We're going to get started. We're pleased to have with us today Liam McGee, Chairman, President, CEO of The Hartford. Liam's been CEO now for just over four years. This marks the second consecutive year that The Hartford and Liam are participating in the conference. Since he spoke last year, shares of The Hartford are up over 70%, outpacing most of the life and property casualty insurance companies. Liam has been influential in changing the risk management culture of the organization, as well as positioning the company to grow profitably in its P&C group and mutual fund businesses, where it has market-leading positions. With that, I'm happy to turn things over to Liam.
Thanks. Good morning. Chris, thank you very much. That was music to my ears, that stock price performance, so I appreciate that. As you said, Chris Swift, Chief Financial Officer, myself, and Sabra Purtill, who runs investor relations, and I are delighted to be back for our second consecutive year. Let me do the required please note that as indicated on the slide, today's presentation contains statements that should be considered forward-looking under the Private Securities Litigation Reform Act of 1995. I'm going to spend my time today discussing the significant accomplishments in The Hartford's transformation, as well as our optimism and confidence heading into 2014. I think by any measure, 2013 has been an important year for our company.
By early January, we had closed the sales of Woodbury Financial individual life and retirement plans, as you know, generating a statutory capital benefit of more than $2 billion. I want to point out importantly, that by the end of the year, we will have eliminated virtually all of the expenses associated with those businesses. We've made significant progress this year in reducing the size and the risk of the variable annuity blocks. We expanded the Japan VA hedging program, which contributed to our April announcement that Talcott Resolution is capital self-sufficient. The Japan variable annuity risk is very manageable for The Hartford. Favorable global equity and currency markets, coupled with the aging of the book and our policyholder education efforts, have driven a significant increase in contract surrenders. Year-to-date through November, Japan VA contracts in force have declined 22%.
For the first two months of this or the fourth quarter, surrenders remain elevated at an annualized rate of 37%. At the same time, we continue to evaluate other opportunities to reduce the size and risk of the block. As we said during our October earnings call, there is growing interest for runoff blocks of annuity liabilities, and we will evaluate transactions that permanently transfer these risks, considering the price and the amount of capital that would be released as compared to the underlying value of the business. In the U.S., we've also meaningfully reduced the size and risk of the VA block. The number of contracts has decreased by 13% year-to-date. This decline was driven in part by our successful ESV program, where the cumulative acceptance rate has risen to 38%.
With the ESV program nearly complete, the U.S. full surrender rate for the first two months of this quarter or the fourth quarter declined about 4 points to 16%. This is still meaningfully higher than the pre-2013 surrender levels, we expect to introduce additional customer initiatives similar to ESV in 2014. Finally, we've received regulatory approval for the sale of our U.K. VA business to Berkshire Hathaway, we expect this transaction to close later this week. With the business sales, the focus on our ongoing businesses, and our success in reducing Talcott's risk profile, we announced a significant capital management plan earlier this year, increasing the dividend by 50%, reducing debt by nearly $1 billion, and a $1.25 billion share repurchase plan. Our businesses, property and casualty, Group Benefits, and Hartford Funds, are delivering substantially improved results.
We expect full-year 2013 core earnings for these businesses to grow almost 40% from the prior year, with significant improvement in margins due to pricing and underwriting actions. We expect the business' profitability will continue to further improve and deliver increased shareholder value in 2014 and beyond. With core earnings from the businesses and expense reductions offsetting the approximate 20% decline in Talcott earnings in 2014. We are investing in and managing these businesses to drive growth, improve margins, and generate higher returns. We will invest about $1 billion through 2016 in areas such as technology, product, distribution, and claims to continue to be a preferred provider for agents and brokers, which is critical in this environment considering the continued consolidation in those channels. Our Commercial Markets business has had a great year.
In small commercial, ex-CAT current accident year margins improved 2.5 points year to date through September. To support continued profitability and growth in our small commercial sector, we invested in a best-in-class new business platform called ICON. We released the 2nd product on this platform, the Spectrum Business Owner's Policy, earlier this year. Quotes quickly jumped by 10%, in the third quarter, new business for the line grew more than 8%. With ICON, more than 50% of new business is bindable to the customer immediately, and time to quote a policy is down from 15 to 5 minutes, which is very important to our agency CSR partners and their productivity. This system gives us greater underwriting control, deeper analytical tools, and lower underwriting costs. We believe ICON is the market leader.
In middle market, we've earned strong renewal written price increases and a 3.8-point improvement in the combined ratio ex-CAT, ex-prior year. Importantly, we're making progress in diversifying our product portfolio, which is key to profitable growth and building our position as an important partner to agents and brokers. For example, new business in the third quarter of 2013 in middle market was up nearly 25%, with workers' compensation accounting for 32% of the mix as compared to more than 50% 2 years ago. To do so, we're investing in experienced property, liability, and commercial auto underwriters. We have a revamped middle market training program and a new account review process. Group Benefits has had a meaningful turnaround in profitability this year, largely driven by pricing discipline and improved disability loss ratios.
Core earnings margin through the first three quarters was 3.7%, up 1.7 points over the same period in 2012. This is very good progress toward our objective of core earnings margin in this business greater than 5%. Our new business pipeline in Group Benefits is building, particularly with middle market companies. New sales in the third quarter were up 15%, with good underwriting quality and expected profitability. We are in the process of currently aggressively working January renewals and are optimistic about retention rates. We continue to see evidence of a positive pricing environment in the long-term disability marketplace, which together with improving loss trends, are promising signs for continued earnings improvement in this business.
As you might imagine, we're also investing in our voluntary benefits capabilities, including new products and a simplified employee enrollment tool that will enable us to compete more effectively as more companies require employees to pay for coverage. In Consumer Markets, we continue to focus on margin expansion while improving growth. Through September, Consumer achieved an 18% increase in underwriting gains, excluding CATs and prior year development, as well as written premium growth of 2.3%. Our nearly 30-year partnership with AARP is the core of this business. We expect, as we've done for that 30-year period, to continue to produce strong results in the direct channel. In addition, with more than 7,000 independent agents now authorized, the AARP agency channel has significant momentum and growth potential, with new business growth of 40% so far this year.
Finally, we're also investing in a new P&C claims management system to improve customer satisfaction, drive new efficiencies, and increase our analytics capabilities. We'll roll this system out in mid-2014. In our final business in Hartford Funds, our goal is to grow AUM in the retail and defined contributions businesses through product performance, increased sales, positive net flows, and expense management. Fund performance remains strong. Over the last year, 60% of our funds beat their Morningstar peers, which has helped drive sales growth of 34% through September. I'm pleased to report that positive sales trends are continuing into the fourth quarter. Before we turn to questions, which Chris and I will be delighted to take, let me update our fourth quarter and full year 2013 outlook.
Including the combination of the CATs from the Midwest tornadoes and recent ice storms, we expect fourth quarter 2013 results to be at the low end of our $0.87-$0.92 per diluted share range. Including this outlook, we expect full year 2013 core earnings to be approximately $1.7 billion, well above our outlook at the beginning of the year. We'll provide detailed 2014 guidance in February, as I said, we expect core earnings growth in P&C, Group Benefits, and Hartford Funds to offset the expected decline in Talcott's earnings. We are optimistic about capital generation in 2014 and beyond. In February, we will also provide our update for capital management for both 2014 and 2015, including capital return from Talcott. 2013 is a year of strong execution for The Hartford. We're delivering earnings growth and investing in our businesses while successfully reducing our risk profile.
We are well-positioned to generate profitable growth and superior shareholder value over the next few years. Thanks again for having me, Chris and I are now delighted to take your questions.
Thanks, Liam. Any questions, feel free to raise your hands. We'll get a mic to you. Maybe I'll just kick things off. Thanks. Some real good updates and insights into the past couple of months. At the end there, you talked about creating value over the next several years, and I think a lot of the conversations we had, there's certainly a big focus on Talcott. Can you talk a little bit more about the next few years, right? This transformation that you're taking, we think of a lot of self-help attributes to the story in terms of improving the underlying profitability. Can you point us to where you're steering this thing over the next several years?
Well, I think, Chris, first of all, we will continue to improve the performance of the businesses that we are now focused on, our property and casualty business, our Group Benefits business, and Hartford Funds business. I think you've seen that in the last couple of quarters. I'm confident you'll see it as we report the fourth quarter. Certainly, margins and profitability, we've been very disciplined in our focus on that, around combined ratio, around pricing, and certainly around underwriting. That's why we're investing in the businesses so that we can continue that performance. I think for investors, that's a very promising opportunity with The Hartford. Certainly, the capital that we have backing the Talcott liabilities, we're increasingly confident, as I think you could tell from my remarks, about our ability to get that capital out.
The Japan lapse rates and the reduction in number of policies in both Japan and the VA, I think are very encouraging. We think returning that capital and using it for accretive shareholder actions will be very good. The combination of just growing our businesses, growing the profitability of our businesses. We have good franchises that we've got momentum. I think we've got the right leadership in place, and then getting the capital over the next few years out of Talcott and using it in an accretive fashion, I think is a compelling answer for us. I think also I want to emphasize, we are investing in these businesses to grow them. Chris, anything you'd add?
I think you framed it right. If you look at the business model, we've talked in other settings that we think this is a low vol business. Small commercial, middle market franchises that we have, combined with the Group Benefits margins, which are stable and predictable, should result in, I think, a superior valuation over the long term, Chris.
Maybe when you think about the core P&C businesses. You're maybe in different places with some of them when you just look at the underlying combined ratios. The balance of trying to grow in certain lines, well, in most lines, but you clearly have some margin improvement that still needs to come through. Can you talk about your initiatives to get that margin improvement? Maybe in an environment where pricing appears to maybe be getting a bit more competitive relative to where we were at the start of the year.
Well, I'd say first of all, if Doug Elliot were here or Andy Napoli were here, who run our property and casualty businesses, they would say that our mindset towards pricing has not changed. We are very focused on the profitability of the business. I think we've clearly demonstrated that over the last year. I'd remind you, Chris, that when you look at us in our commercial businesses, sometimes people forget we have a very attractive small commercial business, which has exceptional returns historically. We manage the risk there very well. As I said, we've invested in that to create more automation, lower distribution costs, much easier for agents. There is a lot of consolidation going on in the agency and broker, particularly around how the small commercial business is fulfilled and sold. We're very well positioned there. We certainly had improvement to make in middle market.
We have more to make there. Doug has been very consistent in, I think, two things: pricing discipline and broadening the portfolio. The comment I made today, we had become, when I arrived at the company, in our middle market book and particularly, pretty much a workers' comp business. We're good at it, but we are becoming a much more diversified, broader set. The way I look at it is we, along with just a couple of other companies, have really excellent national agency and broker distribution.
We will grow the business at more than acceptable returns just by leveraging that, continuing to be a comp leader, selling property, commercial auto, and general liability. We like that answer very much. With, I think, the discipline we've shown you from pricing and underwriting, to Chris's point, that should be a very compelling answer in terms of results, more predictable results, and valuation over time. You asked about P&C. Certainly, we have the same discipline in place for home and auto, I think benefits is another place. We gave up top-line to focus on profitability, and we're very pleased by the outcome of that decision. You've seen the margin improvement to 3.7 on our journey to 5. The market now is becoming more rational.
We're getting the margin improvement we want, we're also now beginning to see the new business we want because the market came to the same conclusion we did. We arguably got there earlier, that you've got to manage this business with profitability. We also have very good distribution there. I think for The Hartford and the property casualty benefits business, it's really good distribution, more focused on profitability now, much broader product suite in commercial P&C, and in benefits, improving profitability, and now you'll begin to see new business generation that has acceptable margins for us. We're very excited about that.
Can you talk about reinvestment yields in your investment book and how you're positioned for [temp here] on the plus side, higher interest rates, on the potential negative side, potential interest rate volatility?
Sorry, Chris, to jump in. Just to repeat the question, reinvestment rates is the basis of the question.
Yeah.
I think from the reinvestment side, we've been putting new money to work generally in the 3.75% range to 3.8% in the last couple of quarters. Our duration is about five and a half, so we don't think we're exceptionally long or short. We have taken some positions to anticipate a rising rate. We don't envision a spike, but we do envision a sort of a slow grind over the next 12 to 24 months. I don't think there's a lot of rate exposure that would create any issues for us. We're also watching particularly our tax positions in our muni portfolio. That's a preference item for us. We, from time to time, might lighten up on munis going forward.
Sure. I guess one question on your comp book, a couple different perspectives here. Dovetailing off of the interest rate comment, do you anticipate, are you seeing maybe a little bit more competition now versus a year ago, just given how much pricing people have taken and where the profitability of the books are generally today versus the potential for that competition to increase given higher rates? On the flip side, all the large competitors in the space are pulling back from an exposure basis, as you are as well. Taking the flip side of that argument, is there an opportunity at some point where you would look to grow exposures despite the fact that you're looking to reduce your overall concentration in that line?
I think the important thing, Mike, is we like the comp business, we're not pulling back from the comp business inordinately. Certainly, we're going through and being sure what we write is profitable. We like the underwriting characteristics, got a little bit longer tail, as you know, and medical inflation phenomena. We're well aware of that. What we really want to do is we want it to become less a percentage of our book because we're growing the other pieces as well, which we have not done until recently. For us, I wouldn't view it as pulling back on comp, but just be viewing leverage our leadership in comp and to do what we're doing now, which is write more property for that same insured, typically, liability, and I think in the future, commercial auto.
I think that there's some good news in the fact that the larger, better underwriters are more rational and focused on profitability. Does that give opportunities to some who may not have the service and sales capabilities and expertise that a company like The Hartford and those other notable competitors who are very good do? Sure. Over time, I think those that have discipline and have the ability to stay in that line through ups and downs will win. For us, the important thing is we realize we just need to become more diversified, leveraging what some would say is our leadership in comp. Chris, anything you'd add?
Just in comp, remember, small commercial, middle market, two different worlds.
Sure.
At least if Doug were here, I would say that in the small side of things, it's tuning particular classes of business or particular regions. I think in middle market, there's still a little bit more aggressive mindset to continue to get rate in certain aspects of the books, particularly in certain states. I think if Doug were here, he would say California, Florida, the Carolinas continue to be states that we're watching very closely. His overall goal and mission is to still build that more diversified book of business using comp maybe as a lead.
We'll grow comp if other lines of business come with it from a package basis.
Right. There may very well be opportunities. The last part of your question I didn't answer, which is certainly, good underwriters, good operators, when profitability and underwriting characteristics are attractive, and that's one of the hallmarks of great P&C companies, obviously, is to know when to be in and be out. I think the point Chris made is very important. For the most part, we're not really interested in going forward and being a monoline comp player. If we're going to do comp, we want the rest of the business.
Right. Just in terms of, you kind of alluded to bundling and maybe cross-selling as an area to potentially grow the other segments using comp as a leader there or a lure. How should we think about that in terms of that as a driver for growing these other lines versus other factors as we move from here?
Well, in the simplest of levels, I would look at our commercial businesses, which I think you're largely talking about and say.
Correct
The Hartford has really excellent distribution. I mean, again, there are only a few companies that have what we have. More profitable throughput through that is a good answer. Secondly, a company that either made a decision or allowed itself to kind of focus on one product now is, I think, appropriately diversifying that. I think that's a growth driver, and particularly with the discipline that Doug and his team are demonstrating pricing. I'd say the same thing about benefits and P&C. We are going to be a disciplined player from pricing and profitability. We're in it to make money, not to drive volume just for volume's sake.
I'd like to follow up on that. You referenced pricing pressure in some parts of the business. I mean, across your product suite, where are you seeing relatively more profitability pressure and which businesses are relatively more stable?
You want it?
Sure. I don't mind. From the stability side, Liam mentioned it earlier, small commercial is just a wonderful franchise. If you look at our year-to-date combined ratios, XX at 88, Doug would always say put a point or 2 points for CATs, normalized CAT. That business producing a 90 all-in combined ratio, we'll do that all day and more of it from a growth side. If you look at the same metrics in middle market, it's about, I'll call it 95.5. If you add 2.5 points in the middle market for CATs, you're maybe at 98. Our targets are 94, 95-ish. There's still some rate action needed in that book in totality.
Within that, if Doug were here, and again, he and I and Sabra were just in Texas last week, I'm benefiting firsthand from some of his insights. He would say that commercial auto, both on the small commercial side and the middle market side needs some attention across the country.
The industry. Country and the industry.
Implying the-
Yeah
I can't speak for the industry, yeah, we think it's an industry phenomenon, Liam.
What about, Liam, I opened with some of the comments around the expansion of the risk management-
culture within Hartford, and you gave some great updates in terms of further acceleration, in terms of lapses in Japan, maybe some stability or slowdown on the U.S. side, you alluded to maybe a next generation of the ESV. Can you talk a little bit about that? And then kind of the continued exploration of full risk transfer to the extent that it makes economic sense. Can you talk about just the market generally there in terms of what you're seeing? Because I think consensus has kind of moved to we will see more annuity-like transactions beyond just the fixed transactions that we've seen, and we've seen a few, your U.K. block being one as an example. Is there hiccups that are slowing this momentum down, be it regulatory, or is it just time?
Well, first, you were kind to acknowledge the evolution of risk management to The Hartford. I would say, Chris, we're a very different company today than when Chris and I arrived, myself a little over four years ago, Chris, a little over three and a half years ago. We truly do understand the aggregate risks to the firm, in terms of correlations, concentrations, and the interaction between finance, risk, and Beth Bombara runs Talcott, as an example, are outstanding. We can make decisions, as we've demonstrated, informed and in a collaborative way, in a way the company just couldn't do four years ago. I think in Japan, we've obviously studied Japan, Abenomics, all that very extensively, gotten the benefit of third-party observations as well.
I mean, it does appear as if the yen is likely to stay weaker than it was at least a year ago, and there appear to be some fundamentals that equities in Japan could perform reasonably well. That's good for our portfolio. Also, our team has done a very good job of informing policyholders of their options. It's a manageable book for us now.
As I said, to your point, Chris, there are interested parties in aggregate, in VA portfolios in general. For us, we will consider those opportunities, but for us, it's going to be the combination of price and how much capital could we free up versus what our view is of the underlying economics of the book. I think under Chris' leadership, we've been a bit of an industry leader in valuing these books. I think we have a clear view of the trade-offs from our perspective. The good news is we can manage this book under either of those circumstances. We'll make the right decision for the shareholder.
Okay. The Enhanced Surrender Value in the U.S. and-
I think I wouldn't make more of that than to say, that was a program. It had a beginning and an end. It obviously performed well beyond our expectations. Gratified by that. As I said, you'll see a little bit of a couple point reduction in the lapse rate because that program is kind of winding to, not to an end, but its momentum is slowing a bit. Beth and her team will, in all likelihood, have other customer offers in 2014. Based on their success and understanding the customer and the offering, I'm excited about it.
Can you just talk a little bit more about on the slide you had $1 billion of investments through 2016. I wasn't sure if that was new or if that's something you talked about in the past. Just give us some more color what that.
I'll have to ask the CFO if we've put that number out publicly. I mean, we've talked about investing in the business, but.
Yeah, I think we've quantified it before.
That's right
from a three-year time horizon as far as what our capital management plans are. What we're focused on, I mean, Liam mentioned some of them, a new claims system, new underwriting cockpit, as Doug would call it, administration systems, Group Benefits capabilities. If you really look at it might sound like a large number, but it averages out about $300 million-$350 million a year, Len. From our perspective, is just given the underinvestment in the organization, this is some catch-up from years of not investing in some basic capabilities, and I think it's a wise investment. It passes all our internal rate of return requirements and hurdle rates, now it's about execution.
Sabra just whispered to me, we had put that number out in our annual shareholders meeting. It might be a slightly different number, because we included 2013 in the number I put out there. The number I just gave you is 2014, 2015, 2016.
We have time maybe for one more question. If not, maybe can you talk a little bit just about healthcare reform and the impacts on the Group Benefits? You looked at kind of building out a platform there to better service that opportunity, but as you've gone from fixing the Group Benefits to maybe now looking for some growth opportunities, how do you assess kind of The Hartford's capabilities in that space?
Well, Chris, I would think if we're not the leader, we're one of two leaders in the employer business in life and disability. As I noted, obviously we're cognizant of the migration in some companies, and our historic focus had been on larger and, to some degree, higher end of the middle market. Large companies are not facing, at least today, the same pressures that middle-sized to smaller companies are facing with the implications of ACA. We are investing and developing, and we'll be rolling out voluntary capabilities, as I noted. I won't repeat them. We've spent a lot of time, I would just say, as a company. We're becoming a much more externally focused company about what might the implications of ACA or Obamacare, if you will, be on our industries, whether it be comp and/or benefits.
I think including health insurers and other distribution partners, et cetera, I think the clear answer is there is no conclusion to that. I think what's happened in the last couple of months has probably added greater uncertainty. I would say that while we're not in the healthcare insurance or the medical insurance business, which I probably am glad of at the moment, we are a leader in the life and disability part of benefits and in workers' comp. We have advantages, and we also have distribution, and many of the players in other parts of that don't have distribution. As we've had conversations, we've grown to more greatly appreciate what a competitive advantage that is, our distribution with brokers and agents for both P&C and life and disability products. We don't know the answer. No one knows the answer.
I can assure you that as we've tried to demonstrate, and we will be nimble, and we will be opportunistic, and we will always be informed by what's best for the shareholder.
Okay, I think we're out of time.
Okay. Thank you.
Thank you, Chris.