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Section 1: 10-Q (FORM 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended September 30, 2011 September 30, 2011

 

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

For the transition period from         to        

Commission File Number 1-13754

 

 

THE HANOVER INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   04-3263626

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

440 Lincoln Street, Worcester, Massachusetts 01653

(Address of principal executive offices) (Zip Code)

(508) 855-1000

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The number of shares outstanding of the registrant’s common stock was 44,870,688 as of November 1, 2011.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  

Item 1.

  Financial Statements   
 

Consolidated Statements of Income

     2   
 

Consolidated Balance Sheets

     3   
 

Consolidated Statements of Shareholders’ Equity

     4   
 

Consolidated Statements of Comprehensive Income

     5   
 

Consolidated Statements of Cash Flows

     6   
 

Notes to Interim Consolidated Financial Statements

     7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      56   

Item 4.

  Controls and Procedures      57   

PART II. OTHER INFORMATION

  

Item 1.

  Legal Proceedings      58   

Item 1A

  Risk Factors      58   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      62   

Item 6.

  Exhibits      63   

SIGNATURES

     64   


Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

     Three Months
Ended
September 30,
    Nine Months
Ended
September 30,
 

(in millions, except per share data)

   2011     2010     2011     2010  

REVENUES

      

Premiums

   $ 1,018.6      $ 728.0      $ 2,550.8      $ 2,092.3   

Net investment income

     67.8        61.3        189.2        184.2   

Net realized investment gains (losses):

        

Net realized gains from sales and other

     9.7        7.1        28.6        24.3   

Net other–than–temporary impairment losses recognized in income

     (1.5     (1.4     (3.7     (7.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized investment gains

     8.2        5.7        24.9        16.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fees and other income

     13.4        9.0        30.8        25.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     1,108.0        804.0        2,795.7        2,318.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

LOSSES AND EXPENSES

        

Losses and loss adjustment expenses

     734.9        454.6        1,863.4        1,384.6   

Policy acquisition expenses

     241.1        173.4        603.2        490.8   

Interest expense

     17.4        11.8        38.6        32.8   

Other operating expenses

     133.3        91.1        331.4        275.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total losses and expenses

     1,126.7        730.9        2,836.6        2,183.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (18.7     73.1        (40.9     135.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense (benefit):

        

Current

     (18.4     21.2        (40.7     (8.5

Deferred

     9.4        0.5        14.0        48.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income tax expense (benefit)

     (9.0     21.7        (26.7     39.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     (9.7     51.4        (14.2     95.8   

Gain from discontinued operations (net of income tax benefit of $0.1 and $0.4 for the three months ended September 30, 2011 and September 30, 2010 and $0.6 for the nine months ended September 30, 2010)

     —          0.9        2.0        0.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (9.7   $ 52.3      $ (12.2   $ 96.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

PER SHARE DATA

        

Basic

        

Income (loss) from continuing operations

   $ (0.21   $ 1.14      $ (0.31   $ 2.09   

Gain from discontinued operations

     —          0.02        0.04        0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

   $ (0.21   $ 1.16      $ (0.27   $ 2.11   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

     45.3        44.9        45.4        45.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Income (loss) from continuing operations

   $ (0.21   $ 1.12      $ (0.31   $ 2.06   

Gain from discontinued operations

     —          0.03        0.04        0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

   $ (0.21   $ 1.15      $ (0.27   $ 2.08   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

     45.3        45.7        45.4        46.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

2


Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

     September 30,     December 31,  

(in millions, except per share data)

   2011     2010  

ASSETS

    

Investments:

    

Fixed maturities, at fair value (amortized cost of $5,966.1 and $4,598.8)

   $ 6,227.6      $ 4,797.9   

Equity securities, at fair value (cost of $249.2 and $120.7)

     246.3        128.6   

Other investments

     194.1        39.4   
  

 

 

   

 

 

 

Total investments

     6,668.0        4,965.9   
  

 

 

   

 

 

 

Cash and cash equivalents

     922.7        290.4   

Accrued investment income

     106.1        53.8   

Premiums and accounts receivable, net

     1,204.4        772.0   

Reinsurance recoverable on paid and unpaid losses, benefits and unearned premiums

     2,202.9        1,254.2   

Deferred policy acquisition costs

     509.9        345.3   

Deferred income taxes

     215.6        177.4   

Goodwill

     200.6        179.2   

Other assets

     527.0        398.1   

Assets of discontinued operations

     127.3        133.6   
  

 

 

   

 

 

 

Total assets

   $ 12,684.5      $ 8,569.9   
  

 

 

   

 

 

 

LIABILITIES

    

Loss and loss adjustment expense reserves

   $ 5,722.0      $ 3,277.7   

Unearned premiums

     2,401.9        1,520.3   

Expenses and taxes payable

     672.8        541.7   

Reinsurance premiums payable

     402.9        34.4   

Debt

     901.6        605.9   

Liabilities of discontinued operations

     128.4        129.4   
  

 

 

   

 

 

 

Total liabilities

     10,229.6        6,109.4   
  

 

 

   

 

 

 

Commitments and contingencies

    

SHAREHOLDERSEQUITY

    

Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued

     —          —     

Common stock, $0.01 par value, 300.0 million shares authorized,

    

$60.5 million shares issued

     0.6        0.6   

Additional paid-in capital

     1,785.2        1,796.5   

Accumulated other comprehensive income

     191.5        136.7   

Retained earnings

     1,200.7        1,246.8   

Treasury stock, at cost (15.9 and 15.6 million shares)

     (723.1     (720.1
  

 

 

   

 

 

 

Total shareholders’ equity

     2,454.9        2,460.5   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 12,684.5      $ 8,569.9   
  

 

 

   

 

 

 

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

 

3


Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

 

      Nine Months  Ended
September 30,
 

(in millions)

   2011     2010  

PREFERRED STOCK

    

Balance at beginning and end of period

   $ —        $ —     
  

 

 

   

 

 

 

COMMON STOCK

    

Balance at beginning and end of period

     0.6        0.6   
  

 

 

   

 

 

 

ADDITIONAL PAID-IN CAPITAL

    

Balance at beginning of period

     1,796.5        1,808.5   

Employee and director stock-based awards and other

     (11.3     (9.9
  

 

 

   

 

 

 

Balance at end of period

     1,785.2        1,798.6   
  

 

 

   

 

 

 

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

    

NET UNREALIZED APPRECIATION ON INVESTMENTS AND DERIVATIVE INSTRUMENTS:

    

Balance at beginning of period

     218.3        107.7   

Net appreciation during the period:

    

Net appreciation on available-for-sale securities and derivative instruments

     48.1        227.1   

Benefit (provision) for deferred income taxes

     11.1        (57.4
  

 

 

   

 

 

 
     59.2        169.7   
  

 

 

   

 

 

 

Balance at end of period

     277.5        277.4   
  

 

 

   

 

 

 

DEFINED BENEFIT PENSION AND POSTRETIREMENT PLANS:

    

Balance at beginning of period

     (81.6     (78.9

Amount recognized as net periodic benefit cost during the period

     7.7        7.3   

Provision for deferred income taxes

     (2.7     (2.6
  

 

 

   

 

 

 
     5.0        4.7   
  

 

 

   

 

 

 

Balance at end of period

     (76.6     (74.2
  

 

 

   

 

 

 

CUMULATIVE FOREIGN CURRENCY TRANSLATION ADJUSTMENT:

    

Balance at beginning of period

     —          —     

Amount recognized as cumulative foreign currency translation during the period

     (14.5     —     

Benefit (provision) for deferred income taxes

     5.1        —     
  

 

 

   

 

 

 
     (9.4     —     
  

 

 

   

 

 

 

Balance at end of period

     (9.4     —     
  

 

 

   

 

 

 

Total accumulated other comprehensive income

     191.5        203.2   
  

 

 

   

 

 

 

RETAINED EARNINGS

    

Balance at beginning of period

     1,246.8        1,141.1   

Net income (loss)

     (12.2     96.4   

Dividends to shareholders

     (37.5     (35.9

Treasury stock issued for less than cost

     (6.1     (7.9

Recognition of employee stock-based compensation

     9.7        7.6   
  

 

 

   

 

 

 

Balance at end of period

     1,200.7        1,201.3   
  

 

 

   

 

 

 

TREASURY STOCK

    

Balance at beginning of period

     (720.1     (620.4

Shares purchased at cost

     (20.0     (126.0

Net shares reissued at cost under employee stock-based compensation plans

     17.0        21.5   
  

 

 

   

 

 

 

Balance at end of period

     (723.1     (724.9
  

 

 

   

 

 

 

Total shareholders’ equity

   $ 2,454.9      $ 2,478.8   
  

 

 

   

 

 

 

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

 

4


Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

     Three Months  Ended
September 30,
    Nine Months  Ended
September 30,
 

(in millions)

   2011     2010     2011     2010  

Net income (loss)

   $ (9.7   $ 52.3      $ (12.2     96.4   

Other comprehensive income:

        

Available-for-sale securities:

        

Net appreciation during the period

     6.2        99.1        43.7        220.5   

Portion of other-than-temporary impairment losses transferred from other comprehensive income

     0.8        2.3        6.2        6.6   

(Provision) benefit for deferred income taxes

     9.7        (25.9     10.5        (57.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

     16.7        75.5        60.4        169.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Derivative instruments:

        

Net appreciation (depreciation) during the period

     0.1        —          (1.8     —     

(Provision) benefit for deferred income taxes

     (0.1     —          0.6        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative instruments

     —          —          (1.2     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Pension and postretirement benefits:

        

Amortization recognized as net periodic benefit costs:

        

Net actuarial loss

     3.9        4.3        11.6        12.9   

Prior service cost

     (1.3     (1.5     (3.9     (4.4

Transition asset

     —          (0.4     —          (1.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total amortization recognized as net periodic benefit costs

     2.6        2.4        7.7        7.3   

Provision for deferred income taxes

     (0.9     (0.9     (2.7     (2.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total pension and postretirement benefits

     1.7        1.5        5.0        4.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative foreign currency translation adjustment:

        

Amount recognized as cumulative foreign currency translation during the period

     (14.5     —          (14.5     —     

Benefit (provision) for deferred income taxes

     5.1        —          5.1        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cumulative foreign currency translation adjustment

     (9.4     —          (9.4     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     9.0        77.0        54.8        174.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (0.7   $ 129.3      $ 42.6        270.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

5


Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     Nine Months Ended
September 30,
 

(in millions)

   2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income (loss)

   $ (12.2   $ 96.4   

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Net loss from retirement of debt

     2.3        —     

Net realized investment gains

     (13.4     (16.4

Net amortization and depreciation

     12.3        12.0   

Stock-based compensation expense

     9.7        8.6   

Amortization of deferred benefit plan costs

     7.7        7.4   

Deferred income taxes

     14.2        48.1   

Change in deferred acquisition costs

     16.5        (58.5

Change in accrued investment income

     (30.7     (0.9

Change in premiums receivable, net of reinsurance premiums payable

     41.1        (241.9

Change in loss, loss adjustment expense and unearned premium reserves

     254.6        276.2   

Change in reinsurance recoverable

     (53.7     (14.7

Change in expenses and taxes payable

     62.7        (104.6

Other, net

     (24.8     (26.7
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     286.3        (15.0
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from disposals and maturities of fixed maturities

     1,138.2        998.6   

Proceeds from disposals of equity securities and other investments

     17.7        44.9   

Purchases of fixed maturities

     (1,122.5     (981.7

Purchases of equity securities and other investments

     (58.6     (95.3

Cash used for business acquisitions, net of cash acquired

     268.4        (13.3

Capital expenditures

     (9.8     (6.6

Net payments related to swap agreements

     (1.9     —     

Other investing items

     (0.3     —     
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     231.2        (53.4
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from exercise of employee stock options

     3.9        9.3   

Proceeds from debt borrowings

     314.4        205.6   

Change in collateral related to securities lending program

     (32.6     (23.4

Dividends paid to shareholders

     (37.5     (35.9

Repurchases of debt

     (86.8     (0.4

Repurchases of common stock

     (20.0     (130.6

Other financing activities

     (0.6     0.1   
  

 

 

   

 

 

 

Net cash provided by financing activities

     140.8        24.7   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (28.4     —     

Net change in cash and cash equivalents

     658.3        (43.7

Net change in cash related to discontinued operations

     2.4        (1.2

Cash and cash equivalents, beginning of period

     290.4        316.5   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 922.7      $ 271.6   
  

 

 

   

 

 

 

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

 

6


Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation and Principles of Consolidation

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

The interim consolidated financial statements of THG include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America, THG’s principal U.S. domiciled property and casualty companies; and certain other insurance and non-insurance subsidiaries. These legal entities conduct their operations through several business segments discussed in Note 10 – “Segment Information”. In addition, effective July 1, 2011, the Company acquired Chaucer Holdings PLC (“Chaucer”), a specialist underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s) (See Note 3 – “Acquisitions”). The interim consolidated financial statements include Chaucer’s results for the period from July 1, 2011 through September 30, 2011. Additionally, the interim consolidated financial statements include the Company’s discontinued operations, consisting of the Company’s former life insurance businesses and its accident and health business. All intercompany accounts and transactions have been eliminated.

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

In the opinion of the Company’s management, the accompanying interim consolidated financial statements reflect all adjustments, consisting of normal recurring items, necessary for a fair presentation of the financial position and results of operations. The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year. The acquisition of Chaucer on July 1, 2011, which has added meaningful business volumes to THG third quarter results, has affected the comparability of the consolidated financial statements. These financial statements should be read in conjunction with THG’s 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 24, 2011 and the unaudited Pro Forma Condensed Combined Financial Statements of THG and Chaucer included as Exhibit 99.2 in Amendment No. 1 to THG’s Form 8K/A, which was filed with SEC on September 19, 2011.

2. New Accounting Pronouncements

Recently Implemented Standards

In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Update No. 2010-29 (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force). This update provides clarity on the presentation of comparable pro forma financial statements for business combinations. Revenues and earnings of the combined entity should be disclosed as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. Additionally, this update requires the disclosure to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The disclosure guidance provided in this ASC update is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company has implemented this guidance as of January 1, 2011. Implementing this guidance did not have an effect on the Company’s financial position or results of operations upon adoption; however, the disclosure requirements were applied to the Company’s acquisition of Chaucer. See Note 3 – “Acquisitions” for pro forma results of operations of THG and Chaucer.

In December 2010, the FASB issued ASC Update No. 2010-28 (Topic 350) When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). This update modifies Step 1 of the goodwill impairment test for companies with zero or negative carrying amounts to require Step 2 of the goodwill impairment test to be performed if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. This ASC update is effective for annual and interim periods beginning after December 15, 2010. The Company has implemented this guidance as of January 1, 2011. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.

 

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In July 2010, the FASB issued ASC Update No. 2010-20 (Topic 310) Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASC update is applicable for financing receivables recognized on a company’s balance sheet that have a contractual right to receive payment either on demand or on fixed or determinable dates. This update enhances the disclosure requirements about the credit quality of financing receivables and the allowance for credit losses, at disaggregated levels. The disclosure guidance provided in the update relating to those required as of the end of the reporting period was effective for interim and annual reporting periods ending on or after December 15, 2010. The effect of implementing the guidance was not significant to the Company’s financial statement disclosures. The disclosure guidance related to activity that occurs during the reporting period is effective for interim and annual reporting periods beginning on or after December 15, 2010. The implementation of the disclosure guidance related to activity was not significant to the Company’s financial statement disclosures.

Recently Issued Standards

In September 2011, the FASB issued ASC Update 2011-08 (Topic 350) Testing Goodwill for Impairment. This ASC update allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The update provides that an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on its qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The update further improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Also, the update improves the examples of events and circumstances that should be considered by an entity that has a reporting unit with a zero or negative carrying amount in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test. This ASC update is effective for annual and interim periods beginning after December 15, 2011, with early adoption permitted. The Company does not expect the adoption of ASC Update 2011-08 to have a material impact on its financial position or results of operations.

In June 2011, the FASB issued ASC Update 2011-05 (Topic 220) Presentation of Comprehensive Income. This ASC update requires companies to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity is eliminated. In addition, an entity is required to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. This ASC update should be applied retrospectively and except for the provisions related to reclassification adjustment, is effective for interim and annual periods beginning after December 15, 2011. In October 2011, the implementation date of the reclassification adjustment guidance was deferred. The Company expects that the implementation of the guidance related to financial statement presentation will not have a significant impact to its current financial statement presentation. The Company is evaluating the impact of presenting the reclassification adjustment to its Consolidated Statements of Income and Comprehensive Income.

In May 2011, the FASB issued ASC Update 2011-04 (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASC update results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new guidance includes changes to how and when the valuation premise of highest and best use applies, clarification on the application of blockage factors and other premiums and discounts, as well as new and revised disclosure requirements. This ASC update is effective for interim and annual periods beginning after December 15, 2011. The Company is currently evaluating its fair value measurements to determine which, if any, of the measurement techniques that the Company uses will have to change as a result of the new guidance, and what additional disclosures will be required. The Company does not expect the adoption of ASC Update 2011-04 to have a material impact on its financial position or results of operations.

In October 2010, the FASB issued ASC Update 2010-26 (Topic 944), Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force). This update provides clarity in defining which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral, commonly known as deferred acquisition costs. Additionally, this update specifies that only costs associated with the successful acquisition of a policy or contract may be deferred, whereas current industry practice often includes costs relating to unsuccessful contract acquisition. This ASC Update is effective for fiscal years beginning after December 15, 2011. Retrospective application to all prior periods upon the date of adoption is also permitted. The Company has elected to apply this guidance retrospectively. Although the Company continues to evaluate the impact of this guidance, management anticipates that the implementation of ASC Update 2010-26 would result in an after-tax reduction to our stockholders’ equity as of January 1, 2012 of approximately $25 million to $30 million, or approximately 1%. The adoption of this guidance is not expected to have a material impact on our results of operations on either a historical or prospective basis.

 

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3. Acquisitions

Chaucer Acquisition

On July 1, 2011, the Company completed the previously announced acquisition of Chaucer, a United Kingdom (“U.K.”) insurance business. Chaucer is a leading specialist managing agency at Lloyd’s. Chaucer underwrites business in several lines of business, including property, marine and aviation, energy, U.K. motor and casualty and other coverages (which include international liability, specialist coverages, and syndicate participations). Chaucer is headquartered in London, with a regional presence in Whitstable, England and locations in Houston, Singapore, Buenos Aires, and Copenhagen.

This transaction is expected to advance the Company’s specialty lines strategy and result in broader product and underwriting capabilities, as well as greater geographic and product diversification. The acquisition adds a presence in the Lloyd’s market, which includes access to international licenses, an excess and surplus insurance business and the ability to syndicate certain risks.

Determination of Purchase Price

Shareholders of Chaucer received 53.3 pence for each Chaucer share, which was paid in either cash or loan notes to those shareholders who elected to receive such notes in lieu of cash. The closing of the acquisition followed approval of the transaction by Chaucer shareholders on June 7, 2011, subsequent court approval in the U.K. and regulatory approvals in various jurisdictions. The following table summarizes the transaction in both U.K. Pounds Sterling (“GBP”) and U.S. dollars:

 

(in millions)              

Aggregate purchase price announced on April 20, 2011

     

Based on 53.3p contract price

   £ 297.7       $ 485.3   

Actual consideration on July 14, 2011:

     

Cash

   £ 287.4       $ 455.0   

Loan notes and other payables

     9.0         14.4   

Foreign exchange forward settlement

     —           11.3   
  

 

 

    

 

 

 

Total

   £ 296.4       $ 480.7   
  

 

 

    

 

 

 

The difference between the aggregate purchase price at signing and closing is attributable to the effect of currency fluctuations between the GBP and the U.S. dollar, as well as a change in outstanding shares.

In connection with the transaction, the Company entered into a foreign exchange forward contract, which provided for an economic hedge between the agreed upon purchase price of Chaucer in GBP and currency fluctuations between the GBP and U.S. dollar prior to close. This contract effectively locked in the U.S. dollar equivalent of the purchase price to be delivered in GBP and was settled at a loss of $11.3 million, of which $4.7 million and $6.6 million was recognized during the three months ended June 30, 2011 and September 30, 2011, respectively. The loss on the contract was due to a decrease in the exchange rate between the GBP and U.S. dollar and the impact in the third quarter was essentially offset by the lower U.S. dollars required to meet the GBP-based purchase price, resulting in a $6.4 million gain on foreign exchange.

This payment was funded from the THG holding company, which included approximately $300 million of proceeds from the senior unsecured notes issued on June 17, 2011. See Note 4 – “Debt” for additional information.

 

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Allocation of Purchase Price

The purchase price has been allocated as follows based on an estimate of the fair value of assets acquired and liabilities assumed as of July 1, 2011 (converted to U.S. dollars using an exchange rate of 1.6053):

 

(in millions)       

Cash

   $ 756.1   

Premiums and accounts receivable, net

     467.9   

Investments

     1,628.1   

Reinsurance recoverables, net

     558.3   

Deferred acquisition costs

     186.3   

Deferred income taxes

     39.6   

Other assets

     16.5   

Loss and loss adjustment expense reserves

     (2,300.6

Unearned premiums

     (857.3

Debt

     (64.8

Other liabilities

     (64.5
  

 

 

 

Net tangible assets

     365.6   

Goodwill

     22.5   

Intangible assets

     87.7   
  

 

 

 

Purchase price allocated to Chaucer

     475.8   

Additional hedge-related adjustment based upon July 14, 2011 settlement

     4.9   
  

 

 

 

Total purchase price, excluding transaction costs

     480.7   

Transaction costs

     11.6   
  

 

 

 

Total purchase price

   $ 492.3   
  

 

 

 

The foregoing allocation of the purchase price is based on information that was available to management at the time the consolidated financial statements were prepared. The allocation may change as additional information becomes available; the impact of such changes, if any, may be material. The Company’s balance sheet accounts denominated in foreign currencies are translated to U.S. dollars using current exchange rates as of the balance sheet date.

Identification and Valuation of Intangible Assets

A summary of the preliminary fair value of goodwill and the identifiable intangible assets and their respective estimated useful lives at July 1, 2011 is as follows:

 

     Amount      Estimated
Useful Life
     Amortization
Method
 
(in millions)         

Intangibles:

        

Lloyd’s syndicate capacity

   $ 78.7         Indefinite         N/A   

Other intangibles

     9.0         2 -5years         Straight line   
  

 

 

       

Total intangible assets

     87.7         

Goodwill

     22.5         Indefinite         N/A   
  

 

 

       

Total goodwill and intangibles

   $ 110.2         
  

 

 

       

The purchase price of the acquisition exceeded the fair value of the net tangible and intangible assets acquired, with the excess purchase price recorded as goodwill. Factors that contributed to the recognition of goodwill included the expected growth rate and profitability of Chaucer and the value of Chaucer’s experienced workforce. The goodwill recognized is deductible for income tax purposes.

 

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Pro Forma Results

The following unaudited pro forma information presents the combined revenues, net income and net income per share of THG and Chaucer for the nine months ended September 30, 2011 and for the three and nine months ended September 30, 2010, respectively, with pro forma purchase accounting adjustments as if the acquisition had been consummated as of the beginning of the periods presented. This pro forma information is not necessarily indicative of what would have occurred had the acquisition and related transactions been made on the dates indicated, or of future results of the Company. The Company’s income statement accounts denominated in foreign currencies are translated to U.S. dollars at the average rates of exchange for the period indicated.

 

(in millions, except per share data)

   Nine Months Ended
September 30,
     Three Months Ended
September 30,
 
   2011     2010      2010  

Revenue

   $ 3,223.3      $ 3,042.2       $ 1,026.1   

Net income (loss)

   $ (61.5   $ 119.5       $ 60.3   

Net income (loss) per share – basic

   $ (1.36   $ 2.61       $ 1.34   

Net income (loss) per share – diluted

   $ (1.36   $ 2.57       $ 1.32   

Weighted average shares outstanding – basic

     45.4        45.7         44.9   

Weighted average shares outstanding – diluted

     45.4        46.4         45.7   

The Company recognized approximately $3 million in foreign currency transaction losses in the Statement of Income during the three months ended September 30, 2011.

Other Prior Acquisitions

On March 31, 2010, the Company acquired Campania Holding Company, Inc. (“Campania”) for a cash purchase price of approximately $24 million, subject to various terms and conditions. During 2011, the Company recognized an additional $4.1 million of consideration based upon the terms of the agreement. Campania specializes in insurance solutions for portions of the healthcare industry.

On December 3, 2009, the Company entered into a renewal rights agreement with OneBeacon Insurance Group, LTD. (“OneBeacon”). Through this agreement, the Company acquired access to a portion of OneBeacon’s small and middle market commercial business at renewal, including industry programs and middle market niches. This transaction included consideration of $23 million, plus additional contingent consideration which totaled $11 million, primarily representing purchased renewal rights intangible assets which are included as Other Assets in the Consolidated Balance Sheets. The agreement was effective for renewals beginning January 1, 2010.

 

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4. Debt and Credit Arrangements

Debt consists of the following:

 

(in millions)

   September 30,
2011
    December 31,
2010
 

Senior debentures (unsecured) maturing March 1, 2020

   $ 200.0      $ 200.0   

Senior debentures (unsecured) maturing June 15, 2021

     300.0        —     

Senior debentures (unsecured) maturing October 15, 2025

     121.6        121.6   

Junior debentures

     59.7        129.2   

Subordinated note maturing November 16, 2034

     16.1        —     

Subordinated note maturing September 21, 2036

     50.0        —     

FHLBB borrowings

     152.8        134.5   

Capital securities

     7.0        18.0   

Surplus notes

     —          4.0   
  

 

 

   

 

 

 

Total principal debt

   $ 907.2      $ 607.3   

Unamortized fair value adjustment

     (2.5     (0.5

Unamortized debt issuance cost

     (3.1     (0.9
  

 

 

   

 

 

 

Total

   $ 901.6      $ 605.9   
  

 

 

   

 

 

 

On June 17, 2011, the Company issued $300 million aggregate principal amount of 6.375% senior unsecured notes due June 15, 2021. The senior debentures are subject to certain restrictive covenants, including limitations on the issuance or disposition of capital stock of restricted subsidiaries. These debentures pay interest semi-annually. At September 30, 2011, the Company was in compliance with the covenants associated with this indenture.

In 2011, the Company repurchased in several transactions, $69.5 million of Series B 8.207% Subordinated Deferrable Interest Debentures (“Junior Debentures”) at a cost of $72.0 million, resulting in a net loss of $2.5 million on the repurchases. In addition, the Company repurchased $4.0 million of surplus notes outstanding related to AIX Holdings, Inc (“AIX”), $8.0 million of capital securities related to AIX and $3.0 million of capital securities related to Professionals Direct, Inc.

The Company borrowed $125.0 million in 2009 from Federal Home Loan Bank of Boston (FHLBB”). In July 2010, the Company committed to borrow an additional $46.3 million from FHLBB to finance the development of the City Square Project. These borrowings will be drawn in several increments from July 2010 to January 2012. These additional amounts mature on July 20, 2020 and carry fixed interest rates with a weighted average of 3.88%. Through September 30, 2011, the Company has borrowed $27.8 million under this arrangement. Interest associated with the $46.3 million will be capitalized through the construction phase of the City Square Project.

As collateral to FHLBB, Hanover Insurance pledged government agency securities with a fair value of $192.3 million and $162.7 million, for the aggregate borrowings of $152.8 million and $134.5 million as of September 30, 2011 and December 31, 2010, respectively. The fair value of the collateral pledged must be maintained at certain specified levels of the borrowed amount, which can vary depending on the type of assets pledged. At December 31, 2011, the Company was in compliance with the covenants associated with these borrowings. If the fair value of this collateral declines below these specified levels, Hanover Insurance would be required to pledge additional collateral or repay outstanding borrowings. Hanover Insurance is permitted to voluntarily repay the outstanding borrowings at any time, subject to a repayment fee. As a requirement of membership in the FHLBB, Hanover Insurance maintains a certain level of investment in FHLBB stock. Total purchases of FHLBB stock were $8.9 million and $8.6 million at September 30, 2011 and December 31, 2010, respectively.

In April 2011, the Company entered into a bridge credit agreement for borrowings in an aggregate principal amount of up to $180 million to be used solely in connection with the acquisition of Chaucer. This bridge agreement terminated upon the issuance, on June 17, 2011, of the aforementioned $300 million aggregate principal amount of 6.375% senior unsecured notes. See Note 3 – “Acquisitions” for additional information.

 

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On July 1, 2011, the Company acquired all of the outstanding shares of Chaucer. In 2004, Chaucer issued €12 million aggregate principal amount of floating rate subordinated unsecured notes due November 16, 2034. These notes pay interest semi-annually based on the European Inter bank offer rate (Euribor), plus an agreed margin of 3.75%. These notes are converted from Euro to GBP at current rates and then translated to U.S. dollars based upon the September 30, 2011 exchange rate between GBP and U.S. dollars of 1.56. Additionally, in 2006, Chaucer issued $50 million aggregate principal amount of floating rate subordinated unsecured notes due September 21, 2036. These notes pay interest quarterly based on the U.S. dollar 3-month Libor, plus an agreed margin of 3.1%.

On August 2, 2011, the Company entered into a $200.0 million committed syndicated credit agreement which expires in August 2015. Borrowings, if any, under this agreement are unsecured and incur interest at a rate per annum equal to, at the Company’s option, a designated base rate or the U.S. dollar Libor plus applicable margin. The agreement provides covenants, including but not limited to, requirements to maintain a certain level of consolidated equity, consolidated leverage ratios, and an RBC ratio in the Company’s primary U.S. domiciled property and casualty companies of 175%. There were no borrowings under this agreement during 2011.

In 2010, Chaucer entered into a £90.0 million Standby Letter of Credit Facility (Standby Facility) that is used to provide regulatory capital supporting Chaucer’s underwriting through two managed syndicates. The Standby Facility expires on December 31, 2015. Chaucer pays an annual commitment fee of 1.14 percent. The Standby Facility contains restrictive financial covenants, including but not limited to, maintaining a minimum consolidated tangible net worth and a leverage ratio of less than or equal to 35 percent for Chaucer. We collateralized £10 million of the facility under the terms of the agreement. We were in compliance with the covenants at September 30, 2011.

5. Income Taxes

Income tax expense for the nine months ended September 30, 2011 and 2010 has been computed using estimated effective tax rates. In the third quarter of 2011, the Company revised its estimated annual effective tax rate to include the tax effect of non-U.S. income resulting from its acquisition of Chaucer.

For the nine months ended September 30, 2011, the tax provision is comprised of a $34.0 million U.S. federal income tax benefit and $7.3 million in foreign income taxes. For the nine months ended September 30, 2010, the tax provision was comprised of $39.7 million in U.S. federal income tax expense.

Certain of the Company’s non-U.S. income is not subject to U.S. tax until repatriated, since these earnings currently are expected to be permanently reinvested overseas. Foreign taxes on this non – U.S. income is accrued at the local foreign tax rate and do not have an accrual for U.S. deferred taxes. This assumption could change, as a result of a sale of the subsidiaries, the receipt of dividends from the subsidiaries, a change in management’s intentions, or as a result of various other events. It is not practical to calculate the residual income tax which would result if any of these events occurred, due to the complexities of the tax law and the hypothetical nature of such calculations.

The Company and its domestic subsidiaries file a consolidated federal income tax return with the U.S. Internal Revenue Service. The Company is no longer subject to U.S. federal income tax examinations for years prior to 2005. Certain issues remain open for the 2005 through 2008 tax years. In addition, the Company and its subsidiaries file income tax returns in various state and foreign jurisdictions and are generally not subject to state income tax examinations for years prior to 2002 and foreign examinations for years prior to 2009.

 

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6. Pension and Other Postretirement Benefit Plans

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

 

     Three Months Ended September 30,  

(in millions)

   2011     2010     2011     2010  
     Pension Benefits     Postretirement Benefits  

Service cost – benefits earned during the period

        
   $ 0.4      $ 0.1      $ 0.1      $ —     

Interest cost

     9.2        8.2        0.6        0.7   

Expected return on plan assets

     (9.9     (8.8     —          —     

Recognized net actuarial loss

     3.8        4.2        0.1        0.1   

Amortization of transition asset

     —          (0.4     —          —     

Amortization of prior service cost

     —          —          (1.3     (1.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 3.5      $ 3.3      $ (0.5   $ (0.7
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Nine Months Ended September 30,  

(in millions)

   2011     2010     2011     2010  
     Pension Benefits     Postretirement Benefits  

Service cost – benefits earned during the period

   $ 0.4      $ 0.1      $ 0.1      $ 0.1   

Interest cost

     25.0        24.5        1.8        2.0   

Expected return on plan assets

     (27.0     (26.3     —          —     

Recognized net actuarial loss

     11.3        12.6        0.3        0.3   

Amortization of transition asset

     —          (1.2     —          —     

Amortization of prior service cost

     —          —          (3.9     (4.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 9.7      $ 9.7      $ (1.7   $ (2.0
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s net periodic pension cost for defined benefit pension plans recognized during the three and nine months ended September 30, 2011 includes expenses for the period from July 1, 2011 through September 30, 2011 related to defined benefit plan obligations assumed with the acquisition of Chaucer.

 

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7. Investments

A. Fixed maturities and equity securities

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

 

     September 30, 2011  

(in millions)

   Amortized
Cost or
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized

Losses
     Fair
Value
     OTTI
Unrealized
Losses
 

Fixed maturities:

              

U.S. Treasury and government agencies

   $ 272.0       $ 7.3       $ 0.3       $ 279.0       $ —     

Foreign government

     302.6         0.4         0.1         302.9         —     

Municipal

     970.0         67.2         4.3         1,032.9         —     

Corporate

     3,150.7         188.3         47.6         3,291.4         15.7   

Residential mortgage-backed

     825.7         47.0         8.0         864.7         6.3   

Commercial mortgage-backed

     338.1         9.3         1.3         346.1         —     

Asset-backed

     107.0         4.0         0.4         110.6         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

   $ 5,966.1       $ 323.5       $ 62.0       $ 6,227.6       $ 22.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

   $ 249.2       $ 9.7       $ 12.6       $ 246.3       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2010  
     Amortized
Cost or
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized

Losses
     Fair
Value
     OTTI
Unrealized
Losses
 

Fixed maturities:

              

U.S. Treasury and government agencies

   $ 259.4       $ 5.0       $ 3.2       $ 261.2       $ —     

Municipal

     952.7         21.3         19.3         954.7         —     

Corporate

     2,276.0         174.6         30.2         2,420.4         19.5   

Residential mortgage-backed

     704.2         41.8         11.9         734.1         8.3   

Commercial mortgage-backed

     349.3         18.3         1.0         366.6         —     

Asset-backed

     57.2         3.7         —           60.9         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

   $ 4,598.8       $ 264.7       $ 65.6       $ 4,797.9       $ 27.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

   $ 120.7       $ 9.8       $ 1.9       $ 128.6       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Other-than-temporary impairments (“OTTI”) unrealized losses in the tables above represent OTTI recognized in accumulated other comprehensive income. This amount excludes net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date of $26.2 million and $36.1 million as of September 30, 2011 and December 31, 2010, respectively.

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

 

(in millions)

   September 30, 2011  
   Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ 634.1       $ 636.1   

Due after one year through five years

     1,802.7         1,870.2   

Due after five years through ten years

     1,594.0         1,696.1   

Due after ten years

     664.5         703.8   
  

 

 

    

 

 

 
     4,695.3         4,906.2   

Mortgage-backed and asset-backed securities

     1,270.8         1,321.4   
  

 

 

    

 

 

 

Total fixed maturities

   $ 5,966.1       $ 6,227.6   
  

 

 

    

 

 

 

 

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Table of Contents

B. Securities in an unrealized loss position

The following tables provide information about the Company’s fixed maturities and equity securities that were in an unrealized loss position at September 30, 2011 and December 31, 2010.

 

     September 30, 2011  
     12 months or less      Greater than 12 months      Total  

(in millions)

   Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value  

Fixed maturities:

                 

Investment grade:

                 

U.S. Treasury and government agencies

   $ 0.3       $ 26.8       $ —         $ —         $ 0.3       $ 26.8   

Foreign governments

     0.1         155.1         —           —           0.1         155.1   

Municipal

     0.5         31.4         3.8         66.0         4.3         97.4   

Corporate

     24.5         851.8         4.0         21.6         28.5         873.4   

Residential mortgage-backed

     4.7         76.8         2.6         10.8         7.3         87.6   

Commercial mortgage-backed

     0.8         60.2         0.5         4.5         1.3         64.7   

Asset-backed

     0.1         34.2         —           —           0.1         34.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment grade

     31.0         1,236.3         10.9         102.9         41.9         1,339.2   

Below investment grade:

                 

Corporate

     18.1         206.2         1.0         1.5         19.1         207.7   

Residential mortgage-backed

     0.7         11.4         —           —           0.7         11.4   

Asset-backed

     0.3         1.1         —           —           0.3         1.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total below investment grade

     19.1         218.7         1.0         1.5         20.1         220.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     50.1         1,455.0         11.9         104.4         62.0         1,559.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

     12.4         160.9         0.2         1.3         12.6         162.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 62.5       $ 1,615.9       $ 12.1       $ 105.7       $ 74.6       $ 1,721.6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     12 months or less      Greater than 12 months      Total  

(in millions)

   Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value  

Fixed maturities:

                 

Investment grade:

                 

U.S. Treasury and government agencies

   $ 2.7       $ 84.9       $ 0.5       $ 16.4       $ 3.2       $ 101.3   

Municipal

     10.3         289.1         9.0         86.7         19.3         375.8   

Corporate

     6.7         256.1         10.5         66.8         17.2         322.9   

Residential mortgage-backed

     3.1         89.1         8.8         31.0         11.9         120.1   

Commercial mortgage-backed

     0.1         13.1         0.9         7.3         1.0         20.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment grade

     22.9         732.3         29.7         208.2         52.6         940.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Below investment grade:

                 

Corporate

     1.0         51.1         12.0         90.0         13.0         141.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     23.9         783.4         41.7         298.2         65.6         1,081.6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

     1.9         45.8         —           —           1.9         45.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 25.8       $ 829.2       $ 41.7       $ 298.2       $ 67.5       $ 1,127.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company employs a systematic methodology to evaluate declines in fair value below amortized cost for fixed maturity securities or cost for equity securities. In determining OTTI of fixed maturity and equity securities, the Company evaluates several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below the Company’s cost. With respect to fixed maturity investments, the Company considers any factors that might raise doubt about the issuer’s ability to pay all amounts due according to the

 

16


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contractual terms and whether the Company expects to recover the entire amortized cost basis of the security. With respect to equity securities, the Company considers its ability and intent to hold the investment for a period of time to allow for a recovery in value. The Company applies these factors to all securities.

C. Proceeds from sales

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

 

     Three Months Ended September 30,  
     2011      2010  

(in millions)

   Proceeds
from Sales
     Gross
Gains
     Gross
Losses
     Proceeds
from Sales
     Gross
Gains
     Gross
Losses
 

Fixed maturities

   $ 188.5       $ 2.2       $ 0.1       $ 195.2       $ 8.4       $ 0.1   

Equity securities

     14.1         1.1         0.1         —           —           —     

 

     Nine Months Ended September 30,  
     2011      2010  

(in millions)

   Proceeds
from
Sales
     Gross
Gains
     Gross
Losses
     Proceeds
from
Sales
     Gross
Gains
     Gross
Losses
 

Fixed maturities

   $ 592.3       $ 18.1       $ 1.1       $ 371.3       $ 17.9       $ 1.4   

Equity securities

     15.9         1.5         0.1         25.8         6.2         —     

D. Derivative Instruments

The Company maintains an overall risk management strategy that may incorporate the use of derivative instruments to manage significant unplanned fluctuations in earnings that may be caused by foreign currency exchange and interest rate volatility.

In April 2011, the Company entered into a foreign currency forward contract as an economic hedge of the foreign currency exchange risk embedded in the purchase price of Chaucer, which was denominated in GBP. For the three months and nine months ended September 30, 2011, the Company recorded a loss of $6.6 million and $11.3 million, respectively, reflected in other operating expenses in the Consolidated Statements of Income. This contract had a notional amount of £297.9 million and was settled on July 14, 2011. Since a foreign currency hedge in which the hedged item is a forecasted transaction relating to a business combination does not qualify for hedge accounting under ASC 815, Derivatives and Hedging (“ASC 815”), the Company did not apply hedge accounting to this transaction. See Note 3 – “Acquisitions” for additional information.

In May 2011, the Company entered into a treasury lock forward agreement to hedge the interest rate risk associated with the planned issuance of senior debt, which was completed on June 17, 2011. This hedge qualified as a cash flow hedge under ASC 815. It matured in June 2011 and resulted in a loss of $1.9 million, which was recorded in accumulated other comprehensive income and will be recognized as an expense over the term of the senior notes. All components of the derivative’s loss were included in the assessment of hedge effectiveness. There was no ineffectiveness on this hedge. The Company expects $0.2 million to be reclassified into expense over the next 12 months.

During the third quarter of 2011, Chaucer held foreign currency forward contracts utilized to mitigate changes in fair value caused by foreign currency fluctuation in converting the fair value of Sterling and Euro denominated investment portfolios into their U.S. dollar denominated equivalent. During the third quarter, the Company recognized a gain of $6.5 million related to these instruments, reflected in net realized investment gains in the Consolidated Statements of Income. All Chaucer forward contracts were terminated in October 2011.

E. Other Investments

Other investments consist primarily of overseas deposits, which are investments maintained in overseas funds and managed exclusively by Lloyd’s. These funds are required in order to protect policyholders in overseas markets and enable the Company to operate in those markets. Also included in other investments are investments in limited partnerships, which are accounted for by the equity method of accounting or at cost.

 

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F. Other-than-temporary impairments

For the three months ended September 30, 2011, total OTTI of fixed maturities were $1.1 million. Of this amount, $1.5 million was recognized in earnings, including $0.4 million that was transferred from unrealized losses in accumulated other comprehensive income. For the first nine months of 2011, total OTTI of fixed maturities and equity securities were $2.8 million. Of this amount, $3.7 million was recognized in earnings, including $0.9 million that was transferred from unrealized losses in accumulated other comprehensive income.

For the three months ended September 30, 2010, total OTTI of fixed maturities were $0.2 million. Of this amount, $1.4 million was recognized in earnings, including $1.2 million that was transferred from unrealized losses in other comprehensive income. For the first nine months of 2010, total OTTI of fixed maturities and equity securities were $3.5 million. Of this amount, $7.5 million was recognized in earnings, including $4.0 million that was transferred from unrealized losses in accumulated other comprehensive income.

The methodology and significant inputs used to measure the amount of credit losses on fixed maturities in 2011 and 2010 were as follows:

Asset-backed securities, including commercial and residential mortgage-backed securities - the Company utilized cash flow estimates based on bond specific facts and circumstances that include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including subordination and guarantees.

Corporate bonds – the Company utilized a financial model that derives expected cash flows based on probability-of-default factors by credit rating and asset duration and loss-given-default factors based on security type. These factors are based on historical data provided by an independent third-party rating agency.

The following table provides rollforwards of the cumulative amounts related to the Company’s credit loss portion of the OTTI losses on fixed maturity securities for which the non-credit portion of the loss is included in other comprehensive income.

 

(in millions)

   Three Months
Ended
September 30
    Nine Months
Ended
September 30,
 
   2011     2010     2011     2010  

Credit losses, beginning of period

   $ 14.8      $ 19.5      $ 16.7      $ 20.0   

Credit losses for which an OTTI was not previously recognized

     —          —          —          0.3   

Additional credit losses on securities for which an OTTI was previously recognized

     0.4        0.2        0.6        2.4   

Reductions for securities sold or matured during the period

     (0.3     (2.9     (1.6     (5.9

Reduction for securities reclassified as intend to sell

     —          (0.4     (0.8     (0.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Credit losses, end of period

   $ 14.9      $ 16.4      $ 14.9      $ 16.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

G. Restricted assets

In accordance with Lloyd’s operating guidelines, the Company deposits funds at Lloyd’s to support underwriting operations. These funds are available only to fund claim obligations. These restricted assets consisted of approximately $392 million of fixed maturities and $99 million of cash and cash equivalents as of September 30, 2011. The Company also deposits funds with various state and governmental authorities in the U.S. For a discussion of the Company’s deposits with state and governmental authorities, see also Note 4 – “Investments” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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Table of Contents

8. Fair Value

The Company follows the guidance in ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), as it relates to the fair value of its financial assets and liabilities. ASC 820 provides for a standard definition of fair value to be used in new and existing pronouncements. This guidance requires disclosure of fair value information about certain financial instruments (insurance contracts, real estate, goodwill and taxes are excluded) for which it is practicable to estimate such values, whether or not these instruments are included in the balance sheet at fair value. The fair values presented for certain financial instruments are estimates which, in many cases, may differ significantly from the amounts that could be realized upon immediate liquidation.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, i.e., exit price, in an orderly transaction between market participants and also provides a hierarchy for determining fair value, which emphasizes the use of observable market data whenever available. The three broad levels defined by the hierarchy are as follows, with the highest priority given to Level 1 as these are the most reliable, and the lowest priority given to Level 3.

Level 1 – Quoted prices in active markets for identical assets.

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

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

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

The following methods and assumptions were used to estimate the fair value of each class of financial instruments. Except for a discussion on foreign government fixed maturities and other investments, which have been added as a result of the acquisition of Chaucer, these methods and assumptions have not changed since last year.

Cash and Cash Equivalents

The carrying amount approximates fair value.

Fixed Maturities

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

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

 

   

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

 

   

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

 

   

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

 

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

 

   

Residential mortgage-backed securities – estimates of prepayment speeds based upon: historical prepayment rate trends; underlying collateral interest rates; geographic concentration; vintage year; borrower credit quality characteristics; interest rate and yield curve forecasts; U.S. government support programs; tax policies; and delinquency/default trends; and, in the case of non-agency collateralized mortgage obligations, severity of loss upon default and length of time to recover proceeds following default.

 

   

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

 

   

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

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

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

Equity Securities

Level 1 includes publicly traded securities valued at quoted market prices. Level 2 includes securities that are valued using pricing for similar securities and pricing models that incorporate observable inputs. Level 2 also includes fair values obtained from net asset values provided by mutual fund investment managers, upon which subscriptions and redemptions can be executed. Level 3 consists of common or preferred stock of private companies for which observable inputs are not available.

The Company utilizes a third party pricing service for the valuation of the majority of its equity securities and receives one quote for each equity security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Generally, all prices provided by the pricing service, except quoted market prices, are reported as Level 2. The company holds certain equity securities that have been issued by privately-held entities that do not have an active market and for which the pricing service cannot provide fair values. Generally, the Company estimates fair value for these securities based on the issuer’s book value and market multiples. These securities are reported as Level 3.

Mortgage Loans

Fair values are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.

Other Investments

Fair values of overseas trust funds are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2.

Derivative Instruments

The Company’s derivatives are traded in the over-the-counter (“OTC”) derivative market and are classified as Level 2 in the fair value hierarchy. The Company’s counterparties in the derivative agreements are highly rated major financial institutions. OTC derivatives classified as Level 2 are valued using discounted cash flow models widely accepted in the financial services industry that use actively quoted or observable market input values from external market data providers, third party pricing vendors and/or recent trading activity. Key assumptions include the contractual terms of the contracts along with significant observable inputs including currency rates, interest rates and non-performance risk. The Company uses mid-market pricing in determining its best estimate of fair value.

 

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Table of Contents

Legal Indemnities

Fair values are estimated using probability-weighted discounted cash flow analyses.

Debt

If available, the fair value of debt is estimated based on quoted market prices. If a quoted market price is not available, fair values are estimated using discounted cash flows that are based on current interest rates and yield curves for debt issuances with maturities and credit risks consistent with the debt being valued.

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

 

(in millions)

   September 30, 2011      December 31, 2010  
     Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
 

Financial Assets

           

Cash and cash equivalents

   $ 922.7       $ 922.7       $ 290.4       $ 290.4   

Fixed maturities

     6,227.6         6,227.6         4,797.9         4,797.9   

Equity securities

     246.3         246.3         128.6         128.6   

Mortgage loans

     4.9         5.2         5.5         5.8   

Other investments

     143.9         143.9         —           —     

Derivative instruments

     5.4         5.4         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total financial assets

   $ 7,550.8       $ 7,551.1       $ 5,222.4       $ 5,222.7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial Liabilities

           

Legal indemnities

     5.6         5.6         5.4         5.4   

Debt

     901.6         986.2         605.9         603.9   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total financial liabilities

   $ 907.2       $ 991.8       $ 611.3       $ 609.3   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company performs a review of the fair value hierarchy classifications and of prices received from its third party pricing service on a quarterly basis. The Company reviews the pricing services’ policy describing its processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing. Securities with changes in prices that exceed a defined threshold are verified to independent sources. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2011 and 2010, the Company did not adjust any prices received from brokers or its pricing service.

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

 

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Table of Contents

The following tables provide, for each hierarchy level, the Company’s assets at September 30, 2011 and December 31, 2010 that are measured at fair value on a recurring basis. Equity securities exclude FHLBB common stock of $8.9 million at September 30, 2011 and $8.6 million at December 31, 2010, which is carried at cost.

 

     September 30, 2011  

(in millions)

   Total      Level 1      Level 2      Level 3  

Fixed maturities:

           

U.S. Treasury and government agencies

   $ 279.0       $ 153.0       $ 126.0       $ —     

Foreign government

     302.9            302.9      

Municipal

     1,032.9         —           1,017.1         15.8   

Corporate

     3,291.4         —           3,268.9         22.5   

Residential mortgage-backed, U.S. agency backed

     701.0         —           701.0         —     

Residential mortgage-backed, non-agency

     163.7         —           158.2         5.5   

Commercial mortgage-backed

     346.1         —           333.9         12.2   

Asset-backed

     110.6         —           88.8         21.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     6,227.6         153.0         5,996.8         77.8   

Equity securities

     237.4         122.9         89.0         25.5   

Other investments

     143.9         —           143.9         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment assets at fair value

   $ 6,608.9       $ 275.9       $ 6,229.7       $ 103.3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative instruments

   $ 5.4       $ —         $ 5.4       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2010  
     Total      Level 1      Level 2      Level 3  

Fixed maturities:

           

U.S. Treasury and government agencies

   $ 261.2       $ 124.0       $ 137.2       $ —     

Municipal

     954.7         —           938.1         16.6   

Corporate

     2,420.4         —           2,392.2         28.2   

Residential mortgage-backed, U.S. agency backed

     600.4         —           600.4         —     

Residential mortgage-backed, non-agency

     133.7         —           132.9         0.8   

Commercial mortgage-backed

     366.6         —           361.1         5.5   

Asset-backed

     60.9         —           47.4         13.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     4,797.9         124.0         4,609.3         64.6   

Equity securities

     120.0         106.6         10.5         2.9   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment assets at fair value

   $ 4,917.9       $ 230.6       $ 4,619.8       $ 67.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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

 

     Fixed Maturities              

(in millions)

   Municipal     Corporate     Residential
mortgage-
backed,
non-agency
    Commercial
mortgage-
backed
    Asset-
backed
    Total     Equities     Total
Assets
 

Three Months Ended September 30, 2011

                

Balance July 1, 2011

   $ 16.1      $ 36.8      $ 0.5      $ 5.1      $ 13.5      $ 72.0      $ 2.9      $ 74.9   

Transfers into Level 3

     —          6.9        —          —          —          6.9        —          6.9   

Transfers out of Level 3

     —          (8.8     (0.5     —          —          (9.3     —          (9.3

Total gains (losses):

                

Included in earnings

     —          0.1        —          —          —          0.1        —          0.1   

Included in other comprehensive income

     —          (0.3     —          —          (0.2     (0.5     (1.6     (2.1

Purchases and sales:

                

Purchases

     —          —          —          7.3        —          7.3        —          7.3   

Chaucer acquisition

     —          0.1        5.6        —          8.8        14.5        24.2        38.7   

Sales

     (0.3     (12.3     (0.1     (0.2     (0.3     (13.2     —          (13.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance September 30, 2011

   $ 15.8      $ 22.5      $ 5.5      $ 12.2      $ 21.8      $ 77.8      $ 25.5      $ 103.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended September 30, 2010

                

Balance July 1, 2010

   $ 14.9      $ 31.2      $ 1.1      $ 5.9      $ 15.7      $ 68.8      $ 2.8      $ 71.6   

Transfers into Level 3

     —          3.3        —          —          —          3.3        —          3.3   

Transfers out of Level 3

     —          (2.7     —          —          —          (2.7     —          (2.7

Total gains:

                

Included in earnings

     —          —          —          —          0.1        0.1        —          0.1   

Included in other comprehensive income

     0.1        0.3        —          —          0.4        0.8        —          0.8   

Purchases and sales:

                

Purchases

     —          0.4        —          —          —          0.4        1.0        1.4   

Sales

     (0.4     (0.3     (0.1     (0.2     (1.8     (2.8     —          (2.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance September 30, 2010

   $ 14.6      $ 32.2      $ 1.0      $ 5.7      $ 14.4      $ 67.9      $ 3.8      $ 71.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2011

                

Balance January 1, 2011

   $ 16.6      $ 28.2      $ 0.8      $ 5.5      $ 13.5      $ 64.6      $ 2.9      $ 67.5   

Transfers into Level 3

     —          10.6        —          —          —          10.6        —          10.6   

Transfers out of Level 3

     —          (15.3     (0.5     —          —          (15.8     —          (15.8

Total gains (losses):

                

Included in earnings

     —          0.1        —          —          —          0.1        (0.5     (0.4

Included in other comprehensive income

     0.1        —          —          —          0.1        0.2        (1.1     (0.9

Purchases and sales:

                

Purchases

     —          11.8        —          7.3        —          19.1        —          19.1   

Chaucer acquisition

     —          0.1        5.6        —          8.8        14.5        24.2        38.7   

Sales

     (0.9     (13.0     (0.4     (0.6     (0.6     (15.5     —          (15.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance September 30, 2011

   $ 15.8      $ 22.5      $ 5.5      $ 12.2      $ 21.8      $ 77.8      $ 25.5      $ 103.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2010

                

Balance January 1, 2010

   $ 15.5      $ 28.9      $ —        $ 6.2      $ 9.2      $ 59.8      $ 2.8      $ 62.6   

Transfers into Level 3

     —          9.9        —          —          6.9        16.8        —          16.8   

Transfer out of Level 3

     —          (2.7     —          —          (2.0     (4.7     —          (4.7

Total gains (losses):

                

Included in earnings

     —          0.1        —          —          0.1        0.2        (0.3     (0.1

Included in other comprehensive income

     0.3        1.3        —          —          0.6        2.2        0.3        2.5   

Purchases and sales:

                

Purchases

     —          0.7        1.4        —          2.0        4.1        1.0        5.1   

Sales

     (1.2     (6.0     (0.4     (0.5     (2.4     (10.5     —          (10.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance September 30, 2010

   $ 14.6      $ 32.2      $ 1.0      $ 5.7      $ 14.4      $ 67.9      $ 3.8      $ 71.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

During the nine months ended September 30, 2011 and 2010, the Company transferred fixed maturities between Level 2 and Level 3 primarily as a result of assessing the significance of unobservable inputs on the fair value measurement. There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2011 or 2010.

The following table summarizes gains and losses due to changes in fair value that are recorded in net income for Level 3 assets.

 

     Three Months Ended September 30,  
   2011      2010  

(in millions)

   Other-than-
temporary
impairments
     Net realized
investment
gains
     Total      Other-than-
temporary
impairments
     Net realized
investment
gains
     Total  

Level 3 Assets:

                 

Fixed maturities:

                 

Corporate

   $ —         $ 0.1       $ 0.1       $ —         $ —         $ —     

Asset Backed

     —           —           —           —           0.1         0.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ —         $ 0.1       $ 0.1       $ —         $ 0.1       $ 0.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Nine Months Ended September 30,  
   2011     2010  

(in millions)

   Other-than-
temporary
impairments
    Net realized
investment
gains
     Total     Other-than-
temporary
impairments
    Net realized
investment
gains
     Total  

Level 3 Assets:

              

Fixed maturities:

              

Corporate

   $ —        $ 0.1       $ 0.1      $ —        $ 0.1       $ 0.1   

Asset Backed

     —          —           —          —          0.1         0.1   

Equity securities

     (0.5     —           (0.5     (0.3     —           (0.3
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total assets

   $ (0.5   $ 0.1       $ (0.4   $ (0.3   $ 0.2       $ (0.1
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

There were no Level 3 liabilities held by the Company for the nine months ended September 30, 2011 and 2010.

 

24


Table of Contents

9. Other Comprehensive Income

The following table provides a reconciliation of gross unrealized investment gains (losses) to the net balance shown in the Consolidated Statements of Comprehensive Income:

 

     Three Months Ended September 30,  
   2011      2010  

(in millions)

   Pre-Tax      Tax Benefit
(Expense)
    Net of Tax      Pre-Tax      Tax Benefit
(Expense)
    Net of Tax  

Unrealized gains on available-for- sale securities:

               

Unrealized gains arising during period

   $ 15.4       $ 7.8      $ 23.2       $ 110.8       $ (26.4   $ 84.4   

Less: reclassification adjustments for gains realized in net income

     8.4         (1.9     6.5         9.4         (0.5     8.9   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

     7.0         9.7        16.7         101.4         (25.9     75.5   

Unrealized losses on derivative instruments:

               

Unrealized losses arising during period

     0.1         (0.1     —           —           —          —     
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Other comprehensive income

   $ 7.1       $ 9.6      $ 16.7       $ 101.4       $ (25.9   $ 75.5   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

     Nine Months Ended September 30,  
   2011     2010  

(in millions)

   Pre-Tax     Tax Benefit
(Expense)
     Net of Tax     Pre-Tax      Tax Benefit
(Expense)
    Net of Tax  

Unrealized gains on available-for- sale securities:

              

Unrealized gains arising during period

   $ 74.6      $ 12.9       $ 87.5      $ 245.8       $ (58.1   $ 187.7   

Less: reclassification adjustments for gains realized in net income

     24.7        2.4         27.1        18.7         (0.7     18.0   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

     49.9        10.5         60.4        227.1         (57.4     169.7   

Unrealized losses on derivative instruments:

              

Unrealized losses arising during period

     (1.8     0.6         (1.2     —           —          —     
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income

   $ 48.1      $ 11.1       $ 59.2      $ 227.1       $ (57.4   $ 169.7   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

10. Segment Information

The Company’s primary business operations include insurance products and services provided through four operating segments. These operating segments are Commercial Lines, Personal Lines, Other Property and Casualty and, with the acquisition on July 1, 2011, the Chaucer segment. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as specialty program business, inland marine, surety and other bonds, professional liability and management liability. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes property, marine and aviation, energy, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). The Other Property and Casualty segment consists of: Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a voluntary pools business which is in run-off. The segment financial information is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

The Company’s consolidated net income (loss) includes the results of its four operating segments (segment income (loss)), which management evaluates on a pre-tax basis, and interest expense on debt. Segment income (loss) excludes certain items which are included in net income (loss), such as income taxes and net realized investment gains and losses, including gains and losses from certain derivative instruments because fluctuations in these gains and losses are determined by interest rates, financial markets and timing of sales. Also, segment income (loss) excludes net gains and losses on disposals of businesses, discontinued operations, costs to acquire businesses, restructuring costs, extraordinary items, the cumulative effect of accounting changes and certain other items. Although the items excluded from segment income (loss) may be significant components in understanding and assessing the Company’s financial

 

25


Table of Contents

performance, management believes that the presentation of segment income enhances an investor’s understanding of the Company’s results of operations by highlighting net income attributable to the core operations of the business. However, segment income (loss) should not be construed as a substitute for net income (loss) determined in accordance with generally accepted accounting principles.

Summarized below is financial information with respect to business segments:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

   2011     2010     2011     2010  

Segment revenues:

        

Commercial Lines

   $ 449.4      $ 397.2      $ 1,336.6      $ 1,099.3   

Personal Lines

     389.9        397.1        1,164.8        1,190.3   

Chaucer

     257.5        —          257.5        —     

Other Property and Casualty

     4.2        5.1        15.6        15.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     1,101.0        799.4        2,774.5        2,305.5   

Intersegment revenues

     (1.2     (1.1     (3.7     (3.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     1,099.8        798.3        2,770.8        2,302.1   

Net realized investment gains

     8.2        5.7        24.9        16.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 1,108.0      $ 804.0      $ 2,795.7      $ 2,318.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment income (loss) before income taxes:

        

Commercial Lines:

        

GAAP underwriting income (loss)

   $ (56.7   $ 2.3      $ (132.0   $ (22.5

Net investment income

     34.0        32.3        101.6        96.6   

Other income

     0.6        0.5        2.0        0.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Commercial Lines segment income (loss)

     (22.1     35.1        (28.4     74.8   

Personal Lines:

        

GAAP underwriting income (loss)

     (28.9     15.2        (69.8     (8.7

Net investment income

     22.7        25.4        68.5        76.6   

Other income

     1.4        2.4        3.7        6.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Personal Lines segment income (loss)

     (4.8     43.0        2.4        74.0   

Chaucer:

        

GAAP underwriting income (loss)

     12.1        —          12.1        —     

Net investment income

     8.6        —          8.6        —     

Other net expenses

     (0.8     —          (0.8     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Chaucer segment income (loss)

     19.9        —          19.9        —     

Other Property and Casualty:

        

GAAP underwriting income (loss)

     —          0.4        0.1        0.7   

Net investment income

     2.5        3.6        10.5        11.0   

Other net expenses

     (3.1     (2.9     (9.1     (9.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Property and Casualty segment income (loss)

     (0.6     1.1        1.5        2.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (7.6     79.2        (4.6     151.5   

Interest expense on debt

     (17.4     (11.8     (38.6     (32.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment income (loss) before income taxes

     (25.0     67.4        (43.2     118.7   

Adjustments to segment income (loss):

        

Net realized investment gains

     8.2        5.7        24.9        16.8   

Net loss from retirement of debt

     (0.1     —          (2.3     —     

Costs related to acquired businesses

     (1.9     —          (15.7     —     

Loss on derivative instruments

     (6.6     —          (11.3     —     

Net foreign exchange gains

     6.7        —          6.7        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ (18.7   $ 73.1      $ (40.9   $ 135.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

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

 

(in millions)

   September 30,
2011
     December 31,
2010
 

U.S. Companies

   $ 8,468.4       $ 8,436.3   

Chaucer

     4,088.8         —     

Discontinued operations

     127.3         133.6   
  

 

 

    

 

 

 

Total

   $ 12,684.5       $ 8,569.9   
  

 

 

    

 

 

 

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

11. Stock-based Compensation

Compensation cost and the related tax benefits were as follows:

 

     Three Months  Ended
September 30,
    Nine Months  Ended
September 30,
 

(in millions)

   2011     2010     2011     2010  

Stock-based compensation expense

   $ 3.5      $ 3.1      $ 9.5      $ 8.6   

Tax benefit

     (1.2     (1.1     (3.3     (3.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense, net of taxes

   $ 2.3      $ 2.0      $ 6.2      $ 5.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock Options

Information on the Company’s stock option plan activity is summarized as follows:

 

     Nine Months Ended September 30,  
   2011      2010  

(in whole shares and dollars)

   Shares     Weighted
Average
Exercise Price
     Shares     Weighted
Average
Exercise Price
 

Outstanding, beginning of period

     2,843,909      $ 39.22         3,131,142      $ 39.16   

Granted

     297,000        46.47         389,750        42.45   

Exercised

     (118,014     33.13         (249,468     37.07   

Forfeited or cancelled

     (23,665     39.92         (138,760     45.12   

Expired

     (256,250     57.00         (125,400     44.91   
  

 

 

      

 

 

   

Outstanding, end of period

     2,742,980        38.60         3,007,264        39.25   
  

 

 

      

 

 

   

 

27


Table of Contents

Restricted Stock Units

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

 

     Nine Months Ended September 30,  
   2011      2010  

(in whole shares and dollars)

   Shares     Weighted
Average
Grant Date
Fair Value
     Shares     Weighted
Average
Grant Date
Fair Value
 

Time-based restricted stock units:

         

Outstanding, beginning of period

     838,129      $ 40.93         700,904      $ 41.12   

Granted

     179,319        42.85         352,445        42.62   

Vested

     (196,238     45.08         (117,583     47.97   

Forfeited

     (23,194     41.19         (78,104     40.58   
  

 

 

      

 

 

   

Outstanding, end of period

     798,016        40.33         857,662        40.85   
  

 

 

      

 

 

   

Performance-based restricted stock units:

         

Outstanding, beginning of period

     101,680      $ 39.62         145,635      $ 42.79   

Granted

     42,500        46.47         41,250        42.15   

Vested

     (25,055     45.21         (31,558     48.46   

Forfeited

     —