HARTFORD FINANCIAL SERVICES GROUP (THE), INC. 
By NEW YORK, Feb. 14, 2012 /PRNewswire/ -- Paulson & Co., Inc. ("Paulson") (Bloomberg: 573991Z), the beneficial owner of 37, 540,676 shares, or 8.4%, of The Hartford Financial Services Group, Inc. ("Hartford") (NYSE: HIG) today filed a 13D with the U.S. Securities and Exchange Commission (SEC) so that it can begin to engage in discussions or communications with Hartford shareholders relating to a spinoff of Hartford's property and casualty insurance business and to continue discussions with Hartford's management and Board of Directors.
For a full copy of the 13D filing which also includes a presentation to the board, please access the public filing at http://www.sec.gov/Archives/edgar/data/874766/000119312512061267/d301791dsc13d.htm
Below is the letter that Paulson sent to Liam McGee, Hartford's Chairman, President and Chief Executive Officer.
February 14, 2012
Mr. Liam E. McGee
Chairman, President and Chief Executive Officer
The Hartford Financial Services Group, Inc.
One Hartford Plaza
Hartford, CT 06155
Dear Liam:
We appreciate the opportunity to have a dialogue with you on the significant benefits to be achieved through a tax-free spinoff of Hartford's P&C business. As the largest investor in the Company for the past year, we have done exhaustive research on the challenges and opportunities of The Hartford and believe that a spinoff would produce an increase in value for Hartford shareholders of 40 -- 60%+ above the unaffected share price. This valuation range is also consistent with Goldman Sachs' estimate of a valuation enhancement on the order of 70%.
Stated simply, the spin-off would:
-- Create two pure play insurance companies -- one in life and one in P&C
-- whose management is focused solely on each companies' own strategies,
distribution channels and capital requirements.
-- Enable each of the respective companies to achieve a multiple consistent
with its industry, which, for the property casualty business, would mean
a multiple of approximately 1.1x book value versus Hartford's current
multiple of 0.4x -- the lowest of any major US insurance company.
-- Reduce complexity, which limits sell-side coverage and investor
interest.
Given the extremely poor performance of Hartford's stock and the fact that Hartford trades at lower valuation multiples than any of its US insurance peers, addressing these issues should be Hartford's highest priority. That is why we were disappointed that management, on the February 8th earnings call, only addressed the potential "challenges" of a separation. Not only do we believe that you underestimate the potential value that would be created by a spin, the "challenges" you describe are both over-rated and readily manageable.
We shared our view regarding the benefits of a tax-free P&C spinoff initially in November 2011 and again in December 2011. As part of our analysis, we considered all other strategic alternatives including share buybacks, the sales of individual businesses, the sale or IPO of minority stakes in Life and/or P&C, and others, but none of these came close to the dramatic increase in shareholder value to be created by a spinoff. For your reference, we have updated and attached the slides we previously sent to your Board.
Significant Underperformance Could Be Reversed through Spinoff
Prior to the discussion of strategic alternatives on the February 8th earnings call, Hartford's shares stood at 44% of book value -- a huge discount to its closest P&C peers (1.1x on average) and closest Life peers (0.8x on average) and the lowest of any major US insurance company.
(Photo: http://photos.prnewswire.com/prnh/20120214/NY53369-a )
Investor dissatisfaction with Hartford's current direction is reflected in your stock performance. Hartford's share price fell by 38% in 2011 while P&C peers rose by 14%, and even declined more than Life peers which fell 23%.
(Photo: http://photos.prnewswire.com/prnh/20120214/NY53369-b )
The main, but not the only, reason for Hartford's low multiple is because the company combines both a Life and P&C business together. Although P&C companies trade at higher multiples than life companies, by keeping the two together, Hartford trades at the lower life multiples.
If P&C and Life were separately traded, we believe the two companies would be valued at a combined $32 per share, resulting in immediate share price appreciation of more than 60% above the $19.12 price on February 7th before Hartford's fourth quarter earnings call. A tax-free spinoff of 100% of P&C would create both pure play P&C and Life companies that would be easier to understand and benchmark against their peers. It would immediately attract P&C investors and P&C analyst coverage.
2012 (1) If-quoted value
------- ---------------
4Q11 Core If-quoted Implied
BV ex AOCI Earnings ROE P/BV (3) P/E Total Per share
---------- -------- --- -------- --- ----- ---------
P&C 9,851 841
Net
debt
(2) (2,200) (94)
Corp.
other
(4) 508 10
--- ---
Net 8,159 757 8.9% 1.06x 10.3x 8,648 16.82
Life 15,003 1,093
Net
debt
(2) (3,000) (214)
Corp.
other
(4) 1,036 10
----- ---
Net 13,039 889 6.6% 0.59x 8.7x 7,693 14.96
P&C +
Life 21,197 1,645 7.5% 0.77x 9.9x 16,341 31.78
Diluted
shares 514
Share
price
as of: 7-Feb-12 19.12
Upside 66%
(1) Average of core earnings estimates by BAC, Barclays, JPM, CS & MS.
(2) P&C net debt consists of $2.5bn gross debt and $300mm cash, Life net debt consists of $4.3bn gross debt and $1.3bn cash
(3) Average P&C peer multiple for Hartford P&C. LNC multiple for Hartford Life.
(4) Assumes Corporate excluding debt and cash is allocated 50/50 between P&C and Life. Assumes $528mm discount for Allianz jr. sub debt added back to Life Corporate.
In addition, our estimate of the value of a spin-off only reaches $32 per share, well below Hartford's book value of $45 per share. This is due to the low multiple to book value at which we have estimated the Life Company would trade. We would hope that a newly incentivized Life management running a pure Life company would take steps to further improve the separately traded Life's value. The table below shows a range of valuation outcomes based on various P/BV assumptions.
Potential Values Based on
Different P/BV Multiples
--------------------------
P&C P/BV
--------
0.90x 1.00x 1.10x 1.20x
----- ----- ----- -----
Life P/BV 0.40x 25.20 26.59 27.99 29.43
0.50x 27.42 28.85 30.29 31.73
0.60x 29.71 31.15 32.59 34.02
0.70x 32.01 33.45 34.86 36.25
0.80x 34.30 35.69 37.09 38.49
Upside Based on 7-Feb-12
Unaffected Share Price
-------------------------
P&C P/BV
--------
0.90x 1.00x 1.10x 1.20x
----- ----- ----- -----
Life P/BV 0.40x 32% 39% 46% 54%
0.50x 43% 51% 58% 66%
0.60x 55% 63% 70% 78%
0.70x 67% 75% 82% 90%
0.80x 79% 87% 94% 101%
Lack of Research Coverage and Investor Interest
P&C analysts shun Hartford due to its complexity, resulting in a lack of research coverage and investor interest. For example, only 3 of 19 P&C analysts cover Hartford while 18 of the 19 cover Travelers and Chubb and 17 cover ACE.
P&C Covers:
-------
Inst.
Investor
Ranking Analyst Bank Travelers Chubb ACE Hartford
-------- ------- ---- --------- ----- --- --------
1) Jay Cohen BAC V V V V
2) Jay Gelb Barclays V V V V
3) Matt
Heimermann JPM V V V X
RU Keith Walsh Citi V V V X
RU Josh Shanker DB V V V X
RU Brian
Meredith UBS V V V X
Vinay
Misquith Evercore V V V X
Michael
Nannizzi GS V V V X
Larry Janney
Greenberg Montgomery V V V X
Cliff
Gallant KBW V V V X
Alan
Zimmermann Macquarie V V V X
Greg Locraft MS V V V X
Michael
Grasher Piper Jaffray X V V X
Mark Dwelle RBC V V V X
Paul Newsome Sandler O'Neil V V V X
Josh Sanford
Stirling Bernstein V V V X
Dan Farrell Sterne Agee V X X X
Michael
Paisan Stifel V V V V
Adam Klauber Wiilliam Blair V V X X
Few of the Life analysts who cover Hartford understand the P&C side of Hartford. Of the 15 Life analysts who cover Hartford, only 3 also cover its P&C peers.
Life Covers:
-------
Inst. Investor Ranking Analyst Bank HIG P&C
---------------------- ------- ---- --- ---
1) Jimmy
Bhullar JPM V X
2) Andrew
Kligerman UBS V X
3) Tom
Gallagher CS V X
RU Suneet Sanford
Kamath Bernstein V X
RU Ed Spehar BAC V X
RU Nigel Dally MS V X
Alan Devlin Altantic
Equities V V
Mark
Finklestein Evercore V X
Randy Binner FBR V V
Chris
Giovanni GS V X
Bob Janney
Glasspiegal Montgomery V X
Jeff Schuman KBW V X
Eric Berg RBC V X
Ed Shields Sandler
O'Neil X X
John Nadel Sterne Agee V X
John Hall Wells Fargo V V
Many of the largest institutional investors in Hartford's peers are significantly underweight Hartford, which suggests, among other things, the complexity makes the company un-investable, even at the current stock price.
Competitors have Already Realized Value of Separation
While multi-line insurers were common twenty years ago, almost all US multi-lines other than Hartford chose to separate P&C and Life in order to increase shareholder value, including Travelers, CNA, Lincoln, Aetna and CIGNA, as indicated by the table below.
Segment earnings Historical 2011
---------- ----
Date P&C Life Health P&C Life Health
---- --- ---- ------ --- ---- ------
Travelers (1) 2000 75% 25% 0% 100% 0% 0%
CNA 2002 59% 41% 0% 100% 0% 0%
Lincoln (2) 1996 40% 60% 0% 0% 100% 0%
Aetna 1994 8% 42% 50% 0% 8% 92%
Cigna 1996 20% 34% 46% 0% 18% 82%
(1) Pro-forma combination of St. Paul and Citigroup insurance businesses
(2) P&C includes reinsurance segment
Given the extreme undervaluation, poor share price performance, lack of P&C analyst interest and significant value creation, we believe it is incumbent on the Board to focus on implementing a plan to spin off the P&C business in the most efficient manner. This will immediately unlock the P&C value as it should trade at more than twice the multiple at which Hartford trades and be warmly welcomed by analysts and investors. Shareholders are entitled to expect the management and the Board to show leadership by moving beyond the current phase of identifying potential challenges to working actively to address them in a way that is accretive to shareholder value.
Challenges Can Be Readily Addressed
The most significant challenge to a spinoff that you have identified seems to be how to allocate the debt to balance the company's credit ratings objectives with the delivery of greater shareholder value. Your slide suggests that there could be ratings pressure on the Life Company if it assumes more than approximately $2.3bn of debt (one-third of the $6.8bn of holding company debt). The slide also points out the risk that the P&C Company would need to consider potentially dilutive de-leveraging actions if it were allocated the remaining debt.
We believe, as do others, that your analysis understates the debt servicing capabilities of Life. If debt were allocated roughly in proportion to equity, approximately 40% to P&C and 60% to Life, $2.5bn could be allocated to P&C and the balance of $4.3bn of debt would be allocated to Life. P&C would have a debt-to-total capital ratio of 28% and Life's ratio would be 24%. Both would be in line with Hartford's 25% ratio today and well within "A" ratings leverage guidelines of 25-35% from S&P and 30-40% from Moody's. They would also be in line with their peers: P&C peers are currently at 25%, and Lincoln National was at 25% before reclassifying $750mm of debt as a result of an AXXX securitization.
Nevertheless, if allocation of debt is your main concern, there are many ways to reduce leverage.
1) The "challenges" slide made no mention of the $1.6bn of holding company cash. If P&C were to be allocated $300mm, life could be allocated $1.3bn. This would reduce Life net debt to $3.0bn. Alternatively, if Hartford Life would use $700mm to de-lever, Life gross debt would be reduced to $3.6bn and the cost of servicing that debt would still be covered 2.0x by the remaining $600m of cash (more than the 1.8x maintained by Lincoln National, Life's closest peer).
2) A spinoff would likely take 8 to 12 months or more to complete, so debt ratios would be measured off forward financials. By that time, capital, cash and Life dividend capacity should have increased by $400-800mm through retained earnings and other changes to capital.
3) If you still see debt as the principal obstacle, we suggest you consider using the $400mm ear-marked for buybacks to pay down debt instead.
4) At its investor day, Hartford disclosed that it is pursuing an AXXX solution. This could substantially increase dividend capacity and statutory capital. Lincoln reduced debt by $750mm in 2011 using a similar solution.
5) Hartford recently separated several businesses into a run-off segment which it defined as non-core. If these businesses were sold, substantial amounts of capital will be freed up that can be used for deleveraging. For instance, the Institutional Annuity business could be sold in the current market for near book value, freeing up $1.0-1.5bn of capital.
6) If you needed or wanted to reduce leverage further, there are several non-P&C businesses that could be sold for attractive valuations. Press reports suggested that buyers were prepared to pay $1.5bn for the mutual fund business until financing markets dried up in July 2011. With attractive financing again widely available and with higher run-rate earnings as a result of higher equity markets, this business could be sold or IPOd today for a valuation of $1.5 billion or more.
7) There are also other businesses that could be sold between announcement and completion of the spinoff. Atlantic Equities suggests selling the Group business for estimated proceeds of $1.5bn, which would not only reduce debt but also increase shareholder value because it would be sold at higher multiples of book value and earnings than those at which Hartford trades today.
8) There are also various potential internal restructuring steps Hartford could take to increase statutory capital and pre-approved dividend capacity. For instance, Life holds $1.3bn of alternative investments which attract a 19.5% capital charge of $257mm. If this portfolio were sold or redeemed, Life's could dividend $1.1bn to its parent while still maintaining its current approximately 420% RBC ratio.
9) There is ample time between announcement and completion of a spin-off to put in place arrangements that are common amongst Life's peers to increase pre-approved cash flow to the parent such as surplus notes, service agreements with non-insurance subsidiaries and tax-sharing agreements.
10) Many suggestions have been made that the US VA business should be put in runoff. Morgan Stanley estimates that this would result in $250mm of expense savings after tax and free up $853mm in capital. When SunLife of Canada put its US VA business in runoff in December 2011, it said this would lead to $170mm per year of expense reductions. In run-off, Moody's only expects Sun Life US to maintain an RBC ratio in the range of 300 to 350%, which frees up substantial capital versus Hartford's current 420% supporting new VA sales.
11) As a last resort, Hartford could sell up to 19.9% of P&C, use the proceeds to pay down debt and still be able to do a simultaneous tax-free spinoff. This should not be dilutive because the P&C shares could be sold at a much higher multiple than that at which Hartford currently trades and debt would be decreased by an equal amount. This would raise $1.5bn if sold at 90% of book with $2.5bn of debt, and potentially considerably more based on capital structure and where peers are trading at the time.
In short there are many ways to structure a separation in order to free up cash, to reduce leverage and to accomplish the spinoff with little or no dilution to shareholders. You and your advisors can determine the most accretive ways to reduce leverage to accomplish a tax-free spinoff of P&C that creates the greatest shareholder value.
We strongly believe that any additional issues can be resolved favorably to effect a tax-free spinoff in a timely manner. Our analysis of Hartford's bond covenants and intra-group guarantees shows that the Company has broad scope for various approaches to optimize the allocation of capital and debt. Similarly, a well-prepared approach to regulators and rating agencies should be able to address any questions and a well-structured plan should be viewed positively. While there may be small synergies in keeping the businesses together, the economic value of any synergies is immaterial relative to the value unlocked by a separation.
Spinoff Enhances Each Business's Potential for Success
Each of the companies will be in a stronger position to make decisions that serve its discrete objectives. An independent Life company may decide to sharpen its focus and stop selling low-return, capital-intensive types of insurance and focus instead on faster-growing, less capital-intensive businesses such as mutual funds, retirement and group life. When Sun Life announced it would put US VA into runoff, the stock outperformed Hartford by 14% (Sun Life rose 8.4% on a day in which Hartford fell 5.5%). Analysts are increasingly calling on Hartford to follow suit, with Credit Suisse writing after the December investor day "we think putting [US VA] into run off is a no brainer, given the fact that net income ROE (which includes hedging costs) is zero and it is a drag on capital generation." We expect an independent Life company would make logical economic decisions that would allow it to be valued at least equal to the Life insurance average of 0.8x book value.
P&C and Life are already of sufficient size to serve customers and attract and retain management. Both can remain on firm financial footing, as evidenced by Hartford's recent stress test disclosures and announced share repurchase program. The additional capital that will be available to the companies as pure-play entities will also help assure that the companies can continue to improve and grow for the benefit of not only shareholders but policyholders, employees, agents and brokers and the greater Hartford community.
Many leading U.S. companies have announced 100% spinoffs of major divisions to create shareholder value, including McGraw Hill, Abbott Laboratories, Tyco, Kraft, Ralcorp, ConocoPhillips, Procter & Gamble, Marriott, Sara Lee and ITT. As William Stiritz, Chairman and CEO of Ralcorp, said on July 15, 2011 "We firmly believe the separation of Post Foods from Ralcorp by way of a tax-free spin-off will unlock significant value for our shareholders. As independent companies, both Ralcorp and Post Foods will be better positioned to focus on strategies specific to their particular businesses, thereby improving the opportunities to deliver increasing shareholder value."
In summary, we believe a separation of Hartford into pure play Life and P&C companies would maximize shareholder value in both the short term and the long term and enable each company to focus solely on their own strategies, distribution channels and capital requirements. Management and the Board have an excellent opportunity to seize the initiative to adopt this plan, implement it proactively and unlock the shareholder value it will create.
We look forward to continuing to discuss these matters with you.
Sincerely,
John Paulson
Cc:
Robert B.
Allardice, III Trevor Fetter Paul G. Kirk, Jr. Kathryn Mikells
Michael G.
Morris Thomas A. Renyi Charles B. Strauss H. Patrick Swygert
Paulson & Co. is an investment management firm that specializes in merger arbitrage, event-driven and distressed investing. Paulson has approximately US$24 billion in assets under management and has offices in New York, London and Hong Kong.
SOURCE Paulson & Co. Inc.
