Business Context and Reporting Period
The Hartford Financial Services Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2012. The company provides property and casualty insurance, group benefits, life insurance, annuities, retirement products, mutual funds and related financial services. The filing reflects a strategic review announced March 21, 2012: focus on Property & Casualty, Group Benefits and Mutual Funds; place Individual Annuity into runoff; and pursue sales or other strategic alternatives for Individual Life, Retirement Plans and Woodbury Financial Services.
The filing retrospectively adopted ASU 2010-26, reducing January 1, 2011 stockholders’ equity by approximately $1.6 billion after tax and revising prior-period results. The financial statements were reviewed, not audited, by Deloitte & Touche LLP.
Key Financial Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenues | $7.661 billion | $6.300 billion | 22% |
| Earned premiums | $3.442 billion | $3.519 billion | (2%) |
| Fee income | $1.134 billion | $1.209 billion | (6%) |
| Net investment income | $3.936 billion | $1.911 billion | 106% |
| Net realized capital gains/(losses) | $(910) million | $(403) million | Loss increased |
| Income from continuing operations, net | $97 million | $339 million | (71%) |
| Net income | $96 million | $501 million | (81%) |
| Net income available to common shareholders | $86 million | $491 million | (82%) |
| Diluted EPS from continuing operations | $0.19 | $0.67 | (72%) |
| Diluted net EPS | $0.18 | $0.99 | (82%) |
| Cash dividends declared per common share | $0.10 | $0.10 | Unchanged |
Reported revenue benefited from $2.866 billion of trading-equity investment income, primarily supporting international variable annuities, with a corresponding $2.864 billion credited to policyholders. The international variable annuity hedge program generated approximately $1.2 billion of losses, substantially contributing to the net realized capital loss.
- Net cash provided by operating activities was $1.140 billion, compared with $474 million in Q1 2011.
- Net cash used in investing activities was $1.367 billion, compared with $254 million provided in Q1 2011, primarily reflecting net derivative payments and mortgage-loan purchases.
- Net cash used in financing activities was $233 million, compared with $451 million in Q1 2011.
- Ending cash was $2.059 billion, down from $2.581 billion at December 31, 2011.
- Total assets were $310.548 billion, up from $302.609 billion at year-end 2011.
- Total stockholders’ equity was $21.274 billion, down from $21.486 billion; debt was $6.220 billion, approximately unchanged.
- The company had $1.5 billion of holding-company cash, short-term investments and fixed maturities at March 31, 2012.
- The company remained in compliance with its revolving credit facility covenants. The facility provided $1.75 billion of borrowing capacity through January 2016.
Material Changes Versus the Prior Comparable Period
- Net income fell $405 million, primarily because of larger international variable annuity hedge losses and the absence of the $150 million after-tax gain from the 2011 sale of Specialty Risk Services.
- Core earnings, a non-GAAP measure, increased to $612 million from $574 million. The increase included a $214 million after-tax “Unlock” benefit versus $57 million in Q1 2011, reflecting actual separate-account returns above estimated returns.
- Property & Casualty Commercial net income declined to $189 million from $323 million, largely because the prior-year period included the Specialty Risk Services disposal gain. Earned premiums increased 4% to $1.557 billion, while the combined ratio deteriorated to 99.7% from 97.9%.
- Group Benefits net income increased to $18 million from $11 million, although premiums declined 7% and the loss ratio increased to 83.0% from 79.3%, reflecting higher group-disability severity and persistent elevated disability incidence.
- Consumer Markets net income was unchanged at $108 million. Earned premiums declined 5%, while the combined ratio improved modestly to 87.0% from 87.3%.
- Individual Annuity net income increased to $198 million from $143 million, aided by the larger Unlock benefit and lower expenses, despite a 12% decline in assets under management to $83.742 billion.
- Life Other Operations recorded a $405 million net loss versus a $70 million loss, primarily due to international variable annuity hedge losses of $1.2 billion versus $319 million in the prior-year period.
- The company repurchased 2.6 million common shares for $42 million during the quarter and agreed to repurchase Allianz’s Series B and C warrants for $300 million, settled April 17, 2012.
Guidance, Outlook, Risks and Unusual Items
- Management expected Property & Casualty Commercial written-premium growth of low-to-mid single digits for 2012 and a full-year combined ratio before catastrophes and prior-year development in the mid-to-upper 90s.
- Group Benefits premiums were expected to decline for 2012, with an elevated loss ratio due to disability incidence, lower claim terminations and higher severity.
- Consumer Markets written premiums were expected to decline for 2012, while the combined ratio before catastrophes and prior-year development was expected to be flat to slightly lower than 2011’s 91.9%.
- Effective May 1, 2012, new annuity policies were to be reinsured to a third party. Existing annuity policies were not affected, and the company expected to cease annuity sales after the reinsurance arrangement ends in the second quarter of 2013.
- On April 5, 2012, the company issued $1.55 billion of senior notes. On April 17, 2012, it issued $600 million of junior subordinated debentures and repurchased $1.75 billion principal amount of Allianz-held 10% junior subordinated debentures for $2.125 billion. The company expected an approximately $600 million after-tax loss on extinguishment in Q2 2012.
- S&P downgraded Hartford Life and Annuity Insurance Company to BBB+ with a negative outlook and other life subsidiaries to A-. Three derivative relationships totaling $4.7 billion of notional value were affected; counterparties had not exercised termination rights as of March 31, 2012.
- Derivative contracts with credit-related contingent features had $701 million of net liability fair value, of which $687 million was collateralized. A one-level downgrade could require approximately $28 million of additional collateral; a two-level downgrade could require approximately $41 million.
- Net asbestos and environmental reserves were $2.17 billion, within an estimated range of $1.69 billion to $2.52 billion. The company stated that ultimate liabilities could exceed recorded reserves and could materially affect results, financial condition or liquidity. Annual ground-up reserve studies were scheduled for Q2 2012.
- The company faced ongoing litigation, including mutual-fund fee litigation for which potential losses could not reasonably be estimated. Management considered other identified litigation outcomes unlikely to be material, but noted that litigation could adversely affect particular periods.
- Key sensitivities include equity markets, interest rates, implied volatility, foreign exchange rates, credit spreads, policyholder behavior, reinsurance recoveries, reserve development, goodwill valuation, deferred tax assets and regulatory changes.
Investor Verification Checklist
- Verify the reconciliation of GAAP net income to core earnings and quantify the sustainability of the $214 million after-tax Unlock benefit.
- Assess the effect of the international variable annuity hedge program, including yen, equity-market and volatility sensitivities, on future earnings and statutory capital.
- Track execution of the runoff, reinsurance and potential sale plans for Individual Annuity, Individual Life, Retirement Plans and Woodbury Financial Services.
- Review Q2 2012 debt-refinancing effects, including the expected approximately $600 million after-tax loss on the Allianz debenture repurchase.
- Monitor insurer financial-strength ratings, derivative collateral requirements and potential counterparty termination rights.
- Evaluate the adequacy and sensitivity of asbestos, environmental and other long-tail reserves after the scheduled Q2 studies.
- Reconcile the retrospective ASU 2010-26 accounting adjustments when comparing 2012 results with previously reported 2011 figures.
- Review liquidity at the holding-company and regulated-subsidiary levels, including dividend capacity, surrender exposure and the availability of credit facilities.