The Odd Couple: John Paulson & Hartford

From the outside, the cat fight between The Hartford Financial Services Group (NYSE: HIG) and its largest shareholder, John Paulson, looks like a comedy. But from a shareholder's perspective, it's a farce.

The 112-year-old Hartford is essentially a two-sided insurer: life, and property casualty. Before the recession, each side contributed about equally to its profits. But now, property casualty has outpaced life by a country mile, and Paulson says the whole thing has gotten too complex for Wall Street analysts to understand. Spinning off its "best-in-class" property side would allow investors to value it properly.

Paulson, who owns 8.5% of Hartford's common, fired the opening shot with an SEC filing on February 14. Hartford made a peace offering on March 21, but it wasn't what Paulson wanted. The insurer would sell or spin off money-losing pieces, such as its annuities and brokerage unit, and look for ways to exit its individual life business. But Hartford wouldn't touch its property unit.

Both sides have flawed logic -- and flawed personalities. Paulson is a hedge fund manager with close ties to investment bankers such as Goldman Sachs (NYSE: GS), which, along with other Wall Street firms, make obscene amounts of money from mergers and breakups like the one he's proposing. It's not surprising that Paulson would seek a Wall Street solution to his Hartford investment: break up the company rather than fix it.

Paulson "made his bones" as an investor when he bet against the mortgage market in 2007, but hasn't been lucky as of late. Some of his funds were off by as much as 50% in 2011, and according to AR Magazine, he lost $3 billion. This could be one reason why he's so eager to recoup money from his investment in Hartford. Forbes magazine reports that he's trying to emulate raptor investors like Carl Icahn by taking a stake in a down-at-the-heels company, forcing it to spin or sell off assets, and then making quick profits. Thus far, however, he lacks Icahn's willingness to go for the jugular and fight for seats on the board.

Hartford's counter strategy of amputating the weak parts to turn itself into a property insurer isn't smart either. Its plan to sell off its money-losing annuities unit has drawn fire from Connecticut Insurance Commissioner Thomas Leonardi, who warned the Connecticut-based Hartford that even if it sells its annuities unit, it will still have to pay off the people who purchased those contracts for years to come.

According to Credit Suisse (NYSE: CS), Hartford's fire sale could free up $4 billion of capital, even though it isn't desperate for money, having just bought back $2.4 billion of debt from Allianz (NYSE: AZ). A logical supposition is that Hartford will do what insurers usually do when they have free cash: buy back shares. And from whom will it buy them? How about from Paulson, as a way to get him out of its business?

The truth is that many insurers, MetLife (NYSE: MET) and State Farm among them, have two-sided houses and do quite well, probably because they didn't sell variable annuities that made huge bets on the stock market the way Hartford did. These successful insurers say one side of the business sells to the other. In other words, people who buy property insurance to protect their homes from fire will also buy term life insurance to pay the mortgage in case of death.

But Hartford's biggest problem may be its lack of leadership. CEO Liam McGee is a former Bank of America (NYSE: BAC) non-insurance guy who says he was considering all this as early as last summer, but didn't get around to it until Paulson held his feet to the fire. Clearly, he is not as tough as Robert Benmosche, who resurrected AIG (NYSE: AIG) from a worse crisis than this. And Benmosche did it while keeping his company, except for a few foreign pieces, together.