Although shares of Hartford Financial Services Group Inc (NYSE: HIG) have risen 46 percent year-to-date, there is significant value creation potential as the company continues to shed legacy life insurance businesses; improve returns in its core businesses, and actively manage its capital base.
Hartford (HIG) is a diversified insurer that traditionally operated in commercial- and personal-lines property-casualty insurance, retail and institutional retirement products (including a leading position in variable annuities), life insurance, group benefits, and mutual funds. In early January 2013, HIG completed the sales of the Individual Life and Retirement Plans businesses.
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As annuity blocks run off, HIG's capital markets sensitivity diminishes and capital is freed up for share buybacks. There should be continued improvement in profitability of go-forward businesses (P/C insurance, group benefits and mutual funds) as HIG benefits from improved commercial-lines pricing in the U.S., re-underwriting initiatives, and expense discipline.
"Looking ahead three years, assuming sales of Japanese Annuity in 2014 and U.S. Annuity in 2015, we estimate HIG's shares could be worth $57 per share as of year-end 2016, for a compound annual total return of roughly 22%," UBS analyst Brian Meredith said in a client note.
The statutory capital levels associated with the Japanese and U.S. run-off annuity businesses are estimated at about $1.9 billion and $4.6 billion, respectively, which will be freed up over time via surrenders and annuitization.
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The company's property and casualty (P&C) insurance unit are heading toward a mid-teens return on equity (ROE). HIG could achieve 12 percent un-levered operating ROE in its property-casualty insurance operations in 2017, up from 10 percent in 2013.
"In our view, the rising profitability primarily will be the resu! lt of underwriting margin improvement, as price increases in commercial lines likely will exceed loss cost inflation for at least the next 12-24 months," Meredith noted.
Meanwhile, commercial-lines margin expansion would disproportionately benefit HIG's combined (Commercial and Consumer) P&C business, as commercial-business accounts for more than 70 percent of HIG's total P&C underwriting profit.
HIG has strong potential for margin improvement in part from rectifying recent years' profitability issues in the company's workers' compensation business.
At more than 45 percent of total commercial-lines premiums in 2012, workers' comp at HIG was considerably above-average in size for commercial-lines insurers. Workers' compensation insurance currently accounts for roughly 30 percent of HIG's new-business writings, a percentage that is roughly in line with peers.
"As HIG's business mix continues to shift toward smaller percentage contributions from workers' compensation, the overall combined ratio should benefit," Meredith said.
On the personal-lines side, the company should see growth and profitability improvement in its Consumer P&C business as the company has moved past the reduced persistency and decreased new-business writings associated with recent years' corrective price increases.
The shares could see additional upside through the book value per share growth, aided by accretive stock buybacks, and P/B multiple expansion via improved ROE and risk profile.
HIG shares, which trades 9 times its forward earnings, have traded between $20.12 and $35.01 during the past 52-weeks.
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