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HIG AT A GLANCE

P/E ► -4.11   EV/EBITDA ► -6.03   ROA ► -0.6% AVG ROE ► -15.4% LOW Debt to Equity ► 17.1 VERY HIGH Current Ratio ► 0   Interest Coverage Ratio ► -6.59 VERY LOW

 

 

 

 

 

 

The Hartford Financial Services Group (NYSE: HIG) is a multi-line insurance and investment company that operates primarily in the United States. The Hartford operates in two broad segments: Life and Property & Casualty (P&C). Based in Connecticut, the Hartford has offered its services in the United States since 1810, but since has expanded its operations to Canada, Japan, Brazil, Ireland, and the United Kingdom ^[1].

While The Hartford has increased its net income over the past five fiscal years, and had net income of $2.949 billion in FY2007, the company, along with its competitors, and specifically AIG, was significantly affected by the 2008 Financial Crisis. In 3Q08 alone, The Hartford had a net loss of $2.631 billion, and $2.749 billion for FY2008 ^[2], primarily due to loss in its investment portfolio, its Japanese variable annuities business, and other business segments ^[3]. Losses due to pre-tax impairments of The Hartford's investment portfolio were $3.15 billion, of which $2.3 billion were as a result of investments in the financial sector ^[4].

These impairments for corporate debt and equity securities account for losses related to The Hartford's investment portfolio. The net investment loss on equity securities, held for trading also explains the discrepancy between the Life Insurance segment's proportion of total revenue (12%) and net income (84%). As revenue and net income were $8.654 and -$1.943 billion, the $5.84 billion investment loss for 1Q08-3Q08 caused this discrepancy; it has not been consistent ^[5]. Over the same period in FY2007, the Life Insurance segment accounted for 53% of revenue and 54% of net income ^[6]. Lead by losses in the Japanese market of $932 million, The Hartford's International core earnings have fallen from $64 million in 2Q08 to -$75 million in 3Q08 ^[7].

Both senior management and consumers are responding to the economic climate by attempting to avoid risk and leverage. In Japan, there has been a movement from variable to fixed annuities, as deposits of fixed annuities increased by 115% in 4Q08 to $43 million ^[8]. Further, The Hartford's relationship with the AARP helps the company to differentiate its insurance products, which approach being treated as commodities. Personal Line written premiums, directly related to the AARP deal, increased by 3% in 2008 compared to 2007 ^[9], and retirement plan deposits increased from $1.4 billion in 3Q07 to $2.3 billion in 3Q08 ^[10]. Given that there were over 38 million people who were 65 or older in 2008, and that this statistic is projected to double by 2050, the Hartford is positioned to exploit this competitive advantage ^[11].

Business Overview

The Hartford is one of the seven largest multi-line insurance companies, a company that offers both life and non-life policies, in the United States ^[12]. The company's two major operations, Life and Property & Casualty, are further divided into eleven reporting segments. Although the company has expanded its international operations, as of 2007, 95.9% of revenue was earned in North America ^[13].

Business and Financial Metrics

Financial Discussion

The Hartford's revenue and net income, 2005-2007^[14]

From fiscal year 2004 to 2007 The Hartford's net income had increased by an average of 12%, including an increase from $2.745 to $2.949 between FY2006 and FY2007 ^[15]. However, like most companies in the financial sector, The Hartford was negatively impacted by the 2008 Financial Crisis. CEO Ramani Ayer referred to 3Q08 as "the most challenging in the Hartford’s history" ^[16]. This is evident, as The Hartford had a net loss of $2.631 billion for 3Q08 ^[17]. The loss can be attributed to two main causes: impairments and deferred acquisition costs (DAC). Impairments, which resulted in a $2.3 billion net investment loss, had the most significant impact on The Hartford's 3Q08 earnings; however, the $932 million loss as a result of DAC played a role as well ^[16]. Of the significant loss attributed to The Hartford's investment portfolio, of which 73% was tied to the financial services sector, $785 million (~34%) was a result of defaults or capital restructuring and is considered permanent ^[18].

Although The Hartford had a significant net loss for 3Q08, its two main operations, Life and P&C, did perform relatively well, given the economic climate. Life core earnings fell from $1,535 to $302 million from 3Q07 to 3Q08 and assets under management fell by 9%, from $367 to $333 billion, over the same time comparison ^[19]. Yet, certain products in the Life Insurance operations still performed well overall for FY2008, as individual life, group benefits, and international revenue increased by $20, $96, and $186 million, respectively, between FY2007 and FY2008 ^[20]. P&C core earnings fell as well in 3Q08 as compared to 3Q07 ($1,215 to $865 million); however, ongoing written premium remained nearly constant ($7.9 to $7.8 billion)^[21]. The Hartford remains well diversified, as its P&C and retirement and investment products account for 60% and 40% of core earnings for the first nine months of 2008, respectively ^[22].

Business Segments

Life (11.8% of revenue, 84.2% of net income) ^[25]

The Hartford's Life Insurance revenue by reporting segment, 1Q08-3Q08 ^[26]

The Hartford's life insurance operations is carried out by the company's indirect wholly-owned subsidiary, Hartford Life, Inc., which can further be broken down into six reporting segments: Retail Products Group (“Retail”), Retirement Plans, Institutional Solutions Group (“Institutional”), Individual Life, Group Benefits and International ^[27]. The Life segment provides investment products, such as variable annuities, fixed annuities, mutual funds, and retirement plan services individual life policies group benefit products, such as group life and group disability policies and variable corporate-owned life insurance (COLI) policies ^[28]. For the nine months ended September 30, 2008, the Life segment earned $1.018 billion of revenue and had a net loss of $1.636 billion; whereas for the same period in 2007, the Life segment earned $10.779 billion of revenue and had net income of $1.281 billion ^[25].

Property & Casualty (87.9% of revenue, 10.2% of net income) ^[29]

The Hartford's P&C revenue by reporting segment, 1Q08-3Q08 ^[26]

The Property & Casualty operation is conducted through the Hartford itself, and is made up of five unique reporting segments: the underwriting segments of Personal Lines, Small Commercial, Middle Market and Specialty Commercial (collectively “Ongoing Operations”); and the Other Operations segment ^[30]. The P&C segment is among of the top ten in the U.S., based on net premiums written ^[31]. Personal Lines writes automobile and homeowners insurance; Small Commercial and Middle Market offer insurance coverage to small and middle market businesses in the United States, respectively; Specialty Commercial offers customized insurance products and risk management services to primarily large companies; and Other Operations consists of The Hartford's discontinued businesses that still have outstanding policies ^[32]. The Hartford's P&C segment accounted for $7.605 billion and $199 million of revenue and net loss, respectively, for the nine months ended September 30, 2008 ^[25]. Over the same period in 2007, the P&C segment had revenue of $9.431 billion and net income of $1.158 billion ^[25].

Corporate (0.4% of revenue, 5.6% of net income) ^[33]

Though not part of the Hartford's core business segments, the Corporate segment includes operations related to capital structure financing, such as corporate debt financing and interest expenses accompanied by this ^[34]. The Corporate segment of The Hartford's operations contributed $31 million in revenue and lost $108 million of net income for the nine months ended September 30, 2008 ^[25].

Key Trends and Forces

Financial crisis causes The Hartford's investment portfolio to decline in value

The Hartford has a $90 billion investment portfolio, which, as 3Q08 exemplified, is susceptible to market risk that can lead to significant losses for the company ^[35]. Although equity and fixed income securities related to the financial services sector make up only 9% of The Hartford's investment portfolio ($8.4 billion as of 31 October 2008) ^[36], these investments nonetheless caused pre-tax impairments of $2.4 billion in 3Q08 ^[37]. The Hartford has since begun the process of divesting itself of financial services companies and reducing risk and leverage in its investment portfolio, the company still is significantly influenced by its investment decisions and market risk ^[38].

Global market crashes have triggered clauses in Japanese variable annuities, leading to losses for The Hartford

Distinct from the $2.4 billion in pre-tax impairments as a result of losses with its investment portfolio is The Hartford's losses due to its variable annuities business, particularly in the Japanese market. Following an overall 3Q08 loss of $2.63 billion, including $932 million due to variable annuities, The Hartford CEO Ramani Ayer has shifted the focus of senior management to "'de-risk[ing]' its annuities book." ^[39] Given the importance of this business to The Hartford's international presence and that ~35% of 3Q08's net loss and ~20% of FY2007's net income of $2.9 billion can be attributed to the variable annuities business, Mr. Ayer is correct to prioritize this aspect of The Hartford's operations ^[39]. The Hartford's variable annuity business is of particular importance internationally, as it managed $35.1 billion of annuity assets in Japan during 3Q08, including deposits of $868 million and $231 million in variable annuity and fixed annuity assets, respectively ^[40]. At the root of the problem is the October 2008 global stock market crash, as it triggered the account value floor of the riders of $3 billion of Japanese variable annuities. This rider allowed policyholders whose account loses 20% of its original value to either "withdraw 80% of their original investment with no surrender charge," or "recover the entire original investment through a 15-year payout annuity." ^[41] As Mr. Ayer reported, "Our plans are to reassess product features and pricing in light of consumer preferences, risk management and capital needs with the goal of substantially reducing the risk arising out of our variable annuity businesses" ^[42]. The results of this reassessment and "de-risking" will not be observable until 1Q09 to 2Q09 ^[43].

The Hartford is positioned to capitalize on the coming demographic shift in the United States with the retirement of Baby Boomers

The Hartford's long-standing partnership with the AARP, which has existed since 1984 and entitles The Hartford to be the AARP's exclusive provider of Automobile and Homeowners Insurance, provides the company with a competitive advantage. The AARP is a 40 million member organization dedicated to helping people over 50 improve the quality of their lives ^[44]. In 2008, there were about 38 million people who were over 65 year old; however, by 2050, this population figure is projected to double ^[45]. The Hartford's strong branding with this segment of the population through the AARP will help the company to distinguish its products in an otherwise competitive industry, in which products approach being treated as commodities ^[46]. The Hartford's strong relationship with consumers who are retired or are approaching retirement is reflected in the performance of its Retirement Plan and Personal Line divisions. Between 3Q07 and 3Q08, retirement assets under management has grown from $28.6 billion to $43.3 billion, a 51% increase. Retirement deposits grew by an even larger proportion over the same period, as they grew from $1.4 billion to $2.3 billion, a 67% increase ^[47]. Personal Line written premiums have been growing at a 7% compounded annual growth rate (CAGR) and have had over 92% retention in AARP related insurance since 2003 ^[48]. The partnership between The Hartford and AARP has recently been renewed for a third time, and will continue until at least January 2020 ^[49]. Benefits gained by AARP members who also have insurance through The Hartford include personalized customer service and access to a gerontology team that works for the AARP ^[49]. Given that the AARP's current membership base is 38 million ^[50], and that by the end of the current contract, over one-third of all Americans will be eligible for the AARP, this exclusive partnership provides The Hartford with comparative advantage and a catalyst for growth in all its business segments ^[51].

Competition

As The Hartford offers both Life and P&C insurance it competes either directly or offers similar financial products to many different insurance companies. Five of The Hartford's most significant competitors are:

• American International Group (AIG): AIG offers four main operating segments, of which its General Insurance and Life Insurance & Retirement Services segments most directly compete with The Hartford. These two segments accounted for $35,854 and $14,271 million of total revenue for the nine months ended September 30, 2008, respectively. Like The Hartford, AIG also has a significant presence in Japan and earned $10,664 million of revenue for the nine months ended September 30, 2008 in this market ^[52]. In September 2008, as part of a response to over $18 billion in losses caused by the company's exposure to credit-default swaps, the Federal Reserve granted AIG an $85 billion loan, and in return, the U.S. Government was given a 79.9% equity stake in the company ^[53].

• Berkshire Hathaway (BRK): Berkshire Hathaway, managed by famous value-investor Warren Buffett, directly competes with The Hartford through its Insurance group, which earned $22,305 million of revenue from 1Q08-3Q08 ^[54].
• MetLife (MET): MetLife competes with The Hartford in both Life and P&C insurance, and it outperformed The Hartford from 1Q08-3Q08, as it earned net income of $2.224 billion ^[55]. Its life insurance, automobile and homeowner insurance, and annuities businesses all offer substitutes for The Hartford's products ^[56]
• Prudential Financial (PRU): Prudential earned $493 million from 1Q08-3Q08, and competes with The Hartford through its life insurance and annuities businesses. Like The Hartford, Prudential targets both individual and institutional clients, and Prudential has established operations outside the United States in Asia, Europe, and Latin America ^[57].
• Allstate (ALL): Allstate, like The Hartford, had a net loss during 1Q08-3Q08; however, it was less than The Hartford's, as the company lost $505 million ^[58]. It competes with both the Life and P&C divisions of The Hartford, and offers such products as automobile and homeowner's insurance and retirement products ^[59].

References

1. ↑ HIG 10-K, page 3
2. ↑ 2008 HIG 10-K, page F-3
3. ↑ HIG 10-Q, page 3
4. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 6
5. ↑ 2008 HIG 10-Q, page 15
6. ↑ 2008 HIG 10-Q, page 15
7. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 20
8. ↑ 4Q08 Earnings Slides FINAL.pdf HIG 4Q08 Investor Presentation, page 29
9. ↑ 4Q08 Earnings Slides FINAL.pdf HIG 4Q08 Investor Presentation
10. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 18
11. ↑ "An Older and More Diverse Nation by Midcentury." US Census Press Releases.
12. ↑ The New York Times. Insurance - Multiline.
13. ↑ 2007 HIG 10-K, page F-34
14. ↑ 2007 HIG 10-K, page 48
15. ↑ 2008 HIG 10-K, page F-3
16. ↑ ^{16.0 16.1} Seeking Alpha. Hartford Financial Services Group, Inc. Q3 2008 Earnings Call Transcript.
17. ↑ 2008 HIG 10-Q, page 4
18. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 6
19. ↑ 12 5 08 FINAL (2).pdf HIG December 5, 2008 Investor Presentation, page 40, 44
20. ↑ 2008 HIG 10-K, page F-27
21. ↑ 12 5 08 FINAL (2).pdf HIG December 5, 2008 Presentation, page 41
22. ↑ 12 5 08 FINAL (2).pdf HIG December 5,2008 Investor Presentation, page 6
23. ↑ ^{23.0 23.1 23.2 23.3 23.4 23.5 23.6 23.7 23.8} HIG 2007 10-K, Consolidated Results of Operations, page II-48
24. ↑ ^{24.0 24.1 24.2} HIG 2007 10-K, page 31
25. ↑ ^{25.0 25.1 25.2 25.3 25.4} HIG 10-Q, page 14-15
26. ↑ ^{26.0 26.1} 2008 HIG 10-Q, page 14
27. ↑ 2008 HIG 10-Q, page 13
28. ↑ 2007 HIG 10-K, page F-29
29. ↑ 2008 HIG 10-Q, page 4
30. ↑ 2007 HIG 10-K, page F-29-30
31. ↑ The Hartford Investor Relations
32. ↑ 2007 HIG 10-K, page F-29-30
33. ↑ 2008 HIG 10-Q, page 13
34. ↑ HIG 2007 10-K, page F-32
35. ↑ The Hartford Holds New York Investor Meeting. 5 December 2008.
36. ↑ 12 5 08 FINAL (2).pdf HIG 5 December 2008 Investor Presentation, page 20
37. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 6
38. ↑ 12 5 08 FINAL (2).pdf HIG 5 December 2008 Investor Meeting, page 23
39. ↑ ^{39.0 39.1} Scism, Leslie and Liam Pleven. The Wall Street Journal. "Hartford Aims to Take Risk Out of Annuities." 13 January 2009.
40. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 20
41. ↑ Seeking Alpha. Hartford Financial Services Group, Inc. Q3 2008 Earnings Call Transcript, page 3.
42. ↑ The Hartford Holds New York Investor Meeting. 5 December 2008
43. ↑ 12 5 08 FINAL (2).pdf HIG December 5 2008 Investor Presentation, page 38
44. ↑ About AARP
45. ↑ "An Older and More Diverse Nation by Midcentury." US Census Press Releases.
46. ↑ Insurance Journal. "The Hartford, AARP Renew Contract." 5 December 2001.
47. ↑ Slides FINAL 233.pdf HIG 3Q08 Investor Presentation, page 18
48. ↑ 12 5 08 FINAL (2).pdf HIG December 5, 2008 Presentation, page 54
49. ↑ ^{49.0 49.1} The AARP. "Auto & Home Insurance Program from The Hartford." 2009.
50. ↑ The AARP. "About AARP."
51. ↑ All Business. "Implications of Exploding AARP Membership."
52. ↑ 2008 AIG 10-Q, page 13-14
53. ↑ "U.S. to Take Over AIG in $85 Billion Bailout." The Wall Street Journal.
54. ↑ 2008 Berkshire Hathaway 10-Q, page 13
55. ↑ 2008 MET 10-Q
56. ↑ NYTimes Topics, MetLife, Inc.
57. ↑ 2008 PRU 10-Q
58. ↑ 2008 ALL 10-Q, page 1
59. ↑ NYTimes Topics, Allstate Corporation