CAPScall of the Week: Hanover Insurance Group

For years, satirical late-night-TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'd like to take a closer look at Hanover Insurance Group (NYSE: THG  ) .

What Hanover Insurance Group does
Let me guess, it has "insurance" in its name, and you're cringing and/or raging inside already? Hanover Insurance Group is a commercial and consumer property and casualty insurer that underwrites coverage throughout the United States -- including areas recently ravaged by Hurricane Sandy.

In Hanover's latest quarterly report, released last week, the insurer reported a 24% increase in EPS as net premiums rose 6.6% over the previous year and its book value increased 12.1% to $61.00. Catastrophe losses were also more than halved over the previous year. However, Hanover's commercial underwriting proved particularly poor, with a combined ratio of 105.8% (meaning it lost money on underwritten policies) as $17 million in catastrophe losses and an unfavorable prior-year loss reserve development of $4.4 million drove up the loss ratio. 

Whom it competes against
One of the downsides of operating in the P&C insurance industry is that there's very little differentiation between one company and the next. This also means that Hanover's biggest, and constant, obstacle is low customer loyalty.

Perhaps the largest obstacle it'll face over the coming months, however, will be the total bill from Hurricane Sandy. If it's any consolation, Hanover isn't the only company that may need to drastically lower its full-year earnings forecast because of Sandy. Chubb (NYSE: CB  ) , Travelers (NYSE: TRV  ) , and Allstate (NYSE: ALL  ) all stand to face rough waters in the coming quarter or two as they assess the true financial impact of the storm. Even reinsurers like Berkshire Hathaway (NYSE: BRK-B  ) are poised to take a big hit from Hurricane Sandy -- Berkshire reports in a few months.

What's worth remembering here, though, is that these insurers handle one-time catastrophe losses for a living. Although the forecast for these companies may appear bleak now, catastrophes of Sandy's magnitude give insurers valid reasons to raise premiums, which quickly help to wipe out one-time losses. It's also worth noting that flood damage isn't often covered by standard homeowners insurance, which may ultimately get many of these insurers off the hook.

The call
After carefully reviewing the prospects for Hanover Insurance Group, I've decided to make a CAPScall of outperform on the company.

On the downside, we're well aware that the upcoming quarter or two for the entire P&C insurance sector is going to be ugly. Yet there are plenty of positives that signify Hanover is making all the right moves. Net premiums are rising, which signifies to me that the company has significant premium pricing power, and, most importantly, it's focused on increasing shareholder value as is evidenced by the 12% jump in book value. Let me also point out that Hanover is trading at just 58% of its book value -- a bargain even within the already cheap insurance sector. Finally, Hanover's $7.9 billion in investments is largely in cash and fixed-rate maturities, of which 95% are considered investment grade. Not surprisingly, this is one reason I consider its current 3.4% dividend yield to be very safe.

Since reinventing the wheel isn't a part of the P&C insurance sector, I see Hanover's slow but steady approach to creating shareholder value as a long-term driver that'll eventually reward its investors.

Curious if Hurricane Sandy represents a real problem for Berkshire Hathaway's reinsurance business? Find out the answer to this question and much more by getting your copy of our latest premium research report on Berkshire Hathaway. Packed with in-depth analysis on the opportunities and threats facing Berkshire -- and complete with a year of regular updates -- this report will give you the tools needed to make smart long-term decisions. Click here to get your copy.

Also, I encourage you to contribute to the relief effort in the wake of Hurricane Sandy. You can start by making a donation to the Red Cross or your favorite charitable organization. Thank you!


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