The Hartford Financial Services Group, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; filed April 27, 2015. The filing covers The Hartford Financial Services Group, Inc., a holding company for property and casualty insurance, group benefits, mutual funds and runoff life and annuity operations. Interim financial statements are unaudited and were reviewed by Deloitte & Touche LLP.
Business context
- Primary reporting segments are Commercial Lines, Personal Lines, Property & Casualty Other Operations, Group Benefits, Mutual Funds and Talcott Resolution, plus Corporate.
- The Japan business was sold in June 2014 and is reported as discontinued operations; therefore, Q1 2015 had no discontinued-operations income compared with $29 million in Q1 2014.
- The company continues to manage runoff variable annuity and other legacy life businesses through Talcott Resolution.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenues | $4.617 billion | $4.612 billion | Flat |
| Income from continuing operations, pretax | $625 million | $609 million | +3% |
| Income from continuing operations, net | $467 million | $466 million | Flat |
| Net income | $467 million | $495 million | -6% |
| Diluted EPS from continuing operations | $1.08 | $0.97 | +11% |
| Diluted net EPS | $1.08 | $1.03 | +5% |
| Net investment income | $809 million | $824 million | -2% |
| Net realized capital gains | $5 million | $(35) million | Improved |
| Operating cash flow | $447 million | $349 million | +28% |
| Cash at period end | $500 million | $1.285 billion | Lower |
| Stockholders’ equity | $19.077 billion | $18.720 billion at Dec. 31, 2014 | +2% |
| Total debt | $5.820 billion | $6.109 billion at Dec. 31, 2014 | -5% |
| Debt to stockholders’ equity | 31% | 33% at Dec. 31, 2014 | Improved |
The implied net profit margin was approximately 10.1% in both periods. Comprehensive income was $689 million, including $222 million of other comprehensive income, primarily from higher unrealized securities gains.
Material changes versus the prior comparable period
- Net income declined by $28 million, primarily because Q1 2014 included $29 million of discontinued-operations income and materially greater favorable prior-year property and casualty reserve development.
- Current-period property and casualty earned premiums increased 3% in both Commercial Lines and Personal Lines, but underwriting performance weakened. The combined ratio before catastrophes and prior-year development increased to 91.7% from 89.6%.
- Commercial Lines net income was $240 million versus $242 million. Its underlying combined ratio increased to 92.4% from 89.6%, partly because Q1 2014 benefited from a $49 million reduction in New York workers’ compensation assessments.
- Personal Lines net income fell to $76 million from $99 million. Its underlying combined ratio increased to 89.9% from 88.7%, reflecting higher auto liability losses, physical-damage severity and reduced favorable prior-year development.
- Catastrophe losses decreased modestly to $83 million from $86 million, primarily due to winter storms.
- Prior-year reserve development was a $2 million favorable release versus a $40 million favorable release in Q1 2014. Commercial auto liability reserve strengthening partly offset releases in professional liability, general liability and catastrophe reserves.
- Talcott Resolution net income from continuing operations decreased to $111 million from $116 million. Total account value declined to approximately $183 billion from $214 billion, reflecting the Japan sale, runoff and net outflows.
- Mutual Funds net income increased to $22 million from $21 million. Mutual fund assets under management increased to $75.7 billion from $73.3 billion, while total segment assets under management declined because of Talcott runoff and a prior asset transfer.
- Accumulated other comprehensive income increased to $1.150 billion from $928 million, mainly because of unrealized investment gains associated with lower interest rates and tighter credit spreads.
Cash flow, debt and liquidity
- Operating cash flow was $447 million; investing activities provided $295 million; financing activities used $619 million, including $250 million of share repurchases, $289 million of debt repayments and $78 million of dividends paid.
- The holding company held approximately $2.0 billion of cash, short-term investments and fixed maturities as of March 31, 2015. Expected next-twelve-month holding-company requirements included $167 million of debt maturity, approximately $350 million of interest payments and approximately $300 million of dividends.
- The company had no commercial paper outstanding and no borrowings under its $1.0 billion revolving credit facility. It was in compliance with applicable financial covenants.
- The company had $729 million remaining under its $2.775 billion equity repurchase authorization at March 31, 2015 and repurchased 6.1 million shares for $250 million during the quarter.
- On April 24, 2015, the company announced the planned May 27, 2015 redemption of $296 million principal amount of 4.000% senior notes for an estimated $320 million, including the make-whole premium and accrued interest.
- Insurance operations reported sufficient liquidity for anticipated needs. Property and casualty operations had $26.5 billion of fixed maturities, short-term investments and cash net of derivative collateral; life operations had $35.0 billion on the same basis.
Guidance, outlook and management commentary
- Management expected the 2015 annualized net investment income yield, excluding limited partnerships and other alternative investments, to decline slightly from the current level because reinvestment rates were below existing portfolio yields. The Q1 new-money yield was 3.1%, down from 3.9%.
- Management cited lower interest rates, lower reinvestment yields and continued Talcott Resolution runoff as ongoing earnings pressures.
- Management continued capital management actions, including share repurchases and planned debt repayment, subject to market conditions, capital needs and rating considerations.
- The annual asbestos and environmental reserve studies were scheduled for the second quarter of 2015.
- Moody’s upgraded the financial strength ratings of Hartford Fire Insurance Company and Hartford Life and Accident Insurance Company, and upgraded the holding company’s senior debt and commercial paper ratings on April 23, 2015. Outlooks were stable.
Risks, contingencies and unusual items
- Asbestos and environmental net reserves were approximately $1.92 billion, within an estimated range of $1.5 billion to $2.3 billion. Management stated that ultimate liabilities could exceed recorded reserves and that additional amounts could materially affect results and liquidity.
- A mutual funds litigation matter alleges excessive advisory and distribution fees. Discovery was ongoing, the potential loss could not reasonably be estimated, and the defendants expected to seek summary judgment in Q2 2015.
- Derivative agreements could require additional collateral or settlement following financial-strength rating downgrades. A one-level downgrade was estimated to require approximately $1 million of additional collateral and a two-level downgrade approximately $8 million, based on March 31 market values.
- The company remained exposed to interest-rate, equity-market, credit-spread, foreign-exchange, catastrophe, reinsurance-counterparty and policyholder-behavior risks. Variable annuity guarantees and hedging programs can create significant GAAP earnings volatility.
- The investment portfolio included $60.6 billion of fixed maturities available for sale and $273 million of gross unrealized losses on available-for-sale securities. Management concluded the securities were temporarily impaired and expected to recover their amortized cost.
- Energy-sector investments represented approximately 4% of total invested assets and had been reduced during Q1 because of continued oil-price declines. Emerging-market exposure represented approximately 2% of invested assets.
- The company held substantial deferred tax assets, including expected benefits from net operating loss, foreign tax and capital loss carryforwards. Realization depends on future taxable income and tax-planning actions.
Most important facts for investors to verify
- Whether property and casualty underlying combined ratios improve after the comparison is no longer distorted by the 2014 New York assessment benefit.
- Future reserve development, particularly commercial auto, asbestos and environmental claims, and the results of the Q2 2015 reserve studies.
- The pace of Talcott Resolution runoff, variable annuity net outflows and the effect on fee income, DAC amortization and guarantee exposure.
- Investment portfolio credit performance, especially energy, emerging-market, structured-credit and commercial-real-estate exposures.
- The sustainability of operating cash flow, holding-company liquidity, share repurchases, dividends and planned debt reductions.
- Potential GAAP and statutory capital effects from interest-rate, equity-market and volatility changes, including variable annuity hedge performance.
- Developments in the mutual funds litigation, reinsurance recoverability and any rating-related collateral requirements.