Business context and reporting period
The filing is The Hartford Financial Services Group, Inc.’s Form 10-K for the fiscal year ended December 31, 2014. The company is an insurance and financial services holding company focused on Commercial Lines, Personal Lines, Property & Casualty Other Operations, Group Benefits, Mutual Funds and the runoff Talcott Resolution business. At year-end, total assets were $245.0 billion, stockholders’ equity was $18.7 billion and the company had approximately 17,500 employees.
The company completed the sale of its Japanese annuity subsidiary, Hartford Life Insurance KK, on June 30, 2014, and continues to run off legacy annuity and life businesses. Prior periods were retrospectively adjusted for discontinued operations.
Key financial metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Total revenues | $18.614 billion | $20.673 billion | Down $2.059 billion |
| Income from continuing operations | $1.349 billion | $1.225 billion | Up $124 million |
| Net income | $798 million | $176 million | Up $622 million |
| Diluted EPS | $1.73 | $0.36 | Up $1.37 |
| Core earnings | $1.548 billion | $1.419 billion | Up $129 million |
| Earned premiums | $13.336 billion | $13.231 billion | Up $105 million |
| Net investment income | $3.154 billion | $3.264 billion | Down 3.4% |
| Net realized capital gains | $16 million | $1.798 billion | Down $1.782 billion |
| Operating cash flow | $1.886 billion | $1.237 billion | Up $649 million |
| Total debt | $6.109 billion | $6.544 billion | Down 7% |
| Year-end cash | $399 million | $1.428 billion | Down $1.029 billion |
Net income included a $551 million after-tax loss from discontinued operations, compared with a $1.049 billion loss in 2013. Income from continuing operations before tax was $1.699 billion, and income tax expense was $350 million.
Property and casualty written premiums increased 3%. The combined ratio before catastrophes and prior-year development improved to 91.5% from 94.4%. Current-year catastrophe losses increased to $341 million before tax from $312 million, while unfavorable prior-year development was $228 million, primarily from asbestos and environmental reserves.
Segment net income was $983 million for Commercial Lines, $207 million for Personal Lines, $191 million for Group Benefits, $87 million for Mutual Funds, a $108 million loss for Property & Casualty Other Operations, a $187 million loss for Talcott Resolution and a $375 million Corporate loss.
Material changes versus the prior comparable period
- Net income and diluted EPS increased substantially, primarily because the discontinued-operations loss declined and Property & Casualty underwriting improved.
- Commercial Lines net income increased to $983 million from $870 million. Its combined ratio before catastrophes and prior-year development improved to 91.5% from 95.1%.
- Personal Lines net income declined to $207 million from $229 million despite higher premiums; the segment was affected by higher catastrophe losses, lower servicing income and realized capital losses.
- Group Benefits net income was broadly flat at $191 million, but the after-tax core earnings margin excluding buyouts improved to 5.2% from 4.3%.
- Mutual Funds net income increased to $87 million from $76 million, supported by higher average assets under management. Year-end Mutual Fund segment assets under management were $93.6 billion versus $96.7 billion, reflecting market appreciation offset by outflows and Talcott runoff.
- Talcott Resolution’s continuing-operations income declined to $370 million from $414 million, while its total account value decreased to approximately $184.9 billion from $219.1 billion. Variable annuity account value declined to $52.9 billion from $61.8 billion.
- The company sold its Japan annuity business for cash proceeds of $963 million and recorded an after-tax loss on disposition of $659 million.
- The company repurchased 49.5 million common shares for $1.796 billion and ended the year with $979 million remaining under its equity repurchase authorization.
- Accumulated other comprehensive income improved from a $79 million loss to a $928 million gain, primarily because of higher net unrealized investment gains.
Debt, liquidity and capital
- Debt represented 33% of stockholders’ equity and 25% of total capitalization at year-end, compared with 35% and 26%, respectively, in 2013.
- The company held $2.1 billion of cash, short-term investments and fixed maturities at the holding company. Expected next-twelve-month holding-company liquidity needs included approximately $360 million of interest and approximately $300 million of common dividends.
- The company had no commercial paper outstanding and no borrowings under its new $1.0 billion five-year revolving credit facility, which matures in 2019. It was in compliance with all credit-facility covenants.
- Insurance subsidiaries generated approximately $2.5 billion of dividends to the holding company in 2014, including $1.4 billion of extraordinary dividends. Regulatory restrictions limit the timing and amount of future subsidiary dividends.
- Aggregate statutory capital and surplus was $15.2 billion. U.S. property and casualty subsidiaries had an aggregate risk-based capital ratio above 200% of Company Action Level, while principal life subsidiaries were above 425%.
Guidance, outlook, commentary and unusual items
- For 2015, Commercial Lines expected low-to-mid single-digit written-premium growth and a combined ratio before catastrophes and prior-year development of approximately 89.5% to 91.5%.
- Personal Lines expected moderate written-premium growth and a comparable combined ratio of approximately 89.0% to 91.0%.
- Group Benefits expected an after-tax core earnings margin excluding buyouts of approximately 5.0% to 5.5%.
- Mutual Funds expected moderate earnings growth under normal market conditions, offset by runoff of Talcott-related assets.
- Talcott Resolution expected account values and earnings to decline as the legacy annuity block runs off. Management expected surrender rates to decline in 2015 after in-force management initiatives increased 2014 surrenders.
- Net investment income yield excluding limited partnerships and alternative investments was expected to decline slightly in 2015 because reinvestment yields remained below portfolio yields.
- The company recorded a $128 million pretax pension settlement charge, a $62 million after-tax Talcott Unlock charge and $49 million of after-tax restructuring and other costs.
- Asbestos and environmental reserves were strengthened by $212 million and $30 million, respectively, in 2014. Net asbestos and environmental reserves totaled approximately $2.0 billion and were estimated within a range of $1.6 billion to $2.3 billion, before covariance.
- The company disclosed a Mutual Funds litigation matter involving alleged excessive advisory fees. Discovery was ongoing, and management stated that a possible loss or range of loss could not reasonably be estimated.
Principal risks and contingencies
- Reserve adequacy risk, especially for workers’ compensation, general liability, asbestos and environmental claims. A 2% change in workers’ compensation paid loss development patterns was estimated to change reserve needs by approximately $400 million in either direction.
- Catastrophe exposure from hurricanes, earthquakes, wind, hail, winter storms, terrorism and pandemics, including the possibility of multiple events constraining liquidity.
- Market risk from interest rates, credit spreads, equity prices, volatility, foreign exchange and energy-sector exposure. Sustained low rates could reduce investment income and increase annuity hedging costs.
- Variable annuity guarantee risk, including GMDB and GMWB obligations, policyholder behavior, hedging effectiveness and statutory-capital volatility.
- Counterparty and reinsurer credit risk. Net property and casualty reinsurance recoverables were $2.730 billion after a $271 million allowance; life reinsurance recoverables were $20.190 billion, principally from MassMutual and Prudential.
- Rating downgrades could increase derivative collateral requirements, restrict hedging capacity and raise borrowing costs. A one-level downgrade could have required approximately $4 million of additional collateral and a two-level downgrade approximately $18 million, based on year-end market values.
- Regulatory, tax, litigation, cybersecurity, outsourcing, model and accounting risks. The company had $865 million of unfunded investment commitments and $310.041 billion of aggregate contractual obligations, much of which represents estimated insurance cash flows.
Facts an investor should verify
- Reconcile reported net income of $798 million with core earnings of $1.548 billion and identify the sustainability of each adjustment.
- Review the adequacy and sensitivity of the approximately $18.765 billion net property and casualty reserves, particularly the $8.678 billion workers’ compensation reserve and approximately $2.0 billion asbestos and environmental reserve.
- Assess whether the projected 2015 combined-ratio ranges are supported by pricing, loss-cost trends, catastrophe experience and expense levels.
- Monitor Talcott Resolution runoff, surrender rates, guarantee exposure, hedging results, DAC recoverability and statutory capital effects.
- Verify holding-company liquidity, subsidiary dividend capacity, the $456 million of 2015 debt maturities and remaining share-repurchase authorization.
- Evaluate the collectability and concentration of reinsurance recoverables, including the large balances due from MassMutual and Prudential.
- Review the Mutual Funds litigation, asbestos and environmental claims, derivative collateral provisions and other contingencies for changes after the filing date.
- Confirm that subsequent market movements, regulatory developments and accounting changes have not materially altered the filing’s outlook.