Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to The Hartford's call to announce its agreement to acquire The Navigators Group. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question, please press star, then the number 1 on your telephone keypad. To withdraw your question, press the pound key. We ask that you limit your questions to one question with one follow-up, and then you may re-enter the queue for additional questions as time allows. Thank you. Sabra Purtill , Head of Investor Relations, you may begin your conference.
Thank you. Good morning. Thank you all for joining us today. Today's call and webcast covers our announcement to acquire The Navigators Group, a leading specialty underwriter headquartered in Stamford, Connecticut. The news release and presentation addressing this future acquisition are available on our website. In addition, the 8-K, which summarizes the major provisions of the agreement, is also available on our website. Our speakers today include Chris Swift, Chairman and CEO of The Hartford; Doug Elliot, President; and Beth Bombara, CFO. Following their prepared remarks, we will have time for Q&A. Just a few comments before Chris begins. Today's call includes forward-looking statements as defined on the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance, and actual results could be materially different. We do not assume any obligation to update information or forward-looking statements provided on this call.
Investors should also consider the risks and uncertainties that could cause actual results to be different from these statements. A detailed description of those risks and uncertainties can be found in our SEC filings. Our commentary today also includes non-GAAP financial measures. Explanations and reconciliations of these measures to the most comparable GAAP measure are included in our SEC filings as well as in the news release, which is available on our website and also on our slides. Finally, please note that no portion of this conference call may be reproduced or rebroadcast in any form without The Hartford's prior written consent. Replays of this webcast and an official transcript will be available on The Hartford's website for at least one year after this call.
Good morning. Thank you for joining. Earlier today, we announced the agreement to acquire The Navigators Group, a global specialty underwriter, for $70 a share or approximately $2.1 billion in cash. We have been attracted to Navigators' expertise and track record of underwriting profitability for quite some time and are very excited about the future potential this transaction provides. The combination of our two businesses will meaningfully advance several of The Hartford's key strategic initiatives. It enhances our commercial lines market presence with specialty and E&S capabilities. It broadens and deepens our product offerings with expanded industry verticals. It expands our geographic underwriting reach with an international presence. Importantly, we see compelling growth potential in cross-selling the combined product offerings to our respective customer bases. This acquisition brings together two like-minded organizations with compatible cultures focused on disciplined underwriting, innovation, and financial performance.
The transaction is expected to generate attractive financial returns in the low double-digit range over time. In a few minutes, Beth Bombara will cover some of the key financial impacts of the transaction. Earnings expectations will be refined between now and closing based on our go-to-market strategies and integration process. Currently, we expect that within four to five years, the acquisition could contribute annual core earnings approaching $200 million, excluding amortization of intangibles. An important driver of the financial returns on this acquisition is greater profitable growth. While there are some expense efficiencies, they are not the primary driver of future returns. Like us, Navigators' primary focus has been on organic development with a strategy centered on adding products and talented people. Together, we anticipate additional momentum from several opportunities.
As Doug will discuss, Navigators brings underwriting expertise, industry, and product verticals in a global platform that can help us accelerate initiatives we recently launched. With our expanded market presence and product offerings, we can offer more products and services through a shared distribution network enhanced by The Hartford's brand and financial strength. Both Navigators and The Hartford have successful business relationships with the industry's top brokers and agents. The acquisition will further strengthen those partnerships and the coverage solutions that we can tailor for customers. We also look forward to maximizing the potential of Navigators' global reinsurance business. It's a relatively small part of their business with about 13% of gross written premiums and is comprised of traditional P&C reinsurance, A&H, and other product specialties. This business is an efficient way to participate in certain U.S. and international markets.
Together, we are confident that we can accelerate profitable growth. I look forward to welcoming Stan Galanski and his leadership team and the 820 Navigators employees worldwide to The Hartford. Our organizations share a common culture and a commitment to attracting and retaining top talent, and we look forward to working together with our future colleagues. I'll turn the call over to Doug for his perspective on the benefits this acquisition brings to The Hartford.
Thank you, Chris. We're very excited about joining forces with Navigators as we continue our journey to become a deeper and broader commercial underwriter. As we've discussed with you many times, we believe that success in today's property and casualty market requires specialization that comes from highly skilled talent with extensive local market and industry knowledge. Agents, brokers, and customers demand a partner that understands risk and is capable of solving their broad needs for protection, risk management, and service. Navigators' team and product offerings are an excellent complement to our strategy, capabilities, and culture. Let me highlight a few areas where we believe this combination accelerates our business plan. Throughout their 44-year history, Navigators has been known for their expertise in marine liability, cargo, specie, and hull insurance.
In more recent years, with innovation and entrepreneurial spirit, they have been adding capabilities in other specialty areas, including excess casualty, environmental liability, and life sciences. Navigators' build-out of their excess and surplus lines strategy in the wholesale market is distinctive and respected. These capabilities are highly complementary with our own initiatives in industry verticals such as marine, construction, technology, life sciences, and energy, as well as our expansion into surplus lines. In addition, Navigators' Lloyd's platform and recent international expansion initiatives will extend our capabilities and geographic reach, adding a U.K. and European underwriting presence that we do not presently have. We have been impressed with the technical depth and market knowledge of the Navigators leadership team. They clearly know their business well and have developed a well-earned reputation in the market as highly skilled underwriters and business professionals.
We are convinced that the combination of The Hartford and Navigators results in a stronger, more diversified commercial lines company that is even better positioned to compete in the marketplace. Navigators' product and industry specialization will expand our risk-taking skills and add to our growing industry verticals. In areas such as management and professional liability, we will immediately increase our scale and market presence, providing a better platform for profitable growth. Together, we bring a more comprehensive suite of product, underwriting, and service capabilities, including our market-leading workers' compensation offering to address the diverse needs of our agents, brokers, and customers. In the months ahead, we will work on our plans to maximize the strategic and financial value of this acquisition. As we further evaluate our opportunities, we will make decisions about our operating model, assessing the most effective market strategies for various product lines and industries.
From my vantage point, I see ample opportunity for us to accelerate our businesses and build value for our shareholders, customers, and distributors. I'll now turn the call over to Beth.
Thank you, Doug. I just wanted to touch on a few key financial and transaction items. The $2.1 billion purchase price can be paid in cash from existing corporate resources, including those at the holding company and dividends from subsidiaries. We will also evaluate financing alternatives between now and closing, which would reduce the utilization of our current resources. To be clear, we do not intend to issue common equity to fund this acquisition. Our debt levels will increase slightly at closing due to Navigators' $265 million of debt, which will result in a modest increase to our total debt to capital ratio, excluding AOCI, which was 25% at June 30th, 2018.
The actual impact of the acquisition on our income statement and balance sheet will depend on many factors, including the timing of the closing, purchase accounting impacts such as intangible assets and goodwill, integration costs, and acquisition-related charges, including transaction costs and any changes in loss reserve estimates that are deemed necessary. We currently expect the total impact on 2019 shareholders' equity to be immaterial, but could be modestly negative, primarily due to integration costs and acquisition-related charges. Excluding integration costs as well as acquisition-related charges, we expect the acquisition to be immediately accretive. For 2020, The Hartford expects the acquisition to be accretive to core earnings by $60 million-$95 million.
This is comprised of a contribution by Navigators of $110 million-$145 million in core earnings, offset by a reduction of approximately $50 million in The Hartford's net investment income after tax due to the cash used to fund the acquisition. I know that many analyst models may already reflect a reduction in net investment income due to assumptions about share repurchase programs in 2018 and 2019, which we did not include in our outlook. As we further refine our go-to-market strategies and purchase accounting adjustments, we will update our earnings estimates, including 2020 intangible asset amortization expense, currently estimated at $15 million-$30 million after tax. As Chris mentioned, we expect the combination of revenue growth and expense synergies to generate higher earnings beyond 2020 as we will realize the full potential of the acquisition.
We expect to close the acquisition in the first half of 2019, subject to regulatory approval and the Navigators shareholder vote. We expect the shareholder vote to occur by year-end 2018. Navigators' founder and certain other shareholders, who own together about 22% of outstanding shares, have agreed to vote in favor of the transaction. There are various regulatory approvals necessary for us to acquire Navigators. In addition to approvals by regulators in the U.S., principally New York, which is Navigators' state of domicile, we will need approval from a number of international regulatory bodies, including the UK Prudential Regulation Authority, the UK Financial Conduct Authority, the National Bank of Belgium, and the Luxembourg Financial Regulator. We also will need to obtain various consents from Lloyd's of London related to Navigators Syndicate.
With that, I'll now turn it over to our operator, Amy, to repeat the instructions for asking a question as we begin the Q&A session.
At this time, we will be commencing our question and answer session. In order to ask a question, please press star, then the number one on your telephone keypad. We ask that you limit your questions to one question with one follow-up, then you may reenter the queue to ask additional questions as time allows. Your first question comes from the line of Kai Pan with Morgan Stanley. Kai, your line is open.
Thank you, and good morning. My first question is about potential revenue growth opportunity as well as cost savings. You said that in four to five years, Navigators will contribute about $200 million ex amortization, which is about 60% more than sort of 2020 contribution with $110 million-$145 million. That implies about 12%-15% annual growth over the four to five-year period. I just wonder, could you elaborate more about where do you see the revenue opportunities as well as the potential, like you said, modest expense saving opportunities?
Sure, Kai. It's Chris. I think that the revenue assumptions going forward are, we could talk about it, but I would also say importantly, I think we've been realistic with the loss cost assumptions, too, increasingly modestly as we take on some of these new product lines. I think our models would really point to more of a premium growth rate in the 5%-6% range. I think there are expense saves that Beth has mentioned. I would also say I think there's opportunities to increase the portfolio yield. You put it all together, and that's why we're comfortable if you look out, as I said, that four to five-year range, we could see core earnings ex amortization of intangibles in that $200 million range. Beth, would you comment any more on expense synergies or investment?
Yeah. A couple of things. One, I just wanted to also be clear that in the contribution that we talk about from Navigators in 2020, that that would be inclusive of amortization of intangibles. When you're comparing it to the number that Chris gave, which was ex that, you need to make that adjustment. Then as it relates to expense synergies and things that we've put in our model, we're currently modeling about $20 million after tax in expense synergies that we'd anticipate being able to achieve in the near term. Then obviously, over a longer period of time, we will continue with applying The Hartford continuous improvement procedures and so forth to continue to look to find ways to find efficiencies going forward.
My follow-up is on the sort of if you step back, consider alternatives for buybacks, for example. The deal is probably 14-19 times earnings on the Navigators' earnings 2020. If you buy back a share, probably like 10 times earnings. I wonder, give us a little bit your thought process of considering alternatives, including buybacks before you do the deal, and does the deal mean that the buyback will be pushed back further after 2019?
Yeah. Kai, what I would say is, again, we found this transaction financially attractive in addition to all the strategic benefits that Doug and I've talked about. In relation to buybacks, we think it's attractive. What it means for the future is, as Beth said, there's quite a process here to get approvals, which we expect given our reputation and our capabilities, but it's going to take some time, probably early 2019, March, April-ish timeframe. We look at our financials, and we do generate capital, but we're still integrating and digesting the Aetna acquisition. We will begin to determine our go-to-market strategies here, build excess capital. I'm not prepared to really talk specifically about capital management plans as we approach the end of 2019 and into 2020 now.
All I would tell you is, I still believe we will generate significant excess capital over time, and as we approach the right time, we'll tell you what we're going to do with it.
Thank you so much.
The next question comes from the line of Josh Shanker with Deutsche Bank. Josh, your line is open.
Yes, thank you. Given the 30 days, if another suitor comes with a higher offer, are you going to chase it, or is this $70 at best and final?
Josh, yeah. The deal does contain a go shop and a no shop where over the next 30 days, Navigators does have the opportunity to solicit proposals. We granted them that opportunity. We think $70 is a fair value for the shares. I'm not going to speculate on what's going to happen if any suitor emerges. We stand by we negotiated, I think, a fair transaction for both parties, believe in it. That's why we're talking to you about it today, and we'll see what the future holds.
In terms of your own positioning in the areas that you're picking up on Navigators, when you look at the sort of synergies from a revenue perspective, how many of those lines do you have some sort of current market share in? How much is going to be brand new to you? Why do you expect to be the best operator in those areas?
Josh, this is Doug. It's a multifaceted question, let me just take a few of the pieces, and then we can explore further if you'd like to. Clearly, they've got a terrific E&S wholesale operation that they have built out. Two years ago, we purchased Maxum. We've been growing the Maxum franchise, but they do add deep expertise there, I think our wholesale strategies clearly are accelerated with the combination. They also, aside from marine and their financial products, have some excellent specialty offerings in the retail space. I'm thinking specifically about their excess casualty program, their environmental strategies, and some of their life science work. Those are all accelerants to early work that had been going on here as a company, and pivotal to some of the success that we have ambition for in middle market over the next three to five years.
Very excited that their complete array of products offer opportunities for us to do more. There are places that we both compete, I think immediately we develop a scale opportunity in the marketplace. There are also products like life science that we are moving into, they've had a presence for several years that day one, we hit the market with a much more aggressive approach.
In terms of places where you have duplicate capabilities?
Well, I think that is to be worked on over the next six, nine, 12 months, we will figure out how to lever the combination of both of those businesses to create a bigger competitor in the marketplace.
Okay.
Josh, I didn't mention international. I certainly should have. Obviously, our footprint outside the U.S. is very small. The fact that Navigators has been outside the U.S., they have a Lloyd's platform, they've got physical locations in nine cities around the world, and they have experienced a number of products and a number of roll-outs. I think that gives us an acceleration there to think more globally, which is an important part of our strategy over the next three to five years as well.
Well, good luck with it, and we'll see. Thank you.
Your next question comes from the line of Amit Kumar with Buckingham Research. Amit, your line is open.
Thanks, and good morning. Two questions. First of all, can you spend some time and opine on how do you feel about Navigators' reserves, and do you foresee some adjustment to those?
Yeah. Amit, I'll provide some comments, then Beth will follow up. I would say again, during the process of coming to this point, we had the opportunity to do significant due diligence, meet the management teams, understand their strategy, typical stuff. I would say we spent an exceptional amount of time on reserves. You know the old adage, you get three actuaries in a room, and you're going to have three different opinions. I think that's honestly our views is there's a range of outcomes here that Beth will talk about. The $70 a share that we have confirmed with our offer here, I think reflects a wide range of outcomes that make us comfortable with the negotiated purchase price. Beth, what would you add?
Yeah, just to add to that as Chris indicated, obviously when you're evaluating reserves, there's always a range of estimates that depend upon underlying judgments and methodologies. As we look overall through the diligence process at the reserves, they're within a reasonable range. As we look to harmonize kind of our judgments and our processes, there could be areas where we determine that our best estimate is slightly above where they are, and we will take that into consideration between now and closing and make any adjustments that we feel is appropriate. As Chris indicated, as part of our process of just looking at the underlying valuation and where we came up from a price perspective, we took all of that into consideration.
If there are some reserve adjustments that we conclude we should record, that doesn't change our view on the overall attractiveness of this franchise.
Got it. That's helpful. The only other question, I will get back in the queue. Chris, can you sort of just maybe even talk about the background of this deal? Who approached whom? I'm sure there were other companies on the shortlist. What happened at the end of it, why you ended up selecting Navigators versus there's definitely some other companies, too. Maybe just talk about how this came about. Thanks.
Yeah. What I would say, obviously you'll read it in their proxy, but from our perspective, I'd first just start with, this has been and is an attractive property to us. We've been very impressed with the underwriting talent, the claim talent, the support talent that Navigators has. The leadership, it's entrepreneurial, can-do, open-up-new-markets approach. It's been attractive to us for a while. How that management team and their board involved others, I really don't know. I would say that over the last three years, we've made acquaintances with Stan A. Galanski, their CEO. We've stayed in contact informally. I would say earlier this year, March, April-ish, is when there was an informal outreach about seeing if there's anything we could do. Thought about it. We engaged then in a period we would say was exclusive, and we came to this point.
I'd say pretty quickly, over the last four or five months, we figured out that we could get something done, here we are today.
Your next question comes from the line of Elyse Greenspan with Wells Fargo. Elyse, your line is open.
Hi, thanks. Good morning. My first question is just thinking through the financing and paying for this transaction. On your last quarter's call, you guys said that you would end this year with about $2 billion at the holding company. I know you look to keep about one to one and a half of annual dividends and interest at the holdco. Would the financing of this deal maybe cause you to go to the low end there? Then can you talk through, obviously dividends from the subs this year were lower due to the Aetna deal. Just in terms of dividends we could expect next year, I thought maybe some of that might have been second half weighted, whereas this deal is closing in the first half. Just correct me if I'm wrong.
How high you might let your leverage go to finance the deal?
Sure. I'll cover off on that. Yes, as we look at sort of pre this transaction and holding company resources at the end of the year, kind of in that $2 billion range, that was predicated on just other things that we might do as well relative to things like contribution to pension plan and so forth. It's probably a little bit more than that. You're right in that we typically target one to one and a half times interest in dividends. I think the combination between that excess capital we have, as well as taking some dividends from the subsidiaries, I think we can put ourselves in a good position that we would still be within those thresholds.
We had talked about dividends in 2019 potentially being more in the second half, we might look to accelerate some of those as we think about paying for this transaction. As far as our debt leverage, one of the things that we're also just evaluating is, as you know, we do have some debt that's maturing in January. Obviously, that's in our debt ratios today. When I think about just resources that we would use to fund this transaction, where previously we were thinking of paying that maturity down and not issuing debt, we might consider issuing debt to sort of fund that. Again, I wouldn't anticipate that our leverage ratios would increase very significantly from sort of the pro forma that we're describing today.
There might be an opportunity for them just to go up a bit, we would look to manage them down as we continue to generate earnings, which obviously improves our equity position. We also have maturing debt in 2020 that we could look at as far as continuing to pay down and get back into levels that are a little bit lower than where we are today.
Okay. Thank you. That was helpful. My second question, if we look at Navigators' cat exposure, they had about seven points of cats last year. How do we think about their cat exposure going into wind season? I'm assuming given there's smaller reinsurance exposure as part of their bigger portfolio, there's no collar on this deal if in fact we have a pretty strong hurricane season this year.
Elyse, it's Chris. Between Doug and I, let me see if we could paint a picture for you. We do understand their exposures using 1 in 100 return periods, 1 in 250. I would say that we believe they have a robust reinsurance program. I'm not sure if that's changed over the years given their experiences, but what's in place today we think is very robust. It nets down to, I'll call it on a 1 in 100 basis or a 1 in 250 basis on the information we have, in that $35 million-$40 million range. Again, within our tolerances and our balance sheet and our capital position, I think that's very manageable and tolerable. Doug, what would you add?
The only thing I would add, Chris, is that we spent a considerable amount of time with their reinsurance group, their leadership, Clay Bassett, and very comfortable how they manage aggregates. They're disciplined by geography, et cetera. Looking forward to becoming partners. We think they've got a very disciplined group there on the cat side.
Okay, thank you very much.
Your next question comes from the line of Michael Zaremski with Credit Suisse. Mike, your line is open.
Hi, good morning. First, a follow-up to Kai's question. I will say that I don't know Navigators that well, and I think a number of people on this call don't appreciate Navigators as well, and we'll get to know them over time. But if I look at their historical ROE, it's been about 7% and you're playing close to 1.7 book. You feel you can earn a double-digit return over time. It implies that you think Navigators can meaningfully improve its ROE. Even if I take into account the modest expense saves and the 5%-6% premium growth, I guess it implies that I shouldn't be thinking about the 7% ROE as being reflective of, there might have been items in there that suppressed it.
Maybe there's structural items you feel we should better understand about Navigators, which were suppressing its historical ROE.
Yeah, I understand the question, Kai, or excuse me, Michael. As I responded to Kai, it is about growing the premium base, with, I'll call it, a slightly higher loss ratio, and using our financial strength, our distribution networks, cross-selling, in a more effective way. There are some modest expense saves. I do think there will be, I'll call it, a good lift in the investment portfolio with our asset allocation philosophy and methodology. Ultimately, I think that the view that I have, along with Doug, is that one and one's going to equal three here, and we'll be able to contribute to their underwriting process, contribute maybe in risk-taking in different ways to help drive a higher ROE.
As you said, historically, it's been in that seven, eight, nine range, and we're an ROE-focused company, and I think there's some tools, methodology, approach, mindset that I think we'll be able to bring to the organization in, as Doug said, in a partner way. Doug, what would you add?
Mike, I would also add that we have, I think you know, invested mightily over the last decade in data science and data analytics. I think we'll offer something in that regard as we work hard together on improving underwriting results across the board, both at The Hartford and also at Navigators. I'm excited about the tools we've built, and I'm excited to share them at the appropriate time with Navigators.
Okay. That's helpful. My last question. It's tougher for us to appreciate, but you talk about this strengthening your value proposition to agents and customers. Maybe you can update us on whether strategic goals post this deal. I know this deal will take some time to work through. Does this fulfill your desires in commercial lines if we're thinking over the long run, or are there still ambitions to maybe move up market or whatnot?
What I would share with you, Mike, is that we are always pushing ourselves to be the best as we could be. As Doug said, the best underwriters with, we think, outstanding distribution, with a broader array of products and underwriting skills and industry support, as the world gets very specialized. I think this acquisition goes a long way to establishing, to contributing to our desires and vision and aspirations. It'll never be completely satisfied, and we're always going to push ourselves to do more. I think what's particularly attractive to me is some of the international capabilities that we pick up through their Lloyd's presence, their larger London market presence, and a beginning of a European strategy. The Hartford's vision and strategy is focused around small to middle market, in select specialties and select activities and national accounts.
Our bread and butter, and I think our value added over the long term, is going to be in that SME to specialty area to playing at the smaller end of national accounts and financial lines and things like that. We're very mindful of what we think we're good at. We're very mindful of where I think the market allows you to make adequate returns. Really going upmarket in a major way isn't part of our vision at this time.
Mike, let me just add another thought, too. As we think about our small commercial franchise, which we're very proud of, over time, it'll have a bit more of a specialty edge to it, and I think Navigators helps that process, number one. Number two, we've talked over the last several years about our focus with our middle market franchise. Eight years ago, seven years ago, when I arrived, heavily dominant with workers' compensation. We've been working to increase our skill and our product offering in the property and casualty space. Say we've made quite a bit of progress, this acquisition also gives us the ability to have more product faster in that area, which we think is pivotal for us as we grow our franchise over the next three years.
Very excited about what we can do together, pleased with our progress, but I do see some accelerants here with Navigators. They've been deep in the casualty side, and I think we'll learn a lot as we come together.
Thank you.
Your next question comes from the line of Ryan Tunis with Autonomous Research. Ryan, your line is open.
Hey, thanks. Good morning. I guess for Chris, it's been a pretty busy 12 months at The Hartford, M&A-wise, a couple of deals. I guess looking out to the close of this, presumably, there's going to be some integration process. Should we think about mid 2019, 2020? Are we kind of through the try to grow through M&A aspect of, I guess, the life cycle at The Hartford? Should we think about, I guess, more of a balanced form of capital return at that point as you're integrating Navigators? Should the takeaway from this be that still indefinitely there's an appetite for M&A versus any other form of capital return that extends until told otherwise?
Yeah. Thank you, Ryan. I'd say you framed it fairly well, right? Very pleased with the Aetna integration, as we've reported periodically to you. As we get into early 2019, there's some major hurdles, milestones that we feel very comfortable in achieving. I believe that integration is on track, and it's going to achieve or slightly exceed some of the goals that we've put out there. This one's a little different, right? Aetna was like a full integration into our tools and technology, and we were using some of the things we acquired there. This is a little different. They have their own process and systems and legal entities. The integration here from a back office side probably is going to be a little lighter.
As Doug alluded to, it's more, what are the best go-to-market strategies that we need to have to capture and win additional business. That's probably going to take, I would say, most of 2019 to sort through and be in a good position and rebuild the balance sheet. I think from there, philosophically, I think you know me pretty well. We still want to invest in our businesses to make them distinctive, to make them competitive, to differentiate ourselves and offer value to our customer agents, our customers, and have our people feel proud. We always are going to have a mindset of how do we get better? We've always had a mindset of can we build? As Doug just said, over the years, I'm really proud of what we've built and created, and we'll bring that organic mindset.
There's also a part of us that is also going to be aware of opportunities that can accelerate things that we want to achieve. These two acquisitions go a long way. I, again, reserve the right to sort of say that maybe beginning in 2020, we could think about capital differently. As we sit here today, we still want to invest, we still want to be the best we can be and grow, and offer more products and services through our agents and to ultimate customers. We'll see what develops. It's hard to forecast what the world's going to look like in 2020 and beyond. We'd like to keep our options open, and really see what develops.
That's helpful. Then, actually an unrelated one for Doug. I guess with earnings, looking back at earnings, there was a much more cautious stance at Hartford around workers' comp than pretty much any competitor. I guess with that, in retrospect, I'm curious if Doug has any updated thoughts. I know it hasn't been a month, but I guess just kind of trying to square that triangle on why did it sound like there was somewhat of a pickup in inflation at Hartford that we haven't necessarily seen as an industry phenomenon?
Ryan, I don't have much of an update. I can tell you we're spending a lot of time looking at our books of business, evaluating all of our lines, including workers' comp. I can't speak to the other carriers that we compete with, but I stand by my remarks on the second quarter that this is an important line for us. We pay attention to trends, and we'll react to what we see in our book of business in the ensuing months ahead.
Thanks.
Thank you.
Your next question comes from the line of Robert Glasspiegel with Janney Montgomery. Bob, your line is open.
Good morning, everyone. You did a very good job on the strategic basis for the deal. I need a little bit more help on the financial side. The numbers you used on accretion sort of used a 2.3% cost of financing. I'm sure you used a more rigorous analysis than that as a hurdle rate. What hurdle rate do you use in paying 70% over book from a financial point of view for a payback to be in line with what you want to get?
Thanks for the question, Bob. Sorry, we can't square your triangles, as they say. I would say we use our cost of equity capital as a hurdle. I would say we estimate that in an 8.5%-9% range today. This deal, again, and when you get two, three years out, exceeds that. We don't view exceeding it as anything, but we want to try to be as wide as we can to the spread of our equity cost of capital. We understand we mix in debt and maybe other securities from time to time that gets our overall cost of capital down, but we measure hurdle rates as our cost of equity capital over a reasonable period of time.
9% on $2.1 billion would be, you need $180 million of earnings power from the deal in two to three years. Is that a fair statement?
Yeah, that's why I made the statement I did, is that when you get out a little further, four to five in this particular case, given that there is growth aspirations that we have. We approach that $200 million range, ex amortization of intangibles with, I would say, we capitalize that cost so we don't penalize ourselves. That's why we back that out philosophically. We know it's an expense. We don't ignore it. We include it in core earnings. When Beth and I look at our capital allocation, our models, we do back that out.
One last question. What's the breakup fee?
There's two. One, there's during the go-shop period. It's basically 2%. Then there's what the deal lawyers call a no-shop period, that it jumps up to 3.25%. View it as a 2%, and if after 30 days someone emerges, it goes up to 3.25%.
Thank you.
Your next question comes from the line of Yaron Kinar with Goldman Sachs. Uram, your line is open.
Good morning, everybody. My first question is around the reinsurance portion of the operations. I realize it's pretty small and pro forma base. I thought that this was maybe an area that you were less interested in being involved in. I was just curious, is that a core business for you, or do you view it as a core business? If so, is it a business that you'd also be looking to maybe explore some alternative capital growth opportunities in?
We tried to frame it in our comments is that it's about 13% of reinsurance is defined as 13% of their gross written premiums. If you really subdivide that, Uram, is that seven-ish % of that reinsurance premiums is traditional P&C reinsurance. Again, we put some slides together to sort of give you that. Half would be traditional. The other half we would say is A&H and other specialty lines that are ways of getting into markets, in essence, a synthetic direct basis. We're intrigued. Obviously, it's part of the acquisition. We want to try to maximize it. We'll work to continue to allocate capital to that division, but measured against risk-adjusted returns that we think are appropriate over a longer period of time. If it passes that hurdle rate, great.
I'm optimistic given how they use reinsurance in certain territories to enter and try to grow profitably. I think their strategy is I'm looking forward to learning more about it because I'm intrigued by it.
Okay. That's helpful. My second question is just about the broader kind of premium growth assumption for the Navigators business. I think you talked about 5%-6% growth that you're building in, which is, I think, roughly in line with the Navigators' multi-year growth average, but certainly lower than what they've been boasting the last couple of years. Between that kind of the deceleration from recent years and your cross-selling opportunities, I'm just curious as to why it would be 5%-6% and not continuing this improving trajectory that you're thinking of.
Well, look, we debate all the time, what is an appropriate growth mentality because you could grow a lot faster, but you're going to have poor underwriting results and probably not the profitability you want. We're trying to strike what we think is the right balance with their product sets, our product sets, and creating a growth environment that makes prudent sense to grow and maximize ROEs at the same times. That's what we believe is accurate. As Doug just alluded to, workers' comp is under a little pressure right now, still a profitable line, but you got to be really select in how you want to target growth balanced against ROE. Doug, what would you add?
I guess the only other thought is that their markets really do extend outside of the U.S. and around the world, and there are certain product niches in parts of the world where I would say pricing is rather soft, and they have commented on their prior quarterly call. They're managing all of their niches and verticals aggressively, and I think being very thoughtful about that, but all their markets don't exist the same way today. I think there are spots where they're competing differently based on what they think are financial return opportunities in the market as they exist.
Got it. Thank you very much.
Your next question comes from the line of Meyer Shields with KBW. Meyer, your line is open.
Quick modeling questions. Can you talk about the, I guess, premium leakage and PGAAP adjustments that are included in the 2020 core EPS outlook?
Premium leakage and PGAPs. I'll look to Beth on PGAPs. I think on premium leakage, Doug, it's modest. There's good complementary nature of these two franchises. We share a lot of the same distribution relationships, so we don't see any shock losses coming or dyssynergies in the premium leakage. I think it's managing retention in a price environment that makes sense is our basic going-in assumption, Doug.
Also included in our modified expectations of top line. I think it's all rolled together. Because the transaction is legal entity different than certainly the Aetna transaction, I look at that renewal dynamic a little bit differently in this combination with Navigators.
Meyer, as it relates to purchase accounting adjustments, I'm assuming you're referring to sort of amortization of intangible expenses. As I said in my remarks, the numbers that we gave for 2020 include a range of about $15 million-$30 million after tax. Obviously we'll be truing those up as we go through the process of just doing all of the purchase accounting adjustments that come with the balance sheet. That's what's embedded in those numbers right now.
Okay. Perfect, thank you. Second question, if I can. Beth, you talked about possibly truing up Navigators reserves to your best estimate. Hartford obviously has been sort of increasing the excess of recorded reserves to the best estimate. Would you expect to have to use the same standard on the legacy Navigators reserves?
Yeah. Again, we'll look at the overall reserves, as I said, harmonize them with our methods and judgments. We don't necessarily target a specific number as you're referring to it, we'll take that into consideration. As I said, I think that there then may very well likely be some adjustments that we'd make to kind of true it up to our best estimate.
Okay, perfect. Thanks so much.
Your next question comes from the line of Jay Gelb with Barclays. Jay, your line is open.
Thanks. Good morning. I was looking at the, let's see, slide number 24 with the Navigators financial highlights. I can see that in the first half, the company generated a core return on equity of right around 10%. In prior years, it had been lower. I'm just trying to get your view on where you see Navigators' ROE kind of coming in on a normalized basis as it stands currently, then as part of The Hartford.
Yeah. I can't comment, Jay, on Navigators and their history. All I could comment upon is what we think we could do with it going forward, that's what I said is, I think we could get it to a low double-digit range over time as we integrate, as we cross-sell, as we sort of lift our combined premium base, maximize our distribution power that I think that the two organization has. I'm confident, highly confident we can get that into the double-digit range.
I appreciate that. I'm just trying to square your comment where I believe you said within four to five years, Navigators could add $200 million to after-tax core earnings, excluding amortization of intangibles. If I take their first half results, which were around $120 million of core earnings after tax, is there that much expense synergies or other synergies that could get that $120 to $200?
No. Doug's commented upon what we think in terms of expense. That's $20 million. The components of how the math's going to work is ultimately growth, modest expense saves, NII. We think we can add NII, net investment income, to their portfolio, and overall margin improvement with our ROE mentality, our data and analytics, our tool sets. That's the equation.
Okay. Thank you.
Your next question comes from the line of Scott Frost with State Street Global. Scott, your line is open.
Thank you. Thanks for taking my question. You touched on this a little bit with Elyse's question. The change I heard from a credit perspective was that you may issue debt in January versus previous plans to pay that maturing debt down. That sounds like a modification of previous leverage guidance, but not a change. Is that the right way to look at it? Are you still planning to target a low 20% leverage by 2020?
Yeah, Scott. I was talking about the fact that as we look at the resources that we'll utilize for this transaction, the fact that we do have maturing debt in January. As we said, we would explore other financing options, that's what we're taking into consideration. It might take us a bit longer than we originally said relative to kind of getting down to lower leverage ratios. I still think overall, when we look through 2019 going into 2020, that we're still on that path. We want to just keep our options open as we just sort of think about the best way to finance this transaction.
Okay. Just to clarify, you're still planning to target a low 20s% by the end of 2020. Is that my understanding? Or-
Yeah. Mid to low 20s is Yeah. What we said before is mid to low 20s-
Okay
is what we're targeting.
Just to follow up, I think, for NRSROs, for agencies, I think, had you in a leverage band of sub 30%. Do you expect any negative reaction from rating agencies? How would you characterize your conversations with them regarding this transaction?
Yeah, I think they were very constructive and kind of understand how we're thinking about this.
Okay. Thank you very much.
Thank you. Amy, I think we have time for one more question.
Okay. Your last question comes from the line of Mark Dwelle with RBC Capital Markets. Mark, your line is open.
Yeah, good morning. Just a couple quick questions. Are you contemplating retaining The Navigators brand, or is this a vehicle to really push The Hartford brand out into international markets?
Mark, those discussions have just initially kicked off. We'll spend time over the next six, nine months deciding how we do market ourselves. Obviously, there's enormous strength in The Hartford brand. There's also a great recognition of Navigators' brand, particularly in some of their deep-rooted products. We're open on that, and I think Stan and his team will add a lot of thought, and we'll come up with what we think is the best decision for the overall franchise.
I guess related to that, considering that there's not a lot of synergies particularly planned over the near term, can you elaborate a little bit more on some of the integration costs? It wouldn't sound as though a lot would be expended on relocations and headcount adjustments and things of that sort. I'm just trying to get an idea of what goes into the kind of $70 million-$110 million.
I'll take that. Again, as we think about the synergies here, there's obviously some expense. As we said, it's modest, but it's also on just our go-to-market strategies. In order to really set ourselves up best to do that from an integration perspective, we do need to make sure our systems are able to talk to each other. If you're comparing that cost to just expense synergies, it might look high. We're really looking at it more broadly as we bring sort of The Navigators operations into our environment that really allows us to maximize our ability to use our tools and so forth. We really need to think about it from both sides, revenue and expense.
A last real quick question, if I may. Do you intend to kind of show this as a separate operating division, or will this be embedded within the commercial line segment?
Mark, I think, again, preliminarily, we haven't really started to plan activities and integration, I do envision a sort of a global specialty segment. I think we'll have to work together to define what that is, Doug. I think in addition to our standard commercial lines, our national account presence have a specialty, a global specialty segment that makes sense to us. Those are some of the things that we'll work on. Obviously, once we close the deal, we'll announce what we're going to do.
Thanks very much. Appreciate the answers.
This concludes our question and answer session. I will now turn the call back over to Sabra Purtill for closing remarks.
Thank you, Amy. We just wanted to appreciate your availability today to join us at short notice to discuss our agreement to acquire The Navigators. Obviously, we have lots of materials on the website, including, as I mentioned, the 8-K. If you have any additional follow-up questions, please do not hesitate to contact the investor relations team today. Thank you very much and have a good day.
This concludes today's conference call. You may now disconnect.