Hartford Financial Continues To Outperform With Its Differentiated Model (NYSE:HIG)

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.

It’s Still Groundhog Day, With Strong Commercial P&C, But Challenges In Workers Comp And Auto

Not too much has changed in the market since my last update on Hartford, with some further evidence of slowing/softening in what has been an exceptionally hard market. Hartford is still seeing mid-single-digit renewal rate increases, with overall industry pricing still up comfortably in the mid-single-digits, but with a slow quarter by quarter decline. Social inflation remains an ongoing threat, and now it’s combined with real inflation driving higher severity costs.

Overall demand remains strong, though, and Hartford continues to leverage its strong (and differentiated) presence among smaller commercial clients and its growing specialty insurance operations to generate good growth. Commercial premiums rose almost 14% in the last quarter (after growing 12% in Q1’22 and 14% in Q4’21), with 17% growth in the small commercial segment, 11% growth in the middle market commercial, and 12% growth in specialty commercial.

As far as individual markets, not much has really changed. Excess and surplus is still a very attractive market, especially as more businesses have to go to non-admitted markets to find coverage for more challenge business. Workers’ comp also remains a challenging market; loss trends aren’t bad and Hartford continues to see positive reserve development, but rates continue to decline, mitigated partly by growing payrolls (headcount and wages).

The auto market, though, remains challenging. Loss ratios continue to be pressured by higher used car prices, as well as sharply higher repair and parts costs, and Hartford saw its Personal Auto core combined ratio worsen from 92.1% last year to 100% in the second quarter. Companies like Hartford are applying for, and generally getting, higher rates (renewal pricing was up about 4% in Q2), but states like California haven’t been allowing rate increases, so it’s uneven across the states.

Opportunities To Grow Beyond This Hard Market

I do expect to see the commercial P&C market peak in 2023. I don’t think 2024 or 2025 are going to be terrible, but it will likely be another 10 to 20 years before the industry sees an underwriting market like the one it has enjoyed recently.

I don’t think that means Hartford’s growth opportunities are going to go away. First, while rates will soften, there are still opportunities for Hartford to organically grow its business. Small business formation supports a growing addressable market in the small commercial area, and there are also share growth opportunities outside of workers’ comp (workers’ comp is about half of the P&C business). Commercial auto, product liability, and professional liability should all offer growth potential, as well as fidelity & surety and commercial multi-peril.

I also see meaningful growth opportunities in specialty insurance, which includes some of the aforementioned lines like liability. Hartford has had years to build its comfort and analytics capabilities in the specialty market, and I think the combination of that increased capability and capital creates opportunities to expand. I’m particularly curious to see what kind of long-term growth Hartford could see in specialty among its small commercial customer base – quoting/buying specialty insurance can be a headache for smaller businesses, but Hartford’s experience with serving this market should be a significant advantage.

In the Personal business I expect to see improving underwriting margins in the auto business as rate hikes catch up with loss severity growth. I’m also looking forward to the full rollout of Prevail in 2023. Prevail is Hartford’s cloud-based platform for personal lines, and I think this could be a driver for better expense margins over time (and possibly some share growth on an improved/differentiated customer quoting/buying experience).

Last and not least is the investment portfolio. As is the case with most insurers, investment income is a major contributor to Hartford’s earnings base. While Hartford’s portfolio duration isn’t particularly low at around 4.3x, the reinvestment rate is now 4.5% (versus an average maturity yield of 3.6%), so higher rates should benefit this important line item, and I’m not too concerned about the company’s collateralized mortgage investment holdings.

The Outlook

Hartford has continued to outperform on underwriting profitability and management has been funneling some of that outperformance into larger-than-expected buybacks in 2022. Erosion in commercial pricing isn’t something to ignore, but it’s an understood risk and one that I believe Hartford can manage. Along those lines, as the markets get more challenging, core capabilities like analytics (understanding and pricing risk) and customer service will matter more, and I think Hartford can stand out here.

My 2022 and 2023 core earning estimates are now 5% and 3% higher than before, but my long-term outlook doesn’t change too much. I’m still looking for long-term core earnings growth in the 4%-5% range, though the recent outperformance has driven some “positive creep” in my modeling assumptions such that my long-term growth rate is now about 4.5%.

The Bottom Line

I value Hartford on a combination of discounted core earnings, ROE-driven P/B, and P/E. These approaches support a fair value in the neighborhood of $80 and a long-term annualized expected total return in the low double-digits. A 10x multiple on my 12-month EPS estimate gives me a fair value of about $78.50; 10x is roughly in line with the long-term average for the stock, and while using a long-term average estimate as the market cycle is peaking may seem aggressive, I think Hartford is a better company now than it was five or 10 years ago, and I think that should be reflected in a higher multiple.

The biggest negative I see with an investment in Hartford is that the Street has already factored in the idea that 2023 will be as good as it gets, so there’s no point in bothering with insurance companies anymore at this point. I guess that’s fair to a point, but I think more GARP-oriented investors will still be happy with what Hartford does over time, even if “time” is a key consideration here.