We're pleased to have with us today, Liam McGee, the Chairman, President, and CEO of The Hartford. Liam has been CEO of The Hartford since October of 2009. 2012 has been a particularly important year for The Hartford as Liam and his management team completed a strategic review which resulted in three sales transactions and a sharper focus on its market-leading property casualty group benefits and mutual funds business. With that, I'm going to turn things over to Liam.
Good morning, everyone. Thanks, Chris. It's always great to be back at Goldman Sachs for your conference. To get the legal niceties out of the way, before I begin, please note that the statements I make concerning The Hartford's future results or actions should be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance. You should consider the important risks and uncertainties that may cause actual results to differ, including those discussed in our 2011 10-K and other filings we make with the SEC. Thanks again for joining Chris Swift, our Chief Financial Officer, and me here today. We are excited to be back. As Chris was kind enough to note, 2012 has been a year of significant and positive change for The Hartford.
The company has accomplished a great deal, as you know, since we announced our new strategy in March, most notably the Woodbury Financial Services and individual life dispositions. As we enter 2013, we are at a pivot point, well-positioned to complete the transformation of the company and to generate superior shareholder value over the next few years. Now, before I get started, I will briefly comment on Superstorm Sandy. With you, of course, our hearts go out to everyone affected by the storm, and we are working intensely to get policyholder claims handled in a speedy and effective fashion. Just as an anecdote, yesterday on my way to New York from Connecticut, I stopped by a middle-market customer who had significant damage and really, as in other claims visits I've made, experienced the real tragedy of this natural storm.
We expect to provide a loss estimate soon, but the process is taking longer than usual due to the volume and nature of business interruption claims. As I stated on our November earnings call, losses from Superstorm Sandy will be manageable for The Hartford. At this time, recognizing that our work is not complete, it is possible that gross losses will hit our reinsurance deductible of $350 million. As you know, under our reinsurance program, we retain only 10% of losses above $350 million. We will update you as soon as we finalize a loss estimate based on projected claims and average costs. As Chris noted, it's been a little more than three years since I joined The Hartford. We've accomplished a great deal, beginning with considerable groundwork that stabilized the company's financial foundation.
This work has built a base from which we are now focused on our dual objectives of achieving superior financial returns and generating profitable growth. Over the last three years, the company has made important progress in enterprise risk management, de-risking the investment portfolio, expanding annuity hedging, strengthening the balance sheet, and enhancing the leadership team. At this juncture in our history, let me cover each of these points briefly. Enterprise risk management at The Hartford today is much stronger than prior to the financial crisis. Under the leadership of Bob Rupp, our Chief Risk Officer, we have implemented a comprehensive approach to risk management with a focus on measuring and managing all significant market, financial, and operational risks across the company, as well as their correlations.
With these tools in place, along with our risk management team, I am confident that The Hartford is much better prepared for adverse market and economic developments. We also focused on reducing investment portfolio risk, which was a major reason for the company's difficulties during the financial crisis. We've reduced our legacy mortgage and financial institution exposures while rebalancing the portfolio more appropriately toward investment-grade corporate and municipal bonds. We've also reduced our exposures in Europe, cutting investments in higher-risk countries and emphasizing corporate and infrastructure exposures. Importantly, we also expanded our hedging programs, increasing the protection against the adverse impact of equity, interest rate, and currency markets on the run-off annuity business. For example, as you know, historically, The Hartford did not hedge its Japan VA guarantees when they were originated.
We designed a Japan tail hedge program, which was fully implemented by the end of 2011 and is managed dynamically today to limit that block's exposure to capital markets to acceptable levels. Earlier this year, we replaced the last of the company's crisis capital when we refinanced the outstanding Allianz debentures and repurchased their warrants. In total, the company's rating agency adjusted debt to total capital ratio has declined from 32% at the end of 2009 to 26% at the end of the third quarter this year. Over time, we intend to improve this ratio further with a target in the low 20s, a level generally more consistent with the P&C industry. Similarly, the company's debt service coverage ratios are also stronger, particularly with the elimination of the 10% coupon on the Allianz debentures.
Finally, we've also strengthened The Hartford's management team. We've attracted several key leaders who, complemented by internal Hartford talent, are bringing renewed energy and execution focus to our businesses. Notable additions, of course, are Chris Swift, our chief financial officer, Doug Elliott, who heads our commercial businesses, Andy Napoli, who runs consumer markets, and Brion Johnson, the President of HIMCO. These additions, along with Hartford veterans like Beth Bombara, head of life runoff, are working together to drive The Hartford from a, if you will, a consensus-oriented company to a more decisive, nimble, and efficient organization. I'm proud to say, as a result of these activities, The Hartford's foundation has been strengthened, and we are focused on achieving superior performance. The decisions we announced in March and the actions we have subsequently taken have positioned us to achieve that goal.
In July of 2011, when management and our board met to focus on business strategy, it was clear, as we said at year-end last year, that the economic environment would remain challenged for several more years, and that The Hartford status quo was not going to generate superior shareholder returns in an acceptable timeframe. As a result, we launched a detailed strategic review, measuring each of The Hartford's businesses against three important criteria. First, the go-forward businesses had to possess distinct and competitive market positions upon which we could responsibly invest for profitable growth. Second, the businesses had to have strong capital-generating ability. Third, they had to, over time, reduce the capital market sensitivity of our company. As you know, we concluded our evaluation in March with the announcement that The Hartford would focus on the property and casualty group benefits and mutual funds businesses.
In addition, we announced the decision to put U.S. annuity business into runoff and to pursue initiatives to reduce the size and risk of that book, with the ultimate goal of isolating or separating that business from the go-forward businesses. Consistent with the sharper focus strategy, we announced our intention to sell individual life, retirement plans, and Woodbury Financial. As you know, we accomplished these three sales sooner than most expected on excellent financial terms with strong strategic buyers. Since then, we've been working to close the transactions. The Woodbury transaction closed last Friday, we currently expect to close retirement plans by year-end and individual life in the first quarter of 2013. As we said on the third quarter earnings call, the company will eliminate all of the direct and indirect expenses associated with the businesses.
The buyers will assume the premiums and about two-thirds of the expenses from these businesses upon closing. We've already begun the process to eliminate the remaining one-third of those expenses and expect to be substantially complete by the end of 2013. Selling these businesses will substantially enhance the company's financial flexibility with an estimated $2.2 billion statutory capital benefit, and also will result in a more focused, disciplined, and efficient company. We know that investors are interested in our capital management plans. We are developing holistic plans, which we are discussing with regulators and rating agencies. Once the necessary reviews are completed and the transactions are closed, we'll share our capital management plans with you. Our goal in managing capital is to pursue accretive actions for shareholders, while both maintaining a balance sheet sufficient for adverse economic environments and supportive of the go-forward businesses and their current ratings.
Preserving financial flexibility to enable us to be opportunistic in taking future actions to address the company's legacy annuity liabilities. Therefore, we expect that our capital management plans will include the following actions. One, debt repayment to reduce leverage and improve our interest coverage ratios over time. Two, share repurchases, which at current prices are very accretive. Three, capital to provide additional financial flexibility to take future potential actions to address legacy annuity liabilities, which should create significant shareholder value. In the go-forward businesses, our focus is on improving operating margins and generating profitable growth in our P&C group benefits and mutual fund businesses. In property and casualty commercial, we are driving margin expansion with significant rate increases, and we expect that to continue in 2013.
Standard commercial renewal premium rates are up about 7% year to date, with rate increases in all lines of business, but particularly in middle market and middle market workers' compensation, where rate increases have averaged about 15%. Our goal is by leveraging our traditional strength in workers' compensation to become a more diversified commercial lines player with a balanced portfolio of property, liability, marine, auto, and workers' comp businesses. We're focused in particular on growing our property and liability books, and we're beginning to see results. For instance, since we implemented actions in middle market, we've seen a sustained increase in property new business writings. In group benefits, we remained focused on taking necessary price increases to improve profitability, which will shrink the size of the book in the near term, but improve core earnings and return on capital.
Consumer markets is generating close to targeted margins in auto and is focused on growth opportunities in our AARP agency to expand market share in our target 50-plus age demographic group. More than 60% of AARP members prefer to purchase their auto and home insurance through an agent. For 27 years, we've largely only sold to them direct. Obviously, we're targeting this large group with our AARP agency model. Since the inception of this model about 2 years ago, AARP agency has grown to over 6,000 agency locations and represented 46% of new business growth for the entire agency channel in the first nine months of this year.
Finally, the mutual funds business has transitioned management of all the fixed income funds, in addition to the already existing equity funds, to Wellington Management, and is now focused on expanding its marketing and distribution initiatives in order to continue to improve net flows, which did improve significantly in the third quarter. Achieving superior financial performance also depends on effectively balancing economics and the pace in reducing the size and risk of our legacy annuity businesses. Beth Bombara and her Talcott Resolution team are working with urgency on a number of policyholder initiatives, such as the one we announced last month. We are focused on creating greater alignment of management teams, market strategies, and legal entities for our go-forward businesses and those in runoff.
This will take some time, but our goal is to align the mutual funds and group benefits businesses with our go-forward P&C businesses by the end of 2013. In conclusion, we've accomplished a great deal over the past three years. While there is more to do, Chris and I and our entire management team and board are excited about the company's strategic path and the progress we've made over the past three years, but in particular, over the last eight months. This management team is determined to generate superior returns for our shareholders, and we look forward to updating you on our progress. As we mentioned on our earnings call in November, we will provide our 2013 operating outlook on the fourth quarter conference call on February fifth. We intend to host an investor day at our Hartford campus in March.
We'll finalize the date for that meeting in early 2013. Chris, thanks again for having us, and thanks to all of you for your interest in The Hartford. Chris Swift and I now would be pleased to take your questions. Thank you.
Thanks, Liam. Plenty of time for Q&A. If I could kick things off, if you want to have a seat, Chris. Come on up.
Come on up, Chris.
Thank you. You gave some good context there in terms of Sandy losses. Could you maybe provide some context in terms of what you're seeing commercial versus the consumer side of things?
Right.
When you think of the follow-through for rate increases, how are you thinking about the magnitude in loss exposed lines and then potentially in non-impacted lines, but maybe along the coast in terms of what you might be able to do for rate there?
Well, a couple of dimensions to the question, Chris. First of all, in terms of the number of claims, it's about two-thirds and one-third consumer personal lines versus commercial. In terms of what we expect to be the ultimate dollars of claims, it'll be about 60% commercial and about 40% personal lines. Interestingly, in the commercial lines, we would expect about half of that to be business. So I think a couple of things. First of all, clearly it's going to cause a more of a continued focus on getting rate, which we were focused on, and I think other industry leaders have been focused on. I think this increases the urgency on that. Secondly, without a doubt, for us and for the industry, it's going to cause us to relook at risk management and models, particularly in property.
Third, we at The Hartford, and I think the industry, is coming to terms with the fact that undoubtedly weather has changed. We increased our cat loads from 2011 to 2012, and while our numbers aren't final for 2013, I think it's likely we'll do the same in 2013. Whether it's global warming, climate change, I think as an industry, we have to assume this is a new normal, and we'll run our business consistent with that. Chris, anything you'd add?
I think you said it right. I would say that from the overall volume of dollars on Hurricane or Superstorm Sandy, greater than 50% will be BI. Of the numbers that Liam referenced, about 50% of that will come from business interruption alone.
Okay.
All right.
That's why this is a little more complex a process, I think, for those who have commercial businesses.
I guess as a result of Sandy, I guess it aligns well with your focus in terms of the P&C centric business model, pushing for rate, cash flow, clear transparency. As you kind of step back here, I guess eight months or so since you took the strategic review and you look out at your three ongoing businesses, how are those prospects versus just 18 months ago when you went there? Have those changed much, or are they still pretty similar in terms of how you're feeling about them?
For The Hartford, I think in terms of our analysis, Chris, we're really focusing on our core competency, which is the property casualty benefits business. We do have a competency in the mutual fund business as well, which we think we're creating, as we grow that, significant shareholder value. However, realistically, without a doubt, sustained low interest rates, if we are seeing some type of climate change as manifested in higher cats, I think it means that us and the industry are going to be even more disciplined in getting paid for the risks we take. As I said earlier, we will have for us in the industry some risk management elements in terms of risks, and I think some are going to learn some painful lessons through the cycle that perhaps have to look at their risk models differently.
Lastly, like every financial services company in this environment, we have to run even more cost effectively, which is why we're so determined that, and we will, get all the costs out from the businesses we're selling. We're not going to burden our go-forward business with a higher cost burden. In those go-forward businesses under Chris' leadership, we're looking for continuous improvement. As a matter of fact, Chris and I were chatting this morning, our operating expenses are down over 5%-6% year-over-year. We're going to continue to do that. Chris, anything to add?
I think we still like the businesses that we're operating in. The economic environment will drive a lot of the results, particularly the lower rates, but the competitive positions that they have, the improvement actions that we've been after the last 18 months, we feel good about all those businesses.
Remember, Chris, I think going back to July of last year when we began this process, which culminated in our March announcement, I said it earlier in the prepared remarks, there were three filters we looked at our business. We really did look very objectively when we started the process. Exactly what Chris said. Do we have competitive positions? We clearly do in property and casualty and in benefits that we think we could invest responsibly to grow. We have greater conviction on that today than when we began the process. Second of all, we wanted to have businesses that generated capital. We need to move away from this capital consumptive past few years. Third, that over time, in addition with the natural lapsing of the annuity book and actions we may take, is going to dramatically lower the market sensitivity of the firm.
We feel as strongly, if not more strongly, about our decision and our excitement, to Chris's point, about the go-forward business than when we began. Acknowledging it's a challenging environment.
Definitely.
Questions from the audience. I have a few more.
Yeah. I think you're on.
Hello? Yeah. Okay. Chris, or maybe Liam, if you could talk a little bit about the nature of business interruption in your policies. Is that the same limits kind of as the policies that are written? The property policies that I imagine include BI. Are there sub-limits for BI, or is it considered just the same sort of endorsement, I guess, as the underlying coverage?
You want to take a crack at that?
I think on that, again, the business interruption is an endorsement. Obviously, we write most of our business interruption on small commercial.
Right.
It's tailored. There are sub-limits.
Okay.
Obviously, as you know, it follows the peril, the main loss event to trigger the BI claim. That's why it's been taking a lot of time to work through the power companies and really determine what is the causation of the business interruption, flood versus no flood versus power lines down and things along those lines. There are sub-limits on the business interruption.
Got it. That's not standard policy language. That's an additional endorsement.
Correct.
Okay, great. Second question, I guess
Liam, you mentioned an interest in kind of broadening your product profile. Can you talk about how much of your business, your comp business, is part of a bundle versus written on a standalone basis? What are you doing to increase the penetration of those other businesses that you want to write? Thanks.
Well, I don't have the actual statistics, Chris, in May, but I would say, in all honesty, over the past several years, we became a bit of a monoline comp player. I would say the majority, at least the majority, is single product. We like the business. We want to continue to be a leader in it, and I think most would consider us one of the leaders. The diversification is very important because Chris and I would prefer not to have that kind of concentration, notwithstanding our regard for the business. Our efforts in property and liability are very important. Under Doug Elliot's leadership, where we have focused, and particularly in the last six months on selling, you want comp, property liability come with it. We're actually seeing very encouraging results. That'll be more of our future model.
We like the comp business, but we want to leverage our expertise and excellence in that to get a more well-rounded relationship with the insured.
Okay, great. Thanks.
We are seeing encouraging results on that.
A question in terms of the variable annuity business. You guys in early November announced the VA buyout rider that you put into place, and we've seen a few competitors do it. I think we have a belief that more will come to market. The SEC has their 90-day or so preview of this. I think you're working with some of the states to try and get approval.
Yes.
Can you talk a little bit about that process, some of the success or failures you might be seeing with this exploration?
Well, the SEC is under review there, Chris, to your point, and that'll just take the time it takes. I think we're optimistic about the outcome there. We've already been working, to your question, with states, and I think we're at least at 20 states, but perhaps a few more than that, Chris.
A little more.
A little more?
Closer to 30.
Closer to 30 now, I'm a week behind. It's been well-received by the insurance commissioners, and I think there might be a state or two has a question on it, but for the most part, it's being approved. Assuming we get the SEC approval and this approval process continues as satisfactorily as it appears to be, I think we'll be ready to roll.
Okay. In terms of the three sales that you did, obviously, I think they were, at least people we talked to, a lot quicker than what people thought. You're going to be getting the proceeds. You talked about the timing of capital management. Can you walk through maybe a little bit about your philosophy, how you're thinking about using those proceeds?
Well, I'm sure Chris will have a perspective on this as well. I'd say obviously we're going to take shareholder accretive actions wherever possible, but we're going to do that, of course, by ensuring that the company continues as we do today, to have the capital strength to manage through any significant downturn market or economic environments and maintain our ratings and support our go-forward businesses. We also believe that maintaining some additional capital to be opportunistic around opportunities to further accelerate moving the VA books off our books could be a very accretive activity for shareholders. I think that's philosophically kind of how I'd state it. The three areas that I think will undoubtedly be part of our ultimate capital management plan. I would add another element. We're looking at this thing holistically, not just two.
We're looking at the company as a whole, the capital generation, places where we will use capital. It's a holistic view, and I want to be sure shareholders understand this. Not here's two, and what do we do with the two? It's look at the company where we think performance is going to be different in environments, including the two. Then I think undoubtedly it'll be repay debt. We'd like to get our leverage down and our debt service coverage up more like a P&C company. Do some share repurchases, which are clearly very accretive. Then, as I say, preserve some capital for potential transactions. Anything to add?
I just agree completely. I think the only points of emphasis is, we've sequenced the process here pretty refinedly. As Liam said, we're working with regulators and agencies. We want to allow them the time and diligence they need to go through to perform their functions. We'll have a board discussion to get them approved, and then we'll announce it. All that is predicated upon closing the deals and getting the necessary regulatory approval. To Liam's point about holistic, hopefully it's obvious to the people that have been following us. We're thinking two, three years out and what the balance sheet needs to look like to really support our going forward business, recognizing we've got a runoff block of business. Earnings will decline. We'll hopefully free up capital over a longer period of time.
The pace in how we change our balance sheet to match the go-forward businesses and our capital structure, that's really what we're focused on, Chris.
Okay. Just one follow-up. Is there any investing that you would consider on the P&C side in terms of whether it's infrastructure kind of towards this build-out of the product portfolio you were talking about before? New expertise marketing, whatever it is. Do you anticipate any potential opportunities to invest purely on the P&C side to pursue that build-out?
The short answer is yes, we would. There are certainly capabilities that would be wonderful additions to particularly our commercial property and casualty franchise, which we think is a leader. Not only in the product diversification, but also in industry verticals. Because I think if Doug were here, he would say, and I think he knows the businesses as well, if not better than almost anyone in it, that the product diversification is essential if you want to profitably grow and be able to be in and out of sectors as risk-reward changes, which it does in this business. Second of all, that being more expert in industries and delivering yourself to the market from an industry perspective is going to be increasingly important. Sure, whether we hire it or acquire it, we'd be very interested.
We've got a great franchise, we're going to invest in it. I think that's another lost dimension sometimes in investors is, we are returning to the core competency of The Hartford with laser focus. I think that is the way shareholders should want us to run our business, focus on the things we can do well, where we can add value. This financial flexibility and these businesses that are capital generating really give us the ability and the desire to invest in our go-forward businesses to build out the kinds of things you reference.
I would also say the investment in infrastructure has been and will continue. When we rolled out the new business vision, particularly for small commercial, we'll roll it out to workers' comp and our commercial auto package eventually. We're looking at new claims systems. We made a decision to move forward with the new claims system. It's product people in the infrastructure support our go-to-market activity.
Yeah, good point, Chris. Thank you.
I have a question. In your partnership with AARP, which I think you mentioned it's a couple of years now, is there a discount, all other things being the same in the auto, let's say, certain zip code, a husband and wife, good accident record. Do they get a discount versus your competitors, or a discount versus what you would sell if they weren't part of the AARP program?
Yes. Our models, we've been at this for 27 years, our relationship with AARP, mostly almost exclusively up to the last year and a half, as I mentioned in my remarks, on a direct basis, now over 60% of AARP members actually would prefer to buy through an agent. We think we have another number of many years of the kind of growth we had on the direct model and the agency model. Because we understand those customers, we think, better than anybody else because of that age demographic and those AARP members, believe it or not, there is a difference between someone with similar characteristics who's an AARP member and one who's not. The short answer is yes, both in price and both in product features is advantageous to be an AARP member and to get your home and auto from us.
You found that AARP members would rather buy through an independent broker than directly from The Hartford?
Well, we built a $3 billion plus business direct, that 40% who prefer to buy or have bought direct, that's a significant business. The exciting part is there's more members that have not largely bought from us because they like to deal with an agent, take some of the mystery out of it. We now have 6,000 agent locations who are selling that same product to those customers, that's where you've seen the very significant growth quarter-over-quarter.
I guess maybe their preference is an independent broker can check with the competition and see if the AARP policy is the best one for them, as opposed to them doing it on their own and not checking with others.
Well, they can.
Yeah.
They can, still, there's a tremendous loyalty, and that's the whole affinity concept. If I'm an AARP member, I do have a greater propensity to buy an AARP-branded product. Within that agent's suite, to your point, on the product compare and the price compare, the AARP product stacks up very nicely.
Now, does this extend to other types of insurance like homeowners or comprehensive home?
Home and auto is what we sell.
Home and auto.
Other partners with them do other things.
Do you write policies for people that are over 50, AARP members, and have adult children that want to be on their policy?
I guess, yeah, probably.
I guess for an additional charge.
You're getting into product nuances now. Of course. We've been doing this for 27 years. Anything that they need, we undoubtedly service them with it.
Okay. Thank you.
Okay.
We have time maybe for just one last question. You talked about the group benefits business and pushing for rate there. You expect that as a result for that to shrink. Can you just talk as we get up here on the important January 1 season for the group business, what you're seeing from competition, particularly in the large case market, and what you're going for in terms of rate?
Well, I'd say at a high level, Chris can give you his perspectives as well. It's a very competitive space. I would say more players today are going for rate than certainly than a year ago, the same termination trends, loss trends. It's an industry phenomenon. While it's super competitive, I would say with the exception of one or two outliers, more competitors are acting rationally, in our view, as compared before. Chris, you want to give any flavor on what you expect the rate increase to be?
I think you're right on. It's not completely done yet, but I still expect high single-digit rate increases in that book, particularly for 1/1 renewals where there's a substantial renewal base at that point in time, but through the rest of the year. Whether it be incidences in termination rates or low interest rates, that book of business, similar to others, just does need that type of rate increase.
I would think, Chris, our persistency should be about the same, if not maybe a touch higher than it was last year in that same 1/1-
Yeah
renewal period where there is, to your point, there is such a concentration of business being renewed.
Great. We're out of time.
Thank you.
Liam, Chris, thank you much.
Thanks a lot.
All right.