HARTFORD INSURANCE GROUP, INC. quarterly report, Q2 FY2012

Business Context and Reporting Period

The filing is The Hartford Financial Services Group, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The company provides property and casualty insurance, group benefits, life insurance, annuity, retirement-plan, mutual-fund and related financial services. During the quarter, management began implementing a strategic repositioning toward Property & Casualty, Group Benefits and Mutual Funds, while placing Individual Annuities into runoff and pursuing strategic alternatives for Individual Life, Retirement Plans and Woodbury Financial Services.

Key Financial Metrics

Metric	Three months ended June 30, 2012	Three months ended June 30, 2011	Six months ended June 30, 2012	Six months ended June 30, 2011
Total revenues	$4,574 million	$5,401 million	$12,235 million	$11,701 million
Earned premiums	$3,400 million	$3,545 million	$6,842 million	$7,064 million
Fee income	$1,114 million	$1,219 million	$2,248 million	$2,428 million
Net investment income	$(590) million	$507 million	$3,346 million	$2,418 million
Net income (loss)	$(101) million	$33 million	$(5) million	$534 million
Net income (loss) available to common shareholders	$(112) million	$22 million	$(26) million	$513 million
Diluted earnings per share	$(0.26)	$0.05	$(0.06)	$1.06
Operating cash flow	Not separately presented	Not separately presented	$1,236 million	$964 million

The reported net loss margins were approximately negative 2.2% for the quarter and essentially break-even for the six-month period. Management reported core earnings of $119 million for the quarter and $731 million for the six months, excluding discontinued operations, specified realized capital gains and losses, and the debt extinguishment loss.

At June 30, 2012, total assets were $303.977 billion, total investments were $134.935 billion, cash was $2.338 billion, and stockholders’ equity was $21.961 billion. Long-term debt was $7.125 billion, compared with $6.216 billion at December 31, 2011. Debt represented 32% of stockholders’ equity and 24% of capitalization, compared with 29% and 22%, respectively, at year-end 2011.

Material Changes Versus the Prior Comparable Period

Second-quarter net income declined to a $101 million loss from $33 million of income. The six-month result declined to a $5 million loss from $534 million of income.
The principal adverse item was a $910 million pre-tax, or $587 million after-tax, loss on extinguishment of debt related to repurchasing $1.75 billion of Allianz-held 10% junior subordinated debentures.
Quarterly net investment income was reduced by a $1.687 billion loss on trading equity securities, primarily associated with investments supporting international variable annuities. Six-month trading-equity investment income was $1.179 billion.
Quarterly net realized capital gains increased to $589 million from $69 million, largely because of gains in the international variable-annuity hedge program. Six-month net realized capital losses were $321 million versus $334 million in 2011.
Earned premiums declined 4% in the quarter and 3% year to date, while fee income declined 9% and 7%, respectively.
Property & Casualty Commercial quarterly net income improved to $149 million from $118 million, although six-month income decreased to $338 million from $441 million, primarily because of the prior-year gain on the sale of Specialty Risk Services.
Consumer Markets improved to a $50 million quarterly loss from a $172 million loss and reported six-month income of $58 million versus a $64 million loss, reflecting lower catastrophe losses and the absence of a prior-year $73 million after-tax software write-off.
Property & Casualty Other Operations improved to a $15 million quarterly loss from a $164 million loss, as second-quarter net asbestos reserve strengthening was $48 million pre-tax versus $290 million in 2011.
Accumulated other comprehensive income increased to $2.256 billion from $1.251 billion, principally because of improved available-for-sale securities valuations.

Cash Flow, Liquidity and Capital

Six-month operating cash flow was $1.236 billion. Investing activities used $1.551 billion, while financing activities provided $109 million. Cash declined from $2.581 billion to $2.338 billion.
The holding company had approximately $1.2 billion of cash, short-term investments and fixed maturities at June 30, 2012. Expected holding-company liquidity needs over the next 12 months included approximately $440 million of interest, $180 million of common dividends and $42 million of preferred dividends.
The company issued $1.55 billion of senior notes and $600 million of junior subordinated debentures in April 2012, primarily financing the $2.125 billion repurchase of the Allianz-held junior debentures.
A $1.75 billion revolving credit facility extends through January 2016. The company was in compliance with all covenants at June 30, 2012, including minimum consolidated net worth of $14.9 billion and specified debt-to-capitalization limits.
Insurance operations’ liquidity was considered sufficient for anticipated needs over the following 12 months. Property and casualty operations held $26.655 billion of specified fixed maturities, short-term investments and cash after derivative collateral; life operations held $63.172 billion on the comparable basis.
The company completed a $500 million equity repurchase authorization, including $149 million for 8.0 million common shares and $300 million for Allianz warrants.

Guidance, Outlook and Management Commentary

Property & Casualty Commercial written-premium growth was expected to be in the low-to-mid single digits for full-year 2012. The combined ratio before catastrophes and prior accident-year development was expected to remain in the mid-to-upper 90s, compared with 97.3% in 2011.
Group Benefits premiums were expected to decline for the year, with an elevated loss ratio due to persistent group-disability claim incidence, lower claim terminations and higher severity.
Consumer Markets written premiums were expected to decline, although policy retention was improving. The full-year combined ratio before catastrophes and prior accident-year development was expected to be flat to slightly lower than 91.9% in 2011.
Management expected lower Individual Life sales and potentially lower Retirement Plans sales and higher surrender rates following the strategic review and planned sales processes.
The U.S. individual annuity new-business capabilities were agreed to be sold to Forethought Financial Group. Beginning May 1, 2012, new U.S. annuity policies were reinsured to Forethought; the transaction was expected to close in late 2012 or early 2013.
Woodbury Financial Services was agreed to be sold on July 31, 2012, subject to regulatory approval and expected closing by year-end 2012. The company also closed the sale of certain PPLI administration assets on July 13, 2012 and recorded a $61 million after-tax deferred gain.
Restructuring and other costs were estimated at approximately $180 million pre-tax, with substantial activity expected over the following 12 to 18 months. $57 million had been incurred in the first six months.

Risks, Contingencies and Unusual Items

Variable-annuity earnings remain highly sensitive to equity markets, interest rates, volatility, foreign exchange rates and policyholder behavior. International variable-annuity hedging produced significant period-to-period earnings volatility.
Net asbestos and environmental reserves were $2.185 billion at June 30, 2012, including $1.873 billion of asbestos and $312 million of environmental reserves. Management’s estimated reserve range was $1.74 billion to $2.53 billion, and additional losses could be material.
The company recognized $127 million of other-than-temporary impairment losses in earnings during the first six months, including impairments on equity securities and structured securities. Future impairments remain possible.
Derivative agreements with rating-related collateral triggers had $616 million of net liabilities at June 30, 2012, with $597 million already collateralized. A one-level downgrade could require approximately $52 million of additional collateral; a two-level downgrade could require approximately $64 million.
Standard & Poor’s lowered Hartford Life and Annuity Insurance Company’s financial-strength rating to BBB+. Three derivative relationships with $3.8 billion of notional exposure were affected; counterparties had not exercised termination rights as of quarter-end.
A mutual-fund derivative action alleges excessive advisory and distribution fees. The company stated that the potential loss cannot currently be reasonably estimated.
Goodwill totaled $1.006 billion. Individual Life passed its impairment test by less than 10%, so changes in sales projections, earnings, economic capital or discount rates could result in future impairment.
The filing identifies cyber incidents, catastrophic events, litigation, regulatory changes, sovereign-credit stress, low interest rates, credit deterioration and reinsurance counterparty performance as material risks.

Investor Verification Priorities

Verify the sustainability of reported core earnings of $119 million for the quarter and $731 million year to date after excluding volatile investment and debt-related items.
Assess the effect of the strategic repositioning, annuity runoff, planned divestitures and restructuring costs on future earnings, capital deployment and holding-company liquidity.
Review variable-annuity hedge effectiveness and sensitivities to equity markets, interest rates, volatility and the Japanese yen.
Monitor asbestos and environmental reserve development against the disclosed $1.74 billion to $2.53 billion estimated range.
Evaluate debt refinancing, rating actions, derivative collateral requirements and compliance with revolving-credit covenants.
Reconcile reported GAAP results with non-GAAP core earnings and determine whether catastrophe losses, reserve development, impairments and other unusual items are recurring or market-dependent.