Hello, everyone. I'm Jay Gelb from Barclays. I'm the senior equity research analyst covering the insurance stocks. The format of this track will be a fireside chat with Beth Bombara, who is the Chief Financial Officer of The Hartford. The Hartford is among the largest property casualty insurers in the U.S. It also has a presence in Group Benefits and Mutual Funds. Its business also includes the Talcott unit, which largely consists of a runoff annuity business. Beth's previous roles at The Hartford include president of its Talcott unit and controller of the company. Beth, thanks for joining us today.
Glad to be here.
Let's start off by discussing the topic that's on top of everyone's minds, given the events of the past couple of weeks. That would be Hartford's potential exposure to the two major hurricanes, Harvey and Irma. How would you frame the expected impact on Hartford for investors?
Great. Thank you. Yeah. Obviously, two very large events and events that we're still in the process of assessing. We will talk about Harvey first. As we look at that storm and given the unprecedented flooding that we saw with that, it really is taking probably a little bit longer than typical storms to really come up with an estimate that we'd feel comfortable sharing in total. What we've said previously is, as we look at our exposures there, and I'll talk a little bit about where they are, we do not see the exposure to that storm as breaching our reinsurance layer, which kicks in after $350 million. Now, the areas that we have coverage, just to put it in perspective. In the personal line side, again, from a flood perspective, when you think of homeowners insurance, we would not have coverage for flood.
That would not be a part of our policy offering. Obviously auto, you can see exposure. When you look at our market share in Texas for both homeowners and auto, it's about 1%. On the commercial side, from a commercial multi-peril line, we've got about an 8% market share. When you look at commercial lines in total, it's about 2.5%. When you think about our commercial book, again, just focusing on floods since that was such a large impact with that storm. In our small commercial book, we do not offer flood coverage in that book. We do, however, in our middle market book, offer flood endorsements. Depending on where a property is located, because we do have risk tolerances relative to the coastal areas.
As we all know, the flooding went in deeper than even some of the more where the typical flood exposure you'd expect to see. We would have it there. We would also have some flood coverage in our Maxum unit, our E&S writer in small commercial. Based on where they participate in some of the sort of unique risks and in different layers. That's kind of how we're looking at it. Our claims adjusters have been just doing a phenomenal job of getting in there, working with our policyholders. We definitely are starting to see the number of claim intakes decrease. I think we're in a place now where we can really start to get a better indication of what we think that exposure is. Turning to Irma, which is obviously even newer.
In most cases, we really haven't even been able to observe any of the damage other than what people are seeing on television. With that storm, with the amount of evacuations that occurred, you have to wait until people get back into their areas. Our claims adjusters are poised and ready to go in. I had the opportunity to participate on a few calls over the weekend as our CAT teams were getting prepared, and they're very eager to get in there and help our policyholders, and see what the exposure is. It's, again, a very unique storm. Obviously very premature to come up with an estimate. We do model losses, and when we do some of the modeling, the models do indicate that potentially this too would be below our retention. It's very early.
You really have to go in and assess what's there. You can do things via model, and you can look at where the exposures were, we've all seen from the news that it's pretty widespread across Florida. A couple things about our Florida exposure. First of all, from a personal lines perspective, we haven't written new homeowners policies in Florida since 1995. We've got about 21,000 policies that we still have in the homeowners book. I would say even back pre-1995, we were always very intentional and thoughtful about coastal exposures. Again, similar to Texas, similar to all of our homeowners policies, flood would not be covered. Obviously, there's a lot of wind damage that people see there. On the auto side, our market share in Florida is about 1.7%. That's based on 2016 information.
As you know, given some of the challenges that we had in our auto book, we've been doing a lot of rate increases, and we've seen some of the retentions there fall. The market share might be a little bit less than that. Again, we're going in and assessing that damage. On the commercial side, all in, we're a little bit under 1%. If you look at the CMP line, it's about 2.5%. All the comments that I made about small commercial, middle market, and Maxum would also pertain here. The last thing I'll say about Florida is as we think about our underwriting appetite in Florida, again, even for those lines where we are writing, we are always very intentional in looking at where our coastal exposure is.
We really see our exposure higher in that central area as you fan out to the top of the state, which obviously when we were looking at some of the storm paths on Friday, would've had a very different impact. The fact that the storm did go more to the west than straight up. We're, as I said, in the process of assessing. I think that it's fair for investors to expect that given the size and magnitude of these two events, that as we're able to refine our estimates and be able to provide a meaningful estimate of the exposure, that investors should expect that we will communicate that.
Great. That's real helpful, Beth. I appreciate that.
Maybe, do you want me to talk a little bit about how our reinsurance works? Because I know that that's obviously also been an area of focus as it relates to our CAT covers. In our property CAT occurrence-based cover, we retain the first $350 million of exposure for an occurrence. After that, we have several layers in our CAT program. The first layer is for $150 million, and we retain 25% of that exposure. The second layer is for $300 million, and we retain 10%. We have a third $300 million layer for 10%. On top of that, we also have available to us a potential fourth layer for $50 million of coverage where we don't retain any piece of that. That's kind of an occurrence base. We also, several years ago, put in place an aggregate cover.
The reason we did that is we wanted protection from a year where you could have multiple events but maybe don't breach the occurrence level, but in the aggregate provide exposure. The way that treaty works is we retain $850 million net. The way to think about that $850 million of net exposure is every CAT, any CAT that PCS declares, any losses associated with that CAT in a year will go to the aggregate cover up to a $350 million amount. Again, if we breach that $350 where we're participating in some of those other layers, those losses would not go towards the aggregate.
Once we breach $850, we have anywhere from $150 million-$200 million of coverage. The reason why it varies a bit is that fourth layer that I mentioned in our overall occurrence-based treaty.
Right.
It can either stay in the occurrence-based treaty or if we don't need it, so if we don't have an event that goes all the way through all those layers, we can drop that down to the aggregate, and that would give us the $200 million of coverage. We feel really good about both of these programs. We also, for the occurrence treaty, for the first three layers, we do have one reinstatement, and the reinstatement premium is at the same rate as the original placement.
Right.
Lastly, because I think this is important given what we've seen this year, is the way we've structured those first three layers of our CAT program is they're multi-year. We've locked in multi-years over a three-year period. We always have a third of each layer kind of renewing each year, and two-thirds carries over, and there's no change in cost. We did that again several years ago, looking at the favorable terms that we saw in the reinsurance market and wanted to lock in some of that favorability. I would say as terms continue to get more favorable, we sometimes would say, "Gosh, maybe it would've been better if we hadn't locked it in." Again, given the exposure here, we see that as a really attractive part of our program.
Excellent. That's very helpful. It seems like the message here is despite the significant magnitude of both Harvey and Irma, it's unlikely at this point that either would be large enough for The Hartford to pierce the reinsurance program, which is $350 million.
Right
pre-tax per.
I would say it a little different. I feel more confident in saying that about Harvey. With Irma, it's still early, if we were to breach it, I don't think it would be significantly into layers based on the modeling. Again.
Okay
It's early. My comments are based on models, and I need my claim adjusters on the ground and assessing the damage. That's kind of where we sit today.
That's helpful. Thank you very much. Okay. Bigger picture question for The Hartford. The company's trailing return on equity over the past four quarters is 9%, and excluding Talcott, it's 11%. If the company stays in its current form, what do you feel a reasonable expectation is for a long-term return on equity for Hartford?
Jay, very consistent in the question that you ask in that regard. I would say our answer is very similar to what we've talked about before. When we think about our returns, we really do think about them in the two pieces that you discussed, both all-in and ex Talcott. We look at ex Talcott, and we look at the trailing 12 months, taking into consideration that that trailing 12 months incorporates some of the adverse experience that we saw in personal lines and all the things that we've been doing to improve that book. We feel very good about the trajectory on our returns on an ex Talcott basis. When you bring Talcott into the mix, the reality is the earnings base relative to the capital supporting it is going to generate a low ROE. It's been in the mid-single digits.
Absent a significant structural change, that will continue. The earnings power of Talcott is really being felt relative to the fees that we generate on our variable annuity book, the spreads business that we have. Again, we continue to be very disciplined Managing expenses as the book continues to run off, but there's not a lot of leverage to pull relative to that earnings base. We really continue to focus on things from those two perspectives. It's why we've provided enhanced disclosures to make sure that investors can see that, because again, if you look at our ex Talcott businesses, I think the returns that they're generating are very strong.
Good. Okay.
Obviously, CATs will have an impact on those numbers as well.
Of course. Right. All right. Let's focus in on Talcott. What's the company's progress on winding down this business organically?
We've been on a path since 2012 of managing down our exposures. We've done it both through transactions and in sales of businesses, as well as in targeted initiatives as it relates to policyholders, I think that that has all progressed very well. We continue to see our variable annuity contracts kind of lapse, again, at a lower rate, which you'd expect as the book matures. You'd expect the people who haven't lapsed their policies are probably more likely to stay. We start to continue to see a decline in earnings because of that, I think it's commensurate with the reduction in the policies in force. We have been benefited by positive markets, that's helped to improve some of those fees. We're continuing on that process.
We've said before that we would look for opportunities if they presented themselves as it relates to policyholder initiatives, we look at sort of the cost benefit associated with doing that. I think overall the book continues to perform well. The earnings for the year are pretty much in line with what we expected. We've been taking capital out of Talcott, as you know. We anticipated taking $600 million out this year. We took $300 million out in January, we got approval for the second $300 million last week, we'll be taking that out this week. Completely in line with what our expectations have been.
That's good. There's been a pretty significant round of press speculation about the potential for Talcott to be sold. What can you tell us, if anything, about that?
Well, as we consistently say, we're not going to comment on market rumors. I think we've been very clear from the beginning as to what our intention is with Talcott. Long term, we'd like to see it to be a smaller part of The Hartford, and we'll evaluate opportunities as they present themselves.
Is there a point at which, if we think about what Talcott is on the books for from a GAAP basis versus what some have thought the business exit value might ultimately be, it seems like it's signaling a potentially quite significant dilution to book value per share. Is that something that Hartford takes into account as it goes through this process?
When we think about with Talcott, we really start with looking at overall value and value we can achieve today versus over time. To me, it's more about cash flows.
Right
Things of that sort. That, I think, presents itself into some of the analysis that you would discuss. Our objective with Talcott is to run it off in a way that we think provides the most value to our shareholders.
The company's ability to continue to extract capital from Talcott, it's probably funded about half the annual share buybacks. If that were to go away, how is something like that taken into account versus cash up front in an exit opportunity versus maintaining it and extracting it for ongoing buybacks?
Again, I'll go back to what I said previously, that you start with sort of the overall economics and how can you maximize that value. Timing of capital management activities I don't think is a significant part of that objective. Again, I also would point to when you think about our other businesses, they're also generating significant amount of cash flow to the holding company. The P&C business, dividends in the $800 million-$900 million range. Group Benefits, $200 million, $250 million, kind of depending on how we view their capital. Mutual Funds, pretty consistent, $75 million. There's sources of capital to the holding company to fund its needs.
That's helpful. Thank you. The downward draft in interest rates over the past few months, for the potential for an exit opportunity, does that have a large influence?
Yeah. Again, I'm not going to comment on specific market conditions or market events or so forth. I'll go back to what I said previously.
Okay. I'll stop there on Talcott.
Thank you.
With regard to commercial P&C, can you discuss the top line and margin trends-
Yeah
sitting in that business?
Yeah. When we came into 2017, we had talked about in our commercial business that we expected to see a bit of margin compression based on where we were the previous year. I would say All in all, that's kind of how things have played out. There's been pockets of outperformance. We are seeing it as a very competitive marketplace. I would say the competition varies in different parts of our business. We probably feel it more in middle market than we do in small commercial. We continue to find opportunities to take rate in our commercial auto book, which we've talked about, and looking to improve our returns there. We think that we are poised very well to compete in this environment.
We're very thoughtful about the risk that we're putting on the balance sheet and the price that we're getting and really looking to balance that trade-off between loss cost trends and what we can get from a pricing perspective, and to be thoughtful in that. We don't believe that putting a lot of business on our books at levels that we know are not going to get us to our target returns will prove fruitful in the long term. The last thing I'll say on that too, is that means that we're always very focused on our retentions because we see that as very important in this type of marketplace. Again, overall being pleased there, but the competition does exist and as I said, feel it probably a little bit more in middle market than we do in small commercial.
With regard to small commercial, we've seen a number of other insurers looking to expand their presence in that business, which as I think The Hartford has said, is probably among its highest returning business units. What's Hartford doing to make sure it maintains a strong market position in small commercial?
We are very pleased with our market position in small commercial, and we believe that across the board, our capabilities are leaders. We're very focused on maintaining that. My answer to that question, because it's something that we get asked a lot, is that we're not sitting still. We're constantly looking at how we can improve our business model, our product offerings, how we can penetrate more agents, making sure that our technology is as up to speed as it should be so that we can take advantage if trends change as far as how consumers look to purchase their insurance. I feel that we are poised very well and it continues to be a focus of ours to make sure that we maintain those leading capabilities.
Okay. Just kind of turning back to the low interest rate question. With regard to the overall business, the core property casualty, that's been a drag on investment income. What's The Hartford doing in its investment portfolio to try and offset that headwind?
I think that's been an area of continued focus for us and our investment operation, I think, has performed really well relative to managing this environment. I think that the best way to really characterize it is they're constantly evaluating our portfolio and looking for ways that we can enhance yield, but managing that relative to not taking on undue risk. Where we see pockets of opportunities, we'll do that. We're a P&C company, but given our legacy life business, we have some capabilities that maybe you typically wouldn't see in a P&C business. Our capabilities in the mortgage loan area in particular.
Because even on our P&C businesses, some of our liabilities are longer in duration, we're able to take advantage of sometimes the liquidity premium you get for investing in kind of those asset classes where you don't have the liquidity that you might have in others. That has helped us to enhance our overall yield. It's something that we continue to focus on because on average, what we see our investments maturing at or being sold at, and the yield that they have is lower than where we can reinvest it. We've benefited from returns in our limited partnerships that have been very favorable. Not every quarter, but the last several quarters. That has helped us from a yield perspective.
We have benefited from what we refer to as one-timers, where people are maybe refinancing or calling or tendering their bonds and we get additional yield from that. Those are one-timers. Again, the investment team led by Brion Johnson is constantly looking for ways that we can maximize that trade-off between yield and risk.
Right. Okay. In terms of share buyback, that's been a very important part of Hartford's investment thesis. How should investors think about the sources of funds available for buybacks in 2017 and beyond?
Yeah. Again, for 2017, we're executing on our current plan. Through last Friday we had bought in the quarter about $261 million of shares and expect to complete the roughly $325 million that we've allocated per quarter. Based on market conditions, we'd look to complete that in the fourth quarter. Again, the sources of funding for that we laid out at the beginning of the year relative to our expectations for dividends. As we go into 2018-
Sorry to interrupt.
The company's not ceasing buybacks because of the storms for the quarter?
No, not at this point. Again, given where we are in our estimates, feel very comfortable completing the third quarter. We'll evaluate fourth quarter if our estimates change significantly and that causes us to think differently about it. Sitting here today based on what our expectations are, completing through the fourth quarter is our current expectation.
Great. Sorry.
As we go into 2018, the areas I already mentioned relative to the dividends that we get from our operating companies would stand true. We obviously also get capital, as you pointed out, from Talcott. We got $600 million this year. Last year we took out $750 million. The year before that it was $1 billion. We definitely see the potential to continue to extract capital but probably at a declining rate. As we've also said, too, as we think about uses of excess capital, we start with looking for ways that we can invest in our businesses. We've talked about the fact that we do have an appetite to look at acquisitions. Obviously, if we don't have better uses to deploy that capital, we see returning that to shareholders as continuing to be very attractive.
Of course. Well, that's a good segue into the M&A discussion.
Perhaps you can tell us a little bit more about the recent deals that The Hartford's announced and completed and where you see future opportunities in terms of potential fits.
Great. Yeah. Last year, I think it was the last day in July, actually, we closed on our E&S carrier, Maxum. That's in our small commercial book. That really came about because we saw that we had a need for that type of product set and product capabilities. It fit in really nicely with some of the things that we were trying to do in the small commercial area. Relatively small acquisition, but I think that's an example of when we think about a strategy around M&A, we really see it as an opportunity to accelerate in those areas that we know that we want to focus on. Really, we start with any acquisition as having to start with fitting into our overall strategy. Is it a way to accelerate it relative to building it on your own?
The second component, obviously, of looking at any M&A transaction is to evaluate the financial fit. Can we justify to our shareholders that using capital in that way is the best use and will position us well going forward? We also did a very small acquisition in our Mutual Funds business. They look to expand the products that they have, kind of a smart beta shop. It was relatively small, all funded by mutual funds, their cash on hand. It was not something that the holding company contributed to in any way. Again, we look at what Mutual Funds has been able to do is they've diversified their platform. They've been having a very strong year this year with very strong net flows and very pleased with how all of that has come about.
Future M&A activities that we would entertain would really, again, fall in those areas. Focus most likely on our commercial lines business, our Group Benefits business. Probably a little bit of a de-emphasis on personal lines right now as we continue to improve the overall profitability there. As I said, really see it as a means to accelerate our strategy and improve either the types of products that we can offer to our customers, industry verticals, and so forth, or potential ways to increase scale as well.
Do you feel it'll be anything bigger than a bolt-on in terms of acquisitions?
I never like to say never. Again, I go back to when we really think about some of the things that we're doing, it's got to fit in with our strategy. It doesn't mean that we wouldn't have an appetite for something larger. Again, I start with what our core strategies are and how M&A can help us accelerate that.
Okay. We haven't talked about The Hartford's group business, Group Benefits business. Can you tell us about the growth potential there and the potential for earnings improvement?
Well, I think Group Benefits has shown the ability to improve their earnings. If you go back over the last several years, we've done a lot to improve the profitability in that book and very pleased with how it's performing. We went through a process of re-underwriting the book. As you know, oftentimes that business is written over with a three-year rate lock. If you find yourself in a situation where you're underpriced, it takes a bit to work through that, and we did that. We've definitely been seeing the earnings grow there. In addition, we're also looking at expanding our product set. Kind of thinking about the voluntary market, A&H, and so forth. Again, it takes time when you're doing those things organically and building your product set. But the team, I think, is poised very well to compete in those markets.
Performance overall in the book, I think, continues to be strong and the claims experience that we've had. One of the things that we did a few years ago is we moved the Group Benefits claims operation within the broader claims operation of The Hartford, the P&C side. We've definitely seen when we look at our workers' comp experience and our group experience on the disability side, some synergies there and learnings. We highlighted that last year when we talked about our claims operation. We definitely see the ability to continue to benefit from those learnings on both sides and capitalize on that experience that we have.
That's helpful. Let's go to the audience response system. The first question we have for the audience is, if you don't currently own the shares of Hartford or are underweight, what would cause you to change your mind? We can start the countdown. It's either tighter property casualty insurance market conditions, improved P&C insurance underwriting results, higher return on equity, including the divestiture of Talcott, or share buybacks, lower valuation, or increased potential for industry consolidation. The audience responses are coming in. By far the most, 59% saying higher return on equity, including a divestiture of Talcott.
Am I supposed to comment on that?
If you'd like to.
Okay.
The second highest being 24%, the total property casualty insurance market. Probably gives you some perspective for the market's perspective of that. Okay, next question, please. My confidence in The Hartford's ability to fix its personal auto insurance underwriting results in the next 12 months, ranging from very high to very low. Give you about 10 seconds to key in here. Okay, just winding down. The results, 50% saying very high, and-
High.
I'm sorry, you're right, Beth. Sorry. 50% saying high, and just under 40% saying neutral. I'll count that as a not sure. What's your perspective on that, Beth?
Yeah. I'm glad you asked because you didn't ask about personal lines. I think you asked this question last year, and we may have gotten a different result. We're very pleased with the improvement that we've seen in our personal lines results. We've said it was going to take time, and it is taking time, but I think we've been able to show the progress that we're making in looking at our results for first and second quarter. I'd also say that as we continue to evaluate activity related to prior years, that activity is coming in line with our expectations and the reserves that we set. We're very pleased to see that as well.
We remind people, when you look at our printed results for third and fourth quarter, if you just compare it to first and second, you have to keep in mind the seasonality that we see within the auto book. We typically see higher loss costs in the third and fourth quarter. Again, our expectation would be that when you adjust last year's third and fourth quarter for reserve actions that we took and compare it to our expectations for third and fourth quarter this year, that we'll continue to show improvement.
Right.
The last thing I'll comment on, too, is when we think about the improvement, we're really focused on loss cost. We've definitely seen improvement in the expense ratio, that's because we had been turning off some of our marketing efforts as we worked to correct the book and put more rate in the book. Our expectation would not be to run it at those lower expense ratios, that we would turn on our marketing spend as the book got back to profitability. We do anticipate seeing some uptick in the latter half of this year on that. Again, all which was incorporated when we talked about our expectations for the year and kind of putting CAT aside, because obviously that is a variable. Feel very good about the ex CAT, ex prior year development that we're seeing.
Excellent. Okay, next question, please. Should Hartford maintain its current business mix? I'm going to start the countdown. Option 1 is yes, Hartford should remain in its current form. Option 2, no, Hartford should explore options to divest businesses including Talcott. Option 3 is not sure. Don't pick Option 3. We'll see. All right. For those of you on the webcast, 95% said Hartford should explore options to divest businesses, including Talcott. Next question, please. My confidence level on the potential for- Did I write this one? My confidence level on the potential for Hartford to divest its Talcott unit, ranging from very high, neutral, very low. Get some investor perspective here. Okay. Interestingly, 23% saying very high confidence on the potential to divest, 41% saying high, and then kind of trailing off from there. I'd say sentiment is hoping for it and largely expecting it.
Do we have a final question? If Hartford were to sell Talcott- My preference for using the proceeds after funds required for debt repurchase would be? We can start the countdown here. All share buybacks, acquisitions, mix of share buybacks and acquisitions, or other. The highest response coming in at 50%, a mix of share buybacks and acquisitions, and one third saying all share buybacks, with around 10% each all acquisitions or some other form. I hope there's not another Talcott question. Beth's going to not be happy with me. Is that it? Okay, good. We've got a couple minutes left if there's any questions from the audience. Any questions from the audience? Right over here, please, on the left. Bernie?
Here you go.
Hi, Beth.
Hi.
Just a quick question. Do you have Florida Hurricane Catastrophe Fund coverage as part of the
Yes
exclusive from this reinsurance program?
I didn't cover on that, yeah, we disclose that in our 10-K.
Would that get it first, I guess? Would the loss go there first, then whatever's not used up would go to the reinsurance then?
I don't believe that's how it works.
Okay.
It's relatively small, what we get. Again, I know it's disclosed in our 10-K.
Yeah. Okay.
Obviously, I focused more on our larger protections.
Sure. Thanks.
Next question up front here, please. Joel?
Good morning. Just a quick question. You mentioned that your reinsurance programs are multi-year. Did I hear that right? It's a third, a third, a third, so you'd have a one-year term, a two-year term, and a three-year term?
No. It's three-year terms that we've staggered in over time. When you look at it, what we've done is, in the three layers that we have, the first, second, and third layer, there's tranches in each of those. Think of one third of it would expire every three years.
Right.
That's why there's only a third that's coming up for renewal next year. Does that make it clear?
That's what I was getting at.
Yeah.
The maturities would be sort of staggered.
Yeah. We've staggered them, so it's not like it's all at once.
Next question, please. Any finals? Okay, excellent. With that, please join me in thanking Beth Bombara from The Hartford.
Thanks.
We'll have the breakout session in the Madison Suite, and up next on this track is Allstate. Thank you so much.