February 24, 2015 The Hartford Financial Services Group Inc. (HIG-NYSE) Current Recommendation Prior Recommendation Outperform Date of Last Change 02/24/2015 Current Price (02/23/15) $41.16 Target Price $43.00 NEUTRAL SUMMARY We are downgrading our recommendation on The Hartford to Neutral based on low revenues and bleak 2015 outlook. Nevertheless, the fourth-quarter earnings surpassed the Zacks Consensus Estimate on better P&C results, reduced corporate losses and low share count. Its core business strengthening capacities, efficient capital deployments and strong ratings are other positives. Moreover, divestitures, capital management endeavors along with strong auto and home product lines bode well for long-term growth. Apart from reducing market risks, the sale of HLIKK has enhanced the company s financial flexibility to execute capital management plans for 2014 15. Nevertheless, catastrophe exposure and challenging regulatory environment raise concern. A weak Talcott Resolution segment is also a drag. SUMMARY DATA 52-Week High $42.27 52-Week Low $33.30 One-Year Return (%) 20.57 Beta 2.00 Average Daily Volume (sh) 3,314,897 Shares Outstanding (mil) 424 Market Capitalization ($mil) $17,452 Short Interest Ratio (days) 3.47 Institutional Ownership (%) 91 Insider Ownership (%) 1 Annual Cash Dividend $0.72 Dividend Yield (%) 1.75 5-Yr. Historical Growth Rates Sales (%) -0.6 Earnings Per Share (%) -0.9 Dividend (%) 29.1 P/E using TTM EPS 11.7 P/E using 2015 Estimate 10.9 P/E using 2016 Estimate 9.8 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Low, Type of Stock Large-Value Industry Ins-Multi Line Zacks Industry Rank * 97 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 9,043 A 5,465 A 5,641 A 6,087 A 26,236 A 2014 3,901 A 4,087 A 4,147 A 4,158 A 16,293 A 2015 4,326 E 4,532 E 4,599 E 4,475 E 17,932 E 2016 13,750 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.92 A $0.66 A $1.03 A $0.94 A $3.55 A 2014 $1.18 A $0.31 A $1.06 A $0.96 A $3.51 A 2015 $1.00 E $0.77 E $0.94 E $1.07 E $3.78 E 2016 $4.18 E Projected EPS Growth - Next 5 Years % 10 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Founded in 1810 and headquartered in Connecticut, The Hartford Financial Services Group Inc. is one of the major multi-line insurance and investment companies in the country, providing investment products, group life and group disability insurance, property and casualty (P&C) insurance and mutual funds in the U.S. The company sells diverse innovative products through multiple distribution channels to consumers and businesses. It continuously seeks to develop and expand its distribution channels by achieving cost efficiencies through economies of scale and improved technology. It also capitalizes on its brand name and The Hartford Stag Logo, one of the most recognized symbols in the financial services industry. In the fourth quarter of 2012, The Hartford changed its reporting segments. The company now reports through the following segments: The Property & Casualty Commercial segment offers workers compensation, property, automobile, marine, livestock, liability and umbrella coverage mainly in the U.S. The segment also offers various customized insurance products and risk management services including professional liability, fidelity, surety and specialty casualty coverage. The Consumer Markets segment offers standard automobile, homeowners and home-based business coverage to individuals throughout the U.S. The segment also includes a special program designed exclusively for members of American Association of Retired Persons (AARP). Consumer Markets also manage a member contact center for health insurance products offered through the AARP Health program. AARP represents a significant portion of the total Consumer Markets business, generating earned premiums of $2.9 billion in 2013, $2.8 billion in 2012 and 2011, $2.9 billion in 2010 and $2.8 billion in both 2009 and 2008, and $2.7 billion in 2007. The Group Benefits segment provides employers, associations, affinity groups and financial institutions with group life, accident and disability coverage, along with other products and services, including voluntary benefits and group retiree health. The Mutual Funds segment provides retail mutual funds and college savings, along with investment management and administrative services including product design, implementation and oversight. The Talcott Resolution segment includes the U.S. annuity, international annuity, and institutional and private-placement life insurance runoff businesses. The segment also covers the Retirement Plans and Individual Life businesses, which were sold at the beginning of 2013. The Property & Casualty Other Operations segment consists of the management of certain property and casualty operations that have stopped writing new business and almost all of the company s asbestos and environmental exposures. Additionally, the company has a Corporate category, which includes The Hartford s debt financing and related interest expenses, along with other capital raising activities and certain purchase accounting adjustments and miscellaneous charges not allocated to the other segments. As a holding company distinct from its subsidiaries, The Hartford relies on the dividends from its insurance companies and other subsidiaries as the principal source of cash flow to meet its obligations. On Mar 31, 2010, The Hartford made its TARP repayment of $3.4 billion, which was received on Jun 26, 2009. Further, at the end of Sep 2010, the U.S. Treasury liquidated its 52.1 million 10-year warrants held in The Hartford, through the auction process. The warrants were sold at a price of $13.70 each, thereby Equity Research HIG Page 2
raising $706.3 million. These warrants carried a minimum bidding price of $10.50 each. The Hartford s warrants sanction the warrant-holders to purchase its shares for $9.79 each, expiring on Jun 29, 2019. More details will be provided following the release of The Hartford s 10-K filing. REASONS TO BUY The Hartford has been vending non-core businesses to concentrate on its U.S. operations and enhance its operating leverage. Apart from lowering expenses, boosting profitability and improving returns to shareholders, these divestitures are also enhancing financial flexibility by freeing up more capital. The company divested its Japan annuity company, Hartford Life Insurance K.K. (HLIKK) in Jun 2014 that was expected to generate pro-forma capital benefit of about $1.4 billion, of which $1 billion was projected to be deployed for capital management initiatives. Nevertheless, this deal led to an income tax benefit of $350 million in 2014. Meanwhile, the divestment of UK variable annuity (VA) business, Hartford Life International Limited (HLIL), in Dec 2013 has reduced the risk and expenses associated with the overall VA block. Further, the company vended its Retirement Plans and Individual Life Insurance businesses and its new variable annuity business infrastructure in Jan 2013. Earlier, the company divested The Hartford Life Private Placement and Woodbury Financial Services, terminated its Individual Annuity businesses, and sold its subsidiaries SRS, Trumbull Services LLC and Federal Trust Corporation. These efforts increased The Hartford s focus on its P&C, Mutual Funds and Group Benefits segments, which not only generate strong revenues, but also have admirable market standing. Meanwhile, the collaboration with IBM in Apr 2014 has been enhancing the core businesses to drive growth. Following the industry trend, The Hartford has stabilized significantly, since mid-2010, with improved earnings performance, positive credit trends and strengthened capital and liquidity position. The company expects to generate core earnings of $1.55 $1.65 billion in 2015, higher than that in 2014, driven by growth from P&C, Group Benefits and Mutual Funds segments. The company s intentions to focus on expanding its product portfolio and underwriting capabilities, enhancing distribution effectiveness, improving the customer experience and operating efficiency, is expected to boost earnings further. Additionally, the company expects to come up with new industry verticals in middle market to strengthen its global presence. The Hartford s strong monetary results, satisfactory financial leverage, considerable cash balance and limited credit and investment risks have boosted the company s future prospects. Consequently, in April 2014, A.M. Best affirmed the financial strength rating (FSR) of A and Issuer Credit Rating (ICR) of a+ of a subsidiary Hartford Insurance Pool. The rating agency also affirmed the ICR of The Hartford Service Group at bbb+. The outlook of all the ratings was raised to positive from stable. In Mar 2014, Moody s affirmed the debt ratings of The Hartford at Baa3 senior and the IFS rating of the P&C and Hartford Life & Accident Insurance Company subsidiaries at A2. The outlook on these ratings was raised to positive from stable. All the rating actions reflect significant risk-reduction related to the VA block of business, strong risk-adjusted capitalization, underwriting and operating strength and solid market position in P&C business. Previously, in Apr 2012, Standard & Poor's (S&P) had affirmed its BBB/A-2 ratings on The Hartford. A rating upgrade or affirmation reflects the rating agencies increased confidence in the company and hence, leads to an enhancement in investors confidence as well. The Hartford s capital appreciations, repayment of government funds and measures to de-risk its balance sheet have increased its financial strength. The company had authorized a $500 million equity repurchase program in Jan 2013 that was increased thrice by $750 million in Jun 2013, by another $750 million in Jan 2014, followed by a $775 million increase in Jul 2014, bringing the total authorization to $2.775 billion. Under this, The Hartford repurchased shares worth $1.9 billion till Equity Research HIG Page 3
Jan 31, 2015 and is left with equities worth approximately $0.9 billion for repurchases. The $775 million increase in equity buyback authorization in Jul 2014 along with a $500 million debt repayment plan comprised the latest capital management plan worth $3.931 billion for 2014 15. The company s debt repayments worth $200 million in 2014, resorting to refinancing options from time to time and freeing up of capital due to the sale of HLIKK are also consistent with its aim to reduce borrowing costs and boost financial flexibility. Further, the 20% dividend hike in Jul 2014 reflects the company s intentions to boost investors return. Furthermore, the investment portfolio has been strengthened by an improved investment method and active risk management undertaken by the company. The company is now looking forward to more such transactions that can increase the release of capital, thereby executing proficient capital management plans and creating shareholder value. The Hartford expects to deploy $2.6 billion towards the holding company obligations and capital management plans, leading to net holding company cash and short-term investments of nearly $1.8 billion by Dec 31, 2015. This should be accretive to the company s capital deployment activities in 2016 and beyond. After witnessing weakness in its auto and home product lines for some years, The Hartford has recorded improvement in new business premiums over the last two years. New business premiums increased across both the lines of business, whereas policy retention improved in 2012 and 2013. New business premiums increased, while premium retention was stable year over year in 2014 as well, thereby contributing to the overall increase in earned and written premiums. In particular, states like Florida, Illinois and Arizona showcased considerable improvements. Further, with the completion of the new business quoting and issuance platform, ICON as well as the launch of a commercial auto product this year, the company expects to expand its distribution, thereby making way for new business generation. Additionally, improvement in both AARP direct and agency businesses contributed to premium growth. To improve services further, the company launched an online quoting platform in Jun 2014. The introduction of the commercial auto product on this new quote-to-issue platform completes the small product suite of the company and is expected to generate returns going forward. REASONS TO SELL As a P&C insurer, The Hartford is substantially exposed to catastrophic events. While The Hartford and the other P&C insurers had witnessed low catastrophe losses in the first nine months of 2012, the devastation caused by Hurricane Sandy caused the company to incur gross losses of $370 million in fourth-quarter 2012. Although catastrophe losses declined in 2013, there was a rise of 115.5% to $222 million in 2014, mainly due to the winter storms and unfavorable weather conditions across various U.S. geographic regions. The company s 2015 catastrophe loss guidance of $293 million represents nearly 32% increase over that of 2014, discarding the possibility of a trend reversal. The unpredictable nature of such weather-related events continues to raise caution for the coming quarters, thereby posing operating risks. Net investment income of The Hartford varies significantly with changes in market conditions, thereby affecting the net income to a great extent. Net investment income declined 0.8% to $4.2 billion in 2012, 21% to $3.4 billion in 2013 and 3.4% to $3.2 billion in 2014 due to a decline in income from fixed maturities and limited partnerships. Moreover, owing to the recent movement in treasury yields a reversal in the trend is unlikely. Significant fluctuations in the fixed income or equity markets could weaken the company s financial condition in the future. Changes in market interest rates may impact the yield on certain investments such as mortgage-backed securities (MBS) and may result in reinvestment of funds received from calls and prepayments at rates below the average portfolio yield. Equity Research HIG Page 4
The Talcott Resolution segment has been a drag for quite some time owing to lowered earnings from divested businesses and continued run-off of the annuity block. Net income from the segment declined from $540 million in 2011 to $1 million in 2012 and resulted in a loss of $634 million in 2013. While net loss narrowed to $187 million in 2014, even the sale of Retirement Plans and Individual Life failed to strengthen the operational efficiencies in the Talcott Resolution segment and generate earnings. Given the soft performance of the U.S. VA business, we do not expect any longterm trend reversal. Moreover, higher catastrophes and expenses associated with policyholder initiatives on the U.S. annuity business, raise concern going forward. The Hartford s finances and operations are significantly impacted by the challenging regulatory environment. In Apr 2012, the company had to refund premiums worth $24 million to its accidental death and dismemberment policyholders, after failing to meet the minimum medical loss ratio requirement of the Patient Protection and Affordable Care Act. Moreover, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 imposed several restrictions and regulations on financial institutions in order to protect consumers interest. Under this reform, the U.S. and overseas governmental and regulatory authorities are considering enhanced regulatory requirements to prevent future crisis and to stabilize the institutions under their supervision. Further, the Financial Services Oversight Council created under the act has the power to designate chosen financial institutions as systemically important. In case The Hartford is designated as systemically important, it will be subjected to higher levels of scrutiny and regulation than others. Such measures are likely to result in stricter regulation of financial institutions in general and heightened prudential requirements for systemically important companies in particular. RECENT NEWS The Hartford Q4 Earnings Beat Estimates on Better P&C Results Feb 2, 2015 The Hartford Financial Services Group reported fourth-quarter 2014 operating earnings per share of $0.96 which surpassed the Zacks Consensus Estimate by 3.2%. Earnings also improved 22% from the year-ago quarter. Better property and casualty (P&C) underwriting results, decline in Corporate core losses and reduction in share count led to this improvement. Including loss from discontinued operations, pension settlement, net reinsurance gain on dispositions, net realized capital gains and post-tax deferred acquisition costs, restructuring and other expenses and an unlock charge totaling $0.10 in the reported quarter, The Hartford s net income was $0.86 per share, up 32% year over year. Total revenue of The Hartford came in at $4.6 billion, down 3.3% year over year, mainly due to lower premiums, fee income and net investment income. However, the figure breezed past the Zacks Consensus Estimate of $3.1 billion. Segment Results Property & Casualty (P&C): This segment s core earnings were $316 million, up 5% year over year, mainly due to improvement in the current accident year (CAY) underwriting results. P&C reported net income of $327 million in the reported quarter, decreasing 5% from $346 million in the year-ago period. P&C written premiums increased 5% from the year-ago quarter to $2.5 billion on the back of growth in both Commercial and Personal Lines. Moreover, combined ratio improved 370 basis points (bps) to 93.8. Equity Research HIG Page 5
Combined ratio, excluding catastrophes and prior-year development (PYD), improved to 92.0 from 95.8 in the prior-year quarter. Investment income was $282 million, down 13% year over year, while underwriting gain soared 152% to $159 million from $63 million. This segment reported catastrophe losses of $19 million in the reported quarter, narrower than $28 million in the year-ago quarter. This improvement was primarily attributable to a year-over-year decline in the number of catastrophe events in the quarter. Group Benefits: This segment of The Hartford generated core earnings of $45 million in the reported quarter, down 18% year over year owing to a margin reduction in the group disability operations. Net income came in at $48 million, lower than $58 million in the prior-year quarter. This was mainly due to a decline in core earnings. Group Benefits fully insured ongoing premiums declined 3% to $737 million. Meanwhile, loss ratio deteriorated 130 bps year over year to 76%, owing to less favorable group disability results. Mutual Funds: Core earnings at The Hartford s Mutual Funds segment increased 35% year over year to $27 million. Growth in fee revenues from increased average Mutual Fund assets under management (AUM) and encouraging state income tax benefit mainly led to the upside. Total Net income in the quarter also rose 21% year over year to $23 million. Total AUM came in at $93.6 billion as of Dec 31, 2014, down 3% from $96.7 billion as of Dec 31, 2013. Decline in Talcott Resolution AUM including planned AUM transfers within the company during the reported quarter led to the downside. Talcott Resolution: Core earnings at Talcott Resolution came in at $98 million, down 1% year over year. This decrease came on the back of the persistent run-off of the variable annuity (VA) block. The segment reported net income of $144 million, comparing favorably with a net loss of $15 million in the year-ago quarter. Corporate: The Hartford s Corporate segment recorded core loss of $60 million, narrower than the yearago quarter loss of $92 million. The segment s net loss was reported at $160 million, wider than $94 million in the year-ago quarter. Financial Update The Hartford's total invested assets, excluding trading securities, were $76.3 billion as of Dec 31, 2014, compared with $78.7 billion as of Dec 31, 2013. This decline stemmed from the sale of the Japan annuity business in the second quarter of 2014. Net investment income of The Hartford was $752 million in the reported quarter, down 7% year over year due to a decrease in investment income on other alternative investments (LPs), the effect of a reduction in Talcott Resolution AUM and lower annualized investment yields. The Hartford s shareholder equity came in at $18.7 billion as of Dec 31, 2014, down slightly from $18.9 billion as of Dec 31, 2013, due to share repurchases and dividend payouts. Book value per share increased to $42.84 as of Dec 31, 2014, from $39.14 as of Dec 31, 2013. Excluding accumulated other comprehensive income (AOCI), The Hartford s book value increased 4% to $40.71 as of Dec 31, 2014 from $39.30 per share as of Dec 31, 2013. Securities Update In the reported quarter, The Hartford spent $300 million toward share buybacks, bringing the total repurchase worth to $1.8 billion as of Dec 31, 2014. Additionally, the company completed the accelerated share repurchase (ASR) program during the reported quarter. As of Jan 30, 2015, The Hartford has Equity Research HIG Page 6
deployed $1.9 billion toward equity repurchases under its $2.775 billion capital management plan announced in 2014. This includes $101 million deployed for the period Jan 1, 2014 through Jan 30, 2015. Guidance The Hartford expects full-year 2015 core earnings to be in the range of $1.55 $1.65 billion, higher than that of 2014. This includes post-tax catastrophe losses of $293 million in Commercial and Personal Lines and an unfavorable prior-year-development (PYD) of $21 million in Commercial Lines. Adjusted core earnings is expected to be in the range of $1.57 $1.67 billion, compared with $1.51 billion in 2014. P&C catastrophe loss ratio is expected to deteriorate to 4.3 from 3.4 in 2014. Group Benefits core earnings post-tax margin is expected to be in the range of 5.0% 5.5%, compared with 5.2% in 2014. The Hartford expects Talcott Resolution core earnings to decrease to $340 $370 million from $433 million in 2014. Equity Research HIG Page 7
VALUATION The Hartford shares currently trade at 10.9x our earnings estimate for 2015, an 8% discount to the 11.8x industry average. On a price-to-book basis, the shares trade at 0.9x, which is an 18% discount to the 1.1x industry average. The valuation on a price-to-book basis looks slightly stretched, given a trailing 12- month ROE of 8.5%, which is slightly below the industry average of 8.9%. Our six-month target price of $43.00 per share equates to about 11.4x our earnings estimate for 2015. Combined with the $0.72 per share annual dividend, this target price implies an expected return of 5.3% over that period. This is consistent with our Neutral recommendation on the shares. Additionally, the quantitative Zacks Rank for The Hartford is currently 3, indicating no clear directional pressure on the shares over the near term. Short interest is currently 3.5 days. Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF P/E P/E 5-Yr High P/E 5-Yr Low The Hartford Financial Services Group, Inc. (HIG) 10.9 9.8 10.0 5.6 11.7 18.6 4.9 Industry Average 11.8 10.7 11.0 40.7 13.5 43.1 8.9 S&P 500 16.8 15.7 10.7 15.3 19.4 19.4 12.0 Ageas SA/NV (AGESY) 11.6 11.0 13.0 4.7 19.1 59.6 5.6 Cigna Corp. (CI) 14.1 12.8 11.0 12.8 16.0 14.4 6.8 Loews Corporation (L) 13.4 12.1 NA 5.9 16.9 19.4 8.6 SCOR SE (SCRYY) NA NA NA 10.7 7.4 12.2 6.8 TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA The Hartford Financial Services Group (HIG) 0.9 1.0 0.3 8.5 0.3 1.9 9.1 Industry Average 1.1 1.1 1.1 8.9 0.4 1.7 5.5 S&P 500 5.3 9.8 3.2 25.5 NA 2.1 NA Equity Research HIG Page 8
Earnings Surprise and Estimate Revision History Equity Research HIG Page 9
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HIG. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.7%, Neutral - 75.5%, Underperform 8.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Content Ed. Lead Analyst QCA Rageshree Bose Priyanka Bhattacharyya Tanuka De Meenakshi Sharma Tanuka De Equity Research HIG Page 10