Higher Inflation Could Deflate Hartford's Outlook

| About: Hartford Financial (HIG)

Hartford Financial (NYSE:HIG) is one of the largest providers of investment products, individual life, group life and group disability insurance products, as well as property and casualty insurance products in the U.S. In addition to the U.S., the company has operations in Japan, the United Kingdom, Canada, Brazil and Ireland. Its main competitors include large insurers like MetLife (NYSE:MET), Prudential (NYSE:PRU) and AIG (NYSE:AIG).

We have a price estimate of $23.68 on Hartford Financial’s stock, which is about 20% below the current market price. We estimate that property & casualty insurance in the U.S. constitutes about 37% of the company’s stock value.

Inflation’s Nuisance for Insurers

Inflation has a negative impact on the insurance industry for a variety of reasons. As inflation increases, insurance companies have to raise premiums to cover for the increase in prices for future claims. Also the consumer is burdened with the higher cost of living and is left with less income to pay for insurance premiums.

The inflation rate in the U.S. was 1.6% for January 2011 and 1.5% for December 2010 based on the CPI data released by the U.S. Department of Labor. U.S. inflation expectations have been on the rise as investors are concerned about continued monetary stimulus.

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A rise in inflation leads to higher premiums for U.S. property & casualty providers and leads to lower sales as customers are often price elastic. We currently estimate that the U.S. property & casualty premium market will grow by 1% annually and reach $450 billion by 2013.

Operating Margins Could be Impacted

Inflation could also affect Hartford Financial’s property & casualty insurance operating margin. As higher inflation would result in a decline in sales, insurance companies will price their insurance policies more aggressively to retain customers and grab market share. These tactics could lead to a decline in operating margins.

During 2008, the inflation rate in the U.S. rose to about 3.8% from 2.8% in the previous year, and during this period, Hartford Financial’s operating margin declined from 16.6% in 2007 to about 0% in 2008. In 2009, a negative inflation rate of -0.4% corresponded with an operating margin which rose to about 11.7%. A higher inflation rate in the future could coincide with business or macro economic conditions that would result in Hartford’s operating margin to drop below our current expectations.

In a scenario where the operating margin dropped to 10% during our forecast period compared to our current estimate of 12.3%, this would reduce our price estimate by about 5%.

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Disclosure: No positions

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