Hartford Financial Loses Over Half Its Market Value

Insurer may have to raise more capital as variable annuity business suffers

By Alistair Barr
October 30, 2008

SAN FRANCISCO (MarketWatch) -- Hartford Financial Services lost more than half its market value Thursday on concern the insurer may need to raise more capital. The company reported a big third-quarter loss late Wednesday and said that it couldn't gauge the amount of extra capital it has because of market volatility. The results left "lingering capital questions," Andrew Kligerman, an analyst at UBS, wrote in a note to clients on Thursday.

Hartford (HIG: $9.62, -$10.24, -51.6%) got a $2.5 billion investment from German insurance giant Allianz (AZ: $8.04, +0.45, +5.9%) on Oct. 6.

But the stock market, measured by the Standard & Poor's 500 index, has slumped about 10% since then. That's put more pressure on some of Hartford's businesses that rely on equity market returns and fees from managing clients' money.

Chart of HIG

Hartford's third-quarter loss "was dominated by operating and capital volatility in the variable annuity segment, which has left the company unable to estimate its current capital margin, raising the risk of a further capital raise," Bijan Moazami, an analyst at Friedman, Billings, Ramsey, wrote in a note to investors on Thursday.

Hartford shares dropped 52% to close at $9.62 on Thursday. Other insurers with big annuity businesses also fell. Prudential Financial (PRU: $28.87, -$6.38, -18.1%) dropped 18% to $28.87 and Lincoln National Corporation (LNC $17.71 -$2.79, -13.6%) lost 14% to $17.71.


During a tense conference call late Wednesday, analysts peppered Hartford executives with questions about its capital position.

Insurers have to hold a certain amount of extra capital to pay potential claims and keep regulators and rating agencies happy. If capital ebbs and ratings downgrades follow, that can limit insurers' ability to take on new risks and sell new products.

The slump in equity markets, combined with much wider spreads in the credit market and increased volatility, makes it "extraordinarily difficult" to estimate how much of a capital cushion Hartford will have at the end of 2008, Greg McGreevey, the insurer's new chief investment officer, said during the conference call.

Despite not giving an estimate, Chief Financial Officer Liz Zlatkus said Hartford is comfortable with its capital level.

That didn't wash with several analysts, including Edward Spehar of Merrill Lynch.

"I don't understand how you can say you feel comfortable with your capital position. And yet you say you can't give us any idea what the number is," he said. "At this point, it's impossible to say those two things."

When pushed, Zlatkus said that a 30% drop in the Standard & Poor's 500 from the end of the third quarter (leaving the index at roughly 815), would leave Hartford's risk-based capital ratio at about 300%.

At that theoretical level, Hartford would be at risk of needing to raise more capital, Darin Arita, an analyst at Deutsche Bank, wrote in a note to clients.

Stewart Johnson, a portfolio manager at Philo Smith, an insurance-focused investment firm, said Hartford management has put themselves in a "tough spot" by committing publicly that the insurer doesn't need more capital in the current environment.

One of Hartford's main problems centers on its huge variable annuity business.

These products are like mutual funds wrapped up in an annuity. They often include different types of guarantees in which the insurer promises customers that they will get at least their initial investment back in different circumstances.

If customers surrender their annuities early, insurers may have to return their initial investment in full. But if the stock market has fallen a lot, the investments underlying the annuity may not be worth that much. Making up the difference triggers losses that eat into capital.

Hartford and other insurers used complex hedging techniques to try to avoid such shortfalls, but the dramatic slump in the stock market in recent months may have stretched such programs.

When variable annuities are sold, the upfront commission that's paid to the salesperson is expensed by the insurer over the life of the contract. These are called deferred acquisition costs, or DAC.

If customers surrender their variable annuities earlier than expected, some of the cost of the commission is still left and has to be recognized immediately. That hits capital too.

Insurers charge fees when customers surrender variable annuities early, but some customers have had these products with Hartford for long enough that such charges won't be triggered, Johnson explained.

Indeed, Hartford reported a $932 million third-quarter after-tax charge to "unlock" some of its deferred acquisition costs.

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