Hartford's Transformation Is A Multi-Year Proposition

By Stephen D. Simpson, CFA | June 18, 2012 AAA

At a time when many insurance companies are looking to diversify and enter new markets to stimulate growth, Hartford Financial Services (NYSE:HIG) is looking to go in the other direction. Although exiting life insurance, retirement and annuities should both improve and stabilize returns over the long term, but it's likely going to take many years for the benefits to show up. While Hartford's current valuation seems to understate the core value in the business, investors could be looking at dead (or at least very sleepy) money for a while.

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Recent Results a Mixed Bag
Hartford's first quarter results highlight some of the challenges in the business right now. Reported per-share operating earnings up were up 11%, but deferred acquisition cost (DAC) benefits helped.

Commercial P&C net written premiums were a little soft (up 3%), despite good pricing in "small commercial" and worker's comp. Group benefits were a drag, though, as premiums declined 7% and earnings dropped on higher losses. Consumer NWP was soft as the company walked away from some business. Life and retirement results looked solid, but those are the businesses that Hartford is looking to sell.

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Can Hartford Get Good Value in Its Conversion to P&C?
In deciding to get out of the life, retirement and annuity businesses, Hartford is going to be moving to something closer to a pure P&C insurance company. That's not a bad idea in and of itself - companies like Hartford and AXA (OTC:AXAHY) have seen a lot of unexpected volatility from annuity businesses and life insurance is increasingly a commoditized business with unimpressive return potential.

It'll be interesting to see if Hartford can get good value for these units. MetLife (NYSE:MET), Prudential (NYSE:PRU) and Lincoln National (NYSE:LNC) would all be logical interested parties, but the relatively low valuation on those stocks increases the cost of capital for any prospective deal, and MetLife may have regulatory issues in launching a deal of that size (likely on the order of $2 billion).

It's also worth noting that the sale would not immediately improve results. Because of the company's need to deleverage the business and hedge the annuity run-off, returns on equity could easily stay in the high single digits for a while.

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A Change in Business Needs to Lead to a Change in Outlook
I also suspect that Hartford needs to change some of its operating philosophies with this restructuring effort. Hartford has built a good distribution system over the years, but I think the company sometimes puts a premium on market share. Hartford has been pretty aggressive in keeping its group benefits share, and that is likely part of the reason for the weaker results seen recently. Since disciplined underwriting is key to success in P&C, the company has to be more willing to walk away from business in the future if the pricing isn't right.

SEE: Great Expectations: Forecasting Sales Growth

The Bottom Line
There seems to be quite a bit of skepticism on this name right now, and that may be reasonable given the uncertainties over the timing of the restructuring efforts and the limited options for positive capital deployment. Said differently, Hartford is more likely to be playing defense than offense for the next couple of years and that leads to a less impressive book value growth outlook.

Still, if the company can deliver high single-digit returns on equity, then the shares are too cheap today. Investors are going to have to be patient to realize that value, though, and investors may have more compelling options for their money in the near term.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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