The Hartford Financial Services Group, Inc. — First-Quarter 2018 Form 10-Q
Business context and reporting period
Form 10-Q for the three months ended March 31, 2018. The Hartford provides property and casualty insurance, group life and disability products, and mutual fund and exchange-traded product services, primarily in the United States. Reporting segments are Commercial Lines, Personal Lines, Property & Casualty Other Operations, Group Benefits, Mutual Funds, and Corporate.
The Aetna U.S. group life and disability business acquired in November 2017 materially increased Group Benefits results. The life and annuity run-off business was classified as discontinued operations and held for sale; the sale was expected to close by June 30, 2018, subject to regulatory approval and other conditions.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenues | $4,691 million | $4,169 million | 13% |
| Earned premiums | $3,927 million | $3,438 million | 14% |
| Fee income | $323 million | $278 million | 16% |
| Net investment income | $451 million | $410 million | 10% |
| Net realized capital gains (losses) | $(30) million | $24 million | Down $54 million |
| Income from continuing operations, net of tax | $428 million | $303 million | 41% |
| Income from discontinued operations, net of tax | $169 million | $75 million | 125% |
| Net income | $597 million | $378 million | 58% |
| Diluted earnings per share | $1.64 | $1.00 | 64% |
| Core earnings | $461 million | $288 million | 60% |
Benefits, losses and loss adjustment expenses were $2,695 million, compared with $2,424 million. Income before taxes from continuing operations was $519 million, compared with $401 million. Income tax expense declined to $91 million from $98 million, primarily reflecting the reduction in the federal corporate tax rate from 35% to 21%.
Property and casualty combined ratio improved to 93.1% from 97.4%. Catastrophe losses declined to $103 million from $150 million, and prior accident-year development was favorable by $32 million versus unfavorable development of $12 million in Q1 2017. Commercial Lines earned premiums increased 1%, with a 93.3% combined ratio. Personal Lines earned premiums declined 8%, but its combined ratio improved to 92.2% from 99.3%.
Group Benefits premiums and other considerations increased 68% to $1,401 million, primarily from the Aetna acquisition. Net income increased 20% to $54 million. The total loss ratio was 77.4%, and the core earnings margin increased to 5.6% from 4.3%.
Mutual Funds net income increased 48% to $34 million. Average segment assets under management were $117.3 billion, up 16%; mutual fund and ETP assets at period-end were $99.9 billion, up 15% from March 31, 2017.
Cash flow, balance sheet, debt, and liquidity
| Metric | March 31, 2018 | December 31, 2017 |
|---|---|---|
| Total assets | $216,666 million | $225,260 million |
| Total investments | $44,432 million | $45,146 million |
| Stockholders’ equity | $13,143 million | $13,494 million |
| Total debt | $5,168 million | $4,998 million |
| Cash | $228 million | $180 million |
| AOCI, net of tax | $(239) million | $663 million |
- Operating cash flow was $712 million, compared with $225 million in Q1 2017.
- Investing cash flow was $(242) million, compared with $(1,208) million.
- Financing cash flow was $(677) million, compared with $436 million.
- On March 15, 2018, the Company issued $500 million of 4.4% senior notes due 2048, receiving approximately $490 million of net proceeds, and repaid $320 million of 6.3% senior notes at maturity.
- The Company had no commercial paper outstanding and no borrowings under its $1 billion revolving credit facility; $3 million of letters of credit were outstanding.
- Holding-company liquidity included approximately $1.1 billion of cash, short-term investments, and fixed maturities. Expected next-twelve-month requirements included a potential $500 million junior subordinated debt call, $413 million of debt maturities, approximately $270 million of interest, and approximately $365 million of common dividends.
Material changes versus the prior comparable period
- Net income increased 58%, driven by stronger continuing operations, lower catastrophe losses, favorable reserve development, higher investment income, the lower tax rate, and higher discontinued-operation income.
- Group Benefits expanded substantially because of the Aetna acquisition, increasing premiums, invested assets, expenses, and intangible-asset amortization.
- Personal Lines premiums declined because of lower new business and policy retention, although pricing actions and improved loss experience substantially improved underwriting profitability.
- Net realized investment results shifted from a $24 million gain to a $30 million loss, primarily from sales of fixed maturities for duration, liquidity, and credit management.
- Net unrealized investment gains declined by $855 million after tax, primarily from higher interest rates and wider credit spreads. Comprehensive income was a loss of $300 million, compared with comprehensive income of $508 million.
- Adoption of new financial-instrument accounting guidance moved equity securities to fair value through earnings. The Company also adopted guidance permitting reclassification of stranded tax effects from AOCI to retained earnings.
- Book value per diluted share decreased to $36.06 from $37.11 at December 31, 2017, principally because of the decline in AOCI.
Outlook, commentary, risks, contingencies, and unusual items
- Management expected 2018 annualized net investment income yield, excluding limited partnerships and alternative investments, to be flat to slightly below 2017 levels, subject to portfolio composition, reinvestment rates, and non-routine income.
- The sale of the life and annuity run-off business was expected to generate approximately $1.5 billion of net proceeds, including approximately $1.4 billion of cash after a planned $300 million pre-closing dividend and a retained 9.7% ownership interest. The transaction included an estimated loss on sale of approximately $3.2 billion, subject to closing adjustments.
- Net asbestos reserves were $1.184 billion and net environmental reserves were $231 million. The adverse development cover with NICO provided up to $1.5 billion of protection above the December 31, 2016 reserve base; $285 million had been ceded, leaving approximately $1.2 billion of available coverage.
- Asbestos and environmental reserves remain highly uncertain. Adverse development exceeding the $650 million premium threshold may result in significant earnings charges before deferred gains are recognized, and development beyond the treaty limit would be retained by The Hartford.
- Insurance operations were considered sufficiently liquid for anticipated demands over the next twelve months. Key risks include catastrophe events, unfavorable loss development, asbestos and environmental claims, market and interest-rate volatility, credit and counterparty losses, reinsurance collectability, rating downgrades, regulatory constraints, litigation, cyber events, and changes in tax or accounting rules.
- The Mutual Funds litigation remained on appeal after a 2017 judgment for the Company and its subsidiaries. Management could not reasonably estimate a possible loss or range of loss.
- The filing states that disclosure controls and procedures were effective as of March 31, 2018, with no material changes to internal control over financial reporting during the quarter.
Investor verification points
- Verify the closing, proceeds, retained ownership, debt reduction, and final accounting for the life and annuity run-off sale.
- Assess whether the improvement in the property and casualty combined ratio is sustainable after adjusting for lower catastrophe losses and favorable prior-year development.
- Monitor Personal Lines policy counts, retention, premium growth, and the effect of pricing actions on future profitability.
- Evaluate Group Benefits integration costs, Aetna-related reserve development, group life mortality, and the sustainability of the reported growth.
- Track interest rates, credit spreads, unrealized investment losses, AOCI, and realized investment gains or losses.
- Review debt maturities, the planned junior subordinated debt call, dividend capacity, credit-facility covenants, and insurance-subsidiary dividend restrictions.
- Monitor asbestos and environmental reserve reviews, NICO recoveries, remaining ADC capacity, and potential litigation outcomes.