The Hartford Financial Services Group, Inc (HIG) April 22...
Transcript of The Hartford Financial Services Group, Inc (HIG) April 22...
Important disclosures appear on the last page of this report.
Data Source: Yahoo Finance15
The Henry Fund
Henry B. Tippie School of Management
Stuart Hemesath [[email protected]]
The Hartford Financial Services Group, Inc (HIG) April 22, 2015
Financial Services – Property & Casualty Insurance Stock Rating Hold
Investment Thesis Target Price $37-45 The recent performance of The Hartford has been beneficial to our portfolio, but has also readjusted future expectations. Our valuations result in a market performance expectation amid an industry currently driven by interest rate activity.
Drivers of Thesis
The company’s recent efforts to drive growth through increased commercial relationships, improved software for consumers and agents and 3rd party ventures with AARP will create opportunities within previously stalled, core business units.
Recent focus on customer satisfaction rates will improve client growth and retention in the consumer markets, improving policy growth by 5% and 6% over the next two years, respectively.
The fund forecasts the 10 year treasury yield to rise to 2.4% by year-end and 3.3% over the next two years, improving the long-term outlook of the insurance industry and allowing The Hartford to improve revenues driven by investment income.
Risks to Thesis
The Hartford trades at a forward P/E of 19.9, nearly twice its peer average of 11.5, suggesting the company may be overvalued
To support valuations beyond its current trading price, The Hartford relies on revenue growth beyond recent performance and at a premium to its peer group.
The company’s duration of 5.3 years is higher than some of its major P&C peers near 4.1 which means The Hartford will be more adversely impacted in a rising rate environment.
Henry Fund DCF $44.32 Henry Fund DDM $38.59 Relative Multiple $30.90 Price Data Current Price $41.42 52wk Range $33.26 – $42.47 Consensus 1yr Target $45.38 Key Statistics Market Cap (B) $17.24 Shares Outstanding (M) $420.95 Institutional Ownership 91.70% Five Year Beta 1.914 Dividend Yield 1.77% Est. 5yr Growth 7.00% Price/Earnings (TTM) 23.66 Price/Earnings (FY15) 19.90 Price/Sales (TTM) 0.92 Price/Book (MRQ) 0.92 Profitability Operating Margin 10.99% Profit Margin 4.31% Return on Assets (TTM) 0.49% Return on Equity (TTM) 7.17%
Data Source: FactSet7
Earnings Estimates Year 2012 2013 2014 2015E 2016E 2017E
EPS -$0.18 $0.37 $1.82 $1.74 $2.95 $3.79
growth -112.05% N/A 387.49% -4.61% 69.76% 28.50%
12 Month Performance Company Description
The Hartford Financial Services Group is primarily a property and casualty insurance company based in Hartford, Connecticut. It offers an array of insurance and investment products including auto and homeowner’s insurance, business insurance, group employee benefits, mutual funds and still retains legacy variable annuity ventures. The Hartford manages over $245 billion in its investment portfolio.
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EXECUTIVE SUMMARY
Our recommendation is a hold for The Hartford Financial Services Group due to the growth expectations priced into the security to continue its recent outperformance. Despite the initiatives that the Hartford is in the process of implementing to drive future revenues, the growth expectations to achieve a valuation within a buy range are well in excess of recent performance without significant, tangible catalysts as growth drivers. We also believe there is exceptional risk involved with holding this security based on a number of uncertainties within the industry and the securities’ exposure to those risks, which we do not feel are fully absorbed into the current price.
The investment income also draws some concerns. First, the underperformance in net investment income returns in comparison to its peers is an issue to monitor as managing a fixed income portfolio will be crucial to its short-term success in what is expected to be a volatile market in 2015. Secondly, there has been drastic shifts in assets under management (AUM) as the company has sold off its international and variable annuity business ventures and continues to run-off the portion of those ventures still on its balance sheet. Because of that, it remains a major assumption that we have now reached a steady state to resume asset growth.
COMPANY DESCRIPTION
Hartford Financial Services operates in the P&C insurance industry, an industry which is very price competitive and has struggled to maintain margins in both underwriting and investment income. Following the financial crisis of 2008, The Hartford was forced to refocus on its core insurance business units and sell many of its international and variable annuity businesses at a loss.2 Interest rates since then, at historically low levels, have continued to weigh on the company’s profitability. While most of their non-core investment business units have been sold, some of these products still remain on the balance sheet offsetting improved margins within the business.
Source: Hartford Financial Services Group, Inc., 2014 10-K1
Consumer Auto & Homeowner’s Insurance
Consumer P&C remains as one of The Hartford’s two business units, along with commercial insurance, that it considers a core function. Its revenues have remained very steady, nearly unchanged, year-over-year since 2011. Despite its continued focus, growth has yet to be seen in this space. Looking forward, The Hartford has been working with the AARP on joint sponsored plans for AARP members to take advantage of. This is one of their main growth objectives in the short-term.5 The company has also focus on the customer satisfaction and experience aspects of its operations which will also drive growth and customer retention. For these reasons, we see upside on the consumer side of operations with policy volume growing 5% in 2015 and 6% in 2016 before easing to an eventual 2.5% continuous growth rate.
Commercial Insurance
The commercial insurance division includes several products led by workers’ compensation, accounting for 48% of the revenues within its commercial unit, and packaged, or multi-policy, policies. The commercial unit has seen declines in premium revenues in this group for three consecutive years and has been mentioned as an area of focus by management on the most recent 4th quarter conference call.5 The Hartford foresees change in its relationship management, specifically within the middle market, in hopes of regaining some of the market share it has continued to lose since 2011. They also cite improved technology as a means to gain ground on their competitors with the concept of having more instant
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based inquiry results for agents using The Hartford’s resources.4 While this improved software has yet to be released, they feel this will put them at an advantage over their peers which will rely on an underwriting review before they’re able to quote a premium.
The commercial insurance business unit is the company’s largest and most product diversified segment. Its largest sub-segment with 9% of the business unit’s revenues, workers’ compensation, is expected to see growth driven by a stronger focus on relationship management within the middle-market. We have forecasted 6% growth in 2015 and 6% in 2016. The commercial auto sub-segment, however, has shown declining growth in recent years. The company acknowledges this sub-segment as an area for improvement. We forecasted continued declines in this space losing 5% in 2015 and 3% in 2016 before seeing low, but positive growth in the remaining forecast horizon.
Group Benefits
The group benefits units, composed of group disability and group life insurance products, amounts to 17% of the company’s total revenue. This unit has also seen a decline in recent years which the company attributes to lower premiums due to a lack of competitive pricing against the industry.2 The Hartford is focusing on increased sales in 2015 through strong book persistency to regain growth in this space. However, we feel it will take longer to turn around its declining trend. For this reason, we foresee group benefits continuing to decline and have forecasted a decline of 3% in 2015 and 2% in 2016 before seeing positive growth.
Talcott Resolution
Talcott Resolution is comprised of legacy business units tied to the international and variability annuity businesses that the company sold in 2009-2013. Despite making up 10% of the company’s revenues in 2014, the goal of this unit is to shrink and eventually dissolve this source of income as policyholders surrender their policies. This may reduce earnings, but it will also relieve the company of capital requirements due to the significant amount of equity holdings within this unit’s investment portfolio. The company has pushed customers, with success, to convert many of these polies to traditional annuity products to expedite the retirement of this segment. We see this segment decreasing by 10% in 2015 and continuing to decrease at a higher rate until its eventual closure.
Investment Income
Gross investment income accounted for 17% of the company’s 2014 revenue. Net investment income, historically a key income driver for insurance companies in a more favorable interest rate environment, fell dramatically in 2014. While this decline was primarily due to a loss of assets, The Hartford also faced a decline in their net annualized return, excluding alternative assets, from 4.2% in 2013 to 4.1% in year end 2014 citing unfavorable reinvestment rates. The average reinvestment rate in 2014 for The Hartford, 3.6%, lagged the average yield of 3.9% over the same time period.1,2 Despite a positive start in equities and an optimistic outlook for the 10-year treasury rate in 2015, The Hartford’s management foresees further return declines in its 2015 guidance.4
Returns on invested assets create a concern in regards to investment performance moving forward. In addition, AUM declines, while primarily due to business divestures, also pose an inherent risk to the outlook of future net investment income growth. While we have forecasted growth in investment assets through increased fees and premiums, the continued volatility adds to The Hartford’s overall uncertainty on accurate modeling.
Source: Hartford Financial Services Group, Inc., 2014 10-K1
Company Analysis
The Hartford is the 12th largest property and casualty insurer in the US by market share with a market share of 2.01% in 2014.10 The company, as well as several of its peers, has gone through a series of divestures following the financial crisis to refocus on its core business, a topic we will also cover in industry trends. Most notably in recent years, the Hartford sold its UK variable annuity business for $285 million in 2013 and then followed that
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Equity Securities
Mortgage Loans
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LP's and AlternativeInvestmentsShort Term Investments
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up with the sale of its Japanese annuity business for $1.4 billion in 2014.3
Historically Looking
Total revenues continue to slide. While the steep decline in “other sources” is nearly fully explained by divestures, the stagnation of its core P&C businesses raises concern. This segment, both commercial and consumer included, has had a CAGR of -0.6% since 2011. Despite recent financial performance, true growth needs to be seen in its P&C business for long-term stability.
Source: Hartford Financial Services Group, Inc., 2014 10-K1
Future Looking
The previously mentioned business unit sales slimmed down total AUM, but arguably put the company in a better position long-term, where it stands today. With the devaluation of those business units previously accounted for, shedding those loss bearing assets allowed the company to produce significant gains on the bottom line in 2014, improving net income by 387% over its 2013 performance. This structure improvement has been realized in its stock price which has seen a 15% increase since mid-October of 2014, outperforming the S&P which has only risen 9% over that same timeframe. These recent gains have also been the driver giving The Hartford the edge in the most recent 12 months performance. Likewise, we have seen its forward P/E, which was already trading at a premium to its peers, continue to rise increasing from 17.4 in October to its current level of 23.48 over 2015 earnings consensus estimates. This forward P/E, now nearly twice the industry average after a strong performance in late 2014 and early 2015, leaves the price very susceptible to maintaining these growth rates.
Price-to-Earnings Multiples against Peers
Company Price Est EPS ('15) P/E ('15)
American Int'l Group $55.22 $4.94 11.18
ING Groep $14.34 $1.31 10.95
Chubb $100.16 $7.68 13.04
CNA Financial $41.54 $3.52 11.8
Allianz SE $16.78 $1.60 10.49
AXA Group $24.46 $2.56 9.55
Legal & General Group $20.27 $1.46 13.88
Aviva plc $17.03 $1.55 10.99
Average 11.5
Hartford Financial Srv $40.66 $2.04* 19.9
*2015 Estimate derived from attached financial models Source: FactSet7
INDUSTRY TRENDS & DEVELOPMENTS
There are two major and potentially adverse industry trends impacting the insurance industry, interest rate risk and federal regulations, as well as two opportunities to outperform peers and drive growth with a shift to online services and returning to core operations. While it’s possible The Hartford may be less impacted by the proposed legislation in comparison to its larger peers, exposure to these uncertainties may not be favorable to the risk of our portfolio. On the other side, it’s possible for The Hartford to lag behind on both opportunities within the industry. We feel The Hartford is a front-runner on focusing on core operations, but lags in the online services arena, an issue that could cost the company valuable growth.
Interest Rate Risk
Interest rates are the most significant economic driver impacting the insurance industry. Rates, both short and long-term, have remained artificially low for a number of years as a result of the Federal Reserve’s monetary policy and quantitative easing measures. Because of this, the net interest margins for insurers remain compressed, hampering the profitability of their fixed income driven portfolios. Despite the US’s up trending economic outlook and indicators, the Fed remains hesitant to allow rates to increase. This is presumably a result of the poor outlook globally with several countries in the Eurozone concurrently decreasing central bank rates, some with negative short term yields, as well as recent, unfavorable domestic employment data. We foresee the 10 year
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treasury to finally rise in the fourth quarter of 2015 or early 2016. This will drive long-term optimism within the industry which will have a direct impact on the earnings of insurance companies.
10 Year US Treasury Yield
Source: CNBC – US 10 Year Treasury13
The interest rate risk that The Hartford faces will play an integral role in its overall market performance. In the event that rates decline, the company will face higher hedging costs associated with its variable annuity products, face reinvestment risk on its mortgage investments as the current holdings could see repayments through refinancing and, the largest factor, the company will see compressed spreads on its fixed income holdings.
The more likely scenario, rising rates, could also harm the company. If an event triggers long-term interest rates to rise too quickly, the company could face unrealized losses in comparison to its peers due to its disintermediation risk associated with its variable annuity holdings in Talcott Resolutions. Its VA holdings guarantee a certain level of return and a rapid rate increase could cause policyholders to surrender their policies at a rate which would force liquidation of assets below their presumed market value.1 Rising rates will also cause a devaluation to the company’s fixed income portfolio, which accounts for 80% of investable assets. The significance of this devaluation is dependent on the duration, or sensitivity, to rate changes with longer durations facing more impact. At year-end 2014, the company’s fixed maturities had a weighted average duration of 5.3 years. This duration is shorter than most life insurers, but a bit higher than some of its peers. For example, AIG and ACE held durations of 4.3 and 4.0 years, respectively, at year-end 2014.
Despite these risks, The Hartford and the insurance industry as a whole will generally benefit long-term from a rising rate environment. Property and casualty company’s
balance sheets will benefit initially over life insurers, but life insurers have an advantage long-term due the interest margins they’ll receive on their longer duration portfolios.
Regulation
While Dodd-Frank financial reform in the finance industry has generally focused on big banks over the past several years, there has recently been discussions on overlays within the insurance industry. Two issues impacting insurers are increased capital reserve requirements for its investment holdings and the risk of being labeled a systemically important financial institution (SIFI) or, more simply put, too big to fail. While The Hartford is unlikely to be placed in that category, it remains to be seen how this increased attention on insurers will impact the industry long-term.3
There are also two unresolved matters in congress impacting P&C insurers, the National Flood Insurance Program (NFIP) and the Terrorism Risk Insurance Act (TRIA). Both issues include increased policy risks. In regards to NFIP, insurers have removed flood and wind damage from high impact areas requiring NFIP coverage requirements and, similarly with TRIA, insurers have removed damages caused by acts of terrorism from their policies. Resolution on both acts has been extended by Congress, inevitably taking on these risks will play a significant role in future catastrophe reserves.3
Online Consumer Base
Another industry trend which we will see increase in 2015 is the growth of online sales revenues and the need for an online presence. Based on a survey conducted by Deloitte, one in five surveyors stated that they would be “very likely” to buy directly from the insurer online if given the opportunity. Another third would be “somewhat likely” to purchase directly from the insurer online. The likelihood increases significantly when you look at younger demographics and small business owners. Esurance was a pioneer in this space and existed as an online only auto insurance provider. It was acquired by Allstate Insurance in 2011 as it continued to see rapid growth.11
Winning the battle for online sales is vital to spark growth in The Hartford’s stagnant P&C lines. Beyond the initial sale, this creates opportunities for cross-selling products such as group insurance or mutual funds. The ability to offer online services will be a requirement for growth both
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short-term and long. As mentioned earlier, The Hartford has increased focus on providing better online support for its commercial P&C services. It is clear that even with their recent online focus they will face increased competition in this space, potentially lagging some of the leading peers.
Return to Core Operations
While the trend by insurance companies to return to their core business functions has been underway since 2009, we continued to see divestures well into 2014. In addition to the recent business unit sales aforementioned by The Hartford, we saw this trend continue across the industry. For example, struggling competitor AIG sold their airline leasing unit in August of last year with similar efforts to strengthen their balance sheet and return to core insurance operations.3 CNO Financial Group, a diversified insurer and financial services provider, sold its life insurance unit around the same time. The move both reduced overall risk and relieved the company of capital requirement overlays stressing the company. The decision was rewarded with a near instant credit grade lift.12
On the other side, we have also seen multiple instances of non-insurance companies divesting their P&C insurance units in 2014. Two examples of this are Hancock Holding Company and Deere & Company.12 While many of the major P&C institutions have yet to make large acquisitions since the financial crisis, the strengthening and growing confidence in balance sheets could create a buying environment for M&A’s in 2015 as a means to add inorganic growth.
MARKETS AND COMPETITION
As of Q1 2014, the top 15 insurers accounted for only 55% of the market share in written P&C policies which shows the vast market that exists for policy providers. The Hartford found itself at 12th on the list but the spreads are thin among competitors. The competitive landscape to attract new customers primarily exists within marketing. GEICO, a Berkshire Hathaway holding, perhaps has the most recognizable campaign in the “save 15% in 15 minutes” slogan led by the GEICO Gecko. Nearly half of the top 15 below, and several others not included on the list, have memorable characters, slogans or comical themes. The general takeaway is to lure customers to direct online sales channels.
Top 15 P&C Insurance Companies by Market Share
*Denotes mutually owned or privately held Source: National Association of Insurance Commissioners10
Consumers
To many consumers, the decision to choose one policy or policy provider over another comes down to price and customer satisfaction. J.D. Power & Associates provides annual reports surveying various satisfaction rates across companies operating in the US, including P&C insurers. This is an opportunity to understand how consumers view the satisfaction levels of The Hartford as well as its major competitors broken down into separate commercial and consumer level surveys.
The survey proceeding captures small commercial customers’ satisfaction rates based on both the shopping and claims process experiences. The Hartford exists well below its peers in the level 2 rating space, an unacceptable level given it is the leading revenue source for the company at 32%. This is surprisingly an improvement year-over-year. In 2013, The Hartford found itself at the bottom of this list among the 15 included in the survey, however, the industry has also improved 6 points over this period. A noticeable trend on these results is that many of the top ranked companies are mutually or privately held. Among the 11 companies outperforming The Hartford, only four are publicly traded – Allstate, Zurich, Allied and Chubb – none of which received a level 5 rating. Allstate remains a large step ahead of its publicly traded peer group.12
Rank Insurance Company Market Share
1 State Farm Group* 10.33%
2 Liberty Mutual Insurance Cos.* 5.43%
3 Allstate Insurance Group 5.09%
4 Berkshire Hathaway Insurance 4.28%
5 Travelers Group 4.22%
6 Farmers Insurance Group* 3.37%
7 Nationwide Group* 3.34%
8 American International Group 3.29%
9 Progressive Insurance Group 3.24%
10 USAA Group* 2.69%
11 Zurich Insurance Group 2.06%
12 Hartford Insurance Group 2.01%
13 Chubb Group of Insurance Cos. 1.83%
14 ACE Limited Group 1.79%
15 CNA Insurance Cos. 1.65%
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J.D. Power 2014 US Small Business Commercial Insurance Study – Customer Satisfaction Index Rating
Source: J.D. Power12
Other reports published by J.D. Power impacting the P&C industry include “The US Auto Claims Satisfaction Study” and “The US Household Insurance Study”. In the following auto claims satisfaction survey we see a new set of peers and a significant shuffle among those included. Again, private and mutually owned companies continue to take the top spots among the rankings. The Hartford leads among the 8 publicly traded peers included in the survey including Esurance, which is wholly owned by Allstate whom is also included in the survey, and GEICO, a Berkshire Hathaway company. The household insurance study heavily reflects both the same peer group and similar results among that peer group. Results in both surveys, similar to the small commercial survey, represent industry increases year over year.12
J.D. Power 2014 US Auto Claims Satisfaction Study – Overall Customer Satisfaction Index Rating
Source: J.D. Power12
Why do we care?
We believe these publicly available reports are a leading indicator of which companies are best suited to handle future growth and retain its existing customer base. While the industry remains price sensitive to consumers shopping for new policies, companies which can exceed customer expectations are better positioned to retain clients who may otherwise become policy shoppers and attract those conscience of the survey results.
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Peer Comparisons
Company Price Mkt
Cap (B) P/E ('15) P/B
5Y CAGR
Div Yield
The Hartford 40.66 17.4 19.9 0.91 13.53% 1.70%
AIG 55.22 75.1 11.18 0.71 9.33% 0.91%
ING Groep 14.34 54.7 10.95 0.91 11.10% 1.90%
Chubb 100.16 22.9 13.04 1.42 4.32% 2.30%
CNA Financial 41.54 11.0 11.80 0.86 6.26% 2.40%
Progressive 26.32 15.5 13.78 2.24 5.89% 2.60%
Allstate 69.09 28.8 11.13 1.40 6.79% 1.70%
Travelers 105.67 34.0 10.94 1.37 5.48% 2.10%
Data Source: FactSet7
Stock Performance
In comparison to several of its major peers, The Hartford is a distant outperformer in regards to stock market performance, up 61% over the past two years, with Chubb and Progressive as the laggards among the set of 8, up 16% and 6%, respectively. Within the most recent 12 months, Travelers and Allstate have seen the most growth up 27% and 25%. Both, however, retain competitive forward P/E ratios in comparison to their larger peers competing in this space.15
Other Performance Metrics
The composition of several of these companies extend well beyond the P&C industry. ING, for example, provides an array of banking and financial service operations internationally. AIG, the largest in market cap included in this peer set, provides retirement services as well as a vast product line of insurance products. Their performance, product offerings and existence are, to some extent, an anomaly as they were one of the leading financial services companies needed government bailout funds to avoid certain bankruptcy. Their rebuilding and heavy health monitoring can still be seen in their dividend yield, which remains low to ensure they retain sufficient capital requirements. While both of these companies are major P&C competitors, their diversification distances them from the pure play peers.
CNA Financial, a market underperformer (TTM), both disappointed in year-end earnings and received a downgrade on their credit rating to end the year. Their recent performance, which drove down their forward P/E and price-to-book value, makes them an attractive target to look at based on these ratios. They have also announced
expansion plans within Canada that could both provide future growth and limit exposure to US fixed income markets.15
Travelers has managed to drive down expenses in 2014, a key component of the “return to core” process, which has given its value a significant rise within the past 12 months. Despite its recent price increase, it still trades at a forward P/E multiple below the industry average, although it also retains a significantly higher price-to-book ratio. If growth can be added to its progress in cutting costs, there could be opportunity for gains in its stock. From a marketing and online platform perspective, it lags its peer group.15
INVESTMENT POSITIVES
A decision to hold the security maintains exposure to the potential upside of an increasing rate environment and acts as a hedge for securities negatively impacted by rate increases.
The Hartford, now focused on domestic, core P&C operations, has less exposure to the negative impacts of a strengthening dollar. With a primarily large cap portfolio, this again provides a hedge against holdings exposed to large amounts of international revenues.
While we have not seen growth in The Hartford’s primary revenue drivers, their P&C products, new initiatives, including a refocus on commercial lines and improved software for agents and clients, could be the changes needed to positively impact the needed growth in this space.
INVESTMENT NEGATIVES
Continued strength in the economy will continue to drive The Hartford, and the industry sub-sector, further. While this stock would see gains in this environment, there may be peers within the sub-sector better positioned to outperform based on trading multiples and systemic positioning.
As mentioned earlier, there are uncertainties within the sector increasing the risk of holding the security. Any signs suggesting further delays of increasing rates will negatively impact the value and growth expectations systemically as well as
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industry-wide. This holding is not a pure-play on rate increases, but will rise and fall on Fed decisions.
The competition for future growth will be competitive. As we saw on the commercial insurance survey study, The Hartford lags its peers in customer satisfaction rates in the segment driving 32% of 2014 revenues. Management has called for improvements but their competing against an industry that is also showing constant improvement.
With The Hartford announcing improvements on their web interfaces and behind-the-scenes processes to shorten the quote process just last February, there is concern that they may be laggards among their peers. Online sales will continue to play a key role in growth drivers within the industry.
VALUATION
Forecast Assumptions
Despite lagging revenue growth in 2013 and 2014, we have forecasted growth in many business segments based on the prospects of newly implemented and revamped processes and opportunities. Within the P&C commercial business unit, we have forecasted an average growth rate of 2% after one more year of decline in 2015 while we wait to see its initiatives fully implemented. While the initiatives to build relationships and improve the experience should provide a lift, the past declines and disappointing results on the customer satisfaction survey weigh heavily on forecasting an amount any more significant.
The Hartford has best positioned itself to take on growth within the consumer home and auto business units. Its outstanding performance in the consumer satisfaction surveys is also promising as a growth driver in addition to positive unemployment and GDP rates. For this reason, we foresee strong growth at an average of 5% over the next four years before growing at a steady state of 4% as it continues to grow in proportion to its existing commercial lines.
Mutual funds, while not a core operation, have continued to bring in a steady source of income, though only 4% of 2014 revenue. We foresee this growth continuing at an
average rate of 3% moving forward. Group benefits however, accounting for 17% of 2014 revenue, have continued to decline and, with the short-term focus on P&C segments, we see this trend continuing at an average growth rate of -2.5% through 2016. This trend changes in 2017 and beyond where we expect a modest 1% growth rate.
These growth drivers, paired with continued increases in efficiency, both in processes and technologies, and capitalizing on the growth initiatives aforementioned, should be confidently sustainable. In our opinion, these growth rate are generous given past performance, but still lag analyst consensus in many regards.
Relative Valuation Model
As previously mentioned, The Hartford currently trades at a P/E multiple nearly twice its peer group after its recent lift in stock price and also higher than any of the 8 comparable companies within this valuation. As such, its FY1 relative P/E prices its shares at $23.48 or 57% of its current value. Such a disparity suggests that this stock may be overvalued unless the underlying growth rate is achievable. A more indicative measure within the insurance industry is the price-to-book value ratio which can be used to indicate if a stock is undervalued. In this case, The Hartford trades at a P/BV ratio of 0.91, below its peer group average of 1.0, removing an outlier, suggesting that the stock may be undervalued in this case. The price to tangible book value relative model yielded similar results to the P/BV. Given the industry, we believe P/B and P/TB hold stronger as valuation metrics, receiving a two thirds weighting, while P/E (FY1) and P/E (FY2) receive a one thirds weighting. This derived a relative valuation price of $30.90. This result is unsurprising given its high P/E and low P/BV relative to its peer group. This model suggests a significant, continued outperformance is priced in by the market.
Equity Discounted Cash Flow Valuation (DCF)
The equity DCF valuation arrived at a price of $44.32 with the terminal value accounting for 56% of the total value. This presents a potential upside of 7%, considerable of a hold recommendation. As previously mentioned, the value derived from this model plays on the successful completion of the company’s growth initiatives. Because of this, we feel the stock is fairly priced.
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Among the sensitivity analyses in the appendix, the first analysis compares the impact of 1% growth per year on the gross revenue of two products lines, consumer markets and workers’ compensation within the commercial P&C unit. The analysis emphasizes the drastic impact 1% of annual growth has on each of these two product lines and the measures required to achieve a valuation within a favorable recommendation range.
Dividend Discount Model (DDM)
The dividend discount model derived a price of $38.59 with the terminal value accounting for 93% of the total value. The dividends used were within range of analyst expectations suggesting there’s an underlying expectation in equity growth value unaccounted for in this model by the market. The company will need continued performance beyond dividends to support a buy recommendation at this price target.
Valuation Summary
While the DDM shows room for returns in excess of the consensus expected market average, its contingency on meeting or exceeding key growth rates poses significant risks to the overall investment decision. In addition, the uncertainties in the interest rate environment, regulations, and net investment income measures create significant risk overlays. For these reasons we have recommended a hold decision on this security.
REFERENCES
1. THE HARTFORD FINANCIAL SERVICES GROUP, INC., 2014 10-K, February 27, 2015, www.sec.gov
2. THE HARTFORD FINANCIAL SERVICES GROUP, INC., 2013 10-K, February 21, 2014, www.sec.gov
3. S&P Capital IQ, Insurance: Property-Casualty – Industry Overview, September 2014
4. The Hartford Financial Services Group, Inc. (HIG): Q4 2014 Results Earnings Conference Call, February 3, 2015. http://www.nasdaq.com/aspx/call-transcript.aspx?StoryId=2879176&Title=the-hartford-s-hig-ceo-chris-swift-on-q4-2014-results-earnings-call-transcript#ixzz3TZgMIGNPhttp://www.nasdaq.com/aspx/call-
transcript.aspx?StoryId=2879176&Title=the-hartford-s-hig-ceo-chris-swift-on-q4-2014-results-earnings-call-transcript
5. The Hartford: AARP Benefits, Feb 3, 2015, http://www.thehartford.com/aarp/
6. Federal Open Market Committee: 2015 FOMC Meetings, February 14, 2015, http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
7. FactSet 8. Hartford Financial Services Group (HIG),
GuruFocus Charts and Analytics, March 2, 2015, www.gurufocus.com
9. Hartford Financial Services Group (HIG), Y Charts, March 2, 2015, www.ycharts.com
10. Property and Casualty Insurance Industry Top 25 Groups and Companies, National Association of Insurance Commissioners, 2014, http://www.naic.org/documents/web_market_share_140303_2014_property_lob.pdf
11. 2014 Property and Casualty Insurance Industry Outlook, Deloitte, March 6, 2014, https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Financial-Services/dttl-fsi-us-Property-Casualty-Insurance-Outlook-2014-01.pdf
12. CNO Upgraded by S&P after Divesting Insurance Unit, IBJ.com, March 4, 2014, http://www.ibj.com/articles/48423-cno-upgraded-by-s-p-after-divesting-insurance-unit
13. US 10 Year Treasury, CNBC, March 10, 2014, http://data.cnbc.com/quotes/US10Y/tab/2
14. 2014 US Small Business Commercial Insurance Study, J.D. Power, March 10, 2014, http://www.jdpower.com/sites/default/files/2014141_%20Small%20Business%20Insurance_Rev%20NoLink.pdf
15. Yahoo Finance
IMPORTANT DISCLAIMER
Henry Fund reports are created by student enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. These reports are intended to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not
Page 11
registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.
Page 12
The Hartford Financial Services Group, Inc.
Revenue Decomposition (in millions)
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Revenues
Earned premiums, fees, and other considerations
Property & Casualty Commercial
Workers’ compensation 2,987 2,975 2,856 3,027 3,179 3,274 3,340 3,423
Property 505 521 526 542 553 564 578 592
Automobile 587 579 533 506 491 496 506 516
Package business 1,160 1,139 1,048 995 966 975 995 1,015
Liability 562 566 572 589 601 613 628 644
Fidelity and surety 205 201 203 209 213 218 223 229
Professional liability 253 222 213 209 209 211 215 219
Total Property & Casualty Commercial 6,259 6,203 5,951 6,078 6,211 6,350 6,484 6,638
Consumer Markets
Automobile 2,526 2,522 2,547 2,675 2,835 2,948 3,037 3,158
Homeowners 1,110 1,138 1,149 1,207 1,279 1,330 1,370 1,425
Total Consumer Markets 3,636 3,660 3,697 3,881 4,114 4,279 4,407 4,584
Property & Casualty Other Operations -2 1 - - - - - -
Group Benefits
Group disability 1,735 1,452 1,365 1,324 1,297 1,310 1,324 1,337
Group life 1,881 1,717 1,614 1,566 1,534 1,550 1,565 1,581
Other 194 161 151 147 144 145 147 148
Total Group Benefits 3,808 3,331 3,130 3,036 2,976 3,005 3,035 3,066
Mutual Funds
Retail 487 526 531 547 558 564 569 578
Annuity and other 112 152 154 158 161 163 165 167
Total Mutual Funds 599 678 685 705 719 727 734 745
Talcott Resolution 3,548 2,148 1,847 1,663 1,413 1,131 848 594
Corporate 167 11 23 25 26 27 28 30
Total earned premiums and fees 18,017 16,031 15,332 15,388 15,459 15,519 15,537 15,655
Net investment income (loss)
Fixed maturities 3,352 2,623 2,420 2,565 2,739 2,887 3,082 3,221
Equity securities, AFS 37 30 38 44 34 53 55 57
Mortgage loans 337 262 265 303 300 312 322 334
Policy loans 119 83 80 93 92 96 99 103
Limited partnerships and alternative inv 196 287 294 308 305 318 327 340
Other investments 297 200 179 151 149 155 160 166
Investment expense -111 -123 -122 -117 -117 -117 -117 -117
Total securities AFS and other 4,227 3,362 3,154 3,348 3,504 3,704 3,927 4,105
Equity securities, trading 4,364 6,061 - - - - - -
Total net investment income (loss) 8,591 9,423 3,154 3,348 3,504 3,704 3,927 4,105
Net realized capital gains (losses) -744 507 16 -201 -199 -207 -213 -222
Other revenues 258 275 112 276 273 284 293 304
Total Revenues 26,122 26,236 18,614 18,810 19,037 19,300 19,544 19,843
Page 13
The Hartford Financial Services Group, Inc.
Revenue Decomposition (in millions)
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Key Growth Rates
Total Property & Casualty Commercial 2.15% -0.89% -4.07% 2.14% 2.19% 2.24% 2.11% 2.37%
Total Consumer Markets -2.96% 0.66% 1.00% 5.00% 6.00% 4.00% 3.00% 4.00%
Total Group Benefits -8.17% -12.53% -6.03% -3.00% -2.00% 1.00% 1.00% 1.00%
Total Mutual Funds -7.70% 13.19% 1.00% 3.00% 2.00% 1.00% 1.00% 1.50%
Total Earned Premiums & Fees -4.10% -11.02% -4.36% 0.36% 0.46% 0.39% 0.12% 0.76%
Total Net Investment Income 194.41% 9.68% -66.53% 6.14% 4.67% 5.71% 6.03% 4.51%
Total Revenues 20.20% 0.44% -29.05% 1.05% 1.20% 1.38% 1.27% 1.53%
Composition of invested assets & yields
Fixed maturities, AFS, at fair value 85,922 62,357 59,384 61,069 59,543 60,138 61,642 64,415
Fixed maturities, using the fair value option 1,087 844 488 - - - - -
Yield - fixed maturities 4.2% 4.1% 4.2% 4.2% 4.6% 4.8% 5.0% 5.0%
Equity securities, AFS, at fair value 890 868 1,047 1,120 1,109 1,153 1,188 1,236
Yield - equity securities 4.3% 3.6% 4.8% 3.9% 3.1% 4.6% 4.6% 4.6%
Mortgage loans 6,711 5,598 5,556 5,945 5,885 6,121 6,305 6,557
Yield - mortgage loans 5.2% 4.9% 4.7% 5.1% 5.1% 5.1% 5.1% 5.1%
Policy loans, at outstanding balance 1,997 1,420 1,431 1,531 1,516 1,576 1,624 1,689
Yield - policy loans 6.0% 5.9% 5.6% 6.1% 6.1% 6.1% 6.1% 6.1%
Limited partnerships and alternative investments 3,015 3,040 2,942 3,148 3,116 3,241 3,338 3,472
Yield - LP's and alternative investments 7.1% 9.5% 10.4% 9.8% 9.8% 9.8% 9.8% 9.8%
Other investments 1,114 521 536 574 568 590 608 633
Yield - Other investments 26.66% 38.39% 33.40% 26.31% 26.31% 26.31% 26.31% 26.31%
Short-term investments 4,581 4,008 4,883 5,225 5,173 5,379 5,541 5,762
Total investments excluding equity securities, trading 105,318 78,657 76,268 78,613 76,910 78,201 80,246 83,764
Equity securities, trading, at fair value 28,933 19,745 11 - - - - -
Total investments 134,251 98,402 76,279 78,613 76,910 78,201 80,246 83,764
Total investments growth rate -0.52% -26.70% -22.48% 3.06% -2.17% 1.68% 2.62% 4.38%
Page 14
The Hartford Financial Services Group, Inc.
Income Statement (in millions)
Fiscal Years Ending Dec. 31 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Revenues
Earned premiums & fee income 18,788 18,017 16,031 15,332 15,388 15,459 15,519 15,537 15,655
Net Investment income:
Securities available-for-sale & other net investment income 4,263 4,227 3,362 3,154 3,348 3,504 3,704 3,927 4,105
Equity securities, trading -1,345 4,364 6,061 - - - - - -
Total net investment income (expense) 2,918 8,591 9,423 3,154 3,348 3,504 3,704 3,927 4,105
Net realized capital gains (losses):
Net OTTI income (losses) recognized in earnings -174 -349 -73 -59 -56 -53 -51 -48 -46
Net realized capital gains on business dispositions - - 1,575 - - - - - -
Net realized capital gains, excl. net OTTI losses in earnings -52 -395 -995 75 -275 -275 -275 -275 -275
Total net realized capital gains (losses) -226 -744 507 16 -331 -328 -326 -323 -321
Other revenues 253 258 275 112 276 273 284 293 304
Total revenues 21,733 26,122 26,236 18,614 18,680 18,908 19,181 19,434 19,744
Benefits, losses and expenses
Benefits, losses & loss adjustment expenses 14,627 13,248 10,948 10,805 9,941 9,742 9,839 9,888 9,839
Benefits, losses & loss adjustment expenses - returns on int'l VA's -1,345 4,363 6,060 - - - - - -
Amort of deferred policy acquisition costs & PV of future profits 2,444 1,988 2,701 1,729 2,281 2,229 2,186 2,225 2,130
Insurance operating costs & other expenses 5,269 5,204 4,280 4,028 4,689 4,694 4,579 4,454 4,489
Loss on extinguishment of debt - 910 213 - - - - - -
Reinsurance gain (loss) on disposition - 533 1,574 -23 - - - - -
Interest expense 508 457 397 376 449 437 423 417 421
Total benefits, losses & expenses 21,533 26,703 26,173 16,915 17,360 17,102 17,027 16,984 16,878
Income (loss) from cont operations before income taxes 200 -581 63 1,699 1,321 1,806 2,154 2,450 2,866
Income tax expense (benefit) -373 -481 -247 350 - - - - -
Income (loss) from continuing operations, net of tax 573 -100 310 1,349 1,321 1,806 2,154 2,450 2,866
Income (loss) from discontinued operations, net of tax 139 62 -134 -551 -590 -584 -607 -625 -650
Net income (loss) 712 -38 176 798 731 1,222 1,547 1,825 2,215
Preferred stock dividends 42 42 10 - - - - - -
Net income (loss) available to common shareholders 670 -80 166 798 731 1,222 1,547 1,825 2,215
Net income (loss) available per common share
Basic 1.51 -0.18 0.37 1.82 1.74 2.95 3.79 4.50 5.49
Diluted 1.40 -0.18 0.34 1.73 1.65 2.80 3.60 4.27 5.21
Cash dividends declared per common share 0.40 0.40 0.50 0.66 0.72 0.76 0.95 1.14 1.37
Shares Outstanding 442,539 436,306 453,290 424,416 418,050 411,779 405,602 405,805 401,747
Page 15
The Hartford Financial Services Group, Inc.
Balance Sheet (in millions)
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Assets
Fixed maturities investments, AFS, at fair value 87,009 63,201 59,872 61,069 59,543 60,138 61,642 64,415
Equity securities, trading, at fair value 28,933 19,745 11 - - - - -
Equity securities, available-for-sale, at fair value 890 868 1,047 1,120 1,109 1,153 1,188 1,236
Mortgage loans, net 6,711 5,598 5,556 5,945 5,885 6,121 6,305 6,557
Policy loans, at outstanding balance 1,997 1,420 1,431 1,531 1,516 1,576 1,624 1,689
Limited partnerships & other alternative investments 3,015 3,040 2,942 3,148 3,116 3,241 3,338 3,472
Other investments 1,114 521 536 574 568 590 608 633
Short-term investments 4,581 4,008 4,883 5,225 5,173 5,379 5,541 5,762
Total investments 134,250 98,401 76,278 78,612 76,910 78,200 80,245 83,763
Cash 2,421 1,428 399 1,044 3,360 3,436 2,597 1,397
Premiums receivable & agents' balances, net 3,542 3,465 3,429 3,532 3,603 3,675 3,748 3,823
Reinsurance recoverables, net 4,666 23,330 22,920 14,669 10,562 9,083 8,720 8,894
Deferred policy acquisition costs & PV of future profits 5,725 2,161 1,823 1,677 1,543 1,420 1,306 1,202
Deferred income taxes, net 1,942 3,840 2,897 3,100 3,069 3,192 3,287 3,419
Goodwill 654 498 498 498 498 498 498 498
Property & equipment, net 977 877 831 806 766 727 706 670
Other assets 2,767 2,998 1,236 1,323 1,309 1,362 1,403 1,459
Separate account assets 141,569 140,886 134,702 132,008 138,608 143,460 147,763 152,196
Total assets 298,513 277,884 245,013 237,268 240,227 245,051 250,272 257,321
Liabilities & Shareholders' Equity
Reserve for future policy benefits & unpaid losses 40,992 41,373 41,444 42,066 42,697 43,337 43,987 44,647
Other policyholder funds & benefits payable 41,979 39,029 32,532 31,881 31,244 30,619 30,006 29,406
Other policyholder funds & benefits payable - int'l VA's 28,922 19,734 - - - - - -
Unearned premiums 5,145 5,225 5,255 5,334 5,414 5,495 5,577 5,661
Debt - short-term, long-term, consumer notes 7,287 6,628 6,109 5,975 5,377 5,646 5,928 6,225
Other liabilities 10,172 6,104 6,251 6,345 6,440 6,537 6,635 6,734
Separate account liabilities 141,569 140,886 134,702 132,008 138,608 143,460 147,763 152,196
Total liabilities 276,066 258,979 226,293 223,608 229,780 235,093 239,897 244,870
Preferred stock 556 - - - - - - -
Common Stock & Additional paid-in capital 10,043 9,899 17,792 18,148 18,511 18,881 19,259 19,644
Retained earnings 10,745 10,683 10,636 10,109 11,084 11,870 12,948 11,151
Treasury stock, at cost -1,740 -1,598 -1,403 -1,326 -1,253 -1,184 -1,119 -1,057
Pension & other postretirement plan adjustments -1,362 -1,253 -1,272 -1,291 -1,310 -1,330 -1,350 -1,350
Accumulated other comprehensive income (loss), net 4,205 1,174 928 1,650 1,674 1,699 1,725 1,751
Total stockholders' equity 22,447 18,905 26,681 26,290 27,706 28,937 30,463 29,138
Total Liabilities & Shareholders' Equity 298,513 277,884 245,013 237,268 240,227 245,051 250,272 257,321
Page 16
The Hartford Financial Services Group, Inc.
Cash Flow Statement (in millions)
Fiscal Years Ending Dec. 31 2012 2013 2014
Operating Activities
Net income (loss) -80 166 798
Adjustments to reconcile net income to net cash provided by operating activities
Amortization of deferred policy acquisition costs & PV of future profits 1,988 2,701 1,729
Additions to deferred policy acquisition costs & PV of future profits -1,639 -1,330 -1,364
Reserve for future policy benefits, unpaid losses, loss adj expenses, unearned premiums -226 -308 226
Reinsurance recoverables -351 -561 -22
Receivables & other assets -257 -409 -122
Payables & accruals 874 497 -937
Accrued & deferred income taxes -386 -745 328
Net realized capital losses (gains) 711 -828 141
Net receipts (disbursements) from contracts related to policyholder funds - int'l VA's -1,539 -9,189 -3,993
Net decrease (increase) in equity securities, trading 1,566 9,188 3,993
Depreciation & amortization 467 189 276
Loss on extinguishment of debt 910 213 -
Reinsurance loss on disposition 533 1,574 -23
Loss on sale of business - - 653
Other operating activities, net 68 69 203
Net cash flows from operating activities 2,639 1,227 1,886
Investing Activities
Proceeds from the sale or maturity or prepayment of:
Fixed maturities, available-for-sale 42,716 40,266 25,309
Fixed maturities, fair value option 283 322 401
Equity securities, available-for-sale 295 274 354
Mortgage loans 515 468 646
Partnerships 208 368 490
Payments for the purchase of
Fixed maturities, available-for-sale -42,578 -35,446 -22,545
Fixed maturities, fair value option -182 -150 -369
Equity securities, available-for-sale -144 -212 -683
Mortgage loans -1,483 -718 -604
Partnerships -903 -353 -312
Proceeds from business sold 58 815 963
Derivatives, net -2,665 -2,208 10
Change in policy loans, net 4 -5 -11
Change in payables for collateral under securities lending, net - - -121
Change in short-term investments, net 1,400 318 -1,814
Other investing activities, net -81 6 -18
Net cash flows from investing activities -2,557 3,745 1,696
Financing Activities
Deposits & other additions to investment & universal life-type contracts 10,951 5,942 5,289
Withdrawals & other deductions from investment & universal life contracts -25,543 -25,034 -21,870
Net transfer from separate accounts related to inv & universal life contracts 13,196 16,978 14,366
Net issuance (repayments) at maturity or settlement of consumer notes -153 -77 -13
Net increase (decrease) in securities sold under agreements to repurchase 1,988 -1,988 -
Repurchase of warrants -300 -33 -
Repayment of long-term debt & short-term debt -2,133 -1,338 -200
Proceeds from issuance of long-term & short-term debt 2,123 533 -
Proceeds from net issuance of shares under stock compensation plans & other 14 20 30
Treasury stock acquired -154 -600 -1,796
Dividends paid on preferred stock -42 -21 -
Dividends paid on common stock -175 -202 -282
Net cash flows from financing activities -228 -5,820 -4,476
Foreign exchange rate effect on cash -56 -155 -135
Net increase (decrease) in cash -160 -993 -1,029
Cash - beginning of year 2,581 2,421 1,428
Cash - end of year 2,379 1,418 399
Page 17
The Hartford Financial Services Group, Inc.
Cash Flow Statement (in millions)
Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E
Cash Flows from Operating Activities
Net income (loss) 731 1,222 1,547 1,825 2,215
Depreciation and amortization 10 16 15 9 14
Increase (decrease) in amortization of policy acquisitions 552 -53 -43 40 -95
Increase (decrease) in accounts receivable -103 -71 -72 -73 -75
Increase (decrease) in reinsurance recoverables 3,251 1,107 879 363 1,326
Increase (decrease) in deferred income taxes -203 31 -123 -96 -131
Increase (decrease) in reserves -622 -631 -640 -650 -660
Increase (decrease) in benefits payable -651 -638 -625 -612 -600
Increase (decrease) in unearned premiums 79 80 81 82 84
Net cash provided by operating activities 3,045 1,065 1,019 887 2,077
Cash Flows from Investing Activities
(Increase) decrease in total investment assets -2,334 1,702 -1,290 -2,045 -3,518
(Increase) decrease in short-term investments -45 -199 90 94 99
Capital expenditures -15 -24 -23 -13 -21
(Increase) decrease in other assets/liabilities 7 108 44 57 43
Net cash used for investing activities -2,387 1,587 -1,179 -1,907 -3,397
Cash Flows from Financing Activities
Payments of notes payable and long-term debt -90 -399 179 188 198
Payment of dividends -280 -301 -313 -385 -463
(Increase) decrease in issuance of common stock & APIC 356 363 370 378 385
Repurchase of common stock 77 73 69 65 62
Net cash provided by financing activities -14 -337 237 181 120
Net increase (decrease) in cash 645 2,316 76 -839 -1,200
Cash, beginning of year 399 1,044 3,360 3,436 2,597
Cash, end of year 1,044 3,360 3,436 2,597 1,397
Page 18
The Hartford Financial Services Group, Inc.
Common Size Income Statement (As a Percentage of Assets)
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Revenues
Earned premiums 6.04% 5.77% 6.26% 6.49% 6.44% 6.33% 6.21% 6.08%
Net Investment income:
Securities available-for-sale & other net investment income 1.42% 1.21% 1.29% 1.41% 1.46% 1.51% 1.57% 1.60%
Equity securities, trading 1.46% 2.18% - - - - - -
Total net investment income (expense) 2.88% 3.39% 1.29% 1.41% 1.46% 1.51% 1.57% 1.60%
Net realized capital gains (losses): 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Total other-than-temporary impairment ("OTTI") income (losses) -0.13% -0.03% -0.03% -0.03% -0.02% -0.02% -0.02% -0.02%
OTTI losses recognized in other comprehensive income ("OCI") 0.01% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Net OTTI income (losses) recognized in earnings -0.12% -0.03% -0.02% -0.02% -0.02% -0.02% -0.02% -0.02%
Net realized capital gains on business dispositions - 0.57% - - - - - -
Net realized capital gains (losses), excluding net OTTI losses -0.13% -0.36% 0.03% -0.12% -0.11% -0.11% -0.11% -0.11%
Total net realized capital gains (losses) -0.25% 0.18% 0.01% -0.14% -0.14% -0.13% -0.13% -0.12%
Other revenues 0.09% 0.10% 0.05% 0.12% 0.11% 0.12% 0.12% 0.12%
Total revenues 8.75% 9.44% 7.60% 7.87% 7.87% 7.83% 7.77% 7.67%
Benefits, losses and expenses
Benefits, losses & loss adjustment expenses 4.44% 3.94% 4.41% 4.19% 4.06% 4.02% 3.95% 3.82%
Benefits, losses & loss adjustment expenses - returns credited on int'l VA's 1.46% 2.18% - - - - - -
Amortization of deferred policy acquisition costs & PV of future profits 0.67% 0.97% 0.71% 0.96% 0.93% 0.89% 0.89% 0.83%
Insurance operating costs & other expenses 1.74% 1.54% 1.64% 1.98% 1.95% 1.87% 1.78% 1.74%
Loss on extinguishment of debt 0.30% 0.08% - - - - - -
Reinsurance gain (loss) on disposition 0.18% 0.57% -0.01% - - - - -
Interest expense 0.15% 0.14% 0.15% 0.19% 0.18% 0.17% 0.17% 0.16%
Goodwill impairment - - - - - - - -
Other expenses - - - - - - - -
Total benefits, losses & expenses 8.95% 9.42% 6.90% 7.32% 7.12% 6.95% 6.79% 6.56%
Income (loss) from continuing operations before income taxes -0.19% 0.02% 0.69% 0.56% 0.75% 0.88% 0.98% 1.11%
Income tax expense (benefit) -0.16% -0.09% 0.14% - - - - -
Income (loss) from continuing operations, net of tax -0.03% 0.11% 0.55% 0.56% 0.75% 0.88% 0.98% 1.11%
Income (loss) from discontinued operations, net of tax 0.02% -0.05% -0.22% -0.25% -0.24% -0.25% -0.25% -0.25%
Net income (loss) -0.01% 0.06% 0.33% 0.31% 0.51% 0.63% 0.73% 0.86%
Preferred stock dividends 0.01% 0.00% - - - - - -
Net income (loss) available to common shareholders -0.03% 0.06% 0.33% 0.31% 0.51% 0.63% 0.73% 0.86%
Page 19
The Hartford Financial Services Group, Inc.
Common Size Balance Sheet (As a Percentage of Assets)
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Assets
Fixed maturities investments, AFS, at fair value 29.15% 22.74% 24.44% 25.74% 24.79% 24.54% 24.63% 25.03%
Equity securities, trading, at fair value 9.69% 7.11% 0.00% - - - - -
Equity securities, available-for-sale, at fair value 0.30% 0.31% 0.43% 0.47% 0.46% 0.47% 0.47% 0.48%
Mortgage loans, net 2.25% 2.01% 2.27% 2.51% 2.45% 2.50% 2.52% 2.55%
Policy loans, at outstanding balance 0.67% 0.51% 0.58% 0.65% 0.63% 0.64% 0.65% 0.66%
Limited partnerships & other alternative investments 1.01% 1.09% 1.20% 1.33% 1.30% 1.32% 1.33% 1.35%
Other investments 0.37% 0.19% 0.22% 0.24% 0.24% 0.24% 0.24% 0.25%
Short-term investments 1.53% 1.44% 1.99% 2.20% 2.15% 2.20% 2.21% 2.24%
Total investments 44.97% 35.41% 31.13% 33.13% 32.02% 31.91% 32.06% 32.55%
Cash 0.81% 0.51% 0.16% 0.44% 1.40% 1.40% 1.04% 0.54%
Premiums receivable & agents' balances, net 1.19% 1.25% 1.40% 1.49% 1.50% 1.50% 1.50% 1.49%
Reinsurance recoverables, net 1.56% 8.40% 9.35% 6.18% 4.40% 3.71% 3.48% 3.46%
Deferred policy acquisition costs & PV of future profits 1.92% 0.78% 0.74% 0.71% 0.64% 0.58% 0.52% 0.47%
Deferred income taxes, net 0.65% 1.38% 1.18% 1.31% 1.28% 1.30% 1.31% 1.33%
Goodwill 0.22% 0.18% 0.20% 0.21% 0.21% 0.20% 0.20% 0.19%
Property & equipment, net 0.33% 0.32% 0.34% 0.34% 0.32% 0.30% 0.28% 0.26%
Other assets 0.93% 1.08% 0.50% 0.56% 0.55% 0.56% 0.56% 0.57%
Separate account assets 47.42% 50.70% 54.98% 55.64% 57.70% 58.54% 59.04% 59.15%
Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Liabilities & Shareholders' Equity
Reserve for future policy benefits & unpaid losses & adjs 13.73% 14.89% 16.92% 17.73% 17.77% 17.68% 17.58% 17.35%
Other policyholder funds & benefits payable 14.06% 14.05% 13.28% 13.44% 13.01% 12.49% 11.99% 11.43%
Other policyholder funds & benefits payable - int'l VA's 9.69% 7.10% - - - - - -
Unearned premiums 1.72% 1.88% 2.14% 2.25% 2.25% 2.24% 2.23% 2.20%
Debt - short-term, long-term, consumer notes 2.44% 2.39% 2.49% 2.52% 2.24% 2.30% 2.37% 2.42%
Other liabilities 3.41% 2.20% 2.55% 2.67% 2.68% 2.67% 2.65% 2.62%
Separate account liabilities 47.42% 50.70% 54.98% 55.64% 57.70% 58.54% 59.04% 59.15%
Total liabilities 92.48% 93.20% 92.36% 94.24% 95.65% 95.94% 95.85% 95.16%
Preferred stock 0.19% - - - - - - -
Common Stock & Additional paid-in capital 3.36% 3.56% 7.26% 7.65% 7.71% 7.70% 7.70% 7.63%
Retained earnings 3.60% 3.84% 4.34% 4.26% 4.61% 4.84% 5.17% 4.33%
Treasury stock, at cost -0.58% -0.58% -0.57% -0.56% -0.52% -0.48% -0.45% -0.41%
Pension & other postretirement plan adjustments -0.46% -0.45% -0.52% -0.54% -0.55% -0.54% -0.54% -0.52%
Accumulated other comprehensive income (loss), net of tax 1.41% 0.42% 0.38% 0.70% 0.70% 0.69% 0.69% 0.68%
Total stockholders' equity 7.52% 6.80% 10.89% 11.08% 11.53% 11.81% 12.17% 11.32%
Noncontrolling interest - - - - - - - -
Total equity 7.52% 6.80% 10.89% 11.08% 11.53% 11.81% 12.17% 11.32%
Total Liabilities & Shareholders' Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Page 20
The Hartford Financial Services Group, Inc.
Value Driver Estimation
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Net Income -80 166 798 731 1,222 1,547 1,825 2,215
Total Shareholder's Equity 22,447 18,905 26,681 26,290 27,706 28,937 30,463 29,138
Return on Equity (ROE) -0.35% 0.74% 4.22% 2.74% 4.65% 5.58% 6.31% 7.27%
Equity Economic Profit (EEP) -2,678 -2,380 -1,346 -2,295 -1,759 -1,595 -1,457 -1,239
Free Cash Flow to Equity (FCFE) - Easy
Net income -80 166 798 731 1,222 1,547 1,825 2,215
Change in total assets -5,551 -20,629 -32,871 -7,745 2,959 4,825 5,221 7,048
Change in total liabilities -5,088 -17,087 -32,686 -2,685 6,171 5,314 4,804 4,972
Free Cash Flow to Equity 383 3,708 983 5,791 4,435 2,036 1,408 139
Free Cash Flow to Equity (FCFE) - Formal
Cash from operations
Net income -80 166 798 731 1,222 1,547 1,825 2,215
- Preferred dividends 42 10 - - - - - -
Cash from operations -38 176 798 731 1,222 1,547 1,825 2,215
Sources of Cash
Increase in accounts payable -5,172 -12,138 -26,231 -651 -638 -625 -612 -600
+ Increase in reserves -24 381 71 622 631 640 650 660
+ Increase in debt 757 -659 -519 -134 -597 269 282 296
+ Increase in unearned premiums -77 80 30 79 80 81 82 84
+ Increase in separate account liabilities -2,301 -683 -6,184 -2,694 6,600 4,851 4,304 4,433
+ Increase in other liabilities 1,729 -4,068 147 94 95 97 98 100
Sources of Cash -5,088 -17,087 -32,686 -2,685 6,171 5,314 4,804 4,972
Uses of Cash
Increase in investments and cash -858 -36,842 -23,152 2,549 614 1,366 1,206 2,318
+ Increase in accts receivable & recoverables -6 18,587 -446 -5,648 -2,537 -1,407 -290 249
+ Increase in deferred income sources -2,475 -1,666 -1,281 57 -165 -1 -18 27
+ Increase in net PP&E -52 -100 -46 -25 -40 -38 -22 -35
+ Increase in separate account assets -2,301 -683 -6,184 -2,694 6,600 4,851 4,304 4,433
+ Increase in other assets 493 231 -1,762 87 -13 52 41 56
Uses of cash -5,199 -20,473 -32,871 -5,675 4,459 4,825 5,221 7,048
Free Cash Flow to Equity 73 3,562 983 3,721 2,935 2,036 1,408 139
Page 21
The Hartford Financial Services Group, Inc.
Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models
Key Inputs:
CV Growth 3.00%
CV ROE 7.27%
Cost of Equity 11.34%
Beta 1.780
Risk Free 2.71%
Equity Risk Premium 4.85%
Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E
12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019
Equity Discounted Cash Flow (DCF) Model
FCFE 3,721 2,935 2,036 1,408 139
Terminal Value 15,605
Discount Factor 1.08 1.20 1.34 1.49 1.49
Discounted FCFE 3,453 2,446 1,524 946
Discounted Terminal Value 10,488
Present Value of Equity DCF 18,857
- ESOP 47
Net Value 18,810
Shares Outstanding 424,416
Value per Share 44.32
Equity Economic Profit (EP) Model
Equity Economic Profit -2,295 -1,759 -1,595 -1,457 -1,239
Terminal Value 10,402
Discount Factor 1.08 1.20 1.34 1.49 1.49
Discounted Equity EP -2,130 -1,466 -1,194 -979
Discounted Terminal Value 6,992
Present Value of Equity EP 1,224
Beg. Total Stockholders' Equity 24,013
Equity Value 25,237
- ESOP 47
Net Value 25,189
Shares Outstanding 424,416
Value per Share 47.48
Page 22
The Hartford Financial Services Group, Inc.
Dividend Discount Model (DDM)
Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E
Key Assumptions
CV dividend growth 3.50%
CV ROE 7.27%
Cost of Equity 11.34%
Beta 1.780
Risk Free 2.71%
Equity Risk Premium 4.85%
Dividend Discount Model
Dividends Per Share 0.72 0.76 0.95 1.14
Terminal Value 53.29
Discount Factor 1.08 1.20 1.34 1.49 1.49
Discounted Values 0.67 0.63 0.71 0.77 35.81
Present Value DDM 38.59
Page 23
The Hartford Financial Services Group, Inc.
Relative Valuation Models
EPS EPS Ticker Company Price 2015E 2016E P/E 15 P/E 16 P/BV9 P/TBV8
AIG American Int'l Group $55.22 $4.94 $5.58 11.18 9.90 0.71 0.71 ING ING Groep $14.34 $1.31 $1.40 10.95 10.24 0.91 0.93 CB Chubb $100.16 $7.68 $7.81 13.04 12.82 1.42 1.47 CNAz CNA Financial $41.54 $3.52 $3.67 11.80 11.32 0.86 0.87 AZSEY Allianz SE $16.78 $1.60 $1.62 10.49 10.36 0.98 1.25 AXAHY AXA Group $24.46 $2.56 $2.67 9.55 9.16 0.72 2.10 LGGNY Legal & General Group $20.27 $1.46 $1.57 13.88 12.91 3.82 AV Aviva plc $17.03 $1.55 $1.72 10.99 9.90 1.65 2.38
Average 11.5 10.8 1.0 1.7
HIG The Hartford Financial Services Group,
Inc. $40.66 $2.04 $3.26 19.9 12.5 0.91 0.96
Implied Value:
Relative P/E (EPS15) $ 23.48
Relative P/E (EPS16) $ 35.27
Price/Book Value $ 39.28
Price/Tangible Book Value $ 24.03
Relative Value $ 30.90
Page 24
The Hartford Financial Services Group, Inc.
Sensitivity and Scenario Analysis
Commercial P&C - 1% Annual Change in Workers' Compensation Growth
Impact on Equity DCF Value $ 44.32 0% 2% 4% 6% 7% 8% 9%
-1.00% 5.27 10.41 15.99 22.02 25.22 28.54 31.98
1.00% 12.12 17.27 22.84 28.87 32.07 35.39 38.84
3.00% 19.54 24.69 30.26 36.29 39.49 42.81 46.26
Consumer Markets - 1% Annual 5.00% 27.56 32.71 38.28 44.32 47.51 50.83 54.28
Change in Growth 6.00% 31.81 36.96 42.53 48.56 51.76 55.08 58.53
7.00% 36.23 41.37 46.95 52.98 56.17 59.49 62.94
8.00% 40.81 45.95 51.53 57.56 60.75 64.07 67.52
CV Return on Equity
Impact on Equity DCF Value $ 44.32 5.5% 6.0% 7.0% 7.3% 8.0% 8.5% 9.0%
10.00% 43.84 46.22 49.97 50.80 52.78 53.93 54.96
10.50% 41.73 43.92 47.35 48.12 49.93 50.99 51.93
11.00% 39.87 41.89 45.05 45.76 47.43 48.41 49.28
Cost of Equity 11.34% 38.73 40.64 43.64 44.31 45.90 46.83 47.65
11.50% 38.22 40.09 43.02 43.67 45.22 46.12 46.93
12.00% 36.75 38.48 41.20 41.81 43.25 44.09 44.84
12.50% 35.42 37.04 39.57 40.14 41.48 42.26 42.96
Growth/Devaluation of Fixed Income Securities in 2015
Impact on Equity DCF Value $ 44.32 -7.0% -4.0% -1.0% 2.0% 5.0% 8.0% 11.0%
1.00% 38.55 40.35 42.14 43.94 45.74 47.54 49.34
3.00% 38.67 40.47 42.27 44.07 45.87 47.66 49.46
5.00% 38.80 40.59 42.39 44.19 45.99 47.79 49.59
Growth/Devaluation of 7.00% 38.92 40.72 42.52 44.32 46.11 47.91 49.71
Remaining Securities in 2015 9.00% 39.04 40.84 42.64 44.44 46.24 48.04 49.84
11.00% 39.17 40.97 42.77 44.56 46.36 48.16 49.96
13.00% 39.29 41.09 42.89 44.69 46.49 48.29 50.08
Beta
Impact on Equity DCF Value $ 44.32 1.57 1.64 1.71 1.78 1.85 1.92 1.99
3.35% 67.14 64.61 62.30 60.18 58.22 56.41 54.73
3.85% 59.48 57.31 55.31 53.48 51.79 50.23 48.78
4.35% 53.64 51.73 49.97 48.36 46.87 45.49 44.21
Equity Risk Premium 4.85% 49.02 47.32 45.75 44.31 42.97 41.74 40.59
5.35% 45.29 43.74 42.32 41.02 39.81 38.69 37.64
5.85% 42.19 40.78 39.48 38.28 37.18 36.15 35.19
6.35% 39.58 38.28 37.08 35.98 34.96 34.01 33.12
CV Dividend Growth Rate
Impact on DDM Value $ 38.59 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0%
10.00% 72.75 66.13 59.50 52.87 46.24 39.61 32.98
10.50% 63.93 58.13 52.34 46.54 40.75 34.95 29.16
11.00% 56.88 51.75 46.62 41.49 36.36 31.23 26.10
Cost of Equity 11.34% 52.84 48.10 43.35 38.60 33.85 29.10 24.36
11.50% 51.12 46.54 41.95 37.36 32.78 28.19 23.61
12.00% 46.34 42.20 38.07 33.93 29.80 25.66 21.53
12.50% 42.30 38.54 34.79 31.04 27.28 23.53 19.77
Page 25
The Hartford Financial Services Group, Inc.
Key Management Ratios
Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Liquidity Ratios
Current Assets 22,877 38,232 36,351 29,246 27,308 26,184 25,198 24,497
Current Liabilities 117,038 105,361 79,231 79,281 79,354 79,451 79,571 79,714
Current Ratio 19.55% 36.29% 45.88% 36.89% 34.41% 32.96% 31.67% 30.73%
Current Assets 18,296 34,224 31,468 24,021 22,135 20,805 19,658 18,734
Current Liabilities 117,038 105,361 79,231 79,281 79,354 79,451 79,571 79,714
Quick Ratio 15.63% 32.48% 39.72% 30.30% 27.89% 26.19% 24.70% 23.50%
Cash & Cash Equivalents 2,421 1,428 399 1,044 3,360 3,436 2,597 1,397
Current Liabilities 117,038 105,361 79,231 79,281 79,354 79,451 79,571 79,714
Cash Ratio 2.07% 1.36% 0.50% 1.32% 4.23% 4.32% 3.26% 1.75%
Activity or Asset-Management Ratios
Expenses 5,204 4,280 4,028 4,689 4,694 4,579 4,454 4,489
Earned Premiums 18,017 16,031 15,332 15,388 15,459 15,519 15,537 15,655
Expense Ratio 28.88% 26.70% 26.27% 30.47% 30.36% 29.51% 28.67% 28.67%
Net Investment Income 8,591 9,423 3,154 3,348 3,504 3,704 3,927 4,105
Total Investments 134,250 98,401 76,278 78,612 76,910 78,200 80,245 83,763
Return on Investments 6.40% 9.58% 4.13% 4.26% 4.56% 4.74% 4.89% 4.90%
Net Income -38 176 798 731 1,222 1,547 1,825 2,215
Average Total Assets 301,289 288,199 261,449 241,141 238,747 242,639 247,662 253,797
Return on Assets -0.01% 0.06% 0.31% 0.30% 0.51% 0.64% 0.74% 0.87%
Financial Leverage Ratios
Total Debt 7,287 6,628 6,109 5,975 5,377 5,646 5,928 6,225
Total Assets 298,513 277,884 245,013 237,268 240,227 245,051 250,272 257,321
Debt Ratio 2.44% 2.39% 2.49% 2.52% 2.24% 2.30% 2.37% 2.42%
Total Liabilities 7,287 6,628 6,109 5,975 5,377 5,646 5,928 6,225
Shareholders' Equity 22,447 18,905 26,681 26,290 27,706 28,937 30,463 29,138
Debt-to-Equity Ratio 32.46% 35.06% 22.90% 22.73% 19.41% 19.51% 19.46% 21.36%
Long-Term Debt 4,853 4,414 4,069 3,979 3,581 3,760 3,948 4,146
Long-Term Debt & TSE 27,300 23,319 30,750 30,269 31,287 32,697 34,411 33,284
Capitalization Ratio 17.78% 18.93% 13.23% 13.15% 11.45% 11.50% 11.47% 12.46%
Page 26
Profitability Ratios
Incurred Losses and Expenses 18,452 15,228 14,833 14,629 14,436 14,418 14,342 14,328
Earned Premiums 18,017 16,031 15,332 15,388 15,459 15,519 15,537 15,655
Combined Ratio 102.41% 94.99% 96.74% 95.07% 93.38% 92.91% 92.31% 91.52%
Net Income -38 176 798 731 1,222 1,547 1,825 2,215
Revenue 26,122 26,236 18,614 18,680 18,908 19,181 19,434 19,744
Return on Revenue -0.15% 0.67% 4.29% 3.91% 6.46% 8.07% 9.39% 11.22%
Net Income -80 166 798 731 1,222 1,547 1,825 2,215
Beginning TSE 22,910 22,447 18,905 26,681 26,290 27,706 28,937 30,463
Return on Equity -0.35% 0.74% 4.22% 2.74% 4.65% 5.58% 6.31% 7.27%
Payout Policy Ratios
Dividends per Common Share 0.40 0.50 0.66 0.72 0.76 0.95 1.14 1.37
Earnings per Share -0.18 0.37 1.82 1.74 2.95 3.79 4.50 5.49
Dividend Payout Ratio - 133.98% 36.28% 41.49% 25.80% 25.09% 25.34% 24.93%
Dividends & Repurchases 155 317 422 357 374 382 450 524
Net Income -38 176 798 731 1,222 1,547 1,825 2,215
Total Payout Ratio -407.94% 179.84% 52.81% 48.87% 30.59% 24.68% 24.68% 23.66%
Dividends Paid per Share 0.40 0.50 0.66 0.72 0.76 0.95 1.14 1.37
Earnings per Share -0.18 0.37 1.82 1.74 2.95 3.79 4.50 5.49
Retention Ratio 319.71% -33.98% 63.72% 58.51% 74.20% 74.91% 74.66% 75.07%