Hartford Financial Split Would be Credit Positive for P&C Group, but Negative for Life Group

Hartford Financial Split Would be Credit Positive for P&C Group, but Negative for Life Group

Last Tuesday, John Paulson, whose hedge fund Paulson & Co. is the largest single owner of Hartford Financial Services Group (Baa3 stable outlook), issued a letter calling for a split of Hartford into two standalone companies, one dedicated to property and casualty (P&C) insurance and one dedicated to life insurance. A split of the company would be credit positive for the P&C group and credit negative for the life insurance group as the P&C group provides implied credit support and ratings uplift to the weaker life operation.

Mr. Paulson is advocating a spin-off of Hartford’s P&C business from the rest of the organization, with an overall debt allocation of about 40% ($2.5 billion) to the new P&C group and 60% ($4.3 billion) to the remaining life insurance group. Among the benefits Mr. Paulson sees is a higher equity valuation for the sum of the parts than exists today for the whole (Hartford’s market cap is currently 40% of book value), greater management focus and reduced complexity.

Hartford’s management team has identified several challenges to splitting the company, including maintaining competitive ratings, obtaining regulatory approval, the cost of obtaining bondholder waivers on certain covenants, dealing with intercompany guarantees, and a potential write-off of much of the life group’s deferred tax assets.

From a credit standpoint, the P&C operation is stronger than the life operation in terms of business and financial profile, and if the two units were separated, their differing credit profiles would be more pronounced. On a standalone basis, the P&C group would likely have higher insurance financial strength ratings (possibly A1) than it does today owing to the reduced risk that it would be called on to support the life operation. In addition, any debt supported by the P&C group would have a stronger credit profile, and thus likely higher ratings, than Hartford’s current holding company debt.

Conversely, a standalone life insurance group would have a weaker credit profile absent support from the P&C group, and debt supported by a future standalone life insurance group would likely be rated lower than today’s existing debt, implying a below-investment grade senior debt rating. We note that life insurance is a confidence-sensitive business, and operating with below-investment-grade debt ratings and a financial strength rating of Baa would be a significant impediment to generating sales and retaining business.

Mr. Paulson’s spin-off proposal would result in most of Hartford’s debt remaining at the existing holding company supported by the life insurance group. Without substantial action to increase the underlying capital strength, earnings and dividend capacity of the life operation, this would be a strong credit negative for the remaining debt, given the life group’s weaker debt service capacity relative to the P&C group. Also, although it would help, we do not believe reducing the proportion of debt allocated to the life group, such as the one-third debt allocation suggested by company management, would eliminate this downward credit pressure. This is because our concerns over the life group’s credit quality stem from its fundamental business profile and the risk inherent in its legacy variable annuity business (a potential source of capital volatility), which are factors that would not be resolved by reducing the group’s debt burden.

In terms of an operational impact, we believe a division would be possible with limited disruptions, as the two primary P&C and life units are largely run separately (despite some cross-selling initiatives) with limited overlap in distribution, customers and underwriting. Also, a reorganization that reduces the group’s complexity would be a credit positive factor for the organization.