. This system of supervision and regulation relates to numerous aspects of an insurance company’s business and financial condition, including limitations on the authorization of lines of business, underwriting limitations, the ability to utilize credit-based insurance scores, gender, geographic location, information publicly available (such as on social media), education, occupation, income or other factors in underwriting, the ability to terminate agents, supervisory and liability responsibilities for agents, the setting of premium rates, the requirement to write certain classes of business that we might otherwise avoid or charge different premium rates, restrictions on the ability to withdraw from certain lines of business or terminate policies or classes of policyholders, the establishment of standards of solvency, the licensing of insurers and agents, compensation of and contractual arrangements with independent agents, concentration of investments, levels of reserves, the payment of dividends, transactions with affiliates, changes of control, protection of private information of our agents, policyholders, claimants and others (which may include highly sensitive financial or medical information or other private information such as social security numbers, driving records or driver’s license numbers) and the approval of policy forms. From time to time, various states and Congress have proposed to prohibit or otherwise restrict the use of credit-based insurance scores in underwriting or rating our Personal Lines business. The elimination of the use of credit-based insurance scores could cause significant disruption to our business and our confidence in our pricing and underwriting. Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors.

Legislative and regulatory restrictions are constantly evolving and are subject to then-current political pressures. For example, following major events, states have considered, and in some cases adopted, proposals such as homeowners’ “Bill of Rights”, restrictions on storm deductibles, additional mandatory claim handling guidelines and mandatory coverages. More recently, the California Insurance Commissioner restricted the ability of carriers to non-renew certain coverages in wildfire disaster areas, and the New York Department of Financial Services and regulatory agencies in other states have enacted comprehensive cybersecurity regulations and required insurers to take steps related to global climate change.

Also, the federal Medicare, Medicaid and State Children’s Health Insurance Program Extension Act mandates reporting and other requirements applicable to property and casualty insurance companies that make payments to or on behalf of claimants who are eligible for Medicare benefits. These requirements have made bodily injury claim resolutions more difficult, particularly for complex matters or for injuries requiring treatment over an extended period, and impose significant penalties for non-compliance and reporting errors. These requirements also have increased the circumstances under which the federal government may seek to recover from insurers amounts paid to claimants in circumstances where the government had previously paid benefits.

State regulatory oversight and various proposals at the federal level, through the Federal Insurance Office or other agencies, may, in the future, adversely affect our ability to sustain adequate returns in certain lines of business or in some cases, operate lines profitably. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems.

Our business could be negatively impacted by adverse state and federal legislation or regulation, or judicial developments, including those resulting in: decreases in rates, including for example, recent regulatory or bureau actions to mandate reduced premiums for workers’ compensation insurance; limitations on premium levels; coverage and benefit mandates; limitations on the ability to manage care and utilization or other claim costs; requirements to write certain classes of business or in certain geographies; restrictions on underwriting, methods of compensating independent producers, or our ability to cancel or renew certain business (which negatively affects our ability to reduce concentrations of property risks); higher liability exposures for our insureds; increased assessments or

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higher premium or other taxes; and enhanced ability to pierce “no fault” thresholds, recover non-economic damages (such as “pain and suffering”), or pierce policy limits.  

These regulations serve to protect customers and other third parties and are heavily influenced by the then-current political environment. If we are found to have violated an applicable regulation, administrative or judicial proceedings may be initiated against us that could result in censures, fines, civil penalties (including punitive damages), the issuance of cease-and-desist orders, premium refunds or the reopening of closed claim files, among other consequences. These actions could have a material adverse effect on our financial position and results of operations.

In addition, we are reliant upon independent agents and brokers to market our products. Changes in regulations related to insurance agents and brokers that materially impact the profitability of the agent and broker business or that restrict the ability of agents and brokers to market and sell insurance products would have a material adverse effect on our business.

Further, as we continue to expand our business into new regions, either organically or through acquisition, we become subject to the regulations and different regulatory bodies governing such business in those locales.

From time to time, we are also involved in investigations and proceedings by federal, state, and other governmental and self-regulatory agencies. We cannot provide assurance that these investigations, proceedings and inquiries will not result in actions that would adversely affect our results of operations or financial condition.  

We are subject to uncertainties related to Michigan PIP Reform.

Starting in 1973, the state of Michigan required all personal and commercial automobile polices issued in the state to include no-fault personal injury protection (“PIP”) coverage without a cap on maximum benefits allowed (i.e., “unlimited PIP benefits”).  Insurers were required to retain a portion of the risk and the MCCA, a legislatively-created reinsurance mechanism, reinsures the portion of the risk in excess of the insurer’s mandated retention. The mandatory retention amount increases biennially at a statutory mandated rate and is currently $580,000. Premiums on Michigan automobile policies include a charge for both the insurer’s retained amount and a separately identified pass-through charge determined by the MCCA.  

In response to concerns about the overall cost and affordability of automobile insurance in Michigan, the state enacted legislation in June 2019 that significantly changed no-fault and PIP systems. The new legislation, effective July 2, 2020, eliminated the requirement that all insureds purchase unlimited PIP coverage and substituted instead tiered limits, ranging from zero (for those with certain health benefits meeting specified criteria) to unlimited benefits. In contrast, the minimum amounts of bodily injury coverage drivers are required to purchase increased, and we anticipate an increase in tort liability and related litigation from these changes. The legislation includes underwriting and other restrictions and mandates, in addition to subjecting rates, forms and rules to prior approval from the Michigan Department of Insurance and Financial Services (“Michigan Insurance Department”) before implementation.

The legislation also imposes various cost controls, including medical fee schedules based on a multiple of Medicare reimbursement rates, and mandated PIP premium rate reductions with an eight-year premium rate freeze for the PIP component of automobile policies. The Michigan Insurance Department is also preparing regulations to establish utilization controls. The rate freeze was effective contemporaneously with the adoption of the legislation and the mandatory rate reduction was effective July 2, 2020. The expense and utilization controls do not go into effect until July 1, 2021.

In response to the future savings expected to be garnered from the expense and utilization controls, the MCCA reassessed its outstanding liabilities and estimated that the deficit reported in more recent years had been “erased” (notwithstanding a persistent reported annual deficit, the MCCA’s annual operations have always been cash flow positive). As of December 31, 2020, our estimated reinsurance recoverable from the MCCA was $1.0 billion. This estimate has not been reduced for the potential future claim cost savings.

Many medical and other providers who receive reimbursement under the PIP system strenuously objected to the fee schedules, cost controls and utilization restrictions imposed by the new legislation.  Since the reform legislation was adopted, we have experienced an increase in litigation from medical and other providers demanding higher reimbursements under the current system. On October 3, 2019, litigation captioned Andary et. al. v. USAA Casualty Insurance Company and Citizens Insurance Company of America (a subsidiary of THG), Circuit Court for the County of Ingham, Michigan Case 19-738-CZ, was filed. The plaintiffs seek a declaratory judgment that the fee schedules, attendant care reimbursement limits, cost controls and utilization provisions of the new legislation violate multiple provisions of the Michigan state constitution.  We intend to vigorously contest plaintiffs’ claims.

For the year ending December 31, 2020, Michigan personal automobile insurance represented approximately 47% of our total personal automobile net premiums written.  PIP net written premium (which does not include the MCCA pass-through assessment) represents approximately 26% of those Michigan personal automobile premiums. It is not clear at this time whether projected savings from the various cost control measures, assuming they remain in effect, will be commensurate with the required PIP reductions and rate controls. Accordingly, there is increased uncertainty attributable to these changes regarding the future performance of our Michigan personal automobile lines.

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We may incur financial losses resulting from our participation in shared market mechanisms, mandatory reinsurance programs and mandatory and voluntary pooling arrangements.

In most of the jurisdictions that we operate in, our property and casualty insurance subsidiaries are required to participate in mandatory property and casualty shared market mechanisms, government-sponsored reinsurance programs or pooling arrangements. These arrangements are designed to provide various insurance coverages to individuals or other entities that are otherwise unable to purchase such coverage or to support the costs of uninsured motorist claims in a particular state or region. We cannot predict whether our participation in these shared market mechanisms or pooling arrangements will provide underwriting profits or losses to us. For the year ended December 31, 2020, we experienced an underwriting loss of $10.5 million from participation in these mechanisms and pooling arrangements, compared to underwriting losses of $14.1 million and $23.2 million in 2019 and 2018, respectively. We may face similar or more significant earnings fluctuations in the future.

Additionally, increases in the number of participants or insureds in state-sponsored reinsurance pools, FAIR plans or other residual market mechanisms, particularly in the states of Massachusetts, Texas, California, New York, or North Carolina, combined with regulatory restrictions on the ability to adequately price, underwrite, or non-renew business, as well as new legislation, or changes in existing case law, could expose us to significant risks of increased assessments from these residual market mechanisms. There could also be a significant adverse impact as a result of losses incurred in those states due to hurricane or other high loss exposures, as well as the declining number of carriers providing coverage in those regions. We are unable to predict the likelihood or impact of such potential assessments or other actions.

We also have credit risk associated with certain mandatory reinsurance programs, such as the MCCA. See “We are subject to uncertainties related to Michigan PIP Reform,” above for more information on the MCCA.

In addition, we may be adversely affected by liabilities resulting from our previous participation in certain voluntary property and casualty assumed reinsurance pools. We have terminated our participation in virtually all property and casualty voluntary pools, but we remain subject to claims related to the periods when we participated. The property and casualty industry’s assumed reinsurance businesses have suffered substantial losses during the past several years, particularly related to environmental and asbestos exposure for property and casualty coverages, in some cases resulting from incidents alleged to have occurred decades ago. Due to the inherent volatility in these businesses, possible issues related to the enforceability of reinsurance treaties in the industry and the continuing history of increased losses, we cannot provide assurance that our current reserves are adequate or that we will not incur losses in the future. Our operating results and financial position may be adversely affected by liabilities resulting from any such claims in excess of our loss estimates. As of December 31, 2020, our reserves totaled $40.0 million for these legacy voluntary property and casualty assumed reinsurance pools, with the largest being the Excess Casualty Reinsurance Association pool.

We are subject to mandatory assessments by state guaranty funds; an increase in these assessments could adversely affect our results of operations and financial condition.

All fifty U.S. states and the District of Columbia have insurance guaranty fund laws requiring property and casualty insurance companies doing business within the state to participate in guaranty associations. These associations are organized to pay contractual obligations under insurance policies issued by impaired or insolvent insurance companies. The associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired or insolvent insurer is engaged. Although mandatory assessments by state guaranty funds that are used to cover losses to policyholders of insolvent or rehabilitated companies can be substantially recovered over time through policyholder surcharges or a reduction in future premium taxes in many states (provided the collecting insurer continues to write business in such state), there can be no assurance that all funds will be recoupable in the future. During 2020, we had a total assessment of $1.4 million levied against us, with refunds of $0.4 million received in 2020 for a total net assessment of $1.0 million. As of December 31, 2020, we have $0.5 million of reserves related to guaranty fund assessments. In the future, these assessments may increase above levels experienced in prior years. Future increases in these assessments depend upon the rate of insolvencies of insurance companies.

We are subject to litigation risks, including risks relating to the application and interpretation of contracts, and adverse outcomes in litigation and legal proceedings could adversely affect our results of operations and financial condition.

We are subject to litigation risks, including risks relating to the application and interpretation of insurance and reinsurance contracts and our handling of claim matters (which can lead to bad faith and other forms of extra-contractual liability), and are routinely involved in litigation that challenges specific terms and language incorporated into property and casualty contracts, such as claims reimbursements, covered perils and exclusion clauses, among others, or the interpretation or administration of such contracts. We are also involved in legal actions that do not arise in the ordinary course of business, some of which assert claims for substantial amounts. Adverse outcomes could materially affect our results of operations and financial condition.

Risks Related to Our Agency Distribution and Growth Strategies

Our profitability could be adversely affected by our relationships with our agencies.

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Substantially all of our products are distributed through independent agents and brokers who have the principal relationships with policyholders. Agents and brokers generally own the “renewal rights,” and thus our business model is dependent on our relationships with, and the success of, the agents and brokers we do business with.  

We periodically review the agencies, including managing general agencies we do business with to identify those that do not meet our profitability standards or are not aligned with our business objectives. Following these periodic reviews, we may restrict such agencies’ access to certain types of policies or terminate our relationship with them, subject to applicable contractual and regulatory requirements that limit our ability to terminate agents or require us to renew policies. Even through the utilization of these measures, we may not achieve the desired results.

Because we rely on independent agents as our sales channel, any deterioration in the relationships with our independent agents or failure to provide competitive compensation to our independent agents could lead agents to place more premium with other carriers and less premium with us. In addition, we could be adversely affected if the agencies we do business with, including managing general agencies, exceed the authority that we have given them, fail to transfer collected premium to us or breach the obligations that they owe to us. Although we routinely monitor our agency relationships, such actions could expose us to liability.

Also, if agency consolidation continues at its current pace or increases in the future and more agencies are consolidated into larger agencies or managing general agencies, our sales channel could be materially affected in a number of ways, including loss of market access or market share in certain geographic areas if an acquirer is not one of our appointed agencies, loss of agency talent as the people most knowledgeable about our products and with whom we have developed strong working relationships exit the business following a disposition of an agency, increases in our commission costs as larger agencies acquire more negotiating leverage over their fees, and interference with the core agency business of selling insurance due to integration or distraction. Any such disruption that materially affects our sales channel could have a negative impact on our results of operations and financial condition.

As the speed of digitization accelerates, we are subject to risks associated with both our agents’ and our ability to keep pace. In an increasingly digital world, agents who cannot provide a digital or technology-driven experience risk losing customers who demand such an experience, and such customers may choose to utilize more technology-driven agents or abandon the independent agency channel altogether. Additionally, if we are not able to keep pace with competitors’ digital offerings, we may not be able to meet the demand from our agents or their customers, which could lead to a loss of customers, agents or both.

We may not be able to grow as quickly or as profitably as we intend, which is important to our current strategy.

Over the past several years, we have made, and our current plans are to continue to make, significant investments in our Commercial and Personal Lines of business, in order to, among other things, strengthen our product offerings and service capabilities, expand into new geographic areas, improve technology and our operating models, build expertise in our personnel, and expand our distribution capabilities, with the ultimate goal of achieving significant, sustained growth. The ability to achieve significant profitable premium growth in order to earn adequate returns on such investments and expenses, and to grow further without proportionate increases in expenses, is an important part of our current strategy. There can be no assurance that we will be successful at profitably growing our business, or that we will not alter our current strategy due to changes in our markets or an inability to successfully maintain acceptable margins on new or existing business or for other reasons, including general economic conditions as a result of the Pandemic or otherwise, in which case premiums written and earned, operating income and net book value could be adversely affected.

We may be affected by disruptions caused by the introduction of new products, related technology changes, and new operating models in Commercial Lines, Personal Lines and specialty businesses and future acquisitions, and expansion into new geographic areas.

There are increased underwriting risks associated with premium growth and the introduction of new products or programs in our Commercial Lines, Personal Lines and specialty businesses. Additionally, there are increased underwriting risks associated with the appointment of new agencies and managing general agencies and with the expansion into new geographical areas.

The introduction of new Commercial Lines products and the development of new niche and specialty lines presents new risks. Certain new specialty products may present longer “tail” risks and increased volatility in profitability. Our expansion into western states, including California, presents additional underwriting risks since the regulatory, geographic, natural risk, legal environment, demographic, business, economic and other characteristics of these states present challenges different from those in the states where we historically have conducted business. In addition, our agency relationships in these new geographies are not as developed.

Our Personal Lines production and earnings may be unfavorably affected by the continued introduction of new products, expanded risk appetites and our focus on account business (i.e., policyholders who have both automobile and homeowner insurance with us) that we believe, despite pricing discounts, will ultimately be more profitable business. We may also experience adverse selection, which occurs when insureds purchase our products because of under-pricing, operational difficulties or implementation impediments with independent agents or the inability to grow new markets after the introduction of new products or the appointment of new agents.

As we enter new states or regions or grow our business, there can be no assurance that we will not experience higher loss trends than anticipated.  

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Risks Related to Technology, Data Security and Privacy

We may experience difficulties with technology, implementing new technologies, data security and/or outsourcing relationships, which could have a negative impact on our ability to conduct our business.

We use computer systems to store, retrieve, evaluate and utilize customer and company data and information. Our computer, information technology and telecommunications systems, in turn, interface with and rely upon third-party systems, including cloud-based data storage. Our business is highly dependent on our ability and the ability of certain third parties, to access these systems to perform necessary business functions, including, without limitation, providing insurance quotes, processing premium payments, making changes to existing policies, filing and paying claims, providing customer support and managing investment portfolios. Systems attacks, failures or outages could compromise our ability to perform these functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with our business partners and customers. In the event of a disaster such as a natural catastrophe, an industrial accident, a blackout, a computer virus, a cyber security attack or intrusion, a terrorist attack or war, or interference from solar flares, our systems or the external systems that we rely on may be inaccessible to our employees, customers or business partners for an extended period of time. Even if our employees are able to report to work, they may be unable to perform their duties for an extended period of time if our data or the systems that we rely on are disabled or destroyed or if our disaster recovery plans are inadequate or suffer from unforeseen consequences. This could result in a materially adverse effect on our business results and liquidity.

We increasingly rely on technological and data-driven solutions to operate our business. If we are slow to adapt to, roll out or implement new technologies, particularly those that leverage data and analytics, it could materially affect our ability to meet the expectations of our customers or compete with more technologically adept competitors, particularly those with greater resources to devote to new technologies or technological enhancements.

In addition, we outsource certain technology and business process functions and data storage to third parties and may do so increasingly in the future. If we do not effectively develop, implement and monitor our outsourcing strategies, third-party providers do not perform as anticipated or we or they experience technological or other problems with a transition or in operations, we may not realize productivity improvements or cost efficiencies and may experience operational difficulties, liabilities for breaches of confidential information, increased costs and a loss of business. Our outsourcing of certain technology, data storage and business process functions to third parties may expose us to enhanced risk related to data security, which could result in monetary and reputational damages. In addition, our ability to receive services from third-party providers outside of the United States might be impacted by cultural differences, political instability, regulatory requirements or policies inside or outside of the United States. As a result, our ability to conduct our business might be adversely affected.

Data security incidents, including, but not limited to, those resulting from a malicious cyber security attack on us or our business partners and service providers, or intrusions into our systems or data sources could disrupt or otherwise negatively impact our business.

Our systems and the systems that we rely on, like others in the financial services industry, are vulnerable to cyber security risks, and we are subject to disruption and other adverse effects caused by such activities. Large corporations such as ours are subject to daily attacks on their systems and other vulnerabilities to data security incidents. These attacks and incidents have included, or may in the future include: unauthorized access, viruses, malware or other malicious code, ransomware, deceptive social engineering campaigns (also known as “phishing” or “spoofing”), loss or theft of assets, employee errors or malfeasance, third-party errors or malfeasance, as well as system failures and other security events. Such attacks may have various goals, from seeking confidential information or the misdirection of payments, to causing operational disruption. Such activities could result in material disruptions to our operations, financial loss or material damage to our reputation. Like other companies, we have from time to time experienced, and are likely to continue to experience, security events and data intrusion, and while none of these events to date have had a material adverse effect on our business, no assurances can be made that such attacks or security events will not have a material adverse effect on our business in the future. As the breadth and complexity of cyber security attacks and other data security events become more prevalent and the methods used to perpetrate them evolve, we may be required to devote additional personnel, or financial or systems resources, to protecting our data security or investigating or remediating vulnerabilities as a result of data security incidents. Such resources could be costly in time and expenses, and could detract from resources spent on our core property and casualty insurance operations. In addition, we may not be able to detect an incident, assess its severity or impact, or appropriately respond in a timely manner, which could increase our exposure to an incident.

The third parties with whom we work are also subject to these same risks, and we are vulnerable if a cyber security attack or other data security incident involves a third-party vendor or service provider. Such an event could threaten to disrupt our business if the third party’s operations are compromised, or provide attackers an avenue to pivot and attack our systems by exploiting the relationships that we have with our trusted business partners. While we take measures to protect against such events (e.g., utilizing secure transmission capabilities with third-party vendors and others with whom we do business when possible), review and assess our third-party providers’ cybersecurity controls, as appropriate, and make changes to our business processes to manage these risks, we cannot assure that our efforts will always be successful.

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Any failure to protect the confidentiality of customer information could adversely affect our reputation or expose us to fines, penalties or litigation, which could have a material adverse effect on our business, financial condition and results of operations.

We are required to safeguard the confidential personal information of our customers and applicants and are subject to an increasing number of federal, state, local and international laws and regulations regarding privacy and data security, as well as contractual commitments. These laws and regulations are rapidly evolving, complex, vary significantly from jurisdiction to jurisdiction, and sometimes conflict. In the absence of updated, uniform federal privacy legislation, there is a growing trend in the states in which we operate, to adopt comprehensive privacy legislation that provides consumers with various privacy rights and imposes significant compliance burdens on covered companies. Failure to comply with any privacy laws or regulations could subject us to governmental enforcement actions and fines, penalties, litigation, private rights of action or public statements against us by consumer advocacy groups or others if confidential customer information is misappropriated from our computer systems, those of our vendors or others with whom we do business, or otherwise. Despite the security measures that may be in place, any such systems may be vulnerable to the types of attacks and security incidents described above. Any well-publicized compromise of security could deter people from entering into transactions that involve transmitting confidential information, impart reputational or other harm and/or have a material adverse effect on our business. Additionally, privacy legislation may make our business partners more reluctant to share information with us that is useful in conducting our business.

Risks Related to Competition and Competitors in the Property and Casualty Insurance Market

Intense competition could negatively affect our ability to maintain or increase our profitability, particularly in light of the various competitive, financial, strategic, technological, structural, informational and resource advantages that our competitors have.

We compete, and will continue to compete, with a large number of companies, including international, national and regional insurers, specialty insurance companies, underwriting agencies and financial services institutions. We also compete with mutual insurance companies, reciprocal and exchange companies that may not have shareholders and may have different profitability targets than publicly or privately owned companies. In recent years, there has been substantial consolidation and convergence among companies in the financial services industry, resulting in increased competition from large, well-capitalized financial services firms. Many of our competitors have greater financial, technical, technological, and operating resources than we do, greater access to data analytics or “big data”, and may be able to offer a wider range of, or more sophisticated, commercial and personal line products. Some of our competitors also have different marketing, advertising and sales strategies than we do and market and sell their products to consumers directly. In addition, competition in the U.S. property and casualty insurance market has intensified over the past several years. This competition has had, and may continue to have, an adverse impact on our revenues and profitability.

The industry and we are challenged by changing practices caused by the Internet, application-based programs relying on algorithms and computer modeling to underwrite policies and administer claims, and the increased usage of real time comparative rating tools and claims management processes, which have led to greater competition in the insurance business in general, particularly on the basis of price and pressure to reduce coverages to compete on price and to respond to customer requests as quickly as possible.

We also face heightened competition resulting from the entry of new competitors and the introduction of new products by new and existing competitors. Recent entries into the property and casualty marketplace by large technology companies, retail companies, so-called “Insurtech” companies and other non-traditional insurance providers, who aim to leverage their information about technology and direct access to customers, without the burden of legacy systems, access and ability to manipulate “big data,” artificial intelligence, speed in responding to customer requests or other developing opportunities, may increase competition. Increased competition could make it difficult for us to obtain new or retain existing customers. It could also result in increasing our service, administrative, policy acquisition or general expenses as we seek to distinguish our products and services from those of our competitors. In addition, our administrative, technology and management information systems’ expenditures could increase substantially as we try to maintain or improve our competitive position or keep up with evolving technology in order to deliver the same or similar customer or agency experience as those offered by our competitors.

We compete for business not just on the basis of price, but also on the basis of product coverages, reputation, financial strength, quality of service (including claims adjustment service), experience and breadth of product offering. We cannot provide assurance that we will be able to maintain a competitive position in the markets where we operate, or that we will be able to expand our operations into new markets.

Risks Related to Financial Strength and Debt Ratings

We are rated by several rating agencies, and downgrades to our ratings could adversely affect our operations.

Our ratings are important in establishing our competitive position and marketing the products of our insurance companies to our agents and customers. Rating information is broadly disseminated and generally used throughout the industry. Many policyholders, particularly larger commercial customers, will not purchase, and many agents will not distribute, products of insurers that do not meet certain financial strength ratings.

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Our insurance company subsidiaries are rated by A.M. Best, Moody’s, and Standard & Poor’s. These ratings reflect the rating agency’s opinion of our insurance subsidiaries’ financial strength, operating performance, position in the market place, risk management, and ability to meet their obligations to policyholders. These ratings are not evaluations directed to investors, and are not recommendations to buy, sell or hold our securities. Our ratings are subject to periodic review by the rating agencies, and we cannot guarantee the continued retention or improvement of our current ratings. This is particularly true given that rating agencies may change their criteria or increase capital requirements for various rating levels.

A downgrade in one or more of our or any of our subsidiaries’ claims-paying ratings could negatively impact our business and competitive position, particularly in lines where customers require us to maintain minimum ratings. Additionally, a downgrade in one or more of our debt ratings could adversely impact our ability to access the capital markets and other sources of funds, increase the cost of current credit facilities, and/or adversely affect pricing of new debt that we may seek in the capital markets in the future. Our ability to raise capital in the equity markets could also be adversely affected.

Negative changes in our level of statutory surplus could adversely affect our ratings and profitability.

The capacity for an insurance company’s growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by state insurance regulators, is considered important by state insurance regulatory authorities and by rating agencies. As our business grows, or due to other factors, regulators may require that additional capital be retained or contributed to increase the level of statutory surplus. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by private rating agencies. Surplus in our insurance company subsidiaries is affected by, among other things, results of operations and investment gains, losses, impairments, and dividends from each of those companies to its parent company. A number of these factors affecting our level of statutory surplus are, in turn, influenced by factors that are out of our control, including the frequency and severity of catastrophes, changes in policyholder behavior, changes in rating agency models and economic factors, such as changes in equity markets, credit markets or interest rates.

The NAIC uses a system for assessing the adequacy of statutory capital for property and casualty insurers. The system, known as risk-based capital, is in addition to the states’ fixed dollar minimum capital and other requirements. The system is based on risk-based formulas that apply prescribed factors to the various risk elements in an insurer’s business and investments to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. Any failure to maintain appropriate levels of statutory surplus would have an adverse impact on our ability to maintain or grow our business.

Risks Related to Discontinued Operations

We could be subject to additional losses related to the sales of our discontinued FAFLIC and variable life insurance and annuity businesses and our former Chaucer business.

On January 2, 2009, we sold our remaining life insurance subsidiary, FAFLIC, to Commonwealth Annuity and Life Insurance Company (“Commonwealth Annuity”).  Coincident with the sale transaction, Hanover Insurance and FAFLIC entered into a reinsurance contract whereby Hanover Insurance assumed FAFLIC’s discontinued accident and health insurance business.  We previously owned Commonwealth Annuity, but sold it in 2005 in conjunction with our disposal of our variable life insurance and annuity business.  In connection with these transactions, we have agreed to indemnify Commonwealth Annuity for certain contingent liabilities, including litigation and other regulatory matters.

On December 28, 2018, we sold the majority of our Chaucer business (specifically our U.K.-based Lloyd’s entities) to China Re, with the rest of the Chaucer sale completed in April 2019. In connection with these transactions, we made certain representations and warranties and agreed to indemnify China Re for certain pre-sale contingent liabilities, including tax and litigation matters.

We cannot provide assurance as to what the costs of any indemnifications will be when they ultimately settle.

We may incur financial losses related to our discontinued assumed accident and health reinsurance pools and arrangements.

We previously participated, through FAFLIC, in approximately 40 assumed accident and health reinsurance pools and arrangements. The business was retained in the sale of FAFLIC and assumed by Hanover Insurance through a reinsurance agreement. In 1999, prior to the sale of FAFLIC to Commonwealth Annuity, FAFLIC had ceased writing new premiums in this business, subject to certain contractual obligations. We are currently monitoring and managing the run-off of our related participation in the 24 pools with remaining liabilities. See “Item 1 – Business – Discontinued Operations,” for information on the processes and risks associated with reserves established for these businesses.

Our long-term care pool accounts for the majority of our remaining accident and health reinsurance pool business.  The potential risk and exposure of our long-term care pool is based upon expected estimated claims and payment patterns, using assumptions for, among other things, morbidity, lapses, future premium rates, the impact of policy inflation protection riders, and the interest rate used for discounting the future projected cash flows. The long-term exposure of this pool depends upon how our actual experience compares with these future cash flow projection assumptions. If any of our assumptions prove to be inaccurate, our reserves may be inadequate, which may have a material adverse effect on our results of operations.

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Based on the information provided by the pool managers, we believe that the reserves recorded related to this business are appropriate. However, due to the inherent volatility in this business and the reporting lag of losses that tend to develop over time and which ultimately affect excess covers, as well as uncertainty surrounding both future claim expenses and with future premium rate levels for certain of these businesses, there can be no assurance that current reserves are adequate or that we will not have additional losses in the future.

Risks Related to Investments, Capital Markets and Economic Conditions

Other market fluctuations and general economic, market and political conditions may also negatively affect our business, profitability, investment portfolio, and the market value of our common stock.

It is difficult to predict the impact of a challenging economic environment on our business. In Commercial Lines, a difficult economy in the past has resulted in reductions in demand for insurance products and services since there are more companies ceasing to do business and there are fewer business start-ups, particularly as businesses are affected by a decline in overall consumer and business spending. Additionally, claims frequency could increase as policyholders submit and pursue claims more aggressively than in the past, fraud incidences may increase, or we may experience higher incidents of abandoned properties or poorer maintenance, which may also result in more claims activity. We have experienced higher workers’ compensation claims as injured employees take longer to return to work, increased surety losses as construction companies experience financial pressures and higher retroactive premium returns as audit results reflect lower payrolls. Our business could also be affected by an ensuing consolidation of independent insurance agencies. Our ability to increase pricing has been impacted as agents and policyholders have been more price sensitive, customers shop for policies more frequently or aggressively, utilize comparative rating models or, in Personal Lines in particular, turn to direct sales channels rather than independent agents. We have experienced decreased new business premium levels, retention and renewal rates, and renewal premiums. Specifically, in Personal Lines, policyholders may reduce coverages or change deductibles to reduce premiums, experience declining home values, or be subject to increased foreclosures, and policyholders may retain older or less expensive automobiles and purchase or insure fewer ancillary items such as boats, trailers and motor homes for which we provide coverages. Additionally, if as a result of a difficult economic environment, drivers continue to eliminate automobile insurance coverage or to reduce their bodily injury limit, we may be exposed to more uninsured and underinsured motorist coverage losses. Conversely, favorable economic conditions may also impact our business and results of operations.

At December 31, 2020, we held approximately $9.0 billion of investment assets in categories such as fixed maturities, equity securities, other investments, and cash and short-term investments. Our investments are primarily concentrated in the domestic market. Our investment returns, and thus our profitability, statutory surplus and shareholders’ equity, may be adversely affected from time to time by conditions affecting our specific investments and, more generally, by bond, stock, real estate and other market fluctuations and general economic, market and political conditions, including the impact of the Pandemic, changing government policies, including monetary policies, and geopolitical risks (which may include the impact of terrorism in various parts of the world or pandemic events). These broader market conditions are out of our control. Our ability to make a profit on insurance products depends in significant part on the returns on investments supporting our obligations under these products, and the value of specific investments may fluctuate substantially depending on the foregoing conditions. We may use a variety of strategies to hedge our exposure to interest and currency rates and other market risks. However, hedging strategies are not always available and carry certain credit risks, and our hedging could be ineffective. Moreover, increased government regulation of certain derivative transactions used to hedge certain market risks has served to prevent (or otherwise substantially increase the cost associated with) hedging such risks.

Additionally, the aggregate performance of our investment portfolio depends, to a significant extent, on the ability of our investment managers to select and manage appropriate investments. As a result, we are also exposed to operational and compliance risks, which may include, but are not limited to, a failure to follow our investment guidelines, technological and staffing deficiencies and inadequate disaster recovery plans. The failure of these investment managers to perform their services in a manner consistent with our expectations and investment objectives could adversely affect our ability to conduct our business.

Debt securities comprise a material portion of our investment portfolio. Although we have an investment strategy that provides for asset diversification, the concentration of our investment portfolio in any one type of investment, industry or geography could have a disproportionately adverse effect on our investment portfolio. The issuers of debt securities, as well as borrowers under the loans we make, customers, trading counterparties, counterparties under swaps and other derivative contracts, banks which have commitments under our various borrowing arrangements, and reinsurers, may be affected by declining market conditions or credit weaknesses. These parties may default on their obligations to us due to lack of liquidity, downturns in the economy or real estate values, operational failure, bankruptcy or other reasons. Future increases in interest rates could result in increased defaults as borrowers are unable to pay the additional borrowing costs on variable rate securities or obtain refinancing. We cannot provide assurance that impairment charges will not be necessary in the future. In addition, evaluation of available-for-sale securities for credit-related impairment losses includes inherent uncertainty and subjective determinations. We cannot be certain that such impairments are adequate as of any stated date. Our ability to fulfill our debt and other obligations could be adversely affected by the default of third parties on their obligations owed to us.

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Deterioration in the global financial markets may adversely affect our investment portfolio and have a related impact on our other comprehensive income, shareholders’ equity and overall investment performance. Recent economic activity has slowed, although growth continues at a moderate rate, and monetary policies in developed economies currently remain accommodative.  However, the effects of geo-political developments and conditions in global financial markets could change rapidly in ways that we cannot anticipate, resulting in additional realized and unrealized losses.

Market conditions also affect the value of assets under our employee pension plans, including our Cash Balance Plan. The expense or benefit related to our employee pension plans results from several factors, including, but not limited to, changes in the market value of plan assets, interest rates, regulatory requirements or judicial interpretation of benefits. At December 31, 2020, our plan assets included approximately 90% of fixed maturities and 10% of equity securities and other assets. Additionally, our qualified plan assets exceeded liabilities by $27.4 million at December 31, 2020. Declines in the market value of plan assets and lower interest rates from levels at December 31, 2020, among other factors, could impact our funding estimates and negatively affect our results of operations. Deterioration in market conditions, including as a result of the Pandemic, and differences between our assumptions and actual occurrences, and behaviors, could result in a need to fund more into the qualified plans to maintain an appropriate funding level.

Additional uncertainties, which could affect our business prospects and investments include the current U.S. political environment, which is characterized by potentially sharp policy differences that may affect all aspects of the economy.

We may experience unrealized losses on our investments, especially during a period of heightened volatility, or if assumptions related to our investment valuations are changed, which could have a material adverse effect on our results of operations or financial condition.

Our investment portfolio and shareholders’ equity can be, and in the past have been, significantly impacted by changes in the market values of our securities. U.S. and global financial markets and economies remain uncertain, particularly in light of the Pandemic. Market uncertainty could result in unrealized and realized losses in future periods, and adversely affect the liquidity of our investments, which could have a material adverse impact on our results of operations and our financial position. Information with respect to interest rate sensitivity is included in “Quantitative and Qualitative Disclosures” in Management’s Discussion and Analysis. Valuation of financial instruments (i.e., Level 1, 2, or 3) include methodologies, estimates, assumptions and judgments that are inherently subjective and open to different interpretations and could result in changes to investment valuations or the ability to receive such valuations on sale. During periods of market disruption, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. In addition, in times of financial market disruption, certain asset classes that were in active markets with significant observable data may become illiquid. In those cases, the valuation process includes inputs that are less observable and require more subjectivity and judgment by management. Changes in these subjective methodologies, estimates, assumptions and judgments used to value our investments could also materially affect the valuation of certain investments.

If, following such declines, we are unable to hold our investment assets until they recover in value, or if such asset value never recovers, we would incur impairment losses that would be recognized as realized losses in our results of operations, reduce net income and earnings per share and adversely affect our liquidity and capital position. Impairment determinations, like valuations, are also subjective, and changes to the methodologies, estimates, assumptions and judgments used to determine impairments may affect the timing and amount of impairment losses recognized in our results of operations. Temporary declines in the market value of fixed maturities are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce other comprehensive income, which is reflected on our Consolidated Balance Sheets. We cannot provide assurance that we will not have additional impairment losses and/or unrealized or realized investment losses in the future.

We invest a portion of our portfolio in common stock or preferred stocks. The value of these assets fluctuates with the equity markets. Particularly in times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income, capital and cash flows.

We are exposed to significant capital market risks related to changes in interest rates, credit spreads, and equity prices, which may adversely affect our results of operations, financial position or cash flows.

We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, and equity prices. Significant declines in equity prices, changes in interest rates, and changes in credit spreads each could have a material adverse effect on our results, financial position or cash flows. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in market yields would reduce the fair value of our investment portfolio, but provide the opportunity to earn higher rates of return on funds reinvested. A further decline in interest rates, on the other hand, would increase the fair value of our investment portfolio, but we would earn lower rates of return on reinvested assets. We may be forced to liquidate investments prior to maturity at a loss in order to cover liabilities, and such liquidation could be accelerated in the event of significant loss events, such as catastrophes. Although we take measures to manage the economic risks of investing in a changing interest rate environment, we may not be able to mitigate the interest rate risk of our assets relative to our liabilities.

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Our investment portfolio is invested primarily in high quality, investment-grade fixed income securities. However, we also invest in non-investment-grade high yield fixed income securities and alternative investments. These securities, which pay a higher rate of interest, also have a higher degree of credit or default risk. These securities may also be less liquid in times of economic weakness or market disruptions. Additionally, reported values of our investments do not necessarily reflect the lowest current market price for the asset, and if we require significant amounts of cash on short notice, we may have difficulty selling our investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both. While we have procedures to monitor the credit risk and liquidity of our invested assets, we expect from time to time, and particularly in periods of economic weakness, to experience default losses in our portfolio. This would result in a corresponding reduction of net income, capital and cash flows.

Inflationary pressures may negatively impact expenses, reserves and the value of investments.

Inflationary pressures in the U.S. with respect to medical and health care, automobile repair and construction costs, as well as social inflation of litigation costs, jury awards and settlement expectations, all of which are significant components of our indemnity liabilities under policies we issue to our customers, and which could also impact the adequacy of reserves we have set aside for prior accident years, may have a negative effect on our results of operations. Inflationary pressures also cause or contribute to, or are the result of, increases in interest rates, which would reduce the fair value of our investment portfolio.

Risks Related to Capital, Liquidity and Cash Flow

We are a holding company and rely on our insurance company subsidiaries for cash flow; we may not be able to receive dividends from our subsidiaries in needed amounts and may be required to provide capital to support their operations.

We are a holding company for a group of insurance companies, and our principal assets are the shares of capital stock of these subsidiaries. Our ability to make required interest payments on our debt, as well as our ability to pay operating expenses and pay dividends to shareholders, depends upon the receipt of sufficient funds from our subsidiaries. The payment of dividends by our insurance company subsidiaries is subject to regulatory restrictions and will depend on the surplus and future earnings of these subsidiaries, as well as these regulatory restrictions. We are required to notify insurance regulators prior to paying any dividends from our insurance subsidiaries, and pre-approval is required with respect to “extraordinary dividends.”

Because of the regulatory limitations on the payment of dividends from our insurance company subsidiaries, we may not always be able to receive dividends from these subsidiaries at times and in amounts necessary to meet our debt and other obligations, or to pay dividends to our shareholders. The inability of our subsidiaries to pay dividends to us in an amount sufficient to meet our debt interest and funding obligations would have a material adverse effect on us. These regulatory dividend restrictions also impede our ability to transfer cash and other capital resources among our subsidiaries. Similarly, our insurance subsidiaries may require capital from the holding company to support their operations.

Our dependence on our insurance subsidiaries for cash flow, and their potential need for capital support, exposes us to the risk of changes in their ability to generate sufficient cash inflows from new or existing customers or from increased cash outflows. Cash outflows may result from claims activity, expense payments or investment losses. Because of the nature of our business, claims activity can arise suddenly and in amounts which could outstrip our capital or liquidity resources (particularly in the event of a large catastrophe loss). Reductions in cash flow or capital demands from our subsidiaries could have a material adverse effect on our business and results of operations.

We may require additional capital or credit in the future, which may not be available or only available on unfavorable terms.

We monitor our capital adequacy on a regular basis. Our future capital and liquidity requirements depend on many factors, including premiums written, loss reserves and claim payments, investment portfolio composition and risk exposures, the availability of letters and lines of credit, as well as regulatory and rating agency capital requirements. In addition, our capital strength can affect our ratings.

To the extent that our existing capital is insufficient or unavailable to fund our future operating requirements and/or cover claim losses, we may need to raise additional funds through financings or limit our growth. Any equity or debt financing, if available, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result and, in any case, such securities may have rights, preferences, and privileges that are senior to our common stock. If we are not able to obtain additional capital as necessary, our business, results of operations and financial condition could be adversely affected.

Risks Related to the Pandemic

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 in March 2020. Circumstances relating to the Pandemic are unprecedented in scope and impact, continue to evolve, and are complex and uncertain. We are continually monitoring and assessing the impact of the Pandemic due to such uncertainty and cannot estimate the full extent of its future impact on our business, financial condition or results of operations. A prolonged economic downturn or recession as a result of the Pandemic could impact the ability of our insureds to remain solvent, affect their ability to pay premiums or renew their existing

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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 or maintain our current premium levels, particularly if these conditions exist for a significant amount of time.  Decreases in premiums from current levels could result in higher expense ratios. Also, it may be more difficult or costly to obtain reinsurance for certain types of coverages or at retention levels appropriate for our business mix.  

As a result of the Pandemic and related economic conditions, our investment portfolio has become volatile, impairment losses are higher than experienced in recent years 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, investment income, liquidity and capital position, of which the impact could be material.  

Due to government-mandated social distancing, public health guidance, 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. Also, with a large percentage of our workforce working remotely, we are highly reliant on the effective functioning of our business continuity plans and technology, 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 ongoing execution of the business continuity plans of such entities in the current environment. While we closely monitor the business continuity activities of these third parties, successful ongoing 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 claims that they cannot perform due to a force majeure, it could adversely impact our business, results of operations and/or financial condition.

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, to impose presumptions on insurance policy interpretation, and/or limit policy exclusions for losses allegedly related to the Pandemic. While we believe that many of those proposals, including 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 both our Commercial and Personal 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, and/or mandate additional 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.

General Risk Factors

If we are unable to attract, develop and retain qualified personnel, or if we experience the loss or retirement of key executives or other key employees, particularly those experienced in the property and casualty industry, we may not be able to compete effectively, and our operations could be impacted significantly.

Errors or omissions, misconduct or fraud in connection with the administration of any of our insurance or investment management operations may cause our business and profitability to be negatively impacted.

Changes in current accounting practices and future pronouncements may require us to incur considerable additional compliance expenses, to retroactively apply new requirements, or to make financial restatements.

Failure to design, implement or maintain effective internal control over financial reporting could have a material adverse effect on financial statements, financial reporting, investor confidence, our business and stock price.

Our stock price is influenced by our financial performance, industry trends and sentiment and other larger macro-economic factors described above in risk factors related to investments, capital markets and economic conditions that are out of our control. These factors could cause the market price of our common stock to fluctuate, become volatile, and there is no guarantee that it will remain at or exceed current or historical levels.

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ITEM 1B–UNRESOLVED STAFF COMMENTS

None.

ITEM 2–PROPERTIES

We conduct our business operations primarily in our company-owned facilities in Worcester, Massachusetts and Howell, Michigan. We also lease offices throughout the United States for branch sales, underwriting and claims processing functions, and the operations of acquired subsidiaries.

We believe our facilities are adequate for our present needs in all material respects.

ITEM 3–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, examination 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 4–MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5–MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

COMMON STOCK AND STOCKHOLDER OWNERSHIP

Our common stock is traded on the New York Stock Exchange under the symbol “THG”. On February 19, 2021, we had approximately 15,449 shareholders of record and 36,387,389 shares of common stock outstanding. On the same date, the trading price of our common stock was $113.31 per share.

DIVIDENDS

We currently expect that quarterly cash dividends, comparable to the $0.70 per share dividend we paid in the fourth quarter of 2020, will continue to be paid in the future; however, the payment of future quarterly or special dividends on our common stock will be determined by the Board of Directors from time to time based upon cash available at our holding company, our results of operations and financial condition and such other factors as the Board of Directors considers relevant.

Dividends to shareholders may be funded from dividends paid to us from our subsidiaries. Dividends from insurance subsidiaries are subject to restrictions imposed by state insurance laws and regulations. See “Liquidity and Capital Resources” in Management’s Discussion and Analysis and Note 12 – “Dividend Restrictions” in the Notes to Consolidated Financial Statements.

ISSUER PURCHASES OF EQUITY SECURITIES

The Board of Directors has authorized a stock repurchase program which provides for aggregate repurchases of our common stock of up to $900 million, and under which we have approximately $124 million available at December 31, 2020. Under the repurchase authorization, we may repurchase our common stock from time to time, in amounts, at prices, and at times we deem appropriate, subject to market conditions and other considerations. Our 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. Pursuant to the terms of an accelerated share repurchase (“ASR”) agreement executed on December 9, 2019 (the “December 2019 ASR”), we repurchased approximately 0.9 million shares of our common stock for $150.0 million, which represented approximately 80% of the total number of shares expected to be repurchased under this agreement. 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. On October 29, 2020, pursuant to the terms of an ASR agreement (the “October 2020 ASR”) we paid $100.0 million and received an initial delivery of approximately 0.8 million shares of common stock, which was approximately 80% of the total number of shares expected to be repurchased under the October 2020 ASR. On January 29, 2021, we received approximately 45,000 shares of our common stock as final settlement of shares repurchased under the October 2020 ASR.

Shares purchased in the fourth quarter of 2020 were as follows:

PERIOD

 

Total

Number of

Shares

Purchased

 

 

Average

Price Paid

per Share

 

 

Total

Number of

Shares

Purchased

as Part of

Publicly

Announced

Plans

or Programs

 

 

Approximate

Dollar

Value of

Shares

That May Yet

be

Purchased

Under

the Plans or

Programs

(in millions)

 

October 1 - 31, 2020 (1)

 

 

1,034,963

 

 

$

114.63

 

 

 

1,033,859

 

 

$

124

 

November 1 - 30, 2020 (1)

 

 

847

 

 

 

106.06

 

 

 

 

 

 

124

 

December 1 - 31, 2020 (1)

 

 

743

 

 

 

116.38

 

 

 

 

 

 

124

 

Total

 

 

1,036,553

 

 

$

114.63

 

 

 

1,033,859

 

 

$

124

 

 

 

(1)

Includes 1,104, 847 and 743 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 October 31, November 30 and December 31, 2020, respectively.

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ITEM 6 - SELECTED FINANCIAL DATA

FIVE YEAR SUMMARY OF SELECTED FINANCIAL HIGHLIGHTS

 

YEARS ENDED DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

 

2017

 

 

2016

 

(in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Statements of Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premiums

 

$

4,527.4

 

 

$

4,474.5

 

 

$

4,254.4

 

 

$

3,980.4

 

 

$

3,789.5

 

Net investment income

 

 

265.1

 

 

 

281.3

 

 

 

267.4

 

 

 

243.9

 

 

 

231.6

 

Net realized investment gains (losses)

 

 

5.0

 

 

 

109.4

 

 

 

(50.7

)

 

 

21.1

 

 

 

10.2

 

Fees and other income

 

 

29.8

 

 

 

25.5

 

 

 

23.2

 

 

 

22.5

 

 

 

22.6

 

Total revenues

 

 

4,827.3

 

 

 

4,890.7

 

 

 

4,494.3

 

 

 

4,267.9

 

 

 

4,053.9

 

Losses and Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

2,845.2

 

 

 

2,865.5

 

 

 

2,724.6

 

 

 

2,579.6

 

 

 

2,546.0

 

Amortization of deferred acquisition costs

 

 

951.0

 

 

 

926.7

 

 

 

891.8

 

 

 

840.7

 

 

 

803.6

 

Loss on repayment of debt

 

 

6.2

 

 

 

 

 

 

28.2

 

 

 

 

 

 

88.3

 

Other operating expenses

 

 

580.1

 

 

 

576.4

 

 

 

567.2

 

 

 

554.7

 

 

 

550.0

 

Total losses and expenses

 

 

4,382.5

 

 

 

4,368.6

 

 

 

4,211.8

 

 

 

3,975.0

 

 

 

3,987.9

 

Income from continuing operations before income taxes

 

 

444.8

 

 

 

522.1

 

 

 

282.5

 

 

 

292.9

 

 

 

66.0

 

Income tax expense (benefit)

 

 

82.8

 

 

 

93.1

 

 

 

43.5

 

 

 

76.8

 

 

 

(1.0

)

Income from continuing operations, net of taxes

 

 

362.0

 

 

 

429.0

 

 

 

239.0

 

 

 

216.1

 

 

 

67.0

 

Discontinued Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sale of Chaucer business, net of taxes

 

 

 

 

 

(1.2

)

 

 

131.9

 

 

 

 

 

 

 

Income (loss) from Chaucer business, net of taxes

 

 

0.4

 

 

 

1.6

 

 

 

20.0

 

 

 

(13.1

)

 

 

89.1

 

Income (loss) from discontinued life businesses, net of taxes

 

 

(3.7

)

 

 

(4.3

)

 

 

0.1

 

 

 

(16.8

)

 

 

(1.0

)

Net income

 

$

358.7

 

 

$

425.1

 

 

$

391.0

 

 

$

186.2

 

 

$

155.1

 

Net income per common share (diluted)

 

$

9.42

 

 

$

10.46

 

 

$

9.09

 

 

$

4.33

 

 

$

3.59

 

Dividends declared per common share

 

$

2.65

 

 

$

4.95

 

 

$

6.97

 

 

$

2.04

 

 

$

1.88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheets (at December 31)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

13,443.7

 

 

$

12,490.5

 

 

$

12,399.7

 

 

$

15,469.6

 

 

$

14,220.4

 

Debt

 

 

780.8

 

 

 

653.4

 

 

 

777.9

 

 

 

786.9

 

 

 

786.4

 

Total liabilities

 

 

10,241.5

 

 

 

9,574.3

 

 

 

9,445.0

 

 

 

12,471.9

 

 

 

11,362.9

 

Shareholders' equity

 

 

3,202.2

 

 

 

2,916.2

 

 

 

2,954.7

 

 

 

2,997.7

 

 

 

2,857.5

 

 

 

 

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ITEM 7–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 consolidated results of operations and financial condition of The Hanover Insurance Group, Inc. and its subsidiaries (“THG”). Consolidated results of operations and financial condition are prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). This discussion should be read in conjunction with the Consolidated Financial Statements and related footnotes included elsewhere herein.

Results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), our principal property and casualty companies, and certain other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting primarily of our former Chaucer international business, Chaucer Holdings Limited (“Chaucer”), a United Kingdom (“U.K.”) domiciled specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s”), and international insurance and non-insurance subsidiaries, which collectively constituted our former Chaucer segment. On December 28, 2018, we completed the sale of Chaucer to China Reinsurance (Group) Corporation (“China Re”), and subsequently completed the sales of the Chaucer-related Irish and Australian entities on February 14, 2019 and April 10, 2019, respectively. For all periods presented, operations from Chaucer are presented as discontinued operations. Discontinued operations also include the results of our accident and health and former life insurance businesses.

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, supports 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”) significantly impacted the U.S. and global financial markets and economies during the year ended December 31, 2020.  Circumstances relating to the Pandemic are unprecedented in scope and impact, continue to evolve, and are complex and uncertain.  Our investment portfolio was affected by the deterioration in investment markets during March 2020, as well as volatility in the subsequent months. In addition, we experienced both favorable and adverse effects from the Pandemic on our underwriting results and operations, as well as our financial condition, during March through December 2020. We continue to believe that the Pandemic’s impacts on our near-term 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).

Net income was $358.7 million in 2020, compared to $425.1 million in 2019, a decrease of $66.4 million, primarily due to changes in the fair value of equity securities and, to a lesser extent, 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 $484.7 million in 2020 compared to $453.6 million in 2019, an increase of $31.1 million. This increase is primarily due to lower non-catastrophe current accident year losses, primarily in our personal and commercial automobile lines, and favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”), partially offset by higher catastrophe losses and, to a lesser extent, lower net investment income. The lower non-catastrophe current accident year losses reflect a reduced level of economic activity as a result of the Pandemic.

Pre-tax catastrophe losses were $286.7 million in 2020, compared to $169.3 million in 2019, an increase of $117.4 million primarily due to higher property damages related to riots and civil unrest in several major cities across the country, hurricane Isaias, wildfires on the West Coast, and wind and hailstorms in the Midwest and Southeast. Net favorable development on prior years’ loss reserves was $15.5 million in 2020, compared to $0.9 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 through continued investment in industry segmentation. Net premiums written increased 1.0% in 2020 compared to 2019. The modest premium growth during 2020 reflects a reduction in insured business activity as a result of the Pandemic.

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Underwriting results declined in 2020, primarily due to higher catastrophe losses, partially offset by lower large non-catastrophe current accident year losses. The lower non-catastrophe current accident year losses were primarily due to lower loss activity in our specialty industrial property and marine lines, and lower losses in our commercial automobile line, partially offset by reserve provisions for exposures related to the Pandemic and to higher property losses in our commercial multiple peril line. The lower non-catastrophe current accident year losses reflect a reduced level of economic activity as a result of the Pandemic. 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 many lines of business. Due to uncertainty caused by the Pandemic, there is a level of uncertainty in our ability to grow our business, and to maintain or improve our underwriting profitability in this environment.

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/or 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 uncertainty caused by the Pandemic, there is a level of uncertainty in our ability to grow our business, and to maintain or improve our underwriting profitability in this environment.

Net premiums written decreased by 0.5% in 2020. During the second quarter of 2020, we returned approximately $30 million of premiums to our eligible personal automobile customers in all of our markets, providing financial relief during the Pandemic.  Excluding the impact of the premium refund, net premiums written would have increased 1.1%. Underwriting results improved in 2020, primarily due to lower non-catastrophe current accident year losses in our personal automobile line, a favorable change in development of prior years’ loss reserves and a non-recurring premium tax benefit, partially offset by higher catastrophe losses. The lower personal automobile losses were due to fewer accidents and decreased claim activity resulting from fewer miles driven as a result of the Pandemic.

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. The operations of Chaucer are classified as discontinued operations for all periods presented. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance.

We report interest expense on debt separately from the earnings of our operating segments. This consists of interest on our senior and subordinated debentures.

RESULTS OF OPERATIONS – CONSOLIDATED

2020 Compared to 2019

Consolidated net income was $358.7 million in 2020, compared to $425.1 million in 2019, a decrease of $66.4 million. The year over year comparison of consolidated net income reflects a decrease in after-tax net realized and unrealized investment gains of $82.5 million, principally related to changes in the fair value of equity securities. This was partially offset by an increase in operating income before interest expense and income taxes of $31.1 million, primarily due to lower non-catastrophe current accident year losses, primarily in our personal and commercial automobile lines, and favorable development on prior years’ loss reserves, partially offset by higher catastrophe losses and, to a lesser extent, lower net investment income.

2019 Compared to 2018

Consolidated net income was $425.1 million in 2019, compared to $391.0 million in 2018, an increase of $34.1 million. The year over year comparison of consolidated net income reflects an increase in after-tax net realized and unrealized investment gains of $132.1 million, principally related to changes in the fair value of equity securities. Additionally, operating income before interest expense and income taxes increased $47.1 million, primarily due to lower catastrophe losses, earned premium growth, lower expenses and higher net investment income, partially offset by higher current accident year large loss activity, particularly in the property lines. The increase in the year over year net income comparison was partially offset by the $131.9 million gain from the sale of our former Chaucer business in 2018.

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The following table reflects operating income (loss) 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).

YEARS ENDED DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Commercial Lines

 

$

275.4

 

 

$

300.1

 

 

$

265.7

 

Personal Lines

 

 

212.5

 

 

 

144.9

 

 

 

146.2

 

Other

 

 

(3.2

)

 

 

8.6

 

 

 

(5.4

)

Operating income before interest expense and income taxes

 

 

484.7

 

 

 

453.6

 

 

 

406.5

 

Interest expense on debt

 

 

(37.1

)

 

 

(37.5

)

 

 

(45.1

)

Operating income before income taxes

 

 

447.6

 

 

 

416.1

 

 

 

361.4

 

Income tax expense on operating income

 

 

(92.6

)

 

 

(84.5

)

 

 

(69.3

)

Operating income

 

 

355.0

 

 

 

331.6

 

 

 

292.1

 

Non-operating items:

 

 

 

 

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains (losses)

 

 

5.0

 

 

 

109.4

 

 

 

(50.7

)

Net loss from repayment of debt

 

 

(6.2

)

 

 

 

 

(28.2

)

Other

 

 

(1.6

)

 

 

(3.4

)

 

 

Income tax benefit (expense) on non-operating items

 

 

9.8

 

 

 

(8.6

)

 

 

25.8

 

Income from continuing operations, net of taxes

 

 

362.0

 

 

 

429.0

 

 

 

239.0

 

Discontinued operations (net of taxes):

 

 

 

 

 

 

 

 

 

 

 

 

Sale of Chaucer business

 

 

 

 

(1.2

)

 

 

131.9

 

Income from Chaucer business

 

 

0.4

 

 

 

1.6

 

 

 

20.0

 

Income (loss) from discontinued life businesses

 

 

(3.7

)

 

 

(4.3

)

 

 

0.1

 

Net income

 

$

358.7

 

 

$

425.1

 

 

$

391.0

 

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 interest expense and income 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 interest expense and income 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 interest expense and income taxes are important components in understanding and assessing our overall financial performance, we believe a discussion of operating income before interest expense and income 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 interest expense and income 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, income 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:

 YEARS ENDED DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

4,598.5

 

 

$

4,581.7

 

 

$

4,384.8

 

Net premiums earned

 

$

4,527.4

 

 

$

4,474.5

 

 

$

4,254.4

 

Net investment income

 

 

265.1

 

 

 

281.3

 

 

 

267.4

 

Other income

 

 

29.8

 

 

 

25.5

 

 

 

23.2

 

Total operating revenues

 

 

4,822.3

 

 

 

4,781.3

 

 

 

4,545.0

 

Losses and operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

Losses and LAE

 

 

2,844.5

 

 

 

2,864.6

 

 

 

2,724.6

 

Amortization of deferred acquisition costs

 

 

951.0

 

 

 

926.7

 

 

 

891.8

 

Other operating expenses

 

 

542.1

 

 

 

536.4

 

 

 

522.1

 

Total losses and operating expenses

 

 

4,337.6

 

 

 

4,327.7

 

 

 

4,138.5

 

Operating income before interest expense and income taxes

 

$

484.7

 

 

$

453.6

 

 

$

406.5

 

2020 Compared to 2019

Operating income before interest expense and income taxes was $484.7 million for the year ended December 31, 2020, compared to $453.6 million for the year ended December 31, 2019, an increase of $31.1 million. This increase was primarily due to lower non-catastrophe current accident year losses primarily in our personal and commercial automobile lines, and favorable development on prior years’ loss reserves, partially offset by higher catastrophe losses and lower net investment income. The lower non-catastrophe current accident year losses reflect a reduced level of economic activity as a result of the Pandemic. The increase in catastrophe losses was primarily due to higher property damages related to riots and civil unrest in several major cities across the country, hurricane Isaias, wildfires on the West Coast, and wind and hailstorms in the Midwest and Southeast.  

Net premiums written increased by $16.8 million for the year ended December 31, 2020, compared to the year ended December 31, 2019. Premiums grew during 2020 in both our Commercial and Personal Lines segments, partially offset by the personal automobile premium refund of approximately $30 million in the second quarter of 2020.

2019 Compared to 2018

Operating income before interest expense and income taxes was $453.6 million for the year ended December 31, 2019, compared to $406.5 million for the year ended December 31, 2018, an increase of $47.1 million. This increase was primarily due to lower catastrophe losses, earned premium growth, lower expenses and higher net investment income, partially offset by higher current accident year large loss activity in our specialty industrial property line, personal automobile and, to a lesser extent, our homeowners and marine lines.

Net premiums written increased by $196.9 million for the year ended December 31, 2019, compared to the year ended December 31, 2018, due to growth in both our Commercial and Personal Lines segments.

PRODUCTION AND UNDERWRITING RESULTS

The following table summarizes 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 were not meaningful for our Other segment.

 

 

YEAR ENDED DECEMBER 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

 

$

3,201.0

 

 

$

2,733.1

 

 

$

2,683.3

 

 

 

4.9

 

 

 

61.4

 

 

 

34.4

 

 

 

95.8

 

Personal Lines

 

 

1,953.5

 

 

 

1,865.4

 

 

 

1,844.1

 

 

 

8.4

 

 

 

64.7

 

 

 

27.7

 

 

 

92.4

 

Total

 

$

5,154.5

 

 

$

4,598.5

 

 

$

4,527.4

 

 

 

6.3

 

 

 

62.8

 

 

 

31.6

 

 

 

94.4

 

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Table of Contents

 

 

YEAR ENDED DECEMBER 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

 

$

3,127.3

 

 

$

2,707.2

 

 

$

2,654.2

 

 

 

3.1

 

 

 

60.6

 

 

 

34.6

 

 

 

95.2

 

Personal Lines

 

 

1,991.2

 

 

 

1,874.5

 

 

 

1,820.3

 

 

 

4.7

 

 

 

68.9

 

 

 

27.4

 

 

 

96.3

 

Total

 

$

5,118.5

 

 

$

4,581.7

 

 

$

4,474.5

 

 

 

3.8

 

 

 

64.0

 

 

 

31.6

 

 

 

95.6

 

 

 

 

YEAR ENDED DECEMBER 31, 2018

 

(dollars in millions)

 

Gross

Premiums

Written

 

 

Net

Premiums

Written

 

 

Net

Premiums

Earned

 

 

Catastrophe

Loss Ratios

 

 

Loss &

LAE Ratios

 

 

Expense

Ratios

 

 

Combined

Ratios

 

Commercial Lines

 

$

2,968.1

 

 

$

2,610.7

 

 

$

2,548.4

 

 

 

5.6

 

 

 

61.5

 

 

 

34.9

 

 

 

96.4

 

Personal Lines

 

 

1,875.6

 

 

 

1,774.1

 

 

 

1,706.0

 

 

 

4.5

 

 

 

67.7

 

 

 

27.8

 

 

 

95.5

 

Total

 

$

4,843.7

 

 

$

4,384.8

 

 

$

4,254.4

 

 

 

5.2

 

 

 

64.0

 

 

 

32.1

 

 

 

96.1

 

The following tables summarize 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.

 

 

YEAR ENDED DECEMBER 31, 2020

 

(dollars in millions)

 

Net

Premiums

Written

 

 

Loss &

LAE Ratios

 

 

Catastrophe

Loss Ratios

 

Commercial Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

921.7

 

 

 

68.6

 

 

 

9.3

 

Commercial automobile

 

 

336.0

 

 

 

69.0

 

 

 

0.6

 

Workers' compensation

 

 

320.3

 

 

 

49.5

 

 

 

 

Other commercial

 

 

1,155.1

 

 

 

56.6

 

 

 

4.1

 

Total Commercial Lines

 

 

2,733.1

 

 

 

61.4

 

 

 

4.9

 

Personal Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Personal automobile

 

 

1,151.5

 

 

 

62.7

 

 

 

1.0

 

Homeowners

 

 

653.4

 

 

 

71.1

 

 

 

22.1

 

Other personal

 

 

60.5

 

 

 

31.6

 

 

 

2.5

 

Total Personal Lines

 

 

1,865.4

 

 

 

64.7

 

 

 

8.4

 

Total

 

$

4,598.5

 

 

 

62.8

 

 

 

6.3

 

 

 

 

YEAR ENDED DECEMBER 31, 2019

 

(dollars in millions)

 

Net

Premiums

Written

 

 

Loss &

LAE Ratios

 

 

Catastrophe

Loss Ratios

 

Commercial Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

909.4

 

 

 

63.0

 

 

 

7.5

 

Commercial automobile

 

 

336.1

 

 

 

71.9

 

 

 

0.4

 

Workers' compensation

 

 

334.6

 

 

 

50.7

 

 

 

 

Other commercial

 

 

1,127.1

 

 

 

58.3

 

 

 

1.4

 

Total Commercial Lines

 

 

2,707.2

 

 

 

60.6

 

 

 

3.1

 

Personal Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Personal automobile

 

 

1,186.1

 

 

 

74.0

 

 

 

0.5

 

Homeowners

 

 

636.9

 

 

 

61.5

 

 

 

12.8

 

Other personal

 

 

51.5

 

 

 

41.5

 

 

 

2.8

 

Total Personal Lines

 

 

1,874.5

 

 

 

68.9

 

 

 

4.7

 

Total

 

$

4,581.7

 

 

 

64.0

 

 

 

3.8

 

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Table of Contents

 

 

YEAR ENDED DECEMBER 31, 2018

 

(dollars in millions)

 

Net

Premiums

Written

 

 

Loss &

LAE Ratios

 

 

Catastrophe

Loss Ratios

 

Commercial Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

861.4

 

 

 

66.4

 

 

 

10.7

 

Commercial automobile

 

 

344.8

 

 

 

79.9

 

 

 

0.8

 

Workers' compensation

 

 

317.1

 

 

 

51.0

 

 

 

 

Other commercial

 

 

1,087.4

 

 

 

54.9

 

 

 

4.7

 

Total Commercial Lines

 

 

2,610.7

 

 

 

61.5

 

 

 

5.6

 

Personal Lines:

 

 

 

 

 

 

 

 

 

 

 

 

Personal automobile

 

 

1,127.5

 

 

 

72.0

 

 

 

0.5

 

Homeowners

 

 

604.0

 

 

 

61.2

 

 

 

12.1

 

Other personal

 

 

42.6

 

 

 

48.1

 

 

 

2.2

 

Total Personal Lines

 

 

1,774.1

 

 

 

67.7

 

 

 

4.5

 

Total

 

$

4,384.8

 

 

 

64.0

 

 

 

5.2

 

The following tables summarize 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.

 

 

YEAR ENDED DECEMBER 31, 2020

 

(in millions)

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Total

 

Underwriting profit (loss), excluding prior year reserve

   development and catastrophes

 

$

219.5

 

 

$

286.7

 

 

$

(0.1

)

 

$

506.1

 

Prior year favorable (unfavorable) loss and LAE reserve

   development on non-catastrophe losses

 

 

19.0

 

 

 

0.7

 

 

 

(4.2

)

 

 

15.5

 

Prior year favorable (unfavorable) catastrophe development

 

 

18.8

 

 

 

(1.7

)

 

 

 

 

 

17.1

 

Current year catastrophe losses

 

 

(151.0

)

 

 

(152.8

)

 

 

 

 

 

(303.8

)

Underwriting profit (loss)

 

 

106.3

 

 

 

132.9

 

 

 

(4.3

)

 

 

234.9

 

Net investment income

 

 

175.3

 

 

 

76.7

 

 

 

13.1

 

 

 

265.1

 

Fees and other income

 

 

12.2

 

 

 

10.6

 

 

 

7.0

 

 

 

29.8

 

Other operating expenses

 

 

(18.4

)

 

 

(7.7

)

 

 

(19.0

)

 

 

(45.1

)

Operating income (loss) before interest expense and income taxes

 

$

275.4

 

 

$

212.5

 

 

$

(3.2

)

 

$

484.7

 

 

 

 

YEAR ENDED DECEMBER 31, 2019

 

(in millions)

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Total

 

Underwriting profit (loss), excluding prior year reserve

   development and catastrophes

 

$

176.0

 

 

$

171.8

 

 

$

(0.1

)

 

$

347.7

 

Prior year favorable (unfavorable) loss and LAE reserve

   development on non-catastrophe losses

 

 

28.7

 

 

 

(26.6

)

 

 

(1.2

)

 

 

0.9

 

Prior year favorable catastrophe development

 

 

24.6

 

 

 

2.9

 

 

 

 

 

 

27.5

 

Current year catastrophe losses

 

 

(107.8

)

 

 

(89.0

)

 

 

 

 

 

(196.8

)

Underwriting profit (loss)

 

 

121.5

 

 

 

59.1

 

 

 

(1.3

)

 

 

179.3

 

Net investment income

 

 

180.1

 

 

 

80.1

 

 

 

21.1

 

 

 

281.3

 

Fees and other income

 

 

9.2

 

 

 

11.4

 

 

 

4.9

 

 

 

25.5

 

Other operating expenses

 

 

(10.7

)

 

 

(5.7

)

 

 

(16.1

)

 

 

(32.5

)

Operating income before interest expense and income taxes

 

$

300.1

 

 

$

144.9

 

 

$

8.6

 

 

$

453.6

 

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Table of Contents

 

 

YEAR ENDED DECEMBER 31, 2018

 

(in millions)

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Total

 

Underwriting profit (loss), excluding prior year reserve

   development and catastrophes

 

$

193.2

 

 

$

176.8

 

 

$

(3.0

)

 

$

367.0

 

Prior year favorable (unfavorable) loss and LAE reserve

   development on non-catastrophe losses

 

 

34.1

 

 

 

(33.3

)

 

 

(1.2

)

 

 

(0.4

)

Prior year favorable catastrophe development

 

 

6.8

 

 

 

2.5

 

 

 

 

 

 

9.3

 

Current year catastrophe losses

 

 

(149.1

)

 

 

(79.4

)

 

 

 

 

 

(228.5

)

Underwriting profit (loss)

 

 

85.0

 

 

 

66.6

 

 

 

(4.2

)

 

 

147.4

 

Net investment income

 

 

182.2

 

 

 

73.7

 

 

 

11.5

 

 

 

267.4

 

Fees and other income

 

 

8.9

 

 

 

11.6

 

 

 

2.7

 

 

 

23.2

 

Other operating expenses

 

 

(10.4

)

 

 

(5.7

)

 

 

(15.4

)

 

 

(31.5

)

Operating income (loss) before interest expense and income taxes

 

$

265.7

 

 

$

146.2

 

 

$

(5.4

)

 

$

406.5

 

2020 Compared to 2019

Commercial Lines

Commercial Lines net premiums written were $2,733.1 million for the year ended December 31, 2020, compared to $2,707.2 million for the year ended December 31, 2019, an increase of $25.9 million. The modest premium growth during 2020 reflects a reduction of insured business activity as a result of the Pandemic.

Commercial Lines underwriting profit for the year ended December 31, 2020 was $106.3 million, compared to $121.5 million for the year ended December 31, 2019, a decrease of $15.2 million. Catastrophe-related losses for the year ended December 31, 2020 were $132.2 million, compared to $83.2 million for the year ended December 31, 2019, an increase of $49.0 million. Favorable development on prior years’ loss reserves, excluding catastrophes, for the year ended December 31, 2020 was $19.0 million, compared to $28.7 million for the year ended December 31, 2019, a decrease of $9.7 million.

Commercial Lines current accident year underwriting profit, excluding catastrophes, was $219.5 million for the year ended December 31, 2020, compared to $176.0 million for the year ended December 31, 2019. This $43.5 million increase was primarily due to lower non-catastrophe current accident year losses. The lower current year non-catastrophe losses were primarily due to lower large loss activity in our specialty industrial property and marine lines, and lower losses in our commercial automobile line, partially offset by reserve provisions for exposures due to the Pandemic and to higher property losses in our commercial multiple peril line. The reserve provisions for exposures due to the Pandemic of approximately $19 million were primarily reflected in our workers’ compensation, healthcare, commercial multiple peril, management and professional liability, and surety lines. The lower non-catastrophe current accident year losses reflect a reduced level of economic activity as a result of the Pandemic.

We continue 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 uncertainty caused by the Pandemic, there is a level of uncertainty in our ability to grow our business, and to maintain or improve our underwriting profitability in this environment. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in continued 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 reduction in our insureds’ underlying business activity, as well as the inability of certain businesses to fully 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 $1,865.4 million for the year ended December 31, 2020, compared to $1,874.5 million for the year ended December 31, 2019, a decrease of $9.1 million. During the second quarter of 2020, we returned approximately $30 million of premiums to our eligible Personal Lines automobile customers in all markets, providing financial relief during the Pandemic.  Excluding the impact of the premium refund, net premiums written would have increased 1.1%.

Net premiums written in the personal automobile line of business for the year ended December 31, 2020 were $1,151.5 million, compared to $1,186.1 million for the year ended December 31, 2019, a decrease of $34.6 million. This decrease was primarily due to the aforementioned premium refund of approximately $30 million and a decrease in policies in force of 2.8%. Net premiums written in the homeowners line of business for the year ended December 31, 2020 were $653.4 million, compared to $636.9 million for the year ended December 31, 2019, an increase of $16.5 million. This increase was primarily driven by pricing increases, partially offset by a 1.1% decrease in policies in force.

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Personal Lines underwriting profit for the year ended December 31, 2020 was $132.9 million, compared to $59.1 million for the year ended December 31, 2019, an increase of $73.8 million. Catastrophe losses for the year ended December 31, 2020 were $154.5 million, compared to $86.1 million for the year ended December 31, 2019, an increase of $68.4 million. Favorable development on prior years’ loss reserves for the year ended December 31, 2020 was $0.7 million, compared to unfavorable development of $26.6 million for the year ended December 31, 2019, a favorable change of $27.3 million.

Personal Lines current accident year underwriting profit, excluding catastrophes, was $286.7 million in the year ended December 31, 2020, compared to $171.8 million for the year ended December 31, 2019. This $114.9 million increase was primarily due to lower current accident year losses in our personal automobile line, and, to a lesser extent, a non-recurring premium tax benefit.  Personal automobile losses were lower due to fewer accidents and decreased claim activity resulting from fewer miles driven as a result of the Pandemic.

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 activity and legal 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 uncertainty caused by the Pandemic, there is a level of uncertainty in our ability to retain or grow our business, and to maintain or improve our underwriting profitability in this environment. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in a continued moderation in claims volumes due to a substantial reduction in customer activity including, for example, fewer miles driven by the insureds in our personal automobile line.

In addition, in 2019, Michigan enacted major reforms of its current system governing personal and commercial automobile insurance, especially related to automobile Personal Injury Protection (“PIP”) coverage. We believe that we are effectively executing the transition and will be able to navigate this market successfully. As of December 31, 2020, the net impact of these reforms was not significant to our total net premiums written and underwriting profit. For 2020, net premiums written that were attributable to PIP coverage in Michigan were $144.3 million, or 3.1% of our total company full year 2020 net premiums written, while Michigan personal automobile net premiums written represented 11.7% of our total company full year 2020 net premiums written. For more information, please refer to “Risk Factors” in Part I – Item 1A.

Other

Other operating losses were $3.2 million for the year ended December 31, 2020, compared to other operating income of $8.6 million for the year ended December 31, 2019, a decrease of $11.8 million. This was primarily due to lower net investment income as a result of the deployment of proceeds in 2019 from the sale of our former Chaucer business, as well as increased charitable contributions in 2020.

2019 Compared to 2018

Commercial Lines

Commercial Lines net premiums written were $2,707.2 million for the year ended December 31, 2019, compared to $2,610.7 million for the year ended December 31, 2018. This $96.5 million increase was primarily driven by pricing increases and strong retention.

Commercial Lines underwriting profit for the year ended December 31, 2019 was $121.5 million, compared to $85.0 million for the year ended December 31, 2018, an increase of $36.5 million. Catastrophe-related losses for the year ended December 31, 2019 were $83.2 million, compared to $142.3 million for the year ended December 31, 2018, a decrease of $59.1 million. This decrease is partially attributable to an increase in prior year favorable catastrophe development of $17.8 million, primarily due to the sale of subrogation rights on certain California wildfire losses incurred in 2017 and 2018. Favorable development on prior years’ loss reserves, excluding catastrophes, for the year ended December 31, 2019 was $28.7 million, compared to $34.1 million for the year ended December 31, 2018, a decrease of $5.4 million.

Commercial Lines current accident year underwriting profit, excluding catastrophes, was $176.0 million for the year ended December 31, 2019, compared to $193.2 million for the year ended December 31, 2018. This $17.2 million decrease was primarily due to higher current accident year large property loss activity in our specialty industrial property line and, to a lesser extent, in our marine and Hanover Programs lines within other commercial lines, partially offset by earned premium growth and lower expenses.

Personal Lines

Personal Lines net premiums written were $1,874.5 million for the year ended December 31, 2019, compared to $1,774.1 million for the year ended December 31, 2018, an increase of $100.4 million. This was primarily due to higher renewal premium driven by rate increases, which was modestly offset by lower policy retention.

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Net premiums written in the personal automobile line of business for the year ended December 31, 2019 were $1,186.1 million, compared to $1,127.5 million for the year ended December 31, 2018, an increase of $58.6 million. This increase was primarily due to rate increases and an increase in policies in force of 1.4%. Net premiums written in the homeowners line of business for the year ended December 31, 2019 were $636.9 million, compared to $604.0 million for the year ended December 31, 2018, an increase of $32.9 million. This is attributable to rate increases and an increase in policies in force of 2.1%.

Personal Lines underwriting profit for the year ended December 31, 2019 was $59.1 million, compared to $66.6 million for the year ended December 31, 2018, a decrease of $7.5 million. Catastrophe losses for the year ended December 31, 2019 were $86.1 million, compared to $76.9 million for the year ended December 31, 2018, an increase of $9.2 million. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2019 was $26.6 million, compared to $33.3 million for the year ended December 31, 2018, a decrease of $6.7 million.

Personal Lines current accident year underwriting profit, excluding catastrophes, was $171.8 million in the year ended December 31, 2019, compared to $176.8 million for the year ended December 31, 2018. This $5.0 million decrease was primarily due to higher current accident year losses in our personal automobile and homeowners lines, partially offset by earned premium growth and lower expenses.

Other

Other operating income was $8.6 million for the year ended December 31, 2019, compared to other operating losses of $5.4 million for the year ended December 31, 2018, an improvement of $14.0 million. This was primarily due to higher net investment income, which includes the investment of the remaining proceeds from the Chaucer sale transaction. All of the proceeds of the Chaucer transaction were distributed in 2019 through share repurchases or special dividends.

Reinsurance Recoverables

Reinsurance recoverables were $1,874.3 million and $1,814.0 million at December 31, 2020 and December 31, 2019, respectively, of which $88.4 million and $89.8 million, respectively, represent billed recoverables. A reinsurance recoverable is billed after an eligible reinsured claim is paid by an insurer. Billed reinsurance recoverables related to the Michigan Catastrophic Claims Association (“MCCA”) were $35.5 million and $29.2 million at December 31, 2020 and December 31, 2019, respectively, and billed non-MCCA reinsurance recoverables totaled $52.9 million and $60.6 million at December 31, 2020 and December 31, 2019, respectively. As of December 31, 2020 and December 31, 2019, there were no balances outstanding greater than 90 days.

RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Overview of Loss Reserve Estimation Process

We maintain reserves for our property and casualty insurance products to provide for our ultimate liability for losses and loss adjustment expenses (our “loss reserves”) with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, taking into account past loss experience, modified for current trends, as well as prevailing economic, legal and social conditions. Loss reserves represent our largest liability.

Management’s process for establishing loss reserves is a comprehensive process that involves input from multiple functions throughout our organization, including actuarial, finance, claims, legal, underwriting, distribution and business operations management. The process incorporates facts currently known, as well as the current, and in some cases, the anticipated, state of the law and coverage litigation. Based on information currently available, we believe that the aggregate loss reserves at December 31, 2020 were adequate to cover claims for losses that had occurred as of that date, including both those known to us and those yet to be reported. However, as described below, there are significant uncertainties inherent in the loss reserving process. Our estimate of the ultimate liability for losses that had occurred as of December 31, 2020 is expected to change in future periods as we obtain further information, and such changes could have a material effect on our results of operations and financial position.

Our loss reserves include case estimates for claims that have been reported and estimates for claims that have been incurred but not reported (“IBNR”) at the balance sheet date. They also include estimates of the expenses associated with processing and settling all reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Our property and casualty loss reserves are not discounted to present value.

Case reserves are established by our claim personnel individually on a claim by claim basis and based on information specific to the occurrence and terms of the underlying policy. For some classes of business, average case reserves are used initially. Case reserves are periodically reviewed and modified based on new or additional information pertaining to the claim.

Our ultimate IBNR reserves are estimated by management and our reserving actuaries on an aggregate basis for each line of business or coverage for loss and loss expense liabilities not reflected within the case reserves. The sum of the case reserves and the IBNR reserves represents our estimate of total unpaid losses and loss adjustment expenses.

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We regularly review our loss reserves using a variety of industry accepted analytical techniques. We update the loss reserves as historical loss experience develops, additional claims are reported and resolved, and new information becomes available. Net changes in loss reserves are reflected in operating results in the period in which the reserves are changed.

The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which may not yet be known to the insured, as well as a provision for future development on reported claims. IBNR represents a significant proportion of our total net loss reserves, particularly for long-tail liability classes. In fact, approximately 50% of our aggregate net loss reserves at December 31, 2020 were for IBNR losses and loss expenses.

Critical Judgments and Key Assumptions

We determine the amount of our net loss reserves (i.e., net of estimated reinsurance recoverables) based on an estimation process that is complex and considers information from both company specific and industry data, as well as general economic and other information. The estimation process utilizes a combination of objective and subjective information, the blending of which requires significant professional judgment. There are various assumptions required, including future trends in frequency and severity of claims, operational changes in claim handling and case reserving practices and trends related to general economic and social conditions. Informed judgments as to our ultimate exposure to losses are an integral component of our loss reserve estimation process.

There is greater inherent uncertainty in estimating insurance reserves for certain types of property and casualty insurance lines, particularly liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability and losses may be made (sometimes referred to as “long-tail” business). In addition, the technological, judicial, regulatory and political climates involving these types of claims are continuously evolving. The emergence of the Pandemic during 2020 resulted in an increased level of uncertainty for many lines of business, particularly for our long-tail lines. There is also greater uncertainty in establishing reserves with respect to business that is new to us, particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business. In both of these cases, there is less historical experience or knowledge, and less data upon which we can rely. A combination of business that is both new to us and has longer development periods provides even greater uncertainty in estimating insurance reserves. In our management and professional liability lines, we are modestly increasing, and expect to continue to increase, our exposure to longer-tailed liability lines, including directors and officers liability, errors and omissions liability and product liability coverages. In addition, in recent periods, we have experienced extensions of the “tails” in certain lines of business as the full value of claims are presented later than had been our historical experience. The broad impact of the Pandemic on our claims environment may extend these “tails” even further.

We regularly update our reserve estimates as new information becomes available and additional events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in the results of operations as adjustments to losses and LAE. Often, these adjustments are recognized in periods subsequent to the period in which the underlying policy was written and the loss event occurred. When these types of subsequent adjustments affect prior years, they are described separately as “prior year reserve development”. Such development can be either favorable or unfavorable to our financial results and may vary by line of business. As discussed below, estimated loss and LAE reserves for claims occurring in prior years, in the aggregate, developed favorably by $15.5 million and $0.9 million for the years ended December 31, 2020 and 2019, respectively and unfavorably by $0.4 million for the year ended December 31, 2018, although there was some significant variance by line of business. Additionally, our estimated loss and LAE reserves for catastrophe claims occurring in prior years developed favorably by $17.1 million, $27.5 million and $9.3 million for the years ended December 31, 2020, 2019 and 2018, respectively. There can be no assurance that current loss and LAE reserves will be sufficient.

We regularly review our reserving techniques, our overall reserving position and our reinsurance. Based on (i) our review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages and policy coverage, political attitudes and trends in general economic conditions, (ii) our review of per claim information, (iii) our historical loss experience and that of the industry, (iv) the nature of policies written by us, and (v) our internal estimates of required reserves, we believe that adequate provision has been made for loss reserves. Given the inherent complexity of our loss reserve estimation process and the potential variability of the assumptions used, the actual emergence of losses will vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly in those instances where settlements or other claim resolutions do not occur until well into the future. Our net loss reserves at December 31, 2020 were $4.4 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on our results of operations. Similarly, a one percentage point change in the aggregate loss and LAE ratio resulting from a change in reserve estimation is currently projected to have an approximate $46 million impact on operating income, based on 2020 full year premiums.

The major causes of material uncertainty relating to ultimate losses and LAE (“risk factors”) generally vary for each line of business, as well as for each separately analyzed component of the line of business. In some cases, such risk factors are explicit assumptions of the estimation method and in others, they are implicit. For example, a method may explicitly assume that a certain percentage of claims will close each year, but will implicitly assume that the legal interpretation of existing contract language will remain substantially unchanged. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.

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Some risk factors affect multiple lines of business. Examples include changes in claim handling and claim reserving practices, changes in claim settlement patterns due to the Pandemic and other factors, regulatory and legislative actions, court actions, so-called “social inflation,” timeliness of claim reporting, state mix of claimants and degree of claimant fraud. Additionally, there is also a higher degree of uncertainty due to growth in our acquired businesses, with respect to which we have less familiarity and, in some cases, limited historical claims experience. The extent of the impact of a risk factor will also vary by components within a line of business. Individual risk factors are subject to interactions with other risk factors within line of business components. Thus, risk factors can have offsetting or compounding effects on required reserves.

Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation varies by product. Our property and casualty insurance premiums are established before the amount of losses and LAE and the extent to which inflation may affect such expenses are known. Consequently, we attempt, in establishing rates and reserves, to anticipate the potential impact of inflation in the projection of ultimate costs. For example, we monitor, and continue to experience, increases in medical costs, wages and legal costs, which are key considerations in setting reserve assumptions for workers’ compensation, bodily injury and other liability lines. We are also monitoring the continued advancements in technology and design found in automobiles and homes and the increased claims settlement costs that result from repairs or replacement of such equipment. Estimated increases are reflected in our current reserve estimates, but continued increases are expected to contribute to increased losses and LAE in the future.

We are also defendants in various litigation matters, including putative class actions, which may seek punitive damages, bad faith or extra-contractual damages, legal fees and interest, or claim a broader scope of policy coverage or settlement and payment obligations than our interpretation. Resolution of these cases is often highly unpredictable and could involve material unanticipated damage awards. We have experienced, and others in the industry have reported, increased attorney involvement in claims including COVID-19-related matters, delayed submissions of medical and other expense claims, and a trend toward higher valued settlements and litigation, all of which contribute to uncertainty regarding reserve estimates.

Loss and LAE Reserves by Line of Business

Reserving Process Overview

Our loss reserves include amounts related to short-tail and long-tail classes of business. “Tail” refers to the time period between the occurrence of a loss and the final settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim (i.e., a longer tail), the more the ultimate settlement amount may likely vary from our original estimate.

Short-tail classes consist principally of automobile physical and property damage, homeowners property, commercial property and marine business. For these property coverages, claims are generally reported and settled shortly after the loss occurs because the claims relate to tangible property and are more likely to be discovered shortly after the loss occurs. Consequently, the estimation of loss reserves for these classes is generally less complex.

While we estimate that approximately half of our written premium is in what we would characterize as shorter-tail classes of business, most of our loss reserves relate to longer-tail liability classes of business. Long-tailed classes include automobile liability, commercial liability, third-party coverage and workers’ compensation. For many liability claims, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the discovery and reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for long-tailed liability coverage has limited statistical credibility because a relatively small proportion of losses in these accident years (the calendar years in which losses are incurred) are reported claims and an even smaller proportion are paid losses. Liability claims are also more susceptible to litigation and can be significantly affected by changing contract interpretations, the legal, political and social environment, the risk and expense of protracted litigation and inflation. Consequently, the estimation of loss reserves for these coverages is more complex and typically subject to a higher degree of variability and uncertainty compared to short-tailed coverages.

Most of our indirect business from our run-off voluntary and ongoing involuntary pools is assumed long-tailed casualty reinsurance. Reserve estimates for this business are therefore subject to the variability caused by extended loss emergence periods. The estimation of loss reserves for this business is further complicated by delays between the time the claim is reported to the ceding insurer and when it is reported by the ceding insurer to the pool manager and then to us, and by our dependence on the quality and consistency of the loss reporting by the ceding company and actuarial estimates by the pool manager. These reserving factors also apply to our discontinued assumed accident and health reinsurance pools and arrangements that are included in our liabilities of discontinued life businesses (See “Risk Factors” in Part I – Item 1A for further discussion).

A review of loss reserves for each of the classes of business in which we write is conducted regularly, generally quarterly. This review process takes into consideration a variety of trends that impact the ultimate settlement of claims. Where appropriate, the review includes a review of overall payment patterns and the emergence of paid and reported losses relative to expectations.

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The loss reserve estimation process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for predicting future outcomes. As part of this process, we use a variety of analytical methods that consider experience, trends and other relevant factors. IBNR reserves are generally calculated by first projecting the ultimate cost of all claims that have been reported or expected to be reported in the future and then subtracting reported losses and loss expenses. Reported losses include cumulative paid losses and loss expenses plus case reserves. Within the loss reserving process, standard actuarial methods which include: (1) loss development factor methods; (2) expected loss methods (Bornheutter-Ferguson); and (3) adjusted loss methods (Berquist-Sherman), are given due consideration. These methods are described below:

 

Loss development factor methods generally assume that the losses yet to emerge for an accident year are proportional to the paid or reported loss amount observed to date. Historical patterns of the development of paid and reported losses by accident year can be predictive of the expected future patterns that are applied to current paid and reported losses to generate estimated ultimate losses by accident year.

 

Bornheutter-Ferguson methods utilize the product of the expected ultimate losses times the proportion of ultimate losses estimated to be unreported or unpaid to calculate IBNR. The expected ultimate losses are based upon current estimates of ultimate losses from prior accident years, adjusted to reflect expected earned premium, current rating, claims cost levels and changes in business mix. The expected losses, and corresponding loss ratios, are a critical component of Bornheutter-Ferguson methodologies and provide a general reasonability guide.

 

Berquist-Sherman methods are used for estimating reserves in business lines where historical development patterns may be deemed less reliable for more recent accident years’ ultimate losses. Under these methods, patterns of historical paid or reported losses are first adjusted to reflect current payment settlement patterns and case reserve adequacy and then evaluated in the same manner as the loss development factor methods described above. When the adequacy of case reserves change, the Berquist-Sherman incurred method may be deemed more reliable than the reported loss development factor method. Likewise, when the settlement patterns change, the Berquist-Sherman paid method may be deemed more reliable than the paid loss development factor method.

In addition to the methods described above, various tailored reserving methodologies are used for certain businesses. For example, for some low volume and high volatility classes of business, special reserving techniques are utilized that estimate IBNR by selecting the loss ratio that balances actual reported losses to expected reported losses as defined by the estimated underlying reporting pattern. Also, for some classes with long exposure periods (e.g., construction defect, engineering and surety), earnings patterns plus an estimated reporting lag applied to the Bornheutter-Ferguson initial expected loss ratio are used to estimate IBNR. This is done in order to reflect the changing average exposure periods by policy year (and consequently accident year).

In completing the loss reserve analysis, a variety of assumptions must be made for each line of business, coverage and accident year. Each estimation method has its own pattern, parameter and/or judgmental dependencies, with no estimation method being better than the others in all situations. The relative strengths and weaknesses of the various estimation methods, when applied to a particular class of business, can also change over time, depending on the underlying circumstances. In many cases, multiple estimation methods will be valid for the particular facts and circumstances of the relevant class of business. The manner of application and the degree of reliance on a given method will vary by line of business and coverage, and by accident year based on an evaluation of the above dependencies and the potential volatility of the loss frequency and severity patterns. The estimation methods selected or given weight at a particular valuation date are those that are believed to produce the most reliable indication for the loss reserves being evaluated. Selections incorporate input from claims personnel, pricing actuaries, and underwriting management on loss cost trends and other factors that could affect ultimate losses.

For most classes of shorter-tailed business in our Commercial and Personal Lines segments, the emergence of paid and incurred losses generally exhibits a relatively stable pattern of loss development from one accident year to the next. Thus, for these classes, the loss development factor method is generally appropriate. For many of the classes of shorter-tailed business, the emergence of paid and incurred losses may exhibit a relatively volatile pattern of loss development from one accident year to the next. In certain cases where there is a relatively low level of reliability placed on the available paid and incurred loss data, expected loss methods or adjusted loss methods are considered appropriate for the most recent accident year.

For longer-tailed lines of business, applying the loss development factor method often requires even more judgment in selecting development factors, as well as more significant extrapolation. For those long-tailed lines of business with high frequency and relatively low per-loss severity (e.g., personal automobile liability), volatility will often be sufficiently modest for the loss development factor method to be given significant weight, even in the most recent accident years, but expected loss methods and adjusted loss methods are always considered and frequently utilized in the selection process. For those long-tailed lines of business with low frequency and high loss potential (e.g., commercial general liability), anticipated loss experience is less predictable because of the small number of claims and erratic claim severity patterns. In these situations, the loss development factor methods may not produce a reliable estimate of ultimate losses in the most recent accident years since many claims either have not yet been reported or are only in the early stages of the settlement process. Therefore, the loss reserve estimates for these accident years may be based on methods less reliant on extrapolation, such as Bornheutter-Ferguson. Over time, as a greater number of claims are reported and the

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statistical credibility of loss experience increases, loss development factor methods or adjusted loss methods are given increasing weight.

Management endeavors to apply as much available data as practicable to estimate the loss reserve amount for each line of business, coverage and accident year, utilizing varying assumptions, projections and methods. The ultimate outcome is expected to fall within a range of potential outcomes around this loss reserve estimated amount.

Our carried reserves for each line of business and coverage are determined based on our quarterly loss reserving process. In making the determination, we consider numerous quantitative and qualitative factors. Quantitative factors include changes in reserve estimates in the period, the maturity of the accident year, trends observed over the recent past, the level of volatility within a particular class of business, the estimated effects of reinsurance, including reinstatement premiums, general economic trends and other factors. Qualitative factors may include legal and regulatory developments, changes in claim handling and case reserving practices, recent entry into new markets or products, changes in underwriting practices or business mix, concerns that we do not have sufficient or quality historical reported and paid loss and LAE information with respect to a particular line or segment of our business, effects of the economy and political outlook, perceived anomalies in the historical results, evolving trends or other factors such as the impact of the Pandemic. In doing so, we must evaluate whether a change in the data represents credible actionable information or an anomaly. Such an assessment requires considerable judgment. Even if a change is determined to be apparent, it is not always possible to determine the extent of the change. As a result, there can be a time lag between the emergence of a change and a determination that the change should be partially or fully reflected in the carried loss reserves. In general, changes are made more quickly to reserves for more mature accident years and less volatile classes of business.

Reserving Process Uncertainties

As stated above, numerous factors (both internal and external) contribute to the inherent uncertainty in the process of establishing loss reserves, including changes in the rate of inflation for goods and services related to insured damages (e.g., medical care, home repairs, etc.), changes in the judicial interpretation of policy provisions and settlement obligations, changes in the general attitude of juries in determining damage awards, legislative actions, such as expanding liability, coverage mandates or expanding or suspending statutes of limitations which otherwise limit the times within which claims can be made, changes in the extent of insured injuries, changes in the trend of expected frequency and/or severity of claims, changes in our book of business (e.g., change in mix due to new or modified product offerings, new or rapidly expanding geographic areas, etc.), changes in our underwriting practices and changes in claim handling procedures and/or systems. Regarding our indirect business from voluntary and involuntary pools, we are periodically provided loss estimates by managers of each pool. We adopt reserve estimates for the pools that consider this information and other facts.

In addition, we must consider the uncertain effects of emerging or potential claims and coverage issues that arise as legal, judicial, social conditions, political risks and economic conditions change. For example, claims which we consider closed may be re-opened as additional damages surface or new liability or damage theories are presented. Also, historically, we have observed more frequent and higher severity in workers’ compensation, bodily injury and other liability claims and more credit related losses (for example, in our surety business) during periods of economic uncertainty or high unemployment. These, and other issues, could have a negative effect on our loss reserves by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims.

As part of our loss reserving analysis, we consider the various factors that contribute to the uncertainty in the loss reserving process. Those factors that could materially affect our loss reserve estimates include loss development patterns and loss cost trends, reporting lags, rate and exposure level changes, the effects of changes in coverage and policy limits, business mix shifts, the effects of regulatory and legislative developments, economic circumstances, the effects of changes in judicial interpretations, the effects of emerging claims and coverage issues and the effects of changes in claim handling and claim reserving practices. In making estimates of reserves, however, we do not necessarily make an explicit assumption for each of these factors. Moreover, all estimation methods do not utilize the same assumptions and typically no single method is determinative in the reserve analysis for a line of business and coverage. Consequently, changes in our loss reserve estimates generally are not the result of changes in any one assumption. Instead, the variability will be affected by the interplay of changes in numerous assumptions, many of which are implicit to the approaches used.

For each line of business and coverage, we regularly adjust the assumptions and methods used in the estimation of loss reserves in response to our actual loss experience, as well as our judgments regarding changes in trends and/or emerging patterns. In those instances where we primarily utilize analyses of historical patterns of the development of paid and reported losses, this may be reflected, for example, in the selection of revised loss development factors. In longer-tailed classes of business and for which loss experience is less predictable due to potential changes in judicial interpretations, potential legislative actions, the cost of litigation or determining liability and the ultimate loss, inflation, potential claims and other issues, this may be reflected in a judgmental change in our estimate of ultimate losses for particular accident years. Most of the insurance policies we have written over many years are written on an “occurrence” basis, which means we insure specified acts or events which occurred during the covered period, even if claims first arise from such events many years later. For example, the industry incurred significant losses as a result of claims arising

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from asbestos and environmental damage which occurred decades ago and was not known at such time, and in many cases policy limits were available for each year during which such occurrence policies were in place.

The impact of the Pandemic could have a material adverse effect on our carried loss reserves. 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 to retroactively amend insurance contracts to provide business interruption coverage, to impose presumptions on insurance policy interpretation, and/or limit policy exclusions for losses allegedly related to the Pandemic. If these changes were to be enacted and upheld, we would be exposed to a significant unfunded liability.

The future impact of the various factors that contribute to the uncertainty in the loss reserving process is impossible to predict. There is potential for significant variation in the development of loss reserves, particularly for long-tailed classes of business and classes of business that are more vulnerable to economic or political risks.

Reserving Process for Catastrophe Events

The estimation of claims and claims expense reserves for catastrophes also comprises estimates of losses from reported claims and IBNR, primarily for damage to property. In general, our estimates for catastrophe reserves are determined on an event basis by considering various sources of available information, including specific loss estimates reported to us based on claim adjuster inspections, overall industry loss estimates, our internal data regarding exposures related to the geographical location of the event and estimates of potential subrogation recoveries. However, depending on the nature of the catastrophe, the estimation process can be further complicated by other impediments. For example, for hurricanes, other severe wind storms and wildfires, complications often include the inability of insureds to promptly report losses, delays in the ability of claims adjusting staff to inspect losses, difficulties in determining whether wind storm losses are covered by our homeowners policy (generally for damage caused by wind or wind driven rain) or are specifically excluded from coverage caused by flood, and challenges in estimating additional living expenses, assessing the impact of demand surge, exposure to mold or smoke damage and the effects of numerous other considerations. Another example is the complication of estimating the cost of business interruption coverage on Commercial Lines policies. Estimates for catastrophes which occur at or near the end of a financial reporting period may be even less reliable since we will have less claims data available and little time to complete our estimation process. In such situations, we may adapt our practices to accommodate the circumstances.

For events designated as catastrophes, we generally calculate IBNR reserves directly as a result of an estimated IBNR claim count and an estimated average claim amount for each event. Such an assessment involves a comprehensive analysis of the nature of the event, of policyholder exposures within the affected geographic area and of available claims intelligence. Depending on the nature of the event, available claims intelligence could include surveys of field claims associates within the affected geographic area, aerial photographs of the affected area, feedback from a catastrophe claims team sent into the area, as well as data on claims reported as of the financial statement date. In addition, loss emergence from similar historical events is compared to the estimated IBNR for our current catastrophe events to help assess the reasonableness of our estimates. However, in some cases, it may be difficult to estimate certain catastrophe losses which are unique and do not have instances of historical precedence, such as the property damage arising from the 2020 riots and civil unrest.

Reserving Sensitivity Analysis

The following discussion presents disclosure related to possible variation in net reserve estimates (i.e., net of estimated reinsurance recoverables) due to changes in key assumptions. This information is provided for illustrative purposes only. Many other assumptions may also lead to material reserve adjustments. If any such variations do occur, then they would likely occur over a period of several years and therefore their impact on our results of operations would be recognized during the same periods. It is important to note, however, that there is the potential for future variations greater than the amounts described below and for any such variations to be recognized in a single quarterly or annual period. No consideration has been given to potential correlation or lack of correlation among key assumptions or among lines of business and coverage as described below. As a result, and because there are so many other factors which affect our net reserve estimate, it would be inappropriate to take the amounts described below and simply add them together in an attempt to estimate volatility in total. While we believe these are reasonably possible scenarios, the reader should not consider the following sensitivity analysis as illustrative of a net reserve range.

 

Personal and Commercial Automobile Bodily Injury – loss reserves recorded for bodily injury on voluntary business were $769.9 million as of December 31, 2020. A key assumption for bodily injury is the inflation rate underlying the estimated reserve. A five point change (e.g., 4% changed to 9% or -1%) in the embedded inflation rate would have changed total reserves by approximately $71 million, either positive or negative, respectively, at December 31, 2020.

 

Personal Automobile Personal Injury Protection Medical Payment – loss reserves recorded for personal injury protection medical payment on voluntary business were $148.5 million as of December 31, 2020, of which approximately 95% relates to Michigan policies. A key assumption for this coverage is the inflation rate underlying the estimated reserve. Given the long reporting pattern for this line of business, an additional key assumption is the amount of additional development required to reach full maturity, thereby reflecting ultimate costs, as represented by the tail factor. A five point change in the embedded inflation rate and a one point change to the tail factor assumption (e.g., 2% changed to 1%

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or 3%) would have changed total reserves by approximately $52 million, either positive or negative, at December 31, 2020.

 

Workers’ Compensation – loss reserves recorded for workers’ compensation on voluntary business were $448.0 million as of December 31, 2020. A key assumption for workers’ compensation is the inflation rate underlying the estimated reserve. Given the long reporting pattern for this line of business, an additional key assumption is the amount of additional development required to reach full maturity, thereby reflecting ultimate costs, as represented by the tail factor. A five point change in the embedded inflation rate and a one point change to the tail factor assumption would have changed total reserves by approximately $132 million, either positive or negative, at December 31, 2020.

 

Monoline and Multiple Peril General Liability – loss reserves recorded for monoline and multiple peril general liability on voluntary business were $899.8 million as of December 31, 2020. A key assumption for monoline and multiple peril general liability is the implied adequacy of the underlying case reserves. A ten point change in case adequacy (e.g., 10% deficiency changed to 0% or 20% deficiency) would have changed total reserves by approximately $99 million, either positive or negative, at December 31, 2020.

 

Specialty Programs - loss reserves recorded for Hanover Programs were $361.3 million as of December 31, 2020. Two key assumptions underlying the actuarial reserve analysis for specialty programs are the inflation rate underlying the estimated reserve for our commercial automobile liability, general liability and workers' compensation coverages, as well as the tail factor selection for workers' compensation. A five point change to the embedded inflation rate for the aforementioned coverages, and a one point change in the workers' compensation tail factor on Hanover Programs would have changed total reserves by approximately $49 million at December 31, 2020.

Carried Reserves and Reserve Rollforward

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

YEARS ENDED DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Gross reserve for losses and LAE, beginning of year

 

$

5,654.4

 

 

$

5,304.1

 

 

$

5,058.5

 

Reinsurance recoverable on unpaid losses

 

 

1,574.8

 

 

 

1,472.6

 

 

 

1,455.0

 

Net reserve for losses and LAE, beginning of year

 

 

4,079.6

 

 

 

3,831.5

 

 

 

3,603.5

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Current year

 

 

2,877.8

 

 

 

2,893.0

 

 

 

2,733.5

 

Prior year non-catastrophe development

 

 

(15.5

)

 

 

(0.9

)

 

 

0.4

 

Prior year catastrophe development

 

 

(17.1

)

 

 

(27.5

)

 

 

(9.3

)

Total incurred losses and LAE

 

 

2,845.2

 

 

 

2,864.6

 

 

 

2,724.6

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Current year

 

 

1,347.7

 

 

 

1,315.4

 

 

 

1,232.3

 

Prior years

 

 

1,194.7

 

 

 

1,301.1

 

 

 

1,264.3

 

Total payments

 

 

2,542.4

 

 

 

2,616.5

 

 

 

2,496.6

 

Net reserve for losses and LAE, end of year

 

 

4,382.4

 

 

 

4,079.6

 

 

 

3,831.5

 

Reinsurance recoverable on unpaid losses

 

 

1,641.6

 

 

 

1,574.8

 

 

 

1,472.6

 

Gross reserve for losses and LAE, end of year

 

$

6,024.0

 

 

$

5,654.4

 

 

$

5,304.1

 

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

DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

1,211.0

 

 

$

1,122.0

 

 

$

1,043.7

 

Workers' compensation

 

 

699.4

 

 

 

698.2

 

 

 

677.3

 

Commercial automobile

 

 

454.8

 

 

 

427.0

 

 

 

399.6

 

Other commercial lines:

 

 

 

 

 

 

 

 

 

 

 

 

Hanover Programs

 

 

565.3

 

 

 

512.9

 

 

 

492.0

 

Management and professional liability

 

 

340.8

 

 

 

281.5

 

 

 

257.7

 

Monoline general liability

 

 

280.3

 

 

 

265.5

 

 

 

246.6

 

Umbrella

 

 

230.2

 

 

 

197.9

 

 

 

166.8

 

Marine

 

 

94.0

 

 

 

95.9

 

 

 

99.5

 

Surety

 

 

93.6

 

 

 

76.9

 

 

 

99.0

 

Specialty industrial and commercial property

 

 

76.9

 

 

 

71.1

 

 

 

54.5

 

Other lines

 

 

29.5

 

 

 

28.4

 

 

 

21.9

 

Total other commercial lines

 

 

1,710.6

 

 

 

1,530.1

 

 

 

1,438.0

 

Total Commercial Lines

 

 

4,075.8

 

 

 

3,777.3

 

 

 

3,558.6

 

Personal automobile

 

 

1,670.3

 

 

 

1,645.1

 

 

 

1,532.8

 

Homeowners and other personal

 

 

237.5

 

 

 

194.3

 

 

 

174.8

 

Total Personal Lines

 

 

1,907.8

 

 

 

1,839.4

 

 

 

1,707.6

 

Total Other Segment

 

 

40.4

 

 

 

37.7

 

 

 

37.9

 

Total loss and LAE reserves

 

$

6,024.0

 

 

$

5,654.4

 

 

$

5,304.1

 

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

Prior Year Development

Conditions and trends that have affected reserve development in the past will not necessarily recur in the future. As discussed under “Reserving Process Overview” in the preceding section, our historical loss experience and loss development patterns are important factors in estimating loss reserves, however, they are not the only factors we evaluate to establish reserves. Therefore, a mechanical application of standard actuarial methodologies in projecting ultimate claims could result in materially different reserves to those held. Accordingly, it is not appropriate to extrapolate future favorable or unfavorable development based on amounts experienced in prior periods.

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

 

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

Loss

&

LAE

 

 

Catastrophe

 

 

Total

 

 

Loss

&

LAE

 

 

Catastrophe

 

 

Total

 

 

Loss

&

LAE

 

 

Catastrophe

 

 

Total

 

Commercial Lines

 

$

(19.0

)

 

$

(18.8

)

 

$

(37.8

)

 

$

(28.7

)

 

$

(24.6

)

 

$

(53.3

)

 

$

(34.1

)

 

$

(6.8

)

 

$

(40.9

)

Personal Lines

 

 

(0.7

)

 

 

1.7

 

 

 

1.0

 

 

 

26.6

 

 

 

(2.9

)

 

 

23.7

 

 

 

33.3

 

 

 

(2.5

)

 

 

30.8

 

Other Segment

 

 

4.2

 

 

 

 

 

 

4.2

 

 

 

1.2

 

 

 

 

 

 

1.2

 

 

 

1.2

 

 

 

 

 

 

1.2

 

Total prior year (favorable)

   unfavorable development

 

$

(15.5

)

 

$

(17.1

)

 

$

(32.6

)

 

$

(0.9

)

 

$

(27.5

)

 

$

(28.4

)

 

$

0.4

 

 

$

(9.3

)

 

$

(8.9

)

Catastrophe Loss Development

In 2020, favorable catastrophe development was $17.1 million, primarily due to lower than expected losses related to certain 2017, 2018, and 2019 wind storms, winter storms and hurricanes and the 2017 and 2018 California wildfires. In 2019, favorable catastrophe development was $27.5 million, 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, and the 2018 hurricane Florence. In 2018, favorable catastrophe development was $9.3 million, primarily due to lower than expected losses related to the 2017 hurricanes Harvey, Irma and Maria and California wildfires.

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Loss and LAE Development, excluding catastrophes

The following table provides a summary of unfavorable/(favorable) loss and LAE reserve development, excluding catastrophes.

YEARS ENDED DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Commercial multiple peril

 

$

14.2

 

 

$

(6.6

)

 

$

(1.2

)

Workers’ compensation

 

 

(36.0

)

 

 

(32.6

)

 

 

(31.0

)

Commercial automobile

 

 

15.5

 

 

 

6.4

 

 

 

23.2

 

Other commercial lines:

 

 

 

 

 

 

 

 

 

 

 

 

Hanover Programs

 

 

12.3

 

 

 

24.6

 

 

 

18.2

 

General liability

 

 

0.3

 

 

 

(7.8

)

 

 

(27.9

)

Marine

 

 

(15.2

)

 

 

(6.9

)

 

 

(4.7

)

Surety

 

 

(3.5

)

 

 

(4.1

)

 

 

(9.0

)

Umbrella

 

 

(1.5

)

 

 

2.8

 

 

 

0.6

 

Other lines

 

 

(5.1

)

 

 

(4.5

)

 

 

(2.3

)

Total other commercial lines

 

 

(12.7

)

 

 

4.1

 

 

 

(25.1

)

Total Commercial Lines

 

 

(19.0

)

 

 

(28.7

)

 

 

(34.1

)

Personal automobile

 

 

4.5

 

 

 

22.0

 

 

 

15.0

 

Homeowners and other personal lines

 

 

(5.2

)

 

 

4.6

 

 

 

18.3

 

Total Personal Lines

 

 

(0.7

)

 

 

26.6

 

 

 

33.3

 

Total Other Segment

 

 

4.2

 

 

 

1.2

 

 

 

1.2

 

Total loss and LAE reserve development, excluding catastrophes

 

$

(15.5

)

 

$

(0.9

)

 

$

0.4

 

2020 Loss and LAE Development, excluding catastrophes

In 2020, net favorable loss and LAE development, excluding catastrophes, was $15.5 million. Commercial Lines favorable development of $19.0 million was primarily due to lower than expected losses of $36.0 million within the workers’ compensation line in accident years 2016 through 2019. This was partially offset by higher than expected losses in our commercial automobile line driven by higher bodily injury and personal protection losses, primarily in accident years 2017 through 2019, and the commercial multiple peril line, primarily in accident years 2017 and 2019. Within other commercial lines, lower than expected losses in our marine line, in accident years 2017 through 2019 and specialty industrial property lines were partially offset by higher than expected losses in the general liability coverages within Hanover Programs. In addition, the adverse prior development in our Other Segment was due to our run-off voluntary assumed property and casualty reinsurance pools business primarily 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 consists primarily of asbestos and environmental exposures.

2019 Loss and LAE Development, excluding catastrophes

In 2019, net favorable loss and LAE development, excluding catastrophes, was $0.9 million. Commercial Lines favorable development of $28.7 million was primarily due to lower than expected losses of $32.6 million within the workers’ compensation line in accident years 2015 through 2018, and lower than expected losses in our commercial multiple peril line, primarily in accident years 2015 through 2016, partially offset by higher than expected losses in our commercial automobile and other commercial lines. Higher than expected losses in the commercial automobile line was driven by higher bodily injury severity and personal injury protection in accident years 2016 through 2017.  Within other commercial lines, higher than expected losses of $24.6 million in Hanover Programs, primarily in accident years 2011, 2013, 2015, and 2017, was partially offset by lower than expected losses in our general liability, marine and surety lines. Personal Lines unfavorable development of $26.6 million was primarily due to higher than expected losses of $22.0 million in the personal automobile line, driven by bodily injury severity and personal injury protection in accident years 2016 through 2017. In addition, Other Segment unfavorable development of $1.2 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.

2018 Loss and LAE Development, excluding catastrophes

In 2018, net unfavorable loss and LAE development, excluding catastrophes, was $0.4 million. Commercial Lines favorable development of $34.1 million was primarily due to lower than expected losses of $31.0 million within the workers’ compensation line in accident years 2015 through 2017, and $25.1 million in other commercial lines, partially offset by higher than expected losses of $23.2 million in the commercial automobile line, driven by higher bodily injury severity in the 2014, 2016 and 2017 accident years. Within other commercial lines, lower than expected losses in our general liability lines, related to the 2014 through 2016 accident years, and our surety line in accident years 2015 and 2017, was partially offset by higher than expected losses in Hanover Programs, primarily in accident years 2010 through 2014. Personal Lines unfavorable development of $33.3 million was primarily due to higher than expected losses within the homeowners line in accident years 2015 through 2017, and in the personal automobile line, driven by bodily injury severity in the 2016 accident year and, to a lesser extent, the 2015 accident year. In addition, Other segment unfavorable

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development of $1.2 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.

Asbestos and Environmental Reserves

As of December 31, 2020, we have $39.8 million of net asbestos and environmental reserves, comprised of $8.3 million of direct reserves and $31.5 million of assumed reinsurance pool reserves. This compares to net reserves of $37.9 million and $38.9 million as of December 31, 2019 and 2018, respectively. Ending loss and LAE reserves for all direct business written by our property and casualty companies related to asbestos and environmental damage liability were $8.3 million, $8.4 million and $8.9 million, net of reinsurance of $17.9 million, $17.6 million and $18.7 million for the years ended December 31, 2020, 2019 and 2018, respectively. Activity for our direct asbestos and environmental reserves was not significant to our 2020, 2019 or 2018 financial results. As a result of our historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to our total loss and LAE incurred experience. Although we attempt to limit our exposures to asbestos and environmental damage liability through specific policy exclusions, we have been and may continue to be subject to claims related to these exposures.

In addition to reserves we carry to cover exposure in our direct business, we have established gross and net loss and LAE reserves for assumed reinsurance pool business with asbestos and environmental damage liability of $31.5 million, $29.5 million and $30.0 million at December 31, 2020, 2019 and 2018, respectively. These reserves relate to pools in which we have terminated our participation; however, we continue to be subject to claims related to years in which we were a participant. Results of operations from these pools are included in our Other segment. A significant part of our pool reserves relates to our participation in the ECRA voluntary pool from 1950 to 1982. In 1982, the pool was dissolved and since that time, the business has been in run-off. Our percentage of the total pool liabilities varied from 1% to 6% during these years. Our participation in this pool has resulted in average paid losses of approximately $2 million annually over the past ten years. In the first quarter of 2020, we received an updated third-party actuarial study for the ECRA voluntary pool which resulted in the aforementioned modest increase in our asbestos and environmental reserves.

We estimate our ultimate liability for asbestos, environmental and toxic tort liability claims, whether resulting from direct business, assumed reinsurance or pool business, based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not believed to be significant, their existence gives rise to uncertainty and are discussed because of the possibility that they may become significant. We believe that, notwithstanding the evolution of case law expanding liability in asbestos and environmental claims, recorded reserves related to these claims are adequate. Nevertheless, the asbestos, environmental and toxic tort liability reserves could be revised, and any such revisions could have a material adverse effect on our results of operations for a particular quarterly or annual period or on our financial position.

INVESTMENTS

INVESTMENT RESULTS

Net investment income before income taxes was as follows:

DECEMBER 31

 

2020

 

 

2019

 

 

2018

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$

222.5

 

 

$

232.4

 

 

$

217.7

 

Mortgage loans

 

 

17.5

 

 

 

16.3

 

 

 

14.0

 

Limited partnerships

 

 

16.7

 

 

 

19.7

 

 

 

24.1

 

Equity securities

 

 

14.8

 

 

 

16.3

 

 

 

17.0

 

Other investments

 

 

3.2

 

 

 

5.3

 

 

 

4.8

 

Investment expenses

 

 

(9.6

)

 

 

(8.7

)

 

 

(10.2

)

Net investment income

 

$

265.1

 

 

$

281.3

 

 

$

267.4

 

Earned yield, fixed maturities

 

 

3.33

%

 

 

3.58

%

 

 

3.62

%

Earned yield, total portfolio

 

 

3.35

%

 

 

3.65

%

 

 

3.74

%

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

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INVESTMENT PORTFOLIO

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

DECEMBER 31

 

2020

 

 

2019

 

(dollars in millions)

 

Carrying

Value

 

 

% of Total

Carrying

Value

 

 

Carrying

Value

 

 

% of Total

Carrying

Value

 

Fixed maturities, at fair value

 

$

7,454.4

 

 

 

83.2

%

 

$

6,687.1

 

 

 

81.4

%

Equity securities, at fair value

 

 

598.5

 

 

 

6.7

 

 

 

575.7

 

 

 

7.0

 

Mortgage and other loans

 

 

467.6

 

 

 

5.2

 

 

 

441.2

 

 

 

5.4

 

Other investments

 

 

325.6

 

 

 

3.6

 

 

 

292.0

 

 

 

3.6

 

Cash and cash equivalents

 

 

120.6

 

 

 

1.3

 

 

 

215.7

 

 

 

2.6

 

Total cash and investments

 

$

8,966.7

 

 

 

100.0

%

 

$

8,211.7

 

 

 

100.0

%

CASH AND INVESTMENTS

Total cash and investments increased $755.0 million, or 9.2%, for the year ended December 31, 2020, primarily due to operational cash flows, net proceeds from our senior debt issuance in August 2020 and market value appreciation.  These increases were partially offset by the funding of financing activities, including our stock repurchases, debt retirement and dividend payments.

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

DECEMBER 31

 

2020

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Type

 

Amortized

Cost, net of Allowance for Credit Losses

 

 

Fair Value

 

 

Net

Unrealized

Gains

 

 

Change in Net

Unrealized for

the Year

 

U.S. Treasury and government agencies

 

$

376.4

 

 

$

392.0

 

 

$

15.6

 

 

$

7.8

 

Foreign government

 

 

2.2

 

 

 

2.7

 

 

 

0.5

 

 

 

0.1

 

Municipals:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

1,005.8

 

 

 

1,065.7

 

 

 

59.9

 

 

 

34.7

 

Tax-exempt

 

 

36.3

 

 

 

38.0

 

 

 

1.7

 

 

 

0.5

 

Corporate

 

 

3,769.9

 

 

 

4,111.3

 

 

 

341.4

 

 

 

183.7

 

Asset-backed:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed

 

 

978.2

 

 

 

1,010.7

 

 

 

32.5

 

 

 

16.5

 

Commercial mortgage-backed

 

 

705.4

 

 

 

760.0

 

 

 

54.6

 

 

 

29.1

 

Asset-backed

 

 

71.4

 

 

 

74.0

 

 

 

2.6

 

 

 

1.5

 

Total fixed maturities

 

$

6,945.6

 

 

$

7,454.4

 

 

$

508.8

 

 

$

273.9

 

The increase in net unrealized gains on fixed maturities was primarily due to lower prevailing interest rates.

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

DECEMBER 31

 

 

 

2020

 

 

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

 

$

4,590.6

 

 

$

4,894.2

 

 

 

65.7

%

 

$

4,373.0

 

 

$

4,522.7

 

 

 

67.6

%

2

 

Baa

 

 

2,075.6

 

 

 

2,258.9

 

 

 

30.3

 

 

 

1,785.2

 

 

 

1,857.6

 

 

 

27.8

 

3

 

Ba

 

 

162.3

 

 

 

173.6

 

 

 

2.3

 

 

 

160.2

 

 

 

167.6

 

 

 

2.6

 

4

 

B

 

 

109.3

 

 

 

118.3

 

 

 

1.6

 

 

 

130.2

 

 

 

135.2

 

 

 

2.0

 

5

 

Caa and lower

 

 

7.3

 

 

 

7.7

 

 

 

0.1

 

 

 

2.0

 

 

 

2.2

 

 

 

 

6

 

In or near default

 

 

0.5

 

 

 

1.7

 

 

 

 

 

 

1.6

 

 

 

1.8

 

 

 

 

Total fixed maturities

 

$

6,945.6

 

 

$

7,454.4

 

 

 

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 our fixed maturity portfolio consisted of investment grade securities at December 31, 2020 and 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”. 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:

DECEMBER 31

 

2020

 

 

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

 

$

1,460.6

 

 

$

1,510.5

 

 

 

20.3

%

 

$

1,253.1

 

 

$

1,276.0

 

 

 

19.1

%

2-4 years

 

 

1,738.4

 

 

 

1,872.5

 

 

 

25.1

 

 

 

1,811.9

 

 

 

1,872.9

 

 

 

28.0

 

4-6 years

 

 

1,570.0

 

 

 

1,734.0

 

 

 

23.3

 

 

 

1,841.2

 

 

 

1,917.0

 

 

 

28.7

 

6-8 years

 

 

1,016.6

 

 

 

1,134.0

 

 

 

15.2

 

 

 

1,113.9

 

 

 

1,177.2

 

 

 

17.6

 

8-10 years

 

 

812.2

 

 

 

837.8

 

 

 

11.2

 

 

 

316.2

 

 

 

322.2

 

 

 

4.8

 

10+ years

 

 

347.8

 

 

 

365.6

 

 

 

4.9

 

 

 

115.9

 

 

 

121.8

 

 

 

1.8

 

Total fixed maturities

 

$

6,945.6

 

 

$

7,454.4

 

 

 

100.0

%

 

$

6,452.2

 

 

$

6,687.1

 

 

 

100.0

%

Weighted average duration

 

 

 

 

 

 

4.8

 

 

 

 

 

 

 

 

 

 

 

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 5 - “Fair Value” in the Notes to Consolidated Financial Statements.

Equity securities primarily consist of U.S. income-oriented large capitalization common stocks and developed market equity index and corporate bond 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 privately-held 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, or as a practical expedient using the fund’s net asset value, with financial information provided by the partnership on a two or three month lag.

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.

We deposit funds with various state and governmental authorities. See Note 3 – “Investments” in the Notes to Consolidated Financial Statements for additional information.

IMPAIRMENTS

For the years ended December 31, 2020, 2019 and 2018, we recognized in earnings $26.3 million, $2.0 million and $4.6 million, respectively, of impairments. In 2020, impairments primarily consisted of $17.6 million on fixed maturities, primarily relating to intend-to-sell securities, and $6.7 million of estimated credit losses on mortgage loans. In 2019, impairments consisted entirely of corporate fixed maturity securities. In 2018, impairments consisted of $2.6 million on fixed maturities and $2.0 million on other invested assets.

At December 31, 2020 and 2019, the allowance for credit losses on mortgage loans was $7.9 million and $1.3 million, respectively. The allowance for credit losses on available-for-sale securities was $0.1 million at December 31, 2020. There was no allowance for credit losses on available-for-sale securities at December 31, 2019.

The carrying values of fixed maturity securities on non-accrual status at December 31, 2020 and 2019 were not material. The effects of non-accruals compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities for the years ended December 31, 2020, 2019 and 2018 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 December 31, 2020 were $3.3 million, a decrease of $4.3 million compared to December 31, 2019, primarily attributable to lower prevailing interest rates. At December 31, 2020, gross unrealized losses consisted

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primarily of $2.0 million on U.S. government securities, $0.6 million on residential mortgage-backed securities and $0.4 million on corporate fixed maturities. See also Note 3 – “Investments” in the Notes to 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 Resources”). Inherent in our assessment are the risks that market factors may differ from our expectations; the global 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 December 31, 2020 and 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.

DECEMBER 31

 

2020

 

 

2019

 

(in millions)

 

 

 

 

 

 

 

 

Due after one year through five years

 

$

 

 

$

1.1

 

Due after five years through ten years

 

 

0.5

 

 

 

3.3

 

Due after ten years

 

 

2.0

 

 

 

2.0

 

 

 

 

2.5

 

 

 

6.4

 

Mortgage-backed and asset-backed securities

 

 

0.8

 

 

 

1.2

 

Total fixed maturities

 

$

3.3

 

 

$

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.

During 2020, the Pandemic resulted in widespread economic disruption due to various government-mandated emergency orders, consumer and business uncertainty, and forced business closures. Financial markets have substantially recovered from the significant declines experienced earlier in the year; however, the timing and strength of an economic recovery remains uncertain as global infection rates remain elevated and approval, production and distribution of vaccines will be phased in over time. Unemployment rates remain elevated, the number of companies issuing forward guidance remains below average, several foreign countries have placed restrictions on travel by U.S. citizens and many small businesses remain closed. The U.S. government and its agencies have taken extraordinary measures to stabilize the economy through fiscal policy actions, such as passage of the CARES Act and other bills that will provide trillions of dollars in economic support. These actions have largely muted the recessionary dynamics that occur in a downturn and have supported a strong but uneven recovery in labor markets. In addition, because the Pandemic still poses downside risks to economic activity and labor markets over the medium term, U.S. government officials are working toward another round of fiscal policy actions to support the economy and the flow of credit to households and businesses experiencing the greatest financial impact from the Pandemic. It is unclear whether such actions will be sufficient to support continued economic recovery in 2021 and in the intermediate term, and what long-term effects such unprecedented actions will ultimately have on our investment portfolio.   

Due to the Pandemic, global monetary policies remain 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”) is maintaining its federal funds target range at 0% to 0.25% and is conducting unprecedented quantities of asset purchases.

Fundamental conditions in certain corporate sectors directly impacted by the Pandemic, such as energy, lodging, restaurant and transportation services, have deteriorated. While market values have recovered with government fiscal and monetary support, the value of our holdings of related fixed maturities in these sectors remain most at risk in the near term. We may experience defaults on fixed income securities, particularly with respect to non-investment grade debt securities. Although we perform rigorous credit analysis of our fixed income investments, 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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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE SENSITIVITY

The valuation of the investment portfolio is subject to risk resulting from interest rate fluctuations, which may adversely impact the valuation of the investment portfolio. In a rising interest rate environment, the value of the fixed maturity sector, which comprises approximately 83% of our investment portfolio, may decline as a result of decreases in the fair value of the securities. Our intent is to hold securities to maturity and recover the decline in valuation as prices accrete to par. However, our intent may change prior to maturity due to changes in the financial markets, our analysis of an issuer’s credit metrics and prospects, or as a result of changes in cash flow needs. Interest rate fluctuations may also reduce net investment income and, as a result, profitability. The portfolio may realize lower yields and therefore lower net investment income on securities because securities with prepayment and call features may prepay at a different rate than originally projected. In an increasing rate environment, the duration of our fixed maturity portfolio could lengthen as issuers choose not to exercise their option to call or prepay their debt. For this and other reasons, funds may not be available to invest at higher interest rates.  

In a declining interest rate environment, prepayments and calls may increase as issuers exercise their option to refinance at lower rates. The resulting funds would be reinvested at lower yields.

The following table illustrates the estimated impact on the fair value of our fixed maturity portfolio at December 31, 2020 and 2019 of hypothetical changes in prevailing interest rates, defined as changes in interest rates on U.S. Treasury debt. It does not reflect changes in credit spreads, liquidity spreads and other factors that also affect the value of securities. Since changes in prevailing interest rates are often accompanied by changes in these other factors, the reader should not assume that an actual change in interest rates would result in the values illustrated.

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INVESTMENT TYPE

 

+300bp

 

 

+200bp

 

 

+100bp

 

 

0

 

 

-100bp

 

 

-200bp

 

 

-300bp

 

Residential mortgage-backed securities

 

$

845

 

 

$

905

 

 

$

960

 

 

$

1,011

 

 

$

1,040

 

 

$

1,065

 

 

$

1,105

 

Municipal securities

 

 

905

 

 

 

965

 

 

 

1,035

 

 

 

1,104

 

 

 

1,180

 

 

 

1,250

 

 

 

1,335

 

All other fixed maturity securities

 

 

4,645

 

 

 

4,865

 

 

 

5,095

 

 

 

5,339

 

 

 

5,585

 

 

 

5,850

 

 

 

6,130

 

Total December 31, 2020

 

$

6,395

 

 

$

6,735

 

 

$

7,090

 

 

$

7,454

 

 

$

7,805

 

 

$

8,165

 

 

$

8,570

 

Total December 31, 2019

 

$

5,835

 

 

$

6,110

 

 

$

6,395

 

 

$

6,687

 

 

$

6,970

 

 

$

7,255

 

 

$

7,565

 

Our overall investment strategy is intended to balance investment income with credit and interest rate risk, while maintaining sufficient liquidity and the opportunity for capital growth. The asset allocation process takes into consideration the types of business written and the level of surplus required to support our different businesses and the risk return profiles of the underlying asset classes. We look to balance the goals of capital preservation, net investment income stability, liquidity and total return.

The majority of our assets are invested in the fixed income markets. Through fundamental research and credit analysis, with a focus on value investing, our investment professionals seek to identify a portfolio of stable income-producing higher quality U.S. government, foreign government, municipal, corporate, residential and commercial mortgage-backed securities and asset-backed securities. We have a general policy of diversifying investments both within and across major investment and industrial sectors to mitigate credit and interest rate risk. We monitor the credit quality of our investments and our exposure to individual markets, borrowers, industries, sectors and, in the case of commercial mortgage-backed securities and commercial mortgage loan participations, property types and geographic locations. In addition, we currently carry debt that is subject to interest rate risk, which was issued at fixed interest rates between 2.50% and 8.207%. Current market conditions, in light of our risk tolerance, restrict our ability to invest fixed income assets at similar rates of return; therefore, earnings on a similar level of assets are not sufficient to cover current debt interest costs.

EQUITY PRICE RISK

Our equity securities portfolio is exposed to equity price risk arising from potential volatility in equity market prices. Portfolio characteristics are analyzed regularly and price risk is actively managed through a variety of techniques. A hypothetical increase or decrease of 10% in the market price of our equity securities would have resulted in an increase or decrease in the fair value of the equity securities portfolio of approximately $60 million at December 31, 2020 and $58 million at December 31, 2019, which amounts, after taxes, would be reported in net income.

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OTHER ITEMS

Net income also included the following items:

 

 

YEARS ENDED DECEMBER 31

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2020

 

Commercial

Lines

 

 

Personal

Lines

 

 

Other

 

 

Discontinued

Operations

 

 

Total

 

Net realized and unrealized investment gains (losses)

 

$

5.2

 

 

$

3.5

 

 

$

(3.7

)

 

$

 

 

$

5.0

 

Loss from repayment of debt

 

 

 

 

 

 

 

 

(6.2

)

 

 

 

 

 

(6.2

)

Other non-operating items

 

 

(0.9

)

 

 

(0.7

)

 

 

 

 

 

 

 

 

(1.6

)

Discontinued operations - Chaucer business, net of taxes

 

 

 

 

 

 

 

 

 

 

 

0.4

 

 

 

0.4

 

Discontinued life businesses, net of taxes

 

 

 

 

 

 

 

 

 

 

 

(3.7

)

 

 

(3.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains

 

$

75.0

 

 

$

33.4

 

 

$

1.0

 

 

$

 

 

$

109.4

 

Other non-operating items

 

 

(1.3

)

 

 

(1.2

)

 

 

(0.9

)

 

 

 

 

 

(3.4

)

Discontinued operations - Chaucer business, including gain

   on sale, net of taxes

 

 

 

 

 

 

 

 

 

 

 

0.4

 

 

 

0.4

 

Discontinued life businesses, net of taxes

 

 

 

 

 

 

 

 

 

 

 

(4.3

)

 

 

(4.3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized and unrealized investment losses

 

$

(35.5

)

 

$

(13.6

)

 

$

(1.6

)

 

$

 

 

$

(50.7

)

Net loss from repayment of debt

 

 

(18.7

)

 

 

(7.6

)

 

 

(1.9

)

 

 

 

 

 

(28.2

)

Discontinued operations - Chaucer business, including gain

   on sale, net of taxes

 

 

 

 

 

 

 

 

 

 

 

151.9

 

 

 

151.9

 

Discontinued life businesses, net of taxes

 

 

 

 

 

 

 

 

 

 

 

0.1

 

 

 

0.1

 

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 investment gains were $5.0 million and $109.4 million in 2020 and 2019, respectively, compared to net realized and unrealized investment losses of $50.7 million in 2018. Net realized and unrealized investment gains in 2020 were primarily due to net realized gains from sales and other of $17.9 million and, to a lesser extent, appreciation in the fair value of our equity securities of $13.4 million, partially offset by impairment losses on investments. Net realized and unrealized investment gains in 2019 were primarily due to $106.5 million of appreciation in the fair value of our equity securities. Net realized and unrealized investment losses in 2018 were primarily due to $43.4 million of losses from the net change in the fair value of equity securities. The change in the fair value of equity securities in both 2019 and 2018 resulted from prevailing market conditions. Additionally, in 2018 we recognized $4.6 million of OTTI losses and $2.7 million of losses recognized from the sale of securities, primarily fixed maturities.

In 2020, we repurchased all of our outstanding 6.35% subordinated debentures due March 30, 2053 with a net carrying value of $168.9 million, at a cost of $175.0 million, resulting in a pre-tax loss of $6.1 million. Additionally, in 2020 we repurchased a portion of our 7.625% senior debentures with a net carrying value of $0.8 million.

At December 31, 2018, we had informed the Federal Home Loan Bank (“FHLB”) of our intent to repay a $125 million FHLB note due 2029 with a coupon of 5.5%, with settlement occurring on January 2, 2019. In the fourth quarter of 2018, we recorded a non-operating charge of $20.8 million after-taxes related to the pre-payment provision. Additionally, in 2018 we repurchased a portion of our 8.207% subordinated debentures with a net carrying value of $9.6 million at a cost of $11.5 million, resulting in a loss of $1.9 million.

Discontinued operations include our discontinued accident and health and life businesses as well as our former Chaucer operations. In 2020 and 2019, discontinued operations, in total, generated net losses of $3.3 million and $3.9 million, net of tax, respectively, primarily related to the long-term care pool in our discontinued accident and health business. In 2018, discontinued operations, in total, generated a gain of $152.0 million, net of tax, primarily related to the sale of the Chaucer business. See also “Discontinued Operations – Chaucer Business” below and Note 2 – “Discontinued Operations” in the Notes to Consolidated Financial Statements.

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DISCONTINUED OPERATIONS - CHAUCER BUSINESS

Gain on Sale of Chaucer Business

On December 28, 2018, we completed the sale of Chaucer Holdings Limited to China Re and recognized a pre-tax gain on the sale of $174.4 million and an income tax expense of $42.5 million. THG paid customary transaction costs along with providing certain representations and warranties and agreeing to indemnify China Re for certain pre-sale contingent liabilities.

The following table summarizes the components of the estimated gain in 2018 related to the sale of the Chaucer business as of December 28, 2018. As discussed below the table, both the pre-tax gain and income tax expense were updated in 2019.

YEAR ENDED DECEMBER 31

 

2018

 

(in millions)

 

 

 

 

Initial consideration received from sale (1)

 

$

779.0

 

Adjustment(1)

 

 

(17.0

)

Contingent proceeds (1) (2)

 

 

31.7

 

Total cash proceeds expected from sale of Chaucer Holdings Limited (1)

 

 

793.7

 

Less:

 

 

 

 

Carrying value of Chaucer business (3)

 

 

530.0

 

Transaction and other sale related costs (4)

 

 

30.6

 

Net realized losses on securities, pension and currency translation obligations related to Chaucer business (5)

 

 

58.7

 

Total pre-tax reductions

 

 

619.3

 

Pre-tax gain on sale

 

 

174.4

 

Income tax expense (6)

 

 

42.5

 

Gain on sale

 

$

131.9

 

(1)

Initial consideration for Chaucer Holdings Limited as determined in the sales and purchase agreement was $779 million.  This amount, along with $28 million in cash proceeds received from the sale of the Irish entity on February 14, 2019 and $13 million from the sale of the Australian entities on April 10, 2019, estimated contingent consideration of $31.7 million, and an $85 million pre-signing dividend from Chaucer that was received in the second quarter of 2018, resulted in expected total proceeds from the entire transaction of $936.7 million.  These amounts were partially offset by $17.0 million paid to China Re to adjust the purchase price for amounts received by the Company from Chaucer prior to December 28, 2018.

(2)

Contingent proceeds, as reflected in the sales and purchase agreement, could have been up to $45 million and was determined based upon 2018 catastrophe losses.  In 2018, our best estimate of contingent consideration was $31.7 million.

(3)

The carrying value of the Chaucer business reflects its U.S. GAAP book value at December 28, 2018, excluding $7.9 million of U.S.-related deferred tax assets that are no longer likely to be realized and therefore are reflected in the income tax expense category.

(4)

Transaction and other sale related costs primarily included brokerage, legal, actuarial, tax and other professional fees, employee retention costs, costs for the purchase of aggregate excess of loss catastrophe coverage in consideration of the contingent proceeds provision, along with certain other miscellaneous charges related to the execution of the transaction.

(5)

As part of the transaction, investments held by Chaucer were transferred to China Re resulting in the recognition of net realized investment losses that were previously reflected in accumulated other comprehensive income.  Additionally, Chaucer’s deferred pension obligations and currency translation obligations previously recognized in accumulated other comprehensive income were recognized as losses associated with the transaction.  

(6)

The income tax expense represented the current tax obligation on the sale and the derecognition of deferred tax assets that were no longer likely to be realized.

Included in the previously recorded $174.4 million gain was $31.7 million of contingent proceeds, which were subject to change, based on development of Chaucer’s 2018 catastrophe losses. During the first half of 2019, Chaucer experienced unfavorable development on its 2018 catastrophe losses, primarily due to higher than expected losses for hurricane Michael, Typhoon Jebi and a Colombian dam construction loss. Accordingly, we updated and reduced our best estimate of pre-tax contingent proceeds by $9.7 million. We received a cash payment of $22.0 million in final settlement of the contingent proceeds.

In addition, we recognized an income tax charge of $1.2 million in 2019 related to new tax regulations that were issued on June 14, 2019 by the U.S. Department of the Treasury, with an effective date retroactive to January 1, 2018. These new regulations retroactively changed the taxation of certain non-U.S. income. Although the impact of these regulations relates to the calculation of the income tax expense related to the sale of Chaucer, unlike the $42.5 million of income tax expense, noted above, that was reflected in discontinued operations, ASC 740, Income Taxes, prescribes that the effect of certain retroactive tax law changes be presented in continuing operations. Accordingly, we have presented this charge as a separate component of our non-operating items from continuing operations. (See also “Income Taxes” below). Additionally, in the third quarter of 2019, we recognized $3.4 million of tax benefits related to prior years.

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On February 14, 2019, we completed the sale of our Chaucer-related Irish entity and on April 10, 2019, we finalized the sale of the Australian entities, completing the transfer of all Chaucer-related companies. Collectively, these entities constituted the Chaucer business in 2018 and prior, whereas just the Irish and Australian entities comprised the Chaucer business reported in our results in 2019, until their respective sales to China Re. The sale of the Irish entity provided total proceeds of $28 million and resulted in a pre-tax gain of $0.4 million, with a related income tax benefit of $0.5 million. The sale of the Australian entities for total proceeds of $13 million resulted in a pre-tax gain of $1.2 million and a related income tax expense of $0.1 million.

Income from Operations of Chaucer Business

During the year ended December 31, 2019, revenues from the portion of the Chaucer business remaining after the sale of the U.K. entities in 2018 was $6.7 million. Pre-tax operating losses in this business totaled $0.5 million during the same period, whereas this business provided after-tax income of $1.6 million for the year ended December 31, 2019. Income from the Chaucer business in the year ended December 31, 2019 included a $2.0 million benefit related to a decrease in an uncertain tax position due to the expiration of the statute of limitations.

The following table summarizes the results of operations for Chaucer for 2018, reflecting the results of operations for the period in which we owned the Chaucer U.K. entities, which concluded with their sale on December 28, 2018.

(in millions)

 

2018

 

 

Revenues

 

 

 

 

 

Net premiums earned

 

$

850.0

 

 

Net investment income

 

 

54.9

 

 

Other income

 

 

7.5

 

 

 

 

 

912.4

 

 

Losses and operating expenses

 

 

 

 

 

Losses and LAE

 

 

515.5

 

 

Amortization of deferred acquisition costs

 

 

252.5

 

 

Other expenses

 

 

115.0

 

 

 

 

 

883.0

 

 

Income from Chaucer business before income taxes and other items

    (previously presented as Chaucer's operating income)

 

 

29.4

 

 

Other items:

 

 

 

 

 

Interest expense

 

 

(3.8

)

 

Net realized and unrealized investment gains (losses)

 

 

(1.3

)

 

Other income

 

 

0.4

 

 

Income from Chaucer business before income taxes

 

$

24.7

 

 

 

 

 

 

 

 

Loss and LAE ratio:

 

 

 

 

 

Current accident year, excluding catastrophe losses

 

 

54.8

 

%

Prior accident year reserve development, excluding catastrophe losses

 

 

(4.3

)

%

Current accident year catastrophe losses

 

 

12.1

 

%

Prior accident year favorable catastrophe loss development

 

 

(2.0

)

%

Total loss and LAE ratio

 

 

60.6

 

%

Expense ratio

 

 

42.5

 

%

Combined ratio

 

 

103.1

 

%

 

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INCOME TAXES

We are subject to the tax laws and regulations of the U.S. and foreign countries in which we operate or where we operated previously. 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 the U.S. operations. Our primary non-U.S. jurisdiction was the U.K., until the sale of our Chaucer business, which completed on April 10, 2019 with the final sale of the Australian entities. The U.K. statutory tax rate was 19% during 2018.  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, were utilized to offset U.S. tax as permitted.

The provision for income taxes from continuing operations was an expense of $82.8 million, $93.1 million, and $43.5 million in 2020, 2019 and 2018, respectively. These amounts resulted in consolidated effective tax rates of 18.6%, 17.8% and 15.4% on pre-tax income for 2020, 2019 and 2018, respectively. The provisions in 2020, 2019 and 2018 reflect benefits related to tax planning strategies implemented in prior years of $9.2 million, $14.8 million and $9.2 million, respectively. The provisions in 2020, 2019 and 2018 also included excess tax benefits related to stock-based compensation of $2.1 million, $3.0 million and $2.3 million, respectively. The provision for 2019 includes a charge of $1.2 million, which relates to the 2017 changes in the tax law related to the 2018 sale of Chaucer. The provision for 2018 reflects a tax benefit related to prior years of $4.3 million primarily resulting from a $40.0 million contribution to our U.S. pension plan made in September 2018, and reflected as a deduction in our 2017 U.S. income tax return at the then higher statutory tax rate of 35%. Absent these items, the provision for income taxes for 2020, 2019 and 2018 would have been expenses of $94.1 million, $109.7 million and $59.3 million, respectively, or 21.2% for 2020 and 21.0% for 2019 and 2018.

The income tax provision on operating income was an expense of $92.6 million, $84.5 million and $69.3 million for 2020, 2019 and 2018, respectively. These provisions resulted in effective tax rates for operating income of 20.7%, 20.3% and 19.2% in 2020, 2019 and 2018, respectively. The provisions for 2020, 2019 and 2018 reflect the aforementioned excess tax benefits related to stock-based compensation. In addition, the 2018 provision included the aforementioned tax benefit related to prior years of $4.3 million. Absent these items, the provision for income taxes for 2020, 2019 and 2018 would have been expenses of $94.7 million, $87.5 million and $75.9 million, or 21.2% for 2020 and 21.0% for 2019 and 2018.  

The income tax provision on our former Chaucer business was an expense of $4.7 million for 2018. The 2018 income tax provision on the gain from the disposal of Chaucer business was an expense of $42.5 million. This provision includes a write off of $8.0 million of deferred tax assets primarily attributable to Lloyd’s underwriting losses.  

During 2020 and 2019, we recorded decreases in reserves related to uncertain tax positions, due to the expirations of certain statutes of limitations. The 2020 reserve release of $0.5 million was recorded as a benefit to the income (loss) from discontinued life businesses, net of taxes. The 2019 reserve release of $2.0 million was recorded as a benefit to income from Chaucer business, net of taxes. We are subject to U.S. federal and state examinations and foreign examinations for years after 2016. There are no ongoing audits on our open tax years.

In prior years, we completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in our investment portfolio. As a result of these transactions, we were able to realize capital losses carried forward and release the valuation allowance recorded against the deferred tax asset related to those losses. The releases of valuation allowances were recorded as a benefit in accumulated other comprehensive income.  Previously unrealized benefits of $9.2 million, $14.8 million and $9.2 million, attributable to non-operating income, were recognized as part of our income from continuing operations during 2020, 2019 and 2018, respectively. The remaining amount of $11.6 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature.

CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. These statements have been prepared in accordance with U.S. GAAP, which requires us 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. The following critical accounting estimates are those which we believe affect the more significant judgments and estimates used in the preparation of our financial statements. Additional information about other significant accounting policies and estimates may be found in Note 1 – “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements.

RESERVE FOR LOSSES AND LOSS EXPENSES

See “Reserve for Losses and Loss Adjustment Expenses” within “Results of Operations – Segments” for a discussion of our critical accounting estimates for loss reserves.

REINSURANCE RECOVERABLE BALANCES

See “Reinsurance Recoverables” in Part I – Item 1 for information on our reinsurance recoverable balances.

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PENSION BENEFIT OBLIGATIONS

We currently have a qualified defined benefit plan and several smaller non–qualified benefit plans. In order to measure the liabilities and expense associated with these plans, we must make various estimates and key assumptions, including discount rates used to value liabilities, assumed rates of return on plan assets, employee turnover rates and anticipated mortality rates. These estimates and assumptions are reviewed at least annually and are based on our historical experience, as well as current facts and circumstances. In addition, we use outside actuaries to assist in measuring the expenses and liabilities associated with our defined benefit pension plan.

Two significant assumptions used in the determination of benefit plan obligations and expenses that are dependent on market factors, which have been subject to a greater level of volatility in recent years, are the discount rate and the return on plan asset assumptions. The discount rate enables us to state expected future benefit payments as a present value on the measurement date. We also use this discount rate in the determination of our pre-tax pension expense or benefit. A lower discount rate increases the present value of benefit obligations and increases pension expense. We determined our discount rate for the qualified benefit plan utilizing independent yield curves which provide for a portfolio of high quality bonds that are expected to match the cash flows of our pension plans. Bond information used in the yield curve included only those rated Aa or better as of December 31, 2020 and 2019, respectively, and had been rated by at least two well-known rating agencies. The discount rates used to value liabilities in our qualified pension plan were 3.00% and 3.75% as of December 31, 2020 and 2019, respectively.

To determine the expected long-term return on plan assets, we generally consider historical mean returns by asset class for passive indexed strategies, as well as current and expected asset allocations, and adjust for certain factors that we believe will have an impact on future returns. Actual returns on plan assets in any given year seldom result in the achievement of the expected rate of return on assets. Actual returns on plan assets in excess of these expected returns will generally reduce our net actuarial losses (or increase actuarial gains) that are reflected in the accumulated other comprehensive income balance in shareholders’ equity, whereas actual returns on plan assets that are less than expected returns will generally increase our net actuarial losses (or decrease actuarial gains) that are reflected in accumulated other comprehensive income. These gains or losses are amortized into expense in future years. The qualified benefit plan held assets consisting of approximately 90% fixed maturities and 10% equity securities at December 31, 2020.

The expected return on asset assumption was 4.75% and 5.50% in 2020 and 2019, respectively. Asset returns are reflected net of administrative expenses.

Net actuarial gains related to the qualified benefit plan of $7.2 million and $20.5 million were reflected as changes to accumulated other comprehensive income in 2020 and 2019, respectively. Net actuarial gains in 2020 and 2019 resulted from net investment gains during each year, as well as favorable mortality experience, partially offset by decreases in the discount rate. In 2020 and 2019, amortization of actuarial losses from prior years was $5.4 million and $11.1 million, respectively.

Expenses related to our qualified benefit plan are generally calculated based upon information available at the beginning of the plan year. Our pre-tax expense related to our qualified benefit plan was $0.3 million and $7.6 million for 2020 and 2019, respectively. As a result of favorable market returns in 2020 and favorable mortality experience, that were only partially offset by decreases in the discount rate, our pension expense related to our qualified benefit plan is expected to decrease from $0.3 million in 2020 to a benefit of $2.3 million in 2021.

Holding all other assumptions constant, sensitivity to changes in our key assumptions related to our qualified benefit plan is as follows:

(in millions)

 

 

 

 

Discount Rate -

 

 

 

 

25 basis point increase

 

 

 

 

Change in Benefit Obligation

 

$

(10.0

)

Change in 2021 Expense

 

 

(1.2

)

25 basis point decrease

 

 

 

 

Change in Benefit Obligation

 

 

10.4

 

Change in 2021 Expense

 

 

1.2

 

Expected Return on Plan Assets -

 

 

 

 

25 basis point increase

 

 

 

 

Change in 2021 Expense

 

 

(1.2

)

25 basis point decrease

 

 

 

 

Change in 2021 Expense

 

 

1.2

 

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

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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” and Note 4 – “Investment Income and Gains and Losses” in the Notes to Consolidated Financial Statements for further discussion regarding securities in an unrealized loss position and impairments.

DEFERRED TAXES

Deferred tax assets and liabilities primarily result from temporary differences between the amounts recorded in our consolidated financial statements and the tax basis of our assets and liabilities and loss and tax credit carryforwards. These temporary differences are measured at the balance sheet date using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse.

The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. Consideration is given to available positive and negative evidence, including reversals of deferred tax liabilities, projected future taxable income in each tax jurisdiction, tax planning strategies and recent financial operations. Valuation allowances are established if, based on the weight of available information, it is more likely than not that all or some portion of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions. Changes in valuation allowances are generally reflected in income tax expense or as an adjustment to other comprehensive income, depending on the nature of the item for which the valuation allowance is being recorded.

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The following are the components of our deferred tax assets and liabilities as of December 31, 2020.

DEFERRED TAX ASSETS (LIABILITIES)

 

Amount

 

(in millions)

 

 

 

 

Loss, LAE and unearned premium reserves, net

 

$

150.8

 

Employee benefit plan

 

 

6.0

 

Investments, net

 

 

(146.7

)

Deferred acquisition costs

 

 

(100.3

)

Software capitalization

 

 

(24.0

)

Other, net

 

 

16.9

 

Total

 

$

(97.3

)

As of December 31, 2020, we did not have a valuation allowance and believe it is more likely than not that the remaining deferred tax assets will be realized.

STATUTORY SURPLUS OF INSURANCE SUBSIDIARIES

The following table reflects statutory surplus for our insurance subsidiaries:

DECEMBER 31

 

2020

 

 

2019

 

(in millions)

 

 

 

 

 

 

 

 

Total Statutory Capital and Surplus

 

$

2,588.5

 

 

$

2,470.2

 

The statutory capital and surplus for our insurance subsidiaries increased $118.3 million during 2020, primarily due to approximately $383 million of underwriting profits, partially offset by the payment of a $245 million dividend.

The NAIC prescribes an annual calculation regarding risk based capital (“RBC”). RBC ratios for regulatory purposes, as described in the glossary, 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 December 31, 2020 and 2019, 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)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2020

 

Company

Action

Level

 

 

Authorized

Control

Level

 

 

RBC Ratio

Industry

Scale

 

 

RBC Ratio

Regulatory

Scale

 

The Hanover Insurance Company

 

$

1,105.2

 

 

$

552.6

 

 

 

233

%

 

 

467

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DECEMBER 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Hanover Insurance Company

 

$

1,063.7

 

 

$

531.8

 

 

 

231

%

 

 

463

%

 

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”). Hanover Insurance paid $245.0 million in dividends to the holding company in 2020. In both 2019 and 2018, Hanover Insurance paid $140.0 million in 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 $707.6 million during 2020, as compared to $602.9 million during 2019 and $551.3 million in 2018. The $104.7 million increase in cash provided in 2020 as compared to 2019 was primarily due to lower loss and LAE payments, a decrease in Federal income tax payments, and a slight increase in premium collections. The $51.6 million increase in cash provided in 2019 as compared to 2018 was primarily the result of an increase in premiums collected, partially offset by higher loss payments.

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Net cash used in investing activities was $608.8 million during 2020, as compared to $311.9 million during 2019 and net cash provided of $271.3 million in 2018. 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. During 2018, cash provided by investing activities primarily related to net proceeds received from the sale of Chaucer. These proceeds were partially offset by net purchases of fixed maturities, commercial mortgage loan participations, and other investments.

Net cash used in financing activities was $193.9 million during 2020, as compared to $1,099.3 million during 2019 and $171.0 million in 2018. During 2020, cash used in financing activities primarily resulted from repurchases of common stock through both an accelerated share repurchase (“ASR”) agreement and the open market, the repayment of subordinated debentures and the payment of quarterly dividends to shareholders, partially offset by cash received from the issuance of senior debentures. During 2019, cash used in financing activities primarily resulted from repurchases of common stock through three ASR agreements, the payments of two special dividends in addition to regular quarterly dividends to shareholders, and the repayment of the FHLB advances. (See further discussion below for additional information regarding the special dividend, the ASR agreements and the repayment of the FHLB advances). During 2018, cash used in financing activities primarily resulted from the payment of dividends to shareholders and repurchases of common stock. 

Dividends to common shareholders are subject to quarterly board approval and declaration. During 2020, our Board declared dividends that totaled $100.7 million. This included three quarterly dividends of $0.65 per share and one quarterly dividend of $0.70 per share. We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them.

At December 31, 2020, THG, as a holding company, held approximately $396.9 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 and debt. We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 2021 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. We believe that this plan is fully funded. 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 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 has authorized a stock repurchase program which provides for aggregate repurchases of our common stock of up to $900 million. Under the repurchase authorization, we may repurchase, from time to time, common shares 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. Pursuant to the terms of an ASR agreement executed on December 9, 2019 (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.

On October 29, 2020, pursuant to the terms of a second ASR agreement (the “October 2020 ASR”), we paid $100.0 million in exchange for shares of our common stock. Under the terms of the October 2020 ASR, we received an initial delivery of approximately 0.8 million shares of our common stock, which was approximately 80% of the total number of shares expected to be repurchased under the October 2020 ASR agreement. On January 29, 2021, we received approximately 45,000 shares of our common stock as final settlement of shares repurchased under the October 2020 ASR. In addition to the shares repurchased under the December 2019 ASR and the October 2020 ASR, during 2020 we repurchased approximately 1.1 million shares at an aggregate cost of $112.8 million. As of December 31, 2020, we have repurchased 6.4 million shares under this $900 million program and have approximately $124 million available for additional repurchases.

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On August 24, 2020, we issued $300.0 million aggregate principal amount of 2.50% senior unsecured debentures due September 1, 2030. Net proceeds of the debt issuance were $297.7 million. A portion of the net proceeds was used to redeem $175.0 million outstanding 6.35% subordinated notes due 2053, resulting in a pre-tax loss of $6.1 million, related primarily to the accelerated amortization of debt issuance costs.

We maintain our membership in the FHLB to provide access to additional liquidity based on our holdings of FHLB stock and pledged collateral. At December 31, 2020, we had borrowing capacity of $94.9 million. There were no borrowings outstanding under this short-term facility at December 31, 2020; however, we have borrowed and 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. We currently have no borrowings under this agreement during 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 December 31, 2020, we were in compliance with the covenants of our debt and credit agreements.

CONTRACTUAL OBLIGATIONS

Financing obligations generally include repayment of our senior debentures, subordinated debentures and lease payments. The following table represents our annual payments related to the contractual principal and interest payments of these financing obligations as of December 31, 2020, unless otherwise noted, and lease payments reflect expected cash payments based upon active lease terms. It is expected that in the normal course of business, leases that expire will generally be renewed or replaced by leases on similar property and equipment. In addition, we also have included our estimated payments related to our loss and LAE obligations and our current expectation of payments to be made to support the obligations of our benefit plans. The following table also includes commitments to purchase investment securities at a future date. Actual payments may differ from the contractual and/or estimated payments in the table.

DECEMBER 31, 2020

 

Maturity less than 1 year

 

 

Maturity

1-3 years

 

 

Maturity

4-5 years

 

 

Maturity in

excess of

5 years

 

 

Total

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt (1)

 

$

 

 

$

 

 

$

61.8

 

 

$

725.1

 

 

$

786.9

 

Interest associated with debt (1)

 

 

33.2

 

 

 

66.4

 

 

 

66.4

 

 

 

52.1

 

 

 

218.1

 

Lease commitments (2)

 

 

14.0

 

 

 

16.9

 

 

 

4.9

 

 

 

 

 

 

35.8

 

Defined benefit pension and post-retirement benefit

   obligation (3)

 

 

4.0

 

 

 

7.3

 

 

 

6.6

 

 

 

13.6

 

 

 

31.5

 

Investment commitments (4)

 

 

62.8

 

 

 

60.0

 

 

 

33.1

 

 

 

 

 

 

155.9

 

Loss and LAE obligations (5)

 

 

1,901.6

 

 

 

1,835.1

 

 

 

729.6

 

 

 

1,557.7

 

 

 

6,024.0

 

(1)

The debt with a maturity of 4-5 years reflects our senior debentures due in 2025, which pay annual interest at a rate of 7.625%. Debt in the maturity in excess of 5 years category includes our senior debentures due in 2026, which pay annual interest at a rate of 4.50%, our subordinated debentures due in 2027, which pay interest at an annual rate of 8.207%, and our senior debentures due in 2030, which pay annual interest at a rate of 2.50%. Payments related to the principal amounts of these agreements represent contractual maturity; therefore, principal and interest associated with these obligations are reflected in the above table based upon the contractual maturity dates.

(2)

Our subsidiaries are lessees with a number of leases.

(3)

Amounts represent non-qualified defined benefit pension and postretirement benefit obligations and reflect estimated payments to be made through plan year 2030 for pension, postretirement, and postemployment benefits, although it is likely that payments will be made beyond 2030. Estimates of these payments and the payment patterns are based upon historical experience. We do not expect to make any significant contributions to our qualified plan in order to meet our minimum funding requirements for the next several years; therefore, no contributions for this plan are included in this schedule. However, additional contributions may be required in the future based on the level of pension assets and liabilities in future periods. The ultimate payment amount for our pension 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 and the ultimate valuation of benefit obligations.

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Differences between actual plan experience and our assumptions are likely and will likely result in changes to our funding obligations in future periods.

(4)

Investment commitments relate primarily to limited partnerships.

(5)

Unlike many other forms of contractual obligations, loss and LAE reserves do not have definitive due dates and the ultimate payment dates are subject to a number of variables and uncertainties. As a result, the total loss and LAE reserve payments to be made by period, as shown in the table, are estimates based principally on historical experience.

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

Information regarding litigation and legal contingencies appears in Note 16 – “Commitments and Contingencies” in the Notes to Consolidated Financial Statements. Information related to certain regulatory and industry developments are contained in “Regulation” in Part I - Item 1 and in “Risk Factors” in Part I – Item 1A.

RATING AGENCIES

Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers information on specific insurance companies. Higher ratings generally indicate the rating agencies’ opinion regarding financial stability and a stronger ability to pay claims.

We believe that strong ratings are important factors in marketing our products to our agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Insurance company financial strength ratings are assigned to an insurer based upon factors deemed by the rating agencies to be relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. Customers typically focus on claims-paying ratings, while creditors focus on debt ratings. Investors use both to evaluate a company’s overall financial strength.

RISKS AND FORWARD-LOOKING STATEMENTS

Management’s Discussion and Analysis contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of indicators of forward-looking statements and specific important factors that could cause actual results to differ materially from those contained in forward-looking statements, see “Risk Factors” in Part I – Item 1A. This Management’s Discussion and Analysis should be read and interpreted in light of such factors.

GLOSSARY OF SELECTED INSURANCE TERMS

Account business - Customers with multiple policies and/or coverages.

Account rounding – The conversion of single policy customers to accounts with multiple policies and/or additional coverages, to address customers’ broader objectives.

Benefit payments – Payments made to an insured or their beneficiary in accordance with the terms of an insurance policy.

Big data – large, diverse, complex sets of information that grow at ever-increasing rates and require special tools and methods to process. It encompasses the volume of information, the velocity or speed at which it is created and collected, and the variety or scope of the data points being covered. Big data analytics refers to the use of predictive analytics, user behavior analytics, or certain other advanced data analytics methods that extract value from big data.

Casualty insurance – Insurance that is primarily concerned with the losses caused by injuries to third persons and their property (other than the policyholder) and the related legal liability of the insured for such losses.

Catastrophe – A severe loss, resulting from natural or manmade events, including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, severe winter weather, fire, explosions, and terrorism.

Catastrophe loss – Loss and directly identified loss adjustment expenses from catastrophes, including development on prior years’ catastrophe loss reserves. The Insurance Services Office (“ISO”) Property Claim Services (“PCS”) defines a catastrophe loss as an event that causes $25 million or more in insured property losses from U.S. direct writers and affects a significant number of property and casualty policyholders and insurers. In limited instances where the impact of an event extends across multiple geographic areas or time periods, but is not within the specific parameters established by PCS, THG may determine that certain losses are better included within the same catastrophe event. In addition to those catastrophe events declared by ISO, claims management also generally includes within the definition of a “catastrophe loss”, a property loss event that causes approximately $5 million or more in Company insured losses and affects in excess of one hundred policyholders. For the international business in our Commercial Lines segment, management utilizes a “catastrophe loss” definition that is substantially consistent with the ISO definition framework.

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Cede; cedent; ceding company – When a party reinsures its liability with another party, it “cedes” business and is referred to as the “cedent” or “ceding company”.

Credit spread – The difference between the yield on the debt securities of a particular corporate debt issue and the yield of a similar maturity of U.S. Treasury debt securities.

Current accident year results – A non-GAAP measure of the estimated earnings impact of current premiums offset by estimated loss experience and expenses for the current accident year. This measure includes the estimated increase in revenue associated with higher prices (premiums), including those caused by price inflation and changes in exposure, partially offset by higher volume driven expenses and inflation of loss costs. Volume driven expenses include acquisition costs such as commissions paid to agents, which are typically based on a percentage of premium dollars.

Earned premium – The portion of a premium that is recognized as income, or earned, based on the expired portion of the policy period, that is, the period for which loss coverage has actually been provided. For example, after six months, $50 of a $100 annual premium is generally considered earned premium. The remaining $50 of annual premium is unearned premium. Net earned premium is earned premium net of reinsurance.

Excess of loss reinsurance – Reinsurance that indemnifies the insured against all or a specific portion of losses under reinsured policies in excess of a specified dollar amount or “retention”.

Exposure – As it relates to underwriting, a measure of the rating units or premium basis of a risk; for example, an exposure of a number of automobiles. As it relates to loss events, the maximum value of claims made on an insurer from an event or events that would result in the total exhaustion of the cover or indemnity offered by an insurance policy.

Exposure management actions – Actions that focus on improving underwriting profitability and/or lessening earnings volatility by reducing our exposures and property concentrations in certain geographies and lines that are believed to be more prone to catastrophe and non-catastrophe losses. These actions include, but are not limited to, non-renewal, rate increases, stricter underwriting standards and higher deductible utilization, agency management actions, and more selective portfolio management by modifying our business mix.

Frequency – The number of claims occurring during a given coverage period.

Loss adjustment expenses (“LAE”) – Expenses incurred in the adjusting, recording, and settlement of claims. These expenses include both internal company expenses and outside services. Allocated LAE (“ALAE”) refers to defense and cost containment expenses, including legal fees, court costs, and investigation fees.  Unallocated LAE (“ULAE”) refers to expenses that generally cannot be associated with a specific claim. ULAE includes internal costs such as salaries, fringe benefits and other overhead costs associated with the claim settlement process and external adjustment and appraisal fees.

Loss costs – An amount of money paid for an insurance claim.

Loss reserves – Liabilities established by insurers to reflect the estimated cost of claims payments and the related expenses that the insurer will ultimately be required to pay in respect of insurance it has written. Reserves are established for losses and for LAE.

Lower (higher) expenses – Represents the period over period comparison of expenses relative to growth in earned premium.  Volume driven expenses typically fluctuate commensurate with changes in premium.  Accordingly, as we grow premium, these expenses increase from an absolute dollar perspective, but tend to stay proportionate compared to premium.  Fixed expenses can remain constant or increase or decrease irrespective of the growth or decline in premium.  When describing expenses as being “lower” or “higher” we are generally referring to changes in fixed costs relative to premium (fixed cost leverage).  These “lower” or “higher” expenses correspond to a lower or higher expense ratio.

Marine Insurance – In Commercial Lines, this is a type of coverage developed for insuring businesses against physical losses to property such as contractor’s equipment, builder’s risk and goods in transit. It covers articles in transit by all forms of land and air transportation as well as bridges, tunnels, ocean and other means of transportation and communication. In the context of Personal Lines, this term relates to floater policies that cover expensive personal items such as fine art and jewelry.

Morbidity – Morbidity relates to the occurrence of illness, disability or other physical or psychological impairment, whether temporary or permanent, for insured risks. Morbidity is a key assumption for long-term care insurance and other forms of individual and group health benefits.

Partner agents; partner agencies; partner independent agents; agency partners; business partners – Independent agents (agencies) are self-employed, commission-based businesses who generally represent, and sell insurance policies provided by, several insurance companies.  THG has appointed and developed mutually beneficial relationships with a limited number of independent agents who are demonstrated experts in their field, growth-oriented and align with our strategy.  Although we may refer to those agencies as “partner agents”, these are not legally binding “partnerships”, but rather an opportunity for both the agent (agencies) and THG to work together and achieve common goals.

Peril – A cause of loss.

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Price(ing) increase or decrease (Commercial Lines) – Represents the average change in premium on renewed policies caused by the estimated net effect of base rate changes, discretionary pricing, inflation or changes in policy level exposure or insured risk.

Price(ing) increase or decrease (Personal Lines) – The estimated cumulative premium effect of approved rate actions applied to policies available for renewal, regardless of whether or not policies are actually renewed. Pricing changes do not represent actual increases or decreases realized by THG.

Property insurance – Insurance that provides coverage for tangible property in the event of loss, damage or loss of use.

Rate – The estimated pure pricing factor upon which the policyholder’s premium is based excluding changes in exposure or risk.

Ratios: (1)

Catastrophe loss ratio –The ratio of catastrophe losses incurred to premiums earned.

Combined ratio – This ratio is the GAAP equivalent of the statutory ratio that is widely used as a benchmark for determining an insurer’s underwriting performance. A ratio below 100% generally indicates profitable underwriting prior to the consideration of investment income (loss). A combined ratio over 100% generally indicates unprofitable underwriting prior to the consideration of investment income (loss). The combined ratio is the sum of the loss and loss adjustment expense ratio and the expense ratio.

Expense Ratio – The ratio of underwriting expenses (including the amortization of deferred acquisition costs), less premium installment and other fee income and premium charge offs, to premiums earned for a given period.

Loss and Loss adjustment expense (“LAE”) ratio – The ratio of loss and loss adjustment expenses to premiums earned for a given period. The LAE ratio includes catastrophe losses and prior year reserve development.

Loss ratio – The ratio of losses (including catastrophe losses) to premiums earned for a given period.

Reinstatement premium – A pro-rata reinsurance premium that may be charged to us by our reinsurers. A reinstatement premium may be contractually required to be charged for restoring an amount of reinsurance coverage reduced as the result of a reinsurance loss payment that depletes or exhausts a reinsurance treaty or treaty layer. For example, in 2005, this premium was required to ensure that our property catastrophe occurrence treaty, which was exhausted by hurricane Katrina, was available again in the event of another large catastrophe loss in 2005. Reinsurance reinstatement premiums accrued by us are accounted for as a reduction in net premiums earned rather than as an “expense”. For certain reinsurance treaties, a ceding commission adjustment is recorded commensurate with a reinstatement premium accrual. A ceding commission is a fee paid by a reinsurance company to a direct writer to cover the costs of issuing the policy and is recorded as a contra-expense.

Reinsurance – An arrangement in which an insurance company, or a reinsurance company, known as the reinsurer, agrees to indemnify another insurance or reinsurance company, known as the ceding company, against all or a portion of the insurance or reinsurance risks underwritten by the ceding company under one or more policies. Reinsurance can provide a ceding company with several benefits, including a reduction in net liability on risks and catastrophe protection from large or multiple losses. Reinsurance does not legally discharge the primary insurer from its liability with respect to its obligations to the insured.

Risk based capital (“RBC”) – A method of measuring the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The RBC ratio for regulatory purposes is calculated as total adjusted capital divided by required risk based capital. Total adjusted capital for property and casualty companies is capital and surplus, adjusted for the non-tabular reserve discount applicable to our assumed discontinued accident and health insurance business. The Company Action Level is the first level at which regulatory involvement is specified based upon the level of capital.

Regulators may take action for reasons other than triggering various RBC action levels. The various action levels are summarized as follows:

 

The Company Action Level, which equals 200% of the Authorized Control Level, requires a company to prepare and submit a RBC plan to the commissioner of the state of domicile. A RBC plan proposes actions which a company may take in order to bring statutory capital above the Company Action Level. After review, the commissioner will notify the company if the plan is satisfactory.

 

The Regulatory Action Level, which equals 150% of the Authorized Control Level, requires the insurer to submit to the commissioner of the state of domicile a RBC plan, or if applicable, a revised RBC plan. After examination or analysis, the commissioner will issue an order specifying corrective actions to be taken.

 

The Authorized Control Level authorizes the commissioner of the state of domicile to take whatever regulatory actions are considered necessary to protect the best interest of the policyholders and creditors of the insurer.

 

The Mandatory Control Level, which equals 70% of the Authorized Control Level, authorizes the commissioner of the state of domicile to take actions necessary to place the company under regulatory control (i.e., rehabilitation or liquidation).

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Securities Lending – We have, from time to time, engaged our banking provider to lend securities from our investment portfolio to third parties. These lent securities are fully collateralized by cash. When securities are lent, we monitor the fair value of the securities on a daily basis to assure that the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. We record securities lending collateral as a cash equivalent, with an offsetting liability in expenses and taxes payable.

Severity – A monetary increase in the loss costs associated with the same or similar type of event or coverage.

Social Inflation – A term used to explain rising insurance claim payouts due to various factors associated with a more costly legal environment, such as increased litigation frequency, expanded theories of liability and higher jury awards. Higher than the expected litigation payouts to plaintiffs due to these and other factors, may then give rise to the initiation of additional lawsuits seeking similarly elevated awards and increasing settlement costs, which can compound the effect.

Specialty Lines – A major component of our Other commercial lines. There is no accepted industry definition of “specialty lines”, but for our purpose specialty lines consist of products such as marine, surety, specialty industrial property, professional liability, management liability and various other program businesses. When discussing net premiums written and other financial measures of our specialty businesses, we may include non-specialty premiums that are written as part of the entire account.

Statutory accounting practices – Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by insurance regulatory authorities including the National Association of Insurance Commissioners, which in general reflect a liquidating, rather than going concern, concept of accounting.

Underwriting – The process of selecting risks for insurance and determining in what amounts and on what terms the insurance company will accept risks.

Underwriting expenses – Expenses incurred in connection with the acquisition, pricing and administration of a policy or contract, and other insurance company expenses unrelated to claims handling or investments.

Unearned premiums – The portion of a premium representing the unexpired amount of the contract term as of a certain date.

Written premium – The premium assessed for the entire coverage period of an insurance policy or contract without regard to how much of the premium has been earned. See also “Earned premium” above. Net premium written is written premium net of reinsurance.

(1) Ratios may not be comparable to similarly titled measures of other companies.

ITEM 7A–QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Reference is made to “Quantitative and Qualitative Disclosures about Market Risk” in Management’s Discussion and Analysis.

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ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

The Hanover Insurance Group, Inc.:

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of The Hanover Insurance Group, Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of income, of comprehensive income, of shareholders' equity and of cash flows for each of the three years in the period ended December 31, 2020, including the related notes and schedules of condensed financial information of the registrant, of supplementary insurance information, and of supplemental information concerning property and casualty insurance operations as of December 31, 2020 and 2019 and for each of the three years in the period ended December 31, 2020, schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2020, and schedule of summary of investments – other than investments in related parties as of December 31, 2020 listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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Critical Audit Matters

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Valuation of loss and loss adjustment expense reserves

As described in Notes 1 and 15 to the consolidated financial statements, loss and loss adjustment expense reserves were $6.0 billion as of December 31, 2020. These liabilities are determined using case basis evaluations and statistical analyses of historical loss patterns and represent estimates of the ultimate cost of all losses incurred but not paid. The loss reserve estimation process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for management to predict future outcomes.  As part of this process, management uses a variety of analytical methods that consider experience, trends and other relevant factors, as well as considers numerous quantitative and qualitative factors, including the maturity of the accident year, the level of volatility within a particular class of business, the sufficiency or quality of historical reported and paid loss and loss adjustment expenses information, legal and regulatory developments and changes in underwriting, claim handling and case reserving practices. The Company’s ultimate incurred but not reported (“IBNR”) reserves are estimated by management and reserving actuaries on an aggregate basis for each line of business or coverage for loss and loss expense liabilities not reflected within the case reserves.

The principal considerations for our determination that performing procedures relating to the valuation of loss and loss adjustment expense reserves is a critical audit matter are the significant judgment by management when developing their estimate. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence relating to the various analytical methods and factors used by management in developing the estimate, such as historical loss patterns and other relevant quantitative and qualitative factors, which related to the maturity of the accident year, the level of volatility within a particular class of business, and the sufficiency or quality of historical reported and paid loss and loss adjustment expenses information. Also, our audit effort included the involvement of professionals with specialized skill and knowledge to assist in performing procedures and evaluating the audit evidence obtained from these procedures.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the Company’s valuation of loss and loss adjustment expense reserves, including controls over the analytical methods applied and development of qualitative and quantitative fact