================================================================================UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549------------------FORM 10-Q
(Mark(Mark One)
[X][X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(D)15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Quarterly Period Ended
September 30, 2003March 31, 2004OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(D)15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from ____________ to ______________from____________ to_____________Commission file number 001-13958
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact(Exact name of registrant as specified in its charter)DELAWARE 13-3317783 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) HARTFORD PLAZA, HARTFORD, CONNECTICUT
Delaware 13-3317783 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) Hartford Plaza, Hartford, Connecticut 06115-1900
(Address
(Address of principal executive offices)(860) 547-5000
(Registrant's
(Registrant’s telephone number, including area code)Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]No[No [ ]Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [X]No[No [ ]As of
October 31, 2003,April 23, 2004, there were outstanding282,903,893292,023,474 shares of Common Stock, $0.01 par value per share, of the registrant.================================================================================ - 1 -INDEX
PAGE ---- Independent Accountants' Review Report 3 PART I. FINANCIAL INFORMATION - ------------------------------ ITEM 1. FINANCIAL STATEMENTS 4 Condensed Consolidated Statements of Operations - Third Quarter and Nine Months Ended September 30, 2003 and 2002 4 Condensed Consolidated Balance Sheets - September 30, 2003 and December 31, 2002 5 Condensed Consolidated Statements of Changes in Stockholders' Equity - Nine Months Ended September 30, 2003 and 2002 6 Condensed Consolidated Statements of Comprehensive Income (Loss) - - Third Quarter and Nine Months Ended September 30, 2003 and 2002 6 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2003 and 2002 7 Notes to Condensed Consolidated Financial Statements 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 25 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 59 ITEM 4. CONTROLS AND PROCEDURES 59 PART II. OTHER INFORMATION - -------------------------- ITEM 1. LEGAL PROCEEDINGS 60 ITEM 5. OTHER INFORMATION 61 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 61 Signature 62 Exhibits Index 63 -2
-INDEPENDENT
ACCOUNTANTS'ACCOUNTANTS’ REVIEW REPORTTo the Board of Directors and Stockholders
of
The Hartford Financial Services Group, Inc.
Hartford, ConnecticutWe have reviewed the accompanying condensed consolidated balance sheet of The Hartford Financial Services Group, Inc. and subsidiaries (the
"Company"“Company”) as ofSeptember 30, 2003March 31, 2004, and the related condensed consolidated statements of operations,andchanges in stockholders’ equity, comprehensive income (loss)for the third quarter and nine months ended September 30, 2003 and 2002, and changes in stockholders' equity, and cash flows for thenine monthsfirst quarter endedSeptember 30, 2003March 31, 2004 and2002.2003. These interim financial statements are the responsibility of theCompany'sCompany’s management.We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of the Company as of December 31,
2002,2003, and the related consolidated statements ofincome,operations, changes instockholders'stockholders’ equity, comprehensive income, and cash flows for the year then ended (not presented herein); and in our report dated February19, 2003, which includes an explanatory paragraph relating to the Company's change in its method of accounting for goodwill and indefinite-lived intangible assets in 2002,25, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31,20022003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.DELOITTE & TOUCHE LLP
Hartford, ConnecticutNovember
May 3,2003 -20043
-PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- ----------------------------- (IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ (Unaudited) (Unaudited)REVENUES Earned premiums $ 3,249 $ 2,774 $ 8,910 $ 8,000 Fee income 716 627 1,989 1,961 Net investment income 825 729 2,431 2,161 Other revenues 145 115 414 348 Net realized capital gains (losses) 12 (160) 216 (333) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 4,947 4,085 13,960 12,137 -------------------------------------------------------------------------------------------------------------------------- BENEFITS, CLAIMS AND EXPENSES Benefits, claims and claim adjustment expenses 2,998 2,557 10,872 7,455 Amortization of deferred policy acquisition costs and present value of future profits 633 568 1,754 1,696 Insurance operating costs and expenses 609 567 1,801 1,661 Other expenses 271 199 693 563 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 4,511 3,891 15,120 11,375 -------------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES 436 194 (1,160) 762 Income tax expense (benefit) 93 (71) (615) 20 - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ 343 $ 265 $ (545) $ 742 - ------------------------------------------------------------------------------------------------------------------------------------ BASIC EARNINGS (LOSS) PER SHARE $ 1.21 $ 1.06 $ (2.03) $ 3.00 - ------------------------------------------------------------------------------------------------------------------------------------ DILUTED EARNINGS (LOSS) PER SHARE [1] $ 1.20 $ 1.06 $ (2.03) $ 2.96 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted average common shares outstanding 282.5 248.9 268.9 247.4 Weighted average common shares outstanding and dilutive potential common shares [1] 284.8 250.5 268.9 250.3 - ------------------------------------------------------------------------------------------------------------------------------------ Cash dividends declared per share $ 0.27 $ 0.26 $ 0.81 $ 0.78 ====================================================================================================================================[1] As a result of the net loss for the nine months ended September 30, 2003, Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", requires the Company to use basic weighted average common shares outstanding in the calculation of the nine months ended September 30, 2003 diluted earnings (loss) per share, since the inclusion of options of 1.5 would have been antidilutive to the earnings per share calculation. In the absence of the net loss, weighted average common shares outstanding and dilutive potential common shares would have totaled 270.4.SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 4 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, DECEMBER 31, (IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ (Unaudited)ASSETS Investments ----------- Fixed maturities, available-for-sale, at fair value (amortized cost of $55,649 and $46,241) $ 58,909 $ 48,889 Equity securities, available-for-sale, at fair value (cost of $584 and $937) 639 917 Policy loans, at outstanding balance 2,533 2,934 Other investments 1,539 1,790 - ------------------------------------------------------------------------------------------------------------------------------------ Total investments 63,620 54,530 Cash 496 377 Premiums receivable and agents' balances 2,831 2,611 Reinsurance recoverables 6,215 5,027 Deferred policy acquisition costs and present value of future profits 7,247 6,689 Deferred income taxes 888 545 Goodwill 1,720 1,721 Other assets 3,238 3,397 Separate account assets 125,110 107,078 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $ 211,365 $ 181,975 ========================================================================================================================== LIABILITIES Reserve for future policy benefits and unpaid claims and claim adjustment expenses Property and casualty $ 21,444 $ 17,091 Life 9,351 8,567 Other policyholder funds and benefits payable 26,240 23,956 Unearned premiums 4,560 3,989 Short-term debt 515 315 Long-term debt 3,660 2,596 Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures ("trust preferred securities") 962 1,468 Other liabilities 8,179 6,181 Separate account liabilities 125,110 107,078 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES 200,021 171,241 --------------------------------------------------------------------------------------------------------------------------- COMMITMENTS AND CONTINGENCIES (NOTE 5) STOCKHOLDERS' EQUITY Common stock - 750,000,000 shares authorized, 285,666,976 and 258,184,483 shares issued, $0.01 par value 3 3 Additional paid-in capital 3,897 2,784 Retained earnings 6,124 6,890 Treasury stock, at cost - 2,948,161 and 2,943,565 shares (37) (37) Accumulated other comprehensive income 1,357 1,094 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY 11,344 10,734 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 211,365 $ 181,975 ============================================================================================================================SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 5 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- (IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------COMMON STOCK/ADDITIONAL PAID-IN CAPITAL (Unaudited) Balance at beginning of period $ 2,787 $ 2,364 Issuance of common stock in underwritten offering 1,161 330 Issuance of equity units (112) (33) Issuance of shares and compensation expense associated with incentive and stock compensation plans 56 89 Tax benefit on employee stock options and awards 8 19 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of period 3,900 2,769 - ------------------------------------------------------------------------------------------------------------------------------------ RETAINED EARNINGS Balance at beginning of period 6,890 6,152 Net income (loss) (545) 742 Dividends declared on common stock (221) (193) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of period 6,124 6,701 - ------------------------------------------------------------------------------------------------------------------------------------ TREASURY STOCK, AT COST Balance at beginning of period (37) (37) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of period (37) (37) - ------------------------------------------------------------------------------------------------------------------------------------ ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of period 1,094 534 - ------------------------------------------------------------------------------------------------------------------------------------ Change in net unrealized gain/loss on securities, net of tax 349 899 Change in net gain/loss on cash-flow hedging instruments, net of tax (81) 81 Foreign currency translation adjustments (5) (4) - ------------------------------------------------------------------------------------------------------------------------------------ Total other comprehensive income 263 976 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of period 1,357 1,510 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY $ 11,344 $ 10,943 ==================================================================================================================================== OUTSTANDING SHARES (IN THOUSANDS) Balance at beginning of period 255,241 245,536 Issuance of common stock in underwritten offering 26,377 7,303 Issuance of shares under incentive and stock compensation plans 1,101 2,170 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of period 282,719 255,009 - ------------------------------------------------------------------------------------------------------------------------------------ CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------------------------------- (IN MILLIONS) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ COMPREHENSIVE INCOME (LOSS) (Unaudited) (Unaudited) Net income (loss) $ 343 $ 265 $ (545) $ 742 - ------------------------------------------------------------------------------------------------------------------------------------ OTHER COMPREHENSIVE INCOME (LOSS) Change in net unrealized gain/loss on securities, net of tax (383) 716 349 899 Change in net gain/loss on cash-flow hedging instruments, net of tax (43) 67 (81) 81 Foreign currency translation adjustments (24) (1) (5) (4) - ------------------------------------------------------------------------------------------------------------------------------------ Total other comprehensive income (450) 782 263 976 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL COMPREHENSIVE INCOME (LOSS) $ (107) $ 1,047 $ (282) $ 1,718 - ------------------------------------------------------------------------------------------------------------------------------------SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER, 30, ---------------------------------- (IN MILLIONS) 2003 2002 - -------------------------------------------------------------------------------------------------------------------------------- (Unaudited)OPERATING ACTIVITIES Net income (loss) $ (545) $ 742 ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES Amortization of deferred policy acquisition costs and present value of future profits 1,754 1,696 Additions to deferred policy acquisition costs and present value of future profits (2,434) (2,129) Change in: Reserve for future policy benefits and unpaid claims and claim adjustment expenses and unearned premiums 5,601 1,055 Reinsurance recoverables (1,246) 208 Receivables (215) (282) Payables and accruals (151) 114 Accrued and deferred income taxes (520) 229 Net realized capital (gains) losses (216) 333 Depreciation and amortization 199 61 Other, net 651 34 - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 2,878 2,061 - -------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Purchase of investments (24,559) (15,992) Sale of investments 14,909 8,304 Maturity of investments 2,818 2,033 Sale of affiliates 33 3 Additions to property, plant and equipment (74) (128) - -------------------------------------------------------------------------------------------------------------------------------- NET CASH USED FOR INVESTING ACTIVITIES (6,873) (5,780) - -------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Issuance of short-term debt, net -- 16 Issuance of long-term debt 1,235 617 Repayment of trust preferred securities (500) -- Issuance of common stock in underwritten offering 1,162 330 Net proceeds from investment and universal life-type contracts charged against policyholder accounts 2,399 2,916 Dividends paid (215) (192) Proceeds from issuance of shares under incentive and stock purchase plans 34 84 - -------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 4,115 3,771 ================================================================================================================================ Foreign exchange rate effect on cash (1) 8 - -------------------------------------------------------------------------------------------------------------------------------- Net increase in cash 119 60 Cash - beginning of period 377 353 - -------------------------------------------------------------------------------------------------------------------------------- CASH - END OF PERIOD $ 496 $ 413 ================================================================================================================================ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: - ------------------------------------------------- NET CASH PAID (RECEIVED) DURING THE PERIOD FOR: Income taxes $ (121) $ (162) Interest $ 178 $ 167SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. - 7 -Item 1. Financial Statements
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Condensed Consolidated Statements of Operations
First Quarter Ended March 31, (In millions, except for per share data) 2004 2003 (Unaudited) RevenuesEarned premiums $ 3,181 $ 2,849 Fee income 786 617 Net investment income 1,517 788 Other revenues 104 122 Net realized capital gains (losses) 144 (45 )
Total revenues5,732 4,331
Benefits, claims and expensesBenefits, claims and claim adjustment expenses 3,297 5,245 Amortization of deferred policy acquisition costs and present value of future profits 679 564 Insurance operating costs and expenses 692 538 Interest expense 66 66 Other expenses 180 143
Total benefits, claims and expenses4,914 6,556
Income (loss) before income taxes and cumulative effect of accounting change818 (2,225 ) Income tax expense (benefit) 227 (830 ) Income (loss) before cumulative effect of accounting change591 (1,395 ) Cumulative effect of accounting change, net of tax (23 ) —
Net income (loss)$ 568 $ (1,395 )
Basic earnings (loss) per shareIncome (loss) before cumulative effect of accounting change $ 2.04 $ (5.46 ) Cumulative effect of accounting change, net of tax (0.08 ) —
Net income (loss)$ 1.96 $ (5.46 ) Diluted earnings (loss) per shareIncome (loss) before cumulative effect of accounting change $ 2.01 $ (5.46 ) Cumulative effect of accounting change, net of tax (0.08 ) —
Net income (loss)$ 1.93 $ (5.46 )
Weighted average common shares outstanding 289.9 255.4 Weighted average common shares outstanding and dilutive potential common shares 294.9 255.4
Cash dividends declared per share $ 0.28 $ 0.27
See Notes to Condensed Consolidated Financial Statements.
4
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Condensed Consolidated Balance Sheets
March 31, December 31, (In millions, except for share data) 2004 2003 (Unaudited) Assets InvestmentsFixed maturities, available-for-sale, at fair value (amortized cost of $68,138 and $58,127) $ 72,814 $ 61,263 Equity securities, held for trading, at fair value 7,831 — Equity securities, available-for-sale, at fair value (cost of $557 and $505) 612 565 Policy loans, at outstanding balance 2,655 2,512 Other investments 1,845 1,507
Total investments 85,757 65,847 Cash 638 462 Premiums receivable and agents’ balances 2,969 3,085 Reinsurance recoverables 5,968 5,958 Deferred policy acquisition costs and present value of future profits 7,511 7,599 Deferred income tax 245 845 Goodwill 1,720 1,720 Other assets 5,315 3,704 Separate account assets 127,141 136,633
Total assets$ 237,264 $ 225,853
LiabilitiesReserve for future policy benefits and unpaid claims and claim adjustment expenses Property and casualty $ 20,246 $ 21,715 Life 11,658 11,402 Other policyholder funds and benefits payable 45,321 26,185 Unearned premiums 4,612 4,423 Short-term debt 573 1,050 Long-term debt 4,580 4,613 Other liabilities 9,596 8,193 Separate account liabilities 127,141 136,633
Total liabilities223,727 214,214
Commitments and Contingencies (Note 5) Stockholders’ EquityCommon stock - 750,000,000 shares authorized, 294,661,289 and 286,339,430 shares issued, $0.01 par value 3 3 Additional paid-in capital 4,419 3,929 Retained earnings 6,986 6,499 Treasury stock, at cost - 2,984,622 and 2,959,692 shares (39 ) (38 ) Accumulated other comprehensive income, net of tax 2,168 1,246
Total stockholders’ equity13,537 11,639
Total liabilities and stockholders’ equity$ 237,264 $ 225,853
See Notes to Condensed Consolidated Financial Statements.
5
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
First Quarter Ended March 31, (In millions, except for share data) 2004 2003 (Unaudited) Common Stock/Additional Paid-in CapitalBalance at beginning of period $ 3,932 $ 2,787 Issuance of common stock in underwritten offering 411 — Issuance of shares under incentive and stock compensation plans 67 8 Tax benefit on employee stock options and awards 12 1
Balance at end of period 4,422 2,796
Retained EarningsBalance at beginning of period 6,499 6,890 Net income (loss) 568 (1,395 ) Dividends declared on common stock (81 ) (69 )
Balance at end of period 6,986 5,426
Treasury Stock, at CostBalance at beginning of period (38 ) (37 ) Return of shares under incentive and stock compensation plans to treasury stock (1 ) —
Balance at end of period (39 ) (37 )
Accumulated Other Comprehensive Income, Net of TaxBalance at beginning of period 1,246 1,094 Change in unrealized gain/loss on securities 574 177 Cumulative effect of accounting change 292 — Change in net gain/loss on cash flow hedging instruments 59 (23 ) Foreign currency translation adjustments (3 ) 9
Total other comprehensive income 922 163
Balance at end of period 2,168 1,257
Total stockholders’ equity$ 13,537 $ 9,442
Outstanding Shares (in thousands)Balance at beginning of period 283,380 255,241 Issuance of common stock in underwritten offering 6,703 — Issuance of shares under incentive and stock compensation plans 1,619 200 Return of shares under incentive and stock compensation plans to treasury stock (25 ) —
Balance at end of period 291,677 255,441
Condensed Consolidated Statements of Comprehensive Income (Loss)
First Quarter Ended March 31, (In millions) 2004 2003 (Unaudited) Comprehensive Income (Loss)Net income (loss) $ 568 $ (1,395 )
Other Comprehensive IncomeChange in unrealized gain/loss on securities 574 177 Cumulative effect of accounting change 292 — Change in net gain/loss on cash flow hedging instruments 59 (23 ) Foreign currency translation adjustments (3 ) 9
Total other comprehensive income 922 163
Total comprehensive income (loss)$ 1,490 $ (1,232 )
See Notes to Condensed Consolidated Financial Statements.
6
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Condensed Consolidated Statements of Cash Flows
First Quarter Ended March 31, (In millions) 2004 2003 (Unaudited) Operating ActivitiesNet income (loss) $ 568 $ (1,395 ) Adjustments to reconcile net income (loss) to net cash provided by operating activitiesAmortization of deferred policy acquisition costs and present value of future profits 679 564 Additions to deferred policy acquisition costs and present value of future profits (952 ) (807 ) Change in: Reserve for future policy benefits and unpaid claims and claim adjustment expenses and unearned premiums (1,022 ) 4,576 Reinsurance recoverables 151 (1,459 ) Receivables (904 ) (95 ) Payables and accruals 575 (34 ) Accrued and deferred income taxes 641 (839 ) Net realized capital (gains) losses (144 ) 45 Net increase in equity securities, held for trading (1,611 ) — Net receipts from investment and universal life-type contracts credited to policyholder accounts associated with equity securities, held for trading 1,915 — Depreciation and amortization 33 72 Cumulative effect of accounting change, net of tax 23 — Other, net 147 39
Net cash provided by operating activities99 667
Investing ActivitiesPurchase of available-for-sale investments (4,674 ) (5,859 ) Sale of available-for-sale investments 4,315 3,364 Maturity of available-for-sale investments 763 931 Additions to property, plant and equipment, net (18 ) (43 )
Net cash provided by (used for) investing activities386 (1,607 )
Financing ActivitiesIssuance (repayment) of short-term debt, net (477 ) — Issuance of long-term debt 197 — Repayment of long-term debt (250 ) — Issuance of common stock in underwritten offering 411 — Net receipts from investment and universal life-type contracts charged against policyholder accounts (164 ) 1,279 Dividends paid (79 ) (69 ) Proceeds from issuance of shares under incentive and stock compensation plans 55 6
Net cash provided by (used for) financing activities(307 ) 1,216
Foreign exchange rate effect on cash (2 ) 2
Net increase in cash 176 278 Cash - beginning of period 462 377
Cash - end of period$ 638 $ 655
Supplemental Disclosure of Cash Flow Information: Net Cash Paid (Received) During the Period For:Income taxes $ 30 $ (45 ) Interest $ 55 $ 48 See Notes to Condensed Consolidated Financial Statements.
7
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Dollar
(Dollar amounts in millions except per share data unless otherwise stated)
(unaudited)NOTENote 1.
BASIS OF PRESENTATION AND ACCOUNTING POLICIES (A) BASIS OF PRESENTATIONBasis of Presentation and Accounting PoliciesBasis of Presentation
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries
("(“TheHartford"Hartford” or the"Company"“Company”) provide investment products and life and property and casualty insurance to both individual and business customers in the United States and internationally.On December 31, 2003, the Company acquired the group life and accident, and short-term and long-term disability business of CNA Financial Corporation. Accordingly, the Company’s results of operations for the quarter ended March, 31, 2004 reflect the inclusion of this business. These results were not material to consolidated operations. For further discussion of the CNA Financial Corporation acquisition, see Note 18 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.
The condensed consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America, which differ materially from the accounting
practicesprescribed by various insurance regulatory authorities. Subsidiaries in which The Hartford has at least a 20% interest, but less than a majority ownership interest, are reportedonusing the equitybasis.method. Allmaterialintercompany transactions and balances between The Hartford, its subsidiaries and affiliates have been eliminated.The accompanying condensed consolidated financial statements and
the condensednotes as ofSeptember 30, 2003,March 31, 2004, and for thethird quarterfirst quarters ended March 31, 2004 andnine months ended September 30,2003and 2002are unaudited. These financial statements reflect all adjustments (consisting only of normal accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations, and cash flows for the interim periods. These condensedconsolidatedfinancial statements andcondensednotes should be read in conjunction with the consolidated financial statements and notes thereto included in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.(B) RECLASSIFICATIONSReclassifications
Certain reclassifications have been made to prior period financial information to conform to the current period classifications.
(C) USE OF ESTIMATESUse of Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The most significant estimates include those used in determining reserves for future policy benefits and unpaid
claimclaims and claim adjustment expenses; deferred policy acquisitioncosts; valuationcosts and present value ofinvestments and derivative instruments;future profits; investments; pension and other postretirement benefits; and contingencies.(D) SIGNIFICANT ACCOUNTING POLICIESSignificant Accounting Policies
For a description of accounting policies, see Note 1 of Notes to Consolidated Financial Statements included in The
Hartford's 2002Hartford’s 2003 Form 10-K Annual Report.(E) ADOPTION OF NEW ACCOUNTING STANDARDS In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. Generally, SFAS No. 150 requires liability classification for two broad classes of financial instruments: (a) instruments that represent, or are indexed to, an obligation to buy back the issuer's shares regardless of whether the instrument is settled on a net-cash or gross physical basis and (b) obligations that (i) can be settled in shares but derive their value predominately from another underlying instrument or index (e.g. security prices, interest rates, and currency rates), (ii) have a fixed value, or (iii) have a value inversely related to the issuer's shares. Mandatorily redeemable equity and written options requiring the issuer to buyback shares are examples of financial instruments that should be reported as liabilities under this new guidance. SFAS No. 150 specifies accounting only for certain freestanding financial instruments and does not affect whether an embedded derivative must be bifurcated and accounted for in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 150 is effective for instruments entered into or modified after May 31, 2003 and for all other instruments beginning with the first interim reporting period beginning after June 15, 2003. Adoption of this statement did not have a material impact on the Company's consolidated financial condition or results of operations. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group ("DIG") process that effectively required amendments to SFAS No. 133, in connection with other FASB projects dealing with financial instruments. SFAS No. 149 also clarifies under what circumstances a contract with an initial net investment and purchases and sales of when-issued securities that do not yet exist meet the characteristics of a derivative asInvestments
As discussed in
SFAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting inthestatement“Adoption ofcash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except as statedNew Accounting Standards” section below,and for hedging relationships designated after June 30, 2003. The provisions of this statement should be applied prospectively, except as stated below. - 8 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED) (E) ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED) The provisions of SFAS No. 149 that relate to SFAS No. 133 DIG issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, the guidance in SFAS No. 149 related to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 did not have a material impactonthe Company's consolidated financial condition or results of operations. InJanuary2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"), which requires an enterprise to assess whether consolidation of an entity is appropriate based upon its interests in a variable interest entity ("VIE"). A VIE is an entity in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The initial determination of whether an entity is a VIE shall be made on the date at which an enterprise becomes involved with the entity. An enterprise shall consolidate a VIE if it has a variable interest that will absorb a majority of the VIE's expected losses if they occur, receive a majority of the entity's expected residual returns if they occur or both. FIN 46 was effective immediately for new VIEs established or purchased subsequent to January 31, 2003. For VIEs established or purchased subsequent to January 31, 2003, the adoption of FIN 46 did not have a material impact on the Company's consolidated financial condition or results of operations as there were no material VIEs identified which required consolidation. For VIEs entered into prior to February1,2003, FIN 46 was originally effective for interim periods beginning after June 15, 2003. In October 2003, the FASB deferred this effective date until interim or annual periods ending after December 15, 2003. Early adoption is permitted. The Company has elected to defer the adoption of FIN 46 for VIEs created before February 1, 2003 until the fourth quarter of 2003. The adoption of FIN 46 for these VIEs is not expected to have a material impact on the Company's consolidated financial condition or results of operations. FIN 46 further requires the disclosure of certain information related to VIEs in which2004 the Companyholds a significant variable interest. As of September 30, 2003, the Company did not own any such interests that required disclosure. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45" or "the Interpretation"). FIN 45 requires certain guarantees to be recorded at fair value and also requires a guarantor to make new disclosures, even when the likelihood of making payments under the guarantee is remote. In general, the Interpretation applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying instrument or indices (e.g., security prices, interest rates, or currency rates) that are related to an asset, liability or an equity security of the guaranteed party. The recognition provisions of FIN 45 are effective on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002. For further discussion, see Note 5(c), "Lease Commitments", of Notes to Condensed Consolidated Financial Statements and Note 1(h), "Other Investment and Risk Management Activities-Specific Strategies", of Notes to Consolidated Financial Statements included in The Hartford's 2002 Form 10-K Annual Report. Adoption of this statement did not have a material impact on the Company's consolidated financial condition or results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). The principal difference between SFAS No. 146 and Issue 94-3 is that SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than at the date of an entity's commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. Adoption of SFAS No. 146 resulted in a change in the timing of when a liability is recognized for certain restructuring activities after December 31, 2002. Adoption of this statement did not have a material impact on the Company's consolidated financial condition or results of operations. (F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS In July 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued a final Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" (the "SOP"). The SOP addresses a wide variety of topics, some of which may have a significant impact on the Company. The major provisions of the SOP require: o Recognizing expenses for a variety of contracts and contract features, including guaranteed minimum death benefits ("GMDB") and annuitization options, on an accrual basis versus the previous method of recognition upon payment; o Reporting and measuring assets and liabilities ofreclassified certain separate accountproducts as general accountassetsand liabilities when specified criteria are not met; o Reporting and measuring seed money in separate accounts as general account assets based on the insurer's proportionate beneficial interest in the separate account's underlying assets; and o Capitalizing sales inducements that meet specified criteria and amortizing such amounts over the life of the contracts using the same methodology as used for amortizing deferred acquisition costs ("DAC"). - 9 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED) (F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED) The SOP is effective for financial statements for fiscal years beginning after December 15, 2003. At the date of initial application of this SOP, the Company will have to make various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements not meeting the criteria of the SOP, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits, all of which may have a significant effect on the Company's financial condition and results of operations. Based on management's preliminary review of the SOP and market conditions as of September 30, 2003, the requirement for recording a liability for variable annuity products with a guaranteed minimum death benefit feature will have an impact on the Company's results of operations. The determination of this liability is based on models that involve numerous estimates and subjective judgments, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience. The unrecorded GMDB liabilities, net of anticipated reinsurance recoverables of approximately $270, are estimated to be between $60 and $70 at September 30, 2003. Net of estimated DAC and income tax effects, the cumulative effect of establishing the required GMDB reserves as of September 30, 2003 would result in an estimated reduction of net income of between $30 and $40. The ultimate actual impact on the Company's financial statements will differ from management's current estimates and will depend in part on market conditions and other factors at the date of adoption. Through September 30, 2003, the Company has not recorded a liability for the risks associated with GMDB offered on the Company's variable annuity business, but has consistently recorded the related expenses in the period the benefits are paid to contractholders. Net of reinsurance, the Investment Products segment paid $12 and $43 for the third quarter and nine months ended September 30, 2003, respectively, and $17 and $33 for the third quarter and nine months ended September 30, 2002, respectively, in GMDB benefits to contractholders. Downturns in the equity markets could increase these payments. At September 30, 2003, the Investment Products segment held $68.8 billion of variable annuities in its separate accounts. The estimate of the net amount at risk relating to these variable annuities (the amount by which current account values of its variable annuity contracts are not sufficient to meet its GMDB commitments) was $16.2 billion. However, at September 30, 2003, approximately 77% of the net amount at risk was covered by reinsurance, resulting in a retained net amount at risk of $3.7 billion. In addition to the foregoing impact of the SOP, liabilities for certain of the Company's fixed annuity products (primarily the Company's compound rate contract ("CRC")), of approximately $11 billion, which are currently recorded at fair value as guaranteed separate account liabilities will be revalued at current account value in the general account. The related guaranteed separate account assets supporting CRC will also be reclassifiedto the general account and classified a portion of these assets asavailable for saletrading securities. Trading securitiesand will continue to beare recorded at fair value withsubsequentperiodic changes in fair valuenet of amortization of deferred acquisition costs and income taxes, recorded in other comprehensive income. Upon adoption of the SOP, the Company will record a cumulative effect adjustment to earnings equal to the revaluation of the liabilities from fair value to account value plus the adjustment to record unrealized gains (losses) on the invested assets, previously recorded as a component of net income, as other comprehensive income. The cumulative adjustment to earnings as well as the adjustment to other comprehensive income will be recorded net of amortization of deferred acquisition costs. The earnings adjustment will also be recorded net of income taxes. As of September 30, 2003, the Company is still in the process of evaluating the impact of these changes on its consolidated financial condition and results of operations. However, it is expected that the impact to stockholders' equity (accumulated other comprehensive income) will be positive and significant. Moreover, the interest rate environment at the date of the adoption of the SOP will have a significant impact on the cumulative effect change in earnings and other comprehensive income. The Company's liability for variable annuity products offered in Japan, recorded at account value in the separate account, will also be reclassified to the general account. The related separate account assets supporting the Japanese variable annuity liabilities will be reclassified to the general account, as well, and recorded in accordance with the Company's investment accounting policies. As of September 30, 2003, the Company is still in the process of evaluating the impact of revaluing these separate account assets and liabilities upon their movement into the general account. The Company does not expect the impact of adopting the remaining provisions of the SOP to be significant. In May 2003, the EITF reached a consensus in EITF Issue No. 03-4, "Determining the Classification and Benefit Attribution Method for a Cash Balance Pension Plan", that cash balance plans should be considered defined benefit plans for purposes of applying SFAS No. 87, "Employers' Accounting for Pension Plans". The EITF also concluded that the attribution method used to determine the benefit for the entire plan for certain cash balance plans should be the traditional unit credit method. The consensus is effective as of the next measurement date of the plan, which is December 31, 2003, for the Company's cash balance plan. Any difference between the valuation under the previous attribution method and the new attribution method should berecognizedas an actuarial gain or loss. Adoption of this issue is not expected to have a material impact on the Company's consolidated financial condition or results of operations. In April 2003, the FASB issued guidance in Statement 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments", ("DIG B36") that addresses the instances in which bifurcation of an instrument into a debt host contract and an embedded credit derivative is required. DIG B36 indicates that bifurcation is necessary in a modified coinsurance arrangement - 10 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED) (F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED) when the yield on the receivable and payable is based on a specified proportion of the ceding company's return on either its general account assets or a specified block of those assets, rather than the overall creditworthiness of the ceding company. The Company believes that the majority of its modified coinsurance and funds withheld agreements are not impacted by DIG B36 as they were entered into prior to the Company's "grandfather" date for embedded derivatives, without substantive modifications, or the "modco" payable or receivable is recorded in the separate account, and is already recorded at fair value with changes in fair value recordedin net investment income.The Company has determined that one of its modified coinsurance does contain an embedded derivative. The Company believes the embedded derivative is akin to a total return swap and is in the process of determining the fair value for the swap. DIG B36 is also applicable to corporate issued debt securities that incorporate credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor. The Company is currently evaluating the impact of DIG B36 on such corporate issued debt securities. The Company does not believe the adoption of DIG B36 will have a material effect on the Company's consolidated financial condition or results of operations. (G) STOCK-BASED COMPENSATION In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-BasedStock–Based Compensation
- Transition and Disclosure, an Amendment of FASB Statement No. 123", which provides three optional transition methods for entities that decide to voluntarilyadopt the fair value recognition principles of SFAS No. 123, "Accounting for Stock-Based Compensation", and modifies the disclosure requirements of SFAS No. 123.In January 2003, the Company
adoptedbegan expensing all stock-based compensation awards granted or modified after January 1, 2003 under the fair value recognition provisions ofaccountingStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting foremployee stock compensation and used the prospective transition method. Under the prospective method, stock-based compensation expense is recognized for awards granted or modified after the beginning of the fiscal year in which the change is made.Stock-Based Compensation”. The fair value of stock-based awards granted or modified during thenine monthsquarters endedSeptember 30,March 31, 2004 and 2003 was$40, after-tax.$36 and $31, after-tax, respectively. The fair value of these awards will be recognizedas expenseover theawards'awards’ vestingperiods,period, generallythree3 years. The expense associated with stock-based compensation awards for the first quarters ended March 31, 2004 and 2003, was $4 and $1, after-tax, respectively. Prior to January 1, 2004, the Company used the Black-Scholes model to estimate the fair value of the Company’s stock-based compensation. For all awards granted or modified on or after January 1, 2004, the Company used a binomial option-pricing model that incorporates the possibility of early exercise of options into the valuation. The binomial model also incorporates the Company’s historical forfeiture and exercise experience to determine the option value. For these reasons, the Company believes the binomial model provides a fair value that is more representative of actual historical experience than the value calculated under the Black-Scholes model.All stock-based awards granted or modified prior to January 1, 2003
willcontinue to be valued using the intrinsic value-based provisions set forth in Accounting Principles Board("APB"(“APB”) Opinion No. 25,"Accounting“Accounting for Stock Issued toEmployees"Employees”. Under the intrinsic value method, compensation expense is determined on the measurement date, which is the first date on which both the number of shares the employee is entitled to receive and the exercise price are known. Compensation expense, if any, is measured based on theaward'saward’s intrinsic value, which is the excess of the market price of the stock over the exercise price on the measurement date. The expenseincluding non-option plans,related to stock-based employee compensation, including non-option plans, included in the determination of net income for thethird quarterfirst quarters ended March 31, 2004 andnine months ended September 30,2003and 2002is less than that which would have been8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 1. Basis of Presentation and Accounting Policies (continued)
recognized if the fair value method had been applied to all awards
grantedsince the effective date of SFAS No. 123.For(For further discussion of theCompany's stock-basedCompany’s stock compensation plans, see Note 11 of Notes to Consolidated Financial Statements included in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report.)The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the fair value method had been applied to all outstanding and unvested awards in each period. The pro forma fair values disclosed below related to awards granted prior to 2004 were calculated using the Black-Scholes option-pricing model and were not recalculated using the binomial model. The change in valuation methodology would have an insignificant impact on the pro forma amounts disclosed.
First Quarter Ended March 31, 2004 2003 (Unaudited) Net income (loss), as reported $ 568 $ (1,395 ) Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects [1] 4 1 Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects (7 ) (9 )
Pro forma net income (loss) [2] $ 565 $ (1,403 )
Earnings (loss) per share: Basic – as reported $ 1.96 $ (5.46 ) Basic – pro forma [2] $ 1.95 $ (5.49 ) Diluted – as reported [3] $ 1.93 $ (5.46 ) Diluted – pro forma [2] [3] $ 1.92 $ (5.49 )
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- ----------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Net income (loss), as reported $ 343 $ 265 $ (545) $ 742 Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects [1] 4 2 15 4 Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects (11) (16) (37) (41) - ------------------------------------------------------------------------------------------------------------------------------------ Pro forma net income (loss) [2] $ 336 $ 251 $ (567) $ 705 ==================================================================================================================================== Earnings (loss) per share: Basic - as reported $ 1.21 $ 1.06 $ (2.03) $ 3.00 Basic - pro forma [2] $ 1.19 $ 1.01 $ (2.11) $ 2.85 Diluted - as reported [3] $ 1.20 $ 1.06 $ (2.03) $ 2.96 Diluted - pro forma [2] [3] $ 1.18 $ 1.00 $ (2.11) $ 2.82 ====================================================================================================================================[1] [1]Includes the impact of non-option plans of $2 and $0, respectively,$1 for thethird quarter,first quarters ended March 31, 2004 and$4 and $2, respectively, for the nine months ended September 30, 2003 and 2002. [2]2003. [2]The pro forma disclosures are not representative of the effects on net income (loss) and earnings (loss) per share in future periods. [3] [3]As a result of the net loss in the nine monthsquarter endedSeptember 30,March 31, 2003, SFAS No. 128,"Earnings“Earnings PerShare"Share,” requires the Company to use basic weighted averagecommonshares outstanding in the calculation ofthe nine months ended September 30,first quarter 2003 diluted earnings(loss)per share,sinceas the inclusion of options of1.50.7 would have been antidilutive to the earnings per share calculation. In the absence of the net loss, weighted average common shares outstanding and dilutive potential common shares would have totaled270.4.256.1.- 11 -Adoption of New Accounting Standards
In July 2003, Accounting Standards Executive Committee of the American Institute of Certified Public Accounts (“AICPA”) issued a final Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (the “SOP”). The SOP addresses a wide variety of topics, some of which have a significant impact on the Company. The major provisions of the SOP require:
Recognizing expenses for a variety of contracts and contract features, including guaranteed minimum death benefits (“GMDB”), certain death benefits on universal-life type contracts and annuitization options, on an accrual basis versus the previous method of recognition upon payment;Reporting and measuring assets and liabilities of certain separate account products as general account assets and liabilities when specified criteria are not met;Reporting and measuring the Company’s interest in its separate accounts as general account assets based on the insurer’s proportionate beneficial interest in the separate account’s underlying assets; andCapitalizing sales inducements that meet specified criteria and amortizing such amounts over the life of the contracts using the same methodology as used for amortizing deferred acquisition costs (“DAC”).The SOP was effective for financial statements for fiscal years beginning after December 15, 2003. At the date of initial application, January 1, 2004, the cumulative effect of the adoption of the SOP on net income and other comprehensive income was comprised of the following individual impacts:
Net Other Income Comprehensive Cumulative Effect of Adoption (Loss) Income Establishing GMDB and other benefit reserves for annuity contracts $ (54 ) $ — Reclassifying certain separate accounts to general accounts 30 294 Other 1 (2 )
Total cumulative effect of adoption $ (23 ) $ 292
Death Benefits and Other Insurance Benefit Features
The Company sells variable annuity contracts that offer various guaranteed death benefits. For certain guaranteed death benefits, the Company pays the greater of (1) the account value at death; (2) the sum of all premium payments less prior withdrawals; or (3) the maximum anniversary value of the contract, plus any premium payments since the contract anniversary, minus any withdrawals following the contract anniversary. For certain guaranteed death benefits sold with variable annuity contracts beginning in June of 2003, the Company pays the greater of (1) the account value at death; or (2) the maximum anniversary value; not to exceed the account value plus the greater of (a) 25% of premium payments, or (b) 25% of the maximum anniversary value of the contract.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETSNote 1. Basis of Presentation and Accounting Policies (continued)
The Company currently reinsures a significant portion of these death benefit guarantees associated with its in-force block of business. As of January 1, 2004, the Company has recorded a liability for GMDB and other benefits sold with variable annuity products of $225 and a related reinsurance recoverable asset of $108. As of March 31, 2004 the liability from GMDB and other benefits sold with variable annuity products was $218 with a related reinsurance recoverable asset of $101. The determination of the GMDB liability and related reinsurance recoverable is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience. The assumptions used are consistent with those used in determining estimated gross profits for purposes of amortizing deferred acquisition costs.
The Individual Life segment sells universal life-type contracts with certain secondary guarantees, such as a guarantee that the policy will not lapse, even if the account value is reduced to zero, as long as the policyholder makes scheduled premium payments. The cumulative effect on net income upon recording liabilities for secondary guarantees was not material. Currently there is diversity in industry practice and inconsistent guidance surrounding the application of the SOP to universal life-type contracts. An AICPA task force has been convened to develop guidance surrounding the methodology for determining reserves for universal life-type contracts and the related secondary guarantees. This may result in an adjustment to the cumulative effect of adopting the SOP and could impact future earnings but is not expected to be material to the Company’s financial position or results of operations.
Separate Account Presentation
The Company had recorded certain market value adjusted (“MVA”) fixed annuity products and modified guarantee life insurance (primarily the Company’s Compound Rate Contract (“CRC”) and associated assets) as separate account assets and liabilities through December 31, 2003. Notwithstanding the market value adjustment feature in this product, all of the investment performance of the separate account assets is not being passed to the contractholder, and it therefore, does not meet the conditions for separate account reporting under the SOP. On January 1, 2004, market value reserves included in separate account liabilities for CRC, of $10.8 billion, were revalued at current account value in the general account to $10.1 billion. The related separate account assets of $11.0 billion were also reclassified to the general account. Fixed maturities and equity securities were reclassified to the general account, as available-for-sale securities, and will continue to be recorded at fair value, however, subsequent changes in fair value, net of amortization of deferred policy acquisition costs and income taxes, will be recorded in other comprehensive income rather than net income. On January 1, 2004, the Company recorded a cumulative effect adjustment to earnings equal to the revaluation of the liabilities from fair value to account value plus the adjustment to record unrealized gains (losses) on available-for-sale invested assets, previously recorded as a component of net income, as other comprehensive income. The cumulative adjustments to earnings and other comprehensive income were recorded net of amortization of deferred policy acquisition costs and income taxes. Through December 31, 2003, the Company had recorded CRC assets and liabilities on a market value basis with all changes in value (market value spread) included in current earnings as a component of other revenues. Since adoption of the SOP, the components of CRC spread on a book value basis are recorded in interest income and interest credited. Realized gains and losses on investments and market value adjustments on contract surrenders are recognized as incurred.
The Company had also recorded its variable annuity products offered in Japan in separate account assets and liabilities through December 31, 2003. As the separate account arrangement in Japan is not legally insulated from the general account liabilities of the Company, it does not meet the conditions for separate account reporting under the SOP. On January 1, 2004, separate account liabilities in Japan of $6.2 billion recorded at account value in the separate account, were reclassified to the general account with no change in value. The related separate account assets of $6.2 billion were also reclassified to the general account with no change in value. The investment assets were recorded at fair value in a trading securities portfolio. As of March 31, 2004, due to strong sales of Japan variable annuity products and positive performance of the Japanese equity markets these assets had grown to $7.8 billion.
Interests in Separate Accounts
As of December 31, 2003, the Company had $24 representing unconsolidated interests in its own separate accounts. These interests were recorded as available-for-sale equity securities, with changes in fair value recorded through other comprehensive income. On January 1, 2004, the Company reclassified $11 to investment in trading securities, where the Company’s proportionate beneficial interest in the separate account was less than 20%. In instances where the Company’s proportionate beneficial interest was between 20-50%, the Company reclassified $13 of its investment to reflect the Company’s proportionate interest in each of the underlying assets of the separate account. The Company has designated its proportionate interest in these equity securities and fixed maturities as available-for-sale. As of March 31, 2004, the Company had $1 of interests in separate accounts recorded as equity trading securities and $0 recorded as available-for-sale securities.
Sales Inducements
The Company currently offers enhanced crediting rates or bonus payments to contract-holders on certain of its individual and group annuity products. Through December 31, 2003, the expense associated with offering certain of these bonuses was deferred and amortized over the contingent deferred sales charge period. Others were expensed as incurred. Effective January 1,
2002,2004, upon adopting the SOP, the expense associated with offering a bonus will be deferred and amortized over the life of the related contract in a pattern consistent with the amortization of deferred policy acquisition costs. Effective January 1, 2004, amortization10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 1. Basis of Presentation and Accounting Policies (continued)
expense associated with expenses previously deferred will be recorded over the remaining life of the contract rather than over the contingent deferred sales charge period. For the quarter ended March 31, 2004, amortization of sales inducements was $6.
Future Adoption of New Accounting Standards
In March 2004, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 adopts a three-step impairment model for securities within its scope. The three-step model must be applied on a security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is impaired if the fair value of the investment is less than its cost basis. Step 2: Evaluate whether an impairment is other-than-temporary. For debt securities that cannot be contractually prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost, an impairment is deemed other-than-temporary if the investor does not have the ability and intent to hold the investment until a forecasted market price recovery or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost basis and its fair value. Subsequent to an other-than-temporary impairment loss, a debt security should be accounted for in accordance with Statement of Position (“SOP”) 03-3, “Accounting for Loans and Certain Debt Securities Acquired in a Transfer”. EITF 03-1 does not replace the impairment guidance for investments accounted for under EITF Issue 99-20, “Recognition of Interest Income and Impairments on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”), however, investors will be required to determine if a security is other-than-temporarily impaired under EITF 03-1 if the security is determined not to be impaired under EITF 99-20. The disclosure provisions of EITF 03-1 adopted by the Company effective December 31, 2003 and included in Note 3 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report will prospectively include securities subject to EITF 99-20.
The impairment evaluation and recognition guidance in EITF 03-1 will be applied prospectively for all relevant current and future investments, effective in reporting periods beginning after June 15, 2004. Besides the disclosure requirements adopted by the Company effective December 31, 2003, the final version of EITF 03-1 included additional disclosure requirements that are effective for fiscal years ending after June 15, 2004. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
In March 2004, the EITF reached a final consensus on Issue 03-16, “Accounting for Investments in Limited Liability Companies” (“EITF 03-16”). EITF 03-16 will require investors in limited liability corporations that have specific ownership accounts to follow the equity method accounting for investments that are more than minor (e.g. greater than 3% ownership interest) as prescribed in SOP 78-9, “Accounting for Investments in Real Estate Ventures” and EITF Topic No. D-46, “Accounting for Limited Partnership Investments”. Investors that do not have specific ownership accounts or minor ownership interests should follow the significant influence model prescribed in APB Opinion No. 18, “Accounting for Certain Investments in Debt and Equity Securities”, for corporate investments. EITF 03-16 excludes securities that are required to be accounted for as debt securities based on the guidance in paragraph 14 of SFAS No.
142, "Goodwill140, “Accounting for Transfers andOther Intangible Assets"Servicing of Financial Assets and Extinguishments of Liabilities”, andaccordingly ceased all amortization of goodwill.EITF 99-20. EITF 03-16 is effective for quarters beginning after June 15, 2004 and should be applied as a change in accounting principle. Thefollowing table shows the Company's acquired intangible assets that continue to be subject to amortization and aggregate amortization expense. Except for goodwill, the Company has no intangible assets with indefinite useful lives.
SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------------------- --------------------------------------- GROSS CARRYING ACCUMULATED NET GROSS CARRYING ACCUMULATED NET AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION AMOUNT AMORTIZATION - ------------------------------------------------------------------------------------------------------------------------------------Present value of future profits $ 1,406 $ 346 $ 1,406 $ 274 Renewal rights 46 32 42 27 Other 9 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 1,461 $ 378 $ 1,448 $ 301 ====================================================================================================================================Net amortization expense for the third quarter and nine months ended September 30, 2003 was $25 and $77, respectively. Net amortization expense for the third quarter and nine months ended September 30, 2002 was $35 and $87, respectively. Estimated future net amortization expense for the succeeding five years is as follows: FOR THE YEAR ENDED DECEMBER 31, - ----------------------------------------------------------------- 2003 $ 109 2004 $ 124 2005 $ 101 2006 $ 88 2007 $ 73 ================================================================= The carrying amounts of goodwill as of September 30, 2003 and December 31, 2002, are shown below. SEPTEMBER 30, DECEMBER 31, 2003 2002 - ------------------------------------------------------------------- Life $ 796 $ 796 Property & Casualty 152 153 Corporate 772 772 - ------------------------------------------------------------------- Total $ 1,720 $ 1,721 =================================================================== The decrease of $1 to Property & Casualty's goodwill asset is attributable to the sale of Trumbull Associates, LLC. For further discussionadoption of thissale, seestandard is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.Note
6. NOTE 3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (A) SECURITIES LENDING The Company participates in a securities lending program to generate additional income, whereby certain domestic fixed income securities are loaned for a short period of time from the Company's portfolio to qualifying third parties, via a lending agent. Borrowers of these securities provide collateral of 102% of the market value of the loaned securities. Acceptable collateral may be in the form of cash or U.S. Government securities. The market value of the loaned securities is monitored2. Derivatives andadditional collateral is obtained if the market value of the collateral falls below 100% of the market value of the loaned securities. Under the terms of the securities lending program, the lending agent indemnifies the Company against borrower defaults. As of September 30, 2003, the fair value of the loaned securities wasapproximately $1.1 billion and was included in fixed maturities. The cash collateral received as of September 30, 2003 of approximately $1.1 billion was invested in short-term securities and was also included in fixed maturities, with a corresponding liability for the obligation to return the collateral recorded in other liabilities. The Company retains a portion of the income earned from the cash collateral or receives a fee from the borrower. The Company recorded before-tax income from securities lending transactions, net of lending fees, of $0.5 for the third quarter and $0.8 for the nine months ended September 30, 2003, which was included in net investment income. (B) DERIVATIVE INSTRUMENTSHedging ActivityThe Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards, futures and options
fordesigned to achieve one of four Company-approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; to control transaction costs; or to enter intoincome enhancement andreplication transactions.AllOn the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the
Company'sfair value of a recognized asset or liability (“fair value” hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge), (3) a foreign-currency fair value or cash flow hedge (“foreign-currency” hedge), (4) a hedge of a net investment in a foreign operation or (5) held for other investment and risk management activities, which primarily involve managing asset or liability related risks which do not qualify for hedge accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”.The Company’s derivative transactions are permitted uses of derivatives under the derivatives use plan filed
withand/or approved,by,as applicable, by the State of Connecticut and the State of New York insurance departments. The Company does not make a market or trade in these instruments for the express purpose of earning short-term trading profits.11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 2. Derivatives and Hedging Activity (continued)
For a detailed discussion of the
Company'sCompany’s use of derivative instruments, seeNote 1(h)Notes 1 and 3 of Notes to Consolidated Financial Statements included in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report.Due to the adoption of the SOP, derivatives previously included in separate accounts were reclassified into various other balance sheet classifications. On January 1, 2004, the notional amount and net fair value of derivative instruments reclassified totaled $2.9 billion and $(71), respectively. As of
September 30, 2003March 31, 2004, $50 of the derivatives were reported in other investments, $(93) in other liabilities, and $6 in fixed maturities in the condensed consolidated balance sheets. Management’s objective with regard to the reclassified derivatives along with the notional amount and net fair value as of March 31, 2004 are as follows:
Notional Hedging Strategy Amount Fair Value Cash Flow Hedges Interest rate swaps- Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed maturity investments to fixed rates. These derivatives are predominantly used to better match cash receipts from assets with cash disbursements required to fund liabilities.$ 1,511 $ 68 Foreign currency swaps- Foreign currency swaps are used to convert foreign denominated cash flows associated with certain foreign denominated fixed maturity investments to U.S. dollars. The foreign fixed maturities are primarily denominated in Euros and are swapped to minimize cash flow fluctuations due to changes in currency rates.413 (98 ) Fair Value Hedges Interest rate caps and floors- Interest rate caps and floors are used to offset the changes in fair value related to corresponding interest rate caps and floors that exist in certain of the Company’s variable-rate fixed maturity investments.111 (3 ) Other Investment and Risk Management Activities Credit default and total return swaps -The Company enters into swap agreements in which the Company assumes credit exposure or reduces credit exposure from an individual entity, referenced index or asset pool.234 1 Interest rate swaps- The Company enters into interest rate swaps to economically terminate existing swaps in hedging relationships and thereby offset the changes in value in the original swap. In addition, the Company uses interest rate swaps to manage interest rate risk.345 — Options -The Company writes option contracts for a premium to monetize the option embedded in certain of its fixed maturity investments.417 — Foreign currency swaps- The Company enters into foreign currency swaps to hedge the foreign currency exposures in certain of its foreign fixed maturity investments.13 (5 )
Total$ 3,044 $ (37 )
In addition to the derivatives transferred to the general account as a result of the adoption of the SOP, during the first quarter of 2004, the Company entered into a series of interest rate swap agreements with a combined notional value of $350, to hedge a portion of the Company’s floating rate guaranteed investment contracts. These swaps have been designated as cash flow hedges, with the objective of hedging changes in the benchmark interest rate (i.e. LIBOR), and were structured to offset the payments associated with the guaranteed investment contracts. As of March 31, 2004 the notional amount and net fair value of these swaps totaled $350 and $(7), respectively.
The Company offers certain variable annuity products with a guaranteed minimum withdrawal benefit (“GMWB”) rider. As of March 31, 2004, and December 31,
2002,2003, $9.7 billion or 46% and $6.2 billion or 36%, respectively, of account value with the GMWB feature was unreinsured. In order to minimize the volatility associated with the unreinsured GMWB liabilities, the Companycarried $297has established an alternative risk management strategy. During the third quarter of 2003, the Company began hedging its unreinsured GMWB exposure using interest rate futures, and$299, respectively,Standard and Poor’s (“S&P”) 500 and NASDAQ index options and futures contracts. During the first quarter of 2004, the Company entered into Europe, Asia and Far East (“EAFE”) Index swaps to hedge GMWB exposure to international equity markets.The total notional amount of derivative
assets in other investments and $228 and $208, respectively,contracts purchased to hedge the GMWB exposure, as ofderivative liabilities in other liabilities. In addition, the Company recognized embedded derivative (assets) liabilities related to guaranteed minimum withdrawal benefits ("GMWB") on certain of its variable annuity contracts of $(39) and $48 at September 30, 2003March 31, 2004 and December 31,2002,2003, was $1.7 billion and $544, respectively,in other policyholder funds. The Company has entered into an offsetting reinsurance arrangement, which is recognized as a derivative asset. Theand net fair value was $100 and $21, respectively. For the quarter ended March 31, 2004, net realized capital gains and losses included the change in market value ofthisboth the embedded derivative(liability) asset,related to the GMWB liability and the related derivative contracts that were purchased as economic hedges, the net effect of which was a $2 loss before deferred policy acquisition costs and tax effects.Derivative instruments are recorded at
September 30, 2003fair value andDecember 31, 2002 was $(42) and $48, respectively, and was -presented in the condensed consolidated balance sheets as follows:12
-NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTE 3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED) (B) DERIVATIVE INSTRUMENTS (CONTINUED) included in reinsurance recoverables. See "ProductNote 2. Derivatives and
Risk Management" section below forHedging Activity (continued)
March 31, 2004 December 31, 2003 Asset Liability Asset Liability Values Values Values Values Other investments $ 375 $ — $ 199 $ — Reinsurance recoverables — 73 — 89 Other policyholder funds and benefits payable 79 — 115 — Fixed maturities 15 — 7 — Other liabilities — 342 — 303
Total$ 469 $ 415 $ 321 $ 392
The increase in the asset values of derivative instruments since December 31, 2003 was primarily due to derivatives transferred to the general account pursuant to the adoption of the SOP, the increase in derivatives used to hedge GMWB exposure and market appreciation associated with interest rate swaps due to a
discussion concerningdecrease in interest rates.The following table summarizes the
Company's risk management strategies fornotional amount and fair value of derivatives by hedge designation as of March 31, 2004 and December 31, 2003. The notional amount of derivative contracts represents theunreinsured GMWB business. Cash-Flow Hedgesbasis upon which pay or receive amounts are calculated and are not reflective of credit risk. The fair value amounts of derivative assets and liabilities are presented on a net basis in the following table.
March 31, 2004 December 31, 2003 Notional Notional Amount Fair Value Amount Fair Value Cash flow hedge $ 5,999 $ (80 ) $ 3,659 $ (84 ) Fair value hedge 1,023 18 956 4 Net investment hedge 200 (9 ) 200 (4 ) Other investment and risk management activities 38,581 125 30,989 13
Total$ 45,803 $ 54 $ 35,804 $ (71 )
For the
third quarterquarters endedSeptember 30,March 31, 2004 and March 31, 2003, theCompany reported a net realized lossCompany’s gross gains and losses representing the total ineffectiveness of allcash-flowcash flow, fair value and net investment hedgesof $1.were immaterial, with the net impact reported as net realized capital gains and losses.For the
nine monthsquarters endedSeptember 30, 2002,March 31, 2004 and 2003, theCompany'sCompany recognized an after-tax net gainor loss representing(loss) of $17 and $(3), respectively, (reported as net realized capital gains and losses in the condensed consolidated statements of operations), which represented the totalineffectiveness of all cash-flow hedges was immaterial. Gains and losses on derivative contracts that are reclassified from accumulatedchange in value for othercomprehensive income ("AOCI") to current period earnings are included inderivative-based strategies which do not qualify for hedge accounting treatment, including theline item in the statement of income in which the hedged item is recorded.periodic net coupon settlements.As of
September 30, 2003 and 2002,March 31, 2004, the after-tax deferred net gains on derivative instruments accumulated inAOCIaccumulated other comprehensive income (“AOCI”) that are expected to be reclassified to earnings during the next twelve monthswere $8 and $5, respectively.are $15. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the Company will recognize the deferred net gainsand losses(losses) as an adjustment to interest income over the term of the investment cash flows. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments onvariable-rate debt)variable rate fixed maturities) is twenty-four months.As of each of September 30, 2003 and December 31, 2002, the Company held derivative notional value related to strategies categorized as cash-flow hedges of $3.2 billion.For thethird quarterquarters ended March 31, 2004 andnine months ended September 30,2003,and 2002,the net reclassifications from AOCI to earnings resulting from the discontinuance ofcash-flowcash flow hedges were immaterial.Fair-Value Hedges During the third quarter of 2003,The
Company entered into an interest rate swap with a notional value of $250 as an economic hedge of a portion of the Company's senior debt. The interest rate swap agreement was structured to exactly offset the terms and conditions of the hedged senior debt (i.e., notional value, maturity date and payment dates) and has been designated as anet investment hedge of thebenchmark interest rate (i.e., LIBOR). ForJapanese Life operation was established in thethirdfourth quarterand nine months ended September 30, 2003 and 2002,of 2003. The after-tax amount of net gain (loss) included in theCompany's gross gains and losses representing the total ineffectiveness of all fair-value hedges were immaterial,foreign currency cumulative translation adjustment associated with the netimpact reportedinvestment hedge was $(6) and $(3) asnet realized capital gains and losses. All componentsofeach derivative's gain or loss are included in the assessment of hedge effectiveness. As of September 30, 2003March 31, 2004 and December 31, 2003, respectively.Note 3. Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company
held $1.0 billionadopted SFAS No. 142, “Goodwill and$800, respectively, in derivative notional value related to strategies categorizedOther Intangible Assets”, and accordingly ceased all amortization of goodwill.The carrying amount of goodwill as
fair-value hedges. Other Investment and Risk Management Activities General The Company's other investment and risk management activities primarily relate to strategies used to reduce economic risk or enhance income, and do not receive hedge accounting treatment. Swap agreements, interest rate cap and floor agreements and option contracts are used to reduce economic risk. Income enhancement and replication transactions include the useofwritten covered call options, which offset embedded equity call options, total return swaps and synthetic replication of cash market instruments. The change in the value of all derivatives held for other investment and risk management purposes is reported in current period earnings as net realized capital gains and losses. As of September 30, 2003March 31, 2004 and December 31,2002, the Company held $7.6 billion and $6.8 billion, respectively, in derivative notional value related to strategies categorized as Other Investment and Risk Management Activities, excluding Product Derivatives and Risk Management activities. Product Derivatives and Risk Management The Company offers certain variable annuity products with a GMWB rider. The GMWB provides the policyholder with a guaranteed remaining balance ("GRB") if the account value2003, isreduced to zero through a combination of market declines and withdrawals. The GRB is generally equal to premiums less withdrawals. However, annual withdrawals that exceed 7% of the premiums paid may reduce the GRB by an amount greater than the withdrawals and may also impact the guaranteed annual withdrawal amount that subsequently applies after the excess annual withdrawals occur. The policyholder also has the option, after a specified time period, to reset the GRB to the then-current account value, if greater. The GMWB represents an embedded derivative in the variable annuity contract that is required to be reported separately from the host variable annuity contract. It is carried at fair value and reported in other policyholder funds. The fair value of the GMWB obligations is calculated based on actuarial assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. Because of the dynamic and complex nature of these cash flows, stochastic techniques under a variety of market return scenarios and other best estimate assumptions are used. Estimating these cash flows involves numerous estimates and subjective judgments including those regarding expected market rates of return, market volatility, correlations of market returns and discount rates. In valuing the embedded derivative, the Company attributes a portion of the fees collected from the policyholder equal to the present value of future GMWB claims (the "Attributed Fees"). All changes in the fair value of the embedded derivative are recorded in net realized capital gains and losses. The excess of fees collected from the policyholder for the GMWB over the Attributed Fees is recorded in fee income. For all contracts in effect through July 6, 2003, the Company entered into a reinsurance arrangement to offset its exposure to the GMWB for the lives of those contracts. This arrangement is recognized as a derivative and carried at fair value in reinsurance recoverables. Changes in the fair value of both the derivative -shown below.
Life $ 796 Property & Casualty 152 Corporate 772
Total $ 1,720
13
-NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTENote 3.
INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED) (B) DERIVATIVE INSTRUMENTS (CONTINUED)Goodwill and Other Intangible Assets (continued)The following table shows the Company’s acquired intangible assets that continue to be subject to amortization and
liabilities related to the reinsured GMWB are recorded in net realized capital gains and losses. As of July 6, 2003, the Company exhausted all but a small portion of the reinsurance capacity under the current arrangement, as it relates to new business, and will be ceding only a very small number of new contracts subsequent to July 6, 2003. Substantially all new contracts with the GMWB are not covered by reinsurance. As of September 30, 2003, $9.8 billion out of $12.6 billion of account value with the GMWB feature was reinsured. In order to minimize the volatility associated with the unreinsured GMWB liabilities,accumulated amortization expense. Except for goodwill, the Company hasestablished an alternative risk management strategy. During the third quarter of 2003, the Company began hedging its unreinsured GMWB exposure using interest rate futures, Standard and Poor's ("S&P") 500 and NASDAQ index put options and futures contracts. At September 30, 2003, the notional value of the options and futures contracts purchased was $475. During the third quarter of 2003, net realized capital gains and losses included the change in market value of both the value of the embedded derivative related to the GMWB liability and the related derivative contracts that were purchased as economic hedges, the net effect of which was a loss of less than $1 before deferred policy acquisition costs and tax effectsno intangible assets with indefinite useful lives.
March 31, 2004 December 31, 2003 Gross Accumulated Gross Accumulated Carrying Net Carrying Net Amortized Intangible Assets Amount Amortization Amount Amortization Present value of future profits $ 1,459 $ 408 $ 1,459 $ 380 Renewal rights 30 18 30 17 Other 11 2 11 1
Total $ 1,500 $ 428 $ 1,500 $ 398
Net amortization expense for the quarter ended
September 30, 2003. For further discussionMarch 31, 2004 and 2003 was $30 and $26, respectively.Estimated future net amortization expense for the succeeding five years is as follows:
For the year ended December 31, 2004 $ 124 2005 $ 104 2006 $ 95 2007 $ 80 2008 $ 69 The following is detail of the
Company's other investmentnet acquired intangible asset activity as of March 31, 2004 andrisk management activities, see "Other Investments and Risk Management Activities" in2003:
Present Value of Future Renewal Profits Rights Other Total For the quarter ended March 31, 2004 Balance, beginning of period$ 1,079 $ 13 $ 10 $ 1,102 Amortization, net of the accretion of interest 28 1 1 30
Balance, ending of period$ 1,051 $ 12 $ 9 $ 1,072
For the quarter ended March 31, 2003 Balance, beginning of period$ 1,132 $ 15 $ — $ 1,147 Acquisition of business — 4 9 13 Amortization, net of the accretion of interest 24 2 — 26
Balance, ending of period$ 1,108 $ 17 $ 9 $ 1,134
Note
1(h) of Notes to Consolidated Financial Statements included in The Hartford's 2002 Form 10-K Annual Report. NOTE4.EARNINGS (LOSS) PER SHAREEarnings (Loss) Per ShareThe following tables present a reconciliation of net income (loss) and shares used in calculating basic earnings (loss) per share to those used in calculating diluted earnings (loss) per share.
Net March 31, 2004 Income/(Loss) Shares Per Share Amount Basic Earnings per ShareNet income available to common shareholders $ 568 289.9 $ 1.96
Diluted Earnings per ShareOptions — 3.1 Equity Units — 1.9
Net income available to common shareholders plus assumed conversions $ 568 294.9 $ 1.93
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 4. Earnings (Loss) Per Share (continued)
March 31, 2003 Basic Loss per ShareNet loss available to common shareholders $ (1,395 ) 255.4 $ (5.46 )
Diluted Loss per Share [1]Options — —
Net loss available to common shareholders plus assumed conversions $ (1,395 ) 255.4 $ (5.46 )
THIRD QUARTER ENDED NINE MONTHS ENDED -------------------------------------- ------------------------------------- NET PER SHARE NET INCOME PER SHARE SEPTEMBER 30, 2003 INCOME SHARES AMOUNT (LOSS) SHARES AMOUNT - ------------------------------------------------------------------------------------------------------------------------------------BASIC EARNINGS (LOSS) PER SHARE Income (loss) available to common shareholders $ 343 282.5 $ 1.21 $ (545) 268.9 $ (2.03) ------------- ----------- DILUTED EARNINGS (LOSS) PER SHARE [1] Options -- 2.3 -- -- ------------------------- -------------------------- Income (loss) available to common shareholders plus assumed conversions $ 343 284.8 $ 1.20 $ (545) 268.9 $ (2.03) ====================================================================================================================================[1] [1]As a result of the net loss in the nine monthsquarter endedSeptember 30,March 31, 2003, SFAS No. 128 requires the Company to use basic weighted averagecommonshares outstanding in the calculation ofthe nine months ended September 30,first quarter 2003 diluted earnings(loss)per share,sinceas the inclusion of options of1.50.7 would have been antidilutive to the earnings per share calculation. In the absence of the net loss, weighted average common shares outstanding and dilutive potential common shares would have totaled270.4.256.1.
THIRD QUARTER ENDED NINE MONTHS ENDED -------------------------------------- ------------------------------------- NET PER SHARE NET PER SHARE SEPTEMBER 30, 2002 INCOME SHARES AMOUNT INCOME SHARES AMOUNT - ------------------------------------------------------------------------------------------------------------------------------------BASIC EARNINGS PER SHARE Income available to common shareholders $ 265 248.9 $ 1.06 $ 742 247.4 $ 3.00 ------------- ----------- DILUTED EARNINGS PER SHARE Options -- 1.6 -- 2.9 ------------------------- -------------------------- Income available to common shareholders plus assumed conversions $ 265 250.5 $ 1.06 $ 742 250.3 $ 2.96 ====================================================================================================================================Basic earnings (loss) per share reflects the actual weighted average number of
commonshares outstanding during the period. Diluted earnings (loss) per share includes the dilutive effect of outstanding options and equity units, using the treasury stock method. Under the treasury stock method exercise of optionsisand equity units are assumed, with the proceeds used torepurchasepurchase common stock at the average market price for the period.- 14 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTEThe equity units are reflected in diluted earnings per share during periods where the average market price of the Company’s common stock exceeds the applicable appreciation threshold. For a discussion of the Company’s equity units, see Note 8 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 10-K Annual Report.Note 5.
COMMITMENTS AND CONTINGENCIES (A) LITIGATIONCommitments and ContingenciesLitigation
The Hartford is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Hartford accounts for such activity through the establishment of unpaid claim and claim adjustment expense reserves. Subject to the
discussion of the litigation below involving Mac Arthur Company and its subsidiary, Western MacArthur Company, both former regional distributors of asbestos products (collectively or individually, "MacArthur"), and theuncertainties discussed in(b) belowNote 16 of Notes to Consolidated Financial Statements under the caption"Asbestos“Asbestos and EnvironmentalClaims,"Claims”, included in The Hartford’s 2003 Form 10-K Annual Report, management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of The Hartford.The Hartford is also
isinvolved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, underpayment of claims or improper underwriting practices in connection with various kinds of insurance policies, such as personal and commercial automobile, premises liability andinland marine.marine, and improper sales practices in connection with the sale of life insurance and other investment products. The Hartford also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition of The Hartford. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on theCompany'sCompany’s consolidated results of operations or cash flows in particular quarterly or annual periods.The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford A&I"), a subsidiaryAs discussed in Note 16 of
the Company, issued primary general liability policiesNotes toMacArthur during the period 1967 to 1976. MacArthur sought coverage for asbestos-related claims from Hartford A&I under these policies beginning in 1978. During the period between 1978 and 1987, Hartford A&I paid its full aggregate limits under these policies plus defense costs. In 1987, Hartford A&I notified MacArthur that its available limits under these policies had been exhausted, and MacArthur ceased submitting claims to Hartford A&I under these policies. On October 3, 2000, thirteen years after it had accepted Hartford A&I's notice of exhaustion, MacArthur filed an action against Hartford A&I and another insurer in the U.S. District Court for the Eastern District of New York, seeking, for the first time, additional coverage for asbestos bodily injury claimsConsolidated Financial Statements under theHartford A&I primary policies on the theory that Hartford A&I had not exhausted limits that MacArthur alleges to be available for non-products liability.caption “Asbestos and Environmental Claims”, included in Thecomplaint sought a declaration of coverage and unquantified damages. On March 28,Hartford’s 2003the District Court dismissed this action without prejudice on MacArthur's motion. On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a settlement of a coverage action brought by MacArthur against United States Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos liability to MacArthur in conjunction with a proposed bankruptcy petition and pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at least twelve years of primary general liability coverage to MacArthur, but, unlike Hartford A&I, had denied coverage and had refused to pay for defense or indemnity. On October 7, 2002, MacArthur filed an action in the Superior Court in Alameda County, California, against Hartford A&I and two other insurers. As in the now-dismissed New York action, MacArthur seeks a declaration of coverage and damages for asbestos bodily injury claims. Four asbestos claimants who allegedly have obtained default judgments against MacArthur also are joined as plaintiffs; they seek to recover the amount of their default judgments and additional damages directly from the defendant insurers and assert a right to an accelerated trial. On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of reorganization, which seeks to implement the terms of its settlement with St. Paul. MacArthur asked the bankruptcy court to determine the full amount of its current and future asbestos liability in an amount substantially more than the alleged liquidated but unpaid claims. On October 31, 2003, the bankruptcy court ruled that it would neither determine nor estimate the total amount of current and future asbestos liability claims against MacArthur. The Company expects that MacArthur will ask the Alameda County court instead to determine the total amount of current and future asbestos liability claims against MacArthur and to enter judgment against Hartford A&I for a substantial portion of that amount. A confirmation trial currently is scheduled to begin November 10, 2003. In a second amended complaint filed on July 21, 2003 in the Alameda County action, following Hartford A&I's successful demurrer to the first two complaints, MacArthur alleges that its liability for liquidated but unpaid asbestos bodily injury claims is $2.5 billion, of which more than $1.8 billion consists of unpaid judgments. The ultimate amount of MacArthur's asbestos liability, including any unresolved present claims and future demands, is currently unknown. - 15 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) (A) LITIGATION (CONTINUED) Hartford A&I intends to defend the MacArthur action vigorously. In the opinion of management, the ultimate outcome is highly uncertain for many reasons. It is not yet known, for example, whether Hartford A&I's defenses based on MacArthur's long delay in asserting claims for further coverage will be successful; how other significant coverage defenses will be decided; or the extent to which the claims and default judgments against MacArthur involve injury outside of the products and completed operations hazard definitions of the policies. In the opinion of management, an adverse outcome could have a material adverse effect on the Company's results of operations, financial condition and liquidity. Bancorp Services, LLC - In the third quarter of 2003, Hartford Life Insurance Company ("HLIC") and its affiliate International Corporate Marketing Group, LLC ("ICMG") settled their intellectual property dispute with Bancorp Services, LLC ("Bancorp"). The dispute concerned, among other things, Bancorp's claims for alleged patent infringement, breach of a confidentiality agreement, and misappropriation of trade secrets related to certain stable value corporate- owned life insurance products. The dispute was the subject of litigation in the United States District Court for the Eastern District of Missouri, in which Bancorp obtained in 2002 a judgment exceeding $134 against HLIC and ICMG after a jury trial on the trade secret and breach of contract claims, and HLIC and ICMG obtained summary judgment on the patent infringement claim. Based on the advice of legal counsel following entry of the judgment, the Company recorded an $11 after-tax charge in the first quarter of 2002 to increase litigation reserves. Both components of the judgment were appealed. Under the terms of the settlement, The Hartford will pay a minimum of $70 and a maximum of $80, depending on the outcome of the patent appeal, to resolve all disputes between the parties. The appeal from the trade secret and breach of contract judgment will be dismissed. The settlement resulted in the recording of an additional charge of $40 after-tax in the third quarter of 2003, reflecting the maximum amount payable under the settlement. (B) ASBESTOS AND ENVIRONMENTAL CLAIMSForm 10-K Annual Report, The Hartford continues to receiveclaims that assert damages from asbestos- and environmental-related exposures. Asbestos claims relate primarily to bodily injuries asserted by those who came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and the related costs. The Hartford wrote several different categories of insurance coverage to whichasbestos and environmental claimsmay apply. First,that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartfordwrote direct policies as a primary liability insurance carrier. Second, The Hartford wrote direct excess insurance policies providing additional coverage for insureds that exhausted their underlying liability insurance coverage. Third, The Hartford acted as a reinsurer assuming a portion of risks previously assumed by other insurers writing primary, excesscontinually reviews its overall reserve levels, methodologies and reinsurance coverages.Fourth, The Hartford participated as a London Market company that wrote both direct insurance and assumed reinsurance business. With regard to both environmental and particularly asbestos claims,Because of the significantuncertainty limitsuncertainties which limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and relatedexpenses. Traditional reserving techniques cannot reasonably estimate the ultimate cost of these claims, particularly during periods where theories of law are in flux. As a result of the factors discussed in the following paragraphs, the degree of variability of reserve estimates for these exposures is significantly greater than for other, more traditional exposures. In particular, The Hartford believes there is a high degree of uncertainty inherent in the estimation of asbestos loss reserves. In the case of the reserves for asbestos exposures, factors contributing to the high degree of uncertainty include inadequate development patterns, plaintiffs' expanding theories of liability, the risks inherent in major litigation, and inconsistent emerging legal doctrines. Courts have reached inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are covered; whether there is an insurer obligation to defend; how policy limits are applied; whether particular injuries are subject to the product/completed operation claims aggregate limit; and how policy exclusions and conditions are applied and interpreted. Furthermore, insurers in general, including The Hartford, recently have experienced an increase in the number of asbestos-related claims due to, among other things, more intensive advertising by lawyers seeking asbestos claimants, plaintiffs' increased focus on new and previously peripheral defendants, and an increase in the number of insureds seeking bankruptcy protection as a result of asbestos-related liabilities. Plaintiffs and insureds have sought to use bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and increase loss payments by insurers. In addition, some policyholders have begun to assert new classes of claims for so-called "non-product" coverages to which an aggregate limit of liability may not apply. Recently, many insurers, including The Hartford, also have been sued directly by asbestos claimants asserting that insurers had a duty to protect the public from the dangers of asbestos. Management believes these issues are not likely to be resolved in the near future. Further uncertainties include the effect of the recent acceleration in the rate of bankruptcy filings by asbestos defendants on the rate and amount of The Hartford's asbestos claims payments; a further increase or decrease in asbestos and environmental claims that cannot be anticipated at this time, whether some policyholders' liabilities will reach the umbrella or excess layer of their coverage; the resolution or adjudication of some disputes pertaining to the amount of available coverage for asbestos claims in a manner inconsistent with The Hartford's previous assessment of these claims; the number and outcome of direct actions against The Hartford; and unanticipated developments pertaining to The Hartford's ability to recover reinsurance for asbestos and environmental claims. It also is not possible to predict changes - 16 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) (B) ASBESTOS AND ENVIRONMENTAL CLAIMS (CONTINUED) in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. In particular, it is unknown whether a potential Federal bill concerning asbestos litigation approved by the Senate Judiciary Committee, or some other potential Federal asbestos-related legislation, will be enacted and, if so, what its effect will be on The Hartford's aggregate asbestos liabilities. Additionally, the reporting pattern for excess insurance and reinsurance claims is much longer than direct claims. In many instances, it takes months or years to determine that the policyholder's own obligations have been met and how the reinsurance in question may apply to such claims. The delay in reporting excess and reinsurance claims and exposures adds to the uncertainty of estimating the related reserves. In the case of the reserves for environmental exposures, factors contributing to the high degree of uncertainty include court decisions that have interpreted the insurance coverage to be broader than originally intended; inconsistent decisions, especially across jurisdictions; and uncertainty as to the monetary amount being sought by the claimant from the insured. Given the factors and emerging trends described above, The Hartford believes the actuarial tools and other techniques it employs to estimate the ultimate cost of claims for traditional kinds of insurance exposure are less precise in estimating reserves for its asbestos and environmental exposures. In the first quarter of 2003, several events occurred that in the Company's view confirmed the existence of a substantial long-term deterioration in the asbestos litigation environment. For example, in February 2003, Combustion Engineering, long a major asbestos defendant, filed a pre-packaged bankruptcy plan under which it proposed to emerge from bankruptcy within five weeks, before opponents of the plan could have a meaningful opportunity to object, and included many novel features in its plan that its insurers found objectionable. In December 2002, Halliburton had announced its intention to file a similar plan through one or more subsidiaries, although it has not yet filed, and in January 2003, Honeywell announced that it had reached an agreement with the plaintiffs' bar that would enable it to file a pre-negotiated plan through its former NARCO subsidiary, then already in bankruptcy. In January 2003, Congoleum, a floor tile manufacturer, which previously had defended claims successfully in the tort system, announced its intention to file a pre-packaged plan of reorganization to be funded almost entirely with insurance proceeds. Moreover, prominent members of the plaintiffs' and policyholders' bars announced publicly their intention to file many more such plans. These events represented a worsening of conditions the Company observed in 2002, which were described in the Company's 2002 Form 10-K Annual Report. As a result of these worsening conditions, the Company conducted a comprehensive, ground-up study of its asbestos exposures in the first quarter of 2003 in an effort to project, beginning at the individual account level, the effect of these trends on the Company's estimated total exposure to asbestos liability. Based on the results of the study and the Company's reevaluation of the deteriorating conditions described above, the Company strengthened its gross and net asbestos reserves by $3.9 billion and $2.6 billion, respectively. The Company believes that its current asbestos reserves are reasonable and appropriate. However, analyses of future developments could cause The Hartford to change its estimates of its asbestos and environmental reserves, and the effect of these changes could be material to the Company's consolidated operating results, financial condition and liquidity. As of September 30, 2003 and December 31, 2002, the Company reported $3.6 billion and $1.1 billion of net asbestos reserves and $517 and $591 of net environmental reserves, respectively. Because of the significant uncertainties previously described,expenses, principally those related to asbestos, the ultimate liabilities may exceed the currently recorded reserves. Any such additional liability (or any range of additional amounts) cannot be reasonably estimated now but could be material to TheHartford'sHartford’s future consolidated operating results, financial condition and liquidity.Consistent with the Company's longstanding reserving practices,The MacArthur Litigation– On December 19, 2003, Hartford
will continue to regularly reviewAccident andmonitor these reserves and, where future circumstances indicate, make appropriate adjustments to the reserves. (C) LEASE COMMITMENTS On June 30, 2003, theIndemnity Company (“Hartford A&I”) entered into asale-leasebackconditional settlement to resolve all claims relating to general liability policies that Hartford A&I issued to Mac Arthur Company and its subsidiary, Western MacArthur Company, both former regional distributors of asbestos products (collectively or individually, “MacArthur”), during the period 1967 to 1976. MacArthur had filed a pre-negotiated bankruptcy and plan of reorganization in November 2002 pursuant to a settlement with another of its insurers, United States Fidelity and Guaranty Company. The Hartford settlement was contingent on the occurrence of certainfurnitureconditions, including the entry of final, non-appealable court orders approving the settlement agreement andfixturesconfirming a bankruptcy plan under which, among other things, all claims against the Company relating to the asbestos liability of MacArthur would be enjoined. Under the settlement agreement, Hartford A&I paid $1.15 billion into an escrow account in the first quarter of 2004, pending the occurrence of the conditions. On April 22, 2004, all conditions to the settlement were satisfied, and the escrowed funds were disbursed to a trust established for the benefit of present and future asbestos claimants pursuant to the bankruptcy plan. The completion by the Company of the settlement resolves all disputes concerning15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 5. Commitments and Contingencies (continued)
Hartford A&I’s alleged obligations from MacArthur’s asbestos liability.
Bancorp Services, LLC– In the third quarter of 2003, Hartford Life Insurance Company and its affiliate International Corporate Marketing Group, LLC settled their intellectual property dispute with Bancorp Services, LLC (“Bancorp”). The dispute concerned, among other things, Bancorp’s claims for alleged patent infringement, breach of a
net bookconfidentiality agreement, and misappropriation of trade secrets related to certain stable value corporate-owned life insurance products. The settlement provided that The Hartford would pay a minimum of$40.$70 and a maximum of $80, depending on the outcome of the patent appeal, to resolve all disputes between the parties. Thesale-leasebacksettlement resulted ina gainthe recording of$15, which was deferredan additional charge of $40, after-tax, in the third quarter of 2003, reflecting the maximum amount payable under the settlement, andwill be amortized into earnings overin November of 2003, The Hartford paid the initiallease term of three years. The lease qualifies as an operating lease for accounting purposes. At the end$70 of theinitial lease term,settlement. On March 1, 2004, the Federal Circuit Court of Appeals decided the patent appeal adversely to The Hartford, and on March 22, 2004, The Hartford paid Bancorp an additional $10 in full and final satisfaction of its obligations under the settlement. Because the charge taken in the third quarter of 2003 reflected the maximum amount payable under the settlement, the amount paid in the first quarter of 2004 had no effect on the Company’s results of operations.Regulatory Developments
There continues to be significant federal and state regulatory activity relating to financial services companies, particularly mutual funds companies. These regulatory inquiries have focused on a number of mutual fund issues. The Company has received requests for information and subpoenas from the Securities and Exchange Commission (“SEC”), a subpoena from the New York Attorney General’s Office, and requests for information from the Connecticut Securities and Investments Division of the Department of Banking, in each case requesting documentation and other information regarding various mutual fund regulatory issues. Representatives from the SEC’s Office of Compliance Inspections and Examinations continue to request documents and information in connection with their ongoing compliance examination. In addition, the SEC’s Division of Enforcement has commenced an investigation of the Company’s variable annuity and mutual fund operations. The Company continues to cooperate fully with the SEC and other regulatory agencies.
The Company’s mutual funds are available for purchase by the separate accounts of different variable life insurance policies, variable annuity products, and funding agreements, and they are offered directly to certain qualified retirement plans. Although existing products contain transfer restrictions between subaccounts, some products, particularly older variable annuity products, do not contain restrictions on the frequency of transfers. In addition, as a result of the settlement of litigation against the Company with respect to certain owners of older variable annuity products, the Company’s ability to restrict transfers by these owners is limited.
A number of companies have announced settlements of enforcement actions with various regulatory agencies, primarily the SEC and the New York Attorney General’s Office. While no such action has
the option to purchase the leased assets, renew the lease for two one-year periods or return the leased assets to the lessor. Ifbeen initiated against the Company,elects to returnit is possible that theassets to the lessor at the end of the initial lease term, the assets will be sold, andSEC or one or more other regulatory agencies may pursue action against the Companyhas guaranteedin the future. If such an action is brought, it could have aresidual valuematerial effect on thefurniture and fixtures of $20. At September 30, 2003, no liability was recorded for this guarantee, as the expected fair value of the furniture and fixtures at the end of the initial lease term was greater than the residual value guarantee. (D) TAX MATTERSCompany.Tax Matters
The
Hartford's FederalHartford’s federal income tax returns are routinely audited by the Internal Revenue Service("IRS"(“IRS”). The Company is currently under audit for the1998-20011998–2001 tax years.No material issues have been raised to date by the IRS.Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from tax examinations and other tax-related matters for all open tax years.TheAlthough there has been no agreement reached between the Company and the IRS at this time, the amount of tax
provision recorded during the nine months ended September 30, 2003, reflects a benefit of $30, consisting primarily of a change in estimate of the dividends-received deduction ("DRD") tax benefit reported during 2002. The change in estimate was the result of actual 2002 investment performance on the related separate accounts being unexpectedly out of pattern with past performance, which had been the basis for the estimate. The total DRD benefitrelated to the separate account dividends-received deduction (“DRD”) that is under discussion for all open tax years could result in a benefit to the Company’s future results of operations. There can be no assurances that such an agreement will be reached. (For further discussion of the Company’s separate account DRD, see Note 16 of Notes to Consolidated Financial Statements included in The Hartford’s 2003tax year for the nine months ended September 30, 2003 was $65. NOTEForm 10-K Annual Report.)Note 6.
SEGMENT INFORMATIONSegment InformationThe Hartford is organized into two major operations: Life and Property & Casualty. In the quarter ended March 31, 2004, and as more fully described below, the Company changed its reporting segments to reflect the current manner by which its chief operating decision maker views and manages the business. All segment data for prior reporting periods have been adjusted to reflect the current segment reporting. Within
thesethe Life and Property & Casualty operations, The Hartford conducts business principally innineeight operating segments. Additionally, Corporate now includes all of the Company’s debt financing and related interest expense, as well as certain capital raising and purchase accounting adjustmentactivities related to the June 27, 2000 acquisition of all of the shares of Hartfordactivities.Life
Inc. ("HLI") that the Company did not already own ("the HLI Repurchase"), as well as capital raised thathasnot been contributed to the Company's insurance subsidiaries are included in Corporate. Life is organized into fourchanged its reportable operatingsegments:segments from Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance("COLI"(“COLI”). Investmentto Retail Products Group (“Retail”), Institutional Solutions Group (“Institutional”), Individual Life and Group Benefits. Retail offers individual variable and fixed annuities, mutual funds, retirement plan products and services to corporations under Section 401(k) plans and other investment products. Institutional primarily offers retirement plan products and services to municipalities under Section 457 plans, other institutional investment products and private placement life insurance. Individual Life sells a variety of life insurance products, including variable universal life, universal life,interest-sensitiveinterest sensitive whole life and term life insurance. Group Benefits sells group insurance products, including group life and group disability insurance as well as other products, including medical stop loss and supplementary medicalcoveragecoverages to employers andemployer-sponsoredemployer sponsored plans, accidental death and16
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 6. Segment Information (continued)
dismemberment, travel accident and other special risk coverages to employers and associations.
COLI primarily offers variable products used by employers to fund non-qualified benefits or other postemployment benefit obligations as well as leveraged COLI.Life also includes in an Other category its- 17 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 6. SEGMENT INFORMATION (CONTINUED)international operations, which are primarily located in Japan and Brazil; net realized capital gains andlosses; as well aslosses other than periodic net coupon settlements on non-qualifying derivatives and net realized capital gains and losses related to guaranteed minimum withdrawal benefits; corporate items not directly allocated to any of its reportable operatingsegments, principally interest expense;segments; and intersegment eliminations. Periodic net coupon settlements on non-qualifying derivatives and net realized capital gains and losses related to guaranteed minimum withdrawal benefits are reflected in each applicable segment in net realized capital gains and losses.Property & Casualty is now organized into
fivefour reportable operating segments: theNorth Americanunderwriting segments of Business Insurance, Personal Lines, and Specialty Commercialand Reinsurance;(collectively “Ongoing Operations”); and the Other Operations segment. Prior to the segmentwhich includes substantially allreporting change made in the first quarter of 2004, Property and Casualty had also included a Reinsurance segment. With theCompany's asbestos and environmental exposures. "North American" includesdiscontinuance of writing new reinsurance assumed business, thecombined underwriting results of the Business Insurance, Personal Lines, Specialty Commercial and Reinsurance underwriting segments. Property & Casualty also includes income and expense items not directly allocated to these segments, such as net investment income, net realized capital gains and losses, and other expenses including interest, severance and income taxes. Included in net income for Property & Casualty for the nine months ended September 30, 2003reinsurance assumed business isan expense of $27, after-tax, related to severance costs associated with several expense reduction initiatives announced in May 2003. On September 1, 2003, the Company sold a wholly owned subsidiary, Trumbull Associates, LLC, for $33, resulting in a gain of $15, after-tax. The gain isnow included innet realized capital gains. The revenues and net income of Trumbull Associates, LLC were not material totheCompany or the Property & Casualty operation.Other Operations segment.Business Insurance provides standard commercial insurance coverage to small commercial and middle market commercial business primarily throughout the United States. This segment offers
workers'workers’ compensation, property, automobile, liability, umbrella and marine coverages. Commercial risk management products and services are alsoareprovided.Personal Lines provides automobile,
homeowners'homeowners’ and home-based business coverages to the members of AARP through a direct marketing operation; to individuals who prefer local agent involvement through a network of independent agents in the standard personal lines market; and through the Omni Insurance Group in the non-standard automobile market. Personal Lines also operates a member contact center for health insurance products offered throughAARP'sAARP’s Health Care Options.The Specialty Commercial segment offers a variety of customized insurance products and risk management services. Specialty Commercial provides standard commercial insurance products including
workers'workers’ compensation, automobile and liability coverages to large-sized companies. Specialty Commercial also provides bond, professional liability, specialty casualty and agricultural coverages, as well as core property and excess and surplus lines coverages not normally written by standard lines insurers. Alternative markets, within Specialty Commercial, provides insurance products and services primarily to captive insurance companies, pools and self-insurance groups. In addition, Specialty Commercial provides third party administrator services for claims administration, integrated benefits, loss control and performance measurement through Specialty Risk Services, a subsidiary of the Company.On May 16, 2003, as part of the Company's decision to withdraw from the assumed reinsurance business, the Company entered into a quota share and purchase agreement with Endurance Reinsurance Corporation of America ("Endurance") whereby the Reinsurance segment retroceded the majority of its inforce book of business as of April 1, 2003 and sold renewal rights to Endurance. Under the quota share agreement, Endurance will reinsure most of the segment's assumed reinsurance contracts that were written on or after January 1, 2002 and that had unearned premium as of April 1, 2003. In consideration for Endurance reinsuring the unearned premium as of April 1, 2003, the Company paid Endurance an amount equal to unearned premiums less the related unamortized commissions/deferred acquisition costs and an override commission, which was established by the contract. In addition, Endurance will pay a profit sharing commission based on the loss performance of property treaty, property catastrophe and aviation pool unearned premium. Under the purchase agreement, Endurance will pay additional amounts, subject to a guaranteed minimum of $15, based on the level of renewal premium on the reinsured contracts over the next two years. The guaranteed minimum is reflected in net income for the nine months ended September 30, 2003. The Company remains subject to reserve development relating to all retained business. Prior to the Endurance transaction, the Reinsurance segment assumed reinsurance in North America and primarily wrote treaty reinsurance through professional reinsurance brokers covering various property, casualty, property catastrophe, marine and alternative risk transfer ("ART") products. ART included non-traditional reinsurance products such as multi-year property catastrophe treaties, aggregate of excess of loss agreements and quota share treaties with single event caps. International property catastrophe, marine and ART were also written outside of North America through a London contact office.The Other Operations segment consists of certain property and casualty insurance operations of The Hartford which have discontinued writing new business and includes substantially all of the
Company'sCompany’s asbestos and environmental exposures.The measure of profit or loss used by The
Hartford'sHartford’s management in evaluating the performance of its Life segments is net income. The Property & Casualty underwriting segments are evaluated by TheHartford'sHartford’s management primarily based upon underwriting results. Underwriting results represent premiums earnedpremiumsless incurred claims, claim adjustment expenses and underwriting expenses.Certain transactions between segments occur during the year that primarily relate to tax settlements, insurance coverage, expense reimbursements, services provided, security transfers and capital contributions. In addition, certain reinsurance stop loss agreements exist between the segments which specify that one segment will reimburse another for losses incurred in excess of a predetermined limit. Also, one segment may purchase group annuity contracts from another to fund pension costs and annuities to settle casualty claims. In addition, certain intersegment transactions occur in Life. These transactions include interest - 18 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 6. SEGMENT INFORMATION (CONTINUED) income on allocated surplus and the allocation of certain net realized capital gains and losses through net investment income utilizing the duration of the segment's investment portfolios. During the nine months ended September 30, 2003, $1.8 billion of securities were sold by the Property & Casualty operation to the Life operation. For segment reporting, the net gain on this sale was deferred by the Property & Casualty operation and will be reported as realized when the underlying securities are sold by the Life operation. On December 1, 2002, the Property & Casualty segments entered into a contract with a subsidiary, whereby reinsurance will be provided to the Property & Casualty operation. The financial results of this reinsurance program, net of retrocessions to unrelated reinsurers, are included in the Specialty Commercial segment.The following tables present revenues and net income (loss). Underwriting results are presented for the Business Insurance, Personal Lines, Specialty Commercial
Reinsuranceand Other Operations segments, while net income is presented for Life,andProperty &Casualty.Casualty and Corporate. Segment information for the previous period has been restated to reflect the change in composition of reportable operating segments.17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)Note 6. Segment Information (continued)
First Quarter Ended March 31, 2004 2003 RevenuesLife Retail Products Group $ 763 $ 478 Institutional Solutions Group 442 422 Individual Life 254 244 Group Benefits 1,004 667 Other [1] [2] 595 (25 )
Total Life 3,058 1,786
Property & Casualty Ongoing Operations Earned premiums and other revenues Business Insurance 1,019 880 Personal Lines 864 800 Specialty Commercial 395 422
Total Ongoing Operations earned premiums and other revenues 2,278 2,102 Other Operations earned premiums 12 159 Net investment income 311 281 Net realized capital gains (losses) 71 (1 )
Total Property & Casualty 2,672 2,541
Corporate 2 4
Total revenues$ 5,732 $ 4,331
REVENUES THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ----------------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Life Investment Products $ 1,182 $ 761 $ 2,832 $ 2,337 Individual Life 249 239 733 720 Group Benefits 663 645 1,968 1,943 COLI 117 145 370 451 Other [1] 37 (125) 93 (252) - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 2,248 1,665 5,996 5,199 - ------------------------------------------------------------------------------------------------------------------------------------ Property & Casualty Earned premiums and other revenues Business Insurance 947 795 2,724 2,293 Personal Lines 837 789 2,454 2,308 Specialty Commercial 512 414 1,370 1,037 Reinsurance 82 178 296 521 Other Operations -- 19 14 58 - ------------------------------------------------------------------------------------------------------------------------------------ Total earned premiums and other revenues 2,378 2,195 6,858 6,217 Net investment income 302 262 878 787 Net realized capital gains (losses) 14 (42) 216 (80) - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty 2,694 2,415 7,952 6,924 - ------------------------------------------------------------------------------------------------------------------------------------ Corporate 5 5 12 14 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES $ 4,947 $ 4,085 $ 13,960 $ 12,137 ====================================================================================================================================[1] [1]Amounts include net realized capital gains (losses) , before-tax,of$(2)$75 and$(118)$(48) for thethird quarterfirst quarters endedSeptember 30,March 31, 2004 and 2003,and 2002, respectively, and $0 and $(253)respectively. [2]With the adoption of SOP 03-1, certain annuity products were required to be accounted for in the nine months ended September 30, 2003 and 2002, respectively.- 19 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 6. SEGMENT INFORMATION (CONTINUED)
NET INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ----------------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Life Investment Products $ 129 $ 100 $ 368 $ 335 Individual Life 36 33 104 99 Group Benefits 38 34 107 92 COLI (30) 10 (11) 20 Other [1] (12) (16) (38) (114) - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 161 161 530 432 - ------------------------------------------------------------------------------------------------------------------------------------ Property & Casualty Underwriting results Business Insurance 20 21 50 17 Personal Lines 37 (13) 92 (48) Specialty Commercial (50) 3 (54) 1 Reinsurance (10) (4) (105) (17) Other Operations (12) (42) (2,657) (129) - ------------------------------------------------------------------------------------------------------------------------------------ Total Underwriting results (15) (35) (2,674) (176) Net servicing and other income 9 4 15 7 Netgeneral account. This change in accounting resulted in an increase in net investmentincome 302 262 878 787 Net realized capital gains (losses) 14 (42) 216 (80) Other expenses [2] (42) (68) (161) (162) Income tax (expense) benefit (66) (11) 692 (48) - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty 202 110 (1,034) 328 - ------------------------------------------------------------------------------------------------------------------------------------ Corporate (20) (6) (41) (18) - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ 343 $ 265 $ (545) $ 742 ====================================================================================================================================[1]income.
First Quarter Ended March 31, 2004 2003 Net Income (Loss)Life Retail Products Group $ 107 $ 77 Institutional Solutions Group 28 31 Individual Life 33 32 Group Benefits 47 34 Other [1] 66 (29 )
Total Life 281 145
Property & Casualty Ongoing Operations Underwriting results Business Insurance 225 7 Personal Lines 106 56 Specialty Commercial (110 ) 5
Total Ongoing Operations underwriting results 221 68 Other Operations underwriting results [2] (65 ) (2,651 )
Total Property & Casualty underwriting results 156 (2,583 ) Net servicing and other income [3] 9 3 Net investment income 311 281 Other expenses (68 ) (41 ) Net realized capital gains (losses) 71 (1 ) Income tax (expense) benefit (138 ) 846
Total Property & Casualty 341 (1,495 )
Corporate (54 ) (45 )
Net income (loss)$ 568 $ (1,395 )
[1]Amounts include net realized capital gains (losses) ,after-tax, of$(1)$49 and$(71)$(31) for thethird quarterfirst quarters endedSeptember 30,March 31, 2004 and 2003,and 2002, respectively, and $0 and $(154) for the nine months ended September 30,respectively. [2]Includes $2,604 in 2003 and 2002, respectively. [2] Amounts includeof before-taxseverance chargesimpact of$41 for the nine months ended September 30, 2003.asbestos reserve addition. [3]Net of expenses related to service business. NOTE 7. DEBT SEPT. 30, DEC. 31, 2003 2002 - -------------------------------------------------------------------- SHORT-TERM DEBT Commercial paper $ 315 $ 315 Current maturities of long-term debt 200 -- - -------------------------------------------------------------------- TOTAL SHORT-TERM DEBT $ 515 $ 315 ==================================================================== LONG-TERM DEBT [1] 6.9% Notes, due 2004 $ -- $ 199 7.75% Notes, due 2005 247 247 2.375% Notes, due 2006 254 -- 7.1% Notes, due 2007 198 198 4.7% Notes, due 2007 300 300 2.56% Equity Units Notes, due 2008 690 -- 6.375% Notes, due 2008 200 200 4.1% Equity Units Notes, due 2008 330 330 7.9% Notes, due 2010 274 274 4.625% Notes, due 2013 319 -- 7.3% Notes, due 2015 200 200 7.65% Notes, due 2027 248 248 7.375% Notes, due 2031 400 400 - -------------------------------------------------------------------- TOTAL LONG TERM DEBT $ 3,660 $ 2,596 - -------------------------------------------------------------------- [1] The Hartford's long-term debt securities are issued by either The Hartford Financial Services Group, Inc. ("HFSG") or HLI and are unsecured obligations of HFSG or HLI and rank pari passsu with all other unsecured and unsubordinated indebtedness of HFSG or HLI. (A) LONG-TERM DEBT Equity Units Offering - --------------------- On May 23, 2003, The Hartford issued 12.0 million 7% equity units at a price of fifty dollars per unit and received net proceeds of $582. Subsequently, on May 30, 2003, The Hartford issued an additional 1.8 million 7% equity units at a price of fifty dollars per unit and received net proceeds of $87. Each equity unit offered initially consists of a corporate unit with a stated amount of fifty dollars per unit. Each corporate unit consists of one purchase contract for the sale of a certain number of shares of the Company's stock and a 5% ownership interest in one thousand dollars principal amount of senior notes due August 16, 2008. The corporate unit may be converted by the holder into a treasury unit consisting of the purchase contract and a 5% undivided beneficial interest in a zero-coupon U.S. Treasury security with a principal amount of one thousand dollars that matures on August 15, 2006. The holder of an equity unit owns the underlying senior notes or treasury securities but has pledged the senior notes or treasury securities to the Company to secure the holder's obligations under the purchase contract. - 20 -18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTENote 7.
DEBT (CONTINUED) (A) LONG-TERM DEBT (CONTINUED) The purchase contract obligates the holder to purchase, and obligates The Hartford to sell, on August 16, 2006, for fifty dollars, a variable number of newly issued common shares of The Hartford. The number of The Hartford's shares to be issued will be determined at the time the purchase contracts are settled based upon the then current applicable market value of The Hartford's common stock. If the applicable market value of The Hartford's common stock is equal to or less than $45.50, thenDebt
Short-Term Debt March 31, 2004 December 31, 2003 Commercial paper $ 373 $ 850 Current maturities of long-term debt 200 200
Total Short-Term Debt$ 573 $ 1,050
Long –Term Debt [1] March 31, 2004 December 31, 2003 Senior Notes and Debentures 7.75% Notes, due 2005 $ 249 $ 249 2.375% Notes, due 2006 254 252 7.1% Notes, due 2007 198 198 4.7% Notes, due 2007 300 300 6.375% Notes, due 2008 200 200 4.1% Equity Units Notes, due 2008 330 330 2.56% Equity Units Notes, due 2008 690 690 7.9% Notes, due 2010 275 275 4.625% Notes, due 2013 319 319 4.75% Notes, due 2014 199 — 7.3% Notes, due 2015 200 200 7.65% Notes, due 2027 248 248 7.375% Notes, due 2031 400 400
Total Senior Notes and Debentures$ 3,862 $ 3,661
Junior Subordinated Debentures 7.20% Notes, due 2038 — 245 7.625% Notes, due 2050 200 200 7.45% Notes, due 2050 518 507
Total Junior Subordinated Debentures718 952
Total Long-Term Debt$ 4,580 $ 4,613
[1]The Hartford’s long-term debt securities are issued by either The Hartford Financial Services Group, Inc. (“HFSG”) or HLI and are unsecured obligations of HFSG or HLI and rank on a parity with all other unsecured and unsubordinated indebtedness of HFSG or HLI. On March 9, 2004, the Company
will deliver 1.0989 shares to the holder of the equity unit, or an aggregate of 15.2 million shares. If the applicable market value of The Hartford's common stock is greater than $45.50 but less than $56.875, then the Company will deliver the number of shares equal to fifty dollars divided by the then current applicable market value of The Hartford's common stock to the holder. Finally, if the applicable market value of The Hartford's common stock is equal to or greater than $56.875, then the Company will deliver 0.8791 shares to the holder, or an aggregate of 12.1 million shares. Accordingly, upon settlement of the purchase contracts on August 16, 2006, The Hartford will receive proceeds of approximately $690 and will deliver between 12.1 million and 15.2 million common shares in the aggregate. The proceeds will be credited to stockholders' equity and allocated between the common stock and additional paid-in capital accounts. The Hartford will make quarterly contract adjustment payments to the equity unit holders at a rate of 4.44% of the stated amount per year until the purchase contract is settled. Each corporate unit also includes a 5% ownership interest in one thousand dollars principal amount of senior notes that will mature on August 16, 2008. The aggregate maturity value of the senior notes is $690. The notes are pledged by the holders to secure their obligations under the purchase contracts. The Hartford will make quarterly interest payments to the holders of the notes initially at an annual rate of 2.56%. On May 11, 2006, the notes will be remarketed. At that time, The Hartford's remarketing agent will have the ability to reset the interest rate on the notes in order to generate sufficient remarketing proceeds to satisfy the holder's obligation under the purchase contract. If the initial remarketing is unsuccessful, the remarketing agent will attempt to remarket the notes, as necessary, on June 13, 2006, July 12, 2006 and August 11, 2006. If all remarketing attempts are unsuccessful, the Company will exercise its rights as a secured party to obtain and extinguish the notes. The total distributions payable on the equity units are at an annual rate of 7%, consisting of interest (2.56%) and contract adjustment payments (4.44%). The corporate units are listed on the New York Stock Exchange under the symbol "HIG PrD". The present value of the contract adjustment payments of $95 was accrued upon the issuance of the equity units as a charge to additional paid-in capital and is included in other liabilities in the accompanying condensed consolidated balance sheet as of September 30, 2003. Subsequent contract adjustment payments will be allocated between this liability account and interest expense based on a constant rate calculation over the life of the purchase contracts. Additional paid-in capital as of September 30, 2003 also reflected a charge of $17 representing a portion of the equity unit issuance costs that were allocated to the purchase contracts. The equity units have been reflected in the diluted earnings per share calculation using the treasury stock method, which would be used for the equity units at any time before the settlement of the purchase contracts. Under the treasury stock method, the number of shares of common stock used in calculating diluted earnings per share is increased by the excess, if any, of the number of shares issuable upon settlement of the purchase contracts over the number of shares that could be purchased by The Hartford in the market, at the average market price during the period, using the proceeds received upon settlement. The Company anticipates that there will be no dilutive effect on its earnings per share related to the equity units, except during periods when the average market price of a share of the Company's common stock is above the threshold appreciation price of $56.875. Because the average market price of The Hartford's common stock during the quarter and nine months ended September 30, 2003 was below this threshold appreciation price, the shares issuable under the purchase contract component of the equity units have not been included in the diluted earnings per share calculation. Senior Notes Offerings - ---------------------- On May 23, 2003, The Hartfordissued2.375%4.75% senior notes dueJuneMarch 1,20062014, and received net proceeds of$249.$197. Interest on the notes is payable semi-annually onJuneMarch 1 andDecemberSeptember 1, commencing on September 1, 2004.On March 15, 2004, HLI redeemed $250 of its 7.2% junior subordinated debentures underlying the trust preferred securities issued by Hartford Life Capital 1.
Shelf Registrations
On December
1, 2003. On July 10,3, 2003, The Hartford’s shelf registration statement (Registration No. 333-108067) for the potential offering and sale of debt and equity securities in an aggregate amount of up to $3.0 billion was declared effective by the SEC. The Registration Statement allows for the following types of securities to be offered (i) debt securities, preferred stock, common stock, depositary shares, warrants, stock purchase contracts, stock purchase units and junior subordinated deferrable interest debentures of the Company,issued 4.625% senior notes due Julyand (ii) preferred securities of any of one or more capital trusts organized by The Hartford (“The Hartford Trusts”). The Company may enter into guarantees with respect to the preferred securities of any of The Hartford Trusts. As of March 31, 2004, The Hartford had $2.4 billion remaining on its shelf.On May 15,
20132001, HLI filed with the SEC a shelf registration statement for the potential offering andreceived net proceedssale of$317. Interestup to $1.0 billion in debt and preferred securities. The registration statement was declared effective onthe notes is payable semi-annuallyMay 29, 2001. As of March 31, 2004, HLI had $1.0 billion remaining onJanuary 15 and July 15, commencing on January 15, 2004. (B) TRUST PREFERRED SECURITIESits shelf.Junior Subordinated Debentures
The Hartford and its subsidiary HLI have formed statutory business trusts which exist for the exclusive purposes of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust Securities in Junior Subordinated Deferrable Interest Debentures
("(“Junior SubordinatedDebentures"Debentures”) of The Hartford orHLI as applicable;HLI; and (iii) engaging in only those activities necessary or incidental thereto.These Junior Subordinated Debentures andThe Company may enter into guarantees with respect to therelated income effects are eliminated in the consolidated financial statements.preferred securities of any of Thefinancial structure ofHartfordCapital I and III, and Hartford Life Capital I and II, as of September 30, 2003 and December 31, 2002, were as follows: - 21 -Trusts. 19
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTENote 7.
DEBT (CONTINUED) (B) TRUST PREFERRED SECURITIES (CONTINUED)
Hartford Capital Hartford Life Hartford Life Hartford III Capital II Capital I Capital I [4] - ------------------------------------------------------------------------------------------------------------------------------------TRUST PREFERRED SECURITIES Issuance date Oct. 26, 2001 Mar. 6, 2001 June 29, 1998 Feb. 28, 1996 Securities issued 20,000,000 8,000,000 10,000,000 20,000,000 Liquidation preference per security (in dollars) $25 $25 $25 $25 Liquidation value $500 $200 $250 $500 Coupon rate 7.45% 7.625% 7.20% 7.70% Distribution payable Quarterly Quarterly Quarterly Quarterly Distribution guaranteed by [1] The Hartford HLI HLI The Hartford Balance September 30, 2003 $517 $200 $245 $-- Balance December 31, 2002 $523 $200 $245 $500 JUNIOR SUBORDINATED DEBENTURES [2] [3] Amount owed $500 $200 $250 $500 Coupon rate 7.45% 7.625% 7.20% 7.70% Interest payable Quarterly Quarterly Quarterly Quarterly Maturity date Oct. 26, 2050 Feb. 15, 2050 June 30, 2038 Feb. 28, 2016 Redeemable by issuer on or after Oct. 26, 2006 Mar. 6, 2006 June 30, 2003 Feb. 28, 2001 ====================================================================================================================================[1] The Hartford has guaranteed, on a subordinated basis, all of the Hartford Capital III obligations under the Hartford Series C Preferred Securities, including the payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation, but only to the extent that Hartford Capital III has funds to make such payments. [2] For each of the respective debentures, The Hartford or HLI, has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters up to the debentures' maturity date. During any such period, interest will continue to accrue and The Hartford or HLI may not declare or pay any cash dividends or distributions on, or purchase, The Hartford's or HLI's capital stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Junior Subordinated Debentures. The Hartford or HLI will have the right at any time to dissolve the Trust and cause the Junior Subordinated Debentures to be distributed to the holders of the Preferred Securities. [3] The Hartford Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all senior debt of The Hartford and are effectively subordinated to all existing and future liabilities of its subsidiaries. [4] $180 of the securities for Hartford Capital I were redeemed on June 30, 2003. The remaining $320 of these securities were redeemed on September 30, 2003.(C) SHORT-TERM DEBT The following is a summary of short-term borrowings available to the Company and outstanding balances at September 30, 2003 and December 31, 2002
OUTSTANDING AS OF ------------------------------- EFFECTIVE EXPIRATION MAXIMUM SEPTEMBER 30, DECEMBER 31, DESCRIPTION DATE DATE AVAILABLE 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Debt (continued) Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 315 HLI 2/7/97 N/A 250 -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial paper $ 2,250 $ 315 $ 315 Revolving Credit Facility 5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ -- 3-year revolving credit facility 12/31/02 12/31/05 490 -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Total revolving credit facility $ 1,490 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL SHORT-TERM DEBT [1] $ 3,740 $ 315 $ 315 ====================================================================================================================================[1] Excludes current maturities of long-term debt of $200 and $0 as of September 30, 2003 and December 31, 2002, respectively.- 22 -NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (unaudited) NOTE 7. DEBT (CONTINUED) (C) SHORT-TERM DEBT (CONTINUED) On December 31, 2002, the Company and HLI entered into a joint three-year Competitive Advanceand Revolving CreditFacility with a group of participating banks to enable the Company and HLI to borrow an aggregate amount of up to $490. As of September 30, 2003 and December 31, 2002, there were no outstanding borrowings under this facility. On February 26, 2003, the Company entered into a Second Amended and Restated Five-Year Competitive Advance and Revolving Credit Facility with a group of participating banks to amend and restate the Company's ability to borrow an aggregate amount of up to $1 billion. As of September 30, 2003 and December 31, 2002, there were no outstanding borrowings under this facility. (D) INTEREST EXPENSEFacilities
Outstanding as of Effective Expiration Maximum March 31, December 31, Description Date Date Available 2004 2003 Commercial Paper The Hartford 11/10/86 N/A $ 2,000 $ 373 $ 850 HLI 2/7/97 N/A 250 — —
Total commercial paper $ 2,250 $ 373 $ 850 Revolving Credit Facility 5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ — $ — 3-year revolving credit facility 12/31/02 12/31/05 490 — —
Total revolving credit facility $ 1,490 $ — $ —
Total Outstanding Commercial Paper and Revolving Credit Facilities$ 3,740 $ 373 $ 850
Interest Expense
The following table presents interest expense incurred
related to debt and trust preferred securitiesfor thethird quarterquarters ended March 31, 2004 andnine months ended September 30,2003,and 2002,respectively.
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Short-term debt $ 1 $ 1 $ 4 $ 4 Long-term debt 52 44 141 127 Trust preferred securities 17 22 60 67 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INTEREST EXPENSE $ 70 $ 67 $ 205 $ 198 ====================================================================================================================================NOTE
First Quarter Ended March 31, 2004 2003 Short-term debt $ 2 $ 1 Long-term debt 64 65
Total interest expense$ 66 $ 66
Note 8.
STOCKHOLDERS' EQUITY Issuance of Common Stock - ------------------------Stockholders’ EquityOn
May 23, 2003,January 22, 2004, The Hartford issued approximately24.26.3 million shares of common stock pursuant to an underwritten offering at a price to the public of$45.50$63.25 per share and received net proceeds of$1.1 billion.$388. Subsequently, onMayJanuary 30,2003,2004, The Hartford issued approximately2.2 million377 thousand shares of common stock at a price to the public of$45.50$63.25 per share and received net proceeds of$97. On May 23, 2003 and May 30, 2003,$23. TheHartfordCompany used the proceeds from these issuances to repay $411 of commercial paper issued12.0 million 7% equity units and 1.8 million 7% equity units, respectively. Each equity unit contains a purchase contract obligatingin connection with theholder to purchase and The Hartford to sell, a variable number of newly issued shares of The Hartford's common stock. Upon settlementacquisition of thepurchase contracts on August 16, 2006, The Hartford will receive proceedsgroup life and accident, and short-term and long-term disability business ofapproximately $690 and will deliver between 12.1 million and 15.2 million shares in the aggregate. ForCNA Financial Corporation. (For further discussion ofthe equity units issuance,this acquisition, see Note7 above. NOTE18 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.)Note 9.
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)Pension Plans and Postretirement Health Care and Life Insurance Benefit PlansComponents of Net Periodic Benefit Cost
Total net periodic benefit cost for the quarters ended March 31, 2004 and 2003 include the following components:
Other Postretirement Pension Benefits Benefits 2004 2003 2004 2003 Service cost $ 26 $ 26 $ 4 $ 3 Interest cost 43 42 7 7 Expected return on plan assets (43 ) (42 ) (2 ) (2 ) Amortization of prior service cost 1 1 (6 ) (6 ) Amortization of unrecognized net losses 7 6 2 1
Net periodic benefit cost$ 34 $ 33 $ 5 $ 3
Employer Contributions
There were no employer contributions paid during the quarter ended March 31, 2004. On April 15, 2004, the Company made a $312 voluntary contribution into its U.S. qualified defined benefit pension plan. No additional contributions are expected to be made in 2004.
Note 10. Accumulated Other Comprehensive Income
Comprehensive income
(loss)is defined as all changes instockholders'stockholders’ equity, except those arising from transactions with stockholders. Comprehensive income(loss)includes net income (loss) and other comprehensive income (loss), which for the Company consists of changes in unrealized appreciation or depreciation of investments carried at market value, changes in gains or losses oncash-flowcash flow hedging instruments, changes in foreign currency translation gains or losses and changes in theCompany'sCompany’s minimum pension liability.The components of accumulated other comprehensive income (loss) were as follows:
NET NET GAIN UNREALIZED (LOSS) ON FOREIGN MINIMUM GAIN (LOSS) CASH-FLOW CURRENCY PENSION ON HEDGING CUMULATIVE LIABILITY ACCUMULATED OTHER SECURITIES, INSTRUMENTS, TRANSLATION ADJUSTMENT, COMPREHENSIVE FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 2003 NET OF TAX NET OF TAX ADJUSTMENTS NET OF TAX INCOME (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------BALANCE, BEGINNING OF PERIOD $ 2,176 $ 90 $ (76) $ (383) $ 1,807 Unrealized gain/loss on securities [1] [2] (383) -- -- -- (383) Net gain/loss on cash-flow hedging instruments [1] [3] -- (43) -- -- (43) Foreign currency translation adjustments -- -- (24) -- (24) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $ 1,793 $ 47 $ (100) $ (383) $ 1,357 - ------------------------------------------------------------------------------------------------------------------------------------ FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, BEGINNING OF PERIOD $ 789 $ 77 $ (119) $ (19) $ 728 Unrealized gain/loss on securities [1] [2] 716 -- -- -- 716 Net gain/loss on cash-flow hedging instruments [1] [3] -- 67 -- -- 67 Foreign currency translation adjustments -- -- (1) -- (1) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $ 1,505 $ 144 $ (120) $ (19) $ 1,510 ====================================================================================================================================- 23 -20
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)(continued)
(unaudited)NOTE 9. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (CONTINUED)Note 10. Accumulated Other Comprehensive Income (continued)
The components of AOCI, net of tax, were as follows:
Foreign Currency Net Gain (Loss) on Cumulative Minimum Pension Accumulated Other Unrealized Gain Cash flow Hedging Translation Liability Comprehensive For the first quarter ended March 31, 2004 on Securities Instruments Adjustments Adjustment Income Balance, beginning of period$ 1,764 $ (42 ) $ (101 ) $ (375 ) $ 1,246 Unrealized gain/loss on securities [1] [2] 574 — — — 574 Foreign currency translation adjustments — — (3 ) — (3 ) Net gain/loss on cash flow hedging instruments [1] [3] — 59 — — 59 Cumulative effect of accounting change [4] 292 — — — 292
Balance, end of period$ 2,630 $ 17 $ (104 ) $ (375 ) 2,168
For the first quarter ended March 31, 2003 Balance, beginning of period$ 1,444 $ 128 $ (95 ) $ (383 ) $ 1,094 Unrealized gain/loss on securities [1] [2] 177 — — — 177 Foreign currency translation adjustments — — 9 — 9 Net gain/loss on cash flow hedging instruments [1] [3] — (23 ) — — (23 )
Balance, end of period$ 1,621 $ 105 $ (86 ) $ (383 ) $ 1,257
NET GAIN NET (LOSS) ON FOREIGN MINIMUM UNREALIZED CASH-FLOW CURRENCY PENSION GAIN ON HEDGING CUMULATIVE LIABILITY ACCUMULATED OTHER SECURITIES, INSTRUMENTS, TRANSLATION ADJUSTMENT, COMPREHENSIVE FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 NET OF TAX NET OF TAX ADJUSTMENTS NET OF TAX INCOME (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------BALANCE, BEGINNING OF PERIOD $ 1,444 $ 128 $ (95) $ (383) $ 1,094[1] Unrealized gain/loss on securities [1] [2] 349 -- -- -- 349 Net gain/loss on cash-flow hedging instruments [1] [3] -- (81) -- -- (81) Foreign currency translation adjustments -- -- (5) -- (5) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $ 1,793 $ 47 $ (100) $ (383) $ 1,357 - ------------------------------------------------------------------------------------------------------------------------------------ FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, BEGINNING OF PERIOD $ 606 $ 63 $ (116) $ (19) $ 534 Unrealized gain/loss on securities [1] [2] 899 -- -- -- 899 Net gain/loss on cash-flow hedging instruments [1] [3] -- 81 -- -- 81 Foreign currency translation adjustments -- -- (4) -- (4) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, END OF PERIOD $ 1,505 $ 144 $ (120) $ (19) $ 1,510 - ------------------------------------------------------------------------------------------------------------------------------------[1] Unrealized gain/lossgain on securities is net of tax and other items of$(465)$276 and$385$131 for thethird quarterfirst quarters ended March 31, 2004 and$152 and $484 for the nine months ended September 30,2003,and 2002,respectively. Netgain/lossgain oncash-flowcash flow hedging instruments is net of tax expense (benefit) of$(24)$32 and$36$(12) for thethird quarterfirst quarters ended March 31, 2004 and$(44) and $44 for the nine months ended September 30,2003,and 2002,respectively.[2][2] Net of reclassification adjustment for gains (losses) realized in net income (loss)of$33$83 and$(106)$(31) for thethird quarterfirst quarters ended March 31, 2004 and$148 and $(210) for the nine months ended September 30,2003,and 2002,respectively.[3][3] Net of amortization adjustment of $3$4 and$1$9 to net investment income for thethird quarterfirst quarters ended March 31, 2004 and$16 and $32003, respectively.[4] Cumulative effect of accounting change is net of tax of $157 for the nine monthsfirst quarter endedSeptember 30, 2003 and 2002, respectively.March 31, 2004.NOTE 10. REINSURANCE RECAPTURE On June 30, 2003, the Company recaptured a block of business previously reinsured with an unaffiliated reinsurer. Under this treaty, HLI reinsured a portion of the GMDB feature associated with certain of its annuity contracts. As consideration for recapturing the business and final settlement under the treaty, the Company has received assets valued at approximately $32 and one million warrants exercisable for the unaffiliated company's stock. This amount represents to the Company an advance collection of its future recoveries under the reinsurance agreement and will be recognized as future losses are incurred. Prospectively, as a result of the recapture, HLI will be responsible for all of the remaining and ongoing risks associated with the GMDB's related to this block of business. The recapture increased the net amount at risk retained by the Company, which is included in the net amount at risk discussed in Note 1(f). - 24 -ITEM21
Item 2.
MANAGEMENT'SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Dollar(Dollar amounts in millions except share data unless otherwise stated)
Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations
("(“MD&A"&A”) addresses the financial condition of The Hartford Financial Services Group, Inc. and its subsidiaries (collectively,"The Hartford"“The Hartford” or the"Company"“Company”) as ofSeptember 30, 2003,March 31, 2004, compared with December 31,2002,2003, and its results of operations for thethirdfirst quarterand nine monthsendedSeptember 30, 2003,March 31, 2004, compared to the equivalent2002 periods.2003 period. This discussion should be read in conjunction with the MD&A in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report.Certain reclassifications have been made to prior year financial information to conform to the current year presentation.Certain of the statements contained herein are forward-looking statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the
Company'sCompany’s control and have been made based uponmanagement'smanagement’s expectations and beliefs concerning future developments and their potential effect upon the Company. There can be no assurance that future developments will be in accordance withmanagement'smanagement’s expectations or that the effect of future developments on The Hartford will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of various factors. These factors include: the difficulty in predicting theCompany'sCompany’s potential exposure for asbestos and environmental claims and relatedlitigation, in particular, significant uncertainty with regard tolitigation; theoutcomepossible occurrence of terrorist attacks; theCompany's current dispute with Mac Arthur Company and its subsidiary, Western MacArthur Company (collectively or individually, "MacArthur"); the uncertain natureresponse ofdamage theories and loss amountsreinsurance companies under reinsurance contracts and thedevelopmentavailability, pricing and adequacy ofadditional facts relatedreinsurance to protect theSeptember 11 terrorist attack ("September 11");Company against losses; changes in the stock markets, interest rates or other financial markets, including the potential effect on the Company’s statutory capital levels; the inability to effectively mitigate the impact of equity market volatility on the Company’s financial position and results of operations arising from obligations under annuity product guarantees; the uncertain effect on the Company of the Jobs and Growth Tax Relief Reconciliation Act of 2003, in particular the reduction in tax rates on long-term capital gains and most dividend distributions; theresponse of reinsurance companies under reinsurance contracts, the impact of increasing reinsurance rates and the availability and adequacy of reinsurance to protect the Company against losses; the inability to effectively mitigate the impact of equity market volatility on the Company's financial position and results of operations arising from obligations under annuity product guarantees; thepossibility of more unfavorable loss experience than anticipated; the incidence and severity of catastrophes, both natural and man-made; stronger than anticipated competitive activity; unfavorable judicial or legislative developments, including the possibility that the Terrorism Risk Insurance Act of 2002 is not extended beyond 2005; the potential effect of domestic and foreign regulatory developments, including those which could increase the Company’s business costs and required capital levels; the possibility of general economic and business conditions that are less favorable than anticipated; theincidence and severity of catastrophes, both natural and man-made; the effect of changes in interest rates, the stock markets or other financial markets; stronger than anticipated competitive activity; unfavorable legislative, regulatory or judicial developments; the Company'sCompany’s ability to distribute its products through distribution channels, both current and future; the uncertain effects of emerging claim and coverage issues; the effect of assessments and other surcharges for guaranty funds and second-injury funds and other mandatory pooling arrangements; a downgrade in theCompany'sCompany’s claims-paying, financial strength or credit ratings; the ability of theCompany'sCompany’s subsidiaries to pay dividends to the Company; and other factors described in such forward-looking statements.- --------------------------------------------------------------------------------INDEX
- -------------------------------------------------------------------------------- Critical Accounting Estimates 25 Consolidated Results of Operations: Operating Summary 27 Life 31 Investment Products 32 Individual Life 33 Group Benefits 33 Corporate Owned Life Insurance ("COLI") 34 Property & Casualty 35 Business Insurance 38 Personal Lines 39 Specialty Commercial 40 Reinsurance 41 Other Operations (Including Asbestos and Environmental Claims) 42 Investments 45 Capital Markets Risk Management 49 Capital Resources and Liquidity 55 Accounting Standards 59 - --------------------------------------------------------------------------------
Critical Accounting Estimates 22 Consolidated Results of Operations 23 Life 25 Retail Products Group 26 Institutional Solutions Group 27 Individual Life 28 Group Benefits 28 Property & Casualty 29 Business Insurance 32 Personal Lines 33 Specialty Commercial 34 Other Operations (Including Asbestos and Environmental Claims) 35 Investments 39 Investment Credit Risk 43 Capital Markets Risk Management 47 Capital Resources and Liquidity 48 Accounting Standards 52 CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America,
("GAAP"),requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.The Company has identified the following estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability:
reserves; valuation of investmentsreserves for future policy benefits andderivative instruments;unpaid claim and claim adjustment expenses; Life operations deferred policy acquisitioncosts;costs and present value of future profits; investments; pension and other postretirement benefits; and commitments and contingencies. In developing these estimates management makes subjective and complex judgments that are inherently uncertain and subject to material change as facts and circumstances develop. Although variability is inherent in these estimates, management believes the amounts provided are appropriate based upon the facts available upon compilation of the financial statements.- 25 -RESERVES ASBESTOS AND ENVIRONMENTAL CLAIMS In the first quarterDeferred Policy Acquisition Costs and Present Value of
2003, The Hartford conducted a detailed study of its asbestos exposures. The Company undertook the study consistent with its practice of regularly updating its reserve estimates as new information becomes available. The Company strengthened its gross and net asbestos reserves by $3.9 billion and $2.6 billion, respectively, during the first quarter ended March 31, 2003. The process of estimating asbestos reserves remains subject to a wide variety of uncertainties, which are detailed in Note 5(b) of Notes to Condensed Consolidated Financial Statements. Due to these uncertainties, further developments could cause The Hartford to change its estimates of asbestos reserves and the effect of these changes could be material to the Company's consolidated operating results, financial condition and liquidity. DEFERRED POLICY ACQUISITION COSTS LIFEFuture ProfitsLife
Policy acquisition costs, which include commissions and certain other expenses that vary with and are primarily associated with
22
acquiring business, are deferred and amortized over the estimated lives of the contracts, usually 20 years. These deferred costs, together with the present value of future profits of acquired business, are recorded as an asset commonly referred to as deferred policy acquisition costs and present value of future profits
("DAC"(“DAC”). AtSeptember 30, 2003March 31, 2004 and December 31,2002,2003, the carrying value of theCompany'sCompany’s Lifeoperations'operations’ DAC was$6.3$6.5 billion and$5.8$6.6 billion, respectively. For statutory accounting purposes, such costs are expensed as incurred.DAC related to traditional policies are amortized over the premium-paying period in proportion to the present value of annual expected premium income. DAC related to investment contracts and universal life-type contracts are deferred and amortized using the retrospective deposit method. Under the retrospective deposit method, acquisition costs are amortized in proportion to the present value of the estimated gross profits ("EGPs") arising principally from projected investment, mortality and expense margins and surrender charges. The attributable portion of the DAC amortization is allocated to realized gains and losses on investments. The DAC balance is also adjusted through other comprehensive income by an amount that represents the amortization of deferred policy acquisition costs that would have been required as a charge or credit to operations had unrealized gains and losses on investments been realized. Actual gross profits can vary from management's estimates, resulting in increases or decreases in the rate of amortization. The Company regularly evaluates its EGPs to determine if actual experience or other evidence suggests that earlier estimates should be revised. In the event that the Company were to revise its EGPs, the cumulative DAC amortization would be adjusted to reflect such revised EGPs in the period the revision was determined to be necessary. Several assumptions considered to be significant in the development of EGPs include separate account fund performance, surrender and lapse rates, estimated interest spread and estimated mortality. The separate account fund performance assumption is critical to the development of the EGPs related to the Company's variable annuity and variable life insurance businesses. The average annual long-term rate of assumed separate account fund performance (before mortality and expense charges) used in estimating gross profits for the variable annuity and variable life business was 9% for the nine months ended September 30, 2003 and September 30, 2002. For other products, including fixed annuities and other universal life-type contracts, the average assumed investment yield ranged from 5% to 8.5% for the periods ended September 30, 2003 and 2002. Due to increased volatility and the decline experienced by the U.S. equity markets in recent periods, the Company continues to enhance its DAC evaluation process.The Company has developed sophisticated modeling capabilities to evaluate its DAC asset, which allowed it to run a large number of stochastically determined scenarios of separate account fund performance. These scenarios were then utilized to calculate a statistically significant range of reasonable estimates of
EGPs.gross profits or “EGPs”. This range was then compared to the present value of EGPs currently utilized in the DAC amortization model. As ofSeptember 30, 2003,March 31, 2004, the present value of the EGPs utilized in the DAC amortization model fall within a reasonable range of statistically calculated present value of EGPs. As a result, the Company does not believe there is sufficient evidence to suggest that a revision to the EGPs (and therefore, a revision to the DAC) as ofSeptember 30, 2003March 31, 2004 is necessary; however, if in the future the EGPs utilized in the DAC amortization model were to exceed the margin of the reasonable range of statistically calculated EGPs, a revision could be necessary. Furthermore, the Company has estimated that the present value of the EGPs is likely to remain within a reasonable range if overall separate account returns decline by10%15% or less forthe remainder of 2003, and if overall separate account returns decline by 5% or less for the next twelve months,2004, and if certain other assumptions that are implicit in the computations of the EGPs are achieved.Additionally, the Company continues to perform analyses with respect to the potential impact of a revision to future EGPs. If such a revision to EGPs were deemed necessary, the Company would adjust, as appropriate, all of its assumptions for products accounted for in accordance with Statement of Financial Accounting Standards
("SFAS"(“SFAS”) No. 97,"Accounting“Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale ofInvestments"Investments”, and reproject its future EGPs based on current account values at the end of the quarter in which a revision is deemed to be necessary. To illustrate the effects of this process, assume the Company had concluded that a revision of theCompany'sCompany’s EGPs was required atSeptember 30, 2003.March 31, 2004. If the Company assumed a 9% average long-term rate of growth fromSeptember 30, 2003March 31, 2004 forward along with other appropriate assumption changes in determining the revised EGPs, the Company estimates the cumulative increase to amortization would be approximately$75-$40-$80,45, after-tax. If instead the Company were to assume a long-term growth rate of 8% in determining the revised EGPs, the adjustment would be approximately$100-$60-$110,70, after-tax. Assuming that such an adjustment were to have been required, the Company anticipates that there would have been immaterial impacts on its DAC amortization for the20032004 and20042005 years exclusive of the adjustment, and that there would have been positive earnings effects in later years. Any such adjustment- 26 -would not affect statutory income or surplus, due to the prescribed accounting for such amounts that is discussed above. Aside from absolute levels and timing of market performance assumptions, additional factors that will influence this determination include the degree of volatility in separate account fund performance and shifts in asset allocation within the separate account made by policyholders. The overall return generated by the separate account is dependent on several factors, including the relative mix of the underlying sub-accounts among bond funds and equity funds as well as equity sector weightings. The Company's overall separate account fund performance has been reasonably correlated to the overall performance of the Standard & Poor's 500 Index ("S&P") (which closed at 996 on September 30, 2003), although no assurance can be provided that this correlation will continue in the future.The overall recoverability of the DAC asset is dependent on the future profitability of the business. The Company tests the aggregate recoverability of the DAC asset by comparing the amounts deferred to the present value of total EGPs. In addition, the Company routinely stress tests its DAC asset for recoverability against severe declines in its separate account assets, which could occur if the equity markets experienced another significant sell-off, as the majority of
policyholders'policyholders’ funds in the separate accounts is invested in the equity market. As ofSeptember 30, 2003,March 31, 2004, the Company believed variable annuity separate account assets could fall by at least30%45% before portions of its DAC asset would be unrecoverable.VALUATION OF DERIVATIVE INSTRUMENTS Derivative instruments are reported at fair value based upon internally established valuations that are consistent with external valuation models, quotations furnished by dealers in such instrument or market quotations. The Company has calculated the fair value of the guaranteed minimum withdrawal benefit ("GMWB") liability (see Note 3(b) of Notes to Condensed Consolidated Financial Statements) based on actuarial assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. Because of the dynamic and complex nature of these cash flows, stochastic techniques under a variety of market return scenarios and other best estimate assumptions are used. Estimating these cash flows involves numerous estimates and subjective judgments including those regarding expected market rates of return, market volatility, correlations of market returns and discount rates. At each valuation date, the Company has assumed expected returns based on risk-free rates as represented by the current LIBOR forward curve rates; market volatility assumptions for each underlying index will be based on a blend of observed market "implied volatility" data and annualized standard deviations of monthly returns using the most recent 20 years of observed market performance; correlations of market returns across underlying indices shall be based on actual observed market returns and relationships over the ten years preceding the valuation date; and current risk-free spot rates as represented by the current LIBOR spot curve shall be used to determine the present value of expected future cash flows produced in the stochastic projection process. OTHER CRITICAL ACCOUNTING ESTIMATESOther Critical Accounting Estimates
There have been no material changes to the
Company'sCompany’s critical accounting estimates regardingProperty & Casualty DAC; valuation ofreserves for future policy benefits and unpaid claims and claim adjustment expenses; investments; pension and other postretirement benefits; and contingencies since the filing of theCompany's 2002Company’s 2003 Form 10-K Annual Report.- --------------------------------------------------------------------------------CONSOLIDATED RESULTS OF
OPERATIONS: OPERATING SUMMARY - --------------------------------------------------------------------------------OPERATIONS
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Earned premiums $ 3,249 $ 2,774 17% $ 8,910 $ 8,000 11% Fee income 716 627 14% 1,989 1,961 1% Net investment income 825 729 13% 2,431 2,161 12% Other revenues 145 115 26% 414 348 19% Net realized capital gains (losses) 12 (160) NM 216 (333) NM - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 4,947 4,085 21% 13,960 12,137 15% Benefits, claims and claim adjustment expenses 2,998 2,557 17% 10,872 7,455 46% Amortization of deferred policy acquisition costs and present value of future profits 633 568 11% 1,754 1,696 3% Insurance operating costs and expenses 609 567 7% 1,801 1,661 8% Other expenses 271 199 36% 693 563 23% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 4,511 3,891 16% 15,120 11,375 33% - ------------------------------------------------------------------------------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES 436 194 125% (1,160) 762 NM Income tax expense (benefit) 93 (71) NM (615) 20 NM - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ 343 $ 265 29% $ (545) $ 742 NM ====================================================================================================================================Operating Summary
First Quarter Ended March 31, 2004 2003 Change Earned premiums $ 3,181 $ 2,849 12 % Fee income 786 617 27 % Net investment income 1,517 788 93 % Other revenues 104 122 (15 %) Net realized capital gains (losses) 144 (45 ) NM
Total revenues5,732 4,331 32 % Benefits, claims and claim adjustment expenses 3,297 5,245 (37 %) Amortization of deferred policy acquisition costs and present value of future profits 679 564 20 % Insurance operating costs and expenses 692 538 29 % Interest expense 66 66 — Other expenses 180 143 26 %
Total benefits, claims and expenses4,914 6,556 (25 %)
Income (loss) before income taxes and cumulative effect of accounting change818 (2,225 ) NM Income tax expense (benefit) 227 (830 ) NM
Income (loss) before cumulative effect of accounting change591 (1,395 ) NM
Cumulative effect of accounting change, net of tax (23 ) — NM
Net income (loss)$ 568 $ (1,395 ) NM
23
The Hartford defines
the following“NM” as"NM" ornotmeaningful:meaningful for increases or decreases greater than 200%, or changes from a net gain to a net loss position, or vice versa.OPERATING RESULTS Revenues forOperating Results
Net income increased $2.0 billion, due primarily to $1.7 billion, after-tax, in reserve strengthening resulting from the
thirdcompletion of the Company’s asbestos reserve study in the first quarterand nine months ended September 30, 2003 increased $862 and $1.8 billion, respectively, overof 2003. The remaining difference, an increase of $262, was primarily thecomparable 2002 periods. Contributing to these increases were - 27 -result of an increase in net realized capital gains, and earned pricing increases within bothafter-tax, of $124; improved underwriting results in the Business Insurance andSpecialty Commercial segments. Higher earned premiumsPersonal Lines segments; and an increase in netinvestmentincome in theInvestmentRetail Productssegment also contributed to these increases. Total benefits, claimsGroup andexpenses increased $620Group Benefits segments; partially offset by a $23 net of tax cumulative effect of accounting change charge resulting from the adoption of Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (the “SOP”, or “SOP 03-1”).Revenues for the
thirdfirst quarter endedSeptember 30, 2003 over the comparable prior year period. The increase was primarily due to growth within the Business Insurance, Specialty Commercial and Investment Products segments. Total benefits, claims and expensesMarch 31, 2004 increased$3.7$1.4 billionfor the nine months ended September 30, 2003over the comparable prior year period, primarily due to theCompany's asbestos reserve strengthening actions duringadoption of thefirst quarter of 2003. As comparedSOP, which resulted in an additional $656 in net investment income ($495 related to trading securities income and $154 related to income earned on separate account assets reclassified to thethird quarter ended September 30, 2002, net income increased $78 forgeneral account as a result of thethird quarter ended September 30, 2003. Theadoption of the SOP). Also contributing to the increaseis primarily due towas a $313 increase in earned premiums in the Group Benefits segment, a $189 increase in net realized capital gains,as well as strong earned pricing increasesand a $142 increase in fee income and other in thePersonal Lines segment and the favorable effect of the rebound in the equity markets on the InvestmentRetail Productssegment, partially offset by $40 of after-tax expense related to the settlement of litigation with Bancorp Services, LLC ("Bancorp"). For further discussion of the Bancorp litigation, see Note 5(a) of Notes to Condensed Consolidated Financial Statements. The net loss for the nine months ended September 30, 2003 is primarily due to the Company's first quarter 2003 asbestos reserve strengthening of $1.7 billion, after-tax, partially offset by net realized capital gains. Included in net loss for the nine months ended September 30, 2003 is $27 of severance charges, after-tax, in Property & Casualty. Included in net income for the nine months ended September 30, 2002 is the $8 after-tax benefit recognized by Hartford Life, Inc. ("HLI") related to the reduction of HLI's reserves associated with September 11 and $11 of after-tax expense related to litigation with Bancorp. INCOME TAXES The Hartford's Federal income tax returns are routinely audited by the Internal Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001 tax years. No material issues have been raised to date by the IRS. Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from tax examinations and other tax-related matters for all open tax years. The tax provision recorded during the nine months ended September 30, 2003, reflects a benefit of $30, consisting primarily of a change in estimate of the dividends-received deduction ("DRD") tax benefit reported during 2002. The change in estimate was the result of actual 2002 investment performance on the related separate accounts being unexpectedly out of pattern with past performance, which had been the basis for the estimate. The total DRD benefit related to the 2003 tax year for the nine months ended September 30, 2003 was $65.Group segment.Income Taxes
The effective tax rate for the
thirdfirst quarterand nine monthsendedSeptember 30, 2003March 31, 2004 was21% and 53%, respectively, as28% compared with(37%) and 3%, respectively,37% for the comparableperiodsperiod in2002.2003. Tax-exempt interest earned on invested assets and thedividends-receiveddividends received deduction were the principal causes of the effective tax ratesdiffering frombeing different than the 35% U.S. statutory rate.ADOPTION OF FAIR VALUE RECOGNITION PROVISIONS FOR STOCK-BASED COMPENSATION In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123", which provides three optional transition methods for entities that decide to voluntarily adopt the fair value recognition principles of SFAS No. 123, "Accounting for Stock-Based Compensation", and modifies the disclosure requirements of SFAS No. 123. In January 2003, the Company adopted the fair value recognition provisions of accounting for employee stock compensation and used the prospective transition method. Under the prospective method, stock-based compensation expense is recognized for awards granted or modified after the beginning of the fiscal year in which the change is made. The fair value of stock-based awards granted during the nine months ended September 30, 2003 was $40, after-tax. The fair value of these awards will be recognized as expense over the awards' vesting periods, generally three years. All stock-based awards granted or modified prior to January 1, 2003 will continue to be valued using the intrinsic value-based provisions set forth in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". Under the intrinsic value method, compensation expense is determined on the measurement date, which is the first date on which both the number of shares the employee is entitled to receive and the exercise price are known. Compensation expense, if any, is measured based on the award's intrinsic value, which is the excess of the market price of the stock over the exercise price on the measurement date. The expense, including non-option plans, related to stock-based employee compensation included in the determination of net income for the third quarter and nine months ended September 30, 2003 and 2002 is less than that which would have been recognized if the fair value method had been applied to all awards since the effective date of SFAS No. 123. For further discussion of the Company's stock-based compensation plans, see Note 11 of Notes to Consolidated Financial Statements included in The Hartford's 2002 Form 10-K Annual Report. The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the fair value method had been applied to all outstanding and unvested awards in each period. - 28 -
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------- ------------- ------------- ----------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Net income (loss), as reported $ 343 $ 265 $ (545) $ 742 Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects [1] 4 2 15 4 Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax (11) (16) (37) (41) effects - ------------------------------------------------------------------------------------------------------------------------------------ Pro forma net income (loss) [2] $ 336 $ 251 $ (567) $ 705 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings (loss) per share: Basic - as reported $ 1.21 $ 1.06 $ (2.03) $ 3.00 Basic - pro forma [2] $ 1.19 $ 1.01 $ (2.11) $ 2.85 Diluted - as reported [3] $ 1.20 $ 1.06 $ (2.03) $ 2.96 Diluted - pro forma [2] [3] $ 1.18 $ 1.00 $ (2.11) $ 2.82 ====================================================================================================================================[1] Includes the impact of non-option plans of $2 and $0, respectively, for the third quarter and $4 and $2, respectively, for the nine months ended September 30, 2003 and 2002. [2] The pro forma disclosures are not representative of the effects on net income (loss) and earnings (loss) per share in future periods. [3] As a result of the net loss in the nine months ended September 30, 2003, SFAS No. 128, "Earnings Per Share", requires the Company to use basic weighted average common shares outstanding in the calculation of the nine months ended September 30, 2003 diluted earnings (loss) per share, since the inclusion of options of 1.5 would have been antidilutive to the earnings per share calculation. In the absence of the net loss, weighted average common shares outstanding and dilutive potential common shares would have totaled 270.4.ORGANIZATIONAL STRUCTUREOrganizational Structure
The Hartford is organized into two major operations: Life and Property & Casualty. In the quarter ended March 31, 2004, and as more fully described below, the Company changed its reporting segments to reflect the current manner by which its chief operating decision maker views and manages the business. All segment data for prior reporting periods have been adjusted to reflect the current segment reporting. Within
thesethe Life and Property & Casualty operations, The Hartford conducts business principally innineeight operating segments. Additionally, Corporate now includes all of the Company’s debt financing and related interest expense, as well as certain capital raising and purchase accounting adjustmentactivities related to the June 27, 2000 acquisition of all of the shares of Hartfordactivities.Life
Inc. ("HLI") that the Company did not already own ("the HLI Repurchase"), as well as capital raised thathasnot been contributed to the Company's insurance subsidiaries are included in Corporate. Life is organized into fourchanged its reportable operatingsegments:segments from Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance("COLI"(“COLI”).to Retail Products Group (“Retail”), Institutional Solutions Group (“Institutional”), Individual Life and Group Benefits. Retail offers individual variable and fixed annuities, mutual funds, retirement plan products and services to corporations under Section 401(k) plans and other investment products. Institutional primarily offers retirement plan products and services to municipalities under Section 457 plans, other institutional investment products and private placement life insurance. Individual Life sells a variety of life insurance products, including variable universal life, universal life, interest sensitive whole life and term life insurance. Group Benefits sells group insurance products, including group life and group disability insurance as well as other products, including medical stop loss and supplementary medical coverages to employers and employer sponsored plans, accidental death and dismemberment, travel accident and other special risk coverages to employers and associations. Life also includes, in an Other category, its international operations, which are primarily located in Japan and Brazil; net realized capital gains andlosses; as well aslosses other than periodic net coupon settlements on non-qualifying derivatives and net realized capital gains and losses related to guaranteed minimum withdrawal benefits; corporate items not directly allocated to any of its reportable operatingsegments, principally interest expense;segments; and intersegment eliminations. Periodic net coupon settlements on non-qualifying derivatives and net realized capital gains and losses related to guaranteed minimum withdrawal benefits are reflected in each applicable segment in net realized capital gains and losses.Property & Casualty is now organized into
fivefour reportable operating segments: theNorth Americanunderwriting segments of Business Insurance, Personal Lines, and Specialty Commercialand Reinsurance;(collectively “Ongoing Operations”); and the Other Operations segment. Prior to the segmentwhich includes substantially allreporting change made in the first quarter of 2004, Property and Casualty had also included a Reinsurance segment. With theCompany's asbestos and environmental exposures. "North American" includes the combined underwriting resultsdiscontinuance ofthe Business Insurance, Personal Lines, Specialty Commercial and Reinsurance underwriting segments. Property & Casualty also includes income and expense items not directly allocated to these segments, such as net investment income, net realized capital gains and losses, and other expenses including interest, severance and income taxes. Included in net income for the nine months ended September 30, 2003 for Property & Casualty is $27, after-tax, related to severance costs associated with several expense reduction initiatives announced in May 2003. On May 16, 2003, as part of the Company's decision to withdraw from thewriting new reinsurance assumedreinsurancebusiness, theCompany entered into a quota share and purchase agreement with Endurance Reinsurance Corporation of America ("Endurance") whereby the Reinsurance segment retroceded the majority of its inforce book ofreinsurance assumed businessas of April 1, 2003 and sold renewal rights to Endurance. Under the quota share agreement, Endurance will reinsure most of the segment's assumed reinsurance contracts that were written on or after January 1, 2002 and that had unearned premium as of April 1, 2003. In consideration for Endurance reinsuring the unearned premium as of April 1, 2003, the Company paid Endurance an amount equal to unearned premiums less the related unamortized commissions/deferred acquisition costs and an override commission, which was established by the contract. In addition, Endurance will pay a profit sharing commission based on the loss performance of property treaty, property catastrophe and aviation pool unearned premium. Under the purchase agreement, Endurance will pay additional amounts, subject to a guaranteed minimum of $15, based on the level of renewal premium on the reinsured contracts over the next two years. The guaranteed minimumisreflected in net income for the nine months ended September 30, 2003. The Company remains subject to reserve development relating to all retained business. On September 1, 2003, the Company sold a wholly owned subsidiary, Trumbull Associates, LLC, for $33, resulting in a gain of $15, after-tax. The gain is included in net realized capital gains. The revenues and net income of Trumbull Associates, LLC were not material to the Company or the Property & Casualty operation. The measure of profit or loss used by The Hartford's management in evaluating the performance of its Life segments is net income. Property & Casualty underwriting segments are evaluated by The Hartford's management primarily based upon underwriting results. Underwriting results represent earned premiums less - 29 -incurred claims, claim adjustment expenses and underwriting expenses. Certain transactions between segments occur during the year that primarily relate to tax settlements, insurance coverage, expense reimbursements, services provided, security transfers and capital contributions. In addition, certain reinsurance stop loss agreements exist between the segments which specify that one segment will reimburse another for losses incurred in excess of a predetermined limit. Also, one segment may purchase group annuity contracts from another to fund pension costs and annuities to settle casualty claims. In addition, certain intersegment transactions occur in Life. These transactions include interest income on allocated surplus and the allocation of certain net realized capital gains and losses through net investment income utilizing the duration of the segment's investment portfolios. During the nine months ended September 30, 2003, $1.8 billion of securities were sold by the Property & Casualty operation to the Life operation. For segment reporting, the net gain on this sale was deferred by the Property & Casualty operation and will be reported as realized when the underlying securities are sold by the Life operation. On December 1, 2002, the Property & Casualty segments entered into a contract with a subsidiary, whereby reinsurance will be provided to the Property & Casualty operations through this subsidiary, allowing for reinsurance decisions to be made on a corporate-wide basis. The financial results of this reinsurance program, net of retrocessions by the reinsuring subsidiary to unrelated reinsurers, arenow included in theSpecialty CommercialOther Operations segment.SEGMENT RESULTS24
Segment Results
The following is a summary of net income
(loss)for each of theCompany'sCompany’s Life segments and aggregate net income(loss)for theCompany'sCompany’s Property & Casualty operations.
NET INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Life Investment Products $ 129 $ 100 29% $ 368 $ 335 10% Individual Life 36 33 9% 104 99 5% Group Benefits 38 34 12% 107 92 16% COLI (30) 10 NM (11) 20 NM Other (12) (16) 25% (38) (114) 67% - ------------------------------------------------------------------------------------------------------------------------------------ Total Life 161 161 -- 530 432 23% - ------------------------------------------------------------------------------------------------------------------------------------ Total Property & Casualty 202 110 84% (1,034) 328 NM - ------------------------------------------------------------------------------------------------------------------------------------ Corporate (20) (6) NM (41) (18) (128%) - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ 343 $ 265 29% $ (545) $ 742 NM ====================================================================================================================================Net Income (Loss)
First Quarter Ended March 31, 2004 2003 Change Life Retail Products Group $ 107 $ 77 39 % Institutional Solutions Group 28 31 (10 %) Individual Life 33 32 3 % Group Benefits 47 34 38 % Other 66 (29 ) NM
Total Life 281 145 94 %
Total Property & Casualty 341 (1,495 ) NM Corporate (54 ) (45 ) (20 %)
Total net income (loss)$ 568 $ (1,395 ) NM
The following is a summary of
theProperty & Casualty underwriting results by segment.Underwriting
results represent premiums earned less incurred claims, claim adjustment expenses and underwriting expenses.Results (before-tax)
First Quarter Ended March 31, 2004 2003 Business Insurance $ 225 $ 7 Personal Lines 106 56 Specialty Commercial (110 ) 5 Other Operations [1] (65 ) (2,651 )
UNDERWRITING RESULTS (BEFORE-TAX) THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- -----------------------------------[1] Includes $2,604 in 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Business Insurance $ 20 $ 21 (5%) $ 50 $ 17 194% Personal Lines 37 (13) NM 92 (48) NM Specialty Commercial (50) 3 NM (54) 1 NM Reinsurance (10) (4) (150%) (105) (17) NM Other Operations (12) (42) 71% (2,657) (129) NM ====================================================================================================================================of before-tax impact of asbestos reserve addition.In the sections that follow, the Company analyzes the results of operations of its various segments using the performance measurements that the Company believes are meaningful. - 30 -- --------------------------------------------------------------------------------LIFE
- --------------------------------------------------------------------------------Operating Summary
First Quarter Ended March 31, 2004 2003 Change Earned premiums $ 995 $ 683 46 % Fee income 786 617 27 % Net investment income [1] 1,201 503 139 % Other revenues — 27 (100 %) Net realized capital gains (losses) 76 (44 ) NM
Total revenues3,058 1,786 71 % Benefits, claims and claim adjustment expenses [1] 1,877 1,083 73 % Amortization of deferred policy acquisition costs and present value of future profits 233 163 43 % Insurance operating costs and expenses 526 351 50 % Other expenses 1 4 (75 %)
Total benefits, claims and expenses2,637 1,601 65 %
Income before income taxes and cumulative effect of accounting change421 185 128 % Income tax expense 117 40 193 %
Income before cumulative effect of accounting change304 145 110 %
Cumulative effect of accounting change, net of tax [2] (23 ) — NM
Net income$ 281 $ 145 94 %
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Earned premiums $ 981 $ 667 47% $ 2,370 $ 2,040 16% Fee income 716 627 14% 1,989 1,961 1% Net[1] With the adoption of SOP 03-1, certain annuity products were required to be accounted for in the general account. This change in accounting resulted in an increase in net investment income 518 462 12% 1,538 1,360 13% Other revenues 35 27 30% 99 91 9% Net realized capital gains (losses) (2) (118) 98% -- (253) 100% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 2,248 1,665 35% 5,996 5,199 15% Benefits,and benefits, claims and claim adjustmentexpenses 1,375 1,050 31% 3,544 3,135 13% Amortizationexpenses.[2] For the quarter ended March 31, 2004, represents the cumulative impact of deferred policy acquisition costs and present valuethe Company’s adoption offuture profits 202 163 24% 540 486 11% Insurance operating costs and expenses 379 335 13% 1,125 1,050 7% Other expenses 94 34 176% 159 114 39% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 2,050 1,582 30% 5,368 4,785 12% - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 198 83 139% 628 414 52% Income tax expense (benefit) 37 (78) NM 98 (18) NM - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 161 $ 161 -- $ 530 $ 432 23% ====================================================================================================================================SOP 03-1.RevenuesLife’s net income increased, largely due to a significant increase in realized capital gains. (See the Investments section for further discussion of investment results and related realized capital gains.) Also contributing to the
third quarterearnings growth were increases in net income in the Retail andnine months ended September 30, 2003Group Benefits segments. Net income in the Retail segment increased, principally driven by growth in the variable annuity and mutual fund businesses as a result ofhigher revenues in the Investment Products segment and a decrease in realized capital losses reported in the Other category compared to the prior year comparable periods. Earned premiums in Investment Products increased due to higher sales in the institutional investment products business. Additionally, net investment income increased due to higher general accountincreasing assetsin the individual annuity business and growth in assets in the institutional investments business. Fee income in the Investment Products segment was higher for the third quarter ended September 30, 2003 as a result of higher average account values, specifically in individual annuities and mutual fund businesses, due primarily to stronger variable annuity sales and the higher equity market values compared to the prior year period.under management. Partially offsetting these increaseswerewas lowerfeespread income on market value adjusted (“MVA”) fixed annuities due to the adoption of the SOP. Net income in the Group Benefits segment increased due to earned premiums and net investment income growth, primarily resulting from the Company’s acquisition of the group life and accident, and short-term and long-term disability businesses of CNA Financial Corporation (“CNA Acquisition”).25
Partially offsetting the positive earnings drivers discussed above was the cumulative effect of accounting change from the Company’s adoption of the SOP. The adoption of the SOP also resulted in certain changes in presentation in the
COLI segment. The decreaseCompany’s financial statements, including reporting of the spreads on the Company’s MVA fixed annuities and variable annuity products offered inCOLIJapan on a gross basis in net investment incomefor the third quarterandnine months ended September 30, 2003 was primarily due to lower average leveraged COLI account values as compared to a year ago. In addition, COLI had lower fee income due in part to lower sales in the third quarter of 2003 and for the nine months ended September 30, 2003, as compared to the prior year comparable periods. Benefits, claims and expenses increased for the third quarter and nine months ended September 30, 2003 primarily due to increases in the Investment Products segment associated with the growth in the institutional investment business, partially offset by lower benefit costs in COLI related to the decline in the account valuesbenefits expense. Exclusive of theleveraged COLI business. For the third quarter ended September 30, 2003, COLI other expenses increased due to a $40 after-tax charge, associated with the settlementcumulative effect, overall application of theBancorp litigation.SOP resulted in an immaterial reduction in net income. (For further discussion of theBancorp litigation,impact of the Company’s adoption of the SOP see Note5(a)1 of Notes to Condensed Consolidated FinancialStatements.) Net income remained the same for the third quarter and increased for the nine months ended September 30, 2003 as compared to the prior year comparable periods. Net income has been favorably impacted by growth in the InvestmentStatements).Retail Products
segment and a decrease in net realized capital losses compared to a year ago. Additionally,GroupBenefits net income increased due principally to more favorable loss ratios as compared to the prior year. Partially offsetting these increases was a decrease in COLI net income of $31 for the nine months ended September 30, 2003, as compared to the prior year period. This decrease included the effects of a year over year increase in the charge for the Bancorp litigation, aggregating $29, and the positive $8 after-taxOperating Summary
First Quarter Ended March 31, 2004 2003 Change Fee income and other $ 506 $ 364 39 % Earned premiums (14 ) (9 ) (56 %) Net investment income 272 117 132 % Net realized capital (losses) gains (1 ) 6 NM
Total revenues763 478 60 % Benefits, claims and claim adjustment expenses 257 147 75 % Insurance operating costs and other expenses 175 132 33 % Amortization of deferred policy acquisition costs and present value of future profits 167 103 62 %
Total benefits, claims and expenses599 382 57 %
Income before income taxes and cumulative effect of accounting change164 96 71 % Income tax expense 38 19 100 %
Income before cumulative effect of accounting change126 77 64 %
Cumulative effect of accounting change, net of tax[1] (19 ) — NM
Net income$ 107 $ 77 39 %
March 31, March 31, 2004 2003 Change Individual variable annuity account values $ 90,386 $ 64,047 41 % Other individual annuity account values 11,312 10,602 7 % 401K and Specialty products account values 5,230 3,219 62 %
Total account values [2]106,928 77,868 37 % Mutual fund assets under management 22,977 14,328 60 %
Total assets under management$ 129,905 $ 92,196 41 %
S&P 500 Index value at end of period1,126 848 33 %
[1] For the quarter ended March 31, 2004, represents the cumulative impact recorded in the first quarter of 2002 related to favorable development on the Company's estimated September 11 exposure. The tax provision recorded during the nine months ended September 30, 2003, reflects a benefit of $30, consisting primarily of a change in estimate of the DRD tax benefit reported during 2002. The change in estimate was the result of actual 2002 investment performance on the related separate accounts being unexpectedly out of pattern with past performance, which had been the basis for the estimate. The total DRD benefit related to the 2003 tax year for the nine months ended September 30, 2003 was $65. Future net income for the Company will be affected by the effectiveness of the risk management strategies the Company has implemented to mitigate the net income volatility associated with the unreinsured GMWB rider currently being sold with the majority of new variable annuity contracts. The GMWB represents an embedded derivative in the variable annuity contract that is required to be reported separately from the host variable annuity contract. Beginning July 7, 2003, substantially all new contracts with the GMWB have not been covered by reinsurance. These unreinsured contracts are expected to generate volatility in net income as the underlying embedded derivative liabilities are recorded at fair value each reporting period, resulting in the recognition of net realized capital gains or losses in response to changes in certain critical factors including capital market conditions and policyholder behavior. In order to minimize the volatility associated with the unreinsured GMWB liabilities, the Company established an alternative risk management strategy. - 31 -During the third quarter of 2003, the Company began hedging its unreinsured GMWB exposure using interest rate futures, S&P 500 and NASDAQ index put options and futures contracts. The net impact to the Company's net income for the third quarter of the change in value of the embedded derivative net of the results of the hedging program was immaterial. - -------------------------------------------------------------------------------- INVESTMENT PRODUCTS - --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Fee income and other $ 459 $ 385 19% $ 1,243 $ 1,253 (1%) Earned premiums 393 96 NM 627 306 105% Net investment income 330 280 18% 962 778 24% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 1,182 761 55% 2,832 2,337 21% Benefits, claims and claim adjustment expenses 707 368 92% 1,552 1,068 45% Insurance operating costs and other expenses 165 157 5% 470 489 (4%) Amortizationofdeferred policy acquisition costs 145 108 34% 375 342 10% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 1,017 633 61% 2,397 1,899 26% - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 165 128 29% 435 438 (1%) Income tax expense 36 28 29% 67 103 (35%) - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 129 $ 100 29% $ 368 $ 335 10% - ------------------------------------------------------------------------------------------------------------------------------------ Individual variable annuity account values $ 77,572 $ 59,618 30% Other individual annuity account values 10,939 10,513 4% Other investment products account values 24,295 19,368 25% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ACCOUNT VALUES [1] 112,806 89,499 26% Mutual fund assets under management 18,900 14,092 34% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $ 131,706 $ 103,591 27% ====================================================================================================================================[1]the Company’s adoption of SOP 03-1.[2] Includes policyholder balances for investment contracts and reserves for future policy benefits for insurance contracts. RevenuesNet income in the
Investment ProductsRetail segment increased,for the third quarter and nine months ended September 30, 2003. The increase in earned premiums is due to higher sales of terminal fundingprincipally driven by significant growth in theinstitutional investment products business. Net investment income increased due to higher general account assets in the individual annuity business. General account individual annuity assets were $9.8 billion as of September 30, 2003, an increase of $2.2 billion, or 29%, from September 30, 2002, due to policyholders transfer activity and increased sales of individual annuities. Additionally, net investment income related to other investment products increased as a result of the growth in average assets over the last twelve months in the institutional investment business, where relatedassets under managementincreased $2.2 billion, or 22%, since September 30, 2002, to $11.9 billion as of September 30, 2003.within the variable annuity and mutual fund businesses. Assets under management is an internal performance measure used by theCompany since a significant portionsegment as relative profitability is highly correlated to the growth in assets under management which is driven by net flows and performance of theCompany's revenue is based upon asset values. These revenues increase or decrease with a rise or fall, respectively, in the level of average assets under management.equity markets. Fee incomeingenerated by theInvestment Products segment was higher for the third quarter ended September 30, 2003variable annuity operation increased, asa result of higheraverage account valuesspecificallyincreased inindividual annuities and mutual fund businesses, due primarily to stronger variable annuity sales andthehigher equity market valuesfirst quarter as compared to the prioryearyear. The increase in average account values can be attributed to approximately $8.6 billion of net flows over the past four quarters and growth in the equity markets, more specifically the average daily value of the S&P 500, which rose by approximately 31% in this time period.However,The Company uses the S&P 500 Index as an indicator for evaluating market returns of the underlying account portfolios. Another contributing factor to the increase in fee income wasslightly lower forthenine months ended September 30, 2003mutual fund business. Mutual fund assets under management increased due to equity market growth asthose average account valueswell as higher net sales, which werelower when$1.1 billion in the first quarter as compared to $132 in the first quarter of 2003.Partially offsetting the positive earnings drivers discussed above were the cumulative effect of accounting change from the Company’s adoption of the SOP and the resulting lower net income associated with the individual fixed annuity business. The decrease in net income in the individual fixed annuity business was attributed to a lower investment spread from the market value adjusted fixed annuity product in the first quarter of 2004 as compared to prior
year period. Totalyear. With the adoption of the SOP, the Company includes the investment return from the product in net investment income and includes interest credited to contract holders in the benefits, claims and claim adjustment expensesincreasedline on the income statement rather than reporting the net spread in fee income. Additionally, the ratio of DAC amortization to gross profits for thethird quarter and nine months ended September 30, 2003, primarily driven by growth in the institutional investments business. Additionally,individual annuity business (defined as amortization of deferred policy acquisition costsincreasedas a percentage of income before taxes and amortization of deferred policy acquisition costs) was slightly higher in the first quarter as compared to the prior year, which reduced net income.26
Institutional Solutions Group
Operating Summary
First Quarter Ended March 31, 2004 2003 Change Fee income and other $ 74 $ 77 (4 %) Earned premiums 109 100 9 % Net investment income 257 244 5 % Net realized capital gains 2 1 100 %
Total revenues442 422 5 % Benefits, claims and claim adjustment expenses 355 335 6 % Insurance operating costs and other expenses 37 36 3 % Amortization of deferred policy acquisition costs and present value of future profits 9 6 50 %
Total benefits, claims and expenses401 377 6 %
Income before income taxes and cumulative effect of accounting change41 45 (9 %) Income tax expense 12 14 (14 %)
Income before cumulative effect of accounting change29 31 (6 %)
Cumulative effect of accounting change, net of tax[1] (1 ) — NM
Net income$ 28 $ 31 (10 %)
March 31, March 31, 2004 2003 Change Institutional account values $ 12,941 $ 9,963 30 % Governmental account values 9,243 7,199 28 % Private Placement Life Insurance account values Variable products 21,305 19,863 7 % Leveraged COLI 2,537 3,159 (20 %)
Total account values [2]46,026 40,184 15 % Mutual fund assets under management 1,246 717 74 %
Total assets under management$ 47,272 $ 40,901 16 %
[1] For the quarter ended March 31, 2004, represents the cumulative impact of the Company’s adoption of SOP 03-1. [2] Includes policyholder balances for investment contracts and reserves for future policy benefits for insurance contracts. Net income for the
third quarter and nine months ended September 30, 2003 due to higher gross profits. Net income increased for the third quarter and nine months ended September 30, 2003. Net income was higher for the nine months ended September 30, 2003 dueInstitutional segment decreased as compared to thefavorable impact of $21, resulting from the Company's previously discussed change in estimate of the DRD tax benefit reported during 2002. The change in estimatecomparable prior year period. This decrease was the result of2002 actual investment performancelower earnings from the private placement life insurance business and the institutional business, which includes structured settlements and institutional annuities. Lower net income in private placement life insurance was due primarily to lower revenues earned as a result of lower account values in the leveraged COLI product due primarily to surrenders that occurred in 2003. The leveraged COLI product continues to contribute favorably to the segment’s profitability, although the contribution may decline in the future depending on therelated separate accounts being unexpectedly outsurrender activity ofpattern with past performance which had beenthese policies. In addition, thebasis forinstitutional business contributed lower earnings in theestimate. The total DRD benefit relatedfirst quarter of 2004 compared to the2003 tax year forsame period in 2003. This decrease was primarily thenine months ended September 30, 2003result of favorable mortality experienced in 2003. Partially offsetting these declines was$60. - 32 -- -------------------------------------------------------------------------------- INDIVIDUAL LIFE - --------------------------------------------------------------------------------a small increase in the net income before the cumulative effect of accounting change of the Governmental business when compared to the same period in 2003. This increase was primarily attributable to higher revenues earned from the growth in the average account values as a result of positive net flows and market appreciation since the first quarter of 2003.27
Individual Life
Operating Summary
First Quarter Ended March 31, 2004 2003 Change Fee income and other $ 186 $ 182 2 % Earned premiums (5 ) (4 ) (25 %) Net investment income 73 66 11 %
Total revenues254 244 4 % Benefits, claims and claim adjustment expenses 125 112 12 % Amortization of deferred policy acquisition costs and present value of future profits 39 46 (15 %) Insurance operating costs and other expenses 40 39 3 %
Total benefits, claims and expenses204 197 4 %
Income before income taxes and cumulative effect of accounting change50 47 6 % Income tax expense 16 15 7 %
Income before cumulative effect of accounting change34 32 6 %
Cumulative effect of accounting change, net of tax[1] (1 ) — NM
Net income$ 33 $ 32 3 %
March 31, March 31, 2004 2003 Change Variable universal life account values $ 4,797 $ 3,673 31 % Total account values $ 8,836 $ 7,583 17 %
Variable universal life insurance in force $ 67,101 $ 66,631 1 % Total life insurance in force $ 132,482 $ 127,029 4 %
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Fee income and other $ 190 $ 178 7% $ 556 $ 528 5% Earned premiums (4) (3) (33%) (14) (5) (180%) Net investment income 63 64 (2%) 191 197 (3%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 249 239 4% 733 720 2% Benefits, claims and claim adjustment expenses 117 104 13% 337 330 2% Insurance operating costs and other expenses 38 37 3% 116 116 -- Amortization[1] For the quarter ended March 31, 2004, represents the cumulative impact of deferred policy acquisition costs 42 49 (14%) 131 128 2% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 197 190 4% 584 574 2% - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 52 49 6% 149 146 2% Income tax expense 16 16 -- 45 47 (4%) - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 36 $ 33 9% $ 104 $ 99 5% ==================================================================================================================================== Variable life account values $ 4,284 $ 3,458 24% Total account values $ 8,247 $ 7,360 12% - ------------------------------------------------------------------------------------------------------------------------------------ Variable life insurance in force $ 66,561 $ 65,797 1% Total life insurance in force $ 128,462 $ 125,138 3% ====================================================================================================================================the Company’s adoption of SOP 03-1.RevenuesNet income in the Individual Life segment increased
forslightly as compared to thethird quarter and nine months ended September 30, 2003comparable prior year period. This increase was primarily driven byincreasesgrowth infeesaccount values andcost of insurance charges aslife insurancein force values grew,in-force andvariable life account values increased 24% fromfavorable equity market conditions. The impact of this growth was partially offset by higher mortality costs than the prior year.TheseHowever, the increased mortality costs reduced the amount of amortization of deferred policy acquisition costs recorded during the quarter. Net investment income increased partially due to the adoption of the SOP, which resulted in increaseswere partially offset by decreasesin net investment income andlower earned premiums. The decrease in investment income was due primarily to lower investment yields. The lower earned premiums were driven by higher ceded premiums and declining assumed premiums on the Fortis block of business. Totalbenefits, claims and claim adjustment expensesincreasedfor thethird quarter ended September 30, 2003 principallysegment’s Modified Guarantee Life Insurance product, which was formerly classified as a separate account product.Group Benefits
Operating Summary
First Quarter Ended March 31, 2004 2003 Change Earned premiums and other $ 915 $ 602 52 % Net investment income 89 68 31 % Net realized capital losses — (3 ) 100 %
Total revenues1,004 667 51 % Benefits, claims and claim adjustment expenses 684 489 40 % Amortization of deferred policy acquisition costs and present value of future profits 5 4 25 % Insurance operating costs and other expenses 252 131 92 %
Total benefits, claims and expenses941 624 51 %
Income before income taxes63 43 47 % Income tax expense 16 9 78 %
Net income$ 47 $ 34 38 %
Fully insured – ongoing premiums $ 905 $ 568 59 % Buyout premiums — 28 (100 %) Other 10 6 83 %
Earned premiums and other $ 915 $ 602 52 %
28
Net income in the Group Benefits segment increased due to
higher benefit costs when compared to the prior year favorable results. Year-to-date mortality was higher in 2003 largely due to the increased sizeearned premiums andage of the inforce business. Net income increased for the third quarter and nine months ended September 30, 2003 due to increases in fee income and growth in the in force business. These increases were partially offset by mortality experience and lowernet investment incomeforgrowth, both in thethird quarter and nine months ended September 30, 2003 compared toformer Group Benefits business as well as theequivalentresult of the CNA Acquisition. The increase in earned premiums was driven by sales of $341, a 54% increase over sales reported in the comparable prior yearperiods. Additionally, net income forperiod and favorable persistency. Although benefits, claims and claim adjustment expenses increased, thenine months ended September 30, 2003 includes the favorable impact of $2 DRD benefit resulting from the Company's previously discussed change in estimate of the DRD tax benefit reported during 2002. The total DRD benefit related to the 2003 tax year for the nine months ended September 30, 2003 was $3. - -------------------------------------------------------------------------------- GROUP BENEFITS - --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Earned premiums and other $ 597 $ 582 3% $ 1,772 $ 1,754 1% Net investment income 66 63 5% 196 189 4% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 663 645 3% 1,968 1,943 1% Benefits,segment’s loss ratio (defined as benefits, claims and claim adjustment expenses472 471 -- 1,412 1,431 (1%) Amortization of deferred policy acquisition costs 4 4 -- 13 11 18% Insurance operating costs and other expenses 137 127 8% 406 385 5% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 613 602 2% 1,831 1,827 -- - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 50 43 16% 137 116 18% Income tax expense 12 9 33% 30 24 25% - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 38 $ 34 12% $ 107 $ 92 16% ====================================================================================================================================Revenues increased for the third quarter and nine months ended September 30, 2003 primarily due to an increase in earned premiums. The Group Benefits segment had premium buyouts of $11 and $40 for the third quarter and nine months ended September 30, 2003 compared with $6 for both the third quarter and nine months ended September 30, 2002. Premiums, excluding buyouts, for the third quarter ended September 30, 2003 were higher primarily due to sales growth and improved persistency. Premiums, excluding buyouts, for the nine months ended September 30, 2003 were lower as a result of the Group Benefits division's continued pricing and risk management discipline in light of a challenging competitive and economic environment. - 33 -Total benefits, claims and expenses increased 2% for the third quarter and remained essentially flat for the nine months ended September 30, 2003 due to an increase in commission expenses and operating expenses, partially offset by lower loss costs for the nine months ended September 30, 2003 as compared to the equivalent prior year period. The segment's loss ratio (defined as benefits and claimsas a percentage of premiums and other considerations excluding buyouts) was79% for both the third75%, down from 80% in first quarterand nine months ended September 30,2003,respectively as comparedwhich contributed favorably to81% and 82% for the comparable prior year periods. Net income increased for the third quarter and nine months ended September 30, 2003 principallynet income. Partially offsetting these favorable items were higher commissions due tofavorable loss ratioshigher sales and premiums previously discussedabove. However, future net income growth will be dependent uponand sales from theGroup Benefits segment's ability to increase earned premiums and continue to control benefitCNA Acquisition. Additionally, operating costswithin pricing assumptions. - -------------------------------------------------------------------------------- CORPORATE OWNED LIFE INSURANCE ("COLI") - --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Fee income and other $ 64 $ 79 (19%) $ 201 $ 238 (16%) Net investment income 53 66 (20%) 169 213 (21%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 117 145 (19%) 370 451 (18%) Benefits, claims and claim adjustment expenses 78 108 (28%) 242 325 (26%) Insurance operating costs and expenses 72 15 NM 93 70 33% Dividends to policyholders 14 7 100% 53 27 96% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 164 130 26% 388 422 (8%) - ------------------------------------------------------------------------------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES (47) 15 NM (18) 29 NM Income tax expense (benefit) (17) 5 NM (7) 9 NM - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) $ (30) $ 10 NM $ (11) $ 20 NM ==================================================================================================================================== Variable COLI account values $ 20,557 $ 19,298 7% Leveraged COLI account values 2,602 3,601 (28%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ACCOUNT VALUES $ 23,159 $ 22,899 1% ====================================================================================================================================COLI revenues decreased for the third quarter and nine months ended September 30, 2003 due to lower net investment and fee income. Net investment income decreased, primarilyincreased due to thedecline in leveraged COLI account values as a result of surrender activity. Fee income was reduced as the result of lower sales for the third quarter and nine months ended September 30, 2003 as compared to the equivalent prior year periods. Total benefits, claims and expenses increased for the third quarter ended September 30, 2003 due primarily to a $40 after-tax expense related to the Bancorp litigation. Total benefits, claims and expenses decreased for the nine months ended September 30, 2003 primarily as a result of a decline in interest credited expenses due to lower general account assets and policy loans compared to prior year due to the declinegrowth in theleveraged COLI account values noted above. These decreases forsegment and thenine months ended September 30, 2003 were partially offset by anCNA Acquisition. Consistent with the increase in commissions and operating costs, the segment’s ratio of insurance operating costs and other expensesdue primarilytothe $40 after-tax expense relatedpremiums and other considerations (excluding buyouts) increased tothe Bancorp litigation expense recorded28%, from 23% in2003, compared with the $11 after-tax expense recorded in 2002. In addition, dividends to policyholders increased for the third quarter and nine months ended September 30, 2003 due to an increase in mortality dividends on the leveraged COLI product related primarily to surrender activity. Net income decreased for the third quarter and nine months ended September 30, 2003 as compared to the prior periods principally as a result2003. As part of theBancorp litigation expense. Excluding the expenses associated with the Bancorp litigation discussed above, net income was $10 for the third quarter ended September 30, 2003 and 2002, and was $29 and $31 for the nine months ended September 30, 2003 and 2002. This decline in net income for the nine months ended September 30, 2003 was principally related to the declineCNA Acquisition, a larger block of affinity business is now included in theleveraged COLIGroup Benefits segment in 2004. This businessdiscussed above. - 34 -- --------------------------------------------------------------------------------typically has lower expected loss ratios and higher expected commission ratios than other products within the business. Due to this change in business mix, the segment, as expected, has a lower loss ratio and higher commission ratio than in 2003.PROPERTY & CASUALTY
- --------------------------------------------------------------------------------Operating Summary
First Quarter Ended March 31, 2004 2003 Change Earned premiums $ 2,186 $ 2,166 1 % Net investment income 311 281 11 % Other revenues [1] 104 95 9 % Net realized capital gains (losses) 71 (1 ) NM
Total revenues2,672 2,541 5 % Benefits, claims and claim adjustment expenses Current year 1,469 1,504 (3 %) Prior year (51 ) 2,657 NM
Total benefits, claims and claim adjustment expenses 1,418 4,161 (66 %) Amortization of deferred policy acquisition costs 446 401 11 % Insurance operating costs and expenses 166 187 (11 %) Other expenses 163 133 23 %
Total benefits, claims and expenses2,193 4,882 (55 %)
Income (loss) before income taxes479 (2,341 ) NM Income tax expense (benefit) 138 (846 ) NM
Net income (loss) [2]$ 341 $ (1,495 ) NM
Ongoing Operations Underwriting Ratios [3]Loss and loss adjustment expense ratio Current year 66.8 69.9 3.1 Prior year (4.5 ) — 4.5
Total loss and loss adjustment expense ratio 62.2 69.9 7.7 Expense ratio 27.3 26.2 (1.1 ) Policyholder dividend ratio 0.3 0.5 0.2
Combined ratio 89.8 96.6 6.8 Catastrophe ratio (12.2 ) 2.7 14.9
Combined ratio before catastrophes 102.0 93.8 (8.2 ) Combined ratio before catastrophes and prior accident year development 92.7 93.8 1.1
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Earned premiums $ 2,268 $ 2,107 8% $ 6,540 $ 5,960 10% Net investment income 302 262 15% 878 787 12% Other revenues [1] 110 88 25% 318 257 24% Net realized capital gains (losses) 14 (42) NM 216 (80) NM - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 2,694 2,415 12% 7,952 6,924 15% Benefits, claims and claim adjustment expenses 1,622 1,505 8% 7,324 4,315 70% Amortization of deferred policy acquisition costs 431 405 6% 1,214 1,210 -- Insurance operating costs and expenses 230 232 (1%) 676 611 11% Other expenses 143 152 (6%) 464 412 13% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS, CLAIMS AND EXPENSES 2,426 2,294 6% 9,678 6,548 48% - ------------------------------------------------------------------------------------------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES 268 121 121% (1,726) 376 NM Income tax expense (benefit) 66 11 NM (692) 48 NM - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME (LOSS) [2] $ 202 $ 110 84% $ (1,034) $ 328 NM ==================================================================================================================================== NORTH AMERICAN PROPERTY & CASUALTY GAAP UNDERWRITING RATIOS - ------------------------------------------------------------------------------------------------------------------------------------ Loss ratio 59.8 59.1 (0.7) 59.7 59.6 (0.1) Loss adjustment expense ratio 11.6 10.9 (0.7) 11.9 11.2 (0.7) Expense ratio 27.5 28.0 0.5 26.8 28.3 1.5 Policyholder dividend ratio 0.4 0.7 0.3 0.4 0.7 0.3 Combined ratio 99.2 98.7 (0.5) 98.9 99.8 0.9 Catastrophe ratio 3.4 1.1 (2.3) 3.6 1.6 (2.0) Combined ratio before catastrophes 95.8 97.5 1.7 95.3 98.2 2.9 ====================================================================================================================================[1][1] Represents servicing revenue. [2][2] Includes net realized capital gains (losses), after-tax, of $9$47 and$(29)$0 for thethird quarterquarters endedSeptember 30,March 31, 2004 and 2003,and 2002, respectively, and $141 and $(53) for the nine months ended September 30, 2003 and 2002,respectively.[3] Excludes Other Operations. Revenues for Property & Casualty increased
$279$131 for thethirdfirst quarterand $1.0 billion forended March 31, 2004 compared with thenine months ended September 30,first quarter of 2003. Theimprovementincrease was due primarily to an increase inboth periodsnet realized capital gains (losses) and net investment income as well as earned premium growth. The increase in earned premiums in the Business Insurance and Personal Lines segments was due primarily to earnedpremiumpricing increases and new business growth. Partially offsetting the growth inthe Business Insurance andearned premiums was a decrease of $90 in Specialty Commercialsegments, primarily asearned premiums, reflecting aresult ofreduction in estimated earnedpricing increases, as well as an improvement in net realized capital gains and losses, and net investment income.premium under retrospectively-rated policies.Net income increased
$92 for the third quarter and decreased $1.4$1.8 billion for thenine monthsfirst quarter endedSeptember 30, 2003. The increase for the quarter was primarily due to an improvement in net realized capital gains and losses, an increase in net investment income and improved underwriting results in the Personal Lines segment. Strong earned pricing and favorable frequency loss costs resulted in an increase in underwriting results in Personal Lines, which offset a decrease in underwriting results in the Specialty Commercial segment. Net investment income, after-tax, rose $24 for the third quarter due to higher invested assets as a result of strong cash flows and additional capital raised during the second quarter of 2003. Partially offsetting these factors was an increase in after-tax catastrophe losses of $35, or 2.3 combined ratio points, for the third quarter, primarily due to losses related to Hurricane Isabel of $25, or 1.7 points. The $1.4 billion decrease in net income for the nine month period wasMarch 31, 2004, primarily due to the net asbestos reserve strengthening of $1.7 billion, after-tax, in the firstquarter.quarter ended March 31, 2003. Results for thenine month periodquarter also were favorably impacted byan increaseimproved underwriting results and increases in net realized capital gains (losses) andlosses and improved underwriting results in Personal Lines. In addition,net investment income. Pre-tax net investment incomeafter-tax,rose$56$30 for thenine months ended September 30, 2003quarter ending March 31, 2004, due to higher invested assets, primarily from strong cash flows.RATIOS29
Ratios
The previous table and the following segment discussions for the
third quarterquarters ended March 31, 2004 andnine months ended September 30,2003and 2002include variousunderwritingoperating ratios. Management believes that these ratios are useful in understanding the underlying trends in TheHartford's currentHartford’s insurance underwriting business. However, these measures should only be used in conjunction with, and not in lieu of, underwriting income and net income for the Property & Casualty segments and may not be comparable to other performance measures used by theCompany'sCompany’s competitors. The"loss ratio"“loss and loss adjustment expense ratio” is the ratio of claimsexpense (exclusive of claim adjustment expenses) to earned premiums. The "loss adjustment expense ratio" represents the ratio ofand claim adjustment expenses to earned premiums. The"expense ratio"“expense ratio” is the ratio of underwriting expensesexcluding bad debt expense,to earned premiums. The"policyholder“policyholder dividendratio"ratio” is the ratio of policyholder dividends to earned premiums. The"combined ratio"“combined ratio” is the sum of the lossratio, theand loss adjustment expense ratio, the expense ratio and the policyholder dividend ratio. These ratios are relative measurements that describe for every $100 of net premiums earned, the cost of losses and expenses,as defined above,respectively. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting losses. The"catastrophe ratio"“loss and loss expense paid ratio” represents the ratio of paid claims and claim adjustment expenses to earned premiums. The “catastrophe ratio” represents the ratio of catastrophe losses to earned premiums. A catastrophe is an event that causes $25 or more in industry insured property losses- 35 -and affects a significant number of property and casualty policyholders and insurers. WRITTEN PREMIUMSSee the Reserve section for explanation of prior accident year development.Premium Measures
Written premiums are a non-GAAP financial measure which
representsrepresent the amount of premiums charged for policies issued, net of reinsurance, during a fiscal period. Earned premiumsisare a GAAP measure. Premiums are considered earned and are included in the financial results on a pro rata basis over the policy period. The following segment discussions for thethird quarterquarters ended March 31, 2004 andnine months ended September 30,2003and 2002, respectively,include the presentation of written premiums in addition to earned premiums. Management believes that this performance measure is useful to investors as it reflects current trends in theCompany's saleCompany’s sales of property and casualty insurance products, as compared to earnedpremium.premiums. Premium renewal retention is defined as renewal premium written in the current period divided bynew and renewaltotal premium written in the prior period.Reinstatement premium represents additional ceded premium paid for the reinstatement of the amount of reinsurance coverage that was reduced as a result of a reinsurance loss payment under a catastrophe cover. RISK MANAGEMENT STRATEGY The Hartford's property and casualty operations have well-developed processes to manage catastrophic risk exposures to natural catastrophes, such as hurricanes and earthquakes, and other perils, such as terrorism. These processes involve establishing underwriting guidelines for both individual risk and in aggregate including individual policy limits and aggregate exposure limits by geographic zone and peril. The Company establishes exposure limits and actively monitors the risk exposures as a percent of North American property-casualty surplus. Generally the Company limits its exposure from a single 250-year event to less than 30% of surplus for losses prior to reinsurance and to less than 15% of surplus for losses net of reinsurance. The Company monitors exposures monthly and employs both internally developed and externally purchased loss modeling tools. The Hartford utilizes reinsurance to manage risk and transfer exposures to well-established and financially secure reinsurers. Reinsurance is used to manage both aggregate exposures as well as specific risks based on accumulated property and casualty liabilities in certain geographic zones. All treaty purchases are administered by a centralized function to support a consistent strategy and ensure that the reinsurance activities are fully integrated into the organization's risk management processes. A variety of traditional reinsurance products are used in the development and execution of the overall corporate risk management strategy. The risk transfer products used include both excess of loss occurrence-based products, protecting aggregate property and workers compensation exposures, and individual risk or quota share products, protecting specific classes or lines of business. Facultative reinsurance is also used to manage policy-specific risk exposures based on established underwriting guidelines. The Hartford also participates in governmentally administered reinsurance facilities such as the Florida Hurricane Catastrophe Fund ("FHCF"). To minimize the potential credit risk resulting from the use of reinsurance, a centralized group evaluates the credit standing of potential reinsurers and establishes the Company's schedule of approved reinsurers. The assessment process reviews reinsurers against a set of predetermined financial and management criteria and distinguishes between long-tail casualty and short-tail property business. A committee meets regularly to review activity with each reinsurer and affirm the schedule of approved reinsurers. REINSURANCE RECOVERABLES The Company's net reinsurance recoverables from various property and casualty reinsurance arrangements amounted to $5.5 billion and $4.2 billion at September 30, 2003 and December 31, 2002, respectively. Of the total net reinsurance recoverables as of December 31, 2002, $494 relates to the Company's mandatory participation in various involuntary assigned risk pools, which are backed by the financial strength of the property and casualty insurance industry. Of the remainder, $2.7 billion, or 72%, were rated by A.M. Best. Of the total rated by A.M. Best, 91% were rated A- (excellent) or better. The remaining $1.0 billion, or 28%, of net recoverables from reinsurers were comprised of the following: 9% related to Equitas, 6% related to voluntary pools, 1% related to captive insurance companies, and 12% related to companies not rated by A.M. Best, of which no single reinsurer constituted more than 0.75% of the Company's reinsurance recoverables. There have been no material changes to the distribution of net recoverables from reinsurers for the Company since December 31, 2002. Where its contracts permit, the Company secures future claim obligations with various forms of collateral including irrevocable letters of credit, New York Regulation 114 trusts, funds held accounts and group wide offsets. The allowance for unrecoverable reinsurance was $464 at September 30, 2003 and $211 at December 31, 2002. The significant increase was primarily related to the Company's asbestos reserve strengthening actions during the first quarter of 2003. RESERVESReserves
Reserving for property and casualty losses is an estimation process. As additional experience and other relevant claim data become available, reserve levels are adjusted accordingly. Such adjustments of reserves related to claims incurred in prior years are a natural occurrence in the loss reserving process and are referred to as
"reserve development"“reserve development”. Reserve development that increases previous estimates of ultimate cost is called"reserve strengthening"“reserve strengthening”. Reserve development that decreases previous estimates of ultimate cost is called"reserve releases"“reserve releases”. Reserve development can influence the comparability of year over year underwriting results and is set forth in the paragraphs and tables that follow. The"prior“prior accident yeardevelopment (pts.)"development” in the followingtables for the third quarter and nine months ended September 30, 2003table represents the ratio of reserve development to earned premiums. For a detailed discussion of theCompany'sCompany’s reserve policies, see Notes1(l),1, 7 and16(b)16 of Notes to Consolidated Financial Statements and the Critical Accounting Estimates section of the MD&A included in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report.- 36 -There was no significant reserve strengthening or release in the Business Insurance and Personal Lines segments for the third quarter and nine months ended September 30, 2003. Specialty Commercial strengthened prior accident year reserves by $45 in the third quarter and nine month periods as a result of losses in the bond and professional liability lines of business. There was no significant reserve strengthening or release in the Reinsurance segment for the third quarter ended September 30, 2003. For the nine month period, reserve strengthening of $94 in the Reinsurance segment occurred across multiple accident years, primarily 1997 through 2000, and principally in the casualty line of traditional reinsurance. In addition, the Other Operations segment for the nine months ended September 30, 2003 reflects the Company's net asbestos reserve strengthening of $2.6 billion duringDuring the first quarter of
2003.2004, the aggregate net reserve development relative to the Company’s Property & Casualty reserves was not material. The amount of reserve development in the first quarter for each of the Company’s Property & Casualty segments varied. During the first quarter of 2004, the Company completed a gross asbestos reserve evaluation. The evaluation indicated no change in the overall required gross asbestos reserves. It is anticipated that the related net reserve evaluation will be completed during the second quarter of 2004. The results of the gross study may not be an indication of what may result from the net study. Until the application of ceded reinsurance to the direct and assumed reserves and an assessment of collectibility are completed, the Company will not know the impact, if any, on the required net reserves.As indicated in the Company’s segment level reserve discussion in the 2003 Annual Report on Form 10-K, at the end of 2003 several areas of reserve exposure were being closely monitored. Consistent with the Company’s practices to regularly review its reserves, the Company continued to monitor these reserve exposures throughout the first quarter and completed several reserve studies, including studies related to September 11 reserves and construction defects claims. As a result of these monitoring activities and studies, the Company made reserve adjustments with regard to certain of those reserve exposures, most notably related to September 11, construction defects and certain assumed reinsurance reserves. These reserve adjustments and the effects on the Company’s segments are more fully discussed in the paragraphs that follow.
With respect to September 11 claim reserves, the Company observed continued favorable developments, including the closure of all but 44 primary insurance property cases, no additional significant anticipated loss notices on assumed reinsurance property treaties, a high participation rate within the Victim’s Compensation Fund and the expiration of the deadline for filing a liability claim in March 2004. Based on these sustained favorable events, the Company determined in the first quarter that it was appropriate to reduce both the gross and net estimate of loss from September 11. The Company’s gross estimate of loss of $1.1 billion was reduced to $845. Gross reserves remaining are $430. The corresponding reduction in net reserves for September 11 was $175 in Business Insurance, $116 in Specialty Commercial, $7 in Personal Lines and $97 in Other Operations. Net reserves remaining are $152. Most of the remaining September 11 net reserves carried by the Company relate to incurred but not reported (“IBNR”) reserves for workers compensation exposures.
The Company has exposure to losses from construction defects, particularly from contractors in California. The Company has been evaluating and closely monitoring these reserves over time. Based on the Company’s first quarter study that used various predictive models and reflected the increasing severity of construction defect claims, the Company concluded an increase in reserves of $190 was required. This increase consisted of $23 for Business Insurance and $167 for Specialty Commercial.
As indicated in the Company’s year-end 2003 reserve discussion, assumed casualty reinsurance reserves have been difficult to
30
project. The Company has been evaluating and closely monitoring these reserves over time and during 2003 and 2002 booked unfavorable reserve development of $129 and $77, respectively. Unfavorable trends continued in the first quarter of 2004 and, as a result, the Company increased reserves by $130. The majority of the $130 is for assumed casualty treaty reinsurance for the years 1997-2001, with $30 for certain alternative risk transfer contracts.
In addition to the foregoing reserve adjustments in the first quarter of 2004, within the Specialty Commercial segment, there were other offsetting positive and negative adjustments. The principal offsetting adjustments related to a strengthening in specialty large deductible workers compensation reserves and a release in other liability reserves, each approximately $150.
A rollforward of liabilities for unpaid claims and claim adjustment expenses by segment for the
thirdfirst quarterand nine monthsendedSeptember 30, 2003March 31, 2004 for Property & Casualtyis asfollows:
First Quarter Ended March 31, 2004 Business Insurance Personal Lines Specialty Commercial Ongoing Operations Other Operations Total P&C Beginning liabilities for unpaid claims and claim adjustment expenses-gross$ 5,296 $ 1,733 $ 5,148 $ 12,177 $ 9,538 $ 21,715 Reinsurance and other recoverables 395 43 2,096 2,534 2,963 5,497
Beginning liabilities for unpaid claims and claim adjustment expenses-net4,901 1,690 3,052 9,643 6,575 16,218
Add provision for unpaid claims and claim adjustment expensesCurrent year 626 533 293 1,452 17 1,469 Prior year [1] (147 ) 1 47 (99 ) 48 (51 )
Total provision for unpaid claims and claim adjustment expenses 479 534 340 1,353 65 1,418 Less payments [2] (447 ) (545 ) (258 ) (1,250 ) (1,176 ) (2,426 )
Ending liabilities for unpaid claims and claim adjustment expenses-net [1]4,933 1,679 3,134 9,746 5,464 15,210 Reinsurance and other recoverables 369 42 1,932 2,343 2,693 5,036
Ending liabilities for unpaid claims and claim adjustment expenses-gross [1]$ 5,302 $ 1,721 $ 5,066 $ 12,089 $ 8,157 $ 20,246
Earned premiums $ 1,018 $ 835 $ 321 $ 2,174 $ 12 $ 2,186 Loss and loss expense paid ratio 43.9 65.4 80.5 57.6 Loss and loss expense incurred ratio 47.1 64.1 105.2 62.2 Prior accident year development (pts.) (14.5 ) 0.1 14.9 (4.5 )
THIRD QUARTER ENDED SEPTEMBER 30, 2003 - ------------------------------------------------------------------------------------------------------------------------------------ NORTH BUSINESS PERSONAL SPECIALTY AMERICAN OTHER INSURANCE LINES COMMERCIAL REINSURANCE P&C OPERATIONS TOTAL P&C - ------------------------------------------------------------------------------------------------------------------------------------BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 5,057 $ 1,721 $ 4,675 $ 1,611 $ 13,064 $ 8,004 $ 21,068 Reinsurance and other recoverables 400 45 1,690 385 2,520 2,612 5,132 - ------------------------------------------------------------------------------------------------------------------------------------ BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 4,657 1,676 2,985 1,226 10,544 5,392 15,936 - ------------------------------------------------------------------------------------------------------------------------------------ Add: provision for unpaid claims and claim adjustment expenses 595 583 366 73 1,617 5 1,622 Less: payments 416 551 236 68 1,271 107 1,378 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 4,836 1,708 3,115 1,231 10,890 5,290 16,180 Reinsurance and other recoverables 429 44 1,800 411 2,684 2,580 5,264 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 5,265 $ 1,752 $ 4,915 $ 1,642 $ 13,574 $ 7,870 $ 21,444 - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums $ 947 $ 805 $ 434 $ 82 $ 2,268 $ -- $ 2,268 Combined ratio 96.4 95.1 110.7 111.3 99.2 Loss and loss expense paid ratio 44.1 68.6 54.6 82.1 56.2 Loss and loss expense incurred ratio 63.0 72.5 84.3 87.8 71.3 Catastrophe ratio 3.2 4.2 2.5 3.0 3.4 Prior accident year development (pts.) -- -- 10.4 -- 2.0 Prior accident year development ($) $ -- $ -- $ 45 $ -- $ 45 ==================================================================================================================================== NINE MONTHS ENDED SEPTEMBER 30, 2003 - ------------------------------------------------------------------------------------------------------------------------------------ NORTH BUSINESS PERSONAL SPECIALTY AMERICAN OTHER INSURANCE LINES COMMERCIAL REINSURANCE P&C OPERATIONS TOTAL P&C - ------------------------------------------------------------------------------------------------------------------------------------ BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,744 $ 1,692 $ 4,957 $ 1,614 $ 13,007 $ 4,084 $ 17,091 Reinsurance and other recoverables 366 49 1,998 388 2,801 1,149 3,950 - ------------------------------------------------------------------------------------------------------------------------------------ BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 4,378 1,643 2,959 1,226 10,206 2,935 13,141 - ------------------------------------------------------------------------------------------------------------------------------------ Add: provision for unpaid claims and claim adjustment expenses 1,754 1,725 871 324 4,674 2,650 7,324 Less: payments 1,296 1,660 715 319 3,990 295 4,285 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 4,836 1,708 3,115 1,231 10,890 5,290 16,180 Reinsurance and other recoverables 429 44 1,800 411 2,684 2,580 5,264 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 5,265 $ 1,752 $ 4,915 $ 1,642 $ 13,574 $ 7,870 $ 21,444 - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums $ 2,724 $ 2,362 $ 1,144 $ 296 $ 6,526 $ 14 $ 6,540 Combined ratio 96.7 95.6 101.5 135.2 98.9 Loss and loss expense paid ratio 47.6 70.2 62.6 107.6 61.2 Loss and loss expense incurred ratio 64.4 73.0 76.1 109.0 71.6 Catastrophe ratio 3.4 4.6 2.0 2.8 3.6 Prior accident year development (pts.) [1] -- -- 3.9 31.7 2.1 Prior accident year development ($) [1] $ -- $ -- $ 45 $ 94 $ 139 ====================================================================================================================================[1] In addition to prior year loss[1] The quarter ended March 31, 2004 included a net reserve development of $94, Reinsurance had $10 of earned premium in 2003 thatrelease related toexposure periods prior to 2003.- 37 -- -------------------------------------------------------------------------------- BUSINESS INSURANCE - --------------------------------------------------------------------------------
UNDERWRITING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Written premiums $ 987 $ 867 14% $ 2,951 $ 2,527 17% ChangeSeptember 11 of $175 inunearned premium reserve 40 72 (44%) 227 234 (3%) - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums 947 795 19% 2,724 2,293 19% Benefits,Business Insurance, $7 in Personal Lines, $116 in Specialty Commercial and $97 in Other Operations, an increase of $190 for construction defects claims, an increase in assumed casualty reinsurance reserves of $130, andclaim adjustment expenses 595 489 22% 1,754 1,452 21% Amortization of deferred policy acquisition costs 236 195 21% 654 575 14% Insurance operating costsoffsetting strengthening in large deductible workers compensation reserves andexpenses 96 90 7% 266 249 7% - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING RESULTS $ 20 $ 21 (5%) $ 50 $ 17 194% ==================================================================================================================================== Loss ratio 50.6 50.1 (0.5) 51.7 51.6 (0.1) Loss adjustment expense ratio 12.4 11.5 (0.9) 12.7 11.7 (1.0) Expense ratio 32.7 32.7 -- 31.4 32.7 1.3 Policyholder dividend ratio 0.8 1.6 0.8 0.8 1.5 0.7 Combined ratio 96.4 95.9 (0.5) 96.7 97.6 0.9 Catastrophe ratio 3.2 0.7 (2.5) 3.4 0.9 (2.5) Combined ratio before catastrophes 93.3 95.2 1.9 93.3 96.7 3.4 ==================================================================================================================================== THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------ WRITTEN PREMIUMS BREAKDOWN [1] - ------------------------------------------------------------------------------------------------------------------------------------ Small Commercial $ 454 $ 418 9% $ 1,393 $ 1,238 13% Middle Market 533 449 19% 1,558 1,289 21% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 987 $ 867 14% $ 2,951 $ 2,527 17% ==================================================================================================================================== EARNED PREMIUMS BREAKDOWN [1] Small Commercial $ 449 $ 391 15% $ 1,321 $ 1,142 16% Middle Market 498 404 23% 1,403 1,151 22% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 947 $ 795 19% $ 2,724 $ 2,293 19% ====================================================================================================================================[1] The difference between written premiums and earned premiums is attributablerelease in other liability reserves, each approximately $150.[2] Other Operations reflects payments pursuant to the change in unearned premium reserve.MacArthur settlement.Reinsurance Recoverables
The Company’s net reinsurance recoverables from various property and casualty reinsurance arrangements amounted to $5.2 billion and $5.4 billion at March 31, 2004 and December 31, 2003, respectively. Of the total net reinsurance recoverables as of December 31, 2003, $446 relates to the Company’s mandatory participation in various involuntary assigned risk pools, which are backed by the financial strength of the property and casualty insurance industry. Of the remainder, $3.5 billion, or 71%, were rated by A.M. Best. Of the total rated by A.M. Best, 92%, were rated A- (excellent) or better. The remaining $1.4 billion, or 29%, of net recoverables from reinsurers were comprised of the following: 5% related to voluntary pools, 2% related to captive insurance companies, and 22% related to companies not rated by A.M. Best. There have been no material changes to the distribution of net recoverables from reinsurers for the Company since December 31, 2003.
31
Where its contracts permit, the Company secures future claim obligations with various forms of collateral including irrevocable letters of credit, secured trusts such as New York Regulation 114 trusts, funds held accounts and group wide offsets.
The allowance for unrecoverable reinsurance was $348 and $381 at March 31, 2004 and December 31, 2003, respectively. The allowance for unrecoverable reinsurance is based on an assessment of the credit quality of our reinsurers as well as an estimate (if any) of the cost of resolution of reinsurer disputes.
In the second quarter, the Company expects to complete an updated study of the reinsurance recoverable asset associated with older, long-term casualty liabilities reported in the Other Operations segment, including asbestos liabilities. The Company has observed certain developments that could potentially have implications for its ability to recover reinsurance cessions of such liabilities, including recent trends in commutation activity between reinsurers and cedants and recent trends in arbitration and litigation outcomes in disputes between these parties. The Company is also analyzing recent changes in the mix of The Hartford’s estimated liabilities in the Other Operations segment to determine whether these have implications for its ability to cede liabilities.
Business Insurance
Underwriting Summary
First Quarter Ended March 31, 2004 2003 Change Written premiums $ 1,136 $ 990 15 % Change in unearned premium reserve 118 110 7 %
Earned premiums $ 1,018 $ 880 16 % Benefits, claims and claim adjustment expenses Current year 626 598 5 % Prior year (147 ) — —
Total benefits, claims and claim adjustment expenses 479 598 (20 %) Amortization of deferred policy acquisition costs 255 204 25 % Insurance operating costs and expenses 59 71 (17 %)
Underwriting results$ 225 $ 7 NM
Loss and loss adjustment expense ratio Current year 61.6 67.9 6.3 Prior year (14.5 ) — 14.5
Total loss and loss adjustment expense ratio 47.1 67.9 20.8 Expense ratio 30.3 30.5 0.2 Policyholder dividend ratio 0.4 0.8 0.4
Combined ratio 77.9 99.2 21.3 Catastrophe ratio (15.4 ) 4.6 20.0
Combined ratio before catastrophes 93.4 94.6 1.2 Combined ratio before catastrophes and prior accident year development 90.3 94.6 4.3
Premium Breakdown
Written Premiums [1] Earned Premiums [1] First Quarter Ended First Quarter Ended March 31, March 31, 2004 2003 Change 2004 2003 Change Small Commercial $ 560 $ 480 17 % $ 481 $ 430 12 % Middle Market 576 510 13 % 537 450 19 %
Total$ 1,136 $ 990 15 % $ 1,018 $ 880 16 %
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
Business Insurance achieved written premium growth of
$120$146 reflecting new business growth of 11% and$424 for the third quarter and nine months ended September 30, 2003, respectively, compared with the same periods in 2002. Growth for both periods was primarily due towritten pricing increases of9%4%. Premium renewal retention was 84% and 90% for thethirdfirst quarter ending March 31, 2004 and10%2003, respectively. Small commercial and middle market written premiums increased $80 and $66, respectively, as a result of new business growth and written pricing increases. Premium renewal retention remains strong in both small commercial and middle market.Earned premiums for the
nine month periodsegment increased $138 due to strong 2003 andstrong premium renewal retention of 85% and 88%, respectively, for the third quarter and nine months ended September 30, 2003. The written premium increases in middle market business of $84 and $269 for the third quarter and nine month periods, respectively, were driven primarily by continued strong2004 written pricingincreases and new business growth. Small commercial business increased $36 for the third quarter and $155 for the nine month period, reflecting strong written pricing increases and premium renewal retention.increases. Earned premiums increased$152 for the third quarter$87 and$431 for the nine months ended September 30, 2003 due to strong 2002 and 2003 written pricing increases impacting 2003 earned premium. Earned premiums$51 for middle marketbusiness increased $94and$252 for the third quarter and nine month periods, respectively, and earned premiums forsmall commercial,business increased $58 and $179 for the third quarter and nine months ended September 30, 2003,respectively, reflectingdouble-digitstrong earned pricing increases.Underwriting results
decreased $1 for the third quarter,improved $218, with a corresponding0.5 point increase in the combined ratio, and improved $33, with a corresponding 0.921.3 point decrease in the combined ratio, for thenine monthsfirst quarter endedSeptember 30, 2003. Both periods were negatively affectedMarch 31, 2004. The improvement was driven by asignificantdecrease in the loss and loss adjustment expense ratio due primarily to a reduction in reserves for September 11 of $175, which was partially offset by an increase in reserves of $23 for construction defects. These reserve actions represent 14.9 points of the 14.5 point favorable development in prior year losses. The catastrophelosses.ratio includes 17.2 points of favorable development related to the $175 decrease in September 11 reserves. Before this favorable32
impact, catastrophe losses in the first quarter of 2004 decreased by 2.8 points from the same period in the prior year. Before catastrophes and all prior accident year development, underwriting results
for the third quarter increased $24,improved $52 with a corresponding1.94.3 point decrease in the combinedratio, and, for the nine month period, underwriting results increased $106, withratio. The improvement was driven by acorresponding 3.4 pointdecrease in thecombinedloss and loss adjustment expense ratiocompared to the prior year periods. The improvement in underwriting results and combined ratio before catastrophes, for both 2003 periods, was driven by improvement in the loss ratio before catastrophesfor both small commercial and middle market, primarily due to improved frequency of loss anddouble-digitearned pricing increases.- 38 -- -------------------------------------------------------------------------------- PERSONAL LINES - --------------------------------------------------------------------------------
UNDERWRITING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Written premiums $ 845 $ 779 8% $ 2,469 $ 2,294 8% Change in unearned premium reserve 40 21 90% 107 76 41% - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums 805 758 6% 2,362 2,218 6% Benefits, claims and claim adjustment expenses 583 594 (2%) 1,725 1,735 (1%) Amortization of deferred policy acquisition costs 99 92 8% 303 316 (4%) Insurance operating costs and expenses 86 85 1% 242 215 13% - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING RESULTS $ 37 $ (13) NM $ 92 $ (48) NM ==================================================================================================================================== Loss ratio 61.4 67.0 5.6 61.8 66.5 4.7 Loss adjustment expense ratio 11.0 11.1 0.1 11.2 11.7 0.5 Expense ratio 22.6 23.0 0.4 22.6 23.5 0.9 Combined ratio 95.1 101.1 6.0 95.6 101.7 6.1 Catastrophe ratio 4.2 1.9 (2.3) 4.6 3.0 (1.6) Combined ratio before catastrophes 90.8 99.3 8.5 91.0 98.7 7.7 Other revenues [1] $ 32 $ 31 3% $ 92 $ 90 2% ====================================================================================================================================[1] Represents servicing revenues.
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- WRITTEN PREMIUMS BREAKDOWN [1] 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Business Unit AARP $ 537 $ 479 12% $ 1,562 $ 1,400 12% Other Affinity 35 43 (19%) 113 137 (18%) Agency 212 194 9% 599 559 7% Omni 61 63 (3%) 195 198 (2%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 845 $ 779 8% $ 2,469 $ 2,294 8% ==================================================================================================================================== Product Line Automobile $ 632 $ 587 8% $ 1,897 $ 1,774 7% Homeowners 213 192 11% 572 520 10% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 845 $ 779 8% $ 2,469 $ 2,294 8% ====================================================================================================================================
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- EARNED PREMIUMS BREAKDOWN [1] 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Business Unit AARP $ 499 $ 446 12% $ 1,446 $ 1,290 12% Other Affinity 40 48 (17%) 125 147 (15%) Agency 202 201 -- 599 594 1% Omni 64 63 2% 192 187 3% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 805 $ 758 6% $ 2,362 $ 2,218 6% - ------------------------------------------------------------------------------------------------------------------------------------ Product Line Automobile $ 620 $ 591 5% $ 1,828 $ 1,732 6% Homeowners 185 167 11% 534 486 10% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 805 $ 758 6% $ 2,362 $ 2,218 6% ==================================================================================================================================== COMBINED RATIOS Automobile 95.9 101.2 5.3 96.7 102.6 5.9 Homeowners 92.1 100.7 8.6 91.9 98.5 6.6 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL 95.1 101.1 6.0 95.6 101.7 6.1 ====================================================================================================================================[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.Personal Lines
Underwriting Summary
First Quarter Ended March 31, 2004 2003 Change Written premiums $ 836 $ 770 9 % Change in unearned premium reserve 1 (2 ) NM
Earned premiums $ 835 $ 772 8 % Benefits, claims and claim adjustment expenses Current year 533 540 (1 %) Prior year 1 — —
Total benefits, claims and claim adjustment expenses 534 540 (1 %) Amortization of deferred policy acquisition costs 125 104 20 % Insurance operating costs and expenses 70 72 (3 %)
Underwriting results$ 106 $ 56 89 %
Loss and loss adjustment expense ratio Current year 64.0 69.7 5.7 Prior year 0.1 — (0.1 )
Total loss and loss adjustment expense ratio 64.1 69.7 5.6 Expense ratio 23.3 23.0 (0.3 )
Combined ratio 87.4 92.7 5.3 Catastrophe ratio 0.8 1.4 0.6
Combined ratio before catastrophes 86.6 91.3 4.7 Combined ratio before catastrophes and prior accident year development 86.1 91.3 5.2 Other revenues [1] $ 29 $ 28 4 %
[1] Represents servicing revenue.
Premium Breakdown
Written Premiums [1] Earned Premiums [1] First Quarter Ended First Quarter Ended March 31, March 31, 2004 2003 Change 2004 2003 Change Business UnitAARP $ 523 $ 475 10 % $ 520 $ 466 12 % Other Affinity 34 42 (19 %) 36 44 (18 %) Agency 210 186 13 % 215 199 8 % Omni 69 67 3 % 64 63 2 %
Total$ 836 $ 770 9 % $ 835 $ 772 8 % Product LineAutomobile $ 649 $ 609 7 % $ 633 $ 598 6 % Homeowners 187 161 16 % 202 174 16 %
Total$ 836 $ 770 9 % $ 835 $ 772 8 % Combined RatiosAutomobile 90.1 96.1 6.0 Homeowners 78.7 80.8 2.1
Total87.4 92.7 5.3
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
Written premiums increased $66
for the third quarter and $175 for the nine months ended September 30, 2003, compared to the same periods in 2002,due to growth in both the automobile and homeowners lines. The increase in automobile of$45 for the third quarter and $123 for the nine month period$40 wasprimarilydue to strong new business growth and written pricing increases of6% and 8% for the third quarter and nine month period, respectively.4%. Automobile premium renewal retentionremained strong at 91%was 88% and 90% for thethirdfirst quarter ending March 31, 2004 and92% for the nine months ended September 30, 2003.2003, respectively. Homeowners growth of$21 for the third quarter and $52 for the - 39 -nine month period$26 was also largely driven by increased new business and written pricing increases of14% and 15%, respectively.10%. Homeowners premium renewal retentioncontinued to be strongwas 101% and 103% for thethirdfirst quarter ending March 31, 2004 andnine months ended September 30, 2003.2003, respectively. The increases in both automobile and homeowners written premiumsfor both periodswere primarily due to growth in the AARPprogram.program and the agency business unit. AARP increased$58 for the third quarter$48 and$162 for the nine month periodagency increased $24, primarily as a result of strong new business growth and written pricing increases. Although written premium growth in agency increased 13%, this increase reflects the dampening effects of the Company’s conversion from twelve to six-month policies written under a new automobile class plan product. Partially offsetting the33
increase in written premiums for the Personal Lines segment was
ana $8 decreasefor the third quarter and a $24 decrease for the nine month periodin written premiums in other affinitybusinessdue toa plannedan expected reduction in policycounts as a result of the Company's strategic decision to de-emphasize other affinity business.counts. Earned premiums increased$47 for the third quarter and $144 for the nine months ended September 30, 2003$63 due primarily to growth in AARP. AARP increased$53 and $156 for the third quarter and nine month periods, respectively,$54 primarily as a result of earned pricing increases.Underwriting results increased $50, with a corresponding
6.05.3 point decrease in the combinedratio, for the third quarter and improved $140, with a corresponding 6.1 point decrease in the combined ratio, for the nine month period. The improvement was primarily due to the successful execution of the segment's state-specific strategies to manage pricing and loss costs.ratio. Automobile results improved5.36.0 combined ratio pointsfor the quarterdue to earned pricing increases. The underwriting experience related to homeowners continued to remain favorable and5.9improved 2.1 combined ratio pointsforover thenine monthprior year period due primarily to double-digit earned pricing increases and favorablefrequencylosscosts. Homeowners results improved 8.6 combined ratio points forfrequency.Specialty Commercial
Underwriting Summary
First Quarter Ended March 31, 2004 2003 Change Written premiums $ 426 $ 406 5 % Change in unearned premium reserve 105 51 106 %
Earned premiums $ 321 $ 355 (10 %) Benefits, claims and claim adjustment expenses Current year 293 265 11 % Prior year 47 — —
Total benefits, claims and claim adjustment expenses 340 265 28 % Amortization of deferred policy acquisition costs 61 56 9 % Insurance operating costs and expenses 30 29 3 %
Underwriting results$ (110 ) $ 5 NM
Loss and loss adjustment expense ratio Current year 90.3 75.1 (15.2 ) Prior year 14.9 — (14.9 )
Total loss and loss adjustment expense ratio 105.2 75.1 (30.1 ) Expense ratio 28.1 22.6 (5.5 ) Policyholder dividend ratio 0.8 0.7 (0.1 )
Combined ratio 134.1 98.4 (35.7 ) Catastrophe ratio (35.6 ) 0.9 36.5
Combined ratio before catastrophes 169.7 97.5 (72.2 ) Combined ratio before catastrophes and prior accident year development 117.5 97.5 (20.0 ) Other revenues [1] $ 74 $ 67 10 %
[1] Represents servicing revenue.
Premium Breakdown
Written Premiums [1] Earned Premiums [1] First Quarter Ended First Quarter Ended March 31, March 31, 2004 2003 Change 2004 2003 Change Property 83 97 (14 %) 87 89 (2 %) Casualty 192 187 3 % 81 148 (45 %) Bond 48 45 7 % 44 42 5 % Professional Liability 78 65 20 % 82 64 28 % Other 25 12 108 % 27 12 125 %
Total$ 426 $ 406 5 % $ 321 $ 355 (10 %)
[1] The difference between written premiums and earned premiums is attributable to the
quarter and 6.6 points for the nine month period due primarily to earned pricing increases and favorable frequency loss costs. Personal Lines financial performance was negatively affected by pre-tax catastrophe increases of $20, or 2.3 points, for the third quarter and $43, or 1.6 points, for the nine month period due largely to Hurricane Isabel. - -------------------------------------------------------------------------------- SPECIALTY COMMERCIAL - --------------------------------------------------------------------------------
UNDERWRITING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Written premiums $ 469 $ 383 22% $ 1,274 $ 1,028 24% Change in unearned premium reserve 35 26 35% 130 158 (18%) - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums 434 357 22% 1,144 870 31% Benefits, claims and claim adjustment expenses 366 247 48% 871 597 46% Amortization of deferred policy acquisition costs 78 73 7% 189 189 -- Insurance operating costs and expenses 40 34 18% 138 83 66% - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING RESULTS $ (50) $ 3 NM $ (54) $ 1 NM ==================================================================================================================================== Loss ratio 72.6 57.8 (14.8) 63.7 56.2 (7.5) Loss adjustment expense ratio 11.7 11.4 (0.3) 12.4 12.4 -- Expense ratio 25.9 28.1 2.2 24.7 29.4 4.7 Policyholder dividend ratio 0.6 0.5 (0.1) 0.7 0.6 (0.1) Combined ratio 110.7 97.8 (12.9) 101.5 98.6 (2.9) Catastrophe ratio 2.5 0.5 (2.0) 2.0 0.3 (1.7) Combined ratio before catastrophes 108.2 97.4 (10.8) 99.5 98.3 (1.2) Other revenues [1] $ 78 $ 57 37% $ 226 $ 167 35% ====================================================================================================================================[1] Represents servicing revenues.
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- WRITTEN PREMIUMS BREAKDOWN [1] 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Property $ 147 $ 139 6% $ 360 $ 335 7% Casualty 179 156 15% 515 428 20% Bond 42 43 (2%) 123 119 3% Professional Liability 93 71 31% 236 164 44% Other 8 (26) NM 40 (18) NM - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 469 $ 383 22% $ 1,274 $ 1,028 24% ==================================================================================================================================== EARNED PREMIUMS BREAKDOWN [1] Property $ 140 $ 118 19% $ 325 $ 251 29% Casualty 165 141 17% 454 353 29% Bond 33 39 (15%) 110 110 - Professional Liability 77 57 35% 213 145 47% Other 19 2 NM 42 11 NM - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 434 $ 357 22% $ 1,144 $ 870 31% ====================================================================================================================================[1] The difference betweenchange in unearned premium reserve.Specialty Commercial written
premiums and earned premiums is attributable to the change in unearned premium reserve.- 40 -Writtenpremiums increased$86 and $246$20, driven by an increase in professional liability, partially offset by a reduction in premium renewal retention in property. The increase in written premiums forthe third quarter and nine months ended September 30, 2003, respectively, compared with the same periods in 2002professional liability is primarily due todouble-digita decrease in the portion of risks ceded to reinsurers, offset in part by a decrease in written pricing and a decrease in premium renewal retention. Casualty experienced written pricing increases of 11 to 15%, offset by a decrease in renewal retention. Within the “other” category, written premiums increased due to increased premiums on internal reinsurance arrangements.Premiums receivable under retrospectively-rated policies were reduced by $90, reflecting a decrease in estimated earned premiums under the terms of these policies. This reduction in retrospective premiums receivable, which is based on the Company’s most recent estimates, was reflected as a reduction in earned premiums in the first quarter of 2004, which is the main cause of the $34 decrease in earned premiums. Partially offsetting the decrease in earned premiums was growth in the casualty and professional
liability. Professionalliabilitywritten premiums grew $22 for the third quarter and $72 for the nine month period due to significant written pricing increases. Written premiums for casualty increased $23 and $87 for the third quarter and nine month period, respectively, due primarily to strong written pricing increases and new business growth as a result of an improved operating environment. While property pricing has begun to turn negative, written premiums increased $8 and $25 for the third quarter and nine months ended September 30, 2003, respectively. Bond growth for both periods was negatively impacted by ceded reinstatement premium. Earned premiums increased $77 and $274 for the third quarter and the nine month periods, respectively, due to earned premium growth across substantially alllines of business as a result of strong earned pricing increases.Underwriting results
deteriorated $53decreased $115 for thethirdfirst quarterand $55 foras compared with thenine months ended September 30, 2003, respectively,same prior year period, due primarily to the $90 decrease in earned premiums under retrospectively-rated policies and net unfavorable prior accident year loss development. Prior accident year loss development of $47 for the first quarter included $167 of reserve strengthening for34
construction defect claims, a release of
$20$116 in September 11 reserves, and strengthening in large deductible workers compensation reserves and a release in other liability reserves, each approximately $150. The combined effect of all prior accident year loss development and earned premium adjustment on retrospectively-rated policies caused a 34.7 point increase in thebondtotal loss and$25 in the professional liability lines of businessloss expense ratio, andhigher catastrophes compared to unusually low catastrophes in the prior periods. The bond reserve strengthening is isolated toafew severe contract surety claims related to accident year 2002. The professional liability reserve strengthening involved a provision for anticipated settlements of reinsurance obligations for contracts outstanding at the time of the original acquisition of Reliance Group Holdings' auto residual value portfolio in the third quarter of 2000. In addition, an increase in doubtful accounts expense of $27 contributed to the decrease in underwriting results for the nine months ended September 30, 2003. Excluding catastrophes, property underwriting results continued to be favorable due to earned pricing increases. Casualty continued to show underwriting improvement over prior year. The Specialty Commercial combined ratio deteriorated 12.9 points and 2.9 points for the third quarter and nine months ended September 30, 2003, respectively, due primarily to the reserve strengthening and higher catastrophes referenced above, partially mitigated by strong earned pricing and prudent expense management. - -------------------------------------------------------------------------------- REINSURANCE - --------------------------------------------------------------------------------
UNDERWRITING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Written premiums $ 19 $ 167 (89%) $ 194 $ 550 (65%) Change in unearned premium reserve (63) (11) NM (102) 29 NM - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums 82 178 (54%) 296 521 (43%) Benefits, claims and claim adjustment expenses 73 132 (45%) 324 394 (18%) Amortization of deferred policy acquisition costs 18 44 (59%) 68 130 (48%) Insurance operating costs and expenses 1 6 (83%) 9 14 (36%) - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING RESULTS $ (10) $ (4) (150%) $ (105) $ (17) NM ==================================================================================================================================== Loss ratio 82.0 68.3 (13.7) 101.5 71.0 30.5) Loss adjustment expense ratio 5.8 6.2 0.4 7.5 4.7 (2.8) Expense ratio 23.5 27.6 4.1 26.2 27.5 1.3 Combined ratio 111.3 102.2 (9.1) 135.2 103.2 (32.0) Catastrophe ratio 3.0 1.2 (1.8) 2.8 0.7 (2.1) Combined ratio before catastrophes 108.2 101.0 (7.2) 132.4 102.5 (29.9) ====================================================================================================================================
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- WRITTEN PREMIUMS BREAKDOWN [1] 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Traditional reinsurance $ 17 $ 162 (90%) $ 156 $ 468 (67%) Alternative risk transfer ("ART") 2 5 (60%) 38 82 (54%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 19 $ 167 (89%) $ 194 $ 550 (65%) ==================================================================================================================================== EARNED PREMIUMS BREAKDOWN [1] Traditional reinsurance $ 70 $ 155 (55%) $ 261 $ 450 (42%) Alternative risk transfer ("ART") 12 23 (48%) 35 71 (51%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 82 $ 178 (54%) $ 296 $ 521 (43%) ====================================================================================================================================[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.On May 16, 2003, as part of the Company's decision to withdraw from the assumed reinsurance business, the Company entered into a quota share and purchase agreement with Endurance Reinsurance Corporation of America ("Endurance"), whereby the Reinsurance segment retroceded the majority of its inforce book of business as of April 1, 2003 and sold renewal rights to Endurance. Under the quota share agreement, Endurance will reinsure most of the segment's assumed reinsurance contracts that were written on or after January 1, 2002 and that had unearned premium as of April 1, 2003. In consideration for Endurance reinsuring the unearned premium as of April 1, 2003, the Company paid Endurance an amount equal to unearned premium - 41 -less the related unamortized commissions/deferred acquisition costs and an override commission which was established by the contract. In addition, Endurance will pay a profit sharing commission based on the loss performance of property treaty, property catastrophe and aviation pool unearned premium. Under the purchase agreement, Endurance will pay additional amounts, subject to a guaranteed minimum of $15, based on the level of renewal premium on the reinsured contracts over the next two years. The guaranteed minimum is reflected in net income for the nine months ended September 30, 2003. The Company remains subject to reserve development relating to all retained business. Reinsurance written premiums decreased $148 for the third quarter and $356 for the nine months ended September 30, 2003 and earned premiums decreased $96 and $225 for the third quarter and nine month periods, respectively, primarily due to the Company's decision to withdraw from most of the assumed reinsurance business as discussed above. The decrease in written premiums for the nine months ended September 30, 2003 also reflects the $145 cession of the unearned premium to Endurance related to contracts written by the Company prior to April 1, 2003. Underwriting results decreased $6, with a corresponding 9.141.1 point increase in the combined ratio. Before considering the $116 release in September 11 reserves, the catastrophe ratioforwas 0.6 points, which is down slightly from thethird quarter primarily due toprior year period.Before catastrophes, all prior year accident development, and the
impacts of the Company's decision to withdraw from most of the assumed reinsurance business. For the nine month period,earned premium adjustment on retrospectively-rated policies, underwriting resultsdecreased $88,improved $24 with a corresponding32.05.8 pointincreasedecrease in the combined ratio primarilyas a result of adverse loss development ondue to underwriting improvement over the priorunderwriting years, primarily 1997 through 2000, particularlyyear period in the casualty and professional liability lines oftraditional reinsurance. - -------------------------------------------------------------------------------- OTHER OPERATIONS (INCLUDING ASBESTOS AND ENVIRONMENTAL CLAIMS) - --------------------------------------------------------------------------------business.
UNDERWRITING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------- ----------------------------------- 2003 2002 CHANGE 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Written premiums $ (2) $ 9 NM $ 11 $ 48 (77%) Change in unearned premium reserve (2) (10) 80% (3) (10) 70% - ------------------------------------------------------------------------------------------------------------------------------------ Earned premiums -- 19 (100%) 14 58 (76%) Benefits, claims and claim adjustment expenses 5 43 (88%) 2,650 137 NM Insurance operating costs and expenses 7 18 (61%) 21 50 (58%) - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING RESULTS $ (12) $ (42) 71% $ (2,657) $ (129) NM ====================================================================================================================================Other Operations (Including Asbestos and Environmental Claims)
First Quarter Ended March 31, Operating Summary 2004 2003 Change Written premiums $ (1 ) $ 281 NM Change in unearned premium reserve (13 ) 122 NM
Earned premiums 12 159 (92 %) Benefits, claims and claim adjustment expenses Current year 17 101 (83 %) Prior year 48 2,657 (98 %)
Total benefits, claims and claim adjustment expenses 65 2,758 (98 %) Amortization of deferred policy acquisition costs 5 37 (95 %) Insurance operating costs and expenses 7 15 (33 %)
Underwriting results$ (65 ) $ (2,651 ) 98 %
The Other Operations segment includes operations that are under a single management structure, Heritage Holdings, which is responsible for two related activities. The first activity is the management of certain subsidiaries and operations of The Hartford that have discontinued writing new business. The second is the management of claims (and the associated reserves) related to asbestos and environmental exposures. Effective January 1, 2004, the financial results of the Company’s Reinsurance segment are reported in Other Operations and 2003 results of operations have been reclassified to reflect this change.
The decline in written and earned premiums
forin thethirdfirst quarterand nine months ended September 30, 2003was due to therunoffCompany’s decision to exit the assumed domestic reinsurance business in May 2003. The Company entered into a quota share and purchase agreement with Endurance Reinsurance Corporation of America (“Endurance”), whereby the majority of theinternationalCompany’s inforce book of business was retroceded as of April 1, 2003 to Endurance. Under the quota share agreement, Endurance reinsured most of the assumed reinsurancebusinesscontracts thatwas transferredwere written by the Company on or after January 1, 2002 and that had unearned premium as of April 1, 2003. The Company remains subject tothe Other Operations segment in January 2002.ongoing reserve development relating to all retained business.The underwriting loss in 2003 reflects $2.6 billion of asbestos reserve strengthening. As indicated in the Company’s first quarter of 2004 reserves discussion, for Other Operations, September 11 net reserves were reduced by $97 and assumed reinsurance reserves, primarily for casualty business written during the
nine months ended September 30,1997 – 2001 period and certain alternative risk transfer contracts, were increased by $130.On December 19, 2003,
was due primarily toHartford Accident and Indemnity Co. (“Hartford A&I”) entered into a settlement agreement with MacArthur Co. and its subsidiary, Western MacArthur Co. Under the settlement agreement, during the first quarternet reserve strengtheningof$2.62004, Hartford A&I paid $1.15 billion into an escrow account owned by Hartford A&I. The funds were held in an escrow account until conditions precedent to the settlement occurred in April. On April 22, 2004, the funds were disbursed from the escrow account into a trust established for the benefit of present and future asbestos claimants pursuant to the bankruptcy plan. The settlement payments have been accounted for asdiscusseda reduction in unpaid claim and claim adjustment expenses during thesection that follows.first quarter of 2004. Because the escrow funds would have reverted back to Theparagraphs that followHartford’s ownership if the conditions precedent had not occurred, the $1.15 billion payment also resulted in an increase in both other assets and other liabilities as of March 31, 2004. These will decrease in an equal amount when the escrowed funds arebackground information and a discussion of asbestos and environmental claims,paid into thedeteriorating trends with respect to asbestos, and a summary of the Company's detailed study of asbestos reserves.trust.Asbestos and Environmental Claims
The Hartford continues to receive asbestos and environmental claims, both of which affect Other Operations. These claims are made pursuant to several different categories of insurance coverage. First, The Hartford wrote direct policies as a primary liability insurance carrier. Second, The Hartford wrote direct excess insurance policies providing additional coverage for insureds that exhaust their underlying liability insurance coverage. Third, The Hartford acted as a reinsurer assuming a portion of risks previously assumed by other insurers writing primary, excess and reinsurance coverages. Fourth, The Hartford participated as a London Market company that wrote both direct insurance and assumed reinsurance business.With regard to both environmental and particularly asbestos claims, significant uncertainty limits the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses. Traditional actuarial reserving techniques cannot reasonably estimate the ultimate cost of these claims, particularly during periods when theories of law are in flux.
As a result of the factors discussed in the following paragraphs, theThe degree of variability of reserve estimates for these exposures is significantly greater than for other more traditional exposures. In particular, TheHartfordCompany believes there is a high degree of uncertainty inherent in the estimation of asbestos loss reserves.In the case of the reserves for asbestos exposures, factors contributing to the high degree of uncertainty include inadequate development patterns,
plaintiffs'plaintiffs’ expanding theories of liability, the risks inherent in major litigation, and inconsistent emerging legal doctrines.Courts have reached inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are covered; whether there is an insurer obligation to defend; how policy limits are applied; whether particular claims are product/completed operation claims subject to an aggregate limit; and how policy exclusions and conditions are applied and interpreted.Furthermore, insurers in general, includingThe Hartford,the Company, have recently experienced an increase in the number of asbestos-related claims due to, among other things,more intensive advertising by lawyers seeking asbestos claimants, plaintiffs'plaintiffs’35
increased focus on new and previously peripheral defendants, and an increase in the number of insureds seeking bankruptcy protection as a result of
asbestos- - 42 -relatedasbestos-related liabilities. Plaintiffs and insureds have sought to use bankruptcy proceedings, including"pre-packaged"“pre-packaged” bankruptcies, to accelerate and increase loss payments by insurers. In addition, some policyholders havebegun to assertasserted new classes of claims for so-called"non-product"“non-products” coverages to which an aggregate limit of liability may not apply. Recently, many insurers, including The Hartford, also have been sued directly by asbestos claimants asserting that insurers had a duty to protect the public from the dangers of asbestos. Management believes these issues are not likely to be resolved in the near future.Further uncertainties include
the effect of the recent acceleration in the rate of bankruptcy filings by asbestos defendants on the rate and amount of The Hartford's asbestos claims payments; a further increase or decrease in asbestos and environmental claims that cannot now be anticipated;whether somepolicyholders'policyholders’ liabilities will reach the umbrella or excesslayerlayers of their coverage; the resolution or adjudication of some disputes pertaining to the amount of available coverage for asbestos claims in a manner inconsistent with TheHartford'sHartford’s previous assessment of these claims; insolvencies of other carriers; the number and outcome of direct actions against The Hartford; and unanticipated developments pertaining to TheHartford'sHartford’s ability to recover reinsurance for asbestos and environmental claims. It is also not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. It is unknown whethera potential Federal bill concerning asbestos litigation approved by the Senate Judiciary Committee, or some otherpotential Federal asbestos-related legislation will be enacted and, if so, what its effect will be on TheHartford'sHartford’s aggregate asbestos liabilities.Additionally, theThe reporting pattern for excess insurance and reinsurance claims is much longer than for direct claims. In many instances, it takes months or years to determine that the policyholder’s own obligations have been met and how the reinsurance in question may apply to such claims. The delay in reporting excess and reinsurance claims adds to the uncertainty of estimating the related reserves.
In the case of the reserves for environmental exposures, factors contributing to the high degree of uncertainty
include:include court decisions that have interpreted the insurance coverage to be broader than originally intended; inconsistent decisions, especially across jurisdictions; and uncertainty as to the monetary amount being sought by the claimant from the insured.Given the factors and emerging trends described above, The Hartford believes the actuarial tools and other techniques it employs to estimate the ultimate cost of claims for
more traditionalother kinds of insurance exposure are less precise in estimating reserves for its asbestos and environmental exposures.The HartfordFor this reason, the Company relies on an exposure based analysis to estimate the ultimate costs of these claims and regularly evaluates new information in assessing its potential asbestos and environmental exposures.Reserve Activity
Reserves and reserve activity in the Other Operations segment are categorized and reported as asbestos, environmental or
"all other"“all other” activity. The following discussion below relates to reserves and reserve activity, net of applicable reinsurance.There are a wide variety of claims that drive the reserves
associated with asbestos, environmental and the "all other"within each categorythe Company has included inof Other Operations. Asbestos claims relate primarily to bodily injuries asserted by those who came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up costs. Theall other“all other” category of reserves covers a wide range of insurance and reinsurance coverages, including potential liability for breast implants, blood products, construction defects,andlead paintas well as unallocated loss adjustment expense for the Other Operations segment.and other long-tail liabilities.The Other Operations
historicbook of business contains policies written from the1940's1940’s to1992, with the majority of the business spanning the interval 1960 to 1990.2003. TheHartford'sHartford’s experience has been that this book of business has over time produced significantly higher claims and losses than were contemplated at inception. The areas of active claim activity have also shifted based on changes in plaintiff focus and the overall litigation environment. A significant portion of the claim reserves of the Other Operations segment relates to exposure to the insurance businesses of other insurers or reinsurers("(“wholeaccount"account” exposure). Many of these whole account exposures arise from reinsurance agreements previously written by The Hartford. TheHartford'sHartford’s net exposure in these arrangements has increased for a variety of reasons, including TheHartford'sHartford’s commutation of previous retrocessions of such business. Due to the reporting practices of cedants to their reinsurers, determination of the nature of the individual risks involved in these whole account exposures (such as asbestos, environmental, or other exposures) requires various assumptions and estimates, which are subject to uncertainty, as previously discussed.In the first quarter of 2003, several events occurred that in the Company's view confirmed the existence of a substantial long-term deterioration in the asbestos litigation environment. For example, in February 2003, Combustion Engineering, long a major asbestos defendant, filed a pre-packaged bankruptcy plan under which it proposed to emerge from bankruptcy within five weeks, before opponents of the plan could have a meaningful opportunity to object, and included many novel features in its plan that its insurers found objectionable. In December 2002, Halliburton had announced its intention to file a similar plan through one or more subsidiaries, although it has not yet filed, and in January 2003, Honeywell announced that it had reached an agreement with the plaintiffs' bar that would enable it to file a pre-negotiated plan through its former NARCO subsidiary, then already in bankruptcy. In January 2003, Congoleum, a floor tile manufacturer, which previously had defended claims successfully in the tort system, announced its intention to file a pre-packaged plan of reorganization to be funded almost entirely with insurance proceeds. Moreover, prominent members of the plaintiffs' and policyholders' bars announced publicly their intention to file many more such plans. These events represented a worsening of conditions the Company observed in 2002, which were described in the Company's 2002 Form 10-K Annual Report. As a result of these worsening conditions, the Company conducted a comprehensive, ground-up study of its asbestos exposures in the first quarter of 2003 in an effort to project, beginning at the individual account level, the effect of these trends on the Company's estimated total exposure to asbestos liability. Based on the results of the study and the Company's reevaluation of the deteriorating conditions described above, the Company strengthened its gross and net asbestos reserves by $3.9 billion and $2.6 billion, respectively. The Company believes that its current asbestos reserves are reasonable and appropriate. However, analyses of future developments could cause The Hartford to change its estimates of its asbestos and environmental reserves and the effect of these changes could be material to the Company's consolidated operating results, financial condition and liquidity.Consistent with the
Company'sCompany’s long-standing reserving practices, The Hartford will continue to review and monitor these reserves regularly and, where future developments indicate, make appropriate adjustments to the reserves. The loss reserving assumptions, drawn from both industry data and theCompany'sCompany’s experience, have over time been appliedover timeto all of this business and have resulted inreservestrengthening or reserve releases at various times over the past decade.The following
tables presenttable presents reserve activity, inclusive of estimates for both reported and incurred but not reported claims, net of reinsurance, for Other Operations, categorized by asbestos, environmental andall other“all other” claims, for thethirdquarterand nine monthsendedSeptember 30, 2003.March 31, 2004. Also included are the remaining asbestos and environmental exposures ofNorth American Property & Casualty. - 43 -Ongoing Operations. 36
Other Operations Claims and Claim Adjustment Expenses
For the First Quarter Ended March 31, 2004 Asbestos Environmental All Other [1] Total Beginning liability - net [2][3] $ 3,794 $ 408 $ 2,392 $ 6,594 Claims and claim adjustment expenses incurred 3 3 61 67 Claims and claim adjustment expenses paid [5] 1,091 19 67 1,177
Ending liability – net [2] [3]$ 2,706 [4] $ 392 $ 2,386 $ 5,484
OTHER OPERATIONS CLAIMS AND CLAIM ADJUSTMENT EXPENSES FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 2003 ASBESTOS ENVIRONMENTAL ALL OTHER [1] TOTAL - ------------------------------------------------------------------------------------------------------------------------------------Beginning liability - net $ 3,639 $ 536 $ 1,242 $ 5,417 Claims and claim adjustment expenses incurred [2] 2 3 3 8 Claims and claim adjustment expenses paid 40 22 50 112 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITY - NET [3] [4] [5] $ 3,601 $ 517 $ 1,195 $ 5,313 - ------------------------------------------------------------------------------------------------------------------------------------ FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 ASBESTOS ENVIRONMENTAL ALL OTHER [1] TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Beginning liability - net $ 1,118 $ 591 $ 1,250 $ 2,959 Claims and claim adjustment expenses incurred 2,609 7 42 2,658 Claims and claim adjustment expenses paid 126 81 97 304 - ------------------------------------------------------------------------------------------------------------------------------------ ENDING LIABILITY - NET [3] [4] [5] $ 3,601 $ 517 $ 1,195 $ 5,313 - ------------------------------------------------------------------------------------------------------------------------------------[1][1] Includes unallocated loss adjustment expense reserves. [2] The asbestos claimsreserves andclaim adjustment expenses incurred forthethird quarter ended September 30, 2003 related to the unwinding of the discount on certain reserves. [3]Reinsurance segment.[2] Ending liabilities include asbestos and environmental reserves reported in North American Property & CasualtyOngoing Operations of$13$11 and$10,$9, respectively, as ofSeptember 30, 2003March 31, 2004 and$14of $11 and$10,$8, respectively, as of December 31,2002. [4]2003. The total net claim and claim adjustment expenses incurred of $67 includes $2 related to asbestos and environmental claims reported in Ongoing Operations.[3] Gross of reinsurance, asbestos and environmental reserves were $5,768$4,644 and$594,$513, respectively, as ofSeptember 30, 2003March 31, 2004 and$1,994$5,884 and$682,$542, respectively, as of December 31,2002. [5] As of September 30, 2003, the2003.[4] The one year and average three year net paid amounts for asbestos claims are $171$1,215 and$119,$1,443, respectively, resulting in a one year net survival ratio of 2.2 (13.7 excluding the MacArthur payments) and a three year net survivalratiosratio of21.1 and 30.2 years, respectively.5.6 (19.1 excluding MacArthur). Net survival ratio is the quotient of the net carried reserves divided by the average annual payment amount and is an indication of the number of years that the net carried reserve would last (i.e. survive) if the future annual claim payments were consistent with the calculated historical average.[5] Asbestos payments include $1.15 billion of payments pursuant to the MacArthur settlement. At
September 30, 2003,March 31, 2004, asbestos reserves were$3.6$2.7 billion,an increasea decrease of$2.5$1.1 billion compared to$1.1$3.8 billion as of December 31,2002. Net incurred losses and loss adjustment expenses were $2 for2003. The decrease in asbestos reserves is primarily driven by thethirdMacArthur settlement payment made in the first quarter of20032004. During the first quarter of 2004, the Company completed a gross asbestos reserve evaluation. As part of this evaluation, the Company reviewed all of its open direct domestic insurance accounts exposed to asbestos liability as well as assumed reinsurance accounts and$2.6 billioncertain closed accounts. The Company also examined its London Market exposures for both direct insurance and assumed reinsurance. The evaluation indicated no change in thenine months ended September 30, 2003. The increase in reserves foroverall required gross asbestos reserves. It is anticipated that thenine month period reflects asbestos claimnet reserve evaluation will be completed during the second quarter of 2004 andlitigation trends.net reserve estimates could change as a result of this evaluation.The Company classifies its asbestos reserves into three categories: direct insurance; assumed reinsurance and London Market. Direct insurance includes primary and excess coverage. Assumed Reinsurance includes both
"treaty"“treaty” reinsurance (covering broad categories of claims or blocks of business) and"facultative"“facultative” reinsurance (covering specific risks or individual policies of primary or excess insurance companies). London Market business includes the business written by one or more of TheHartford'sHartford’s subsidiaries in the United Kingdom, which are no longer active in the insurance or reinsurance business. Such business includes both direct insurance and assumed reinsurance.The Company continues to divide its direct asbestos exposures into the following categories: Major Asbestos Defendants (the “Top 70” accounts in Tillinghast’s published Tiers 1 and 2 and Wellington accounts collectively divided into: structured settlements, Wellington, and Other Major Asbestos Defendants), Accounts with Future Expected Exposures greater than $2.5, Accounts with Future Expected Exposures less than $2.5 and Unallocated. An account may move between categories from one evaluation to the next. For example, an account with future expected exposure of greater than $2.5 in one evaluation may be reevaluated due to changing conditions in the account’s profile within the claim and legal environment such that the exposure may be viewed as less than $2.5 in a subsequent evaluation, or vice versa. During the first quarter of 2004, the Company reclassified some losses paid more than three years ago to different categories. These reclassifications had no effect on total reserves or on the one-year or three-year gross survival ratios.
Structured settlements are those accounts where the Company has reached an agreement with the insured as to the amount and timing of the claim payments to be made to the insured.
The Wellington category includes insureds that entered into the “Wellington Agreement” dated June 19, 1985. The Wellington Agreement provided terms and conditions for how the signatory asbestos producers would access their coverage from the signatory insurers.
The Other Major Asbestos Defendants subcategory represents insureds included in Tiers 1 and 2, as defined by Tillinghast. The Tier 1 and 2 classifications are meant to capture the insureds for which there is expected to be significant exposure to asbestos claims.
The unallocated category includes an estimate of the reserves necessary for asbestos claims related to direct insureds who have not previously tendered asbestos claims to the company, potential non-products exposures and closed accounts exclusive of Major Asbestos Defendants.
Assumed Reinsurance exposures are inherently less predictable than direct insurance exposures because the Company may not receive notice of a reinsurance claim until the underlying direct insurance claim is mature. This causes a delay in the receipt of information at the reinsurer level reflecting changes in the asbestos tort litigation and direct insurance coverage environments.
Estimating liabilities for London Market business is the most uncertain of the three categories of claims, (direct, assumed reinsurance and London Market.) As a participant in the London Market (comprised of both Lloyd’s of London and London Company Markets), the Company wrote business on a subscription basis, with the Company’s involvement being limited to a relatively small percentage of a total contract placement. Claims are reported, via a broker, to the “lead” underwriter and, once agreed to, are presented to the following markets for concurrence. This reporting and claim agreement process makes estimating liabilities for this business the most uncertain of the three categories of claims.
37
The following
tables settable displays gross asbestos reserves and other statistics by policyholder category, as of March 31, 2004, reflecting the Company’s most recent gross reserve study:Summary of Gross Asbestos Reserves
3 Year Gross Survival 3 Year Ratio [1] [2] % of Gross Survival before Number of All Time Total Asbestos All Time Ratio [1] [2] MacArthur Accounts [5] Paid Reserves Reserves Ultimate (in years) (in years) As of Most Recent Reserve Evaluation [4]Major asbestos defendants Structured settlements (includes 2 Wellington accounts) 7 $ 257 $ 358 6 % $ 615 9.1 9.1 Wellington (direct only) 31 682 281 5 % 963 5.3 5.3 Other major asbestos defendants 27 178 443 8 % 621 27.3 27.3 No known policies (includes 3 Wellington accounts) 5 — — — — — — Accounts with future exposure > $2.5 106 369 1,210 20 % 1,579 16.7 16.7 Accounts with future exposure < $2.5 930 152 135 2 % 287 12.9 12.9 MacArthur settlement 1 32 1,150 20 % 1,182 Unallocated [3] — 100 896 15 % 996
Total direct 1,770 4,473 76 % 6,243 22.0 16.8 Assumed reinsurance 560 931 16 % 1,491 15.5 15.5 London market 373 480 8 % 853 13.6 13.6
Total 2,703 5,884 100 % 8,587 19.7 16.1
First Quarter 2004 MacArthur payments 1 1,162 (1,162 ) — First Quarter 2004 Activity, excluding MacArthur 82 (78 ) 4
Total as of March 31, 2004 [2]$ 3,947 $ 4,644 $ 8,591 6.6 14.8
[1]Survival ratio is a commonly used industry ratio for comparing reserve levels between companies. While the method is commonly used, it is not a predictive technique. Survival ratios may vary over time due to numerous factors such as large payments due to the final resolution of certain asbestos liabilities, or reserve re-estimates. The survival ratio presented in the above table is computed by dividing the recorded reserves by the average of the past three years of payments. The ratio is the calculated number of years the recorded reserves would survive if future annual payments were equal to the average annual payments for the past three years. The 3-year gross survival ratio as of March 31, 2004 is computed based on total paid losses of $2,105 for the period from April 1, 2001 to March 31, 2004. All other 3-year gross survival ratios presented are based on total paid losses for the 3-year period ended December 31, 2003. [2]As of March 31, 2004, the one year gross paid amount for total asbestos claims is $1.5 billion resulting in a one year gross survival ratio of 3.1. If the ratio was calculated without considering the $1.16 billon in payments for MacArthur in the first quarter of 2004, the one year gross survival ratio would be 13.7. [3]Includes closed accounts, exclusive of Major Asbestos Defendants, and unallocated IBNR. [4]The information presented by account category reflects the first quarter 2004 reserve evaluation of gross asbestos losses incurred as of December 31, 2003. [5]An account may move between categories from one evaluation to the next. Reclassifications were made as a result of the reserve evaluation completed in the first quarter of 2004. There was no impact on total all-time paid losses or total reserves. 38
The following table sets forth, for the
thirdquarterand nine monthsendedSeptember 30, 2003,March 31, 2004, paid and incurred loss activity by the three categories of claims for asbestos and environmental.Paid and Incurred Loss and Loss Adjustment Expense (“LAE”) Development – Asbestos and Environmental
Asbestos Environmental Paid Incurred Paid Incurred For the First Quarter Ended March 31, 2004 Loss & LAE [1] Loss & LAE Loss & LAE Loss & LAE Gross Direct $ 1,233 $ 4 $ 20 $ 3 Assumed – Domestic 7 — 3 — London Market 4 — 9 —
Total 1,244 4 32 3 Ceded (153 ) (1 ) (13 ) —
Net$ 1,091 $ 3 $ 19 $ 3
PAID AND INCURRED LOSS AND LOSS ADJUSTMENT EXPENSE ("LAE") DEVELOPMENT - ASBESTOS AND ENVIRONMENTAL ASBESTOS ENVIRONMENTAL ---------------------------------------- ---------------------------------- PAID INCURRED PAID INCURRED FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 2003 LOSS & LAE LOSS & LAE LOSS & LAE LOSS & LAE - ------------------------------------------------------------------------------------------------------------------------------------Gross Direct $ 65 $ 3 $ 25 $ 3 Assumed - Domestic 8 -- 4 -- London Market 8 -- 3 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total 81 3 32 3 Ceded (41) (1) (10) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET $ 40 $ 2 $ 22 $ 3 ==================================================================================================================================== ASBESTOS ENVIRONMENTAL ---------------------------------------- ---------------------------------- PAID INCURRED PAID INCURRED FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 LOSS & LAE LOSS & LAE LOSS & LAE LOSS & LAE - ------------------------------------------------------------------------------------------------------------------------------------ Gross Direct $ 160 $ 3,030 $ 76 $ 10 Assumed - Domestic 27 585 10 (3) London Market 17 363 9 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total 204 3,978 95 7 Ceded (78) (1,369) (14) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET $ 126 $ 2,609 $ 81 $ 7 ==================================================================================================================================== [1]Reflects payments pursuant to the MacArthur settlement. - 44 -- --------------------------------------------------------------------------------INVESTMENTS
- --------------------------------------------------------------------------------General
The
Hartford'sHartford’s investment portfolios are primarily divided between Life and Property & Casualty. The investment portfolios are managed based on the underlying characteristics and nature of eachoperation'soperation’s respective liabilities and within established risk parameters. (Forafurther discussiononof TheHartford'sHartford’s approach to managing risks, see theCapital MarketsInvestment Credit Risk section.)The investment portfolios of Life and Property & Casualty are managed by Hartford Investment Management
section.Company and its affiliates (“Hartford Investment Management”)Please refer to, a wholly-owned subsidiary of The Hartford. Hartford Investment Management is responsible for monitoring and managing theInvestments section of the MD&A in The Hartford's 2002 Form 10-K Annual Report for a description of the Company'sasset/liability profile, establishing investment objectives andpolicies.guidelines, and determining, within specified risk tolerances and investment guidelines, the appropriate asset allocation, duration, convexity and other characteristics of the portfolios. Security selection and monitoring are performed by asset class specialists working within dedicated portfolio management teams.As discussed in Note 1 of Notes to Condensed Consolidated Financial Statements, on January 1, 2004, the Company reclassified $17.9 billion of separate account assets to the general account as a result of adopting the SOP. Of this amount, $11.7 billion was associated with guaranteed separate accounts and was primarily comprised of fixed maturities. These assets are designated as available-for-sale securities with changes in fair value reported in other comprehensive income. The remaining $6.2 billion is primarily comprised of equity securities related to variable annuity products offered in Japan. These assets are designated as trading securities with changes in fair value reported in net investment income.
Return on
general accountinvested assets is an important element of TheHartford'sHartford’s financial results. Significant fluctuations in the fixed income or equity markets could weaken theCompany'sCompany’s financial condition or its results of operations. Additionally, changes in market interest rates may impact the period of time over which certain investments, such as mortgage-backed securities, are repaid and whether certain investments are called by the issuers. Such changes may, in turn, impact the yield on these investments and also may result in reinvestment of funds received from calls and prepayments at rates below the average portfolio yield. Net investment income and net realized capital gains and losses accounted for approximately 29% and 17% of the Company’s consolidated revenues for the quarters ended March 31, 2004 and 2003, respectively. The increase in the percentage of consolidated revenues is primarily due to income earned on separate account assets reclassified to the general account as a result of the adoption of the SOP.Fluctuations in interest rates affect the
Company'sCompany’s return on, and the fair value of, fixed maturity investments, which comprised approximately93%85% and90%93% of the fair value of itsgeneral accountinvested assets as ofSeptember 30, 2003March 31, 2004 and December 31,2002,2003, respectively. Other events beyond theCompany'sCompany’s control could also adversely impact the fair value of these investments. Specifically, a downgrade of anissuer'sissuer’s credit rating or default of payment by an issuer could reduce theCompany'sCompany’s investment return.The Company invests in private placement securities, mortgage loans and limited partnership arrangements in order to further diversify its investment portfolio. These investment types comprised approximately 16% and 17% of the fair value of its invested assets as of March 31, 2004 and December 31, 2003, respectively. These security types are typically less liquid than direct investments in publicly traded fixed income or equity investments. However, generally these securities have higher yields to compensate for the liquidity risk.
A decrease in the fair value of any investment that is deemed
other than temporaryother-than-temporary would result in theCompany'sCompany’s recognition of a net realized capital loss in its financial results prior to the actual sale of the investment.LIFE(For further discussion, see the Company’s discussion of the evaluation of other-than-temporary impairments in Critical Accounting Estimates under the “Investments” section in the Hartford’s 2003 Form 10-K Annual Report.)Life
The primary investment objective of Life is to maximize after-tax returns consistent with acceptable risk parameters, including the management of the interest rate sensitivity of invested assets and the generation of sufficient liquidity relative to that of policyholder and corporate obligations.
39
The following table identifies Life’s invested assets by type
held in the Life general accountas ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003.
COMPOSITION OF INVESTED ASSETS - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------ --------------------------- AMOUNT PERCENT AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------------------------------Fixed maturities, at fair value $ 35,237 90.2% $ 29,377 86.7% Equity securities, at fair value 424 1.1% 458 1.3% Policy loans, at outstanding balance 2,533 6.5% 2,934 8.7% Limited partnerships, at fair value 236 0.6% 519 1.5% Other investments 655 1.6% 603 1.8% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS $ 39,085 100.0% $ 33,891 100.0% ====================================================================================================================================Composition of Invested Assets
March 31, 2004 December 31, 2003 Amount Percent Amount Percent Fixed maturities, available-for-sale, at fair value $ 49,580 80.4 % $ 37,462 91.0 % Equity securities, available-for-sale, at fair value 406 0.7 % 357 0.9 % Equity securities, held for trading, at fair value 7,831 12.7 % — — Policy loans, at outstanding balance 2,655 4.3 % 2,512 6.1 % Mortgage loans, at cost 620 1.0 % 466 1.1 % Limited partnerships, at fair value 197 0.3 % 177 0.4 % Other investments 350 0.6 % 180 0.5 %
Total investments$ 61,639 100.0 % $ 41,154 100.0 %
Fixed maturity investments and equity securities held for trading increased
20%32% and 100%, respectively, since December 31,2002,2003, primarily the result ofinvestmentfixed maturities anduniversal life contract sales and operating cash flows. In March 2003,equity securities that were reclassified from separate accounts to theCompany decided to liquidate its hedge fund limited partnership investments and reinvestgeneral account as a result of theproceedsadoption of the SOP. The remaining increase in fixed maturityinvestments. Hedge fund liquidations have totaled approximately $323 since December 31, 2002. Asinvestments was primarily due to an increase in market prices driven by a decline in interest rates during the first quarter ofSeptember 30, 2003, Life owned approximately $71 of hedge fund investments, all of which are expected to be liquidated by March 31,2004.INVESTMENT RESULTSInvestment Results
The following table
belowsummarizesLife'sLife’s investment results.
First Quarter Ended March 31, (Before-tax) 2004 2003 Net investment income – excluding income on policy loan and trading securities [1] $ 661 $ 445 Policy loan income 45 58 Trading securities income [2] 495 —
Net investment income – total [1] $ 1,201 $ 503 Yield on average invested assets [3] 5.7 % 6.1 %
Gross gains on sale $ 100 $ 57 Gross losses on sale (18 ) (47 ) Impairments (8 ) (67 ) Periodic net coupon settlements on non-qualifying derivatives [1] 2 4 GMWB derivatives, net (2 ) — Other, net [4] 2 9
Net realized capital gains (losses) [1] [5] $ 76 $ (44 )
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ -------------------------- (Before-tax) 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Net [1]The prior period reflects the reclassification of periodic net coupon settlements on non-qualifying derivatives from net investment income - excluding policy loan income $ 467 $ 401 $ 1,375 $ 1,164 Policy loan income 51 61 163 196 -------------------------------------------------------------- Net investment income - total $ 518 $ 462 $ 1,538 $ 1,360 Yield on average invested assets [1] 5.7% 6.0% 5.9% 6.1% - ------------------------------------------------------------------------------------------------------------------------------------ Gross gains on sale $ 61 $ 44 $ 209 $ 118 Gross losses on sale (31) (28) (95) (75) Impairments (27) (132) (111) (291) Other,to net[2] [3] (5) (2) (3) (5) -------------------------------------------------------------- Netrealized capital gains (losses)$ (2) $ (118) $ -- $ (253) ====================================================================================================================================[1]to conform to the current year presentation. [2]Represents the change in value of securities classified as trading. [3]Represents annualized net investment income (excluding net realized capital gains (losses))the change in fair value of trading securities) divided by average invested assets at cost or amortized cost, as applicable, for thethirdfirst quarter ended March 31, 2004 andnine months ended September 30, 2003 and 2002.2003. Average invested assets are calculated by dividing the sum of the beginning and ending period amounts bytwo. [2]two, excluding trading securities and collateral received associated with the securities lending program. [4]Primarily consists of changes in fair value on non-qualifying derivatives and hedge ineffectiveness on qualifying derivative instruments. [3] Includesinstruments as well as the amortization of deferred acquisition costs associated with realized capital gains (losses). [5]First quarter 2004 includes $5 of net GMWB derivative activity, which was a lossrealized gains (losses) associated with guaranteed separate accounts classified within the general account amounts pursuant to the adoption ofless than $1 forthethird quarter and nine months ended September 30, 2003.SOP .- 45 -For the
thirdquarterand nine monthsendedSeptember 30, 2003,March 31, 2004, net investment income, excluding policyloan income,loans and trading securities, increased$66,$216, or16%, and $211, or 18%49%, compared to therespective prior year periods.same period in 2003. Approximately $154 of the increase related to income earned on separate account assets reclassified to the general account as a result of the adoption of the SOP and approximately $26 of the increase related to income earned on assets acquired in the CNA acquisition, which was consummated on December 31, 2003. Theincreases in net investment income wereremaining increase was primarily due to income earned on a higher invested asset base, as compared to the first quarter 2003, partially offset by lower investment yields. Yields on average invested assets decreased as a result of lower rates on new investment purchases and decreased policy loan income. Since the Company invests primarily in long-term fixed rate debt securities, current period changes in interest rates impact the yield on new asset purchases and, therefore, have a gradual impact on the overall portfolio yield. The weighted average yield on new invested asset purchases in the first quarter of 2004 of approximately 4.8%, before-tax, continues to be below the average portfolio yield.Net realized capital gains (losses) for the
thirdfirst quarterand nine monthsendedSeptember 30, 2003March 31, 2004 improved by$116 and $253, respectively,$120 compared to theprior year periods,same period in 2003, primarily the result of higher realized gains on sales of fixed maturity and equity securities and lower other-than-temporary impairments. Realized gains on sales of fixed maturity investments were concentrated in the corporate, foreign government and asset-backed securities (“ABS”) sectors. The majority of the sales in the corporate and ABS sectors were the40
result of portfolio rebalancing that resulted in divesting of securities that had appreciated in value due to a decline in interest rates and an improved corporate credit environment. Foreign government securities were sold in the first quarter of 2004 primarily to realize gains associated with the decline in value of the U.S. Dollar against foreign currencies. (For further discussion of other-than-temporary impairments, see the Other-Than-Temporary Impairments commentary in this section of the MD&A.)
Property & Casualty
The investment objective for Property & Casualty’s ongoing operations is to maximize economic value while generating after-tax income and sufficient liquidity to meet policyholder and corporate obligations. For Property & Casualty’s Other Operations segment, the investment objective is to ensure the full and timely payment of all liabilities. Property & Casualty’s investment strategies are developed based on a variety of factors including business needs, regulatory requirements and tax considerations.
The following table identifies Property & Casualty’s invested assets by type as of March 31, 2004 and December 31, 2003.
Composition of Invested Assets
March 31, 2004 December 31, 2003 Amount Percent Amount Percent Fixed maturities, available-for-sale, at fair value $ 23,196 96.4 % $ 23,715 96.4 % Equity securities, available-for-sale, at fair value 206 0.9 % 208 0.8 % Real estate/Mortgage loans, at cost 309 1.3 % 328 1.3 % Limited partnerships, at fair value 164 0.7 % 168 0.7 % Other investments 177 0.7 % 186 0.8 %
Total investments$ 24,052 100.0 % $ 24,605 100.0 %
Total fixed maturities decreased 2% since December 31, 2003, primarily due to $1.15 billion of payments made pursuant to the MacArthur settlement, partially offset by premium cash flow and an increase in the fair value of fixed maturities as a result of a decrease in
other than temporary impairments on fixed maturities.interest rates.Investment Results
The table below summarizes Property & Casualty’s investment results.
First Quarter Ended March 31, 2004 2003 Net investment income, before-tax [1] $ 311 $ 281 Net investment income, after-tax [1] [2] $ 232 $ 215 Yield on average invested assets, before-tax [3] 5.5 % 5.8 % Yield on average invested assets, after-tax [2] [3] 4.1 % 4.4 %
Gross gains on sale $ 72 $ 80 Gross losses on sale (5 ) (60 ) Impairments (6 ) (22 ) Periodic net coupon settlements on non-qualifying derivatives [1] 4 4 Other, net [4] 6 (3 )
Net realized capital gains (losses), before-tax [1] $ 71 $ (1 )
[1]The prior period reflects the reclassification of periodic net coupon settlements on non-qualifying derivatives from net investment income to net realized capital gains (losses) to conform to the current year presentation. [2]Due to significant holdings in tax-exempt investments, after-tax net investment income and yield are also included. [3]Represents annualized net investment income divided by average invested assets at cost or amortized cost, as applicable, for the first quarter ended March 31, 2004 and 2003. Average invested assets are calculated by dividing the sum of the beginning and ending period amounts by two, excluding the collateral obtained from the securities lending program. [4]Primarily consists of changes in fair value on non-qualifying derivatives and hedge ineffectiveness on qualifying derivative instruments. For the first quarter ended March 31, 2004, before- and after-tax net investment income increased $30, or 11%, and $17, or 8%, respectively, compared to the prior year period. The increase in net investment income was primarily due to income earned on a higher invested asset base, partially offset by lower investment yields. Invested assets as of March 31, 2004 increased as compared to March 31, 2003, due to positive operating cash flow partially offset by payments made pursuant to the MacArthur settlement. Yields on average invested assets decreased from the prior year period as a result of lower rates on new investment purchases. Since the Company invests primarily in long-term fixed rate debt securities, current period changes in interest rates impact the yield on new asset purchases and, therefore, have a gradual impact on the overall portfolio yield. The weighted average yield on new asset purchases in the first quarter of 2004 of approximately 4.7%, before-tax, continues to be below the average portfolio yield.
Net realized capital gains (losses) for the first quarter ended March 31, 2004 improved by $72 compared to the same period in 2003, primarily the result of higher net realized gains on sales of fixed maturity securities and lower other-than-temporary
41
impairments. Realized gains on sales of fixed maturity investments were concentrated in the corporate, foreign government and ABS sectors. The majority of the sales in the corporate and ABS sectors were the result of portfolio rebalancing that resulted in divesting of securities that had appreciated in value due to a decline in interest rates and an improved corporate credit environment. Foreign government securities were sold in the first quarter of 2004 primarily to realize gains associated with the decline in value of the U.S. Dollar against foreign currencies. (For further discussion of other-than-temporary impairments, see the Other-than-Temporary Impairments commentary in this section of the MD&A.)
Corporate
Certain proceeds from the Company’s September 2002 and May 2003 capital raising activities have been retained in Corporate. As of March 31, 2004 and December 31, 2003, Corporate held $38 and $86, respectively, of short-term fixed maturity investments. In addition, Corporate held $28 and $2 of other investments as of March 31, 2004 and December 31, 2003, respectively.
Other-Than-Temporary Impairments
The following
discussion identify Life's other than temporarytable identifies the Company’s other-than-temporary impairments by type.
OTHER THAN TEMPORARY IMPAIRMENTS BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ -------------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Asset-backed securities ("ABS") Aircraft lease receivables $ 15 $ 53 $ 15 $ 72 Corporate debt obligations ("CDO") -- 13 10 22 Credit card receivables -- -- 12 -- Interest only securities -- 3 5 3 Manufacturing housing ("MH") receivables 9 12 9 12 Mutual fund fee receivables -- 7 3 14 Other ABS 2 3 3 5 Commercial mortgage-backed securities ("CMBS") -- -- 4 -- Corporate Basic industry 1 -- 1 -- Consumer non-cyclical -- -- 7 -- Financial services -- 1 4 1 Technology and communications -- 10 3 125 Transportation -- -- 7 1 Utilities -- 6 -- 12 Equity -- 14 21 14 Foreign government -- 10 -- 10 Mortgage-backed securities ("MBS") - interest only securities -- -- 7 -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL IMPAIRMENTS $ 27 $ 132 $ 111 $ 291 ====================================================================================================================================Other-Than-Temporary Impairments by Type
First Quarter Ended First Quarter Ended March 31, 2004 March 31, 2003 Property & Property & (before-tax) Life Casualty Consolidated Life Casualty Consolidated ABS Corporate debt obligations (“CDO”) $ 4 $ 1 $ 5 $ 10 $ 5 $ 15 Credit card receivables — — — 12 2 14 Other ABS — 5 5 4 1 5
Total ABS 4 6 10 26 8 34 Corporate Consumer non-cyclical — — — 7 2 9 Technology and communications — — — 3 2 5 Transportation — — — 7 3 10 Other corporate 3 — 3 3 1 4
Total corporate 3 — 3 20 8 28 Equity — — — 21 6 27 Mortgage-backed securities (“MBS”) – interest only securities 1 — 1 — — —
Total other-than-temporary impairments$ 8 $ 6 $ 14 $ 67 $ 22 $ 89
ABS
- ---— During2003,the first quarter of 2004, other-than-temporary impairments were recorded for various ABS security types as a result of acontinueddeterioration of cash flows derived from the underlyingcollateral.collateral of several securities. TheABS securities supported by aircraft lease and enhanced equipment trust certificates (together, "aircraft lease receivables") have continueddecrease in impairments compared todeclinethe prior year period is primarily the result of a general stabilization in the performance of the underlying collateral, which has resulted in improved pricing levels. Pricing levels for CDOs recovered modestly during the first quarter of 2004 due toa reductionan increase inlease paymentsdemand for these asset types, driven by improved economic andaircraft valuesoperating fundamentals of the underlying security issuers, better market liquidity and attractive yields. The increase in pricing levels for credit card receivables was primarily driven by improvement in collateral performance.Impairments of ABS during the first quarter of 2003 were driven by a
decline in airline travel.deterioration of collateral cash flows. CDO impairments were primarily the result of increasing default rates and lower recovery rates on the collateral. Impairments onsecurities supportedABS backed byMHcredit card receivables wereprimarily thea result ofrepossessed units liquidated at depressed levels. Interest only security impairments recorded during 2003issuers extending credit to sub-prime borrowers and2002 were due totheflattening of the forward yield curve. Impairments of ABS during the nine months ended September 30, 2002 were driven by deterioration of collateral cash flows. Numerous bankruptcies, collateral defaults, weak economic conditions and reduced airline travel were all factors contributing to lower collateral cash flows and broker quoted market prices of ABS in 2002.higher default rates on these loans.Corporate
- ---------— The decline in corporate bankruptcies and improvement in general economic conditions have contributed tomuchlower corporate impairment levels in2003the first quarter of 2004 compared to2002. Corporate impairments recorded duringthethirdfirst quarter of2003 were concentrated in the United States steel industry and resulted from a decision to dispose of securities, which were in an unrealized loss position.2003.A significant portion of corporate impairments during the
nine monthsquarter endedSeptember 30,March 31, 2003were driven by a deterioration in the transportation sector, specifically issuers of airline debt as the result of a decline in airline travel. Impairments during the nine months ended September 30, 2003 were alsowas the result of one consumer non-cyclical issuer in the healthcare industry stemming from its decline in value due to accounting fraud, and one communications sector issuer in the cable television industry due to deteriorating earnings forecasts, debt restructuring issues and accounting irregularities.For the third quarter and nine months ended September 30, 2002, impairments of corporate securities were concentrated in the technology and communications sector and for the nine months ended September 30, 2002 included a $74 before-tax loss related to securities issued by WorldCom. Other - ----- Other than temporaryAdditional impairments werealso recorded in 2003 and 2002, on various diversified seeded equity and mutual fund investments that had experienced declines in fair value for an extended period of time. - 46 -PROPERTY & CASUALTY The following table identifies invested assets by type as of September 30, 2003 and December 31, 2002.
COMPOSITION OF INVESTED ASSETS - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 ------------------------------ --------------------------- AMOUNT PERCENT AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------------------------------Fixed maturities, at fair value $ 23,565 96.5% $ 19,446 94.5% Equity securities, at fair value 215 0.9% 459 2.2% Limited partnerships, at fair value 193 0.8% 362 1.8% Other investments 451 1.8% 306 1.5% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS $ 24,424 100.0% $ 20,573 100.0% ====================================================================================================================================Total fixed maturities increased 21% since December 31, 2002, primarily due to increased operating cash flow, changes in portfolio allocation and the May capital raising proceeds. In March 2003, the Company decided to liquidate its hedge fund limited partnership investments and certain equity securities and reinvest the proceeds into fixed maturity investments. Equity securities and hedge fund investment liquidations have totaled $289 and $168, respectively, since December 31, 2002. As of September 30, 2003, Property & Casualty owned approximately $22 of hedge fund investments, all of which are expected to be liquidated by March 31, 2004. INVESTMENT RESULTS The table below summarizes Property & Casualty's investment results.
THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ -------------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Net investment income, before-tax $ 302 $ 262 $ 878 $ 787 -------------------------------------------------------------- Net investment income, after-tax [1] $ 228 $ 204 $ 668 $ 612 Yield on average invested assets, before-tax [2] 5.4% 5.6% 5.5% 5.7% -------------------------------------------------------------- Yield on average invested assets, after-tax [1] [2] 4.0% 4.4% 4.2% 4.5% - ------------------------------------------------------------------------------------------------------------------------------------ Gross gains on sale [3] $ 71 $ 48 $ 363 $ 191 Gross losses on sale (49) (54) (116) (125) Impairments (2) (43) (34) (162) Other, net [4] (6) 7 3 16 -------------------------------------------------------------- Net realized capital gains (losses) $ 14 $ (42) $ 216 $ (80) ====================================================================================================================================[1] Due to significant holdings in tax-exempt investments, after-tax net investment income and yield are also included. [2] Represents annualized net investment income (excluding net realized capital gains (losses)) divided by average invested assets at cost or amortized cost, as applicable, for the third quarter and nine months ended September 30, 2003 and 2002. Average invested assets are calculated by dividing the sum of the beginning and ending period amounts by two. [3] Includes a gain of $23 associated with the sale of Trumbull Associates, LLC. [4] Primarily consists of changes in fair value and hedge ineffectiveness on derivative instruments.For the third quarter and nine months ended September 30, 2003, before-tax net investment income increased $40, or 15%, and $91, or 12%, respectively, and after-tax net investment income increased $24, or 12%, and $56, or 9%, respectively, compared to the respective prior year periods. The increases in net investment income were primarily due to income earned on a higher invested asset base partially offset by lower investment yields. Yields on average invested assets decreased from the prior yearincurred as a result oflower rates on new investment purchases. Net realized capital gains (losses) forthethird quarter and nine months ended September 30, 2003 improved by $56 and $296, respectively, compared to the prior year periods. The improvements were primarily the result of net gains on sales of fixed maturity investments, Trumbull Associates, LLC and a decrease in other than temporary impairments. The table below and following discussion identify Property & Casualty's other than temporary impairments by type. - 47 -
OTHER THAN TEMPORARY IMPAIRMENTS BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ THIRD QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ -------------------------- 2003 2002 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ABS Aircraft lease receivables $ -- $ 3 $ -- $ 11 CDO 1 4 6 10 Credit card receivables -- -- 2 -- Interest only securities -- 4 7 4 MH receivables -- 8 -- 8 Other ABS -- 3 -- 5 Corporate Basic industry 1 -- 1 -- Consumer non-cyclical -- -- 2 -- Technology and communications -- 7 2 76 Transportation -- 4 3 4 Utilities -- 2 1 12 Equity -- 8 9 32 MBS - interest only securities -- -- 1 -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL IMPAIRMENTS $ 2 $ 43 $ 34 $ 162 ====================================================================================================================================ABS - --- During 2003, impairments were recorded for various ABS security types as a result of a continued deterioration of cash flows derived from the underlying collateral. CDO impairments were primarily the result of increasing default rates and lower recovery rates on the collateral. Interest only security impairments recorded during 2003 and 2002 were due to the flattening of the forward yield curve. Impairments of ABS during the nine months ended September 30, 2002 were driven by deterioration of collateral cash flows. Numerous bankruptcies, collateral defaults, weak economic conditions and reduced airline travel were all factors contributing to lower collateral cash flows and broker quoted market prices of ABS in 2002. Corporate - --------- The decline in corporate bankruptcies and improvement in general economic conditions have contributed to much lower corporate impairment levels in 2003 compared to 2002. Corporate impairments recorded during the third quarter of 2003 were concentrated in the United States steel industry and resulted from a decision to dispose of securities, which were in an unrealized loss position. A significant portion of corporate impairments during the nine months ended September 30, 2003 were driven by adeterioration in the transportation sector, specifically issuers of airline debt, as a result of a decline in airline travel.Impairments during the nine months ended September 30, 2003 were also the result of one consumer non-cyclical sector issuer in the healthcare industry stemming from its decline in value due to accounting fraud, and one communications sector issuer in the cable television industry due to deteriorating earnings forecasts, debt restructuring issues and accounting irregularities. For the third quarter and nine months ended September 30, 2002, impairments of corporate securities were concentrated in the technology and communications sector and for the nine months ended September 30, 2002 included a $36 before-tax loss related to securities issued by WorldCom.Other
- ----- Other than temporary— Other-than-temporary impairments were also recorded in the first quarter of 2003 on various diversified mutualfundfunds and preferred stockinvestments and in 2002 on various common stock investments, primarily ininvestments.In addition to the
technology and communications sector, all of which had experienced declines in fair value for an extended period of time. CORPORATE Certain proceeds from the Company's September 2002 and May 2003 capital raising activities have been retained in Corporate. As of September 30, 2003 and December 31, 2002, Corporate held $107 and $66, respectively, of short-termimpairments described above, fixed maturityinvestments. In addition, Corporate held $4and equity securities were sold during the quarters ended March 31, 2004 and 2003 at total gross losses ofother investments as$22 and $99, respectively. No single security was sold at a loss in excess ofSeptember 30, 2003. These investments earned $0 and $2 of income for the third quarter and nine months ended September 30, 2003, respectively. In connection with the HLI Repurchase, the carrying value of the purchased fixed maturity investments was adjusted to fair market value as of the date of the repurchase. This adjustment was reported in Corporate. The amortization of the adjustment to the fixed maturity investments' carrying values is reported in Corporate's net investment income. The total amount of amortization for the third quarter and nine months ended September 30, 2003 was$5 and$13,$9 during the quarters ended March 31, 2004 and 2003, respectively.The total amount of amortization for the third quarter and nine months ended September 30, 2002 was $4 and $13, respectively. - 48 -- -------------------------------------------------------------------------------- CAPITAL MARKETS42
INVESTMENT CREDIT RISK
MANAGEMENT - --------------------------------------------------------------------------------The Hartford has
a disciplined approach to managing risks associated with its capital marketsestablished investment credit policies that focus on the credit quality of obligors andasset/liability management activities.counterparties, limit credit concentrations, encourage diversification and require frequent creditworthiness reviews. Investmentportfolio management is organized to focus investment management expertise on specific classesactivity, including setting ofinvestments, while asset/liability management is the responsibility of dedicated risk management units supporting Life, including guaranteed separate accounts, and Property & Casualty operations. Derivative instruments are utilized in compliance with established Companypolicy andregulatory requirementsdefining acceptable risk levels, is subject to regular review andare monitored internally and reviewedapproval by seniormanagement. The Company is exposed to two primary sourcesmanagement and by the Finance Committee ofinvestment and asset/liability management risk: credit risk, relating totheuncertainty associated with the abilityCompany’s Board ofan obligor or counterparty to make timely payments of principal and/or interest, and market risk, relating to the market price and/or cash flow variability associated with changes in interest rates, securities prices, market indices, yield curves or currency exchange rates. The Company does not hold any financial instruments purchased for trading purposes.Directors.Please refer to the
Capital MarketsInvestment Credit RiskManagementsection of the MD&A in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report for a description of theCompany'sCompany’s objectives, policies andstrategies. CREDIT RISKstrategies, including the use of derivative instruments.The Company invests primarily in securities that are rated investment grade, and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by an internal credit evaluation supplemented by consideration of external determinants of creditworthiness, typically ratings assigned by nationally recognized ratings agencies. Obligor, asset sector and industry concentrations are subject to established limits and are monitored on a regular basis. The Hartford is not exposed to any credit concentration risk of a single issuer greater than 10% of the
Company's stockholders'Company’s stockholders’ equity.The following table identifies fixed maturity securities by type on a consolidated basis
including guaranteed separate accounts,as ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003.Consolidated Fixed Maturities by Type
March 31, 2004 December 31, 2003 Percent of Percent of Total Total Amortized Unrealized Unrealized Fair Fair Amortized Unrealized Unrealized Fair Fair Cost Gains Losses Value Value Cost Gains Losses Value Value ABS $ 6,276 $ 168 $ (71 ) $ 6,373 8.8 % $ 6,483 $ 154 $ (113 ) $ 6,524 8.9 % CMBS 10,791 724 (20 ) 11,495 15.8 % 10,230 545 (44 ) 10,731 14.7 % Collateralized mortgage obligation (“CMO”) 882 21 (1 ) 902 1.2 % 1,059 17 (3 ) 1,073 1.5 % Corporate Basic industry 3,333 278 (5 ) 3,606 5.0 % 4,035 286 (15 ) 4,306 5.9 % Capital goods 2,076 179 (4 ) 2,251 3.1 % 1,850 133 (11 ) 1,972 2.7 % Consumer cyclical 3,330 268 (4 ) 3,594 4.9 % 3,167 210 (12 ) 3,365 4.6 % Consumer non-cyclical 3,373 298 (7 ) 3,664 5.0 % 3,572 236 (18 ) 3,790 5.2 % Energy 2,070 190 (2 ) 2,258 3.1 % 2,036 142 (10 ) 2,168 3.0 % Financial services 7,830 675 (27 ) 8,478 11.6 % 7,767 536 (45 ) 8,258 11.3 % Technology and communications 5,001 561 (8 ) 5,554 7.6 % 4,955 489 (18 ) 5,426 7.5 % Transportation 739 61 (4 ) 796 1.1 % 777 51 (6 ) 822 1.1 % Utilities 3,110 269 (11 ) 3,368 4.6 % 2,941 221 (20 ) 3,142 4.3 % Other 859 63 (1 ) 921 1.3 % 720 33 (5 ) 748 1.0 % Government/Government agencies Foreign 1,385 154 (4 ) 1,535 2.1 % 1,605 171 (3 ) 1,773 2.4 % United States 1,292 41 — 1,333 1.8 % 1,401 33 (4 ) 1,430 1.9 % MBS – agency 2,415 55 — 2,470 3.4 % 2,794 43 (3 ) 2,834 3.9 % Municipal Taxable 742 32 (9 ) 765 1.1 % 625 19 (15 ) 629 0.9 % Tax-exempt 9,469 816 (3 ) 10,282 14.1 % 9,445 775 (4 ) 10,216 14.0 % Redeemable preferred stock 71 3 — 74 0.1 % 77 3 — 80 0.1 % Short-term 3,094 1 — 3,095 4.3 % 3,708 3 — 3,711 5.1 %
Total fixed maturities$ 68,138 $ 4,857 $ (181 ) $ 72,814 100.0 % $ 69,247 $ 4,100 $ (349 ) $ 72,998 100.0 %
Total general account fixed maturities $ 58,127 $ 3,413 $ (277 ) $ 61,263 83.9 % Total guaranteed separate account fixed maturities [1] $ 11,120 $ 687 $ (72 ) $ 11,735 16.1 %
CONSOLIDATED FIXED MATURITIES BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 ---------------------------------------------------- ------------------------------------------------ PERCENT PERCENT OF TOTAL OF TOTAL AMORTIZED UNREALIZED UNREALIZED FAIR FAIR AMORTIZED UNREALIZED UNREALIZED FAIR FAIR COST GAINS LOSSES VALUE VALUE COST GAINS LOSSES VALUE VALUE - ------------------------------------------------------------------------------------------------------------------------------------ABS $ 6,544 $ 152 $ (150) $ 6,546 9.3% $ 6,109 $ 155 $ (173) $ 6,091 10.1% CMBS 9,414 637 (34) 10,017 14.2% 6,964 607 (10) 7,561 12.6% Collateralized mortgage obligation ("CMO") 1,023 26 (2) 1,047 1.5% 909 45 (2) 952 1.6% Corporate Basic industry 3,554 243 (15) 3,782 5.3% 2,931 194 (19) 3,106 5.2% Capital goods 1,691 135 (9) 1,817 2.6% 1,399 92 (10) 1,481 2.5% Consumer cyclical 2,764 192 (12) 2,944 4.2% 1,873 121 (5) 1,989 3.3% Consumer non-cyclical 3,532 259 (10) 3,781 5.4% 3,101 220 (22) 3,299 5.5% Energy 1,938 160 (9) 2,089 3.0% 1,812 137 (10) 1,939 3.2% Financial services 7,133 580 (55) 7,658 10.8% 6,454 441 (100) 6,795 11.3% Technology and communications 4,595 514 (14) 5,095 7.2% 3,972 337 (92) 4,217 7.0% Transportation 744 60 (11) 793 1.1% 707 57 (20) 744 1.2% Utilities 2,711 212 (28) 2,895 4.1% 2,371 147 (60) 2,458 4.1% Other 619 37 (2) 654 0.9% 483 23 -- 506 0.9% Government/Government agencies Foreign 1,395 141 (6) 1,530 2.2% 1,780 162 (8) 1,934 3.2% United States 1,019 55 (2) 1,072 1.5% 764 53 -- 817 1.4% MBS - agency 3,026 54 (2) 3,078 4.4% 2,739 79 -- 2,818 4.7% Municipal Taxable 451 18 (11) 458 0.6% 147 20 (1) 166 0.3% Tax-exempt 9,399 800 (8) 10,191 14.4% 10,029 822 (5) 10,846 18.1% Redeemable preferred stock 77 5 (1) 81 0.1% 97 6 (1) 102 0.2% Short-term 5,058 2 (1) 5,059 7.2% 2,151 2 -- 2,153 3.6% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 66,687 $ 4,282 $ (382) $ 70,587 100.0% $ 56,792 $ 3,720 $ (538) $ 59,974 100.0% ==================================================================================================================================== Total general account fixed maturities $ 55,649 $ 3,561 $ (301) $ 58,909 83.5% $ 46,241 $ 3,062 $ (414) $ 48,889 81.5% Total [1]Effective January 1, 2004, guaranteed separate account fixed maturities $ 11,038 $ 721 $ (81) $ 11,678 16.5% $ 10,551 $ 658 $ (124) $ 11,085 18.5% ====================================================================================================================================assets were included with general account assets as a result of adopting the SOP.The
Company'sCompany’s fixed maturity gross unrealized gains and losses have improved by$562$757 and$156,$168, respectively, from December 31,20022003 toSeptember 30, 2003,March 31, 2004, primarilyasdue to aresult of improved corporate credit qualitydecline in long-term interest rates and, to a lesser extent,asset sales,credit spread tightening associated with ABS, partially- 49 -offset by an increasesales of securities ininterest rates. The improvement in corporate credit quality wasa gain position. During the quarter ended March 31, 2004, the ten year U.S. treasury rate declined approximately 40 basis points since December 31, 2003, largely due tothe security issuers' renewed emphasis on improving liquidity, reducing leveragedisappointing new job creation andvarious cost cutting measures. Throughout 2003, the general economic outlook has continueda capacity utilization percentage. The Company expects U.S. fiscal and monetary policy torebound, the result of improved profitability supported by improved manufacturing demand, a continued strong housing market and robust consumer and government spending. The apparent economic acceleration has resulted in the increase of the 10-year Treasury rate since December 2002, including an 80 basis point increase from its low in June 2003 of 3.1%. In recent months, there has been a considerable amount of volatility in the Treasury market. Speculation over the possibility of the Federal Reserve purchasing Treasuries combined with talk of deflation on the part of the Federal Reserve pushed the yield on 10-year Treasuries down to its June low. However, signs of a rebound in the economy and the Federal Reserve's comments downplaying the prospects for both deflation and market intervention have caused the price of 10-year Treasuries to fall by almost 9% between mid-June and the end of July, as the yield rose to nearly 4.5%. As of September 30, 2003, the 10-year Treasury yield dipped down to 3.94%. Except for CMBS, municipal tax-exempt and short-term securities, the investmentremain stimulative until inflationary pressures return.Investment allocations as a percentage of total fixed maturities have remained materially consistent since December 31,
2002. Portfolio allocations to2003, except for CMBS and short-term securities. CMBS increased as a result of a tactical decision to increase the Company’s investment in the asset class due tothe asset class'sits stable spreads, high quality andhigh quality. CMBSattractive yields. Investments in short-term securitieshave lower prepayment risk than MBS due to contractual penalties. The Companydecreasedits percentage of tax-exempt municipal holdings due to the alternative minimum tax implications. Short-term securities have increased43
primarily due to
the receipt of operating cash flows awaiting investment in longer term securities and from the collateral obtained relatedpayments made pursuant to theCompany's securities lending program.MacArthur settlement.(For
afurther discussion of risk factors associated with sectors with significant unrealized loss positions,pleasesee the sector risk factor commentary under the Consolidated Total Securities with Unrealized Loss Greater than Six Months bySectorType schedule in this section of the MD&A.)The following table identifies fixed maturities by credit quality on a consolidated basis,
including guaranteed separate accounts,as ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003. The ratings referenced below are based on the ratings of a nationally recognized rating organization or, if not rated, assigned based on theCompany'sCompany’s internal analysis of such securities.Consolidated Fixed Maturities by Credit Quality
March 31, 2004 December 31, 2003 Percent of Percent of Amortized Total Fair Amortized Total Fair Cost Fair Value Value Cost Fair Value Value United States Government/Government agencies $ 4,662 $ 4,777 6.6 % $ 5,274 $ 5,357 7.3 % AAA 15,799 16,854 23.1 % 15,672 16,552 22.7 % AA 7,479 8,043 11.0 % 7,377 7,855 10.8 % A 16,863 18,220 25.0 % 17,646 18,750 25.7 % BBB 17,025 18,350 25.2 % 16,143 17,114 23.4 % BB & below 3,216 3,475 4.8 % 3,427 3,659 5.0 % Short-term 3,094 3,095 4.3 % 3,708 3,711 5.1 %
Total fixed maturities$ 68,138 $ 72,814 100.0 % $ 69,247 $ 72,998 100.0 %
Total general account fixed maturities $ 58,127 $ 61,263 83.9 % Total guaranteed separate account fixed maturities [1] $ 11,120 $ 11,735 16.1 %
CONSOLIDATED FIXED MATURITIES BY CREDIT QUALITY - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------------------------- ------------------------------------ PERCENT OF PERCENT OF AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR COST FAIR VALUE VALUE COST FAIR VALUE VALUE - ------------------------------------------------------------------------------------------------------------------------------------United States Government/Government agencies $ 5,020 $ 5,146 7.3% $ 4,234 $ 4,397 7.3% AAA 14,542 15,490 21.9% 13,344 14,358 24.0% AA 7,082 7,583 10.7% 7,267 7,784 13.0% A 17,000 18,200 25.8% 15,082 16,034 26.7% BBB 14,567 15,536 22.0% 11,531 12,121 20.2% BB & below 3,418 3,573 5.1% 3,183 3,127 5.2% Short-term 5,058 5,059 7.2% 2,151 2,153 3.6% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 66,687 $ 70,587 100.0% $ 56,792 $ 59,974 100.0% ==================================================================================================================================== Total general account fixed maturities $ 55,649 $ 58,909 83.5% $ 46,241 $ 48,889 81.5% Total [1]Effective January 1, 2004, guaranteed separate account fixed maturities $ 11,038 $ 11,678 16.5% $ 10,551 $ 11,085 18.5% ====================================================================================================================================assets were included with general account assets as a result of adopting the SOP.As of
September 30, 2003March 31, 2004 and December 31,2002, over 94%2003, greater than 95% and 95%, respectively, of the fixed maturity portfolio was invested in short-term securities or securities rated investment grade (BBB and above).- 50 -The following table presents the Below Investment Grade ("BIG"(“BIG”) fixed maturities by type,including guaranteed separate accounts,as ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003.Consolidated BIG Fixed Maturities by Type
March 31, 2004 December 31, 2003 Percent of Percent of Amortized Total Fair Amortized Total Fair Cost Fair Value Value Cost Fair Value Value ABS $ 233 $ 239 6.9 % $ 293 $ 275 7.5 % CMBS 196 208 6.0 % 185 190 5.2 % Corporate Basic industry 364 385 11.0 % 365 381 10.4 % Capital goods 181 189 5.4 % 177 187 5.1 % Consumer cyclical 395 430 12.4 % 377 408 11.2 % Consumer non-cyclical 350 367 10.6 % 423 442 12.1 % Energy 115 124 3.6 % 113 123 3.4 % Financial services 21 22 0.6 % 20 20 0.5 % Technology and communications 379 454 13.1 % 418 505 13.8 % Transportation 32 37 1.1 % 58 61 1.7 % Utilities 465 488 14.0 % 529 549 15.0 % Foreign government 429 476 13.7 % 416 463 12.7 % Other 56 56 1.6 % 53 55 1.4 %
Total fixed maturities$ 3,216 $ 3,475 100.0 % $ 3,427 $ 3,659 100.0 %
Total general account fixed maturities $ 2,681 $ 2,877 78.6 % Total guaranteed separate account fixed maturities [1] $ 746 $ 782 21.4 %
CONSOLIDATED BIG FIXED MATURITIES BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------------------------- ------------------------------------ PERCENT OF PERCENT OF AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR COST FAIR VALUE VALUE COST FAIR VALUE VALUE - ------------------------------------------------------------------------------------------------------------------------------------ABS $ 305 $ 260 7.3% $ 237 $ 209 6.7% CMBS 213 218 6.1% 196 214 6.8% Corporate Basic industry 329 335 9.4% 338 339 10.8% Capital goods 190 196 5.5% 177 180 5.8% Consumer cyclical 361 384 10.7% 289 298 9.5% Consumer non-cyclical 390 403 11.3% 263 255 8.2% Energy 112 119 3.3% 111 113 3.6% Financial services 19 20 0.6% 53 45 1.4% Technology and communications 451 528 14.7% 612 571 18.3% Transportation 44 45 1.3% 44 40 1.3% Utilities 485 490 13.7% 415 376 12.0% Foreign government 468 525 14.7% 397 441 14.1% Other [1] 51 50 1.4% 51 46 1.5% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL FIXED MATURITIES $ 3,418 $ 3,573 100.0% $ 3,183 $ 3,127 100.0% - ------------------------------------------------------------------------------------------------------------------------------------ Total general account fixed maturities $ 2,631 $ 2,753 77.1% $ 2,494 $ 2,443 78.1% Total [1]Effective January 1, 2004, guaranteed separate account fixed maturities $ 787 $ 820 22.9% $ 689 $ 684 21.9% ====================================================================================================================================assets were included with general account assets as a result of adopting the SOP. [1] Other represents tax-exempt municipal bonds, redeemable preferred stocks and real estate investment trusts.As of
September 30, 2003March 31, 2004 and December 31,2002,2003, the Company held no issuer of a BIG security with a fair value in excess of 3%and 4%, respectively,of the total fair value for BIG securities. Total BIG securities decreased since December 31, 2003 as a result of tactical decisions to reduce exposure to lower credit quality assets and re-invest in investment grade securities.The following table presents the
Company'sCompany’s unrealized loss aging for total fixed maturity and equity securities classified as available-for-sale on a consolidated basis,including guaranteed separate accounts,as ofSeptember 30, 2003March 31, 2004 and December 31,2002,2003, by length of time the security was in an unrealized loss position.44
Consolidated Unrealized Loss Aging of Total Securities
March 31, 2004 December 31, 2003 Amortized Fair Unrealized Amortized Fair Unrealized Cost Value Loss Cost Value Loss Three months or less $ 3,596 $ 3,551 $ (45 ) $ 4,867 $ 4,826 $ (41 ) Greater than three months to six months 233 229 (4 ) 3,991 3,854 (137 ) Greater than six months to nine months 1,760 1,731 (29 ) 404 382 (22 ) Greater than nine months to twelve months 235 225 (10 ) 151 142 (9 ) Greater than twelve months 1,418 1,305 (113 ) 1,844 1,688 (156 )
Total$ 7,242 $ 7,041 $ (201 ) $ 11,257 $ 10,892 $ (365 )
Total general account $ 9,234 $ 8,941 $ (293 ) Total guaranteed separate accounts [1] $ 2,023 $ 1,951 $ (72 )
CONSOLIDATED UNREALIZED LOSS AGING OF TOTAL SECURITIES - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------------------------- ------------------------------------ AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED COST VALUE LOSS COST VALUE LOSS - ------------------------------------------------------------------------------------------------------------------------------------Three months or less $ 5,806 $ 5,670 $ (136) $ 2,042 $ 1,949 $ (93) Greater than three months to six months 597 572 (25) 1,542 1,463 (79) Greater than six months to nine months 312 299 (13) 703 611 (92) Greater than nine months to twelve months 387 357 (30) 1,820 1,719 (101) Greater than twelve months 2,037 1,849 (188) 2,351 2,103 (248) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 9,139 $ 8,747 $ (392) $ 8,458 $ 7,845 $ (613) ==================================================================================================================================== Total general accounts $ 7,355 $ 7,044 $ (311) $ 6,339 $ 5,852 $ (487) Total [1]Effective January 1, 2004, guaranteed separate accounts $ 1,784 $ 1,703 $ (81) $ 2,119 $ 1,993 $ (126) ====================================================================================================================================account assets were included with general account assets as a result of adopting the SOP.The decrease in the unrealized loss amount since December 31,
20022003 is primarily the result of slightly improvedcorporate fixed maturity credit qualitypricing levels for ABS securities, a decline in long-term interest rates and, to a lesser extent, assetsales, partially offset by an increase in interest rates. Forsales. (For further discussion,pleasesee the economic commentary under the Consolidated Fixed Maturities by Type table in this section of the MD&A.)As of
September 30,March 31, 2004 and December 31, 2003, fixed maturities represented$382,$181, or97%90%, and $349, or 96%, of theCompany'sCompany’s total unrealizedloss.loss associated with securities classified as available-for-sale, respectively. There were no fixed maturities as ofSeptember 30,March 31, 2004 or December 31, 2003 with a fair value less than 80% of thesecurity'ssecurity’s amortized cost basis for six continuous months other than certain asset-backed and commercial mortgage-backed securities.Other than temporaryOther-than-temporary impairments for certain asset-backed and commercial mortgage-backed securities are recognized if the fair value of the security, as determined by external pricing sources, is less than its carrying amount and there has been a decrease in the present value of the expected cash flows since the last reporting period. There were no asset-backed or commercial mortgage-backed securities included in the table above, as ofSeptember 30, 2003March 31, 2004 and December 31,2002,2003, for whichmanagement'smanagement’s best estimate of future cash flows adversely changed during the reporting period. As ofSeptember 30,March 31, 2004 and December 31, 2003, no asset-backed or commercial mortgage-backed securities had an unrealized loss in excess of$20. For a detailed$13 and $15, respectively. (For further discussion of theother than temporary impairmentother-than-temporary impairments criteria, see"Valuation of Investments and Derivative Instruments"“Investments” included in the Critical Accounting Estimates section of the MD&A and in Note1(g)1 of Notes to Consolidated Financial Statements both of which are included in TheHartford's 2002Hartford’s 2003 Form 10-K Annual Report.As of September 30, 2003 and December 31, 2002, the)The Company held no securities of a single issuer that were at an unrealized loss position in excess of
5%8% and6%, respectively,5% of the total unrealized lossamount.amount as of March 31, 2004 and December 31, 2003, respectively.The total securities classified as available-for-sale in an unrealized loss position for longer than six months by type as of
September 30, 2003March 31, 2004 and December 31,20022003 are presented in the following table.- 51 -Consolidated Total Securities with Unrealized Loss Greater Than Six Months by Type
March 31, 2004 December 31, 2003 Percent of Percent of Total Total Amortized Fair Unrealized Amortized Fair Unrealized Unrealized Cost Value Unrealized Loss Loss Cost Value Loss Loss ABS and CMBS Aircraft lease receivables $ 149 $ 98 $ (51 ) 33.6 % $ 174 $ 116 $ (58 ) 31.0 % CDOs 90 86 (4 ) 2.6 % 176 153 (23 ) 12.3 % Credit card receivables 79 75 (4 ) 2.6 % 123 111 (12 ) 6.4 % Other ABS and CMBS 851 835 (16 ) 10.6 % 693 673 (20 ) 10.7 % Corporate Financial services 952 910 (42 ) 27.6 % 747 710 (37 ) 19.8 % Technology and communications 145 143 (2 ) 1.3 % 55 52 (3 ) 1.6 % Transportation 70 66 (4 ) 2.6 % 42 38 (4 ) 2.1 % Utilities 220 211 (9 ) 5.9 % 103 95 (8 ) 4.3 % Other 562 550 (12 ) 7.9 % 268 248 (20 ) 10.7 % Other securities 295 287 (8 ) 5.3 % 18 16 (2 ) 1.1 %
Total$ 3,413 $ 3,261 $ (152 ) 100.0 % $ 2,399 $ 2,212 $ (187 ) 100.0 %
Total general accounts $ 1,760 $ 1,619 $ (141 ) 75.4 % Total guaranteed separate accounts [1] $ 639 $ 593 $ (46 ) 24.6 %
CONSOLIDATED TOTAL SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 ---------------------------------------------- -------------------------------------------- PERCENT OF PERCENT OF TOTAL TOTAL AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED COST VALUE LOSS LOSS COST VALUE LOSS LOSS - ------------------------------------------------------------------------------------------------------------------------------------ABS and CMBS Aircraft lease receivables $ 182 $ 117 $ (65) 28.1% $ 94 $ 79 $ (15) 3.4% CDOs 211 175 (36) 15.6% 262 217 (45) 10.2% Credit card receivables 273 253 (20) 8.7% 408 359 (49) 11.1% MH receivables 30 28 (2) 0.9% 21 20 (1) 0.2% ther ABS and CMBS 815 798 (17) 7.4% 763 748 (15) 3.4% Corporate Financial services 725 683 (42) 18.2% 910 831 (79) 17.9% Technology and communications 26 23 (3) 1.3% 609 536 (73) 16.6% Transportation 44 36 (8) 3.5% 89 72 (17) 3.9% Utilities 163 147 (16) 6.9% 361 325 (36) 8.2% Other 213 199 (14) 6.1% 821 781 (40) 9.1% Diversified equity mutual funds 6 5 (1) 0.4% 113 88 (25) 5.7% Other securities 48 41 (7) 2.9% 423 377 (46) 10.3% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 2,736 $ 2,505 $ (231) 100.0% $ 4,874 $ 4,433 $(441) 100.0% ==================================================================================================================================== Total general accounts $ 1,951 $ 1,780 $ (171) 74.0% $ 3,597 $ 3,258 $ (339) 76.9% Total [1]Effective January 1, 2004, guaranteed separate accounts $ 785 $ 725 $ (60) 26.0% $ 1,277 $ 1,175 $ (102) 23.1% ====================================================================================================================================account assets were included with general account assets as a result of adopting the SOP.The ABS securities in an unrealized loss position for six months or more as of
September 30,March 31, 2004 and December 31, 2003, were primarily supported by aircraft lease receivables, CDOs and credit card receivables. TheCompany'sCompany’s current view of risk factors relative to these fixed maturity types is as follows:45
Aircraft lease receivables
- The— During the first quarter of 2004, securities supported by aircraftaircraftleasepayments and enhanced equipment trust certificates (together, "aircraft lease receivables") have continued to declinereceivables sustained a modest increase in value, continuing an upward trend that began in the fourth quarter of 2003. This increase is primarily due to areduction inmodest improvement on certain aircraft leasepayments and aircraft valuesrates, driven by greater demand for aircraft as a result of increased airline travel. In prior periods, these securities had suffered a considerable decrease in value as a result of a prolonged decline in airline travelwhich resulted in bankruptciesandother financial difficultiesthe uncertainty ofairline carriers. Asaresult of these factors, significant risk premiums have been required bypotential industry recovery. While themarket for securitiesCompany has seen modest price increases and greater liquidity in this sectorresulting in reduced liquidityduring the first quarter of 2004 andlower broker quoted prices. The levelfourth quarter of 2003, any additional price recovery will depend on continued improvement in economic fundamentals, political stability and airline operating performance.Aircraft lease receivables will be further stressed if passenger air traffic declines or airlines liquidate rather than emerge from bankruptcy protection.CDOs— Pricing levels for CDOs
- Adverse CDO experience can be attributedrecovered modestly during the first quarter of 2004 due tohigher than expected default rates on the collateral, particularlyan increase inthe technology and utilities sectors, and lower than expected recovery rates. Improveddemand for these asset types, driven by improved economic and operating fundamentals of the underlying security issuers,should lead to improved pricing levels.better market liquidity and attractive yields.Credit card receivables
-— The decrease in the unrealized loss position in credit card securitieshasduring the first quarter of 2004 is primarilybeen causedthe result of an increase in pricing levels, driven byexposure to companies originating loans to sub-prime borrowers.an improvement in collateral performance. While the unrealized loss position has improved for these holdings,duringconcerns remain regarding theyear, the Company believes thatlong-term viability of certain issuers within thissub-sector will continue to be under stress and expects holdings to be very sensitive to changes in collateral performance.sub-sector.As of
September 30,March 31, 2004 and December 31, 2003, security types other than ABS and CMBS that were in a significant unrealized loss position for greater than six months were corporate fixed maturities primarily within the financial servicesand utilities sectors.sector.Financial
Services - Theservices— As of March 31, 2004, the securities in the financial servicessecurities in ansector unrealized loss position for greater than six months were comprised of approximately 60 different securities. The securities in this category are primarily investment grade and the majority of these securities are priced at or greater than 90% of amortized cost as of March 31, 2004. These positions are primarily variable rate securities with extended maturity dates, which have been adversely impacted by the reduction in forward interest rates resulting in lower expected cash flows. Unrealized loss amounts for these securities havedeclinedincreased during theyearfirst quarter of 2004 as interest rates haverisen.declined. Additional changes in fair value of these securities are primarily dependent on future changes in forward interest rates. A substantial percentage of these securities are currently hedged with interest rate swaps, which convert the variable rate earned on the securities to a fixed amount. The swaps receive cash flow hedge accounting treatment and are currently in an unrealized gain position.Utilities - The utilities sector remains adversely impacted by several events that primarily occurred in 2001 including the bankruptcy of Enron Corp., the decline in the energy trading industry and the regulatory, political and legal effect of the California utility crisis. These events led to credit downgrades, which continue to negatively impact security price levels. Companies have begun to reduce leverage, selling various non-core businesses and have secured liquidity sources either through capital market issuances or bank lines to support cash flow needs. Improved credit fundamentals coupled with increased energy prices and demand should allow the price of these companies' securities to improve.As part of the
Company'sCompany’s ongoing security monitoring process by a committee of investment and accounting professionals, the Company has reviewed its investment portfolio and concluded- 52 -that there were no additional other than temporaryother-than-temporary impairments as ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003. Due to theissuers'issuers’ continued satisfaction of thesecurities'securities’ obligations in accordance with their contractual terms and the expectation that they will continue to do so, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of theissuers'issuers’ financial condition and other objective evidence, the Company believes that the prices of the securities in the sectors identified above were temporarilydepressed primarily as a result of a market dislocation and generally poor cyclical economic conditions and sentiment. See "Valuation of Investments and Derivative Instruments" included in the Critical Accounting Estimates section of MD&A and in Note 1(g) of Notes to Consolidated Financial Statements both included in The Hartford's 2002 Form 10-K Annual Report.depressed.The evaluation for
other than temporaryother-than-temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments areother than temporary.other-than-temporary. The risks and uncertainties include changes in general economic conditions, theissuer'sissuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. In addition, for securitized financial assets with contractual cash flows (e.g. ABS and CMBS), projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral. As of March 31, 2004 and December 31, 2003, management’s expectation of the discounted future cash flows on these securities was in excess of the associated securities’ amortized cost. (For further discussion, see “Investments” included in the Critical Accounting Estimates section of MD&A and in Note 1 of Notes to Consolidated Financial Statements both of which are included in The Hartford’s 2003 Form 10-K Annual Report.)The following table presents the
Company'sCompany’s unrealized loss aging for BIG and equity securities classified as available-for-sale on a consolidated basis,including guaranteed separate accounts,as ofSeptember 30, 2003March 31, 2004 and December 31,2002.2003.Consolidated Unrealized Loss Aging of BIG and Equity Securities
March 31, 2004 December 31, 2003 Amortized Fair Unrealized Amortized Fair Unrealized Cost Value Loss Cost Value Loss Three months or less $ 300 $ 292 $ (8 ) $ 133 $ 129 $ (4 ) Greater than three months to six months 43 41 (2 ) 134 129 (5 ) Greater than six months to nine months 54 52 (2 ) 81 73 (8 ) Greater than nine months to twelve months 75 67 (8 ) 18 17 (1 ) Greater than twelve months 271 229 (42 ) 417 349 (68 )
Total$ 743 $ 681 $ (62 ) $ 783 $ 697 $ (86 )
Total general accounts $ 663 $ 593 $ (70 ) Total guaranteed separate accounts [1] $ 120 $ 104 $ (16 )
CONSOLIDATED UNREALIZED LOSS AGING OF BIG AND EQUITY SECURITIES - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 --------------------------------------- ------------------------------------ AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED COST VALUE LOSS COST VALUE LOSS - ------------------------------------------------------------------------------------------------------------------------------------Three months or less $ 401 $ 386 $ (15) $ 274 $ 229 $ (45) Greater than three months to six months 144 133 (11) 308 267 (41) Greater than six months to nine months 77 73 (4) 266 213 (53) Greater than nine months to twelve months 86 76 (10) 576 515 (61) Greater than twelve months 460 383 (77) 610 517 (93) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 1,168 $ 1,051 $ (117) $ 2,034 $ 1,741 $ (293) ==================================================================================================================================== Total general accounts $ 987 $ 887 $ (100) $ 1,702 $ 1,444 $ (258) Total [1]Effective January 1, 2004, guaranteed separate accounts $ 181 $ 164 $ (17) $ 332 $ 297 $ (35) ====================================================================================================================================account assets were included with general account assets as a result of adopting the SOP.Similar to the decrease in the Consolidated Unrealized Loss Aging of Total Securities table from December 31,
20022003 toSeptember 30, 2003,March 31, 2004, the decrease in the BIG and equity security unrealized loss amount for securities classified as available-for-sale was primarily the result of slightly improvedcorporate fixed maturity credit qualitypricing levels for ABS securities, a decline in long-term interest rates and, to a lesser extent, assetsales, partially offset by an increase in interest rates. Forsales. (For further discussion,pleasesee the economic46
commentary under the Consolidated Fixed Maturities by Type table in this section of the MD&A.)
The BIG and equity securities classified as available-for-sale in an unrealized loss position for longer than six months by type as of
September 30, 2003March 31, 2004 and December 31,20022003 are presented in the following table.Consolidated BIG and Equity Securities with Unrealized Loss Greater Than Six Months by Type
March 31, 2004 December 31, 2003 Percent of Percent of Total Total Amortized Fair Unrealized Unrealized Amortized Fair Unrealized Unrealized Cost Value Loss Loss Cost Value Loss Loss ABS and CMBS Aircraft lease receivables $ 31 $ 17 $ (14 ) 26.9 % $ 55 $ 36 $ (19 ) 24.6 % CDOs 22 21 (1 ) 1.9 % 44 34 (10 ) 13.0 % Credit card receivables 42 38 (4 ) 7.7 % 45 34 (11 ) 14.3 % Other ABS and CMBS 40 33 (7 ) 13.6 % 59 49 (10 ) 13.0 % Corporate Financial services 143 125 (18 ) 34.6 % 142 128 (14 ) 18.2 % Transportation 4 3 (1 ) 1.9 % 21 18 (3 ) 3.9 % Utilities 56 51 (5 ) 9.6 % 76 70 (6 ) 7.8 % Other 60 58 (2 ) 3.8 % 69 65 (4 ) 5.2 % Other securities 2 2 — — 5 5 — —
Total$ 400 $ 348 $ (52 ) 100.0 % $ 516 $ 439 $ (77 ) 100.0 %
Total general accounts $ 417 $ 355 $ (62 ) 80.5 % Total guaranteed separate accounts [1] $ 99 $ 84 $ (15 ) 19.5 %
CONSOLIDATED BIG AND EQUITY SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE - ------------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2003 DECEMBER 31, 2002 ----------------------------------------------- -------------------------------------------- PERCENT OF PERCENT OF TOTAL TOTAL AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED COST VALUE LOSS LOSS COST VALUE LOSS LOSS - ------------------------------------------------------------------------------------------------------------------------------------ABS and CMBS Aircraft lease receivables $ 62 $ 38 $ (24) 26.4% $ 4 $ 2 $ (2) 1.0% CDOs 47 38 (9) 9.9% 4 2 (2) 1.0% Credit card receivables 53 36 (17) 18.7% 36 23 (13) 6.3% Other ABS and CMBS 54 47 (7) 7.7% 45 39 (6) 2.9% Corporate Financial services 80 75 (5) 5.5% 141 131 (10) 4.8% Technology and communications 21 19 (2) 2.2% 325 267 (58) 28.0% Transportation 21 17 (4) 4.4% 33 26 (7) 3.4% Utilities 148 134 (14) 15.4% 209 182 (27) 13.0% Other 127 120 (7) 7.7% 379 346 (33) 15.9% Diversified equity mutual funds 6 5 (1) 1.1% 113 88 (25) 12.1% Other securities 4 3 (1) 1.0% 163 139 (24) 11.6% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL $ 623 $ 532 $ (91) 100.0% $ 1,452 $ 1,245 $(207) 100.0% ==================================================================================================================================== Total general accounts $ 502 $ 428 $ (74) 81.3% $ 1,191 $ 1,012 $(179) 86.5% Total [1]Effective January 1, 2004, guaranteed separate accounts $ 121 $ 104 $ (17) 18.7% $ 261 $ 233 $ (28) 13.5% ====================================================================================================================================account assets were included with general account assets as a result of adopting the SOP.- 53 -For a discussion of the
Company'sCompany’s current view of risk factors relative to certain security types listed above, please refer to the Consolidated Total Securities with Unrealized Loss Greater Than Six Months by Type table in this section of the MD&A.EQUITYCAPITAL MARKETS RISK MANAGEMENT
The
Company'sHartford has a disciplined approach to managing risks associated with its capital markets and asset/liability management activities. Investment portfolio management is organized to focus investment management expertise on specific classes of investments, while asset/liability management is the responsibility of dedicated risk management units supporting Life and Property & Casualty operations. Derivative instruments are utilized in compliance with established Company policy and regulatory requirements and are monitored internally and reviewed by senior management.Market Risk
The Hartford has material exposure to both interest rate and equity market risk. The Company analyzes interest rate risk using various models including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, including derivative instruments. (For further discussion of market risk see the Capital Markets Risk Management section of MD&A in The Hartford’s 2003 Form 10-K Annual Report.) There have been no material changes in market risk exposures from December 31, 2003.
Derivative Instruments
The Hartford utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in compliance with Company policy and regulatory requirements designed to achieve one of four Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity, to control transaction costs; or to enter into replication transactions. The Company does not make a market or trade in these instruments for the express purpose of earning short term trading profits. (For further discussion on The Hartford’s use of derivative instruments, refer to Note 2 of Notes to Condensed Consolidated Financial Statements.)
Life’s Equity Risk
The Company’s operations are significantly influenced by changes in the equity markets. The
Company'sCompany’s profitability depends largely on the amount of assets under management, which is primarily driven by the level of sales, equity market appreciation and depreciation and the persistency of the in-force block of business. Prolonged and precipitous declines in the equity markets can have a significant impact on theCompany'sCompany’s operations, as sales of variable products may decline and surrender activity may increase,ifas customer sentiment towards the equity market turns negative. Lower assets under management will have a negative impact on theCompany'sCompany’s financial results, primarily due to lower fee income related to theInvestmentRetail Products Group and Institutional Solutions Group and, to a lesser extent, Individual Life segments, where a heavy concentration ofequity-linkedequity linked products are administered and sold. Furthermore, the Company may experience a reduction in profit margins if a significant portion of the assets held in the variable annuity separate accounts move to the general account and the Company is unable to earn an acceptable investment spread,47
particularly in light of the low interest rate environment and the presence of contractually guaranteed minimum interest credited rates, which for the most part are at a 3% rate.
In addition, prolonged declines in the equity market may also decrease the
Company'sCompany’s expectations of future gross profits, which are utilized to determine the amount of DAC to be amortized in a given financial statement period. A significant decrease in theCompany'sCompany’s estimated gross profits would require the Company to accelerate the amount of DAC amortization in a given period, potentially causing a material adverse deviation in thatperiod'speriod’s net income. Although an acceleration of DAC amortization would have a negative impact on theCompany'sCompany’s earnings, it would not affect theCompany'sCompany’s cash flow or liquidity position.Additionally, the
InvestmentRetail Products Group segment sells variable annuity contracts that offer various guaranteed death benefits. For certain guaranteed death benefits,The Hartfordthe Company pays the greater of (1) the account value at death; (2) the sum of all premium payments less prior withdrawals; or (3) the maximum anniversary value of the contract, plus any premium payments since the contract anniversary, minus any withdrawals following the contract anniversary. For certain guaranteed death benefits sold with variable annuity contracts beginning in June of 2003, the Company pays the greater of (1) the account value at death; or (2) the maximum anniversary value; not to exceed the account value plus the greater of (a) 25% of premium payments, or (b) 25% of the maximum anniversary value of the contract. The Company currently reinsures a significant portion ofthethese death benefit guarantees associated with its in-force block of business. The Companycurrently recordsmaintains a liability for the death benefit costs, net of reinsurance, of $117, asthey are incurred.of March 31, 2004. Declines in the equity market may increase theCompany'sCompany’s net exposure to death benefits under these contracts.The
InvestmentRetail Productssegment'sGroup segment’s total gross exposure (i.e. before reinsurance) to these guaranteed death benefits as ofSeptember 30, 2003 was $16.2March 31, 2004 is $10.5 billion. Due to the fact that77%80% of this amount is reinsured, the net exposure is$3.7$2.0 billion. This amount is often referred to as theretainednet amount at risk. However, the Company will incur these guaranteed death benefit payments in the future only if the policyholder has an in-the-money guaranteed death benefit at their time of death.In order to analyze the total costs that the Company may incur in the future related to these guaranteed death benefits, the Company performed an actuarial present value analysis. This analysis included developing a model utilizing stochastically generated scenarios and best estimate assumptions related to mortality and lapse rates. A range of projected costs was developed and discounted back to the financial statement date utilizing the Company's cost of capital, which for this purpose was assumed to be 9.25%. Based on this analysis, the Company estimated a 95% confidence interval of the present value of the retained death benefit costs to be incurred in the future to be a range of $110 to $368 for these contracts. The median of the stochastically generated investment performance scenarios was $176. On June 30, 2003, the Company recaptured a block of business previously reinsured with an unaffiliated reinsurer. Under this treaty, Hartford Life reinsured a portion of the guaranteed minimum death benefit ("GMDB") feature associated with certain of its annuity contracts. As consideration for recapturing the business and final settlement under the treaty, the Company has received assets valued at approximately $32 and one million warrants exercisable for the unaffiliated company's stock. This amount represents to the Company an advance collection of its future recoveries under the reinsurance agreement and will be recognized as future losses are incurred. Prospectively, as a result of the recapture, Hartford Life will be responsible for all of the remaining and ongoing risks associated with the GMDB's related to this block of business. The recapture increased the net amount at risk retained by the Company, which is included in the net amount at risk discussed in Note 1 (f). In the first quarter of 2004, the Company will adopt the provisions of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts", (the "SOP"). The provisions of the SOP include a requirement for recording a liability for variable annuity products with a guaranteed minimum death benefit feature. The determination of this liability is also based on models that involve numerous estimates and subjective judgments, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience. Based on management's preliminary review of the SOP and current market conditions, the unrecorded GMDB liabilities, net of reinsurance, are estimated to be between $60 and $70 at September 30, 2003. Net of estimated DAC and income tax effects, the cumulative effect of establishing the required GMDB reserves is expected to result in a reduction of net income of between $30 and $40. The ultimate actual impact on the Company's financial statements will differ from management's current estimates and will depend in part on market conditions and other factors at the date of adoption.In addition, the Company offers certain variable annuity products with a GMWB rider.
The GMWB provides the policyholder with a guaranteed remaining balance ("GRB") if the account value is reduced to zero through a combination of market declines and withdrawals. The GRB is generally equal to premiums less withdrawals. However, annual withdrawals that exceed 7% of the premiums paid may reduce the GRB by an amount greater than the withdrawals and may also impact that guaranteed annual withdrawal amount that subsequently applies after the excess annual withdrawals occur. The policyholder also has the option, - 54 -after a specified time period, to reset the GRB to the then-current account value, if greater. The GMWB represents an embedded derivative liability in the variable annuity contract that is required to be reported separately from the host variable annuity contract. It is carried at fair value and reported in other policyholder funds. The fair value of the GMWB obligations are calculated based on actuarial assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. Because of the dynamic and complex nature of these cash flows, stochastic techniques under a variety of market return scenarios and other best estimate assumptions are used. Estimating cash flows involves numerous estimates and subjective judgments including those regarding expected market rates of return, market volatility, correlations of market returns and discount rates.Declines in the equity market may increase theCompany'sCompany’s exposure to benefits underthesethe GMWB contracts. For all contracts in effect through July 6, 2003, the Company entered into a reinsurance arrangement to offset its exposure to the GMWB for the remaining lives of those contracts. As of July 6, 2003, the Company exhausted all but a small portion of the reinsurance capacity for new business under the current arrangement and will be ceding only a very small number of new contracts subsequent to July 6, 2003. Substantially all new contracts with the GMWB are not covered by reinsurance. These unreinsured contracts are expected to generate volatility in net income as the underlying embedded derivative liabilities are recorded at fair value each reporting period, resulting in the recognition of net realized capital gains or losses in response to changes in certain critical factors including capital market conditions and policyholder behavior. In order to minimize the volatility associated with the unreinsured GMWB liabilities, the Company established an alternative risk management strategy. During the third quarter of 2003, the Company began hedging its unreinsured GMWB exposure usingcapital market instruments. - --------------------------------------------------------------------------------interest rate futures, Standard and Poor’s (“S&P”) 500 and NASDAQ index options and futures contracts. During the first quarter of 2004, the Company entered into Europe, Asia and Far East (“EAFE”) Index swaps to hedge GMWB exposure to international equity markets.The net impact of the change in value of the embedded derivative, net of the results of the hedging program was a $2 loss before deferred policy acquisition costs and tax effects for the three months ended March 31, 2004.
CAPITAL RESOURCES AND LIQUIDITY
- --------------------------------------------------------------------------------Capital resources and liquidity represent the overall financial strength of The Hartford and its ability to generate strong cash flows from each of the business segments,
andborrow funds at competitive rates and raise new capital to meet operating and growth needs.Liquidity Requirements
The
capital structureliquidity requirements of The Hartfordconsistshave been and will continue to be met by funds from operations as well as the issuance of commercial paper, common stock, debt securities andequity summarized as follows:
SEPTEMBER 30, DECEMBER 31, 2003 2002 CHANGE - ------------------------------------------------------------------------------------------------------------------------------------Short-term debt (includes current maturities of long-term debt) $ 515 $ 315 63% Long-term debt 3,660 2,596 41% Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures ("trust preferred securities") 962 1,468 (34%) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL DEBT $ 5,137 $ 4,379 17% - ------------------------------------------------------------------------------------------------------------------------------------ Equity excluding accumulated other comprehensive income ("AOCI"), net of tax $ 9,987 $ 9,640 4% AOCI, net of tax 1,357 1,094 24% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY $ 11,344 $ 10,734 6% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL CAPITALIZATION INCLUDING AOCI $ 16,481 $ 15,113 9% - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL CAPITALIZATION EXCLUDING AOCI $ 15,124 $ 14,019 8% - ------------------------------------------------------------------------------------------------------------------------------------ Debt to equity [1] 45% 41% Debt to capitalization [1] 31% 29% ====================================================================================================================================[1] Excluding trust preferred securities from total debt and AOCI from total stockholders' equity and total capitalization, the debt to equity ratio was 42% and 30% and the debt to capitalization ratio was 28% and 21% as of September 30, 2003 and December 31, 2002, respectively.CAPITALIZATIONborrowings from its credit facilities. The principal sources of operating funds are premiums and investment income, while investing cash flows originate from maturities and sales of invested assets.The Hartford endeavors to maintain a capital structure that provides financial and operational flexibility to its insurance subsidiaries, ratings that support its competitive position in the financial services marketplace (see the Ratings section below for further discussion), and strong shareholder returns. As a result, the Company may from time to time raise capital from the issuance of stock, debt or other capital securities. The issuance of common stock, debt or other capital securities could result in the dilution of shareholder interests or reduced net income due to additional interest expense.
DuringThe Hartford Financial Services Group, Inc. (“HFSG”) and HLI are holding companies which rely upon operating cash flow in the
second quarterform of dividends from their subsidiaries, which enable them to service debt, pay dividends, and pay certain business expenses.Dividends to HFSG from its subsidiaries are restricted. The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. Under these laws, the insurance subsidiaries may only make their dividend payments out of unassigned surplus. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer’s policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory
48
insurance accounting policies. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer’s earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The insurance holding company laws of the other jurisdictions in which The Hartford’s insurance subsidiaries are incorporated (or deemed commercially domiciled) generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. Through April 30, 2004, the Company’s insurance subsidiaries had paid $301 to HFSG and HLI and are permitted to pay up to a maximum of approximately $1.1 billion in dividends to HFSG and HLI for the remainder of 2004 without prior approval from the applicable insurance commissioner.
The primary uses of funds are to pay claims, policy benefits, operating expenses and commissions and to purchase new investments. The Hartford has a policy of carrying a significant short-term investment position and accordingly does not anticipate selling intermediate and long-term fixed maturity investments to meet its liquidity needs. (For a discussion of the Company’s investment objectives and strategies, see the Investments and Capital Markets Risk Management sections.)
Sources of Liquidity
Shelf Registrations
On December 3, 2003, The Hartford’s shelf registration statement (Registration No. 333-108067) for the potential offering and sale of debt and equity securities in an aggregate amount of up to $3.0 billion was declared effective by the Securities and Exchange Commission. The Registration Statement allows for the following types of securities to be offered: (i) debt securities, preferred stock, common stock, depositary shares, warrants, stock purchase contracts, stock purchase units and junior subordinated deferrable interest debentures of the Company,
increased its capitalization by $2.1 billion through the issuanceand (ii) preferred securities of$1.2 billion in common stock, $669 in equity units and $249 in senior notes. Contributions of proceeds included: $300 to the Company's qualified pension plan, $150 to the life insurance subsidiaries, $180 to redeem a portion of its Series A 7.7% Cumulative Quarterly Income Preferred Securities due February 28, 2016, with the balance to be used in the property and casualty insurance subsidiaries. The Hartford's total capitalization increased $1.4 billion and total capitalization excluding AOCI increased $1.1 billion as of September 30, 2003 compared to December 31, 2002. This increase was due to the capital raising stated above, partially offset by a net loss of $(545) for the nine months ended September 30, 2003, which reflects the $1.7 billion, after-tax, charge taken to strengthen reserves for asbestos related exposure. DEBT On May 23, 2003, The Hartford issued 12.0 million 7% equity units at a price of fifty dollars per unit and received net proceeds of $582. Subsequently, on May 30, 2003, The Hartford issued an additional 1.8 million 7% equity units at a price of fifty dollars per unit and received net proceeds of $87. - 55 -Each equity unit offered initially consists of a corporate unit with a stated amount of fifty dollars per unit. Each corporate unit consistsany of onepurchase contract for the sale of a certain number of shares of the Company's stock and a 5% ownership interest in one thousand dollars principal amount of senior notes due August 16, 2008. The corporate unit may be converted by the holder into a treasury unit consisting of the purchase contract and a 5% undivided beneficial interest in a zero-coupon U.S. Treasury security with a principal amount of one thousand dollars that matures on August 15, 2006. The holder of an equity unit owns the underlying senior notesortreasury securities but has pledged the senior notes or treasury securities to the Company to secure the holder's obligations under the purchase contract. The purchase contract obligates the holder to purchase, and obligates The Hartford to sell, on August 16, 2006, for fifty dollars, a variable number of newly issued common shares of The Hartford. The number of The Hartford's shares to be issued will be determined at the time the purchase contracts are settled based upon the then current applicable market value of The Hartford's common stock. If the applicable market value of The Hartford's common stock is equal to or less than $45.50, then the Company will deliver 1.0989 shares to the holder of the equity unit, or an aggregate of 15.2 million shares. If the applicable market value of The Hartford's common stock is greater than $45.50 but less than $56.875, then the Company will deliver the number of shares equal to fifty dollars divided by the then current applicable market value of The Hartford's common stock to the holder. Finally, if the applicable market value of The Hartford's common stock is equal to or greater than $56.875, then the Company will deliver 0.8791 shares to the holder, or an aggregate of 12.1 million shares. Accordingly, upon settlement of the purchase contracts on August 16, 2006, The Hartford will receive proceeds of approximately $690 and will deliver between 12.1 million and 15.2 million common shares in the aggregate. The proceeds will be credited to stockholders' equity and allocated between the common stock and additional paid-in-capital accounts. The Hartford will make quarterly contract adjustment payments to the equity unit holders at a rate of 4.44% of the stated amount per year until the purchase contract is settled. Each corporate unit also includes a 5% ownership interest in one thousand dollars principal amount of senior notes that will mature on August 16, 2008. The aggregate maturity value of the senior notes is $690. The notes are pledged by the holders to secure their obligations under the purchase contracts. The Hartford will make quarterly interest payments to the holders of the notes initially at an annual rate of 2.56%. On May 11, 2006, the notes will be remarketed. At that time, The Hartford's remarketing agent will have the ability to reset the interest rate on the notes in order to generate sufficient remarketing proceeds to satisfy the holder's obligation under the purchase contract. If the initial remarketing is unsuccessful, the remarketing agent will attempt to remarket the notes, as necessary, on June 13, 2006, July 12, 2006 and August 11, 2006. If all remarketing attempts are unsuccessful, the Company will exercise its rights as a secured party to obtain and extinguish the notes. The total distributions payable on the equity units are at an annual rate of 7%, consisting of interest (2.56%) and contract adjustment payments (4.44%). The corporate units are listed on the New York Stock Exchange under the symbol "HIG PrD". The present value of the contract adjustment payments of $95 was accrued upon the issuance of the equity units as a charge to additional paid-inmore capitaland is included in other liabilities in the accompanying condensed consolidated balance sheet as of September 30, 2003. Subsequent contract adjustment payments will be allocated between this liability account and interest expense based on a constant rate calculation over the life of the purchase contracts. Additional paid-in capital as of September 30, 2003 also reflected a charge of $17 representing a portion of the equity unit issuance costs that were allocated to the purchase contracts. The equity units have been reflected in the diluted earnings per share calculation using the treasury stock method, which would be used for the equity units at any time before the settlement of the purchase contracts. Under the treasury stock method, the number of shares of common stock used in calculating diluted earnings per share is increased by the excess, if any, of the number of shares issuable upon settlement of the purchase contracts over the number of shares that could be purchasedtrusts organized by The Hartfordin the market, at the average market price during the period, using the proceeds received upon settlement.(“The Hartford Trusts”). The Companyanticipates that there will be no dilutive effect on its earnings per share relatedmay enter into guarantees with respect to theequity units, except during periods when the average market pricepreferred securities ofa share of the Company's common stock is above the threshold appreciation price of $56.875. Because the average market priceany of TheHartford's common stock during the quarter and nine months ended September 30, 2003 was below this threshold appreciation price, the shares issuable under the purchase contract component of the equity units have not been included in the diluted earnings per share calculation. On May 23, 2003, TheHartfordissued 2.375% senior notes due June 1, 2006 and received net proceeds of $249. Interest on the notes is payable semi-annually on June 1 and December 1, commencing on December 1, 2003. On July 10, 2003,Trusts.In January 2004, the Company issued
4.625% senior notes due July 15, 2013 and received net proceeds of $317. Interest on the notes is payable semi-annually on January 15 and July 15, commencing on January 15, 2004. - 56 -The table below details the Company's short-term debt programs and the applicable balances outstanding.
OUTSTANDING AS OF ----------------- --------------- EFFECTIVE EXPIRATION MAXIMUM SEPTEMBER 30, DECEMBER 31, DESCRIPTION DATE DATE AVAILABLE 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------Commercial Paper The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 315 HLI 2/7/97 N/A 250 -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial paper $ 2,250 $ 315 $ 315 Revolving Credit Facility 5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ -- 3-year revolving credit facility 12/31/02 12/31/05 490 -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Total revolving credit facility $ 1,490 $ -- $ -- - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL SHORT-TERM DEBT [1] $ 3,740 $ 315 $ 315 ====================================================================================================================================[1] Excludes current maturities of long-term debt of $200 and $0 as of September 30, 2003 and December 31, 2002, respectively.TRUST PREFERRED SECURITIES On June 30, 2003, the Company redeemed $180 of its 7.7% trust preferred securities issued by Hartford Capital I. On September 30, 2003, the Company redeemed the remaining $320 of its 7.7% trust preferred securities issued by Hartford Capital I. STOCKHOLDERS' EQUITY Issuance of common stock - On May 23, 2003, The Hartford issuedapproximately24.26.7 million shares of common stock pursuant to an underwritten offering at a price to the public of$45.50$63.25 per share and received net proceeds of$1.1 billion. Subsequently,$411. On March 9, 2004, the Company issued $200 of 4.75% senior notes due March 1, 2014. As of March 31, 2004, the Company had $2.4 billion remaining on its shelf.On May 15, 2001, HLI filed with the SEC a shelf registration statement for the potential offering and sale of up to $1.0 billion in debt and preferred securities. The registration statement was declared effective on May
30,29, 2001. As of March 31, 2004, HLI had $1.0 billion remaining on its shelf.Commercial Paper and Revolving Credit Facilities
The table below details the Company’s short-term debt programs and the applicable balances outstanding.
Outstanding As of Effective Expiration Maximum March 31, December 31, Description Date Date Available 2004 2003 Change Commercial Paper The Hartford 11/10/86 N/A $ 2,000 $ 373 $ 850 (56 %) HLI 2/7/97 N/A 250 — — —
Total commercial paper $ 2,250 $ 373 $ 850 (56 %) Revolving Credit Facility 5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ — $ — — 3-year revolving credit facility 12/31/02 12/31/05 490 — — —
Total revolving credit facility $ 1,490 $ — $ — —
Total Outstanding Commercial Paper and Revolving Credit Facility$ 3,740 $ 373 $ 850 $ (56 %)
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
There have been no material changes to the Company’s off-balance sheet arrangements and aggregate contractual obligations since the filing of the Company’s 2003 Form 10-K Annual Report.
Pension Plans and Other Postretirement Benefits
While the Company has significant discretion in making voluntary contributions to the Plan, the Employee Retirement Income Security Act of 1974 regulations mandate minimum contributions in certain circumstances. On April 10, 2004, the Pension Funding Equity Act of 2004 was signed into law. This Act provided pension funding relief by replacing the defunct 30-year Treasury bond rate with a composite rate based on conservatively invested long-term corporate bonds. As a result of the passage of this legislation, the Company’s minimum funding requirement in 2004 has been eliminated.
On April 15, 2004 the Company made a $312 voluntary contribution into its U.S. qualified defined benefit pension plan. No additional contributions are expected to be paid during the current fiscal year.
49
Capitalization
The capital structure of The Hartford as of March 31, 2004 and December 31, 2003 consisted of debt and equity, summarized as follows:
March 31, December 31, 2004 2003 Change Short-term debt (includes current maturities of long-term debt) $ 573 $ 1,050 (45 %) Long-term debt 4,580 4,613 (1 %) Total debt$ 5,153 $ 5,663 (9 %)
Equity excluding accumulated other comprehensive income, net of tax (“AOCI”) $ 11,369 $ 10,393 9 % AOCI 2,168 1,246 74 %
Total stockholders’ equity$ 13,537 $ 11,639 16 %
Total capitalization including AOCI$ 18,690 $ 17,302 8 %
Debt to equity 38 % 49 % Debt to capitalization 28 % 33 %
The Hartford’s total capitalization increased $1.4 billion as of March 31, 2004 as compared with December 31, 2003. This increase was due to an increase in stockholders’ equity partially offset by a decrease in debt. The increase in total stockholders’ equity is primarily due to an increase in AOCI of $922, issuance of common stock of $411 and net income of $568. The increase in AOCI is primarily a result of an increase in unrealized gains of $574 and Life’s adoption of SOP 03-1, which resulted in a $292 cumulative effect on unrealized gains on securities in the first quarter of 2004 related to the reclassification of investments from separate account assets to general account assets. The decrease in total debt reflects repayments of commercial paper of $477 and the redemption of $250 of junior subordinated debentures, partially offset by issuance of $199 in long-term debt.
Debt
The following discussion describes the Company’s debt financing activities for the first quarter of 2004.
On March 15, 2004, HLI redeemed its 7.2% junior subordinated debentures underlying the trust preferred securities issued by Hartford Life Capital I.
During the quarter ended March 31, 2004, the Company repaid $477 of commercial paper utilizing the proceeds from the equity offering and internal sources.
On March 9, 2004, the Company issued 4.75% senior notes due March 1, 2014 and received net proceeds of $197. Interest on the notes is payable semi-annually on March 1 and September 1, commencing on September 1, 2004.
For additional information regarding debt, see Note 8 of Notes to Consolidated Financial Statements in The Hartford’s 2003 Form 10-K Annual Report.
Stockholders’ Equity
Issuance of Common Stock —On January 22, 2004, The Hartford issued approximately
2.26.3 million shares of common stock pursuant to an underwritten offering at a price to the public of$45.50$63.25 per share and received net proceeds of$97. On May 23, 2003 and May$388. Subsequently, on January 30,2003,2004, The Hartford issued12.0 million 7% equity units and 1.8 million 7% equity units, respectively. Each equity unit contains a purchase contract obligating the holder to purchase and The Hartford to sell, a variable number of newly issuedapproximately 377 thousand shares of common stock pursuant to an underwritten offering at a price to the public of $63.25 per share and received net proceeds of $23. TheHartford's common stock. Upon settlementCompany used the proceeds from these issuances to repay $411 of commercial paper issued in connection with the acquisition of thepurchase contracts on August 16, 2006, The Hartford will receive proceedsgroup life and accident, and short-term and long-term disability business ofapproximately $690 and will deliver between 12.1 million and 15.2 million shares in the aggregate. For further discussion of the equity units issuance, see the Debt section above.CNA Financial Corporation.Dividends
-— OnJuly 17, 2003,February 19, 2004, The Hartford declared a dividend on its common stock of$0.27$0.28 per share payable onOctoberApril 1,20032004 to shareholders of record as ofSeptember 2,March 1, 2004.AOCI- AOCI increased by $922 as of March 31, 2004 compared with December 31, 2003.
CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, -------------------------- 2003 2002 - ------------------------------------------------------------------ Cash provided by operating activities $ 2,878 $ 2,061 Cash used for investing activities $ (6,873) $ (5,780) Cash provided by financing activities $ 4,115 $ 3,771 Cash - end of period $ 496 $ 413 ==================================================================The increase incash provided by financing activities wasAOCI is primarilythea result ofcapital raising activitiesan increase in unrealized gains of $574 and Life’s adoption of SOP 03-1, which resulted in a $292 cumulative effect on unrealized gains on securities in thesecondfirst quarterpartially offset by lower proceedsof 2004 related to the reclassification of investments frominvestmentseparate account assets to general account assets.The funded status of the Company’s pension and
universal life-type contracts.postretirement plans is dependent upon many factors, including returns on invested assets and the level of market interest rates. Declines in the value of securities traded in equity markets coupled with declines in long-term interest rates have had a negative impact on the funded status of the plans. As a result, the Company recorded a minimum pension liability as of March 31, 2004 and December 31, 2003, which resulted in an after-tax reduction of stockholders’ equity of $375. This minimum pension liability did not affect the Company’s results of operations.For additional information on stockholders’ equity and AOCI see Notes 9 and 19, respectively, of Notes to Consolidated Financial Statements in The
increaseHartford’s 2003 Form 10-K Annual Report.Cash Flow
First Quarter Ended
March 31,2004 2003 Net cash provided by operating activities $ 99 $ 667 Net cash provided by (used for) investing activities $ 386 $ (1,607 ) Net cash provided by (used for) financing activities $ (307 ) $ 1,216 Cash – end of period $ 638 $ 655 The decrease in cash
provided byfrom operating activities was primarily the result ofincome beforetheimpactfunding of $1.15 billion in settlement of the2003 asbestos reserve addition, as well as changesMacArthur litigation partially offset by net income inreceivables2004. Financing activities decreased primarily due to decreased proceeds from investment andliabilities balances.universal life-type contracts and capital raising activities relating to issuance of common stock and long-term debt offset by repayments on commercial paper and early retirement of junior subordinated debentures. The increase in cash50
from
operating andfinancing activities and settlement of the MacArthur litigation accounted for the majority of the change in cashused forfrom investing activities.Operating cash flows for the
nine monthsquarters endedSeptember 30,March 31, 2004 and 2003and 2002 werehave been adequate to meet liquidity requirements.PENSION PLAN During September 2003,Equity Markets
For a discussion of the
Company announced its approval to amend its pension plan to implement, effective January 1, 2009,potential impact of thecash balance formula for purposes of calculating pension benefits for all employees hired before January 1, 2001. On May 29, 2003,equity markets on capital and liquidity, see theCompany contributed $300 to its U.S. qualified defined benefit pension plan. RATINGSCapital Markets Risk Management section under “Market Risk”.Ratings
Ratings are an important factor in establishing the competitive position in the insurance and financial services marketplace. There can be no assurance that the
Company'sCompany’s ratings will continue for any given period of time or that they will not be changed. In the event theCompany'sCompany’s ratings are downgraded, the level of revenues or the persistency of theCompany'sCompany’s business may be adversely impacted.Upon completion of the Company's asbestos reserve study and the Company's capital-raising activities, certain of the major independent ratings organizations revised The Hartford's financial ratings as follows: On May 23, 2003, Fitch affirmed all ratings on The Hartford Financial Services Group, Inc. including the fixed income ratings and the insurer financial strength rating of the Hartford Fire Intercompany Pool. Further, these ratings have been removed from Rating Watch Negative and now have a Stable Rating Outlook. On May 20, 2003, Standard & Poor's removed from CreditWatch and affirmed the long-term counterparty credit and senior debt rating of The Hartford Financial Services Group, Inc. and the counterparty credit and financial strength ratings on the operating companies following the Company's completion of the capital-raising activities. The outlook is stable. - 57 -On May 14, 2003, Moody's downgraded the debt ratings of both The Hartford Financial Services Group, Inc. and Hartford Life, Inc. to A3 from A2 and their short-term commercial paper ratings to P-2 from P-1. The outlook on all of the ratings except for the P-2 rating on commercial paper is negative. On May 13, 2003, A.M. Best affirmed the financial strength ratings of A+ (Superior) of The Hartford Fire Intercompany Pool and the main operating life insurance subsidiaries of HLI. Concurrently, A.M. Best downgraded to "a-" from "a+" the senior debt ratings of The Hartford Financial Services Group, Inc. and Hartford Life Inc. and removed the ratings from under review.The following table summarizes The
Hartford'sHartford’s significantUnited Statesmembercompanies'companies’ financial ratings from the major independent rating organizations as ofNovember 3, 2003. A.M. STANDARD BEST FITCH & POOR'S MOODY'S - ------------------------------------------------------------------ INSURANCE FINANCIAL STRENGTH RATINGS: Hartford Fire A+ AA AA- Aa3 Hartford Life Insurance Company A+ AA AA- Aa3 Hartford Life & Accident A+ AA AA- Aa3 Hartford Life & Annuity A+ AA AA- Aa3 OTHER RATINGS: The Hartford Financial Services Group, Inc.: Senior debt a- A A- A3 Commercial paper AMB-2 F1 A-2 P-2 Hartford Capital I quarterly income preferred securities bbb A- BBB Baa1 Hartford Capital III trust originated preferred securities bbb A- BBB Baa1 Hartford Life, Inc.: Senior debt a- A A- A3 Commercial paper -- F1 A-2 P-2 Hartford Life, Inc.: Capital I and II trust preferred securities bbb A- BBB Baa1 Hartford Life Insurance Company: Short Term Rating -- -- A-1+ P-2 ==================================================================April 30, 2004.
A.M. Standard Best Fitch & Poor’s Moody’s Insurance Financial Strength Ratings:Hartford Fire A+ AA AA- Aa3 Hartford Life Insurance Company A+ AA AA- Aa3 Hartford Life and Accident A+ AA AA- Aa3 Hartford Life Group Insurance Company A+ AA AA- — Hartford Life and Annuity A+ AA AA- Aa3 Hartford Life Insurance KK — — AA- — Other Ratings:The Hartford Financial Services Group, Inc.: Senior debt a- A A- A3 Commercial paper AMB-2 F1 A-2 P-2 Hartford Capital III trust originated preferred securities bbb A- BBB Baa1 Hartford Life, Inc.: Senior debt a- A A- A3 Commercial paper — F1 A-2 P-2 Hartford Life, Inc.: Capital II trust preferred securities bbb A- BBB Baa1 Hartford Life Insurance Company: Short Term Rating — — A-1+ P-1 These ratings are not a recommendation to buy or hold any of The
Hartford'sHartford’s securities and they may be revised or revoked at any time at the sole discretion of the rating organization.The agencies consider many factors in determining the final rating of an insurance company. One consideration is the relative level of statutory surplus necessary to support the business written. Statutory surplus represents the capital of the insurance company reported in accordance with accounting practices prescribed by the applicable state insurance department.
The table below sets forth statutory surplus for the
Company'sCompany’s insurance companies.SEPTEMBER 30, DECEMBER 31, (in billions) 2003 2002 - ------------------------------------------------------------------ Life operations $ 3.6 $ 3.0 Property & Casualty operations 5.6 4.9 - ------------------------------------------------------------------ TOTAL $ 9.2 $ 7.9 ================================================================== LIQUIDITY REQUIREMENTS
March 31, December 31, (in billions) 2004 2003 Life Operations $ 4.6 $ 4.5 Property & Casualty Operations 6.1 5.9
Total$ 10.7 $ 10.4
Contingencies
Regulatory Developments —There continues to be significant federal and state regulatory activity relating to financial services companies, particularly mutual funds companies. These regulatory inquiries have focused on a number of mutual fund issues. The
Hartford Financial Services Group, Inc.Company has received requests for information andHLIsubpoenas from the Securities and Exchange Commission (“SEC”), a subpoena from the New York Attorney General’s Office, and requests for information from the Connecticut Securities and Investments Division of the Department of Banking, in each case requesting documentation and other information regarding various mutual fund regulatory issues. Representatives from the SEC’s Office of Compliance Inspections and Examinations continue to request documents and information in connection with their ongoing compliance examination. In addition, the SEC’s Division of Enforcement has commenced an investigation of the Company’s variable annuity and mutual fund operations. The Company continues to cooperate fully with the SEC and other regulatory agencies.The Company’s mutual funds are
holdingavailable for purchase by the separate accounts of different variable life insurance policies, variable annuity products, and funding agreements, and they are offered directly to certain qualified retirement plans. Although existing products contain transfer restrictions between subaccounts, some products, particularly older variable annuity products, do not contain restrictions on the frequency of transfers. In addition, as a result of the settlement of litigation against the Company with respect to certain owners of older variable annuity products, the Company’s ability to restrict transfers by these owners is limited.A number of companies
which rely upon operating cash flowhave announced settlements of enforcement actions with various regulatory agencies, primarily the SEC and the New York Attorney General’s Office. While no such action has been initiated against the Company, it is possible that the SEC or one or more other regulatory agencies may pursue action against the Company in theformfuture. If such an action is brought, it could have a material effect on the Company.For further information on other contingencies, see Note 16 of
dividends fromNotes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.51
ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 1 of Notes to Condensed Consolidated Financial Statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in the Capital Markets Risk Management section of Management’s Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Item 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
The Company’s principal executive officer and its principal financial officer, based on their
subsidiaries, which enable them to service debt, pay dividends, and pay certain business expenses. The insurance holding company lawsevaluation of thejurisdictionsCompany’s disclosure controls and procedures (as defined inwhichExchange Act Rule 13a-15(e)) have concluded that theCompany's insurance subsidiariesCompany’s disclosure controls and procedures areincorporated (or deemed commercially domiciled) limit the payment of dividends. As of October 31, 2003, the Company's insurance subsidiaries have paid $326 to HFSGadequate andHLI and are permitted to pay up to a maximum of approximately $1.1 billion in dividends to HFSG and HLIeffective for theremainderpurposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of2003 without prior approval fromMarch 31, 2004.Change in internal control over financial reporting
There was no change in the
applicable insurance commissioner. CONTRACTUAL OBLIGATIONS AND COMMITMENTS On June 30, 2003,Company’s internal control over financial reporting that occurred during theCompany entered into a sale-leasebackfirst quarter ofcertain furniture and fixtures with a net book value of $40. The sale-leaseback resulted in a gain of $15, which was deferred and will be amortized into earnings2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control overthe initial lease term of three years. The lease qualifies as an operating lease for accounting purposes. At the end of the initial lease term, the Company has the option to purchase the leased assets, renew the lease for two one-year periods or return the leased assets to the lessor. If the Company elects to return the assets to the lessor at the end of the initial lease term, the assets will be sold, and the Company has guaranteed a residual value on the furniture and fixtures of $20. If the fair value of the furniture and fixtures were to decline below the residual value, the Company would have to make up the difference under the residual value guarantee. The Company will periodically evaluate whether an accrual is required related to this residual value guarantee. At September 30, 2003, no liability was recorded for this guarantee, as the expected fair value of the furniture and fixtures at the end of the initial lease term was greater than the residual value guarantee. CONTINGENCIESfinancial reporting.Part II. OTHER INFORMATION
Item 1. Legal Proceedings
-The Hartford is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Hartford accounts for such activity through the establishment of unpaid claim and claim adjustment expense reserves. Subject to the
discussion of the litigation involving MacArthur in Part II, Item 1. Legal Proceedings and theuncertaintiesrelated to asbestos and environmental claimsdiscussed inthe MD&ANote 16 of Notes to Condensed Consolidated Financial Statements under the caption"Other Operations,"“Asbestos and Environmental Claims” in The Hartford’s 2003 Annual Report Form 10-K, management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of The Hartford.The Hartford is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions
- 58 -include, among others, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, underpayment of claims or improper underwriting practices in connection with various kinds of insurance policies, such as personal and commercial automobile, premises liability, and inland marine.marine, and improper sales practices in connection with the sale of life insurance and other investment products. The Hartford also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition of The Hartford. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on theCompany'sCompany’s consolidated results of operations or cash flows in particular quarterly or annual periods.Legislative Initiatives - Certain elements of the Jobs and Growth Tax Relief Reconciliation Act of 2003, in particular the reduction in tax rates on long-term capital gains and most dividend distributions, could have a material effect on The Hartford's sales of variable annuities and other investment products. In addition, other tax proposals and regulatory initiatives which have been or are being considered by Congress could have a material effect on the insurance business. These proposals and initiatives include changes pertaining to the tax treatment of insurance companies and life insurance products and annuities, reductions in certain individual tax rates and the estate tax, reductions in benefits currently received by The Hartford stemming from the dividends received deduction, changes to the tax treatment of deferred compensation arrangements, and changes to investment vehicles and retirement savings plans and incentives. Prospects for enactment and the ultimate market effect of these proposals are uncertain. Any potential effect to The Hartford's financial condition or results of operations from the Jobs and Growth Act of 2003 or future tax proposals cannot be reasonably estimated at this time. On July 10, 2003, the Senate Judiciary Committee approved legislation that, if enacted, would provide for the creation of a Federal asbestos trust fund in place of the current tort system for determining asbestos liabilities. The prospects for enactment and the ultimate details of any legislation creating a Federal asbestos trust fund are uncertain. Therefore, any potential effect on the Company's financial condition or results of operations cannot be reasonably estimated at this time. On August 15, 2003, the Treasury Department announced that it would not use its legislatively-granted authority to include group life insurance under the Federal backstop for terrorism losses in the Terrorism Risk Insurance Act of 2002. In announcing this decision, the Treasury stated that they would continue to monitor the group life situation. - -------------------------------------------------------------------------------- ACCOUNTING STANDARDS - -------------------------------------------------------------------------------- For a discussion of accounting standards, see Note 1 of Notes to Condensed Consolidated Financial Statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information contained in the Capital Markets Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's principal executive officer and its principal financial officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) have concluded that the Company's disclosure controls and procedures are adequate and effective for the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of September 30, 2003. CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING There was no change in the Company's internal control over financial reporting that occurred during the third quarter of 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. - 59 -PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Hartford is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Hartford accounts for such activity through the establishment of unpaid claim and claim adjustment expense reserves. Subject to the discussion of the litigation involving Mac Arthur Company and its subsidiary, Western MacArthur Company, both former regional distributors of asbestos products (collectively or individually, "MacArthur"), below and the uncertainties discussed in Note 5(b) of Notes to Condensed Consolidated Financial Statements under the caption "Asbestos and Environmental Claims," management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of The Hartford. The Hartford is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, underpayment of claims or improper underwriting practices in connection with various kinds of insurance policies, such as personal and commercial automobile, premises liability, and inland marine. The Hartford also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition of The Hartford. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's consolidated results of operations or cash flows in particular quarterly or annual periods.As further discussed in the MD&A under the caption
"Other“Other Operations,"” The Hartford continues to receiveenvironmentalasbestos andasbestosenvironmental claims that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartford continually reviews its overall reserve levels, methodologies and reinsurance coverages. Because of the significant uncertainties which limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses, principally those related to asbestos, the ultimate liabilities may exceed the currently recorded reserves. Any such additional liability (or any range of additional amounts) cannot be reasonably estimated now but could be material to The Hartford’s future consolidated operating results, financial condition and liquidity.The MacArthur Litigation
-– On December 19, 2003, Hartford Accident and Indemnity Company("(“Hartford A&I"&I”),entered into asubsidiary of the Company, issued primaryconditional settlement to resolve all claims relating to general liability policies that Hartford A&I issued to Mac Arthur Company and its subsidiary, Western MacArthur Company, both former regional distributors of asbestos products (collectively or individually, “MacArthur”), during the period 1967 to 1976. MacArthursought coverage for asbestos-related claims from Hartford A&I under these policies beginninghad filed a pre-negotiated bankruptcy and plan of reorganization in1978. During the period between 1978 and 1987, Hartford A&I paid its full aggregate limits under these policies plus defense costs. In 1987, Hartford A&I notified MacArthur that its available limits under these policies had been exhausted, and MacArthur ceased submitting claimsNovember 2002 pursuant toHartford A&I under these policies. On October 3, 2000, thirteen years after it had accepted Hartford A&I's notice of exhaustion, MacArthur filed an action against Hartford A&I and another insurer in the U.S. District Court for the Eastern District of New York, seeking for the first time additional coverage for asbestos bodily injury claims under the Hartford A&I primary policies on the theory that Hartford A&I had note exhausted limits MacArthur alleges to be available for non-products liability. The complaint sought a declaration of coverage and unquantified damages. On March 28, 2003, the District Court dismissed this action without prejudice on MacArthur's motion. On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announceda settlement with another ofa coverage action brought by MacArthur againstits insurers, United States Fidelity and Guaranty Company. The Hartford settlement was contingent on the occurrence of certain conditions, including the entry of final, non-appealable court orders approving the settlement agreement and confirming a bankruptcy plan under which, among other things, all claims against the Company("USF&G"), a subsidiaryrelating to the asbestos liability ofSt. Paul.MacArthur would be enjoined. Under the settlementSt. Paul agreed to pay a total of $975 to resolve its asbestos liability to MacArthur in conjunction with a proposed bankruptcy petition and pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at least twelve years of primary general liability coverage to MacArthur, but, unlikeagreement, Hartford A&Ihad denied coverage and had refused to pay for defense or indemnity. On October 7, 2002, MacArthur filedpaid $1.15 billion into anactionescrow account in theSuperior Court in Alameda County, California, against Hartford A&Ifirst quarter of 2004, pending the occurrence of the conditions. On April 22, 2004, all conditions to the settlement were satisfied, andtwo other insurers. As inthenow-dismissed New York action, MacArthur seeksescrowed funds were disbursed to adeclarationtrust established for the benefit ofcoverage and damages for asbestos bodily injury claims. Four asbestos claimants who allegedly have obtained default judgments against MacArthur also are joined as plaintiffs; they seek to recover the amount of their default judgments and additional damages directly from the defendant insurers and assert a right to an accelerated trial. On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of reorganization, which seeks to implement the terms of its settlement with St. Paul. MacArthur asked the bankruptcy court to determine the full amount of its currentpresent and future asbestosliability in an amount substantially more than the alleged liquidated but unpaid claims. On October 31, 2003,claimants pursuant to the bankruptcycourt ruled that it would neither determine nor estimateplan. The completion by thetotal amount of current and future asbestos liability claims against MacArthur. TheCompanyexpects that MacArthur will ask the Alameda County court instead to determine the total amount of current and future asbestos liability claims against MacArthur and to enter judgment against Hartford A&I for a substantial portion of that amount. A confirmation trial currently is scheduled to begin November 10, 2003. In a second amended complaint filed on July 21, 2003 in the Alameda County action, following Hartford A&I's successful demurrer to the first two complaints, MacArthur alleges that its liability for liquidated but unpaid asbestos bodily injury claims is $2.5 billion, of which more than $1.8 billion consists of unpaid judgments. The ultimate amount of MacArthur's asbestos liability, including any unresolved present claims and future demands, is currently unknown. - 60 -Hartford A&I intends to defend the MacArthur action vigorously. In the opinion of management, the ultimate outcome is highly uncertain for many reasons. It is not yet known, for example, whether Hartford A&I's defenses based on MacArthur's long delay in asserting claims for further coverage will be successful; how other significant coverage defenses will be decided; or the extent to which the claims and default judgments against MacArthur involve injury outsideof theproducts and completed operations hazard definitions of the policies. In the opinion of management, an adverse outcome could have a material adverse effect on the Company's results of operations, financial condition and liquidity.settlement resolves all disputes concerning Hartford A&I’s alleged obligations arising from MacArthur’s asbestos liability.52
Bancorp Services, LLC
-– In the third quarter of 2003, Hartford Life Insurance Company("HLIC")and its affiliate International Corporate Marketing Group, LLC("ICMG")settled their intellectual property dispute with Bancorp Services, LLC("Bancorp"(“Bancorp”). The dispute concerned, among other things,Bancorp'sBancorp’s claims for alleged patent infringement, breach of a confidentiality agreement, and misappropriation of trade secrets related to certain stable value corporate-owned life insurance products. Thedispute was the subject of litigation in the United States District Court for the Eastern District of Missouri, in which Bancorp obtained in 2002 a judgment exceeding $134 against HLIC and ICMG after a jury trial on the trade secret and breach of contract claims, and HLIC and ICMG obtained summary judgment on the patent infringement claim. Based on the advice of legal counsel following entry of the judgment, the Company recorded an $11 after-tax charge in the first quarter of 2002 to increase litigation reserves. Both components of the judgment were appealed. Under the terms of thesettlement provided that The Hartfordwillwould pay a minimum of $70 and a maximum of $80, depending on the outcome ofthea patent appeal, to resolve all disputes between the parties.The appeal from the trade secret and breach of contract judgment will be dismissed.The settlement resulted in the recording of an additional charge of $40, after-tax, in the third quarter of 2003, reflecting the maximum amount payable under thesettlement. ITEM 5. OTHER INFORMATION Whilesettlement, and in November of 2003, The Hartford paid theCompany's Board of Directors has not set the dateinitial $70 of theCompany'ssettlement. On March 1, 2004,annual meetingthe Federal Circuit Court ofshareholders,Appeals decided the patent appeal adversely to The Hartford, and on March 22, 2004, The Hartford paid Bancorp an additional $10 in full and final satisfaction of its obligations under the settlement. Because the charge taken in the third quarter of 2003 reflected the maximum amount payable under the settlement, the amount paid in the first quarter of 2004 had no effect on the Company’s results of operations.Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits – See Exhibit Index on page 55.
(b) Reports on Form 8-K: During the quarter ended March 31, 2004, the Company
anticipates thatfiled thedatefollowing Current Reports on Form 8-K:Filed January 30, 2004, Item 7, Financial Statements and Exhibit, to file and incorporate by reference certain exhibits into the Registration Statement on Form S-3 (File No. 333-108067), as amended, of
the meeting will be May 20, 2004. As a result, proposals submitted by shareholders for inclusion in the proxy statement relating to the 2004 annual meeting of shareholders must be received by the Company no later than the close of business on January 5, 2004, as compared to the original deadline of November 12, 2003, which was included in the proxy statement for the Company's 2003 annual meeting of shareholders. Any proposal received after January 5, 2004 will not be included in the Company's proxy materials for 2004. In addition, all proposals for inclusion in the 2004 proxy statement must comply with all of the requirements of SEC Rule 14a-8 under the Securities Exchange Act of 1934. In accordance with the Company's bylaws, no proposal may be presented at the 2004 annual meeting of shareholders unless the Company receives notice of the proposal by January 17, 2004. Proposals must be addressed to Brian S. Becker, Senior Vice President and Corporate Secretary,The Hartford Financial Services Group, Inc.,690 Asylum Avenue,HartfordCT 06105. All proposals must comply withCapital IV, Hartford Capital V and Hartford Capital VI.Filed March 12, 2004, Item 7, Financial Statements and Exhibit, to file and incorporate by reference certain exhibits into the
requirements set forth in the Company's bylaws, a copy of which may be obtained from the Corporate Secretary of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - See Exhibit Index on page 63. (b) ReportsRegistration Statement on Form8-K: During the quarterly period ended September 30, 2003, the Company filed the following Current Report on Form 8-K: Dated July 8, 2003, Item 5, Other Events, to report the saleS-3 (File No. 333-108067), as amended, of$320 aggregate principal amount of 4.625% senior notes due July 15, 2013. - 61 -The Hartford Financial Services Group, Inc., Hartford Capital IV, Hartford Capital V and Hartford Capital VI. 53
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
The Hartford Financial Services Group, Inc. (Registrant) /s/ Robert J. Price ------------------------------------------- Robert J. Price Senior Vice President and Controller November 5, 2003 - 62 -
The Hartford Financial Services Group, Inc.
(Registrant)/s/ Robert J. Price Robert J. Price Senior Vice President and Controller May 4, 2004
54
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
FOR THEQUARTERLY PERIODFIRST QUARTER ENDEDSEPTEMBER 30, 2003MARCH 31, 2004
FORM 10-QEXHIBITS INDEX
EXHIBIT NO. DESCRIPTION ---------- ----------- 4.01 Supplemental Indenture No. 4, dated as of July 10, 2003, to the Senior Indenture, dated as of October 20, 1995, between ITT Hartford Group, Inc. and The Chase Manhattan Bank (National Association) as Trustee, between the Company and JPMorgan Chase Bank, as Trustee. 15.01 Deloitte & Touche LLP Letter of Awareness. 31.1 Certification of Ramani Ayer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of David M. Johnson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Ramani Ayer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of David M. Johnson pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - -------------------------------------------------------------------------------- - 63 -
Exhibit No. Description 10.01Form of Employment Agreement, dated as of July 1, 1997, and amended as of February 6, 2004 between The Hartford and Ramani Ayer. 10.02Form of Employment Agreement, dated as of July 1, 1997, and amended as of February 17, 2004 between The Hartford and David K. Zwiener. 10.03Form of Employment Agreement, dated as of July 1, 2000, and amended as of January 29, 2004 between The Hartford and Thomas M. Marra. 10.04Form of Employment Agreement, dated as of March 20, 2001, and amended as of February 18, 2004 between The Hartford and Neal S. Wolin. 10.05Form of Employment Agreement, dated as of April 26, 2001, and amended as of February 10, 2004 between The Hartford and David M. Johnson. 10.06Form of Employment Agreement, dated as of November 5, 2001, and amended as of February 25, 2004 between The Hartford and David M. Znamierowski. 10.07Form of Key Executive Employment Protection Agreement between The Hartford and certain executive officers of The Hartford. 10.08The Hartford Senior Executive Severance Pay Plan, as amended. 10.09The Hartford Incentive Stock Plan, as amended. 15.01Deloitte & Touche LLP Letter of Awareness. 31.01Certification of Ramani Ayer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02Certification of David M. Johnson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.01Certification of Ramani Ayer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.02Certification of David M. Johnson pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 55