The next company is The Hartford. I was watching The Weather Channel this morning. We got some pretty bad weather in the south that's heading this way, but as usual, they send one of the reporters directly into the storm. Sam Champion was out there looking, picking up ice on the ground. He was kind of questioned how insane those people must be. Again, you did have Liam McGee joining The Hartford in the midst of a storm as well. In 2009, he came on as Chairman, President, and CEO, and there's been a dramatic amount of change since then. We've got Liam and Chris Swift, The Hartford's CFO, with us today. I'm going to open it up to Liam to start off with some comments, and then we'll jump into Q&A.
Good morning, everyone. Can you hear me okay?
Now you can.
Jay, thank you for having us. Chris and I are delighted to be with you. We just announced our earnings last week, so I'll just make a few brief high-level remarks, and then Chris and I look forward to taking your and your guests' questions. 2013 culminating in the fourth quarter really was an outstanding year for The Hartford on a number of fronts. I think very specifically, we're proud of the fact that we executed our strategy with great discipline. Our strategy really has three elements to profitably grow the businesses we selected to go forward with. As you saw in the fourth quarter and a continuation through the preceding three quarters, margin expansion, good top-line new business momentum in virtually all of our businesses.
Whether it's the profit margins in Group Benefits or combined margin improvement in our property and casualty businesses, we're very proud of that. Going into 2014, we expect to see that trend continuing. Obviously, the size and risk of the legacy variable annuity portfolios continue to decline. We had 26% fewer policies in Japan at the end of 2013 than we had at the beginning. As you know, we had a 42% annualized lapse rate in the fourth quarter in Japan. As Beth said on our earnings call, in January, policies were down another 3% just in that month. That combination of the moneyness of the book and better-performing market has been very favorable for The Hartford in combination with, I think, the appropriate proactive hedging decisions we made as the yen/dollar, yen/euro, and Nikkei relationships began to become more favorable to us.
U.S. also down 14% year-over-year in policy count. The ESV program has exceeded our expectations. As Beth and Chris said in earnings call, we're now looking at some fixed annuity-type offerings. We use a kind of a working phrase, ISV, for that, as opposed to ESV that we used in the variable annuity front. We worked very hard at making the company work more effectively and efficiently. 90% of that $850 million we said we would reduce, most of which coming from the decision businesses, but some just running the company better in addition to that. 90% of that is out of the company. The rest will come out this year, largely as a function of the TSAs rolling off between ourselves and a couple of the buyers. Good year in capital management.
We returned in 2013 $633 million of capital to shareholders in the form of equity repurchases and repaid on a net basis, reduced, I should say, on a net basis, about $820 million of debt. We thought it was an outstanding year. We're very proud of it. I would say in a kind of a subjective, descriptive sense, 2013 was a milestone for us in the turnaround and transformation of the firm. We gave forward guidance. I'd just say at a high level, when you normalize for more favorable CAT than we had planned for, better returns on our alternative investments and some prior year development our guidance showed us up on a coring basis year-over-year slightly. I think what's significant is that offsets about $165 million less in corings from Talcott. Risk is coming down. With that come lower return earnings, yet earnings.
The go-forward businesses are profitably growing sufficiently to offset that. We think that's a very significant development in our outlook, and investors seem to get that and understand the significance of it. Of course, in 2014, Chris and I thought it was important to demonstrate our financial strength, our flexibility, and our confidence in the firm. We announced our two-year capital management plan, $2 billion in equity repurchases and, of course, a further debt repayment on two maturing debt tranches in 2014 and 2015 to total about $656 million. Capital generation from our go-forward business and our property and casualty business we anticipate to continue to be strong. As you know, as a result of the restructuring of the firm, we can now dividend up to the holding company from Group Benefits, or will be able to shortly, and from our mutual funds as well.
We expect to take capital out of Talcott 2014, beginning with Japan, and then in 2015, both Japan and the U.S. All in all, we thought very eventful, very positive. Chris and I are very proud of the progress the company has made. Last sentiment I leave with you is we have a lot more work to do. We intend to run the company with the same discipline focused on the three strategic elements, run the businesses more profitably, continue to reduce the size and risk of Talcott or legacy VA businesses, and continue to run the company more effectively. With that, Jay, it's great to be here. Chris and I'll be glad to take your questions.
That's great. Just throwing into the last statement about your strategic goals for 2014, some of the things you're focusing on. As far as measuring what you can achieve, let's say we're sitting here a year from now, and we look back on 2014, what are some of the things from a financial standpoint you'd want to point to and say, "Hey, we achieved what we did"?
Well, in our company, Jay, all of our employees are aligned around that strategic goal. I'm very proud to say, there's a lot of companies that have strategic plans about that thick, and usually in two or three months, they got about that much dust on top of them. We have a one-page strategic plan. It's to grow the business more profitably, reduce the size and risk of our legacy VA blocks, and transform the company, make it work more effectively and efficiently. We're going to measure our success on that really in three broad categories. Financial, which is to improve the ROE of the firm, to grow tangible book value. Second is employee engagement. We want to be a top quartile company in terms of employee engagement scores. We have achieved that. We use the largest vendor for our employee surveys, that's used by most of the Fortune 500.
We are benchmark now. We are a top quartile company. We want to delight our customers. We tend to use the Net Promoter Score in our company to track that business by business. That's how we measure our success. If you're looking as an analyst tangibly, and Chris will, I'm sure, want to elaborate on this, we're maniacally focused on actions and running the firm that's going to grow ROE, and that we think conversely will drive our cost of equity down. As I said, drive growth and tangible book value. Chris, I'm sure, has some other perspective on that.
No, I think those are good points to anchor around. On the operational side, I just would give you two, Jay, to think about. We want to try to run the organization with about $200 million less of expenses. We'll make progress on that next year. We're not going to achieve it all in 2014. It's a 2016 goal. I think you could begin to measure our expense ratio. Lastly, maybe more of an intangible, but one that we track internally. Nick, you know we've been working hard to build out product capability, primarily in property and GL. Writing all lines to our client base as opposed to writing just workers' compensation is an important internal metric we're focused on. As Doug goes to market, we're measuring the all line new business production.
What's interesting, Jay, is we do have financial strength. We have capital flexibility. Chris, I thought, did a great job and along with the detail that he presented to investors on a number of fronts around capital and cash flows and the legacy books. We're going to buy back equity. We're going to pay down debt, but we still are going to invest, as a further demonstration of the flexibility we have, about $1 billion plus, $1 billion to $1.2 billion in the next three years in our business. A lot of it will get to what Chris was talking about, which is simplifying how our underwriters go to market, particularly in our commercial business, furthering the broadening of the product portfolio.
A large part of that will make our company. Quite frankly, there hasn't been a lot of investments made in The Hartford over the last 15 to 20 years. This is very exciting for us to invest, create more contemporary platforms, more contemporary work processes, make it easier for us to compete in the marketplace, broaden the product portfolio, as Chris said, and be much more efficient. I think we're getting at the things that you would want us as an investor to use our capital for in an accretive fashion. Investing in the organic growth, the profit growth of the business, I think is particularly accretive, besides the buyback shares.
Because of those investments, should we actually expect to see the expense ratio come down, or will it just stay flat? Which is fine if you're making the investments, but is it too much to expect to see a combined expense ratio coming down at all?
I'll reiterate what Chris said, I'll leave it to the CFO to get into the efficiency ratio. As Chris said, we're going to take the controllable, what we call controllable insurance expenses on a run rate basis down from year-end 2013 to year-end 2016 by $200 million. That will be net, including after in the investment. What that does for the efficiency ratio, Chris, I know you have some perspectives on that.
Yeah. From the pure expense ratio, we measure efficiency from the overall organization perspective across all the go-forward businesses. Jay, from the property and casualty group benefit with growth and lower cost base, I think we are going to lower our expense ratio going forward.
Obviously, some of that will be a function of top-line growth and expenses. As Chris points out, I think he appropriately emphasizes the point that we have a wonderful franchise, a unique national franchise, and certainly in commercial property and casualty and benefits. In a commercial property and casualty space, up until the last couple of years, it had really devolved to be a monoline workers' compensation. Under Doug Elliot's leadership, now we are becoming a more meaningful player in property, liability, and eventually commercial auto. We want to remain a comp player, but a more balanced player. That's a profitable growth strategy, leveraging what we already have that a lot of people would like, which is this great national distribution system with agents and brokers, and without compromising our underwriting or pricing, which we won't do. We think we get them.
It's a function of expense, but as Chris reminds all of our teammates, it's also a function of profitable growth as well on the top line.
I guess speaking of growth, one of the franchises within The Hartford P&C I've always felt is the small commercial business. What are some of the specific steps you're taking there to expand that business?
Well, Jay, 50% of our commercial property, actually written premium, is small commercial. A lot of times people look at us, and I don't think they fully appreciate, yes, this is a more competitive market. No question about that. Half of our written premium is in, what I would say, is the most attractive part of the market. In 30 years in the small commercial business, we've never exceeded 100 combined ratio. The ROEs in that business are very attractive. Ironically, that is the one place that the company, in years past, invested pretty significantly to build a very automated sales and service and origination platform. That's why you're seeing good growth there, good pricing, and outstanding return.
I do think as the broker and agency business is beginning to consolidate, particularly the larger end, that is going to work very much to our advantage strategically because more and more of those companies are not going to want their producers handling the lower average premium business. There's very few companies who are at the top of the list, in my view, that can handle that business on a flow basis efficiently, effectively, and make the distribution partner look very good. I think there's a lot more good stuff to come there. I always emphasize to investors that I think when looking at us versus others, remember that 50% of our commercial written premium is small commercial, 35% is middle market, largely low end of the middle market. I like that position strategically, particularly with what's happening at a macro level in the industry.
I guess those businesses historically have tended to be less cyclical in nature.
Yeah. There's still cyclicality. I'm not being naive about that. I think less so is an accurate way to put it.
One thing that perplexed me a bit about The Hartford is you have developed arguably an excellent direct distribution platform through AARP, a long-standing relationship. The feeling was that that expertise could be expanded with other affinity groups and other direct relationship business. It doesn't seem like it's happening that quickly. Has there been a frustration? What's holding it back? Is there an opportunity to expand that business?
Well, certainly when I took the job four and a half years ago, Jay, you know my background, I have a lot of experience with affinity groups through my association with MBNA who kind of invented that space in financial services. I had the same question. I think it's important to remember a couple of things. There isn't any affinity group even remotely close to the size and loyalty of members of AARP. The Hartford's journey with AARP, which has clearly been a direct strategy, is 28 years. It took a number of years, and the first 8-10 years of that, to break even.
In this business, because of risk selection compared to perhaps the card business or other financial services, you've got to be very careful because you can't set up an affinity group and only be able to have a risk appetite of 20% of the group.
Right.
I think we have done some that were tried at the beginning. I think they were good learnings for us. Some have been more successful than others. You have to be very patient. The break-even period takes a number of years, and I think you have to go into these understanding that you better have clarity about the members and what your likely risk appetite is within that group. I think what's most exciting for us in AARP is it has largely been a direct strategy. When you look at the research, the AARP membership base, 40 million members, more of them, notwithstanding the great success of The Hartford AARP program, which as you know, has another 10 years to run, more of their members want to buy through an agent. We're just tapping that now in the last couple of years.
When you look at the AARP results for us, still good growth in the direct business, but outstanding growth in the AARP product sold through agents. I think we'll continue to evaluate affinity possibilities. I think it's important to remind investors, we and you would have to be patient because those take a while in any industry. The AARP through agency opportunity is a very significant one for us, and we know the membership base, and we know that demographic very well. We have, I think, 8,000 agency locations now signed up to sell the AARP product.
The other benefit that we talk about internally is that was primarily an older age segment for a long time. With Indianapolis leadership, we are starting to write much younger members in AARP. That younger member demographic, we're trying to extend into the 40-plus market as opposed to 55 to 75. I think there's a lot of learnings that we're developing to write a broader base of customers. The investments we're making in digital. I think the digital phase of the AARP relationship, I would say, is really beginning to take hold.
How old do you have to be to become a member of AARP?
50. I know. You want to see my card?
I might be giving you a call in a couple years. Are there any questions from the audience? Do not be shy. Please raise your hand. We'll get a mic to you. At any point, just shoot your hand up and we'll make sure your question is heard. Within property casualty, I guess the challenging piece recently has been the specialty business. How are you feeling about that business in 2014? A year from now, do you think we'll still be talking about that business as being challenged?
Well, if Doug were here, he'd describe the "specialty business" in three elements. One is the national accounts business, a liability product, so larger companies average. That business is doing outstanding. Had another really good quarter. We had some transportation programs in specialty, Jay, which is the second element. We've largely exited that. Did not meet our profitability requirements. As Doug commented, I think pretty directly in his earnings comments a week ago, he believes he's got his arms around that. There were some captive programs, again, where I think the risk versus reward just was not acceptable to us. I think the ones we have now are more acceptable to us than the ones that just didn't meet our criteria for equity.
I think going forward, the tough steps we took, correct steps in the transportation program and the captive will serve us very well, and we're very excited about the national liability business.
I think the other focus too, Doug talks about is we have, I'll call it rewritten our E&O, D&O book. That was geared more towards the financial institution, large bank space. We still are E&O, D&O fans. We like that product line from a specialty side, but it's going to be geared toward more the middle market where we have great distribution, an existing client base to cross-sell into that and grow in a more controlled way.
We've got a question over here. Why don't we get the mic over there?
Just a quick question on, you mentioned one of your goals being tangible book value growth. How is that tied into your compensation or compensation of management? How do you get there given that you've got Talcott, which, while it's running off very quickly, the hedging is sort of eating into your ability to grow tangible book value growth? If you look at your book value over the last two years or so, it's sort of been flattish, and there's a lot of other things that went into that, but some of it is clearly the hedging cost of Talcott.
Well, my performance, Chris's performance is tied as the board evaluates my performance, those same four or three large categories, financial, employee engagement, and customer is the same things they use as it relates to tangible book value. I know Chris will have a lot to say about this as well. You did acknowledge, remember, whether it's writing off the Japan DAC, paying a bit of a premium to de-lever the firm, I think was a very intelligent thing to do, and there have been a few other things. It has driven the book value down, I think now to a more realistic number. We're going to continue to grow that by executing our strategy. It's going to be profitable growth in the businesses. It is going to be a continuation of the runoff of Talcott.
It's going to be managing the expense dynamic of the firm, as we've described. I think we have demonstrated very clearly that we're serious about this. That $850 million, large part of it admittedly went to the buyers, but a significant part of that we took out by doing some rationalization, by eliminating functions that were supporting those businesses that didn't go with the sale. Those things are very much within our control. My personal compensation is aligned with those things. Certainly, the relationship between ROE and book value and all that is going to drive share price. Most of my compensation, I think, is appropriately around that dynamic. Chris, anything you'd want to say?
We commented on the call about our hedging costs for 2014, which are coming down primarily due to market levels and then obviously just given the heavy lapse rate. We estimated about $225 million of hedging losses if the markets follow our sort of 4% growth in the S&P 500, FX stays basically stable, and rates rise modestly. As we see it going forward, the difference between our core and net income will shrink dramatically going forward, just given Talcott's risk profile. We've always said we do believe we could begin to grow book value, as Liam said, now that 2013's behind us, given really the transformation that we went through as an organization and a balance sheet and from a book value per share basis. Those hedging costs are coming down going forward.
Can you just remind me what the hedge cost was for 2013?
I don't have the number handy right now, but it was on a net after-tax basis somewhere in the $700 million-$800 million range for Talcott, and primarily that was our Japan business and our macro protection. The U.S. program is producing very minor losses, just given the liabilities and the assets match up pretty well. The mismatch that we have in our accounting results for Talcott Japan.
Thanks.
I think that's a very important point to watch, is that as the core and net, assuming markets behave, we have not very aggressive upside scenarios in our market and economic assumptions. We do expect net. That will create growth potential.
Any other questions from the audience? We do have one. Great.
On your P&C operation, could you comment on what your ROE targets are as you try to expand the business? At least to the outsiders, it seems like the business is getting tougher, maybe we're a little too myopic on what we're looking at.
Well, I'm going to ask Chris to give you specifics, but again, I'd remind you, when you look at The Hartford's commercial business in particular, which I think is what the question was primarily getting at, yeah, we acknowledge that the market is competitive. Remember about us that half of our written premium is small commercial, where I think if you go back historically and look at returns, they've been very attractive. Had their ebbs and flows like any part of the market. Another 35% is middle market, primarily the low end of the middle market. Yes, I think at the higher end of the market, CAT pricing pressure is impacting the high end. We're not impervious to that.
I'd just remind you, perhaps what investors don't fully appreciate is the composition of our book is probably proportionally different than others that you might consider as a peer. In terms of target ROEs, Chris, any specifics you want to give in both new and existing business?
If you look at 2013, the business that we wrote in 2013, adjusting for CATs that were more favorable than our loads. If you have a normal CAT load, we would say that we're still writing new business in aggregate in the high single digits, maybe low double digits on an overall ROE basis, on an accident year basis.
I just wanted to stick with the P&C side for a second. One thing that has distinguished The Hartford, and unfortunately not in a good way, has been the reserve development. Not that it's adverse, but your competitors, many of them have continued to show very favorable development. Workers' comp was an issue, doesn't seem to be, but other issues seem to be popping up. Are you at a point now where you believe you've gotten that behind you? We should start to see a more attractive development pattern?
I think the succinct answer is yes. I mean, what Chris and I have been working very hard to do is build a strong balance sheet, a lower leverage balance sheet, very good, robust reserves, et cetera. Yeah, I'd say we've managed through things others may or may not have had the specific things. I think we feel really good about where we're at right now from a reserve perspective. I'd remind you, to your point, we have not really driven growth with large prior period releases. It's been fundamental improvement in margins which has driven our improvement, which we think positions us very well. Feel really good about our balance sheet and reserves.
No, I think you said it right. I mean, the area that created a little bit of noise this year was the programs business, primarily auto liability. We believe that's behind us. If you look at comp, we actually have been releasing older accident reserves from older accident years with some minor tweaks to the '10 and '11. The other data point I would give you, Jay, is once we file the 10-K, I think we're one of the few companies that sort of discloses our reserves carried above our actuarial point estimate. Last year, they were 1.8% above our actuarial point estimate. When we file the K this year, you'll see that number at 2.6%.
Any last-minute questions? All right. We're just running up against the end of the time. Great job, guys. Thanks.