HANOVER INSURANCE GROUP, INC. 10-Q

ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS TABLE OF CONTENTS Introduction 28 Executive Overview 28 Description of Operating Segments 29 Results of Operations - Consolidated 29 Results of Operations - Segments 31 Investments 38 Other Items 42 Income Taxes 43 Critical Accounting Estimates 44 Statutory Surplus of Insurance Subsidiaries 45 Liquidity and Capital Resources 45 Off - Balance Sheet Arrangements 47 Contingencies and Regulatory Matters 47 Risks and Forward - Looking Statements 47 27 Table of Contents Introduction The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist readers in understanding the interim consolidated results of operations and financial condition of The Hanover Insurance Group, Inc. and its subsidiaries (“THG”). Consolidated results of operations and financial condition are prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). This discussion should be read in conjunction with the interim consolidated financial statements and related footnotes included elsewhere in this Quarterly Report on Form 10-Q and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 24, 2020. 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 other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting of our accident and health and former life insurance businesses, as well as our former Chaucer business. Executive Overview Business operations consist of three operating segments: Commercial Lines, Personal Lines and Other. Our strategy, which focuses on the independent agency distribution channel, reinforces THG’s commitment to our agency partners. It is designed to generate profitable growth by leveraging the strengths of our distribution approach, including expansion of our agency footprint in underpenetrated geographies, as warranted. As part of that strategy, we have increased our capabilities in specialty markets and made investments designed to develop growth solutions for our agency distribution channel. Our goal is to grow responsibly in all of our businesses, while managing volatility. The outbreak of the novel coronavirus, also known as COVID-19, and subsequent global pandemic (“Pandemic”) significantly impacted the U.S. and global financial markets and economies during the six months ended June 30, 2020. Circumstances relating to the Pandemic are unprecedented in scope, continue to evolve, and are complex and uncertain. Our investment portfolio was affected by the deterioration in investment markets during March 2020, as well as the partial recovery in the subsquent months. In addition, we experienced both favorable and adverse effects from the Pandemic on our underwriting results and operations, as well as our financial condition, during March through June of 2020. However, we continue to believe that the Pandemic’s economic impacts on our 2020 results should be manageable. The severity, duration and long-term impacts of the Pandemic, including continued declines in general economic conditions, adverse impacts to our investment portfolio and uncertainty around possible and actual governmental responses to the crisis, may significantly affect the property and casualty insurance industry, our business, and our financial results over the intermediate and long-term. (See “Contingencies and Regulatory Matters” and “Item 1A – Risk Factors” for further discussion). During the six months ended June 30, 2020, our net income was $75.2 million, compared to $196.4 million for the six months ended June 30, 2019, a decrease of $121.2 million, primarily due to a decrease in fair value of equity securities and, to a lesser extent, impairment losses on fixed income securities. Operating income before interest expense and income taxes (a non-GAAP financial measure; see also “Results of Operations – Consolidated – Non-GAAP Financial Measures”) was $206.0 million for the six months ended June 30, 2020, compared to $216.8 million for the six months ended June 30, 2019, a decrease of $10.8 million. This decrease was primarily due to higher catastrophe losses and lower net investment income. These items were partially offset by lower non-catastrophe current accident year losses, primarily in our personal and commercial automobile lines, and a non-recurring premium tax benefit of $13.8 million due to a Michigan refund related to tax years 2014 through 2016. The lower current accident year losses were primarily due to a reduced level of economic activity as a result of the Pandemic. Pre-tax catastrophe losses were $185.7 million for the six months ended June 30, 2020, compared to $99.0 million during the same period of 2019. The increase of $86.7 million was due to several wind and hail storms throughout the Midwest and Southeast, as well as from property damages related to riots and civil unrest in several major cities across the country. Net favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”) was $6.9 million for the six months ended June 30, 2020, while development was insignificant overall for the six months ended June 30, 2019. Commercial Lines Our account-focused approach to the small commercial market, distinctiveness in the middle market and continued development of specialty lines provides us with a diversified portfolio of products and delivers significant value to agents and policyholders. We continue to pursue our core strategy of developing strong partnerships with agents, enhanced franchise value through selective distribution, distinctive products and coverages, and continued investment in industry segmentation. Commercial Lines net premiums written in the first six months of 2020, were consistent with the same period in 2019. The premium growth in the first quarter of 2020 was offset by a reduction in insured business activity as a result of the Pandemic during the second quarter. 28 Table of Contents Underwriting results declined in the first six months of 2020 , primarily due to higher catastrophe losses , partially offset by lower non- catastrophe current accident year losses. The lower non-catastrophe current accident year losses in our commercial automobile, specialty industrial property and marine lines were partially offset by reserve provision s for exposure s related to the Pandemic . The lower current accident year losses were primarily due to a reduced level of economic activity as a result of the Pandemic. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins, and we continue to seek rate increases across our lines of business. Due to the Pandemic , and the resulting economic downturn affecting our Commercial Lines businesses, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability. Personal Lines Personal Lines focuses on partnering with high quality, value-oriented agencies that deliver consultative selling to customers and stress the importance of account rounding (the conversion of single policy customers to accounts with multiple policies and additional coverages, to address customers’ broader objectives). Approximately 85% of our policies in force have been issued to customers with multiple policies and/or coverages with us. We are focused on seeking profitable growth opportunities, building a distinctive position in the market in order to meet our customers’ needs and diversifying geographically. We continue to seek appropriate rate increases that meet or exceed underlying loss cost trends, subject to regulatory and competitive considerations. Due to the Pandemic, and the resulting economic downturn affecting our Personal Lines businesses, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability. Net premiums written decreased by 2.0% in the first six months of 2020, compared to the same period in 2019. During the second quarter of 2020, we returned approximately $30 million of premiums to our eligible personal automobile customers in all of our markets, providing financial relief during the Pandemic. Excluding the impact of the premium refund, net written premiums increased 1.3%. Underwriting results improved in the first six months of 2020, primarily due to lower non-catastrophe current accident year losses in our personal automobile line, a favorable change in development of prior years’ loss reserves and a non-recurring premium tax benefit, partially offset by higher catastrophe losses. The lower personal automobile losses were due to fewer vehicles on the road as a result of the Pandemic. Description of Operating Segments Primary business operations include insurance products and services currently provided through three operating segments: Commercial Lines, Personal Lines and Other. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation and other commercial coverages, such as management and professional liability, marine, Hanover Programs, specialty industrial and commercial property, monoline general liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages, such as umbrella. Included in the “Other” segment are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds, and other organizations; earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to our former life insurance employees and agents; and a run-off voluntary property and casualty pools business. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance. We report interest expense on debt separately from the earnings of our operating segments. This consists primarily of interest on our senior and subordinated debentures. Results of Operations – Consolidated Consolidated net income for the three months ended June 30, 2020 was $115.2 million, compared to consolidated net income of $74.0 million for the three months ended June 30, 2019, an increase of $41.2 million. This increase was primarily due to an increase in after-tax net realized and unrealized investment gains of $39.8 million, as compared to the second quarter of 2019, principally related to changes in fair value of equity securities. This increase was partially offset by operating income before interest expense and income taxes which decreased $18.1 million for the three months ended June 30, 2020. This decrease was primarily due to higher catastrophe losses and lower net investment income, partially offset by lower non-catastrophe current accident year losses, as well as a non-recurring premium tax benefit. Consolidated net income for the six months ended June 30, 2020 was $75.2 million, compared to $196.4 million for the six months ended June 30, 2019, a decrease of $121.2 million. The year-over-year comparison of consolidated net income was primarily affected by an increase in after-tax net realized and unrealized investment losses of approximately $128 million, primarily related to the change in fair value of equity securities and, to a lesser extent, the increase in impairment losses on investments. These losses were primarily offset by operating income before interest expense and income taxes for the six months ended June 30, 2020, which decreased by $10.8 million. This decrease was primarily due to higher catastrophe losses and lower net investment income, partially offset by lower non-catastrophe current accident year losses, as well as a non-recurring premium tax benefit. 29 Table of Contents The following table reflects operating income before interest expense and income taxes for each operating segment and a reconciliation to consolidated net income from operating income before interest expense and income taxes (a non-GAAP measure). Three Months Ended Six Months Ended June 30, June 30, (in millions) 2020 2019 2020 2019 Operating income (loss) before interest expense and income taxes: Commercial Lines $ 55.3 $ 72.8 $ 109.9 $ 153.0 Personal Lines 32.6 31.7 97.5 58.5 Other 1.0 2.5 (1.4 ) 5.3 Operating income before interest expense and income taxes 88.9 107.0 206.0 216.8 Interest expense on debt (9.4 ) (9.3 ) (18.8 ) (18.7 ) Operating income before income taxes 79.5 97.7 187.2 198.1 Income tax expense on operating income (16.8 ) (20.0 ) (37.7 ) (39.7 ) Operating income 62.7 77.7 149.5 158.4 Non-operating items: Net realized and unrealized investment gains (losses) 63.7 12.1 (97.9 ) 60.3 Effect of new tax regulations on Chaucer gain on sale — (5.6 ) — (5.6 ) Other non-operating (0.1 ) — (0.1 ) — Income tax benefit (expense) on non-operating items (11.0 ) 0.8 25.1 (5.5 ) Income from continuing operations, net of taxes 115.3 85.0 76.6 207.6 Discontinued operations (net of taxes): Sale of Chaucer business — (9.9 ) — (9.0 ) Loss from Chaucer business — (0.2 ) — (0.5 ) Loss from discontinued life businesses (0.1 ) (0.9 ) (1.4 ) (1.7 ) Net income $ 115.2 $ 74.0 $ 75.2 $ 196.4 Non-GAAP Financial Measures In addition to consolidated net income, discussed above, we assess our financial performance based upon pre-tax “operating income,” and we assess the operating performance of each of our three operating segments based upon the pre-tax operating income (loss) generated by each segment. As reflected in the table above, operating income before interest and taxes excludes interest expense on debt and certain other items which we believe are not indicative of our core operations, such as net realized and unrealized investment gains and losses. Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income before interest and taxes excludes net gains and losses on disposals of businesses, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income before interest and taxes are important components in understanding and assessing our overall financial performance, we believe a discussion of operating income before taxes enhances an investor’s understanding of our results of operations by highlighting net income attributable to the core operations of the business. However, operating income before interest and taxes, which is a non-GAAP measure, should not be construed as a substitute for income before income taxes or income from continuing operations, and operating income should not be construed as a substitute for net income. Catastrophe losses and prior years’ reserve development are significant components in understanding and assessing the financial performance of our business. Management reviews and evaluates catastrophes and prior years’ reserve development separately from the other components of earnings. References to “current accident year underwriting results” exclude prior accident year reserve development, and may also be presented “excluding catastrophes.” Prior years’ reserve development and catastrophes are not predictable as to timing or the amount that will affect the results of our operations and have an effect on each year’s operating and net income. Management believes that providing certain financial metrics and trends excluding the effects of catastrophes and prior years’ reserve development helps investors to understand the variability in periodic earnings and to evaluate the underlying performance of our operations. Discussion of catastrophe losses in this Management’s Discussion and Analysis includes development on prior years’ catastrophe reserves and, unless otherwise indicated, such development is excluded from discussions of prior year loss and LAE reserve development. 30 Table of Contents Results of Operations – Segments The following is our discussion and analysis of the results of operations by business segment. The operating results are presented before interest expense, taxes and other items which management believes are not indicative of our core operations, including realized gains and losses, as well as unrealized gains and losses on equity securities, and the results of discontinued operations. The following table summarizes the results of operations for the periods indicated: Three Months Ended Six Months Ended June 30, June 30, (in millions) 2020 2019 2020 2019 Operating revenues Net premiums written $ 1,081.0 $ 1,137.8 $ 2,217.9 $ 2,235.8 Net premiums earned $ 1,096.6 $ 1,111.0 $ 2,238.0 $ 2,206.1 Net investment income 57.7 69.6 127.3 139.8 Other income 6.3 5.9 13.1 11.9 Total operating revenues 1,160.6 1,186.5 2,378.4 2,357.8 Losses and operating expenses Losses and LAE 712.0 717.7 1,440.2 1,417.3 Amortization of deferred acquisition costs 237.3 230.5 474.2 460.0 Other operating expenses 122.4 131.3 258.0 263.7 Total losses and operating expenses 1,071.7 1,079.5 2,172.4 2,141.0 Operating income before interest expense and income taxes $ 88.9 $ 107.0 $ 206.0 $ 216.8 Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019 Operating income before interest expense and income taxes was $88.9 million in the three months ended June 30, 2020, compared to $107.0 million in the three months ended June 30, 2019, a decrease of $18.1 million. This decrease was primarily due to higher catastrophe losses and lower net investment income, partially offset by lower non-catastrophe current accident year losses and a non-recurring premium tax benefit. The lower non-catastrophe current accident year losses are primarily due to lower personal and commercial automobile losses and lower large property loss activity in our commercial multiple peril and marine lines, partially offset by additional reserve provisions for exposures related to the Pandemic. The lower current accident year losses were primarily due to a reduced level of economic activity as a result of the Pandemic. Net premiums written decreased $56.8 million in the three months ended June 30, 2020, compared to the three months ended June 30, 2019, primarily due to the aforementioned premium refund and economic impacts of the Pandemic in both our Commercial and Personal Lines segments. Production and Underwriting Results The following tables summarize premiums written on a gross and net basis, net premiums earned and loss (including catastrophe losses), LAE, expense and combined ratios for the Commercial Lines and Personal Lines segments. Loss, LAE, catastrophe loss and combined ratios shown below include prior year reserve development. These items are not meaningful for our Other segment. Three Months Ended June 30, 2020 (dollars in millions) Gross Premiums Written Net Premiums Written Net Premiums Earned Catastrophe Loss Ratios Loss & LAE Ratios Expense Ratios Combined Ratios Commercial Lines $ 726.4 $ 614.9 $ 658.6 9.8 62.2 34.4 96.6 Personal Lines 497.6 466.1 438.0 18.9 69.0 26.7 95.7 Total $ 1,224.0 $ 1,081.0 $ 1,096.6 13.5 64.9 31.3 96.2 Three Months Ended June 30, 2019 (dollars in millions) Gross Premiums Written Net Premiums Written Net Premiums Earned Catastrophe Loss Ratios Loss & LAE Ratios Expense Ratios Combined Ratios Commercial Lines $ 749.5 $ 644.7 $ 658.8 3.5 61.0 34.4 95.4 Personal Lines 522.0 493.1 452.2 8.1 69.8 27.2 97.0 Total $ 1,271.5 $ 1,137.8 $ 1,111.0 5.4 64.6 31.5 96.1 31 Table of Contents The following table summarizes net premiums written, and loss and LAE and catastrophe loss ratios by line of business for the Commercial Lines and Personal Lines segments. Loss and LAE and catastrophe loss ratios include prior year reserve development. Three Months Ended June 30, 2020 2019 (dollars in millions) Net Premiums Written Loss & LAE Ratios Catastrophe Loss Ratios Net Premiums Written Loss & LAE Ratios Catastrophe Loss Ratios Commercial Lines: Commercial multiple peril $ 204.3 73.8 23.1 $ 210.7 62.5 7.3 Commercial automobile 77.7 65.3 0.7 77.9 72.8 1.1 Workers’ compensation 65.2 46.7 — 78.9 53.4 — Other commercial 267.7 55.9 4.5 277.2 58.3 2.2 Total Commercial Lines $ 614.9 62.2 9.8 $ 644.7 61.0 3.5 Personal Lines: Personal automobile $ 276.8 51.9 1.9 $ 310.4 70.8 0.7 Homeowners 173.7 100.2 48.0 169.1 70.6 22.2 Other personal 15.6 31.3 5.2 13.6 34.2 3.5 Total Personal Lines $ 466.1 69.0 18.9 $ 493.1 69.8 8.1 The following table summarizes GAAP underwriting results for the Commercial Lines, Personal Lines and Other segments and reconciles them to operating income before interest expense and income taxes. Three Months Ended June 30, 2020 2019 (in millions) Commercial Lines Personal Lines Other Total Commercial Lines Personal Lines Other Total Underwriting profit (loss), excluding prior year reserve development and catastrophes $ 81.0 $ 100.3 $ (0.1 ) $ 181.2 $ 48.1 $ 50.8 $ — $ 98.9 Prior year favorable (unfavorable) loss and LAE reserve development on non-catastrophe losses 5.1 0.1 (0.3 ) 4.9 4.0 (3.3 ) (0.3 ) 0.4 Prior year favorable catastrophe development 6.0 1.0 — 7.0 5.3 1.7 — 7.0 Current year catastrophe losses (70.8 ) (84.0 ) — (154.8 ) (28.3 ) (38.3 ) — (66.6 ) Underwriting profit (loss) 21.3 17.4 (0.4 ) 38.3 29.1 10.9 (0.3 ) 39.7 Net investment income 37.9 16.5 3.3 57.7 44.4 19.7 5.5 69.6 Fees and other income 2.4 1.8 2.1 6.3 2.0 2.7 1.2 5.9 Other operating expenses (6.3 ) (3.1 ) (4.0 ) (13.4 ) (2.7 ) (1.6 ) (3.9 ) (8.2 ) Operating income before interest expense and income taxes $ 55.3 $ 32.6 $ 1.0 $ 88.9 $ 72.8 $ 31.7 $ 2.5 $ 107.0 Commercial Lines Commercial Lines net premiums written were $614.9 million in the three months ended June 30, 2020, compared to $644.7 million in the three months ended June 30, 2019. This $29.8 million decrease was primarily driven by the reduction in insured business activity during the period as a result of the Pandemic. Commercial Lines underwriting profit for the three months ended June 30, 2020 was $21.3 million, compared to $29.1 million for the three months ended June 30, 2019, a decrease of $7.8 million. Catastrophe losses for the three months ended June 30, 2020 were $64.8 million, compared to $23.0 million for the three months ended June 30, 2019. The $41.8 million increase was primarily driven by property damages related to riots and civil unrest in several major cities across the country. Commercial Lines current accident year underwriting profit, excluding catastrophes, was $81.0 million for the three months ended June 30, 2020, compared to $48.1 million for the three months ended June 30, 2019. This $32.9 million increase was primarily driven by lower non-catastrophe current accident year losses. The lower non-catastrophe current accident year losses were due to lower loss activity in our commercial multiple peril, workers’ compensation, marine and commercial automobile lines, primarily due to a reduced level of economic activity as a result of the Pandemic. This lower loss activity was partially offset by approximately $6 million of additional reserve provisions for exposures related to the Pandemic, reflected in our workers’ compensation line. 32 Table of Contents We continu e to manage underwriting performance through increased rates, pricing segmentation, specific underwriting actions and targeted new business growth. Our ability to achieve overall rate increases is affected by many factors, including regulatory activity and the current competitive pricing environment, particularly within the workers’ compensation line. Due to the Pandemic and the resulting economic downturn affecting our Commercial Lines segment, there is an increased level of uncertainty in our ability to grow our business and maintain or improve our underwriting profitability. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in continued moderation in claims volumes due to a substantial reduction in business activity, for example, less traffic and congestion on the roads may result in fewer accidents involving our insureds in our commercial automobile line. In addition, a reduction in our insured's underlying business activity, as well as the inability of certain businesses to restart operations and recover from the economic impacts of the prolonged stay-at-home orders, may result in a significant reduction in our future commercial multiple peril, workers' compensation and general liability premium levels. Personal Lines Personal Lines net premiums written were $466.1 million in the three months ended June 30, 2020, compared to $493.1 million in the three months ended June 30, 2019, a decrease of $27.0 million. This was due to the premium refund on personal automobile policies. Net premiums written in the personal automobile line of business for the three months ended June 30, 2020 were $276.8 million, compared to $310.4 million for the three months ended June 30, 2019, a decrease of $33.6 million. This was primarily due to the personal automobile policy premium refund of $29.4 million. Personal automobile policies in force decreased by 0.1%. Net premiums written in the homeowners line of business for the three months ended June 30, 2020 were $173.7 million, compared to $169.1 million for the three months ended June 30, 2019, an increase of $4.6 million. This was attributable to rate increases and an increase in policies in force of 0.8%. Personal Lines underwriting profit for the three months ended June 30, 2020 was $17.4 million, compared to $10.9 million for the three months ended June 30, 2019, an increase of $6.5 million. Catastrophe losses for the three months ended June 30, 2020 were $83.0 million, compared to $36.6 million for the three months ended June 30, 2019, an increase of $46.4 million primarily due to several wind and hail storms throughout the Midwest and Southeast. Favorable development on prior year’s loss reserves for the three months ended June 30, 2020 was $0.1 million, compared to unfavorable development of $3.3 million for the three months ended June 30, 2019, a favorable change of $3.4 million. Personal Lines current accident year underwriting profit, excluding catastrophes, was $100.3 million for the three months ended June 30, 2020, compared to $50.8 million for the three months ended June 30, 2019. This $49.5 million increase was primarily due to lower current accident year losses in our personal automobile line and a non-recurring premium tax benefit. The lower personal automobile losses were due to fewer vehicles on the road as a result of the Pandemic. The non-recurring premium tax benefit of $13.8 million was due to a Michigan refund related to tax years 2014 through 2016. We have been able to obtain rate increases in our Personal Lines markets and believe that our ability to obtain increases will continue over the long term. Our ability to maintain Personal Lines net premiums written may be affected, however, by price competition, and regulatory and legal activity and developments. See “Contingencies and Regulatory Matters.” Additionally, these factors along with weather-related loss volatility may also affect our ability to maintain and improve underwriting results. We monitor these trends and consider them in our rate actions. Due to the Pandemic and the resulting economic downturn affecting our Personal Lines segment, there is an increased level of uncertainty in our ability to retain or grow our business and maintain or improve our underwriting profitability. The extent and duration of the Pandemic's future disruption to our businesses are unknown and may result in a continued moderation in claims volumes due to a substantial reduction in customer activity, for example, lower miles driven by the insureds in our personal automobile line. In addition, and as discussed under “Risk Factors – Michigan PIP Reform” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019, Michigan enacted major reforms of its current system governing personal and commercial automobile insurance in 2019. Michigan business represents 46% of our total personal automobile net premiums written. As of June 30, 2020, the net impact of these reforms is not significant to our total net premiums written and underwriting income. Other Our Other segment had operating income of $1.0 million for the three months ended June 30, 2020, compared to $2.5 million for the three months ended June 30, 2019, a decline of $1.5 million. The decline was primarily due to lower net investment income as a result of the deployment of proceeds from the sale of our former Chaucer business in the prior year. 33 Table of Contents Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019 Operating income before interest expense and income taxes was $206.0 million in the six months ended June 30, 2020, compared to $216.8 million in the six months ended June 30, 2019, a decrease of $10.8 million. This decrease was primarily due to higher catastrophe losses and lower net investment income, partially offset by lower non-catastrophe current accident year losses, primarily in our personal and commercial automobile lines, and a non-recurring premium tax benefit. The increase in catastrophe losses is due to several wind and hail storms throughout the Midwest and Southeast and property damages related to riots and civil unrest in several major cities across the country. The lower current accident year losses were primarily due to a reduced level of economic activity as a result of the Pandemic. Net premiums written decreased by $17.9 million in the six months ended June 30, 2020, compared to the six months ended June 30, 2019. The personal automobile premium refund and reduction in commercial insured business activity during the second quarter as a result of the Pandemic more than offset the premium growth in the first quarter in both our Commercial and Personal Lines segments. Production and Underwriting Results The following tables summarize premiums written on a gross and net basis, net premiums earned and loss (including catastrophe losses), LAE, expense and combined ratios for the Commercial Lines and Personal Lines segments. Loss, LAE, catastrophe loss and combined ratios shown below include prior year reserve development. These items are not meaningful for our Other segment. Six Months Ended June 30, 2020 (dollars in millions) Gross Premiums Written Net Premiums Written Net Premiums Earned Catastrophe Loss Ratios Loss & LAE Ratios Expense Ratios Combined Ratios Commercial Lines $ 1,556.9 $ 1,322.5 $ 1,334.5 6.6 63.2 34.2 97.4 Personal Lines 956.0 895.4 903.5 10.7 65.7 27.1 92.8 Total $ 2,512.9 $ 2,217.9 $ 2,238.0 8.3 64.4 31.3 95.7 Six Months Ended June 30, 2019 (dollars in millions) Gross Premiums Written Net Premiums Written Net Premiums Earned Catastrophe Loss Ratios Loss & LAE Ratios Expense Ratios Combined Ratios Commercial Lines $ 1,529.0 $ 1,322.1 $ 1,311.2 2.5 60.1 34.7 94.8 Personal Lines 968.8 913.7 894.9 7.3 70.2 27.4 97.6 Total $ 2,497.8 $ 2,235.8 $ 2,206.1 4.5 64.2 31.7 95.9 The following table summarizes net premiums written, and loss and LAE and catastrophe loss ratios by line of business for the Commercial Lines and Personal Lines segments. Loss and LAE and catastrophe loss ratios include prior year reserve development. Six Months Ended June 30, 2020 2019 (dollars in millions) Net Premiums Written Loss & LAE Ratios Catastrophe Loss Ratios Net Premiums Written Loss & LAE Ratios Catastrophe Loss Ratios Commercial Lines: Commercial multiple peril $ 439.2 73.9 14.7 $ 434.3 60.5 5.8 Commercial automobile 167.6 68.7 0.5 163.7 72.7 0.6 Workers’ compensation 162.1 50.9 — 172.0 53.7 — Other commercial 553.6 56.3 3.8 552.1 57.9 1.3 Total Commercial Lines $ 1,322.5 63.2 6.6 $ 1,322.1 60.1 2.5 Personal Lines: Personal automobile $ 556.2 60.7 1.2 $ 587.1 71.9 0.5 Homeowners 311.3 77.3 27.9 302.7 68.9 20.3 Other personal 27.9 29.5 3.4 23.9 44.1 2.7 Total Personal Lines $ 895.4 65.7 10.7 $ 913.7 70.2 7.3 34 Table of Contents The following table summarizes GAAP underwriting results for the Commercial Lines, Personal Lines and Other segments and reconciles them to operating income (loss) before interest expense and income taxes. Six Months Ended June 30, 2020 2019 (in millions) Commercial Lines Personal Lines Other Total Commercial Lines Personal Lines Other Total Underwriting profit (loss), excluding prior year reserve development and catastrophes $ 111.5 $ 156.9 $ (0.1 ) $ 268.3 $ 87.7 $ 93.0 $ — $ 180.7 Prior year favorable (unfavorable) loss and LAE reserve development on non-catastrophe losses 8.8 1.7 (3.6 ) 6.9 11.5 (10.8 ) (0.6 ) 0.1 Prior year favorable (unfavorable) catastrophe development 9.3 (2.3 ) — 7.0 18.8 1.7 — 20.5 Current year catastrophe losses (97.9 ) (94.8 ) — (192.7 ) (52.2 ) (67.3 ) — (119.5 ) Underwriting profit (loss) 31.7 61.5 (3.7 ) 89.5 65.8 16.6 (0.6 ) 81.8 Net investment income 84.3 36.8 6.2 127.3 88.7 39.4 11.7 139.8 Fees and other income 4.8 4.5 3.8 13.1 4.0 5.5 2.4 11.9 Other operating expenses (10.9 ) (5.3 ) (7.7 ) (23.9 ) (5.5 ) (3.0 ) (8.2 ) (16.7 ) Operating income (loss) before interest expense and income taxes $ 109.9 $ 97.5 $ (1.4 ) $ 206.0 $ 153.0 $ 58.5 $ 5.3 $ 216.8 Commercial Lines Commercial Lines net premiums written were $1,322.5 million in the six months ended June 30, 2020, compared to $1,322.1 million in the six months ended June 30, 2019. The premium growth in the first quarter of 2020 was offset by a reduction in insured business activity as a result of the Pandemic during the second quarter. Commercial Lines underwriting income for the six months ended June 30, 2020 was $31.7 million, compared to $65.8 million for the six months ended June 30, 2019, a decrease of $34.1 million. Catastrophe losses for the six months ended June 30, 2020 were $88.6 million, compared to $33.4 million for the six months ended June 30, 2019. The $55.2 million increase was primarily due to property damages related to the riots and civil unrest in several major cities across the country. Favorable development on prior years’ loss reserves for the six months ended June 30, 2020 was $8.8 million, compared to $11.5 million for the six months ended June 30, 2019, a change of $2.7 million. Commercial Lines current accident year underwriting profit, excluding catastrophes, was $111.5 million for the six months ended June 30, 2020, compared to $87.7 million for the six months ended June 30, 2019, an increase of $23.8 million primarily due to lower current accident year losses. The lower current year non-catastrophe losses were primarily due to lower commercial automobile losses and lower large property loss activity in our specialty industrial property and marine lines, partially offset by reserve provisions for exposures due to the Pandemic. These reserve provisions of approximately $19 million were primarily reflected in our workers’ compensation, healthcare, commercial multiple peril, management and professional liability and surety lines. The lower current accident year losses were primarily due to a reduced level of economic activity as a result of the Pandemic. Personal Lines Personal Lines net premiums written were $895.4 million in the six months ended June 30, 2020, compared to $913.7 million in the six months ended June 30, 2019, a decrease of $18.3 million. During the second quarter of 2020, we returned approximately $30 million of premiums to our eligible Personal Lines customers in all our markets, providing financial relief during the Pandemic. Excluding the impact of the premium refund, net written premiums would have increased 1.2%. Personal Lines underwriting profit for the six months ended June 30, 2020 was $61.5 million, compared to $16.6 million for the six months ended June 30, 2019, an increase of $44.9 million. Catastrophe losses for the six months ended June 30, 2020 were $97.1 million, compared to $65.6 million for the six months ended June 30, 2019. The increase of $31.5 million was primarily due to several wind and hail storms throughout the Midwest and Southeast. Favorable development on prior years’ loss reserves for the six months ended June 30, 2020 was $1.7 million, compared to unfavorable development of $10.8 million for the six months ended June 30, 2019, a favorable change of $12.5 million. 35 Table of Contents Personal Lines current accident year underwriting profit, excluding catastrophes, was $156.9 million in the six months ended June 30, 2020, compared to $93.0 million in the six months ended June 30, 201 9 . This $63.9 million increase was primarily due to lower current accident year losses in our personal automobile line and a non - recurring premium tax benefit. Personal automobile losses were lower due to fewer vehicles on the road as a result of the Pandemi c. Other Our Other segment had an operating loss of $1.4 million for the six months ended June 30, 2020, compared to operating income of $5.3 million for the six months ended June 30, 2019. The decline of $6.7 million was primarily due to lower net investment income as a result of the deployment of proceeds from the sale of our former Chaucer business in the prior year. Reserve for Losses and Loss Adjustment Expenses The table below provides a reconciliation of the gross beginning and ending reserve for unpaid losses and loss adjustment expenses. Six Months Ended June 30, (in millions) 2020 2019 Gross loss and LAE reserves, beginning of period $ 5,654.4 $ 5,304.1 Reinsurance recoverable on unpaid losses 1,574.8 1,472.6 Net loss and LAE reserves, beginning of period 4,079.6 3,831.5 Net incurred losses and LAE in respect of losses occurring in: Current year 1,454.1 1,437.9 Prior year non-catastrophe loss development (6.9 ) (0.1 ) Prior year catastrophe development (7.0 ) (20.5 ) Total incurred losses and LAE 1,440.2 1,417.3 Net payments of losses and LAE in respect of losses occurring in: Current year 468.6 497.0 Prior years 788.5 778.4 Total payments 1,257.1 1,275.4 Net reserve for losses and LAE, end of period 4,262.7 3,973.4 Reinsurance recoverable on unpaid losses 1,574.6 1,505.1 Gross reserve for losses and LAE, end of period $ 5,837.3 $ 5,478.5 The table below summarizes the gross reserve for losses and LAE by line of business. June 30, December 31, (in millions) 2020 2019 Commercial multiple peril $ 1,181.4 $ 1,122.0 Workers’ compensation 700.0 698.2 Commercial automobile 433.9 427.0 Other commercial lines: Hanover Programs 525.4 512.9 Management and professional liability 317.6 281.5 Monoline general liability 270.8 265.5 Umbrella 196.7 197.9 Marine 96.6 95.9 Surety 79.5 76.9 Specialty industrial and commercial property 79.5 71.1 Other lines 31.7 28.4 Total other commercial lines 1,597.8 1,530.1 Total Commercial Lines 3,913.1 3,777.3 Personal automobile 1,627.7 1,645.1 Homeowners and other personal 255.9 194.3 Total Personal Lines 1,883.6 1,839.4 Total Other Segment 40.6 37.7 Total loss and LAE reserves $ 5,837.3 $ 5,654.4 36 Table of Contents “Other commercial lines – Other lines ” in the table above is primarily comprised of fidelity and crime lines of business . Loss and LAE reserves in our “Total Other Segment” relate to our run-off voluntary assumed property and casualty reinsurance pools business. The following table summarizes prior year (favorable) unfavorable development for the periods indicated: Six Months Ended June 30, 2020 2019 (in millions) Loss & LAE Catastrophe Total Loss & LAE Catastrophe Total Commercial Lines $ (8.8 ) $ (9.3 ) $ (18.1 ) $ (11.5 ) $ (18.8 ) $ (30.3 ) Personal Lines (1.7 ) 2.3 0.6 10.8 (1.7 ) 9.1 Other Segment 3.6 — 3.6 0.6 — 0.6 Total prior year favorable development $ (6.9 ) $ (7.0 ) $ (13.9 ) $ (0.1 ) $ (20.5 ) $ (20.6 ) It is not possible to know whether the factors that affected loss reserves in the first six months of 2020 will also occur in future periods. We encourage you to read our 2019 Annual Report on Form 10-K for more information about our reserving process and the judgments, uncertainties and risks associated therewith. Catastrophe Loss Development In the six months ended June 30, 2020 and 2019, favorable catastrophe development was $7.0 and $20.5 million, respectively. The favorable catastrophe development during the six months ended June 30, 2020 was primarily due to lower than expected losses related to certain 2017 and 2019 wind storms, winter storms and hurricanes. The favorable catastrophe development during the six months ended June 30, 2019 was primarily due to lower than expected losses related to the 2017 and 2018 California wildfires, including the sale of subrogation rights on certain California wildfire losses. 2020 Loss and LAE Development, excluding catastrophes For the six months ended June 30, 2020, net favorable loss and LAE development, excluding catastrophes, was $6.9 million. Lower than expected losses in the workers’ compensation line of $15.8 million in accident years 2016 through 2019 and other commercial lines were partially offset by higher than expected losses in the commercial and personal automobile lines and the commercial multiple peril line. Within other commercial lines, lower than expected losses in our marine line of $11.5 million, in accident years 2017 through 2019, and commercial miscellaneous property line were partially offset by higher than expected losses in the general liability lines. The adverse prior year development for our Other Segment was due to our run-off voluntary assumed property and casualty reinsurance pools business primarily based on an updated third-party actuarial study received in the first quarter of 2020 for the legacy ECRA pool that primarily consists of asbestos and environmental exposures. 2019 Loss and LAE Development, excluding catastrophes For the six months ended June 30, 2019, net favorable loss and LAE development, excluding catastrophes, was $0.1 million. Lower than expected losses in the workers’ compensation line of $10.7 million in accident years 2017 and 2018 and the commercial multiple peril line were substantially offset by higher than expected losses in the personal and commercial automobile lines. In addition, Other Segment unfavorable development of $0.6 million was due to adverse loss trends in our run-off voluntary assumed property and casualty reinsurance pools business which includes asbestos and environmental reserves. Reinsurance Recoverables Reinsurance recoverables were $1,813.7 million and $1,814.0 million at June 30, 2020 and December 31, 2019, respectively, of which $78.2 million and $89.8 million represent billed recoverables. A reinsurance recoverable is billed after an eligible reinsured claim is paid by an insurer. Billed reinsurance recoverables related to the MCCA were $38.9 million and $29.2 million at June 30, 2020 and December 31, 2019, respectively, and billed non-MCCA reinsurance recoverables totaled $39.3 million and $60.6 million at June 30, 2020 and December 31, 2019, respectively. At June 30, 2020, $0.8 million of the billed non-MCCA recoverables were outstanding greater than 90 days, whereas at December 31, 2019, there were no balances outstanding greater than 90 days. 37 Table of Contents Investments Investment Results Net investment income before income taxes was as follows: Three Months Ended June 30, Six Months Ended June 30, (dollars in millions) 2020 2019 2020 2019 Fixed maturities $ 56.2 $ 57.8 $ 112.4 $ 115.8 Mortgage loans 4.3 4.0 8.6 7.9 Equity securities 3.6 4.0 7.4 7.6 Limited partnerships (4.6 ) 4.8 2.0 9.3 Other investments 0.8 1.1 1.7 3.2 Investment expenses (2.6 ) (2.1 ) (4.8 ) (4.0 ) Net investment income $ 57.7 $ 69.6 $ 127.3 $ 139.8 Earned yield, fixed maturities 3.45 % 3.57 % 3.45 % 3.59 % Earned yield, total portfolio 2.99 % 3.67 % 3.30 % 3.66 % The decrease in net investment income for the three and six months ended June 30, 2020 was primarily due to lower partnership income and the deployment of Chaucer proceeds during 2019 for accelerated share repurchases and special dividends, as well as the impact of lower new money yields. These decreases were partially offset by the continued investment of operational cash flows. Income from limited partnerships is recorded one quarter in arrears as financial information is provided by the partnership on a two or three month lag. Therefore, limited partnership results in the second quarter of 2020 reflect lower valuations due to Pandemic-related business and financial market disruptions experienced during the first quarter of 2020. We expect average fixed income yields to continue to decline as new money rates remain lower than embedded book yield. Investment Portfolio We held cash and investment assets diversified across several asset classes, as follows: June 30, 2020 December 31, 2019 (dollars in millions) Carrying Value % of Total Carrying Value Carrying Value % of Total Carrying Value Fixed maturities, at fair value $ 7,079.0 83.4 % $ 6,687.1 81.4 % Equity securities, at fair value 458.9 5.4 575.7 7.0 Mortgage and other loans 458.9 5.4 441.2 5.4 Other investments 304.7 3.6 292.0 3.6 Cash and cash equivalents 182.6 2.2 215.7 2.6 Total cash and investments $ 8,484.1 100.0 % $ 8,211.7 100.0 % Cash and Investments Total cash and investments increased $272.4 million, or 3.3%, for the six months ended June 30, 2020, as compared to December 31, 2019, primarily due to operational cashflows and market value appreciation, partially offset by the funding of financing activities, including dividend payments and stock repurchases. 38 Table of Contents Th e following table provides information about the investment types of our fixed maturities portfolio: June 30, 2020 (in millions) Investment Type Amortized Cost, net of Allowance for Credit Losses Fair Value Net Unrealized Gains Change in Net Unrealized For the Year U.S. Treasury and government agencies $ 286.8 $ 306.9 $ 20.1 $ 12.3 Foreign government 4.2 4.7 0.5 0.1 Municipals: Taxable 874.2 922.7 48.5 23.3 Tax-exempt 44.0 45.6 1.6 0.4 Corporate 3,771.4 4,061.0 289.6 131.9 Asset-backed: Residential mortgage-backed 922.3 964.5 42.2 26.2 Commercial mortgage-backed 659.2 706.1 46.9 21.4 Asset-backed 65.4 67.5 2.1 1.0 Total fixed maturities $ 6,627.5 $ 7,079.0 $ 451.5 $ 216.6 The increase in net unrealized gains on fixed maturities was primarily due to lower prevailing interest rates partially offset by wider credit spreads. Amortized cost and fair value by rating category were as follows: June 30, 2020 December 31, 2019 (dollars in millions) NAIC Designation Rating Agency Equivalent Designation Amortized Cost, net of Allowance for Credit Losses Fair Value % of Total Fair Value Amortized Cost Fair Value % of Total Fair Value 1 Aaa/Aa/A $ 4,373.6 $ 4,670.7 66.0 % $ 4,373.0 $ 4,522.7 67.6 % 2 Baa 1,974.0 2,121.1 30.0 1,785.2 1,857.6 27.8 3 Ba 160.0 162.9 2.3 160.2 167.6 2.6 4 B 109.8 113.3 1.6 130.2 135.2 2.0 5 Caa and lower 9.6 9.3 0.1 2.0 2.2 — 6 In or near default 0.5 1.7 — 1.6 1.8 — Total fixed maturities $ 6,627.5 $ 7,079.0 100.0 % $ 6,452.2 $ 6,687.1 100.0 % Based on ratings by the National Association of Insurance Commissioners (“NAIC”), approximately 96% and 95% of the fixed maturity portfolio consisted of investment grade securities at June 30, 2020 and December 31, 2019, respectively. The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security, issuer diversification and yield curve position. 39 Table of Contents Our investment portfolio primarily consists of fixed maturity securities whose fair value is susceptible to market risk, including interest rate changes. See also “Quantitative and Qualitative Disclosures about Market Risk” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 201 9 Annual Report on Form 10-K. Duration is a measurement used to quantify our inherent interest rate risk and analyze invested assets relative to our reserve liabilities. The duration of our fixed maturity portfolio was as follows: June 30, 2020 December 31, 2019 (dollars in millions) Duration Amortized Cost, net of Allowance for Credit Losses Fair Value % of Total Fair Value Amortized Cost Fair Value % of Total Fair Value 0-2 years $ 1,666.9 $ 1,720.8 24.3 % $ 1,253.1 $ 1,276.0 19.1 % 2-4 years 1,589.0 1,690.1 23.9 1,811.9 1,872.9 28.0 4-6 years 1,620.5 1,762.9 24.9 1,841.2 1,917.0 28.7 6-8 years 1,009.7 1,119.6 15.8 1,113.9 1,177.2 17.6 8-10 years 558.0 587.2 8.3 316.2 322.2 4.8 10+ years 183.4 198.4 2.8 115.9 121.8 1.8 Total fixed maturities $ 6,627.5 $ 7,079.0 100.0 % $ 6,452.2 $ 6,687.1 100.0 % Weighted average duration 4.4 4.3 Our fixed maturity and equity securities are carried at fair value. Financial instruments whose value was determined using significant management judgment or estimation constituted less than 1% of the total assets we measured at fair value. See also Note 4 – “Fair Value” in the Notes to Interim Consolidated Financial Statements. Equity securities primarily consist of U.S. income-oriented large capitalization common stocks and developed market equity index exchange-traded funds. Mortgage and other loans consist primarily of commercial mortgage loan participations which represent our interest in commercial mortgage loans originated by a third party. We share, on a pro-rata basis, in all related cash flows of the underlying mortgage loans, which are investment-grade quality and diversified by geographic area and property type. Other investments consist primarily of our interest in corporate middle market and real estate limited partnerships. Corporate middle market limited partnerships may invest in senior or subordinated debt, preferred or common equity or a combination thereof, of middle market businesses. Real estate limited partnerships hold equity ownership positions in real properties and invest in debt secured by real properties. Our limited partnerships are generally accounted for under the equity method, or as a practical expedient using the fund’s net asset value, with financial information provided by the partnership on a two or three month lag. Although we expect to invest new funds primarily in investment grade fixed maturities, we have invested, and expect to continue to invest, a portion of funds in limited partnerships, common equity securities, below investment grade fixed maturities and other investment assets. Impairments For the three months ended June 30, 2020, we recognized a $1.4 million net decrease in credit losses on fixed maturities, primarily resulting from increased market values during the quarter. For the six months ended June 30, 2020, we recognized $27.1 million of impairments, consisting primarily of $20.8 million on fixed maturities and $4.8 million on mortgage loans. Impairments on fixed maturities included $16.2 million categorized as intend-to-sell and $4.6 million of credit-related losses, primarily in the energy sector, and to a lesser degree, consumer non-cyclical and consumer cyclical sectors. For the three and six months ended June 30, 2019, we recognized $0.4 million of other-than-temporary impairments on corporate fixed maturity securities. At June 30, 2020 and December 31, 2019, the allowance for credit losses on mortgage loans was $6.1 million and $1.3 million, respectively. The allowance for credit losses on available-for-sale securities was $3.8 million at June 30, 2020. There was no allowance for credit losses on available-for-sale securities at December 31, 2019. The carrying values of fixed maturity securities on non-accrual status at June 30, 2020 and December 31, 2019 were not material. The effects of non-accruals for the six months ended June 30, 2020 and 2019, compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities, were also not material. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income. Unrealized Losses Gross unrealized losses on fixed maturities at June 30, 2020 were $4.3 million, a decrease of $3.3 million compared to December 31, 2019, primarily attributable to lower interest rates, partially offset by wider credit spreads. At June 30, 2020, gross unrealized losses consisted primarily of $3.7 million on corporate fixed maturities. See Note 3 – “Investments” in the Notes to Interim Consolidated Financial Statements. 40 Table of Contents We view gross unrealized losses on fixed maturities as non-credit related since it is our assessment that these securities will recover, allowing us to realize their anticipated long-term economic value. Further, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also “Liquidity and Capital Resources” ). Inherent in our assessment are the risks that market factors may differ from our expectations; the global econom ic downturn resulting from the Pandemic is longer and more severe than current expectations ; we may decide to subsequently sell a security for unforeseen business needs; or changes in the credit assessment from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, an impairment would be recognized as a realized loss. Although unrealized losses on fixed maturities are not reflected in the results of financial operations until they are realized , the fair value of the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets. The following table sets forth gross unrealized losses for fixed maturities by maturity period at June 30, 2020 and December 31, 2019. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers. June 30, December 31, (in millions) 2020 2019 Due after one year through five years $ 1.9 $ 1.1 Due after five years through ten years 1.9 3.3 Due after ten years 0.2 2.0 4.0 6.4 Mortgage-backed and asset-backed securities 0.3 1.2 Total fixed maturities $ 4.3 $ 7.6 Our investment portfolio and shareholders’ equity can be significantly impacted by changes in market values of our securities. Market volatility could increase and defaults on fixed income securities could occur. As a result, we could incur additional realized and unrealized losses in future periods, which could have a material adverse impact on our results of operations and/or financial position. In the first six months of 2020, the Pandemic resulted in significant economic disruption due to various government-mandated emergency orders, consumer and business uncertainty, and forced business closures. Financial markets have substantially recovered from the significant declines experienced earlier in the year, however the economic outlook remains uncertain. Unemployment rates remain elevated, many corporations have eliminated forward revenue and earnings guidance, several foreign countries have placed restrictions on travel by U.S. citizens and many small businesses remain closed. A resurgence of the infection rate in many southern and western U.S. states has added to the uncertainty of timing of re-opening of businesses and schools. While the U.S. government and its agencies have taken extraordinary measures to stabilize the economy, it is unclear whether such actions will be sufficient to minimize the economic recession in the near and intermediate term, and what effect such unprecedented events will ultimately have on our investment portfolio. Due to the Pandemic, global monetary policies have become extremely accommodative in support of financial market stability. Major central banks have lowered interest rates, relaxed collateral requirements and instituted various asset purchase programs to stabilize financial markets and support economic growth. In the U.S., for example, the Federal Reserve (the “Fed”) is maintaining its federal funds target range at 0% to 0.25%. The Fed has also offered support for the flow of credit to households and businesses by providing up to $2.3 trillion in loans to support the economy and assist households and employers, and bolster state and local governments to deliver critical services during the Pandemic. Fiscal stimulus by major market economies has also been enacted. The U.S. has declared a national emergency and earmarked approximately $50 billion in emergency funding, Congress provided a $2.2 trillion stimulus package to support households and businesses and the U.S. gave individuals and small businesses a three-month tax deferral, among other measures. In May, the House of Representatives passed an additional stimulus relief package that includes $3.0 trillion of support for essential workers in the form of hazard pay, funding for state and local governments and continued small business and household assistance. Fundamental conditions in certain corporate sectors are particularly tenuous, especially in the energy sector where the decline in global demand has driven meaningful declines in the value of our holdings of related fixed maturities. Further, the lodging, restaurant and transportation services subsectors are severely impacted by the Pandemic. While we may experience defaults on fixed income securities, particularly with respect to non-investment grade debt securities, it is difficult to foresee which issuers, industries or markets will be most affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate, and we could incur additional realized and unrealized losses in future periods. 41 Table of Contents Other Items Net income also included the following items: Three Months Ended June 30, (in millions) Commercial Lines Personal Lines Other Discontinued Operations Total 2020 Net realized and unrealized investment gains (losses) $ 48.4 $ 19.8 $ (4.5 ) $ — $ 63.7 Discontinued life businesses — — — (0.1 ) (0.1 ) 2019 Net realized and unrealized investment gains $ 11.9 $ — $ 0.2 $ — $ 12.1 Discontinued operations - Chaucer business, including sale, net of taxes — — — (10.1 ) (10.1 ) Discontinued life businesses — — — (0.9 ) (0.9 ) Six Months Ended June 30, (in millions) Commercial Lines Personal Lines Other Discontinued Operations Total 2020 Net realized and unrealized investment losses $ (65.4 ) $ (28.1 ) $ (4.4 ) $ — $ (97.9 ) Discontinued life businesses — — — (1.4 ) (1.4 ) 2019 Net realized and unrealized investment gains (losses) $ 45.9 $ 15.1 $ (0.7 ) $ — $ 60.3 Discontinued operations - Chaucer business, including sale, net of taxes — — — (9.5 ) (9.5 ) Discontinued life businesses — — — (1.7 ) (1.7 ) We manage investment assets for our Commercial Lines, Personal Lines and Other segments based on the requirements of our combined property and casualty companies. We allocate the investment income, expenses and realized gains and losses to our Commercial Lines, Personal Lines and Other segments based on actuarial information related to the underlying businesses. We managed investment assets separately for our former Chaucer business. Net realized and unrealized gains on investment were $63.7 million for the three months ended June 30, 2020, compared to $12.1 million for the three months ended June 30, 2019. Net realized and unrealized gains in both 2020 and 2019 were primarily due to changes in the fair value of equity securities. Net realized and unrealized losses on investment were $97.9 million for the six months ended June 30, 2020, compared to net realized and unrealized gains of $60.3 million for the six months ended June 30, 2019. For the six months ended June 30, 2020, net realized and unrealized losses were primarily due to changes in the fair value of equity securities and, to a lesser extent, from impairment losses on investments. For the six months ended June 30, 2019, net realized and unrealized gains were primarily due to changes in the fair value of equity securities. Discontinued operations in 2020 include our discontinued accident and health and life businesses. In 2019, our discontinued operations primarily included our former Chaucer business and, to a lesser extent, our discontinued life business. For the three months and six months ended June 30, 2019, results related to our discontinued Chaucer business, including the sale, net of taxes, primarily reflects a revision to our best estimate of Chaucer’s 2018 catastrophe losses, which reduced our estimate of pre-tax contingent proceeds by $13.5 million. This was partially offset by gains from the sale of the Chaucer-related Australian entity in both the three and six month periods, and by the gain from the sale of the Chuacer-related Irish entity for the six month period. Losses of $1.4 million and $1.7 million in the discontinued life businesses for the six months ended June 30 , 2020 and 2019, respectively, primarily reflect adverse loss trends related to the long-term care pool. 42 Table of Contents Income Taxes We are subject to the tax laws and regulations of the U.S. and foreign countries in which we operate. We file a consolidated U.S. federal income tax return that includes our holding company and its U.S. subsidiaries. Generally, taxes are accrued at the U.S. statutory tax rate of 21% for income from U.S. operations. We accrue taxes on certain non-U.S. income that is subject to U.S. tax at the enacted U.S. tax rate. Foreign tax credits, where available, are utilized to offset U.S. tax as permitted. Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019 The provision for income taxes from continuing operations was an expense of $27.8 million and $24.8 million for the three months ended June 30, 2020 and 2019, respectively. These provisions resulted in consolidated effective federal tax rates of 19.4% and 22.6% for the three months ended June 30, 2020 and 2019, respectively. These provisions reflect benefits related to tax planning strategies implemented in prior years of $2.5 million and $3.4 million for the three months ended June 30, 2020 and 2019, respectively. In addition, the provision for 2019 includes a charge of $5.6 million, which reflects the effect of changes in the tax law related to the 2018 sale of Chaucer. Lastly, the provision for 2019 also includes excess tax benefits related to stock-based compensation of $0.6 million for the three months ended June 30, 2019. Absent these items, the provision for income taxes would have been an expense of $30.3 million, or 21.2%, and $23.2 million, or 21.1%, for the three months ended June 30, 2020 and 2019, respectively. The income tax provision on operating income was an expense of $16.8 million and $20.0 million for the three months ended June 30, 2020 and 2019, respectively. These provisions resulted in effective tax rates for operating income of 21.1% and 20.5% for the three months ended June 30, 2020 and 2019, respectively. The provision for 2019 includes excess tax benefits related to stock-based compensation of $0.6 million for the three months ended June 30, 2019. Absent this item, the provision for income taxes for 2019 would have been an expense of $20.6 million, or 21.1%, for the three months ended June 30, 2019. Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019 The provision for income taxes from continuing operations was an expense of $12.6 million and $50.8 million for the six months ended June 30, 2020 and 2019, respectively. These provisions resulted in consolidated effective federal tax rates of 14.1% and 19.7% for the six months ended June 30, 2020 and 2019, respectively. These provisions reflect benefits related to tax planning strategies implemented in prior years of $4.4 million and $7.2 million for the six months ended June 30, 2020 and 2019, respectively. In addition, these provisions also included excess tax benefits related to stock-based compensation of $1.9 million and $2.1 million for the six months ended June 30, 2020 and 2019, respectively. Finally, the provision for 2019 includes a charge of $5.6 million, which reflects the effect of changes in the tax law related to the 2018 sale of Chaucer. Absent these items, the provision for income taxes would have been an expense of $18.9 million, or 21.2%, and $54.5 million, or 21.1%, for the six months ended June 30, 2020 and 2019, respectively. The income tax provision on operating income was an expense of $37.7 million and $39.7 million for the six months ended June 30, 2020 and 2019, respectively. These provisions resulted in effective tax rates for operating income of 20.1% and 20.0% for the six months ended June 30, 2020 and 2019, respectively. These provisions include excess tax benefits related to stock-based compensation of $1.9 million and $2.1 million for the six months ended June 30, 2020 and 2019, respectively. Absent this item, the provision for income taxes would have been an expense of $39.6 million, or 21.2%, and $41.8 million, or 21.1%, for the six months ended June 30, 2020 and 2019, respectively. 43 Table of Contents Critical Accounting Estimates Interim consolidated financial statements have been prepared in conformity with U.S. GAAP and include certain accounting policies that we consider to be critical due to the amount of judgment and uncertainty inherent in the application of those policies. While we believe that the amounts included in our consolidated financial statements reflect our best judgment, the use of different assumptions could produce materially different accounting estimates. As disclosed in our 2019 Annual Report on Form 10-K, we believe the following accounting estimates are critical to our operations and require the most subjective and complex judgment: • Reserve for losses and loss expenses • Reinsurance recoverable balances • Pension benefit obligations • Deferred taxes For a more detailed discussion of these critical accounting estimates, see our 2019 Annual Report on Form 10-K. Additionally, as a result of the recent economic disruption to the financial markets and overall challenges to economic conditions worldwide as a result of the Pandemic, we experienced a higher level of impairments in the first six months of 2020 than in recent years. Accordingly, the following critical accounting estimate has been added. INVESTMENT CREDIT LOSSES We employ a systematic methodology to evaluate declines in fair values below amortized cost for all fixed maturity investments. The methodology utilizes a quantitative and qualitative process that seeks to ensure 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 should be recorded as an impairment, 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; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the degree to which the fair value of an issuer’s securities is below our cost. We consider factors that might raise doubt about the issuer’s ability to make contractual payments as they become due and whether we expect to recover the entire amortized cost basis of the security. We monitor corporate fixed maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit deterioration, as evidenced by 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 and supportable 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. 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 available information relevant to the collectability of cash flows, including information about the payment terms of the security, prepayment speeds, the financial condition of the underlying borrowers, collateral trustee reports, credit ratings analysis and other market data when developing our estimate of the expected cash flows. When an impairment of a fixed maturity 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 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. We estimate the amount of the credit impairment by comparing the amortized cost of the fixed maturity security with the net present value of the fixed maturity security’s projected future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment. Declines in market value which are not credit loss related are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce accumulated other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide assurance that the impairments will be adequate to cover future losses or that we will not have substantial additional impairments in the future. See Note 3 — “Investments” in the Notes to Interim Consolidated Financial Statements for further discussion regarding impairments and securities in an unrealized loss position. 44 Table of Contents Statutory Surplus of Insurance Subsidiaries The following table reflects statutory surplus for our insurance subsidiaries: June 30, December 31, (in millions) 2020 2019 Total Statutory Capital and Surplus $ 2,313.4 $ 2,470.2 The statutory capital and surplus for our insurance subsidiaries decreased $156.8 million during the first six months of 2020. This decrease was primarily due to the payment of a $245 million dividend and from unrealized and realized net investment losses, primarily due to changes in the fair value of equity securities. These decreases were partially offset by underwriting profits. The NAIC prescribes an annual calculation regarding risk based capital (“RBC”). RBC ratios for regulatory purposes are expressed as a percentage of the capital required to be above the Authorized Control Level (the “Regulatory Scale”); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios for Hanover Insurance (which includes Citizens and other insurance subsidiaries), as of June 30, 2020, 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): (dollars in millions) Company Action Level Authorized Control Level RBC Ratio Industry Scale RBC Ratio Regulatory Scale The Hanover Insurance Company $ 1,100.3 $ 550.1 210 % 419 % Liquidity and Capital Resources Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our insurance subsidiaries are subject to limitations imposed by regulators, such as prior notice periods and the requirement that dividends in excess of a specified percentage of statutory surplus or prior year’s statutory earnings receive prior approval (so called “extraordinary dividends”). During the second quarter of 2020, Hanover Insurance paid $245.0 million in dividends to the holding company. Sources of cash for our insurance subsidiaries primarily consist of premiums collected, investment income and maturing investments. Primary cash outflows are payments for losses and loss adjustment expenses, policy and contract acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to losses and loss adjustment expenses can be variable because of uncertainties surrounding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. We periodically adjust our investment policy to respond to changes in short-term and long-term cash requirements. Net cash provided by operating activities was $225.8 million during the first six months of 2020, as compared to $150.6 million during the first six months of 2019. The $75.2 million increase in cash provided was primarily the result of lower federal income tax payments in the first six months of 2020, compared to the first six months of 2019 and, to a lesser extent, a reduction in operating expense payments, partially offset by slightly higher net loss and LAE payments. Net cash used in investing activities was $156.7 million during the first six months of 2020, as compared to $215.4 million during the first six months of 2019. During the first six months of 2020, cash used in investing activities primarily related to net purchases of fixed maturities. During the first six months of 2019, cash used in investing activities primarily related to net purchases of fixed maturities and, to a lesser extent, equity securities and other investments, partially offset by net proceeds received from the sale of the Chaucer-related Irish and Australian entities. Net cash used in financing activities was $102.2 million during the first six months of 2020, as compared to $779.4 million during the first six months of 2019. During the first six months of 2020, cash used in financing activities primarily resulted from two quarterly dividend payments to shareholders and from the repurchase of common stock. During the first six months of 2019, cash used in financing activities primarily resulted from repurchases of common stock through two accelerated share repurchase (“ASR”) agreements, the payments of a special dividend and two quarterly dividends to shareholders, and the repayment of the Federal Home Loan Bank (“FHLB”) advances. Dividends to common shareholders are subject to quarterly board approval and declaration. During the first six months of 2020, as declared by the Board, we paid two quarterly dividends of $0.65 per share to our shareholders totaling approximately $50 million. We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them. 45 Table of Contents At June 30 , 2020 , THG, as a holding company, held approximately $ 481.5 million of fixed maturities and cash. We believe our holding company assets will be sufficient to meet our current year obligations, which we expect to consist primarily of quarterly dividends to our shareholders (as and to the extent declared), interest on our senior and subordinated debentures, certain costs associated with benefits due to our former life employees and agents, and, to the extent required, payments related to indemnification of liabilities associated with the sale of various subsidiaries. As discussed below, we have, and opportunistically may continue to, repurchase our common stock. Additionally, from time to time, we may also repurchase our debt on an opportunistic basis . We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 20 20 holding company obligations; however, we may decide to do so. We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan. The ultimate payment amounts for our benefit plan is based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes, both positive and negative, to our current funding status and ultimately our obligations in future periods are likely. Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. We believe that the quality of the assets we hold will allow us to realize the long-term economic value of our portfolio, including securities that are currently in an unrealized loss position. We do not anticipate the need to sell these securities to meet our insurance subsidiaries’ cash requirements since we expect our insurance subsidiaries to generate sufficient operating cash to meet all short-term and long-term cash requirements relating to current operations. However, there can be no assurance that unforeseen business needs or other items, including any effects of the Pandemic or associated legislative, judicial or regulatory actions on our liquidity and investment portfolio, will not occur causing us to have to sell those securities in a loss position before their values fully recover, thereby causing us to recognize impairment charges in that time period. The Board of Directors authorized a stock repurchase program which provides for aggregate repurchases of our common stock of up to $900 million, including a $300 million increase to the program that was authorized on December 5, 2019. Under the repurchase authorization, we may repurchase, from time to time, common stock in amounts, at prices and at such times as we deem appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. On December 9, 2019, pursuant to the terms of an ASR agreement (the “December 2019 ASR”) we paid $150.0 million in exchange for shares of our common stock. Under the terms of the December 2019 ASR, we received an initial delivery of approximately 0.9 million shares of our common stock. On February 26, 2020, we received approximately 0.2 million shares of our common stock as final settlement of shares repurchased under the December 2019 ASR. In addition to the shares repurchased under the December 2019 ASR, during the first six months of 2020 we repurchased approximately 0.5 million shares at an aggregate cost of $49.3 million. As of June 30 , 2020, we have repurchased 4.9 million shares under this $900 million program and have approximately $287 million available for additional repurchases. We maintain our membership in FHLB which provides us with access to additional liquidity based on our stock holdings and pledged collateral. At June 30 , 2020, we had borrowing capacity of $116.3 million. There were no outstanding borrowings under this short-term facility at June 30 , 2020; however we have and may continue to borrow, from time to time, through this facility to provide short-term liquidity. On April 30, 2019, we entered into a new credit agreement that provides for a five-year unsecured revolving credit facility not to exceed $200.0 million at any one time outstanding, with the option to increase the facility up to $300.0 million (assuming no default and satisfaction of other specified conditions, including the receipt of additional lender commitments). The agreement also includes an uncommitted subfacility of $50.0 million for standby letters of credit. Borrowings, if any, under this new agreement are unsecured and incur interest at a rate per annum equal to, at our election, either (i) the greater of, (a) the prime commercial lending rate of the administrative agent, (b) the NYFRB Rate plus half a percent, or (c) the one month Adjusted LIBOR plus one percent and a margin that ranges from 0.25% to 0.625% depending on our debt rating, or (ii) Adjusted LIBOR for the applicable interest period, plus a margin that ranges from 1.25% to 1.625% depending on our debt rating. The agreement also contains certain financial covenants such as maintenance of specified levels of consolidated equity and leverage ratios, and requires that certain of our subsidiaries maintain minimum RBC ratios. Concurrent with our entry into this agreement, we voluntarily terminated our then existing $200.0 million credit agreement, dated November 12, 2013. We currently have no borrowings under this agreement and had no borrowings under this agreement during the first six months of 2020. The LIBOR rate, upon which Adjusted LIBOR is based, is expected to be discontinued by the end of 2021. Our credit agreement permits us to agree with the Administrative Agent for the credit facility on a replacement to Adjusted LIBOR subject to the satisfaction of certain conditions. At June 30, 2020, we were in compliance with the covenants of our debt and credit agreements. 46 Table of Contents 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 REGULATORY AND INDUSTRY DEVELOPMENTS In response to the Pandemic, regulators in many of the states in which we operate have issued orders or guidance pertaining to, among other things, (a) premium refunds, credits or reductions for personal automobile insurance premiums and premiums for other insurance lines that regulators have determined are disproportionately impacted by the Pandemic, including certain commercial lines, for the periods during which stay-at-home orders and other governmental restrictions were or remain in effect, with premium adjustments based on factors such as the ongoing frequency and severity of claims, inflation, repair costs and reinsurance pricing, among others; (b) premium payment grace periods, moratoriums on policy non-renewals and cancellations, and other measures that are similar to actions historically implemented in regions heavily impacted by catastrophes, which we anticipate to be manageable, depending on the duration of the regulatory orders and the degree to which policyholder payment patterns vary as a result; and (c) a reassessment of rates in light of current exposures, loss experience and economic conditions. Regulatory restrictions on rate increases, underwriting and the ability to non-renew business may, depending on their duration, limit THG’s ability to manage our mix of business and any potential exposures that emerge in our lines of business in the near term. Draft legislation has been proposed in several state legislatures and in the United States Congress that seeks to require insurers to retroactively pay unfunded Pandemic business interruption claims that insurance policies do not currently cover, and/or to mandate prospective pandemic coverage. The impact of such legislation, were it to be adopted, would, according to a statement of the NAIC on March 25, 2020, “create substantial solvency risks” for the property and casualty insurance sector, “significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.” Industry trade groups further assert that any such legislation would be violative of basic contract law and well-founded principles of constitutional law. Federal stimulus plans such as the CARES Act providing financial support individuals and businesses during the Pandemic may mitigate the political pressure to continue advancing such proposed legislation. Proposals are also being considered at the federal level to establish government-funded pandemic insurance programs, possibly similar to the federal flood program. Details on such proposals are too preliminary to estimate their potential impact on our business. Information regarding litigation, legal contingencies and regulatory matters appears in Part I – Note 13 “Commitments and Contingencies” in the Notes to Interim Consolidated Financial Statements. Risks and Forward-Looking Statements Information regarding risk factors and forward-looking information appears in Part II – Item 1A of this Quarterly Report on Form 10-Q and in Part I – Item 1A of our 2019 Annual Report on Form 10-K. This Management’s Discussion and Analysis should be read and interpreted in light of such factors. 47 Table of Contents