THG 2018 Annual Report

2018 ANNUAL REPORT | THE HANOVER INSURANCE GROUP E N D N O T E S (1) Operating income and operating income per diluted share are non-GAAP measures. The following is a reconciliation of operating income and operating income per diluted share to the closest GAAP measures, income from continuing operations and income from continuing operations per diluted share, respectively: YEARS ENDED December 31, 2017 December 31, 2018 (In millions, except per share data) $ Amount Per Share Diluted $ Amount Per Share Diluted OPERATING INCOME (LOSS) Commercial Lines $177.4 $265.7 Personal Lines 158.7 146.2 Other (8.8) (5.4) Total 327.3 406.5 Interest expense (45.2) (45.1) Operating income before income taxes 282.1 $6.56 361.4 $8.40 Income tax expense on operating income (89.5) (2.08) (69.3) (1.61) Operating income after income taxes 192.6 4.48 292.1 6.79 Non-operating items: Net realized gains (losses) from sales and other 26.7 0.62 (2.7) (0.06) Net change in fair value of equity securities - - (43.4) (1.01) Net other-than-temporary impairment losses on investments recognized in earnings (5.6) (0.13) (4.6) (0.11) Loss from repayment of debt - - (28.2) (0.65) Other (10.3) (0.24) - - Income tax benefit on other non-operating items 12.7 0.30 25.8 0.60 Income from continuing operations, net of taxes 216.1 5.03 239.0 5.56 Discontinued Operations: Gain from sale of Chaucer business, net of taxes - - 131.9 3.07 Income (loss) from Chaucer business, net of taxes (13.1) (0.30) 20.0 0.46 Income (loss) from discontinued life businesses, net of taxes (16.8) (0.40) 0.1 - Net income $186.2 $4.33 $391.0 $9.09 Weighted average shares outstanding 43.0 43.0 (2) Current accident year combined ratio, excluding catastrophe losses, is a non-GAAP measure, which is equal to the combined ratio, excluding prior-year reserve development and catastrophe losses. The combined ratio, (which includes catastrophe losses and prior-year loss reserve development) is the most directly comparable GAAP measure. The following is a reconciliation of the GAAP combined ratio to the current accident year combined ratio, excluding catastrophes: YEARS ENDED 2014 2015 2016 2017 2018 Total combined ratio 99.4% 98.1% 100.4% 97.3% 96.1% Less: Prior-year reserve development ratio 0.2% 0.7% 6.2% - - Catastrophe ratio 5.6% 4.5% 3.1% 6.4% 5.2% Current accident year combined ratio, excluding catastrophe losses 93.6% 92.9% 91.1% 90.9% 90.9% (3) Operating return on average equity and adjusted operating return on average equity (“Operating ROE” and “Adjusted Operating ROE”) are non-GAAP measures. Operating ROE is calculated by dividing operating income after income taxes (see endnote (1)), by the sum of the total shareholders’ equity, excluding unrealized appreciation (depreciation) on fixed maturity investments, net of taxes, for the quarters in the noted period, divided by the number of quarters in the noted period. Total shareholders’ equity, excluding net unrealized appreciation (depreciation) on fixed maturity investments, net of taxes, is also a non-GAAP measure. For Adjusted Operating ROE, shareholders’ equity is further adjusted for “equity attributable to Chaucer” for measurement periods prior to the close, which occurred on December 28, 2018, and “the un-deployed equity” for measurement periods post-close, which are also non-GAAP measures. Total shareholders’ equity is the most directly comparable GAAP measure, and is reconciled in the following table. Operating ROE and adjusted operating ROE should not be construed as substitutes for GAAP ROE. The following is a calculation of GAAP ROE using net income and average shareholders’ equity without adjustments, operating ROE and adjusted operating ROE: PERIODS ENDED (In millions) Dec. 31, 2017 Mar. 31, 2018 Jun. 30, 2018 Sep. 31, 2018 Dec. 31, 2018 Total shareholders’ equity (GAAP) $2,997.7 $2,913.1 $2,939.8 $2,982.4 $2,954.7 Less: net unrealized appreciation (depreciation) on fixed maturity investments, net of tax 205.4 0.3 (48.8) (74.0) (27.2) Total shareholders’ equity, excluding net unrealized appreciation (depreci- ation) on fixed maturity investments, net of tax $2,792.3 $2,912.8 $2,988.6 $3,056.4 $2,981.9 Less: pre-sale, equity attributable to Chaucer; or post-close, un-deployed equity 614.6 614.6 614.6 614.6 656.6 Adjusted shareholders’ equity, excluding both net unrealized appreciation (depreciation) on fixed maturity investments, net of tax, and pre-sale, equity attributable to Chaucer; or post-close, un-deployed equity $2,177.7 $2,298.2 $2,374.0 $2,441.8 $2,325.3 Average shareholders’ equity $2,957.5 Average shareholders’ equity, excluding net unrealized appreciation (depreci- ation) on fixed maturity investments, net of tax $2,946.4 Average adjusted shareholders’ equity, excluding both net unrealized appreci- ation (depreciation) on fixed maturity investments, net of tax, and pre-sale, equity attributable to Chaucer; or post-close, un-deployed equity $2,323.4 YEAR ENDED NET INCOME ROE December 31, 2018 Net income (GAAP) $391.0 Average shareholders’ equity (GAAP) 2,957.5 Return on average equity 13.2% OPERATING INCOME ROE (NON-GAAP) Operating income after income taxes $292.1 Average shareholders’ equity, excluding net unrealized appreciation (depreciation) on fixed maturity investments, net of tax 2,946.4 Operating return on average equity 9.9% ADJUSTED OPERATING INCOME ROE (NON-GAAP) Operating income after income taxes $292.1 Average adjusted shareholders’ equity, excluding both net unrealized appreciation (depreciation) on fixed maturity investments, net of tax, and pre-sale, equity attributable to Chaucer; or post-close, un-deployed equity 2,323.4 Adjusted operating return on average equity 12.6% (4) The expense ratio is reduced by installment fee revenues for purposes of the calculation. (5) Book value per share, excluding the impact of the $4.75 per share special dividend declared on December 30, 2018, is a non-GAAP measure. Book value per share, which includes the impact of the special dividend, is the most directly comparable GAAP measure. The following is a reconciliation of book value per share and book value per share, excluding the impact of the $4.75 per share special dividend: PERIOD ENDED December 31, 2018 BOOK VALUE PER SHARE GROWTH CALCULATION: End of period book value $69.81 Less: beginning of period book value 70.59 Change in book value (0.78) Special dividend declared on December 30, 2018 4.75 Change in book value and declared special dividend $3.97 Total change in book value, adding back the impact of special dividend* 5.6 % * Change in book value and declared special dividend divided by beginning of period book value.