Annuity Pioneer Calls it Quits

On March 21, 2012,  The Hartford, (HIGFortune 500) one of the oldest companies in the United States with a market valuation of nearly $10 billion, announced that it is exiting the individual annuity business (Press Release here) and will discontinue new annuity sales effective April 27, and expects to take a related after-tax charge of $15 million to $20 million in the second quarter of 2012.

The Hartford is also pursuing the sale or “other strategic alternatives” of its individual life business, one of the 10 biggest in the U.S. as measured by annual premium, its broker-dealer Woodbury Financial Services and its retirement plans unit, which has $52.3 billion under management and is a prominent seller of 401(k) and other employee retirement-savings programs. President and CEO Liam McGee said, “The Hartford’s sharper focus will lead to an organization that, over time, will be positioned for higher returns on equity, reduced sensitivity to capital markets, a lower cost of capital and increased financial flexibility,” Credit Suisse’s Thomas Gallagher said in a client note that Hartford could get between $2 billion to $3 billion by selling the businesses.

“The actions announced today will allow us to build on our strong financial foundation by concentrating our resources on a smaller number of businesses to position The Hartford for long-term success,” said The Hartford’s Executive Vice President and CFO Christopher J. Swift, executive vice president and chief financial officer. “Individual Life, Woodbury Financial Services and Retirement Plans are strong businesses with distinct market positions and talented employees, but they do not align with our go-forward focus. They will be better positioned for success as part of other organizations. As we have done for more than 200 years, The Hartford will continue to honor its commitments to policyholders and provide a high level of service to its customers. In addition, we will continue to maintain capital resources and financial strength required by our business strategy and consistent with our current ratings.”

CEO Liam McGee has called the property-casualty business the company’s “crown jewel.” The Hartford will also keep its mutual-fund arm, with $85.5 billion in assets under management, and a unit that offers employer-sponsored benefits. Together, the three operations are targeting a return on equity of 12%-13% in 2012, Mr. McGee said. The company wanted to keep all three because each had “a competitive market position against which we believed we can invest to create future profitable growth,” Mr. McGee said. “The businesses had to be strong generators of capital, not consumers of capital” and will leave Hartford with “lower sensitivity to capital markets than the company does today,” he said.

A video provided by the Wall Street Journal reviews the story.

The Troubled Variable Annuities Business

The Hartford helped pioneer variable annuities, a product that offers a tax-advantaged way of investing in mutual funds. Their product innovations touched off an “arms race” that helped lift industrywide variable-annuity sales to $180 billion by 2007, the peak year, as retirement products became increasingly important. However, annuities have always had a thin margin, and intense product features competition has hurt the business in the past, such as during the tech bubble crash of 2000. During the market free fall of 2008-09, The Hartford suffered big losses, which exposed gaps in the company’s risk-management tools, such as hedging, that it and other annuity providers use. Because The Hartford was smaller than some of its rivals, it was one of the hardest-hit by the turmoil, and its stock lost about 95% of its value at one point in 2008. The company was one of only three insurers that took federal bailout money, which it has since repaid.

In response, The Hartford retreated from the variable annuity business in 2009 as its then-CEO put a team of top aides to work to “de-risk” its offerings to better protect the company’s shareholders, while maintaining enough value in the products that consumers would want to continue buying them. Chief Executive Liam McGee, a former top Bank of America executive, was then brought in to try to turn the company around.

From a top sales spot in the mid 2000s, Hartford finished 2010 in 20th place among leading variable-annuity sellers, and last year it didn’t even make the top-20 chart compiled by industry-funded research firm LIMRA.  Other insurers that have pulled back or exited the variable-annuity business entirely include Sun Life Financial Inc., Genworth Financial Inc. and Massachusetts Mutual Life Insurance Co.

In February, Hartford reported that earnings for its individual annuity business fell to $86 million in the fourth quarter, down from $96 million in the prior-year period. The company’s overall net income plummeted to $127 million in the quarter from $619 million a year earlier. The individual annuity segment had 2011 revenue of $1.84 billion, while total company revenue was $21.86 billion for the year.

Moody’s lowered the outlook of Hartford Life & Annuity Insurance Co., which houses most of the group’s individual annuity business, from stable to negative. It kept the outlook for the parent company, its life subsidiaries and property and casualty insurance subsidiaries at stable.Following a fourth-quarter report last week that missed some Wall Street expectations, analysts said the company was likely to face increased pressure to restructure somehow.

Bowing To A Major Shareholder

The pressure to take action came at the urging of shareholder John Paulson whose hedge fund, Paulson & Co. Inc. owns an 8.5% stake in the company, making it the largest shareholder Although insurers have been on the receiving end of investor outrage before, rarely has it been carried this far. In 2010, hedge fund manager Steve Eisman threatened the management of Genworth Financial on a conference call, saying he would launch a proxy fight unless it improved returns, but he did not follow through on the threat. More recently, the largest shareholder in reinsurer Transatlantic Holdings vetoed a deal with peer Allied World, saying the offer undervalued the company.

Hartford’s announcement comes a little over a month after hedge fund manager and majority shareholder John Paulson publicly demanded on a February 8 conference call with analysts that the company to spin off its property and casualty insurance business, and  break itself into two companies. He said that it could boost Hartford’s value to shareholders by 40% to 60%. He added that breaking up the company would allow management of each new company to focus on what they do best, while making each new company more streamlined.

At that time Hartford said that it would review Paulson’s plan, warning that a breakup wouldn’t be easy.  However, Paulson sharply rejected management’s assertions on insurmountable challenges and said a tax-free spinoff of the property and casualty business would give shareholders as much as 60 percent more value than they are getting now.

“Given the extremely poor performance of Hartford’s stock and the fact that Hartford trades at lower valuation multiples than any of its U.S. insurance peers, addressing these issues should be Hartford’s highest priority,” Paulson wrote in a letter to management. Shares of The Hartford trade at a substantial discount to book value, even more so than their peers in the property insurance sector, and they also trade at a lower price-to-earnings ratio than peers in the life insurance business. Paulson blamed the company’s structure. “The main, but not the only, reason for Hartford’s low multiple is because the company combines both a Life and a P&C business together,” he said.

Paulson argued that most large multiline insurers have chosen to split off one side of the business or the other, and he said shareholders were “entitled to expect the management and the board to show leadership” on the issue.

Still More To Come?

Paulson said in a statement that it supports The Hartford’s actions as a first step in separating its property and casualty business from its other businesses. However, Hartford’s actions don’t address what Paulson sees as the company’s biggest problem: a property and casualty business tied to complex, unrelated and lower-return businesses that make it less attractive to investors. Credit Suisse’s Thomas Gallagher says while Hartford’s plan doesn’t achieve the legal separation of businesses that Paulson was looking for, it “could very well be the initial step down that path.” The analyst estimates that Hartford’s actions could free up $2.5 billion to $4 billion of capital over the next few years.

Moody’s agrees. “Overall we think the shift in focus toward The Hartford’s stronger property and casualty operations and decision to shut down its highest risk line of business is credit positive; however, given the nature of variable annuity contracts, it will nevertheless take a long time to materially reduce total risk,” Moody’s analyst Paul Bauer said in a statement.
Analyst John Nadel of Sterne, Agee & Leach states, “In discontinuing the sale of individual annuities in the U.S combined with the exit of individual life and retirement plans businesses, the company should be in a position to cut significant costs and run the remaining Life Company at a lower level of capital.” The company also said the changes will give it “reduced sensitivity to capital markets.”
Shares of Hartford jumped 5% following the announcement. The stock has gained more than than 13% since Feb. 8, when John Paulson publicly pushed for a breakup during an earnings conference call. Hartford’s shares rose 27 cents to $21.98 in afternoon trading. The stock has traded between $14.56 and $29.59 in the past year.

“The actions announced today will allow us to build on our strong financial foundation by concentrating our resources on a smaller number of businesses to position Hartford for long-term success,” said chief financial officer Christopher Swift.

A Big Win for Private Equity

This video puts the issue into the larger perspective of activist private equity: mkts_bz_hedge_fund_activists.cnnmoney. According to CNN Money, should a breakup of Hartford continue to unlock shareholder value expected, it would be a rare recent win for Paulson.

Paulson, one of the big winners from the carnage of the financial crisis, has made a series of failed bets over the past year. After betting big on bank stocks, such as Bank of America and Citigroup, Paulson sold those same shares ahead of their recent run-up.

Hartford’s move also signals yet another win this year for activist investors. Companies appear to be increasingly bowing to pressures from hedge fund and other outside investors to make strategic or board changes to increase share value. During this same week, UPS  announced it would buy Dutch shipping company TNT Express for $6.8 billion. Activist investor Jana Partners had been pushing TNT for a sale or a shakeup at the company.

Many investors and analysts expect activism to heat up over the next few months as proxy season gets underway. During proxy season, shareholders have the chance to vote for or against a company’s board of directors and other resolutions. Yahoo is also in the midst of its own battle with activist shareholder Third Point. According to an SEC filing late Tuesday night, Third Point’s Dan Loeb is proposing its own slate of four directors for Yahoo’s board to change the direction of the company.

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