MET MetLife Inc

Hartford Financial Services Group Inc. (HIG) is facing mounting pressure from its largest investor - hedge fund manager, John Paulson – to spin-off its property and casualty (P&C) business. The hedge fund manager, who holds an 8.51% stake in the company through Paulson & Co., insists that a split of Hartford’s life insurance and P&C business can boost its share value by up to 62%.

John Paulson filed a presentation with the U.S. Securities and Exchange Commission on Friday, detailing the potential advantages of a spin-off and urging the company to announce a split by April and conclude the same by the second or third quarter of 2013. He also recommended the closure of Hartford’s variable annuity business to release substantial capital and reduce leverage. Other suggestions included sale of the company’s mutual fund, retirement or group benefits business to enhance liquidity.

The conflict between Paulson and Hartford started in February 2012, when the hedge fund manager questioned the company’s complex business model during its fourth-quarter earnings conference call and demanded an explanation for not splitting the P&C and life insurance businesses to unlock the value of its shares.

Hartford’s management responded by affirming its focus on enhancing shareholder value while also citing various challenges to the spin-off such as allocation of debt, impact of the spin-off on ratings and regulatory hurdles. Management holds the opinion that a split will not create shareholder value in the present environment.

Paulson later wrote a letter to the company advocating the spin-off, prompting management to issue a statement declaring that it is assessing the company’s business structure and policies. The hedge fund manager opines that Hartford’s P&C business is a strong contender in the commercial insurance market. However, it gets overshadowed by the company’s large scale and fails to realize its full potential.

Moreover, P&C and life insurance businesses have inherently different risk profiles. While life insurance companies have longer duration of liabilities and relatively lower business risk, P&C business is unpredictable in nature and hence, typically faces high risk. Consequently, P&C companies need a higher capital cushion against potential liabilities, which adversely affects Hartford’s life insurance business. Thus, a split would allow both the businesses to focus on their individual strengths and risks, thereby enabling them to realize their full potential.

Thus, Paulson suggests the formation of a new company with no debt to take over the P&C business. The new company can then issue low interest rate bonds to raise cash and repurchase Hartford’s existing debt.

Hartford is highly undervalued compared to peers such as MetLife Inc. (MET), Prudential Financial Inc. (PRU) and American International Group Inc. (AIG), which focus on either life insurance or P&C business. The company witnessed a 30% plunge in its share price in a year, leaving the investors dissatisfied. Paulson is trying to gather the support of other investors and analysts to pressurize the company further.

However, the fund manager fails to consider the opinion of Hartford’s debt holders, who might be against the split up as putting the entire burden of the company’s debt on the life insurance business may strain its cash flows. Thus, it remains to be seen whether Hartford bucks under the pressure or stays firm on its grounds.

Currently, the shares of the company carry a Zacks #3 Rank (short-term Hold). Also, we maintain a long-term ‘Neutral’ recommendation on the shares.

 
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