Good morning. My name is Keisha, and I will be your conference operator. At this time, I would like to welcome everyone to The Hartford fourth quarter 2011 earnings 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 then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Ms. Purtill, you may begin your conference.
Thank you. Good morning and welcome everyone to The Hartford's fourth quarter 2011 conference call. The press release, financial supplement, and slide presentation for today's call are posted in the investor information section of our website. Liam McGee, The Hartford's chairman, president, and CEO, has some opening comments, after which Chris Swift, our CFO, will provide a financial overview. We will then open the call for questions. Other members of our senior management team are also present for our call, in Doug Elliot, Alan Kreczko, David Levenson, Andy, Bob Rupp, and Hugh Whelan. Please note that as discussed on page two of the presentation, any statements made today concerning The Hartford's future results or actions should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, and actual results may differ materially.
We assume no obligation to update these statements. You should also consider the important risks and uncertainties that could cause actual results to differ, which are listed in our press release, our third quarter 10-Q, 2010 10-K, and other filings we make with the SEC. In our presentation, we use some financial measures that are not derived from generally accepted accounting principles or GAAP. Definitions and reconciliations of these measures to the comparable GAAP measures are provided in our financial filings. I'll now turn the call over to Liam.
Thank you, Sabra. Good morning, everyone, and thank you for joining us today. Last evening, we announced fourth quarter results that were in line with what we discussed in December, with book value per diluted share up 17% over the last year. Results were improved from the third quarter, but 2011 was a challenging year, with a weak macroeconomic environment and unusually bad weather. We're encouraged by some of the recent economic developments. Domestic business activity, employment data, and consumption trends all suggest a return to moderate GDP growth. The European Central Bank's additional support measures have had a positive impact in the marketplace. We remain cautious about the operating environment for 2012. Many of the factors, low interest rates and market volatility, are likely to continue to have some impact in 2012.
Given this environment, as we said in December, we are aggressively managing the levers within our control to increase profitability and generate shareholder value. Across the organization, as you will hear, we are prioritizing profit over sales volume, driving greater expense efficiencies, and growing where we are generating appropriate return. In Commercial Markets, we achieved accelerated rate increases across most P&C Commercial lines. As we expected, pricing crossed the inflection point and exceeded loss costs for most of our lines in the fourth quarter. As these written pricing changes earn in over 2012, we expect to see margin expansion throughout the P&C Commercial portfolio, particularly in our middle market book. Doug and his team have accomplished a great deal since his arrival. They're making material improvements across their business, like building our property capabilities to move us to a more diversified P&C Commercial book.
We now have dedicated property specialists in each of our middle market regions. In addition, we've hired several senior underwriters to strengthen our core property team and have significantly enhanced our property risk tools. This focused effort has already turned several strong prospects into The Hartford customers. We've also realigned the sales force against customer segments for both Commercial and Consumer Markets. This will increase our responsiveness to customers, brokers, and agents while heightening accountability for results. In Consumer Markets, Andy and his team have focused the book on a more targeted preferred customer segment. This strategy is paying off with notable margin improvement in the fourth quarter. The AARP relationship continues to be a competitive advantage for us. Along with strong new business growth in the AARP direct business, we are seeing good momentum with the AARP products sold through the agency channel.
About 80% of new business is hitting our targeted mature preferred demographic. For Wealth Management, as you know, we separated several of the division's businesses into a runoff segment in December. The financials are broken out for the first time this quarter, so you can better evaluate progress on our ongoing businesses as well as those in runoff. Earlier this week, we appointed a new, separate, dedicated leadership team for the group, with David Bedard, the former CFO for Wealth Management, heading the team. Dave is a 26-year finance veteran with expert knowledge of these and other complex financial products. Dave will be joined by Aidan Kidney, who was the CEO and President of Japan business, and Peter Sannizzaro, who was most recently CFO of the Global Annuity business. I'm pleased that Dave, Aidan, and Pete are taking on these important new roles.
This team is charged with more efficiently managing these blocks of business, reducing their size, risk, volatility, and capital consumption. We will run this business as its own segment with segregated financials. In the ongoing Wealth Management businesses, David Levenson and his team are focused on increasing returns and managing risk in this low rate environment. As an example, we've raised rates on life insurance several times in the last 18 months. We also believe that our targeted product and distribution initiatives are ensuring that we successfully compete in the marketplace and achieve adequate returns. For example, we recently announced an agreement where Wellington Management will serve as the sole sub-adviser, pending the mutual fund board approval, for The Hartford's fixed income and equity mutual funds.
Our largest distribution partners are excited about this relationship, as it positions The Hartford as a more significant player in the fixed income space and the mutual fund industry overall. In life insurance, we have significantly expanded our distribution efforts, opening up new sales channels. We're maintaining our leadership in wirehouses and banks, but the independent channel now makes up about 48% of our total sales. As you know, we are also focused on driving greater efficiency at The Hartford and are making good progress toward our aggregate $450 million target by streamlining operations, rationalizing management layers, and leveraging technology. This is a three-year effort. We reduced run rate expenses by $150 million in 2011 and will continue to deliver on this objective in 2012 and 2013. Fourth quarter results also demonstrated the effectiveness of our risk management capabilities.
We discussed our Japan hedging program in detail back in October. Year-end surplus performed in line with what we told you in December. As a result of continued confidence in our capital position, in December, we began repurchasing shares. We have bought back just under $100 million of shares to date and expect to be active in the market again shortly. We intend to complete the full $500 million share buyback by early second quarter 2012. With the company stabilized and strengthened, our entire team is working to increase shareholder value. We do not believe the current stock price reflects the true value of the company. As I said in December at our investor presentation, we are evaluating our strategy and our business portfolio for opportunities to deliver greater value for shareholders. We will be objective and pragmatic about the best ways to achieve this goal.
I'll now turn the call over to Chris.
Thank you, Liam. Good morning, everyone. I'll begin on slide five. As Liam mentioned, fourth quarter results were in line with the outlook we provided in December. We saw areas of good performance throughout the ongoing businesses that provide positive momentum for 2012. Fourth quarter core earnings were $339 million, including a $47 million DAC unlock benefit. On slide five, you'll see several items that adversely impacted core earnings this quarter. These items totaled $69 million, including several items that I estimated at our Investor Day. The principal difference was that the original estimate was for catastrophe losses, which totaled $14 million pre-tax. During the quarter, we had $39 million of new cat losses that were offset by $25 million of favorable development on second and third quarter cats. This compares to our fourth quarter estimate of about $50 million. In addition, we had favorable DAC unlock of $47 million.
We estimated fourth quarter core earnings would be between $0.80 and $0.85 per diluted share, adjusted for the items that we just discussed. Actual results were $0.83. Returns on alternative investments, which are volatile, were essentially zero in the quarter versus $67 million pre-tax in the third quarter. Fund valuations were negatively impacted by third quarter equity market performance. Given the typical one-quarter lag, we'd expect alternative returns to rebound in the first quarter of 2012. On slide six, we have broken out fourth quarter core earnings into our ongoing and run-off divisions. These numbers exclude the corporate division, which reflects holding company interest, income, and expenses. Going forward, we'll provide you with this breakout on a quarterly basis to clearly show the earnings performance of our ongoing businesses.
On slide seven, book value per diluted share rose to $47.25, an increase of 17% over the last 12 months. Excluding AOCI, book value per diluted share rose by 6% to $44.86. These amounts do not reflect the implementation of the new DAC accounting standard, which is effective January first of this year. After adoption, all-in book value would decline about $1.5 billion, or $3.09 per share. We will publish restated 2011 segment results that reflect the impact of the new accounting standard in March. As Liam mentioned, we began our share repurchase program in December. Through early 2012, we have completed $94 million of the $500 million authorization. We will be active in the market very soon and intend to complete the authorization by early second quarter of 2012. Let's turn to our business results by segment. Slide eight shows the summary results for Commercial Markets.
Core earnings were $40 million compared with $231 million in the prior year. This quarter results reflect adverse reserve development in P&C Commercial, as well as challenges in Group Benefits. P&C Commercial reported core earnings of $25 million, reflecting the $109 million pre-tax of net prior year development and $87 million pre-tax of current year development. These increases, which we discussed in early December, reflect higher claim frequency on the 2010 accident year in our workers' compensation book and the roll forward impact on the 2011 accident year. The increase in frequency is an industry-wide trend. The current accident year of strengthening was 5.6 points on the fourth quarter combined ratio of 101.5 ex cats and ex prior year. Early indications of claim activity since this adjustment show our estimates for 2010 and 2011 are holding, but it's still early for these accident years.
As Liam mentioned, we saw accelerating rate increases across all lines in the fourth quarter. Overall renewal pricing increased 5%, with stronger results in our middle market business, where we achieved a 10% increase on workers' comp renewals. This grew from 7.5% in October to over 11% in December. We did see a decline in retention, but we are willing to shed some renewal business to improve margins. Shifting to Group Benefits, core earnings of $15 million were below our expectations. The loss ratio of 80.5 reflected elevated disability incidents. Our management actions have been focused on improving pricing to offset loss ratio pressure. We continue our highly selective pricing approach, targeting specific rate actions on a case-by-case basis. While we are making progress in putting more rate into the book, the market remains competitive for well-performing accounts. Consumer Markets core earnings of $83 million are summarized on slide nine.
The combined ratio ex cats, ex prior year was 93.0, 3.8 points better than prior year. This largely reflects 2011 price increases earning into our book of business, particularly in auto. New business written premium rebounded strongly in the second half of 2011, is now back to acceptable levels after a decline in 2010 and the first half of 2011. These improvements are a direct result of targeted new business initiatives and the expansion of the AARP agency platform. While new business and retention have increased significantly year-over-year, we have not yet reached the pivot point where new business outweighs non-renewals. Our retention level in auto has improved by two points to 83%, still a few points below our target. Improving retention remains a key goal for this segment.
Turning to slide 10, wealth management core earnings, ex DAC and LOC, were $155 million, 11% lower than prior year. This decrease was largely due to an 11% decline in assets under management, primarily from net outflows in individual annuities. As a reminder, results for international annuity, institutional annuity, and private placement life insurance are included in the run-off division, not wealth management. Individual annuity core earnings, ex the DAC and LOC, were $86 million, down 10% from prior year. Sales improved in the quarter, marking the first sequential sales increase since 2008. We also have began rolling out our new Fixed Indexed Annuity. As we said in December, we are optimistic about growing the annuity business, but our time frame is not unlimited. In terms of risk-return trade-off, we like our balanced product position.
Our VA product is priced for competitive returns, and the product design prudently balances our risk-management appetite with customer needs. This innovative design is working from a risk-management perspective and offers features that appeal to consumers. Individual life core earnings, ex DAC and LOC, were $40 million, $4 million lower than prior year, reflecting modestly elevated mortality in the quarter. Fourth quarter individual life sales were strong. It's important to note that we did not win this business by being the low-cost provider. Our pricing is responsible, and we can achieve adequate returns on the business we're putting on the books. With that said, the current interest rate environment is causing pricing pressure. In order to stay ahead of this, we have made periodic pricing adjustments, including an increase we made earlier this week.
The catalyst behind the increase in fourth quarter life insurance sales were our innovative product riders and a focus on expanded distribution. Sales grew in every distribution channel, including a 58% increase in sales through P&C agents. Retirement plans core earnings, ex DAC and LOC, were $9 million, $2 million lower than prior year, reflecting spread compression on the general account products. Assets under management were flat, and deposits were down 2%, primarily reflecting weakness in the tax-exempt market. We are pleased with the progress we're making to grow the 401 business. Sales were up modestly in the quarter, and our efforts to expand distribution are beginning to pay off. Sales in the five to $25 million middle market space were up 29%, and sales in the P&C channel grew 33%.
Mutual fund core earnings of $20 million were $4 million lower than last year, reflecting a 15% decline in retail assets under management. This quarter was challenging for the mutual fund industry, in particular for equity funds. Right now, about two-thirds of our mutual fund AUM is in equity funds. As Liam mentioned, our expanded partnership with Wellington strengthens our product offering by providing competitive products for various economic environments. As a result, over time, we expect our concentration in equity funds to be reduced and to have a more balanced fund family. The results for our runoff division are on slide 11. Core earnings ex-DAC and LOC were $84 million. We have provided additional details on the runoff division in the IFS. As Liam mentioned, we recently named a new management team for the life portion of the division.
We look forward to updating you on the progress they are making to more efficiently manage these blocks of business in the quarters ahead. Slide 12 has the results of the hedging program. The program continues to work as designed. These losses are offset by reductions in required reserves. On a GAAP basis, VA generated a net loss of $430 million. On a statutory basis, VA generated a gain of $107 million, as the decline in the VA CARVM liability was greater than the change in value of the hedges. The difference in results on a GAAP versus statutory basis reflects the inherent differences in the accounting for the liabilities. The investment portfolio performed well this quarter. As you can see on slide 13, impairments and changes to the mortgage loan loss reserve were $35 million.
Our net unrealized gain position improved to $2.8 billion pre-tax, largely due to declining interest rates. Our portfolio yield was 4.1%, excluding alternatives, down 10 basis points from the fourth quarter of 2010. Given the Fed's recent announcement that it plans to keep short-term interest rates at historic lows through 2014, we updated our sensitivity analysis of lower rates on our investment portfolio on slide 14. If interest rates stay flat through 2014 as opposed to following the forward curve, the impact to our outlook for after-tax core earnings is negligible in 2012, given the low level of rates. The impact on the current portfolio rises to $30 million-$40 million in 2013 and up to and up to $100 million in 2014 under this scenario. Importantly, these impacts do not reflect any changes we would make in our investment strategy to offset an extended period of low interest rates.
On slide 15 is our statutory surplus roll forward. Surplus levels at the end of the quarter were essentially unchanged at both the P&C and life companies. VA-related impacts to surplus were a positive $300 million. Increased reserves related to cash flow testing resulted in a negative non-VA statutory earnings for the life company of $100 million. During the quarter, we contributed $100 million to Champlain Life Reinsurance, our life insurance captive, to reflect the impact of lower interest rates on life insurance-related reserves. This contribution was primarily funded from life company resources. On slide 16, you can see that we ended the year with a strong balance sheet. We have over $17.7 billion of resources in the U.S. insurance operations in Japan and at the holding company. We ended the year with $1.6 billion of holding company resources, down $500 million from September 30th.
Four hundred million of this decline relates to the October debt repayment. In addition, we completed $51 million of share repurchases before the end of the year. For the first quarter of 2012, we expect results to be in the range of $0.85-$0.90 per diluted share. The improvement reflects a rebound in alternative investment returns, as well as seasonality in catastrophe budgets and assumed weather-related losses. The budget for first quarter catastrophes is about $70 million pre-tax. For the full year 2012, as we discussed in December, we see core earnings of $3.30-$3.60 per diluted share, ex-DAC and LOCs and prior year development.
Before I wrap up, we have received a number of calls from investors recently looking for our perspectives on the idea of separating the P&C and life companies. The company has reviewed this idea in the past, but this management team recently took a fresh look with assistance from advisors. We wanted to share with you some of the meaningful challenges to creating shareholder value via split that may not be fully understood. As you can see on slide 17, these challenges fall into three categories: the interplay of ratings and debt allocation, the need for regulatory approval, and other costs. Put briefly, due to the life company's limited capacity to generate statutory earnings and dividends, at least two-thirds of our current holding company debt would need to be allocated to the P&C group.
As a consequence, we would need to take potentially dilutive actions at the P&C company to delever its balance sheet. As a condition of approval, our regulators might require capital contributions or keep-well agreements between the standalone companies. In addition, we would have to deal with other challenges to creating shareholder value, including those listed on the slide. You can see that there are significant challenges to creating shareholder value from a separation of the companies. In closing, although we have accomplished much over the past two years, we know more is required in order to create ROE expansion and deliver more consistent operating performance. As we've said, we are evaluating our strategy and business portfolio for opportunities to deliver greater value for shareholders. We will be objective and pragmatic about the best way to achieve these goals.
As we start 2012, we are confident that our portfolio review, balance sheet strength, business momentum, and efficiency plans will position us well to achieve these goals we have set for the organization. At this point, I'd like to turn the call over to Sabra to begin the Q&A session.
Thank you, Chris. We have about 30 minutes for questions, and we'd like to take as many questions as possible from you all. Therefore, we ask you to limit yourself to one question and a follow-up in order to allow enough time for everyone to ask. Keisha, could you please pull the call for questions?
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Again, that's star one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jay Gelb with Barclays Capital.
Thanks, and good morning. I had two questions for you. Thanks for the update on what you view as the challenges to separate the life and the P&C companies. You talked about the financial reasons why it may not make sense, I'd like to hear your thoughts strategically whether you feel these two operations should still be together.
Hi, Jay Gelb. Thanks for the question. As we said, and I think Chris's comments were pretty complete in addition to the slide, there are significant challenges to making a split possible. We're not unaware of some of the potential benefits if it was possible in terms of greater focus. In our view, the challenges are fairly significant at the present time.
Okay. As a follow-up, Liam, in terms of the process in terms of looking at which units are potentially underperforming or need to be reduced in presence, when will we get some more news on that?
Well, Jay, thanks again for the follow-up. Let's go back to our December investor conference. As you recall, in my remarks, I did break the company down into a portfolio of businesses, I think, in a fairly granular fashion. I made comments on each of the businesses in terms of, first of all, where it stood relative to its current returns and our growth or profit maximization strategies. As you recall, in the top right quadrant, there were a number of businesses that have actually very current attractive returns. We're trying to grow those because we can do so profitably. There were some in the middle to bottom left that have below optimal returns today. We're really working hard to maximize the profitability. Since we met with you in December, I would say this team is working on that very thoroughly, very rigorously.
We have a sense of urgency about doing that because first of all, we don't believe the current stock price reflects the value of the company. We're evaluating these businesses individually by their ROE, their capital generation, their future capital requirements or capital consumption, their risk profile, and their growth potential. What I'll say is we're being objective, rigorous, and thorough about the types of actions that might enable us to achieve the goal of increasing shareholder value. I think we'll keep you informed as we make those decisions.
Okay. Thank you.
Your next question comes from the line of Chris Giovanni with Goldman Sachs.
Thanks so much. Good morning.
Morning, Chris.
Wanted to drill down a bit more just on the commentary regarding the strategy that you alluded to in December. Can you maybe just put some parameters around what this may or may not include? How are you thinking about sort of balancing your review sort of with kind of the voices you've been hearing from investors in terms of their patience in terms of generating shareholder value?
Thanks, Chris, for the question. I think I commented pretty extensively in the prior question about the process we're going through. I'd add a couple of other things. First of all, in this environment, this management team is very focused on managing the levers that we can control. I think the progress we've made on making the company more efficient in 2011, we'll continue to do so in 2012 and 2013, are appropriate and necessary in view of the current low interest rate environment and the market volatility. The balance sheet is much stronger today, starting with the investment portfolio, the progress that we've made there over the last two years, number one. Secondly, the transparency we gave you in October around our balance sheet. Japan, our overall VA book, our ability to withstand stress scenarios.
I think our enterprise risk management is much stronger and enables us to manage the company better. We are seeing benefits as a result of our three customer-aligned businesses. Just to reiterate, the management team does not believe that the current share price reflects the value of the company. I think to your point, Chris, we've heard that from shareholders. We've heard it from some other observers, I think that's why we're communicating very clearly that we will be objective and pragmatic about the types of actions that may best enable to achieve our goal of realizing greater value for shareholders.
Okay. That's very helpful. Just wanted to follow up on slide 17 here. I guess focusing more on the life side of things. You point to not having infinite patience on the VA business and potentially doing something. You alluded in December that you wouldn't rule out putting that into runoff. I guess if you put that into runoff, you'd have a lot of the wealth management business in the runoff block. Why would there be such an intense focus on preserving the single A rating if so much of the business was in runoff? Could you look to then potentially sell some of the remaining attractive assets like the group or mutual fund business?
Well, Chris Swift may have some comment on this as well. I just remind you that first of all, let's talk about the VA business for a moment. We're well aware of the questions about our strategy in the U.S. VA book. I think in short, we believe we have the components we need to succeed in the business. Distribution, new products that have been out relatively short period of time. As Chris noted, some period-over-period momentum. We're seeing signs of that continue early on in the year. In addition, the macro environment appears to be shifting in a way that may be more favorable to the types of products that we're offering. However, just to reiterate what I said in December, I think I was very clear on this to your question. We are managing the business very closely, watching the trends.
David Levenson, I think, is watching them very closely. Our timeframe, as I said in December, and as Chris reiterated, is not unlimited. We do need, and I need to see meaningful progress in profitable sales in the near future. I think that's very consistent with the tone and the statements that we made in December, and I think in appropriate position. In terms of ratings, I'll just say at a high level. First of all, I think the notion that if we were to decide to put U.S. VA into runoff, that it would create immediate material amounts of capital liberated is not true in our view, number one. Number two, remember that we have other businesses. The mutual fund business, the life business, and the retirement business that are very rating sensitive.
If we were ever to do that scenario, we would not want to do anything to destroy their value. Chris, anything you'd add to that?
I think that's well said, particularly on the businesses. I think the only other point on allocating a third of the debt to the holding company. Chris, I think you remember that we believe statutory earnings and capital generation, particularly in the near term, the 2012, is limited. Allocating almost two-thirds of the holding company debt is probably even aggressive on the surface. Liam, I think your points are good as far as the impacts of other business if those decisions are taken.
Okay. Thank you. Really appreciate the increased discussion.
Thanks, Chris.
Your next question comes from the line of John Nadel with Sterne Agee.
Hi. Good morning, everybody.
Morning, John.
Two quick ones. Just to follow up real quick on slide seventeen. I guess my question is, it seems like debt allocation or just debt levels might be an impediment here or might be one of the most meaningful impediments here. I guess it begs the question, why not spend your excess capital instead of on share repurchases on debt paydown? At least to provide some optionality.
John, it's Chris. Thanks for the question. The debt restructuring is a priority for us. I think given how we've defined deployable capital in the past, roughly about $500 million, we've targeted the share buyback as the higher priority, the most accretive to shareholders. The debt restructuring and its associated impact on earnings and leverage is high on the list, and it's something that we think about very aggressively.
Okay.
Well said, Chris.
I think it's not only from a flexibility perspective, John, but also just a carrying cost perspective on some of the components of our debt that you're well aware of.
Absolutely
I think the management team is very focused. We're proud of the strengthening we've done in the balance sheet in the first couple of years. Your question is a very appropriate one that Chris and I, and the management team are factoring into things like share repurchases, potential warrant repurchases, et cetera.
Okay. Thank you. Then just a quick one on the life company capital. Certainly given strong equity markets in the quarter, I was pleased to see the $300 million improvement in the statutory capital from the VA business. Obviously, interest rates remain a pressure point. Following the moves in the life company statutory capital and the reserves, where would you estimate the risk-based capital would come in for year-end?
Yeah. John, it's Chris again. I'd say, thanks for noticing the decent recovery in VA. I would also just point out that as we closed out year-end, quickly in the life insurance business, we updated our cash flow testing analysis, and that created a little bit of a headwind for us. When you put it all together, we would estimate that our main company is the RBC is between 415 and 420. Our capital at White River Re is well excess of our 125-basis-point target, and we have approximately $400 million of actual tangible surplus there. In Champlain, we did make a capital contribution to Champlain.
Yep.
$80 million of that was funded by the life company. We sent a dividend up to the holding company of $80 million contributed back to Champlain with another $20 million of holding company resources. Champlain is above our targets, and it actually has $265 million of stated surplus. Then you saw the $1.3 billion of surplus in Japan.
Yep.
If you put it all together, we actually feel pretty good about our statutory resources in the various entities.
Sounds good. Thank you very much.
Thank you, John.
Your next question comes from the line of Mark Finkelstein with Evercore Partners.
Hi, good morning.
Morning.
Sort of a follow-up to John's question. Chris, you talked about statutory capital flattish sequentially. Obviously, markets were up, but that had a mark-to-market on the derivatives, which overwhelmed the reserve change. Not to get too technical, but I guess what I'm asking is, at what point in the market, if we continue to go up, would you actually see that reversal where you actually start increasing your statutory capital as the reserve changes are more meaningful than the mark-to-market on the derivatives?
Mark, it's Chris. Thanks. I would say, too, just as context, the U.S. equity markets were up nicely. The other markets where we participate in with our Japanese annuity blocks, I would say were mixed to down.
Right.
If you look at interest rates, if you look at Europe, if you look at Japan, the Nikkei was substantially down. I think the positive impacts on VA CARVM reserves in the life book were offset by the net negatives around the world. That said, I think you're really trying to, and we've talked about it before, as measures sort of the inflection point of where things start to turn positive from a capital generation side. I'll just go back to our comments that we do see substantial capital generation in 2013 and beyond, obviously, as market levels improve. I don't think there's a precise number I'd give you, but when you're north of 13.70 and approaching those types of levels, it really does take a lot of pressure off the VA CARVM reserves. As you know, we've talked about somewhat those being on a lag.
There's not a precise thing. I'll call it continued healing. There's also, I would say, a lot of continued pressure in the low interest rate environment also. You could have a muting impact of just looking at one equity market index, and you really got to consider all our indices that go into the liability calculation.
Okay. Just a question on the variable annuity business. You're launching some new products. It feels like the products are a little bit more consistent with some of the living benefit guarantees that are out there in the market. It feels like you're jumping into that kind of game a little bit. It feels like a little bit of a different strategy than what it's been, which is kind of pick your spots, very focused on lower risk, but obviously value to the consumer. I'm just curious about the product that you're selling, how you think it's positioned, and I guess ultimately, how you're making sure that the risk management around it is very robust.
Mark, this is David Levenson. Good morning, and thanks for the question. As it relates to the new product filing, which is what you're referring to, we are always looking to make improvements in product as part of the normal course of business. What you saw was clearly a filing for the annuity business, but as we're in a quiet period with the SEC, I really don't want to comment too much as it relates to the details. Our absolute focus right now is really on growing the business with the product portfolio that we have today. As it relates to your question around profitability and risk, I would say we pay very close attention to this, as you heard Liam say in his comments with the focus on profitability.
The ROE and the product that we have today is what I would say on a fully hedged basis, very close to the cost of capital at scale. From a risk perspective, we think the product that we sell today is more than acceptable. Three things to add to that. First, we hedge the product fully. Second, the NAR of the business that we put on the books is less than 1% of our total sales. Third, the Personal Protection Portfolio, which is a core part of the product, had a volatility last year that was about one-third of the level of the S&P. The issue for us is really a scale issue.
Okay. Just one very quick follow-up. How are you defining cost of capital in this business?
It's the weighted average cost of capital that we hold on a GAAP basis.
Okay. Well, follow up next.
Thanks, Mark.
Your next question comes from the line of Randy Binner with FBR.
Hey, thanks. Just a follow-up in the annuity area, kind of more on the sales side. I think back at the December day, you all had talked about a $3 billion-$5 billion all-in sales goal across annuities. I think you also said that the fourth quarter should be somewhat of a litmus test for the new VA product. The run rate's considerably low to achieve $3 billion. Just be interested if there was something that made the fourth quarter not a good litmus test for VA, and if you still think that goal is attainable and if indexed annuities might play a big part in that.
Randy, it's Dave again. Thanks for the question. We recognize that the $258 million that we did in the quarter does not get us to our guidance. I'd say that said, we really only had a competitive product in the marketplace for the last six months. We've been essentially out of the market since 2009, and back in since June. The PDF Fund, which again is the secret sauce underlying the product, it's very innovative, and frankly, it needed some proof of concept, which I think took a little bit longer than we expected. With six months behind our belt, I feel very good about where that is right now. As it relates to the fourth quarter specifically, as was mentioned earlier in the remarks, 2008 was the first time that we saw a sequential increase in sales.
When you start looking inter-quarter, our story gets a little bit more interesting, where December was the best month we had in the year, and it was up 45% over October. Let me address your question about 2012 and whether or not I still feel like we can achieve it. The answer is yes. Clearly, as Liam McGee mentioned, the market is rationalizing. Competitors are raising fees. They're reducing benefits. They're getting out of the business. We think this is all good for us. Our biggest distributor in wealth management added the product just recently. It was the end of October. We are in very good discussions right now to add the product to shelves at two of the top 20 firms, the only two of the 20 firms in the industry that don't carry this product today.
We changed our national sales manager in September, we have much greater discipline, focus, and accountability. As importantly, we're attracting some of the top wholesalers from many of our competitors. With that backdrop, I think the punchline is that we really know what we have to do with respect to showing sales and sales momentum. The management team is confident and committed to getting there.
Randy, you can see that Dave is managing this business very closely. I think that reflects the fact that we need to see meaningful, profitable sales progress, and I think he's doing all the right things to make that happen.
That's great. Just a quick follow-up. With indexed annuities, could those become a material part of this in 2012, or should we really think of this as being a kind of a VA phenomenon to get to that goal?
Randy, the FIA product that we launched in 2011 was really a table stakes product. It's really going to be the offering that we bring out in the summertime that we think is very innovative, combined with WealthVest, which as you know, is our third-party focused distributor on this.
Yeah.
I would say it will contribute, but it will be more of the second half of the year where it contributes.
Thank you.
Thanks, Randy.
Your next question comes from the line of Meyer Shields with Stifel Nicolaus.
Thanks. Good morning. I want to applaud your candor with discussing the separation of the life and the P&C companies. I don't want a contradiction, can you share your thoughts about how this disclosure is actually going to impact the unit's performance in the near term?
I'm not sure I understand the question.
Well, I'm putting it in probably overly blunt terms. If distributors look at the life business as being somewhat on the block, is that going to make it harder for them to actually sell the product?
I think you completely misinterpreted the nature of our discussion. I don't think we said that. We did not say that. I think we commented very specifically and very precisely on questions that we've been asked by shareholders about a potential tax-free split of the P&C company. Thank you for recognizing our candor.
I would just go back to what I've said a couple of times, which is as we, and I, more specifically, went through, and then the business leaders went in great detail, we are managing our company as a portfolio of businesses. We intend to maximize the value of each of those businesses because we do not believe our share price accurately reflects the value of the company and of the enterprise. That we are evaluating our strategy and business portfolio for opportunities as a result of that philosophy to deliver greater value for shareholders. We'll be objective and pragmatic and thorough and rigorous about the best ways to achieve this goal. I just want to be sure that you heard me correctly.
Yeah. No, I think I did. If I can shift gears just a little bit. The workers' compensation rate increases that you've talked about, is that impacting retention for other product lines?
It is not. This is Doug Elliot. It is not impacting our retentions across other lines. It is impacting some of the workers' comp retentions. At the moment, we are more than pleased with the trade-off we're seeing in that book of business and very encouraged as we finish the year with really strong pricing momentum across those workers' compensation lines. Very pleased about the last three months. As Chris noted, incremental progress between October to November to December as we head off into 2012.
Okay. Thank you.
Your next question comes from the line of Lauren Sarley with Paulson & Co..
Yeah, good morning. This is John Paulson speaking.
Hello, John.
Liam, I want to go back to the slide 17, talking about the potential separating the life and P&C business. I know you're doing a strategic review, but there's no slide talking about what the potential would be, just that there's challenges. Goldman Sachs came out with, I think, a very good analysis a few months ago where they showed that they estimate the upside to doing a tax-free spin-off of P&C could be over 70% of what the current stock price is trading at. I agree that there's going to be challenges. Isn't your job to really overcome those challenges to achieve the maximum value for shareholders? I would say that Hartford needs to do something drastic because the stock is the lowest valuation relative to book value of any major insurance company.
Last year, Hartford stock was down 38%, while the P&C stocks were up 14% and even declined much more than the life index, which was down 21%. What I'd like to see you do is not merely come back and say, "Yes, we're looking at strategic options," but there's challenges to achieving them. First of all, do you agree that you could create as much as 70% value for your shareholders by spinning off separating P&C? Secondly, is incentive to overcome the challenges that it's going to take to spin this off? How long do we have to wait to hear if there's going to be a positive recommendation to separate these two businesses?
Thanks, John, for the question. First of all, the analysis and the intent of the comments was to acknowledge that their challenges are significant, not to say that they could not be overcome. Second of all, our analysis, including the frictional costs, if you will, that are the third category, would suggest that a split would not create the kind of shareholder value that particular report suggested. Third, in addition, I think your sense of urgency about realizing greater value for shareholders is shared by me and by this team. I hope I answered your questions succinctly and directly.
Partially, Liam. If you share the interest all shareholders have in increasing shareholder value, I'm surprised that as part of the discussion, you don't talk about how much value could be created by separating the P&C business from the life business. Not the only slide you devote to it talking about that there's some obstacles to overcome.
Yeah.
Not talking about the upside and weighing the upside of a separation against what the obstacles are.
Yeah, John.
Better yet, not just listing those obstacles, but what I'd like to see is how you will overcome those obstacles to result in a more fair valuation for The Hartford. Not that there's obstacles, but how are you going to overcome those obstacles? That's what I, as a shareholder, look from you as the management to do.
Thank you, John, that is our mindset. Our purpose in the slide was to identify the hurdles. If you heard our language, we did not say they were not surmountable, number one. We said there were significant costs to surmount them in a number of areas. We felt we owed shareholders that disclosure. Number two, we do not believe that splitting them in the current environment for the reasons that we cited will create shareholder value. Third, again, I'll reiterate we have an incredible sense of urgency on looking at all ideas to create shareholder value.
Well, I think you need to do a much better job of explaining that because Goldman Sachs' report is a very good report on a path to separate the business and create what they estimate as a 70% increase in shareholder value. Then you merely say there's some obstacles, and you don't equate what the costs are to the benefit and what value you think could be created. Right now, with the stock performing as poorly as it has relative to both P&C and life companies, I think you need a better explanation of what you're going to do to enhance shareholder value. Merely that you're working hard and you're committed, but there's obstacles. What we need you to do is overcome the obstacles to enhance the valuation for your shareholders, not merely to point out that there's obstacles.
Hey, John. Thank you. I hear you loud and clear.
I hope so.
Your next question comes from the line of Andrew Kligerman with UBS.
Okay, great timing to have the next question.
Hi, Andrew. Welcome.
Good morning. It looked like you had some improvement in the life CO stat capital, and that was a surprise to me. For the investor day, you're going to generate about $800 million in capital a year out of the P&C company. What I'd like to know is, when you finish up the half billion dollar buyback, which I think you're saying is early 2Q, it will have been about a year since your last authorization of $500 million. Could you give a little color on the flexibility that you might have to authorize another buyback? I don't know, just flexibility, amount, timing. I know you can't be overly specific, but a little flexibility commentary would help.
Andrew, it's Chris. Thanks for the comments. I think your comments are right. Again, we finished fourth quarter in decent shape, particularly at the life company. I would say one point of clarification that we plan to take out $800 million of dividends out of the P&C company, but we expect the P&C company to generate slightly more in statutory earnings and that the life group we're still calling right now for flat to slightly down. A lot of that is path dependence on markets, hedging performance. Directionally, I'd like you to take away it's still a constrained model for 2012. As we said, and as Liam said and I said, we are going to complete the program in early second quarter. At that time, we'll evaluate, I'll call it our deployable capital level needs for different initiatives.
Determine our future actions and communicate them at that point in time. As we said, we see capital and surplus increasing in 2013 at the life company. That gives us hope and optimism that we will continue to have flexibility in 2013 and beyond particularly.
Okay. Possibly in mid 2012.
Possibly. Again, hard to predict. We would like to finish what we started, do the evaluation, compare obviously a lot of different options for our deployable capital and come up with the best solution at that time.
Okay. Just following up on one of the business lines. One of your rationales for being a multi-line company was aligning the Commercial Markets businesses, the Group Benefits, along with the commercial P&C. I'd like an update on the-- well, first off, it looks like AIG actually copied what you did based on some of the things I've been reading about. Secondly, I'd like to get a sense of sales volumes and some of the impact that you're having there.
Andrew, this is Doug. We talked about that at the December 8th day in quite some detail, those discussions continue as we close 2011 and head into 2012. We had quite a bit of success, greater than $125 million of sales working across our Group and P&C space in 2011. We have challenging goals for 2012. As I travel, two weeks ago I was in Orlando, I spent several hours in the morning with our comp and Group people together to talk about issues, to make sure that we're firing on all cylinders and we're looking for opportunities in the marketplace. Absolutely, on a day-to-day basis, those opportunities continue to be chased, and we're looking for more to leverage the breadth of product that we have here at The Hartford.
You think that could result in a turnaround in -3% in sales year-over-year?
The dynamics of the sales process themselves is much more related to our need for margin improvement in group and our margin improvement needs across middle markets. When I think about top line, given the scale of those businesses, we're clearly driving rate change at those two businesses. As you looked at the bubble chart that Liam took you through in December, we have several businesses that need significant rate. We're doing everything we can on a day-to-day basis to get that done. That's more a driver relative to top line than this other dynamic.
Perfect. Thanks.
Thank you, Andrew. Keisha, we have time for one more question, please.
Your next question comes from the line of Bob Glasspiegel with Langen McAlenney.
Thank you. I wanted to zero in on AARP. Chris, you said that you're pleased with where you are and in position to grow. Liam, you sort of said that's a franchise operation, which I totally concur. I'm just confused on where it is in the sort of fix versus grow mode. With premiums down 4% and the overall at 96%, it seems like AARP should be in a position to grow, not be one of the fixed candidates. If it is a franchise, as I think, and it's in a demographic that's favorable, why is it not growing more?
Bob, this is Andy. Great question. I take you back 18 months ago, we had profit issues in the division, probably more pronounced in agency than with AARP. Nonetheless, we were taking above-market rate increases across all channels and products. We knew growth would be impacted, but quite frankly, given the competitive environment that confronted us in 2010 and 2011, it was greater than anticipated, affecting both new business and retention. Since then, we've been working really hard to achieve rate adequacy and restore growth to the division, especially AARP. It's very much still a work in progress, but as you commented, in AARP Direct, we are converging on our combined ratio pricing targets. I actually expect that to happen sometime in 2012. New business has rebounded very nicely, and that will continue to play out as 2012 plays out.
The big objective for us right now is to get retention where it needs to be. Until we do that, we expect that to happen throughout 2012 and into 2013, we'll restore total premium growth to AARP. Still a valuable franchise, extremely important to us strategically, and we're well on our way to getting that back on track.
Where does auto have to be to get to your ROE objective? You don't break out AARP, so if you could give me AARP's targeted combined ratio to get to the ROE, that'd be great. I'll take auto in general if you can-
Auto around a 95 or so.
Okay. You're at 96 overall. AARP is, I assume, better than agency. Why couldn't AARP be growing right now?
I think it's just a timing thing. It's the way the rate increases played out in 2009 into 2010. Retention was impacted more than we thought it would be. We're recovering it.
Thank you.
You're welcome.
Thank you, Bob, and thank you also, Keisha. We look forward to seeing and talking to you all soon.