Good morning, everybody. Thanks for joining us this morning. My name is Yaron Kinar. I am the new property and casualty insurance analyst here at Goldman. Very pleased to have The Hartford with us today, represented by Chairman and CEO, Chris Swift, and CFO, Beth Bombara. The Hartford is a leading domestic insurance company with about a $20 billion market cap. Its focuses are on the P&C commercial lines, where it has a core strength in the small end of the market. It also has a P&C personal lines business led by its affiliation with the AARP, and a group benefits business where it announced a deal this quarter that makes it the second-largest group disability and group life provider in the U.S. Chris joined The Hartford in 2010 as CFO, was named the CEO in 2014, and Beth succeeded Chris in the CFO role in 2014.
I will just note for this morning, we are not rated on The Hartford, and we are restricted from asking any questions about the Talcott deal, so I will not ask Beth and Chris about that. With those introductory comments, I will turn it over to Chris to make some comments of his own, and then we will dive into the Q&A.
Great. Thank you, Yaron. It is good to be with everyone. It is good to see everyone. Goldman was an advisor to us on the Talcott transaction, so ergo, the conflict on that side of the shop. I thought I would just make some opening statements about 2017 in general, particularly two of our most recent transactions, and then the business environment in general. Starting with the benefits opportunity. We described that at the time we announced it almost a month or six weeks ago as just a unique opportunity to create, in essence, the second-largest benefits player in the industry by purchasing our cross-town friend at Aetna's group benefits opportunity for $1 billion $450. We are very pleased with that opportunity. We have always said, since we announced our new strategy, that benefits was a core part of The Hartford going forward.
Ostensibly, it is another form of an underwriting business, very complementary to our P&C underwriting businesses that share a lot of the similar distribution. You should expect from us more emphasis on cross-selling within the new 20 million members that we approximately have in our combined benefit and using other parts of the franchise to just sell into that, particularly small commercial. That transaction, I think, fits very well. It was a good use of capital. We think from an earnings side, a couple of years out, pre-tax and pre-amortization, we should get to the $150 million level. It will produce double-digit returns. That business performance in 2017, meaning our benefits business, is performing exceptionally well. Low unemployment, low incidence rate, people returning to work quicker.
The margins in that business have been expanding over the last 2 years, I see them continuing to expand into 2018 and beyond. I thought that was a good use of our excess capital. Beth could talk about the financial implications, but in essence, we pulled forward dividends, excess capital out of P&C and Talcott to fund that acquisition. Monday's announcement was a culmination of, I would just say, months of hard work. Many months of hard work to think in terms of what is the exit strategy for Talcott. There's been debates amongst our management team, and I'm sure many people in here. Was it the Big Bang? Is it piecemeal? Was it using the division statute? As we described it was the perfect transaction for us. It was a clean break, selling 2 legal entities.
We get to keep a 10% equity stake in it, which I viewed as participating in the upside of Talcott going forward. I thought the economics were good. I know maybe given the recent dividend activity out of Talcott, the headline price might have been lower than people expected, but it was still a good deal from an economic side. I think we've talked to many of you in this room over the years that if we could get close to statutory capital out of this business, we would be pleased, that's exactly what we did, if you include some tax benefits. I've also seen commentary on the timing of tax. Why didn't you wait? It's classic training in M&A. When you have a deal, you take it. You don't wait for a perfect moment.
You wait for the right moment when there's a willing counterparty to pay you over $2 billion cash, in essence. That's the reason why we did. As Beth explained in our earnings, the economics of tax reform are unchanged. Whether we did the deal or didn't do the deal, we would be impacted one way or the other, depending on what Congress ultimately decides to do. When you put it together, though, I have to acknowledge that we took a little over $8 a book value hit. I think from a valuation side, most valuation models that I'm familiar with didn't give us credit for that value anyway, so it's more optics of diluting book value. I believe over a longer period of time, we will rerate. Our earnings multiple will increase. Our ROEs are going to definitely increase.
We talked about a minimum of 10% in 2018. You know My finance training as a conservative finance person, I would say that's conservative to realistic. You get into 2019, when we deploy capital, our ROE should track nicely and continue to increase. I'm pleased with our 2 big transactions that sort of capstone our turnaround as a multiline company into a more focused organization going forward, generating, I think, superior returns in attractive parts of the market that will allow us to earn good returns over a longer period of time. On the 2017 business performance side, I'll be guided by any additional questions, Beth and I, but I'm very pleased with our performance. Personal lines is turning around. Benefits, it continues to expand our margins. Our mutual funds business is going to have over $3 billion of net flows.
Middle market, small commercial, our specialty commercial P&C operations continue to perform very well. It's no less competitive, particularly in the middle side of the market. I feel very good about the overall performance, even in a heavy cat season. I think you should take away from our cat results, and Beth updated you all for the fourth quarter. We're under indexed. We're not a large property player. We do have some home exposure in different parts of the country, but given the level of catastrophe activity in our reported cat numbers to date, I feel very good about how we manage our cat exposures in zones across the country. With that, Yaron, I'd be happy to take any, and Beth and I, any additional questions.
Great. Thank you, and thanks for the overview. I thought maybe we can start with the deal. I can ask you about the Aetna deal. Maybe you can talk a little bit about the group benefits market, both currently and maybe what you see longer term. Is there a correlation between that and the commercial P&C market? Are there advantages of having both businesses under the same roof? What's pricing like, competitive pressures? Why don't we start there?
Well, that covers just about everything. Distribution, product, and pricing. Yeah, I would definitely say there is benefits to have it under one roof. I would tell you that 40% of our distribution partners' revenues come from benefits today. Benefits is an important part of our distribution partners' strategy going forward, and particularly as they consolidate. I would observe, and you all know this, that in the benefits space, it's really controlled, 75%-80% of the premiums by the top 10 benefits players. It's already a consolidated marketplace, and we were able to jump up to the number 2 space. I think going forward, again, the ability to earn attractive returns in this area, benefits will continue to be important offerings employers offer to their employees to differentiate. Now, compensation might change, meaning over time, there might be more that needs to be paid by employees.
Still a platform of benefit offerings, I think is going to be with us for a long time in the employer market space. I think our strategy really continues to focus on the core products, life and disability, but we've built out our voluntary product offering over the last three years. We would describe that as supplemental products such as critical illness, hospital indemnity, accidental death and dismemberment, AD&D. That's really what we want to cross-sell into our customers today. We are under-penetrated with those products. Aetna was under-penetrated with those products. That's what the key part of the strategy is to do, is that 20 million members that we have access to, is to bring in additional products that, again, from an overall benefit side, I think fits nicely, particularly as we get potential medical reform in our country.
Got it. Does scale matter? You talk about being a top 2 player now in both of the group disability and group life market. Does that give you a competitive advantage?
I've always said in and of itself, scale doesn't provide you with a competitive advantage. The scale that we do have, I think, provides us opportunities to create competitive advantage through data and analytics. With more claim data, with Aetna's disability book, our disability book, in integrating then our workers' comp expertise, I think we can differentiate ourselves long term, and that's what scale gets us there. I would also say that one of the attractive aspects of the Aetna book of business was their integrated claims management system. We describe it as part digital, part leave management where we can provide insights to employers on overall absence management. It's really a combination of 40 individual systems that is integrated in a fashion that delivers seamless data and analytics to customers. We're particularly excited about to integrate that into our customer base, including our workers' comp capabilities.
Got it. Beth, question for you around the deal. I couldn't help but notice that was basically all internally funded. When you were thinking about the funding sources and maybe other prioritization of capital, the internal capital you had, can you maybe walk us through how you prioritized that, how you decided to basically use all internal funds?
Yeah, absolutely. Yes, to your point, we did use internal funds and accelerated dividends both from Talcott. We took $800 million out of Talcott in October, as well as accelerating some dividends that we otherwise would have taken out from P&C next year. The way we really thought about that was a better use of that capital being able to invest it in a business, revenue-generating business that would provide earnings to us over the long term, we looked at the trade-off there versus using that excess capital next year for potentially share repurchases as this as being a better use. As we talked about when we did announce the Aetna acquisition, we suspended our current share repurchase plan for the rest of this year and indicated that we did not anticipate doing a share repurchase program in 2018, given that.
Once we close the Talcott transaction, we evaluate the use of that excess capital, we've said we've earmarked a portion of that for debt repayment. We'll evaluate what the best use is. That could potentially change in 2018. At the time we did Aetna, we really felt that we had a way to maximize the capital that was on our balance sheet today. The last point I'd make is that we were using some of the excess capital in the legal entity where group benefits is as well. Again, with not taking dividends out from that entity next year, we will be able to get it back to the capitalization level that we think is appropriate.
I know there's been some question as to whether or not we would use some of the Talcott proceeds to sort of recapitalize the group benefits entity. That's not our intent at all.
Okay. More maybe about the capitalization of the group entity. You're targeting 375% RBC ratio. Looking at peers that have purely group benefits businesses, seems like that's a pretty high target.
Yeah.
What led to you targeting that number? Do you think that maybe longer-term, bring that number down?
We have been bringing that number down. When we first moved our group benefits business to sort of be standalone outside of the Talcott entities, we were targeting a much higher RBC, over 400%. Part of that was because the performance in group had come under some pressure, and we were very focused on the ratings of that entity. Over the last several years, as we have improved the underlying profitability and we look at what the capitalization levels should be, we've reduced the target. We really think about it in that 350-400 range. When we think about capitalization levels, we're always thinking about what they need to be if there was a stressed environment. What you print today isn't necessarily what we're managing to.
We want to ensure that if market environments changed, that we have adequate capital in that entity. We'll continue to evaluate capitalization levels. As we said, we're taking that down this year pretty significantly as a way of funding the acquisition. Again, we think in that 350-400 is an appropriate range.
Got it. Since I'm now the P&C analyst, I thought maybe we can switch to the P&C business and maybe start with commercial. Hearing a lot of talk and a lot of prognostications around the market. Market hardening, not hardening, stability, no stability. What are you seeing now after the $100 billion or so of catastrophe losses, loss cost trends picking up in commercial, maybe potentially impact on reinsurance rates from the tax bill. How are you thinking of the rates in commercial going forward? What are you seeing going into 1/1 renewals?
Like anything, it's really, you got to get more segmented. You can make the argument that from a large property cat-exposed area, they'd probably need to raise double digits to support sort of a refresh view of risk. We're not in a large property market in any material way historically. We just did hire a large property underwriter to build a team in New York to begin to get more proactive in that area. Again, steady, nothing terribly aggressive from a growth side. If anything, now is the right time to try to grow in large property. Rates in general, I would say in those high cat-exposed areas, are beginning to firm. I think it'll be a process, particularly as companies like ours renew our cat programs 1/1 and just see what the final rate increase is there.
I would tell you from our expectation of our cat program, we didn't cede any losses to it on a per occurrence. Depending where we come out fire-wise this year, particularly in Southern California, there's more fires going on right now in Southern California, the Ventura area. There's a high probability we cede to our aggregate treaty which would put some pressure on that renewal pricing going forward, probably in that 10%-15% range. That's not a lot of premium, but that's just indicative. Our per occurrence non-ceded loss activity during 2017 and the last couple of years, we would expect to renew flat to up a couple points. Again, everything depends on your strategy, your segmentation, where are you going from there. If you look at other lines of business, if you think of the largest line for us, comp.
Comp is performing very well from a profitability side. I would say from our loss cost side, we're outperforming our expectations this year, particularly on the frequency side and the severity side. We're still booking to our long-term assumptions. If those trends materialize the way that they appear to be materializing in 2017, we would have built up additional margin that's up on the balance sheet. I would say GL and commercial auto are probably the other lines. Commercial auto's probably in that 8%-10% range in 2018. The market is being more disciplined in that space. I would say again, we've been talking about it at least the last three or four quarters, where GL activity, particularly slip and falls and just more litigation on simple liabilities are driving up average settlements.
That probably needs six to seven points of rate into 2018, which we're going to try to get. You put it all together, there's going to be some rate pressures in comp as rate rollback continues. There are building pressures in property, commercial auto continuing, and GL where more rate is needed, and we're going to try to get it.
Okay. When you say that you're going to try and get rate, let's say in GL. I can kind of understand going into an account that actually has a loss. How does the conversation go when you turn to somebody who's actually loss free? Do you try to get a rate increase from them, or are those accounts that you set aside for the time being?
Yeah, those are all the tactics and strategies that happen at the front line every day because you, in essence, have a distributed underwriting model where you're trying to give guidance to your underwriters to produce an overall premium level that is indicative of overall loss cost trends. A lot of it is specifics on relationships and accounts. What we try to do with our distribution partners is we don't want to surprise them. We don't want to shock them. We could manage over a multi-year period of time to get back to where we need. Our strategy is, as opposed to trying to push for a big rate increase this year, let's take bite-sized chunks at it over a one to two year period of time.
Okay. Makes sense. Then, historically, when I looked at the cycle or the market, you really saw these big peaks and troughs, combined ratios, price firming, and so on. We haven't really seen that kind of classic cycle in more recent years, let's say the last decade plus. Do you have any thoughts as to why we haven't seen that? Do you think that we're still due one of those?
It's hard to speculate. I would observe that you all in this room probably have something to do with that. Honestly, from better transparency compared to the old days to higher expectations on performance. I think with the amount of data that we have today, timeliness of that data, you're taking out lags in a lot of our information. I think we can just be more timely and more reactive to trends in the marketplace that you would expect us to deliver as shareholders.
Okay. We spent some time talking about the group benefits deal. Are there any gaps in the commercial platform that you'd look to close with deals, or are you pretty comfortable with where the platform is today?
I'll interpret your question as being, what are you going to do with your excess capital? I would remind people again, we're highly confident that we could get the Talcott deal closed by June 30th of this year, so that slug of cash would come in, call it mid-year. What I would just share with you is that if I look at all our P&C businesses, ex personal lines, because that is a unique franchise in itself, focused on the mature market through a direct response mechanism through an AARP endorsement. That's a niche market and a specialized market that we like and will continue to focus on it more in an organic way of improving our underwriting skills, improving our offering, improving our digital capabilities to that mature market.
If you look in the commercial side of it, we have all the capabilities internally in the scale to compete in small commercial for a long time. That's been a business that we've invested heavily in over the last 30 years. We have excellent service centers. We're expanding our risk appetites into different markets. We have experiments with innovation going on. I feel very good that we're going to continue to remain competitive, if not the leader in that marketplace, one of the leaders in that marketplace. You get into middle and specialty, we could use a little more scale. We could use a little bit more industry, the vertical product sets. We could think about specialty in a different way.
If we have opportunities to continue to focus our organic earnings growth capabilities in that area by hiring teams, rolling out new products, sort of R&D internally, we'll do that. Those might be the areas of the market that we would look to deploy capital into an M&A side. Again, needs to be priced right, needs to make strategic and financial sense. The middle market and the specialty orientation would be an area for additional growth.
That makes a lot of sense. Maybe we mentioned the competitive advantage and the strength, the core strength in the small size of the market. Just listening to other large insurers, sounds like that's an area that's increasingly of interest to them. How do you perceive that as a competitive threat longer term if you have a lot more capital all of a sudden focused on your core strength?
It's what we do every day. You compete to win, you compete to innovate, you compete to differentiate yourselves, and we've got a pretty good track record of doing that in small. I'm not saying it's going to be easy. I know the bars get continually raised, but we raise the bars internally on ourselves to outperform and think differently in the future. With almost $4 billion of premium there, we got a pretty good head start to continue to differentiate ourselves.
That's helpful. We talked about reinsurance. Just given the tough cat season we went through, would you consider increasing your year program, or are you comfortable with the program as it is today?
Yeah. That's the debate we're having right now as we go to market. I'll add my views, and Beth, as the balance sheet manager-
Yeah
will add hers. I think over the years, we've increased our retention from maybe $250 million when I first arrived, at $350 million. The last two years, we added an aggregate program, which was wise. I think we've been thoughtful about using our capital to take on more risk to earn a profit, while protecting ourselves, either from a single event or multiple events as we're experiencing this year. I think the design makes sense. We've locked in. Why don't you talk about pricing and locking in multiple years?
Yeah. The way our per occurrence cat treaty works in the various layers, two of the layers, we basically have three-year terms, only two-thirds of those layers would be coming up for renewal this year. To Chris's point, we do year-to-year kind of look at where our participation is. Even in that first layer, we've increased our participation over the years, and really trying to take advantage of when we have very competitive pricing, competitive terms, to continue to evaluate that. As Chris mentioned earlier, given the wildfires in California this quarter, the ones that occurred in October, the one that's happening now, it's very likely that we might breach the aggregate treaty for the first time. We're pleased with how that program works.
We're not looking to make any wholesale changes, we do constantly evaluate just kind of where should the right levels be and how do we maximize the return that we get from the program.
Got it. Maybe we can talk a little bit about tax reform before I open it up to the audience for questions. One question is around the windfall, assuming there is a windfall from lower corporate taxes. Does that basically get passed through the customer, and if so, how quickly do you think it goes to the customer or do you pocket most of that?
Well, you like to keep as much as possible, recognizing it's going to be a competitive environment and different folks might have different strategies in different segments of the marketplace. It's hard to make a generalization, is the entire 15 point, if that what it turns out to be, going to drop to the bottom line? I would say for those that make the argument that it shouldn't matter, it's just we focus on combined ratios or underwriting ratios. That's not probably totally accurate in that it will affect your overall cost of capital, both on the debt side and the equity side. Depending on leverage, then depending on how you finance yourself on the equity side, there could be some adjustments there. Again, our philosophy would be, we always like to maintain a healthy spread-
Try to maximize that spread between our aggregate cost of equity, which again, given these transactions that we've just done, particularly the Talcott transaction, I think should come down over a period of time. It's hard to say in a competitive environment exactly how much that will stick to the bones and just how much of that might be lost to competition.
Okay. I know on Monday's call, we spent a little bit of time on the potential impacts from the different versions, the Senate version, the House version of the bill. Can you maybe give us a little more color or a summary of how you think the different versions would impact your DTA position or your tax benefit?
Again, looking at it from a total company perspective, if we stick with the House version, obviously the tax rate going from 35% to 20%, just on a carried value of your deferred tax assets, would result in a decrease, because now it's not a 35% rate, it's a 20% rate. AMT, though, you already paid that. That's just a credit. That carrying value wouldn't change. Where we see the benefit on the House side, aside from just the rate going down, is that it did call for the repeal of AMT and the refund of AMT. When we look at it from a cash flow perspective, even though the value of the NOLs goes down to that 20% value, the AMT credits we're going to get faster.
On an NPV basis, it's actually they're worth more to us on a present value basis because we'll get that cash sooner. If you go to the Senate bill, which there's a lot of discussion about the provisions that they left in for AMT and keeping the AMT rate the same as the corporate rate. That as you kind of go through the pieces and you look at how you'd use NOLs, the fact that we've actually used all of our AMT operating losses through the years, so we don't have any of those left. We've monetized those in the past. For us, you basically are in a position where you're always paying AMT. You're never going to get those credits back, which is why, at the end of the day, it's hard to see how you'd realize those benefits.
There's been a lot of discussion, a lot of commentary on the fact that that provision just does not make sense as is. We feel it's very likely that that's not how it will come through. Again, we like the House version, which repeals and refunds. At the very least, if the AMT is going to stay in place, the rate has to come down. Otherwise, it really doesn't even make sense.
Makes sense. Why don't I stop for a second and see if there are any questions from the audience?
Beth, you talked about stress capital. Could you talk about your holdco company needs for stress capital once Talcott closes, and some sense of how much that might come down?
Yeah. When we think about holding company requirements, we typically look at holding one and a half times our interest in dividends obligations. We really manage all of our legal entities so that they themselves can withstand stresses. We don't necessarily hold additional amounts of excess capital in the holding company for that because those entities are stressed themselves. However, given the improved risk profile of the organization in total, we have been thinking about that holding company requirement one and a half times can probably come down over time. Maybe it's one times. That's how we think about the amount of capital that we need at the holding company.
A very broad question about.
Can you just wait for the microphone?
A couple of very broad questions about the benefits business. Firstly, how do you see the medium-term growth drivers for that business? Secondly, how would it be potentially impacted by healthcare reform?
Medium-term growth drivers and healthcare reform. The medium-term growth drivers is unemployment. As we create more jobs, if the tax bill is stimulated to the economy, creating more jobs, higher-paying jobs, that'll be good for the business. I've always said, if you look at our business models and most insurance companies' business models, it is economically sensitive to employment, workers' comp benefits. We see continued margin expansion in that area due to those trends. If we could get a bump in GDP, a continued grind down slowly of unemployment without significant inflationary pressures, I think that is a positive trend for that business. The medical dynamic, to me, is we would be somewhat directly exempt from any radical reform of medical reimbursements. What do I mean?
We're not in the medical business. Most of these products work in tandem or side by side with your medical benefits. Medical benefits, obviously, is the largest, most expensive portion of an employer's overall benefit package. As I said, critical illness, hospital indemnity usually work in conjunction with an overall benefits package, including medical. Our growth opportunity there is cross-selling those members that we haven't been able to reach in prior years, given that we now have a full product suite. I don't see a direct impact. I think it would be supplemental to just how much cash is left over to spend on voluntary benefits.
Well, I think we've basically exhausted our time. Beth, Chris, thank you very much for joining us today and for your insights.
Thanks.
Thank you.