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Section 1: 10-Q (10-Q)

thg-10q_20180930.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended September 30, 2018

or

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

For the transition period from                      to                    

Commission File Number 1-13754

 

THE HANOVER INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

04-3263626

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

440 Lincoln Street, Worcester, Massachusetts 01653

(Address of principal executive offices) (Zip Code)

(508) 855-1000

(Registrant’s telephone number, including area code)

 

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

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

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

  

Smaller reporting company

 

 

Emerging growth company

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

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

The number of shares outstanding of the registrant’s common stock was 42,332,507 as of October 30, 2018.  

 

 

 

 

 

 

 

 

 

 


 

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

2

 

Consolidated Statements of Income

 

2

 

Consolidated Statements of Comprehensive Income

 

3

 

Consolidated Balance Sheets

 

4

 

Consolidated Statements of Shareholders’ Equity

 

5

 

Consolidated Statements of Cash Flows

 

6

 

Notes to Interim Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

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

 

31

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

54

 

 

 

 

Item 4.

Controls and Procedures

 

54

 

 

 

 

PART II.

OTHER INFORMATION

 

55

 

 

 

 

Item 1.

Legal Proceedings

 

55

 

 

 

 

Item 1A.

Risk Factors

 

55

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

58

 

 

 

 

Item 6.

Exhibits

 

59

 

 

 

 

SIGNATURES

 

60

 

 

 

 


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

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

(In millions, except per share data)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premiums

 

$

1,071.7

 

 

$

1,004.4

 

 

$

3,172.4

 

 

$

2,957.0

 

Net investment income

 

 

66.4

 

 

 

62.6

 

 

 

198.0

 

 

 

181.3

 

Net realized and unrealized investment gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net realized gains (losses) from sales and other

 

 

(0.2

)

 

 

14.6

 

 

 

(0.1

)

 

 

25.0

 

Net change in fair value of equity securities

 

 

23.6

 

 

 

 

 

 

6.7

 

 

 

 

Net other–than–temporary impairment losses on investments

   recognized in earnings

 

 

(0.4

)

 

 

(1.3

)

 

 

(2.8

)

 

 

(4.5

)

Total net realized and unrealized investment gains

 

 

23.0

 

 

 

13.3

 

 

 

3.8

 

 

 

20.5

 

Fees and other income

 

 

5.5

 

 

 

5.6

 

 

 

17.3

 

 

 

16.6

 

Total revenues

 

 

1,166.6

 

 

 

1,085.9

 

 

 

3,391.5

 

 

 

3,175.4

 

Losses and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

676.4

 

 

 

656.5

 

 

 

2,018.5

 

 

 

1,938.2

 

Amortization of deferred acquisition costs

 

 

224.4

 

 

 

211.4

 

 

 

664.7

 

 

 

625.6

 

Interest expense

 

 

11.2

 

 

 

11.3

 

 

 

33.9

 

 

 

33.9

 

Other operating expenses

 

 

131.9

 

 

 

124.0

 

 

 

393.0

 

 

 

380.1

 

Total losses and expenses

 

 

1,043.9

 

 

 

1,003.2

 

 

 

3,110.1

 

 

 

2,977.8

 

Income from continuing operations before income taxes

 

 

122.7

 

 

 

82.7

 

 

 

281.4

 

 

 

197.6

 

Income tax expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

16.2

 

 

 

16.8

 

 

 

27.1

 

 

 

8.6

 

Deferred

 

 

2.5

 

 

 

6.4

 

 

 

17.4

 

 

 

44.8

 

Total income tax expense

 

 

18.7

 

 

 

23.2

 

 

 

44.5

 

 

 

53.4

 

Income from continuing operations

 

$

104.0

 

 

$

59.5

 

 

$

236.9

 

 

$

144.2

 

Income (loss) from discontinued Chaucer business (net of

   income tax benefit (expense) of $1.1 and $26.6 for the

   three months ended September 30, 2018 and 2017,

   respectively, and ($6.6) and $10.4 for the nine months

   ended September 30, 2018 and 2017, respectively)

 

 

(3.6

)

 

 

(47.2

)

 

 

30.5

 

 

 

(8.3

)

Net loss from discontinued life business (net of tax benefit

   of $0.8 for the three and nine months ended

   September 30, 2017)

 

 

 

 

 

(1.2

)

 

 

 

 

 

(1.2

)

Net income

 

$

100.4

 

 

$

11.1

 

 

$

267.4

 

 

$

134.7

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

2.45

 

 

$

1.40

 

 

$

5.57

 

 

$

3.39

 

Income (loss) from discontinued Chaucer business

 

 

(0.09

)

 

 

(1.11

)

 

 

0.72

 

 

 

(0.19

)

Net loss from discontinued life business

 

 

 

 

 

(0.03

)

 

 

 

 

 

(0.03

)

Net income per share

 

$

2.36

 

 

$

0.26

 

 

$

6.29

 

 

$

3.17

 

Weighted average shares outstanding

 

 

42.5

 

 

 

42.4

 

 

 

42.5

 

 

 

42.5

 

Diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

2.41

 

 

$

1.38

 

 

$

5.50

 

 

$

3.36

 

Income (loss) from discontinued Chaucer business

 

 

(0.08

)

 

 

(1.10

)

 

 

0.71

 

 

 

(0.19

)

Net loss from discontinued life business

 

 

 

 

 

(0.02

)

 

 

 

 

 

(0.03

)

Net income per share

 

$

2.33

 

 

$

0.26

 

 

$

6.21

 

 

$

3.14

 

Weighted average shares outstanding

 

 

43.1

 

 

 

42.9

 

 

 

43.1

 

 

 

42.9

 

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

2


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

(In millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net income

 

$

100.4

 

 

$

11.1

 

 

$

267.4

 

 

$

134.7

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (depreciation) appreciation during the period

 

 

(25.0

)

 

 

1.7

 

 

 

(197.9

)

 

 

40.0

 

Change in other-than-temporary impairment losses

   recognized in other comprehensive (loss) income

 

 

(0.2

)

 

 

2.0

 

 

 

0.1

 

 

 

2.5

 

Total available-for-sale securities

 

 

(25.2

)

 

 

3.7

 

 

 

(197.8

)

 

 

42.5

 

Pension and postretirement benefits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net change in net actuarial loss and prior service cost

 

 

1.9

 

 

 

2.3

 

 

 

0.5

 

 

 

7.0

 

Cumulative foreign currency translation adjustment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount recognized as cumulative foreign currency

   translation during the period

 

 

1.6

 

 

 

1.1

 

 

 

0.6

 

 

 

1.7

 

Total other comprehensive (loss) income, net of tax

 

 

(21.7

)

 

 

7.1

 

 

 

(196.7

)

 

 

51.2

 

Comprehensive income

 

$

78.7

 

 

$

18.2

 

 

$

70.7

 

 

$

185.9

 

 

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 BALANCE SHEETS (UNAUDITED)

 

 

 

September 30,

 

 

December 31,

 

(In millions, except share data)

 

2018

 

 

2017

 

Assets

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

Fixed maturities, at fair value (amortized cost of $6,204.3 and $5,657.1)

 

$

6,092.6

 

 

$

5,749.3

 

Equity securities, at fair value

 

 

574.8

 

 

 

576.2

 

Other investments

 

 

633.2

 

 

 

562.7

 

Total investments

 

 

7,300.6

 

 

 

6,888.2

 

Cash and cash equivalents

 

 

117.9

 

 

 

297.9

 

Accrued investment income

 

 

53.0

 

 

 

48.2

 

Premiums and accounts receivable, net

 

 

1,217.8

 

 

 

1,095.7

 

Reinsurance recoverable on paid and unpaid losses and unearned premiums

 

 

1,586.0

 

 

 

1,625.5

 

Deferred acquisition costs

 

 

456.9

 

 

 

430.0

 

Deferred income taxes

 

 

33.5

 

 

 

17.0

 

Goodwill

 

 

178.8

 

 

 

178.8

 

Other assets

 

 

330.0

 

 

 

333.7

 

Assets held-for-sale

 

 

4,247.2

 

 

 

4,466.6

 

Assets of discontinued life business

 

 

102.6

 

 

 

88.0

 

Total assets

 

$

15,624.3

 

 

$

15,469.6

 

Liabilities

 

 

 

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

5,188.9

 

 

$

5,058.5

 

Unearned premiums

 

 

2,314.4

 

 

 

2,131.7

 

Expenses and taxes payable

 

 

538.6

 

 

 

620.7

 

Reinsurance premiums payable

 

 

46.4

 

 

 

51.5

 

Debt

 

 

777.6

 

 

 

786.9

 

Liabilities held-for-sale

 

 

3,660.4

 

 

 

3,707.2

 

Liabilities of discontinued life business

 

 

115.6

 

 

 

115.4

 

Total liabilities

 

$

12,641.9

 

 

 

12,471.9

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

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

       60.5 million shares issued

 

 

0.6

 

 

 

0.6

 

Additional paid-in capital

 

 

1,868.9

 

 

 

1,857.0

 

Accumulated other comprehensive income (loss)

 

 

(190.8

)

 

 

107.6

 

Retained earnings

 

 

2,277.6

 

 

 

1,975.0

 

Treasury stock at cost (18.2 million and 18.0 million shares)

 

 

(973.9

)

 

 

(942.5

)

Total shareholders’ equity

 

 

2,982.4

 

 

 

2,997.7

 

Total liabilities and shareholders’ equity

 

$

15,624.3

 

 

$

15,469.6

 

 

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

4


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

(In millions)

 

2018

 

 

2017

 

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

 

 

1,857.0

 

 

 

1,846.7

 

Employee and director stock-based awards and other

 

 

11.9

 

 

 

9.7

 

Balance at end of period

 

 

1,868.9

 

 

 

1,856.4

 

Accumulated Other Comprehensive Income (Loss), net of tax

 

 

 

 

 

 

 

 

Net Unrealized Appreciation (Depreciation) on Investments:

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

205.4

 

 

 

186.0

 

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

 

 

(197.8

)

 

 

42.5

 

Adoption of Accounting Standards Update 2016-01 and 2018-02

 

 

(81.6

)

 

 

 

Balance at end of period

 

 

(74.0

)

 

 

228.5

 

Defined Benefit Pension and Postretirement Plans:

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(79.5

)

 

 

(102.5

)

Net change in net actuarial loss and prior service cost

 

 

0.5

 

 

 

7.0

 

Adoption of Accounting Standards Update 2018-02

 

 

(16.2

)

 

 

 

Balance at end of period

 

 

(95.2

)

 

 

(95.5

)

Cumulative Foreign Currency Translation Adjustment:

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(18.3

)

 

 

(20.7

)

Amount recognized as cumulative foreign currency translation during the period

 

 

0.6

 

 

 

1.7

 

Adoption of Accounting Standards Update 2018-02

 

 

(3.9

)

 

 

 

Balance at end of period

 

 

(21.6

)

 

 

(19.0

)

Total accumulated other comprehensive income (loss)

 

 

(190.8

)

 

 

114.0

 

Retained Earnings

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

1,975.0

 

 

 

1,875.6

 

Cumulative effect of accounting change, net of taxes

 

 

104.3

 

 

 

 

Balance at beginning of period, as adjusted

 

 

2,079.3

 

 

 

1,875.6

 

Net income

 

 

267.4

 

 

 

134.7

 

Dividends to shareholders

 

 

(69.1

)

 

 

(63.8

)

Balance at end of period

 

 

2,277.6

 

 

 

1,946.5

 

Treasury Stock

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(942.5

)

 

 

(928.2

)

Shares purchased at cost

 

 

(44.2

)

 

 

(37.2

)

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

 

 

12.8

 

 

 

19.9

 

Balance at end of period

 

 

(973.9

)

 

 

(945.5

)

Total shareholders’ equity

 

$

2,982.4

 

 

$

2,972.0

 

 

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

5


Table of Contents

 

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

(In millions)

 

2018

 

 

2017

 

Cash Flows From Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

267.4

 

 

$

134.7

 

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

 

 

 

 

 

 

 

 

Net realized and unrealized investment gains

 

 

(3.8

)

 

 

(21.2

)

Net amortization and depreciation

 

 

21.0

 

 

 

23.0

 

Stock-based compensation expense

 

 

12.1

 

 

 

11.5

 

Amortization of defined benefit plan costs

 

 

7.3

 

 

 

10.5

 

Deferred income tax (benefit) expense

 

 

5.8

 

 

 

(3.1

)

Net loss from repayment of debt

 

 

1.9

 

 

 

 

Change in deferred acquisition costs

 

 

(28.0

)

 

 

(45.0

)

Change in premiums receivable, net of reinsurance premiums payable

 

 

(134.2

)

 

 

(96.5

)

Change in loss, loss adjustment expense and unearned premium reserves

 

 

473.7

 

 

 

917.5

 

Change in reinsurance recoverable

 

 

(88.6

)

 

 

(337.4

)

Change in expenses and taxes payable

 

 

(49.7

)

 

 

(53.9

)

Other, net

 

 

(18.5

)

 

 

(7.9

)

Net cash provided by operating activities

 

 

466.4

 

 

 

532.2

 

Cash Flows From Investing Activities

 

 

 

 

 

 

 

 

Proceeds from disposals and maturities of fixed maturities

 

 

871.0

 

 

 

819.7

 

Proceeds from disposals of equity securities and other investments

 

 

77.3

 

 

 

138.2

 

Purchase of fixed maturities

 

 

(1,273.6

)

 

 

(1,296.9

)

Purchase of equity securities and other investments

 

 

(127.8

)

 

 

(139.8

)

Capital expenditures

 

 

(12.4

)

 

 

(10.7

)

Other investing activities

 

 

 

 

 

(9.7

)

Net cash used in investing activities

 

 

(465.5

)

 

 

(499.2

)

Cash Flows From Financing Activities

 

 

 

 

 

 

 

 

Proceeds from exercise of employee stock options

 

 

12.7

 

 

 

19.2

 

Change in cash collateral related to securities lending program

 

 

(8.3

)

 

 

(7.3

)

Dividends paid to shareholders

 

 

(68.9

)

 

 

(63.8

)

Repurchases of common stock

 

 

(44.2

)

 

 

(37.2

)

Repayment of debt

 

 

(11.6

)

 

 

-

 

Other financing activities

 

 

(3.2

)

 

 

(3.0

)

Net cash used in financing activities

 

 

(123.5

)

 

 

(92.1

)

Effect of exchange rate changes on cash

 

 

(2.5

)

 

 

3.7

 

Net change in cash and cash equivalents

 

 

(125.1

)

 

 

(55.4

)

Net change in cash related to discontinued operations

 

 

(54.9

)

 

 

27.7

 

Cash and cash equivalents, beginning of period

 

 

297.9

 

 

 

147.3

 

Cash and cash equivalents, end of period

 

$

117.9

 

 

$

119.6

 

 

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 in the United States of America (“U.S. GAAP”) for interim financial information and with the requirements of Form 10-Q. Certain financial information that is provided in annual financial statements, but is not required in interim reports, has been omitted.

The interim consolidated financial statements of THG include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America, THG’s principal 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 9 – “Segment Information”. On September 13, 2018, the Company entered into a definitive agreement to sell Chaucer Holdings Limited (“Chaucer”), a specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s and the international insurance and non-insurance subsidiaries, which collectively constitute our Chaucer segment, to China Reinsurance (Group) Corporation (“China Re”). Accordingly, as of September 30, 2018 and for all prior periods, Chaucer’s results have been presented as discontinued operations and its assets and liabilities have been classified as held-for-sale in the consolidated financial statements (see Note 3 – “Discontinued Operations”). The interim consolidated financial statements also include discontinued operations of the Company’s accident and health and former life insurance businesses. All intercompany accounts and transactions have been eliminated.

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

In the opinion of the Company’s management, the accompanying interim consolidated financial statements reflect all adjustments, consisting of normal recurring items, necessary for a fair presentation of the financial position and results of operations. The results of operations for the three and nine months ended September 30, 2018  are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s  Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 27, 2018.

2. New Accounting Pronouncements

Recently Implemented Standards

In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASC Update No. 2018-02 (Topic 220) Income Statement – Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  This ASC update allows for a reclassification into retained earnings of the stranded tax effects in accumulated other comprehensive income (“AOCI”) resulting from the enactment of the Tax Cuts and Jobs Act (“TCJA”). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts at the date of the enactment of the TCJA related to items in AOCI. The updated guidance is effective for interim and annual periods beginning after December 15, 2018.  Early adoption is permitted. The Company early adopted this guidance effective January 1, 2018 with a cumulative effect adjustment, which reclassified $6.5 million of benefits from AOCI to retained earnings with no overall impact on the Company’s financial position.

In March 2017, the FASB issued ASC Update No. 2017-07, (Topic 715) Compensation – Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This guidance requires that an employer report in its income statement the service cost component of both net periodic pension and net periodic postretirement benefit cost in the same line item or items as other compensation costs arising from services rendered by pertinent employees during the period, and present in the income statement separately from the other components of benefit cost, if appropriate under the company’s current presentation of its income statement. Additionally, the guidance allows only the service cost component to be eligible for capitalization when applicable. The updated guidance is effective for annual and interim periods beginning after December 15, 2017, and should be applied retrospectively for the presentation of the service cost component and other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement, and prospectively for the capitalization of the service cost component of net periodic cost in assets. The Company implemented this guidance effective January 1, 2018. The effect of implementing this guidance was not material to the Company’s financial position or results of operations as the Company does not have any service cost remaining related to its pension and postretirement plans.

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In January 2017, the FASB issued ASC Update No. 2017-01, (Topic 805) Business Combinations – Clarifying the Definition of a Business. The amendments in this update provide a more robust framework to use in determining when a set of assets and activities constitute a business. This guidance narrows the definition of a business by providing specific requirements that contribute to the creation of outputs that must be present to be considered a business. The guidance further clarifies the appropriate accounting when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets is that of an acquisition (disposition) of assets, not a business. This framework will reduce the number of transactions that an entity must further evaluate to determine whether transactions are business combinations or asset acquisitions. The updated guidance is effective for interim and annual periods beginning after December 15, 2017, and should be applied on a prospective basis. Early adoption is permitted only for transactions that have not been reported in financial statements that have been issued. The Company implemented this guidance effective January 1, 2018. The implementation of this guidance did not have an effect on the Company’s financial position or results of operations.

In November 2016, the FASB issued ASC Update No. 2016-18 (Topic 230) Statement of Cash Flows – Restricted Cash (a consensus of the FASB Emerging Issues Task Force). The amendments in this update require that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Current GAAP does not include specific guidance on the cash flow classification and presentation of changes in restricted cash. The updated guidance is effective for interim and annual periods beginning after December 15, 2017 and is required to be applied using a retrospective transition method to each period presented. The Company implemented this guidance effective January 1, 2018. Implementing this guidance did not have an impact on the Company’s statement of cash flows, as restricted cash, if any, has already been included in total cash and cash equivalents.

In October 2016, the FASB issued ASC Update No. 2016-16, (Topic 740) Income Taxes – Intra-Entity Transfers of Assets Other Than Inventory. Under current GAAP, the tax effects of intra-entity transfers of assets (intercompany sales) are deferred until the assets are sold to an outside party or otherwise recovered through use. This ASC update eliminates this deferral of taxes for assets other than inventory and requires the recognition of taxes when the transfer occurs. The updated guidance is effective for interim and annual periods beginning after December 15, 2017, and should be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings. Early adoption is permitted, but this election must be made in the first interim period of the adoption year. The Company implemented this guidance effective January 1, 2018. Implementation of this guidance did not have a net impact on the Company’s financial position or results of operations.

In August 2016, the FASB issued ASC Update No. 2016-15, (Topic 230) Classification of Certain Cash Receipts and Cash Payments. This ASC update provides specific guidance on the presentation of certain cash flow items where there is currently diversity in practice, including, but not limited to, debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, and distributions received from equity method investees. The updated guidance is effective for interim and annual periods beginning after December 15, 2017, and should be applied retrospectively unless impracticable. The Company implemented this guidance effective January 1, 2018. The adoption of ASC Update No. 2016-15 did not have a significant impact on the Company’s statement of cash flows.

In January 2016, the FASB issued ASC Update No. 2016-01, (Subtopic 825-10) Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU No. 2016-01”). This ASC update requires unconsolidated equity investments to be measured at fair value with changes in the fair value recognized in net income, except for those accounted for under the equity method. This update eliminates the cost method for equity investments without readily determinable fair values, replacing it with other methods, including the use of Net Asset Value (“NAV”). Additionally, when a public entity is required to measure fair value for disclosure purposes and holds financial instruments measured at amortized cost, the updated guidance requires these instruments to be measured using exit price. It also requires financial assets and financial liabilities to be presented separately in the notes to the financial statements, grouped by measurement category and form of financial asset. The updated guidance is effective for annual periods beginning after December 15, 2017.  In February 2018, the FASB issued ASC Update No. 2018-03, (Subtopic 825-10) Technical Corrections and Improvements to Financial Instruments – Overall. This ASC update clarifies the transition method for equity investments without readily determinable fair values. Specifically, if an entity elects to measure these investments at cost, less impairment, adjusted for changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer (the “measurement alternative”), then transition is prospective. For all others, transition is modified retrospective, requiring a cumulative effect adjustment. This ASU is effective for annual periods beginning after December 15, 2017, and interim periods within those years beginning after June 15, 2018. Early adoption is permitted for interim periods beginning after December 15, 2017 as long as ASU No. 2016-01 has been adopted. The Company implemented this guidance effective January 1, 2018 concurrent with ASU No. 2016-01 for certain limited partnerships without readily determinable fair values. The implementation of these standards resulted in a benefit to retained earnings, through a cumulative effect adjustment, of $97.8 million, including a reclassification of after-tax unrealized gains of $95.2 million from AOCI and an adjustment of $2.6 million of gains to record partnership investments at NAV.

 


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In May 2014, the FASB issued ASC Update No. 2014-09, (Topic 606) Revenue from Contracts with Customers. This ASC was issued to clarify the principles for recognizing revenue. Insurance contracts and financial instrument transactions are not within the scope of this updated guidance, and; therefore, only an insignificant amount of the Company’s revenue is subject to this updated guidance. In August 2015, the FASB issued ASC Update No. 2015-14, (Topic 606) Revenue from Contracts with Customers, which deferred the effective date of ASC Update No. 2014-09 by one year. Accordingly, the updated guidance is effective for periods beginning after December 15, 2017. The Company implemented this guidance effective January 1, 2018. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.

Recently Issued Standards

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

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

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

In March 2017, the FASB issued ASC Update No. 2017-08, (Subtopic 310-20) Receivables – Nonrefundable Fees and Other Costs: Premium Amortization on Purchased Callable Debt Securities. This guidance shortens the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The updated guidance is effective for annual and interim periods beginning after December 15, 2018, and should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASC Update No. 2017-08 to have a material impact on its financial position or results of operations.


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

In June 2016, the FASB issued ASC Update No. 2016-13, (Topic 326) Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. This ASC update introduces new guidance for the accounting for credit losses on financial instruments within its scope. A new model, referred to as the current expected credit losses model, requires an entity to determine credit-related impairment losses for financial instruments held at amortized cost and to estimate these expected credit losses over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider both historical and current information, reasonable and supportable forecasts, as well as estimates of prepayments. The estimated credit losses and subsequent adjustment to such loss estimates, will be recorded through an allowance account which is deducted from the amortized cost of the financial instrument, with the offset recorded in current earnings. ASC No. 2016-13 also modifies the impairment model for available-for-sale debt securities. The new model will require an estimate of expected credit losses only when the fair value is below the amortized cost of the asset, thus the length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer affect the determination of whether a credit loss exists. In addition, credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The updated guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted for periods beginning after December 15, 2018. The Company is evaluating the impact of the adoption of ASC Update No. 2016-13 on its financial position and results of operations.

In February 2016, the FASB issued ASC Update No. 2016-02, (Topic 842) Leases. This ASC update requires a lessee to recognize a right-of-use asset, which represents the lessee’s right to use a specified asset for the lease term, and a corresponding lease liability, which represents a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, for all leases that extend beyond 12 months. For finance or capital leases, interest on the lease liability will be recognized separately from amortization of the right-of-use asset in the statements of income and comprehensive income. In addition, the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. For operating leases, the asset and liability will be amortized as a single lease cost, such that the cost of the lease is allocated over the lease term, on a generally straight-line basis, with all cash flows included within operating activities in the statement of cash flows. ASC Update No. 2016-02 requires that implementation of this guidance be through a modified retrospective transition approach. In July 2018, the FASB issued ASC Update No. 2018-11, (Topic 842) Leases Targeted Improvements, which provides entities with an additional transition method to adopt ASC Update No. 2016-02. Under this optional transition method, an entity can initially apply the new guidance at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The updated guidance in ASC Update No. 2016-02 is effective for interim and annual periods beginning after December 15, 2018 and the Company expects to adopt the guidance using the optional transition method provided in ASC Update No. 2018-11. Additionally, the Company plans to elect the practical expedient package available in ASC Update No. 2017-02 upon adoption. It is expected that total assets and total liabilities will each increase by approximately $40 million to $50 million upon implementation, and that the adoption of this ASC update is not expected to be material to the Company’s results of operations.

 

3. Discontinued Chaucer Business

On September 13, 2018, the Company entered into a definitive agreement to sell Chaucer to China Re, for cash consideration of up to $865 million, consisting of initial consideration of $820 million, payable at closing, and contingent consideration of $45 million to be held in escrow. This contingent consideration may be adjusted downward if catastrophe losses incurred in 2018 are above a certain threshold. The Company anticipates that this transaction will result in a net gain. Several factors will affect the ultimate amount of the net gain recognized at the completion of the transaction, including the future earnings of the Chaucer business, the level of catastrophe losses incurred during 2018, the value of investment securities at closing and various tax attributes. The transaction is anticipated to close late this year or in the first quarter of next year, subject to regulatory approvals and other customary closing conditions. THG has agreed to indemnify China Re for certain litigation, regulatory matters and other liabilities related to pre-closing activities of the business being sold.

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The following table summarizes the results of Chaucer’s operations:

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

September 30,

 

 

September 30,

 

(in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

212.4

 

 

$

222.5

 

 

$

648.2

 

 

$

632.4

 

Net investment income

 

 

12.8

 

 

 

13.4

 

 

 

41.7

 

 

 

37.1

 

Other income

 

 

1.9

 

 

 

2.7

 

 

 

5.4

 

 

 

5.0

 

 

 

 

227.1

 

 

 

238.6

 

 

 

695.3

 

 

 

674.5

 

Losses and operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and LAE

 

 

137.0

 

 

 

221.7

 

 

 

364.3

 

 

 

431.7

 

Amortization of deferred acquisition costs

 

 

60.1

 

 

 

63.7

 

 

 

196.7

 

 

 

180.5

 

Other expenses

 

 

26.2

 

 

 

27.0

 

 

 

85.7

 

 

 

81.5

 

 

 

 

223.3

 

 

 

312.4

 

 

 

646.7

 

 

 

693.7

 

Income (loss) from discontinued Chaucer business before income

   taxes and other items (previously presented as Chaucer's

   operating income (loss))

 

 

3.8

 

 

 

(73.8

)

 

 

48.6

 

 

 

(19.2

)

Other items:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(1.5

)

 

 

(0.8

)

 

 

(2.8

)

 

 

(2.4

)

Net realized and unrealized investment gains (losses)

 

 

0.1

 

 

 

0.1

 

 

 

(0.4

)

 

 

0.7

 

Expenses related to the anticipated sale of Chaucer

 

 

(6.9

)

 

 

-

 

 

 

(8.7

)

 

 

-

 

Other income (expense)

 

 

(0.2

)

 

 

0.7

 

 

 

0.4

 

 

 

2.2

 

Income (loss) from discontinued Chaucer business before

   income taxes

 

$

(4.7

)

 

$

(73.8

)

 

$

37.1

 

 

$

(18.7

)

Income tax benefit (expense)

 

 

1.1

 

 

 

26.6

 

 

 

(6.6

)

 

 

10.4

 

Income (loss) from discontinued Chaucer business, net of

   income taxes

 

$

(3.6

)

 

$

(47.2