Hartford Financial: A mixed result, but the future is bright (NYSE: HIG)
After mixed results in the third quarter, near-term business trends are expected to be choppy for Hartford Financial Services (New York stock market :RAISED), a leading provider of property and casualty insurance, group life and disability insurance products, among others. All eyes will be on the evolution of the underlying loss ratio over the next few quarters, but for long-term investors, the more diversified composition of HIG compared to its peers makes it an attractive vehicle to navigate the current macroeconomic environment. The capital allocation option is also attractive, mainly due to the resilient capital return program. A take-home scenario could also still be on the table, even after HIG pushed back Chubb’s (CC) last offer last year as the updated P/E valuation could draw shareholder activism down the line. Coupled with the potential for mid- to long-term margin expansion on the cost side (eg Hartford Next’s higher cost savings forecast), the stock is worth a look, in my opinion.
Earnings headline, but headwinds remain
HIG’s revenue and core profit margin beat consensus this time around, thanks to the outperformance of alternative investments and a more favorable development in prior year reserves (PYD). This was partially offset, however, by higher cat losses (i.e. dollar losses incurred due to catastrophic events) and COVID benefit claims. On the latter, COVID excess mortality losses declined year-over-year to $26 million (from $212 million in Q3 2021), but increased quarter-over-quarter from ~10 million. dollars in the second quarter of 2022. together with the excessive mortality losses, resulted in a slight compression of the base margin for the quarter. Even excluding excess mortality, however, the group life loss ratio would have deteriorated further year-on-year due to a less favorable development of the life premium waiver reserve and higher reserve assumptions. higher expenses.
Nonetheless, the results will be a welcome relief to investors. While much of the delta was due to higher investment income (versus recurring operating income), the rise in core investments (excluding alternatives) should continue for some time, in my view , with high rates supporting base yields. In addition, group benefits margins and mutual fund fees also benefited earnings; however, these drivers tend to fluctuate and could reverse in the coming quarters.
That said, HIG remains a profit generator and has sufficient capital for deployment. So far, the priority seems to be buyouts, with around $350 million spent in the quarter. Expect more buybacks down the line, with the stock trading at a low valuation and there is ample room for buyout clearance to be lifted (note that clearance has already been lifted several times since the resumption of activity at the beginning of 2021).
Workers’ compensation outlook weighs on business lines
Worryingly, the underlying loss ratio (i.e. insurance claims net of adjustments as a proportion of total premiums earned) of 57.5% deteriorated by 2.3% from year-on-year, primarily due to non-cat commercial property losses exceeding expectations by approximately 1%. However, even excluding the impact of property losses other than cats, the underlying loss ratio would have deteriorated by approximately 30 basis points year-on-year due to a workers’ compensation loss ratio higher.
Why is flexible pricing in workers’ compensation a concern? For one thing, HIG derives almost half of its commercial line bonuses here – well above the worker contribution of its peers. There will also be a regulatory approval process to implement price increases in the offset line, so the path forward is far from straightforward. Importantly, until loss trends deteriorate (not soon, given HIG’s vulnerable small-account customer base), it will be difficult to raise prices and protect segment margins.
Volatility in personal lines but there are upsides
While the personal lines business recorded solid premium growth, the underlying loss ratio deteriorated by around 4.4 pts year-on-year to 68.8% due to severe higher in home and automobile insurance. Still, the silver lining is that HIG managed to push through the price increases won this time around. To recap, price trends saw a slight uptick in homes with renewal underwritten prices increasing by +11.8% in Q3, while autos also saw an increase of +5.0%. With written premium growth still strong at +5% YoY, the highest level since 2016, there is clearly pricing power to be harnessed here.
Along with the growth of prevailing auto policy, HIG has a clear path to insulate personal insurance margins against the pressures of inflation-induced auto severity (primarily due to high car prices from occasion caused by the current imbalance of supply and demand, as well as the resulting effects on replacement cost and repair costs).
A mixed result but the future looks bright
Looking beyond near-term headwinds, HIG remains well-positioned to deliver steady mid to long-term EPS growth, aided by margin gains from cost-cutting and share buybacks. Although third quarter earnings were mixed, Hartford Next’s updated guidance for higher cost savings bodes well for margins going forward. While speculators eyeing HIG as a take-out candidate may be disappointed after CBs acquisition of Cigna (CI) Asia business, I suspect an activist-driven floor price (à la Paulson in 2012/2013) could emerge if results continue to fall short of targets. Meanwhile, the updated P/E multiple offers long-term investors an attractive entry point.