Hartford Financial Continues To Outperform With Its Differentiated Model

I can understand if investors in The Hartford Financial Services Group (NYSE:HIG) (“Hartford”) feel a little frustrated. While the company has continued to outperform expectations, delivering good premium growth and core P&C underwriting/core earnings growth, as well as bigger returns of capital (buybacks) than expected, the shares have muddled along. Down about 4% since my last update, Hartford has done slightly better than other comps like Chubb (CB), Selective (SIGI), and Travelers (TRV), more than slightly better than AIG (AIG), and not as well as W. R. Berkley (WRB).

I do think the view on the Street that 2023 will be as good as it gets for commercial P&C insurance is weighing on shares, and I think that view is basically right. Still, I think what the Street may be overlooking is that lesser insurance companies need hard markets to rebuild their reserves, but companies like Hartford can outperform through the cycle when underwriting conditions aren’t as favorable. I still think Hartford is poised to generate 4%-plus long-term core earnings growth, and I still think the shares are undervalued, but investors will have to have some patience here.

 

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Hartford Financial Continues To Outperform With Its Differentiated Model

Hartford's Consistent Performance Not Quite In Step With The Hard Commercial P&C Market

 

The commercial P&C market continues to enjoy a rare period of profitable underwriting, but shares of The Hartford Financial Services Group (NYSE:HIG) ("Hartford") aren't really reflecting that. Up about 5% since my last update, Hartford has outpaced the S&P 500 but come in well short of peers/comps like Allianz (OTCPK:ALIZY), Chubb (CB), Travelers (TRV), W. R. Berkley (WRB), and Zurich (OTCQX:ZURVY).

I believe at least some of the underperformance can be tied to Hartford's business mix - while the company's strong exposure to small commercial is a positive over a full cycle, it hasn't benefited as much from this hard market. I also think Hartford's large exposure to workers' comp is an issue; pricing is weak here and Hartford doesn't have the same strength in specialty lines that Berkley has to offset that pressure.

I still like Hartford shares, but this is more of a "slow and steady wins the race" sort of call. I believe there will be slow improvement in the personal lines business from here, and I would expect to see management try to drive more specialty growth in the years to come. Hartford Next, a cost-saving program, still has more to contribute, and I continue to expect solid core earnings growth for years to come.

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Hartford's Consistent Performance Not Quite In Step With The Hard Commercial P&C Market

Chubb Throws A Stag Party For Hartford Financial Services

Writing about Chubb (NYSE:CB) earlier this week, I said that I thought it was pretty likely that Chubb was going to turn to M&A to build the business further, with exposure to small-/medium-sized commercial clients being a prime target. Three days later, Chubb announced an unsolicited bid for Hartford Financial Services (HIG) ("Hartford").

Although initial reaction to the bid hasn't been universally positive for Chubb, I don't think it's a bad deal. In fact, I see it as a highly accretive deal, and I think Hartford will try to negotiate a higher price and see that a bit more of that accretion is "shared" with Hartford shareholders. The market would seem to think so too, as Hartford shares already trade above the proposed deal price.

I do think that Hartford is a good target for Chubb and I do think that Chubb can afford to pay more and still achieve worthwhile synergies. How far investors want to push their luck, and whether investing today in pursuit of a higher price makes sense, is up to them, but I would note that I would have previously said that $65 was a good fair value for Hartford on a standalone basis.

 

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Chubb Throws A Stag Party For Hartford Financial Services

Amid COVID-19 Uncertainties And Low Rates, Hartford Financial Looks Too Cheap

This is a challenging time for insurers as far as valuations go, and there are good reasons why. Rising claim costs/losses were already an issue, and COVID-19 has only magnified that issue, and weak rates are sapping a vital income source. On top of that, it remains to be seen whether a recent trend towards a harder market (higher rates) will persist, and there are serious questions as to how much the industry may have to pay out for workers comp and business interruption claims that would otherwise seem to be secure from COVID-19.

I was neutral on Hartford Financial Services (HIG) back in December, more for valuation reasons that core company quality issues. Nobody had the COVID-19 pandemic in their models at this point, and it has indeed had a significant impact on Hartford's outlook, as has the drop in rates that have come along with the COVID-19 economic carnage. Although my estimates for Hartford are now indeed lower, even a low single-digit long-term core earnings growth rate can support the shares now, not to mention the double-digit adjusted ROE that the company is likely to report this year and next.

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Amid COVID-19 Uncertainties And Low Rates, Hartford Financial Looks Too Cheap

Hartford Financial Delivering On A Model With Both Growth And Defensive Traits

I let Hartford Financial (HIG) fall off my regular paper route, but a lot of the things I liked about the company when I last wrote about it, including its Navigators acquisition, have worked out and my bullish stance has been rewarded with a decent 25% or so total return since then – pretty good next to Chubb (CB) and Travelers (TRV), though not quite as good as W.R. Berkley (WRB) and Arch Capital (ACGL) (another one I’ve long been fond of).

Re-examining the story again today, I like the company’s comparatively healthy reserve position and disciplined underwriting strategy – two factors that should let the company benefit from a very hard market where pricing is being driven by underwriting mistakes made by other insurers and claims inflation. I also like the potential for ongoing growth in the small business category, not to mention the potential to continue leveraging the Navigators deal to expand its product line-up.

As far as valuation goes, though, I’m not as bullish as I was. Between discounted core earnings and ROE-driven price/book, Hartford should be trading between the low and mid $60’s and that’s where the shares are today.

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Hartford Financial Delivering On A Model With Both Growth And Defensive Traits

It Seems Challenging To Reconcile Selective Insurance's Performance And Valuation

Good companies deserve, and often get, a premium valuation. Although I believe Selective Insurance (SIGI) is an above-average small P&C insurer, and one with opportunities to generate better results in the coming years, I have a hard time reconciling that performance with a book value multiple well over 2x and a P/E ratio that seems to assume quite a bit more growth than I think is likely.

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It Seems Challenging To Reconcile Selective Insurance's Performance And Valuation

Employers Holdings A Well-Run Play On Small Business Growth Through Workers Comp

Focused and disciplined, Employers Holdings (EIG) isn’t likely to ever be a fiery growth stock, but then I think you could argue that aggressive growth in insurance doesn’t often work out so well. Instead, Employers has delivered consistent shareholder value growth since going public by staying focused on its core market opportunity of underwriting workers’ comp insurance for small businesses in industries with low-to-medium hazard risk.

I’m less than comfortable making a big leap into a pure workers’ comp play today, though. The industry has benefited from an extended period of lower losses due in part to the benefits of the ACA and rates have come under pressure in recent years as a result of lower losses and strong returns. Worsening loss trends are a threat, as is a slowdown in employment growth, and more insurers are trying to target the smaller business markets that Employers has targeted. While I do think the shares are modestly undervalued today, another dip toward $40 would certainly get my attention.

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Employers Holdings A Well-Run Play On Small Business Growth Through Workers Comp

Hartford Defies The Market And Announces A $2.1 Billion Deal For Navigators

Wall Street has a one-size-fits-all answer for what insurance companies should do with any extra capital - buy back shares. Hartford Financial (HIG) had frustrated the Street's push for a buyback all year, and at least some investors and analysts were disappointed that the company didn't announce a buyback with second quarter earnings, and now they've gone and announced a $2.1 billion acquisition of another insurance company (specialty insurer The Navigators Group (NAVG), or Navigators). As you might expect, the shares sold off on the announcement.

I'm not completely sold that Navigators is the right deal at the right price, but I don't believe it is liable to destroy shareholder value to any large extent. As I believed Hartford to be undervalued before the deal announcement, I still believe that to be the case, but sentiment is going to be an even greater obstacle now and it's going to take noticeably better than expected results from Hartford and Navigators to move the shares.

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Hartford Defies The Market And Announces A $2.1 Billion Deal For Navigators

United Fire Looks A Little Overheated In A Still-Challenging Sector

These are challenging times for the insurance industry, and small-cap player United Fire (UFCS) has not been immune. Healthy reserve releases have helped boost underwriting results, but the top line remains pressured, and management has decided to reinvest in the business by boosting its technology platform - a decision that should pay off long term, but that will pressure expense ratios in the near term. While United Fire has a decent enough business focusing on smaller businesses and offering coverage for commercial auto, fire (and allied lines), workers' comp, and product liability, the valuation more or less already captures the positives of the story.

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United Fire Looks A Little Overheated In A Still-Challenging Sector

Near-Term Trends Masking The Long-Term Potential For ProAssurance

Transitional periods are never fun, and ProAssurance (PRA) is likely looking at a couple of years where core earnings and book value growth will be pressured by rising claims costs. This is a sector-wide phenomenon, though, and many of ProAssurance’s competitors have been less conservative with their accounting assumptions and lack the same quality of reserves, which should lead to stronger industry-wide pricing.

Valuing ProAssurance is complicated by the likelihood that the near-term results aren’t really representative of the long-term earnings power of the business. Although there is a practical reality that insurance companies don’t usually outperform without underlying earnings and book value growth, I believe there is worthwhile long-term potential here.

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Near-Term Trends Masking The Long-Term Potential For ProAssurance

Rates And Loss Ratios Remain Risks, But Chubb's Valuation Is Getting Interesting

I have long thought that the managers of ACE, now operating under the name of Chubb (NYSE:CB) after that merger, are some of the best in the business and I continue to believe that that is a strong foundation for a positive investment thesis. That said, the P&C business has been flooded with capital and only recently have there been signs of rate improvement. At the same time, underwriting margins are getting squeezed and I’m worried about the outlook for loss trends.

Like many other insurers, Chubb has seen some share price weakness since January of this year, with the shares off about 10% from the 52-week high and up only a little bit over the last year. While I have some concerns about the impact of higher losses and lower reserve releases, that’s balanced by the reality that good names like Chubb don’t get all that cheap all that often. I do have some “falling knife” worries here, but the share price is getting to a point where long-term investors might want to freshen up their due diligence.

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Rates And Loss Ratios Remain Risks, But Chubb's Valuation Is Getting Interesting

W.R. Berkley Has A Lot To Live Up To

I understand that good companies should trade at a premium, but it is getting harder for me to reconcile W.R. Berkley’s (WRB) valuation with the realities in the insurance market today and the likely trajectory over the next few years. W.R. Berkley is a very well-run specialty insurance company, but rate growth is hard to find, claims severity is worsening in some lines, and reserves are looking a little thin across the industry.

The insurance industry is cyclical and the difficult market conditions of today will eventually improve, but the shares seem to be pricing in high single-digit long-term earnings growth, and I don’t think that leaves much upside in the share price.

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W.R. Berkley Has A Lot To Live Up To

Hartford Financial Services Repositioned For Better Returns

The sell-side had long been waiting for Hartford (HIG) to “do something” on the M&A front, with widespread expectations that the company would eventually sell its Talcott run-off annuity business as well as rumors that Hartford could be a buyer or a seller in other areas of insurance. The last couple of months have seen most of these expectations come true, as the company sold its Talcott business and acquired Aetna’s (AET) group insurance business.

These deals leave Hartford better-positioned to reach and exceed that elusive 10% ROE threshold and shrink the valuation gap with peers like Travelers (TRV) and Chubb (CB). To that end, the shares are up about 25% since my last write-up, more or less running in line with Travelers and Chubb over that time.

At this point, I would consider Hartford more of a strong hold than a buy. The company has improved itself over the past two years and is active in attractive segments of the market, but there are increasing competitive risks and opportunities to improve returns that management may or may not be able to execute.

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Hartford Financial Services Repositioned For Better Returns

Arch Capital's Cycle-Management Capabilities Serving It Well

Arch Capital (NASDAQ:ACGL) continues to demonstrate why I regard it as among the best of the best insurance companies in the market. While the company's acquisition of AIG's (NYSE:AIG) mortgage insurance business (United Guaranty) was perhaps not universally lauded, I believe investors who understand the dynamics of the mortgage insurance and Arch Capital's strategy here will appreciate the value that it will add in the coming years - particularly as available returns in the primary insurance and reinsurance market are pretty lousy.

Arch Capital shares are up another 20% or so from when I last wrote about the company, beating broader insurance stock indices (like the Dow Jones U.S. Select Insurance Index) and other quality insurers like Chubb (NYSE:CB) and W.R. Berkley (NYSE:WRB) (XL Group (NYSE:XL) has done a fair bit better). The shares certainly aren't cheap on a conventional book value multiple basis, but I do believe and expect that Arch Capital's diversification into mortgage insurance and careful management of its insurance and reinsurance businesses can support high single-digit to low double-digit growth at a time when many other insurers are going to be hard-pressed. Granted, I don't think these shares are undervalued on a discounted earnings basis either, but they're not out of line if you believe in management's guidance and this management team has given investors few reasons for persistent pessimism.

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Arch Capital's Cycle-Management Capabilities Serving It Well

Aspen Insurance Not Operating At A Top-Notch Level

Aspen (NYSE:AHL) wasn't my favorite idea in P&C insurance back when I last wrote about the stock in early 2016 (I preferred Chubb (NYSE:CB)), as I thought the apparent undervaluation in the shares was overshadowed by some operational risks. While the shares have climbed about 10% since then, a lot of those operational risks have emerged as bigger issues, and Aspen has underperformed other insurance companies like Chubb and Travelers (NYSE:TRV), as well as the broader Dow Jones P&C Insurance Index (which is up about 25% since I last wrote about Aspen).

Aspen's "build it and they will come" strategy for insurance hasn't worked out yet, and the company has seen both higher adjusted loss ratios and higher expense ratios. The company's underwriting profitability has declined significantly and weak pricing is not going to help matters.

Aspen is shrinking its programs business and taking a harder look at expenses, but shrinking reserve releases and the prospect of claims inflation are worries. While I still believe that Aspen can get to low double-digit ROEs over the long term, and the shares are priced for high single-digit to low double-digit returns, there is still risk to those projections and it's hard for me to get excited about Aspen outside of potential M&A interest.

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Aspen Insurance Not Operating At A Top-Notch Level

Seeking Alpha: Hartford Financial Services Largely Performing To Plan

Back in June of 2015, I thought that Hartford's (NYSE:HIG) double-digit discount to fair value and its ongoing self-improvement efforts made it a good name to consider in the insurance space. Since then, the shares are up about 6% - which isn't super, but isn't too bad next to Allstate (NYSE:ALL) or AIG (NYSE:AIG). It also hasn't been a smooth ride, as the shares have been knocked back by worries about rising loss frequency in auto insurance and feeble prospects for near-term rate increases.

With the shares up some and the company performing more or less in line with my expectations, the valuation argument doesn't seem quite as compelling. Hartford does still look like one of the more undervalued companies I pay attention to in the property & casualty space, but that undervaluation comes with lower growth prospects and near-term pricing concerns. While I think the shares still make some sense for more value-inclined investors, it's hard to work up a lot of enthusiasm.

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Hartford Financial Services Largely Performing To Plan

Seeking Alpha: Hartford Financial Still Has More To Give

Hartford Financial (NYSE:HIG) has the unenviable task of running off a multibillion-dollar portfolio of assets through a run-off operation that is unlikely to generate returns much above the mid-single digits. Even so, this excellent small commercial underwriter is on a path back to double-digit ROEs as strong underwriting results in commercial and personal P&C and aggressive capital management add value. If Hartford can get to 10% ROE in five years (and move closer to 12% over the long term), I think $45 is a fair price today. I'd also note that the Hartford is an appealing asset and its five-year performance may be moot as larger insurance companies ponder what to do with their surplus capital.

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Hartford Financial Still Has More To Give

Seeking Alpha: W.R. Berkley Pushing On Through A Tough Market

Tougher times are in the property and casualty insurance market, as insurers like ACE Limited (NYSE:ACE), Chubb (NYSE:CB), Hartford (NYSE:HIG), Travelers (NYSE:TRV), and W.R. Berkley (NYSE:WRB) are finding it harder to push rate increases and weak interest rates limit returns on conventional investment options. With loss trends having been pretty benign in recent years, there are worries among some investors and analysts that the industry is setting itself up for a string of weak performance as losses bite into capital and push down returns.

I'm really not that concerned about W.R. Berkley in that context. I am worried about limited premium growth potential and the year-to-year risks of the company's more aggressive investment philosophy, but I think the company's underwriting quality has shown itself over time and I still see opportunities for the company to grow its underwriting operations organically. I'm still not crazy about the valuation, but bargains in the P&C are hard to find these days.

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W.R. Berkley Pushing On Through A Tough Market

Seeking Alpha: ACE Limited Earns Its Premium, But Excess Capital Weighs On Returns

P&C insurance company ACE Limited (NYSE:ACE) is another of those examples of the sometimes-frustrating difference between a company and a stock. As a company, I think anybody who follows insurance will appreciate and admire how ACE limited runs itself. As a stock, though, the shares didn't look cheap a year ago and they still don't look all that cheap today. While ACE arguably still merits a place in a long-term portfolio and has ample capital with which to build the business, it's hard for me to work up a lot of enthusiasm for buying shares today.

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ACE Limited Earns Its Premium, But Excess Capital Weighs On Returns

Seeking Alpha: Hartford Financial Services Offers Self-Improvement And Takeover Potential

Although The Hartford Financial Services Group (NYSE:HIG) (or "The Hartford") has taken several significant steps to reposition itself as a quality P&C operator, the Street hasn't fully bought into the story. While the shares have appreciated about 50% over the last three years, ACE Limited (NYSE:ACE) and Travelers (NYSE:TRV) have done even better (up more than 60% each) and there's little differentiation among them over the past year despite ongoing self-improvement efforts at The Hartford.

To be sure, there are some reasons for The Hartford to lag. The company's expense ratio is a little higher than its peer group (or at least the better-run members) and investors worry that the variable annuity run-off process will tie-up capital with poor returns and that the group benefits business won't improve as much as management hopes. Although the shares are near a 52-week high, that skepticism still creates a window of opportunity for investors; The Hartford is perhaps not the cheapest stock in the space today, but it is cheap enough to merit interest and it could be an acquisition target.

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Hartford Financial Services Offers Self-Improvement And Takeover Potential