HANOVER INSURANCE GROUP INC

Investment Results

Net investment income before income taxes was as follows:

The increase in net investment income for the three months ended March 31, 2024 was primarily due to the impact of higher new money yields, higher partnership income and the continued investment of operational cashflows. Income from partnerships can vary significantly from period to period based on the performance in the underlying portfolios.

Investment Portfolio

We held cash and investment assets diversified across several asset classes, as follows:

Cash and Investments

Total cash and investments decreased $17.4 million, or 0.2%, for the three months ended March 31, 2024 as compared to December 31, 2023. The decrease was primarily due to net market value depreciation and the funding of financing activities, including our dividend payment, partially offset by continued investment of cashflows from operations.

The following table provides information about the investment types of our fixed maturities portfolio:

The increase in net unrealized losses on fixed maturities was due to higher interest rates, partially offset by tighter credit spreads.

Amortized cost and fair value by rating category were as follows:

Based on ratings by the National Association of Insurance Commissioners (“NAIC”), approximately 95% of the fixed maturity portfolio consisted of investment-grade securities at March 31, 2024 and December 31, 2023. The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security, issuer diversification and yield curve position. Our U.S. Treasury and government agencies fixed maturities are directly or indirectly backed by the full faith and credit of the U.S. government. Our municipal bonds include revenue bonds and general obligations of state and local issuers. Corporate fixed maturities include publicly traded and privately placed securities in the industrial, financial, and utility sectors. Residential mortgage-backed securities are structured securities that are collateralized by residential real estate loans and are primarily U.S. agency-backed. Our commercial mortgage-backed securities are structured securities that are collateralized by commercial real estate loans and are well-diversified by geography, property type, expected maturity and vintage year. Our other asset-backed securities are structured securities that are primarily collateralized by consumer and corporate borrowings.

Our investment portfolio primarily consists of fixed maturity securities whose fair value is susceptible to market risk, including interest rate changes. See also “Quantitative and Qualitative Disclosures about Market Risk” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2023 Annual Report on Form 10-K. Duration is a measurement used to quantify our inherent interest rate risk and analyze invested assets relative to our reserve liabilities.

The duration of our fixed maturity portfolio is as follows:

Our fixed maturity and equity securities are carried at fair value. Financial instruments, whose value was determined using significant management judgment or estimation, constituted less than 1% of the total assets we measured at fair value. See also Note 4 – “Fair Value” in the Notes to Interim Consolidated Financial Statements.

Limited partnerships and other investments consist primarily of our interest in corporate middle market and real estate limited partnerships. Corporate middle market limited partnerships may invest in senior or subordinated debt, preferred or common equity or a combination thereof, of privately-held middle market businesses. Real estate limited partnerships hold equity ownership positions in real properties and invest in debt secured by real properties. Our limited partnerships are generally accounted for under the equity method, or as a practical expedient using the fund’s net asset value, with financial information provided by the partnership on a two- or three-month lag.

Mortgage and other loans consist primarily of commercial mortgage loan participations, which represent our interest in commercial mortgage loans originated by a third-party. We share, on a pro-rata basis, in all related cash flows of the underlying mortgage loans, which are primarily investment-grade quality and diversified by geographic area and property type.

Equity securities primarily consist of U.S. income-oriented large capitalization common stocks and a broadly diversified U.S. equity index exchange-traded fund.

Although we expect to invest new funds primarily in investment-grade fixed maturities, we have invested, and expect to continue to invest, a portion of funds in below investment-grade fixed maturities, limited partnerships, common equity securities and other investment assets.

Impairments (Recoveries)

For the three months ended March 31, 2024, we recognized $0.3 million of recoveries on previously impaired fixed maturities. For the three months ended March 31, 2023, we recognized net impairments of $14.8 million, consisting of losses of $10.7 million on fixed maturity securities, primarily related to intent to sell securities in the banking sector, and $4.1 million of estimated credit losses on mortgage loans.

At March 31, 2024 and December 31, 2023, the allowance for credit losses on mortgage loans was $9.7 million and $10.0 million, respectively, and the allowance for credit losses on available-for-sale debt securities was $1.6 million and $1.9 million, respectively.

The carrying value of fixed maturity securities on non-accrual status at March 31, 2024, December 31, 2023, and March 31, 2023 was $14.8 million. At March 31, 2024, a mortgage loan with a carrying value of $7.1 million was also on non-accrual status. The effects on income of non-accruals for fixed maturity securities and mortgage loans for the three months ended March 31, 2024 and March 31, 2023, compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities and mortgage loans, were not material. Any defaults in the fixed maturities or mortgage loan portfolios in future periods may negatively affect investment income.

Unrealized Losses

Gross unrealized losses on fixed maturities at March 31, 2024 were $654.2 million, an increase of $29.5 million compared to December 31, 2023, primarily attributable to higher interest rates, partially offset by tighter credit spreads. At March 31, 2024, gross unrealized losses consisted primarily of $235.8 million on corporate fixed maturities, $145.7 million on residential mortgage-backed securities, $131.5 million on municipals, $67.5 million on commercial mortgage-backed securities and $58.8 million on U.S. government securities. See Note 3 – “Investments” in the Notes to Interim Consolidated Financial Statements.

We view gross unrealized losses on fixed maturities as non-credit related since it is our assessment that these securities will recover, allowing us to realize their anticipated long-term economic value. Further, we do not intend to sell, nor is it more likely than not we will be required to sell, such debt securities before this expected recovery of amortized cost (See also “Liquidity and Capital Resources”). Inherent in our assessment are the risks that market factors may differ from our expectations; we may decide to subsequently sell a security for unforeseen business needs or an economic purpose; or changes in the credit assessment from our original assessment may lead us to determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, an impairment would be recognized as a realized loss. Although unrealized losses on fixed maturities are not reflected in the results of financial operations until they are realized, the fair value of the underlying investment, which does reflect the unrealized loss, is reflected in our Consolidated Balance Sheets.

The following table sets forth gross unrealized losses for fixed maturities by maturity period at March 31, 2024 and December 31, 2023. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers.

Our investment portfolio and shareholders’ equity can be significantly impacted by changes in market values of our securities. Market volatility could increase and defaults on fixed income securities could occur. As a result, we could incur additional realized and unrealized losses in future periods, which could have a material adverse impact on our results of operations and/or financial position.

During the first quarter of 2024, the U.S. economy continued its trend of economic resiliency. Strength in consumer spending and the labor market persisted, however inflation continues to exceed the Federal Reserve’s (the “Fed”) two percent long-term target. In light of this, the Fed held the federal funds target rate at a range of 5.25% to 5.50% and has indicated that it does not expect to reduce the target range until it has greater confidence that inflation is moving toward its two percent target. Tighter financial conditions remain a challenge to the U.S. economy and may increase the likelihood of defaults on our fixed income investments, particularly with respect to non-investment grade debt securities. Geopolitical risks also create economic uncertainty, the extent of which is unknown. Although we perform rigorous credit analysis of our fixed income investments, it is difficult to foresee which issuers, industries or markets, if any, will be most affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate, and we could incur additional realized and unrealized losses in future periods.