THG 2018 Annual Report

TERRORISM As a result of the continuing threat of terrorist attacks, the insurance industry maintains a high level of focus with respect to the potential for losses caused by terrorist acts. Insured losses may encompass people, property and business operations cover HG XQGHU ZRUNHUV¶ compensation, commercial multiple peril and other Commercial Lines policies, as well as Personal Lines policies. In certain cases, we are not able to exclude coverage for these losses, either because of regulatory requirements or competitive pressures. We continually evaluate the potential effect of these low frequency, but potentially high severity events in our overall pricing and underwriting plans, especially for policies written in major metropolitan areas. Although certain terrorism-related risks embedded in our Commercial and Personal Lines are covered under the existing Catastrophe, 3URSHUW\ SHU 5LVN DQG &DVXDOW\ ([FHVV RI /RVV FRUSRUDWH UHLQVXUDQFH WUHDWLHV VHH ³5HLQVXUDQFH´ IRU DGGLWLRQDO LQIRUPDWLRQ private sector catastrophe reinsurance is limited and generally unavailable for losses attributed to acts of terrorism, particularly those involving QXFOHDU ELRORJLFDO FKHPLFDO DQG RU UDGLRORJLFDO HYHQWV $V D UHVXOW WKH LQGXVWU\¶V SULPDU\ UHLQVXUDQFH SURWHFWLRQ DJDLQVW large-scale terrorist attacks in the U.S. is provided through a Federal program that provides compensation for insured losses resulting from acts of terrorism. 7KH 7HUURULVP 5LVN ,QVXUDQFH $FW RI ILUVW HVWDEOLVKHG WKH 7HUURULVP 5LVN ,QVXUDQFH 3URJUDP WKH ³3URJUDP´ &RYHUDJH XQGHU WKH 3URJUDP DSSOLHV WR ZRUNHUV¶ FRPSHQVDWLRQ FRPPHUFLDO PXOWLSOH SHULO DQG FHUWDLQ RWKHU &RPPHUFLDO /LQHV SROLFLHV IRU GLUHFW Z ritten policies. TRIPRA extended the Program through December 31, 2020. All commercial property and casualty insurers participate in the program. Under the program, a participating issuer, in exchange for making terrorism insurance available, may be entitled to be reimbursed by the Federal government for a portion of its aggregate losses. The Program does not cover losses in surety, Personal Lines or certain other lines of business. Losses caused by terrorist acts are not excluded from homeowners or personal automobile policies. As required by the current Program, we offer policyholders in specific lines of commercial insurance the option to elect terrorism coverage. In order for a loss to be reinsured under the Program, the loss must meet aggregate industry loss minimums and must be the result of an act of terrorism as certified by the Secretary of the Treasury in consultation with the Secretary of Homeland Security and the U.S. Attorney General. Losses from acts which do not qualify or are not so certified will not receive the benefit of the Program and in fact, may be deemed covered losses whether or not terrorism coverage was purchased. The current Program requires insurance carriers to retain 19% of any claims from a certified terrorist event in excess of the federally mandated deductible in 2019, subject to an annual industry-wide cap of $100 billion. This retention will increase to 20% in 2020. The federally mandated deductible represents 20% of direct earned premium for the covered lines of business of the prior year. In 2018, our deductible was $412 million, which represents 19.9% of year-end 2017 statutory policyholder surplus of our insurers, and is estimated to be $431 million in 2019, representing 19.8% of 2018 year-end statutory policyholder surplus. Given the unpredictability of terrorism losses, future losses from acts of terrorism could be material to our operating results, financial position, and/or liquidity. We attempt to manage our exposures on an individual line of business basis and in the aggregate by one-half square mile grids in major metropolitan areas. REGULATION Our property and casualty insurance subsidiaries are subject to extensive regulation in the states in which they transact business and are supervised by the individual state insurance departments. Numerous aspects of our business are subject to regulation, including premium rates, mandatory covered risks, limitations on the ability to non-renew or reject business, prohibited exclusions, licensing and appointment of agents, restrictions on the size of risks that may be insured under a single policy, reserves and provisions for unearned premiums, losses and other obligations, deposits of securities for the benefit of policyholders, investments and capital, policy forms and coverages, advertising, and other conduct, including restrictions on the use of credit information and other factors in underwriting, as well as other underwriting and claims practices. States also regulate various aspects of the contractual relationships between insurers and independent agents. Such laws, rules and regulations are usually overseen and enforced by the various state insurance departments, as well as through private rights of action and by state attorneys general. Such regulations or enforcement actions are often responsive to current consumer and political sensitivities, such as automobile and homeowners insurance rates and coverage forms, or which may arise after a major event. Such rules and regulations may result in rate suppression, limit our ability to manage our exposure to unprofitable or volatile risks, or lead to fines, premium refunds or other adverse consequences. The federal government also may regulate aspects of our businesses, such as the use of insurance (credit) scores in underwriting and the protection of confidential information. In addition, as a condition to writing business in certain states, insurers are required to participate in various pools or risk sharing mechanisms or to accept certain classes of risk, regardless of whether such risks meet their underwriting requirements for voluntary business. Some states also limit or impose restrictions on the ability of an insurer to withdraw from certain classes of business. For H[DPSOH 0DVVDFKXVHWWV 1HZ <RUN DQG &DOLIRUQLD HDFK LPSRVH PDWHULDO UHVWULFWLRQV RQ D FRPSDQ\¶V DELOLW\ WR PDWHULDOO\ UHGXFH its exposures or to withdraw from certain lines of business in their respective states. The state insurance departments can impose significant charges on an insurer in connection with a market withdrawal or refuse to approve withdrawal plans on the grounds that they could lead to market disruption. Laws and regulations that limit cancellation and non-renewal of policies or that subject withdrawal plans to prior approval requirements may significantly restrict our ability to exit unprofitable markets. Such actions and related regulatory restrictions may limit our ability to reduce our potential exposure to hurricane-related losses. The insurance laws of many states subject property and casualty insurers doing business in those states to statutory property and casualty guaranty fund assessments. The purpose of a guaranty fund is to protect policyholders by requiring that solvent property and casualty 12 THE HANOVER INSURANCE GROUP | 2018 ANNUAL REPORT