We have downgraded our recommendation on Hartford Financial Services Group Inc. (HIG) to ‘Underperform’ from ‘Neutral’ based on the expected losses in the fourth-quarter 2012 from Hurricane Sandy. The low home and auto renewal rates, high fluctuations in investment income and a challenging regulatory environment are the other negatives.
Hartford reported third-quarter 2012 operating earnings of $378.0 million or 78 cents per share, significantly lagging the Zacks Consensus Estimate of 82 cents. Operating earnings, however, surpassed the year-ago earnings of $50.0 million or 8 cents per share.
Hartford has been witnessing weakness in its auto and home product lines over the past few years. The increases in pricing and underwriting actions during 2010 and 2011 lowered the policy issue rate of Hartford and negatively impacted the auto and home new business written premium. Although the auto and home new business written increased in the first nine months of 2012, the increase was offset by a decline in renewal of the existing policies, leading to lower earned premium as well as reduced number of policies-in-force as of September 30, 2012.
Moreover, as a property and casualty insurer, Hartford is substantially exposed to catastrophic events, the latest being Hurricane Sandy, while the unpredictable nature of these events poses significant risk to the company. The company witnessed low catastrophe losses in the first nine months of 2012. However, the company’s initial estimate for post-tax net catastrophe losses incurred in the first two months of the fourth quarter stands at about $230 million, primarily due to Hurricane Sandy.
Thus, after including December’s catastrophe loss, the fourth-quarter catastrophe loss should be higher than the combined catastrophe loss of $241 million incurred in the first three quarters of 2012. Hartford expects pre-tax gross losses and loss adjustment expenses of around $370 million due to Sandy. Consequently, we expect the bottom-line results of Hartford for the fourth quarter of 2012 to be disappointing.
Further, the net investment income of Hartford varies significantly with changes in market conditions, thereby impacting the net income to a great extent. While Hartford’s net investment income improved substantially to $7.2 billion in 2009 from a negative $6.0 billion in 2008, it declined to $3.6 billion in 2010 and further to $2.9 billion in 2011. The first quarter of 2012 again saw a remarkable improvement in net investment income due to the strong income from equity securities. This was followed by a decline in the second quarter and a surge in the third quarter. We believe that the company needs to adopt some hedging strategies to reduce the risk posed by the equity market fluctuations.
However, Hartford has been selling off its non-core businesses to concentrate more on its U.S. operations, reduce expenses and enhance operating leverage. Measures to improve financial and risk management, along with increased focus on the high-yielding mutual funds business are the other positives.
Hartford is expected to announce its financial results for the fourth quarter and full year 2012 after the closing bell on February 4, 2012. The Zacks Consensus Estimate for the company’s fourth-quarter earnings is 28 cents per share, down 60% year over year, based on higher catastrophe losses. Additionally, the Zacks Consensus Estimate for 2012 is $2.61 per share, up 35% over 2011.
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