Hartford Financial Q1 Earnings Call Transcript

123jump.com Staff
26 May, 2010
New York City

First quarter net income was $319 million or 42 cents a share & core earnings were $545 million. On a per-share basis core earnings of $0.14 and a net loss of $0.42. Underwriting profitability was strong with ex-cat accident year combined ratio of 92.8%. First-quarter impairments were $152 million.

Hartford Financial Services Group Inc. ((HIG))
Q1 2010 Earnings Call Transcript
April 30, 2010 9:00 a.m. ET

Executives

Richard Costello – Investor Relations
Liam E. McGee – Chairman, President and Chief Executive officer
Christopher J. Swift – Executive Vice President and Chief Financial Officer
Juan C. Andrade – President and Chief Operating Officer of Property and Casualty Operations
Gregory McGreevey – Executive Vice President, Chief Investment Officer and President of The Hartford Investment Management Company
John C. Walters – President and Chief Operating Officer of Life Operations

Analysts

Andrew Kligerman – UBS
John Nadel – Sterne Agee
Jimmy Bhullar – J.P. Morgan
Randy Binner – FBR Capital Markets
Darin Arita – Deutsche Bank
Paul Sarran – Macquarie
Thomas Gallagher – Credit Suisse
Scott Frost – HSBC

Presentation

Operator

Good morning. My name is Conchita, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hartford First Quarter 2010 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers'' remarks, there will be a question-and-answer session. If you would like to ask a question at this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Rick Costello, you may begin your conference.

Richard Costello

Thank you, Conchita. Good morning and thank you for joining us for The Hartford''s first-quarter 2010 financial results conference call. Our earnings release and financial supplement were issued yesterday. The slide presentation for today''s call is available on the company''s website at TheHartford.com. CEO Liam McGee and CFO Chris Swift will provide prepared remarks this morning, and we will finish with Q&A. Also participating on today''s call are Juan Andrade, President of the Property and Casualty operations; John Walters, President of the Life operations; Greg McGreevey, Chief Investment Officer; and Alan Kreczko, General Counsel.

Turning to the presentation, on slide two please note that we will make certain statements during the call that should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These include statements about The Hartford''s future results of operations. We caution investors that these forward-looking statements are not guarantees of future performance and actual results may differ materially. Investors should consider the important risks and uncertainties that may cause actual results to differ, including those discussed in our press release issued yesterday, our quarterly report on Form 10-Q for the first quarter of 2010, our 2009 annual report on Form 10-K and other filings we make with the Securities and Exchange Commission. We assume no obligation to update this presentation, which speaks as of today''s date.

Today''s discussion on The Hartford''s financial performance includes financial measures that are not derived from generally accepted accounting principles or GAAP. Information regarding these non-GAAP and other financial measures, including reconciliations to the most directly comparable GAAP measures, is provided in the investor financial supplement for the first quarter of 2010, in the press release we issued yesterday, and in the investor relations section of The Hartford''s website at www.TheHartford.com.

Now I will hand the call over to The Hartford''s Chairman, President, and CEO, Liam McGee.

Liam E. McGee

Thank you, Rick and good morning everyone and thank you again for joining us today. Before we get started, I want to welcome Chris Swift to his first Hartford earnings call. I am pleased to have him on board and appreciate his contributions to what the company has accomplished in the past 60 days.

I also want to thank those of you, who joined us earlier this month for our investor presentation, either in person in New York or on the webcast. We appreciate the positive feedback, as well as the questions we’ve received and we’re now focused on executing our strategy in achieving the financial targets we set, high single-digit core earnings growth and an 11% ROE by 2012.

I’ll provide some additional color on the strategy today and share some of our earlier progress. Obviously, success will not come in one quarter, and instead, will be measured by the results we generate over the next few years. As I’ve said since my arrival, our goal is to deliver superior shareholder returns over time, through sustained profitable growth and that is what we intend to do.

We made good progress in the first quarter. We continued to execute on our 2010 plans, strengthen the balance sheet with the successful capital raise and the TARP re-payment and launched our new strategy. While there is more to do, frankly, we got a lot done. I want to thank the Hartford team for all their hard work and efforts.

With net income of $319 million, the first quarter marked our second consecutive profitable quarter and as a company committed to driving sustained profitability, this is an important result. A strong equity market, our continued commitment to the underwriting discipline and improving credit markets, all contributed to our results.

Chris will go into more detail, but we did have a few one-time charges for the quarter relating to the TARP repurchase, the settlement of the litigation matter and the impact of new Federal healthcare legislation. Without these items, core earnings would have been over $1.30 per share.

The first quarter also showed growing top line momentum across many of our business lines, including mutual funds, retirement plans and PNC commercial lines. Both small commercial and middle market continued to generate profitable new business growth in the first quarter. They also reported meaningful increases in policy retention. In fact, in small commercial, we added more new business policies and had the highest policy count retention in three years.

In wealth management, net flows were positive and sales showed year-over-year gains in most of our ongoing businesses. Mutual fund sales were up 63% over the prior year, and retirement plan deposits were at 15%.

In individual life, we posted a year-over-year sales increase for the first time since the second quarter of 2008. In consumer markets, the AARP through agent program continues to generate top line growth accounting now for 20% of new business in the state where it is available. We’re on track to have the AARP through agent offering in 42 states in the second half of this year.

For the rest of 2010, we anticipate a modestly improving economic environment, which should help to drive top line improvements in our more economically sensitive lines.

Finally, we were pleased to finish the quarter with book value per common share 61% higher than last March at $38.94. More important is the fact that book value per share was essentially flat. We think this is a good result as rising prices on our fixed maturity holdings and the earnings power of our businesses offset the dilutive impacts of the capital raise.

We made significant progress strengthening the balance sheet this quarter. We had a very successful capital raise and we’re pleased by the reception we received from investors. We believe The Hartford now has the right capital structure for this environment and has positioned to move forward with the balance sheet that can handle any reasonable stress scenario.

As you know, we announced our go-forward plan earlier this month. The strategy leverages The Hartford''s key strengths, a strong brand, the unique product breadth, enviable distribution and a large growing customer base across our organization.

To ensure that we execute this plan and instill discipline and accountability for delivering results, Chris has established a team that will drive consistency in terms of our change processes and how we will measure progress and success.

We are already well underway on work related to commercial markets, operations, IT and overall efficiency. The Hartford’s organization is shifting to the customer focus structure and teams are working together to call on customers, leverage best practices and importantly win new business.

As an example, within the last couple of weeks, our commercial markets business, the combination of group benefits and P&C commercial lines has had some early customer wins. Sales teams are beginning to join together sharing information about relationships, sales practices and industry appetites. They are quickly uncovering new opportunities and we are encouraged by these early results.

Brokers and agents have expressed support and enthusiasm as this is the way many of them go to market and they see the value of having a partner with a single point of accountability. Innovation is an important element of our strategy and earlier this week, we launched an important new product that combines in a unique way our expertise and workers’ compensation, a traditional P&C discipline and group benefits, a traditional life discipline.

With this innovative offering, which we call the Hartford Productivity Advantage, employers will be able to manage all types of employee leaves, workers’ compensation, short-term and long-term disability and FMLA in one system. For an employer, this will make it easier for them to manage this complex process and will help them achieve efficiencies and improve productivity.

This product gives us a distinct market advantage. This is something that a P&C-only or a life-only company can not easily match and it provides considerable advantages to time and money strap benefit managers. This is just the first of what we expect will be more one of a kind value-added offerings that leverage our product breadth.

So in summary, the first quarter was a profitable and productive one for The Hartford. We executed our 2010 plan, strengthened the balance sheet and launched our go-forward strategy. We are moving forward to generate sustained profitable growth with strength, confidence, focus and discipline.

The Hartford will celebrate its 200th anniversary on May 10th and over the next few weeks, you can expect to see The Hartford brand highly visible as we celebrate our history, but more importantly our future. Our employees and partners are excited to take this company into our third century.

With that, I will turn it over to Chris Swift, who’ll get into more detail on our financial results and outlook. Chris?

Christopher J. Swift

Thank you, Liam. Good morning, everyone. It''s great to be with you today. Let''s begin on slide four. As we reported yesterday, net income for the first quarter was $319 million and core earnings were $545 million. On a per-share basis, we reported core earnings of $0.14 and a net loss of $0.42. These numbers reflect the $440 million CPP repayment charge that was previously disclosed.

Because the CPP charge runs through retained earnings, it reduces the computation of per-share amounts for net income and core earnings. The first-quarter core earnings impact from this charge was $1.03 per share. First-quarter results were generally in line with our expectations and reflect strong performance in most segments. The quarter also benefited from several items, including an $85 million DAC unlock, net prior-year reserve releases of $58 million and lower realized capital losses.

As Liam mentioned, several one-time charges impacted first-quarter results. In addition to the CPP charge, we accrued a litigation charge of $47 million or $0.11 per share. This relates to an agreement in principle that we reached earlier this month to resolve a 2005 class action related to our structured settlement business.

The quarter also included a $19 million tax charge arising from the new federal healthcare bill, as we disclosed on April 1. In total, these one-time items amounted to roughly $1.18 per share in the quarter.

As Liam also mentioned, all-in book value per share was essentially flat in the quarter when compared to year-end 2009. As we said at our April 1 investor event, going forward we report diluted book value per share excluding AOCI. This calculation has two benefits. First, it eliminates volatility from mark-to-mark changes in our investment portfolio. And second, it takes into account the preferred shares we issued in March as well as the outstanding warrants. You can see on the slide that diluted book value per share excluding AOCI ended the first quarter at $39.85.

Finally, core earnings ROE 12 months ended March 2010 was 10.6%. This includes the benefit of approximately $750 million of positive DAC unlocks over the past four quarters. This benefit was partially offset by the $440 million CPP charge in the first quarter. Excluding these two items, core earnings ROE was 9%.

Let''s move to slide five. Before I begin I wanted to update you on a few changes in our segment reporting. In our investor event in April, we announced that we would organize The Hartford around its customer segments. The process of reorganizing the company is under way and we intend to align our segment reporting with the new organization later this year, beginning with our third-quarter results. That said, we did make two changes in our Life segment in the first quarter.

The first change was to move the Mutual Fund business from the old Retail segment into a new segment called Retirement. The new Retirement segment includes Mutual Fund and Retirement Plans businesses. The first-quarter investor supplement restates prior periods to reflect this change.

The second change was to combine all Mutual Fund related assets and results within the Mutual Funds business. This change was made on a prospective basis only beginning with the first quarter of 2010.

Previously, the Mutual Fund related asset and results were reported in several segments. As a result, it was impossible for investors to see the totality of our Mutual Fund complex. With almost $98 billion of assets under management, we believed it was important to clarify the size and scale of this operation.

Now moving back to slide five, let''s discuss our operating performance for the quarter. Although we intend to formally change our reporting structure for our third-quarter results, my comments on the slide are organized around our new customer-centric businesses.

First, consumer markets. We continue to strike the right balance between growth and profitability. Written premiums were $941 million, essentially flat to last year. The current-year accident year combined ratio was 91.1%, excluding cats, which were in line with our expectations.

We''ve been taking a number of actions to improve profitability in both auto and home. These steps include improving rate in both lines while focusing new business on more profitable 40-plus preferred and near-preferred consumer segments.

We are seeing the benefits of these actions, as 80% of the new business in the first quarter came from these more profitable segments. Additionally, premium retention improved to 87%, driven by 5% and 9% increases in auto and home, respectively. We are pleased with the growth opportunities in this business. Policies in-force grew year-over-year in both auto and home, even as we raised rates. A significant contributor to that growth is our unique AARP relationship, which we continue to expand with our AARP-through-agents initiative.

Now let''s turn to slide six for the discussion of the commercial markets results. Our Property and Casualty Commercial lines continued to execute well in the quarter. Underwriting profitability was strong, with ex-cat accident year combined ratio of 92.8%. This ratio reflects strong performance in Small Commercial, Middle Market, in Specialty Commercial Operations, with loss costs remaining within expectation.

Our renewal pricing was positive in Middle Market and Small Commercial, as we continue to take rate where appropriate. Written premiums for the first quarter were essentially unchanged from the first quarter of 2009. The weak economy continues to depress exposure levels, particularly for our larger policyholders.

In Middle Market, a reduction in auto premiums lowered year-over-year growth by three percentage points. However, improving policy and premium retention and new business growth were enough to offset the impact of the weak economy in the quarter. Small Commercial business climbed 9% in the quarter; and year-over-year policies in-force grew 4%, driven by the success of our Growing Spectrum business owners policy.

Also highlighted on slide six is our Group Benefits business. Fully-insured premiums for group insurance have been pressured by lower payrolls. The lower premium along with the increase in morbidity and higher commissions in our loss rated business weighed on first-quarter results. The quarter also reflected typical seasonality we expect with respect to severity.

Now let''s turn to the first-quarter wealth management results on slide seven. Our wealth management business showed increasing sales momentum in the first quarter. Mutual Fund business had another outstanding quarter with deposits totaling $4.4 billion, up 63% over first-quarter 2009 on a comparable basis. The significant growth was driven by a combination of strong fund performance and improving equity markets.

Looking ahead, we have launched several initiatives to increase institutional Mutual Fund activity in the remainder of 2010. In Retirement Plans, strong fourth-quarter sales drove a 15% year-over-year increase in first-quarter deposits to $2.6 billion.

First-quarter sales were also strong and we could end the year closer to the top end of our deposit guidance if payrolls rise and plan sponsors restart their matching programs. We also sell top-line improvement in Individual Life with sales up 5% year-over-year. The growth was driven by traction in the independent producer channel. Activity levels have been steadily rising and we are optimistic about sales growth potential from this new distribution opportunity.

As expected, U.S. variable annuity sales for the first quarter were down from prior year at $454 million. Feedback on our Personal Retirement Manager product continues to be positive; however the process of launching the product in all states and with all our key distribution partners is frankly taking longer than we anticipated. In light of first-quarter sales and the slower product launch, we have lowered our full-year guidance for VA sales to range from $1.4 billion to $2.2 billion.

Finally, profitability in all our wealth management businesses in the first quarter was significantly higher than prior-year levels. Margins have increased due to strong equity market appreciation and the expense actions the company completed in 2009. In addition, we have benefited from positive net flows in our non-annuity businesses.

Now let''s turn to slide eight for a review of our investment results. We saw significant improvements in our investment portfolio in the first quarter. Slide eight shows the extent to which unrealized losses declined. Spread tightening was the primary driver for the improvement. This favorable trend has continued in April as prices in the CMBS market have continued to improve.

First-quarter impairments were $152 million. This is the lowest level The Hartford has seen since before the financial crisis. Primary source of the impairments was collateral deterioration in specific CMBS and CRE CDO securities. We also recorded a mortgage loan valuation allowance of $112 million in the first quarter.

In connection with our ongoing derisking efforts, we have been selling mezzanine loans and B-piece loan participations. During the quarter, we sold approximately $600 million of these loans. We have also identified another $400 million of loans that we intend to sell over the next 90 to 180 days. Most of the valuation that we accrued in the first quarter is attributable to these loans.

Once we complete the planned sales the carrying value of the company''s mezzanine and B-piece loans will be less than $500 million, down over 70% since year-end 2008. These actions have meaningfully reduced the risk in our ongoing portfolio and Greg and his team are doing an outstanding job in this effort.

Now let''s turn to slide nine for our updated guidance. As we announced last evening, our new core earnings guidance for 2010 is between $2.70 and $3.00 per share. The updated range takes into account our first-quarter results as well as a slightly weaker Group Benefits outlook for the remainder of the year. A number of assumptions embedded in the guidance are listed on slide nine. I won''t review them with you today, but they are key to understanding the guidance.

Finally, you will see in our earnings release that we updated guidance for deposits, net flows and ROA in our Mutual Funds business to reflect the reporting changes we made.

Our first-quarter results can be summarized as follows. Core earnings were generally in line with our expectation. Top-line momentum is building across many of our ongoing businesses. Our investment portfolio benefited from favorable credit markets, a trend that we continue to see in April. And finally, we increased our full-year core earnings guidance by $0.10 per share.

With that, I will turn the call over to Rick as we move into the Q&A session.

Richard Costello

Thank you, Chris. Before we begin the Q&A session, I would ask each caller to limit himself or herself to two questions. This will allow us to get to as many callers as possible. Conchita, you may now open the call to questions.

Question-and-Answer Session

Operator

Okay. At this time, if you’d like to ask a question or comments, please press star one on your telephone keypad. Again, that’s star one, if you would like to ask a question or comment at this time. We’ll pause for just a moment to compile the Q&A roster. Your first question is from the line of Andrew Kligerman.

Andrew Kligerman – UBS

Hey, good morning.

Liam E. McGee

Good morning, Andrew.

Andrew Kligerman – UBS

Two quick questions. One, the targeted ROE for ''12 of 11%, just looking at the property-casualty business, where I might have the most skepticism, would the combined ratio ex-cat prior-year development, need to be in your guided range of 91.5% to 94.5%? That''s the first question. Then real quickly on the alternative investment income, what is it? About $1.7 billion of investments. I think you earned about $6 million this quarter. Not a big yield but -- and you''ve got the zero [ph] guidance for the balance of the year. What is it going to -- when might you expect to see an improvement? What might it take for that to turn and generate some material yield to The Hartford?

Liam E. McGee

Andrew, this is Liam. I will have one Juan answer the first question, then Greg will take the second question.

Juan Andrade

Andrew, this is Juan. If I understood your question correctly, I think you are asking us if, in order for us to generate target ROEs in our range, whether we need to be within the combined ratio guidance range that we have provided. The answer is the combined ratio guidance we have actually will produce better ROEs than that. And we''re confident with the profitability that we are currently generating.

Andrew Kligerman – UBS

Right. Juan, do you think -- I guess this kind of ties back to Chris. When you look out to ''12, do you need to stay in that range in ''12 or can it even go outside that range and you would feel comfortable with an 11% ROE?

Juan Andrade

So from a property-casualty standpoint, I think you do have some flexibility in going outside of that range. Now, we clearly don''t discuss the target combined ratios per segment but you can actually have some flexibility with that range.

Andrew Kligerman – UBS

So the company could -- overall the Corporation could do an 11% ROE if -- I guess I understand P&C ROEs. I am talking Hartford corporate overall.

Christopher J. Swift

Yes. No, Andrew, it''s Chris. That is the guidance and the objective and the goals Liam and I sent out in April, an overall 11% ROE for the organization in 2012. So yes, we have some flexibility within the loss ratios. The guidance also for the remainder of the year does not include any -- I''ll call it favorable developments. So we are not predicting that at this point in time. We do have our other operations guidance that we continue to give. But again I think if your overall question is -- what is the overall Hartford enterprise target? It is 11%.

Andrew Kligerman – UBS

Right. Just to make sure I am clear, if the combined ratio went out of the 94%, the high end a little bit, you think you could still do it?

Christopher J. Swift

Yeah. We have flexibility. Again, the overall strategy if you recall is driven by organic growth. So we think we have ability to continue to generate organic growth. And then we will have other, I will call it, capital management levers to utilize at the appropriate time.

Liam E. McGee

Greg, you want to take the second part of Andrew''s question?

Gregory McGreevey

Yes. So Andrew, just on the alternative side, our alternative performance did improve significantly as you pointed out, in the first quarter compared to prior quarters over the past year. Wanted to give you just a couple of pieces of information. We did have very strong returns in private equity funds and to a lesser extent hedge funds, which were offset by additional price declines in our real estate funds.

So we''re encouraged by these results, clearly; but we do want to see longer-term stabilization of results before changing any projections of returns, especially as it relates to the real estate market. Over time we do anticipate, as I think I mentioned on the last call, getting back to average historical returns in this asset class, somewhere in the 7% to 8% range.

Andrew Kligerman – UBS

Thanks a lot.

Operator

And the next question comes from the line of John Nadel with Sterne, Agee.

John Nadel – Sterne Agee

Hey, good morning, everyone. Two questions. I am wondering if you could give us maybe a little bit more behind the increase in your guidance for 2010. I am looking at the segment guidance in your release and it looks like everything is sort of flat, maybe even down a little bit modestly in some of the Life pieces. So just wondering what is driving the $0.10 increase in the overall guidance. Is that something on the investment income line? Is it lower share count than you previously expected? Or is it just a function of the market?

Christopher J. Swift

John, it''s Chris. It''s really a function of our actual first-quarter results that we printed. And then I will call it the remaining three quarters, plus the favorable tailwinds that we feel in the market, in the general improvements that we are experiencing.

John Nadel – Sterne Agee

Okay. So it''s -- okay. I will follow up with you guys on that one. Then I have a philosophical one for you, maybe Chris, especially in light of the change, the transition now at CFO. The Hartford reports the results of hedging programs, I guess especially related to the VA business, below the line or outside of your operating earnings. And clearly hedging is a cost of doing that business or being in that business. If I compare you guys to just about every one of your larger peers, they include those costs in operating results; but you don''t. I am wondering if you would contemplate a change there.

Christopher J. Swift

John, as we sort of get up to speed here, it''s a good point. I can tell you honestly, we don''t contemplate any changes at this point in time. We are fully aware of the economics and manage it that way. But from a reporting side, we haven''t concluded if we''re going to make any changes at this point in time.

John Nadel – Sterne Agee

Okay. Thank you.

Liam E. McGee

Thank you, John.

Operator

And your next question comes from the line of Jimmy Bhullar with J.P. Morgan.

Liam E. McGee

Hi, Jimmy.

Jimmy Bhullar – J.P. Morgan

Hi, for Juan maybe. Just on favorable reserve development in your P&C business, it''s sustained a lot longer and at a higher level than I would have assumed maybe a year or two years ago. So if you could just give us some color on which accident years are developing positively; if it''s across your various businesses? Then secondly, on employee benefits your sales were weak this quarter, both Group Life and Group Disability were down. I''m assuming this is partly because of disruption and capital issues around midyear last year. But if you could comment on -- have things stabilized over the last few months and whether you expect a recovery from this or is the first quarter a market share that you would have a new base of off which you would grow?

Juan Andrade

So let me address first the question on prior-year reserve development. So we continue to have very strong reserve position. For the quarter we had releases before tax of $90 million. Those were primarily in the liability lines including Middle Market umbrella, Specialty Casualty, General Liability and also Professional Liability, Directors and Officers.

With specific question regarding the accident years that they came from, it really depends on the line of business. So, for example, if we look at the financial lines those were primarily accident years 2001 to 2006. If you look at the umbrella prior-year development, those were accident year 2004, 2008 and also if you look at our Personal Lines you''re looking at also essentially 2005, 2006, so essentially that provides you a context for the accident years.

Liam E. McGee

Jimmy, John is going to take the Group Benefits question since that business reported to him this last quarter.

John C. Walters

Hi, Jimmy. On the Group Benefits side, I think we have been saying for some time that we expected sales in the first quarter to be slower because of the disruption that we had last year. This is our longest sales cycle business that is in the Life company, so we expected it to be the longest to see the downturn; and therefore the upturn should occur during 2010, culminating in the first quarter of 2011, which is when we get all of our national account sales. So the biggest clients that we have, which is about 60% of our business, are generally 1/1 clients for when the sales occur and that is what you are seeing in the first quarter here. We do see positive trends developing now, although the market continues to be very competitive from a pricing standpoint. And there is somewhat less activity in the market as people are effectively defending their existing positions.

Jimmy Bhullar – J.P. Morgan

Just following up, another one on Group Benefits. Your loss ratio has been relatively stable year-over-year; I think it was up by 10 basis points or something. Have you seen an uptick in the disability claims with the economy getting worse? It doesn''t seem you like you have on a year-over-year basis, though.

John C. Walters

We''re seeing some normal volatility in disability claims experience. We are seeing some minor uptick in things that we would say are more economically sensitive, but not enough yet to call that a conclusion as to really affecting our disability claims experience. It is something we are watching closely and carefully managing, but we can''t say yet that that is really a driver of it.

Jimmy Bhullar – J.P. Morgan

Okay. Thank you.

Operator

And your next question comes from the line of Randy Binner with FBR Capital Markets.

Randy Binner – FBR Capital Markets

Hi, thanks. This question is probably for Chris Swift. But just wondering, it sounds like you sold almost $1 billion or you are planning to sell almost $1 billion of these subordinated mortgage loans. Is there a material RBC pickup there and also wondering where you might be looking to reinvest some of those proceeds.

Liam E. McGee

We will have Greg take that one, Randy.

Randy Binner – FBR Capital Markets

Okay.

Gregory McGreevey

Thanks for your question. I guess two parts to it. We have sold or are in the process of selling $1 billion of -- down in capital structure financials. When we look at that, we will take a small loss on those sales. But at the same time we will get some capital impact from the investments that we are going to be taking that cash and reinvest it into. As we have talked about before, we are continuing to reinvest assets in high-quality corporate bonds primarily and driving towards our long-term model portfolio. So when you think of this on a capital basis, we really think that the trades that we are doing are going to be capital-neutral over time and will have little impact to ongoing and future income. So it would probably be capital-neutral, I guess, is the easiest way to think about it from a capital standpoint.

Randy Binner – FBR Capital Markets

That''s great. As long as we''re on the topic, just any thoughts on the proposal from some NAIC members to potentially increase the base rate for commercial mortgages?

Gregory McGreevey

Yes. We have been part of the working group discussions with the NAIC and have been monitoring that very closely. Clearly, it is our understanding that the NAIC proposal is open to further comment. That comment is being considered by a proposal by the ACLI. It is really too early to tell right now because the proposal is still open to interpretation. I think the important thing for you to realize is, if the NAIC draft need proposal was adopted as written, we expect it would have a very insignificant impact on our capital base, somewhere around $100 million or so.

Randy Binner – FBR Capital Markets

When you say -- so insignificant on capital base or on RBC overall?

Gregory McGreevey

On RBC. And that is on a levered RBC. So we think that if the proposal is adopted as is, that on a levered basis the total impact from an RBC standpoint would be $100 million or less on our portfolio.

Randy Binner – FBR Capital Markets

So much less than the recent Moody''s report on the subject might imply.

Gregory McGreevey

That is correct.

Randy Binner – FBR Capital Markets

Okay, great. Thanks.

Gregory McGreevey

Thanks Randy.

Operator

And your next question comes from the line of Darin Arita with Deutsche Bank.

Liam E. McGee

Hi, Darin. Darin Arita.

Darin Arita – Deutsche Bank

I’m here. Sorry. Just a question on capital, I appreciate all the work that Harford has done with its stress scenarios. And it makes sense given everything that we have gone through. But I am wondering also if we could flip it around and say -- what could go right? What happens if the markets continue to rise here? If the S&P gets up say 1400 or 1500, rather than the stress scenario of 700?

Liam E. McGee

This is Liam. At a high level, as we talked about at our investor conference, we are well aware that we could conceivably have capital flexibility in the future. Obviously, we think 30 days after showing you our stress scenario it is too early to anticipate that. It is also too early to -- if it were to occur -- to speculate on what actions we might take. We think today and particularly in view of what happened in the markets around Greece this week, that we have the appropriate amount of capital for any reasonable stress scenario. If the scenarios you describe occur, obviously we are running the firm to maximize shareholder value and we will evaluate our options at that time.

Darin Arita – Deutsche Bank

Okay. And then secondly, if I look at the Mutual Fund business, that franchise is coming together very well. I was wondering if you could give a little more detail on the initiatives that you are taking to increase the Institutional Mutual Fund business later this year.

Liam E. McGee

John will take that, Darin.

John C. Walters

Thank you, Darin, and good morning. We''re very excited about how the Mutual Fund business is going today. We have very strong performance across a broad array of different asset classes. You can see that in the sales numbers from the first quarter. The strongest part of our sales in the first quarter was in the Institutional space where for some time we have had an Institutional team that is out there trying to build that business. I would say we are getting increased traction.

We have reorganized that team to align better with the rest of our Mutual Fund business over the last six months. It used to be in our Institutional segment; we have aligned it with the Mutual Funds segment to give a better opportunity there. We are also expanding into more of the registered investment advisor space with that theme, which is a group of independent advisors that can move large dollars in that business and where we think we have got the right product line to be successful. So that is very early, but we expect to see improving trends there over time. It will be somewhat lumpy. So when you look quarter to quarter, you may see strong quarters and weaker quarters because they can be very large deposits but we think that the trend overall will be positive.

Darin Arita – Deutsche Bank

Thank you.

Operator

And your next question comes from the line of Paul Sarran with Macquarie.

Paul Sarran – Macquarie

Hi, guys. Good morning.

Liam E. McGee

Good morning.

Paul Sarran – Macquarie

A question on variable annuities. It seems that with the delays in getting the Personal Retirement Manager product rolled out nationwide that Hartford could maybe be at risk of becoming increasingly out of sight, out of mind among producers, advisors, and so on. So my question is, with each extra month or quarter of delay in getting the product approved in the bigger states, does that make it incrementally more difficult for The Hartford to reestablish a prominent position in the VA market once the product rollout is finally complete?

Liam E. McGee

This is Liam and John may certainly have some detail. I think it''s important to emphasize two things. First of all, because it''s a new product and a new concept, it has taken longer than we expected to get it approved in states and with large distributors as John indicated. However, to your point of relevance and out of sight, out of mind, as John can elaborate the distributors themselves are very excited about the product.

It''s a different concept and I''ll remind you that we said we are aiming to generate about $5 billion in annuity sales by the year 2012. We are going to run our annuity business against those three principles that we been consistent in communicating. We want it to be a lower-cost product for the customer. We want it to be a simpler product and we want it to be focused on guaranteed income. So because it''s different in concept it is taking longer. But that should not take from the fact that the distributors are actually quite excited about it. So a little slower startup, but I actually think we will be quite relevant.

John C. Walters

So the other thing I would add to that is in the meantime, in the states where we are not yet approved with the new product, we are continuing to sell our existing products. So we are not out of those states in the meantime. I think that is very important to understand. We have an outstanding sales organization that is continuing to actively engage with all of our historical producers and new producers, and to lay the groundwork for the new product as it comes out.

We will be launching one of our key distributors in the month of May, which is a big move -- a big next move for us. There is only one other major distributor that we are preparing to bring on. And then as we have said, we''ve got a couple of key states that are pending. And we are optimistic that those will get approved either in the second or early third quarters.

Paul Sarran – Macquarie

Okay. Are you seeing any higher turnover or maybe other signs of frustration within your internal producers, wholesalers? Just with the sales levels down so significantly from a year ago, and the delay in getting the product rolled out. Have you seen any effect there?

John C. Walters

No, we really haven''t. We made the decision almost six months ago now to streamline our sales force. We think we retained the very best talent and we have put programs in place to make sure that we continue to retain them. Their enthusiasm for the new product is quite high. So it''s a question of executing on it and getting the sales momentum to build, which they are very focused on at this point.

Paul Sarran – Macquarie

Okay. Then one other question on the macro hedging strategy. Has there been any change in the approach to this strategy then -- and can you just maybe update us generally how you are thinking about the program?

Christopher J. Swift

Sure, Paul. It''s Chris. Again, I think generally you could think in terms of things are consistent. I think the one major change we could talk about is that we extended our macro equity protection into 2011 within the last two weeks. Again, which we think is prudent given -- we took advantage of the market levels and some lower volatility. Put on a little currency protection, again as the yen particularly weakened. We took some opportunities to put some protection on there just to cover some tail risk. So I would say generally as we have thought about it -- as you thought about the program in the past, it is relatively consistent with another year of protection on a macro equity basis.

Paul Sarran – Macquarie

So the equity program is still essentially buying straight equity puts and from a cost basis if the market trends as expected, should we continue to see hedge losses around $75 million, $80 million a quarter?

Christopher J. Swift

Yes, that''s a good point. Again, I would call it out of the money, you know, puts on the equity side. And again given the market levels, I think you should maybe begin to think about it as $60 million a quarter as far as the cost of the new program in 2011.

Richard Costello

Thanks, Paul. I would like to get on to the next one.

Paul Sarran – Macquarie

Okay. Thank you.

Operator

And your next question comes from the line of Thomas Gallagher with Credit Suisse.

Thomas Gallagher – Credit Suisse

I just wanted to follow up on the hedge to something John Nadel was asking before. Can you just remind us what is included in operating or core earnings? What is below the line? My recollection, it''s a little foggy here since it was probably a while ago before we were as obsessed about core earnings here. But my recollection was it with something like 30 basis points or maybe it was 20 basis points of a cost was actually being run through core earnings. And then everything else like the macro hedge that were being discussed now is all below the line. Is that accurate? Or maybe you could just give us an update on what is included in core, what is below the line related to hedge costs.

Christopher J. Swift

Yes, it''s simple. I think your statements are accurate as they are here today, yes.

Thomas Gallagher – Credit Suisse

Okay. So, Chris, there is some element that is being included in core earnings, which would be more the hedge that is specifically designed to match the liability. The macro hedge, which is more of a capital hedge, is not included. Is that fair to say?

Christopher J. Swift

You know, I would describe it as, again, generally that way. I think in terms of our reinsurance costs and obviously sort of net -- net fees in there, and so yes, I think you are correct.

Liam E. McGee

So, Tom, you are describing it accurately.

Thomas Gallagher – Credit Suisse

Okay, thanks. Then just one other question on the variable annuities. Is there a minimum level -- and maybe this is for John and/or Chris. But is there a minimum level of sales that you need to produce on the variable annuities side in order to avoid a meaningful back writeoff?
By that I mean, is there some fixed cost element that is DAC-able? Whether it is internal wholesaler costs or the like, that would require you to produce a minimum sales level of VAs that we should be aware of and/or that would require a much more substantial DAC amortization to be run through the P&L?

Christopher J. Swift

It''s Chris. I mean from the DAC policy, we capitalize costs that sort of vary with and are directly related to the production of new business. So from a fixed cost side, I am not aware of anything meaningfully we are capitalizing at this point in time.

John C. Walters

Sales cannot create a big DAC writeoff for us. So regardless of what the sales number is, that won''t create a big DAC writeoff. We are operating today at a sales level that is below what we would like to operate to fully cover all of our distribution costs. We expect to build back into that over time. That is a conscious decision that we have made to protect the franchise as we get back into this business.

Thomas Gallagher – Credit Suisse

Okay. Thanks.

Operator

And your next question comes from the line of Scott Frost with HSBC.

Liam E. McGee

Hi, Scott.

Scott Frost – HSBC

Hi, I want to talk about the proposed new derivatives rule. There is an article out in The Times, for example, speculating on the hit that broker-dealers could take if the rules are implemented. I wanted to ask if anyone -- I came to the call late; if you have covered this already, I apologize. But has anyone at your shop assessed the potential effect of new derivatives rules, what they would have on your results? If so, what have they said? If not, are there plans to do so and when would you have some sort of determination as to whether the new rules would affect you and what sort of magnitude of effect that might be?

Liam E. McGee

Scott, as you know, it''s not just a Hartford issue; it is an industry issue, number one.

Scott Frost – HSBC

Right.

Liam E. McGee

Number two, that is a work in flux and in change, and there is just not enough specificity for us to even speculate on that. Now I can assure you that our teammates are engaged and involved with that process but I think it is too early to tell.

Scott Frost – HSBC

Right. Would this effect hold GAAP results as well -- would it affect statutory results as well as GAAP results do you think? Or do you have any kind of clarity with respect to that even?

Christopher J. Swift

Scott, if costs increase through exchange-traded activities, if the Life industry does not get an exemption, yes; we would have to record this costs both on statutory and GAAP income statement.

Scott Frost – HSBC

Great. Okay. Thank you very much.

Richard Costello

Conchita, this is Rick. Are there any more questions?

Operator

Yes, sir. You did have a follow-up question from Randy Binner.

Richard Costello

Thank you.

Randy Binner – FBR Capital Markets

Hey, thanks. I was going to ask about the derivative thing as well. But just maybe to touch on the other pieces of Financial Services Reform, I guess there is Volcker Rule, there is TARP tax. Liam, I just would just be curious to get your take on how Hartford and the industry might be affected by those measures as well?

Liam E. McGee

Randy, as you know, I would have to repeat what I said just a few seconds ago, that we are well aware of the three primary categories that you described that could impact our industry. But there is just not enough specificity yet for me to comment on what impact, if any, it might have on us.

Randy Binner – FBR Capital Markets

All right. Fair enough. Actually maybe -- a follow-up to what Paul was saying. Is there any thought that the new Personal Retirement Manager product might also be better suited for a different distribution channel? Because it''s a more simplified lower-cost product, would it necessarily be something -- as long as you are at an inflection point on distribution anyway, should we think of this as something that could maybe be distributed more through a bank or another channel instead of the heavy independent financial adviser focus?

John C. Walters

This is John Walters, Randy. We think that this product will work well in all of our different channels. As you know, we have very broad distribution through banks, through independent financial advisers, through major Wall Street firms. The independent channel is where we can get the quickest traction because it''s the easiest place to gain entry for a new product from an operational standpoint and an approval standpoint. But we are launching it at all of our major distributors and we expect to get traction in each of those channels. I think over time we will find that some channels have greater success with it than others. But it is too early to call that at this point. We''re after all of them aggressively.

Randy Binner – FBR Capital Markets

Okay. Thank you.

Liam E. McGee

Thanks a lot. As there are no more questions, thank you for joining us this morning. We appreciate your interest in The Hartford. Thank you.

Operator

This concludes today''s conference. You may now disconnect.