10. STOCK-BASED COMPENSATION PLANS

On May 16, 2006, the shareholders approved the adoption of The Hanover Insurance Group, Inc. 2006 Long-Term Incentive Plan (the “Plan”). Key employees, directors and certain consultants of the Company and its subsidiaries are eligible for awards pursuant to the Plan, which is administered by the Compensation Committee of the Board of Directors (the “Committee”) of the Company. Under the Plan, awards may be granted in the form of non-qualified or incentive stock options, stock appreciation rights, performance awards, restricted stock, unrestricted stock, stock units, or any other award that is convertible into or otherwise based on the Company’s stock, subject to certain limits. The Plan authorized the issuance of 3,000,000 new shares that may be used for awards. In addition, shares of stock underlying any award granted and outstanding under the Company’s Amended Long-Term Stock Incentive Plan (the “1996 Plan”) as of the adoption date of the Plan that are forfeited, cancelled, expire or terminate without the issuance of stock become available for future grants under the Plan. As of December 31, 2012, there were 1,351,319 shares available for grants under the Plan. The Company utilizes shares of stock held in the treasury account for option exercises and other awards granted under both plans.

Compensation cost for the years ended December 31, 2012, 2011, and 2010 totaled $12.8 million, $12.2 million and $11.1 million, respectively. Related tax benefits were $4.5 million, $4.3 million and $3.9 million, respectively.

Stock Options

Under the Plan, options may be granted to eligible employees, directors or consultants at an exercise price equal to the market price of the Company’s common stock on the date of grant. Option shares may be exercised subject to the terms prescribed by the Committee at the time of grant. Options granted in 2012, 2011, and 2010 generally vest over 4 years with a 50% vesting rate in the third year and a 50% vesting rate in the fourth year. Options must be exercised not later than ten years from the date of grant.

Information on the Company’s stock option plans is summarized below.


FOR THE YEARS ENDED DECEMBER 31	2012					2011					2010
(in whole shares and dollars)	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price
Outstanding, beginning of year		2,715,430		$	38.57		2,843,909		$	39.22		3,131,142		$	39.16
Granted		529,500			36.84		297,000			46.47		412,250			42.72
Exercised		(90,624	)		25.47		(120,064	)		32.82		(326,823	)		36.88
Forfeited or cancelled		(101,574	)		41.45		(49,165	)		41.67		(247,260	)		44.49
Expired		(159,850	)		44.05		(256,250	)		57.00		(125,400	)		44.91
Outstanding, end of year		2,892,882		$	38.28		2,715,430		$	38.57		2,843,909		$	39.22
Exercisable, end of year		1,630,382		$	37.18		1,686,930		$	37.69		2,037,159		$	39.74

Cash received for options exercised for the years ended December 31, 2012, 2011 and 2010 was $2.3 million, $3.9 million and $12.1 million, respectively. The intrinsic value of options exercised for the years ended December 31, 2012, 2011 and 2010 was $1.2 million, $1.8 million and $2.6 million, respectively.

The excess tax expense realized from options exercised for the years ended December 31, 2012, 2011, and 2010 was $0.4 million, $1.5 million, and $0.1 million, respectively. The aggregate intrinsic value at December 31, 2012 for shares outstanding and shares exercisable was $8.4 million and $6.5 million, respectively. At December 31, 2012, the weighted average remaining contractual life for shares outstanding and shares exercisable was 5.0 years and 2.7 years, respectively. Additional information about employee options outstanding and exercisable at December 31, 2012 is included in the following table:


	Options Outstanding						Options Currently Exercisable
Range of Exercise Prices	Number		Weighted Average Remaining Contractual Lives		Weighted Average Exercise Price		Number		Weighted Average Exercise Price
$14.94 to $28.88		263,195		0.65		23.37		263,195	$	23.37
$30.29 to $34.19		387,750		6.15		34.11		189,500	$	34.11
$35.00 to $36.50		362,913		2.03		36.17		362,913	$	36.17
$36.81		496,500		9.06		36.81		—		—
$36.88 to $41.10		369,195		1.45		36.95		357,195	$	36.90
$42.15 to $44.88		301,423		6.91		42.35		21,673	$	44.87
$45.21 to $46.47		318,500		7.69		46.27		50,000	$	45.21
$46.28 to $48.46		393,406		4.11		47.84		385,906	$	47.85

The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. For all options granted through December 31, 2012, the exercise price equaled the market price on the grant date. Compensation cost related to options is based upon the grant date fair value and expensed on a straight-line basis over the service period for each separately vesting portion of the option as if the option was, in substance, multiple awards.

The weighted average grant date fair value of options granted during the years ended December 31, 2012, 2011 and 2010 was $8.87, $12.23 and $11.48, respectively.

The following significant assumptions were used to determine the fair value for options granted in the years indicated.


	2012			2011			2010
Dividend yield		3.13% to 3.26	%		2.152	%		1.68% to 2.37	%
Expected volatility		32.86% to 35.27	%		31.53% - 33.30	%		32.45% to 39.18	%
Weighted average expected volatility		34.05	%		32.42	%		33.50	%
Risk-free interest rate		0.61% - 1.06	%		2.00% - 2.35	%		0.87% to 2.70	%
Expected term, in years		4.5 to 5.5			4.5 to 5.5			2.5 to 5.5

The expected dividend yield is based on the Company’s dividend payout rate(s), in the year noted. Expected volatility is based on the Company’s historical daily stock price volatility. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term of options granted represents the period of time that options are expected to be outstanding and is derived using historical exercise, forfeit and cancellation behavior, along with certain other factors expected to differ from historical data.

The fair value of shares that vested during the year ended December 31, 2012 was $1.6 million. For the years ended December 31, 2011 and 2010, the market price of shares that vested was lower than the value of these shares on their grant date. As of December 31, 2012, the Company had unrecognized compensation expense of $6.0 million related to unvested stock options that is expected to be recognized over a weighted average period of 2.6 years.

Restricted Stock Units

Stock grants may be awarded to eligible employees at a price established by the Committee (which may be zero). Under the Plan, the Company may award shares of restricted stock, restricted stock units, as well as shares of unrestricted stock. Restricted stock grants may vest based upon performance criteria, market criteria or continued employment and be in the form of shares or units. Vesting periods are established by the Committee.

The Company granted market-based restricted share units in 2012 and performance-based restricted share units in 2011 and 2010 to certain employees. These share units vest after the achievement of certain performance targets at a rate of 50% after three years and the remaining 50% after four years of continued employment. The Company also granted restricted stock units to eligible employees that generally vest at a rate of 50% after three years and the remaining 50% after 4 years of continued employment. The following table summarizes information about employee restricted stock units.


FOR THE YEARS ENDED DECEMBER 31	2012					2011					2010
	Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Time-based restricted stock units:
Outstanding, beginning of year		768,529		$	40.17		838,129		$	40.93		700,904		$	41.12
Granted		174,841			37.01		198,957			42.08		367,197			42.77
Vested		(137,194	)		36.19		(230,613	)		44.40		(118,730	)		47.92
Forfeited		(55,339	)		40.47		(37,944	)		41.23		(111,242	)		40.73
Outstanding, end of year		750,837		$	40.15		768,529		$	40.17		838,129		$	40.93
Performance and market-based restricted stock units:
Outstanding, beginning of year		69,500		$	45.37		101,680		$	39.62		145,635		$	42.79
Granted		96,150			36.91		42,500			46.47		41,250			42.15
Vested		—			—		(27,059	)		45.21		(31,558	)		48.46
Forfeited		(32,875	)		43.28		(47,621	)		34.16		(53,647	)		44.97
Outstanding, end of year		132,775		$	39.97		69,500		$	45.37		101,680		$	39.62

Time-based restricted stock units granted in 2012 and 2011 were significantly lower compared to 2010 due to a shift in awards granted to non-executive officers from time-based restricted stock units to time-based cash awards.

Performance based restricted stock units are based upon the achievement of the performance metric at 100%. These units have the potential to range from 0% to 133% of the shares disclosed, which varies based on grant year and individual participation level. Increases above the 100% target level are reflected as granted in the period in which performance-based stock unit goals are achieved. Decreases below the 100% target level are reflected as forfeited. In 2012, performance-based stock units of 31,750 were included as forfeited due to completion levels of less than the threshold achievement level for shares granted in 2010. The weighted average grant date fair value for these awards was $42.15. In 2011, performance-based stock units of 47,375 were included as forfeited due to completion levels of less than the threshold achievement level for shares granted in 2009. The weighted average grant date fair value for these awards was $34.19. In 2010, performance-based stock units of 11,472 were included as forfeited due to completion levels less than 100% for units granted in 2007. The weighted average grant date fair value for these awards was $48.46. Additionally, in 2010, 25,055 performance-based stock units were included as forfeited due to completion levels of less than 100% for units originally granted in 2008. The weighted average grant date fair value for these awards was $45.21.

In 2012, the Company granted 92,400 market-based awards to certain members of senior management, which are included in the table above as performance and market-based restricted stock activity. The attainment of these stock units is based on the relative total shareholder return (“TSR”) of the Company. This metric is based on a three-year average relative TSR as compared to a Property and Casualty Index of peer companies. The fair value of market based awards was estimated at the date of grant using a valuation model. These units have the potential to range from 0% to 150% of the shares disclosed.

The intrinsic value, which is equal to the fair value for restricted stock and for restricted stock units that vested during the year ended December 31, 2012, was $1.7 million. There was no intrinsic value of performance-based restricted stock since units that would have vested in 2012 were forfeited in the previous year due to the aforementioned completion levels of less than threshold. The intrinsic value of restricted stock units and performance-based restricted units that vested during the year ended December 31, 2011 were $10.2 million and $1.3 million, respectively. The intrinsic value of restricted stock units and performance-based restricted units that vested during the year ended December 31, 2010 were $5.0 million and $1.3 million, respectively.

At December 31, 2012, the aggregate intrinsic value of restricted stock and restricted stock units was $29.1 million and the weighted average remaining contractual life was 1.5 years. The aggregate intrinsic value of performance and market-based restricted stock units was $5.1 million and the weighted average remaining contractual life was 2.7 years. As of December 31, 2012, there was $14.5 million of total unrecognized compensation cost related to unvested restricted stock units and performance and market-based restricted stock units, assuming performance and market-based restricted stock units are achieved at 100% of the performance metric. The cost is expected to be recognized over a weighted-average period of 2.3 years. Compensation cost associated with restricted stock, restricted stock units and performance and market-based restricted stock units is generally calculated based upon grant date fair value, which is determined using current market prices.