Business Context and Reporting Period
The Hartford Financial Services Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2011. The company is an insurance and financial services holding company with four divisions: Commercial Markets, Consumer Markets, Wealth Management, and Runoff Operations. Its products include property and casualty insurance, group benefits, life insurance, annuities, retirement plans, mutual funds, and investment management. At year-end, total assets were $304.1 billion, stockholders’ equity was $22.9 billion, and the company had approximately 24,400 employees.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total revenues | $21.859 billion | $22.049 billion | Down $190 million |
| Earned premiums | $14.088 billion | $14.055 billion | Up $33 million |
| Fee income | $4.750 billion | $4.748 billion | Essentially flat |
| Net investment income | $2.913 billion | $3.590 billion | Down $677 million |
| Net realized capital gains/(losses) | $(145) million | $(611) million | Improved $466 million |
| Net income | $662 million | $1.680 billion | Down $1.018 billion |
| Net income available to common shareholders | $620 million | $1.165 billion | Down $545 million |
| Diluted EPS | $1.30 | $2.49 | Down $1.19 |
| Operating cash flow | $2.274 billion | $3.309 billion | Down $1.035 billion |
| Total debt | $6.216 billion | $6.607 billion | Down 6% |
Continuing operations generated net income of $576 million, compared with $1.744 billion in 2010. The effective tax rate was unusual at (150%), reflecting a tax benefit, including deferred tax valuation allowance releases and dividends-received-deduction items.
Stockholders’ equity increased 13% to $22.9 billion, primarily because accumulated other comprehensive income improved from a $1.001 billion loss to a $1.157 billion gain. The improvement largely reflected higher valuations of available-for-sale securities as interest rates declined.
Segment Performance
- Property & Casualty Commercial: Net income declined to $528 million from $995 million. The combined ratio deteriorated to 104.5% from 89.7%, while the combined ratio before catastrophes and prior-year development increased to 97.2% from 93.4%.
- Group Benefits: Net income declined to $90 million from $185 million. The loss ratio increased to 79.5% from 77.6%, driven by higher mortality and morbidity.
- Consumer Markets: Net income declined to $5 million from $143 million. The combined ratio increased to 101.5% from 99.0%, despite improvement in the ratio before catastrophes and prior-year development to 92.2% from 93.6%.
- Wealth Management: Net income declined to $232 million from $935 million. Individual Annuity lost $14 million versus income of $527 million, primarily because of an unfavorable Unlock and higher variable-annuity hedge losses.
- Life Other Operations: Net income improved to $358 million from a $90 million loss, aided by favorable international hedging results and lower impairment losses.
- Property & Casualty Other Operations: Net loss increased to $117 million from $53 million, primarily because of higher asbestos reserve strengthening.
Material Changes Versus the Prior Period
- The company recorded a $530 million after-tax Unlock charge in 2011, compared with a $111 million benefit in 2010. The charge reflected lower projected future gross profits, higher Japan and U.S. variable-annuity hedging costs, and actual separate-account returns below assumptions.
- Current accident-year catastrophe losses increased to $484 million after tax from $294 million, mainly from tornadoes, windstorms, Hurricane Irene, and winter storms.
- Prior accident-year property and casualty reserves were strengthened by $31 million after tax, compared with a $294 million release in 2010. Workers’ compensation deterioration was a principal contributor.
- Net asbestos reserve strengthening increased to $189 million after tax, compared with $110 million in 2010. Net asbestos reserves were approximately $1.9 billion at year-end; net environmental reserves were $328 million.
- The company recorded a $73 million after-tax charge for discontinued policy-administration software costs and a $30 million pretax goodwill impairment in Property & Casualty Commercial.
- Net investment income declined because of a $1.359 billion loss on trading equities supporting international variable annuities and lower yields on fixed maturities. Variable-annuity hedge results were volatile: the U.S. program produced a $613 million loss, partly offset by a $775 million gain from international programs.
- The company formed the Runoff Operations division and continued reviewing its strategy and business portfolio, including potential restructurings, divestitures, runoffs, or separation of property and casualty and life businesses. No separation decision had been made as of the filing.
Cash, Debt, Liquidity, Guidance and Risks
Year-end cash was $2.581 billion. The holding company had approximately $1.6 billion of cash, short-term investments, and fixed maturities available for liquidity needs. Expected holding-company requirements for the next twelve months included approximately $480 million of interest, $170 million of common dividends, and $42 million of preferred dividends. The company had no commercial paper outstanding and maintained $3.9 billion of combined commercial-paper and revolving-credit capacity at year-end. In January 2012, it replaced the $1.9 billion facility with a $1.75 billion revolving credit facility maturing in 2016.
Management expected 2012 Property & Casualty Commercial written-premium growth of low to mid-single digits and a combined ratio before catastrophes and prior-year development in the mid-to-upper 90s. Group Benefits premiums were expected to decline, with the loss ratio improving from 79.5%. Consumer Markets written premiums were expected to decline, while the underlying combined ratio was expected to be flat to slightly lower. Management expected portfolio yields excluding limited partnerships to remain relatively consistent with 2011.
- Major exposures include equity markets, interest rates, credit spreads, foreign exchange, real estate valuations, variable-annuity guarantees, and hedging effectiveness.
- Statutory surplus declined to $14.8 billion from $15.5 billion. Life subsidiaries’ statutory surplus was expected to be flat to negative in 2012, primarily because of variable-annuity hedge losses, low interest rates, and Group Benefits loss trends.
- Insurance reserves remain highly judgmental. A 3% change in workers’ compensation loss-development patterns could change estimated reserve needs by approximately $400 million; a 2.5-point change in recent auto-liability severity could change reserve needs by approximately $80 million.
- Derivative agreements could require additional collateral after ratings downgrades. A one-level downgrade could require approximately $37 million of additional collateral and a two-level downgrade approximately $48 million, based on year-end market values.
- Other risks include reinsurer default, asbestos and environmental claims, catastrophes, litigation, regulatory changes including Dodd-Frank, tax-law changes affecting the separate-account dividends-received deduction, cyber or systems failures, and potential goodwill or deferred-tax-asset impairments.
Investor Verification Checklist
- Verify the sustainability of 2011 earnings excluding the $530 million Unlock charge, catastrophe losses, reserve development, discontinued operations, and other unusual items.
- Reconcile statutory capital and risk-based-capital trends with GAAP equity, particularly for the life subsidiaries and variable-annuity guarantees.
- Review workers’ compensation, asbestos, and environmental reserve adequacy, including the disclosed sensitivity ranges and reinsurance collectability.
- Assess variable-annuity hedge effectiveness and sensitivity to equity markets, interest rates, implied volatility, and the Japanese yen.
- Confirm the impact of the 2012 deferred-acquisition-cost accounting adoption, which management estimated would reduce year-end 2011 equity by approximately $1.5 billion after tax.
- Evaluate liquidity at the holding company and insurance-subsidiary levels, including dividend restrictions, debt maturities, collateral requirements, and the replacement revolving-credit facility.
- Monitor the ongoing strategic portfolio review, the proposed PPLI transaction, Wellington Management’s mutual-fund role, and unresolved mutual-fund litigation.