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The Gadfly's Bite

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It is earnings season once more, and this means that for those who follow the quarterlies of stock insurers, there are plenty of earnings calls to sit in on. These are usually toned-down affairs, where the financial nuts and bolts of a company’s current standings are explained. They don’t often have a whole lot of surprises in store, but the Hartford’s call last week was certainly the exception.

The Hartford, as we all know, is not doing very well for a number of reasons. And a recurring question its top management must ask itself is whether or not it would be wise to split its P&C and life operations, a move that could boost the stock value of the company by as much as 605, according to some analysts. The Hartford’s senior management, led by CEO Liam McGee, noted this during their earnings call, but also noted that such a split would be a difficult thing to do. No doubt it would be, but the Hartford never really went into detail as to why, and in the subsequent Q&A, various analysts threw fairly softball questions at McGee and his colleagues to go into further detail about the Hartford’s standing. These were all met with similarly softball answers that still did not get into detail. All McGee could reiterate was that such a split would be tough…and that was about it.

Enter John Paulson. Now, if you don’t know who he is, he is a hedge fund manager who made about $4.9 billion in 2010 (compared to the Hartford’s net income of only $1.7 billion in 2010). As of last September, he was worth about $15.5 billion, and he was recently listed by Forbes as the 11th wealthiest man on the planet. He also owns 8.9 percent of Hartford stock, so he’s one of those shareholders who has, shall we say, a certain amount of gravity when he offers his opinion.

Paulson burst into the earnings Q&A like a bull in a china shop, and what you don’t get from reading a transcript of the call is the tone of Paulson’s questions, and the anger in his voice. This clearly was somebody who was not happy with McGee’s handling of the Hartford, and he let into McGee with the kind of tone one might normally hear from a boss chewing out a subordinate.

I know you’re doing a strategic review, but there’s no slide talking about what the potential would be, just that there’s challenges. Goldman Sachs came out with, I think, a very good analysis a few months ago, where they showed this is — that they estimate the upside to doing a tax-free spinoff of P&C can be over 70% of what the current stock price is trading at. Now I agree that there’s going to be challenges, but isn’t your job to really overcome those challenges to achieve the maximum value for shareholders? Now I would say that Hartford needs to do something drastic because the stock is the lowest valuation relative to book value of any major insurance company. Last year, Hartford stock was down 38% while the P&C stocks were up 14% and even declined much more than the Life index, which was down 21%. So what I’d like to see you do is not merely come back and say yes, we’re looking at strategic options, but there’s challenges to achieving them. But what — first of all, do you agree that you could create as much as 70% value for your shareholders by spinning off — separating P&C? And secondly, is [indiscernible] incentive to overcome the challenges that it’s going to take to spin this off? And how long is — how long do we have to wait to hear if there’s going to be a positive recommendation to separate these two businesses?

McGee, to his credit, tried to reiterate the points he made during the earnings call, but Paulson would not be denied, and he ended up not only talking over McGee, but finally going after him in something just short of a tirade:

Well, I think you need to do a much better job of explaining that because Goldman’s report is a very good report on a path to separate the business and create what they estimate is a 70% increase in shareholder value. And then you merely say there’s some obstacles and you don’t equate what the costs are to the benefit and what value you think could be created. Because right now, with the stock performing as poorly as it has relative to both P&C and Life companies, I think you need a better explanation of what you’re going to do to enhance shareholder value, merely that you’re working hard and you’re committed, but there’s obstacles. What we need you to do is overcome the obstacles to enhance the valuation for your shareholders, not merely to point out that there’s obstacles.

At that point, what could McGee do but agree to everything Paulson had said and hope the browbeating would come to a swift end? McGee did just that, but Paulson had to get the last dig in.

Liam E. McGee: Hey, John, thank you. I hear you loud and clear.

John Paulson (angrily): I hope so.

That last line you won’t find on any transcription, but if you listen to the audio of the conference call, it’s definitely there. What’s just as telling is the next question, at which point the folks on the call have that kind of nervous energy to their voices that belies an unspoken agreement: That was one hell of a lecture somebody just got.

Paulson was hardly done there. He has since issued a letter directly calling for the breakup of Hartford, and after both the issuing of this letter, as well as his Tasmanian Devil impersonation on the earnings call, The Hartford’s stock got a nice upward bump. Clearly there are folks out there who agree with Paulson, or who at least are willing to blindly trust a guy who made billions on hedge fund operations over the executive team of what is by any fair description a troubled insurance company.

See: Hedge Fund Manager Makes Case for Splitting Hartford P&C, Life Businesses

But here’s the thing: Paulson isn’t just some stock market whiz. His conviction that a split of Hartford would yield handsome dividends relies heavily on a Goldman & Sachs report to that effect. Paulson’s own hedge fund had a close and perhaps troubling relationship with Goldman. In 2010, the Securities and Exchange Commission fined Goldman $500 million for improper trading practices in the formation of ABACUS 2007-AC1, a subprime mortgage collateralized debt obligation (remember those?). And who was the trading partner in that deal? Why, it was none other than Paulson’s own hedge fund. 

To see a single trader who had made billions off of the same kinds of toxic debt packages that helped cause the Great Recession get on a bully pulpit and demand the Balkanization of an insurance company like the Hartford is extremely troubling to me. I have spent many hours speaking to insurance industry executives who talk at length about the difference between the mutual and stock model for insurers, and it always comes back to the same distinction: mutuals are beholden to their policyholders. Stock companies are beholden to the shareholders. And the shareholders, when you get right down to it, do not care one bit about the welfare of the policyholders.

Paulson certainly doesn’t. He just wants the stock price of the Hartford to go up because he’s got a big investment in it. (Though most of his personal wealth, it appears, is invested in gold, which says a lot about how much confidence he has in the very same system he’s hedging against.) And while there is nothing inherently wrong with stock companies, they are vulnerable to just this kind of problem; the heavyweight investor who is driven by the short-term realities of quarterly results and demands changes in what is a very long-term kind of business to meet his financial expectations. This is a serious divergence in financial realities, and it has driven plenty of stock insurance companies to adopt questionable practices that, were they not routinely whipsawed by investor expectations, they might otherwise decline or take on more conservatively.

I suspect Paulson will eventually get his way unless the executive leadership at the Hartford circle the wagons and figure out how to placate the guy. But Paulson seems fairly bent on breaking the Hartford into two, and if or when he succeeds, let his actions serve as a notice for every other stock company out there. I am sure they all think that what’s happening at the Hartford couldn’t happen to them; we’re too well reserved, we underwrite too conservatively, we don’t take foolish chances, etc. That’s all well and good, but at the end of the day, just remember that at one time, the Hartford probably told itself the exact same thing. And to the other Paulsons of the world, it might as well have never been said at all.