THG 2018 Annual Report

Negative changes in our level of statutory surplus could adversely affect our ratings and profitability. 7KH FDSDFLW\ IRU DQ LQVXUDQFH FRPSDQ\¶V JURZWK LQ SUHPLXPV LV LQ SDUW D IXQFWLRQ RI LWV VWDWXWRU\ VXUSOXV 0DLQWDLQLQJ DSSURS riate levels of statutory surplus, as measured by state insurance regulators, is considered important by state insurance regulatory authorities and by UDWLQJ DJHQFLHV WKDW UDWH LQVXUHUV¶ FODLPV -paying abilities and financial strength. As our business grows, or due to other factors, regulators may require that additional capital be retained or contributed to increase the level of statutory surplus. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by private rating agencies. Our surplus is affected by, among other things, results of operations and investment gains, losses, impairments, and dividends from the insurance operating company to its parent company. A number of these factors affecting our level of statutory surplus are, in turn, influenced by factors that are out of our control, including the frequency and severity of catastrophes, changes in policyholder behavior, changes in rating agency models and economic factors such as changes in equity markets, credit markets, interest rates or foreign currency exchange rates. The NAIC uses a system for assessing the adequacy of statutory capital for property and casualty insurers. The system, known as risk- EDVHG FDSLWDO LV LQ DGGLWLRQ WR WKH VWDWHV¶ IL[HG GROODU PLQLPXP FDSLWDO DQG RWKHU UHTXLUHPHQWV 7KH V\VWHP LV EDVHG RQ ULVN -based IRUPXODV WKDW DSSO\ SUHVFULEHG IDFWRUV WR WKH YDULRXV ULVN HOHPHQWV LQ DQ LQVXUHU¶V EXVLQHVV DQG LQYHVWPHQWV WR UHSRUW D PLQL mum capital requirement proportional to the amount of risk assumed by the insurer. Any failure to maintain appropriate levels of statutory surplus would have an adverse impact on our ability to maintain or grow our business. We may not be able to grow as quickly or as profitably as we intend, which is important to our current strategy. Over the past several years, we have made, and our current plans are to continue to make, significant investments in our Commercial and Personal Lines of business, in order to, among other things, strengthen our product offerings and service capabilities, expand into new geographic areas, improve technology and our operating models, build expertise in our personnel, and expand our distribution capabilities, with the ultimate goal of achieving significant, sustained growth. The ability to achieve significant profitable premium growth in order to earn adequate returns on such investments and expenses, and to grow further without proportionate increases in expenses, is an important part of our current strategy. There can be no assurance that we will be successful at profitably growing our business, or that we will not alter our current strategy due to changes in our markets or an inability to successfully maintain acceptable margins on new or existing business or for other reasons, in which case premiums written and earned, operating income and net book value could be adversely affected. An impairment in the carrying value of goodwill and intangible assets could negatively impact our consolidated results of operations and shareholders’ equity. Upon an acquisition of a business, we record goodwill and intangible assets at fair value. Goodwill and intangible assets determined to have indefinite useful lives are not amortized, while other intangible assets are amortized over their estimated useful lives. Goodwill and intangible assets that are not amortized are reviewed for impairment at least annually. Evaluating the recoverability of such assets requires us to rely on estimates and assumptions related to return on equity, margin, growth rates, discount rates, and other data. There are inherent uncertainties related to these factors, and significant judgment is required in applying these factors. Goodwill and intangible asset impairment charges can result from declines in operating results, divestitures or sustained market declines and other factors. As of December 31, 2018, goodwill and intangible assets that are not amortized totaled $207 million and represented approximately 7% of VKDUHKROGHUV¶ HTXLW\ 2XU OHJDF\ +DQRYHU DQG &LWL]HQV EXVLQHVVHV UHSUHVHQW RI WKLV EDODQFH $,; UHSUHVHQWV RI WKLV ED lance; and, the remaining acquisitions combined represent 13% of this balance. Although we believe these assets are recoverable, we cannot provide assurance that future market or business conditions would not result in the impairment of a portion of these assets. Impairment charges could materially affect our financial position and our financial results in the quarter or annual period in which they are recognized. We could be subject to additional losses related to the sale of our discontinued FAFLIC and variable life insurance and annuity businesses and our recent sale of our Chaucer business. On January 2, 2009, we sold our remaining life insurance subsidiary, FAFLIC, to Commonwealth Annuity and Life Insurance Company. Coincident with the sale transaction, Hanover Insurance and FAFLIC entered into a reinsurance contract whereby Hanover Insurance DVVXPHG )$)/,&¶V GLVFRQWLQXHG DFFLGHQW DQG KHDOWK LQVXUDQFH EXVLQHVV :H SUHYLRXVO\ RZQHG &RPPRQZHDOWK $QQXLW\ EXW VROG LW L n 2005 in conjunction with our disposal of our variable life insurance and annuity business. In connection with these transactions, we have agreed to indemnify Commonwealth Annuity for certain contingent liabilities, including litigation and other regulatory matters. On December 28, 2018, we sold the majority of our Chaucer business (specifically our U.K.- EDVHG /OR\G¶V HQWLWLHV WR &KLQD 5H ,Q connection with this transaction, we made certain representations and warranties and agreed to indemnify China Re for certain pre-sale contingent liabilities. We cannot provide assurance as to what the costs of any indemnifications will be when they ultimately settle. 28 THE HANOVER INSURANCE GROUP | 2018 ANNUAL REPORT