It's a chilly February morning here in New York City. We've had blizzards in the past. A little snow is not going to scare us. My name is Jay Cohen. I'm the Senior Property Casualty Insurance Analyst at BofA Merrill. On behalf of Seth Weiss, Alison Jacobowitz, Matt Palazzola, and Ian Ryvlin, that's the whole team, I'm going to welcome you to our annual insurance conference. People are beginning to describe this market in 2016 in historical terms. We've had this confluence of events, commodity prices falling, obviously declining equity markets, mostly in financials, as we see. Interest rates retracing multiple year lows, tech stocks seemingly blowing up left and right. There's not a lot of places to hide. I noticed one statistic. Since the beginning of the year, the Dow Jones has moved more than three digits, triple digit moves in all but three days.
That tells you how volatile things are. Not only is it hard to pick stocks in this environment, but try running an insurance company. That's not that easy. The leaders of the companies presenting at our conference are faced with this uncertain macro environment, but they also have to manage their business for the long term. It's a pretty tough challenge. Over the next two days, we'll hear from, and I think this is a well-timed conference given to everything that's happening, we'll hear from these management teams and what they're doing to try to defend their ROEs and grow their business, again, given the uncertainty. This is a nice excuse for us to maybe get away from our Bloomberg machines and get back to fundamentals for everyone. Before we kick off with the first speaker, just some housekeeping items.
When you come into this room, always wear your name badge. We have security guys out there. That's how you're able to get in. One-on-one meetings or small groups are on the ninth floor and the fifth floor. There's elevators here and around the corner. On your badge it will tell you, or on your schedule it tells you where those rooms are. For many of the sessions, including this first one, we'll be having a fireside chat format. We have questions prepared, but we don't have a monopoly of great questions. We want this to be as open as possible. If you do have questions, certainly feel free to raise your hand. Next point, if you do ask a question, just wait for the mic because this is webcast. That ringing phone is also another good reminder to mute your cell phones.
Didn't have that down, but thank you for having that ring. Let's see. Conference planning staff is here to help you. They're phenomenal. If you have any questions, comments, concerns, please feel free to go to them. Lastly, lunches. If you're in this main room as an audience member, there'll be boxed lunches outside. Delicious, but boxed. If you have a one-on-one during that time, there'll be some buffet lunches upstairs. Let's move on to our first presenter, which is Hartford Financial. We're very pleased to have Chairman and Chief Executive Officer, Chris Swift, along with Chief Financial Officer Beth Bombara. Chris joined Hartford in 2010 as the Chief Financial Officer, a time at the company when not much was happening, really. You must have been just twiddling your thumbs first couple years, probably. Obviously, that wasn't the case.
Beth joined the firm back in 2004 and was elevated to controller in 2007, also a time of relative calm at the company. Chris and Beth have been critical in leading The Hartford through a very challenging time. The tone of the questions we ask now is very different than it was back in 2007, 2008, and 2009. It's kind of a pleasure to think more about fundamentals versus just capital. Why don't I have Chris and Beth come up and we'll start the session. Chris is just going to open up with some comments, and then we'll get into the Q&A.
Great. Thank you. Good morning. It's always great to be with you, Jay, and be invited, Beth and myself, to join and have a dialogue with our investors. I thought what I'd do is if you just allow me just a couple minutes to summarize just where we're at as an organization, just talk about our strategy. What I won't talk about is New Hampshire's elections. All right? I'm not expert in what happened up in New Hampshire yesterday, so we'll leave that to others. Largely, The Hartford had, we described, a successful 2015. We described successful in a number of the metrics which I won't go through, but maybe just a few to highlight that we were able to grow earnings per share on a diluted basis 15%. We increased our ROE to 9.2%.
We paid off about $750 million of dividends and returned over $1.6 billion to shareholders. What we've been described as 2015 was a year that largely our strategic and financial transformation, as Jay referenced, is behind us. There's a couple little things still to look after, but we feel we worked very hard over the last four or five years to put the firm in this position today, both on all the dispositions and the restructurings of the firm. Equally important, the benefits of what Doug Elliot and his team have done over the years of fundamentally improving our businesses with underwriting actions, with pricing actions, with investing in our capabilities are really paying the dividends in that we've laid over the last four or five years. As we look forward, our strategy is really unchanged.
We describe it as sort of the five pillars. The five pillars we focus on is expanding our products and risk appetite, maximizing our distribution partners. We enjoy deep, longstanding distribution relationships, and we can do more business with them if we had a broader risk appetite and a broader product set. Putting the customer at the center of everything we do, from our technology improvements, to our interactions, to our communications, to our digital capabilities that we're investing in. Fourth, I would say that we are investing in technology, big data, and we describe it as our continuous improvement mindset within the organization. Then lastly, the last pillar is talent. We enjoy 17,500 great employees that are dedicated and passionate about The Hartford and what we do every day.
We're also looking to grow that talent base, particularly in the areas that we're looking to grow in in the future. As we set upon the journey here in 2016, we talked about our goals and guidance last week. I would say that we are entering 2016, with fundamental strengths that we have not enjoyed before to weather a difficult environment. Our really main focuses are continuing to defend our margins, particularly in commercial, expand our margins in personal lines and group benefits, and continue to improve our net flows in our mutual fund business. We enjoy significant capital flexibility. All our businesses are generating capital. We do have a capital plan to return about $1.3 billion to shareholders in the forms of buybacks. In addition, we also will disperse about $300 million in dividends.
We enjoy a stable management team, a team that's been together for a while. We know what we're trying to accomplish, Jay, and I just think we enjoy a lot of fruits of our labor over the years. We're remaining focused on underwriting discipline, our expense efficiency, and trying to grow into areas where we don't have capabilities today.
You're obviously instituting a lot of change at the company. If there were one or two changes that you could accelerate, maybe what's frustrating you a little bit at the pace of change at the company?
There is a lot to be proud of. We have changed a lot. We've made a lot of improvements. If I look at, I would say, two areas, if we had the opportunity to run maybe a little quicker, it would be in our geographic expansion. If I look at our footprint, we have great strengths along the East Coast and the West Coast, and we have opportunities to capture additional market share. Over the last 15 months, we've hired about 30 underwriters, primarily in the middle of the country, through Texas and a little bit along the West Coast. That would be one area if we could really hit the ground running and they get up to their production targets would be a great benefit for us to capture more market share.
The other area, the major areas, and you've heard me before and Beth talk about it, we are fixing a lot of our legacy IT systems. Some of these systems are 30, 35, 40 years old, and have just served its purpose, but we need a more modern platform, a more digital oriented platform. That sounds easy on the surface, but the tedious detailed work of unhooking, connecting new things to your operating environment takes a great deal of time, patience, quality assurance. You want to get it right so you don't disrupt any customer experience. Again, progress, but if you could click your heels and say we're done, I'd love to be able to do that, but that's not the case. We probably have at least three more years of hard work ahead of us.
Doesn't sound easy to me, actually. That's pretty tough. It wasn't that long ago we would think of a 10% ROE as sort of a floor you didn't want to get below. Now there's a lot of companies that are shooting for that. You're sort of in the upper single digits. To get into that double-digit territory, given the headwinds which feel like they're getting maybe a little worse even, will you have to take more dramatic action than you're doing now? What you're doing now, will that get you there or does it need to accelerate even further?
Well, I think if you look at the facts, we have been able to steadily improve our ROEs over the last three or four years. We're on a path to continually, to steadily improve that. I would say we also talked about our ROEs this quarter for the first time more on a granular basis by business unit and ex Talcott so that our investors can see the fundamentally strong ROEs in the businesses that we're trying to grow going forward and how all of them are achieving returns above our cost of capital today, which we estimate in that nine to nine and a half percent range. You come to the overall aggregate ROE on a trailing 12 months basis. As I said, we're at 9.2. We think that generally exceeds our cost of capital.
That was the first major hurdle we wanted to get to have our returns exceeding our cost of capital, and we always talked about a 10% ROE as just sort of the next logical leg forward. We still speak in those terms. As you said, it is more challenged to get there quickly. In this environment, particularly if you look at the balance sheet and the amount of capital, and the type of capital that we have allocated to Talcott. There is a lot of intangible capital in Talcott, both on a GAAP and statutory accounting basis, which means deferred acquisition costs, DTAs, goodwill that is not tangible, so you can't distribute, you can't divvy that stuff out. There is some headwinds on the structural limits to getting to a 10% ROE. As I always said, it is a goal.
We want to get there. If a lot goes right in the environment, meaning we were able to outperform from a margin side, outperform from a cat, a catastrophe side every year, if our alternative investments produce greater than a 6% return that we assume. If we have a lot of things go right, we could get close to a 10% ROE, but that's not our plan, and that's not what we really forecast when we gave guidance last week.
It'd be nice to have a tailwind from the macro environment at some point, too.
We have enjoyed that over the last two or three years, though.
Yeah, that's true.
The winds have shifted a little bit. Again, I think we entered 2016 with greater flexibility and more tools to manage in this headwind environment.
You'd mentioned Talcott, maybe a question for Beth. It's kind of a semi-permanent overhang unless for some reason it goes away, which we know you've talked about. The pace at which it is shrinking currently, is that as you expected it, faster or slower?
Overall, I would say it's in line with our expectations. It does tend to bounce around a lot as markets move. We've historically seen some correlation between market movements and how policyholders behave. In addition, over the last couple of years, we've done some policyholder initiatives which have accelerated some of the runoff, now we see ourselves kind of plateauing to kind of a new level. All in all, I would say that the book continues to perform in line with the expectations that we have.
The hedging on that book, you said it's worked reasonably well.
Yes.
Given the macro environment, are those hedges getting more expensive?
Yeah. We have had a hedge program in effect for many years, we have targets that we hedge to for both equity exposures and interest rates. On the equity side, we're for the most part hedged, except we don't hedge the underlying fees that come from the annuity contracts. On interest rates, we are not 100% hedged. We do see some volatility that comes through because of that. Yeah, in volatile markets, hedging will become more expensive, we have a process in place where we're constantly evaluating our positions and determining how to take advantage of market conditions as they move around to either expand some of our programs, put more protection on at more attractive rates.
It's a very actively managed process that the Chief Risk Officer, the head of Talcott, who is also the head of our investment operations, and myself talk about quite often. We did include this past earnings call an update of our summary of stress scenario impacts to the Talcott business, which shows the impact that hedging has, which does provide us significant protection in situations where we see significant market disruption.
I would also point out, too, Jay, again, because we haven't needed to talk about this too often, is we do have a sizable capital markets reinsurance program, too, on the book. If you look at our disclosures in our supplement, the gross amount of NAR, net amount at risk, the amount of capital reinsurance, and then as Beth describes, the hedge programs that work pretty well. We feel it's very well contained.
All these questions are coming up again when the market does what it's doing. A couple of years ago, the thought of Hartford making an acquisition just didn't make a lot of sense. You had your own issues. Your capital base arguably in really great shape. Operationally, you're in very good shape. There are strategically some things you want to do that may be able to be accomplished through M&A. Is it coming up a bit more in the boardroom and in the executive offices?
Well, I think you've said the key point is that we worked hard to put ourselves into a position to think a little bit more offensively minded about M&A. Yeah, we do talk about it more, but I want to make sure investors don't think it's everything we think about. It's one of the many things that we think about every day of how to accelerate the pace of our change as a more and deeper risk player here in the U.S. marketplace. Yeah, we do think about it. We also weigh it against organic plans to grow, organic plans to add new products and capabilities, how we can hire talent in the marketplace in areas where we need it. It's that balance that we go through. We are active in understanding what at least is available in the marketplace.
We've always said, any M&A, particularly in this environment, needs to be both strategic and financially make sense. We haven't announced anything, so all I can tell you is that we're fairly disciplined in our approach to what's been available in the marketplace.
What do you think the election in New Hampshire meant for-- No, I'm just kidding. We won't. It was the one topic you said don't ask you about. You mentioned that you have given a bit more granular detail on the ROE, which is helpful. We appreciate that. The P&C business was around 13% last year, a solid result. I guess the problem with giving information is we want more. Not maybe quantitatively, but maybe qualitatively, if you looked at your small commercial business, which many would say is really one of your key franchises, is that much higher from a return standpoint than the mid-market or the small commercial or personal lines? Is that driving things much higher?
Well, if you look at all our businesses, I think it was 13.5.
It was, yeah.
Just half a point does matter, Jay.
Absolutely.
I just want to be accurate as possible.
Actually, I wrote over 13, I did capture that.
13.5 P&C. In the P&C business, small, middle, large, and specialty and personal lines really comprises those businesses. It has been no secret historically. We're not afraid to talk about it. I mean, the small commercial franchise is our largest premium volume. It's the largest by our core earnings. It is our largest, most significant ROE business. It is higher than the others. It's like children. We have four children at home. Love them all dearly, right? They all have different talents and strengths and potential. We love all four of our P&C businesses. They all have different potential and needs. We're trying to expand and grow all of them.
I actually had asked a question on the conference call on small commercial that I thought you could have answered better. The question had to do with.
Please, let me take your feedback. Let me just.
You should. I've got a good answer for you.
The question was relating to one competitor who has at least discussed and is launching a direct distribution platform in a small commercial business. If you needed to turn that switch on, given your systems, given your service center capabilities, couldn't you do that in a second? Aren't you doing that to some extent already? What's your next question? In all seriousness, we tried to answer it from the point of view of awareness, capabilities you need to be successful, particularly in small business. Yeah, I still stand by that question. Can we turn it on today and have an alternative distribution channel? I think it's no secret. You could buy through hartford.com, a small business policy direct on our platform today. We enjoy great distribution through our independent agents. We're continuing to try to maximize that distribution channel.
We have a small alternative right now that we're experimenting with and learning from. If it becomes more important in the future, we'll talk about it at that point in time. A lot of our technology, I think it's important, is already contained in ICON, really the platform that the CSRs interface with us every day to quote business. I think you were down with us in Charlotte when Sabra-
Yeah
hosted us down there. 50% of all our policies are quoted and binded on the glass and are issued. There's a great deal of efficiency in that platform today that we can continue to expand on. We're continuing to invest. You should take away that we're going to defend and grow our small commercial franchise very aggressively going forward.
By the way, do you think small businesses want to buy direct? Isn't it a bit of a headache for them? Isn't it the kind of thing that they would just normally outsource to an agent?
If you really look at the micro end of small, say those firms that might have one to 15 employees, more and more are getting more comfortable doing things directly if it's understandable, if it's easy, if it's holistic. Remember, ultimately, brand does matter here because at the end of the day, what people are really buying is a promise to respond. Our claim service, I think, is second to none in the industry, and that is also an important differentiator. There are certain segments of the market that, just like we've seen in personal lines over the years, Jay, are willing to buy BOP policies and basic workers' comp policies in a straightforward, efficient fashion.
If that ever does happen, the point is you are there, that if you needed to go that way, you easily could.
We have a lot of capabilities already in place.
Another arguably important franchise is the AARP relationship. Maybe taking a step back, can you talk about the expected growth in that channel for you, given demographic changes, given your market positioning?
I would say that this maybe is the third area, if I had to list three, that if we wanted to accelerate or think through this differently. The history was we probably tried to do too much with independent agents outside of sort of our value proposition, including appointing agents that were going to sell and represent the AARP product.
We didn't get the desired results that we wanted, either from a, I'll call it consistency, persistency of the business, profitability of the business, and we've rethought our strategy, and it's really a little bit more of a differentiated smaller offering, shrink our agency footprint, shrink the number of appointed AARP agents that we haven't been able to grow a meaningful relationship with them and it's sort of a one-off offering. It's a little bit shrink to grow going forward. We're still excited about the channel. I mean, the channel of mature drivers, whether it be direct through AARP or through those valued agents, is a great channel. It is differentiated. We talk about it in the differences in frequency, which we've experienced a little bit of an increase, but it's still a lot lower than the broad-based market. It is a tremendous growth channel.
AARP is increasing its presence and its rebranding. We do a lot of things together strategically to appeal to a broader marketplace of potential AARP members. We're very excited still about the opportunities to grow direct and with a more refined and value-producing independent agency system.
I think, if I could, I'd add to that is the other area that we talk about, not just the auto product, but the home product as well, and opportunities there to expand our penetration through further enhancements in that product offering is something we talk a lot about as well.
That's very cool.
I've hit the magic age where I'm getting a lot of AARP mailings. I put them in a top drawer. I don't.
I'll deliver them to you personally if you like.
One of the things with our earnings model, every third quarter, we have to put something in there for as best as an environment. We're always wrong.
Well, hopefully by the third quarter, because we do ours in the second quarter.
Second quarter, sorry.
You would know what it was.
I can't keep track, Paula. We have to put something in there every year. We've been too low in the size of the charges. Is there any reason we shouldn't think that these charges, reserve additions should continue for the foreseeable future?
As I said, we do a study every second quarter. For the last several years, we have seen increases that have been required coming out of that study and really has been centered on a very small number of accounts where we're not seeing the decreases that we expect to see in claims reported. The way our process works is that we're really extrapolating those results over many years, and even though it's a small number of accounts, we see the activity that we have. We do make our best call each year. It's hard to predict and to say that we'll have a charge every year because our process is to use all the information that we have to make our best call. There has been this momentum that we've seen.
Others have seen it too, and we're not unique in that area for those that continue to have this coverage, and we'll continue with that process. We do try and take as much of the information that we can into account when we do these models. As I said, these claims do go out for many, many years, and they're hard to predict.
Are there questions from the audience? Just raise your hand. We'll get you a mic if you do have one. Shoot them up at any time. It's okay. With your investment portfolio, this lower for longer environment seems like it's definitely coming to pass, maybe even lower for longer, we should say. Do you think about changing the dynamics of your portfolio a bit more significantly given the headwinds from lower interest rates?
I'll comment and Beth could add some additional color. I think particularly over the last five years, I've been very pleased with the overall investment performance from our core fixed income capabilities, from our alternatives, and some of the de-risking that's happened over that time. Today, I think the portfolio is positioned very, very well. I don't think it's too conservative, and I don't think it's necessarily too aggressive. I think we struck that right balance. If you think about it, our investment management operations, we call it HIMCO, manages over $80 billion of fixed income and alternative investments. They have some deep expertise in value-adding asset classes such as munis, such as high yield, private equity. I mentioned some of the alternatives in our core fixed income capability.
I don't think it needs dramatic change or restructuring because I think we've done that over the last 5 years, as I said. I think it's positioned well, and I think the only headwind we really face is with our alternatives. Beth has described our yield and our NII earnings potential going forward with our guidance, I think that's fairly well understood. The big variable is just how will those 3 billions of alternatives perform in a choppy market? I think what it really amplifies for investors the need to be disciplined underwriters because more and more of your sources of earnings, as I describe them, needs to come from pure underwriting margin and profit as opposed to investment profit.
Investment profit still makes up a large % of that overall source of earnings, but increasingly in a lower rate environment, underwriting margins is contributing a larger %.
I would agree. I think as Chris said, our Himco folks actively manage our portfolio and look at ways where we can expand maybe into certain asset classes that we hadn't been in, they're very measured in doing that and evaluating the market conditions. For example, we have talked about allocating more to equity exposure. If you look at our P&C company, we're probably underweight equities compared to others. A lot of that is because we, as a company, have had a lot of equity exposure in the past with our life business. Even with that, they have been very measured and deliberate as to when do we want to put some of that money to work and to make sure that we're getting into the market at the right time.
I look at it as just constantly evaluating the portfolio, as Chris says, no major shifts that we see at this point that we need to make.
I think one of the great things, we talked a little bit about our call, I think one of your peers asked a question about energy and sort of the de-risking we did.
Yeah.
I can remember back December of 2014 when oil really corrected from I think $75 down to $45, $50 a barrel. Saw the Himco team had a number of discussions and thought the trend was only going to get worse and started taking actions in the cash market, also, as Beth described on the call, started taking actions in the derivative market to protect on a radical downside move, and turned out to be a good move.
Any questions out there? Let's move to personal lines. Maybe I'll ask more of a bigger picture question. This is a business that, given changes from a technology standpoint, distribution standpoint, feels like it is being increasingly commoditized. In that environment, let's assume that's true for a second. In that environment, arguably size and scale become more important. In your agency distribution platform, you're not the biggest player. What do you need to do to make sure that going forward as the environment could be tougher, that you can really compete effectively in that area?
Yeah. I think what I would like investors really to understand that the personal line strategy is all about AARP going forward. That's really 75% of the business today, both auto and home. We go to AARP members either on a direct basis or through an independent agent. There's still a number of AARP members from the surveys and the intelligence that we have from that membership group that prefer to interact with the agent. Our agency strategy then is to appoint the right agents that understand the value that we bring, the policy forms and conditions, the claim capabilities, and align ourselves to those independent agents that can represent our product into a mature marketplace where we can grow.
I think anything in a mass market, as you said, is more competitive and there's people with more scale, more capabilities, and we're going to continue to elect not to compete in a broad mass market, rather our niche in AARP in the more mature market. There could be developments in the future where we look at other segments of a personal lines market, again, on a niche basis where we see opportunities. Right now, our primary focus is on AARP.
On AARP, you clearly have developed a skill for selling directly. Over the years, going back many years, there's been various efforts, initiatives to say, "Hey, we can take this skill and sell through other affinity groups or other ways directly." None of them were really ever successful from what I could tell. Is that something you've sort of given up on, or are there other affinity groups you can use that skill and sell to?
Yeah. I think it was a good experiment at the time to see if we could do it. We didn't enjoy the success, it's not a strategy going forward for us.
Got it. We got 30 seconds. Any last-minute questions? Why don't we leave it there? Chris.
Good
Beth, thanks so much.