HARTFORD FINANCIAL SERVICES GROUP (THE), INC. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts in millions except for per share data, unless otherwise stated) TheHartford provides projections and other forward-looking information in the following discussions, which contain many forward-looking statements, particularly relating to the Company's future financial performance. These forward-looking statements are estimates based on information currently available to the Company, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to the cautionary statements set forth on pages 4 and 5 of this Form 10-Q. Actual results are likely to differ, and in the past have differed, materially from those forecast by the Company, depending on the outcome of various factors, including, but not limited to, those set forth in the following discussion; Part II, Item 1A, Risk Factors of this Quarterly Report on Form 10-Q; Part I, Item 1A, Risk Factors in TheHartford's 2019 Form 10-K Annual Report; and our other filings with theSecurities and Exchange Commission . TheHartford undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future developments or otherwise. OnSeptember 30, 2020 , the Company entered into a definitive agreement to sell all of the issued and outstanding equity ofNavigators Holdings (Europe) N.V. , aBelgium holding company, and its subsidiaries,Bracht, Deckers & Mackelbert N.V. ("BDM") andAssurances Contintales Contintale Verzekeringen N.V. ("ASCO"), (collectively referred to as "Continental Europe Operations"). For discussion of this transaction, see Note 2 - Business Acquisition and Disposition of Notes to Condensed Consolidated Financial Statements. OnMay 23, 2019 , the Company completed the acquisition ofNavigators Group , a specialty underwriter. For discussion of this transaction, see Note 2 - Business Acquisition and Disposition of Notes to Condensed Consolidated Financial Statements. Certain reclassifications have been made to historical financial information presented in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") to conform to the current period presentation. TheHartford defines increases or decreases greater than or equal to 200% as "NM" or not meaningful. INDEX Description Page Key Performance Measures and Ratios 57 The Hartford's Operations 62 Consolidated Results of Operations 69 Investment Results 75 Critical Accounting Estimates 77 Commercial Lines 85 Personal Lines 90
Property & Casualty Other Operations 95
Group Benefits 96 Hartford Funds 99 Corporate 101 Enterprise Risk Management 102 Capital Resources and Liquidity 114 Impact of New Accounting Standards 121 KEY PERFORMANCE MEASURES AND RATIOS The Company considers the measures and ratios in the following discussion to be key performance indicators for its businesses. Management believes that these ratios and measures are useful in understanding the underlying trends in TheHartford's businesses. However, these key performance indicators should only be used in conjunction with, and not in lieu of, the results presented in the segment discussions that follow in this MD&A. These ratios and measures may not be comparable to other performance measures used by the Company's competitors.
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Definitions of Non-GAAP and Other Measures and Ratios
Assets Under Management ("AUM")- Include mutual fund and exchange-traded
products ("ETP") assets. AUM is a measure used by the Company's Hartford Funds
segment because a significant portion of the Company's mutual fund and ETP
revenues are based upon asset values. These revenues increase or decrease with a
rise or fall in AUM whether caused by changes in the market or through net
flows.
Book Value per Diluted Share excluding accumulated other comprehensive income
("AOCI")- This is a non-GAAP per share measure that is calculated by dividing
(a) common stockholders' equity, excluding AOCI, after tax, by (b) common shares
outstanding and dilutive potential common shares. The Company provides this
measure to enable investors to analyze the amount of the Company's net worth
that is primarily attributable to the Company's business operations. The Company
believes that excluding AOCI from the numerator is useful to investors because
it eliminates the effect of items that can fluctuate significantly from period
to period, primarily based on changes in interest rates. Book value per diluted
share is the most directly comparable U.S. GAAP measure.
Combined Ratio- The sum of the loss and loss adjustment expense ratio, the
expense ratio and the policyholder dividend ratio. This ratio is a relative
measurement that describes the related cost of losses and expenses for every
$100 of earned premiums. A combined ratio below 100 demonstrates underwriting
profit; a combined ratio above 100 demonstrates underwriting losses.
Core Earnings- The Hartford uses the non-GAAP measure core earnings as an
important measure of the Company's operating performance. The Hartford believes
that core earnings provides investors with a valuable measure of the performance
of the Company's ongoing businesses because it reveals trends in our insurance
and financial services businesses that may be obscured by including the net
effect of certain items. Therefore, the following items are excluded from core
earnings:
•Certain realized capital gains and losses - Some realized capital gains and
losses are primarily driven by investment decisions and external economic
developments, the nature and timing of which are unrelated to the insurance and
underwriting aspects of our business. Accordingly, core earnings excludes the
effect of all realized gains and losses that tend to be highly variable from
period to period based on capital market conditions. The Hartford believes,
however, that some realized capital gains and losses are integrally related to
our insurance operations, so core earnings includes net realized gains and
losses such as net periodic settlements on credit derivatives. These net
realized gains and losses are directly related to an offsetting item included in
the income statement such as net investment income.
•Restructuring and other costs - Costs incurred as part of a restructuring plan
are not a recurring operating expense of the business.
•Loss on extinguishment of debt - Largely consisting of make-whole payments or
tender premiums upon paying debt off before maturity, these losses are not a
recurring operating expense of the business.
•Gains and losses on reinsurance transactions - Gains or losses on reinsurance,
such as those entered into upon sale of a business or to reinsure loss reserves,
are not a recurring operating expense of the business.
•Integration and transaction costs in connection with an acquired business - As
transaction costs are incurred upon acquisition of a business and integration
costs are completed within a short period after an acquisition, they do not
represent ongoing costs of the business.
•Change in loss reserves upon acquisition of a business - These changes in loss
reserves are excluded from core earnings because such changes could obscure the
ability to compare results in periods after the acquisition to results of
periods prior to the acquisition.
•Deferred gain resulting from retroactive reinsurance and subsequent changes in
the deferred gain - Retroactive reinsurance agreements economically transfer
risk to the reinsurers and including the full benefit from retroactive
reinsurance in core earnings provides greater insight into the economics of the
business.
•Change in valuation allowance on deferred taxes related to non-core components
of pre-tax income - These changes in valuation allowances are excluded from core
earnings because they relate to non-core components of pre-tax income, such as
tax attributes like capital loss carryforwards.
•Results of discontinued operations - These results are excluded from core
earnings for businesses sold or held for sale because such results could obscure
the ability to compare period over period results for our ongoing businesses.
In addition to the above components of net income available to common
stockholders that are excluded from core earnings, preferred stock dividends
declared, which are excluded from net income available to common stockholders,
are included in the determination of core earnings. Preferred stock dividends
are a cost of financing more akin to interest expense on debt and are expected
to be a recurring expense as long as the preferred stock is outstanding.
Net income (loss) and net income (loss) available to common stockholders are the
most directly comparable U.S. GAAP measures to core earnings. Core earnings
should not be considered as a substitute for net income (loss) or net income
(loss) available to common stockholders and does not reflect the overall
profitability of the Company's business. Therefore, The Hartford believes that
it is useful for investors to evaluate net income (loss), net income (loss)
available to common stockholders, and core earnings when reviewing the Company's
performance.
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Reconciliation of Net Income to Core Earnings
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Net income $ 459 $ 535 $ 1,200 $ 1,537
Preferred stock dividends 6 11 16 16
Net income available to common stockholders 453 524 1,184 1,521
Adjustments to reconcile net income available to common stockholders to core earnings: Net realized capital losses (gains) excluded from core earnings, before tax
(6) (88) 119 (327)
Restructuring and other costs, before tax 87 - 87 -
Loss on extinguishment of debt, before tax - 90 - 90
Loss on reinsurance transaction, before tax - - - 91
Integration and transaction costs associated with acquired business, before tax
14 29 40 70
Change in loss reserves upon acquisition of a business, before tax
- - - 97
Change in deferred gain on retroactive reinsurance, before tax 14
- 97 -
Income tax expense (35) (7) (77) (2)
Core earnings $ 527 $ 548 $ 1,450 $ 1,540
Core Earnings Margin- The Hartford uses the non-GAAP measure core earnings
margin to evaluate, and believes it is an important measure of, the Group
Benefits segment's operating performance. Core earnings margin is calculated by
dividing core earnings by revenues, excluding buyouts and realized gains
(losses). Net income margin, calculated by dividing net income by revenues, is
the most directly comparable U.S. GAAP measure. The Company believes that core
earnings margin provides investors with a valuable measure of the performance of
Group Benefits because it reveals trends in the business that may be obscured by
the effect of buyouts and realized gains (losses) as well as other items
excluded in the calculation of core earnings. Core earnings margin should not be
considered as a substitute for net income margin and does not reflect the
overall profitability of Group Benefits. Therefore, the Company believes it is
important for investors to evaluate both core earnings margin and net income
margin when reviewing performance. A reconciliation of net income margin to core
earnings margin is set forth in the Results of Operations section within MD&A -
Group Benefits.
Current Accident Year Catastrophe Ratio- A component of the loss and loss
adjustment expense ratio, represents the ratio of catastrophe losses incurred in
the current accident year (net of reinsurance) to earned premiums. For U.S.
events, a catastrophe is an event that causes $25 or more in industry insured
property losses and affects a significant number of property and casualty
policyholders and insurers, as defined by the Property Claim Service office of
Verisk . For international events, the Company's approach is similar, informed,
in part, by how Lloyd's of London defines catastrophes. Lloyd's of London is an
insurance market-place operating worldwide ("Lloyd's"). Lloyd's does not
underwrite risks. The Company accepts risks as the sole member of Lloyd's
Syndicate 1221 ("Lloyd's Syndicate"). The current accident year catastrophe
ratio includes the effect of catastrophe losses, but does not include the effect
of reinstatement premiums.
Expense Ratio- For the underwriting segments of Commercial Lines and Personal
Lines is the ratio of underwriting
expenses less fee income, to earned premiums. Underwriting expenses include the
amortization of deferred policy acquisition costs ("DAC") and insurance
operating costs and expenses, including certain centralized services costs and
bad debt expense. DAC include commissions, taxes, licenses and fees and other
incremental direct underwriting expenses and are amortized over the policy term.
The expense ratio for Group Benefits is expressed as the ratio of insurance
operating costs and other expenses including amortization of intangibles and
amortization of DAC, to premiums and other considerations, excluding buyout
premiums.
The expense ratio for Commercial Lines, Personal Lines and Group Benefits does
not include integration and other transaction costs associated with an acquired
business.
Fee Income- Is largely driven from amounts earned as a result of contractually
defined percentages of assets under management in our Hartford Funds business.
These fees are generally earned on a daily basis. Therefore, the growth in
assets under management either through positive net flows or favorable market
performance will have a favorable impact on fee income. Conversely, either
negative net flows or unfavorable market performance will reduce fee income.
Loss and Loss Adjustment Expense Ratio- A measure of the cost of claims incurred
in the calendar year divided by earned premium and includes losses and loss
adjustment expenses incurred for both the current and prior accident years.
Among other factors, the loss and loss adjustment expense ratio needed for the
Company to achieve its targeted return on equity fluctuates from year to year
based on changes in the expected investment yield over the claim settlement
period, the timing of expected claim settlements and the targeted returns set by
management based on the competitive environment.
The loss and loss adjustment expense ratio is affected by claim frequency and
claim severity, particularly for shorter-tail property lines of business, where
the emergence of claim frequency and severity is credible and likely indicative
of ultimate
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
losses. Claim frequency represents the percentage change in the average number of reported claims per unit of exposure in the current accident year compared to that of the previous accident year. Claim severity represents the percentage change in the estimated average cost per claim in the current accident year compared to that of the previous accident year. As one of the factors used to determine pricing, the Company's practice is to first make an overall assumption about claim frequency and severity for a given line of business and then, as part of the rate-making process, adjust the assumption as appropriate for the particular state, product or coverage. Loss and Loss Adjustment Expense Ratio before Catastrophes and PriorAccident Year Development - A measure of the cost of non-catastrophe loss and loss adjustment expenses incurred in the current accident year divided by earned premiums. Management believes that the current accident year loss and loss adjustment expense ratio before catastrophes is a performance measure that is useful to investors as it removes the impact of volatile and unpredictable catastrophe losses and prior accident year development. Loss Ratio, excluding Buyouts- Utilized for the Group Benefits segment and is expressed as a ratio of benefits, losses and loss adjustment expenses, excluding those related to buyout premiums, to premiums and other considerations, excluding buyout premiums. Since Group Benefits occasionally buys a block of claims for a stated premium amount, the Company excludes this buyout from the loss ratio used for evaluating the profitability of the business as buyouts may distort the loss ratio. Buyout premiums represent takeover of open claim liabilities and other non-recurring premium amounts.Mutual Fund and Exchange-Traded Product Assets- Are owned by the shareholders of those products and not by the Company and, therefore, are not reflected in the Company's Condensed Consolidated Financial Statements except in instances where the Company seeds new investment products and holds an investment in the fund for a period of time. Mutual fund and ETP assets are a measure used by the Company primarily because a significant portion of the Company's Hartford Funds segment revenues are based upon asset values. These revenues increase or decrease with a rise or fall in AUM whether caused by changes in the market or through net flows. New Business Written Premium- Represents the amount of premiums charged for policies issued to customers who were not insured with the Company in the previous policy term. New business written premium plus renewal policy written premium equals total written premium. Policies in Force- Represents the number of policies with coverage in effect as of the end of the period. The number of policies in force is a growth measure used for Personal Lines and standard commercial lines (small commercial and middle market lines within middle & large commercial) within Commercial Lines and is affected by both new business growth and policy count retention. Premium Retention- Represents renewal premium written in the current period divided by total premium written in the prior period. Policy Count Retention- Represents the ratio of the number of policies renewed during the period divided by the number of policies available to renew. The number of policies available to renew represents the number of policies, net of any cancellations, written in the previous policy term. Policy count retention is affected by a number of factors, including the percentage of renewal policy quotes accepted and decisions by the Company to non-renew policies because of specific policy underwriting concerns or because of a decision to reduce premium writings in certain classes of business or states. Policy count retention is also affected by advertising and rate actions taken by competitors. Policyholder Dividend Ratio- The ratio of policyholder dividends to earned premium. Prior Accident Year Loss and Loss Adjustment Expense Ratio- Represents the increase (decrease) in the estimated cost of settling catastrophe and non-catastrophe claims incurred in prior accident years as recorded in the current calendar year divided by earned premiums. Reinstatement Premiums- Represents additional ceded premium paid for the reinstatement of the amount of reinsurance coverage that was reduced as a result of the Company ceding losses to reinsurers. Renewal Earned Price Increase (Decrease)- Written premiums are earned over the policy term, which is six months for certain Personal Lines automobile business and twelve months for substantially all of the remainder of the Company's Property and Casualty business. Since the Company earns premiums over the six to twelve month term of the policies, renewal earned price increases (decreases) lag renewal written price increases (decreases) by six to twelve months. Renewal Written Price Increase (Decrease)- For Commercial Lines, represents the combined effect of rate changes, amount of insurance and individual risk pricing decisions per unit of exposure on standard commercial lines policies that renewed. For Personal Lines, renewal written price increases represent the total change in premium per policy since the prior year on those policies that renewed and includes the combined effect of rate changes, amount of insurance and other changes in exposure. For Personal Lines, other changes in exposure include, but are not limited to, the effect of changes in number of drivers, vehicles and incidents, as well as changes in customer policy elections, such as deductibles and limits. The rate component represents the change in rate filed with and approved by state regulators during the period and the amount of insurance represents the change in the value of the rating base, such as model year/vehicle symbol for automobiles, building replacement costs for property and wage inflation for workers' compensation. A number of factors affect renewal written price increases (decreases) including expected loss costs as projected by the Company's pricing actuaries, rate filings approved by state regulators, risk selection decisions made by the Company's underwriters and marketplace competition. Renewal written price changes reflect the property and casualty insurance market cycle. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
has been favorable or when competition among insurance carriers increases.
Renewal written price statistics are subject to change from period to period,
based on a number of factors, including changes in actuarial estimates and the
effect of subsequent cancellations and non-renewals, and modifications made to
better reflect ultimate pricing achieved.
Return on Assets ("ROA"), Core Earnings- The Company uses this non-GAAP
financial measure to evaluate, and believes is an important measure of, the
Hartford Funds segment's operating performance. ROA, core earnings is calculated
by dividing annualized core earnings by a daily average AUM. ROA is the most
directly comparable U.S. GAAP measure. The Company believes that ROA, core
earnings, provides investors with a valuable measure of the performance of the
Hartford Funds segment because it reveals trends in our business that may be
obscured by the effect of items excluded in the calculation of core earnings.
ROA, core earnings, should not be considered as a substitute for ROA and does
not reflect the overall profitability of our Hartford Funds business. Therefore,
the Company believes it is important for investors to evaluate both ROA, and
ROA, core earnings when reviewing the Hartford Funds segment performance. A
reconciliation of ROA to ROA, core earnings is set forth in the Results of
Operations section within MD&A - Hartford Funds.
Underlying Combined Ratio- This non-GAAP financial measure of underwriting
results represents the combined ratio before catastrophes, prior accident year
development and current accident year change in loss reserves upon acquisition
of a business. Combined ratio is the most directly comparable GAAP measure. The
underlying combined ratio represents the combined ratio for the current accident
year, excluding the impact of current accident year catastrophes and current
accident year change in loss reserves upon acquisition of a business. The
Company believes this ratio is an important measure of the trend in
profitability since it removes the impact of volatile and unpredictable
catastrophe losses and prior accident year loss and loss adjustment expense
reserve development. The changes to loss reserves upon acquisition of a business
are excluded from underlying combined ratio because such changes could obscure
the ability to compare results in periods after the acquisition to results of
periods prior to the acquisition as such trends are valuable to our investors'
ability to assess the Company's financial performance.
A reconciliation of combined ratio to underlying combined ratio is set forth in
the Results of Operations section within MD&A - Commercial Lines and Personal
Lines.
Underwriting Gain (Loss)- The Hartford's management evaluates profitability of
the Commercial and Personal Lines segments primarily on the basis of
underwriting gain or loss. Underwriting gain (loss) is a before tax non-GAAP
measure that represents earned premiums less incurred losses, loss adjustment
expenses and underwriting expenses. Net income (loss) is the most directly
comparable GAAP measure. Underwriting gain (loss) is influenced significantly by
earned premium growth and the adequacy of The Hartford's pricing. Underwriting
profitability over time is also greatly influenced by The Hartford's
underwriting discipline, as management strives to manage exposure to loss
through favorable risk selection and diversification, effective management of
claims, use of reinsurance and its ability to manage its expenses. The Hartford
believes that the measure underwriting gain (loss) provides investors with a
valuable measure of profitability, before tax, derived from underwriting
activities, which are managed separately from the Company's investing
activities.
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Reconciliation of Net Income to Underwriting Gain (Loss)
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Commercial Lines
Net income $ 323 $ 336 $ 378 $ 890
Adjustments to reconcile net income to underwriting
gain (loss):
Net servicing income (1) (2) (2) (3)
Net investment income (316) (291) (797) (831)
Net realized capital losses (gains) 26 (60) 105 (229)
Other expense 8 20 25 27
Loss on reinsurance transaction - - - 91
Income tax expense 52 79 71 202
Underwriting gain (loss) $ 92 $ 82 $ (220) $ 147
Personal Lines
Net income $ 79 $ 94 $ 548 $ 252
Adjustments to reconcile net income to underwriting
gain (loss):
Net servicing income (5) (4) (10) (11)
Net investment income (41) (46) (110) (134)
Net realized capital losses (gains) (3) (9) 12 (36)
Other expense 2 - 1 1
Income tax expense 20 23 142 60
Underwriting gain $ 52 $ 58 $ 583 $ 132
P&C Other Ops
Net income $ 2 $ 18 $ 12 $ 52
Adjustments to reconcile net income to underwriting
gain (loss):
Net investment income (14) (21) (40) (64)
Net realized capital losses (gains) (2) (4) 3 (17)
Income tax expense 1 4 2 11
Underwriting loss $ (13) $ (3) $ (23) $ (18)
Written and Earned Premiums- Written premium represents the amount of premiums
charged for policies issued, net of reinsurance, during a fiscal period.
Premiums are considered earned and are included in the financial results on a
pro rata basis over the policy period. Management believes that written premium
is a performance measure that is useful to investors as it reflects current
trends in the Company's sale of property and casualty insurance products.
Written and earned premium are recorded net of ceded reinsurance premium.
Traditional life and disability insurance type products, such as those sold by
Group Benefits, collect premiums from policyholders in exchange for financial
protection for the policyholder from a specified insurable loss, such as death
or disability. These premiums together with net investment income earned are
used to pay the contractual obligations under these insurance contracts. Two
major factors, new sales and persistency, impact premium growth. Sales can
increase or decrease in a given year based on a number of factors, including but
not limited to, customer demand for the Company's product offerings, pricing
competition, distribution channels and the Company's reputation and ratings.
Persistency refers to the percentage of premium remaining in-force from
year-to-year.
THE HARTFORD'S OPERATIONS
The Hartford conducts business principally in five reporting segments including
Commercial Lines, Personal Lines, Property & Casualty Other Operations, Group
Benefits and Hartford Funds, as well as a Corporate category. The Company
includes in the Corporate category reserves for run-off structured settlement
and terminal funding agreement liabilities, restructuring costs, capital raising
activities (including equity financing, debt financing and related interest
expense), transaction expenses incurred in connection with an acquisition,
purchase accounting adjustments related to goodwill and other expenses not
allocated to the reporting segments. Corporate also includes investment
management fees and expenses related to managing third party business, including
management of the invested assets of Talcott Resolution Life, Inc. and its
subsidiaries ("Talcott Resolution"). Talcott Resolution is the holding company
of the life and annuity business that was sold in May 2018 . In addition,
Corporate
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
includes a 9.7% ownership interest in the legal entity that acquired the life and annuity business sold. The Company derives its revenues principally from: (a) premiums earned for insurance coverage provided to insureds; (b) management fees on mutual fund and ETP assets; (c) net investment income; (d) fees earned for services provided to third parties; and (e) net realized capital gains and losses. Premiums charged for insurance coverage are earned principally on a pro rata basis over the terms of the related policies in-force. The profitability of the Company's property and casualty insurance businesses over time is greatly influenced by the Company's underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance, the size of its in force block, actual mortality and morbidity experience, and its ability to manage its expense ratio which it accomplishes through economies of scale and its management of acquisition costs and other underwriting expenses. Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future loss cost frequency and severity based on historical loss experience adjusted for known trends, the Company's response to rate actions taken by competitors, its expense levels and expectations about regulatory and legal developments. The Company seeks to price its insurance policies such that insurance premiums and future net investment income earned on premiums received will cover underwriting expenses and the ultimate cost of paying claims reported on the policies and provide for a profit margin. For many of its insurance products, the Company is required to obtain approval for its premium rates from state insurance departments and the Lloyd's Syndicate's ability to write business is subject to Lloyd's approval for its premium capacity each year. Most of Personal Lines written premium is associated with our exclusive licensing agreement withAARP . This agreement provides an important competitive advantage given the size of the 50 plus population and the strength of the AARP brand. During the second quarter of this year, the Company extended this agreement throughDecember 31, 2032 . Similar to property and casualty, profitability of the group benefits business depends, in large part, on the ability to evaluate and price risks appropriately and make reliable estimates of mortality, morbidity, disability and longevity. To manage the pricing risk, Group Benefits generally offers term insurance policies, allowing for the adjustment of rates or policy terms in order to minimize the adverse effect of market trends, loss costs, declining interest rates and other factors. However, as policies are typically sold with rate guarantees of up to three years, pricing for the Company's products could prove to be inadequate if loss and expense trends emerge adversely during the rate guarantee period or if investment returns are lower than expected at the time the products were sold. For some of its products, the Company is required to obtain approval for its premium rates from state insurance departments. New and renewal business for group benefits business, particularly for long-term disability, are priced using an assumption about expected investment yields over time. While the Company employs asset-liability duration matching strategies to mitigate risk and may use interest-rate sensitive derivatives to hedge its exposure in the Group Benefits investment portfolio, cash flow patterns related to the payment of benefits and claims are uncertain and actual investment yields could differ significantly from expected investment yields, affecting profitability of the business. In addition to appropriately evaluating and pricing risks, the profitability of the Group Benefits business depends on other factors, including the Company's response to pricing decisions and other actions taken by competitors, its ability to offer voluntary products and self-service capabilities, the persistency of its sold business and its ability to manage its expenses which it seeks to achieve through economies of scale and operating efficiencies. The financial results of the Company's mutual fund and ETP businesses depend largely on the amount of assets under management and the level of fees charged based, in part, on asset share class and product type. Changes in assets under management are driven by the two main factors of net flows and the market return of the funds, which are heavily influenced by the return realized in the equity and bond markets. Net flows are comprised of new sales less redemptions by mutual fund and ETP shareholders. Financial results are highly correlated to the growth in assets under management since these products generally earn fee income on a daily basis. The investment return, or yield, on invested assets is an important element of the Company's earnings since insurance products are priced with the assumption that premiums received can be invested for a period of time before benefits, losses and loss adjustment expenses are paid. Due to the need to maintain sufficient liquidity to satisfy claim obligations, the majority of the Company's invested assets have been held in available-for-sale securities, including, among other asset classes, corporate bonds, municipal bonds, government debt, short-term debt, mortgage-backed securities, asset-backed securities and collateralized loan obligations. The primary investment objective for the Company is to maximize economic value, consistent with acceptable risk parameters, including the management of credit risk and interest rate sensitivity of invested assets, while generating sufficient net of tax income to meet policyholder and corporate obligations. Investment strategies are developed based on a variety of factors including business needs, regulatory requirements and tax considerations. Impact of COVID-19 on our financial condition, results of operations and liquidity Impact to revenues Earned premiums The COVID-19 pandemic has caused significant disruption to the economy of theU.S. and other countries in which we operate. Due to government restrictions that have prevented some businesses from offering goods and services to their customers and due to shelter-in-place guidelines that have reduced business activity, many of our customers, especially small businesses, have had to curtail their operations or have found they are unable to meet cash flow needs due to declining business volume, causing some to lay off workers. As one of the largest providers of small business insurance in theU.S. , we experienced a 3% year over year decline in our small commercial written premium in the first nine months of 2020 though only a 1% decline in third quarter 2020. In addition to the expected decline in small commercial written and earned premium, other business lines in Commercial Lines have also been negatively affected due to government-
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
mandated restrictions and stay-at-home guidelines reducing business activity and due to consumers having less disposable income or less willingness to spend on the products and services that our commercial lines policyholders sell. Excluding the effect of the Navigators acquisition, Commercial Lines written premium declined$249 , or 4%, year over year for the nine months endedSeptember 30, 2020 and we expect written premium declines to continue for the remainder of 2020, driven by lower new business and due to endorsements or other changes to in-force policies that decrease premiums to reflect reduced exposures. Within Commercial Lines, workers' compensation written premium declined year over year in the nine month period and is expected to continue to decline over the remainder of 2020, partly due to declining payrolls as a result of the economic effects of COVID-19. While the impact of the COVID-19 pandemic on Personal Lines written premium has been less than the effect in Commercial Lines, we expect written premium declines to continue for the remainder of 2020 in part due to increased shopping behaviors, and lower new business levels arising out of the competitive marketplace. In addition, TheHartford provided a 15 percent refund on policyholders' April, May and June personal automobile insurance premiums which reduced Personal Lines written and earned premiums by$81 in the second quarter of 2020. In Group Benefits, we expect fully insured ongoing premium for 2020 to decline modestly year over year due to the economic downturn causing lower sales of new policies, declining payrolls reducing premiums on existing accounts and the potential that some employers may cancel coverage. Because of the economic stress caused by COVID-19, we also expect a higher amount of uncollectible premiums receivable. As a result, to reflect our higher expectation of credit losses, TheHartford increased its allowance for credit losses ("ACL") on premiums receivable by$55 in the nine months endedSeptember 30, 2020 . Fee revenues Our Hartford Funds segment revenues are based on average daily assets under management. While fee revenues have also been affected by a continued shift to lower fee generating funds, if daily average assets under management were to decrease due to a decline in markets over the balance of the year, we could experience a larger decrease in 2020 full year net income from ourHartford Funds segment relative to 2019 net income. Net investment income and realized capital gains (losses) Reflecting the trend year-to-date, we expect lower net investment income in 2020 than in 2019. In an effort to stimulate the economy, central banks have reduced benchmark interest rates to near zero, impacting our yields on floating rate securities and reinvestment rates. From late March to mid-May, 2020, the Company temporarily reinvested receipts of interest and proceeds from maturing fixed maturity investments in liquid, short-term investments. While the Company resumed investing in fixed maturities in May, 2020, lower interest rates since the pandemic began have generally resulted in lower investment yields on newly invested funds. Income or losses on investments in limited partnerships and other alternative investments are recognized on a lag as results from private equity investments and other funds are generally reported on a three-month delay. A prolonged period of lower interest rates could depress the Company's net investment income such that to earn the same level of return on equity we may have to charge higher premiums for the insurance products we sell unless loss costs similarly lessen. Net realized capital gains (losses) for the three and nine month periods included a total$42 and$(269) respectively, of before tax unrealized mark-to-market gains (losses) on equity securities held and net realized gains (losses) on equity securities sold, net of realized gains on equity derivative hedges. While equity markets in the second and third quarter of 2020 largely recovered the value they lost during the first quarter, economic conditions remain uncertain and if equity markets were to experience similar declines as occurred earlier this year, we may incur more net realized capital losses in future periods; however, the Company reduced its investments in public equity securities during March and April of 2020, with the fair value of equity securities declining from$1.7 billion as ofDecember 31, 2019 to$819 as ofSeptember 30, 2020 . Net realized capital losses for the three and nine month periods also included ($4 ) and$52 , respectively, of increases (decreases) in the allowance for credit losses, partially offset by reversals of the allowance due to improvements in market value or sales, and$0 and$5 , respectively, of intent-to-sell impairments. The increase (decrease) in the allowance for credit losses in the three and nine month periods included increases of$1 and$33 , respectively, on available for sale fixed maturities and increases (decreases) of ($5 ) and$19 , respectively, on commercial mortgage loans. If it takes a prolonged period for the economy to recover or if the impacts of the economic downturn are deeper than anticipated, we could experience further credit losses and intent-to-sell impairments, particularly with highly leveraged companies and issuers in the energy, commercial real estate, and travel and leisure sectors, resulting in further net realized capital losses. Impact to direct benefits, losses and loss adjustment expenses from COVID-19 claims For the three and nine months endedSeptember 30, 2020 , we recorded direct COVID-19 incurred losses of$72 and$339 , respectively, including$37 and$250 , respectively, in P&C and$35 and$89 , respectively, in Group Benefits, reflecting management's best estimate of the ultimate cost of settling COVID-19 claims incurred. For the nine months endedSeptember 30, 2020 , COVID-19 incurred losses and loss adjustment expenses in P&C primarily included$141 for property claims,$52 for workers' compensation, net of favorable frequency on other workers' compensation claims, and$57 of incurred losses largely concentrated in financial lines such as D&O and E&O and domestic wholesale. For the three months endedSeptember 30, 2020 , P&C incurred COVID-19 losses and loss adjustment expenses included$17 for workers' compensation, net of favorable frequency, and$20 in financial lines and other. Nearly all of our property insurance policies require direct physical loss or damage to property and contain standard exclusions that we believe preclude coverage for COVID-19 related claims, and the vast majority of such policies contain exclusions for virus-related losses. Included in the$141 of COVID-19 property incurred losses and loss adjustment expenses in the nine month period were$101 of losses arising from a small number of property policies that do not require
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
direct physical loss or damage and from policies intended to cover specific business needs, including crisis management and performance disruption. In addition, we recorded a reserve of$40 for legal defense costs. Given the significant business disruptions that have occurred due to the COVID-19 pandemic, the Company has experienced increased property claims, resulting in increased litigation activity and legal expenses. Within Property & Casualty, we incur COVID-19 workers' compensation losses when it is determined that workers were exposed to COVID-19 out of and in the course of their employment and in other cases where states have passed laws providing for the presumption of coverage for certain industry classes, including health care and other essential workers. While current accident year losses for workers' compensation in the three and nine months endedSeptember 30, 2020 increased$65 and$140 , respectively, due to COVID-19 claims, this has been partially offset by lower claim frequency of non-COVID-19 related workers' compensation claims due to reduced business activity, resulting in a net increase in incurred losses of$17 and$52 , respectively. Favorable non-COVID-19 workers' compensation claim frequency could continue over the remainder of 2020 though possibly to a lesser extent if more business activity resumes. COVID-19 incurred losses in the three and nine month periods of$35 and$89 , respectively, in Group Benefits consisted of$28 and$71 , respectively, of losses on group life claims and$7 and$18 , respectively, of losses on short-term disability and paid family leave claims. The Company could incur additional COVID-19 direct incurred losses over the remainder of 2020, particularly for workers' compensation and financial lines within P&C and in group life. Other impacts from COVID-19 and resulting economic downturn Apart from impacts on the investment portfolio, net investment income and net realized capital gains (losses), in third quarter 2020, the Company incurred a number of other insurance business impacts from the COVID-19 pandemic and the resulting economic downturn as follows: •For the three and nine months endedSeptember 30, 2020 , we recognized an estimated decrease in current accident incurred losses in Personal Lines automobile of$62 and$173 , respectively, due to a significant reduction in miles driven since the pandemic began, though miles driven has begun to increase again. In the second quarter of 2020, Personal Lines written and earned premiums were reduced by$81 due to providing automobile policyholders with premium refunds or credits in recognition of the decrease in miles driven. •The Company reduced audit premiums receivable by$100 in second quarter 2020 driven by the economic effects of COVID-19 reducing our insured exposures, principally in workers' compensation. Net of a related reduction in estimated incurred losses and commissions attributable to the reduction in exposure, the net effect in second quarter was a$34 reduction in income before tax. In the third quarter of 2020, there was virtually no change in estimated audit premiums receivable due to COVID-19 though we continue to expect lower audit premiums based on expected lower exposures. Estimated audit premiums receivable could decrease over the remainder of 2020 with the magnitude of the impact depending on how economic conditions change in theU.S. in the fourth quarter. •From April through approximately July of 2020, the Company waived late payment fees for a period of time for business and personal insurance customers and temporarily suspended the policy cancellation process for policyholders of our Commercial Lines, Personal Lines and Group Benefits segments with the period of policy cancellations for non-payment varying by state. •Because of the economic stress caused by COVID-19 and partly due to the extension of billing terms, we expect a higher amount of uncollectible premiums receivable. As a result, to reflect our higher expectation of credit losses, TheHartford increased its ACL on premiums receivable by$55 in the nine months endedSeptember 30, 2020 . The allowance on premiums receivable decreased in the third quarter of 2020 as the provision required on premiums written in the quarter was more than offset by write-offs and a$9 reduction in the provision reflecting improved collection experience, largely in Group Benefits. •Apart from the increase in the premiums receivable allowance, we have experienced a decline in insurance operating costs and other expenses partly due to lower acquisition-related and other operating costs associated with lower earned premium volumes and expect that trend to continue for the remainder of 2020. •As a result of the effects of COVID-19 on our economy, we evaluated our goodwill and other intangible assets for impairment as ofSeptember 30, 2020 and determined that no impairments were necessary. The estimated fair values of reporting units with goodwill and of certain intangible assets are sensitive to changes in discount rates and are based on expected cash flows assuming improvement due to the gradual reopening of the economy continuing into 2021. For information about additional resources the Company has to manage capital and liquidity during the COVID-19 pandemic and financial crisis, refer to the Capital Resources & Liquidity section of MD&A. For additional information about the potential impacts of the COVID-19 pandemic and resulting economic crisis, see the risk factor "The pandemic caused by the spread of COVID-19 has disrupted our operations and may have a material adverse impact on our business results, financial condition, results of operations and/or liquidity" in Item 1A of Part II. P&C combined ratios and Group Benefits margin In 2020, we expect our combined ratio for Commercial Lines to be higher than the outlook range we provided in our 2019 Form 10-K, primarily due to COVID-19 incurred losses and higher than budgeted current accident year catastrophe losses, partially offset by net favorable prior accident year development. We expect the underlying combined ratio for Commercial Lines in 2020 to be higher due to COVID-19 incurred losses. In 2020, we expect our combined ratio for Personal Lines to be lower than the outlook range we provided in our 2019 Form 10-K, primarily due to favorable prior accident year catastrophe reserve development year-to-date, including a$260 subrogation recoverable from PG&E recorded in the second quarter, partially offset by higher than expected current accident year
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
catastrophes, and expect the underlying combined ratio for Personal lines to be lower primarily due to favorable automobile claim frequency and lower non-catastrophe homeowners' claims, partially offset by$81 before tax of premium credits issued to policyholders in the second quarter. Our net income margin and core earnings margin for Group Benefits has been trending toward the higher end of the outlook ranges we provided in our 2019 Form 10-K and will continue to be influenced by the net effect of COVID-19 group life claims and continued favorable emergence of claim incidence on group disability over the balance of 2020. Common stockholders' equity Apart from the direct loss and premium impacts of COVID-19 on net income, we could also experience a reduction in AOCI within common stockholders' equity. The net unrealized gain position on our portfolio of fixed maturities, AFS increased by$933 fromDecember 31, 2019 toSeptember 30, 2020 , due to an increase in valuations resulting from a decline in interest rates, partially offset by wider credit spreads. If credit spreads widen going forward or if interest rates increase from the level they were at as ofSeptember 30, 2020 , we would recognize a decline in the fair value of fixed maturities, AFS in future periods through a reduction of AOCI within common stockholders' equity. During the nine months endedSeptember 30, 2020 , the Company repurchased 2.7 million common shares for$150 under a$1.0 billion share repurchase authorization by the Board of Directors approved in February, 2019. Any repurchase of shares under the remaining equity repurchase authorization of$650 is dependent on market conditions and other factors including the extent to which COVID-19 impacts our business, results of operations, financial condition and liquidity. For further information on the Company's reporting segments refer to Part I, Item 1, Business - Reporting Segments in TheHartford's 2019 Form 10-K Annual Report. Operational Transformation and Cost Reduction Plan In recognition of the need to become more cost efficient and competitive along with enhancing the experience we provide to agents and customers, onJuly 30, 2020 , the Company announced an operational transformation and cost reduction plan it refers to asHartford Next. Through reduction of its headcount, IT investments to further enhance our capabilities, and other activities, relative to 2019, the Company expects to achieve a reduction in annual insurance operating costs and other expenses of approximately$500 by 2022. The Hartford Next program will contribute to our goal of reducing the 2022 P&C expense ratio by about 2.0 to 2.5 points, reducing the 2022 Group Benefits expense ratio by about 1.5 to 2.0 points and reducing our 2022 claim expense ratio by 0.5 point. To achieve those expected savings, we expect to spend approximately$360 , with those costs expected to be approximately$156 over the last six months of 2020,$90 in 2021,$64 in 2022 and$50 after 2022. The estimated costs of approximately$360 includes an expected$60 in capitalized development costs for internal use software to be amortized over the useful life of the software, typically 3 years. Of the estimated costs of$360 , approximately$310 would be recognized as an expense through the end of 2022, with$50 of IT asset amortization after 2022. Included in the estimated costs of$360 , we expect to incur restructuring costs of approximately$150 , including$78 of employee severance, and approximately$72 of other costs, including consulting expenses and the cost to retire certain IT applications. These estimated restructuring and other costs do not include all of the costs associated with a real estate consolidation plan as those plans are not yet sufficiently developed to provide a full estimate of those costs and related savings. Restructuring costs are reported as a charge to net income but not in core earnings. All other costs of the Hartford Next program will be included in insurance operating costs and other expenses in the Condensed Consolidated Statement of Operations. Relative to 2019 full year actual expenses, the Company estimates a net increase in insurance operating costs and other expenses of approximately$81 over the last six months of 2020 and expects a net expense reduction of approximately$210 in 2021 and approximately$436 in 2022. The following table shows the expected costs of the Hartford Next program, including restructuring costs, and expected expense savings through 2022:
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Hartford Next Expected Costs and Expense Savings
Estimate for Second
Half of 2020 Estimate for 2021 Estimate for 2022
Employee severance $ 78 $ - $ -
IT costs to retire applications 4 10 14
Professional fees and other expenses 34 10 -
Estimated restructuring costs to be expensed and 116 20 14
paid
Non-capitalized IT costs to be paid 30 50 30 Other costs to be paid 10 20 10 Amortization of capitalized IT development costs - - 10
[1]
Estimated costs within core earnings 40 70 50 Total estimated Hartford Next program costs to $ 156 $ 90 $ 64
be expensed [2]
Cumulative savings relative to 2019 beginning $ (75) $ (300) $ (500)
Net expense (savings) before-tax: $ 81 $ (210) $ (436) Net expense (savings) before-tax: To be accounted for within core earnings $ (35) $ (230) $ (450) Restructuring costs recognized outside of core 116 20 14
earnings
Net expense (savings) before tax $ 81 $ (210) $ (436)
[1]Does not include approximately
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Financial Highlights
Net Income Available to Net Income Available to Common Book Value per
Common Stockholders Stockholders per Diluted Share Diluted Share
[[Image Removed: hig-20200930_g2.jpg]] [[Image Removed: hig-20200930_g3.jpg]]
[[Image Removed: hig-20200930_g4.jpg]]
Þ Decreased
Ý Increased
- Higher current accident year - Decrease in net income
+ Increase in common
catastrophes largely due to stockholders' equity largely
losses from wildfires, due to an increase in AOCI,
hurricanes, tropical storms, + Decrease in dilutive shares,
primarily driven by unrealized
and other wind and hail and consequently weighted capital gains on available for
events. average shares outstanding, sale securities.
principally due to a decrease
in the dilutive effect of
stock compensation as a
result of average market
price declines during the
- Restructuring costs related to period. + Net income in excess of
the Hartford Next initiative, stockholder dividends.
primarily severance costs.
- Lower net realized capital
+ Decrease in dilutive shares.
gains, including a loss on
sale of Continental Europe
Operations of
-
claims across group life,
disability, financial lines
and workers' compensation, net
of favorable workers'
compensation frequency.
- A change from income to loss
from the retained interest in
Talcott Resolution.
+ Loss on extinguishment of debt
in 2019 period.
+ Lower non-COVID-19 current
accident year non-catastrophe
property losses and lower
personal automobile claim
frequency.
+ Greater net favorable prior
accident year development.
+ Lower insurance operating
costs and other expenses,
partly driven by lower
variable incentive costs and
reduced travel expenses.
Property & Casualty Group Benefits Net Income
Investment Yield, After Tax Combined Ratio
Margin
[[Image Removed: hig-20200930_g5.jpg]] [[Image Removed: hig-20200930_g6.jpg]]
[[Image Removed: hig-20200930_g7.jpg]]Þ Decreased 10 bps Ý Increased 0.2 points Þ Decreased 1.6 points
- Lower reinvestment + Higher current accident year - COVID-19 incurred benefits and
rates and lower yield catastrophes, largely due to losses of
on variable rate losses from Pacific Coast securities due to the wildfires, hurricanes and - Lower net investment income.
decline in interest tropical storms.
rates.
+ Greater income from + Higher current accident year - A decrease in net realized
non-routine income loss ratio in Commercial Lines capital gains.
items, including driven by COVID-19 losses,
make-whole payments on partially offset by lower + Lower insurance operating costs
fixed maturities. non-catastrophe property and other expenses, including
losses. lower variable incentive
compensation and lower
integration costs.
+ Higher income on - Lower current accident year + Excluding COVID-19 impacts, a
limited partnerships loss ratio in Personal Lines, lower group disability loss
and other alternative due to lower automobile claim ratio, driven by lower claim
investments in 2020. frequency. incidence partially offset by
- More favorable prior accident less favorable prior incurral
year development year development.
- Lower amortization of DAC and
lower underwriting expenses,
mostly driven by lower
variable incentive
compensation and travel costs.
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Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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