8. PENSION PLANS

Defined Benefit Plans

The Company recognizes the funded status of its defined benefit plans in its Consolidated Balance Sheets. The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation of the Company’s defined benefit plans. The Company is required to aggregate separately all overfunded plans from all underfunded plans.

U.S. Defined Benefit Plans

Prior to 2005, THG provided retirement benefits to substantially all of its employees under defined benefit pension plans. These plans were based on a defined benefit cash balance formula, whereby the Company annually provided an allocation to each covered employee based on a percentage of that employee’s eligible salary, similar to a defined contribution plan arrangement. In addition to the cash balance allocation, certain transition group employees who had met specified age and service requirements as of December 31, 1994 were eligible for a grandfathered benefit based primarily on the employees’ years of service and compensation during their highest five consecutive plan years of employment. The Company’s policy for the plans is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974 (“ERISA”).

As of January 1, 2005, the defined benefit pension plans were frozen and since that date, no further cash balance allocations have been credited to participants. Participants’ accounts are credited with interest daily, based upon the General Agreement of Trades and Tariffs. In addition, the grandfathered benefits for the transition group were also frozen at January 1, 2005 levels with an annual transition pension adjustment calculated at an interest rate equal to 5% per year up to 35 years of completed service, and 3% thereafter.

On January 4, 2010 the Company made a discretionary contribution of $100 million to the qualified defined benefit pension plan. Including this contribution, and based on current estimates of plan liabilities and other assumptions, the qualified defined benefit pension plan is underfunded by approximately $15 million as of December 31, 2012.

Chaucer Pension Plan

Prior to 2002, the Chaucer segment provided defined benefit pension retirement benefits to certain of its employees. As of December 31, 2001, the defined benefit pension plan was closed to new members. The defined benefit obligation for this plan is based on the employees’ years of service and final pensionable salary. Contributions are made at least annually to this plan by both the Company and by employees. As of December 31, 2012, based on current estimates of plan liabilities and other assumptions, this plan is underfunded by approximately $25 million.

Assumptions

In order to measure the expense associated with these plans, management must make various estimates and assumptions, including discount rates used to value liabilities, assumed rates of return on plan assets, employee turnover rates and anticipated mortality rates, for example. The estimates used by management are based on the Company’s historical experience, as well as current facts and circumstances. In addition, the Company uses outside actuaries to assist in measuring the expense and liability associated with these plans.

The Company measures the funded status of its plans as of the date of its year-end statement of financial position. The Company utilizes a measurement date of December 31st to determine its benefit obligations, consistent with the date of its Consolidated Balance Sheets.

Weighted-average assumptions used to determine the U.S. pension benefit obligations are as follows:


DECEMBER 31	2012		2011		2010
Discount rate – qualified plan		4.25%		5.13%		5.63%
Discount rate – non-qualified plan		4.13%		5.00%		5.50%
Cash balance interest crediting rate		3.50%		4.00%		4.50%

Weighted-average assumptions used to determine the Chaucer pension benefit obligations are as follows:


DECEMBER 31	2012		2011
Discount rate		4.80%		4.90%
Rate of increase in future compensation		4.20%		4.30%

The Company utilizes a measurement date of January 1st to determine its periodic pension costs. Weighted-average assumptions used to determine net periodic pension costs for the U.S. defined benefit plans are as follows:


FOR THE YEARS ENDED DECEMBER 31	2012		2011		2010
Qualified plan
Discount rate		5.13%		5.63%		6.13%
Expected return on plan assets		6.00%		6.50%		7.00%
Cash balance interest crediting rate		4.00%		4.50%		4.50%
Non-qualified plan
Discount rate		5.00%		5.50%		6.00%

Weighted-average assumptions used to determine net periodic pension costs for the Chaucer pension plan are as follows for the year ended December 31, 2012 and the six months ended December 31, 2011:


FOR THE PERIOD ENDED DECEMBER 31	2012		2011
Discount rate		4.90%		5.50%
Rate of increase in future compensation		4.30%		4.60%
Expected return on plan assets		7.50%		7.40%

The expected rates of return were determined by using historical mean returns, adjusted for certain factors believed to have an impact on future returns. Specifically, for the U.S. defined benefit plans, because the allocation of assets between fixed maturities and equities has changed, as discussed in “Plan Assets” below, the historical mean return was adjusted downward slightly to reflect this asset mix. The adjusted mean returns were weighted to the plan’s expected target asset allocation at December 31, 2012, resulting in an expected rate of return on plan assets for 2012 of 6.00%. The Company reviews and updates, at least annually, its expected return on plan assets based on changes in the actual assets held by the plans.

Plan Assets

U.S. Qualified Defined Benefit Plans

The Company utilizes a target allocation strategy, which focuses on creating a mix of assets that will generate modest growth from equity securities while minimizing volatility in the Company’s earnings from changes in the markets and economic environment. Various factors are taken into consideration in determining the appropriate asset mix, such as census data, actuarial valuation information and capital market assumptions. During 2012 and 2011, the plan assets were invested 84% and 82%, respectively, in fixed income securities and 16% and 18%, respectively, in equity securities. The Company reviews and updates, at least annually, the target allocation and makes changes periodically.

The following table provides target allocations and actual invested asset allocations for 2012 and 2011.


DECEMBER 31	2012 TARGET LEVELS		2012		2011
Fixed Income Securities:
Fixed Maturities		80%		83%		81%
Money Market Funds		2%		1%		1%
Total Fixed Income Securities		82%		84%		82%
Equity Securities:
Domestic		13%		10%		11%
International		5%		3%		4%
THG Common Stock		0%		3%		3%
Total Equity Securities		18%		16%		18%
Total Assets		100%		100%		100%

Included in total plan assets of $591.6 million at December 31, 2012 were $586.6 million of invested assets carried at fair value and $5.0 million of cash and equivalents. Total plan assets at December 31, 2011 of $574.7 million included $568.8 million of invested assets carried at fair value and $5.9 million of cash and equivalents.

The following tables present for each hierarchy level the U.S. qualified defined benefit plan’s investment assets that are measured at fair value at December 31, 2012 and 2011. (Please refer to Note 5 – “Fair Value” for a description of the different levels in the Fair Value Hierarchy).

DECEMBER 31, 2012

(in millions)

Fair Value

Total

Level 1

Level 2

Level 3

Fixed Income Securities:

Fixed Maturities

491.4

3.3

488.1

—

Equity Securities:

Domestic

58.3

0.4

57.9

—

International

18.8

0.1

18.7

—

THG Common Stock

18.1

—

Total Equity Securities

95.2

18.6

76.6

—

Total Investments at Fair Value

586.6

21.9

564.7

—


DECEMBER 31, 2011
(in millions)	Fair Value
	Total		Level 1		Level 2		Level 3
Fixed Income Securities:
Fixed Maturities	$	465.9	$	3.2	$	462.7	$	—
Equity Securities:
Domestic		61.4		0.3		61.1		—
International		25.2		0.2		25.0		—
THG Common Stock		16.3		16.3		—		—
Total Equity Securities		102.9		16.8		86.1		—
Total Investments at Fair Value	$	568.8	$	20.0	$	548.8	$	—

Fixed Income Securities

Securities classified as Level 1 at December 31, 2012 and 2011 include actively traded mutual funds and publicly traded securities which are valued at quoted market prices. Securities classified as Level 2 at December 31, 2012 and 2011 include a separate investment account, which is invested entirely in the Vanguard Total Bond Market Index Fund, a mutual fund that in turn invests in investment grade fixed maturities, as well as a custom fund that invests in commingled pools and investment grade fixed income securities. The fair value of each of the Level 2 investments is determined daily as the Net Asset Value (“NAV”) based on the value of the underlying investments, which is determined independently by the investment manager. The daily NAV, which is not published as a quoted market price for these investments, is used as the basis for transactions. Redemption of these funds is not subject to restriction.

Equity Securities

Level 1 securities primarily consist of 466,755 shares of THG common stock held by the plan at December 31, 2012 and 2011. THG common stock is valued at quoted market prices. Securities also classified as Level 1 at December 31, 2012 and 2011 include actively traded mutual funds that are publicly traded and which primarily invest in equity securities that are valued at quoted market prices. Securities classified as Level 2 include investments in commingled pools that primarily invest in publicly traded common stocks and international equity securities. The fair value of each of the Level 2 investments is determined daily as the NAV based on the value of the underlying investments, which is determined independently by the investment manager. The daily NAV, which is not published as a quoted market price for these investments, is used as the basis for transactions. Redemption of these funds is not subject to restriction.

Chaucer Pension Plan

The investment strategy of the Chaucer defined benefit pension plan is to invest primarily in growth assets in the form of equity funds which are expected to provide a positive return that exceeds inflation over the longer term in order to protect the existing and future liabilities of the pension plan. In order to reduce volatility and diversify the portfolio, the target allocation includes an exposure to corporate bond and commercial property funds. The plan will be reviewed annually and target allocation changes will be made as appropriate. The following table provides target allocations and actual invested asset allocations for 2012 and 2011.

DECEMBER 31

2012

TARGET
LEVELS

2012

2011

Fixed Income Securities:

Fixed Maturities

10%

14%

12%

Equity Securities:

Domestic (United Kingdom)

35%

33%

34%

International

45%

44%

44%

Total Equity Securities

80%

77%

78%

Real Estate Funds

10%

10%

Total Assets

100%

100%

Included in total plan assets of $90.9 million at December 31, 2012 were $90.7 million of invested assets carried at fair value and $0.2 million of cash and equivalents. Total plan assets at December 31, 2011 of $74.3 million included $74.1 million of invested assets carried at fair value and $0.2 million of cash and equivalents.

The following table presents for each hierarchy level the Chaucer defined benefit plan’s investment assets that are measured at fair value at December 31, 2012 and 2011.


DECEMBER 31, 2012
(in millions)	Fair Value
	Total		Level 1		Level 2		Level 3
Fixed Income Securities:
Fixed Maturities	$	12.9	$	—	$	12.9	$	—
Equity Securities:
Domestic		29.9		—		29.9		—
International		39.7		—		39.7		—
Total Equity Securities		69.6		—		69.6		—
Real Estate Funds		8.2		—		—		8.2
Total Investments at Fair Value	$	90.7	$	—	$	82.5	$	8.2

December 31, 2011
(in millions)	Fair Value
	Total		Level 1		Level 2		Level 3
Fixed Income Securities:
Fixed Maturities	$	8.5	$	—	$	8.5	$	—
Equity Securities:
Domestic		25.5		—		25.5		—
International		32.4		—		32.4		—
Total Equity Securities		57.9		—		57.9		—
Real Estate Funds		7.7		—		—		7.7
Total Investments at Fair Value	$	74.1	$	—	$	66.4	$	7.7

Fixed Income and Equity Securities

Securities classified as Level 2 at December 31, 2012 and 2011 include pooled funds which are valued at the close of business using a third party pricing service. These values are adjusted by the fund manager to reflect outstanding dividends, taxes and investment fees and other expenses to calculate the NAV.

Real Estate Funds

Real estate fund investments classified as Level 3 at December 31, 2012 and 2011 are valued based upon the values of the net assets of the fund. Although the NAV is calculated daily, transactions also consider cash inflows and outflows of the fund. The price where units are transacted includes the NAV, which is adjusted for investment charges and other estimated acquisition costs such as legal fees, taxes, planning and architect fees, survey and agent fees, among others.

The table below provides a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).


FOR THE PERIOD ENDED	2012		2011⁽¹⁾
(in millions)
Balance at beginning of period	$	7.7	$	7.7
Actual return on plan assets related to assets still held		—		0.2
Foreign currency translation		0.5		(0.2	)
Balance at end of year	$	8.2	$	7.7

(1)	For the period July 1, 2011 (date of acquisition) to December 31, 2011.

Obligations and Funded Status

The Company recognizes the current net underfunded status of its plans in its Consolidated Balance Sheets. Changes in the funded status of the plans are reflected as components of accumulated other comprehensive loss or income. The components of accumulated other comprehensive loss or income are reflected as either a net actuarial gain or loss or a net prior service cost. The following table reflects the benefit obligations, fair value of plan assets and funded status of the plans at December 31, 2012 and 2011. U.S. qualified and non-qualified plan amounts represent activity for the calendar year. Chaucer pension plan amounts in 2012 represent activity for the calendar year and in 2011 reflect activity since the date of acquisition of July 1, 2011.


DECEMBER 31	U.S. Qualified Pension Plans						U.S. Non-Qualified Pension Plans						Chaucer Pension Plan
(in millions)	2012			2011			2012			2011			2012			2011
Accumulated benefit obligation	$	607.0		$	570.8		$	41.2		$	39.2		$	116.6		$	104.4
Change in benefit obligation:
Projected benefit obligation, beginning of period	$	570.8		$	548.0		$	39.2		$	39.1		$	104.4		$	99.7
Employee contributions		—			—			—			—			0.4			0.3
Service cost – benefits earned during the period		—			—			—			—			1.6			0.7
Interest cost		28.1			29.6			1.9			2.0			5.2			2.7
Actuarial losses		49.0			24.5			3.3			1.2			1.8			6.4
Benefits paid		(40.9	)		(31.3	)		(3.2	)		(3.1	)		(2.4	)		(1.9	)
Foreign currency translation		—			—			—			—			5.6			(3.5	)
Projected benefit obligation, end of year		607.0			570.8			41.2			39.2			116.6			104.4
Change in plan assets:
Fair value of plan assets, beginning of period		574.7			547.8			—			—			74.3			82.1
Actual return on plan assets		57.8			58.2			—			—			9.9			(4.6	)
Company contribution		—			—			3.2			3.1			4.5			1.0
Employee contributions		—			—			—			—			0.4			0.3
Benefits paid		(40.9	)		(31.3	)		(3.2	)		(3.1	)		(2.4	)		(1.9	)
Foreign currency translation		—			—			—			—			4.2			(2.6	)
Fair value of plan assets, end of year		591.6			574.7			—			—			90.9			74.3
Funded status of the plans	$	(15.4	)	$	3.9		$	(41.2	)	$	(39.2	)	$	(25.7	)	$	(30.1	)

Components of Net Periodic Pension Cost

The components of total net periodic pension cost are as follows:


FOR THE YEARS ENDED DECEMBER 31	2012			2011			2010
(in millions)
Service cost – benefits earned during the period	$	1.6		$	0.7		$	0.1
Interest cost		35.2			34.3			32.6
Expected return on plan assets		(38.7	)		(37.1	)		(35.1	)
Recognized net actuarial loss		12.8			15.0			16.8
Amortization of transition asset		—			—			(1.6	)
Amortization of prior service cost		0.1			0.1			0.1
Net periodic pension cost	$	11.0		$	13.0		$	12.9

The following table reflects the total amounts recognized in accumulated other comprehensive income relating to both the U.S. defined benefit pension plans and the Chaucer pension plan as of December 31, 2012 and 2011.


DECEMBER 31	2012		2011
(in millions)
Net actuarial loss	$	147.3	$	135.0
Net prior service cost		—		0.1
	$	147.3	$	135.1

The unrecognized net actuarial gains (losses) which exceed 10% of the greater of the projected benefit obligation or the fair value of plan assets are amortized as a component of net periodic pension cost in future years. The following table reflects the total estimated amount of actuarial losses that will be amortized from accumulated other comprehensive income into net periodic pension cost in 2013:


Estimated Amortization in 2013	Expense
(in millions)
Net actuarial loss	$	14.3

Contributions

On January 4, 2010, the Company made a discretionary contribution of $100.0 million to the U.S. qualified defined benefit pension plan. These funds were invested primarily in fixed income investments. With this contribution, and based upon the current estimate of liabilities and certain assumptions regarding investment return and other factors, the Company’s U.S. qualified defined benefit pension plan is underfunded by approximately $15 million. However, the Company is not required to fund its U.S. qualified benefit plan in 2013. The Company expects to contribute $3.1 million to its U.S. non-qualified pension plans to fund 2013 benefit payments, and $4.5 million to the Chaucer pension plan. At this time, no additional discretionary contributions are expected to be made to the plans during 2013 and the Company does not expect that any funds will be returned from the plans to the Company during 2013.

Benefit Payments

The Company estimates that benefit payments over the next 10 years will be as follows:


FOR THE YEARS ENDED DECEMBER 31	2013		2014		2015		2016		2017		2018 - 2022
(in millions)
Qualified pension plans	$	39.1	$	39.8	$	40.5	$	40.3	$	41.8	$	208.0
Non-qualified pension plans	$	3.1	$	3.2	$	3.4	$	3.1	$	3.0	$	14.3
Chaucer pension plan	$	2.5	$	2.6	$	2.7	$	2.8	$	2.9	$	15.9

The benefit payments are based on the same assumptions used to measure the Company’s benefit obligations at the end of 2012. Benefit payments related to the U.S. qualified plans and the Chaucer plan will be made from plan assets, whereas those payments related to the non-qualified plans will be provided for by the Company.

Defined Contribution Plan

In addition to the defined benefit plans, THG provides a defined contribution 401(k) plan for its U.S. employees, whereby the Company matches employee elective 401(k) contributions, up to a maximum percentage of 6% in 2012, 2011, and 2010. The Company’s expense for this matching provision was $17.9 million, $17.8 million and $16.5 million for 2012, 2011 and 2010, respectively. In addition to this matching provision, the Company can elect to make an annual contribution to employees’ accounts. There were no additional contributions in 2012, 2011, and 2010.

Chaucer also provides a defined contribution plan for its employees which provides for employer provided contributions. The Company’s expense for the year ended December 31, 2012 and the six months ended December 31, 2011 was $4.8 million and $2.4 million, respectively.