We'll get started here with our next presentation. Mike Nati, I cover property and casualty insurance here at Goldman. We're pleased to have The Hartford joining us here. Representing The Hartford is Chris Swift, The Hartford's CEO. The Hartford is a leading domestic insurance company with a market cap of about $19 billion, and a franchise focus on commercial lines, particularly on the small commercial side, as well as in personal lines led by its exclusive affiliation with the AARP. Chris joined The Hartford in 2010, as Executive Vice President and CFO, was named CEO in June of last year. Beth Bombara is also going to be up here with us. She is the company's CFO, and is, aside from everything financial, the go-to for all questions Talcott.
Beth was the President of Talcott since its formation in 2012, and prior to that, acted as Controller for The Hartford since 2004. With that, I'll turn it over to Chris for a few opening comments, and then we'll sit down and ask some questions.
Thank you, Mike.
Yep. Thanks, Chris.
Great to be here. Good to see everyone. It's always nice to get an invitation to speak to your investors and discuss some of our activities at The Hartford. I thought I'd start with just a review, a little bit of 2015, in that from an operational and financial side, we're very pleased with our overall performance. In spite of maybe a challenging economic environment of continued low interest rates and increasing competition, we think we executed well on our strategies. Our strategic direction of the firm, I think, has been set over the last two years, and even somewhat prior with Liam's leadership in transforming The Hartford. We're focused on five major pillars, as we call them. First pillar would be ultimately becoming a broader risk player, expanding our risk appetite. Second pillar would be maximizing our great distribution system that we enjoy today.
Third pillar would be putting the customer at the center of everything we do so that we become an easier company, whether it be for our agents or the ultimate customer to interact with, more digital capabilities in particular. Fourth area would be we're making investments in our capabilities. That's really code for technology and data and analytics. We've been on that path a while, and we're going to continue on that path going forward because there's more to do. Lastly, from a talent side, we think we have 17,000 very talented employees throughout the organization. We're looking to acquire additional talent to fill in those skill gaps that we need to be a broader risk player, to make the investments that we need in our platform. Our goals remain fairly consistent.
We are focused on expanding our margins to improve our ROE over time, and we're focused on growing book value per share year-over-year. If I just flip to a little bit of some recent activities before maybe I touch upon the fourth quarter and full year. A lot of the recent activities and discussions that I think are on a lot of investors' and analysts' minds is personal lines frequency. I think everyone's well aware that we reported third quarter results, and we saw a little bit of a blip for the first time in July and August in personal lines frequency. Frequency was up about 3%. As we looked at our data through October and November, I am pleased to report that our trends have gone back to more normal expectations for 2015.
We can talk about some of the drivers maybe in Q&A, but I would say that what we see in our data is a little bit of a regional pressure in the Southeast and West with higher frequencies compared to other territories. I think the primary driver, at least for our book of business, is we see consistency in frequency, no matter if it's a newer customer to us, if it's a seasoned renewal customer for us, if it's in our AARP book, or if it's in our independent agent channel book. Those trends are consistent no matter what type of segment you look at. What's different, and I think it bodes well for us, is that the primary driver, at least in our data that we're seeing right now, is that for drivers older than 60, there is lower frequency.
In drivers under 60, we tend to see a higher frequency across the country. As our book is 70% AARP related, I think that bodes well for us. I think the other important factor that I would just point out is, as we developed our 2015 plans last year at this time, we did plan for a modest uptick in frequency and a little bit more in severity. Those plans we've been executing to, whether it be in pricing actions or whether it be in rate filing, whether it be in underwriting or improving our class plan capabilities. We had been on an expectation of slightly higher frequency this year compared to prior years, which frequencies were tending to be more negative and a little bit more severity. We feel good about what that means for us to maintain our margins and potentially expand them going forward.
As we head into the fourth quarter and all of 2015, what I just say is we are going to end the year in good fashion. If I look back at what we've guided to from an overall core earnings perspective for full year 2015, I think we'll be right at the midpoint of that guidance range. As we head into 2016, our practice, and Beth will talk more about it, is when we do our fourth quarter earnings call, we'll update you on, I'll call it, key drivers and expectations for core earnings in early February. Any questions on 2016 outlook, I'm just going to ask you to wait until we talk through it in February. I think the other fourth-core items maybe we just touch upon is our variable net investment income partnership and hedge funds.
We saw a little bit of a decline in third quarter. As we sit here today, we probably are going to be in the 2% yield area for the quarter on an annualized yield basis. Again, a little bit lower than even our third quarter numbers. That's just the environment, particularly with hedge funds and partnership valuations coming down a little bit. I think those are the key points I would highlight for the fourth and full year, Mike.
Great. Well, thank you for that. Well, certainly, you did steal my thunder on the frequency question, let me dig into that.
How did we know?
Yeah, that's right. You must've been clairvoyant on that one. I guess could you just dig in a little bit. Is the trend that you saw in July and August as you've combed through the data, does that feel more like just summer driving with maybe a lift for some environmental factors that maybe magnified that trend in the summer, or is there maybe something else?
I think we commented upon it, Beth could explain a little bit more from her perspective because we look at the data together. If Doug were here, he'd be also explaining what we're seeing. I think, again, summer activity, driving, highway activity. We probably saw more, I'll call it, high speed incidences than we had in the past. Whether that be highway or freeway type of activity, which tends to imply people traveling longer distances during the summer months. Again, maybe with low oil, people taking advantage of driving as opposed to flying or taking the train. It was at least what we're seeing again through November data, a blip in July and August.
Got it.
Would you add anything else?
Yeah, no, I would agree with that. As Chris said, we spent a lot of time looking at the data, and as he said in his introductory comments, really trying to see if it was into a particular cohort. Obviously, you always worry about new business. Is there something there? As you said, when we looked at it was kind of across the board. It does appear that primarily July and August did have this uptick, and as Chris said, now sort of things back in line with our expectations. I think one thing to keep in mind when you think about that and think about trends is that fourth quarter typically is a higher frequency quarter for us. We just tend to see more accidents as it relates probably to weather and things of that sort.
Our trend for fourth quarter is kind of, as Chris said, in line with what we were expecting, but that typically is one of our higher quarters. We've been following, as others have in the industry, what people have been seeing on frequency. We've been looking for when we might see an uptick, which is why we reacted the way we did when we saw it in the third quarter and took the actions that we did take.
I guess you talked on the quarter about those actions, some rate taking and commencing more of a rate taking cycle. How should we sort of think about that? Should we expect that at this point that you will reverse some of that rate taking activity, or do you expect that you will just continue along the path that you were on?
Again, we saw the blip in July and August, and the way we talked about that is it's not as if you can all of a sudden get that into your rate filings.
Right.
As Chris said, we entered the year expecting there to be some uptick in frequency, and that was already built into our plans. We were really saying on the third quarter call is we needed to watch this trend because if this trend continued, we would have to take more action in those rate filings. What we're seeing is it's kind of in line with what we were expecting, and that's kind of been our process as we've been looking to.
That trend affected your loss picks.
Right
for that quarter's results.
Okay.
That's why we highlighted it.
Right.
That's why if you look at it year-over-year, that was a contributor into a little bit of the increase in higher loss ratios. To Beth's point, that's what I forgot to say in my opening comments, if you look at our fourth quarter, that's always our highest seasonal month as far, or quarter as far as activity. If you go back to last year's combined ratio or loss ratios for personal lines, I would expect a slight improvement from last year's for auto. If you look at home, though, home last year was extremely favorable from a weather-related activity. On a comparable basis, if we have a normal quarter in home, which we're expecting this quarter, that trend might look like it ticked up a little bit, but you got to dive a little bit deeper into the underlying trends between year-over-year.
I see. Okay.
Right. Then the only other item that I'll point out that we talked about again on our third quarter call is that from a marketing perspective and how we can direct the flow of business with our direct channel, if we start to see certain areas that are running a little hot and we're seeing activity, we can pull back on that spend and kind of control the flow. Doug talked a little bit about that as well. As you start to see Potentially higher frequencies in certain parts of the country, you can react to that, and that's things that we have been doing.
Lastly, as it relates to our personal lines book in general and auto, we've been really focused on agency actions as well, because when you parse through our book and you look at our AARP book, you look at our agency book we, like others, have been focused on improving the profitability on the agency side. That's where we've been taking actions to really look at what agents are we doing business with. We really want to do business with agents that are selling the same value proposition that we think. We believe it's not just about price. Those actions, I think, are also starting to take place as well.
Why that's important is because, again, we have a great partnership, particularly with AARP. We have a direct model through AARP and an agent model through AARP, and we can differentiate by channel pricing and trends. What I would want investors and analysts to know is that we don't have to peanut butter, I'll call it, trend in our direct channel versus our agency channel. We could be more targeted in those actions that I think really allows us to be more stable and predictable, particularly for an AARP member.
If you were to look at those two sort of cohorts in exactly that way, the agency channel and AARP, how has the rate taking been different, or how has the loss experience or frequency impact been different across those two cohorts? Or has it really not been?
From a frequency side, that's what I'm saying.
Yeah.
There really hasn't.
There really hasn't been.
There is similarities across all those channels. Now, there's a basis difference, as I always like to say, between direct and agent as far as overall loss cost, but we price for that and expect that difference.
Okay. Maybe we'll shift topics, and if others have in the audience have more questions on that, we can pick that back up later. Maybe we can talk a little bit about the commercial auto book and some adverse trend that you guys have been seeing there. Can you talk a little bit about what are the underwriting actions that you've taken? Maybe give us a little bit of an update on what you're seeing now in the commercial auto book, and where do you sort of expect that to shake out?
Sure. I think the commercial auto, let me just give you a couple data points. The prior development we've been seeing as we reported in our third quarter is primarily 2010 to 2013, really related to, I'll call it, loss cost or medical costs that have been sort of accumulated without our knowledge.
Meaning without being reported to us, which implies there is some type of activity that's happening in the marketplace where someone's fronting medical costs and then reporting to us usually four years to five years out. We're seeing a blip in our triangles. Really what we've been doing, if you think about it over the last four or five quarters, is we've been beefing up our prior year reserve estimates. Third quarter, we did take a $30 million pre-tax charge in commercial auto. If we look at our data through October, November, we feel pretty good about that. Our assumptions are holding as it relates to that book and particularly that cohort, 2010 to 2013. What we've done in our reserving actions for 2014 and 2015 has made an assumption that those late reported claims, beginning at month 48 and continuing through month 60, do continue.
I think our early read on development and reported activity in 2014 and 2015 is we feel pretty good about the trends that we're seeing. This is a longer developing line, it'll take a little bit of time to really know if we've captured those trends correctly. I think from an underwriting side, what we've really been focused in on is a little bit of our class plan, a little bit on drivers, really looking closely at all drivers on a commercial book as opposed to just a sampling or a population. Looking more closely at vehicles, age of vehicles, and obviously past driving records. We've made tweaks in our underwriting approach over the last two or three years that we think will enable a better result going forward.
Have you talked about what sort of rate increases you're pushing through there at this point?
Yeah, I think last quarter Doug would have said high single digits.
Okay.
That eight, nine-ish, and we continue to push that going forward.
Is there a subsection of the book? We've heard long haul trucking, livery as areas that are relatively more problematic than others. Can you give us a little bit maybe of color in terms of those areas and, I guess, with long haul trucking being more economically sensitive to fuel prices?
Yeah, that's an easy one. We don't do long haul trucking.
Okay. There we go.
If you look at our commercial auto book in total, round numbers, it's about $500 million. I would say split somewhat half and half between small commercial and middle market. The small commercial book is performing as expected.
The real issue with prior development and this 48-month development is in middle market. That middle market book's roughly $250 million. It's, I'll call it mainstream commercial middle market business. We're not doing anything with high hazard trucking. We're not doing anything in the commercial trucking area. It is vehicles used in our middle market customers' business that we're insuring.
Got it. Okay.
I just want to emphasize what Chris said. As we look at our loss picks for those years where we're seeing that development in that 2010 to 2013 year, we are assuming that trend continues. Chris is right, as it can take 40 to 60 months to kind of see the ultimate view. We start to see the late reporting in the 24 to 36 months. For more current years, we're watching those very closely to see if that trend changes. As Doug, I think, said very well on our last call, we want to see that happen before we would change our view on loss picks. Feel very good with what we're seeing in the fourth quarter that things are holding.
Got it. Maybe we can broaden out a little bit more, sort of talking about looking at the business from two different perspectives. On the first side, the profitability side, on the second side, just from a revenue or growth perspective. From a profitability perspective, it would seem that the areas where improvement is most plausible, middle markets and the homeowners book. If that's fair, maybe the non-AARP auto business. Maybe lastly, the specialty commercial. How would you sort of rank those in terms of the most salient opportunities to drive margins? Secondly, when you look at the top line, where are the places, and I'm guessing they're different than those, but where are the places that you look at plausibly for growth from here?
Let's sort of bifurcate the question. One is a growth orientation, one is an improvement orientation. I think the way I would describe it is our small commercial franchise is our most profitable business. It is a high ROE business, it is a growth orientation where we're trying to expand our risk appetite in how we use our technology to ultimately bind on the classes we say it. That's one. I think in middle market, from an improvement opportunity, I think it's fair to recognize and acknowledge the significant improvement that we've made in that book over the last three years, really, again, led by Doug Elliott and David Carter, who has really improved the business.
Whether it be in our comp book, whether it be all the changes that we're making in commercial auto, whether it's building out our property capabilities, we feel good at sort of the underlying loss ratio of 92 in our key account area. That performance is good, we still need a little bit more rate, particularly in commercial auto. If you bifurcate it just a little bit more, I would say that our specialty or national account business has a higher loss ratio because it's an excess book. The economics of that business still work for us, even with a combined ratio in excess of 100, even in a low interest rate environment. As far as the other opportunities to improve, I think you're right. If you look at agency, personal lines, and homeowners, those are the businesses that we fundamentally still need to improve.
We could talk through some of the actions that we're taking in the agency area. View it as we're still committed to that channel, but we know the comparative rater impact it has on that channel. Ultimately, we want good distribution partners that can sell our value. Not just sort of quote rate, because we think our products have value for the customer, and we can differentiate over, I'll call it, a longer period of time. Ultimately, what I think you'll see is continue to shrink in certain areas of that agency channel. That won't necessarily be a growth area. Both, I'll call it the independent agent or non-member as we call it internally, and a little bit even on the member AARP agent. We expanded to basically 7,000 different independent agents that are AARP licensed.
We're probably going to shrink back from that because that value proposition, we don't think is all there. That said, that is a very important channel, particularly for AARP, the membership, so that they have their members able to access our product and capabilities either on a direct basis or if they want to seek advice. Very committed, but it's probably a little bit of shrink to improve profitability and then a growth orientation going forward. Lastly, on homeowners, what I would say is that is a critically strategic important product to any personal lines carrier these days, particularly as autonomous cars come online. We're committed to that, whether it be improving our direct capabilities or our agent capabilities in that channel. If you step back and say, okay, how do you think in terms of profitability versus growth orientation?
Clearly, we're putting much more emphasis on profitability and margin expansion. We're not going to grow just for the sake of growing, excuse me, or getting larger. We'll always stress profitability, which in this environment. The strategy is relatively straightforward. We want to continue to lock up our best accounts on renewal in commercial, be very selective on new business opportunities, and find those opportunities and work with our distribution partners, work on our sales management and sales execution to identify those to grow. I think that the growth opportunities, if you dive deeper into our numbers that we really enjoyed over the last three or four quarters, involve commercial construction, marine, technology, and healthcare. We're going to expand our risk appetites into other aspects of the U.S. economy where we haven't had a big risk appetite. We think we have all the product sets.
We just need to be able to apply those product sets in a broader array of industries or SIC codes in our U.S. economy.
Got it. Great. Maybe just touch on homeowners for just a minute. What are you doing there to try, you'd think, in this environment, homeowners, even aside from the sort of considerations that you mentioned on the bundling side, homeowners, pretty decent business today. Rates are decent. Loss trends have been good. Reinsurance costs remain inexpensive. You're in an exclusive channel with less competition, at least direct competition. What have been the obstacles that you've encountered there in order to get the profitability where you want it?
I would say our niche within homeowners, particularly through AARP and even our agent channel, is in the home values in the $300,000-$600,000 range.
When we get outside of that range, our risk appetite needs to be tweaked a little bit. We need to think about underwriting a little differently. In that sweet spot, our capabilities are pretty good. I think the biggest obstacle that we still need to overcome is how we think about roofs and some of the features that we need to continue to roll out to manage roof exposures. Again, with our base, we tend to insure older homes.
I think there's some tweaks in our underwriting that we need to continue to make for an older home demographic also.
Got it. You're in the process of
Yes
going through that now. I'm going to shift, if I could, just maybe Beth. Obviously, a lot of questions about capital deployment, capital generation. Maybe if you could give us an update on any expectations out of Talcott. I'm guessing we're still expecting the $500 million early next year. Then just thoughts on a lot of conversations about rising rates. If we do encounter a period of rising rates, can you just talk about how you think about the allocation of capital between debt and share repurchase?
Yeah, sure. A couple of things on that as it relates to Talcott. As you know, we've taken out $1 billion in dividends this year, as we had said that we would. Our plan is to take out another $500 million in the beginning of 2016. We've also talked about needing to see how 2015 ends from an overall surplus generation to determine what, if any, additional dividends we would take out in 2016. We'll see how the year ends there. Through the nine months to September, our statutory surplus is up a little bit over $400 million if you back out the effect of dividends. We still anticipate that coming down a little bit in the fourth quarter. In the past, we've talked about surplus generation for Talcott in the $200 million-$300 million range.
Sitting here today, still think it will be on the higher end of that, but just kind of need to see where things land and what interest rates are. As it relates to capital management, we have the plans that we've been executing on, as you know, which is a combination of share repurchase and debt reduction. We did pay down a maturity in November as scheduled. For the quarter, we went into the quarter with a trading plan in place to buy back about $350 million worth of shares. We did do some open market purchases as well of about $75 million. For the quarter, expect about $425 million of share repurchase. Then we'll just continue executing on our plan as we go into next year. For further capital deployment going forward, to some extent, our calculus on that I think stays the same.
We have the stated goal of reducing our leverage ratios over time into the low 20s. We're on that path. We have a debt scheduled to mature next year that we will pay down. As we continue to generate excess capital and bring that to the holding company, we'll evaluate the best use of that. As we've talked about in the last two earnings calls, as we think about deploying capital, we also put into the mix investing in our businesses as well. Of course, we have to get the right return objective to do that. Given all the improvement that we've made in sort of our financial picture, we believe that now we're in a position to be able to think about that more than we were in the past.
Great. Last one from me, I'll open it up for questions. Obviously, another topic, Chris, that has come up very frequently and more so this year than probably any other I can remember is just M&A. The questions we get is, which side of the fence is The Hartford on? Can you talk a little bit about how you think about the potential for Hartford to maybe fill in some of those areas that you're looking to grow with acquisitions, or any other thoughts on how that might be a tool that you would use, and how you think about that relative to some of the stuff Beth just talked about?
Sure. I think the context for that question is, I view it as that we're in four major risk businesses, right? Years ago, we wanted to be in the risk business as opposed to the market risk business. Commercial P&C, personal lines P&C, group mortality, group morbidity. Any of those businesses from a M&A side would be interesting.
We primarily think about things, though, in an organic fashion of what do we need to do organically to improve our risk appetite or our capabilities. As Beth said, the calculus for our excess capital, which all our businesses are generating excess capital, gives us great flexibility. We've driven down our cost of equity capital. We've de-levered the firm. I think we said at one point in time, we could be more offensive-minded about opportunities. We do think of it in terms of build versus buy trade-offs, IRR on buybacks or debt pay downs versus the IRR you could earn over a reasonable period of time in doing M&A. I think we've also framed it that, look, we're not looking to do anything transformational. We're a national carrier that's trying to expand in certain regions of the country, expand certain elements of our risk appetite.
If there's things that come across our desk or things that we are proactively cultivating, I think that is a legitimate use of excess capital if it fits strategically and fits financially as far as the payback.
Great. Any questions from the audience? Give you a chance to take one if you have one. Other than that, I guess one other question from me. If we go back to the AARP channel specifically, and I guess personal lines, you mentioned small commercial as a product area that can grow. Do you view personal lines that way, or is that more kind of hang on to your demographic and maybe tweak around the edges and just try to make sure you're getting the offering right?
Definitely view AARP, direct or agent, as our personal lines growth engine.
Okay.
As Beth said, we have the ability to market and drive responses from our direct response system, whether it be digital, whether it be paper, whether it be TV. We really have strong capabilities to drive response. What we're focused on is expanding the risk appetite in those areas, underwriting it in a consistent and appropriate fashion, and building out our homeowners capabilities. If I look at where AARP, again, a very strategic partner for us and with us, but where they're trying to take their membership base and some of the things that they're trying to do, and I think how we could fit into that.
Particularly that, I'll call it, younger cohort of AARP members below 60, that's a real growth opportunity because I think we have the opportunity to provide them with high-quality product, but we need our underwriting tools lined up to do that. Even, I saw a report this morning that the fastest growing demographic of drivers is 85-plus. Right? Who would have thought? Again, there are opportunities, again, with good underwriting sound discipline. The overall AARP member base of roughly 38 million members, and we have roughly two and a half million of those members, I think gives us a great growth opportunity when we execute our sales plan, our underwriting plan, and our risk appetite.
Great. I think we have time maybe for one quick one here in the audience.
Yeah, just thanks for the opportunity. With traditional pricing, with pricing in the reinsurance market on a traditional basis than alternative capital that's coming into play, how is Hartford taking advantage of that in both their property and casualty lines as well as their excess casualty coverages?
Let me just repeat that for the webcast. The question is inexpensive reinsurance pricing, how is Hartford able to or taking advantage of that in either property or casualty lines? Is that fair?
Yeah. I'll let Beth add her views, too. I would say our reinsurance buying is fairly modest. We don't put out huge lines. I think what we're proud of, particularly as we grow our property capabilities, we do have a $500 million reinsurance treaty per risk or $500 million per risk on location. We feel like we have the appropriate reinsurance to back us to be competitive in the marketplace. We're in the market right now to place our property cat treaty that comes up January 1. We're not big users-
Right
of reinsurance with our book of business.
Yeah, I would agree. We have been able to, over the last couple of years, take advantage of the pricing that we've seen and make some changes to our program. It's not a large spend for us. Even though we've seen some savings there and expect some as we head into this renewal, it's just not as large because of just the size of what we buy.
That said, Beth and I and Doug and others, we routinely meet with providers of alternative capital. We met with our reinsurance brokers to sort of keep abreast of activity. Always challenging ourselves to think differently about capital and risk. To date, we're pretty satisfied with our current approach.
Great. Well, thank you very much, Chris and Beth, for joining us. Really appreciate it.
Mike.
Thank you all for listening.