Investment Thesis: Hanover Insurance Group manages its inflation risk fairly well and continued growth in net premiums means the company is well positioned to see long-term upside.
In a previous articleI argued that Hanover Insurance Group (NYSE: THG) could be in a good position to boost earnings from here, I also warned that inflation could hamper near to medium-term growth.
My main reason for making this argument was that as a P&C insurance company, rising real estate prices due to inflation could make it more expensive for the company to pay insurance claims to the future.
I would like to reassess this assumption in light of recent performance and determine the extent to which Hanover Insurance Group is able to mitigate this risk going forward.
When viewing a company snapshot financial resultswe can see that Hanover Insurance Group has significantly increased its net profit over the past year.
Additionally, the company’s debt to total capital remained virtually unchanged, which is encouraging as it indicates that Hanover Insurance Group has not had to increase its debt to fund its operations.
If catastrophes are included, the company’s combined ratio is 92.9 with a 9.2% growth in net premiums written. In my previous article, I pointed out that from 2013 at the time of writing, Hanover Insurance Group had seen a median combined ratio of 96 with a low of 94.2 and a high of 107.7.
The fact that the company recorded a combined ratio well below the median in the last quarter is encouraging, as it indicates that the company is making a significant underwriting profit by continuing to earn more premiums than what is paid in claims and other expenses.
I would like to further assess the potential implications of inflation on Hanover Insurance Group, as my last article referred to it as a potential risk without discussing in detail the strategies Hanover Insurance Group uses to mitigate this risk.
According to Swiss Association of Actuariesan insurance company may attempt to mitigate the impact of inflation by combining contract design, reinsurance, and other investment strategies.
With specific regard to Hanover Insurance Group, the company uses reinsurance strategies for its Commercial Lines and Personal Lines segments to mitigate risk. By reinsurance, it means an agreement whereby Hanover Insurance Group would transfer part of its risk portfolio to another insurance company in order to reduce its own risk.
Concretely, the corporate and private branches of the company are protected by a property claim program with coverage of up to $1.1 billion nationwide plus retentions of $200 million. In this regard, Hanover Insurance Group has taken steps to insure its own risk against catastrophic losses and, provided net premium growth continues as the company simultaneously manages its own risk, I am of the view that the ratio handset as a whole should remain at acceptable levels.
Additionally, it is worth taking a look at the geographical markets of the company in terms of personal and business lines drafted.
We can see that Michigan is the largest geographic area for Hanover Insurance Group in terms of net premiums written.
Notably, 66% of the company’s personal lines in Michigan belong to the personal automobile line, while 31% belong to the owners’ line. Similarly, in Massachusetts, 66% of net written premiums belong to the personal auto class, and 31% to the home class.
In this regard, while I previously warned that inflation could be a problem for P&C insurers as a whole in the future:
1) Hanover Insurance Group takes appropriate measures to manage this risk through appropriate reinsurance policies.
2) The automotive market represents a higher proportion of retail exposure in the main geographies of the business compared to the real estate market, which further limits the risk of exposure to inflation.
Of course, the auto sector is not immune to the effects of inflation either. On the one hand, car insurance premiums have increased by 20% in some American states, according to Fortune. In this regard, one would expect the auto insurance industry to become more price competitive in the future, and it is unclear how this might affect overall profitability.
Additionally, rising gas prices may mean that potential drivers decide to cancel their policies due to increased operating expenses for a vehicle. While these are challenges ahead, my view is that overall demand should remain robust – particularly as overall traffic levels continue to increase following the COVID lockdowns.
In conclusion, I am of the opinion that Hanover Insurance Group is managing its inflation risk quite well and that the continued growth of net premiums means that the company is in a good position to see a long-term upside.
Additional Disclosure: This article is written “as is” and without warranty. The content represents my opinion only and does not constitute professional investment advice. It is the reader’s responsibility to exercise due diligence and seek investment advice from a licensed professional before making any investment decision. The author assumes no responsibility for any action taken based on the information in this article.