Good morning, everyone. I'm Jay Gelb, the Senior Equity Insurance Analyst here at Barclays. We're very pleased to have with us Beth Costello. Beth is Chief Financial Officer of The Hartford. The Hartford is, of course, you all know, is a leader in property and casualty insurance, sold primarily through a network of independent agents and brokers, as well as among the largest providers of group benefits. The Hartford also has a sizable retail mutual fund business. Beth, thanks again for joining us today.
Glad to be here.
My first question is on The Hartford's recent M&A and divestiture activity. The Hartford's been among the most active among insurers in terms of its acquisition and dispositions over the past several years. The Hartford acquired two major businesses, that being Navigators' property and casualty business, as well as Aetna's group life and disability business. The company also, prior to that, sold its Talcott Resolution unit, which was mostly legacy U.S. variable annuities. Can you describe what made these deals attractive and whether The Hartford would be interested in future M&A?
Sure. Thank you. Yes, as you point out, we have been very busy over the last couple of years. I'll start with the Talcott divestiture. Obviously, that was a continuation of the strategy that we had implemented in 2012. Our objective over time was to divest of those legacy businesses, and we were very pleased to be able to come to terms which we thought were very attractive given that property. We completed that in May of 2018. It's hard to believe it's well over a year ago at this point. At the same time, as we looked at our core businesses, we, like other companies, are always evaluating if there's opportunities to accelerate our strategies through M&A activities. In the fall of 2017, the group benefits acquisition manifest itself.
We looked at that and really saw that as an opportunity for us to increase our scale in group benefits, as you pointed out, now being the number two writer of disability and life in the group space. As well as some of the capabilities that we also acquired through that acquisition from Aetna. Most notably, their lead management or claim system that they have for disability. That had been an area that was on our list of technology improvements that we needed to do. We had done a lot on the front-end side of group benefits, and we're now starting to focus on the back end. We've been very pleased with how that acquisition has gone. We closed a week within signing the transaction, the integration activities have been on track.
We said at the time it would be a lengthy integration because this was a reinsurance transaction. We wanted to make sure that we were thoughtful in how to bring that book of business onto our paper and do it sort of as renewals happen. As you know, most of that business is under a two or three-year rate guarantee process. We've been doing that. We moved the claim system into our environment and now are continuing on the process of moving legacy Aetna business onto our front-end systems, over time, legacy Hartford business onto the claims platform. Most all metrics that we set out for ourselves at the beginning of that acquisition as it relates to top line synergies, the integration plan itself, all on track and very pleased with how that has gone.
Excellent.
Navigators, which we just closed on this past May. There, too, we saw an opportunity to accelerate the strategy that we had primarily in our middle market business. We've talked in the past that the attractiveness of Navigators was really the products that they could bring to our platform that we didn't have. Through Doug and his team, they've been working to build some of those capabilities. As you all know, that takes time to do, we saw this acquisition as an opportunity to really accelerate those capabilities. It's early on. We just closed in May, we've been very pleased with the reaction that we've had from our distribution partners who see the value now that The Hartford brings in having a full suite of products that we can offer.
Right. Okay. You also put out, or the company put out some financial metrics, targets that it'll be thinking about over the next couple of years, especially in regards to Navigators. Can you remind us of those and kind of give perspective on what the second quarter was showing?
Again, the second quarter, we only had owned Navigators for about five weeks. Really not a significant impact in the second quarter. When we did the acquisition and we announced it, we talked about our goal of getting to, from a run rate perspective, about $200 million in core earnings, sort of ex amortization of intangibles in the next few years. We still see that as achievable. At the time when we looked at that analysis and when we thought about the starting point and the activities that were going to get us there were a few buckets that we looked at. One was expense synergies, which again, for a deal like this, you wouldn't expect a lot of expense synergies because again, we're buying capabilities. We had put out that we anticipated about $25 million pre-tax in expense synergies over time.
We probably will trend a little bit better than that, but feel very good about our ability to do that. Net investment income was also a component, and that's one where we're feeling a little bit of pressure. Obviously, with the current rate environment, our expectations relative to repositioning that portfolio, we brought the asset management activities in-house. They had outsourced it, and obviously with our platform that we have at HIMCO, we were able to bring those assets on really at no additional cost. Obviously the reinvestment rates are a little bit lower than what we had anticipated. On the other side, we are seeing very favorable pricing trends, that environment is probably better than we had anticipated when we announced the transaction. When we put all of that together, when we think about that longer-term goal, we see a path to get there.
In the short term, we had also put out some expectations related to 2020 at the time. Again, we had done that in August of 2018. As Chris commented on our earnings call, we're probably at the lower end of that range, primarily because of investment income. Again, when you think about the components of how we would go from what the run rate was to getting to that $200 million, we saw net investment income and expense as sort of being the early wins. That we would see that build in quicker, and then pricing and underwriting actions would take a little bit longer. Because of what we're seeing in the rate environment, that's why we're feeling that pressure as it relates to 2020.
Again, as I step back and we look at overall what this acquisition brings to our platform, we're probably more excited today than we were when we announced the deal.
Huh.
We really can feel the synergies there. As those that followed know that it took us a bit longer to close than we had originally anticipated. Not because there were any issues, but just that was the process. That time really allowed us to get our teams as best we could, position them within all the rules you have to obviously follow, to be able to hit the ground running as soon as we closed.
Right.
Over the course of the summer and into the fall, just a lot of activity as it relates to meeting with brokers and making sure that they understand the capabilities that we bring end to end. We're really focused on making sure that our distribution partners see us as one company. That they don't have someone from legacy The Hartford coming to them and then someone from legacy Navigators, that we really are integrated. We're using our field force across the place, the teams are really excited, and you can feel that when you talk to them.
Oh, that's fantastic. All right, it's tracking better than you thought from a business perspective.
Yeah, from the reaction that we received from those external folks, again, really appreciating and seeing how we can benefit from these capabilities. We've had some early successes on deals where we're not sure we would have even been asked to quote, because we didn't have the full spectrum of products. It's also, I think, been very good from a defensive position as well.
Okay. That's very helpful. To bring it back up a little bit, can you discuss the targeted business mix for Hartford? If you think about the three major parts of the business, property casualty insurance, group benefits, mutual funds, compared to where it is presently, what do you envision the mix of Hartford ultimately being?
Yeah. When you think about the mix that we have today, I put mutual funds off for a moment. When you look at our commercial lines, our personal lines, and our group business, I think on average, taking into consideration obviously the scale that we got from the Navigators acquisition to our commercial lines business, that it's a good mix, what you see today. We also feel that all of our businesses, we have a lot of what we need to compete, because I think one of the other questions we sometimes get is our appetite for additional M&A and where that might come from.
We've been very clear to say that as we look at our businesses today and the capabilities that we have, we don't feel that there is a hole in any of our offerings that would say that we need to accelerate our strategy by doing M&A. We'll obviously look at things that are more bolt-on and able to leverage our current capabilities, but nothing like what we gained from Navigators. We feel very good with our mix. Mutual funds, as we've talked about over the years, is really separate. It's a self-contained business unit. It really does operate on its own. It does not require a lot of management time.
Right.
If you think about when we had the Talcott business, that took up a lot of our time, a lot of our mental thinking. Mutual funds runs very well. Been very pleased with things that they've done to be able to expand their platform, and they provide a very nice cash flow to the holding company. We're very pleased with that business as well.
Strategically, sometimes I get the question as to the mutual funds business, which of course, as you did mention, generates a strong return on equity and very healthy distributable cash flow. There does seem to be a question of strategic fit of that business within Hartford, which is otherwise entirely focused on insurance. Would Hartford shareholders benefit more perhaps if mutual funds were sold to another company?
As we see it today, we believe that it's increasing in its value, and the value that it brings to us. To the extent that it continues to do that, we're very pleased to hold it. As I said, it generates a nice cash flow. If we saw some change in the environment or something that we felt that over time we thought that there'd be value to be lost there, we might have to rethink that. Again, it is separate. It's obviously no linkage to our other businesses.
Right.
Oftentimes we've said it's our highest generating limited partnership investment, if you can think of it that way.
Okay. Right.
With, like I said, a very healthy cash flow to the holding company.
All right. When Hartford announced the Navigators deal, the company said share buybacks would initially be on hold until 2020. Hartford subsequently announced that it was moving up that timeframe to the second quarter of 2019. How should investors think about the sources of funds available for buybacks for the remainder of 2019, 2020, and perhaps beyond?
Yeah. We did announce a share repurchase authorization in February of this year of $1 billion. We indicated that the majority of that we would anticipate using in 2020. We've sort of, size-wise, have talked about it sort of like 20% maybe this year, 80% in 2020. We talked about, at the time when we were doing that, because we knew that in 2019, our ability to generate a significant amount of excess cash flow at the holding company was somewhat limited because of the Navigators acquisition. We had accelerated dividends from our P&C company at the end of 2018, so we're really not expecting any dividends in 2019. As we looked at our sources and uses of cash, we got more clarity on how we would be refunded some of our AMT tax credits-
Right
As we looked at that cash flow, we did have some capacity in 2019. We felt that it was important to put out a share repurchase authorization to be clear with investors on what our intent was in the short term. We'd clearly said that from an M&A perspective, we have what we need. We knew we were going to be generating excess cash at the holding company, and we wanted to be able to take advantage of that as we were going into 2019. We started in the second quarter again after the Navigators acquisition, or right around the time that that closed. As I said, we had a bit better clarity as to expectation of timing relative to some of our tax refunds that we'd be getting, and we did get our AMT tax refund in July, the first tranche of that.
We started to implement our share repurchases. As we go into 2020, I really see that as sort of returning to more normal as it relates to cash flow generation to the holding company, which I see as very strong. Our P&C company, we'd anticipate dividends in the $850 million-$900 million range annually. Again, we'll start that again in 2020, not in 2019. Group benefits have been performing very strong, and we anticipate dividends in the $250 million-$300 million range there. Mutual funds are kind of in that $100 million-$125 million range. When you think about uses of cash at the holding company, it's primarily dividends and interest.
Right.
We don't have really other expenses at the holding company. We allocate nearly all of our corporate expenses to our business units. Dividends and interest is probably sort of in that $750 million range. When you kind of put all that together, we will be generating excess cash at the holding company. We do have some tax refunds that we'll continue to enjoy into 2020. We've been very pleased with being able to finally monetize those assets because we've talked about them for a while. I t's great. Our AMT refunds, we should be mostly through those into 2020. Our NOLs, again, dependent on what the underlying taxable income is at the operating units. That also generates cash to the holding company through our tax-sharing arrangements. For next year, probably like in the $500 million range.
$500 for the NOL?
NOL and AMT together.
Oh, okay
in 2020.
That could put you $1.7 billion, $1.8 billion.
Yeah. The only other thing I would mention is that we do have some debt maturing in March of next year, and we've indicated our intent to pay that down. That would obviously be a use of cash as we think about 2020.
How much is that?
That's about $100 million.
Yeah. Okay.
I think once we get through that, when we think about our debt, I think that will, based on our projections, put us in a very good place as it relates to leverage ratios.
Right.
Again, all the things that we've been working on to strengthen our balance sheet, sort of improve our underlying profitability, and really see it as having a steady source of cash to the holding company.
Of course.
A lot less volatility than maybe we've talked about in the past.
Yes. Well, that's a very strong story. How do you feel that translates into return on equity profile? Hartford's return on equity on a core basis, the trailing four quarters is 11.7%. What do you think a reasonable expectation or run rate is now that we've got the major acquisition of Navigators and the Aetna life and disability business, plus Talcott being off the books? You talked about strong distributable-
Yeah
cash flow with the share buybacks.
Yeah.
Take the debt off the balance sheet as well.
Yeah. One, we're very pleased with the 11.7%. I remember being on the stage with you many times, we used to ask the audience if we'd ever get over 10%. Obviously a very strong result. I'll remind you that when we quote that 11.7%, that's on a rolling 12 months. That's looking at the past 12 months, which would include the fourth quarter of last year's wildfire losses that we had. When you look at it on a run rate through the six months, it's much higher than that. As you know, there's lots of puts and takes as to where our ROE will be over time. We've talked about the 11%-12% range, obviously we're ticking towards the high end of that range. Again, depending on what actual cats are for this year, what happens with limited partnership returns.
There's a path where we would be over 12% for 2019. Looking forward, obviously continuing to focus on the core profitability of our underwriting operations is key. We do have to be mindful of a bit of a headwind with interest rates and what will happen with that over time. Again, the portfolio doesn't turn over all at once. You did see in the second quarter that our reinvestment rate was below what our sales and maturities were. I would anticipate third quarter we'll see a little bit of that as well. From my perspective, in this rate environment, and all things considered, if we can be in that 11%-12%, I think that's a very healthy return given the environment that we probably will be in.
Including in 2020. You wouldn't think, given expense saving opportunities and productivity enhancements plus the benefit of the buyback might boost that a little bit.
Yeah. Again, that's going to be impacted, as I said, on what happens with overall investment returns. Obviously, a component of that is what happens with limited partnership returns. If you anticipate a 6% return on limited partnerships, probably harder to get past that. If the limited partnership returns continue to be where we've seen, obviously that would be a little bit of a tailwind. Again, overall, when you step back and you look at overall cost of capital and current rate environment and what all that means, I'd say they're very healthy returns.
Okay. Of course. Near term, of course, the industry and, of course, the people affected are dealing with Hurricane Dorian. Any initial thoughts on what the impact could be on Hartford or perhaps the broader industry?
Yeah. Obviously it's very early, the storm has taken lots of turns and estimates have changed over time. I don't really want to give an estimate because it's obviously hard to do. It obviously is a much lower impact than probably what some were predicting before it changed course and obviously didn't hit Florida, and even in the areas that it did hit, did not hit at the speeds that people thought. For us, we would expect it to be under $50 million, just to put some sort of cap on that, and I would say well inside of that. We do have a little bit of exposure in the Bahamas through Navigators.
Okay.
Even considering that, we see it as a very manageable event, and obviously very happy for those affected on the East Coast that it turned out to be much less intense than originally anticipated.
Of course. A normal cat load for Hartford in third quarter during hurricane season, what would that typically be?
Yeah. When we budget, we typically, for third quarter, we're usually about $135 million-ish pre-tax is kind of what our load is. We do seasonalize our cat load, second and third quarter tend to be higher than first and fourth quarter. Again, based on what we've seen to date, we're not necessarily expecting to be outside of that.
Right. Otherwise, it's been.
Pretty mild. Up through.
Pretty easy.
Yeah, up through August, we are probably, if we trend things on a month-to-month basis, we're a little bit under what our cat budget had been. Obviously has been some activity, but nothing of significance at this point.
Of course. Okay. That's good news. Let's focus on The Hartford's commercial P&C business more broadly. What are you seeing there in terms of top line and margin trends?
Good question. It's a hot topic I know people are very focused on. I'll go back to what we said in our second quarter call. I think Doug was pretty explicit as he went through the various businesses and some of the things that we're seeing. There are definitely areas where we're continuing to take rate. We've talked about it before in commercial auto where we need rate. That's obviously important for us to get and to continue to track well there. Definitely seeing that in our general liability and construction lines. From a margin perspective, we obviously are feeling a little bit of pressure in comp, we and others have talked about that as you've seen rate decreases being rolled in across various states. I always start that conversation with the fact that comp is a very profitable line for us.
Even with a bit of compression, it's still business that we want to write and we believe we write very well and can manage in this rate environment. We're watching that closely. Then Doug also commented on our call that we were feeling a little bit of loss cost pressure in our Builder's risk book, kind of a construction Builder's risk marine book, we're taking action there as well. All of that was contemplated when we provided our update on our combined ratio guidance for the second half of the year, including Navigators.
Right.
Because when we had provided our guidance at the beginning of the year, we obviously didn't know when we were going to close Navigators, it excluded all of that. All that was contemplated and feel good about the range that we put out.
The pricing trends have continued to improve in commercial P&C through the first half of the year. Is that a trend that you think will continue in the second half?
We've definitely seen that and continue to see that as we go through the third quarter. Sometimes these things are hard to predict.
Right
Obviously will happen in the future. Our focus right now is where we are seeing the ability to take rate to do that. Obviously, be smart about it. We're very careful as we look at new business that's coming into the market and understanding why it is and what the loss experience is there. In various areas, and especially in some of the Navigators business and in the specialty area, we've been very pleased with the level of rate increases that we're seeing. Again, some aspects of that book need it.
Right.
We're mindful of that. Right now, that trend seems to be continuing.
When we see the pace of rate increases for The Hartford overall, it's just going to be inclusive of Navigators, right? Which has a bit more of a specialty focus right now-
Yeah
getting larger increases.
Yes. If you're referring to the disclosures that we do on price increases, those disclosures we do are more in our standard lines.
Okay.
We're still working on what metrics we'll give on our specialty lines.
That is typically in our old construct was small commercial, middle market.
Okay
Standard businesses, which is what it will continue to be. Yes, if you peel back, we look at the underlying rates that we're seeing in some of the Navigators book. Most of that business will be or is in our global specialty segment. There's some that's in middle market. The most of it is in global specialty. I'm definitely pleased with the rate of pricing increases that we're seeing there.
Good.
We'll continue to share what we see there going forward.
Excellent. The somewhat flip side of that is, we've heard about increased social inflation, how that could be affecting claims cost inflation in casualty lines. Do you see any hotspots around that?
Nothing that I would point out in particular. We do watch that very closely, especially in the general liability lines, to see what we might see in underlying exposures. There's not anything that I would point to specifically as being a dramatic change in trend from what we've seen. We do pretty significant diagnostics in those claims to look for those types of activities. We watch them, and there's always spots that you have your eye on. Nothing that I would point to that at this point I would say is significantly impacting our overall loss ratio.
Okay. Good to know. Let's turn to personal auto. The premium volume for Hartford's personal auto business has been shrinking for the past several years. At what point do you feel premium volume in personal auto might stabilize or perhaps even return to growth?
Yeah. We have been on a path of, one, first improving the core profitability in personal lines. We obviously had some challenges in that line going back a few years. Feel very good now about the profitability, and we look at it not just in total, but by state.
Right.
The level of rate increases that we were able to achieve to really offset some of the increases activity that we saw in loss cost trends. Through that process, we obviously did have an impact on the top line. Some of that was very intentional, especially in our agency book, as we really looked to repurpose sort of what agents we were doing business with, what agents we were giving access to kind of AARP through agents and so forth. That was expected and really was part of our process of returning back to profitability. When we focus on our personal lines business, we're primarily focused on the AARP business.
Yes.
We were very pleased this last quarter to see year-over-year growth in new business, because we see that as sort of a leading indicator of being able to return to overall growth. Doug has talked about in the past that kind of getting through 2019 and into 2020, that our expectation would be as we go through 2020, both with increasing our new business as well as improving our retention. We put a lot of weight into that book.
Yeah.
As we've talked about in the past, a lot of our policies, majority of our policies are 12-month policies. It takes a bit of time for all that rate to come in. In some instances, because of just the number of filings that we're doing and the timing of that, when an individual gets a renewal, it could be a pretty significant increase. It creates a shopping moment, and we definitely were feeling that in our retention. The team is very focused on improving retention rates, getting that new business up, and then obviously trying to stay ahead of loss cost trends and focus on that as well. Putting all those together, I think as we go through 2020, we would anticipate getting back to top line growth.
Excellent. That'd be great. Margins are in great shape too now in personal auto with an underlying combined ratio of around 95%. Do you feel there might be opportunity for further improvement in personal auto underwriting margins, or is that about where you want to keep it relative to restarting growth?
Yeah. I think if we can keep it around there, maybe slightly better, but right in that range, I think that positions us well for growth. Again, as we start to look at new business and turning new business on, obviously that can sometimes be a little bit of a drag as it relates to combined ratios, kind of new business penalty and so forth. We take all of that into consideration when we look at what levels we want to write at and where overall loss costs are. I think we have a good balance there.
Right.
Obviously with some of the challenges that we saw several years ago, we've improved significantly some of our analytics and our ability to look through what's happening in that book at a more granular level.
Right
To stay on top of trend. We've been pleased overall with the trends that we've been seeing in the auto book.
Good. Great. Okay. Well, let's turn to the audience response system. Let me get some audience feedback. The first question, if you don't currently own shares of The Hartford, what would cause you to change your mind? Got a couple options here for folks. Closing out on the last couple seconds here. The feedback from the audience, around 40% saying a tighter property casualty insurance market, around a quarter saying improved return on equity, and 20% saying I'm sorry, lower valuation, which that's a high-class problem, right? What do you think? Obviously, one company alone can't control the overall market environment, but what do you think about that return on equity element?
Yeah. Obviously, there is a lot that goes into that. As I said earlier, I think given the environment that we're in, when I look at our returns versus others, I think we stack very well now. I think in the past, it was a very complicated story for investors to parse through and understand. Now, given what we've done to streamline our businesses and the focus that we have, I think that the areas that I commented on are things that can drive continued improvement in ROE. Again, I think focusing on what happens with the rate environment is going to be key. One of the questions we sometimes get on that topic is, well, won't that manifest itself, or shouldn't it manifest itself in pricing if you're earning a lower return on your investment portfolio?
I think the theory is, yeah, it should, but it's probably over time. It's not like you're going to see it as quickly as you might see some of the impacts that come from just a lower yield environment.
Right. Okay.
Of course, also, the other piece that comes into that is just how much excess capital is in the system.
Yeah.
What returns are attractive to folks.
Exactly. Okay. Next question, please. This has to do with Hartford's operating return on equity in 2020. Please start the clock. Compared to 11.7% in the first half on a trailing basis, we'd be interested to see what investors' expectations are for 2020 return on equity. 70% saying 10%-12%. Then evenly split 15% on lower than that or higher than that, essentially. I think that's pretty consistent with your view.
Okay. Next question, please. This question has to do with the underlying combined ratio expectation for Hartford over the next several years. As a point of reference, it was 92% in the first half of 2019. What do people think directionally about that? Where could it head? The audience is saying that 40% expecting modest deterioration, nearly 30% each saying either no change or a modest improvement. How should people think about that from a structure standpoint?
The only thing I'd comment on, and I don't know if this is part of what might be influencing the 40% for modest deterioration is, don't forget for the first half, the 92.20% obviously didn't include Navigators. Navigators do run at a higher combined ratio. Even with our guidance that we gave for the second half of the year, we were showing that we would anticipate a little bit of deterioration in that. We would really need some time to, as we said, improve the underlying underwriting profitability there of Navigators. That may be influencing a little bit, and maybe people are listening to what we said.
Okay.
Our expectations for the second half of the year.
All right. For 2020, in terms of price improvement, earning through, expense synergies, it seems like.
Yeah. It's early, I think, for us to start putting out 2020 guidance. Obviously want to see how the rest of 2019 plays out. To your point, what sort of price increases we see through the second half. As is our normal practice, we'll update folks as we look towards 2020 and what our expectations are there.
Okay, good. Next question please. This one is with regard to The Hartford's acquisition strategy. We talked about a fair amount today. If The Hartford could target a major acquisition that would not be substantially dilutive to tangible book value per share, it would be quickly accretive to EPS and ROE should they do it. Let's see the feedback from investors, which is slightly over two-thirds saying no, don't target a major acquisition. Just under 30% saying yes. That's pretty consistent with what you've been telling us today. More bolt-on focus perhaps, or adding capabilities.
Yeah. I'm going to stay away from getting too specific on the feedback, but yes.
Fair enough. Is there another ARS? One more. With regard to the potential impact of what we've been hearing about in terms of deterioration in the tort environment, what's investors' level of concern around that? Start the clock. We actually heard one other company today already say they're hearing some challenges around that. Pretty nice bell curve here.
Yeah.
Kind of right down the middle. Moderate, in the middle, nothing too much to take away from that in terms of the data, but you already talked about how you're not seeing too much of a hotspot.
Yeah. Again, we continue to watch it and look for trends, obviously, if we see trends, we'll react to those, as I said.
Great. We have a minute or so in terms of time for questions from the audience, if there are any.
I will say, I do like these questions that you asked this year than some of the questions when I've been up here in the past.
I look-
Feels like we've come a long way. Good. We've acknowledged.
I looked at the one from two years ago, and I remember not meaning to, but I hammered you a bit on Talcott.
You absolutely did.
There were a couple of those. Very quickly afterwards, there was an announcement of the transaction.
Right. Exactly.
Question from the audience? Last call. All right. Looks like we've covered everything.
All right. Thank you.
Please join me in thanking Beth Costello from The Hartford.