HANOVER INSURANCE GROUP, INC. - FORM 10-Q

Attached files

file	filename
EX-32.2 - EX-32.2 - HANOVER INSURANCE GROUP, INC.	thg-ex322_251.htm
EX-32.1 - EX-32.1 - HANOVER INSURANCE GROUP, INC.	thg-ex321_250.htm
EX-31.2 - EX-31.2 - HANOVER INSURANCE GROUP, INC.	thg-ex312_252.htm
EX-31.1 - EX-31.1 - HANOVER INSURANCE GROUP, INC.	thg-ex311_253.htm
EX-10.2 - EX-10.2 - HANOVER INSURANCE GROUP, INC.	thg-ex102_404.htm
EX-10.1 - EX-10.1 - HANOVER INSURANCE GROUP, INC.	thg-ex101_254.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2017

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

For the transition period from to

Commission File Number 1-13754

THE HANOVER INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware

04-3263626

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

440 Lincoln Street, Worcester, Massachusetts 01653

(Address of principal executive offices) (Zip Code)

(508) 855-1000

(Registrant’s telephone number, including area code)

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

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

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


Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐ (Do not check if a smaller reporting company)	Smaller reporting company	☐
		Emerging growth company	☐

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

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

The number of shares outstanding of the registrant’s common stock was 42,382,798 as of August 2, 2017.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements	2
	Consolidated Statements of Income	2
	Consolidated Statements of Comprehensive Income	3
	Consolidated Balance Sheets	4
	Consolidated Statements of Shareholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Interim Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54

Item 4.	Controls and Procedures	54

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	55

Item 1A.	Risk Factors	55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57

Item 6.	Exhibits	58

SIGNATURES		59

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(In millions, except per share data)	2017			2016			2017			2016
Revenues
Premiums	$	1,181.2		$	1,145.5		$	2,362.5		$	2,296.8
Net investment income		72.3			69.1			143.4			137.4
Net realized investment gains (losses):
Net realized gains from sales and other		7.7			4.3			11.0			26.7
Net other–than–temporary impairment losses on investments recognized in earnings		(1.8	)		(5.0	)		(3.2	)		(25.9	)
Total net realized investment gains (losses)		5.9			(0.7	)		7.8			0.8
Fees and other income		6.7			8.1			13.3			14.6
Total revenues		1,266.1			1,222.0			2,527.0			2,449.6
Losses and expenses
Losses and loss adjustment expenses		725.0			729.7			1,491.5			1,429.3
Amortization of deferred acquisition costs		264.6			254.4			531.0			513.5
Interest expense		12.2			15.6			24.2			30.3
Gain on disposal of U.K. motor business		—			(0.4	)		—			(1.2	)
Net loss from repayment of debt		—			86.1			—			86.1
Other operating expenses		153.3			143.7			310.3			290.6
Total losses and expenses		1,155.1			1,229.1			2,357.0			2,348.6
Income (loss) before income taxes		111.0			(7.1	)		170.0			101.0
Income tax expense (benefit):
Current		4.9			6.5			38.8			39.9
Deferred		27.7			(15.5	)		7.6			(18.9	)
Total income tax expense		32.6			(9.0	)		46.4			21.0
Income from continuing operations		78.4			1.9			123.6			80.0
Net gain from discontinued operations (net of tax benefit of $1.7 and $2.2 for the three and six months ended June 30, 2016, respectively)		—			0.1			—			0.2
Net income	$	78.4		$	2.0		$	123.6		$	80.2
Earnings per common share:
Basic:
Income from continuing operations	$	1.85		$	0.04		$	2.91		$	1.86
Net gain from discontinued operations		—			0.01			—			0.01
Net income per share	$	1.85		$	0.05		$	2.91		$	1.87
Weighted average shares outstanding		42.5			43.0			42.5			43.0
Diluted:
Income from continuing operations	$	1.83		$	0.04		$	2.88		$	1.84
Net gain from discontinued operations		—			0.01			—			—
Net income per share	$	1.83		$	0.05		$	2.88		$	1.84
Weighted average shares outstanding		42.8			43.4			42.9			43.5

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

Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(In millions)	2017			2016			2017		2016
Net income	$	78.4		$	2.0		$	123.6	$	80.2
Other comprehensive income (loss), net of tax:
Available-for-sale securities:
Net appreciation during the period		19.4			74.2			38.3		167.8
Change in other-than-temporary impairment losses recognized in other comprehensive income		0.4			2.8			0.5		5.7
Total available-for-sale securities		19.8			77.0			38.8		173.5
Pension and postretirement benefits:
Amortization recognized as net periodic benefit and postretirement cost		2.4			1.7			4.7		3.3
Cumulative foreign currency translation adjustment:
Amount recognized as cumulative foreign currency translation during the period		(4.5	)		(0.7	)		0.6		(1.3	)
Total other comprehensive income, net of tax		17.7			78.0			44.1		175.5
Comprehensive income	$	96.1		$	80.0		$	167.7	$	255.7

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

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THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

	June 30,			December 31,
(In millions, except share data)	2017			2016
Assets
Investments:
Fixed maturities, at fair value (amortized cost of $7,372.8 and $7,235.1)	$	7,509.7		$	7,331.3
Equity securities, at fair value (cost of $490.1 and $498.4)		605.5			584.4
Other investments		604.3			533.8
Total investments		8,719.5			8,449.5
Cash and cash equivalents		317.8			282.6
Accrued investment income		60.5			61.7
Premiums and accounts receivable, net		1,599.4			1,438.1
Reinsurance recoverable on paid and unpaid losses and unearned premiums		2,701.1			2,611.8
Deferred acquisition costs		547.1			517.5
Deferred income taxes		73.7			115.1
Goodwill		185.2			184.8
Other assets		509.7			479.8
Assets of discontinued operations		78.7			79.5
Total assets	$	14,792.7		$	14,220.4
Liabilities
Loss and loss adjustment expense reserves	$	7,162.4		$	6,949.4
Unearned premiums		2,776.0			2,561.0
Expenses and taxes payable		671.3			728.0
Reinsurance premiums payable		334.7			251.9
Debt		786.7			786.4
Liabilities of discontinued operations		89.1			86.2
Total liabilities		11,820.2			11,362.9
Commitments and contingencies
Shareholders’ Equity
Preferred stock, par value $0.01 per share; 20.0 million shares authorized; none issued		—			—
Common stock, par value $0.01 per share; 300.0 million shares authorized 60.5 million shares issued		0.6			0.6
Additional paid-in capital		1,852.0			1,846.7
Accumulated other comprehensive income		106.9			62.8
Retained earnings		1,956.6			1,875.6
Treasury stock at cost (18.1 million shares)		(943.6	)		(928.2	)
Total shareholders’ equity		2,972.5			2,857.5
Total liabilities and shareholders’ equity	$	14,792.7		$	14,220.4

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

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THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

	Six Months Ended
	June 30,
(In millions)	2017			2016
Preferred Stock
Balance at beginning and end of period	$	—		$	—
Common Stock
Balance at beginning and end of period		0.6			0.6
Additional Paid-in Capital
Balance at beginning of period		1,846.7			1,833.5
Employee and director stock-based awards and other		5.3			1.7
Balance at end of period		1,852.0			1,835.2
Accumulated Other Comprehensive Income (Loss), net of tax
Net Unrealized Appreciation on Investments:
Balance at beginning of period		186.0			149.9
Net appreciation on available-for-sale securities		38.8			173.5
Balance at end of period		224.8			323.4
Defined Benefit Pension and Postretirement Plans:
Balance at beginning of period		(102.5	)		(78.6	)
Net amount recognized as net periodic benefit cost		4.7			3.3
Balance at end of period		(97.8	)		(75.3	)
Cumulative Foreign Currency Translation Adjustment:
Balance at beginning of period		(20.7	)		(17.4	)
Amount recognized as cumulative foreign currency translation during the period		0.6			(1.3	)
Balance at end of period		(20.1	)		(18.7	)
Total accumulated other comprehensive income		106.9			229.4
Retained Earnings
Balance at beginning of period		1,875.6			1,803.5
Net income		123.6			80.2
Dividends to shareholders		(42.6	)		(39.6	)
Stock-based compensation		—			(2.6	)
Balance at end of period		1,956.6			1,841.5
Treasury Stock
Balance at beginning of period		(928.2	)		(847.1	)
Shares purchased at cost		(28.0	)		(67.5	)
Net shares reissued at cost under employee stock-based compensation plans		12.6			17.6
Balance at end of period		(943.6	)		(897.0	)
Total shareholders’ equity	$	2,972.5		$	3,009.7

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

Table of Contents

THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Six Months Ended
	June 30,
(In millions)	2017			2016
Cash Flows From Operating Activities
Net income	$	123.6		$	80.2
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on disposal of U.K. motor business		—			(1.2	)
Net loss from repayment of debt		—			86.1
Net realized investment gains		(7.8	)		(0.8	)
Net amortization and depreciation		15.4			16.2
Stock-based compensation expense		7.3			5.5
Amortization of defined benefit plan costs		7.0			5.0
Deferred income tax expense		7.6			(18.0	)
Change in deferred acquisition costs		(29.6	)		(13.5	)
Change in premiums receivable, net of reinsurance premiums payable		(73.8	)		(48.6	)
Change in loss, loss adjustment expense and unearned premium reserves		384.7			332.2
Change in reinsurance recoverable		(72.7	)		(58.8	)
Change in expenses and taxes payable		(74.1	)		(93.8	)
Other, net		(37.8	)		(56.6	)
Net cash provided by operating activities		249.8			233.9
Cash Flows From Investing Activities
Proceeds from disposals and maturities of fixed maturities		578.8			801.5
Proceeds from disposals of equity securities and other investments		65.8			198.1
Purchase of fixed maturities		(668.4	)		(771.0	)
Purchase of equity securities and other investments		(113.5	)		(211.1	)
Capital expenditures		(8.6	)		(8.5	)
Net cash (used in) provided by investing activities		(145.9	)		9.0
Cash Flows From Financing Activities
Proceeds from exercise of employee stock options		10.3			11.3
Proceeds from debt borrowings, net		—			370.5
Change in cash collateral related to securities lending program		(3.4	)		(21.8	)
Dividends paid to shareholders		(42.6	)		(39.6	)
Repayment of debt		—			(461.3	)
Repurchases of common stock		(28.0	)		(67.5	)
Other financing activities		(2.8	)		(11.6	)
Net cash used in financing activities		(66.5	)		(220.0	)
Effect of exchange rate changes on cash		1.6			(0.1	)
Net change in cash and cash equivalents		39.0			22.8
Net change in cash related to discontinued operations		(3.8	)		—
Cash and cash equivalents, beginning of period		282.6			338.8
Cash and cash equivalents, end of period	$	317.8		$	361.6

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

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THE HANOVER INSURANCE GROUP, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation and Principles of Consolidation

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

The interim consolidated financial statements of THG include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America, THG’s principal U.S.-domiciled property and casualty companies; Chaucer Holdings Limited (“Chaucer”), a specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s”) and certain other insurance and non-insurance subsidiaries. These legal entities conduct their operations through several business segments discussed in Note 8 – “Segment Information”. Additionally, the interim consolidated financial statements include the Company’s discontinued operations, consisting primarily of the Company’s former life insurance businesses and its accident and health business. All intercompany accounts and transactions have been eliminated.

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

In the opinion of the Company’s management, the accompanying interim consolidated financial statements reflect all adjustments, consisting of normal recurring items, necessary for a fair presentation of the financial position and results of operations. The results of operations for the three and six months ended June 30, 2017 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 22, 2017.

2. New Accounting Pronouncements

Recently Implemented Standards

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Update No. 2016-09, (Topic 718) Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting (“ASC Update No. 2016-09”). This ASC update requires all excess tax benefits and tax deficiencies to be recognized as income tax expense or benefit in the income statement, and be treated as discrete items in the reporting period in which they occur. Additionally, excess tax benefits will be classified with other income tax cash flows as an operating activity and cash paid by an employer when directly withholding shares for tax withholding purposes will be classified as a financing activity. Awards that are used to settle employee tax liabilities will be allowed to qualify for equity classification for withholdings up to the maximum statutory tax rates in applicable jurisdictions. Regarding forfeitures, a company can make an entity-wide accounting policy election to either continue estimating the number of awards that are expected to vest or account for forfeitures when they occur. The updated guidance was effective for interim and annual periods beginning after December 15, 2016. The Company implemented this guidance effective January 1, 2017 and will retain its current forfeiture policy of accruing the compensation cost based on the number of awards that are expected to vest. Prior period cash flow statements have been retrospectively adjusted to present excess tax benefits and cash paid by an employer when withholding shares for tax withholding purposes in accordance with the updated guidance. The adoption of this guidance did not result in any cumulative effect adjustments. The effect this guidance will have on the Company’s results of operations in future periods is dependent on the future tax benefits or deficiencies that are recognized related to stock-based compensations awards, and could be material in any one quarterly or annual period.

Recently Issued Standards

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

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In March 2017, the FASB issued ASC Update No. 2017-07, (Topic 715) Compensation – Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This guidance requires that an employer report in its income statement the service cost component of both net periodic pension and net periodic postretirement benefit cost in the same line item or items as other compensation costs arising from services rendered by pertinent employees during the period, and present in the income statement separately from the other components of benefit cost, if appropriate under the company’s current presentation of its income statement. Additionally, the guidance allows only the service cost component to be eligible for capitalization when applicable. The updated guidance is effective for annual and interim periods beginning after December 15, 2017, and should be applied retrospectively for the presentation of the service cost component and other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement, and prospectively for the capitalization of the service cost component of net periodic cost in assets. Early adoption is permitted as of the beginning of an annual period for which financial statements have not been issued. The Company had an insignificant amount of service cost expense for both its pension and postretirement benefit plans in 2016. The Company is not expecting to have any service cost remaining related to its pension and postretirement plans upon this guidance becoming effective, therefore the adoption of ASC Update No. 2017-07 will not have a material impact on its financial position or results of operations.

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

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

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

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

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

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

In February 2016, the FASB issued ASC Update No. 2016-02, (Topic 842) Leases. This ASC update requires a lessee to recognize a right-of-use asset, which represents the lessee’s right to use a specified asset for the lease term, and a corresponding lease liability, which represents a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, for all leases that extend beyond 12 months. For finance or capital leases, interest on the lease liability will be recognized separately from amortization of the right-of-use asset in the statements of income and comprehensive income. In addition, the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. For operating leases, the asset and liability will be amortized as a single lease cost, such that the cost of the lease is allocated over the lease term, on a generally straight-line basis, with all cash flows included within operating activities in the statement of cash flows. The updated guidance is effective for interim and annual periods beginning after December 15, 2018 and is required to be implemented by applying a modified retrospective transition approach. The Company is continuing to evaluate the impact of the adoption of ASC Update No. 2016-02 on its results of operations. It is expected that assets and liabilities will increase based on the present value of remaining lease payments for leases in place at the adoption date; however, the impact is not expected to be significant to the Company’s financial position.

In January 2016, the FASB issued ASC Update No. 2016-01, (Subtopic 825-10) Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This ASC update requires unconsolidated equity investments to be measured at fair value with changes in the fair value recognized in net income, except for those accounted for under the equity method. This update eliminates the cost method for equity investments without readily determinable fair values and replaces with other methods, including the use of Net Asset Value (“NAV”). Additionally, when a public entity is required to measure fair value for disclosure purposes and holds financial instruments measured at amortized cost, the updated guidance requires these instruments to be measured using exit price. It also requires financial assets and financial liabilities to be presented separately in the notes to the financial statements, grouped by measurement category and form of financial asset. The updated guidance is effective for annual periods beginning after December 15, 2017. The Company will adopt the guidance effective January 1, 2018 through a cumulative effect adjustment to retained earnings. The adoption is not expected to have a material impact on the Company’s financial position. The impact to the Company is expected to be increased volatility in net income beginning in 2018; the magnitude of such volatility will depend on the composition of the Company’s investment portfolio in the future and changes in the fair value of the Company’s investments.

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

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3. Income Taxes

Income tax expense for the six months ended June 30, 2017 and 2016 has been computed using estimated annual effective tax rates. These rates are revised, if necessary, at the end of each successive interim period to reflect current estimates of the annual effective tax rates.

For the six months ended June 30, 2017, the tax provision was comprised of a $44.3 million U.S. federal income tax expense and a $2.1 million foreign income tax expense. For the six months ended June 30, 2016, the tax provision was comprised of a $3.9 million U.S. federal income tax expense and a $17.1 million foreign income tax expense.

Most of the Company’s non–U.S. income is subject to U.S. federal income tax, although a portion of its non–U.S. income is not subject to U.S. federal income tax until repatriated. Foreign taxes on this non–U.S. income are accrued at the local foreign tax rate, as opposed to the higher U.S. statutory rate, since these earnings currently are expected to be indefinitely reinvested overseas. This assumption could change as a result of a sale of the subsidiaries, the receipt of dividends from the subsidiaries, a change in management’s intentions, or as a result of various other events. The Company has not made a provision for U.S. taxes on $5.6 million and $10.6 million of non-U.S. income for the six months ended June 30, 2017 and 2016, respectively. However, in the future, if such earnings were distributed to the Company, taxes of $47.9 million would be payable on the accumulated undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be indefinitely reinvested overseas, assuming all foreign tax credits are realized.

The Company or its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions, as well as foreign jurisdictions. The Company and its subsidiaries are subject to U.S. federal and state income tax examinations by tax authorities for years after 2012 and foreign examinations for years after 2012.

4. Investments

A. Fixed maturities and equity securities

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

	June 30, 2017
	Amortized		Gross		Gross				OTTI
	Cost or		Unrealized		Unrealized				Unrealized
(in millions)	Cost		Gains		Losses		Fair Value		Losses
Fixed maturities:
U.S. Treasury and government agencies	$	393.3	$	4.5	$	4.0	$	393.8	$	—
Foreign government		224.0		5.0		0.6		228.4		—
Municipal		1,057.3		38.1		5.6		1,089.8		—
Corporate		4,083.0		128.4		33.7		4,177.7		15.4
Residential mortgage-backed		976.7		9.2		10.6		975.3		—
Commercial mortgage-backed		574.9		8.5		2.7		580.7		—
Asset-backed		63.6		0.4		—		64.0		—
Total fixed maturities	$	7,372.8	$	194.1	$	57.2	$	7,509.7	$	15.4
Equity securities	$	490.1	$	115.8	$	0.4	$	605.5	$	—

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	December 31, 2016
	Amortized		Gross		Gross					OTTI
	Cost or		Unrealized		Unrealized					Unrealized
(in millions)	Cost		Gains		Losses		Fair Value			Losses
Fixed maturities:
U.S. Treasury and government agencies	$	342.5	$	3.7	$	5.1	$	341.1	$		—
Foreign government		235.8		5.4

HANOVER INSURANCE GROUP, INC. - FORM 10-Q - August 3, 2017

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