Following the divestiture of its individual life insurance operations and retirement business last year, The Hartford Financial Services Group (NYSE:HIG) is focusing on its property and casualty, group benefits and mutual fund branches. The revenue contribution from these three branches last year was around 70%, 25% and 5% respectively. (Excluding the divested businesses grouped as Talcott Resolution in its 10-K filing) In our previous article, A Look At Hartford’s Commercial Property And Casualty Insurance Business, we analyzed the company’s property and casualty business. In this article, we will focus on the group benefits division.
Hartford’s group benefits division offers group life, accident and disability coverage, group retiree health and voluntary benefits to companies and financial institutions. The policies offered by the company are generally term life insurance policies, which provide coverage for a limited period of time, typically between one to three years at a fixed payment rate. The division also offers reinsurance to other insurers. The company uses a distribution network of brokers, consultants, third-party administrators and trade associations to market policies throughout the U.S.
Our $24 price estimate for Hartford’s stock is at a discount of 10% to the current market price. We are currently restructuring our model to reflect the company’s new structure.
Hartford is the eighth largest group life insurance company in the U.S. However, its market share has gone down from over 17% in 2009 to 14% in 2012.  Strong competition, particularly in terms of pricing from large insurers like MetLife (NYSE:MET) and Prudential Financial (NYSE:PRU) has had an adverse effect on Hartford’s market share.  MetLife and Prudential are the market leaders in the group insurance domain. Low returns from the company’s investments in fixed maturity securities like government and corporate bonds have also led to a decline in operating margins. The division’s pre-tax margin dipped from 5% in 2010 to 2% in 2011, before recovering to around 4% in 2012.
Group insurance can largely be linked to macroeconomic conditions prevalent in the U.S. Premium income for all insurers in this domain fell from $28 billion in 2008 to $25 billion in 2008 and further to $24 billion in 2009, as a consequence of the financial downturn observed during this period which led to an increase in unemployment. The unemployment rate in the country jumped up from 5% in January 2008 to 10% in 2009. 
However, in the last two years, the U.S. economy has shown signs of recovery. The unemployment rate reached a four year low of 7.5% in April. The economic recovery and higher employment rates will lead to higher demand for group insurance products in the coming years. Group insurance premiums in the U.S. grew by 7% in 2011 and 3% in 2012. We expect a premium growth rate of 1-3% through this decade allowing the market size to grow to $30 billion by 2019. For more on the U.S. insurance market, please refer to our article: A Closer Look At The U.S. Life Insurance Market.
Hartford’s group premiums fell from $4.15 billion in 2011 to $3.81 billion in 2012 as the company’s market share dropped from 16% to 14%. Insurance rates are a big factor determining market share and are largely decided by insurance companies while keeping an eye on profitability. Hartford’s loss ratio or ratio between benefits and loss expenses to premiums has increased from 77.9% in 2010 to 79.5% while its expense ratio or ratio between insurance operating costs and other expenses to premiums has been around 28% through the last three years.
Despite this, its pre-tax margins have been suppressed (between 2%-5%), largely due to low returns from its investments in bonds. Nearly 80% of the company’s investment income comes from fixed maturity securities, the yields from which have been influenced by the Federal Reserve’s Quantitative Easing program. The program involves purchasing assets like long term treasuries and mortgage-backed securities from commercial banks and other financial institutions, thereby increasing liquidity and reducing long term interest rates. The 10-year U.S. Treasury rate at the end of 2012 was 1.76%, highlighting the low bond yields in the U.S.
The Open Market Committee met last week and decided to maintain its $85 billion monthly asset repurchase program. Federal Reserve Chairman Ben Bernanke has indicated that the program might be scaled back later this year and wrapped up in 2014, but has not provided a firm time table. The Fed has kept a threshold of 6.5% unemployment rate as a target for the economic recovery before it might start increasing interest rates. 
Higher interest rates will allow insurers like Hartford to increase profitability as investment income will increase. The company has enough reserves for expansion in the group domain, premiums as a percentage of reserves have fallen from 64% in 2010 to 56% in 2012. Higher returns from investments will allow the company to set competitive rates and regain market share. The company can potentially earn around $4.5 billion in premiums from the group insurance division if it increases market share to 15% by the end of the decade.
Our current forecast for the company’s operating margins are based on a long term increase in interest rates. We expect the company to maintain loss ratio of around 78% and an expense ratio of 28% in the coming years. We will keep a close eye on developments and update our model accordingly. You can modify the interactive charts in this article to gauge the effect a change in forecast would have on our price estimate.Notes: