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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
Introduction 24
Executive Overview 24
Description of Operating Segments 25
Results of Operations - Consolidated 25
Results of Operations - Segments 27
Investments 35
Other Items 38
Income Taxes 39
Critical Accounting Estimates 40
Statutory Surplus of Insurance Subsidiaries 40
Liquidity and Capital Resources 40
Contingencies and Regulatory Matters 42
Risks and Forward - Looking Statements 42
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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 25, 2022 . 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 primarily of our former accident and health and life insurance businesses.
Executive Overview
Business operations consist of four operating segments: Core Commercial,
Specialty, Personal Lines and Other.
Our strategy, which focuses on the independent agency distribution channel, supports THG's commitment to our select independent agents. 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 that meet the needs of our customers. Our goal is to grow responsibly in all of our businesses, while managing volatility. During the six months endedJune 30, 2022 , our net income was$127.4 million , compared to$221.2 million for the six months endedJune 30, 2021 , a decrease of$93.8 million , primarily due to changes in the fair value of equity securities, partially offset by higher 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 six months endedJune 30, 2022 , compared to$222.4 million for the six months endedJune 30, 2021 , an increase of$47.0 million . This increase was primarily due to lower catastrophe losses and earned premium growth, partially offset by higher current accident year losses. The higher current accident year losses were primarily due to higher severity in our personal automobile line, as a result of inflation and supply chain disruptions. Pre-tax catastrophe losses were$122.9 million for the six months endedJune 30, 2022 , compared to$210.1 million during the same period of 2021, a decrease of$87.2 million . The higher level of catastrophe losses in 2021 was primarily due to freeze events inTexas and surrounding states. Net favorable development on prior years' loss reserves was$15.2 million for the six months endedJune 30, 2022 , compared to$20.8 million for the six months endedJune 30, 2021 , a decrease of$5.6 million . Due to persistent supply chain disruptions emerging from the COVID-19 pandemic ("Pandemic"), and significant inflation in theU.S economy, among other factors outside our control, we are experiencing higher claims costs, particularly in our automobile and homeowners lines of business. Additionally, several other Pandemic uncertainties persist, including the pace and effectiveness of return to workplace initiatives across the economy, the emergence of virus variants, non-traditional driving patterns and court caseload backlogs. We continue to believe that the effect of these uncertainties on our near-term results should be manageable. However, they 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).
Core Commercial
Core Commercial entails two distinct businesses, small commercial and middle market, both of which focus on account business, including commercial multiple peril, commercial automobile, workers' compensation and other (general liability, ancillary professional, commercial umbrella, and monoline property). Small commercial focuses on small businesses, with annual policy premiums generally up to$50,000 . Small commercial recently launched TAP sales, a quoting platform, that generated approximately a 20% increase in new business submissions during the quarter, enhancing the ease of doing business. Middle market provides coverage to mid-sized businesses with annual policy premiums generally between$50,000 and$500,000 . Middle market offers coverage in distinct industry segments, including technology, manufacturing, human services, retail, real estate, and others. We believe that our account-focused approach to the small commercial market and distinctiveness in the middle market 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 relationships with retail agents, enhanced franchise value through selective distribution, distinctive products and coverages, and through continued investment in industry segmentation. Net premiums written increased 8.7% in the first six months of 2022, compared to the same period in 2021, primarily driven by pricing and exposure increases and continued strong retention. Underwriting results increased in the first six months of 2022, primarily due to lower catastrophe losses. The competitive nature of the Core Commercial 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. 24
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Specialty
Specialty offers a competitive set of products that is focused predominately on
small to mid-sized businesses. This includes numerous specialized product areas
that are organized into four distinct divisions - Professional and Executive
Lines, Specialty Property and Casualty ("Specialty P&C"), Marine, and Surety and
Other. We believe that this distribution of Specialty products, primarily with
retail agents supplemented by select specialists, serves as a complement to our
Core Commercial business and helps to enhance our overall agent value and
increase growth opportunities. Net premiums written increased 11.7% in the first
six months of 2022, compared to the same period in 2021, primarily due to
pricing increases.
Underwriting results increased in the first six months of 2022, primarily due to
lower catastrophe losses, lower current accident year losses, higher favorable
development of prior years' loss reserves, and earned premium growth. The
competitive nature of the Specialty 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 working with high quality, value-oriented agencies that deliver consultative selling to customers and stress the importance of account rounding, which is the conversion of single policy customers to accounts with multiple policies and/or additional coverages, to address customers' broader objectives. Approximately 87% 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 10.4% in the first six months of 2022, compared to the same period in 2021, primarily due to increased new business production and improved retention. Underwriting results decreased in the first six months of 2022, primarily due to higher current accident year personal automobile and homeowners losses.
Description of Operating Segments
Primary business operations include insurance products and services currently provided through four operating segments: Core Commercial, Specialty, Personal Lines and Other. Core Commercial includes commercial multiple peril, commercial automobile, workers' compensation, and other commercial lines coverages provided to small and mid-sized businesses. Specialty includes four divisions of business: Professional and Executive Lines, Specialty P&C, Marine, and Surety and Other. Specialty P&C includes coverages such as program business (provides commercial insurance to markets with specialized coverage or risk management needs related to groups of similar businesses), specialty industrial and commercial property, and excess and surplus lines. 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 our run-off voluntary assumed property and casualty pools and run-off direct asbestos and environmental businesses. During the first quarter of 2022, we disaggregated our former Commercial Lines segment into the aforementioned Core Commercial and Specialty segments. Prior periods reflect this new presentation. This presentation is 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 endedJune 30, 2022 was$22.6 million , compared to$128.5 million for the three months endedJune 30, 2021 , a decrease of$105.9 million . The decrease in consolidated net income was primarily due to after-tax net realized and unrealized investment losses of approximately$60.8 million in 2022 compared to after-tax net realized and unrealized investment gains of$25.6 million in 2021, primarily related to the change in the fair value of equity securities. Additionally, operating income before interest expense and income taxes decreased$22.3 million , primarily due to higher current accident year losses in our Personal Lines segment, partially offset by earned premium growth. Consolidated net income for the six months endedJune 30, 2022 was$127.4 million , compared to$221.2 million for the six months endedJune 30, 2021 , a decrease of$93.8 million . The decrease in consolidated net income was primarily due to after-tax net realized and unrealized investment losses of approximately$73.2 million in 2022 compared to after-tax net realized and unrealized investment gains of$57.0 million in 2021, primarily related to the change in the fair value of equity securities. This was partially offset by operating income before interest expense and income taxes which increased$47.0 million for the six months endedJune 30, 2022 , primarily due to lower catastrophe losses and earned premium growth, partially offset by higher current accident year losses in our Personal Lines segment. 25
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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 Six Months Ended
June 30, June 30,
(in millions) 2022 2021 2022 2021
Operating income before interest
expense and income taxes:
Core Commercial $ 66.9 $ 69.9 $ 134.4 $ 55.1
Specialty 45.2 34.5 95.2 51.5
Personal Lines 2.8 32.2 39.1 114.0
Other 0.1 0.7 0.7 1.8
Operating income before interest
expense and income taxes 115.0 137.3 269.4 222.4
Interest expense on debt (8.5 ) (8.5 ) (17.0 ) (17.0 )
Operating income before income taxes 106.5 128.8 252.4 205.4
Income tax expense on operating income (22.6 ) (24.8 )
(50.8 ) (40.0 ) Operating income 83.9 104.0 201.6 165.4 Non-operating items: Net realized and unrealized investment gains (losses) (77.9 ) 31.1 (93.8 ) 68.6 Other non-operating (0.4 ) - (0.4 ) - Income tax benefit (expense) on non-operating items 17.2 (5.5 ) 20.7 (11.6 ) Income from continuing operations, net of taxes 22.8 129.6 128.1 222.4 Discontinued operations (net of taxes): Loss from discontinued life businesses (0.2 ) (1.1 ) (0.7 ) (1.2 ) Net income$ 22.6 $ 128.5 $ 127.4 $ 221.2 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 four operating segments based upon the pre-tax operating income 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 loss adjustment expenses ("LAE") reserve development. 26
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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 Six Months Ended
June 30, June 30,
(in millions) 2022 2021 2022 2021
Operating revenues
Net premiums written $ 1,332.8 $ 1,207.2 $ 2,645.1 $ 2,403.3
Net premiums earned $ 1,293.8 $ 1,179.8 $ 2,557.6 $ 2,341.6
Net investment income 70.5 75.6 147.4 152.4
Other income 6.5 5.8 12.4 11.8
Total operating revenues 1,370.8 1,261.2 2,717.4 2,505.8
Losses and operating expenses
Losses and LAE 845.5 745.1 1,633.0 1,526.4
Amortization of deferred acquisition
costs 269.3 244.2 532.2 484.5
Other operating expenses 141.0 134.6 282.8 272.5
Total losses and operating expenses 1,255.8 1,123.9 2,448.0 2,283.4
Operating income before interest
expense and income taxes $ 115.0 $ 137.3 $
269.4
Three Months Ended
Operating income before interest expense and income taxes was$115.0 million for the three months endedJune 30, 2022 , compared to$137.3 million for the three months endedJune 30, 2021 , a decrease of$22.3 million . This decrease was primarily due to higher Personal Lines current accident year losses, partially offset by earned premium growth. Net premiums written increased$125.6 million for the three months endedJune 30, 2022 , compared to the three months endedJune 30, 2021 , primarily due to rate and exposure increases and continued strong retention.
Production and Underwriting Results
The following tables summarize premiums written on a gross and net basis, net
premiums earned, and loss (including catastrophe losses) and LAE, expense, and
combined ratios for the Core Commercial, Specialty, and Personal Lines segments.
Loss and LAE, catastrophe loss, and combined ratios shown below include prior
year reserve development. These items are not meaningful for our Other segment.
Three Months Ended June 30, 2022
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Core Commercial $ 525.6 $ 454.2 $ 480.1 3.7 60.1 32.5 92.6
Specialty 354.6 302.3 293.5 2.2 54.1 35.3 89.4
Personal Lines 593.7 576.3 520.2 10.2 76.5 26.7 103.2
Total $ 1,473.9 $ 1,332.8 $ 1,293.8 6.0 65.4 30.8 96.2
Three Months
Ended
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Core Commercial $ 473.6 $ 421.7 $ 447.6 3.1 59.7 32.2 91.9
Specialty 332.1 265.1 255.8 1.7 57.4 34.9 92.3
Personal Lines 537.1 520.4 476.4 12.3 69.4 28.2 97.6
Total $ 1,342.8 $ 1,207.2 $ 1,179.8 6.5 63.2 31.2 94.4
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The following table summarizes
Commercial, Specialty, Personal Lines and Other segments and reconciles them to
operating income before interest expense and income taxes.
Three Months Ended June 30,
2022 2021
Personal Personal
(in millions) Core Commercial Specialty Lines Other Total Core Commercial Specialty Lines Other Total
Underwriting profit,
excluding prior year
reserve
development and
catastrophes $ 49.3 $ 35.7 $ 27.9 $ - $ 112.9 $ 44.3 $ 19.8 $ 63.1 $ - $ 127.2
Prior year favorable
(unfavorable) loss
and LAE reserve
development on
non-catastrophe
losses 2.8 1.2 5.2 - 9.2 4.6 3.3 5.0 (0.3 ) 12.6
Prior year favorable
(unfavorable)
catastrophe
development 10.9 3.1 (2.0 ) - 12.0 8.7 3.3 3.0 - 15.0
Current year
catastrophe
losses (28.7 ) (9.7 ) (51.0 ) - (89.4 ) (22.5 ) (7.7 ) (61.6 ) - (91.8 )
Underwriting profit
(loss) 34.3 30.3 (19.9 ) - 44.7 35.1 18.7 9.5 (0.3 ) 63.0
Net investment
income 32.6 14.8 20.6 2.5 70.5 35.0 16.0 21.8 2.8 75.6
Fees and other
income 0.9 1.5 3.4 0.7 6.5 0.8 1.7 2.2 1.1 5.8
Other operating
expenses (0.9 ) (1.4 ) (1.3 ) (3.1 ) (6.7 ) (1.0 ) (1.9 ) (1.3 ) (2.9 ) (7.1 )
Operating income
before interest
expense and
income taxes $ 66.9 $ 45.2 $ 2.8 $ 0.1 $ 115.0 $ 69.9 $ 34.5 $ 32.2 $ 0.7 $ 137.3
Core Commercial
Core Commercial net premiums written were $454.2 million for the three months
ended June 30, 2022 , compared to $421.7 million for the three months ended June
30, 2021 . This $32.5 million increase was primarily driven by pricing and
exposure increases and continued strong retention.
Core Commercial underwriting profit for the three months ended June 30, 2022 was
$34.3 million , compared to a $35.1 million for the three months ended June 30,
2021 , a decrease of $0.8 million . Catastrophe losses for the three months ended
June 30, 2022 were $17.8 million , compared to $13.8 million for the three months
ended June 30, 2021 , an increase of $4.0 million . Net favorable development on
prior year's loss reserves for the three months ended June 30, 2022 was $2.8
million , compared to $4.6 million for the three months ended June 30, 2021 , a
decrease of $1.8 million .
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Core Commercial current accident year underwriting profit, excluding
catastrophes, was
compared to
million
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 competitive pricing environment, particularly within the workers' compensation line. Due to uncertainty caused by the Pandemic and the increase in inflation, 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 these uncertainties are unknown and may result in an increase in claims costs and reduced premium levels.
Specialty
Specialty net premiums written were$302.3 million for the three months endedJune 30, 2022 , compared to$265.1 million for the three months endedJune 30, 2021 . This$37.2 million increase was primarily driven by improved retention and pricing, especially in our Professional and Executive lines, and improved pricing across substantially all other lines. Specialty underwriting profit for the three months endedJune 30, 2022 was$30.3 million , compared to$18.7 million for the three months endedJune 30, 2021 , an increase of$11.6 million . Catastrophe losses for the three months endedJune 30, 2022 were$6.6 million , compared to$4.4 million for the three months endedJune 30, 2021 , an increase of$2.2 million . Net favorable development on prior year's loss reserves for the three months endedJune 30, 2022 was$1.2 million , compared to$3.3 million for the three months endedJune 30, 2021 , a decrease of$2.1 million . Specialty current accident year underwriting profit, excluding catastrophes, was$35.7 million for the three months endedJune 30, 2022 , compared to$19.8 million for the three months endedJune 30, 2021 . This$15.9 million increase was primarily driven by lower current accident year losses, primarily in our specialty industrial and surety lines. 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 competitive pricing environment. Due to uncertainty caused by the Pandemic and the increase in inflation, 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 these uncertainties are unknown and may result in an increase in claims costs and reduced premium levels. Personal Lines Personal Lines net premiums written were$576.3 million for the three months endedJune 30, 2022 , compared to$520.4 million for the three months endedJune 30, 2021 . This$55.9 million increase was primarily driven by increased retention and new business. Net premiums written in the personal automobile line of business for the three months endedJune 30, 2022 were$340.2 million , compared to$318.6 million for the three months endedJune 30, 2021 , an increase of$21.6 million . Personal automobile policies in force increased by 8.0%. Net premiums written in the homeowners and other lines of business for the three months endedJune 30, 2022 were$236.1 million , compared to$201.8 million for the three months endedJune 30, 2021 , an increase of$34.3 million . Homeowners policies in force increased by 7.6%. Personal Lines underwriting loss for the three months endedJune 30, 2022 was$19.9 million , compared to an underwriting profit of$9.5 million for the three months endedJune 30, 2021 , a decrease of$29.4 million . Catastrophe losses for the three months endedJune 30, 2022 were$53.0 million , compared to$58.6 million for the three months endedJune 30, 2021 , a decrease of$5.6 million . Net favorable development on prior year's loss reserves for the three months endedJune 30, 2022 was$5.2 million , compared to$5.0 million for the three months endedJune 30, 2021 . Personal Lines current accident year underwriting profit, excluding catastrophes, was$27.9 million for the three months endedJune 30, 2022 , compared to$63.1 million for the three months endedJune 30, 2021 . This$35.2 million decrease was primarily due to higher current accident year personal automobile and homeowners losses, partially offset by lower performance-based agency compensation expenses. We experienced an increase in personal automobile physical damage and property loss frequency from the unusually low levels of 2021, as well as an increase in loss severity, driven by inflationary pressures associated with supply chain issues, higher used vehicle prices, and higher cost of parts. In addition, we experienced an increase in homeowners property severity due to higher than usual large loss activity and non-catastrophe weather, as well as higher inflation. 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 29
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consider them in our rate actions. Due to uncertainty caused by the Pandemic and the increase in inflation, there is a level of uncertainty in our ability to retain or grow our business, and may result in an increase in claims costs.
Other
Our Other segment had operating income of
ended
30, 2021
Six Months Ended
Operating income before interest expense and income taxes was$269.4 million for the six months endedJune 30, 2022 , compared to$222.4 million for the six months endedJune 30, 2021 , an increase of$47.0 million . This increase was primarily due to lower catastrophe losses and earned premium growth, partially offset by higher current accident year losses. The higher current accident year losses were primarily due to higher severity in our personal automobile line, as a result of inflation and supply chain disruptions. Net premiums written increased by$241.8 million for the six months endedJune 30, 2022 , compared to the six months endedJune 30, 2021 . This was primarily due to increased new business and retention.
Production and Underwriting Results
The following tables summarize premiums written on a gross and net basis, net
premiums earned, and loss (including catastrophe losses) and LAE, expense, and
combined ratios for the Core Commercial, Specialty, and Personal Lines segments.
Loss and LAE, catastrophe loss, and combined ratios shown below include prior
year reserve development. These items are not meaningful for our Other segment.
Six Months Ended June 30, 2022
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Core Commercial $ 1,117.5 $ 980.8 $ 954.8 3.9 60.2 32.7 92.9
Specialty 733.7 605.1 577.3 2.5 53.2 35.4 88.6
Personal Lines 1,092.8 1,059.2 1,025.5 6.9 73.3 26.9 100.2
Total $ 2,944.0 $ 2,645.1 $ 2,557.6 4.8 63.8 31.0 94.8
Six Months Ended June 30, 2021
Gross Net Net
Premiums Premiums Premiums Catastrophe Loss & LAE Expense Combined
(dollars in millions) Written Written Earned Loss Ratios Ratios Ratios Ratios
Core Commercial $ 1,013.5 $ 902.3 $ 882.8 12.3 69.1 32.6 101.7
Specialty 676.2 541.9 513.5 5.6 60.2 35.4 95.6
Personal Lines 990.7 959.1 945.3 7.7 64.2 28.1 92.3
Total $ 2,680.4 $ 2,403.3 $ 2,341.6 9.0 65.2 31.4 96.6
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The following table summarizes
Commercial, Specialty, Personal Lines and Other segments and reconciles them to
operating income before interest expense and income taxes.
Six Months Ended June 30,
2022 2021
Personal Personal
(in millions) Core Commercial Specialty Lines Other Total Core Commercial Specialty Lines Other Total
Underwriting
profit, excluding
prior year
reserve
development
and catastrophes $ 94.8 $ 64.0 $ 72.0 $ - $ 230.8 $ 84.7 $ 45.6 $ 131.3 $ - $ 261.6
Prior year
favorable
(unfavorable)
loss and
LAE reserve
development on
non-catastrophe
losses 9.2 14.4 (8.4 ) - 15.2 7.3 3.9 10.2 (0.6 ) 20.8
Prior year
favorable
(unfavorable)
catastrophe
development 10.9 3.1 (2.0 ) - 12.0 8.8 3.2 3.0 - 15.0
Current year
catastrophe
losses (48.4 ) (17.3 ) (69.2 ) - (134.9 ) (117.0 ) (32.0 ) (76.1 ) - (225.1 )
Underwriting profit
(loss) 66.5 64.2 (7.6 ) - 123.1 (16.2 ) 20.7 68.4 (0.6 ) 72.3
Net investment
income 68.0 31.0 43.2 5.2 147.4 71.9 30.9 43.9 5.7 152.4
Fees and other
income 1.9 2.8 6.2 1.5 12.4 1.6 3.3 4.5 2.4 11.8
Other operating
expenses (2.0 ) (2.8 ) (2.7 ) (6.0 ) (13.5 ) (2.2 ) (3.4 ) (2.8 ) (5.7 ) (14.1 )
Operating income
before interest
expense and
income taxes $ 134.4 $ 95.2 $ 39.1 $ 0.7 $ 269.4 $ 55.1 $ 51.5 $ 114.0 $ 1.8 $ 222.4
Core Commercial
Core Commercial net premiums written were
ended
30, 2021
exposure increases and continued strong retention.
Core Commercial underwriting profit for the six months endedJune 30, 2022 was$66.5 million , compared to a$16.2 million loss for the six months endedJune 30, 2021 , a favorable change of$82.7 million . Catastrophe losses for the six months endedJune 30, 2022 were$37.5 million , compared to$108.2 million for the six months endedJune 30, 2021 . The higher catastrophe losses in 2021 were primarily due to freeze events inTexas and surrounding states. Net favorable development on prior years' loss reserves for the six months endedJune 30, 2022 was$9.2 million , compared to$7.3 million for the six months endedJune 30, 2021 , an increase of$1.9 million .
Core Commercial current accident year underwriting profit, excluding
catastrophes, was
to
increase was primarily due to earned premium growth.
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Table of Contents Specialty Specialty net premiums written were$605.1 million for the six months endedJune 30, 2022 , compared to$541.9 million for the six months endedJune 30, 2021 . This$63.2 million increase was primarily driven by improved retention and pricing, especially in our Professional and Executive lines, and improved pricing across substantially all other lines. Specialty underwriting profit for the six months endedJune 30, 2022 was$64.2 million , compared to$20.7 million for the six months endedJune 30, 2021 , an increase of$43.5 million . Catastrophe losses for the six months endedJune 30, 2022 were$14.2 million , compared to$28.8 million for the six months endedJune 30, 2021 . The higher catastrophe losses in 2021 were primarily due to freeze events inTexas and surrounding states. Net favorable development on prior years' loss reserves for the six months endedJune 30, 2022 was$14.4 million , compared to$3.9 million for the six months endedJune 30, 2021 , an increase of$10.5 million . Specialty current accident year underwriting profit, excluding catastrophes, was$64.0 million for the six months endedJune 30, 2022 , compared to$45.6 million for the six months endedJune 30, 2021 . This$18.4 million increase was primarily due to lower current accident year losses across all product lines and earned premium growth. Personal Lines Personal Lines net premiums written were$1,059.2 million for the six months endedJune 30, 2022 , compared to$959.1 million for the six months endedJune 30, 2021 . This$100.1 million increase was primarily driven by increased new business and retention. Personal Lines underwriting loss for the six months endedJune 30, 2022 was$7.6 million , compared to$68.4 million profit for the six months endedJune 30, 2021 , a decrease of$76.0 million . Catastrophe losses for the six months endedJune 30, 2022 were$71.2 million , compared to$73.1 million for the six months endedJune 30, 2021 . Unfavorable development on prior years' loss reserves for the six months endedJune 30, 2022 was$8.4 million , compared to$10.2 million favorable development for the six months endedJune 30, 2021 , a decrease of$18.6 million . Personal Lines current accident year underwriting profit, excluding catastrophes, was$72.0 million for the six months endedJune 30, 2022 , compared to$131.3 million for the six months endedJune 30, 2021 . This$59.3 million decrease was primarily due to higher current accident year loss severity in our personal automobile and homeowners lines, partially offset by lower performance-based agency compensation expenses and earned premium growth. We experienced an increase in personal automobile physical damage and property loss severity driven by inflationary pressures associated with supply chain issues, higher used vehicle prices, and higher cost of parts. In addition, we experienced an increase in homeowners property severity due to higher than usual non-catastrophe weather, as well as higher inflation.
Other
Our Other segment had operating income of$0.7 million for the six months endedJune 30, 2022 , compared to$1.8 million for the six months endedJune 30, 2021 , a decrease of$1.1 million .
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.
Six Months Ended
June 30,
(in millions) 2022 2021
Gross reserve for losses and LAE, beginning of period
6,024.0
Reinsurance recoverable on unpaid losses 1,693.8
1,641.6
Net reserve for losses and LAE, beginning of period 4,753.8
4,382.4
Net incurred losses and LAE in respect of losses occurring in: Current year 1,660.2
1,562.2
Prior year non-catastrophe loss development (15.2 ) (20.8 ) Prior year catastrophe loss development (12.0 ) (15.0 ) Total incurred losses and LAE 1,633.0
1,526.4
Net payments of losses and LAE in respect of losses occurring in: Current year 571.0 531.5 Prior years 913.7 739.9 Total payments 1,484.7 1,271.4 Net reserve for losses and LAE, end of period 4,902.1
4,637.4
Reinsurance recoverable on unpaid losses 1,704.8
1,706.0
Gross reserve for losses and LAE, end of period
6,343.4
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The table below summarizes the gross reserve for losses and LAE by line of
business and division.
June 30, December 31,
(in millions) 2022 2021
Commercial multiple peril $ 1,378.6 $ 1,338.4
Workers' compensation 466.2 473.1
Commercial automobile 726.3 698.5
Other core commercial 534.6 481.0
Total Core Commercial 3,105.7 2,991.0
Specialty Property & Casualty 799.9 798.6
Professional and Executive Lines 520.2 494.9
Marine 121.3 122.5
Surety and Other 108.1 106.0
Total Specialty 1,549.5 1,522.0
Personal automobile 1,564.8 1,590.7
Homeowners and Other 322.8 277.7
Total Personal Lines 1,887.6 1,868.4
Total Other 64.1 66.2
Total loss and LAE reserves $ 6,606.9 $ 6,447.6
Loss and LAE reserves in our "Other core commercial" lines include general
liability, commercial umbrella, and monoline property. "Specialty Property &
Casualty" includes program business, specialty industrial and commercial
property, and excess and surplus lines. "Professional and Executive Lines"
includes professional and management liability, fidelity and crime, and other
property and liability lines for healthcare firms. Loss and LAE reserves in our
"Total Other" segment relate to our run-off voluntary assumed property and
casualty reinsurance pools business and our run-off direct asbestos and
environmental business.
The following table summarizes prior year (favorable) unfavorable development
for the periods indicated:
Six Months Ended June 30,
2022 2021
(in millions) Loss & LAE Catastrophe Total Loss & LAE Catastrophe Total
Core Commercial $ (9.2 ) $ (10.9 ) $ (20.1 ) $ (7.3 ) $ (8.8 ) $ (16.1 )
Specialty (14.4 ) (3.1 ) (17.5 ) (3.9 ) (3.2 ) (7.1 )
Personal Lines 8.4 2.0 10.4 (10.2 ) (3.0 ) (13.2 )
Other - - - 0.6 - 0.6
Total prior year
favorable development $ (15.2 ) $ (12.0 ) $ (27.2 ) $ (20.8 ) $ (15.0 ) $ (35.8 )
It is not possible to know whether the factors that affected loss reserves in
the first six months of 2022 will also occur in future periods. We encourage you
to read our 2021 Annual Report on Form 10-K for more information about our
reserving process and the judgments, uncertainties and risks associated
therewith.
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For the six months endedJune 30, 2022 and 2021, favorable catastrophe development was$12.0 million and$15.0 million , respectively. The favorable catastrophe development during the six months endedJune 30, 2022 was primarily due to lower than expected losses related to 2021 events, including hurricane Ida, of$10.0 million and, to a lesser extent, other severe wind and hail storms. The favorable catastrophe development during the six months endedJune 30, 2021 was primarily due to lower than expected losses related to certain 2018 through 2020 hurricanes, tornadoes, and other storms.
2022 Loss and
For the six months endedJune 30, 2022 , net favorable loss and LAE development, excluding catastrophes, was$15.2 million . Core Commercial favorable loss and LAE development of$9.2 million was primarily due to lower than expected losses of$14.2 million in the workers' compensation line, primarily in accident years 2013 through 2017 and 2020, partially offset by higher than expected losses in our commercial automobile line. Specialty favorable loss and LAE development of$14.4 million was primarily due to lower than expected losses in our surety and Professional and Executive lines. In addition, lower than expected losses in our marine line were offset by higher than expected losses in our Specialty P&C lines. Personal Lines unfavorable loss and LAE development of$8.4 million was due to higher than expected loses in the homeowners line of$11.7 million , partially offset by lower than expected losses in the personal automobile line. The increase in homeowners losses was primarily due to higher severity and longer cycle times in repair activity, primarily related to claims incurred in the fourth quarter of 2021.
2021 Loss and
For the six months endedJune 30, 2021 , net favorable loss and LAE development, excluding catastrophes, was$20.8 million . Core Commercial favorable loss and LAE development of$7.3 million was primarily due to lower than expected losses of$10.5 million in the workers' compensation line, primarily in accident years 2014 through 2019, partially offset by higher than expected losses in the commercial automobile line. Specialty favorable loss and LAE development of$3.9 million was primarily due to lower than expected losses in the marine line. Personal Lines favorable loss and LAE development of$10.2 million was primarily due to lower than expected losses of$9.1 million in the personal automobile line, driven by lower bodily injury and personal injury protection losses primarily in accident year 2020.
Reinsurance Recoverables
Reinsurance recoverables were$1,934.7 million and$1,907.3 million atJune 30, 2022 andDecember 31, 2021 , respectively, of which$124.4 million and$100.4 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$50.3 million and$49.8 million atJune 30, 2022 andDecember 31, 2021 , respectively, and billed non-MCCA reinsurance recoverables totaled$74.1 million and$50.6 million atJune 30, 2022 andDecember 31, 2021 , respectively. AtJune 30, 2022 ,$0.5 million of the billed non-MCCA recoverables were outstanding greater than 90 days, whereas atDecember 31, 2021 , there were no balances outstanding greater than 90 days.
Reinsurance - Catastrophe Bonds
EffectiveJuly 1, 2022 , we have catastrophe protection through a per occurrence excess of loss reinsurance agreement withCommonwealth Re Ltd. ("Commonwealth Re"), an independent company, licensed as a Special Purpose Insurer inBermuda . The reinsurance agreement meets the requirements to be accounted for as reinsurance in accordance with the guidance for reinsurance contracts. In connection with the reinsurance agreement, Commonwealth Re issued notes (generally referred to as "catastrophe bonds") to investors in amounts totaling$150.0 million , consistent with the amount of coverage provided under the reinsurance agreement as described below. The proceeds were deposited in a reinsurance trust account. The reinsurance agreement provides us with coverage of up to$150.0 million throughJune 30, 2025 , for catastrophe losses from named tropical storms or hurricanes, including all events or perils directly resulting from such storm or storm system, which may include, by way of example and not limitation, hurricane, wind, gusts, typhoon, hail, rain, tornadoes, cyclones, ensuing flood, storm surge, water damage, fire following, sprinkler leakage, riots, vandalism, and collapse. For events up to and includingJune 30, 2025 , we are entitled to begin recovering amounts under this reinsurance agreement if the covered losses in the covered area for a single occurrence reach an initial attachment amount of$1.3 billion . The full$150.0 million coverage amount is available until such covered losses reach a maximum$1.45 billion . The attachment level and the maximum level (or exhaustion level) under this agreement may be reset annually to adjust the expected loss of the layer within a predetermined range. The coverage under the reinsurance agreement is limited to specified personal and commercial property coverage written in the following geographies inthe United States :Connecticut ,Delaware ,District of Columbia , Maine,Maryland ,Massachusetts ,New Hampshire ,New Jersey ,New York ,Pennsylvania ,Rhode Island ,Vermont andVirginia . Under the terms of the reinsurance agreement, we are obligated to pay annual reinsurance premiums to Commonwealth Re for the reinsurance coverage. Amounts payable under the reinsurance agreement with respect to any covered event cannot exceed our actual losses from such event. The principal amount of the catastrophe bonds will be reduced by any amounts paid to us under the reinsurance agreement. 34
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As with any reinsurance agreement, there is credit risk associated with collecting amounts due from reinsurers. With regard to Commonwealth Re, since the reinsurance coverage is fully collateralized by the proceeds from the catastrophe bond offering, the credit risk is largely mitigated. Commonwealth Re has funded a reinsurance trust account with money market funds that invest primarily in cash or directU.S. federal government obligations and obligations backed by theU.S. federal government with maturities of no more than 397 calendar days. The money market funds must have a principal stability rating of at least AAAm byStandard & Poor's or Aaa by Moody's on the issuance date of the bonds and thereafter must be rated byStandard & Poor's and Moody's, as applicable. At the time the agreement was entered into with Commonwealth Re, we evaluated the applicability of the accounting guidance that addresses variable interest entities ("VIE"). Under this guidance, an entity that is formed for business purposes is considered a VIE if (a) the equity investors lack the direct or indirect ability through voting rights or similar rights to make decisions about an entity's activities that have a significant effect on the entity's operations or (b) the equity investors do not provide sufficient financial resources for the entity to support its activities. Additionally, a company that absorbs a majority of the expected losses from a VIE's activities or is entitled to receive a majority of the entity's expected residual returns, or both, is considered to be the primary beneficiary of the VIE and is required to consolidate the VIE in the company's financial statements. We concluded that Commonwealth Re was a VIE because the conditions described in items (a) and (b) above were present. However, while Commonwealth Re was determined to be a VIE, we concluded that we do not have a variable interest in the entity, as the variability in its results, caused by the reinsurance agreement, is expected to be absorbed entirely by the investors in the catastrophe bonds issued by Commonwealth Re and residual amounts earned by it, if any, are expected to be absorbed by the equity investors (we have neither an equity nor a residual interest in Commonwealth Re). Accordingly, we are not the primary beneficiary of Commonwealth Re and do not consolidate that entity in our consolidated financial statements. Additionally, because we have no intention to pursue any transaction that would result in our acquisition of an interest in and becoming the primary beneficiary of Commonwealth Re, the consolidation of that entity in our consolidated financial statements in future periods is unlikely.
Investments
Investment Results
Net investment income before income taxes was as follows:
Three Months Ended June 30, Six Months Ended June 30,
(dollars in millions) 2022 2021 2022 2021
Fixed maturities $ 57.6 $ 53.9 $ 113.4 $ 108.4
Limited partnerships 7.8 15.5 23.0 30.6
Mortgage loans 4.0 4.2 8.4 9.6
Equity securities 3.1 3.8 6.7 7.6
Other investments 0.8 0.9 1.6 1.6
Investment expenses (2.8 ) (2.7 ) (5.7 ) (5.4 )
Net investment income $ 70.5 $ 75.6 $ 147.4 $ 152.4
Earned yield, fixed maturities 2.97 % 3.02 % 2.96 % 3.07 %
Earned yield, total portfolio 3.19 % 3.65 % 3.35 % 3.70 %
The decrease in net investment income for the three and six months ended June
30, 2022 was primarily due to lower partnership income and, to a lesser extent,
lower yields on fixed maturities, partially offset by the continued investment
of operational cash flows. Income from partnerships can vary significantly from
period to period based on the performance in the underlying portfolios. Lower
income from our limited partnerships reflects a more normalized return
environment as compared to 2021, where performance was driven by substantial
valuation increases across all private capital strategies, and which results are
not indicative of the long-term targeted returns for this asset class.
Investment Portfolio
We held cash and investment assets diversified across several asset classes, as
follows:
June 30, 2022 December 31, 2021
Carrying % of Total Carrying % of Total
(dollars in millions) Value Carrying Value Value Carrying Value
Fixed maturities, at fair value $ 7,244.7 84.1 % $ 7,723.9 82.3 %
Equity securities, at fair value 429.8 5.0 661.3 7.0
Mortgage and other loans 435.0 5.0 434.0 4.6
Other investments 358.6 4.2 333.4 3.6
Cash and cash equivalents 145.9 1.7 230.9 2.5
Total cash and investments $ 8,614.0 100.0 % $ 9,383.5 100.0 %
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Total cash and investments decreased
ended
market value depreciation, partially offset by the continued investment of
operational cashflows.
The following table provides information about the investment types of our fixed
maturities portfolio:
June 30, 2022
Amortized Cost,
Net of Allowance Net Change in Net
(in millions) for Credit Unrealized Unrealized
Investment Type Losses Fair Value Loss For the Year
Foreign government
2.2 2.2 - (0.4 ) Municipals: Taxable 1,187.3 1,079.9 (107.4 ) (131.2 ) Tax-exempt 21.5 20.9 (0.6 ) (1.4 ) Corporate 3,974.9 3,698.3 (276.6 ) (435.5 ) Asset-backed: Residential mortgage-backed 1,074.0 985.4 (88.6 ) (90.0 ) Commercial mortgage-backed 881.6 823.2 (58.4 ) (80.4 ) Asset-backed 276.0 259.0 (17.0 ) (16.9 ) Total fixed maturities$ 7,831.7 $
7,244.7
The change in net unrealized loss on fixed maturities was primarily due to
higher prevailing interest rates and, to a lesser extent, wider credit spreads.
Amortized cost and fair value by rating category were as follows:
June 30, 2022 December 31, 2021
(dollars in Rating
millions) Agency Amortized Cost, Net of Amortized Cost, Net of
NAIC Equivalent Allowance for Credit Fair %
of Total Allowance for Credit Fair % of Total
Designation Designation
Losses Value Fair Value Losses Value Fair Value 1 Aaa/Aa/A$ 5,221.9 $ 4,854.5 67.0 %$ 4,867.5 $ 4,987.6 64.6 % 2 Baa 2,220.5 2,043.5 28.2 2,302.2 2,380.4 30.8 3 Ba 229.9 203.5 2.8 216.9 225.2 2.9 4 B 143.3 127.9 1.8 123.2 125.3 1.6 5 Caa and lower 16.1 15.3 0.2 5.0 5.4 0.1 Total fixed maturities$ 7,831.7 $ 7,244.7 100.0 %$ 7,514.8 $ 7,723.9 100.0 % Based on ratings by theNational Association of Insurance Commissioners ("NAIC"), approximately 95% of the fixed maturity portfolio consisted of investment grade securities at bothJune 30, 2022 andDecember 31, 2021 . 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. 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 2021 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:
June 30, 2022 December 31, 2021
Amortized Cost, Net of Amortized Cost, Net of
(dollars in millions) Allowance for Credit % of Total Allowance for Credit % of Total
Duration Losses Fair Value Fair Value Losses Fair Value Fair Value
0-2 years $ 1,085.7 $ 1,077.6 14.9 % $ 1,080.2 $ 1,108.3 14.3 %
2-4 years 1,804.6 1,757.1 24.2 1,581.1 1,660.9 21.5
4-6 years 2,221.8 2,082.7 28.7 2,263.8 2,349.0 30.4
6-8 years 2,121.8 1,824.2 25.2 1,603.8 1,622.4 21.0
8-10 years 462.5 389.3 5.4 854.9 846.5 11.0
10+ years 135.3 113.8 1.6 131.0 136.8 1.8
Total fixed maturities $ 7,831.7 $ 7,244.7 100.0 % $ 7,514.8 $ 7,723.9 100.0 %
Weighted average duration 4.7 4.9
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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 endedJune 30, 2022 , we recognized a net recovery of$0.3 million , consisting of$1.8 million of recoveries on mortgage loans, partially offset by$1.5 million of impairment losses on fixed maturities. For the six months endedJune 30, 2022 , we recognized net impairments of$0.6 million , consisting of impairment losses on fixed maturities of$2.4 million , which were primarily credit related, partially offset by$1.8 million of recoveries on mortgage loans. For the three months and six months endedJune 30, 2021 , we recognized impairments of$0.2 million on corporate fixed maturities.
At
mortgage loans was
allowance for credit losses on available-for-sale debt securities was
million
AtJune 30, 2022 andDecember 31, 2021 we held no fixed maturities on non-accrual status. The effects of non-accruals for the six months endedJune 30, 2022 and 2021, 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 atJune 30, 2022 were$596.7 million , an increase of$548.7 million compared toDecember 31, 2021 , primarily attributable to higher interest rates and, to a lesser extent, wider credit spreads. AtJune 30, 2022 , gross unrealized losses consisted primarily of$281.7 million on corporate fixed maturities,$111.6 million on municipals,$88.9 million on residential mortgage-backed securities and$58.4 million on commercial mortgage-backed securities. See Note 3 - "Investments" in the Notes to Interim Consolidated Financial Statements. We view gross unrealized losses on fixed maturities as non-credit related since it is our assessment that these securities will recover, allowing us to realize their anticipated long-term economic value. Further, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also "Liquidity and Capital Resources"). Inherent in our assessment are the risks that market factors may differ from our expectations; we may decide to subsequently sell a security for unforeseen business needs; or changes in the credit assessment from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, an impairment would be recognized as a realized loss. Although unrealized losses on fixed maturities are not reflected in the results of financial operations until they are realized, the fair value of the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets. The following table sets forth gross unrealized losses for fixed maturities by maturity period atJune 30, 2022 andDecember 31, 2021 . Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers. June 30, December 31, (in millions) 2022 2021 Due in one year or less$ 0.3 $ - Due after one year through five years 52.1 0.7 Due after five years through ten years 311.7 19.4 Due after ten years 68.2 10.9 432.3 31.0 Mortgage-backed and asset-backed securities 164.4 17.0 Total fixed maturities$ 596.7 $ 48.0 37
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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. Economic factors in theU.S. remain positive, driven by strength in the overall labor market and consumer spending. However, a number of risks have increased uncertainty in the near term. A spike in interest rates has led to a tightening of financial conditions for businesses and consumers, which may impact consumer spending and corporate profitability. Lingering effects of the Pandemic, such as supply chain interruptions and labor market imbalances, have yet to be fully resolved. In addition, implications of the invasion ofUkraine byRussia and the impact of sanctions, higher energy and commodity prices, as well as broad global trade disruptions impose additional inflationary and geopolitical risks. Consequently, economic indicators have started to show some deterioration of strength, indicating an increased risk of recession. With inflation having exceeded their 2 percent target for some time, combined with improvement in the labor market, theFederal Reserve (the "Fed") further raised the federal funds rate by 1.25% in the second quarter to a target range of 1.50% to 1.75% and anticipates that ongoing increases in the target range will be appropriate. Additionally, the Fed began to reduce its holdings ofTreasury and agency securities effectiveJune 1, 2022 .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, accelerated winding down of the program may result in market disruptions. 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.
Other Items
Net income also included the following items:
Three Months Ended June 30,
Personal Discontinued
(in millions) Core Commercial Specialty Lines Other Operations Total
2022
Net realized and unrealized
investment gains (losses) $ (37.0 ) $ (16.8 ) $ (24.4 ) $ 0.3 $ - $ (77.9 )
Discontinued life businesses - - - - (0.2 ) (0.2 )
2021
Net realized and unrealized
investment gains (losses) $ 17.4 $ 7.9 $ 10.8 $ (5.0 ) $ - $ 31.1
Discontinued life businesses - - - - (1.1 ) (1.1 )
Six Months Ended June 30,
Personal Discontinued
(in millions) Core Commercial Specialty Lines Other Operations Total
2022
Net realized and unrealized
investment gains (losses) $ (44.6 ) $ (20.3 ) $ (29.3 ) $ 0.4 $ - $ (93.8 )
Discontinued life businesses - - - - (0.7 ) (0.7 )
2021
Net realized and unrealized
investment gains (losses) $ 35.9 $ 15.5 $ 22.0 $ (4.8 ) $ - $ 68.6
Discontinued life businesses - - - - (1.2 ) (1.2 )
We manage investment assets for our Core Commercial, Specialty, 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 Core Commercial, Specialty, Personal Lines and
Other segments based on actuarial information related to the underlying
businesses.
Net realized and unrealized investment losses were $77.9 million for the three
months ended June 30, 2022 , compared to net realized and unrealized gains of
$31.1 million for the three months ended June 30, 2021 . For both the three
months ended June 30, 2022 and 2021, net realized and unrealized investment
gains (losses) were primarily due to changes in the fair value of equity
securities. Additionally, for the three months ended June 30, 2022 , we
recognized net realized losses of $19.2 million from sales of investments,
primarily fixed maturities.
Net realized and unrealized investment losses were $93.8 million for the six
months ended June 30, 2022 , compared to net realized and unrealized gains of
$68.6 million for the six months ended June 30, 2021 . For the six months ended
June 30, 2022 and 2021, net realized and unrealized investment gains (losses)
were primarily due to changes in the fair value of equity securities.
Additionally, for the six months ended June 30, 2022 , we recognized net realized
losses of $16.2 million from sales of investments, primarily fixed maturities.
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Discontinued operations include our former accident and health and life businesses. Losses of$0.2 million and$1.1 million for the three months endedJune 30, 2022 and 2021, respectively, and$0.7 million and$1.2 million for the six months endedJune 30, 2022 and 2021, respectively, primarily reflect adverse loss trends related to the long-term care pool.
Income Taxes
We file a consolidated
company and its domestic subsidiaries (including non-insurance operations).
Three Months Ended
The provision for income taxes from continuing operations was an expense of$5.4 million and$30.3 million for the three months endedJune 30, 2022 and 2021, respectively. These provisions resulted in consolidated effective federal tax rates of 19.1% and 18.9% for the three months endedJune 30, 2022 and 2021, respectively. These provisions include excess tax benefits related to stock-based compensation of$0.2 million and$0.8 million for the three months endedJune 30, 2022 and 2021, respectively. In addition, these provisions reflect benefits related to tax planning strategies implemented in prior years of$0.8 million and$1.0 million for the three months endedJune 30, 2022 and 2021, respectively. Finally, the provision for 2021 includes net benefits related to prior years' federal tax credit of$1.7 million . Absent these items, the provision for income taxes would have been an expense of$6.4 million , or 22.7%, and$33.8 million , or 21.1% for the three months endedJune 30, 2022 and 2021, respectively. The income tax provision on operating income was an expense of$22.6 million and$24.8 million for the three months endedJune 30, 2022 and 2021, respectively. These provisions resulted in effective tax rates for operating income of 21.2% and 19.3% for the three months endedJune 30, 2022 and 2021, respectively. These provisions include excess tax benefits related to stock-based compensation of$0.2 million and$0.8 million for the three months endedJune 30, 2022 and 2021, respectively. In addition, the provision for 2021 includes a net benefit related to prior years' federal tax credit of$1.7 million . Absent these items, the provisions for income taxes would have been an expense of$22.8 million , or 21.4%, and$27.3 million , or 21.2%, for the three months endedJune 30, 2022 and 2021, respectively.
Six Months Ended
The provision for income taxes from continuing operations was an expense of$30.1 million and$51.6 million for the six months endedJune 30, 2022 and 2021, respectively. These provisions resulted in consolidated effective federal tax rates of 19.0% and 18.8% for the six months endedJune 30, 2022 and 2021, respectively. These provisions include excess tax benefits related to stock-based compensation of$3.0 million and$1.8 million for the six months endedJune 30, 2022 and 2021, respectively. In addition, these provisions reflect benefits related to tax planning strategies implemented in prior years of$0.8 million and$2.9 million for the six months endedJune 30, 2022 and 2021, respectively. Finally, the provision for 2021 includes a net benefit related to prior years' federal tax credit of$1.7 million . Absent these items, the provision for income taxes would have been an expense of$33.9 million , or 21.4%, and$58.0 million , or 21.2%, for the six months endedJune 30, 2022 and 2021, respectively. The income tax provision on operating income was an expense of$50.8 million and$40.0 million for the six months endedJune 30, 2022 and 2021, respectively. These provisions resulted in effective tax rates for operating income of 20.1% and 19.5% for the six months endedJune 30, 2022 and 2021, respectively. These provisions include excess tax benefits related to stock-based compensation of$3.0 million and$1.8 million for the six months endedJune 30, 2022 and 2021, respectively. In addition, the provision for 2021 includes a net benefit related to prior years' federal tax credit of$1.7 million . Absent these items, the provisions for income taxes would have been an expense of$53.8 million , or 21.3%, and$43.5 million , or 21.2%, for the six months endedJune 30, 2022 and 2021, respectively. 39
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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 2021 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
For a more detailed discussion of these critical accounting estimates, see our
2021 Annual Report on Form 10-K.
Statutory Surplus of Insurance Subsidiaries
The following table reflects statutory surplus for our insurance subsidiaries:
June 30, December 31,
(in millions) 2022 2021
The statutory capital and surplus for our insurance subsidiaries decreased$26.5 million during the first six months of 2022. This decrease was primarily driven by unrealized investment losses, primarily due to changes in the fair value of equity securities and the payment of a$100 million dividend to its parent company, partially offset by an increase in underwriting profits and, to a lesser extent, a change in deferred taxes. The NAIC prescribes an annual calculation regarding risk-based capital ("RBC"). RBC ratios for regulatory purposes are expressed as a percentage of the capital required to be above the Authorized Control Level (the "Regulatory Scale"); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios forHanover Insurance (which includes Citizens and other insurance subsidiaries), as ofJune 30, 2022 , expressed both on the Industry Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level): Company Authorized RBC Ratio RBC Ratio (dollars in millions) Action Level Control Level Industry Scale Regulatory Scale The Hanover Insurance Company$ 1,201.5 $ 600.7 223 % 447 %
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 second quarter of 2022,Hanover Insurance paid$100.0 million in dividends, which were provided 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$208.7 million during the first six months of 2022, as compared to$309.0 million during the first six months of 2021. The$100.3 million decrease in cash provided was primarily due to an increase in loss and LAE payments and, to a lesser extent, higher federal income tax payments made in the first six months of 2022, partially offset by an increase in premiums received. Net cash used in investing activities was$217.6 million during the first six months of 2022, as compared to$160.6 million during the first six months of 2021. During the first six months of 2022 and 2021, cash used in investing activities primarily related to net purchases of fixed maturities, partially offset by net sales of equity securities. 40
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Net cash used in financing activities was$76.1 million during the first six months of 2022, as compared to$162.6 million during the first six months of 2021. During the first six months of 2022, cash used in financing activities primarily resulted from two quarterly dividend payments to our shareholders and, to a lesser extent, the repurchase of common stock. During the first six months of 2021, cash used in financing activities primarily resulted from the repurchase of common stock and, to a lesser extent, from two quarterly dividend payments to our shareholders. Dividends to common shareholders are subject to quarterly board approval and declaration. During the first six months of 2022, as declared by the Board, we paid two quarterly dividends, each for$0.75 per share, to our shareholders totaling$53.4 million . We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them. AtJune 30, 2022 , THG, as a holding company, held approximately$377.7 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 2022 holding company obligations; however, we may decide to do so. We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan. The ultimate payment amounts for our benefit plan is based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes, both positive and negative, to our current funding status and ultimately our obligations in future periods are likely. Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. Recently, the financial markets have experienced significant declines in value, including many securities currently held by THG and its subsidiaries. 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 authorized a stock repurchase program which provides for aggregate repurchases of our common stock of up to$1.3 billion . 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. During the first six months of 2022 we repurchased approximately 0.1 million shares at an aggregate cost of$20.4 million . As ofJune 30, 2022 , we had repurchased 7.8 million shares under this$1.3 billion program and had approximately$341 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. AtJune 30, 2022 , we had borrowing capacity of$113.5 million . There were no outstanding borrowings under this short-term facility atJune 30, 2022 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 six months of 2022. The LIBOR rate, upon which Adjusted LIBOR is based, is in process of being discontinued. During 2021, certain key tenors of LIBOR were extended with a new cessation date ofJune 20, 2023 . 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 Coronavirus Aid, Relief, and Economic Security 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 2021 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,
2021 , included in our Annual Report on Form 10-K for the year ended December 31,
2021 . There have been no material changes in the first six months of 2022 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 endedJune 30, 2022 , that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 43
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