Newswires
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
Introduction 26
Executive Overview 26
Description of Operating Segments 27
Results of Operations - Consolidated 27
Results of Operations - Segments 29
Investments 36
Other Items 40
Income Taxes 41
Critical Accounting Estimates 41
Statutory Surplus of Insurance Subsidiaries 42
Liquidity and Capital Resources 42
Contingencies and Regulatory Matters 44
Risks and Forward - Looking Statements 44
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Table of Contents Introduction The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist readers in understanding the interim consolidated results of operations and financial condition ofThe Hanover Insurance Group, Inc. and its subsidiaries ("THG"). Consolidated results of operations and financial condition are prepared in accordance with generally accepted accounting principles inthe United States of America ("U.S. GAAP"). This discussion should be read in conjunction with the interim consolidated financial statements and related footnotes included elsewhere in this Quarterly Report on Form 10-Q and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission (the "SEC") onFebruary 24, 2021 . Results of operations include the accounts ofThe Hanover Insurance Company ("Hanover Insurance ") andCitizens Insurance Company of America ("Citizens"), our principal property and casualty insurance companies, and other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting of our accident and health and former life insurance businesses. 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 customers and 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 and meet the needs
of our customers. Our goal is to grow responsibly in all of our businesses,
while managing volatility.
The global pandemic ("Pandemic") has significantly impacted the U.S. and global
financial markets and economies since March 2020 . Circumstances relating to the
Pandemic are unprecedented in scope and impact, continue to evolve, are complex
and uncertain, and are outside our control. Our investment portfolio was
affected by the deterioration in investment markets during March 2020 , as well
as the 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 the period from March
2020 through September 2021 . Several uncertainties persist related to the
Pandemic, including, among others, return to work initiatives, virus variants,
vaccination rates, driving patterns, court caseload backlogs, and inflationary
pressures. 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 may affect the property and casualty insurance industry,
our business, and our financial results over the intermediate and long-term.
(See "Contingencies and Regulatory Matters" and "Item 1A - Risk Factors" for
further discussion).
During the nine months ended September 30, 2021 , our net income was $255.2
million , compared to $194.1 million for the nine months ended September 30,
2020 , an increase of $61.1 million , primarily due to changes in the fair value
of equity securities and, to a lesser extent, $27.9 million of impairments on
fixed income securities in the prior year that did not recur in 2021, partially
offset by lower operating income.
Operating income before interest expense and income taxes (a non-GAAP financial
measure; see also "Results of Operations - Consolidated - Non-GAAP Financial
Measures") was $269.4 million for the nine months ended September 30, 2021 ,
compared to $334.4 million for the nine months ended September 30, 2020 , a
decrease of $65.0 million . This decrease was primarily due to higher catastrophe
losses and higher Personal Lines non-catastrophe losses, partially offset by
higher net investment income, earned premium growth, and net favorable
development on prior years' loss and loss adjustment expense ("LAE") reserves
("prior years' loss reserves"). The higher Personal Lines non-catastrophe losses
were primarily due to higher personal automobile losses, compared to fewer
accidents and decreased claim activity in 2020 that emerged from changes in
driving patterns as a result of the Pandemic.
Pre-tax catastrophe losses were $363.6 million for the nine months ended
September 30, 2021 , compared to $251.6 million during the same period of 2020.
The increase of $112.0 million was primarily due to Hurricane Ida and several
wind events and hailstorms in the Midwest during the third quarter and the
freeze events in Texas and surrounding states during the first quarter. Net
favorable development on prior years' loss reserves was $41.7 million for the
nine months ended September 30, 2021 , compared to $9.5 million for the nine
months ended September 30, 2020 , an increase of $32.2 million .
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 9.0% in the
first nine months of 2021, compared to the same period in 2020, primarily due to
pricing increases and a reduction in insured business activity in 2020 as a
result of the Pandemic.
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Underwriting results declined in the first nine months of 2021, primarily due to higher catastrophe losses, partially offset by earned premium growth and favorable development of prior years' loss reserves. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins, and we continue to seek rate increases across many lines of business.
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 86% 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. Net premiums written increased by 7.4% in the first nine months of 2021, compared to the same period in 2020, which includes a return of approximately$30 million of premiums in 2020 to our eligible personal automobile customers in all our markets, providing financial relief during the Pandemic. Excluding the impact of the premium refund, net premiums written grew by 5.2%, primarily due to increased new business, retention and, to a lesser extent, renewal rate increases. Underwriting results decreased in the first nine months of 2021, primarily due to higher non-catastrophe losses, catastrophe losses, and expenses, partially offset by favorable development of prior years' loss reserves and earned premium growth. The higher expenses were primarily due to the absence in 2021 of a non-recurring premium tax benefit of$13.8 million from aMichigan refund related to tax years 2014 through 2016 that was received in 2020.
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 areOpus Investment Management, Inc. , which markets investment management services to institutions, pension funds, and other organizations; earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to our former life insurance employees and agents; and a run-off voluntary property and casualty pools business. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance. We report interest expense on debt separately from the earnings of our operating segments. This consists primarily of interest on our senior and subordinated debentures.
Results of Operations - Consolidated
Consolidated net income for the three months endedSeptember 30, 2021 was$34.0 million , compared to$118.9 million for the three months endedSeptember 30, 2020 , a decrease of$84.9 million . The decrease in consolidated net income was primarily due to a decrease in operating income before interest expense and income taxes for the three months endedSeptember 30, 2021 , as well as by lower after-tax net realized and unrealized investment gains of approximately$28.1 million , primarily related to the change in the fair value of equity securities. Operating income before interest expense and income taxes decreased$81.4 million primarily due to higher catastrophe losses and increased Personal Lines non-catastrophe losses, partially offset by favorable development on prior years' loss reserves, earned premium growth, and higher net investment income. Consolidated net income for the nine months endedSeptember 30, 2021 was$255.2 million , compared to$194.1 million for the nine months endedSeptember 30, 2020 , an increase of$61.1 million . The increase in consolidated net income was primarily a result of$61.0 million of after-tax net realized and unrealized investment gains in 2021 as compared to$40.7 million of after-tax net realized and unrealized investment losses in 2020, a change of$101.7 million , primarily related to the change in the fair value of equity securities and, to a lesser extent, a decrease in impairment losses on investments. Operating income before interest expense and income taxes decreased$65.0 million primarily due to higher catastrophe losses and higher Personal Lines non-catastrophe losses, partially offset by higher net investment income, earned premium growth, and net favorable development on prior years' loss reserves. 27
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The following table reflects operating income before interest expense and income
taxes for each operating segment and a reconciliation to consolidated net income
from operating income before interest expense and income taxes (a non-GAAP
measure).
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 2021 2020 2021 2020
Operating income before interest
expense and income taxes:
Commercial Lines $ 42.4 $ 62.3 $ 149.0 $ 172.2
Personal Lines 3.6 64.2 117.6 161.7
Other 1.0 1.9 2.8 0.5
Operating income before interest
expense and income taxes 47.0 128.4 269.4 334.4
Interest expense on debt (8.5 ) (9.8 ) (25.5 ) (28.6 )
Operating income before income taxes 38.5 118.6 243.9 305.8
Income tax expense on operating income (7.7 ) (25.1 )
(47.7 ) (62.8 ) Operating income 30.8 93.5 196.2 243.0 Non-operating items: Net realized and unrealized investment gains (losses) 4.0 37.7 72.6 (60.2 ) Net loss from repayment of debt - (6.1 ) - (6.2 ) Other non-operating - (1.6 ) - (1.6 ) Income tax (expense) benefit on non-operating items - (4.0 ) (11.6 ) 21.1 Income from continuing operations, net of taxes 34.8 119.5 257.2 196.1 Discontinued operations (net of taxes): Loss from discontinued life businesses (0.8 ) (0.6 ) (2.0 ) (2.0 ) Net income$ 34.0 $ 118.9 $ 255.2 $ 194.1 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. 28
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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:
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 2021 2020 2021 2020
Operating revenues
Net premiums written $ 1,375.2 $ 1,268.5 $ 3,778.5 $ 3,486.4
Net premiums earned $ 1,186.0 $ 1,135.4 $ 3,527.6 $ 3,373.4
Net investment income 78.8 67.6 231.2 194.9
Other income 7.6 9.1 21.7 22.2
Total operating revenues 1,272.4 1,212.1 3,780.5 3,590.5
Losses and operating expenses
Losses and LAE 844.0 709.0 2,370.4 2,149.2
Amortization of deferred acquisition
costs 244.0 237.7 728.5 711.9
Other operating expenses 137.4 137.0 412.2 395.0
Total losses and operating expenses 1,225.4 1,083.7 3,511.1 3,256.1
Operating income before interest
expense and income taxes $ 47.0 $ 128.4 $
269.4
Three Months Ended
30, 2020
Operating income before interest expense and income taxes was$47.0 million for the three months endedSeptember 30, 2021 , compared to$128.4 million for the three months endedSeptember 30, 2020 , a decrease of$81.4 million . This decrease was primarily due to higher catastrophe losses and increased Personal Lines non-catastrophe losses, partially offset by favorable development on prior years' loss reserves, earned premium growth, and higher net investment income.
Net premiums written increased
primarily due to rate increases.
Production and Underwriting Results
The following tables summarize premiums written on a gross and net basis, net
premiums earned and loss (including catastrophe losses), LAE, expense and
combined ratios for the Commercial Lines and Personal Lines segments. Loss, LAE,
catastrophe loss and combined ratios shown below include prior year reserve
development. These items are not meaningful for our Other segment.
Three Months Ended September 30, 2021
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Commercial Lines $ 928.3 $ 826.8 $ 698.6 10.7 67.4 33.8 101.2
Personal Lines 564.9 548.4 487.4 16.1 76.5 27.3 103.8
Total $ 1,493.2 $ 1,375.2 $ 1,186.0 12.9 71.2 31.1 102.3
Three Months Ended September 30, 2020
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Commercial Lines $ 884.7 $ 760.5 $ 665.1 5.1 62.4 34.5 96.9
Personal Lines 521.4 508.0 470.3 6.9 62.5 27.9 90.4
Total $ 1,406.1 $ 1,268.5 $ 1,135.4 5.8 62.4 31.8 94.2
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The following table summarizes net premiums written, and loss and LAE and
catastrophe loss ratios by line of business for the Commercial Lines and
Personal Lines segments. Loss and LAE and catastrophe loss ratios include prior
year reserve development.
Three Months Ended September 30,
2021 2020
Net Net
Premiums Loss & LAE Catastrophe Premiums Loss & LAE Catastrophe
(dollars in millions) Written Ratios Loss Ratios Written Ratios Loss Ratios
Commercial Lines:
Commercial multiple peril $ 289.5 87.5 24.1 $ 273.4 68.5 6.6
Commercial automobile 94.7 65.3 0.3 88.8 67.5 0.7
Workers' compensation 93.9 54.4 - 79.0 48.4 -
Other commercial 348.7 55.2 6.0 319.3 59.7 6.5
Total Commercial Lines $ 826.8 67.4 10.7 $ 760.5 62.4 5.1
Personal Lines:
Personal automobile $ 330.8 68.0 2.4 $ 311.6 61.2 1.1
Homeowners 196.7 93.8 41.9 179.7 67.8 18.0
Other personal 20.9 55.8 5.8 16.7 29.1 1.4
Total Personal Lines $ 548.4 76.5 16.1 $ 508.0 62.5 6.9
The following table summarizes U.S. GAAP underwriting results for the Commercial
Lines, Personal Lines and Other segments and reconciles them to operating income
before interest expense and income taxes.
Three Months Ended
2021 2020
Commercial Personal Commercial Personal
(in millions) Lines Lines Other Total Lines Lines Other
Total
Underwriting profit, excluding
prior year reserve development
and catastrophes$ 53.2 $ 48.5 $
-
Prior year favorable (unfavorable)
loss and LAE reserve development
on non-catastrophe losses 11.4 9.9 (0.4 ) 20.9 3.9 (1.0 ) (0.3 ) 2.6 Prior year favorable catastrophe development - - - - 8.9 0.7 - 9.6 Current year catastrophe losses (74.8 ) (78.7 ) - (153.5 ) (42.5 ) (33.0 ) - (75.5 ) Underwriting profit (loss) (10.2 ) (20.3 ) (0.4 ) (30.9 ) 18.7 43.0 (0.3 ) 61.4 Net investment income 52.9 22.6 3.3 78.8 44.4 19.5 3.7 67.6 Fees and other income 4.0 2.6 1.0 7.6 3.8 3.5 1.8 9.1 Other operating expenses (4.3 ) (1.3 ) (2.9 ) (8.5 ) (4.6 ) (1.8 ) (3.3 ) (9.7 ) Operating income before
interest expense and income taxes
Commercial Lines Commercial Lines net premiums written were$826.8 million for the three months endedSeptember 30, 2021 , compared to$760.5 million for the three months endedSeptember 30, 2020 . This$66.3 million increase was primarily driven by pricing increases and a more robust business environment in 2021. Commercial Lines underwriting loss for the three months endedSeptember 30, 2021 was$10.2 million , compared to an$18.7 million profit for the three months endedSeptember 30, 2020 , a decrease of$28.9 million . Catastrophe losses for the three months endedSeptember 30, 2021 were$74.8 million , compared to$33.6 million for the three months endedSeptember 30, 2020 , an increase of$41.2 million . The higher catastrophe losses in 2021 were primarily due to Hurricane Ida and wind and hailstorms in the Midwest. Net favorable development on prior year's loss reserves for the three months endedSeptember 30, 2021 was$11.4 million , compared to$3.9 million for the three months endedSeptember 30, 2020 , an increase of$7.5 million . Commercial Lines current accident year underwriting profit, excluding catastrophes, was$53.2 million for the three months endedSeptember 30, 2021 , compared to$48.4 million for the three months endedSeptember 30, 2020 . This$4.8 million increase was primarily driven by earned premium growth. Within non-catastrophe current accident year losses, higher large property loss activity in our commercial multiple peril line was partially offset by lower loss activity in our inland marine and surety lines. 30
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We continue to manage underwriting performance through rate actions, 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 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 reduction in business activity and reduced premium levels.
Personal Lines
Personal Lines net premiums written were$548.4 million for the three months endedSeptember 30, 2021 , compared to$508.0 million for the three months endedSeptember 30, 2020 . The premium growth of$40.4 million was primarily driven by increased new business, retention and, to a lesser extent, renewal rate increases. Net premiums written in the personal automobile line of business for the three months endedSeptember 30, 2021 were$330.8 million , compared to$311.6 million for the three months endedSeptember 30, 2020 , an increase of$19.2 million . Personal automobile policies in force increased by 2.8%. Net premiums written in the homeowners line of business for the three months endedSeptember 30, 2021 were$196.7 million , compared to$179.7 million for the three months endedSeptember 30, 2020 , an increase of$17.0 million . Homeowners policies in force increased by 3.4%. Personal Lines underwriting loss for the three months endedSeptember 30, 2021 was$20.3 million , compared to$43.0 million profit for the three months endedSeptember 30, 2020 , a decrease of$63.3 million . Catastrophe losses for the three months endedSeptember 30, 2021 were$78.7 million , compared to$32.3 million for the three months endedSeptember 30, 2020 , an increase of$46.4 million . The higher catastrophe losses in 2021 were primarily due to Hurricane Ida and several wind and hailstorms throughout the Midwest. Net favorable development on prior year's loss reserves for the three months endedSeptember 30, 2021 was$9.9 million , compared to$1.0 million unfavorable development for the three months endedSeptember 30, 2020 , a favorable change of$10.9 million . Personal Lines current accident year underwriting profit, excluding catastrophes, was$48.5 million for the three months endedSeptember 30, 2021 , compared to$76.3 million for the three months endedSeptember 30, 2020 . This$27.8 million decrease was primarily due to higher current accident year losses in our personal automobile line due to fewer accidents and decreased claim activity in 2020 resulting from changes in driving patterns as a result of the Pandemic. Additionally, the personal automobile current accident year losses reflected an increase in property severity associated with supply chain issues and limited availability of new vehicles due to chip shortage, higher used vehicle prices and higher cost of parts. We have been able to obtain rate increases in our Personal Lines markets and believe that our ability to obtain increases will continue over the long-term. Our ability to maintain Personal Lines net premiums written may be affected, however, by price competition, and regulatory and legal activity and developments. See "Contingencies and Regulatory Matters." Additionally, these factors along with weather-related loss volatility may also affect our ability to maintain and improve underwriting results. We monitor these trends and consider them in our rate actions. Due to uncertainty caused by the Pandemic, there is a level of uncertainty in our ability to retain or grow our business, and maintain or improve our underwriting profitability in this environment.
Other
Our Other segment had operating income of
ended
Nine Months Ended
2020
Operating income before interest expense and income taxes was$269.4 million for the nine months endedSeptember 30, 2021 , compared to$334.4 million for the nine months endedSeptember 30, 2020 , a decrease of$65.0 million . This decrease was primarily due to higher catastrophe losses and higher Personal Lines non-catastrophe losses, partially offset by higher net investment income, earned premium growth, and net favorable development on prior years' loss reserves. The higher Personal Lines non-catastrophe losses was primarily due to higher personal automobile losses due to fewer accidents and decreased claim activity in 2020 resulting from changes in driving patterns as a result of the Pandemic. Net premiums written increased by$292.1 million for the nine months endedSeptember 30, 2021 , compared to the nine months endedSeptember 30, 2020 . This was primarily due to pricing increases, a reduction in insured business activity in 2020, and the aforementioned 2020 premium refund. 31
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Production and Underwriting Results
The following tables summarize premiums written on a gross and net basis, net
premiums earned and loss (including catastrophe losses), LAE, expense and
combined ratios for the Commercial Lines and Personal Lines segments. Loss, LAE,
catastrophe loss and combined ratios shown below include prior year reserve
development. These items are not meaningful for our Other segment.
Nine
Months Ended
Gross Net Net
Premiums Premiums Premiums
Catastrophe Loss & LAE Expense Combined
(dollars in millions)
Written Written Earned Loss Ratios Ratios Ratios Ratios Commercial Lines$ 2,618.0 $ 2,271.0 $ 2,094.9 10.1 66.3 33.7 100.0 Personal Lines 1,555.6 1,507.5 1,432.7 10.6 68.4 27.8 96.2 Total$ 4,173.6 $ 3,778.5 $ 3,527.6 10.3 67.2 31.3 98.5 Nine
Months Ended
Gross Net Net
Premiums Premiums Premiums
Catastrophe Loss & LAE Expense Combined
(dollars in millions)
Written Written Earned Loss Ratios Ratios Ratios Ratios Commercial Lines$ 2,441.6 $ 2,083.0 $ 1,999.6 6.1 62.9 34.3 97.2 Personal Lines 1,477.4 1,403.4 1,373.8 9.4 64.6 27.4 92.0 Total$ 3,919.0 $ 3,486.4 $ 3,373.4 7.5 63.7 31.5 95.2
The following table summarizes net premiums written, and loss and LAE and
catastrophe loss ratios by line of business for the Commercial Lines and
Personal Lines segments. Loss and LAE and catastrophe loss ratios include prior
year reserve development.
Nine Months Ended September 30,
2021 2020
Net Net
Premiums Loss & LAE Catastrophe Premiums Loss & LAE Catastrophe
(dollars in millions) Written Ratios Loss Ratios Written Ratios Loss Ratios
Commercial Lines:
Commercial multiple peril $ 756.1 81.7 22.4 $ 712.6 72.1 12.0
Commercial automobile 269.8 63.0 0.2 256.4 68.3 0.6
Workers' compensation 269.3 54.4 - 241.1 50.1 -
Other commercial 975.8 58.3 6.0 872.9 57.4 4.7
Total Commercial Lines $ 2,271.0 66.3 10.1 $ 2,083.0 62.9 6.1
Personal Lines:
Personal automobile $ 930.1 63.4 1.9 $ 867.8 60.9 1.2
Homeowners 522.2 79.6 27.0 491.0 74.1 24.6
Other personal 55.2 44.7 2.7 44.6 29.4 2.7
Total Personal Lines $ 1,507.5 68.4 10.6 $ 1,403.4 64.6 9.4
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The following table summarizes GAAP underwriting results for the Commercial
Lines, Personal Lines and Other segments and reconciles them to operating income
(loss) before interest expense and income taxes.
Nine Months Ended
2021 2020
Commercial Personal Commercial Personal
(in millions) Lines Lines Other Total Lines Lines Other Total
Underwriting profit (loss),
excluding prior year reserve
development and catastrophes
$ 363.3 $ 159.9 $ 233.2 $ (0.1 ) $ 393.0 Prior year favorable (unfavorable) loss and LAE reserve development on non-catastrophe losses 22.6 20.1 (1.0 ) 41.7 12.7 0.7 (3.9 ) 9.5 Prior year favorable (unfavorable) catastrophe development 12.0 3.0 - 15.0 18.2 (1.6 ) - 16.6
Current year catastrophe losses (223.8 ) (154.8 ) -
(378.6 ) (140.4 ) (127.8 ) - (268.2 )
Underwriting profit (loss)
(5.7 ) 48.1 (1.0 ) 41.4 50.4 104.5 (4.0 ) 150.9 Net investment income 155.7 66.5 9.0 231.2 128.7 56.3 9.9 194.9 Fees and other income 11.2 7.1 3.4 21.7 8.6 8.0 5.6 22.2 Other operating expenses (12.2 ) (4.1 ) (8.6 )
(24.9 ) (15.5 ) (7.1 ) (11.0 ) (33.6 )
Operating income before
interest expense and income taxes$ 149.0 $ 117.6 $ 2.8
Commercial Lines
Commercial Lines net premiums written were$2,271.0 million for the nine months endedSeptember 30, 2021 , compared to$2,083.0 million for the nine months endedSeptember 30, 2020 . This$188.0 million increase was primarily driven by pricing increases and a reduction in insured business activity in 2020 as a result of the Pandemic. Commercial Lines underwriting loss for the nine months endedSeptember 30, 2021 was$5.7 million , compared to$50.4 million profit for the nine months endedSeptember 30, 2020 , a decrease of$56.1 million . Catastrophe losses for the nine months endedSeptember 30, 2021 were$211.8 million , compared to$122.2 million for the nine months endedSeptember 30, 2020 . The$89.6 million increase was primarily due to freeze events inTexas and surrounding states associated with record low temperatures in the first quarter and Hurricane Ida and several wind and hailstorms in the Midwest in the third quarter. Favorable development on prior years' loss reserves for the nine months endedSeptember 30, 2021 was$22.6 million , compared to$12.7 million for the nine months endedSeptember 30, 2020 , an increase of$9.9 million . Commercial Lines current accident year underwriting profit, excluding catastrophes, was$183.5 million for the nine months endedSeptember 30, 2021 , compared to$159.9 million for the nine months endedSeptember 30, 2020 , an increase of$23.6 million , primarily due to earned premium growth. Within non-catastrophe current accident year losses, higher large property loss activity in our specialty and commercial multiple peril lines were partially offset by lower loss activity in our inland marine, miscellaneous property, commercial automobile and surety lines.
Personal Lines
Personal Lines net premiums written were$1,507.5 million for the nine months endedSeptember 30, 2021 , compared to$1,403.4 million for the nine months endedSeptember 30, 2020 , an increase of$104.1 million . During the second quarter of 2020, we returned approximately$30 million of automobile premiums to our eligible Personal Lines customers in all our markets, providing financial relief during the Pandemic. In addition, 2021 net premiums written grew due to increased new business, retention and, to a lesser extent, renewal rate increases. Personal Lines underwriting profit for the nine months endedSeptember 30, 2021 was$48.1 million , compared to$104.5 million for the nine months endedSeptember 30, 2020 , a decrease of$56.4 million . Catastrophe losses for the nine months endedSeptember 30, 2021 were$151.8 million , compared to$126.2 million for the nine months endedSeptember 30, 2020 . The increase of$25.6 million was primarily due to several wind and hailstorms throughout the Midwest and Hurricane Ida during the third quarter. Favorable development on prior years' loss reserves for the nine months endedSeptember 30, 2021 was$20.1 million , compared to$0.7 million for the nine months endedSeptember 30, 2020 , an increase of$19.4 million . 33
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Personal Lines current accident year underwriting profit, excluding catastrophes, was$179.8 million for the nine months endedSeptember 30, 2021 , compared to$233.2 million for the nine months endedSeptember 30, 2020 . This$53.4 million decrease was primarily due to higher current accident year losses and higher expenses, primarily due to a 2020 non-recurring premium tax benefit, partially offset by earned premium growth. The higher current accident year losses were primarily due to fewer accidents and decreased claim activity for the personal automobile line in 2020 resulting from changes in driving patterns as a result of the Pandemic and increased weather-related losses in the homeowners line in 2021.
Other
Our Other segment had operating income of$2.8 million for the nine months endedSeptember 30, 2021 , compared to$0.5 million for the nine months endedSeptember 30, 2020 , an increase of$2.3 million . This increase was primarily due to prior year's results including a$3.3 million reserve increase, based on the receipt of an updated third-party actuarial study for the legacyExcess and Casualty Reinsurance Association ("ECRA") pool.
Reserve for Losses and Loss Adjustment Expenses
The table below provides a reconciliation of the gross beginning and ending
reserve for unpaid losses and loss adjustment expenses.
Nine Months Ended
September 30,
(in millions) 2021 2020
Gross reserve for losses and LAE, beginning of period
5,654.4
Reinsurance recoverable on unpaid losses 1,641.6
1,574.8
Net reserve for losses and LAE, beginning of period 4,382.4
4,079.6
Net incurred losses and LAE in respect of losses occurring in: Current year 2,427.1
2,176.0
Prior year non-catastrophe loss development (41.7 ) (9.5 ) Prior year catastrophe development (15.0 ) (16.6 ) Total incurred losses and LAE 2,370.4
2,149.9
Net payments of losses and LAE in respect of losses occurring in: Current year 981.0 863.5 Prior years 1,036.5 1,028.7 Total payments 2,017.5 1,892.2 Net reserve for losses and LAE, end of period 4,735.3
4,337.3
Reinsurance recoverable on unpaid losses 1,804.8
1,608.4
Gross reserve for losses and LAE, end of period
5,945.7
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The table below summarizes the gross reserve for losses and LAE by line of
business.
September 30, December 31,
(in millions) 2021 2020
Commercial multiple peril $ 1,377.5 $ 1,211.0
Workers' compensation 723.4 699.4
Commercial automobile 480.6 454.8
Other commercial lines:
Hanover Programs 595.9 565.3
Management and professional liability 379.2 340.8
Monoline general liability 299.4 280.3
Umbrella 258.5 230.2
Specialty industrial and commercial property 178.8 76.9
Surety 102.4 94.0
Marine 98.2 93.6
Other lines 27.4 29.5
Total other commercial lines 1,939.8 1,710.6
Total Commercial Lines 4,521.3 4,075.8
Personal automobile 1,689.4 1,670.3
Homeowners and other personal 289.2 237.5
Total Personal Lines 1,978.6 1,907.8
Total Other Segment 40.2 40.4
Total loss and LAE reserves $ 6,540.1 $ 6,024.0
"Other commercial lines - Other lines" in the table above is primarily comprised
of fidelity and crime lines of business. Loss and LAE reserves in our "Total
Other Segment" relate to our run-off voluntary assumed property and casualty
reinsurance pools business.
The following table summarizes prior year (favorable) unfavorable development
for the periods indicated:
Nine Months Ended September 30,
2021 2020
(in millions) Loss & LAE Catastrophe Total Loss & LAE Catastrophe Total
Commercial Lines $ (22.6 ) $ (12.0 ) $ (34.6 ) $ (12.7 ) $ (18.2 ) $ (30.9 )
Personal Lines (20.1 ) (3.0 ) (23.1 ) (0.7 ) 1.6 0.9
Other Segment 1.0 - 1.0 3.9 - 3.9
Total prior year favorable
development $ (41.7 ) $ (15.0 ) $ (56.7 ) $ (9.5 ) $ (16.6 ) $ (26.1 )
It is not possible to know whether the factors that affected loss reserves in
the first nine months of 2021 will also occur in future periods. We encourage
you to read our 2020 Annual Report on Form 10-K for more information about our
reserving process and the judgments, uncertainties and risks associated
therewith.
For the nine months endedSeptember 30, 2021 and 2020, favorable catastrophe development was$15.0 and$16.6 million , respectively. The favorable catastrophe development during the nine months endedSeptember 30, 2021 was primarily due to lower than expected losses related to certain 2018 through 2020 hurricanes, tornadoes, and other storms. The favorable catastrophe development during the nine months endedSeptember 30, 2020 was primarily due to lower than expected losses related to certain 2017, 2018, and 2019 windstorms, winter storms and hurricanes and the 2017 and 2018 California wildfires.
2021 Loss and
For the nine months endedSeptember 30, 2021 , net favorable loss and LAE development, excluding catastrophes, was$41.7 million , primarily due to lower than expected losses in the personal automobile line of$19.1 million , driven by lower personal injury protection and bodily injury losses, primarily in accident year 2020, lower than expected losses in the workers' compensation line of$13.1 million , primarily in accident years 2014 through 2019, and lower than expected losses in other commercial lines. Within other commercial lines, lower than expected losses in our commercial miscellaneous property, marine, surety, and specialty industrial property lines were partially offset by higher than expected losses in our general liability lines. 35
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2020 Loss and
For the nine months endedSeptember 30, 2020 , net favorable loss and LAE development, excluding catastrophes, was$9.5 million . Lower than expected losses in the workers' compensation line of$25.6 million in accident years 2016 through 2019 and other commercial lines of$11.1 million were partially offset by higher than expected losses in the commercial multiple peril line of$13.3 million , in accident years 2016, 2017 and 2019, and the commercial automobile line of$10.7 million , driven by higher bodily injury and personal injury protection losses, primarily in accident years 2017 through 2019. Within other commercial lines, lower than expected losses in our marine line of$13.1 million , in accident years 2017 through 2019, and specialty industrial property and commercial miscellaneous property lines were partially offset by higher than expected losses in the general liability lines. The adverse prior year development for our Other Segment was due to our run-off voluntary assumed property and casualty reinsurance pools business primarily based on an updated third-party actuarial study received in the first quarter of 2020 for the legacyExcess and Casualty Reinsurance Association ("ECRA") pool that consists of asbestos and environmental exposures.
Reinsurance Recoverables
Reinsurance recoverables were$2,002.8 million and$1,874.3 million atSeptember 30, 2021 andDecember 31, 2020 , respectively, of which$84.1 million and$88.4 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 theMichigan Catastrophic Claims Association (the "MCCA") were$45.3 million and$35.5 million atSeptember 30, 2021 andDecember 31, 2020 , respectively, and billed non-MCCA reinsurance recoverables totaled$38.8 million and$52.9 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. AtSeptember 30, 2021 ,$1.1 million of the billed non-MCCA recoverables were outstanding greater than 90 days, whereas atDecember 31, 2020 , there were no balances outstanding greater than 90 days.
Investments
Investment Results
Net investment income before income taxes was as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in millions) 2021 2020 2021 2020
Fixed maturities $ 54.2 $ 55.3 $ 162.6 $ 167.7
Limited partnerships 18.9 6.0 49.5 8.0
Mortgage loans 4.0 4.5 13.6 13.1
Equity securities 3.7 3.4 11.3 10.8
Other investments 0.7 0.7 2.3 2.4
Investment expenses (2.7 ) (2.3 ) (8.1 ) (7.1 )
Net investment income $ 78.8 $ 67.6 $ 231.2 $ 194.9
Earned yield, fixed maturities 2.96 % 3.26 % 3.03 % 3.38 %
Earned yield, total portfolio 3.72 % 3.37 % 3.70 % 3.32 %
The increase in net investment income for the three months and nine months ended
September 30, 2021 was primarily due to higher limited partnership income and,
to a lesser degree, the continued investment of operational cash flows,
partially offset by the impact of lower new money yields. Higher income from our
limited partnerships primarily reflects increased market valuation due to
positive valuation changes in the funds' equity holdings. In addition, limited
partnership results for the nine months ended September 30, 2020 include low
valuations, particularly in the second quarter, due to Pandemic-related business
and financial market disruptions. Income from partnerships can vary
significantly from period to period and neither the elevated results during
2021, nor the weak results in 2020, reflect expected returns for this asset
class. We expect average fixed income yields to continue to decline as new money
rates remain lower than our embedded book yield.
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Investment Portfolio
We held cash and investment assets diversified across several asset classes, as
follows:
September 30, 2021 December 31, 2020
Carrying % of Total Carrying % of Total
(dollars in millions) Value Carrying Value Value Carrying Value
Fixed maturities, at fair value $ 7,699.2 83.0 % $ 7,454.4 83.2 %
Equity securities, at fair value 615.5 6.6 598.5 6.7
Mortgage and other loans 448.1 4.8 467.6 5.2
Other investments 340.2 3.7 325.6 3.6
Cash and cash equivalents 171.2 1.9 120.6 1.3
Total cash and investments $ 9,274.2 100.0 % $ 8,966.7 100.0 %
Cash and Investments
Total cash and investments increased $307.5 million , or 3.4%, for the nine
months ended September 30, 2021 as compared to December 31, 2020 . This increase
was primarily due to the continued investment of operational cash flows,
partially offset by the funding of financing activities, including our stock
repurchases and dividend payments, and by net market value depreciation.
The following table provides information about the investment types of our fixed
maturities portfolio:
September 30, 2021
Amortized Cost, Net of Change in Net
(in millions) Allowance for Credit Net Unrealized Unrealized
Investment Type Losses Fair Value Gain For the Year
U.S. Treasury and government agencies $ 355.2 $ 358.7 $ 3.5 $ (12.1 )
Foreign government 2.2 2.6 0.4 (0.1 )
Municipals:
Taxable 1,076.2 1,109.6 33.4 (26.5 )
Tax-exempt 28.5 29.3 0.8 (0.9 )
Corporate 3,983.6 4,198.8 215.2 (126.2 )
Asset-backed:
Residential mortgage-backed 1,069.1 1,079.6 10.5 (22.0 )
Commercial mortgage-backed 784.0 817.1 33.1 (21.5 )
Asset-backed 101.6 103.5 1.9 (0.7 )
Total fixed maturities $ 7,400.4 $
7,699.2 $ 298.8
The decrease in net unrealized gains on fixed maturities was primarily due to
higher prevailing interest rates, partially offset by tighter credit spreads.
Amortized cost and fair value by rating category were as follows:
September 30, 2021 December 31, 2020
(dollars in millions) Rating Agency Amortized Cost, Net of Fair % of Total Amortized Cost, Net of Fair % of Total
NAIC Designation Equivalent Designation Allowance for Credit Losses Value Fair Value Allowance for Credit Losses Value Fair Value
1 Aaa/Aa/A $ 4,767.1 $ 4,937.4 64.1 % $ 4,590.6 $ 4,894.2 65.7 %
2 Baa 2,328.7 2,442.5 31.7 2,075.6 2,258.9 30.3
3 Ba 201.2 211.0 2.8 162.3 173.6 2.3
4 B 98.3 102.6 1.3 109.3 118.3 1.6
5 Caa and lower 5.1 5.7 0.1 7.3 7.7 0.1
6 In or near default - - - 0.5 1.7 -
Total fixed maturities $ 7,400.4 $ 7,699.2 100.0 % $ 6,945.6 $ 7,454.4 100.0 %
Based on ratings by the National Association of Insurance Commissioners
("NAIC"), approximately 96% of the fixed maturity portfolio consisted of
investment grade securities at September 30, 2021 and December 31, 2020 . The
quality of our fixed maturity portfolio remains strong based on ratings, capital
structure position, support through guarantees, underlying security, issuer
diversification and yield curve position.
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Our investment portfolio primarily consists of fixed maturity securities whose fair value is susceptible to market risk, including interest rate changes. See also "Quantitative and Qualitative Disclosures about Market Risk" included in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our 2020 Annual Report on Form 10-K. Duration is a measurement used to quantify our inherent interest rate risk and analyze invested assets relative to our reserve liabilities.
The duration of our fixed maturity portfolio was as follows:
September 30, 2021 December 31, 2020
(dollars in millions) Amortized Cost, Net of % of Total Amortized Cost, Net of % of Total
Duration Allowance for Credit Losses Fair Value Fair Value Allowance for Credit Losses Fair Value Fair Value
0-2 years $ 1,078.9 $ 1,112.7 14.5 % $ 1,460.6 $ 1,510.5 20.3 %
2-4 years 1,644.1 1,750.1 22.7 1,738.4 1,872.5 25.1
4-6 years 2,072.7 2,194.3 28.5 1,570.0 1,734.0 23.3
6-8 years 1,226.7 1,269.8 16.5 1,016.6 1,134.0 15.2
8-10 years 1,179.5 1,168.7 15.2 812.2 837.8 11.2
10+ years 198.5 203.6 2.6 347.8 365.6 4.9
Total fixed maturities $ 7,400.4 $ 7,699.2 100.0 % $ 6,945.6 $ 7,454.4 100.0 %
Weighted average duration 5.0 4.8
Our fixed maturity and equity securities are carried at fair value. Financial
instruments whose value was determined using significant management judgment or
estimation constituted less than 1% of the total assets we measured at fair
value. See also Note 4 - "Fair Value" in the Notes to Interim Consolidated
Financial Statements.
Equity securities primarily consist of
common stocks and developed market equity index exchange-traded funds.
Mortgage and other loans consist primarily of commercial mortgage loan participations which represent our interest in commercial mortgage loans originated by a third party. We share, on a pro-rata basis, in all related cash flows of the underlying mortgage loans, which are primarily 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.
Impairments
For the three months endedSeptember 30, 2021 , we recognized net recoveries of$0.1 million , consisting of recoveries of$0.7 million of credit losses on mortgage loans, partially offset by$0.6 million of intend-to-sell impairments on corporate fixed maturities. For the nine months endedSeptember 30, 2021 , we recognized net impairments of$0.1 million , consisting of$0.8 million of impairments on corporate fixed maturities, partially offset by recoveries of$0.7 million of credit losses on mortgage loans. For the three months endedSeptember 30, 2020 , we recognized$0.8 million of impairments, consisting primarily of additional credit losses on mortgage loans, partially offset by recoveries of credit losses on fixed maturities. For the nine months endedSeptember 30, 2020 , we recognized$27.9 million of impairments, consisting primarily of$19.1 million on fixed maturities and$6.6 million on mortgage loans. Impairments on fixed maturities included$16.5 million categorized as intend-to-sell and$2.6 million of credit-related losses.
At
mortgage loans was
allowance for credit losses on available-for-sale debt securities was
million
AtSeptember 30, 2021 , we held no fixed maturities on non-accrual status. AtDecember 31, 2020 , the carrying values of fixed maturities on non-accrual status were not material. The effects of non-accruals for the nine months endedSeptember 30, 2021 and 2020, compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities, were also not material. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income.
Unrealized Losses
Gross unrealized losses on fixed maturities atSeptember 30, 2021 were$35.2 million , an increase of$31.9 million compared toDecember 31, 2020 , primarily attributable to higher interest rates, partially offset by tighter credit spreads. AtSeptember 30, 2021 , gross unrealized losses consisted primarily of$11.4 million on corporate fixed maturities,$7.7 million on residential mortgage-backed 38
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securities,
municipals. See Note 3 - "Investments" in the Notes to Interim Consolidated
Financial Statements.
We view gross unrealized losses on fixed maturities as non-credit related since it is our assessment that these securities will recover, allowing us to realize their anticipated long-term economic value. Further, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also "Liquidity and Capital Resources"). Inherent in our assessment are the risks that market factors may differ from our expectations; the global economic recovery following the Pandemic takes longer 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 atSeptember 30, 2021 andDecember 31, 2020 . 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. September 30, December 31, (in millions) 2021 2020 Due after one year through five years $ 0.1 $
-
Due after five years through ten years 13.3 0.5
Due after ten years 10.6 2.0
24.0 2.5
Mortgage-backed and asset-backed securities 11.2 0.8
Total fixed maturities $ 35.2 $ 3.3
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.
Positive economic growth in the U.S. continues as the vaccination roll-out has
reduced the spread and severity of COVID-19. Amid this progress and strong
policy support, indicators of economic activity and employment have
strengthened. The sectors most adversely affected by the Pandemic, such as
lodging and hospitality, have shown improvement, but remain below pre-Pandemic
levels of economic activity. Inflation has risen and overall financial
conditions remain accommodative, in part reflecting policy measures to support
the economy and the flow of credit to U.S. households and businesses.
Unemployment rates remain somewhat elevated and while the U.S. government and
its agencies have taken extraordinary measures to stabilize the economy through
fiscal and monetary policy actions, the recovery in the labor market has been
uneven. It is unclear how such actions and inflationary pressures will affect
the continued economic recovery and our investment portfolio.
If the economic recovery continues as expected, an adjustment to monetary policy
may be warranted as early as later this year, likely beginning with a moderation
in the Fed's pace of asset purchases. The Fed's asset purchase program
represents a significant source of demand for certain sectors of the fixed
income market and even a well-telegraphed, gradual winding down of the program
may result in market disruption. In addition, the Fed's most recent projections
released in September signaled the greatest likelihood to begin raising interest
rates would be in 2023, assuming forecasts for growth, unemployment and
inflation are achieved. Regarding fiscal policy in the U.S. , failure to reach a
long-term agreement to raise the federal borrowing limit could have negative
implications for certain issuers, sectors, or the economy at large.
Fundamental conditions in certain corporate sectors remain challenging, such as
the lodging and hospitality sectors, which still face lower than pre-Pandemic
levels of demand. 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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Net income also included the following items:
Three Months Ended September 30,
Commercial Personal Discontinued
(in millions) Lines Lines Other Operations Total
2021
Net realized and unrealized
investment gains $ 3.0 $ 0.8 $ 0.2 $ - $ 4.0
Discontinued life businesses - - - (0.8 ) (0.8 )
2020
Net realized and unrealized investment gains$ 25.3 $ 12.2 $ 0.2 $ -$ 37.7 Loss from repayment of debt - - (6.1 ) - (6.1 ) Discontinued life businesses - - - (0.6 ) (0.6 ) Nine Months Ended September 30, Commercial Personal Discontinued (in millions) Lines Lines Other Operations Total 2021 Net realized and unrealized investment gains (losses)$ 54.4 $ 22.8 $ (4.6 ) $ -$ 72.6 Discontinued life businesses - - - (2.0 ) (2.0 )
2020
Net realized and unrealized investment losses$ (40.1 ) $ (15.9 ) $ (4.2 ) $ -$ (60.2 ) Loss from repayment of debt - - (6.2 ) - (6.2 ) Discontinued life businesses - - - (2.0 ) (2.0 ) We manage investment assets for our Commercial Lines, Personal Lines and Other segments based on the requirements of our combined property and casualty insurance 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. Net realized and unrealized investment gains were$4.0 million for the three months endedSeptember 30, 2021 , compared to$37.7 million for the three months endedSeptember 30, 2020 . For the three months endedSeptember 30, 2021 and 2020, net realized and unrealized investment gains were primarily due to changes in the fair value of equity securities. Net realized and unrealized investment gains were$72.6 million for the nine months endedSeptember 30, 2021 , compared to$60.2 million of net realized and unrealized investment losses for the nine months endedSeptember 30, 2020 . For the nine months endedSeptember 30, 2021 , net realized and unrealized investment gains were primarily due to changes in the fair value of equity securities. For the nine months endedSeptember 30, 2020 , net realized and unrealized investment losses were primarily due to changes in the fair value of equity securities and, to a lesser extent, from impairment losses on investments. Discontinued operations include our discontinued accident and health and life businesses. Losses of$2.0 million for both the nine months endedSeptember 30, 2021 and 2020, primarily reflect adverse loss trends related to the long-term care pool. 40
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We file a consolidated
company and its domestic subsidiaries (including non-insurance operations).
Three Months Ended
30, 2020
The provision for income taxes from continuing operations was an expense of$7.7 million and$29.1 million for the three months endedSeptember 30, 2021 and 2020, respectively. These provisions resulted in consolidated effective federal tax rates of 18.1% and 19.6% for the three months endedSeptember 30, 2021 and 2020, respectively. These provisions reflect benefits related to tax planning strategies implemented in prior years of$0.8 million and$2.5 million in the three months endedSeptember 30, 2021 and 2020, respectively. In addition, these provisions also include excess tax benefits related to stock-based compensation of$0.8 million and$0.1 million for the three months endedSeptember 30, 2021 and 2020, respectively. Absent these items, the provision for income taxes would have been an expense of$9.3 million , or 21.9%, and$31.7 million , or 21.3%, for the three months endedSeptember 30, 2021 and 2020, respectively. The increase in 2021 is due to lower underwriting income. The income tax provision on operating income was an expense of$7.7 million and$25.1 million for the three months endedSeptember 30, 2021 and 2020, respectively. These provisions resulted in effective tax rates for operating income of 20.0% and 21.2% for the three months endedSeptember 30, 2021 and 2020, respectively. These provisions include excess tax benefits related to stock-based compensation of$0.8 million and$0.1 million for the three months endedSeptember 30, 2021 and 2020, respectively. Absent this item, the provisions for income taxes would have been an expense of$8.5 million , or 22.1%, and$25.2 million , or 21.2%, for the three months endedSeptember 30, 2021 and 2020, respectively. The increase in 2021 is due to lower underwriting income.
Nine Months Ended
2020
The provision for income taxes from continuing operations was an expense of$59.3 million and$41.7 million for the nine months endedSeptember 30, 2021 and 2020, respectively. These provisions resulted in consolidated effective federal tax rates of 18.7% and 17.5% for the nine months endedSeptember 30, 2021 and 2020, respectively. The provision for 2021 includes a net benefit related to prior years' federal tax credits of$1.7 million . In addition, these provisions reflect benefits related to tax planning strategies implemented in prior years of$3.7 million and$6.9 million for the nine months endedSeptember 30, 2021 and 2020, respectively. Finally, these provisions also include excess tax benefits related to stock-based compensation of$2.6 million and$2.0 million for the nine months endedSeptember 30, 2021 and 2020, respectively. Absent these items, the provision for income taxes would have been an expense of$67.3 million and$50.6 million for the nine months endedSeptember 30, 2021 and 2020, respectively, or 21.3% for both periods. The income tax provision on operating income was an expense of$47.7 million and$62.8 million for the nine months endedSeptember 30, 2021 and 2020, respectively. These provisions resulted in effective tax rates for operating income of 19.6% and 20.5% for the nine months endedSeptember 30, 2021 and 2020, respectively. The provision for 2021 includes a net benefit related to prior years' federal tax credits of$1.7 million . In addition, these provisions include excess tax benefits related to stock-based compensation of$2.6 million and$2.0 million for the nine months endedSeptember 30, 2021 and 2020, respectively. Absent these items, the provision for income taxes would have been an expense of$52.0 million , or 21.3%, and$64.8 million , or 21.2%, for the nine months endedSeptember 30, 2021 and 2020, respectively.
Critical Accounting Estimates
Interim consolidated financial statements have been prepared in conformity withU.S. GAAP and include certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. While we believe that the amounts included in our consolidated financial statements reflect our best judgment, the use of different assumptions could produce materially different accounting estimates. As disclosed in our 2020 Annual Report on Form 10-K, we believe the following accounting estimates are critical to our operations and require the most subjective and complex judgment: • Reserve for losses and loss expenses • Reinsurance recoverable balances • Pension benefit obligations • Investment credit losses • Deferred taxes
For a more detailed discussion of these critical accounting estimates, see our
2020 Annual Report on Form 10-K.
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Statutory Surplus of Insurance Subsidiaries
The following table reflects statutory surplus for our insurance subsidiaries:
September 30, December 31,
(in millions) 2021 2020
The statutory capital and surplus for our insurance subsidiaries decreased$40.1 million during the first nine months of 2021. This decrease was primarily due the payment of a$255 million dividend, primarily offset by an increase in underwriting profits and from net realized and unrealized investment gains, primarily due to changes in the fair value of equity securities. The NAIC prescribes an annual calculation regarding risk-based capital ("RBC"). RBC ratios for regulatory purposes are expressed as a percentage of the capital required to be above the Authorized Control Level (the "Regulatory Scale"); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios forHanover Insurance (which includes Citizens and other insurance subsidiaries), as ofSeptember 30, 2021 , expressed both on the Industry Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level): Company Authorized RBC Ratio RBC Ratio (dollars in millions) Action Level Control Level Industry Scale Regulatory Scale The Hanover Insurance Company$ 1,191.9 $ 596.0 213 % 426 %
Liquidity and Capital Resources
Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our insurance subsidiaries are subject to limitations imposed by regulators, such as prior notice periods and the requirement that dividends in excess of a specified percentage of statutory surplus or prior year's statutory earnings receive prior approval (so called "extraordinary dividends"). During the third quarter of 2021,Hanover Insurance paid$255.0 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$595.4 million during the first nine months of 2021, as compared to$546.6 million during the first nine months of 2020. The$48.8 million increase in cash provided was primarily due to an increase in premiums received, partially offset by an increase in loss payments. Net cash used in investing activities was$337.7 million during the first nine months of 2021, as compared to$480.3 million during the first nine months of 2020. During the first nine months of 2021 and 2020, cash used in investing activities primarily related to net purchases of fixed maturities. Net cash used in financing activities was$207.1 million during the first nine months of 2021, as compared to$50.5 million during the first nine months of 2020. During the first nine months of 2021, cash used in financing activities primarily resulted from the repurchase of common stock and, to a lesser extent, from three quarterly dividend payments to our shareholders. During the first nine months of 2020, cash used in financing activities primarily resulted from the repayment of debt, the repurchase of common stock and three quarterly dividend payments to shareholders, partially offset by net proceeds received from debt borrowings. Dividends to common shareholders are subject to quarterly board approval and declaration. During the first nine months of 2021, as declared by the Board, we paid three quarterly dividends, each for$0.70 per share, to our shareholders totaling approximately$75.6 million . We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them. AtSeptember 30, 2021 , THG, as a holding company, held approximately$371.7 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 our 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. 42
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We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan. The ultimate payment amounts for our benefit plan is based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes, both positive and negative, to our current funding status and ultimately our obligations in future periods are likely. Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. We believe that the quality of the assets we hold will allow us to realize the long-term economic value of our portfolio, including securities that are currently in an unrealized loss position. We do not anticipate the need to sell these securities to meet our insurance subsidiaries' cash requirements since we expect our insurance subsidiaries to generate sufficient operating cash to meet all short-term and long-term cash requirements relating to current operations. However, there can be no assurance that unforeseen business needs or other items 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$1.3 billion , including a$400 million increase to the program onMay 11, 2021 . Under the repurchase authorization, we may repurchase, from time to time, common stock in amounts, at prices and at such times as we deem appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. OnOctober 29, 2020 , pursuant to the terms of an accelerated share repurchase ("ASR") agreement (the "October 2020 ASR"), we paid$100.0 million in exchange for shares of our common stock. We received an initial share 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 theOctober 2020 ASR agreement. OnJanuary 29, 2021 , we received approximately 45,000 shares of our common stock as final settlement of shares repurchased under theOctober 2020 ASR. In addition to the shares repurchased under theOctober 2020 ASR, during the first nine months of 2021 we repurchased approximately 1.1 million shares at an aggregate cost of$142.6 million . As ofSeptember 30, 2021 , we had repurchased 7.5 million shares under this$1.3 billion program and had approximately$381 million available for additional repurchases. We maintain our membership in theFederal Home Loan Bank ("FHLB") to provide access to additional liquidity based on our holdings of FHLB stock and pledged collateral. AtSeptember 30, 2021 , we had borrowing capacity of$109.6 million . There were no outstanding borrowings under this short-term facility atSeptember 30, 2021 ; however, we have and may continue to borrow, from time to time, through this facility to provide short-term liquidity. OnApril 30, 2019 , we entered into a 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 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 and had no borrowings under this agreement during the first nine months of 2021. 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
credit agreements.
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Contingencies and Regulatory Matters
REGULATORY AND INDUSTRY DEVELOPMENTS
In response to the Pandemic, regulators in many of the states in which we operate have issued orders or guidance pertaining to, among other things, (a) premium refunds, credits or reductions for personal automobile insurance premiums and premiums for other insurance lines that regulators have determined are disproportionately impacted by the Pandemic, including certain commercial lines, for the periods during which governmental restrictions were or remain in effect, with premium adjustments based on factors such as the ongoing frequency and severity of claims, inflation, repair costs and reinsurance pricing, among others; (b) premium payment grace periods, moratoriums on policy non-renewals and cancellations, and other measures that are similar to actions historically implemented in regions heavily impacted by catastrophes, which we anticipate to be manageable, depending on the duration of the regulatory orders and the degree to which policyholder payment patterns vary as a result; and (c) a reassessment of rates in light of current exposures, loss experience and economic conditions. Regulatory restrictions on rate increases, underwriting, policy terms, and the ability to non-renew business may, depending on their duration, limit THG's ability to manage our mix of business and any potential exposures that emerge in our lines of business in the near term. Draft legislation has been proposed in several state legislatures and/or in theUnited States Congress that seeks to require insurers to retroactively pay unfunded Pandemic business interruption claims that insurance policies do not currently cover, to impose presumptions on insurance policy interpretation, and/or to mandate prospective pandemic coverage. The impact of such legislation, were it to be adopted, would, according to a statement of the NAIC onMarch 25, 2020 , "create substantial solvency risks" for the property and casualty insurance sector, "significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing." Industry trade groups further assert that any such legislation would be violative of basic contract law and well-founded principles of constitutional law. Federal stimulus plans such as the CARES Act and the American Rescue Plan Act of 2021 providing financial support to individuals and businesses during the Pandemic may mitigate the political pressure to continue advancing such proposed legislation. Proposals are also being considered at the federal level to establish government-funded pandemic insurance programs, possibly similar to the federal terrorism risk insurance program. Discussion on such competing proposals is ongoing and at a preliminary stage such that it is too early to estimate their potential impact, if any, on our business.
Information regarding litigation, legal contingencies and regulatory matters
appears in Part I - Note 12 "Commitments and Contingencies" in the Notes to
Interim Consolidated Financial Statements.
Risks and Forward-Looking Statements
Information regarding risk factors and forward-looking information appears in
Part II - Item 1A of this Quarterly Report on Form 10-Q and in Part I - Item 1A
of our 2020 Annual Report on Form 10-K. This Management's Discussion and
Analysis should be read and interpreted in light of such factors.
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ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Our market risks, the ways we manage them, and sensitivity to changes in
interest rates, and equity price risk are summarized in Management's Discussion
and Analysis of Financial Condition and Results of Operations as of December 31,
2020 , included in our Annual Report on Form 10-K for the year ended December 31,
2020 . There have been no material changes in the first nine months of 2021 to
these risks or our management of them.
ITEM 4
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures Evaluation
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our "disclosure controls and procedures," as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Limitations on the Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Based on our controls evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in theSEC's rules and forms and (ii) material information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate "internal control over financial reporting," as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting, as required by Rule 13a-15(d) of the Exchange Act, to determine whether any changes occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on the that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that there were no such changes during the quarter endedSeptember 30, 2021 , that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 45
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