Important disclosures appear on the last page of this report. The Henry Fund Henry B. Tippie School of Management Qian Wang [[email protected]] The Hartford Financial Services Group, Inc (HIG) April 16, 2016 Financial Services – Property & Casualty Insurance Stock Rating HOLD Investment Thesis Target Price $48 In 2015, HIG increased its income by 110.8% YOY from $798 million to $1,682 million and has been upgraded by all rating bureaus such as Moody’s. HIG has been actively seeking growth opportunity both organically and inorganically, such as launching a new energy practice under its commercial lines and acquiring Maxum Specialty Insurance Group (Maxum) in 2016. Currently HIG has a P/E ratio around 11.2, which is lower than the Property and Casualty (P/C) Insurance industry average. The overall operating environment is favorable for P/C insurers. Thus we recommend to continue holding HIG. Drivers of Thesis Growing auto and housing sales have been boosting policy sales in 2015, and they are continuing in 2016. We expect the personal lines to grow at an annual rate of 2.43% in the following five years. HIG’s acquisition of Maxum and set-up of the new energy practice under the commercial lines will strengthen HIG’s market share in this area. The application of new technology drives efficiency, makes better predictions, and optimizes underwriting standards. HIG can keep or decrease its combined ratio before catastrophe before industry’s average 92.6%. Risks to Thesis The changing climate conditions make it more difficult to predict incidence and severity of catastrophes, which leaves room for uncertainty. The occurrence of severe catastrophes may largely bring down HIG’s profit. Over the long-term, decreasing oil and gasoline price, slowing of the global economy, and low interest rates may have negative impact on the investment income. Henry Fund DCF $43.92 Henry Fund DDM $39.06 Relative Multiple P/E $51.02 Price Data Current Price $46.09 52wk Range $36.54 – 50.95 Consensus 1yr Target $49.80 Key Statistics Market Cap (B) $18.34 Shares Outstanding (M) 396.7 Institutional Ownership 89.9% Beta 1.048 Dividend Yield 1.82% Est. 5yr Growth 7.01% Price/Earnings (TTM) 11.2 Price/Earnings (FY1) 10.8 Price/Book (mrq) 0.95 Price/Tangible Book 0.97 Profitability Operating Margin 12.8% Profit Margin 9.1% Return on Assets (TTM) 0.62% Return on Equity (TTM) 9.2% Earnings Estimates Year 2013 2014 2015 2016E 2017E 2018E EPS $0.37 $1.81 $4.05 $3.83 $4.17 $4.03 growth -305.6% 389.2% 123.8% -5.3% 8.8% -3.4% 12 Month Performance Company Description The Hartford Financial Services Group, Inc started as a fire insurance company in 1810. Headquartered in Hartford, CT, now it mainly provides property and casualty insurance, group benefits, and mutual funds services. In 2015, the Hartford had $11.1 billion net premiums written (NPW), which accounted for 1.90% market share, and ranked the 12 th in the U.S by NPW. 1 11.2 9.2 7.7 12.8 10.0 9.4 12.7 10.4 16.5 0 5 10 15 20 P/E ROE EV/EBITDA HIG P&C Insurance Financials Source: Yahoo Finance & Factset -15% -10% -5% 0% 5% 10% 15% 20% A M J J A S O N D J F M HIG S&P 500 Source: Yahoo Finance
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The Hartford Financial Services Group, Inc (HIG) April 16, 2016 · The Hartford Financial Services Group, Inc started as a fire insurance company in 1810. Headquartered in Hartford,
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Important disclosures appear on the last page of this report.
The Hartford Financial Services Group, Inc (HIG) April 16, 2016
Financial Services – Property & Casualty Insurance Stock Rating HOLD
Investment Thesis Target Price $48 In 2015, HIG increased its income by 110.8% YOY from $798 million to $1,682 million and has been upgraded by all rating bureaus such as Moody’s. HIG has been actively seeking growth opportunity both organically and inorganically, such as launching a new energy practice under its commercial lines and acquiring Maxum Specialty Insurance Group (Maxum) in 2016. Currently HIG has a P/E ratio around 11.2, which is lower than the Property and Casualty (P/C) Insurance industry average. The overall operating environment is favorable for P/C insurers. Thus we recommend to continue holding HIG. Drivers of Thesis
Growing auto and housing sales have been boosting policy sales in
2015, and they are continuing in 2016. We expect the personal lines
to grow at an annual rate of 2.43% in the following five years.
HIG’s acquisition of Maxum and set-up of the new energy practice
under the commercial lines will strengthen HIG’s market share in
this area.
The application of new technology drives efficiency, makes better predictions, and optimizes underwriting standards. HIG can keep or decrease its combined ratio before catastrophe before industry’s average 92.6%.
Risks to Thesis
The changing climate conditions make it more difficult to predict incidence and severity of catastrophes, which leaves room for uncertainty. The occurrence of severe catastrophes may largely bring down HIG’s profit.
Over the long-term, decreasing oil and gasoline price, slowing of the global economy, and low interest rates may have negative impact on the investment income.
Henry Fund DCF $43.92 Henry Fund DDM $39.06 Relative Multiple P/E $51.02 Price Data Current Price $46.09 52wk Range $36.54 – 50.95 Consensus 1yr Target $49.80 Key Statistics Market Cap (B) $18.34 Shares Outstanding (M) 396.7 Institutional Ownership 89.9% Beta 1.048 Dividend Yield 1.82% Est. 5yr Growth 7.01% Price/Earnings (TTM) 11.2 Price/Earnings (FY1) 10.8 Price/Book (mrq) 0.95 Price/Tangible Book 0.97 Profitability Operating Margin 12.8% Profit Margin 9.1% Return on Assets (TTM) 0.62% Return on Equity (TTM) 9.2%
Earnings Estimates Year 2013 2014 2015 2016E 2017E 2018E
EPS $0.37 $1.81 $4.05 $3.83 $4.17 $4.03
growth -305.6% 389.2% 123.8% -5.3% 8.8% -3.4%
12 Month Performance Company Description
The Hartford Financial Services Group, Inc started as a fire insurance company in 1810. Headquartered in Hartford, CT, now it mainly provides property and casualty insurance, group benefits, and mutual funds services. In 2015, the Hartford had $11.1 billion net premiums written (NPW), which accounted for 1.90% market share, and ranked the 12th in the U.S by NPW.1
11.2
9.27.7
12.8
10.0 9.4
12.7
10.4
16.5
0
5
10
15
20
P/E ROE EV/EBITDA
HIG P&C Insurance Financials
Source: Yahoo Finance & Factset
-15%
-10%
-5%
0%
5%
10%
15%
20%
A M J J A S O N D J F M
HIG S&P 500
Source: Yahoo Finance
EXECUTIVE SUMMARY
2015 was a strong year for HIG, which had a phenomenal 110.8% YOY net income increase from $798 million to $1,682 million. Its P/C written premium increased 3% over the prior year, comprised of 3% growth in Commercial Lines and 4% in Personal Lines. The lower interest rate, lower oil price, and improving job market have boosted auto and housing sales, and there were less catastrophes compared with that in previous two years. As oil price may stay around $40 per barrel and Fed will increase the interest rate, the auto and housing sales are expected to grow at a relatively slower rate in the following two years.
Meanwhile, HIG has been selling off its annuity business since its current CEO Chris Swift has been in position in 2014 and trying to focus its growth in P/C lines. Within the past four months in 2016, HIG has already announced two business plans to grow its commercial lines. The first one is the acquisition of Maxum for $170 million in cash by 2016 Q3 with the aim to expand small enterprise segment. The second one is that HIG hired Zurich’s former vice president Ric Pena to lead the newly-created energy practice to include power and utilities besides the existing renewable energy. We believe these two plans will help HIG’s commercial achieve an average 2% annual rate in the following five years.
Besides organic/inorganic growth plans of its core operations, HIG has a $4.375 billion authorization for equity repurchases from 2014 through 2016. It announced $1.3 billion repurchase plan in 2016, which we believe will help to stabilize the stock price if not increase. Overall, HIG is seeing positive growth in its core operation profit, though there is uncertainty of devastative catastrophe that will largely bring down HIG’s profit. Thus, we recommend to continue holding HIG as we believe it is outperforming its peers and the current operating environment is favorable for P/C insurance industry.
COMPANY DESCRIPTION
HIG is a P/C insurance provider headquartered in Hartford, Connecticut. It mainly provides commercial lines, personal lines, group benefit, and workers’ compensation products. It was recognized by J.D. power for delivering outstanding services to customers, and also launched mobile app in Apr 2015 to keep the pace of new technologies. Meanwhile HIG was trying hard to improve the underwriting of its two largest lines – commercial and personal, thus to grow its P/C business. By focusing on generating new business in these profitable areas, HIG was able to expand overall
margins and improve the combined ratio. Currently HIG is trading below its book value, with P/BV ratio at 0.95 and P/TBV ratio at 0.97, while the industry average is 1.3 and 1.5 respectively.4 In 2015, HIG had $11,135 million net written premiums (NWP) and ranked 12th in the US.
Commercial
Lines35%
Personal Lines
21%
Group
Benefits17%
Mutual Funds
4%
Investment17%
Other
6%
2015 REVENUE BY SEGMENT
Source: HIG 10K
Commercial Lines
Accounting for more than 35% revenues in 2015, the Commercial Lines is the largest driver for the profit of HIG and it is growing strongly especially in recent two years. It provides workers’ compensation, property, automobile, marine, livestock, liability, and umbrella coverage primarily throughout the U.S., along with a variety of customized insurance products and risk management services including professional liability, bond, surety, and specialty casualty coverage. In small commercials, the written premiums grew by 4% while the underlying combined ratio stayed below 90. Construction and service sectors are positives, but manufacturing, energy, and commodities face headwinds. In middle market, there has been a strong new business growth and profitability in construction and marine.5 Workers’ compensation began to improve in 2012. The underwriting results deteriorated markedly in 2007 and 2010 and the extreme high revenue% in below chart in 2008 was due to the negative revenue from investment in that year. The growth rate in commercial lines has been fluctuating in the past five years within the range of -0.89% to 6.67%. We expect around 3% growth rate in 2016, with the acquisition of Maxum and the set-up of the new energy practice, which are discussed in more details in the recent developments section.
Page 3
20%
30%
40%
50%
60%
70%
$5,200
$5,400
$5,600
$5,800
$6,000
$6,200
$6,400
$6,600
$6,800
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Commercial Line Revenue
Revenue $ Total Revenue%
Source: HIG 10K. ($in millions)
Personal Lines
Contributed $185 million in core earnings, personal lines is the 2nd largest contributor after commercial lines to HIG’s revenue. It provides standard automobile, homeowners and personal umbrella coverage to individuals, including a special program designed exclusively for members of AARP (American Association of Retired Persons). Since summer 2015, there has been strong growth in personal lines due to the boosting auto and housing sales. The combined ratio raised 1.4 points to 92 though, due to higher auto loss costs and non-weather loss in homeowners. Due to the cheap oil and gasoline price, which also leads to higher disposable income and more miles driven, the stronger economy, and the improving job market, U.S. car sales set record high in 2015, clearing a peak last reached 15 years ago, while the sales have been skewed toward higher light truck volumes.6 The growth rate in personal lines has been fluctuating in the past five years within the range of -5.07% to 3.99%. We expect continuing positive growth in personal lines’ premiums with an average annual rate of 2.43% in the following five years.
10.0%
20.0%
30.0%
40.0%
50.0%
$3,400
$3,500
$3,600
$3,700
$3,800
$3,900
$4,000
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Personal Line Revenue
Revenue $ Total Revenue%
Source: HIG 10K. ($in millions)
Group Benefits
Group Benefits provides employers, associations and financial institutions with group life, accident and disability coverage, along with other products and services, including voluntary benefits, and group retiree health. Group Benefits after-tax core earnings margin, excluding buyouts, increased to 5.2% from 4.3% in 2015. The revenue from group benefits line keeps decreasing with a rate range between -12.6% and 1.32%. As HIG focuses more of its business development in commercial and personal lines and we do not foresee any significant business growth opportunity in this segment, we expect 5.9% decrease in this segment in 2016, which is the average decreasing rate within last five years.
Mutual Funds
Mutual Funds offers investment products for retail and retirement accounts and provides investment management and administrative services such as product design, implementation, and oversight. This business also includes a portion of the run off of the mutual funds which support the Company's variable annuity products. This is a relatively small component of HIG’s total revenue, and in the past 10 years, the growth rate has been as high as 28.19% or as low as -16.18%. We expect it to stay relatively stable at an annual growth rate of 2.93% in the following five years.
Investment
Since 2008, HIG has been selling its trading equity securities, leading fixed maturities to being the first place in its investment portfolio. In 2015, HIG invested more than 80% in fixed maturities. With the decreasing oil price affecting energy companies’ profit, the energy-related investment has been a headache on any company’s balance sheet. HIG proactively reduced its holdings of energy-related securities by $1.2 billion to $2.5 billion in 2015, which also led to higher exposure to BB and above bonds than B and below as many energy companies had been downgraded.9
Policy loans LP and other alternatives Other investments
Short-term investments Equity securities, trading
Source: HIG 10K ($in millions)
The declining investment income in trading equity
securities resulted primarily from declines in market
performance of the underlying investment funds
supporting the Japanese variable annuity product. Net
investment income decreased by 3.4% to $3,154
million compared to the prior year and a 50% shrink since
it bounced back to $7,205 million in 2009, which was
primarily due to a decrease in income from fixed
maturities as a result of a decline in asset levels, primarily
in Talcott Resolution and lower income from repurchase
agreements.10 The overall investment yield has been
steady at 4% after it peaked at 8% in 2007, and we expect
it to stay at 4%.
-40.0%
-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
$(12,000)
$(10,000)
$(8,000)
$(6,000)
$(4,000)
$(2,000)
$-
$2,000
$4,000
$6,000
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Investment Income & Yield
Total securities AFS and other Equity securities, trading
Total securities AFS and other Equity securities, trading
Source: HIG 10K ($in millions)
Talcott Resolution
Talcott Resolution is comprised of runoff business from
the Company's individual annuity, institutional, and
private-placement life insurance businesses. The
Company's individual annuity business consists of variable,
fixed, and payout annuity products. In addition, Talcott
Resolution includes the retained yen denominated fixed
payout annuity liabilities, as well as the Company's
discontinued operations from the Hartford Life Insurance
K.K. (HLIKK) in Japan prior to its sale in 2014. Talcott
Resolution after-tax income from continuing operations
was $370, down from $414 in 2015.
Catastrophe Losses
In 2015 the catastrophe losses of HIG totaled $332 million,
compared to $341 million in 2014, both before tax.
Catastrophe losses for both years were primarily due to
winter storms and wind and hail events across the country.
The incidence and severity of catastrophes are inherently
unpredictable7. Some scientists believe that in recent
years, changing climate conditions have added to the
unpredictability and frequency of natural disasters. These
uncertainties bring a lot of risk. The geographic
distribution of its business subjects HIG to catastrophe
exposure for events occurring in a number of areas,
including, but not limited to, hurricanes in Florida, the Gulf
Coast, the Northeast and the Atlantic coast regions of the
United States, tornadoes in the Midwest and Southeast,
earthquakes in California and the New Madrid region of
the United States, and the spread of disease11. In recent
three years, the catastrophe losses have been decreased
by more than 50%. The main catastrophe in 2011 and 2012
were Hurricane Irene, Tropical Storm Lee, and Storm
Sandy. Below chart shows in recent three years, the
catastrophe losses dropped more than 50%, mostly due to
less tornadoes and winter storms. In 2015Q3, HIG missed
its revenue by $0.12 per share due to a 10% decline in net
investment and higher catastrophe losses (two large
California wildfires).2 It led to almost 25% drop in its stock
Page 5
price between Oct 2015 and Jan 2016. The total benefits
and losses expense as percentage of earned premiums
decreased from 96.76% in 2012 to 79.36% in 2015. We
expect it to stay around 80% in the following five years.
$- $100 $200 $300 $400 $500 $600 $700 $800
2011
2012
2013
2014
2015
Wind and Hail Winter storms Tornadoes Other
Source: HIG 10K. ($in millions)
RECENT DEVELOPMENTS
2015 HIG Development
2015 was a strong year for HIG, which had a phenomenal 110.8% YOY net income increase from $798 million to $1,682 million. There are three main contributors. First, there was a $560 million decrease in the loss from discontinued operations on the sale of the Japan variable annuity business in 2014. Second, there was a 3% increase in total earned premiums. Third, there was a $36 million federal income tax benefit lowering the effective tax rate from 20.60% to 15.42% YOY.3
Historically HIG primarily operates in the east coast. However, since Q4 2014, it hired 24 new middle market underwriters with expansion into Midwest and Western US.
Source: HIG 101 Mar 2016 Report
HIG has been investing in market-leading back-office support, such as policy administration system, claims system, and predictive analytics. The integrating data and analytics in the underwriting and claims process can improve efficiency and customer/partner experience. The P/C, Group Benefits, and Mutual Funds are generating ROEs much higher than the Talcott Resolution. HIG is expecting to continue to run-off of Talcott organically.
Source: HIG 101 Mar 2016 Report
Shifting to pure P/C Insurer
The sale of its Japan variable annuity business and the
continued runoff of the Talcott Resolution annuity
business indicated that HIG has successfully narrowed its
focus on P/C insurance, which enabled it to excel. In 2012,
HIG announced that it would divest its individual life and
variable annuities business to focus on core business. In
2014, HIG sold HLIKK to ORIX Life Insurance Corporation,
which is a financial services group headquartered in
Minato, Japan, for $895 million. It brought HIG
approximately $860 million capital benefit including the
net sales proceeds. Besides the sale of HLIKK and Talcott,
HIG also sold its Retirement plans and Individual Life
Insurance business in Jan 2013 and its UK variable annuity
business – the Hartford Life International Limited (HLIL) in
Dec 2013 to Berkshire Hathaway for approximately $285
Page 6
million cash, which helped HIG lower its expenses and free
up more capital. 12 HIG’s existing CEO Chris Swift has been
in position since 2014, but has no significant business
initiatives besides the stock repurchase plan. Finally, in
March and April this year, HIG announced two business
plans, which we believe will help grow the commercial
lines.
The first one is the acquisition of Maxum for $170 million
in cash by 2016 Q3 with the aim to expand small enterprise
segment. Maxum is a Georgia-based provider of
commercial insurance and it will operate as a separate unit
under HIG’s small commercial business. With only 12
years’ history, Maxum already has $114.6 million statutory
surplus. This acquisition, said by HIG’s president Doug
Elliot, “will accelerate HIG’s efforts to build upon its
market-leading position in small commercial by expanding
its product offerings and capabilities”.
The second one is that HIG hired Zurich’s former vice
president Ric Pena, who has more than 25 years of related
underwriting, sales, and national leadership experience, to
lead the newly-created energy practice to include power
and utilities besides the existing renewable energy under
commercial lines. With this new segment, HIG is aiming to
offer better tailored risk management solutions to energy
companies and increase its commercial line revenues.
Though currently energy industry is in its downturn and oil
price may remain low in the following two years, we
expect this new practice will bring positive growth for HIG
in the long-term and it also shows the management of HIG
are focusing on developing strategies to continue growing
its P/C lines.
INDUSTRY TRENDS
The U.S. insurance industry’s net premiums written totaled $1.1 trillion in 2014, with premiums recorded by life/health (L/H) insurers accounting for 56 percent and premiums by P/C insurers accounting for 44 percent, according to SNL Financial.16 The P/C insurance industry is a well-developed industry with generally standardized policy and regulations. However, along with some regulation changes, there also have been some changes to
policies, such as the separation of flood insurance and terrorism insurance.
Source: Statista (in $billions)
The profitability of P/C insurance shows strong cyclicality. When the economy is good and companies have enough capital, they will usually lower the price to write more policies in order to get the market share and capital for investment. The price war will eventually lower the industry’s profit margin, thus companies have to raise rates to stay profitable. Historically, the ROE of the P/C insurance industry peaked very 8-10 years. Below chart shows the historical ROE of P/C insurance industry. It suggests next ROE peak will be in 2016-2017.
ROE of US P/C Insurance Industry
Source: Insurance Information Institute
Terrorism Insurance
While last year started with uncertainty around terrorism insurance, the passage of the federal Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA) brought greater certainty to organizations that depend on such coverage. Insurers continue to closely monitor aggregate exposures for central business districts in major cities. Some companies are turning to standalone terrorism insurance marketplace, which can be more
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2009 2010 2011 2012 2013 2014* 2015*
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1977:19.0%1987:17.3%
1997:11.6% 2006:12.7%
1984: 1.8% 1992: 4.5% 2001: -1.2%
9 Years
1975: 2.4%
2013 9.8%
2014 8.2%
2015E: 8.8%
Page 7
competitive than TRIPRA coverage18. Without this backstop in place, many high-profile properties would not be insurable in the commercial marketplace. However, workers' compensation is also deeply impacted, as there are large amounts of people working in highly concentrated areas19.
Arising Competition
ACE acquired Chubb in July 2014 for $28.3 billion, which
was the biggest ever deal for the insurance industry8. Allianz, Berkshire Hathaway, AXA, and Travelers also
expressed interest back then, which means there may still
be potential M&A activities in P/C insurance industry in
following years. M&A activity in 2015 reached its highest
level since 1998. Globally, across all sectors, M&A activity
exceeded $200B14. Below chart shows the M&A deal value
in recent 20 years. 1998 witnessed the largest M&A
activities with $55,825 million deals. The M&A activity is
up sharply in 2015.
M&A Activities in US P/C Insurance Industry
Source: Insurance Information Institute ($in millions)
Companies like HIG, which is trading below its book value,
will definitely be attractive to investors. As currently we
are in an increasing interest rate cycle and financial
services companies have been steadily recovering from
the financial crisis, P/C insurers may have to lower their
price to get more cash flow so as to increase the
investment portfolio and invest the proceeds at higher
rates and they also have enough capital to do so. Thus, we
are expecting an intense pricing competition in the P/C
insurance industry, which will eventually pull down the
margin for all players.
Low Investment Yield
Investment performance is a key driver of profitability. Depressed yields will necessarily influence underwriting & pricing. Due to persistent low interest rates, investment income fell in 2012, 2013, and 2014, and is still below the 2007 pre-crisis peak. The FED has raised interest rate in Dec, 2015, which helped improve the investment income last year.
Total Investment Income of US P/C Insurance Industry
Source: Insurance Information Institute ($in billions)
New Technology
New technology is shaping many industries as well as the P/C insurance industry. The big data analytics helps companies to build more precise forecasting models and underwriting standards, thus improve the combined ratio (before catastrophe). As smart phones, tablets, computers are more and more popular, more customers like purchasing their insurance through on-line channel. According to a research conducted by PwC, cyber insurance premiums written could more than triple to $7.5 billion by 2020, thus on-line customer experience becomes more important and it is easier for customers to compare prices and policies. To keep in trend, HIG launched its mobile app in Apr 2015.
Source: PWC; Insurance Information Institute ($in billions)
The development of “Sharing Economy”, such as UBER, AirBnB, and Task Rabbit, also has big impact of the P/C insurance industry. The insurance gaps in lines such as auto and home require new insurance solutions.
Auto insurance is the largest P/C line. 2015 witnessed a record high auto sales in recent 15 years, and we are expecting the auto sales to continue boosting in following two years due to the pent-up demand and favorable economy environment15. However, if Fed is going to increase the interest rate in the following two years, it will slow down the auto sales increasing rate, as the financing cost for customers will increase. more and more vehicles are with fully autonomous models and new technologies are improving the safety of driving, and eventually we may realize “hands-free”. By then, there may be new liability question and challenges for P/C insurers to solve.
MARKETS AND COMPETITION
There are 2,583 P/C insurance companies in 2014 in the US. P/C insurance consists primarily of auto, home, and commercial insurance. The top 25 companies by NWP accounted for 64.55% market share. HIG ranked the 12th on this list, a similar position as Chubb and CNA. The competition is fierce in this industry. Thus companies often have to lower their price to attract more premiums to investment for a higher return. Taking more than 10% of the market share, which almost equaled the total market share of companies in the second and the third place, State Farm has been the No.1 auto insurer in the US since 1942. It is not a public company and its surplus belongs to policyholders. State Farm is a typical example of lowering price to attract more customers. In recent three years, the average underwriting loss of State Farm is $2,200 million, and the investment income led to a
positive net income at $1,400 million on average. Due to the strict regulations and well-developed structure, the insurance policies among different companies are quite similar. Besides price, companies usually compete in services. HIG has been recognized for claims excellence in 2015.17
Source: National Association of Insurance Commissioners
Peer Comparisons
Allstate is the largest publicly traded P/C insurer in the US.
In 2011, it acquired two insurance businesses - Esurance, a
well-known brand in the US private vehicle insurance
market, and Answer Financial, an independent personal
insurance company that gives Allstate a stronger position
with self-directed customers who want a choice between
insurance carriers. During the past five years, its revenue
increased at an annualized rate of 2.7% to $30.1 billion. Its
profitability increased sharply as net income margin grew
from 1.5% of revenue in 2011 to an estimated 8.1% in
2015.20
Liberty Mutual is the third largest public traded P/C insurer
in the US. It has a more international presence as it has a
stake in, or owns, local insurance companies in Argentina,
$1.5$2.0
$7.5
$0
$1
$2
$3
$4
$5
$6
$7
$8
2014 2015E 2020F
Page 9
Brazil, Chile, China, Columbia, India, Poland, Portugal,
Singapore, Spain, Thailand, Turkey, Venezuela and
Vietnam. In 2014, the company's international market is
anticipated to account for 28.5% of its total revenue.
During the past five years, its revenue increased at an
annualized rate of 3.8% to $28.3 billion.
HIG may still have market share and revenue growth gaps compared with the larger insurers. However, in the most recent one year, HIG’s stock returns largely outperformed its main competitors and S&P 500. The CNA Insurance has similar market share and P/BV ratios as HIG. However, its stock return was down by almost 40% in February 2016.
Due to the blurry definition of debt and lack of capital
expenditures and depreciation, price to book ratio is a
good indicator when evaluating financial services industry.
In 2015 Q3, the price to book ratio of the P/C insurance
industry is 0.90. Compared with previous three quarters’
average ratio of 0.98, it indicates that the P/C insurance
industry overall may be underpriced. Meanwhile,
companies such as Allstate, Hartford, and LOEWS also had
a below 1 price to book ratio in 2015Q3.15
Source: Factset
In the recent two years, the combined ratio of HIG improved significantly and dropped below industry’s in 2015, which is mostly due to better predictions, optimized underwriting criteria, and less catastrophe. Overall HIG shows positive growth and it is relatively undervalued compared with its peers.
Source: Factset
In 2015, HIG had a 9.25% ROE, similar to Allstate and Chubb. Though CNA is similar to HIG in terms of market share, HIG outperformed CNA regarding its profitability and operating effectiveness.
Source: Bloomberg
Chubb is outstanding in operating margin.
Source: Bloomberg
-40%
-30%
-20%
-10%
0%
10%
20%
A M J J A S O N D J F M
S&P500 HIG C-N-A Allstate Chubb
Source: Yahoo Finance
9.25
3.9
10.619.65
0
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4
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HIG CNA Allstate Chubb
ROE in 2015
12.71
7.7410.02
18.94
0
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10
15
20
HIG CNA Allstate Chubb
Opearting Margin in 2015
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Though HIG only had half of Allstate’s or Chubb’s market share, its net income in 2015 only lagged Allstate’s by 25%.
Source: Bloomberg
ECONOMIC OUTLOOK
Interest rates will affect HIG’s both investment income and policy premium. With the increase in the fed funds rate, the 1-yr T-Bill and the 10-yr T-Bond yields are expected to increase over the next three years and reached a full normalization of interest rates around 2019. Theoretically the increasing interest rate will benefit HIG with potentially higher investment yield. Historically, however, HIG’s investment yield has remained around 4% despite the macro economy. Regarding the policy premium, the increasing interest rate will also increase the cost for people who buy a house/car or lease a car through financing options. Thus we may see a decreasing auto and homeowners’ insurance market as a result of the increasing interest rate. Overall, the increasing interest rate is not favorable for HIG, unless its investment income can catch up.
Source: Insurance Information Institute
The US unemployment rate has continued to decline with the Dec 2015 rate being reported at 5.0%, and the disposable income has been increasing since 2013. It will
help boost both auto sales and housing sales at least in the following two years. The disposable income has a compound growth rate at 1.5% between 2011-2016 and is forecasted to be 1.9% between 2016 and 2021 by IBIS World. Good job market is essential to higher disposable income, which will lead to higher auto and home sales.
US Per Capita Disposable Income
Source: IBIS World
Oil price dropped below $30 per barrel for the first time since 2001, and it boosted the auto sales and miles driven during 2015. With the sanction on Iran has been lifted, it is foreseen that there will be a supply surplus. OPEC countries discussed the possibility of freeze production from now until Oct 2016 in Doha on April 17th, 2016, however they have not reached an agreement, which may not come true in the near future either. We forecast the oil price will remain below $60 per barrel in the following two years. Because the cost of oil per barrel for shale oil producers is $40. Currently, most shale oil producers reduce production or even went bankruptcy because the price could not cover their cost. Once the oil price arises above $40, shale oil producers will join the game again. With higher supply, the oil price is likely to drop again until it reaches the equilibrium.
1682
479
2055
2834
0
500
1000
1500
2000
2500
3000
HIG CNA Allstate Chubb
Net Income in 2015
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Source: EIA
The construction sector is critical to the economy and the P/C insurance industry. There is an increasing trend in both private residential and private non-residential construction. The new construction peaked at $912 billion in 2006. In 2015, the new construction hit $828 billion, up by 65.4% since 2010 and only 9.1% away from the record in 200613. Job growth, low inventories of existing homes, still-low mortgage rates and demographics should continue to stimulate new home construction for several more years.
Source: US Department of Commerce; Insurance Information Institute (in $billions)
CATALYSTS FOR GROWTH
• Increasing auto and housing sales, especially in new vehicle sales and leasing, are bringing higher unit written premium and policy volume to the auto insurance line. As long as interest rate will not increase significantly and job market stays optimistic, we expect steady growth of personal lines in the following two years.
• HIG has been focusing on developing its commercial lines. We expect Maxum and the new energy practice will fit in HIG’s operations well and start generating more revenues.
• The application of new technology drives efficiency, makes better predictions, and optimizes underwriting standards. HIG can keep or decrease its combined ratio before catastrophe before industry’s average 92.6%.
INVESTMENT POSITIVES
• Boosting auto sales, especially in new vehicles, are bring higher unit written premium and policy volume to the auto insurance line.
• More housing units are being sold and occupied, which dictates a strengthening market in 2016 and will bring more NWP to the homeowners’ insurance line.
• More housing units are being sold and occupied, which dictates a strengthening market in 2016 and will bring more NWP to the homeowners’ insurance line.
INVESTMENT NEGATIVES
• The incidence and severity of catastrophes are difficult to predict. With the changing climate conditions, the unpredictability and frequency of natural disasters could adversely affect P/C insurance industry’s operations, financial conditions, and liquidity.
• The global economy is fluctuating and negative interest rates could hurt the investment income. The rising competition forcing companies to lower price could eventually bring down the premiums margin.
VALUATION
We used a Discounted Cash Flow (DCF), Dividend Discount Model (DDM), and Relative Price to Earnings (P/E) analysis to value HIG. The DCF and DDM models computed stock prices of $43.92 and $39.06. For the relative P/E, P/BV, and P/TBV analysis we calculated a price based on peers, which are $51.02, $57.66, and $62.21 respectively. We believe the true value of Hartford stock is in between at $40 and $48.
The most important assumptions for the valuation model are revenue growth rates, investment amount and yield, losses and expenses, and dividend payout ratio.
Beta was from Bloomberg average 5-year weekly data, which is 1.048. In 2015, HIG’s beta was less than 1. The market risk premium used was the Henry Fund consensus
$0
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03 04 05 06 07 08 09 10 11 12 13 14 15*
Non Residential
Residential
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for 2016 (5.00%), resulting in a cost of equity equal to 7.94%.
Commercial lines are expected to grow at around 3% in 2016 benefiting from the acquisition of Maxum and set-up of the new energy practice. Personal lines are expected to grow at around 2.4% benefiting from the increasing sales of auto and houses. Mutual Funds grew more quickly in recent two years and are expected to continue growing. We used the most recent two years’ average growth rate to forecast, and for the rest lines, we used five-year average.
Though investment yield fluctuated with the financial crisis and low interest rates among different investment assets, the overall investment yield has been steady around 4%. Investment amount decreased almost 50% due to the sale of Japanese business. Investment amount growth rate was forecasted according to each investment assets using recent two years or five years’ trend.
Losses and expenses were calculated as percentage of premiums written, which is expected to stay around 80% as HIG has been improving its underwriting criteria.
Dividend payout ratio was assumed the same as that in 2015, which is around 19.26%.
KEYS TO MONITOR
As we are expecting an increasing contribution from
personal lines as a result of boosting auto and housing
sales, we should keep monitor these two markets’ trends
and also whether HIG’s personal line written premiums
increase along with the market. Another metric to pay
attention to is loss cost. With low oil price, not only the
auto sales increase, but also the average miles driven,
which could potentially increase the accident rate, thus
the claims.
For investment income, as HIG still hold energy-related
securities, we should pay to attention to any significant
drop in investment yield. It is also very sensitive to interest
rate change. A decline in interest rates reduces the returns
available on new investments, thereby negatively
impacting the Company’s net investment income.
Conversely, rising interest rates reduce the market value
of existing investments in investment grade bonds.
REFERENCES
1. National Association of Insurance Commissioners. http://www.naic.org/documents/web_market_share_160301_2015_property_lob.pdf
13. US Department of Commerce. http://www.census.gov/construction/c30/c30index.html
14. Insurance Information Institution, Outlook for P/C insurance industry. http://www.iii.org/presentation/overview-and-outlook-for-the-global-commercial-p-c-insurance-industry-trends-challenges-disruptors-and-opportunities-022316
15. The Wall Street Journal, “U.S. Car Sales Set Record in 2015” by Spector, Bennett, and Stoll, Jan 5, 2016
16. Insurance Information Institution. http://www.iii.org/fact-statistic/industry-overview
the University of Iowa’s Tippie School of Management. These reports are intended to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.
The Hartford Financial Services Group, Inc.Income Statement (in millions)
The Hartford Financial Services Group, Inc.Cash Flow Statement (in millions)
Fiscal Years Ending Dec. 31 2013 2014 2015Operating Activities
Net income (loss) 176 798 1,682Adjustments to reconcile net income (loss) to net cash provided by operating activities
Amortization of deferred policy acquisition costs and present value of future profits 2,701 1,729 1,502Additions to deferred policy acquisition costs and present value of future profits (1,330) (1,364) (1,390)
Change inReserve for future policy benefits, unpaid losses and loss adjustment expenses and unearned premiums (308) 226 305Reinsurance recoverables (561) (22) 146Receivables (409) (122) 183Payables and accruals 497 (937) (704)Accrued and deferred income taxes (526) 328 363Net realized capital losses (1,149) 141 156Net (increase) decrease in equity securities, held for trading 9,188 3,993 0Net receipts (disbursements) from investment contracts credited to policyholder funds —International variable annuities associated with equity securities, held for trading (9,189) (3,993) 0
Goodwill impairment 1,574 (23) (28)Depreciation and amortization 189 276 373Other, net 384 856 168
Net cash provided by operating activities 1,237 1,886 2,756
Investing ActivitiesProceeds from the sale/maturity/prepayment of:
Payments for the purchase of:Fixed maturities, available‐for‐sale, including short‐term investments (35,596) (22,914) (27,995)Equity securities, available‐for‐sale (212) (683) (1,454)Mortgage loans (718) (604) (870)Partnerships (353) (312) (620)
Change in policy loans, net (5) (11) (30)Change in payables for collateral under securities lending, net 0 0 0Derivative receipts (payments) (2,208) 10 (173)Change in all other securities, net 388 (1,832) 3,072Purchase price adjustment of business acquired 0 0 0Sale of subsidiary, net of cash transferred 815 963 0Additions to property and equipment, net (64) (121) (307)
Net cash used for investing activities 3,745 1,696 485
Financing ActivitiesDeposits and other additions to investment and universal life‐type contracts 5,942 5,289 4,718Withdrawals and other deductions from investment and universal life‐type contracts (25,034) (21,870) (17,085)Net transfers from (to) separate accounts related to investment and universal life‐type contracts 16,978 14,366 11,046Issuance of shares from equity unit contracts 0 0 0Issuance of long‐term debt 533 0 0Repayment/maturity of long‐term debt and on capital lease obligations (1,338) (200) (773)Change in short‐term debt 0 0 0Issuance of convertible preferred shares 0 0 0Issuance of warrants (33) 0 0Proceeds from issuance of consumer notes 0 0 0Repayments of consumer notes (77) (13) (33)Proceeds from issuances of shares under incentive and stock compensation plans, and excess tax benefit 20 30 42Treasury stock acquired (600) (1,796) (1,250)Return of shares under incentive and stock compensation plans to treasury stock 0 0 0Redemption of preferred stock issued to the U.S. Treasury 0 0 0Net proceeds from issuance of common shares under public offering 0 0 0Net proceeds from issuance of common shares under discretionary equity issuance plan 0 0 0Changes in bank deposits and payments on bank advances 0 0 0Net increase (decrease) in securities loaned or sold under agreements to repurchase (1,988) 0 507Dividends paid (223) (282) (316)
Net cash used for financing activities (5,820) (4,476) (3,144)
Total revenues 6.93% 6.70% 7.50% 8.25% 7.98% 8.13% 8.07% 8.13%Benefits, losses, and expensesBenefits, losses, and loss adjustment expenses 83.50% 81.02% 79.36% 80.19% 79.78% 79.98% 79.88% 79.93%Amortization of deferred policy acquisition costs and PV of future profits 13.56% 12.96% 11.06% 12.01% 11.54% 11.78% 11.66% 11.72%Insurance operating costs and other expenses 31.56% 30.20% 27.78% 28.99% 28.39% 28.69% 28.54% 28.61%Loss on extinguishment of debt 0.07% 0.00% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%Goodwill imparement 0.53% ‐0.01% ‐0.01% 0.00% 0.00% 0.00% 0.00% 0.00%Other expense 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Interest expense 0.13% 0.14% 0.15% 0.14% 0.14% 0.14% 0.14% 0.14%
Total benefits, losses, and expenses 6.43% 6.09% 6.69% 7.45% 7.14% 7.30% 7.25% 7.33%Income from continuing operations before income tax 0.49% 0.61% 0.81% 0.80% 0.84% 0.82% 0.82% 0.80%
Income tax expense 0.08% 0.13% 0.12% 0.12% 0.13% 0.13% 0.13% 0.12%Income from continuing operations, net of tax 0.41% 0.49% 0.68% 0.68% 0.71% 0.70% 0.69% 0.68%
Income from discontinued operations, net of tax ‐0.35% ‐0.20% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Net income 0.06% 0.29% 0.69% 0.68% 0.71% 0.70% 0.69% 0.68%
Preferred stock dividends 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Net income available to common shareholders 0.06% 0.29% 0.69% 0.68% 0.71% 0.70% 0.69% 0.68%
The Hartford Financial Services Group, Inc.Balance Sheet (in millions)
Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E
DCF ModelFCFE 1,328 673 755 849 955 Terminal Value 19,729 Discount Factor 1.08 1.16 1.25 1.35 1.35 Discounted FCFE 1,232 579 604 630 Discounted Terminal Value 14,635Present Value of Equity DCF 17,680‐ ESOP 34Net Value 17,646Shares Outstanding 401,821
Value per Share 43.92$
EP ModelEquity Economic Profit (151) 314 194 80 (38)Terminal Value (779)Discount Factor 1.08 1.16 1.25 1.35 1.35Discounted Equity EP (140) 271 155 59Discounted Terminal Value (578)Present Value of Equity EP (234)Beg. Total Stockholders' Equity 18,720Equity Value 18,486‐ ESOP 34Net Value 18,452Shares Outstanding 401,821
Value per Share 45.92$
The Hartford Financial Services Group, Inc.Relative Valuation Models
Ticker Symbol HIGCurrent Stock Price $42.83Risk Free Rate 2.70%Current Dividend Yield 1.82%Annualized St. Dev. of Stock Returns 21.96% 2015 Yahoo 21.37%
Number Average Average B‐S ValueRange of of Shares Exercise Remaining Option of OptionsOutstanding Options in thousands Price Life (yrs) Price GrantedRange 1 2,351 30.34 5.20 14.56$ 34,224$ Total 2,351 30.34$ 5.20 17.84$ 34,224$
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding
Number of Options Outstanding (shares): 2,351Average Time to Maturity (years): 5.20Expected Annual Number of Options Exercised: 452
Current Average Strike Price: 30.34$ Cost of Equity: 7.94%Current Stock Price: $42.83
2016E 2017E 2018E 2019E 2020EIncrease in Shares Outstanding: 452 452 452 452 452Average Strike Price: 30.34$ 30.34$ 30.34$ 30.34$ 30.34$ Increase in Common Stock Account: 13,717 13,717 13,717 13,717 13,717
Change in Treasury Stock 1,300 636 720 814 921Expected Price of Repurchased Shares: $42.83 46.23$ 49.90$ 53.86$ 58.14$ Number of Shares Repurchased: 30 14 14 15 16
Shares Outstanding (beginning of the year) 401,821 402,243 402,681 403,119 403,556Plus: Shares Issued Through ESOP 452 452 452 452 452Less: Shares Repurchased in Treasury 30 14 14 15 16 Shares Outstanding (end of the year) 402,243 402,681 403,119 403,556 403,992