ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
38
INTRODUCTION
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist readers in understanding the interim consolidated results of operations and
financial condition of The Hanover Insurance Group, Inc. and subsidiaries (“THG”) and should be read in conjunction with the interim Consolidated Financial Statements and related footnotes included elsewhere in this Quarterly Report on
Form 10-Q and the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
Our results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America
(“Citizens”), our principal property and casualty companies; and certain other insurance and non-insurance subsidiaries. Our results of operations also included the results of First Allmerica Financial Life Insurance Company
(“FAFLIC”), our former run-off life insurance and annuity subsidiary through December 31, 2008. On January 2, 2009, we sold FAFLIC to Commonwealth Annuity and Life Insurance Company (“Commonwealth Annuity”), a
subsidiary of The Goldman Sachs Group, Inc. (“Goldman Sachs”). As of December 31, 2008 and for all prior periods presented, operations from FAFLIC have been reclassified as discontinued operations. Additionally, as of
December 31, 2008, FAFLIC’s balance sheet accounts were classified as assets and liabilities of discontinued operations in the Consolidated Balance Sheets.
EXECUTIVE OVERVIEW
Our property and casualty business includes
our Personal Lines segment, our Commercial Lines segment and our Other Property and Casualty segment. As noted above, on January 2, 2009, we sold FAFLIC to Commonwealth Annuity. Total net proceeds from the sale after transaction expenses were
approximately $230 million. Coincident with the sale transaction, Hanover Insurance and FAFLIC entered into a reinsurance contract whereby Hanover Insurance assumed FAFLIC’s discontinued accident and health insurance business.
During the first nine months of 2009, the U.S. and global financial markets and economies have been and remain strained, as market values have fluctuated
significantly during this period and could continue to fluctuate. Defaults in corporate bonds have and are expected to continue to increase, particularly with respect to non-investment grade securities; however, it is difficult to predict the
specific issuers or industries that may be affected. Credit spreads, however, have continued to tighten during the period resulting in a substantial improvement in unrealized losses during the first nine months of 2009. This improvement has resulted
in our investment portfolio having an unrealized gain position at September 30, 2009. Although the first nine months of 2009 have shown positive momentum in the financial markets, uncertainty still exists in these markets and around possible
implications of governmental funding, as well as the potential impact of the current difficult economy.
Our investment holdings totaled $5.2
billion at September 30, 2009 and consist primarily of investment grade fixed maturities and cash and cash equivalents, with net unrealized gain positions of approximately $120 million. The improvement in our unrealized loss position at
December 31, 2008 to this unrealized gain position at September 30, 2009, particularly in investment-grade securities, is due primarily to market appreciation. We recognized impairment charges of $29.3 million during the first nine months
of 2009. These impairment charges primarily related to credit-related losses on below investment grade fixed maturities in the industrial sector and perpetual preferred securities in the financial sector.
Several U.S. and global government programs have been implemented over the last year to assist in stimulating an economic recovery. There is still
uncertainty regarding what the continuing effect the government programs will have on the financial markets. We believe, however, that these ongoing government actions to support the banking and financial sectors, the quality of the assets we hold,
and our relatively strong capital position will allow us, over time, to realize the anticipated long-term economic value related to securities we hold, including those that are in a gross unrealized loss position. We have a substantially liquid
portfolio with a laddered duration structure which provides for periodic maturities and thus expect to have the ability to hold any securities that are currently in a gross unrealized loss position for the period of time anticipated to allow for a
recovery in fair value.
With respect to underwriting results, the first nine months of 2009 were relatively flat compared to the same period
in 2008. Pre-tax catastrophe losses were $92.3 million, a decrease of $63.3 million from the same period in 2008. This was essentially offset by higher current year claims, lower favorable development on prior year’s loss and loss adjustment
expense (“LAE”) reserves, and higher expenses. The higher current year claims were primarily the result of an unusually high level of non-catastrophe weather-related losses.
39
We have made an explicit decision to invest further in our business despite the fact that our expense ratio
is higher than that of some of our peer companies and other competitors. In Personal Lines, we are investing to improve the competitiveness of our products and in technology and systems enhancements intended to make our interactions with agents more
efficient. In Commercial Lines, most of our investments in people and information systems are directed toward expanding our product capabilities and offerings in various niches and differentiated products. We continue to invest in systems
improvements, particularly with respect to small commercial business. In addition, we recently started to expand into the western part of the country with our middle market niche business and segmented products, along with a full breadth of
specialty offerings. We expect to incur costs associated with this westward expansion ahead of premium growth in this region. Our ability to improve profitability in the future will depend in part on our ability to profitably grow our net written
premiums and reduce our expense ratios accordingly.
During May 2009, A.M. Best Company upgraded the financial strength ratings of our
property and casualty companies to an “A” rating from their prior rating of “A-”. A.M. Best also upgraded the rating related to our Senior Debt to “bbb” from a prior rating of “bbb-”. We believe that these
upgrades, which occurred at a time of such uncertainty in the financial services industry, reflect the strength of our balance sheet, our solid capital position, and the results of our investments in the business over the past several years. These
upgrades are expected to provide access to certain business groups and markets, particularly in Commercial Lines, that have previously not been significant in our mix of business. However, there can be no assurance that the ratings upgrades will
produce the results expected.
Personal Lines
In our Personal Lines business, we are focused on making investments that are intended to help us maintain profitability, build a
distinctive position in the market and provide us with profitable growth opportunities. Current market conditions continue to be challenging as pricing pressures and economic conditions remain difficult, especially in Michigan, impacting our ability
to grow and retain business in this, our largest state, and elsewhere. We are working closely with our partner agents in Michigan to remain a significant writer with strong margins. Also, in 2009 we continued our mix management initiatives relating
to our
Connections
®
Auto
product to improve the overall profitability of the business. We are
focused on reducing our growth in less profitable automobile segments and increasing our multi-car and total account business consistent with our strategy. We believe that market conditions will remain challenging and competitive in Personal Lines.
Despite these challenges, we experienced relatively flat growth levels in Personal Lines and expect that trend to continue during the fourth quarter of 2009 as the industry continues to be impacted by the difficult economic environment.
Our
Connections Auto
product is available in eighteen states. We believe that this product will help us profitably grow
our market share over time. The
Connections Auto
product is designed to be competitively priced for a wide spectrum of drivers through its multivariate rating application, which calculates rates based upon the magnitude and correlation
of multiple risk factors. At the same time, a core strategy is to broaden our portfolio offerings and write “total accounts”, which are accounts that include multiple personal line coverages for the same customer. Our homeowners product,
Connections
®
Home
, is available in sixteen states. It is intended to improve our competitiveness
for total account business by making it easier and more efficient for our agents to write business with us and by providing more comprehensive coverage options for policyholders. We continue to refine our products and work closely with high
potential agents to increase the percentage of business they place with us and to ensure that it is consistent with our preferred mix of business. Additionally, we remain focused on diversifying our state mix beyond our four core states of Michigan,
Massachusetts, New York and New Jersey. We expect these efforts to contribute to profitable growth and improved retention in our Personal Lines segment over time.
Commercial Lines
The Commercial Lines market remains competitive.
Price competition requires us to be highly disciplined in our underwriting process to ensure that we grow the business only at acceptable margins. We focus on mid-sized agents and target small and first-tier middle market clients, whose premiums are
generally below $200,000. We also continue to develop our specialty businesses, which on average are expected to offer higher margins over time and enable us to deliver a more complete product portfolio to our agents and policyholders. Our specialty
lines, including marine and bond lines, now account for approximately one third of our Commercial Lines business, based upon premiums. Additional growth in our specialty lines continues to be a significant part of our strategy. Our ongoing focus on
expanding our product offerings in specialty businesses is evidenced by our recent acquisitions. Over the past two years, we have acquired Verlan Holdings, Inc. (“Verlan”), which we market
40
as Hanover Specialty Property, a specialty company providing property insurance to small and medium-sized manufacturing and distribution companies that are highly protected fire risks, AIX
Holdings, Inc. (“AIX”), a specialty property and casualty insurance carrier that focuses on underwriting and managing program business, and Professionals Direct, Inc. (“PDI”), which we market as Hanover Professionals, a
professional liability insurance carrier for small to medium-sized legal practices. In addition to our specialty lines, we have developed several niche insurance programs, such as for schools, religious institutions and moving and storage companies,
and have added additional segmentation to our core middle market commercial products including real estate, hospitality and wholesale distributors. We believe these acquisitions and the development of our niche businesses and additional segmented
products provide us with better breadth and diversification of products, will ultimately provide better underwriting results and will improve our competitive position with our agents.
In January 2009, we introduced another specialty niche for human services organizations such as non-profit youth and community service organizations. As a complimentary initiative, we have introduced
products focused on management liability, specifically non-profit directors and officers liability and employment practices liability and we plan to extend coverage for private company directors and officers liability. In addition, we have made a
number of enhancements to our core products and technology platforms that are intended to drive more total account placements in our Small Commercial business, which we believe will enhance margins. Our focus continues to be on improving and
expanding our partnerships with agents. We believe our specialty capabilities and small commercial platform, coupled with distinctiveness in the middle market through our development of niches and better segmentation, enables us to deliver
significant value to our agents and policyholders in our target markets and to improve the overall mix of our business and ultimately our underwriting profitability.
DESCRIPTION OF OPERATING SEGMENTS
Our primary business operations
include insurance products and services in three property and casualty operating segments. These segments are Personal Lines, Commercial Lines and Other Property and Casualty. Personal Lines includes personal automobile, homeowners and other
personal coverages, while Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation and other commercial coverages, such as bonds, inland marine business and professional liability. In addition, the Other
Property and Casualty segment consists of: Opus Investment Management, Inc. (“Opus”), which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets, as well as
voluntary pools business in which we have not actively participated since 1995. Prior to its sale on June 2, 2008, Amgro, Inc. (“AMGRO”), our premium financing business, was also included in the Other Property and Casualty segment.
Additionally, prior to the sale of FAFLIC on January 2, 2009, our operations included the results of this run-off life insurance and annuity business as a separate segment. We present the separate financial information of each segment
consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance.
We report interest expense related to our corporate debt separately from the earnings of our operating segments. Corporate debt consists of our senior debentures, our junior subordinated debentures,
surplus notes and advances under our recently established collateralized borrowing program with the Federal Home Loan Bank of Boston (“FHLBB”). Subordinated debentures are held by the holding company and several subsidiaries.
RESULTS OF OPERATIONS
Our consolidated net income includes the results of our three operating segments (segment income), which we evaluate on a pre-tax basis, and our interest expense on corporate debt. In addition, segment income excludes certain items which we
believe are not indicative of our core operations. The income of our segments excludes items such as federal income taxes and net realized investment gains and losses, because fluctuations in these gains and losses are determined by interest rates,
financial markets and the timing of sales. Also, segment income excludes net gains and losses on disposals of businesses, discontinued operations, restructuring costs, extraordinary items, the cumulative effect of accounting changes and certain
other items. Although the items excluded from segment income may be significant components in understanding and assessing our financial performance, we believe segment income enhances an investor’s understanding of our results of operations by
highlighting net income attributable to the core operations of the business. However, segment income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles (“GAAP”).
Catastrophe losses are a significant component in understanding and assessing the financial performance of our business. However,
catastrophic events, such as Hurricanes Katrina, Ike and Gustav make it difficult to assess the underlying trends in this business. Management believes that providing certain financial metrics and trends excluding the effects of catastrophes helps
investors to understand the variability in periodic earnings and to evaluate the underlying performance of our operations.
41
Our consolidated net income for the third quarter of 2009 was $49.7 million, compared to a net loss of $61.8
million for the same period in 2008. The $111.5 million improvement in earnings is primarily due to an improvement in net realized losses. In the third quarter of 2009, we did not have any net realized losses, whereas in the same period of 2008, we
incurred $52.8 million of net realized losses, primarily due to impairments. In addition, a decrease in after-tax catastrophe related activity of $47.8 million also contributed to this improvement. Also, in 2008 we recognized a $21.8 million loss
associated with the discontinued FAFLIC business due to its then pending sale.
Our consolidated net income for the first nine months of 2009
was $139.9 million, compared to a net loss of $13.5 million for the same period of 2008. The $153.4 million improvement is primarily due to a $92.9 million loss recognized in 2008 associated with the discontinued FAFLIC business due to its then
pending sale. This loss did not recur in 2009. In addition, there was an improvement in net realized investment losses of $51.0 million. In 2009, we recognized a pre-tax gain of $34.5 ($22.3 million net of taxes) related to the retirement of
corporate debt in connection with the repurchase of our mandatorily redeemable preferred securities and our senior debentures (see also “Significant Transactions”). These increases in earnings for the period compared to the same period in
2008 were partially offset by the recognition, in 2008, of a $10.1 million gain on the sale of AMGRO.
42
The following table reflects segment income as determined in accordance with generally accepted accounting
standards, and a reconciliation of total segment income to consolidated net income
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
(In millions)
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
Segment income (loss) before federal income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal Lines
|
|
$
|
27.4
|
|
|
$
|
18.1
|
|
|
$
|
56.1
|
|
|
$
|
83.8
|
|
|
Commercial Lines
|
|
|
38.7
|
|
|
|
(6.6
|
)
|
|
|
137.2
|
|
|
|
114.1
|
|
|
Other Property and Casualty
|
|
|
7.5
|
|
|
|
2.3
|
|
|
|
6.5
|
|
|
|
6.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Property and Casualty
|
|
|
73.6
|
|
|
|
13.8
|
|
|
|
199.8
|
|
|
|
204.7
|
|
|
Interest expense on corporate debt
|
|
|
(6.3
|
)
|
|
|
(10.0
|
)
|
|
|
(27.2
|
)
|
|
|
(29.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment income before federal income taxes
|
|
|
67.3
|
|
|
|
3.8
|
|
|
|
172.6
|
|
|
|
174.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal income tax expense on segment income
|
|
|
(22.0
|
)
|
|
|
(0.5
|
)
|
|
|
(56.9
|
)
|
|
|
(58.4
|
)
|
|
Federal income tax settlement
|
|
|
—
|
|
|
|
6.4
|
|
|
|
—
|
|
|
|
6.4
|
|
|
Net realized investment losses
|
|
|
—
|
|
|
|
(52.8
|
)
|
|
|
(9.7
|
)
|
|
|
(60.7
|
)
|
|
Gain on retirement of corporate debt
|
|
|
0.2
|
|
|
|
—
|
|
|
|
34.5
|
|
|
|
—
|
|
|
Federal income tax benefit (expense) on non-segment income (loss)
|
|
|
3.1
|
|
|
|
(0.4
|
)
|
|
|
(8.6
|
)
|
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations, net of taxes
|
|
|
48.6
|
|
|
|
(43.5
|
)
|
|
|
131.9
|
|
|
|
61.7
|
|
|
|
|
|
|
|
|
Discontinued operations (net of taxes):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) from discontinued FAFLIC business (including estimated loss on assets held-for-sale of $6.1 and $72.2 in the quarter
and nine months ended September 30, 2008)
|
|
|
0.4
|
|
|
|
(21.7
|
)
|
|
|
6.3
|
|
|
|
(92.9
|
)
|
|
Gain (loss) from discontinued accident and health business
|
|
|
0.7
|
|
|
|
—
|
|
|
|
(2.4
|
)
|
|
|
—
|
|
|
Income from operations of AMGRO (including gain on disposal of $11.1 in 2008)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
10.1
|
|
|
Gain on disposal of variable life insurance and annuity business
|
|
|
—
|
|
|
|
2.7
|
|
|
|
4.1
|
|
|
|
8.1
|
|
|
Other discontinued operations
|
|
|
—
|
|
|
|
0.7
|
|
|
|
—
|
|
|
|
(0.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
49.7
|
|
|
$
|
(61.8
|
)
|
|
$
|
139.9
|
|
|
$
|
(13.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
Property and Casualty Segment Results
The following is our discussion and analysis of the results of operations by business segment. The segment results are presented before taxes
and other items which management believes are not indicative of our core operations, including realized gains and losses.
The following table
summarizes the results of operations for the Property and Casualty group for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(In millions)
|
|
2009
|
|
2008
|
|
2009
|
|
2008
|
|
Segment revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written
|
|
$
|
688.8
|
|
$
|
651.6
|
|
$
|
1,981.8
|
|
$
|
1,920.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
637.4
|
|
$
|
621.1
|
|
$
|
1,899.4
|
|
$
|
1,858.1
|
|
Net investment income
|
|
|
62.1
|
|
|
65.3
|
|
|
187.9
|
|
|
193.3
|
|
Other income
|
|
|
10.0
|
|
|
9.4
|
|
|
29.1
|
|
|
31.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
|
709.5
|
|
|
695.8
|
|
|
2,116.4
|
|
|
2,082.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and LAE
|
|
|
403.0
|
|
|
474.2
|
|
|
1,225.1
|
|
|
1,239.7
|
|
Policy acquisition expenses
|
|
|
146.8
|
|
|
139.7
|
|
|
434.7
|
|
|
416.1
|
|
Other operating expenses
|
|
|
86.1
|
|
|
68.1
|
|
|
256.8
|
|
|
221.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total losses and operating expenses
|
|
|
635.9
|
|
|
682.0
|
|
|
1,916.6
|
|
|
1,877.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment income
|
|
$
|
73.6
|
|
$
|
13.8
|
|
$
|
199.8
|
|
$
|
204.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30, 2009 Compared to Quarter Ended
September 30, 2008
The Property and Casualty group’s segment income increased $59.8 million, to $73.6 million, in the third
quarter of 2009, compared to $13.8 million in the third quarter of 2008. Catastrophe related activity decreased $73.5 million in the third quarter of 2009, compared with the same period in 2008. During the third quarter of 2008, we incurred
approximately $88 million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophe related activity, segment income would have decreased $13.7 million. This decrease is primarily due to higher expenses and
lower net investment income, partially offset by improved non-catastrophe current accident year results and increased favorable development on prior years’ loss and LAE reserves. Underwriting, loss adjustment and other operating expenses
increased approximately $24 million, of which approximately $7 million relates to higher pension costs. Additionally, there were higher employee and employee benefit costs, increased costs in our specialty lines of business, including the addition
of our recently acquired AIX subsidiary, an increase in variable compensation, and higher technology costs. In addition, net investment income was lower by $3.2 million. These decreases were partially offset by more favorable current accident year
non-catastrophe results of approximately $6 million, primarily in commercial lines, as well as favorable development on prior years’ loss and LAE reserves of $10.3 million from our run-off voluntary pools business.
44
Production and Underwriting Results
The following table summarizes GAAP net premiums written and GAAP loss, LAE, expense and combined ratios for the Personal Lines and Commercial Lines
segments. These items are not meaningful on a stand alone segment basis for our Other Property and Casualty segment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
(In millions, except ratios)
|
|
GAAP
Net
Premiums
Written
|
|
GAAP
Loss
Ratios
(1)(2)
|
|
Cata-
strophe
loss
ratios (3)
|
|
|
GAAP
Net
Premiums
Written
|
|
GAAP
Loss
Ratios
(1)(2)
|
|
Cata-
strophe
loss
ratios (3)
|
|
|
Personal Lines:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal automobile
|
|
$
|
249.1
|
|
59.9
|
|
0.3
|
|
|
$
|
260.8
|
|
58.9
|
|
0.5
|
|
|
Homeowners
|
|
|
136.5
|
|
62.8
|
|
12.7
|
|
|
|
125.8
|
|
81.0
|
|
34.8
|
|
|
Other personal
|
|
|
11.1
|
|
38.1
|
|
3.1
|
|
|
|
10.9
|
|
41.2
|
|
13.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Personal Lines
|
|
|
396.7
|
|
60.3
|
|
4.2
|
|
|
|
397.5
|
|
64.9
|
|
10.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Lines:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Workers’ compensation
|
|
|
27.8
|
|
48.3
|
|
N/M
|
|
|
|
30.8
|
|
43.9
|
|
N/M
|
|
|
Commercial automobile
|
|
|
47.4
|
|
50.9
|
|
1.7
|
|
|
|
46.3
|
|
42.0
|
|
0.2
|
|
|
Commercial multiple peril
|
|
|
98.7
|
|
49.8
|
|
8.9
|
|
|
|
93.6
|
|
105.5
|
|
52.0
|
|
|
Other commercial
|
|
|
118.2
|
|
42.1
|
|
0.4
|
|
|
|
83.4
|
|
47.4
|
|
12.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Commercial Lines
|
|
|
292.1
|
|
46.7
|
|
3.4
|
|
|
|
254.1
|
|
67.3
|
|
23.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
688.8
|
|
51.6
|
|
3.9
|
|
|
$
|
651.6
|
|
65.9
|
|
15.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
GAAP
LAE
Ratio
|
|
GAAP
Expense
Ratio
|
|
GAAP
Combined
Ratio (4)
|
|
|
GAAP
LAE
Ratio
|
|
GAAP
Expense
Ratio
|
|
GAAP
Combined
Ratio (4)
|
|
|
Personal Lines
|
|
|
10.8
|
|
29.1
|
|
100.2
|
|
|
|
10.9
|
|
27.0
|
|
102.8
|
|
|
Commercial Lines
|
|
|
9.6
|
|
41.5
|
|
97.8
|
|
|
|
9.7
|
|
38.1
|
|
115.1
|
|
|
Total
|
|
|
10.3
|
|
34.3
|
|
97.6
|
(5)
|
|
|
10.5
|
|
31.5
|
|
107.8
|
(5)
|
|
(1)
|
GAAP loss ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio reflects incurred claims compared to
premiums earned. Our GAAP loss ratios include catastrophe losses.
|
|
(2)
|
Includes policyholders’ dividends.
|
|
(3)
|
Catastrophe loss ratio reflects incurred catastrophe claims compared to premiums earned.
|
|
(4)
|
GAAP combined ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of incurred claims, claim
expenses and underwriting expenses incurred to premiums earned. Our GAAP combined ratios also include the impact of catastrophes. Federal income taxes, net investment income and other non-underwriting expenses are not reflected in the GAAP combined
ratio.
|
|
(5)
|
Total includes favorable development of $10.5 million and $0.2 million for the quarters ended September 30, 2009 and 2008, respectively, which is reflected in our
Other P&C segment.
|
45
The following table summarizes GAAP underwriting results for the Personal Lines, Commercial Lines and Other
Property and Casualty segments and reconciles it to GAAP segment income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property
and
Casualty
|
|
|
Total
|
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property
and
Casualty
|
|
|
Total
|
|
|
GAAP underwriting profit (loss), excluding prior year reserve development and catastrophes
|
|
$
|
0.3
|
|
|
$
|
(6.8
|
)
|
|
$
|
(0.2
|
)
|
|
$
|
(6.7
|
)
|
|
$
|
10.3
|
|
|
$
|
(2.6
|
)
|
|
$
|
(0.2
|
)
|
|
$
|
7.5
|
|
|
Prior year favorable reserve development
|
|
|
11.0
|
|
|
|
21.3
|
|
|
|
10.5
|
|
|
|
42.8
|
|
|
|
15.7
|
|
|
|
22.4
|
|
|
|
0.2
|
|
|
|
38.3
|
|
|
Pretax catastrophe effect
|
|
|
(15.4
|
)
|
|
|
(9.3
|
)
|
|
|
—
|
|
|
|
(24.7
|
)
|
|
|
(39.7
|
)
|
|
|
(58.5
|
)
|
|
|
—
|
|
|
|
(98.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP underwriting (loss) profit
|
|
|
(4.1
|
)
|
|
|
5.2
|
|
|
|
10.3
|
|
|
|
11.4
|
|
|
|
(13.7
|
)
|
|
|
(38.7
|
)
|
|
|
—
|
|
|
|
(52.4
|
)
|
|
Net investment income
|
|
|
27.8
|
|
|
|
31.9
|
|
|
|
2.4
|
|
|
|
62.1
|
|
|
|
30.1
|
|
|
|
31.5
|
|
|
|
3.7
|
|
|
|
65.3
|
|
|
Fees and other income
|
|
|
3.7
|
|
|
|
4.8
|
|
|
|
1.5
|
|
|
|
10.0
|
|
|
|
3.4
|
|
|
|
4.3
|
|
|
|
1.7
|
|
|
|
9.4
|
|
|
Other operating expenses
|
|
|
—
|
|
|
|
(3.2
|
)
|
|
|
(6.7
|
)
|
|
|
(9.9
|
)
|
|
|
(1.7
|
)
|
|
|
(3.7
|
)
|
|
|
(3.1
|
)
|
|
|
(8.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment income (loss)
|
|
$
|
27.4
|
|
|
$
|
38.7
|
|
|
$
|
7.5
|
|
|
$
|
73.6
|
|
|
$
|
18.1
|
|
|
$
|
(6.6
|
)
|
|
$
|
2.3
|
|
|
$
|
13.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal Lines
Personal Lines’ net premiums written decreased $0.8 million, or 0.2%, to $396.7 million for the third quarter of 2009. The most significant factor contributing to lower net premiums written was a
decrease in average premium size driven by changes in our premium mix toward more desirable account business. Additionally, a decrease in premium from the Massachusetts Commonwealth Automobile Reinsurers (“CAR”) pool and increased
reinsurance costs contributed to the decrease in net premiums written. The decrease in CAR related premium followed the introduction, in April 2008, of “managed competition” in Massachusetts which consequently restructured the automobile
reinsurance mechanism in the state and resulted in reduced premiums. These decreases were partially offset by increases in net premiums written in our targeted growth states.
Policies in force in the personal automobile line of business decreased 1.2% at the end of the third quarter of 2009 compared to the third quarter of 2008, primarily driven by our efforts to improve our
mix of business.
Policies in force in the homeowners line of business increased 4.7% at the end of the third quarter of 2009, compared to the
third quarter of 2008, primarily driven by increases across the majority of our states due to our account rounding initiatives, partially offset by a decrease in policies in force in Florida, where throughout 2008 we non-renewed all homeowners
polices.
Personal Lines underwriting loss improved $9.6 million, to a loss of $4.1 million, in the third quarter of 2009, compared to a loss
of $13.7 million in the third quarter of 2008. Catastrophe related activity decreased $24.3 million in the current quarter, to $15.4 million, from $39.7 million in the prior year. During the third quarter of 2008, we incurred approximately $31
million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophes, our underwriting loss would have increased by $14.7 million, primarily due to increased expenses of approximately $8 million, primarily due to
pension costs, higher technology costs, higher employee and employee benefit costs and higher variable compensation. Also contributing to the decrease was a decrease in favorable development on prior years’ loss and LAE reserves of $4.7
million, as well as less favorable current accident year results of approximately $2 million.
Our ability to maintain and increase Personal
Lines net written premium and to maintain and improve underwriting results is expected to be affected by increasing price competition, regulatory and legal developments and the difficult economic conditions, particularly in Michigan, which is our
largest state.
New business generally experiences higher loss ratios than our renewal business, and is more difficult to predict,
particularly in states in which we have less experience and data. Our ability to maintain or increase earnings could be adversely affected should the loss ratios for new business prove to be higher than our pricing and profitability expectations.
Our ability to grow could be adversely affected if required adjustments to enhance risk segmentation and related agency management actions result in making our products less price competitive.
46
It is difficult to predict the impact that the current recessionary environment will have on our Personal
Lines business. Our ability to increase pricing may continue to be impacted as agents and consumers may become more price sensitive, customers may shop for policies more frequently or aggressively, utilize comparative rating models or turn to direct
sales channels rather than independent agents. Additionally, new business premiums, retention levels and renewal premiums may decrease as policyholders reduce coverages or change deductibles to reduce premiums, home values decline, foreclosures
increase and policyholders retain older or less expensive automobiles and purchase or insure fewer ancillary items such as boats, trailers and motor homes for which we provide coverages. Additionally, claims frequency could increase as policyholders
submit and pursue claims more aggressively than in the past, fraud incidences may increase, or we may experience higher incidence of abandoned properties or poorer maintenance which may also result in more claims activity. Our Personal Lines segment
could also be affected by an ensuing consolidation of independent insurance agencies.
In addition, as discussed under “Contingencies and
Regulatory Matters – Other Regulatory Matters”, certain states have taken, and others may take, actions which significantly affect the property and casualty insurance market, including ordering rate reductions for personal automobile and
homeowners insurance products and subjecting insurance companies that do business in that state to onerous underwriting or other restrictions and potentially significant assessments. Such state actions or our responses thereto could have a
significant impact on our underwriting margins and growth prospects, as well as on our ability to manage exposures to hurricane or other high risk losses.
Notwithstanding these concerns, we believe that our agency distribution strategy, the strength of our market share in key states, our account rounding strategy, the relatively inelastic demand for
insurance products and our capital position, place us in a good position to manage these issues and concerns relative to many of our peer competitors.
Commercial Lines
Commercial Lines’ net premiums written increased $38.0 million, or
15.0%, to $292.1 million for the third quarter of 2009. This increase was driven by growth in our specialty businesses, including our recently acquired subsidiary, AIX, which accounted for $25.0 million, as well as growth in various niche and
segmented businesses. Also contributing to the overall growth in net premiums written was improved rate, partially offset by increased reinsurance costs and lower renewal premium in our unsegmented core business, due to lower renewal retention rates
and to lower exposures. We believe that the improved rate and lower renewal retention rates in our unsegmented core business is reflective of an improving mix in our overall business.
Commercial Lines underwriting income was $5.2 million in the third quarter of 2009 as compared to a loss of $38.7 for the same period in 2008. Catastrophe related activity decreased $49.2 million in the
current quarter, to $9.3 million, from $58.5 million in the prior year. During the third quarter of 2008, we incurred approximately $57 million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophes, our
underwriting income would have decreased by $5.3 million. This decrease was primarily due to higher underwriting expenses of approximately $13 million, which is primarily due to increased costs in our specialty businesses, including our recently
acquired subsidiary, AIX, higher employee and employee benefit costs, higher variable compensation, higher technology costs and higher pension costs. Also contributing to the decrease was a decline in favorable development on prior years’ loss
and LAE reserves of $1.1 million. We expect that our favorable development will continue to decline in future periods. These decreases were partially offset by favorable current accident year results of approximately $8 million. Current accident
year results improved due to lower large property losses in the commercial multiple peril line of business, which were partially offset by increased losses in our surety bond business.
We continue to experience significant price competition in all lines of business in our Commercial Lines segment. The industry is also generally experiencing overall rate decreases. Our ability to
increase Commercial Lines’ net premiums written while maintaining or improving underwriting results is expected to be affected by price competition and the difficult economic conditions.
It is difficult to predict the impact of the current economic environment on our Commercial Lines segment, but businesses have become more price sensitive.
We may experience decreased new business levels, retention and renewal rates and renewal premiums. The overall decline in the economy has resulted in reductions in demand for insurance products and services as more companies cease to do business and
there are fewer business start-ups, particularly as small businesses are affected by a decline in overall consumer and business spending. In addition, economic conditions may also continue to impact our surety bond business, especially in the small
to middle market contractor business.
47
In addition, some businesses have reduced or eliminated coverages to reduce costs and there has been a
reduction in payroll levels, which has reduced workers’ compensation premiums without a corresponding decrease in workers’ compensation claims. Our Commercial Lines segment could also be affected by an ensuing consolidation of independent
insurance agencies.
Notwithstanding these concerns, we believe that our agency distribution strategy, our broad product offerings, the
strength of our growing specialty businesses, disruptions in the marketplace which may result in improved pricing, the relatively inelastic demand for insurance products and our capital position, place us in a good position to manage these issues
and concerns relative to many of our peer competitors.
Other Property and Casualty
Segment income of the Other Property and Casualty segment increased $5.2 million, to $7.5 million for the quarter ended September 30, 2009, from $2.3
million in the same period of 2008. The increase is primarily due to $10.3 million of favorable development in our run-off voluntary pools (see Loss and LAE Reserves by Line of Business –
Asbestos and Environmental Reserves
for further
discussion), partially offset by $3.6 million of higher pension costs from our discontinued life business.
Investment Results
Net investment income before taxes decreased $3.2 million, or 4.9%, to $62.1
million for the quarter ended September 30, 2009. This decrease was primarily due to the impact of selling fixed maturities to fund the 2009 repurchase of our corporate debt as well as lower new money yields. The average pre-tax yield on fixed
maturities was 5.5% for the third quarter of 2009 and 5.6% for the third quarter of 2008.
Nine Months Ended
September 30, 2009 Compared to Nine Months Ended September 30, 2008
The Property and Casualty group’s segment income
decreased $4.9 million, or 2.4%, to $199.8 million, for the nine months ended September 30, 2009, compared to $204.7 million for the nine months ended September 30, 2008. This decrease reflects decreased catastrophe related activity of
$63.3 million compared to the same period of 2008. During 2008, we incurred approximately $88 million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophe related activity, segment income would have
decreased $68.2 million. This decrease is primarily due to higher expenses and lower favorable development on prior years’ loss and LAE reserves, as well as lower current accident year results. Underwriting, loss adjustment and other operating
expenses increased approximately $47 million, of which approximately $22 million relates to higher pension costs. Additionally, there were increased costs in our specialty lines, including the addition of our recently acquired AIX subsidiary, higher
employee and employee benefit costs and higher technology costs. Also, current accident year results decreased by approximately $11 million, primarily in personal lines, due to unusual non-catastrophe weather-related losses throughout 2009.
Additionally, favorable development on prior years’ loss and LAE reserves decreased by $4.0 million.
48
Production and Underwriting Results
The following table summarizes GAAP net premiums written and GAAP loss, LAE, expense and combined ratios for the Personal Lines and Commercial Lines
segments. These items are not meaningful on a stand alone segment basis for our Other Property and Casualty segment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
(In millions, except ratios)
|
|
GAAP
Net
Premiums
Written
|
|
GAAP
Loss
Ratios
(1)(2)
|
|
Cata-
strophe
loss
ratios (3)
|
|
|
GAAP
Net
Premiums
Written
|
|
GAAP
Loss
Ratios
(1)(2)
|
|
Cata-
strophe
loss
ratios (3)
|
|
|
Personal Lines:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal automobile
|
|
$
|
740.6
|
|
59.5
|
|
0.6
|
|
|
$
|
772.4
|
|
58.7
|
|
0.5
|
|
|
Homeowners
|
|
|
344.8
|
|
72.6
|
|
18.0
|
|
|
|
319.5
|
|
69.7
|
|
21.5
|
|
|
Other personal
|
|
|
30.3
|
|
32.8
|
|
2.4
|
|
|
|
30.8
|
|
35.9
|
|
8.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Personal Lines
|
|
|
1,115.7
|
|
62.7
|
|
5.9
|
|
|
|
1,122.7
|
|
61.3
|
|
6.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Lines:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Workers’ compensation
|
|
|
88.3
|
|
48.4
|
|
N/M
|
|
|
|
98.4
|
|
41.7
|
|
N/M
|
|
|
Commercial automobile
|
|
|
147.8
|
|
50.9
|
|
0.8
|
|
|
|
152.6
|
|
45.8
|
|
0.4
|
|
|
Commercial multiple peril
|
|
|
289.4
|
|
49.8
|
|
8.2
|
|
|
|
285.7
|
|
62.4
|
|
24.0
|
|
|
Other commercial
|
|
|
340.4
|
|
38.0
|
|
1.6
|
|
|
|
261.1
|
|
37.9
|
|
6.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Commercial Lines
|
|
|
865.9
|
|
45.3
|
|
3.5
|
|
|
|
797.8
|
|
48.8
|
|
10.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,981.6
|
|
54.8
|
|
4.9
|
|
|
$
|
1,920.5
|
|
56.2
|
|
8.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
GAAP
LAE
Ratio
|
|
GAAP
Expense
Ratio
|
|
GAAP
Combined
Ratio (4)
|
|
|
GAAP
LAE
Ratio
|
|
GAAP
Expense
Ratio
|
|
GAAP
Combined
Ratio (4)
|
|
|
Personal Lines
|
|
|
10.9
|
|
28.5
|
|
102.1
|
|
|
|
11.1
|
|
27.9
|
|
100.3
|
|
|
Commercial Lines
|
|
|
8.1
|
|
41.2
|
|
94.6
|
|
|
|
9.6
|
|
38.9
|
|
97.3
|
|
|
Total
|
|
|
9.7
|
|
33.9
|
|
98.4
|
(5)
|
|
|
10.5
|
|
32.4
|
|
99.1
|
(5)
|
|
(1)
|
GAAP loss ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio reflects incurred claims compared to
premiums earned. Our GAAP loss ratios include catastrophe losses.
|
|
(2)
|
Includes policyholders’ dividends.
|
|
(3)
|
Catastrophe loss ratio reflects incurred catastrophe claims compared to premiums earned.
|
|
(4)
|
GAAP combined ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of incurred claims, claim
expenses and underwriting expenses incurred to premiums earned. Our GAAP combined ratios also include the impact of catastrophes. Federal income taxes, net investment income and other non-underwriting expenses are not reflected in the GAAP combined
ratio.
|
|
(5)
|
Total includes favorable development of $10.4 million and $0.7 million for the nine months ended September 30, 2009 and 2008, which is reflected in our Other
Property and Casualty segment.
|
49
The following table summarizes GAAP underwriting results for the Personal Lines, Commercial Lines and Other
Property and Casualty segments and reconciles it to GAAP segment income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property
and
Casualty
|
|
|
Total
|
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property
and
Casualty
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP underwriting (loss) profit, excluding prior year reserve development and catastrophes
|
|
$
|
(9.1
|
)
|
|
$
|
(8.5
|
)
|
|
$
|
0.2
|
|
|
$
|
(17.4
|
)
|
|
$
|
14.1
|
|
|
$
|
15.1
|
|
|
$
|
(0.4
|
)
|
|
$
|
28.8
|
|
|
Prior year favorable reserve development
|
|
|
39.8
|
|
|
|
78.0
|
|
|
|
10.4
|
|
|
|
128.2
|
|
|
|
48.2
|
|
|
|
83.3
|
|
|
|
0.7
|
|
|
|
132.2
|
|
|
Pretax catastrophe effect
|
|
|
(64.1
|
)
|
|
|
(28.2
|
)
|
|
|
—
|
|
|
|
(92.3
|
)
|
|
|
(75.3
|
)
|
|
|
(80.3
|
)
|
|
|
—
|
|
|
|
(155.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP underwriting (loss) profit
|
|
|
(33.4
|
)
|
|
|
41.3
|
|
|
|
10.6
|
|
|
|
18.5
|
|
|
|
(13.0
|
)
|
|
|
18.1
|
|
|
|
0.3
|
|
|
|
5.4
|
|
|
Net investment income
|
|
|
81.4
|
|
|
|
93.2
|
|
|
|
13.3
|
|
|
|
187.9
|
|
|
|
89.1
|
|
|
|
92.9
|
|
|
|
11.3
|
|
|
|
193.3
|
|
|
Fees and other income
|
|
|
10.8
|
|
|
|
14.0
|
|
|
|
4.3
|
|
|
|
29.1
|
|
|
|
12.2
|
|
|
|
13.8
|
|
|
|
5.0
|
|
|
|
31.0
|
|
|
Other operating expenses
|
|
|
(2.7
|
)
|
|
|
(11.3
|
)
|
|
|
(21.7
|
)
|
|
|
(35.7
|
)
|
|
|
(4.5
|
)
|
|
|
(10.7
|
)
|
|
|
(9.8
|
)
|
|
|
(25.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment income
|
|
$
|
56.1
|
|
|
$
|
137.2
|
|
|
$
|
6.5
|
|
|
$
|
199.8
|
|
|
$
|
83.8
|
|
|
$
|
114.1
|
|
|
$
|
6.8
|
|
|
$
|
204.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal Lines
Personal Lines’ net premiums written decreased $7.0 million, or 0.6%, to $1,115.7 million for the nine months ended September 30, 2009. The most significant factors contributing to lower net
premiums written were a decrease in average premium size driven by changes in our premium mix toward more desirable account business, increased reinsurance costs and a decrease in assumed premium from the CAR pool. These decreases were partially
offset by increases in net premiums written in our targeted growth states.
Personal Lines underwriting income decreased $20.4 million, to a
loss of $33.4 million, in the first nine months of 2009, compared to a loss of $13.0 million in the same period in 2008. Catastrophe losses decreased $11.2 million in 2009, to $64.1 million, from $75.3 million in the prior year. During 2008, we
incurred approximately $31 million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophes, our underwriting income would have decreased by $31.6 million. This decrease was primarily due to less favorable
current accident year results of approximately $13 million, primarily due to non-catastrophe weather-related losses caused by severe storms, and higher operating expenses of approximately $10 million, primarily attributable to higher pension costs
and higher technology costs. Also contributing to the decrease was less favorable development on prior years’ loss and LAE reserves of $8.4 million.
Commercial Lines
Commercial Lines’ net premiums written increased $68.1 million, or
8.5%, to $865.9 million for the first nine months of 2009. This increase was driven by growth in our specialty businesses, including the addition of our recently acquired subsidiary, AIX, which accounted for $71.8 million, as well as growth in
various niche and segmented businesses. Also contributing to the overall growth in net premiums written was improved rate, partially offset by increased reinsurance costs, lower renewal premium in our core business, primarily due to lower renewal
retention rates, and the non-recurring increase in net premiums written of $9.4 million in the first nine months of 2008 resulting from the termination, in 2008, of our umbrella excess of loss reinsurance treaty. We believe that the improved rate
and lower renewal retention rates in our unsegmented core business is reflective of an improving mix in our overall business.
Commercial
Lines underwriting income increased $23.2 million, to $41.3 million, in the first nine months of 2009, compared to $18.1 million in the same period of 2008. Catastrophe losses decreased $52.1 million in 2009, to $28.2 million, from $80.3 million in
the prior year. During 2008, we incurred approximately $57 million of catastrophe losses related to Hurricanes Ike and Gustav. Excluding the impact of catastrophes, our underwriting income would have decreased by $28.9 million. This decrease was
primarily due to higher operating expenses of approximately $26 million, primarily attributable to increased costs in our specialty businesses, including our recently acquired subsidiaries, higher employee and employee benefit costs, higher pension
costs and higher variable compensation. Additionally, favorable development on prior years’ loss and LAE reserves decreased $5.3 million. These decreases were partially offset by favorable current accident year results of approximately $2
million.
50
Other Property and Casualty
Segment income of the Other Property and Casualty segment decreased $0.3 million, to $6.5 million for the nine months ended September 30, 2009, from
$6.8 million in the same period of 2008. The decrease is primarily due to $10.8 million of higher pension costs retained from our discontinued life business, partially offset by $9.7 million of higher favorable development in our run-off voluntary
pools.
Investment Results
Net investment income before taxes decreased $5.4 million, or 2.8%, to $187.9 million for the nine months ended September 30, 2009 due to a decline in new money yields, lower investment income as a
result of fixed maturity sales to fund the repurchase of our corporate debt and the impact of defaulted bonds. These decreases were partially offset by prepayment fees and an increase in investment income related to our recently acquired
subsidiaries. The average pre-tax yield on fixed maturities was 5.6% for the first nine months of 2009 and 2008.
Reserve for Losses and Loss Adjustment Expenses
Overview of Loss Reserve Estimation
Process
We maintain reserves for our property and casualty products to provide for our ultimate liability for losses and
loss adjustment expenses (our “loss reserves”) with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, taking into account past loss experience, modified for current
trends, as well as prevailing economic, legal and social conditions. Loss reserves represent our largest liability.
Our loss reserves include
case estimates for claims that have been reported and estimates for claims that have been incurred but not reported (“IBNR”) at the balance sheet date. They also include estimates of the expenses associated with processing and settling all
reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Our loss reserves are not discounted to present value.
Case reserves are established by our claim personnel individually on a claim by claim basis and based on information specific to the occurrence and terms of the underlying policy. For some classes of
business, average case reserves are used initially. Case reserves are periodically reviewed and modified based on new or additional information pertaining to the claim.
IBNR reserves are estimated by management and our reserving actuaries on an aggregate basis for each line of business, coverage and accident year for all loss and loss expense liabilities not reflected
within the case reserves. The sum of the case reserves and the IBNR reserves represents our estimate of total unpaid loss and loss adjustment expense.
We regularly review our loss reserves using a variety of actuarial techniques. We update the reserve estimates as historical loss experience develops, additional claims are reported and resolved and new information becomes available. Any
changes in estimates are reflected in operating results in the period in which the estimates are changed.
IBNR reserve estimates are
generally calculated by first projecting the ultimate cost of all claims that have occurred or are expected to occur in the future in aggregate and then subtracting reported losses and loss expenses. Reported losses include cumulative paid losses
and loss expenses plus case reserves. The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which may not yet be known to the insured, as well as a provision for future development on
reported claims. IBNR represents a significant proportion of our total net loss reserves, particularly for long tail liability classes. In fact, approximately 51% of our aggregate net loss reserves at September 30, 2009 were for IBNR losses and
loss expenses.
Management’s process for establishing loss reserves is primarily based on the results of our reserving actuaries
quarterly reserving process; however, there are a number of other factors in addition to the actuarial point estimates as further described under the section below entitled “Loss and LAE Reserves by Line of Business.” In establishing our
loss reserves, we consider facts currently known and the present state of the law and coverage litigation. Based on all information currently available, we believe that the aggregate loss reserves at September 30, 2009 were adequate to cover
claims for losses that had occurred as of that date, including both those known to us and those yet to be reported. However, as described below, there are significant uncertainties inherent in the loss reserving process. It is therefore possible
that management’s estimate of the ultimate liability for losses that had occurred as of September 30, 2009 may change, which could have a material effect on our results of operations and financial condition.
51
Management’s Review of Judgments, Uncertainties and Key
Assumptions
We determine the amount of our loss reserves based on an estimation process that is very complex and uses
information from both company specific and industry data, as well as general economic information. The estimation process is a combination of objective and subjective information, the blending of which requires significant actuarial and business
judgment. There are various assumptions required including future trends in frequency and severity of claims, trends in total loss costs, operational changes in claim handling processes, and trends related to general economic and social conditions.
As a result, informed subjective estimates and judgments as to our ultimate exposure to losses are an integral component of our loss reserving process.
Given the inherent complexity of our loss reserving process and the potential variability of the assumptions used, the actual emergence of losses could vary, perhaps substantially, from the estimate of
losses included in our financial statements, particularly in those instances where settlements do not occur until well into the future. Our net loss reserves at September 30, 2009 were $2.1 billion. Therefore, a relatively small percentage
change in the estimate of net loss reserves would have a material effect on our results of operations.
There is greater inherent uncertainty
in estimating insurance reserves for certain types of property and casualty insurance lines, particularly workers’ compensation and other liability lines, where a longer period of time may elapse before a definitive determination of ultimate
liability and losses may be made. In addition, the technological, judicial, regulatory and political climates involving these types of claims change regularly. There is also greater uncertainty in establishing reserves with respect to new business,
particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business, such as the program business written by our recently
acquired AIX subsidiary. In such cases, there is less historical experience or knowledge and less data upon which the actuaries can rely. Historically, we have limited the issuance of long-tailed other liability policies, including directors and
officers (“D&O”) liability, errors and omissions (“E&O”) liability and medical malpractice liability. With the acquisition of Hanover Professionals in 2007, which writes lawyers professional errors and omissions coverage,
and the introduction of new specialty coverages, we are modestly increasing and expect to continue to increase our exposure to longer-tailed liability lines, including D&O coverages.
We regularly update our reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in the
results of operations as adjustments to losses and LAE. Often, these adjustments are recognized in periods subsequent to the period in which the underlying policy was written and the loss event occurred. These types of subsequent adjustments are
described separately as “prior year reserve development”. Such development can be either favorable or unfavorable to our financial results and may vary by line of business.
Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation varies by product. Our property and casualty insurance premiums are established before the amount
of losses and LAE and the extent to which inflation may affect such expenses are known. Consequently, we attempt, in establishing rates and reserves, to anticipate the potential impact of inflation and increasing medical costs in the projection of
ultimate costs. We have experienced increasing medical and attendant care costs, including those associated with personal automobile personal injury protection claims, particularly in Michigan, as well as in our workers’ compensation line in
most states. This increase is reflected in our reserve estimates, but continued increases could contribute to increased losses and LAE in the future.
We regularly review our reserving techniques, our overall reserving position and our reinsurance. Based on (i) our review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages and
policy coverage, political attitudes and trends in general economic conditions, (ii) our review of per claim information, (iii) our historical loss experience and that of the industry, (iv) the relatively short-term nature of most
policies written by us, and (v) our internal estimates of required reserves, we believe that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be
no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on our results of operations and financial position. An increase
or decrease in reserve estimates would result in a corresponding decrease or increase in financial results. For example, each one percentage point change in the aggregate loss and LAE ratio resulting from a change in reserve estimation is currently
projected to have an approximate $25 million impact on property and casualty segment income, based on 2008 full year premiums.
52
As discussed below, estimated loss and LAE reserves for claims occurring in prior years developed favorably
by $128.2 million and $132.2 million for the nine months ended September 30, 2009 and 2008, respectively, which represents 6.1% and 6.0% of net loss reserves held, respectively.
The major causes of material uncertainty relating to ultimate losses and loss adjustment expenses (“risk factors”) generally vary for each line of business, as well as for each separately
analyzed component of the line of business. In some cases, such risk factors are explicit assumptions of the estimation method and in others, they are implicit. For example, a method may explicitly assume that a certain percentage of claims will
close each year, but will implicitly assume that the legal interpretation of existing contract language will remain unchanged. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability
that is different from that being estimated currently.
Some risk factors will affect more than one line of business. Examples include changes
in claim department practices, changes in settlement patterns, regulatory and legislative actions, court actions, timeliness of claim reporting, state mix of claimants, and degree of claimant fraud. Additionally, there is also a higher degree of
uncertainty due to growth in our newly acquired companies, for which we have limited historical claims experience. The extent of the impact of a risk factor will also vary by components within a line of business. Individual risk factors are also
subject to interactions with other risk factors within line of business components. Thus, risk factors can have offsetting or compounding effects on required reserves.
We are also defendants in various litigation, including putative class actions, which claim punitive damages or claim a broader scope of policy coverage than our interpretation, particularly in connection
with losses incurred from Hurricane Katrina. The reserves established with respect to Hurricane Katrina assume that we will prevail with respect to these matters (See also “Contingencies and Regulatory Matters”). Although we believe our
current Hurricane Katrina reserves are adequate, there can be no assurance that our ultimate costs associated with this event will not substantially exceed these estimates. We have fully utilized all of our available reinsurance with respect to
losses and LAE related to Hurricane Katrina.
Loss and LAE Reserves by Line of Business
Reserves Other than those Relating to Asbestos and Environmental Claims
Our loss reserves include amounts related to short tail and long tail classes of business. “Tail” refers to the time period between the occurrence
of a loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary.
Short tail classes consist principally of automobile physical damage, homeowners, commercial property and marine business. For these coverages, claims are generally reported and settled shortly after the
loss occurs because the claims relate to tangible property and are more likely to be discovered shortly after the loss occurs. Consequently, the estimation of loss reserves for these classes is less complex.
While 59% of our written premium is in short tailed classes of business, most of our loss reserves relate to longer tail liability classes of business. Long
tail classes include commercial liability, automobile liability, workers’ compensation and other types of third party coverage. For many liability claims, significant periods of time, ranging up to several years or more, may elapse between the
occurrence of the loss, the discovery and reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for the long tail liability coverage has limited statistical credibility because a
relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. An accident year is the calendar year in which a loss is incurred. Liability claims are also more susceptible to
litigation and can be significantly affected by changing contract interpretations, the legal environment and the expense of protracted litigation. Consequently, the estimation of loss reserves for these coverages is more complex and typically
subject to a higher degree of variability compared to short tail coverages.
Most of our indirect business from voluntary and involuntary
pools is long tail casualty reinsurance. Reserve estimates for this business are therefore subject to the variability caused by extended loss emergence periods. The estimation of loss reserves for this business is further complicated by delays
between the time the claim is reported to the ceding insurer and when it is reported by the ceding insurer to us and by our dependence on the quality and consistency of the loss reporting by the ceding company.
53
Our reserving actuaries, who are independent of the business units, perform a comprehensive review of loss
reserves for each of the numerous classes of business we write at the end of each quarter. This review process takes into consideration a variety of trends that impact the ultimate settlement of claims, including the emergence of paid and reported
losses relative to expectations.
The loss reserve estimation process relies on the basic assumption that past experience, adjusted for the
effects of current developments and likely trends, is an appropriate basis for predicting future outcomes. As part of this process, our actuaries use a variety of actuarial methods that analyze experience, trends and other relevant factors. The
principal standard actuarial methods used by our actuaries in the loss reserve reviews include loss development factor methods, expected loss methods (Bornheutter-Ferguson), and adjusted loss methods (Berquist-Sherman).
Loss development factor methods generally assume that the losses yet to emerge for an accident year are proportional to the paid or reported loss amount
observed so far. Historical patterns of the development of paid and reported losses by accident year can be predictive of the expected future patterns that are applied to current paid and reported losses to generate estimated ultimate losses by
accident year.
Bornheutter-Ferguson methods calculate IBNR directly for each accident year as the product of expected ultimate losses times
the proportion of ultimate losses estimated to be unreported or unpaid (obtained from the loss development factor methods). Expected ultimate losses are determined by multiplying the expected loss ratio times earned premium. The expected loss ratio
uses loss ratios from prior accident years adjusted to reflect current revenue and cost levels. The expected loss ratio is a critical component of Bornheutter-Ferguson and provides a general reasonability guide for all reserving methods.
Berquist-Sherman methods are used in cases where historical development patterns may be deemed less optimal for use in estimating ultimate losses of
recent accident years. Under these methods, patterns of historical paid or reported losses are first adjusted to reflect current payment settlement patterns and case reserve adequacy and then evaluated in the same manner as the paid or reported loss
development factor methods described above. The reported loss development factor method can be less appropriate when the adequacy of case reserves suddenly changes, while the paid loss development factor method can likewise be less appropriate when
settlement patterns suddenly change.
For some low volume and high volatility classes of business, special reserving techniques are utilized
that estimate IBNR by selecting the loss ratio that balances actual reported losses to expected reported losses as defined by the estimated underlying reporting pattern.
In completing their loss reserve analysis, our actuaries are required to determine the most appropriate actuarial methods to employ for each line of business, coverage and accident year. Each estimation
method has its own pattern, parameter and/or judgmental dependencies, with no estimation method being better than the others in all situations. The relative strengths and weaknesses of the various estimation methods when applied to a particular
class of business can also change over time, depending on the underlying circumstances. In many cases, multiple estimation methods will be valid for the particular facts and circumstances of the relevant class of business. The manner of application
and the degree of reliance on a given method will vary by line of business and coverage, and by accident year based on our actuaries’ evaluation of the above dependencies and the potential volatility of the loss frequency and severity patterns.
The estimation methods selected or given weight by our actuaries at a particular valuation date are those that are believed to produce the most reliable indication for the loss reserves being evaluated. Selections incorporate input from claims
personnel, pricing actuaries, and underwriting management on loss cost trends and other factors that could affect ultimate losses.
For short
tail classes, the emergence of paid and incurred losses generally exhibits a reasonably stable pattern of loss development from one accident year to the next. Thus, for these classes in the vast majority of cases, the loss development factor method
is generally appropriate. In certain cases where there is a relatively low level of reliability placed on the available paid and incurred loss data, expected loss methods or adjusted loss methods are considered appropriate for the most recent
accident year.
For long tail lines of business, applying the loss development factor method often requires more judgment in selecting
development factors as well as more significant extrapolation. For those long tail lines of business with high frequency and relatively low per-loss severity (e.g., personal automobile liability), volatility will often be sufficiently modest for the
loss development factor method to be given significant weight, even in the most recent accident years, but expected loss methods and adjusted loss methods are always considered and frequently utilized in the selection process. For those long tail
lines of business with low frequency and high loss potential (e.g., commercial liability), anticipated loss experience is less predictable because of
54
the small number of claims and erratic claim severity patterns. In these situations, the loss development factor methods may not produce a reliable estimate of ultimate losses in the most recent
accident years since many claims either have not yet been reported or are only in the early stages of the settlement process. Therefore, the actuarial estimates for these accident years are based on methods less reliant on extrapolation, such as
Bornheutter-Ferguson. Over time, as a greater number of claims are reported and the statistical credibility of loss experience increases, loss development factor methods or adjusted loss methods are given increasingly more weight.
Using all the available data, our actuaries select an indicated loss reserve amount for each line of business, coverage and accident year based on the
various assumptions, projections and methods. The total indicated reserve amount determined by our actuaries is an aggregate of the indicated reserve amounts for the individual classes of business. The ultimate outcome is likely to fall within a
range of potential outcomes around this indicated amount, but the indicated amount is not expected to be precisely the ultimate liability.
As
stated above, numerous factors (both internal and external) contribute to the inherent uncertainty in the process of establishing loss reserves, including changes in the rate of inflation for goods and services related to insured damages (e.g.,
medical care, home repairs, etc.), changes in the judicial interpretation of policy provisions, changes in the general attitude of juries in determination of damages, legislative actions, changes in the extent of insured injuries, changes in the
trend of expected frequency and/or severity of claims, changes in our book of business (e.g., change in mix due to new product offerings, new geographic areas, etc.), changes in our underwriting norms, and changes in claim handling procedures and/or
systems. Regarding our indirect business from voluntary and involuntary pools, we are provided loss estimates by managers of each pool. We adopt reserve estimates for the pools that consider this information and other facts.
In addition, we must consider the uncertain effects of emerging or potential claims and coverage issues that arise as legal, judicial and social conditions
change. These issues could have a negative effect on our loss reserves by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. As a result of these potential issues, the uncertainties
inherent in estimating ultimate claim costs on the basis of past experience have further complicated the already complex loss reserving process. For example, in the state of Michigan, tort compensation for non-economic damages (for example, pain and
suffering) caused by ownership or use of a motor vehicle is limited by statute to circumstances where the injured person suffered death, serious impairment of body function or permanent serious disfigurement. The application of this statute has been
defined by the Supreme Court of Michigan in the so-called
Kreiner
decision. Accordingly, we establish our “loss picks” and our claim, IBNR and loss adjustment expense reserves based upon our understanding of the current state of the
law. There have been and currently are efforts to change the controlling statute or judicial interpretation in ways which would expand an injured person’s right to sue for non-economic damages. If implemented, such changes may not only impact
future claims, but also past claims which are not settled and therefore an unfavorable adjustment to existing loss reserves would likely be required.
As part of our loss reserving analysis, we take into consideration the various factors that contribute to the uncertainty in the loss reserving process. Those factors that could materially affect our loss reserve estimates include loss
development patterns and loss cost trends, rate and exposure level changes, the effects of changes in coverage and policy limits, business mix shifts, the effects of regulatory and legislative developments, the effects of changes in judicial
interpretations, the effects of emerging claims and coverage issues and the effects of changes in claim handling practices. In making estimates of reserves, however, we do not necessarily make an explicit assumption for each of these factors.
Moreover, all estimation methods do not utilize the same assumptions and typically no single method is determinative in the reserve analysis for a line of business and coverage. Consequently, changes in our loss reserve estimates generally are not
the result of changes in any one assumption. Instead, the variability will be affected by the interplay of changes in numerous assumptions, many of which are implicit to the approaches used.
For each line of business and coverage, we regularly adjust the assumptions and actuarial methods used in the estimation of loss reserves in response to our
actual loss experience, as well as our judgments regarding changes in trends and/or emerging patterns. In those instances where we primarily utilize analyses of historical patterns of the development of paid and reported losses, this may be
reflected, for example, in the selection of revised loss development factors. In those long tail classes of business that comprise a majority of our loss reserves and for which loss experience is less predictable due to potential changes in judicial
interpretations, potential legislative actions and potential claims issues, this may be reflected in a judgmental change in our estimate of ultimate losses for particular accident years.
The future impact of the various factors that contribute to the uncertainty in the loss reserving process is extremely difficult to predict. There is potential for significant variation in the development
of loss reserves, particularly for long tail classes of business. We do not derive statistical loss distributions or confidence levels around our loss reserve estimate, and as a result, do
55
not have reserve range estimates to disclose. Actuarial ranges of reasonable estimates are not a true reflection of the potential volatility between carried loss reserves and the ultimate
settlement amount of losses incurred prior to the balance sheet date. This is due, among other reasons, to the fact that actuarial ranges are developed based on known events as of the valuation date whereas the ultimate disposition of losses is
subject to the outcome of events and circumstances that were unknown as of the valuation date.
The following tables and related discussion
includes disclosure of possible variation from current actuarial estimates of loss reserves due to a change in certain key assumptions for the primary long tail coverages within our major lines of business which typically represent the areas of
greatest uncertainty in our reserving process. We believe that the estimated variation in reserves detailed below is a reasonable estimate of the possible variation that may occur in the future, and are provided to illustrate the relationship
between claim reporting patterns and expected loss ratios, respectively, on actuarial loss reserve estimates for the lines identified. However, if such variation did occur, it would likely occur over a period of several years and therefore its
impact on our results of operations would be spread over the same period. It is important to note, however, that there is the potential for future variation greater than the amounts discussed below and for any such variations to be recognized in a
single quarterly or annual period.
As noted, the tables below illustrate the relationship between the impact on our actuarial loss reserve
estimates of reasonably likely variations to claim reporting patterns and expected actuarial estimates of ultimate loss costs, two key actuarial assumptions used to estimate our net reserves at September 30, 2009, from the assumptions utilized
by our actuaries. The five point change to our expected loss ratio selections, which incorporate variability in both ultimate frequency and severity, are within the historical variation present in our prior accident year development. The three month
change to reporting patterns represent claims reporting that is both faster and slower than our current reporting assumption for reported loss patterns and this degree of change is within the historical variation present in actual reporting
patterns. A faster reporting pattern results in lower indicated net loss reserves due to the presumption that a higher proportion of ultimate claims have been reported thus far and; therefore, a lower proportion of ultimate claims needs to be
carried as IBNR. A slower reporting pattern results in higher indicated net loss reserves due to the presumption that a lower proportion of ultimate claims have been reported thus far and; therefore, a higher proportion of ultimate claims needs to
be carried as IBNR.
The results show the cumulative dollar difference between our current actuarial estimate and the estimate that we would
develop if our understanding with respect to loss reporting patterns and ultimate loss costs were different by three months or five points, respectively. No consideration has been given to potential correlation or lack of correlation among key
assumptions or among lines of business and coverage. As a result, it would be inappropriate to take the amounts described below and add them together in an attempt to estimate volatility in total. While we believe these are reasonably likely
scenarios, we do not believe the reader should consider the below sensitivity analysis as an actual reserve range.
Expected
Dollar Effect on Actuarial Loss Reserve Estimates
Personal Automobile Bodily Injury
(In
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Expected Loss Ratio
|
|
|
Reporting Pattern
|
|
5 points
lower
|
|
|
Unchanged
|
|
|
5 points
higher
|
|
|
3 months faster
|
|
$
|
(27
|
)
|
|
$
|
(25
|
)
|
|
$
|
(23
|
)
|
|
Unchanged
|
|
|
(3
|
)
|
|
|
—
|
|
|
|
3
|
|
|
3 months slower
|
|
|
23
|
|
|
|
27
|
|
|
|
30
|
|
56
Example: Personal Automobile Bodily Injury, if losses are actually developing and emerging three months
slower than we anticipate in our models, our actuarial estimate for this coverage would be understated by $27 million. If our assumed payment patterns are consistent with our expectations, but the expected loss ratio in our model is 5% too low, then
our actuarial estimate for this coverage would be understated by $3 million.
Expected Dollar Effect on Actuarial Loss
Reserve Estimates
Workers’ Compensation Indemnity
(In
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Expected Loss Ratio
|
|
|
Reporting Pattern
|
|
5 points
lower
|
|
|
unchanged
|
|
|
5 points
higher
|
|
|
3 months faster
|
|
$
|
(6
|
)
|
|
$
|
(4
|
)
|
|
$
|
(2
|
)
|
|
Unchanged
|
|
|
(2
|
)
|
|
|
—
|
|
|
|
2
|
|
|
3 months slower
|
|
|
7
|
|
|
|
9
|
|
|
|
12
|
|
Workers’ Compensation Medical
(In millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Expected Loss Ratio
|
|
Reporting Pattern
|
|
5 points
lower
|
|
|
unchanged
|
|
|
5 points
higher
|
|
3 months faster
|
|
$
|
(4
|
)
|
|
$
|
(1
|
)
|
|
$
|
1
|
|
Unchanged
|
|
|
(3
|
)
|
|
|
—
|
|
|
|
3
|
|
3 months slower
|
|
|
1
|
|
|
|
4
|
|
|
|
7
|
Commercial Multiple Peril Liability
(In millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Expected Loss Ratio
|
|
|
Reporting Pattern
|
|
5 points
lower
|
|
|
unchanged
|
|
|
5 points
higher
|
|
|
3 months faster
|
|
$
|
(13
|
)
|
|
$
|
(12
|
)
|
|
$
|
(11
|
)
|
|
Unchanged
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
1
|
|
|
3 months slower
|
|
|
5
|
|
|
|
6
|
|
|
|
8
|
|
Senior management meets with our reserving actuaries at the end of each quarter to review the results
of the latest actuarial loss reserve analysis. Management’s evaluation process to determine our ultimate losses includes various quarterly reserve committee meetings, culminating with the approval of single point best estimates by our Chief
Financial Officer that reflect but often differ from our actuarial reserve analysis. Based on this quarterly process, management determines the carried reserve for each line of business and coverage and assesses the reasonableness of the difference
between recorded and actuarially indicated reserves. In making the determination, management considers numerous factors, such as changes in actuarial indications in the period, the maturity of the accident year, trends observed over the recent past,
the level of volatility within a particular class of business, general economic trends, and other factors not fully captured in the actuarial reserve analysis. In doing so, management must evaluate whether a change in the data represents credible
actionable information or an anomaly. Such an assessment requires considerable judgment. Even if a change is determined to be apparent, it is not always possible to determine the extent of the change. As a result, there can be a time lag between the
emergence of a change and a determination that the change should be reflected in the carried loss reserves. In general, changes are made more quickly to more mature accident years and less volatile classes of business.
57
The table below shows our recorded reserves, net of reinsurance, and the related actuarial reserve point
estimates by line of business at September 30, 2009 and December 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009
|
|
December 31, 2008
|
|
(In millions)
|
|
Recorded
Net
Reserves
|
|
Actuarial
Point
Estimate
|
|
Recorded
Net
Reserves
|
|
Actuarial
Point
Estimate
|
|
Personal Automobile
|
|
$
|
646.0
|
|
$
|
616.7
|
|
$
|
668.4
|
|
$
|
638.0
|
|
Homeowners
|
|
|
96.3
|
|
|
91.3
|
|
|
98.5
|
|
|
96.4
|
|
Other Personal Lines
|
|
|
21.3
|
|
|
18.5
|
|
|
21.0
|
|
|
18.1
|
|
Workers’ Compensation
|
|
|
346.4
|
|
|
326.9
|
|
|
361.7
|
|
|
347.4
|
|
Commercial Automobile
|
|
|
156.2
|
|
|
150.8
|
|
|
159.2
|
|
|
153.1
|
|
Commercial Multiple Peril
|
|
|
422.9
|
|
|
392.2
|
|
|
443.4
|
|
|
409.0
|
|
Other Commercial Lines
|
|
|
277.7
|
|
|
266.4
|
|
|
269.2
|
|
|
257.0
|
|
Asbestos and Environmental
|
|
|
11.3
|
|
|
11.4
|
|
|
18.3
|
|
|
18.3
|
|
Pools and Other
|
|
|
140.3
|
|
|
140.3
|
|
|
173.4
|
|
|
173.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,118.4
|
|
$
|
2,014.5
|
|
$
|
2,213.1
|
|
$
|
2,110.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The principal factors considered by management, in addition to the actuarial point estimates, in
determining the reserves at September 30, 2009 and December 31, 2008 vary by line of business. In our Commercial Lines segment, management considered the growth and product mix changes and recent adverse property related frequency trends
in certain coverages. In addition, management also considered the significant growth in our inland marine and bond businesses for which we have limited actuarial data to estimate losses and the product mix change in our bond business towards a
greater proportion of contract surety bonds where losses tend to emerge over a longer period of time and are cyclical related to general economic conditions. Moreover, in our Commercial Lines segment, management considered the potential for adverse
development in the workers’ compensation line where losses tend to emerge over long periods of time and rising medical costs, while moderating, have continued to be a concern. With the acquisitions of Hanover Professionals and AIX, we are
modestly increasing our exposure to longer-tailed liability lines and there is less historical experience and less actuarial data available, all of which results in less certainty when estimating ultimate reserves. Also, higher retentions on our
reinsurance program beginning January 1, 2008 compared to prior years may impact the emergence of trends in underlying data that could add to the uncertainty and variability of our actuarial estimates going forward. Additionally, there is also
a higher degree of uncertainty due to growth in our newly acquired companies, for which we have limited historical claims experience. In our Personal Lines segment, management considered the adverse personal automobile personal injury development
and related potential for adverse trends due to costs shifting from health insurers to property and casualty insurers resulting from economic concerns and health insurance coverage trends, the potential impact of the Michigan Supreme Court’s
pending review of the so-called
Kreiner
decision, developments in personal automobile property costs in the 2007 and 2008 accident years and an increase in physical damage frequency, all of which have added additional uncertainty to future
development in our personal automobile line. Additionally, management considered the significant growth in our new business with our
Connections Auto
product and related growth in a number of states where there is additional
uncertainty in the ultimate profitability and development of reserves due to the unseasoned nature of our new business and new agency relationships in these markets, as well as emerging loss trends which are higher than expected. Although our
experience and data in these areas is growing with the passage of time, a sufficient number of years of actuarial data is not yet available to base loss estimates solely on this data in new geographical areas and agency relationships and with new
products which results in less certainty when estimating ultimate reserves and requires more judgment by management. Management also considered the likelihood of future adverse development related to significant catastrophe losses experienced in
Hurricanes Katrina and Rita in 2005 and Hurricanes Ike and Gustav in 2008. Regarding our indirect business from voluntary and involuntary pools, we are provided loss estimates by managers of each pool. We adopt reserve estimates for the pools that
consider this information and other factors. At September 30, 2009 and December 31, 2008, total recorded net reserves were 5.2% and 4.9% greater than actuarially indicated reserves, respectively. During the first nine months of 2009, the
increase in the difference between recorded and actuarially indicated reserves is primarily due to a change in our actuarial reserve methodology for estimating loss adjustment expenses. The change involves our changing our reliance from a
traditional paid-to-paid methodology to reliance on a method based on claim counts and cost per claim, taking into account the settlement status of the claim, which we believe more appropriately reflects the ultimate cost of settlement. We
anticipate the impact of this change in methodology on future periods to be immaterial.
58
The table below provides a reconciliation of the gross beginning and ending reserve for unpaid losses and
LAE as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
(In millions)
|
|
2009
|
|
|
2008
|
|
|
Reserve for losses and LAE, beginning of period
|
|
$
|
3,201.3
|
|
|
$
|
3,165.8
|
|
|
Incurred losses and LAE, net of reinsurance recoverable:
|
|
|
|
|
|
|
|
|
|
Provision for insured events of current year
|
|
|
1,352.9
|
|
|
|
1,372.3
|
|
|
Decrease in provision for insured events of prior years; favorable development
|
|
|
(128.2
|
)
|
|
|
(132.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred losses and LAE
|
|
|
1,224.7
|
|
|
|
1,240.1
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments, net of reinsurance recoverable:
|
|
|
|
|
|
|
|
|
|
Losses and LAE attributable to insured events of current year
|
|
|
665.6
|
|
|
|
667.9
|
|
|
Losses and LAE attributable to insured events of prior years
|
|
|
644.2
|
|
|
|
568.4
|
|
|
Hurricane Katrina
|
|
|
9.6
|
|
|
|
28.3
|
|
|
|
|
|
|
|
|
|
|
|
|
Total payments
|
|
|
1,319.4
|
|
|
|
1,264.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in reinsurance recoverable on unpaid losses
|
|
|
(21.8
|
)
|
|
|
(27.5
|
)
|
|
Purchase of Verlan Fire Insurance Company
|
|
|
—
|
|
|
|
4.2
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for losses and LAE, end of period
|
|
$
|
3,084.8
|
|
|
$
|
3,118.0
|
|
|
|
|
|
|
|
|
|
|
|
The table below summarizes the gross reserve for losses and LAE by line of business.
|
|
|
|
|
|
|
|
|
(In millions)
|
|
September 30,
2009
|
|
December 31,
2008
|
|
Personal Automobile
|
|
$
|
1,253.3
|
|
$
|
1,292.5
|
|
Homeowners and Other
|
|
|
144.7
|
|
|
152.1
|
|
|
|
|
|
|
|
|
|
Total Personal
|
|
|
1,398.0
|
|
|
1,444.6
|
|
|
|
|
|
|
|
|
|
Workers’ Compensation
|
|
|
526.8
|
|
|
547.0
|
|
Commercial Automobile
|
|
|
217.8
|
|
|
226.4
|
|
Commercial Multiple Peril
|
|
|
476.6
|
|
|
499.5
|
|
Other Commercial
|
|
|
465.6
|
|
|
483.8
|
|
|
|
|
|
|
|
|
|
Total Commercial
|
|
|
1,686.8
|
|
|
1,756.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total reserve for losses and LAE
|
|
$
|
3,084.8
|
|
$
|
3,201.3
|
|
|
|
|
|
|
|
|
The total reserve for losses and LAE as disclosed in the above table decreased by $116.5 million for
the nine months ended September 30, 2009. This decrease is primarily due to favorable development of prior years’ loss and LAE reserves.
Prior Year Development by Line of Business
When trends emerge that we believe affect the
future settlement of claims, we adjust our reserves accordingly. Reserve adjustments are reflected in the Consolidated Statements of Income as adjustments to losses and LAE. Often, we recognize these adjustments in periods subsequent to the period
in which the underlying loss event occurred. These types of subsequent adjustments are disclosed and discussed separately as “prior year reserve development”. Such development can be either favorable or unfavorable to our financial
results.
59
The following table summarizes the change in provision for insured events of prior years, excluding those
related to Hurricane Katrina by line of business.
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
(In millions)
|
|
2009
|
|
|
2008
|
|
|
(Decrease) increase in loss provision for insured events of prior years:
|
|
|
|
|
|
|
|
|
|
Personal Automobile
|
|
$
|
(44.5
|
)
|
|
$
|
(47.5
|
)
|
|
Homeowners and Other
|
|
|
6.2
|
|
|
|
(2.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total Personal
|
|
|
(38.3
|
)
|
|
|
(50.4
|
)
|
|
|
|
|
|
Workers’ Compensation
|
|
|
(17.1
|
)
|
|
|
(22.3
|
)
|
|
Commercial Automobile
|
|
|
(4.7
|
)
|
|
|
(10.8
|
)
|
|
Commercial Multiple Peril
|
|
|
(16.1
|
)
|
|
|
(29.0
|
)
|
|
Other Commercial
|
|
|
(20.0
|
)
|
|
|
(15.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total Commercial
|
|
|
(57.9
|
)
|
|
|
(77.1
|
)
|
|
|
|
|
|
Voluntary Pools
|
|
|
(10.4
|
)
|
|
|
(0.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in loss provision for insured events of prior years
|
|
|
(106.6
|
)
|
|
|
(128.2
|
)
|
|
Decrease in LAE provision for insured events of prior years
|
|
|
(21.6
|
)
|
|
|
(4.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in total loss and LAE provision for insured events of prior years
|
|
$
|
(128.2
|
)
|
|
$
|
(132.2
|
)
|
|
|
|
|
|
|
|
|
|
|
Estimated loss reserves for claims occurring in prior years developed favorably by $106.6 million and
$128.2 million during the first nine months of 2009 and 2008, respectively. The favorable loss reserve development during the first nine months of 2009 is primarily the result of lower than expected severity of bodily injury in the personal
automobile line, primarily in the 2000 through 2008 accident years, lower than expected severity in the workers’ compensation line, primarily in the 2000 through 2008 accident years and lower than expected severity in the commercial multiple
peril line, primarily in the 2000 through 2007 accident years. In addition, lower than expected severity in the bond line, lower projected losses in our run-off voluntary pools and lower projected exposures to asbestos and environmental liability
for our direct written business contributed to the favorable development. Partially offsetting the favorable development was unfavorable non-catastrophe weather-related property loss development of $15.1 million, primarily related to our commercial
property, homeowners and personal automobile physical damage lines, which developed unfavorably by $7.1 million, $6.4 million and $1.6 million, respectively.
The favorable loss reserve development during the first nine months of 2008 is primarily the result of lower than expected severity of bodily injury in the personal automobile line, primarily in the 2003
through 2007 accident years, and lower than expected severity of liability claims in the commercial multiple peril line for the 2002 through 2007 accident years. In addition, lower than expected severity in the workers’ compensation line,
primarily in the 2003 through 2007 accident years, contributed to the favorable development.
During the first nine months of 2009 and 2008,
estimated LAE reserves for claims occurring in prior years developed favorably by $21.6 million and $4.0 million, respectively. A change in our actuarial methodology for estimating loss adjustment expense reserves increased favorable development of
prior year LAE reserves by $20.0 million in the first nine months of 2009. The favorable development in 2008 was primarily attributable to the aforementioned improvement in ultimate loss activity on prior accident years, primarily in the commercial
multiple peril line.
Although we have experienced significant favorable development in both losses and LAE in recent years, there can be no
assurance that this level of favorable development will occur in the future. We believe that we will experience less favorable prior year development in future years than we experienced recently. The factors that resulted in the favorable
development of prior year reserves, including the aforementioned change in LAE reserve methodology, are considered in our ongoing process for establishing current accident year reserves. In light of our recent years of favorable development, the
factors driving this development were considered to varying degrees in setting the more recent years’ accident year reserves. As a result, we expect the current and most recent accident year reserves not to develop as favorably as they have in
the past. In light of the significance, in recent periods, of favorable development to our Property and Casualty group’s segment income, declines in favorable development could be material to our results of operations.
60
Asbestos and Environmental Reserves
Although we attempt to limit our exposures to asbestos and environmental damage liability through specific policy exclusions, we have been and may continue
to be subject to claims related to these exposures. Ending loss and LAE reserves for all direct business written by our property and casualty companies related to asbestos and environmental damage liability, included in the reserve for losses and
LAE, were $11.3 million and $18.5 million at September 30, 2009 and December 31, 2008, respectively, net of reinsurance of $14.7 million and $13.9 million at September 30, 2009 and December 31, 2008, respectively. In recent
years, average asbestos and environmental payments have declined modestly. As a result of the declining payments, our actuarial indicated point estimate of asbestos and environmental liability reserves was lowered resulting in favorable reserve
development of $6.2 million during the quarter ended September 30, 2009. As a result of our historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability
loss experience has remained minimal in relation to our total loss and LAE incurred experience.
In addition, and not included in the numbers
above, we have established loss and LAE reserves for assumed reinsurance pool business with asbestos and environmental damage liability of $47.7 million and $58.4 million at September 30, 2009 and December 31, 2008, respectively. These
reserves relate to pools in which we have terminated our participation; however, we continue to be subject to claims related to years in which we were a participant. A significant part of our pool reserves relates to our participation in the Excess
and Casualty Reinsurance Association (“ECRA”) voluntary pool from 1950 to 1982. In 1982, the pool was dissolved and since that time, the business has been in runoff. Our percentage of the total pool liabilities varied from 1% to 6% during
these years. Our participation in this pool has resulted in average paid losses of approximately $2 million annually over the past ten years. During the quarter ended September 30, 2009, our ECRA pool reserves were lowered by $6.3 million as
the result of an actuarial study completed by the ECRA pool during the quarter. Management reviewed the ECRA actuarial study, concurred that the study was reasonable, and adopted its actuarial point estimate as of September 30, 2009. In
addition, management lowered its exposure estimate on a separate large claim within these pools by $3.2 million during the quarter. Because of the inherent uncertainty regarding the types of claims in these pools, we cannot provide assurance that
our reserves will be sufficient.
We estimate our ultimate liability for asbestos, environmental and toxic tort liability claims, whether
resulting from direct business, assumed reinsurance or pool business, based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are
not significant, their existence gives rise to uncertainty and are discussed because of the possibility that they may become significant or similar claims may arise. We believe that, notwithstanding the evolution of case law expanding liability in
asbestos and environmental claims, recorded reserves related to these claims are adequate. Nevertheless, the asbestos, environmental and toxic tort liability reserves could be revised, and any such revisions could have a material adverse effect on
our results of operations for a particular quarterly or annual period or on our financial position.
Discontinued Operations: Life Companies
Discontinued operations consist of: (i) FAFLIC’s discontinued operations,
including both the loss associated with the sale of FAFLIC on January 2, 2009 and the loss or income resulting from its prior business operations; and (ii) losses or gains associated with the sale of the variable life insurance and annuity
business in 2005.
FAFLIC Discontinued Operations
On January 2, 2009, we sold our remaining life insurance subsidiary, FAFLIC, to Commonwealth Annuity, a subsidiary of Goldman Sachs. We obtained approval from the Massachusetts Division of Insurance
for a pre-close dividend from FAFLIC consisting of designated assets with a statutory book value of approximately $130 million. Total net proceeds from the sale, including the dividend, were approximately $230 million, net of transaction costs.
Additionally, coincident with the sale transaction, Hanover Insurance and FAFLIC entered into a reinsurance contract whereby Hanover Insurance assumed FAFLIC’s discontinued accident and health insurance business. We also agreed to indemnify
Commonwealth Annuity for certain litigation, regulatory matters and other liabilities related to the pre-closing activities of the business transferred. For the year ended December 31, 2008, we recognized a loss from the sale of FAFLIC of $77.3
million.
61
The following table summarizes the results for this discontinued business for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
(In millions)
|
|
2009
|
|
2008
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
|
Gain (loss) from discontinued FAFLIC business, net of taxes
|
|
$
|
0.4
|
|
$
|
(21.7
|
)
|
|
$
|
6.3
|
|
$
|
(92.9
|
)
|
The gain from FAFLIC’s discontinued operations was $0.4 million for the quarter ended
September 30, 2009 and primarily resulted from a tax adjustment relating to the FAFLIC operations in prior tax years. Net losses in the third quarter of 2008 include net realized investment losses of $15.6 million, primarily resulting from
other-than-temporary impairments principally in the financial services sector, including Lehman Brothers and Washington Mutual. Additionally, we recognized an increase to the preliminary estimate of loss associated with the sale transaction of $6.1
million.
The gain from FAFLIC’s discontinued operations was $6.3 million for the nine months ended September 30, 2009 and resulted
primarily from a change in our estimate of indemnification liabilities related to the sale, the release of sale-related accruals, and the aforementioned tax adjustment. Net losses for the nine months ended September 30, 2008 primarily reflect
our preliminary estimate of the loss associated with the sale transaction of $72.2 million and net realized investment losses of $23.0 million. These net realized investment losses primarily resulted from the aforementioned other-than-temporary
impairments and losses associated with the sale of fixed maturities. These losses were partially offset by favorable results, primarily attributable to both our traditional and group retirement lines of business.
In connection with the sales transaction, we agreed to indemnify Commonwealth Annuity for certain legal, regulatory and other matters that existed as of the
sale. Accordingly, we established a gross liability in accordance with ASC 460,
Guarantees – Overall
(“ASC 460”) (formerly included under FASB Interpretation No. 45,
Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others
) of $9.9 million. As of September 30, 2009, our total gross liability related to these guarantees was $1.9 million. Although we believe our current
estimate for this liability is appropriate, there can be no assurance that this estimate will be sufficient to pay future expenses associated with these guarantees.
Gain on Disposal of Variable Life Insurance and Annuity Business
On
December 30, 2005, we sold our run-off variable life insurance and annuity business to Goldman Sachs. Results currently consist primarily of expense and recoveries relating to indemnification obligations incurred in connection with this sale.
The following table summarizes the results for this discontinued business for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(In millions)
|
|
2009
|
|
2008
|
|
2009
|
|
2008
|
|
Gain on disposal of variable life insurance and annuity business, net of taxes
|
|
$
|
—
|
|
$
|
2.7
|
|
$
|
4.1
|
|
$
|
8.1
|
For the nine months ended September 30, 2009, we recorded a gain of $4.1 million, net of tax,
primarily related to a change in our estimate of liabilities related to certain indemnities to Goldman Sachs relating to pre-sale activities of the business sold. For the nine months ended September 30, 2008, we recorded a gain of $8.1 million,
net of tax, primarily from a $5.8 million release of liabilities in the first half of 2008 related to certain indemnities to Goldman Sachs, and a $2.6 million federal income tax settlement in the third quarter.
As of September 30, 2009, our total gross liability for guarantees and indemnifications provided in connection with the disposal of our former variable
life insurance and annuity business was $6.0 million on a pre-tax basis. Although we believe our current estimate for this liability is appropriate, there can be no assurance that this estimate will be sufficient to pay future expenses associated
with these guarantees.
62
Other Items
In the third quarter of 2008, we recognized a $6.4 million tax benefit resulting from a settlement with the Internal Revenue Service (“IRS”) for
tax years 1995 through 2001.
There were no net realized gains or losses on investments in the third quarter of 2009, compared to $52.8
million in net realized losses in the same period of 2008. The losses in the third quarter of 2008 were primarily due to other-than temporary impairments of fixed maturities. Net realized losses on investments were $9.7 million for the first nine
months of 2009 compared to $60.7 million for the same period of 2008. Net realized losses in 2009 are due to $29.3 million of impairments from both fixed maturities and equity securities, partially offset by $19.6 million of gains recognized
primarily from the sale of fixed maturities. In 2008, losses resulted primarily from $66.7 million of impairments, primarily from fixed maturities, partially offset by $6.0 million of gains recognized principally from the sale of fixed maturities.
We completed a cash tender offer to repurchase a portion of our 8.207% Series B Capital Securities due in 2027 that were issued by AFC
Capital Trust I and a portion of our 7.625% Senior Debentures due in 2025 that were issued by THG. AFC Capital Trust I was subsequently liquidated as of July 30, 2009. As a result of these actions and including securities repurchased prior and
subsequent to the tender offer, we recorded a pre-tax gain of $0.2 million and $34.5 million for the third quarter and the first nine months of 2009 (see “Other Significant Transactions” for further discussion regarding these items).
We recorded a federal income tax benefit on non-segment income of $3.1 million related to the release of a valuation allowance on tax
benefits associated with net realized investment losses recognized in the first half of 2009.
Additionally, we recorded $8.6 million in
federal income tax expense on non-segment income for the first nine months of 2009, primarily related to the gain from the retirement of corporate debt and repurchase of securities, partially offset by the aforementioned tax benefit.
We recognized income of $10.1 million in the first nine months of 2008, which primarily consists of an $11.1 million gain on the sale of AMGRO, partially
offset by losses from the operations of AMGRO during that period.
Net income includes the following items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30, 2009
|
|
|
|
Property and Casualty
|
|
|
|
(In millions)
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property and
Casualty (2)
|
|
Total
|
|
Net realized investment (losses) gains (1)
|
|
$
|
(0.7
|
)
|
|
$
|
(0.4
|
)
|
|
$
|
1.1
|
|
$
|
—
|
|
Gain from retirement of corporate debt
|
|
|
—
|
|
|
|
—
|
|
|
|
0.2
|
|
|
0.2
|
|
Gain from discontinued FAFLIC business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
0.4
|
|
|
0.4
|
|
Gain from discontinued accident and health business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
0.7
|
|
|
0.7
|
63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30, 2008
|
|
|
|
|
Property and Casualty
|
|
|
|
|
|
|
|
|
(In millions)
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property and
Casualty (2)
|
|
|
Life
Companies
|
|
|
Total
|
|
|
Net realized investment losses (1)
|
|
$
|
(25.2
|
)
|
|
$
|
(25.6
|
)
|
|
$
|
(2.0
|
)
|
|
$
|
—
|
|
|
$
|
(52.8
|
)
|
|
Federal income tax settlement
|
|
|
5.5
|
|
|
|
2.1
|
|
|
|
(1.2
|
)
|
|
|
—
|
|
|
|
6.4
|
|
|
Loss from discontinued FAFLIC business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(21.7
|
)
|
|
|
(21.7
|
)
|
|
Gain on disposal of variable life insurance and annuity business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2.7
|
|
|
|
2.7
|
|
|
Other, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
0.7
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2009
|
|
|
|
|
Property and Casualty
|
|
|
|
|
|
(In millions)
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property and
Casualty (2)
|
|
|
Total
|
|
|
Net realized investment (losses) gains (1)
|
|
$
|
(6.6
|
)
|
|
$
|
(5.7
|
)
|
|
$
|
2.6
|
|
|
$
|
(9.7
|
)
|
|
Gain from retirement of corporate debt
|
|
|
—
|
|
|
|
—
|
|
|
|
34.5
|
|
|
|
34.5
|
|
|
Gain from discontinued FAFLIC business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
6.3
|
|
|
|
6.3
|
|
|
Loss from discontinued accident and health business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
(2.4
|
)
|
|
|
(2.4
|
)
|
|
Gain on disposal of variable life insurance and annuity business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
4.1
|
|
|
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2008
|
|
|
|
|
Property and Casualty
|
|
|
|
|
|
|
|
|
(In millions)
|
|
Personal
Lines
|
|
|
Commercial
Lines
|
|
|
Other
Property and
Casualty (2)
|
|
|
Life
Companies
|
|
|
Total
|
|
|
Net realized investment (losses) gains (1)
|
|
$
|
(31.0
|
)
|
|
$
|
(31.2
|
)
|
|
$
|
1.5
|
|
|
$
|
—
|
|
|
$
|
(60.7
|
)
|
|
Federal income tax settlement
|
|
|
5.5
|
|
|
|
2.1
|
|
|
|
(1.2
|
)
|
|
|
—
|
|
|
|
6.4
|
|
|
Loss from discontinued FAFLIC business (including estimated loss on assets held-for-sale of $72.2), net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(92.9
|
)
|
|
|
(92.9
|
)
|
|
Income from operations of AMGRO (including gain on disposal of $11.1), net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
10.1
|
|
|
|
—
|
|
|
|
10.1
|
|
|
Gain on disposal of variable life insurance and annuity business, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
8.1
|
|
|
|
8.1
|
|
|
Other, net of taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(0.5
|
)
|
|
|
(0.5
|
)
|
|
(1)
|
We manage investment assets for our property and casualty business based on the requirements of the entire property and casualty group. We allocate the investment
income, expenses and realized (losses) gains to our Personal Lines, Commercial Lines and Other Property and Casualty segments based on actuarial information related to the underlying businesses.
|
|
(2)
|
Includes corporate eliminations.
|
64
INVESTMENT PORTFOLIO
We held general account investment assets diversified across several asset classes, as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009
|
|
|
December 31, 2008
|
|
|
(In millions, except percentage data)
|
|
Carrying
Value
|
|
|
% of Total
Carrying
Value
|
|
|
Carrying
Value
|
|
|
% of Total
Carrying
Value
|
|
|
Fixed maturities (1)
|
|
$
|
4,913.4
|
|
|
92.5
|
%
|
|
$
|
4,226.3
|
|
|
88.5
|
%
|
|
Equity securities (1)
|
|
|
122.0
|
|
|
2.3
|
%
|
|
|
76.2
|
|
|
1.6
|
|
|
Mortgages
|
|
|
20.4
|
|
|
0.4
|
%
|
|
|
31.1
|
|
|
0.6
|
|
|
Cash and cash equivalents (1)
|
|
|
241.3
|
|
|
4.5
|
%
|
|
|
425.4
|
|
|
8.9
|
|
|
Other long-term investments
|
|
|
16.7
|
|
|
0.3
|
%
|
|
|
18.4
|
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total, including assets of discontinued operations (2)
|
|
|
5,313.8
|
|
|
100.0
|
%
|
|
|
4,777.4
|
|
|
100.0
|
%
|
|
Investment assets of discontinued operations (2)
|
|
|
(116.4
|
)
|
|
|
|
|
|
(113.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment assets of continuing operations
|
|
$
|
5,197.4
|
|
|
|
|
|
$
|
4,664.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
We carry these investments at fair value.
|
|
(2)
|
Investment assets of discontinued operations as of September 30, 2009 and December 31, 2008 include our discontinued accident and health business. The
investment assets of discontinued operations as of December 31, 2008 in this table exclude our discontinued FAFLIC business. Due to the January 2, 2009 sale of FAFLIC, $1,124.6 million of investment assets transferred to the buyer in 2009.
|
Investment Assets
The following discussion includes the investment assets of our continuing operations, as well as the investment assets of our discontinued accident and
health business.
Total investment assets increased $536.4 million, or 11.2%, to $5.3 billion during the first nine months of 2009, of which
fixed maturities increased $687.1 million and cash and cash equivalents decreased $184.1 million. The increase in fixed maturities is primarily due to market value appreciation and from the investment of proceeds from the sale of FAFLIC, as well as
our continued investment of a portion of our cash in the bond and equity markets.
Our fixed maturity portfolio is comprised primarily of
investment grade corporate securities, residential mortgage-backed securities, taxable and tax-exempt issues of state and local governments, U.S. government and agency securities, commercial mortgage-backed securities and asset-backed securities.
65
The following table provides information about the investment type and credit quality of our fixed
maturities portfolio as of September 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions, except percentage data)
Investment Type
|
|
Rating Agency
Equivalent
Designation
|
|
Amortized
Cost
|
|
Fair
Value
|
|
Net
Unrealized
Gain (Loss) (1)
|
|
|
Change in
Net
Unrealized
for the
Period
|
|
|
|
|
|
|
|
|
|
Corporates:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NAIC 1
|
|
Aaa/Aa/A
|
|
$
|
902.1
|
|
$
|
936.3
|
|
$
|
34.2
|
|
|
$
|
94.0
|
|
|
NAIC 2
|
|
Baa
|
|
|
1,059.8
|
|
|
1,103.5
|
|
|
43.7
|
|
|
|
115.9
|
|
|
NAIC 3 or below
|
|
Ba, B, Caa and lower
|
|
|
298.2
|
|
|
294.6
|
|
|
(3.6
|
)
|
|
|
52.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Corporates
|
|
|
|
|
2,260.1
|
|
|
2,334.4
|
|
|
74.3
|
|
|
|
262.8
|
|
|
|
|
|
|
|
|
|
Asset backed:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities
|
|
|
|
|
922.1
|
|
|
938.4
|
|
|
16.3
|
|
|
|
17.6
|
|
|
Commercial mortgage-backed securities
|
|
|
|
|
336.7
|
|
|
337.8
|
|
|
1.1
|
|
|
|
32.0
|
|
|
Asset-backed securities
|
|
|
|
|
67.3
|
|
|
70.1
|
|
|
2.8
|
|
|
|
10.1
|
|
|
Municipals:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
|
|
631.2
|
|
|
635.9
|
|
|
4.7
|
|
|
|
19.8
|
|
|
Tax exempt
|
|
|
|
|
204.8
|
|
|
208.2
|
|
|
3.4
|
|
|
|
19.9
|
|
|
U.S. government
|
|
|
|
|
385.8
|
|
|
388.6
|
|
|
2.8
|
|
|
|
(1.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities (2)
|
|
|
|
$
|
4,808.0
|
|
$
|
4,913.4
|
|
$
|
105.4
|
|
|
$
|
360.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes $44.0 million unrealized loss related to other-than-temporary impairment losses recognized in other comprehensive income.
|
|
(2)
|
Includes discontinued accident and health business of $111.7 million in amortized cost and $108.3 million in fair value at September 30, 2009.
|
During 2009, our net unrealized position improved $360.4 million from a net unrealized loss of $255.0 million at
December 31, 2008, to a net unrealized gain of $105.4 million at September 30, 2009.
Amortized cost and fair value by rating
category were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions, except percentage data)
|
|
September 30, 2009
|
|
|
December 31, 2008
|
|
|
NAIC Designation
|
|
Rating Agency
Equivalent Designation
|
|
Amortized
Cost
|
|
Fair
Value
|
|
% of Total
Fair
Value
|
|
|
Amortized
Cost
|
|
Fair
Value
|
|
% of Total
Fair
Value
|
|
|
1
|
|
Aaa/Aa/A
|
|
$
|
3,208.0
|
|
$
|
3,287.8
|
|
66.9
|
%
|
|
$
|
3,098.1
|
|
$
|
2,997.8
|
|
70.9
|
%
|
|
2
|
|
Baa
|
|
|
1,253.9
|
|
|
1,293.1
|
|
26.3
|
|
|
|
1,074.8
|
|
|
981.5
|
|
23.2
|
|
|
3
|
|
Ba
|
|
|
159.1
|
|
|
147.0
|
|
3.0
|
|
|
|
151.5
|
|
|
133.2
|
|
3.2
|
|
|
4
|
|
B
|
|
|
101.8
|
|
|
99.8
|
|
2.1
|
|
|
|
111.0
|
|
|
83.8
|
|
2.0
|
|
|
5
|
|
Caa and lower
|
|
|
69.1
|
|
|
70.4
|
|
1.4
|
|
|
|
37.1
|
|
|
24.5
|
|
0.6
|
|
|
6
|
|
In or near default
|
|
|
16.1
|
|
|
15.3
|
|
0.3
|
|
|
|
8.8
|
|
|
5.5
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities (1)
|
|
|
$ 4,808.0
|
|
$
|
4,913.4
|
|
100.0
|
%
|
|
$
|
4,481.3
|
|
$
|
4,226.3
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes discontinued accident and health business of $111.7 million in amortized cost and $108.3 million in fair value at September 30, 2009, and $99.3 million in
amortized cost and $85.4 million in fair value at December 31, 2008.
|
Based on ratings by the National Association of
Insurance Commissioners (“NAIC”), approximately 93% of our fixed maturity portfolio consisted of investment grade securities at September 30, 2009, compared to 94% at December 31, 2008.
The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security and
parent ownership and yield curve position. We do not hold any securities in the following sectors: subprime mortgages, either directly or through our mortgage-backed securities; collateralized debt obligations; collateralized loan obligations; or
credit derivatives. Our residential mortgage-backed securities constitute $938.4 million of our invested assets, with 21% held in non-agency prime securities, and the remaining invested in agency-sponsored securities. Commercial mortgage-backed
securities (“CMBS”) constitute $337.8 million of our invested assets, of which approximately 20% is fully defeased with U.S. government securities. The portfolio is seasoned, with approximately 77% of our CMBS holdings from pre-2005
vintages, 8% from the 2007 vintage, 7% from the 2006 vintage and 8% from the 2005 vintage. The CMBS portfolio is of high quality with approximately 82% being AAA rated and 18% rated AA or A. The CMBS portfolio has a weighted average loan-to-value
ratio of
66
approximately 69% as of September 30, 2009. Our direct commercial mortgage portfolio is only $30.9 million as of September 30, 2009, including credit tenant loan fixed maturities. These
mortgages are of high quality, with 54% maturing by the end of 2010. Our municipal bond portfolio constitutes approximately 16% of invested assets and is substantially all investment grade. Financial guarantor insurance enhanced municipal bonds were
$327.7 million, or approximately 39% of our municipal bond portfolio as of September 30, 2009. Without regard to the insurance enhancement, 98% of our municipal bond portfolio is investment grade as of September 30, 2009. U.S. agency debt
securities represent about 4% of the portfolio and we have no investments in their preferred stock or equity except for our $8.1 million equity investment in FHLBB required by our membership in their collateralized borrowing program.
At September 30, 2009, $78.7 million of our fixed maturities were invested in traditional private placement securities, as compared to $75.8 million at
December 31, 2008. Fair values of traditional private placement securities are determined either by a third party broker or by pricing models that use discounted cash flow analyses.
Our fixed maturity and equity securities are classified as available-for-sale and are carried at fair value. Financial instruments whose value is determined using significant management judgment or
estimation constitute approximately 2% of the total assets and liabilities we measured at fair value. (See also Note 6 – Fair Value).
Although we expect to invest new funds primarily in cash, cash equivalents and investment grade fixed maturities, we have invested a small portion of funds in common equity securities, and we may invest a portion in below investment grade
fixed maturities and other assets. The average earned yield on fixed maturities was 5.6% and 5.7% for the nine months ended September 30, 2009 and the year ended December 31, 2008, respectively.
Other-than-Temporary Impairments
Cumulative Effect
As more
fully described in Note 5 of the consolidated financial statements, we account for other-than-temporary impairments in accordance with ASC 320,
Investments - Debt and Equity Securities (“ASC 320”)
(formerly included under FASB Staff
Position No. FAS 115-2 and FAS 124-2,
Recognition and Presentation of Other-Than-Temporary Impairments
). On April 1, 2009, we adopted accounting guidance that is now included in ASC 320, which required us to modify our assessment of
other-than-temporary impairments (“OTTI”) on debt securities, as well as our method of recording and reporting other-than-temporary impairments. In accordance with ASC 320, we reviewed OTTI previously recorded through realized losses on
securities held at April 1, 2009, which were $121.6 million, and determined that $33.3 million of these impairments were related to non-credit factors, such as interest rates and market conditions. Accordingly, we increased the amortized cost
basis of these debt securities and recorded a cumulative effect adjustment of $33.3 million within shareholders’ equity. The cumulative effect adjustment had no effect on total shareholders’ equity as it increased retained earnings and
reduced accumulated other comprehensive income.
Under the new accounting guidance, if a company does not intend to sell the debt security, or
more likely than not will not be required to sell it, the credit loss portion of an other-than-temporary impairment is recorded through earnings while the portion attributable to all other factors is recorded separately as a component of other
comprehensive income.
Other-Than-Temporary Impairments
For the first nine months of 2009, we recorded $39.1 million of other-than-temporary impairments of fixed maturities and equity securities, of which $29.3 million was recognized in earnings and the
remaining $9.8 million was recorded as an unrealized loss in accumulated other comprehensive income. Other-than-temporary impairments recognized in earnings in the first nine months of 2009 primarily include losses on below investment grade fixed
maturities of $18.1 million, principally from corporate bonds in the industrial sector, and $9.5 million from perpetual preferred securities primarily in the finance sector. During the first nine months of 2008, other-than-temporary impairments of
$66.7 million resulted from credit-related losses on fixed maturities in the financial sector, as well as our exposure to below investment grade securities, particularly in the industrial sector.
In our determination of other-than-temporary impairments, we consider 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,
67
including governmental actions such as the enactment of The Emergency Economic Stabilization Act of 2008 and receipt of related funds; a weakening of the general market conditions in the industry
or geographic region in which the issuer operates; the length of time and the degree to which the fair value of an issuer’s securities remains below our cost; with respect to fixed maturity investments, any factors that might raise doubt about
the issuer’s ability to pay all amounts due according to the contractual terms and whether we expect to recover the entire amortized cost basis of the security; and with respect to equity securities, our ability and intent to hold the
investment for a period of time to allow for a recovery in value. We apply these factors to all securities.
We monitor corporate fixed
maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit deterioration whether due to ratings downgrades, unexpected price variances, and/or company or industry specific
concerns. We apply consistent standards of credit analysis which includes determining whether the issuer is current on its contractual payments, and we consider past events, current conditions and reasonable forecasts to evaluate whether we expect
to recover the entire amortized cost basis of the security. We utilize valuation declines as a potential indicator of credit deterioration, and apply additional levels of scrutiny in our analysis as the severity of the decline increases or duration
persists.
For our impairment review of asset-backed fixed maturity securities, we forecast our best estimate of the prospective future cash
flows of the security to determine if we expect to recover the entire amortized cost basis of the security. Our analysis includes estimates of underlying collateral default rates based on historical and projected delinquency rates and estimates of
the amount and timing of potential recovery. We consider all available information relevant to the collectibility of the security, including information about the remaining payment terms of the security, prepayment speeds, the financial condition of
the issuer, industry analyst reports, sector credit ratings and other market data when developing our estimate of the expected cash flows.
When an other-than-temporary impairment of a debt security occurs, and we intend to sell or more likely than not will be required to sell the investment before recovery of its amortized cost basis, the amortized cost of the security is
reduced to its fair value, with a corresponding charge to earnings, which reduces net income and earnings per share. If we do not intend to sell the fixed maturity investment or more likely than not will not be required to sell it, we separate the
other-than-temporary impairment into the amount we estimate represents the credit loss and the amount related to all other factors. The amount of the estimated loss attributable to credit is recognized in earnings, which reduces net income and
earnings per share. The amount of the estimated other-than-temporary impairment that is non-credit related is recognized in other comprehensive income, net of applicable taxes.
We estimate the amount of the other-than-temporary impairment that relates to credit by comparing the amortized cost of the debt security with the net present value of the debt security’s projected
future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment. The non-credit portion of the impairment is equal to the difference between the fair value and the net present value of the fixed maturity
security at the impairment measurement date.
Other-than-temporary impairments of equity securities are recorded as realized losses, which
reduce net income and earnings per share. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value.
Temporary declines in market value are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide
assurance that the other-than-temporary impairments will be adequate to cover future losses or that we will not have substantial additional impairments in the future.
68
Unrealized Losses
The following table provides information about our fixed maturities and equity securities that are in a gross unrealized loss position.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009
|
|
|
|
12 months or less
|
|
Greater than 12 months
|
|
Total
|
|
(In millions)
|
|
Gross
Unrealized
Losses and
OTTI
|
|
Fair Value
|
|
Gross
Unrealized
Losses and
OTTI
|
|
Fair Value
|
|
Gross
Unrealized
Losses and
OTTI (1)
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and U.S. government and agency securities
|
|
$
|
1.9
|
|
$
|
90.1
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1.9
|
|
$
|
90.1
|
|
States and political subdivisions
|
|
|
3.2
|
|
|
92.1
|
|
|
9.0
|
|
|
123.6
|
|
|
12.2
|
|
|
215.7
|
|
Corporate fixed maturities (2)
|
|
|
4.1
|
|
|
75.6
|
|
|
32.3
|
|
|
193.5
|
|
|
36.4
|
|
|
269.1
|
|
Residential mortgage-backed securities
|
|
|
3.9
|
|
|
64.6
|
|
|
4.8
|
|
|
72.1
|
|
|
8.7
|
|
|
136.7
|
|
Commercial mortgage-backed securities
|
|
|
1.2
|
|
|
3.3
|
|
|
11.1
|
|
|
48.9
|
|
|
12.3
|
|
|
52.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade
|
|
|
14.3
|
|
|
325.7
|
|
|
57.2
|
|
|
438.1
|
|
|
71.5
|
|
|
763.8
|
|
Below investment grade (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States and political subdivisions
|
|
|
—
|
|
|
—
|
|
|
3.5
|
|
|
8.6
|
|
|
3.5
|
|
|
8.6
|
|
Corporate fixed maturities (2)
|
|
|
19.7
|
|
|
89.8
|
|
|
13.9
|
|
|
132.2
|
|
|
33.6
|
|
|
222.0
|
|
Residential mortgage-backed securities
|
|
|
4.7
|
|
|
9.5
|
|
|
4.6
|
|
|
19.5
|
|
|
9.3
|
|
|
29.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total below investment grade
|
|
|
24.4
|
|
|
99.3
|
|
|
22.0
|
|
|
160.3
|
|
|
46.4
|
|
|
259.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
38.7
|
|
|
425.0
|
|
|
79.2
|
|
|
598.4
|
|
|
117.9
|
|
|
1,023.4
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common equity securities
|
|
|
0.1
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
0.1
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
0.1
|
|
|
0.1
|
|
|
—
|
|
|
—
|
|
|
0.1
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total (4)
|
|
$
|
38.8
|
|
$
|
425.1
|
|
$
|
79.2
|
|
$
|
598.4
|
|
$
|
118.0
|
|
$
|
1,023.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes $44.0 million unrealized loss related to other-than-temporary impairment losses recognized in other comprehensive income.
|
|
(2)
|
Gross unrealized losses on corporate fixed maturities include $44.4 million in the financial sector, $19.9 million in the industrial sector, and $5.7 million in
utilities and other.
|
|
(3)
|
Substantially all below investment grade securities with an unrealized loss had been rated by the NAIC, Standard & Poor’s or Moody’s at
September 30, 2009.
|
|
(4)
|
Includes discontinued accident and health business of $11.1 million in gross unrealized losses with $36.3 million in fair value at September 30, 2009.
|
69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2008
|
|
|
|
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 securities and U.S. government and agency securities
|
|
$
|
0.7
|
|
$
|
70.2
|
|
$
|
—
|
|
$
|
—
|
|
$
|
0.7
|
|
$
|
70.2
|
|
States and political subdivisions
|
|
|
26.8
|
|
|
352.3
|
|
|
3.9
|
|
|
56.5
|
|
|
30.7
|
|
|
408.8
|
|
Corporate fixed maturities (1)
|
|
|
89.4
|
|
|
1,028.4
|
|
|
70.2
|
|
|
295.9
|
|
|
159.6
|
|
|
1,324.3
|
|
Residential mortgage-backed securities
|
|
|
18.6
|
|
|
110.4
|
|
|
3.2
|
|
|
30.2
|
|
|
21.8
|
|
|
140.6
|
|
Commercial mortgage-backed securities
|
|
|
14.7
|
|
|
162.8
|
|
|
17.1
|
|
|
87.2
|
|
|
31.8
|
|
|
250.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment grade
|
|
|
150.2
|
|
|
1,724.1
|
|
|
94.4
|
|
|
469.8
|
|
|
244.6
|
|
|
2,193.9
|
|
|
|
|
|
|
|
|
|
Below investment grade (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
States and political subdivisions
|
|
|
4.7
|
|
|
6.9
|
|
|
—
|
|
|
—
|
|
|
4.7
|
|
|
6.9
|
|
Corporate fixed maturities (1)
|
|
|
59.5
|
|
|
144.1
|
|
|
—
|
|
|
—
|
|
|
59.5
|
|
|
144.1
|
|
Residential mortgage-backed securities
|
|
|
—
|
|
|
1.5
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total below investment grade
|
|
|
64.2
|
|
|
152.5
|
|
|
—
|
|
|
—
|
|
|
64.2
|
|
|
152.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
214.4
|
|
|
1,876.6
|
|
|
94.4
|
|
|
469.8
|
|
|
308.8
|
|
|
2,346.4
|
|
|
|
|
|
|
|
|
|
Equity securities :
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Perpetual preferred securities
|
|
|
—
|
|
|
—
|
|
|
13.4
|
|
|
28.5
|
|
|
13.4
|
|
|
28.5
|
|
Common equity securities
|
|
|
11.4
|
|
|
32.3
|
|
|
—
|
|
|
—
|
|
|
11.4
|
|
|
32.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
11.4
|
|
|
32.3
|
|
|
13.4
|
|
|
28.5
|
|
|
24.8
|
|
|
60.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total (3)
|
|
$
|
225.8
|
|
$
|
1,908.9
|
|
$
|
107.8
|
|
$
|
498.3
|
|
$
|
333.6
|
|
$
|
2,407.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Gross unrealized losses for corporate fixed maturities include $95.9 million in the industrial sector, $80.5 million in the financial sector, $34.8 million in the
utilities sector and $7.9 million in other.
|
|
(2)
|
Substantially all below investment grade securities with an unrealized loss had been rated by the NAIC, Standard & Poor’s or Moody’s at
December 31, 2008.
|
|
(3)
|
Includes discontinued accident and health business of $15.7 million in gross unrealized losses with $52.3 million in fair value at December 31, 2008.
|
Gross unrealized losses on fixed maturities and equity securities decreased $215.6 million, or 64.6%, from $333.6 million at
December 31, 2008. The decrease in unrealized losses was primarily due to tightening of credit spreads of investment grade corporate bonds, below investment grade corporate bonds, taxable and tax-exempt municipal bonds, and commercial and
residential mortgage-backed securities during the first nine months of 2009. Equity values also increased during the first nine months of 2009. At September 30, 2009, gross unrealized losses primarily consist of $70.0 million of corporate fixed
maturities, $30.3 million of mortgage-backed securities and $15.7 million in municipal bonds. Gross unrealized losses on corporate fixed maturities include $44.4 million in the financial sector, $19.9 million in the industrial sector and $5.7
million in utilities and other.
70
The following table includes our top twenty-five financial sector fixed maturity holdings and related
financial ratings as of September 30, 2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions, except percentage data)
|
|
Issuer
|
|
Amortized
Cost
|
|
Fair Value
|
|
As a % of
Invested Assets
|
|
|
S&P
Ratings
|
|
Bank of America
|
|
$
|
34.2
|
|
$
|
30.4
|
|
0.57
|
%
|
|
A-
|
|
Wells Fargo
|
|
|
21.9
|
|
|
21.9
|
|
0.41
|
%
|
|
AA-
|
|
PNC Bank
|
|
|
19.9
|
|
|
19.3
|
|
0.36
|
%
|
|
A
|
|
GE Capital
|
|
|
19.3
|
|
|
19.6
|
|
0.37
|
%
|
|
AA+
|
|
American Express
|
|
|
18.3
|
|
|
18.0
|
|
0.34
|
%
|
|
BBB+
|
|
Capital One
|
|
|
17.4
|
|
|
17.9
|
|
0.34
|
%
|
|
BBB
|
|
Manufacturers & Traders Bank
|
|
|
15.1
|
|
|
12.6
|
|
0.24
|
%
|
|
A-
|
|
Morgan Stanley
|
|
|
15.0
|
|
|
16.2
|
|
0.31
|
%
|
|
A
|
|
Fifth Third Bancorp
|
|
|
15.0
|
|
|
13.1
|
|
0.25
|
%
|
|
BBB-
|
|
Student Loan Market
|
|
|
14.5
|
|
|
14.2
|
|
0.27
|
%
|
|
BBB-
|
|
Bank of Scotland
|
|
|
13.0
|
|
|
12.8
|
|
0.24
|
%
|
|
BBB
|
|
Genworth Global Funding
|
|
|
12.9
|
|
|
12.7
|
|
0.24
|
%
|
|
BBB
|
|
Branch Bank & Trust
|
|
|
12.5
|
|
|
12.7
|
|
0.24
|
%
|
|
A
|
|
Prudential Financial
|
|
|
12.5
|
|
|
12.9
|
|
0.24
|
%
|
|
A
|
|
Charter One
|
|
|
12.1
|
|
|
12.2
|
|
0.23
|
%
|
|
BBB+
|
|
Goldman Sachs
|
|
|
12.0
|
|
|
12.1
|
|
0.23
|
%
|
|
A
|
|
Union Bank of California
|
|
|
11.5
|
|
|
11.4
|
|
0.21
|
%
|
|
A
|
|
American General Finance
|
|
|
10.8
|
|
|
8.5
|
|
0.16
|
%
|
|
BB+
|
|
Aetna
|
|
|
10.6
|
|
|
11.0
|
|
0.21
|
%
|
|
A-
|
|
FMR
|
|
|
10.5
|
|
|
10.7
|
|
0.20
|
%
|
|
A+
|
|
Simon Property Group
|
|
|
10.1
|
|
|
10.3
|
|
0.19
|
%
|
|
A-
|
|
Regions Bank
|
|
|
10.1
|
|
|
8.2
|
|
0.15
|
%
|
|
BB+
|
|
Bank of Oklahoma
|
|
|
10.0
|
|
|
9.0
|
|
0.17
|
%
|
|
BBB+
|
|
Bank of New York Mellon
|
|
|
9.6
|
|
|
9.8
|
|
0.18
|
%
|
|
A+
|
|
Lincoln National
|
|
|
9.5
|
|
|
7.1
|
|
0.13
|
%
|
|
BBB
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Top 25 Financial
|
|
|
358.3
|
|
|
344.6
|
|
|
|
|
|
|
Other Financial
|
|
|
143.9
|
|
|
137.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Financial
|
|
$
|
502.2
|
|
$
|
482.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71
The following table includes our top twenty-five industrial sector corporate fixed maturity holdings and
related financial ratings as of September 30, 2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In millions, except percentage data)
|
|
|
|
|
|
|
|
|
|
|
Issuer
|
|
Amortized
Cost
|
|
Fair Value
|
|
As a % of
Invested Assets
|
|
|
S&P
Ratings
|
|
Valero Energy
|
|
$
|
19.7
|
|
$
|
19.4
|
|
0.37
|
%
|
|
BBB
|
|
Union Pacific
|
|
|
19.3
|
|
|
20.1
|
|
0.38
|
%
|
|
BBB
|
|
Conoco Phillips
|
|
|
18.0
|
|
|
19.2
|
|
0.36
|
%
|
|
A
|
|
AT&T
|
|
|
17.8
|
|
|
19.0
|
|
0.36
|
%
|
|
A
|
|
Safeway
|
|
|
17.4
|
|
|
18.5
|
|
0.35
|
%
|
|
BBB
|
|
Kroger
|
|
|
17.4
|
|
|
18.4
|
|
0.35
|
%
|
|
BBB
|
|
CVS
|
|
|
17.3
|
|
|
18.3
|
|
0.34
|
%
|
|
BBB+
|
|
Home Depot
|
|
|
16.9
|
|
|
17.8
|
|
0.34
|
%
|
|
BBB+
|
|
Miller Brewing
|
|
|
16.4
|
|
|
17.6
|
|
0.33
|
%
|
|
BBB+
|
|
Comcast
|
|
|
15.8
|
|
|
17.6
|
|
0.33
|
%
|
|
BBB+
|
|
Schering-Plough
|
|
|
15.4
|
|
|
16.7
|
|
0.31
|
%
|
|
A-
|
|
Canadian National Railways
|
|
|
15.0
|
|
|
16.2
|
|
0.30
|
%
|
|
A-
|
|
Shell
|
|
|
15.0
|
|
|
15.8
|
|
0.30
|
%
|
|
AA
|
|
Vodafone
|
|
|
14.9
|
|
|
15.9
|
|
0.30
|
%
|
|
A-
|
|
BP Capital Markets
|
|
|
14.4
|
|
|
14.9
|
|
0.28
|
%
|
|
AA
|
|
Deutsche Telecom
|
|
|
13.9
|
|
|
14.9
|
|
0.28
|
%
|
|
BBB+
|
|
Lowe’s
|
|
|
13.6
|
|
|
14.8
|
|
0.28
|
%
|
|
A+
|
|
XTO Energy
|
|
|
13.3
|
|
|
13.9
|
|
0.27
|
%
|
|
BBB
|
|
Verizon
|
|
|
13.2
|
|
|
13.8
|
|
0.26
|
%
|
|
A
|
|
Encana
|
|
|
12.3
|
|
|
13.0
|
|
0.24
|
%
|
|
A-
|
|
British Telecom
|
|
|
12.3
|
|
|
12.7
|
|
0.24
|
%
|
|
BBB
|
|
Canadian Natural Resources
|
|
|
12.2
|
|
|
12.9
|
|
0.24
|
%
|
|
BBB
|
|
Holcim
|
|
|
12.0
|
|
|
12.7
|
|
0.24
|
%
|
|
BBB-
|
|
Anheuser-Busch
|
|
|
12.0
|
|
|
13.0
|
|
0.24
|
%
|
|
BBB+
|
|
Lockheed Martin
|
|
|
11.9
|
|
|
12.4
|
|
0.23
|
%
|
|
A-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Top 25 Industrial
|
|
|
377.4
|
|
|
399.5
|
|
7.52
|
%
|
|
|
|
Other Industrial
|
|
|
909.5
|
|
|
959.2
|
|
18.05
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Industrial
|
|
$
|
1,286.9
|
|
$
|
1,358.7
|
|
25.57
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions, the U.S. Treasury, U.S. government and agency
securities had associated gross unrealized losses of $17.6 million and $36.6 million at September 30, 2009 and December 31, 2008, respectively.
Substantially all below investment grade securities with an unrealized loss had been rated by the NAIC, Standard & Poor’s or Moody’s.
We view the gross unrealized losses on fixed maturities and equity securities as being temporary since it is our assessment that these securities will
recover in the near term, as evidenced by the improvement in unrealized losses during the year. Management believes that government actions, including The Emergency Economic Stabilization Act of 2008, the 2009 American Recovery and Reinvestment Act
and other U.S. and global government programs and the quality of our assets will allow us to realize the securities’ anticipated long-term economic value. With respect to gross unrealized losses on fixed maturities, we do not intend to sell nor
is it more likely than not we will be required to sell debt securities before this expected recovery of amortized cost (See also “Liquidity and Capital Resources”). With respect to equity securities, we had the intent and ability to retain
such investments for the period of time anticipated to allow for this expected recovery in fair value. The risks inherent in our assessment methodology include the risk that, subsequent to the balance sheet date, market factors may differ from our
expectations; government actions do not have the intended affect of stabilizing financial institutions and financial markets; the global economic slowdown is longer or more severe than we expect; we may decide to subsequently sell a security for
unforeseen business needs; or changes in the credit assessment or equity characteristics from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are
such adverse changes, an other-than-temporary impairment would be recognized. Although unrealized losses are not reflected in the results of financial operations until they are realized or deemed “other-than-temporary”, the fair value of
the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets.
72
The following table sets forth gross unrealized losses for fixed maturities by maturity period and gross
unrealized losses for equity securities at September 30, 2009 and December 31, 2008. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or
prepayment penalties, or we may have the right to put or sell the obligations back to the issuers. Mortgage-backed securities are included in the category representing their ultimate maturity.
|
|
|
|
|
|
|
|
|
(In millions)
|
|
September 30,
2009
|
|
December 31,
2008
|
|
Due in one year or less
|
|
$
|
0.8
|
|
$
|
2.1
|
|
Due after one year through five years
|
|
|
25.4
|
|
|
84.0
|
|
Due after five years through ten years
|
|
|
30.5
|
|
|
115.6
|
|
Due after ten years
|
|
|
61.2
|
|
|
107.1
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
117.9
|
|
|
308.8
|
|
Equity securities
|
|
|
0.1
|
|
|
24.8
|
|
|
|
|
|
|
|
|
|
Total fixed maturities and equity securities (1)
|
|
$
|
118.0
|
|
$
|
333.6
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes discontinued accident and health business of $11.1 million and $15.7 million in gross unrealized losses at September 30, 2009 and December 31, 2008,
respectively.
|
Our investment portfolio and shareholders’ equity can be and have been significantly impacted by the changes
in market values of our securities. During 2008, there were significant declines in the market values of our fixed maturity securities, particularly in the industrial and financial sectors. Although we have seen substantial improvement in unrealized
losses in the first nine months of 2009, economic conditions remain strained, market values could continue to fluctuate, and defaults on corporate fixed income securities are expected to increase. As a result, depending on market conditions, we
could incur additional realized and unrealized losses in future periods, which could have a material adverse impact on our results of operations and/or financial position.
We experienced defaults in the first nine months of 2009 on certain fixed maturities of issuers in the industrial sector. The carrying value of fixed maturity securities on non-accrual status at
September 30, 2009 and December 31, 2008 was not material. The effect of non-accruals for the nine months ended September 30, 2009 and 2008, compared with amounts that would have been recognized in accordance with the original terms
of the fixed maturities, was a reduction in net investment income of $2.4 million and $1.3 million, respectively. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income.
Recent developments have illustrated that the U.S. and global financial markets and economies, while perhaps beginning to recover, are in an unprecedented
period of uncertainty and instability. Many issuers continue to face adverse business and liquidity circumstances, increasing the likelihood of unanticipated defaults during 2009. While we may experience a significant increase in defaults on
corporate fixed income securities in 2009, particularly with respect to non-investment grade securities, it is difficult to foresee what issuers, industries or markets will be affected. As a result, the value of our fixed maturity portfolio could
change rapidly in ways we cannot currently anticipate. Depending on market conditions, we could incur additional realized and unrealized losses in future periods.
INCOME TAXES
We file a consolidated United States federal income
tax return that includes the holding company and its domestic subsidiaries (including non-insurance operations).
Quarter Ended September 30, 2009 Compared to Quarter Ended September 30, 2008
The
provision for federal income taxes from continuing operations was an expense of $18.9 million during the third quarter of 2009, compared to a benefit of $5.5 million during the same period in 2008. These provisions resulted in consolidated effective
federal tax rates of 28.0% and 11.2% for the quarters ended September 30, 2009 and 2008, respectively. The 2009 provision reflects a decrease in our valuation allowance of $3.4 million and the 2008 provision reflects a $6.4 million benefit
resulting from the settlement with the IRS of tax years 1995 through 2001. Absent the aforementioned benefits, the provisions for federal
73
income taxes from continuing operations would have been an expense of $22.3 million or 33.0% and an expense of $0.9 million, or (1.8%), for the quarter ended September 30 2009 and 2008,
respectively. The lower effective rate in 2008 primarily reflects losses in the quarter, which were more than offset by our impairment of tax benefits related to our realized investment losses as it was our opinion that it is more likely than not
that we will be unable to realize these benefits. However, in 2009, a recovery in the value of our investments has resulted in our conclusion that we can realize the tax benefit from our net realized losses occurring in 2009. Accordingly, we
decreased our valuation allowance by the aforementioned $3.4 million.
Our federal income tax expense on segment income was $22.0 million
during the third quarter of 2009, compared to $0.5 million during the same period in 2008. These provisions resulted in effective tax rates for segment income of 32.7% and 13.2% in 2009 and 2008, respectively. The increase in the rate is primarily
due to the increase in underwriting income.
Nine Months Ended September 30, 2009 Compared to Nine
Months Ended September 30, 2008
The provision for federal income taxes from continuing operations was an expense of
$65.5 million for the first nine months of 2009, compared to $52.4 million during the same period in 2008. These provisions resulted in consolidated effective federal tax rates of 33.2% and 45.9% for the nine months ended September 30, 2009 and
2008, respectively. The decrease in the tax rate in the current period is primarily due to the absence of a tax benefit in the prior period related to our realized investment losses.
Our federal income tax expense on segment income was $56.9 million for the first nine months of 2009, compared to $58.4 million during the same period in 2008. These provisions resulted in relatively
consistent effective tax rates for segment income of 33.0% and 33.4% in 2009 and 2008, respectively.
In the first nine months of 2009, we
decreased our valuation allowance related to our deferred tax asset by $118.9 million, from $348.2 million to $229.3 million. The decrease in this valuation allowance resulted from unrealized appreciation in our investment portfolio. Accordingly, we
recorded decreases in our valuation allowance of $108.4 million as an adjustment to Accumulated Other Comprehensive Income and $11.6 million as an adjustment to Retained Earnings for the cumulative effect of adopting revised investment asset
impairment guidance under ASC 320,
Investments – Debt and Equity Securities
(“ASC 320”). These decreases are partially offset by increases in our valuation allowance of $1.1 million as an adjustment to Discontinued Operations
in our Consolidated Statements of Income.
A corporation is entitled to a tax deduction from gross income for a portion of any dividend which
was received from a domestic corporation that is subject to income tax. This is referred to as a “dividends received deduction.” In this and in prior years, we have taken this dividends received deduction when filing our federal income tax
return. Many separate accounts held by life insurance companies receive dividends from such domestic corporations, and therefore, were regarded as entitled to this dividends received deduction. In its Revenue Ruling 2007-61, issued on
September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the dividends received deduction on separate account assets held in connection with variable annuity contracts. Revenue
Ruling 2007-61 suspended a revenue ruling issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. Any regulations that the IRS ultimately proposes for issuance
in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such
regulations. As a result, the ultimate timing and substance of any such regulations are not yet known, but they could result in the elimination of some or all of the separate account dividends received deduction tax benefit that we received. We
believe that it is more likely than not that any such regulation would apply prospectively only, and application of this regulation is not expected to be material to our results of operations in any future annual period. However, there can be no
assurance that the outcome of the revenue ruling will be as anticipated and should retroactive application be required; our results of operations may be adversely affected in a quarterly or annual period. We believe that retroactive application
would not materially affect our financial position.
74
CRITICAL ACCOUNTING ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements. These statements have
been prepared in accordance with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following critical accounting estimates are those which we believe affect the more significant judgments and estimates used
in the preparation of our financial statements. Additional information about our other significant accounting policies and estimates may be found in Note 1 – “Summary of Significant Accounting Policies” of the Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.
Property and Casualty Insurance Reserves
See Segment Results – Reserves for Losses and
Loss Adjustment Expenses on pages 51 to 61 of this form 10-Q for a discussion of our critical accounting estimates for loss reserves.
Property and Casualty Insurance Recoverables
We share a significant amount of insurance
risk of the primary underlying contracts with various insurance entities through the use of reinsurance contracts. As a result, when we experience loss events that are subject to a reinsurance contract, reinsurance recoveries are recorded. The
amount of the reinsurance recoverable can vary based on the size of the individual loss or the aggregate amount of all losses in a particular line, book of business or an aggregate amount associated with a particular accident year. The valuation of
losses recoverable depends on whether the underlying loss is a reported loss, or an incurred but not reported loss. For reported losses, we value reinsurance recoverables at the time the underlying loss is recognized, in accordance with contract
terms. For incurred but not reported losses, we estimate the amount of reinsurance recoverable based on the terms of the reinsurance contracts and historical reinsurance recovery information and apply that information to the gross loss reserve
estimates. The most significant assumption we use is the average size of the individual losses for those claims that have occurred but have not yet been recorded by us. The reinsurance recoverable is based on what we believe are reasonable estimates
and is disclosed separately on the financial statements. However, the ultimate amount of the reinsurance recoverable is not known until all losses are settled.
Pension Benefit Obligations
Prior to 2005, we provided
pension retirement benefits to substantially all of our employees based on a defined benefit cash balance formula. In addition to the cash balance allocation, certain transition group employees, who had met specified age and service requirements as
of December 31, 1994, were eligible for a grandfathered benefit based primarily on the employees’ years of service and compensation during their highest five consecutive plan years of employment. As of January 1, 2005, the defined
benefit pension plans were frozen.
We account for our pension plans in accordance with ASC 715,
Compensation – Retirement
Benefits
(“ASC 715”) (formerly included under Statement of Financial Accounting Standards No. 158,
Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements 87,
88, 106, and 132(R)
and Statement of Financial Accounting Standards No. 87,
Employers’ Accounting for Pensions
). In order to measure the liabilities and expense associated with these plans, we must make various estimates and key
assumptions, including discount rates used to value liabilities, assumed rates of return on plan assets, employee turnover rates and anticipated mortality rates. These estimates and assumptions are reviewed at least annually and are based on our
historical experience, as well as current facts and circumstances. In addition, we use outside actuaries to assist in measuring the expenses and liabilities associated with this plan.
The discount rate enables us to state expected future cash flows as a present value on the measurement date. We also use this discount rate in the determination of our pre-tax pension expense or benefit.
A lower discount rate increases the present value of benefit obligations and increases pension expense. As of December 31, 2008, we determined our discount rate utilizing an independent yield curve which provides for a portfolio of high quality
bonds that are expected to match the cash flows of our pension plan. Bond information used in the yield curve was provided by Standard and Poor’s and included only those rated AA- or better as of December 31, 2008. As of December 31,
2007, we utilized the Citigroup Pension Discount Curve. We changed yield curves in 2008 as a result of the impact that the current sector weightings had on the Citigroup Pension Discount Curve, specifically the impact of a relative lack of financial
sector issues at longer durations. At December 31, 2008, based upon our qualified plan assets and liabilities in relation to this discount curve, we increased our discount rate to 6.625%, from 6.375% at December 31, 2007.
75
To determine the expected long-term return on plan assets, we consider the historical mean returns by asset
class for passive indexed strategies, as well as current and expected asset allocations and adjust for certain factors that we believe will have an impact on future returns. For the year ended December 31, 2008, the expected rate of return on
plan assets was 7.75%. In 2009, we are utilizing an expected rate of return on plan assets of 7.50% to determine our pension expense for the year. The decrease reflects our strategy to shift investment assets from equity securities to fixed maturity
investments over the next few years. Actual returns on plan assets in excess of these expected returns will generally reduce our net actuarial losses that are reflected in our accumulated other comprehensive income balance in shareholders’
equity, whereas actual returns on plan assets which are less than expected returns will generally increase our net actuarial losses that are reflected in accumulated other comprehensive income. These gains or losses are amortized into expense in
future years.
Holding all other assumptions constant, sensitivity to changes in our key assumptions are as follows:
Discount Rate
– A 25 basis point increase in discount rate would decrease our pension expense in 2009 by $1.7 million and
decrease our projected benefit obligation by approximately $11.8 million. A 25 basis point reduction in the discount rate would increase our pension expense by $1.7 million and increase our projected benefit obligation by approximately $12.3
million.
Expected Return on Plan Assets
– A 25 basis point increase or decrease in the expected return on plan
assets would decrease or increase our pension expense in 2009 by $0.8 million.
Other-than-Temporary
Impairments
We employ a systematic methodology to evaluate declines in fair values below amortized cost for all
investments. The methodology utilizes a quantitative and qualitative process ensuring that available evidence concerning the declines in fair value below amortized cost is evaluated in a disciplined manner. In determining whether a decline in fair
value below amortized cost is other-than-temporary, we evaluate several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial
performance, including earnings trends, dividend payments, and asset quality; any specific events which may influence the operations of the issuer, including governmental actions such as the enactment of The Emergency Economic Stabilization Act of
2008 and receipt of related funds; a weakening of the general market conditions in the industry or geographic region in which the issuer operates; the length of time and the degree to which the fair value of an issuer’s securities remains below
our cost; with respect to fixed maturity investments, any factors that might raise doubt about the issuer’s ability to pay all amounts due according to the contractual terms and whether we expect to recover the entire amortized cost basis of
the security; and with respect to equity securities, our ability and intent to hold the investment for a period of time to allow for a recovery in value. We apply these factors to all securities.
We monitor corporate fixed maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit
deterioration whether due to ratings downgrades, unexpected price variances, and/or company or industry specific concerns. We apply consistent standards of credit analysis which includes determining whether the issuer is current on its contractual
payments, and we consider past events, current conditions and reasonable forecasts to evaluate whether we expect to recover the entire amortized cost basis of the security. We utilize valuation declines as a potential indicator of credit
deterioration, and apply additional levels of scrutiny in our analysis as the severity of the decline increases or duration persists.
For our
impairment review of asset-backed fixed maturity securities, we forecast our best estimate of the prospective future cash flows of the security to determine if we expect to recover the entire amortized cost basis of the security. Our analysis
includes estimates of underlying collateral default rates based on historical and projected delinquency rates and estimates of the amount and timing of potential recovery. We consider all available information relevant to the collectibility of the
security, including information about the remaining payment terms of the security, prepayment speeds, the financial condition of the issuer, industry analyst reports, sector credit ratings and other market data when developing our estimate of the
expected cash flows.
When an other-than-temporary impairment of a debt security occurs, and we intend to sell or more likely than not will be
required to sell the investment before recovery of its amortized cost basis, the amortized cost of the security is reduced to its fair value, with a corresponding charge to earnings, which reduces net income and earnings per share. If we do not
intend to sell the fixed maturity investment or more likely than not will not be required to sell it, we separate the other-than-temporary impairment into the amount we estimate represents the credit loss and the amount related to all other factors.
The amount of the estimated loss attributable to credit is recognized in earnings, which reduces net income and earnings per share. The amount of the estimated other-than-temporary impairment that is non-credit related is recognized in other
comprehensive income, net of applicable taxes.
76
We estimate the amount of the other-than-temporary impairment that relates to credit by comparing the
amortized cost of the debt security with the net present value of the debt security’s projected future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment. The non-credit portion of the
impairment is equal to the difference between the fair value and the net present value of the fixed maturity security at the impairment measurement date.
Other-than-temporary impairments of equity securities are recorded as realized losses, which reduce net income and earnings per share. The new cost basis of an impaired security is not adjusted for
subsequent increases in estimated fair value.
Temporary declines in market value are recorded as unrealized losses, which do not affect net
income and earnings per share, but reduce other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide assurance that the other-than-temporary impairments will be adequate to cover future losses or that we
will not have substantial additional impairments in the future. (See “Investment Portfolio” for further discussion regarding other-than-temporary impairments and securities in an unrealized loss position).
OTHER SIGNIFICANT TRANSACTIONS
On September 25, 2009, Hanover Insurance received an advance of $125 million through its membership in the FHLBB as part of a collateralized borrowing program. This advance bears interest at a fixed
rate of 5.50% per annum over a twenty-year term. As collateral to FHLBB, Hanover Insurance has pledged government agency securities with a fair value of $142.8 million as of September 30, 2009. 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. 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 acquired
$2.5 million of FHLBB stock, and as a condition to participating in the FHLBB’s collateralized borrowing program, it was required to purchase additional shares of FHLBB stock in an amount equal to 4.5% of its outstanding borrowings; such
purchases have totaled $5.6 million through September 30, 2009. The proceeds from the borrowing were used by Hanover Insurance to acquire AIX from the holding company.
On September 24, 2009, our Board of Directors authorized a $100 million increase to our existing common stock repurchase program. The Board of Directors, on October 16, 2007, had initially
authorized the repurchase of up to $100 million of common stock. As a result of the increase, the program provides for aggregate repurchases of up to $200 million. Under the repurchase authorization, we may repurchase our common stock from time to
time, in amounts and prices and at such times as we deem appropriate, subject to market conditions and other considerations. Our repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase
programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. In the first nine months of 2009, we purchased 0.9 million shares at a cost of $36.1
million. Total repurchases under this program as of September 30, 2009 were 2.3 million shares at a cost of $96.3 million.
We
liquidated the AFC Capital Trust I (the “Trust”) on July 30, 2009. Each holder of our 8.207% Series B Capital Securities (“Capital Securities”) as of that date received a principal amount of our Series B 8.207% Junior
Subordinated Deferrable Interest Debentures (“Junior Debentures”) due February 3, 2027 equal to the liquidation amount of the Capital Securities held by such holder. The liquidation of the Trust did not have an effect on our results
of operations or financial position.
On June 29, 2009, we completed a cash tender offer to repurchase a portion of our Capital
Securities that were issued by the Trust and a portion of our Senior Debentures that were issued by THG. As of that date, $69.3 million of Capital Securities were tendered at a price equal to $800 per $1,000 of face value. In addition, we accepted
for tender a principal amount of $77.3 million of Senior Debentures. Depending on the time of tender, holders of the Senior Debentures accepted for purchase received a price of either $870 or $900 per $1,000 of face value. Separately, we held $65.0
million of Capital Securities previously repurchased at a discount in the open market prior to the tender offer. In addition, during the third quarter of 2009, we retired an additional $1.1 million of 7.625% Senior Debentures (“Senior
Debentures”) due in 2025. Including securities repurchased through the tender offer, and before and subsequent to the tender offer, we recognized a pre-tax gain of $0.2 million and $34.5 million in the quarter and nine months ended
September 30, 2009. As of September 30, 2009, a principal amount of $165.7 million of Junior Debentures and $121.6 million of Senior Debentures not held by the Company remained outstanding.
On November 28, 2008, we acquired AIX for approximately $100 million, subject to various terms and conditions. AIX is a specialty property and casualty
insurer that underwrites and manages program business.
77
On June 2, 2008, we completed the sale of our premium financing subsidiary, AMGRO, to Premium Financing
Specialists, Inc. We recorded a gain of $11.1 million related to this sale, which was reflected in the Consolidated Statement of Income as part of Discontinued Operations in the second quarter of 2008.
On March 14, 2008, we acquired all of the outstanding shares of Verlan for $29.0 million. Verlan, now referred to as Hanover Specialty Property, is a
specialty company providing property insurance to small and medium-sized manufacturing and distribution companies that are highly protected fire risks.
STATUTORY CAPITAL OF INSURANCE SUBSIDIARIES
The following table
reflects the consolidated Total Adjusted Capital for our property and casualty businesses as of September 30, 2009 and December 31, 2008:
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|
|
|
|
|
|
|
|
(In millions)
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|
September 30,
2009
|
|
December 31,
2008
|
|
|
|
|
|
Total Adjusted Capital–Combined P&C Companies
|
|
$
|
1,709.8
|
|
$
|
1,600.7
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The consolidated total adjusted capital position improved $109.1 million during the first nine months
of 2009. The increase is primarily due to underwriting results in the first nine months of 2009 and net unrealized gains. These increases were partially offset by decreases in surplus relating to the purchase of FAFLIC’s non-admitted assets in
connection with its sale on January 2, 2009.
The NAIC prescribes an annual calculation regarding risk based capital (“RBC”).
RBC ratios for regulatory purposes, as described in the glossary, are expressed as a percentage of the capital required to be above the Authorized Control Level (the “Regulatory Scale”); however, in the insurance industry RBC ratios are
widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios for Hanover Insurance, as of September 30, 2009, expressed both on the Industry
Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level):
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|
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|
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(In millions, except ratios)
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|
Company
Action
Level
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|
Authorized
Control
Level
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|
RBC Ratio
Industry
Scale
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|
|
RBC Ratio
Regulatory
Scale
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|
|
|
|
|
|
|
|
The Hanover Insurance Company
|
|
$
|
516.9
|
|
$
|
258.5
|
|
330
|
%
|
|
660
|
%
|
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our
primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our insurance subsidiaries are subject to limitations imposed by state regulators, such as the requirement that cash dividends be paid
out of unreserved and unrestricted earned surplus. The payment of “extraordinary” dividends, as defined, from any of our insurance subsidiaries is restricted.
In connection with the sale of FAFLIC to Commonwealth Annuity on January 2, 2009, the Division approved a net dividend from FAFLIC to THG, which totaled approximately $130 million. This dividend
consisted primarily of property and equipment, which was subsequently purchased by Hanover Insurance from THG at fair value.
Sources of cash
for our insurance subsidiaries primarily include premiums collected, investment income and maturing investments. Primary cash outflows are paid claims, losses and loss adjustment expenses, policy acquisition expenses, other
78
underwriting expenses and investment purchases. Cash outflows related to claims, losses and loss adjustment expenses can be variable because of uncertainties surrounding settlement dates for
liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. We periodically adjust our investment policy to respond to changes in short-term and long-term cash requirements.
Net cash provided by operating activities was $26.9 million during the first nine months of 2009, as compared to net cash provided of $174.5 million in
2008. The $147.6 million decrease in cash used in operating activities primarily resulted from an increase in net loss and LAE payments, an increased level of funding associated with our qualified defined benefit pension plan, and an increase in
expenditures related to our business investments, primarily investments in product development and technology.
Net cash used in investing
activities was $355.5 million during the first nine months of 2009, compared to net cash provided of $30.0 million for the same period of 2008. During 2009, cash was primarily used as we invested the proceeds from the sale of our Life Companies into
fixed maturities and began reinvesting a portion of existing cash into fixed maturities. This investing activity was partially offset by cash provided from sales of fixed maturities to fund the repurchase of corporate debt and our stock repurchase
program. During 2008, cash was provided by net sales of fixed maturity securities primarily to fund operational cash flow requirements of our property and casualty business, the stock repurchase program and maturity of a trust instrument supported
by a funding obligation. In addition, cash increased in connection with the sale of AMGRO resulting from the settlement, in cash, of an intercompany loan with Hanover Insurance. Partially offsetting these increases were cash payments made in
connection with the acquisition of Verlan Holdings, Inc.
Net cash provided by financing activities was $40.5 million during the first nine
months of 2009, as compared to net cash used of $63.0 million in 2008. During 2009, cash provided by financing activities primarily resulted from a $125.0 million advance received as part of the FHLBB collateralized borrowing program and cash
collateral received related to our securities lending program, partially offset by $125.9 million used to repurchase a portion of our corporate debt (see Significant Transactions), and net repurchases of treasury stock. During 2008, cash used in
financing activities primarily resulted from net repurchases of treasury stock and the maturity of a trust instrument supported by a funding obligation, partially offset by cash inflows from our securities lending program.
At September 30, 2009, THG, as a holding company, held $311.4 million of fixed maturities and cash. During the third quarter, Hanover Insurance
purchased AIX from the holding company for approximately $130 million consisting of both cash and fixed maturities. We believe our holding company assets are sufficient to meet our obligations through the remainder of 2009, which currently consist
primarily of interest on our remaining senior debentures, costs associated with retirement benefits provided to our former life employees and agents, and to the extent required, payments related to indemnification of liabilities associated with the
sale of various subsidiaries. We do not expect that it will be necessary to dividend funds from our insurance subsidiaries in order to fund 2009 holding company obligations.
The sale of FAFLIC provided net cash to the holding company of approximately $225.0 million as follows:
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Proceeds from sale of in-kind dividended assets to Hanover Insurance
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$
|
136.3
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Additional pre-close contributions to FAFLIC
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(6.5
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)
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Gross proceeds from Commonwealth Annuity
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105.8
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Net cost related to exchange of investments between Hanover Insurance and FAFLIC
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(6.7
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)
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Transaction costs and other
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(3.9
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)
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Total cash from the sale of FAFLIC and related intercompany settlements
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$
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225.0
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79
We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term
cash requirements, including the funding of our qualified defined benefit pension plan. For the nine months ended September 30, 2009, we contributed $45.2 million to our qualified defined benefit pension plan of which approximately $32 million
was discretionary. As a result of this discretionary funding and should we elect to apply this excess funding to satisfy the minimum contributions required for the 2010 plan year, we would not be required to contribute cash to the qualified plan
during 2010. Subsequent to 2010, depending on market conditions, we may be required to make significant cash contributions to our qualified defined benefit pension plan.
Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. In 2008 and extending into the early part of
2009, the financial markets experienced unprecedented declines in value, especially in the financial and industrial sectors. Many securities currently held by THG and its subsidiaries experienced the impact of these significant changes in market
value. Due to continued tightening of credit spreads during the second and third quarter of 2009, there has been substantial improvement in our unrealized position from a net unrealized loss position, in the first nine months of 2009, to a net
unrealized gain position, resulting in net unrealized gains of approximately $120 million on securities held. We believe that ongoing government actions and the quality of the assets we hold will allow us to realize the long-term economic value of
our portfolio, including securities that are currently in an unrealized loss position. We do not anticipate the need to sell these securities to meet our insurance subsidiaries’ cash requirements. We expect our insurance subsidiaries to
generate sufficient operating cash to meet all short-term and long-term cash requirements. However, there can be no assurance that unforeseen business needs or other items will not occur causing us to have to sell those securities in a loss position
before their values fully recover; thereby causing us to recognize impairment charges in that time period.
On October 20, 2009, our
Board of Directors declared an annual dividend of $0.75 per share on our issued and outstanding common stock, payable December 9, 2009 to shareholders of record at the close of business on November 25, 2009. In addition, the Board of
Directors also authorized a change in our dividend payment schedule from an annual cash dividend to quarterly dividend payments beginning in fiscal year 2010. These dividend payments will be subject to quarterly board approval and declaration.
On September 24, 2009, our Board of Directors authorized a $100 million increase to our existing common stock repurchase program. The
Board of Directors, on October 16, 2007, had initially authorized the repurchase up to $100 million of common stock. The increase will provide for aggregate repurchases under the program of up to $200 million. Under the repurchase
authorization, we may repurchase our common stock from time to time, in amounts and prices and at such times as we deem appropriate, subject to market conditions and other considerations. Our repurchases may be executed using open market purchases,
privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. In the first nine months of 2009, we
purchased 0.9 million shares at a cost of $36.1 million. Total repurchases under this program as of September 30, 2009 were 2.3 million shares at a cost of $96.3 million.
Through September 30, 2009, we have repurchased $106.2 million of Capital Securities with a face value of $134.3 million that were previously issued by AFC Capital Trust I and $70.5 million of senior
debentures with a face value of $78.4 million that were issued by THG. (See Other Significant Transactions of this form 10-Q for further discussion). On July 30, 2009, we liquidated AFC Capital Trust I, which previously held our Capital
Securities, and exchanged all of the outstanding Capital Securities for like junior debentures, issued by the holding company. We may continue to repurchase senior or junior debentures on an opportunistic basis. As of September 30, 2009, junior
debentures with a face value of $165.7 million and senior debentures with a face value of $121.6 million remained outstanding.
In June 2007,
we entered into a $150.0 million committed syndicated credit agreement which expires in June 2010. Borrowings, if any, under this agreement are unsecured and incur interest at a rate per annum equal to, at our option, a designated base rate or the
Eurodollar rate plus applicable margin. The agreement provides covenants, including, but not limited to, maintaining a certain level of equity and an RBC ratio in our primary property and casualty companies of at least 175% (based on the Industry
Scale). We had no borrowings under this line of credit during the first nine months of 2009. Additionally, we had no commercial paper borrowings as of September 30, 2009 and we do not anticipate implementing a commercial paper program in 2009.
80
OFF-BALANCE SHEET ARRANGEMENTS
We currently do not have any material off-balance sheet arrangements that are reasonably likely to have an effect on our financial position, revenues,
expenses, results of operations, liquidity, capital expenditures, or capital resources.
CONTINGENCIES AND
REGULATORY MATTERS
Litigation
Durand Litigation
On March 12, 2007, a putative class action suit captioned
Jennifer A. Durand v. The Hanover Insurance Group, Inc., The Allmerica Financial Cash Balance Pension Plan
was filed in the United
States District Court for the Western District of Kentucky. The named plaintiff, a former employee who received a lump sum distribution from our Cash Balance Plan at or about the time of her termination, claims that she and others similarly situated
did not receive the appropriate lump sum distribution because in computing the lump sum, we understated the accrued benefit in the calculation. We filed a motion to dismiss on the basis that the plaintiff failed to exhaust administrative remedies,
which motion was granted without prejudice in a decision dated November 7, 2007. This decision was reversed by an order dated March 24, 2009 issued by the United States Court of Appeals for the Sixth Circuit, and the case was remanded to
the district court. In our judgment, the outcome is not expected to be material to our financial position, although it could have a material effect on the results of operations for a particular quarter or annual period.
Hurricane Katrina Litigation
We have been named as a defendant in various litigations, including putative class actions, relating to disputes arising from damages which occurred as a result of Hurricane Katrina in 2005. As of
September 30, 2009, there were approximately 47 such cases. These cases have been filed in both Louisiana state courts and federal district courts. These cases generally involve, among other claims, disputes as to the amount of reimbursable
claims in particular cases (e.g. how much of the damage to an insured property is attributable to flood and therefore not covered, and how much is attributable to wind, which may be covered), as well as the scope of insurance coverage under
homeowners and commercial property policies due to flooding, civil authority actions, loss of landscaping, business interruption and other matters. Certain of these cases claim a breach of duty of good faith or violations of Louisiana insurance
claims handling laws or regulations and involve claims for punitive or exemplary damages.
The putative class actions were consolidated into
the Master Consolidated Class Action Complaint pending in the United States District Court, Eastern District of Louisiana as part of the
In Re: Katrina Canal Breaches Consolidated Litigation, Civil Action No. 05-4182
. On June 16,
2009, the court issued an Order striking all class allegations in the Master Consolidated Class Action Complaint. On June 30, 2009, plaintiffs filed a motion for reconsideration of the court’s ruling dismissing the class allegations.
On August 23, 2007, the State of Louisiana (individually and on behalf of the State of Louisiana, Division of Administration, Office of
Community Development) filed a putative class action (not included in the Master Consolidated Class Action) in the Civil District Court for the Parish of Orleans, State of Louisiana, entitled
State of Louisiana, individually and on behalf of
State of Louisiana, Division of Administration, Office of Community Development ex rel The Honorable Charles C. Foti, Jr., The Attorney General For the State of Louisiana, individually and as a class action on behalf of all recipients of funds as
well as all eligible and/or future recipients of funds through The Road Home Program v. AAA Insurance, et al., No. 07-8970
. The complaint named as defendants over 200 foreign and domestic insurance carriers, including us. Plaintiff seeks to
represent a class of current and former Louisiana citizens who have applied for and received or will receive funds through Louisiana’s “Road Home” program. On August 29, 2007, Plaintiff filed an Amended Petition in this case,
asserting myriad claims, including claims for breach of: contract, the implied covenant of good faith and fair dealing, fiduciary duty and Louisiana’s bad faith statutes. Plaintiff seeks relief in the form of, among other things, declarations
that (a) the efficient proximate cause of losses suffered by putative class members was windstorm, a covered peril under their policies; (b) the second efficient proximate cause of their losses was storm surge, which Plaintiff contends is
not excluded under class members’ policies; (c) the damage caused by water entering affected parishes of Louisiana does not fall within the definition of “flood”; (d) the damages caused by water entering Orleans Parish and
the surrounding area was a result of a man-made occurrence and are properly covered under class members’ policies; (e) many class members suffered total losses to their residences; and (f) many class members are entitled to recover
the full value for their residences stated on their policies pursuant to the Louisiana Valued Policy Law. In accordance with these requested
81
declarations, Plaintiff seeks to recover amounts that it alleges should have been paid to policyholders under their insurance agreements, as well as penalties, attorneys’ fees, and costs.
The case has been removed to the Federal District Court for the Eastern District of Louisiana.
On March 5, 2009, the court issued an
Order granting in part and denying in part a Motion to Dismiss filed by defendants. The court dismissed all claims for bad faith and breach of fiduciary duty and all claims for flood damages under policies with flood exclusions or asserted under the
Valued Policy Law, but rejected the insurers’ arguments that the purported assignments from individual claimants to the state were barred by anti-assignment provisions in the insurers’ policies. On April 16, 2009, the court denied a
Motion for Reconsideration of its ruling regarding the anti-assignment provisions, but certified the issue as ripe for immediate appeal. On April 30, 2009, defendants filed a Petition for Permission to Appeal to the United States Court of
Appeals for the Fifth Circuit.
We have established our loss and LAE reserves on the assumption that we will not have any liability under the
“Road Home” or similar litigation, and that we will otherwise prevail in litigation as to the causes of certain large losses and not incur extra contractual or punitive damages.
Certain Regulatory and Industry Developments
Unfavorable economic conditions may contribute to an increase in the number of insurance companies that are under regulatory supervision. This may result in
an increase in mandatory assessments by state guaranty funds, or voluntary payments by solvent insurance companies to cover losses to policyholders of insolvent or rehabilitated companies. Mandatory assessments, which are subject to statutory
limits, can be partially recovered through a reduction in future premium taxes in some states. We are not able to reasonably estimate the potential impact of any such future assessments or voluntary payments.
Over the past three years, state-sponsored insurers, reinsurers and involuntary pools have increased significantly, particularly in those states which have
Atlantic or Gulf Coast exposures. As a result, the potential assessment exposure of insurers doing business in such states and the attendant collection risks have increased, particularly, in our case, in the states of Massachusetts, Louisiana and
Florida. Such actions and related regulatory restrictions on rate increases, underwriting and the ability to non-renew business may limit our ability to reduce the potential exposure to hurricane related losses. At this time, we are unable to
predict the likelihood or impact of any such potential assessments or other actions.
In February 2009, the Governor of Michigan called upon
every automobile insurer operating in the state to freeze personal automobile insurance rates for 12 months to allow time for the legislature to enact comprehensive automobile insurance reform. In addition, she endorsed a number of proposals by her
appointed Automobile and Home Insurance Consumer Advocate which would, among other things, change the current rate approval process from the current “file and use” system to “prior approval”, mandate “affordable” rates,
reduce the threshold for lawsuits to be filed in “at fault” incidents, and prohibit the use of certain underwriting criteria such as credit-based insurance scores. The Office of Financial and Insurance Regulation (“OFIR”) had
previously issued regulations prohibiting the use of credit scores to rate personal lines insurance policies, which regulations are the subject of litigation being reviewed by the Michigan Supreme Court. Oral arguments were held before the Supreme
Court on October 7, 2009. Pending a determination by the Michigan Supreme Court, OFIR is enjoined from disapproving rates on the basis that they are based in part on credit-based insurance scores. At this time, we are unable to predict the
likelihood of adoption or impact on our business of any such proposals or regulations, but any such restrictions could have an adverse effect on our results of operations.
From time to time, proposals have been made to establish a federal based insurance regulatory system and to allow insurers to elect either federal or state-based regulation (“optional federal
chartering”). In light of the current economic crisis and the focus on increased regulatory controls, particularly with regard to financial institutions, there has been renewed interest in such proposals. In fact, several proposals have been
introduced to create a system of optional federal chartering, to create federal oversight mechanisms for insurance or insurance holding companies which are systemically important to the United States financial system and to create a national office
to monitor insurance companies. We cannot predict the impact that any such change will have on our operations or business or on that of our competitors.
82
Other Matters
We have been named a defendant in various other legal proceedings arising in the normal course of business. In addition, we are involved, from time to time,
in examinations, investigations and proceedings by governmental and self-regulatory agencies. The potential outcome of any such action or regulatory proceedings in which we have been named a defendant or the subject of an inquiry or investigation,
and our ultimate liability, if any, from such action or regulatory proceedings, is difficult to predict at this time. In our opinion, based on the advice of legal counsel, the ultimate resolutions of such proceedings will not have a material effect
on our financial position, although they could have a material effect on the results of operations for a particular quarter or annual period.
Residual Markets
We are required to participate in
residual markets in various states, which generally pertain to high risk insureds, disrupted markets or lines of business or geographic areas where rates are regarded as excessive. The results of the residual markets are not subject to the
predictability associated with our own managed business, and are significant to the workers’ compensation line of business, the homeowners line of business and both the personal and commercial automobile lines of business.
RATING AGENCY ACTIONS
Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers information on specific insurance companies. Higher ratings generally indicate the rating agencies’ opinion regarding
financial stability and a stronger ability to pay claims.
We believe that strong ratings are important factors in marketing our products to
our agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Insurance company financial strength ratings are assigned to an insurer based upon factors deemed by the rating agencies to be
relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security.
On May 8, 2009, A.M. Best upgraded the financial strength rating of our property and casualty subsidiaries to A (excellent) from A- (excellent). Additionally, A.M. Best upgraded our senior debt
ratings to bbb (adequate) from bbb- (adequate) and our capital securities were upgraded to bb+ (speculative) from bb (speculative).
RECENT DEVELOPMENTS
On October 20, 2009, the Board of Directors declared an annual dividend of $0.75 per share on the issued and
outstanding common stock of THG, payable December 9, 2009, to shareholders of record at the close of business on November 25, 2009. In addition, the Board of Directors authorized a change in our dividend payment schedule from an annual
cash dividend to quarterly dividend payments beginning in fiscal year 2010. These dividend payments will be subject to quarterly board approval and declaration.
RISKS AND FORWARD LOOKING STATEMENTS
Management’s Discussion
and Analysis contains “forward–looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of indicators of forward-looking statements and specific important factors that could
cause actual results to differ materially from those contained in forward–looking statements, see Item 1A of this Quarterly Report on Form 10-Q and in Part I – Item 1A of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2008. This Management’s Discussion and Analysis should be read and interpreted in light of such factors.
83
GLOSSARY OF SELECTED INSURANCE TERMS
Benefit payments
– Payments made to an insured or their beneficiary in accordance with the terms of an insurance policy.
Casualty insurance
– Insurance that is primarily concerned with the losses caused by injuries to third persons and their property (other than the
policyholder) and the related legal liability of the insured for such losses.
Catastrophe
– A severe loss, resulting from natural
and manmade events, including risks such as hurricane, fire, earthquake, windstorm, tornado, hailstorm, severe winter weather, explosion, terrorism and other similar events.
Catastrophe loss
– Loss and directly identified loss adjustment expenses from catastrophes. The Insurance Services Office (“ISO”) Property Claim Services (“PCS”) defines a
catastrophe loss as an event that causes $25 million or more in industry insured property losses and affects a significant number of property and casualty policyholders and insurers. In addition to those catastrophe events declared by ISO, claims
management also generally includes within the definition of a “catastrophe loss”, an event that causes approximately $5 million or more in Company insured property losses and affects in excess of one hundred policyholders.
Cede; cedent; ceding company
– When a party reinsures its liability with another, it “cedes” business and is referred to as the
“cedent” or “ceding company”.
Combined ratio, GAAP
– This ratio is the GAAP equivalent of the statutory ratio
that is widely used as a benchmark for determining an insurer’s underwriting performance. A ratio below 100% generally indicates profitable underwriting prior to the consideration of investment income. A combined ratio over 100% generally
indicates unprofitable underwriting prior to the consideration of investment income. The combined ratio is the sum of the loss ratio, the loss adjustment expense ratio and the underwriting expense ratio.
Credit spread
– The difference between the yield on the debt securities of a particular corporate debt issue and the yield of a similar maturity
of U.S. Treasury debt securities.
Current year accident results –
A measure of the estimated earnings impact of current premiums
offset by estimated loss experience and expenses for the current accident year. This measure includes the estimated increase in revenue associated with higher prices (premiums), including those caused by price inflation and changes in exposure,
partially offset by higher volume driven expenses and inflation of loss costs. Volume driven expenses include policy acquisition costs such as commissions paid to property and casualty agents which are typically based on a percentage of premium
dollars.
Dividends received deduction
– A corporation is entitled to a special tax deduction from gross income for dividends
received from a domestic corporation that is subject to income tax.
Earned premium
– The portion of a premium that is recognized
as income, or earned, based on the expired portion of the policy period, that is, the period for which loss coverage has actually been provided. For example, after six months, $50 of a $100 annual premium is considered earned premium. The remaining
$50 of annual premium is unearned premium. Net earned premium is earned premium net of reinsurance.
Excess of loss reinsurance
–
Reinsurance that indemnifies the insured against all or a specific portion of losses under reinsured policies in excess of a specified dollar amount or “retention”.
Expense Ratio, GAAP
– The ratio of underwriting expenses to premiums earned for a given period.
Exposure –
A measure of the rating units or premium basis of a risk; for example, an exposure of a number of automobiles.
Frequency
– The number of claims occurring during a given coverage period.
Inland
Marine Insurance
– In Commercial Lines, this is a type of coverage developed for shipments that do not involve ocean transport. It covers articles in transit by all forms of land and air transportation as well as bridges, tunnels and other
means of transportation and communication. In the context of Personal Lines, this term relates to floater policies that cover expensive personal items such as fine art and jewelry.
Loss adjustment expenses (“LAE”)
– Expenses incurred in the adjusting, recording, and settlement of claims. These expenses include both internal company expenses and outside
services. Examples of LAE include claims adjustment services, adjuster salaries and fringe benefits, legal fees and court costs, investigation fees and claims processing fees.
84
Loss adjustment expense (“LAE”) ratio, GAAP
– The ratio of loss adjustment expenses to
earned premiums for a given period.
Loss costs
– An amount of money paid for a property and casualty claim.
Loss ratio, GAAP
– The ratio of losses to premiums earned for a given period.
Loss reserves
– Liabilities established by insurers to reflect the estimated cost of claims payments and the related expenses that the insurer will ultimately be required to pay in respect of
insurance it has written. Reserves are established for losses and for LAE.
Multivariate product
– An insurance product, the
pricing for which is based upon the magnitude of, and correlation between, multiple rating factors. In practical application, the term refers to the foundational analytics and methods applied to the product construct. Our
Connections Auto
product is a multivariate product.
Peril
– A cause of loss.
Perpetual preferred stock
– Preferred stock that has no fixed maturity date and that cannot be redeemed at the option of the holder. Cumulative
perpetual preferred stock accumulates dividends from one dividend period to the next.
Property insurance
– Insurance that
provides coverage for tangible property in the event of loss, damage or loss of use.
Rate
– The pricing factor upon which the
policyholder’s premium is based.
Rate increase (Commercial Lines)
– Represents the average change in premium on renewal
policies caused by the estimated net effect of base rate changes, discretionary pricing, inflation or changes in policy level exposure.
Rate increase (Personal Lines)
– The estimated cumulative premium effect of approved rate actions during the prior policy period applied to a policy’s renewal premium.
Reinstatement premium
– A pro-rata reinsurance premium that may be charged for reinstating the amount of reinsurance coverage reduced as the
result of a reinsurance loss occurrence under a reinsurance treaty. For example, in 2005 this premium was required to ensure that our property catastrophe occurrence treaty, which was exhausted by Hurricane Katrina, was available again in the event
of another large catastrophe loss in 2005.
Reinsurance
– An arrangement in which an insurance company, the reinsurer, agrees to
indemnify another insurance or reinsurance company, the ceding company, against all or a portion of the insurance or reinsurance risks underwritten by the ceding company under one or more policies. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on risks and catastrophe protection from large or multiple losses. Reinsurance does not legally discharge the primary insurer from its liability with respect to its obligations to the insured.
Risk based capital (“RBC”)
– A method of measuring the minimum amount of capital appropriate for an insurance company
to support its overall business operations in consideration of its size and risk profile. The RBC ratio for regulatory purposes is calculated as total adjusted capital divided by required risk based capital. Total adjusted capital for property and
casualty companies is capital and surplus. The Company Action Level is the first level at which regulatory involvement is specified based upon the level of capital. Regulators may take action for reasons other than triggering various RBC action
levels. The various action levels are summarized as follows:
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•
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The Company Action Level, which equals 200% of the Authorized Control Level, requires a company to prepare and submit a RBC plan to the commissioner of
the state of domicile. A RBC plan proposes actions which a company may take in order to bring statutory capital above the Company Action Level. After review, the commissioner will notify the company if the plan is satisfactory.
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•
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The Regulatory Action Level, which equals 150% of the Authorized Control Level, requires the insurer to submit to the commissioner of the state of
domicile an RBC plan, or if applicable, a revised RBC plan. After examination or analysis, the commissioner will issue an order specifying corrective actions to be taken.
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•
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The Authorized Control Level authorizes the commissioner of the state of domicile to take whatever regulatory actions considered necessary to protect
the best interest of the policyholders and creditors of the insurer.
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•
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The Mandatory Control Level, which equals 70% of the Authorized Control Level, authorizes the commissioner of the state of domicile to take actions
necessary to place the company under regulatory control (i.e., rehabilitation or liquidation).
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85
Security Lending
– We engage our banking provider to lend securities from our investment
portfolio to third parties. These lent securities are fully collateralized by cash. We monitor the fair value of the securities on a daily basis to assure that the collateral is maintained at a level of at least 102% of the fair value of the loaned
securities. We record securities lending collateral as a cash equivalent, with an offsetting liability in expenses and taxes payable.
Severity
– A monetary increase in the loss costs associated with the same or similar type of event or coverage.
Specialty Lines
– A major component of our Other Commercial Lines, includes products such as inland and ocean marine, bond specialty property, professional liability and various other program business.
Statutory accounting principles
– Recording transactions and preparing financial statements in accordance with the rules and procedures
prescribed or permitted by insurance regulatory authorities including the NAIC, which in general reflect a liquidating, rather than going concern, concept of accounting.
Underwriting
– The process of selecting risks for insurance and determining in what amounts and on what terms the insurance company will accept risks.
Underwriting expenses
– Expenses incurred in connection with the acquisition, pricing and administration of a policy.
Underwriting expense ratio, GAAP
– The ratio of underwriting expenses to earned premiums in a given period.
Unearned premiums
– The portion of a premium representing the unexpired amount of the contract term as of a certain date.
Written premium
– The premium assessed for the entire coverage period of a property and casualty policy without regard to how much of the
premium has been earned. See also earned premium. Net written premium is written premium net of reinsurance.
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ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Our market risks, and the ways we manage them, are summarized in
Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2008, included in our Annual Report on Form 10-K for the year ended December 31, 2008. There have been no material changes in the
first nine months of 2009 to these risks or our management of them. The following interest rate sensitivity table is intended to supplement our interest rate sensitivity discussion included in the Annual Report on Form 10-K for the year ended
December 31, 2008.
INTEREST RATE SENSITIVITY
The following table illustrates the estimated impact on the fair value of our investment portfolio at September 30, 2009 of hypothetical changes in prevailing interest rates, defined as changes in
interest rates on U.S. Treasury debt. It does not reflect changes in credit spreads, liquidity spreads and other factors that affect the value of securities. Since changes in prevailing interest rates are often accompanied by changes in these other
factors, the reader should not assume that an actual change in interest rates would result in the values illustrated.
(Fair value, in
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment Type
|
|
+300bp
|
|
+200bp
|
|
+100bp
|
|
0
|
|
-100bp
|
|
-200bp
|
|
-300bp
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities
|
|
$
|
800
|
|
$
|
845
|
|
$
|
890
|
|
$
|
940
|
|
$
|
950
|
|
$
|
950
|
|
$
|
950
|
|
|
|
|
|
|
|
|
|
|
All other fixed income securities
|
|
|
3,475
|
|
|
3,630
|
|
|
3,800
|
|
|
3,975
|
|
|
4,150
|
|
|
4,295
|
|
|
4,385
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,275
|
|
$
|
4,475
|
|
$
|
4,690
|
|
$
|
4,915
|
|
$
|
5,100
|
|
$
|
5,245
|
|
$
|
5,335
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87
ITEM 4
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures Evaluation
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the
“Exchange Act”).
Limitations on the Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls over financial reporting will prevent all error and all fraud. A control
system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of
fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Based on our controls evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required
to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) material information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
Our management is responsible for establishing
and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the
internal control over financial reporting, as required by Rule 13a-15(d) of the Exchange Act, to determine whether any changes occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that there was no such change during the quarter ended September 30, 2009,
that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
88
