Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to The Hartford's second quarter 2015 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by 1 on your telephone keypad. To withdraw your question, please press the pound key. Thank you. Sabra Purtill, Head of Investor Relations, you may begin your conference.
Good morning and welcome everyone to The Hartford's second quarter webcast. Our news release investor financial supplement, second quarter financial results presentation, and 10-Q were all released yesterday afternoon and are posted on our website. Our speakers today include Chris Swift, Chairman and CEO of The Hartford, Doug Elliot, President, and Beth Bombara, CFO. Following their prepared remarks, we will have about 30 minutes for Q&A. Just a few notes before Chris begins. Today's call includes forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance, and actual results could be materially different. We do not assume any obligation to update forward-looking statements, and investors should consider the risks and uncertainties that could cause actual results to differ from these statements.
A detailed description of those risks and uncertainties can be found in our SEC filings, which are available on our website. Our presentation today also includes several non-GAAP financial measures. Explanations and reconciliations of these measures to the comparable GAAP measure are included in our SEC filings, as well as in the news release and financial supplement. I will now turn the call over to Chris.
Thank you, Sabra, and good morning, everyone. Welcome to the call. Last night, we reported strong financial and operational performance for the second quarter of 2015, completing a successful first half of the year. We continued to navigate in a dynamic market environment and reported improved results across all of our businesses. Core earnings per diluted share for the second quarter was $0.91, a significant increase compared with the prior year. P&C, Group Benefits, and Mutual Funds each delivered better operating margins and top-line growth this quarter. This quarter's strong performance contributed to a 12-month core earnings ROE of 9.6%. The quarter also included net favorable items compared with last year, including higher limited partnership income, lower CATs, a federal tax benefit, lower A&E reserve strengthening, and a favorable litigation outcome. Even when adjusting for these items, underlying results were strong.
Doug will provide more details on P&C and Group Benefits in a few minutes, but I'd like to share with you a few highlights from the quarter. In P&C, our combined ratio when adjusted for CATs and prior year development was 88.9, a 3.8-point improvement over the second quarter of 2014. We are especially pleased to see improved underwriting results in both Commercial Lines and Personal Lines. In Group Benefits, the results reflect our focus on new business generation and disciplined underwriting. Sales increased 29%, and after-tax core earnings margin increased to 6.3%. We continued to successfully manage the runoff of Talcott with year-over-year declines in variable and fixed annuity contract counts of 12% and 11%, respectively, since June 2014. In addition to strong earnings, we are also pleased to announce that our board of directors approved an increase in the company's capital management plan and extended it through December 2016.
Beth will review the details in a few moments. The plan reflects the successful strategic and financial transformation of the company, including a sharpened focus on P&C, Group Benefits, and Mutual Funds businesses. Since the beginning of 2014, we have returned to shareholders more than $2.8 billion of capital. With the increase in this plan, we intend to return nearly $5.3 billion in share repurchases and common dividends over the three-year period ending 2016. Our primary focus going forward continues to be on the profitable expansion of P&C, Group Benefits, and Mutual Funds businesses where we hold competitive market positions. As you know, we have been investing aggressively in these businesses with the goal of improving operating capabilities. This effort includes a significant upgrade in technology, such as our market-leading Small Commercial ICON system and the recent introduction of a new claims platform, and we have additional upgrades planned.
As we consider management of excess capital in the future, we will prioritize opportunities that accelerate our premium growth and operating capabilities. In the event that we do not find opportunities that meet our strategic and financial objectives, we will continue to return excess capital to shareholders. Looking forward, I am confident that we have the right strategy, capabilities, and people required to successfully compete in a dynamic market environment. The Hartford strategy is focused on four areas. First is product expansion. We continue to expand our products to meet a broader range of policyholder risk needs. We are also participating more deeply in targeted industries and extending our risk selection capabilities. The second is distribution effectiveness.
We are actively expanding The Hartford's Commercial Lines sales and underwriting presence in key geographies, particularly in the West and Midwest. This expansion, supported by enhanced marketing efforts and rigorous sales execution, is driving better outcomes. Third, we continue to improve the customer experience and the operating capabilities of our company through things like process efficiency improvements, technology upgrades, and digital access. Fourth, we continue to invest in talent. We are proud of our employees, and we are working diligently to attract, retain, and develop the best talent in the industry. For example, we recently hired Mo Tooker as our new Chief Underwriting Officer for the P&C businesses, and we added two new executives to complement the Personal Lines team, Mary Boyd and Casey Campbell. Like the rest of you, we are closely watching developments across the industry, including recent M&A activities.
These activities will certainly have repercussions on our markets. While change brings risk, it also brings opportunity. We are prepared to address and benefit from opportunities that arise, particularly those that fit our primary focus of expanding products, increasing distribution effectiveness, improving the customer experience and our operating capabilities, and becoming a destination for great talent. As I reflect on my first full year as CEO, I am truly appreciative of the many contributions that our Hartford employees make every day. What makes The Hartford special is our strong character. Throughout the past year, we have received numerous accolades for ethical conduct, risk management, governance, and diversity and inclusion practices, and those attributes are incredibly important to us. In conclusion, we are well-positioned to achieve continued success, and we remain focused on our goal of increasing ROE and book value per share to drive shareholder value creation. Thank you.
Now, I'll turn the call over to Doug.
Thanks, Chris, and good morning, everyone. Our Property and Casualty and Group Benefits businesses posted strong bottom-line results for the second quarter. Favorable property experience for both catastrophe and non-catastrophe losses was a significant contributor to earnings. In other lines, our businesses produced solid margins consistent with recent quarters as loss trends remain benign. With the benefit of strong retention, we also delivered solid top-line growth. Favorable weather patterns were clearly the primary force behind our outstanding property results. While we've been increasing our property capabilities in recent years, and I'm confident that our improved acumen and risk selection and analytics is an important driver for our long-term success, we know that quarter-to-quarter results will be subject to the presence or absence of severe weather.
A well-balanced product mix that includes property is a competitive advantage with customers and agents, and we remain steady on our long-term strategic goals in this line of business. Competitive dynamics across all our businesses are largely unchanged from last quarter. As I commented then, adequately priced new business opportunities are more limited, and we remain disciplined in our risk selection approach. We continue to find success in our local relationships with agents and brokers, and we've been investing in sales and underwriting professionals, along with our product and technology capabilities to improve our market position. I'll provide some additional insights on this as I share the second quarter performance of our individual business units. In Commercial Lines, core earnings was $264 million with a combined ratio of 92.2.
This was an earnings increase of $51 million from second quarter 2014, largely driven by favorable property experience, margin improvement in workers' compensation, and higher net investment income. Renewal written pricing in Standard Commercial Lines was 3% for the quarter, essentially flat with first quarter 2015, and down two points from second quarter last year. Pricing continues to be strongest in Commercial auto, where our profit improvement remains a focus. Trends in workers' compensation pricing are generally in line with first quarter as we execute a very disciplined strategy to retain our best performing business at margins that meet or exceed our return targets. Catastrophe losses for second quarter 2015 were slightly higher than a year ago, but below our expectations.
In Small Commercial, written premium grew 4% in the quarter, driven mainly by strong policy retention as our new business growth rate has slowed somewhat in recent quarters due to competitive forces. The underlying combined ratio, excluding catastrophes and prior year development, was an outstanding 85.1. The decrease of two and a half points versus a year ago is the result of lower non-cap property losses and improved workers' compensation margins. We're very pleased with our sustained performance in this business. Our strong written premium growth rate and profit margins have been very resilient as our underwriting and pricing analytics have helped to guide our book of business management actions. In Middle Market, we posted a strong quarter with an underlying combined ratio of 89.3, improving 8.3 points versus second quarter 2014.
Much like in Small Commercial, the improvement is coming primarily from excellent non-cap property experience, with contribution from margin improvement in workers' compensation. A large portion of the favorable property result came from our marine business, where we had an excellent second quarter. Written premium growth was 8%, driven by strong retention in workers' compensation and increased new business in both construction and marine. We're pleased with recent success in these industry-targeted businesses as they are a strategic focus for us. This is a positive indication of the traction we're gaining in the market as a result of talent and product investments made over the last several years. Since earlier this year, we've been adding underwriters in regions where we believe we can cultivate agency partnerships and compete effectively for new business.
This is a longer-term strategy for growth, it will take time to build momentum in these local markets. However, we believe it is the right time to be investing in talent, to put our improved product and technology platform to even greater use in the market, and develop new books of profitable business. In Specialty Commercial, the underlying combined ratio was 98.8 versus 101.5 in the prior year. The three main businesses comprising Specialty Commercial are all operating within our target return range. We posted solid top-line growth of 4%, while margin improvement was driven by improved loss experience in financial products and a mix shift in our results toward bond with a smaller captives business. In Personal Lines, core earnings was $42 million for the quarter versus last year's $27 million loss.
Much of this improvement is due to favorable catastrophes, which are down this year by $64 million pre-tax. In addition, we had significant improvement in our non-catastrophe homeowner losses versus last year, when we experienced elevated homeowner fire losses. Comparatively, fire losses this year were at their lowest level in the last five years. $11 million of the improvement in core earnings was due to a favorable resolution of outstanding litigation. The underlying combined ratio of 89.1 improved two points from last year, largely driven by the homeowner results I just described, partially offset by a slight uptick in auto liability severity. In addition, we've been closely monitoring increased auto physical damage severity, having begun to see adverse trends several quarters ago. Industry trends in early 2015 also appeared to be somewhat elevated.
We have identified several opportunities for improvement to our physical damage claim practices and have taken action. Our early observations from these initiatives indicate that we're driving improved outcomes, particularly in areas such as subrogation and total loss management. Total written premium for the quarter grew 1%, including 1% growth in AARP Direct and 14% growth in AARP Agency. We continue to be encouraged by the growth in solid margins of our AARP business. On the direct side, new business increased by 4%. In other agency, written premium was down 9% versus second quarter 2014. We're aligning ourselves with highly partnered agents who seek to deliver competitive, yet value-based products and services to their customers. As we move in this direction, there'll be some agents and customers that do not match our profile and may seek other options.
Shifting over to Group Benefits, core earnings in the second quarter was $56 million, up 8% over prior year, achieving a core earnings margin of 6.3%. The increase is primarily attributable to top-line growth and a lower expense ratio compared to prior year. Earned premiums, excluding association financial institutions, was up 5% in the quarter, driven by growth in our employer group life and disability lines. For the quarter, fully insured ongoing sales was $58 million, up $13 million from prior year, as we continue to have success marketing our differentiated service offering. In addition, our employer group business continues to maintain strong book persistency around 90% on an annualized basis. The overall loss ratio was essentially flat to prior year. Improvement in the group disability loss ratio was largely offset by less favorable mortality in group life, which looks to be a function of normal volatility in the line.
This was another excellent quarter for Group Benefits. Markets remain competitive, and we're performing well in all aspects of our business. We are well-positioned with strong book persistency and improved capabilities, allowing us to compete for new accounts. We're executing on plan initiatives for our voluntary platform, further enhancing our value proposition. With that, let me conclude my comments by reiterating that we had a strong second quarter. We enjoyed favorable results from catastrophe and non-catastrophe property losses, the performance of other lines of business remained strong. Across our Property and Casualty and Group Benefits businesses, we have strengthened our products, technology, and talent. Over the last six months, we've attracted a number of experienced industry leaders to our team who will help drive our near-term execution and our long-term strategic objectives.
We are confident that the business platform we've been building in recent years will serve us well as we balance growth and profitability for the long term. Let me now turn the call over to Beth.
Thank you, Doug. I'm going to briefly cover results for the other segments and investments and will then review our updated capital management plan. In addition to Commercial Lines and Personal Lines, P&C includes the P&C Other Operations segment, which has a block of runoff liabilities, including asbestos and environmental. Core losses in this segment were $113 million in the quarter, down from losses of $146 million in the second quarter of 2014 due to lower reserve strengthening on our A&E reserves. As many of you know, we complete the annual ground-up A&E reserve study in the second quarter. As a result of this year's study, on a pre-tax basis, we strengthened our net reserves by $146 million for asbestos and by $52 million for environmental, or a total of $198 million.
This is down from 2014, when we had net reserve strengthening of $239 million, comprised of $212 million for asbestos and $27 million for environmental. The asbestos reserve strengthening reflects lower than projected improvement in new mesothelioma claims for a handful of our peripheral accounts, less than 20 out of more than 1,100. The remainder of the accounts are trending in line with the assumptions used to set our reserves. The environmental reserve strengthening was driven by higher new claim severity, including at a handful of Superfund sites, but frequency has declined. We are often asked why we haven't done an A&E reinsurance deal.
We evaluate options for A&E periodically, to date, these deals have not been cost-effective, taking into account many factors, including the value we add by continuing to manage these claims ourselves, the price charged by potential reinsurers, the lack of a full assumption reinsurance or sale option, and the potential loss of investment income. Last year, investment income in the P&C other segment totaled $129 million before tax. Notwithstanding another year of adverse development on the A&E book, we believe that we can create a better outcome for shareholders if we continue to manage this book ourselves. We will, of course, continue to consider alternatives for these exposures as options and costs could change. Turning to the financial results of our other segments.
Mutual Funds core earnings rose 5% in the second quarter, primarily due to higher fee income on increased average assets under management, excluding Talcott variable annuity funds. As expected, Talcott-related AUM continued to run off, which reduced the segment's total AUM over the past year. Fund performance remained solid this quarter, with 69% of funds outperforming peers over the last five years, helping to improve net flows to a positive $250 million in the quarter. For the first half of 2015, net positive flows totaled $779 million, the strongest net flow performance since 2010. Talcott posted very strong core earnings of $171 million this quarter, well above our expectations because of a $48 million federal tax benefit and higher investment income, largely from very good returns on limited partnerships.
Driven by private equity and real estate funds, limited partnership returns have been very strong this year, running at more than double the rate we used in our February outlook. Talcott's annuity contract counts continue to decline. Our ISV program added slightly to the fixed annuity runoff, while variable annuity runoff was a more normal level since we did not have a surrender-focused contract holder initiative this quarter. We continue to evaluate contract holder initiatives and other programs that can help accelerate the decline in these books of business. In July, Talcott paid the second $500 million dividend of the year, bringing the total to $1 billion. We expect another $500 million in early 2016. Corporate segment second quarter 2015 core losses declined compared with the prior year and with the first quarter, largely due to lower interest expense as a result of debt repayments.
We expect interest expense to decrease in the second half due to the second quarter bond call and the fourth quarter $167 million debt maturity. For the full year, interest expense, excluding the impact of any debt tenders or repurchases, is expected to be about $357 million, down 5% from 2014. Turning to investments, the credit performance of our portfolio remains strong, with a modest $11 million of impairments during the quarter. Our annualized portfolio yield, excluding limited partnerships, was 4.1% and continues to hold up reasonably well despite the headwind from low interest rates. New money yields remain low, although within the range we expected for the year, which will continue to put downward pressure on investment income and yields as higher-yielding investments mature and are reinvested at lower returns.
Helping offset this somewhat, similar to the first quarter, we had higher levels of income from fixed income make-whole premiums and other non-routine items, and also from limited partnerships whose annualized yield was about 13% in the quarter. To wrap up on our results, we had a strong quarter with consolidated core earnings per diluted share up significantly and a 12-month rolling core earnings ROE of 9.6%, both reflecting lower CATs, strong limited partnership income, a few favorable tax and other items, partially offset by unfavorable prior development. Excluding net unfavorable items from both periods, core earnings per diluted share was up 66% over second quarter 2014. In addition, book value per diluted share, excluding AOCI, also rose, up 4% from year-end 2014 and 8% from June 30th, 2014, reflecting net growth in shareholders' equity, excluding AOCI, and the accretive impact of the equity repurchase program.
Outstanding and diluted shares have decreased by 9% since June 30th, 2014, as a result of the equity repurchase program. Before turning to Q&A, I'd like to wrap up by reviewing our capital management plan. As announced last night, the equity repurchase authorization was increased by $1.6 billion and extended through year-end 2016. This provides us with slightly more than $2 billion of equity repurchase authorization for the balance of 2015 and 2016. We currently expect to use this amount ratably over the period subject to market conditions and other factors. Yesterday's increase brings the total equity repurchase authorization to nearly $4.4 billion for 2014 through 2016. Debt reduction remains part of our capital management plan as we strive to reduce our rating agency adjusted debt to total capital ratio to the low twenties over time.
Yesterday, we announced that we intend to repay the 2016 debt maturity of $275 million. As previously stated, we intend to repay the $167 million issue that matures in November of this year. In addition, we have $180 million remaining under the current debt management plan, which was extended through December 31st, 2016. When and how we will utilize that portion will depend on various factors, including market conditions. The increase in the capital management plan will be funded by current holding company funds as well as future dividends from the operating subsidiaries and other sources. During July, we received about $900 million in dividends to the holding company, including $500 million funded by Talcott. For the remainder of the year, we expect approximately $300 million in dividends from subsidiaries for a total of about $1.9 billion for the year, unchanged from our February projections.
In 2016, our current outlook is for about $1.9 billion of subsidiary dividends and other cash flows to the holding company, including $800 million in dividends from the P&C companies. Recognizing the strong improvement in our P&C Group Benefits and Mutual Funds earnings, the board authorized a 17% increase in the quarterly common dividend to $0.21 a share, effective with the October dividend payment. Including the impact of share repurchases, we expect to pay dividends of about $330 million over the next 12 months or about 30% of trailing 12 months consolidated net income excluding Talcott. Combined with our equity repurchase plan, we are clearly delivering a substantial amount of excess capital back to shareholders.
As Chris discussed, with our strategic and financial transformation largely complete, our priority for excess capital utilization going forward is to find opportunities to invest in our businesses, helping to drive premium and earnings growth and expand our capabilities. We will continue to evaluate capital management options as it remains a good tool that we can use to return excess capital to shareholders in the event that we do not find opportunities that meet our overall objectives. I will now turn the call over to Sabra so we can begin the Q&A session.
Thank you, Beth. Before beginning the Q&A session, I would like to remind you all that consistent with past practice and company policy, we do not comment on market rumors or speculation. We appreciate your keeping that in mind so the Q&A session can be productive for everyone on the call. Chris, could you please repeat the Q&A instructions?
I certainly can. At this time, I'll just remind everyone, in order to ask a question, please press star then one on your telephone keypad. Our first question is from Michael Nannizzi with Goldman Sachs. Your line is open.
Thank you. Beth, just wanted to circle back, just a comment that you made there. For 2016, you said the current outlook is $1.9 billion in dividends, including $800 million from the sub. Am I missing something? Where is the other $1.1 billion coming from?
Sure, Mike. As you recall, I mentioned that we do anticipate getting $500 million of dividends from Talcott in early 2016.
Yep.
That would be included. We also expect dividends from Group Benefits and Mutual Funds. Similar to this past year, we would expect to have favorable tax receipts at the holding company as well, and all of that comprises the $1.9 that I mentioned.
Got it. Great. Thanks for that. Then maybe for Doug, is it possible to break out the margin improvement that we saw in both Small Commercial and Middle Market that came from either the favorable non-CAT weather or underlying margin improvement related to comp?
Mike, let me try to give you a little bit of color. You're right. It was a very good property quarter and workers' comp improvement too. It was about four points in Middle Market and a little bit less than that in Small Commercial. Just in terms of the margin improvement in that line of business.
Okay. Those points you mentioned are related to the property and the remainder would then be related to workers' comp.
Those are the two line drivers. Yes.
Okay. In homeowners, would it be possible to quantify or just give us some marker around the impact of the favorable fire losses on the underlying?
I could do that. You obviously get the cat numbers and you can see the cats are down Q to Q-
seven points from last year. The fire losses, as I mentioned, were down at the lowest level in the last five years. I think we're about five to seven points less than the higher years during that five-year period. I would use as a gauge inside our non-CAT property element.
Okay. Got it. Great. Last question, I guess. On the other agency business, obviously premiums there have declined. I'm guessing that's because of maybe not acceptable levels of profitability. Can you talk a little bit about what's happening there in terms of your profitability, and what actions you're taking, and it seems like the prudent thing to do, but just to get an idea of where that is relative to your AARP business, for example.
Sure.
Thanks.
Mike, a few things. One is, we're working all angles with this. We're working on tuning our Open Road product, which is our new auto class plan. Those tuning requirements continue throughout the country. We are investing and working hard on our homeowners product, probably a little bit more going forward than over the last three to four years. We think homeowners is an important line relative to our Personal Lines strategy. A lot of work going on in homeowners. Clearly challenged in the agency space, thinking about how we compete and looking for partners that are willing to work with us, work on a value prop play. We've been tuning that segment and we'll continue to tune.
We do feel good about progress, very pleased with our overall return efforts, also want to see if we can get the top line moving a little bit more positive direction.
Great. Thanks so much.
Thank you.
The next question is from John Nadel with Piper Jaffray. Your line is open.
Hi. Good morning, everybody. Doug, maybe just a quick follow-up. I understand the following up on Mike's question about the favorable weather and the impact that that had. Can you just sort of characterize that for the Commercial Lines segment overall as well as for the Personal Lines segment overall? Significant accident year loss ratio improvement, but I'm just wondering what you think the actual underlying sustainable level of improvement really is, recognizing each quarter can be somewhat volatile.
Yeah. John, the underlying and small, again, really across all our Commercial businesses on property, was probably several points less than sustainable. That doesn't mean that we haven't seen improvement, but I would say two to three points. When I look at our Spectrum product in Small Commercial, a couple of points under where we've been last second quarters of prior years. Really, the key property business has performed pretty consistently the last couple of years, so at consistent levels, but at solid levels. I like our loss performance. I think both Underlying and CAT really were in very good shape, but probably a couple points better than a run rate perspective.
Got it. Okay. That's really helpful. Thanks. Maybe a question for you, Chris. I appreciate certainly the improvement that we've seen in the underlying fundamentals, the improvement in the balance sheet, et cetera, and the commentary about seeking opportunities to accelerate growth. I'm curious because it still appears that there's a reasonable amount of financial flexibility and conservatism in your updated capital outlook. The question for you is this, do you think really buybacks versus potential acquisitions to accelerate growth have to be a mutually exclusive concept? Or do you believe you have the capacity to pursue both?
John, thanks for the question. I wouldn't exclude one or the other at this point. I think you've seen our history and track record, particularly working to improve our financial position and de-lever the firm, and obviously reward shareholders with accretive capital management. The way we think about it is, we announced a plan through 2016. That's our intention. That's our highest and best use of excess capital. I think what we were trying to signal is a little bit of an inflection point because we feel we're in a different place. We're in a different company today, and we can be a little bit more offensive-minded about opportunities in the marketplace.
Totally appreciate that. I guess just a quick follow-up along those lines, Chris. Any specific areas within P&C or even on the group insurance side that you feel like are areas where you want to expand, where you want to be able to find that faster pace of growth where you maybe lack some scale today?
Yeah, John, I think we think about opportunities across all our businesses. You mentioned a couple, but in Commercial, you really think about two main themes. If you've heard Doug and I and Beth continually talking about adding product and underwriting capabilities to the platform, being a deeper and broader risk player. That's really what we mean in growing our future capabilities in industry verticals. We think of a specialty in that area. We think in terms of larger parts of the U.S. economy, maybe we haven't participated as deeply as I think we can or should.
Okay.
You referenced and you heard Doug talk about marine, construction, real estate, infrastructure related. Those are the types of things we talk about as far as the real economy and expanding, along with our geographic penetration and focus. Anything along those lines in Commercial would be very intriguing to us. You mentioned Group Benefits. If I really look at our platform, I'd say we gear it more towards a national, a large account platform, a very balanced LTD, STD, and life business, about 50% of premiums in each of those categories. If there were opportunities in the small and medium case segments, and folks that potentially could accelerate the pace of our voluntary sales growth, those are the things we would think about there.
Okay.
Lastly, in Personal Lines, look, we don't aspire to be a broad market player, but we think we have unique skills and capabilities in direct marketing in sort of those niche areas. We think in those terms, John, if there are opportunities to use our brand and direct marketing skills and our wonderful claim skills. That's just to give you a little bit more of a flavor.
No, I really appreciate the color. Thanks very much, Chris.
Yeah, John, just last point there.
Yeah.
I think in all this, and hopefully you of all people know and others, is that we continue to be very thoughtful, I would say disciplined and deliberate in this area, just knowing where we're coming from and how we want to use shareholders' capital in the most prudent fashion going forward. We did signal a change this quarter.
Yeah. No question, Chris. I have a lot of confidence. Thank you.
The next question is from Meyer Shields with KBW. Your line is open.
Thanks. Good morning. Two quick questions, I think for Doug. One, within the overall 3% Standard Commercial rate increases, is there a difference between the property and liability lines?
Meyer, all the lines do have their own nuances to them. As I mentioned, auto is right now achieving more rate across Commercial than the other lines. It is the lead line. Workers' compensation has been a bit more under pressure over the last couple of quarters, and even between small and middle, there are nuances. Yes, very different dynamics across the lines. In general, pleased. We still see rational competition, maybe a bit more pressure, I am very pleased about what we put up this second quarter and feel good about our efforts first half of the year.
Okay. Could you talk a little bit about the adverse development in Commercial besides the asbestos environmental, in terms of what was going on there?
I will take that. This is Beth. We had very modest adverse development, excluding A&E. We had some favorable development in our workers' comp lines, which is offset a little bit by unfavorable development as it relates to the discount on workers' comp reserve, which reflects the fact that as we have been settling claims at a faster pace, the amount of actual discount that you have in the reserve changes. The other aspects were really just small puts and takes across the various lines, really nothing that is worthy of calling out.
Okay, perfect. Thanks so much.
The next question is from Brian Meredith with UBS. Your line is open.
Yeah. Good morning, Chris. I'm just wondering, could you talk a little more about when you're evaluating acquisitions, kind of the financial benchmarks that you're going to be looking at, be it IRRs that you need, return on invested capital, how it relates to share buyback, those types of things, tangible book value dilution?
Brian, happy to. I think a couple points. One, first, any acquisition opportunity first needs to be strategic and financially compelling to make sense. I think second, we also think about it when we talk internally of the comparison to building organically, because largely what we have been doing is an organic focus. An acquisition needs to be weighed generally in terms with an organic build. Those organic builds require investment, requires timelines, obviously patience, because it won't happen overnight. You sort of weigh all that to sort of see would an acquisition opportunity really accelerate our growth and make sense. I think also too, really since our transformation, we've really driven down our cost of equity capital, reduced our leverage, improved our valuation. I think today we have greater flexibility to think about acquisitions.
Ultimately, we view it as a ROI or IRR type of analysis, where it needs to add value over a longer period of time and exceed our cost of equity capital today or else we won't do it. I think from there, then, the historical metrics of EPS and book value per share will emerge in the accounting records that I think then will create value over a longer period of time for shareholders. As I said to John, we continue to be very thoughtful, disciplined, and deliberate in this area. That's how we're thinking.
Do you relate at all to kind of share buyback, your thoughts on return, share buyback versus M&A, organic growth?
Yeah. It's part of the overall equation, again, from a strategic side, when we're trying to grow our capabilities and grow our earnings, that also needs to be weighed in because in and by itself, share buybacks don't increase the nominal dollars of earnings going forward. We do weigh that all very carefully, Brian.
Great. Thanks. Then just one quick follow-up here for Doug. The investment spend that you've been doing the last couple of years, the claims system build out, those types of things, where do we stand in that kind of process as far as new expenses and how much longer do you think it's going to be a drag on the expense ratio?
Brian, when I think about our invest, I think about it over a longer period of time, so I don't think about it in spurts of quarters. This is a long-term process. I know we shared quite a bit of that progress in Charlotte with the investor day in June. We've got some of those invests going on in middle. Yes, a little bit of pressure on the expense ratio, but I look back at where we are in kind of our quarterly expense and our annual expense targets. I think about what's happening through the bottom line in our margins. I'm comfortable with those invests and actually see them over a longer period of time than I do over just 2015 or 2016.
Great. Thank you.
Brian, it's Chris. I think just another thing you need to think in terms of is, I'm not sure where the industry stands in totality. All I could speak from is our company, but we really do need to modernize our tools, capabilities, infrastructure, digital content. As Doug said, this isn't a simple one and done over the next 12 to 18 months here. This is a commitment to fundamentally improve our customer facing
Exchanges, interfaces for the long term. We're going to be disciplined about expense management, on the invest side, we're over-indexing to really improve our capabilities in this area. I think we are balancing the best way we can in this dynamic, make no mistake about it, we're committed to fundamentally improving our infrastructure and capabilities to improve our customer experiences.
Great. Thank you.
The next question is from Erik Bass with Citigroup. Your line is open.
Hi, thank you. In Group Benefits, you continue to have nice growth momentum. I was just hoping you could talk a little bit more about the competitive dynamics in the market, and how much of your growth is coming from new products in your expanded voluntary product set.
Erik, hi, this is Doug. Couple of thoughts about it. Really, we had a terrific start to 2015, so we're encouraged about that progress and really feel like we have priced our way through the challenges of two and three years ago. That is in the rearview mirror. As I look ahead, there are strong competitors around us, but I feel good about our ability to earn our way into the finals, and we've won our share. Inside our new sales, there's a positive story both on new customer, but there also is a positive story on growing inside our current customers with at-issue sales, in addition to where we were last year with that current customer. That's point number 2.
Lastly, voluntary has been an important part of our strategic grow these last couple of years, particularly just getting the product ready to meet the street. I think we feel good that we were able to work those 1/1/2015 and now into 2015 accounts with our abilities in the voluntary area. It is slow. It's probably a little slower than Chris and I thought it might be. As we finish the year, our sales probably in the voluntary area will be just in the gap product area, probably under $10 million for the year. What's important is that we're able to be at the table with customers that demand that as part of their suite, and I think we're there today, and a couple of years ago, I was not able to say that.
Thank you. Just a quick one for Beth. You'd mentioned that you still expect to pay a $500 million dividend from Talcott in early 2016, which I believe in the past you've said doesn't include 2015 statutory earnings. Given the pretty strong results you've seen in Talcott so far in 2015, is there a potential to take either an upsized dividend or an additional dividend from Talcott in 2016?
Yes, that is correct. I have only included the $500 million that we've previously talked about. As it relates to 2015, I think what we've always said is we want to see how 2015 year actually ends. Through six months in June, Talcott statutory surplus is actually relatively flat once you adjust for the dividends. What we really need to see is where we end the year. Right now, we would anticipate that we would generate statutory surplus still in that $200 million-$300 million range, but as we said previously, kind of at the lower end of that range. It really is going to be a function of just where interest rates land at the end of the year, and how that potentially impacts reserves that we have to set.
Until we end the year, we'll evaluate where the statutory surplus is, and there could then be potential, but we're not putting that into our projections at this point.
Got it. Thank you.
The next question is from Tom Gallagher with Credit Suisse. Your line is open.
Good morning. Chris, just to start out, I just want to get a sense for the way you're thinking about potential M&A. Would you contemplate transformative M&A, or are we talking about more modest opportunities as ways of deploying excess capital?
Tom, thanks. I would say, I think our current thinking right now is more modest, adding to capabilities and product lines. I made a point to be clear. We're a U.S.-focused company and organization right now, so I assume if you were talking about transformative, you were thinking maybe beyond our borders. Our intent is, I think we have opportunities to capture more market share with expanded products and capabilities in our U.S. territories, but also be sensitive to maybe following U.S. customers abroad with some of their skills. We don't think about building international local market expansion currently.
Okay. That's helpful. I just want to be clear here that the current buyback authorization, is that going to be competing with M&A when you contemplate what you've announced so far? In other words, if you found attractive deals that could consume some of the buyback, or do you have additional resources or excess capital that's actually slotted for M&A?
Tom, it's a balancing act. I wouldn't say it's competing. That's our plan, that's our intention. That's what we think is the highest and best use, and if there's alternatives that come along, we'll put that as far as the overall equation. I think you know, myself and Beth, we are appropriately prudent in managing the balance sheet and always have flexibility in mind.
Okay. I guess either Chris or Beth, just to be clear, though, your current capital plan doesn't necessarily allocate some additional capital buffer for M&A or can you comment on that at all, whether there's something in the plan through 2016 that is allocating something that you're now holding onto for M&A or anyway, can you comment on that?
Tom, Beth can add her point of view. How we think about it, and maybe others have talked about it too, is we said the deal needs to be strategic and make financial sense. If we find something that from an acquisition side, hits those hurdles and makes our ROIs work, we'll figure out how to finance it. That's why I said earlier, we've reduced our leverage, and we'll continue to reduce it. We do have flexibility to figure out how we would, I'll call it fund or finance a deal if we found the right one. That's all I would say at this point.
Okay, thanks.
The next question is from Randy Binner with FBR Capital Markets. Your line is open.
Thanks. You all discussed the A&E resolution market a little bit in your comments. Do you have any update on the annuity risk transfer market? From our perspective, it seems active, and so would be interested in any update you have on that market or should we think of Talcott as continuing to be internally managed resolution?
Randy, it's Chris. Beth can add her point of view also, but I think right now we're very pleased sort of with the runoff in total of Talcott, particularly the capital that we've been taking out. Remind you, we've taken $1 billion out this year, and we plan, as Beth said, to take $500 million out in early 2016. We understand the risk. It's well managed. It's well contained from our perspective. As Beth might comment upon, we do really believe in this low interest rate environment that does depress valuation. These are all the things that we consider in sort of a transact versus a continued runoff mode. Beth, what would you add?
Yeah, I think Chris, as always, I think you've captured it very well.
Got it.
I think that it's very consistent with what we've talked about in the past, we are always open to the consideration of transactions, at the end of the day, needs to make economic sense for us and where we sit today with the capital that we're able to extract. As Chris says, to manage the risk in that book, we feel very comfortable. Of course, we'll always be open to other considerations as markets change.
Great. The follow-up there is just on the withdrawals, which in the kind of the 12%, 11% year-over-year basis is good. I think that's kind of as some of your programs that increase surrenders are winding down. Do you have any plans to kind of continue to push new programs there to continue to accelerate the wind down of those liabilities?
Yes. As we've said in the past, we'll always consider other policyholder-type initiatives that could further reduce the exposure in that book of business. We've been very pleased with those that we've had in the past. As I've said, pretty consistently is our thought process is to really be very targeted as we look at those initiatives. While we don't have one right now in place, there is a team that consistently evaluates those to see if there's something that could be done. Overall, when we look at the continued reduction in the contract count, we feel very good with the activity that we're seeing.
Those have been well received, those plans by agents, clients. There's been no real pushback. Is that right?
Yeah. I think the results speak for themselves and what we've been able to achieve with those programs. We've always said they're not right for everyone, and that's why policyholders have a choice. As we said, we've been pleased with the results that we've been able to achieve on both the programs we've had in the variable annuity and the fixed annuity space.
All right, great. Thanks so much.
The next question is from Scott Frost with Bank of America Merrill Lynch. Your line is open.
Okay, thank you. From the debt side, appreciate the clarity in communicating your debt management goals. Thank you for that. I wanted to talk briefly about your junior sub issues, as you may have expected. It's topical in our world. First, with respect to the eight and eights and then to the Glen Meadow. How would you characterize the efficiency of each of these instruments in your capital stack? I have a brief follow-up.
Okay. Thanks for the question. Again, as we've been talking about in the past, we are focused on reducing our overall rating agency adjusted debt to capitalization ratios, also focused on things like coverage rates and so forth. We really look at our capital, our debt structure sort of across the spectrum. Today, as we sit here, I think that the eight and eights do provide us benefit in that we do get equity credit as we look at managing that ratio. Over time, we'll continue to evaluate the debt stack, keeping all those factors in mind, but no change in our views as to how we think about those.
Okay. Just specifically for the Glen Meadow, is it your understanding that this issue will continue to receive favorable capital treatment from NRSROs at the float date in 2017?
Yes. We do not expect any change in how we view how those would be considered.
Thank you very much.
The next question is from Jimmy Bhullar with J.P. Morgan. Your line is open.
Thanks. Hi, good morning. Most of my questions were answered, but I had one for Doug. Overall, I thought P&C results were pretty strong, but you did have weak premium growth in the non-AARP Agency channel. Just wondering what's driving that and what are you doing to turn that around, what your expectations are for that business, for that channel?
That part of the challenge in our Personal Lines area is not new to the quarter. We have had pressure in there. We see lots of competition. There are lots of names that continue to compete in that space. I'm very encouraged. I like where our team is headed. We've made a couple of very important additions in the last 90 days, so I feel good about that. I think, Jimmy, we'll be talking more about strategy as we move through the next couple of quarters, particularly in that Personal Lines area.
The next question is from Bob Glasspiegel with Janney. Your line is open.
Good morning, Hartford. It seems like there's a lot of deals going on right now in the marketplace, I've never seen the Property and Casualty world undergo more changes than we're seeing today. The glass half full is just going to create opportunities as there's disruption in competitors. The glass half empty perspective would be maybe you need to rethink where you are as far as scale, tax structure, technology, efficiency, et cetera. Where do you see Hartford in this world? I'm sure you're going to take the glass half full preference, but maybe respond to the negative issues that some might suggest are popping up.
Bob, it's Chris. I think you outline some good points. We think about it, generally as we are entering a very dynamic cycle, and that every company, including our own, needs to think about competitive advantages because there's really a couple drivers that we see. One, not all the industry participants have really enjoyed the price increases that we and others have had over the last 3 years and pushed so hard to maintain. Generally, lower economic growth and continued low interest rates really has a compounding effect on companies' balance sheets and ability to invest in new technology and capabilities while producing good financial results. Alternative capital is obviously disrupting some of the reinsurance space, and it's got the potential to creep into other aspects of the market.
Very important I think for all of us is that distribution and our agents and broker partners are really going through their own form of industry consolidations, which ultimately means, in my judgment, that fewer carriers are going to be on panels, and brokers and agents will continue to look for those companies that have the most to offer for their clients. I think the table stakes are higher to meet the requirements of today. Ultimately, as a national company, Bob, with a lot of great strengths, brand, reputation, capabilities, a new energy and vigor around it, I'm very optimistic of our ability to continue to compete and have competitive advantage to drive shareholder value going forward. It's probably not any one of those things.
It's probably all of it that we're trying to, I'll call it manage for outcomes that we think are best for our shareholders and ultimately our employees and customers.
It's a very fair answer. Is the pivot to M&A recognition that scale is going to be increasingly important and you need more volume to do the technology spend that you are signaling is necessary?
Yeah. I would say in and by itself, scale's not a driver. If you really look at our words and really what we've talked about here is adding new capabilities we don't have today or areas of the market, the risk-taking market we'd like to participate more in. I think that is more of an immediate focus. You make a good point. Scale helps out too, obviously, from an expense and efficiency side. If you look at at least one big deal that happened in New Jersey not too long ago, we really think in terms of it will, over a longer period of time, be a very compelling transaction that drives down unit cost, has greater tax efficiency, has a greater capital base to potentially take on risk. Those are all the things that we're very aware of.
We also know what we're focused on, and particularly our segments of the market that we think we have great competitive advantage in.
Fair answers. Thank you.
There are no further questions at this time.
Thanks, Bob. Thank you, Chris. I'd like to thank you all for joining us today and for your interest in The Hartford. I also want to note that Beth Bombara will be attending the KBW Insurance Conference on September 9th, and we hope to see you all there. If you have any follow-up questions, please don't hesitate to contact either Sean or myself today by phone or email. Thank you. So long.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.