Outside at the Tiller of Hartford’s Turnaround
November 8 2011 by JP Donlon
The economic meltdown of 2008-2009 caught Hartford Financial unaware. Ramani Ayer, its CEO at the time, had bet heavily on variable annuities, which exposed the company to major liabilities when the stock market tumbled. In addition, the company’s general account or investment portfolio, which is a big part of the insurance company, was overly concentrated in commercial real estate, which drove massive investment losses. Hartford’s share price—more than $80 at the beginning of 2008—dropped into single digits by 2009.
The struggling insurer applied for government aid, taking $3.4 billion in TARP money that it has since paid back. By October 2009, the board had decided to reach beyond the insurance industry for a new leader. It chose a former head of consumer banking at Bank of America, Liam McGee, who at one time was viewed as a contender to succeed Kenneth Lewis as CEO. The County Donegal, Ireland-born, but Los Angeles-raised McGee had spent three decades in consumer and small business banking at BofA and earlier held executive positions with Wells Fargo. An admirer of contemporary art, especially Warhol and Rauschenberg, he is also a devoted Boston Red Sox fan, which will hold him in good stead in Hartford, and also a Lakers fan (arch rivals to the Celtics), which may not.
McGee joins a growing roster of CEOs pulled from outside their career industry to restructure and recapitalize their new companies. (IBM’s Lou Gerstner and Ford Motor’s Alan Mulally, an aviation engineer from Boeing, being the best examples.) Like Mulally, McGee saw an opportunity to run a big iconic company and jumped for it. At 201, Hartford is even older than Ford and among the 10 oldest names still traded on the big board. No pressure.
As in any turnaround, the focus is on profitable growth while minimizing exposure to market risks. The company returned to profitability in 2010, reporting $1.7 billion in net income compared to a $900 million loss in 2009. Its core earnings, a measure of Hartford’s operating performance, were up $1.9 billion, up from $800 million in 2009. Since the beginning of 2011, three ratings agencies revised Hartford’s outlook to “stable,” acknowledging improvements in its operating results, capitalization levels and investment portfolio.
Having bought himself some breathing room, McGee still faces an uphill climb. Second quarter, core profit fell 68 percent on disaster and asbestos costs. With the shares trading well below the company’s book value per share, a measure of assets minus liabilities, the company authorized a massive $500 million stock buyback. Since the company’s challenges go to its very core as an insurance company, some observers contend that he, having no industry experience, may not be best positioned to separate the wheat from the chaff in the advice he receives from insiders.
For his part, McGee sees that the challenges the company faces over the next two years will be arguably more demanding than those confronted over the past two. Going forward, he believes the key strength will be a less insular perspective and a broader skill set of the next several levels of leaders within. “I promised board [members] that when the time came for me to pass the baton, they would have a choice of capable insiders who would be compelling, almost inevitable candidates,” he says. Culture is always a work in progress.
What are your strategic priorities, such as changing the capital structure and relying less on annuities to reinvigorate growth?
From a financial perspective, we need to increase our ROE. We’re not getting sufficient returns and we’re very focused on that, not only at the company level, but business by business. Some are quite good. But we have to continue to be very granular.
Second, our average cost of capital, or our beta, is too high. Notwithstanding the progress that we’ve made, there still is a lag in investors’ view of our current situation. We have to continue to communicate and create transparency for investors to show that we’ve mitigated much of those risks. For years, the variable annuity business was a rocket ship that propelled the company’s growth, and our property and casualty franchise hadn’t grown market share for several years. But this is now changed. Our P&C business is growing more slowly, but it generates a lot of capital and we can grow it more. Our wealth management business, where we have mutual funds, individual life, retirement and annuities, is a unique collection. There’s hardly any other company in this space that has those four categories and has meaningful market penetration capabilities. It aligns well with the changing demographics of an aging population, many of whom are much more focused on retirement income on the heels of the financial crisis. Many have lost the equity in their home that they thought was their nest egg. It’s a really good spot for us to grow.
Third, I want this to be a place where the most talented executives want to work. Many like the turnaround story. They see the upside. They like the culture we’re building, a culture of excitement, competitiveness, and a culture of the right ethics and values. We have no trouble finding the very best people when we have opportunities. When my tenure is up, I want people in financial services to appreciate that The Hartford has one of the best management teams.
You’ve set an ROE target of 11 percent for 2012, but the numbers S&P gives suggest that your ROE now is around 8 percent, which is in line with your competitors. It seems like a lot of heavy lifting will be required to get from here to reach your goal.
When we rolled out an 11 percent ROE target in April of 2010, we were convinced it was doable for a variety of factors. Candidly, the slowdown in the economy has challenged some of our underlying assumptions, both in the growth rates and the sustained, unprecedented low interest rates. We’ve told investors that we are still committed to the 11 percent goal, but I don’t think it’s realistic now that we’ll get it by the fourth quarter of 2012.
When a new CEO walks in the door from outside the company—or in your case, outside the industry—no matter how good your due diligence or what the board told you, there will always be surprises. What were yours?
There were a couple. First, I did a lot of due diligence, and the board was really good about that. Let me share one anecdote. I’ve had the good fortune of visiting thousands of companies, walking the hallways and meeting everyone from CEOs to recent hires. I’ve always believed that you get a feel for a place if you walk the hallways and meet folks. I remember asking the board, “If we get to the point where we’re about ready to have a handshake, I really want to visit the campus, and walk the hallways.” The board members were surprised that I would feel this way, but they relented. They snuck me in one night. Because of my prior job, a lot of people knew who I was, so I had to be discrete, not wanting to risk it leaking inappropriately. It was late at night. Nobody was around, but it was helpful to me. I could visualize myself in this place, making it a place that could be home for me, where I could make a difference.
The loyalty and affection that teammates at The Hartford have for the company were beyond what I had imagined. So were the values and ethics. I knew The Hartford was always known for that, but it became much more real to me the more I met and talked to people. It’s a subjective thing but is no less real for me. The people here are, without exception, polite and helpful. The flip side of this—and this was something of a surprise—was learning that the culture was not one of decisiveness.
It was a culture that really didn’t know how to make decisions. It was a consensus culture, where it wasn’t clear who had the decision-making power. If the decision was made and somebody didn’t like it, they’d call another meeting. There was an insatiable need for data and, to some degree, this may have contributed partially to not reacting as quickly to what the issues were and not being decisive during a crisis.
I’m a decisive person. It was disarming to encounter a culture where management was comfortable and accustomed to more meetings, more conversations. My style is collaborative but in a different way. The company has to evolve to where executives are more comfortable making decisions. We’re implementing an entire decision-making framework to teach people who has the decision-making authority. Heretofore, there might be six people who thought they had that power, and there might be 50 people who thought they have input. But one person has to call it and there are a finite number of people who have input.
To what degree do you anticipate emerging technologies, such as cloud computing, mobile telephony or social media disrupting your industry and how will you adapt?
We have to assume it will. Why wouldn’t it? Whether it’s a materially disruptive force or disruptive in targeted areas remains to be seen. We have one person [John Bennett], who is responsible for our digital commerce. One could end up spending a lot of money and not getting much if you don’t focus and prioritize. For example, I followed with great curiosity the debate in Congress over the U.S. Postal Service. The question asked was, do we even need a postal service? I don’t know the answer, but I suspect that even in five years from now, there will be only a narrow reason to send paper mail. My question for my colleagues was why wouldn’t business owners expect to receive a policy digitally, instead of getting it in the mail? You can put it in a digital vault, like many industries do. Customers don’t want to get bills. They want it directly debited and are content with a confirmation e-mail. Underwriting can be done virtually.
The insurance industry somehow thinks that customers will not drive this kind of change. I think they will. This is an industry that has largely been based on paper. To some extent it will continue, but not everywhere. There’s always value in face-to-face contact. Agents and financial advisors create value for the customer. But there are subsets of customers who want to be able to do it on their own, and I want us to be the company that is in the forefront of that. Of course, the concept is easy; the execution is the hard part.
Given that the next generation of millionaires is likely to be led by folks from China, India, Russia and Brazil, have you considered acquiring a vehicle to capture growth in those economies?
I don’t want to put the cart before the horse. Our priorities right now are being sure we’re firing all cylinders in the U.S. and to finish building that strong foundation. North America is the largest insurance market in the world. Its growth rate over the next 10 years will be 2.5 percent. If you look at the emerging markets of China, Brazil and India, as an example, they’ll grow at about 7.5 percent, so the growth rates, not surprisingly, are almost three times. Yet, if you look 10 years out and you look at the size of the revenue pool, even with the slower growth rate in North America versus those countries, we’re still the greatest market in the world.
Our challenge will be in our propertycasualty business. Most small U.S. companies are being formed by immigrants. Asian, Hispanic and African-American and women-owned businesses are being created at three times the rate of Anglocreated businesses. Many of them do business in some way, shape or form in the country of origin and, of course, virtually all companies are becoming more global. I don’t want to give up that revenue of profit pool if my customer in the U.S. were insuring their risks here, but someone else is insuring them in Brazil. We’re going to have to come to terms with that.
If and when we do, I don’t think de novo is the way to go. We’ll either buy a small company with expertise that understands the culture, the social mores [and] the legal and business ethics as well or do a joint venture partnership with somebody. So I think we may decide to do that in the years ahead.
Hartford has generated returns on equity in line with its peers while employing about the same amount of debt.
|Company Debt-to-Equity||Return on Equity||ROE 5-Year Average|
Source: Capital IQ, division of Standard & Poors