UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31,June 30, 2004
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from____________ to_____________fromto
Commission file number 001-13958
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Delaware | ||
(State or other jurisdiction of | ||
incorporation or organization) | 13-3317783 (I.R.S. Employer Identification Number) |
Hartford Plaza, Hartford, Connecticut 06115-1900
(Address of principal executive offices)
(860) 547-5000
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
As of April 23,July 26, 2004, there were outstanding 292,023,474293,188,819 shares of Common Stock, $0.01 par value per share, of the registrant.
1
INDEX
2
REPORT OF INDEPENDENT ACCOUNTANTS’ REVIEW REPORTREGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of The Hartford Financial Services Group, Inc. and subsidiaries (the “Company”) as of March 31,June 30, 2004, and the related condensed consolidated statements of operations and comprehensive income (loss) for the second quarters and six months ended June 30, 2004 and 2003, and changes in stockholders’ equity comprehensive income (loss), and cash flows for the first quartersix months ended March 31,June 30, 2004 and 2003. These interim financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with standards established byof the American Institute of Certified Public Accountants.Company Accounting Oversight Board (United States). 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 inof the United States of America,Public Company Accounting Oversight Board (United States), 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 inof the United States of America,Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2003, and the related consolidated statements of operations, changes in stockholders’ equity, comprehensive income, and cash flows for the year then ended (not presented herein); and in our report dated February 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, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Hartford, ConnecticutMayAugust 3, 2004
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements FINANCIAL STATEMENTS
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||
(In millions, except for per share data) | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | ||||||||||||||||||||||
Revenues | ||||||||||||||||||||||||
Earned premiums | $ | 3,181 | $ | 2,849 | $ | 3,323 | $ | 2,812 | $ | 6,504 | $ | 5,661 | ||||||||||||
Fee income | 786 | 617 | 793 | 656 | 1,579 | 1,273 | ||||||||||||||||||
Net investment income | 1,517 | 788 | 1,158 | 796 | 2,675 | 1,584 | ||||||||||||||||||
Other revenues | 104 | 122 | 118 | 147 | 222 | 269 | ||||||||||||||||||
Net realized capital gains (losses) | 144 | (45 | ) | |||||||||||||||||||||
Net realized capital gains | 52 | 271 | 196 | 226 | ||||||||||||||||||||
Total revenues | 5,732 | 4,331 | 5,444 | 4,682 | 11,176 | 9,013 | ||||||||||||||||||
Benefits, claims and expenses | ||||||||||||||||||||||||
Benefits, claims and claim adjustment expenses | 3,297 | 5,245 | 3,288 | 2,629 | 6,585 | 7,874 | ||||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 679 | 564 | 701 | 557 | 1,380 | 1,121 | ||||||||||||||||||
Insurance operating costs and expenses | 692 | 538 | 653 | 584 | 1,345 | 1,122 | ||||||||||||||||||
Interest expense | 66 | 66 | 62 | 69 | 128 | 135 | ||||||||||||||||||
Other expenses | 180 | 143 | 163 | 214 | 343 | 357 | ||||||||||||||||||
Total benefits, claims and expenses | 4,914 | 6,556 | 4,867 | 4,053 | 9,781 | 10,609 | ||||||||||||||||||
Income (loss) before income taxes and cumulative effect of accounting change | 818 | (2,225 | ) | 577 | 629 | 1,395 | (1,596 | ) | ||||||||||||||||
Income tax expense (benefit) | 227 | (830 | ) | 144 | 122 | 371 | (708 | ) | ||||||||||||||||
Income (loss) before cumulative effect of accounting change | 591 | (1,395 | ) | 433 | 507 | 1,024 | (888 | ) | ||||||||||||||||
Cumulative effect of accounting change, net of tax | (23 | ) | — | — | — | (23 | ) | — | ||||||||||||||||
Net income (loss) | $ | 568 | $ | (1,395 | ) | $ | 433 | $ | 507 | $ | 1,001 | $ | (888 | ) | ||||||||||
Basic earnings (loss) per share | ||||||||||||||||||||||||
Income (loss) before cumulative effect of accounting change | $ | 2.04 | $ | (5.46 | ) | $ | 1.48 | $ | 1.89 | 3.52 | $ | (3.39 | ) | |||||||||||
Cumulative effect of accounting change, net of tax | (0.08 | ) | — | — | — | (0.08 | ) | — | ||||||||||||||||
Net income (loss) | $ | 1.96 | $ | (5.46 | ) | $ | 1.48 | $ | 1.89 | $ | 3.44 | $ | (3.39 | ) | ||||||||||
Diluted earnings (loss) per share | ||||||||||||||||||||||||
Income (loss) before cumulative effect of accounting change | $ | 2.01 | $ | (5.46 | ) | $ | 1.46 | $ | 1.88 | $ | 3.46 | $ | (3.39 | ) | ||||||||||
Cumulative effect of accounting change, net of tax | (0.08 | ) | — | — | — | (0.08 | ) | — | ||||||||||||||||
Net income (loss) | $ | 1.93 | $ | (5.46 | ) | $ | 1.46 | $ | 1.88 | $ | 3.38 | $ | (3.39 | ) | ||||||||||
Weighted average common shares outstanding | 289.9 | 255.4 | 292.3 | 268.8 | 291.1 | 262.1 | ||||||||||||||||||
Weighted average common shares outstanding and dilutive potential common shares | 294.9 | 255.4 | 297.5 | 270.2 | 296.2 | 262.1 | ||||||||||||||||||
Cash dividends declared per share | $ | 0.28 | $ | 0.27 | $ | 0.28 | $ | 0.27 | $ | 0.56 | $ | 0.54 | ||||||||||||
See Notes to Condensed Consolidated Financial Statements.
4
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
March 31, | December 31, | June 30, | December 31, | |||||||||||||
(In millions, except for share data) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Assets | ||||||||||||||||
Investments | ||||||||||||||||
Fixed maturities, available-for-sale, at fair value (amortized cost of $68,138 and $58,127) | $ | 72,814 | $ | 61,263 | ||||||||||||
Fixed maturities, available-for-sale, at fair value (amortized cost of $68,732 and $58,127) | $ | 70,703 | $ | 61,263 | ||||||||||||
Equity securities, held for trading, at fair value | 7,831 | — | 8,995 | — | ||||||||||||
Equity securities, available-for-sale, at fair value (cost of $557 and $505) | 612 | 565 | ||||||||||||||
Equity securities, available-for-sale, at fair value (cost of $545 and $505) | 584 | 565 | ||||||||||||||
Policy loans, at outstanding balance | 2,655 | 2,512 | 2,650 | 2,512 | ||||||||||||
Other investments | 1,845 | 1,507 | 1,917 | 1,507 | ||||||||||||
Total investments | 85,757 | 65,847 | 84,849 | 65,847 | ||||||||||||
Cash | 638 | 462 | 695 | 462 | ||||||||||||
Premiums receivable and agents’ balances | 2,969 | 3,085 | 3,429 | 3,085 | ||||||||||||
Reinsurance recoverables | 5,968 | 5,958 | 5,655 | 5,958 | ||||||||||||
Deferred policy acquisition costs and present value of future profits | 7,511 | 7,599 | 8,086 | 7,599 | ||||||||||||
Deferred income tax | 245 | 845 | ||||||||||||||
Deferred income taxes | 987 | 845 | ||||||||||||||
Goodwill | 1,720 | 1,720 | 1,720 | 1,720 | ||||||||||||
Other assets | 5,315 | 3,704 | 3,961 | 3,704 | ||||||||||||
Separate account assets | 127,141 | 136,633 | 130,840 | 136,633 | ||||||||||||
Total assets | $ | 237,264 | $ | 225,853 | $ | 240,222 | $ | 225,853 | ||||||||
Liabilities | ||||||||||||||||
Reserve for future policy benefits and unpaid claims and claim adjustment expenses | ||||||||||||||||
Property and casualty | $ | 20,246 | $ | 21,715 | $ | 20,562 | $ | 21,715 | ||||||||
Life | 11,658 | 11,402 | 11,746 | 11,402 | ||||||||||||
Other policyholder funds and benefits payable | 45,321 | 26,185 | 46,605 | 26,185 | ||||||||||||
Unearned premiums | 4,612 | 4,423 | 4,843 | 4,423 | ||||||||||||
Short-term debt | 573 | 1,050 | 622 | 1,050 | ||||||||||||
Long-term debt | 4,580 | 4,613 | 4,304 | 4,613 | ||||||||||||
Other liabilities | 9,596 | 8,193 | 8,425 | 8,193 | ||||||||||||
Separate account liabilities | 127,141 | 136,633 | 130,840 | 136,633 | ||||||||||||
Total liabilities | 223,727 | 214,214 | 227,947 | 214,214 | ||||||||||||
Commitments and Contingencies (Note 5) | ||||||||||||||||
Commitments and Contingencies (Note 9) | ||||||||||||||||
Stockholders’ Equity | ||||||||||||||||
Common stock - 750,000,000 shares authorized, 294,661,289 and 286,339,430 shares issued, $0.01 par value | 3 | 3 | ||||||||||||||
Common stock - 750,000,000 shares authorized, 296,024,430 and 286,339,430 shares issued, $0.01 par value | 3 | 3 | ||||||||||||||
Additional paid-in capital | 4,419 | 3,929 | 4,494 | 3,929 | ||||||||||||
Retained earnings | 6,986 | 6,499 | 7,337 | 6,499 | ||||||||||||
Treasury stock, at cost - 2,984,622 and 2,959,692 shares | (39 | ) | (38 | ) | ||||||||||||
Treasury stock, at cost –2,989,744 and 2,959,692 shares | (39 | ) | (38 | ) | ||||||||||||
Accumulated other comprehensive income, net of tax | 2,168 | 1,246 | 480 | 1,246 | ||||||||||||
Total stockholders’ equity | 13,537 | 11,639 | 12,275 | 11,639 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 237,264 | $ | 225,853 | $ | 240,222 | $ | 225,853 | ||||||||
See Notes to Condensed Consolidated Financial Statements.
5
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
First Quarter Ended | Six Months Ended | |||||||||||||||
March 31, | June 30, | |||||||||||||||
(In millions, except for share data) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Common Stock/Additional Paid-in Capital | ||||||||||||||||
Balance at beginning of period | $ | 3,932 | $ | 2,787 | $ | 3,932 | $ | 2,787 | ||||||||
Issuance of common stock in underwritten offering | 411 | — | 411 | 1,161 | ||||||||||||
Issuance of equity units | — | (112 | ) | |||||||||||||
Issuance of shares under incentive and stock compensation plans | 67 | 8 | 135 | 32 | ||||||||||||
Tax benefit on employee stock options and awards | 12 | 1 | 19 | 4 | ||||||||||||
Balance at end of period | 4,422 | 2,796 | 4,497 | 3,872 | ||||||||||||
Retained Earnings | ||||||||||||||||
Balance at beginning of period | 6,499 | 6,890 | 6,499 | 6,890 | ||||||||||||
Net income (loss) | 568 | (1,395 | ) | 1,001 | (888 | ) | ||||||||||
Dividends declared on common stock | (81 | ) | (69 | ) | (163 | ) | (145 | ) | ||||||||
Balance at end of period | 6,986 | 5,426 | 7,337 | 5,857 | ||||||||||||
Treasury Stock, at Cost | ||||||||||||||||
Balance at beginning of period | (38 | ) | (37 | ) | (38 | ) | (37 | ) | ||||||||
Return of shares under incentive and stock compensation plans to treasury stock | (1 | ) | — | |||||||||||||
Return of shares to treasury stock under incentive and stock compensation plans | (1 | ) | — | |||||||||||||
Balance at end of period | (39 | ) | (37 | ) | (39 | ) | (37 | ) | ||||||||
Accumulated Other Comprehensive Income, Net of Tax | ||||||||||||||||
Accumulated Other Comprehensive Income (Loss), Net of Tax | ||||||||||||||||
Balance at beginning of period | 1,246 | 1,094 | 1,246 | 1,094 | ||||||||||||
Change in unrealized gain/loss on securities | 574 | 177 | ||||||||||||||
Change in net unrealized gain/loss on securities | (990 | ) | 732 | |||||||||||||
Cumulative effect of accounting change | 292 | — | 292 | — | ||||||||||||
Change in net gain/loss on cash flow hedging instruments | 59 | (23 | ) | |||||||||||||
Change in net gain/loss on cash-flow hedging instruments | (50 | ) | (38 | ) | ||||||||||||
Foreign currency translation adjustments | (3 | ) | 9 | (18 | ) | 19 | ||||||||||
Total other comprehensive income | 922 | 163 | ||||||||||||||
Total other comprehensive income (loss) | (766 | ) | 713 | |||||||||||||
Balance at end of period | 2,168 | 1,257 | 480 | 1,807 | ||||||||||||
Total stockholders’ equity | $ | 13,537 | $ | 9,442 | $ | 12,275 | $ | 11,499 | ||||||||
Outstanding Shares (in thousands) | ||||||||||||||||
Balance at beginning of period | 283,380 | 255,241 | 283,380 | 255,241 | ||||||||||||
Issuance of common stock in underwritten offering | 6,703 | — | 6,703 | 26,377 | ||||||||||||
Issuance of shares under incentive and stock compensation plans | 1,619 | 200 | 2,982 | 581 | ||||||||||||
Return of shares under incentive and stock compensation plans to treasury stock | (25 | ) | — | |||||||||||||
Return of shares to treasury stock under incentive and stock compensation plans | (30 | ) | — | |||||||||||||
Balance at end of period | 291,677 | 255,441 | 293,035 | 282,199 | ||||||||||||
Condensed Consolidated Statements of Comprehensive Income (Loss)
First Quarter Ended | ||||||||||||||||||||||||
March 31, | Second Quarter Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
(In millions) | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | ||||||||||||||||||||||
Comprehensive Income (Loss) | ||||||||||||||||||||||||
Net income (loss) | $ | 568 | $ | (1,395 | ) | $ | 433 | $ | 507 | $ | 1,001 | $ | (888 | ) | ||||||||||
Other Comprehensive Income | ||||||||||||||||||||||||
Change in unrealized gain/loss on securities | 574 | 177 | ||||||||||||||||||||||
Other Comprehensive Income (Loss) | ||||||||||||||||||||||||
Change in net unrealized gain/loss on securities | (1,564 | ) | 555 | (990 | ) | 732 | ||||||||||||||||||
Cumulative effect of accounting change | 292 | — | — | — | 292 | — | ||||||||||||||||||
Change in net gain/loss on cash flow hedging instruments | 59 | (23 | ) | |||||||||||||||||||||
Change in net gain/loss on cash-flow hedging instruments | (109 | ) | (15 | ) | (50 | ) | (38 | ) | ||||||||||||||||
Foreign currency translation adjustments | (3 | ) | 9 | (15 | ) | 10 | (18 | ) | 19 | |||||||||||||||
Total other comprehensive income | 922 | 163 | ||||||||||||||||||||||
Total other comprehensive income (loss) | (1,688 | ) | 550 | (766 | ) | 713 | ||||||||||||||||||
Total comprehensive income (loss) | $ | 1,490 | $ | (1,232 | ) | $ | (1,255 | ) | $ | 1,057 | $ | 235 | $ | (175 | ) | |||||||||
See Notes to Condensed Consolidated Financial Statements.
6
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
First Quarter Ended | Six Months Ended | |||||||||||||||
March 31, | June 30, | |||||||||||||||
(In millions) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Operating Activities | ||||||||||||||||
Net income (loss) | $ | 568 | $ | (1,395 | ) | $ | 1,001 | $ | (888 | ) | ||||||
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 | 679 | 564 | 1,380 | 1,121 | ||||||||||||
Additions to deferred policy acquisition costs and present value of future profits | (952 | ) | (807 | ) | (1,922 | ) | (1,568 | ) | ||||||||
Change in: | ||||||||||||||||
Reserve for future policy benefits and unpaid claims and claim adjustment expenses and unearned premiums | (1,022 | ) | 4,576 | (387 | ) | 4,791 | ||||||||||
Reinsurance recoverables | 151 | (1,459 | ) | 424 | (1,184 | ) | ||||||||||
Receivables | (904 | ) | (95 | ) | (543 | ) | (169 | ) | ||||||||
Payables and accruals | 575 | (34 | ) | (379 | ) | (217 | ) | |||||||||
Accrued and deferred income taxes | 641 | (839 | ) | 680 | (739 | ) | ||||||||||
Net realized capital (gains) losses | (144 | ) | 45 | |||||||||||||
Net realized capital gains | (196 | ) | (226 | ) | ||||||||||||
Net increase in equity securities, held for trading | (1,611 | ) | — | (2,759 | ) | — | ||||||||||
Net receipts from investment and universal life-type contracts credited to policyholder accounts associated with equity securities, held for trading | 1,915 | — | ||||||||||||||
Net receipts from investment contracts credited to policyholder accounts associated with equity securities, held for trading | 3,072 | — | ||||||||||||||
Depreciation and amortization | 33 | 72 | 198 | 11 | ||||||||||||
Cumulative effect of accounting change, net of tax | 23 | — | 23 | — | ||||||||||||
Other, net | 147 | 39 | 39 | 404 | ||||||||||||
Net cash provided by operating activities | 99 | 667 | 631 | 1,336 | ||||||||||||
Investing Activities | ||||||||||||||||
Purchase of available-for-sale investments | (4,674 | ) | (5,859 | ) | (11,498 | ) | (16,196 | ) | ||||||||
Sale of available-for-sale investments | 4,315 | 3,364 | 9,350 | 8,960 | ||||||||||||
Maturity of available-for-sale investments | 763 | 931 | 2,478 | 1,928 | ||||||||||||
Purchase price adjustment of business acquired | (58 | ) | — | |||||||||||||
Additions to property, plant and equipment, net | (18 | ) | (43 | ) | (77 | ) | (72 | ) | ||||||||
Net cash provided by (used for) investing activities | 386 | (1,607 | ) | 195 | (5,380 | ) | ||||||||||
Financing Activities | ||||||||||||||||
Issuance (repayment) of short-term debt, net | (477 | ) | — | |||||||||||||
Repayment of short-term debt, net | (477 | ) | — | |||||||||||||
Issuance of long-term debt | 197 | — | 197 | 918 | ||||||||||||
Repayment of long-term debt | (250 | ) | — | |||||||||||||
Repayment/maturity of long-term debt | (450 | ) | (180 | ) | ||||||||||||
Issuance of common stock in underwritten offering | 411 | — | 411 | 1,162 | ||||||||||||
Net receipts from investment and universal life-type contracts charged against policyholder accounts | (164 | ) | 1,279 | |||||||||||||
Net receipts (disbursements) from investment and universal life-type contracts credited to policyholder accounts | (227 | ) | 2,313 | |||||||||||||
Dividends paid | (79 | ) | (69 | ) | (160 | ) | (138 | ) | ||||||||
Proceeds from issuance of shares under incentive and stock compensation plans | 55 | 6 | 115 | 17 | ||||||||||||
Net cash provided by (used for) financing activities | (307 | ) | 1,216 | (591 | ) | 4,092 | ||||||||||
Foreign exchange rate effect on cash | (2 | ) | 2 | (2 | ) | 4 | ||||||||||
Net increase in cash | 176 | 278 | 233 | 52 | ||||||||||||
Cash - beginning of period | 462 | 377 | ||||||||||||||
Cash — beginning of period | 462 | 377 | ||||||||||||||
Cash - end of period | $ | 638 | $ | 655 | ||||||||||||
Cash — end of period | $ | 695 | $ | 429 | ||||||||||||
Supplemental Disclosure of Cash Flow Information: | ||||||||||||||||
Net Cash Paid (Received) During the Period For: | ||||||||||||||||
Income taxes | $ | 30 | $ | (45 | ) | $ | 44 | $ | (29 | ) | ||||||
Interest | $ | 55 | $ | 48 | $ | 137 | $ | 133 |
See Notes to Condensed Consolidated Financial Statements.
7
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
Note 1. Basis of Presentation and Accounting Policies
Basis of Presentation
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries (“The Hartford” or the “Company”) provide investment products, life insurance and lifegroup benefits, automobile and propertyhomeowners products, and casualtybusiness property-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 second quarter and six months ended March, 31,June 30, 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 6 of these Notes to Condensed Consolidated Financial Statements and 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 practices prescribed by various insurance regulatory authorities. Subsidiaries in which The Hartford has at least a 20% interest, but less than a majority ownership interest, are reported usingon the equity method. All material intercompany transactions and balances between The Hartford, its subsidiaries and affiliates have been eliminated.
The accompanying condensed consolidated financial statements and the condensed notes as of March 31,June 30, 2004, and for the first quarterssecond quarter and six months ended March 31,June 30, 2004 and 2003 are 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 condensed consolidated financial statements and condensed notes should be read in conjunction with the consolidated financial statements and notes thereto included in The Hartford’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.
Reclassifications
Certain reclassifications have been made to prior period financial information to conform to the current period classifications.
Use 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 claims and claim adjustment expenses; deferred policy acquisition costs and present value of future profits; investments; pension and other postretirement benefits; and contingencies.
Significant Accounting Policies
For a description of accounting policies, see Note 1 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.
Investments
As discussed in the “Adoption of New Accounting Standards” sectionNote 4 below, on January 1, 2004, the Company reclassified certain separate account assets to the general account and classified a portion of these assets as trading securities. Trading securities are recorded at fair value with periodicsubsequent changes in fair value recognized in net investment income.
Stock–BasedStock-Based Compensation
In January 2003, the Company began expensing all stock-based compensation awards granted or modified after January 1, 2003 under the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”. The fair value of stock-based awards granted or modified during the quarterssix months ended March 31,June 30, 2004 and 2003 was $36 and $31,$33, after-tax, respectively. The fair value of these awards will be recognized over the awards’ vesting period, generally 3 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 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 related to stock-based employee compensation, including non-option plans, included in the determination of net income for the first quarterssecond quarter and six months ended March 31,June 30, 2004 and 2003 is less than that which would have been
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)(Unaudited)
Note 1. Basis of Presentation and Accounting Policies (continued)
Stock-Based Compensation (continued)
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 compensation plans, see Note 11 of Notes to Consolidated Financial Statements included in The Hartford’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 insignificantimmaterial impact on the pro forma net income amounts disclosed.
First Quarter Ended | ||||||||||||||||||||||||
March 31, | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
2004 | 2003 | June 30, | June 30, | |||||||||||||||||||||
(Unaudited) | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||
Net income (loss), as reported | $ | 568 | $ | (1,395 | ) | $ | 433 | $ | 507 | $ | 1,001 | $ | (888 | ) | ||||||||||
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects [1] | 4 | 1 | 9 | 9 | 13 | 11 | ||||||||||||||||||
Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects | (7 | ) | (9 | ) | (12 | ) | (17 | ) | (19 | ) | (26 | ) | ||||||||||||
Pro forma net income (loss) [2] | $ | 565 | $ | (1,403 | ) | $ | 430 | $ | 499 | $ | 995 | $ | (903 | ) | ||||||||||
Earnings (loss) per share: | ||||||||||||||||||||||||
Basic – as reported | $ | 1.96 | $ | (5.46 | ) | $ | 1.48 | $ | 1.89 | $ | 3.44 | $ | (3.39 | ) | ||||||||||
Basic – pro forma [2] | $ | 1.95 | $ | (5.49 | ) | $ | 1.47 | $ | 1.86 | $ | 3.42 | $ | (3.45 | ) | ||||||||||
Diluted – as reported [3] | $ | 1.93 | $ | (5.46 | ) | $ | 1.46 | $ | 1.88 | $ | 3.38 | $ | (3.39 | ) | ||||||||||
Diluted – pro forma [2] [3] | $ | 1.92 | $ | (5.49 | ) | $ | 1.45 | $ | 1.85 | $ | 3.36 | $ | (3.45 | ) | ||||||||||
[1] | Includes the impact of non-option plans of $3 and $1, respectively, for the | |
[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 |
Adoption of New Accounting Standards
FSP 97-1
In July 2003,June 2004, the Financial Accounting Standards Executive Committee of the American Institute of Certified Public AccountsBoard (“AICPA”FASB”) issued a finalFASB Staff Position (“FSP”) FAS 97-1, “Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (SFAS No. 97), Permit or Require Accrual of an Unearned Revenue Liability.” The implementation of Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (the “SOP”(“SOP 03-1”)., raised a question regarding the interpretation of the requirements of SFAS No. 97 concerning when it is appropriate to record an unearned revenue liability. This FSP clarifies that SFAS No. 97 is clear in its intent and language; it is appropriate to recognize an unearned revenue liability for amounts that have been assessed to compensate the insurer for services to be performed over future periods. SOP 03-1 describes one situation, when assessments result in profits followed by losses, where an unearned revenue liability is required. SOP 03-1 does not amend SFAS No. 97 or limit the recognition of an unearned revenue liability to the situation described in SOP 03-1. The guidance in the FSP is effective for financial statements for fiscal periods beginning after June 18, 2004. The adoption of this FSP is not expected to have a material impact on the Company’s consolidated financial condition or results of operations. (For further discussion of SOP 03-1, see Note 3.)
SOP 03-1
In July 2003, Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (“AICPA”) issued SOP 03-1. SOP 03-1 addresses a wide variety of topics, some of which have a significant impact on the Company. The major provisions of the SOP 03-1 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; and | |||
• | Capitalizing sales inducements that meet specified criteria and amortizing such amounts over the life of the contracts |
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 1. Basis of contractsPresentation 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 methodAccounting Policies (continued)
Adoption of recognition upon payment;
The SOP 03-1 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 03-1 on net income and other comprehensive income was comprised of the following individual impacts:
Net | Other | |||||||||||||||
Income | Comprehensive | Net | Other Comprehensive | |||||||||||||
Cumulative Effect of Adoption | (Loss) | Income | Income (Loss) | Income (Loss) | ||||||||||||
Establishing GMDB and other benefit reserves for annuity contracts | $ | (54 | ) | $ | — | $ | (54 | ) | $ | — | ||||||
Reclassifying certain separate accounts to general accounts | 30 | 294 | 30 | 294 | ||||||||||||
Other | 1 | (2 | ) | 1 | (2 | ) | ||||||||||
Total cumulative effect of adoption | $ | (23 | ) | $ | 292 | $ | (23 | ) | $ | 292 | ||||||
Death Benefits and Other Insurance Benefit Features
The Company sells variable annuity contracts that offer various guaranteed death benefits. ForWith the adoption of SOP 03-1, 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)(unaudited)
Note 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 profitswere accounted 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 revaluationincluding reporting of the liabilities from fair value to account value plusspreads on 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 earningsCompany’s MVA fixed annuities 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 on a gross basis in separate account assetsnet investment income 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 nobenefits expense. This change in value. The related separate account assetsaccounting resulted in increases of $6.2 billion were also reclassified to$299 and $948 in net investment income and increases of $250 and $854 in benefits, claims and claim adjustment expenses for 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,second quarter and six months ended June 30, 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.respectively.
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, 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, amortization
10
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
EITF 02-14
In MarchJuly 2004, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock If the Investor Has the Ability to Exercise Significant Influence Over the Operating and Financial Policies of the Investee”. The EITF concluded that an investor should only apply the equity method of accounting when it has investments in either common stock or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant influence over the operating and financial policies of the investee. The EITF defined in-substance common stock as an investment that has risk and reward characteristics that are substantially similar to common stock.
EITF 02-14 is effective for reporting periods beginning after September 15, 2004. For investments that are in-substance common stock but that were not accounted for under the equity method prior to the consensus, the effect of adoption should be reported as a change in accounting principle. For investments that are not common stock or in-substance common stock but that were accounted for under the equity method of accounting prior to the consensus, the equity method of accounting should be discontinued prospectively from the date of adoption and the investor should evaluate whether the investment should be prospectively accounted for under SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” or the cost method under APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
FSP 106-2
In May 2004, the FASB issued FSP FAS No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”), which provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”). The Act introduces (1) a prescription drug benefit under Medicare and (2) a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least “actuarially equivalent” to Medicare Part D. The FASB concluded that the subsidy should be treated as an actuarial gain pursuant to SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions".FSP 106-2 is effective for the first interim period or annual period beginning after June 15, 2004. If the effect of the Act is not considered a significant event, the effects of the Act should be incorporated in the next measurement of plan assets and obligations. The Company has determined that it will be entitled to the subsidy. The Company does not consider the impact of adoption of the Act to have a significant impact on net periodic postretirement benefit cost or accumulated postretirement benefit obligation and will include the effects of the Act in the Company’s next scheduled remeasurement, January 1, 2005.
EITF 03-1
In March 2004, the 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”)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
10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 1. Basis of Presentation and Accounting Policies (continued)
Future Adoption of New Accounting Standards (continued)
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 the 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.
In addition to the disclosure requirements adopted by the Company effective December 31, 2003, the final consensus of EITF 03-1 included additional disclosure requirements that are effective for fiscal years ending after June 15, 2004. 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. BesidesThe Company continues to assess the disclosure requirements adopted byimpact of the Company effective December 31, 2003, the final version ofimpairment evaluation and recognition guidance in 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 orand results of operations. While certain provisions of EITF 03-1 require significant judgment by management, the Company currently believes the most significant area of potential impact will be related to certain asset-backed securities supported by aircraft lease receivables that are currently accounted for under EITF 99-20. The Company’s gross unrealized loss related to these securities as of June 30, 2004 was approximately $60. The ultimate impairment recognized upon the adoption of EITF 03-1, if any, will depend on market conditions and management’s intent and ability to hold securities with unrealized losses at the time of impairment evaluation.
EITF 03-16
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. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, and 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. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial condition or results of operations.
Note 2. Derivatives and Hedging Activity
Derivative Instruments
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards, futures and options 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.
On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair 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 and/or approved, as applicable, by the State of Connecticut, the State of Illinois 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’s use of derivative instruments, see Notes 1 and 3 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.
The following table summarizes the notional amount and fair value of derivatives by hedge designation as of June 30, 2004 and December 31, 2003. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and is not necessarily reflective of credit risk. The fair value amounts of derivative assets and liabilities are presented on a net basis in the following table.
June 30, 2004 | December 31, 2003 | |||||||||||||||
Notional Amount | Fair Value | Notional Amount | Fair Value | |||||||||||||
Cash flow hedge | $ | 6,392 | $ | (249 | ) | $ | 3,659 | $ | (84 | ) | ||||||
Fair value hedge | 1,033 | (13 | ) | 956 | 4 | |||||||||||
Net investment hedge | 200 | — | 200 | (4 | ) | |||||||||||
Other investment and risk management activities | 38,551 | 87 | 30,989 | 13 | ||||||||||||
Total | $ | 46,176 | $ | (175 | ) | $ | 35,804 | $ | (71 | ) | ||||||
11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 2. Derivatives and Hedging Activity (continued)
Derivative Instruments (continued)
The increase in notional amount since December 31, 2003 is primarily due to an increase in embedded derivatives associated with guaranteed minimum withdrawal benefits (“GMWB”) product sales, and, to a lesser extent, derivatives transferred to the general account as a result of the adoption of SOP 03-1 and new hedging strategies. The decrease in the net fair value of derivative instruments since December 31, 2003 was primarily due to the rise in interest rates during the second quarter of 2004 and derivatives transferred to the general account pursuant to the adoption of SOP 03-1, partially offset by the increase in derivatives associated with GMWB.
Due to the adoption of the SOP 03-1, 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 March 31,June 30, 2004, $50$22 of the derivatives were reported in other investments, $(93)$103 in other liabilities, and $6$5 of embedded derivatives in fixed maturities in the condensed consolidated balance sheets. Management’s objectiveobjectives with regard to the reclassified derivatives along with the notional amount and net fair value as of March 31, 2004 are as follows:
Notional | As of June 30, 2004 | |||||||||||||||
Hedging Strategy | Amount | Fair Value | Notional 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 | $ | 1,596 | $ | 18 | ||||||||
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 | ) | 413 | (103 | ) | ||||||||||
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 | ) | 111 | (2 | ) | ||||||||||
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 | 444 | — | ||||||||||||
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 | — | ||||||||||||||
Interest rate swaps- The Company uses interest rate swaps to manage interest rate risk. | 250 | 16 | ||||||||||||||
Options -The Company writes option contracts for a premium to monetize the option embedded in certain of its fixed maturity investments. | 417 | — | 162 | — | ||||||||||||
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 | ) | 45 | (5 | ) | ||||||||||
Total | $ | 3,044 | $ | (37 | ) | $ | 3,021 | $ | (76 | ) | ||||||
In addition to the derivatives transferred to the general account as a result of the adoption of the SOP 03-1, 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)(LIBOR), and were structured to offset the payments associated with the guaranteed investment contracts. As of March 31,June 30, 2004, the notional amount and net fair value of these swaps totaled $350 and $(7)$13, respectively.
During the six months ended June 30, 2004, the Company entered into credit default swap agreements in which the Company pays a derivative counterparty a periodic fee in exchange for compensation from the counterparty should a credit event occur on the part of the referenced security issuer. The Company entered into these agreements as an efficient means to reduce credit exposure to the specified issuers. As of June 30, 2004, the notional amount and net fair value of these swaps totaled $534 and less than $1, respectively.
During the second quarter of 2004, the Company also entered into a series of forward starting swap agreements to hedge interest rate exposure on anticipated fixed-rate asset purchases and anticipated variable cash flows on floating rate assets due to changes in the benchmark interest rate (LIBOR). These swaps have been designated as cash flow hedges and were structured to hedge interest rate exposure inherent in the assumptions used to price primarily certain long-term disability products. As of June 30, 2004, the notional amount and net fair value of these swaps totaled $720 and $(22), respectively.
Periodically the Company enters into interest rate swap agreements to terminate existing swaps in hedging relationships, thereby offsetting the prospective changes in value in the original swap. During the second quarter 2004, the Company cash settled both the original and offsetting swap agreements, resulting in a reduction in notional amount of approximately $3.3 billion from December 31, 2003. No net realized gain or loss was recorded as a result of the settlement.
The Company offers certain variable annuity products with a guaranteed minimum withdrawal benefit (“GMWB”)GMWB rider. As of March 31,June 30, 2004 and December 31, 2003, $9.7
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 2. Derivatives and Hedging Activity (continued)
Derivative Instruments (continued)
$12.5 billion, or 46%53%, 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 Company has established an alternative risk management strategy. During the third quarter ofIn 2003, the Company began hedging its unreinsured GMWB exposure using interest rate futures, and Standard and Poor’s (“S&P”) 500 and NASDAQ index options and futures contracts. During the first quarter of 2004, the Company entered intobegan using Europe, AsiaAustralasia and Far East (“EAFE”) Index swaps to hedge GMWB exposure to international equity markets.
The total notional amount of derivative contracts purchased to hedge the GMWB exposure, as of March 31,June 30, 2004 and December 31, 2003, was $1.7$1.9 billion and $544, respectively, and net fair value was $100$79 and $21, respectively. For the second quarter and six months ended March 31,June 30, 2004, net realized capital gains and losses included the change in market value of both 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 $2 lossgain of $6 and $4, respectively, before deferred policy acquisition costs and tax effects.
Derivative instruments are recorded at fair value and presented in the condensed consolidated balance sheets as follows:
12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)
Note 2. Derivatives and Hedging Activity (continued)
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||
Asset | Liability | Asset | Liability | Asset | Liability | Asset | Liability | |||||||||||||||||||||||||
Values | Values | Values | Values | Values | Values | Values | Values | |||||||||||||||||||||||||
Other investments | $ | 375 | $ | — | $ | 199 | $ | — | $ | 148 | $ | — | $ | 199 | $ | — | ||||||||||||||||
Reinsurance recoverables | — | 73 | — | 89 | — | 81 | — | 89 | ||||||||||||||||||||||||
Other policyholder funds and benefits payable | 79 | — | 115 | — | 125 | — | 115 | — | ||||||||||||||||||||||||
Fixed maturities | 15 | — | 7 | — | 5 | — | 7 | — | ||||||||||||||||||||||||
Other liabilities | — | 342 | — | 303 | — | 372 | — | 303 | ||||||||||||||||||||||||
Total | $ | 469 | $ | 415 | $ | 321 | $ | 392 | $ | 278 | $ | 453 | $ | 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 decrease in interest rates.
The following table summarizes the notional 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 the basis 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 quarterssecond quarter and six months ended March 31,June 30, 2004 and March 31, 2003, the Company’s gross gains and losses representing the total ineffectiveness of all cash flow, fair value and net investment hedges were immaterial,was less than $1, with the net impact reported as net realized capital gains and losses.
For the quarterssecond quarter and six months ended March 31,June 30, 2004, and 2003, the Company recognized anrecorded a net loss due to ineffectiveness on cash flow hedges of $3, after-tax, net gain (loss) of $17 and $(3), respectively, (reported asprimarily associated with interest rate swap hedges, in net realized capital gains and losses inlosses. For the condensed consolidated statements of operations), which representedsecond quarter and six months ended June 30, 2003, the cash flow hedge ineffectiveness was less than $1.
The total change in value for other derivative-based strategies which do not qualify for hedge accounting treatment, including the periodic net coupon settlements.settlements, are reported as net realized capital gains and losses in the condensed consolidated statements of operations. For the second quarter and six months ended June 30, 2004, the Company recognized an after-tax net gain of $11 and $28, respectively, for derivative-based strategies which do not qualify for hedge accounting treatment. For the second quarter and six months ended June 30, 2003, the after-tax net gain was $8 and $11, respectively.
As of March 31,June 30, 2004, the after-tax deferred net gains on derivative instruments accumulated in accumulated other comprehensive income (“AOCI”) that are expected to be reclassified to earnings during the next twelve months are $15.$11. 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 gains (losses)or 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 on variable ratevariable-rate fixed maturities) is twenty-four months. For the quarterssecond quarter and six months ended March 31,June 30, 2004 and 2003, the netthere were no reclassifications from AOCI to earnings resulting from the discontinuance of cash flow hedges were immaterial.hedges.
The net investment hedge of the Japanese Life operation was established in the fourth quarter of 2003. The after-tax amount of net gain (loss) included in the foreign currency cumulative translation adjustment associated with the net investment hedge was $(6)less than $1 and $(3) as of March 31,June 30, 2004 and December 31, 2003, respectively.
Note 3. Death Benefits and Other Insurance Benefit Features
The Company sells variable annuity contracts, through separate accounts, that offer various guaranteed death benefits. The Company currently reinsures a significant portion of these death benefit guarantees associated with its in-force block of business. Upon adoption of SOP 03-1, the Company 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 June 30, 2004, the liability from GMDB and other benefits sold with variable annuity products was $212 with a related reinsurance recoverable asset of $92. The net GMDB liability is established by estimating the expected value of net reinsurance costs and net death benefits in excess of the projected account balance and recognizing the excess death benefits and net reinsurance costs ratably over the accumulation period based on total expected assessments. 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.
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 3. Death Benefits and Other Insurance Benefit Features (continued)
The following table provides details concerning GMDB exposure for the Retail Products Group which comprises substantially all of the GMDB exposure:
Breakdown of Variable Annuity Account Value by | Account | Net Amount | Retained Net | |||||||||
GMDB Type | Value | at Risk | Amount at Risk | |||||||||
Maximum anniversary value (MAV) [1] | ||||||||||||
MAV only | $ | 61,264 | $ | 8,299 | $ | 913 | ||||||
With 5% rollup [2] | 4,132 | 672 | 121 | |||||||||
With Earnings Protection Benefit Rider (EPB) [3] | 3,974 | 134 | 40 | |||||||||
With 5% rollup & EPB | 1,469 | 112 | 19 | |||||||||
Total MAV | 70,839 | 9,217 | 1,093 | |||||||||
Asset Protection Benefit (APB) [4] | 11,627 | 17 | 10 | |||||||||
Ratchet [5] (5 years) | 43 | 3 | — | |||||||||
Reset [6] (5-7 years) | 8,478 | 863 | 862 | |||||||||
Return of Premium [7]/Other | 1,517 | 11 | 11 | |||||||||
Total | $ | 92,504 | $ | 10,111 | $ | 1,976 | ||||||
[1] | MAV: the death benefit is the greatest of current account value, net premiums paid and the highest account value on any anniversary before age 80 (adjusted for withdrawals). | |
[2] | Rollup: the death benefit is the greatest of the MAV, current account value, net premium paid and premiums (adjusted for withdrawals) accumulated at generally 5% simple interest up to the earlier of age 80 or 100% of adjusted premiums. | |
[3] | EPB: The death benefit is the greatest of the MAV, current account value, or contract value plus a percentage of the contract’s growth. The contract’s growth is account value less premiums net of withdrawals, subject to a cap of 200% of premiums net of withdrawals. | |
[4] | APB: the death benefit is the greater of current account value or MAV, not to exceed current account value plus 25% times the greater of net premiums and MAV (each adjusted for premiums in the past 12 months). | |
[5] | Ratchet: the death benefit is the greatest of current account value, net premiums paid and the highest account value on any specified anniversary before age 85 (adjusted for withdrawals). | |
[6] | Reset: the death benefit is the greatest of current account value, net premiums paid and the most recent five to seven year anniversary account value before age 80 (adjusted for withdrawals). | |
[7] | Return of premium: the death benefit is the greater of current account value and net premiums paid. |
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, in accordance with SOP 03-1, was not material. Currently there is diversity in industry practice and inconsistent guidance surrounding the application of SOP 03-1 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 SOP 03-1 and could impact future earnings.
Note 4. Separate Account Presentation
The Hartford maintains separate account assets and liabilities, which are reported at fair value. Separate account assets are segregated from other investments and investment income and gains and losses accrue directly to the policyholder. See Note 3 for a discussion of death benefit guarantees offered in variable annuity contracts sold through separate accounts. The fees earned for administrative and contractholder maintenance services performed for these separate accounts are included in fee income. During 2004, there were no gains or losses on transfers of assets from the general account to the separate account. 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 SOP 03-1. Separate account assets and liabilities related to CRC of $11 billion were reclassified to and revalued in, the general account upon adoption of SOP 03-1.
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 4. Separate Account Presentation (continued)
Prior to the adoption of SOP 03-1 the Company had also recorded its variable annuity products offered in Japan in separate account assets and liabilities through December 31, 2003. These assets are not legally insulated from general creditors and therefore did not meet the conditions for separate account reporting under SOP 03-1. On January 1, 2004, separate account assets and liabilities in Japan of $6.2 billion were 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 June 30, 2004, due to strong sales of Japan variable annuity products and positive performance of the Japanese equity markets these assets had increased to $9.3 billion.
Note 5. Sales Inducements
The Company currently offers enhanced crediting rates or bonus payments to contractholders 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, 2004, upon adopting SOP 03-1, the expense associated with offering a bonus is deferred and amortized over the life of the related contract in a pattern consistent with the amortization of deferred policy acquisition costs. Also, effective January 1, 2004, amortization expense associated with expenses previously deferred is recorded over the remaining life of the contract rather than over the contingent deferred sales charge period. Changes in deferred sales inducement activity were as follows:
Second Quarter Ended | Six Months Ended | |||||||
June 30, 2004 | June 30, 2004 | |||||||
Balance, beginning of period | $ | 225 | $ | 198 | ||||
Sales inducements deferred | 30 | 63 | ||||||
Amortization charged to income | (6 | ) | (12 | ) | ||||
Balance at June 30, 2004 | $ | 249 | $ | 249 | ||||
Note 6. Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”, and accordingly ceased all amortization of goodwill.
The carrying amount of goodwill as of March 31,June 30, 2004 and December 31, 2003, is shown below.
Life | $ | 796 | ||
Property & Casualty | 152 | |||
Corporate | 772 | |||
Total | $ | 1,720 | ||
13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)
Note 3. Goodwill and Other Intangible Assets (continued)
The following table shows the Company’s acquired intangible assets that continue to be subject to amortization and accumulated amortization expense. Except for goodwill, the Company has no material intangible assets with indefinite useful lives.
March 31, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||
Gross | Accumulated | Gross | Accumulated | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||
Carrying | Net | Carrying | Net | Gross Carrying | Accumulated Net | Gross Carrying | Accumulated Net | |||||||||||||||||||||||||
Amortized Intangible Assets | Amount | Amortization | Amount | Amortization | Amount | Amortization | Amount | Amortization | ||||||||||||||||||||||||
Present value of future profits | $ | 1,459 | $ | 408 | $ | 1,459 | $ | 380 | $ | 1,453 | $ | 449 | $ | 1,459 | $ | 380 | ||||||||||||||||
Renewal rights | 30 | 18 | 30 | 17 | 30 | 19 | 30 | 17 | ||||||||||||||||||||||||
Other | 11 | 2 | 11 | 1 | 13 | 3 | 11 | 1 | ||||||||||||||||||||||||
Total | $ | 1,500 | $ | 428 | $ | 1,500 | $ | 398 | $ | 1,496 | $ | 471 | $ | 1,500 | $ | 398 | ||||||||||||||||
Net amortization expense for the second quarter ended March 31,June 30, 2004 and 2003 was $30$43 and $26,$27, respectively. Net amortization expense for the six months ended June 30, 2004 and 2003 was $73 and $52, respectively.
15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 6. Goodwill and Other Intangible Assets (continued)
The following is detail of the net acquired intangible asset activity as of June 30, 2004 and 2003:
Present Value of | ||||||||||||||||
Future Profits | Renewal Rights | Other | Total | |||||||||||||
For the six months ended June 30, 2004 | ||||||||||||||||
Balance, beginning of period | $ | 1,079 | $ | 13 | $ | 10 | $ | 1,102 | ||||||||
Acquisition of business [1] | (6 | ) | — | 2 | 4 | |||||||||||
Amortization, net of the accretion of interest | (69 | ) | (2 | ) | (2 | ) | (73 | ) | ||||||||
Balance, ending of period | $ | 1,004 | $ | 11 | $ | 10 | $ | 1,025 | ||||||||
For the six months ended June 30, 2003 | ||||||||||||||||
Balance, beginning of period | $ | 1,132 | $ | 15 | $ | — | $ | 1,147 | ||||||||
Acquisition of business | — | 4 | 9 | 13 | ||||||||||||
Amortization, net of the accretion of interest | (49 | ) | (3 | ) | — | (52 | ) | |||||||||
Balance, ending of period | $ | 1,083 | $ | 16 | $ | 9 | $ | 1,108 | ||||||||
[1]Includes purchase price adjustments on the CNA Acquisition, see discussion below.
Estimated future net amortization expense for the succeeding five years is as follows:
For the year ended December 31, | ||||||||
2004 | $ | 124 | $ | 127 | ||||
2005 | $ | 104 | $ | 104 | ||||
2006 | $ | 95 | $ | 92 | ||||
2007 | $ | 80 | $ | 78 | ||||
2008 | $ | 69 | $ | 69 |
On December 31, 2003, the Company acquired CNA Financial Corporation’s group life and accident, and short-term and long-term disability businesses for $485 in cash. The purchase price paid on December 31, 2003 was based on September 30, 2003 statutory surplus. During the second quarter of 2004, the purchase price was finalized for $543 in cash based on the actual statutory surplus at December 31, 2003. The Company continues to integrate this acquisition and obtain the information necessary to finalize the initial estimates in purchase accounting. The Company expects to finalize those initial fair value estimates within the one year allocation period, ending December 31, 2004.
The following is detailCompany has agreed to offer over 40,000 London Pacific Life and Annuity Company (“London Pacific”) deferred annuity customers, representing approximately $1.5 billion in account value, the opportunity to exchange to a Hartford Life Insurance Company (“HLIC”) contract in the third quarter of 2004. HLIC will also assume approximately 6,000 immediate annuities and 2,000 universal life policies from London Pacific pursuant to orders entered by the Wake County Superior Court of North Carolina. The transactions are expected to be completed in three separate blocks between July 2004 and March 2005.
Note 7. Reinsurance Recoverables
During the second quarter of 2004, the Company completed an evaluation of the reinsurance recoverable asset associated with older, long-term casualty liabilities reported in the Other Operations segment, including asbestos liabilities. As a result of this evaluation, the Company reduced its net acquired intangible asset activity asreinsurance recoverable by $181. The after-tax income effect of March 31, 2004 and 2003:this action was $118.
16
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 | ||||||||||
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 4.8. Earnings (Loss) Per Share
The 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 | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, 2004 | Income/(Loss) | Shares | Per Share Amount | |||||||||||||||||||||||||||||||||
June 30, 2004 | June 30, 2004 | |||||||||||||||||||||||||||||||||||
Net | Per Share | Net | Per Share | |||||||||||||||||||||||||||||||||
Income | Shares | Amount | Income | Shares | Amount | |||||||||||||||||||||||||||||||
Basic Earnings per Share | ||||||||||||||||||||||||||||||||||||
Net income available to common shareholders | $ | 568 | 289.9 | $ | 1.96 | |||||||||||||||||||||||||||||||
Income available to common shareholders | $ | 433 | 292.3 | $ | 1.48 | $ | 1,001 | 291.1 | $ | 3.44 | ||||||||||||||||||||||||||
Diluted Earnings per Share | ||||||||||||||||||||||||||||||||||||
Options | — | 3.1 | — | 3.0 | — | 3.1 | ||||||||||||||||||||||||||||||
Equity Units | — | 1.9 | — | 2.2 | — | 2.0 | ||||||||||||||||||||||||||||||
Net income available to common shareholders plus assumed conversions | $ | 568 | 294.9 | $ | 1.93 | |||||||||||||||||||||||||||||||
Income available to common shareholders plus assumed conversions | $ | 433 | 297.5 | $ | 1.46 | $ | 1,001 | 296.2 | $ | 3.38 | ||||||||||||||||||||||||||
14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)
Note 4. Earnings (Loss) Per Share (continued)
March 31, 2003 | ||||||||||||
Basic Loss per Share | ||||||||||||
Net 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 | ) | |||||
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, 2003 | June 30, 2003 | |||||||||||||||||||||||
Net | Per Share | Net | Per Share | |||||||||||||||||||||
Income | Shares | Amount | Income (Loss) | Shares | Amount | |||||||||||||||||||
Basic Earnings (Loss) per Share | ||||||||||||||||||||||||
Income (Loss) available to common shareholders | $ | 507 | 268.8 | $ | 1.89 | $ | (888 | ) | 262.1 | $ | (3.39 | ) | ||||||||||||
Diluted Earnings (Loss) per Share [1] | ||||||||||||||||||||||||
Options | — | 1.4 | — | — | ||||||||||||||||||||
Income (Loss) available to common shareholders plus assumed conversions | $ | 507 | 270.2 | $ | 1.88 | $ | (888 | ) | 262.1 | $ | (3.39 | ) | ||||||||||||
[1] | As a result of the net loss in the |
Basic earnings (loss) per share reflects the actual weighted average number of shares 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 options and equity units are assumed, with the proceeds used to purchase common stock at the average market price for the period. The 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 Form 10-K Annual Report.
Note 5.9. Commitments and Contingencies
Litigation
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 uncertainties discussed in Note 16 of Notes to Consolidated Financial Statements under the caption “Asbestos and Environmental Claims”,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 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 liabilityproperty, and inland 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 the Company’s consolidated results of operations or cash flows in particular quarterly or annual periods.
As discussed in Note 16 of Notes to Consolidated Financial Statements under the caption “Asbestos and Environmental Claims”,Claims,” included in The Hartford’s 2003 Form 10-K Annual
17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 9. Commitments and Contingencies (continued)
Litigation (continued)
Report, The Hartford continues to receive asbestos and environmental claims that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartford continually reviews its overall reserve levels methodologies and reinsurance coverages.coverages, as well as the methodologies it uses to estimate its exposures. Because of the significant uncertainties whichthat limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses, principallyparticularly 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”) entered into a conditional 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 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 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 concerning
15
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 confidentiality 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 $70 and a maximum of $80, depending on the outcome of the patent appeal, to resolve all disputes between the parties. 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, and in November of 2003, The Hartford paid the initial $70 of the 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. RepresentativesThe Company continues to respond to requests for documents and information from representatives from the SEC’s Office of Compliance Inspections and Examinations continue to request documents and information in connection with their ongoing compliance examination.examinations regarding market timing and late trading, revenue sharing and directed brokerage, fees, fund service providers and transfer agents, and other mutual fund-related issues. 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 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 the future. If such an action is brought, it could have a material effect on the Company.
Like numerous other insurance carriers, The Hartford has received a subpoena from the New York Attorney General’s Office in connection with its inquiry into compensation arrangements between brokers and carriers. The Hartford is cooperating with the inquiry. Consistent with long-standing and wide-spread industry practice, The Hartford makes incentive compensation payments to brokers that may be based on the volume, growth and/or profitability of business placed with The Hartford. The Hartford expects the independent brokers with whom we work to comply with all applicable laws, including any concerning the disclosure of compensation arrangements. At this early stage, it is too soon to tell what impact, if any, the investigation will have on The Hartford.
The Financial Services Agency, the Company’s primary regulator in Japan, is considering new reserving methodologies and Solvency Margin Ratio (“SMR”) standards for variable annuity contracts. The industry and Institute of Actuaries of Japan (“IAJ”) have been consulting with the regulators on the development of the new methodologies and SMR standards. While there has been no formal time frame established, it is expected that the IAJ should conclude its discussions in September and new regulations could go into force as early as April 2005. Although the new reserve methodologies and SMR standards would only apply to capital requirements for Japanese regulatory purposes, it is possible in the future that the Company would need to provide additional capital to support its Japanese operations, which would lower the Company’s return on invested capital for this business. At this time, it is not possible to predict the final form of any reserve methodology or SMR standard changes.
18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 9. Commitments and Contingencies (continued)
Tax Matters
The Hartford’s federalCompany’s Federal income tax returns are routinely audited by the Internal Revenue Service (“IRS”). The Company is currently under audit for the 1998–20011998-2001 tax years. 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.
Although there has been no agreement reached between the Company and the IRS at this time, the amount of tax related 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 financial position and 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’sthe Company’s 2003 Form 10-K Annual Report.) 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.
Note 6.10. Segment Information
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 the Life and Property & Casualty operations, The Hartford conducts business principally in eight 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 adjustment activities.
Life has changed its reportable operating segments from Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance (“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
16
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. Life also includes in an Other category its international operations, which are primarily located in Japan and Brazil; net realized capital gains and losses 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 operating 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 four reportable operating segments: the underwriting segments of Business Insurance, Personal Lines, and Specialty Commercial (collectively “Ongoing Operations”); and the Other Operations segment. Prior to the segment reporting change made in the first quarter of 2004, Property and& Casualty had also included a Reinsurance segment. With the discontinuance of writing new reinsurance assumed business, the reinsurance assumed business is now included in the Other Operations segment.
Business Insurance provides standard commercial insurance coverage to small commercial and middle market commercial businessbusinesses primarily throughout the United States. This segment offers workers’ compensation, property, automobile, liability, umbrella and marine coverages. Commercial risk management products and services are also provided.
Personal Lines provides automobile, 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 through AARP’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’ 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.
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’s asbestos and environmental exposures.
The measure of profit or loss used by The Hartford’s management in evaluating the performance of its Life segments is net income. The Property & Casualty underwriting segments are evaluated by The Hartford’s management primarily based upon underwriting results. Underwriting results represent premiums earned less incurred claims, claim adjustment expenses and underwriting expenses.
19
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 10. Segment Information (continued)
The following tables present revenues and net income (loss). Underwriting results are presented for the Business Insurance, Personal Lines, Specialty Commercial and Other Operations segments, while net income is presented for Life, Property & Casualty and Corporate. Segment information for the previous period hasperiods have 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, | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
2004 | 2003 | June 30, | June 30, | |||||||||||||||||||||
Revenues | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||
Life | ||||||||||||||||||||||||
Retail Products Group | $ | 763 | $ | 478 | ||||||||||||||||||||
Retail Products Group [2] | $ | 764 | $ | 533 | $ | 1,527 | $ | 1,011 | ||||||||||||||||
Institutional Solutions Group | 442 | 422 | 434 | 470 | 876 | 892 | ||||||||||||||||||
Individual Life | 254 | 244 | 252 | 240 | 506 | 484 | ||||||||||||||||||
Group Benefits | 1,004 | 667 | 1,000 | 638 | 2,004 | 1,305 | ||||||||||||||||||
Other [1] [2] | 595 | (25 | ) | 194 | 81 | 789 | 56 | |||||||||||||||||
Total Life | 3,058 | 1,786 | 2,644 | 1,962 | 5,702 | 3,748 | ||||||||||||||||||
Property & Casualty | ||||||||||||||||||||||||
Ongoing Operations | ||||||||||||||||||||||||
Earned premiums and other revenues | ||||||||||||||||||||||||
Business Insurance | 1,019 | 880 | 1,060 | 897 | 2,079 | 1,777 | ||||||||||||||||||
Personal Lines | 864 | 800 | 896 | 817 | 1,760 | 1,617 | ||||||||||||||||||
Specialty Commercial | 395 | 422 | 500 | 436 | 895 | 858 | ||||||||||||||||||
Total Ongoing Operations earned premiums and other revenues | 2,278 | 2,102 | 2,456 | 2,150 | 4,734 | 4,252 | ||||||||||||||||||
Other Operations earned premiums | 12 | 159 | 14 | 69 | 26 | 228 | ||||||||||||||||||
Net investment income | 311 | 281 | 295 | 286 | 606 | 567 | ||||||||||||||||||
Net realized capital gains (losses) | 71 | (1 | ) | |||||||||||||||||||||
Net realized capital gains | 27 | 212 | 98 | 211 | ||||||||||||||||||||
Total Property & Casualty | 2,672 | 2,541 | 2,792 | 2,717 | 5,464 | 5,258 | ||||||||||||||||||
Corporate | 2 | 4 | 8 | 3 | 10 | 7 | ||||||||||||||||||
Total revenues | $ | 5,732 | $ | 4,331 | $ | 5,444 | $ | 4,682 | $ | 11,176 | $ | 9,013 | ||||||||||||
[1] | Amounts include net realized capital gains | |
[2] | 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. |
20
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 | ) | |||
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 10. Segment Information (continued)
Second Quarter Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Net Income (Loss) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
Life | ||||||||||||||||
Retail Products Group | $ | 128 | $ | 121 | $ | 235 | $ | 198 | ||||||||
Institutional Solutions Group | 28 | 29 | 56 | 60 | ||||||||||||
Individual Life | 37 | 36 | 70 | 68 | ||||||||||||
Group Benefits | 48 | 35 | 95 | 69 | ||||||||||||
Other [1] | 28 | 41 | 94 | 12 | ||||||||||||
Total Life | 269 | 262 | 550 | 407 | ||||||||||||
Property & Casualty | ||||||||||||||||
Ongoing Operations | ||||||||||||||||
Underwriting results | ||||||||||||||||
Business Insurance | 97 | 50 | 322 | 57 | ||||||||||||
Personal Lines | 75 | 8 | 181 | 64 | ||||||||||||
Specialty Commercial | 29 | 25 | (81 | ) | 30 | |||||||||||
Total Ongoing Operations underwriting results | 201 | 83 | 422 | 151 | ||||||||||||
Other Operations underwriting results [2] | (214 | ) | (89 | ) | (279 | ) | (2,740 | ) | ||||||||
Total Property & Casualty underwriting results | (13 | ) | (6 | ) | 143 | (2,589 | ) | |||||||||
Net servicing and other income [3] | 21 | 3 | 30 | 6 | ||||||||||||
Net investment income | 295 | 286 | 606 | 567 | ||||||||||||
Other expenses | (60 | ) | (93 | ) | (128 | ) | (134 | ) | ||||||||
Net realized capital gains | 27 | 212 | 98 | 211 | ||||||||||||
Income tax (expense) benefit | (67 | ) | (107 | ) | (205 | ) | 739 | |||||||||
Total Property & Casualty | 203 | 295 | 544 | (1,200 | ) | |||||||||||
Corporate | (39 | ) | (50 | ) | (93 | ) | (95 | ) | ||||||||
Net income (loss) | $ | 433 | $ | 507 | $ | 1,001 | $ | (888 | ) | |||||||
[1] | Amounts include net realized capital gains, | |
[2] | Includes $2,604 | |
[3] | Net of expenses related to service business. |
1821
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)(Unaudited)
Note 7.11. Debt
Short-Term Debt | March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | ||||||||||||
Commercial paper | $ | 373 | $ | 850 | $ | 373 | $ | 850 | ||||||||
Current maturities of long-term debt | 200 | 200 | 249 | 200 | ||||||||||||
Total Short-Term Debt | $ | 573 | $ | 1,050 | $ | 622 | $ | 1,050 | ||||||||
Long –Term Debt [1] | March 31, 2004 | December 31, 2003 | ||||||||||||||
Long–Term Debt [1] | June 30, 2004 | December 31, 2003 | ||||||||||||||
Senior Notes and Debentures | ||||||||||||||||
7.75% Notes, due 2005 | $ | 249 | $ | 249 | $ | — | $ | 249 | ||||||||
2.375% Notes, due 2006 | 254 | 252 | 248 | 252 | ||||||||||||
7.1% Notes, due 2007 | 198 | 198 | 198 | 198 | ||||||||||||
4.7% Notes, due 2007 | 300 | 300 | 300 | 300 | ||||||||||||
6.375% Notes, due 2008 | 200 | 200 | 200 | 200 | ||||||||||||
4.1% Equity Units Notes, due 2008 | 330 | 330 | ||||||||||||||
2.56% Equity Units Notes, due 2008 | 690 | 690 | ||||||||||||||
4.1% Equity Unit Notes, due 2008 | 330 | 330 | ||||||||||||||
2.56% Equity Unit Notes, due 2008 | 690 | 690 | ||||||||||||||
7.9% Notes, due 2010 | 275 | 275 | 275 | 275 | ||||||||||||
4.625% Notes, due 2013 | 319 | 319 | 319 | 319 | ||||||||||||
4.75% Notes, due 2014 | 199 | — | 198 | — | ||||||||||||
7.3% Notes, due 2015 | 200 | 200 | 200 | 200 | ||||||||||||
7.65% Notes, due 2027 | 248 | 248 | 248 | 248 | ||||||||||||
7.375% Notes, due 2031 | 400 | 400 | 400 | 400 | ||||||||||||
Total Senior Notes and Debentures | $ | 3,862 | $ | 3,661 | 3,606 | 3,661 | ||||||||||
Junior Subordinated Debentures | ||||||||||||||||
7.20% Notes, due 2038 | — | 245 | ||||||||||||||
7.2% Notes, due 2038 | — | 245 | ||||||||||||||
7.625% Notes, due 2050 | 200 | 200 | 200 | 200 | ||||||||||||
7.45% Notes, due 2050 | 518 | 507 | 498 | 507 | ||||||||||||
Total Junior Subordinated Debentures | 718 | 952 | 698 | 952 | ||||||||||||
Total Long-Term Debt | $ | 4,580 | $ | 4,613 | $ | 4,304 | $ | 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. |
During the six months ended June 30, 2004, the Company repaid $477 of commercial paper utilizing the proceeds from the equity offering and internal sources.
On June 15, 2004, HLI repaid $200 of 6.9% senior notes at maturity.
On March 15, 2004, HLI redeemed $250 of its 7.2% junior subordinated debentures underlying the trust preferred securities issued by Hartford Life Capital I.
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.
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 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, and (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,June 30, 2004, The Hartford 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 29, 2001. As of March 31,June 30, 2004, HLI had $1.0 billion remaining on its 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 Subordinated Debentures”) of The Hartford or HLI; and (iii) engaging in only those activities necessary or incidental thereto. The Company may enter into guarantees with respect to the preferred securities of any of The Hartford Trusts.
1922
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)(Unaudited)
Note 7.11. Debt (continued)
Commercial Paper and Revolving Credit Facilities
Outstanding as of | Outstanding as of | |||||||||||||||||||||||||||||||||||||||
Effective | Expiration | Maximum | March 31, | December 31, | Effective | Expiration | Maximum | June 30, | December 31, | |||||||||||||||||||||||||||||||
Description | Date | Date | Available | 2004 | 2003 | Date | Date | Available | 2004 | 2003 | ||||||||||||||||||||||||||||||
Commercial Paper | ||||||||||||||||||||||||||||||||||||||||
Commercial paper | ||||||||||||||||||||||||||||||||||||||||
The Hartford | 11/10/86 | N/A | $ | 2,000 | $ | 373 | $ | 850 | 11/10/86 | N/A | $ | 2,000 | $ | 373 | $ | 850 | ||||||||||||||||||||||||
HLI | 2/7/97 | N/A | 250 | — | — | 2/7/97 | N/A | 250 | — | — | ||||||||||||||||||||||||||||||
Total commercial paper | $ | 2,250 | $ | 373 | $ | 850 | 2,250 | 373 | 850 | |||||||||||||||||||||||||||||||
Revolving Credit Facility | ||||||||||||||||||||||||||||||||||||||||
Revolving credit facilities | ||||||||||||||||||||||||||||||||||||||||
5-year revolving credit facility | 6/20/01 | 6/20/06 | $ | 1,000 | $ | — | $ | — | 6/20/01 | 6/20/06 | 1,000 | — | — | |||||||||||||||||||||||||||
3-year revolving credit facility | 12/31/02 | 12/31/05 | 490 | — | — | 12/31/02 | 12/31/05 | 490 | — | — | ||||||||||||||||||||||||||||||
Total revolving credit facility | $ | 1,490 | $ | — | $ | — | ||||||||||||||||||||||||||||||||||
Total revolving credit facilities | 1,490 | — | — | |||||||||||||||||||||||||||||||||||||
Total Outstanding Commercial Paper and Revolving Credit Facilities | $ | 3,740 | $ | 373 | $ | 850 | ||||||||||||||||||||||||||||||||||
Total outstanding commercial paper and revolving credit facilities | $ | 3,740 | $ | 373 | $ | 850 | ||||||||||||||||||||||||||||||||||
Interest Expense
The following table presents interest expense incurred forduring the quarterssecond quarter and six months ended March 31,June 30, 2004 and 2003, respectively.
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||
Short-term debt | $ | 2 | $ | 1 | $ | 1 | $ | 2 | $ | 3 | $ | 3 | ||||||||||||
Long-term debt | 64 | 65 | 61 | 67 | 125 | 132 | ||||||||||||||||||
Total interest expense | $ | 66 | $ | 66 | $ | 62 | $ | 69 | $ | 128 | $ | 135 | ||||||||||||
Note 8.12. Stockholders’ Equity
On January 22, 2004, The Hartford issued approximately 6.3 million 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 $388. Subsequently, on January 30, 2004, The Hartford issued approximately 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. The Company used the proceeds from these issuances to repay $411 of commercial paper issued in connection with the acquisition of the group life and accident, and short-term and long-term disability businessbusinesses of CNA Financial Corporation. (For further discussion of this acquisition, see Note 18 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.)
Note 9.13. Pension Plans and Postretirement Health Care and Life Insurance Benefit Plans
Components of Net Periodic Benefit Cost
Total net periodic benefit cost for the quarterssix months ended March 31,June 30, 2004 and 2003 include the following components:
Other Postretirement | Pension | Other Postretirement | ||||||||||||||||||||||||||||||
Pension Benefits | Benefits | Benefits | Benefits | |||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||
Service cost | $ | 26 | $ | 26 | $ | 4 | $ | 3 | $ | 50 | $ | 52 | $ | 7 | $ | 6 | ||||||||||||||||
Interest cost | 43 | 42 | 7 | 7 | 85 | 84 | 14 | 14 | ||||||||||||||||||||||||
Expected return on plan assets | (43 | ) | (42 | ) | (2 | ) | (2 | ) | (100 | ) | (85 | ) | (4 | ) | (4 | ) | ||||||||||||||||
Amortization of prior service cost | 1 | 1 | (6 | ) | (6 | ) | (6 | ) | 3 | (12 | ) | (12 | ) | |||||||||||||||||||
Amortization of unrecognized net losses | 7 | 6 | 2 | 1 | 23 | 12 | 4 | 2 | ||||||||||||||||||||||||
Net periodic benefit cost | $ | 34 | $ | 33 | $ | 5 | $ | 3 | $ | 52 | $ | 66 | $ | 9 | $ | 6 | ||||||||||||||||
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 10.14. Accumulated Other Comprehensive Income (Loss)
Comprehensive income (loss) is defined as all changes in 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
23
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(Unaudited)
Note 14. Accumulated Other Comprehensive Income (Loss) (continued)
gains or losses on cash flowcash-flow hedging instruments, changes in foreign currency translation gains or losses and changes in the Company’s minimum pension liability.
20
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)(unaudited)
Note 10. Accumulated Other Comprehensive Income (continued)
The components of AOCI, net of tax,accumulated other comprehensive income (loss) were as follows:
Foreign | Net Gain | Foreign | ||||||||||||||||||||||||||||||||||||||
Currency | Net | (Loss) on | Currency | Minimum | Accumulated | |||||||||||||||||||||||||||||||||||
Net Gain (Loss) on | Cumulative | Minimum Pension | Accumulated Other | Unrealized | Cash-Flow | Cumulative | Pension | Other | ||||||||||||||||||||||||||||||||
Unrealized Gain | Cash flow Hedging | Translation | Liability | Comprehensive | Gain on | Hedging | Translation | Liability | Comprehensive | |||||||||||||||||||||||||||||||
For the first quarter ended March 31, 2004 | on Securities | Instruments | Adjustments | Adjustment | Income | |||||||||||||||||||||||||||||||||||
For the second quarter ended June 30, 2004 | Securities | Instruments | Adjustments | Adjustment | Income (Loss) | |||||||||||||||||||||||||||||||||||
Balance, beginning of period | $ | 1,764 | $ | (42 | ) | $ | (101 | ) | $ | (375 | ) | $ | 1,246 | $ | 2,630 | $ | 17 | $ | (104 | ) | $ | (375 | ) | $ | 2,168 | |||||||||||||||
Unrealized gain/loss on securities [1] [2] | 574 | — | — | — | 574 | (1,564 | ) | — | — | — | (1,564 | ) | ||||||||||||||||||||||||||||
Foreign currency translation adjustments | — | — | (3 | ) | — | (3 | ) | — | — | (15 | ) | — | (15 | ) | ||||||||||||||||||||||||||
Net gain/loss on cash flow hedging instruments [1] [3] | — | 59 | — | — | 59 | |||||||||||||||||||||||||||||||||||
Cumulative effect of accounting change [4] | 292 | — | — | — | 292 | |||||||||||||||||||||||||||||||||||
Net gain/loss on cash-flow hedging instruments [1] [3] | — | (109 | ) | — | — | (109 | ) | |||||||||||||||||||||||||||||||||
Balance, end of period | $ | 2,630 | $ | 17 | $ | (104 | ) | $ | (375 | ) | 2,168 | $ | 1,066 | $ | (92 | ) | $ | (119 | ) | $ | (375 | ) | $ | 480 | ||||||||||||||||
For the first quarter ended March 31, 2003 | ||||||||||||||||||||||||||||||||||||||||
For the second quarter ended June 30, 2003 | ||||||||||||||||||||||||||||||||||||||||
Balance, beginning of period | $ | 1,444 | $ | 128 | $ | (95 | ) | $ | (383 | ) | $ | 1,094 | $ | 1,621 | $ | 105 | $ | (86 | ) | $ | (383 | ) | $ | 1,257 | ||||||||||||||||
Unrealized gain/loss on securities [1] [2] | 177 | — | — | — | 177 | 555 | — | — | — | 555 | ||||||||||||||||||||||||||||||
Foreign currency translation adjustments | — | — | 9 | — | 9 | — | — | 10 | — | 10 | ||||||||||||||||||||||||||||||
Net gain/loss on cash flow hedging instruments [1] [3] | — | (23 | ) | — | — | (23 | ) | |||||||||||||||||||||||||||||||||
Net gain/loss on cash-flow hedging instruments [1] [3] | — | (15 | ) | — | — | (15 | ) | |||||||||||||||||||||||||||||||||
Balance, end of period | $ | 1,621 | $ | 105 | $ | (86 | ) | $ | (383 | ) | $ | 1,257 | $ | 2,176 | $ | 90 | $ | (76 | ) | $ | (383 | ) | $ | 1,807 | ||||||||||||||||
Net Gain | Foreign | |||||||||||||||||||
Net | (Loss) on | Currency | Minimum | Accumulated | ||||||||||||||||
Unrealized | Cash-Flow | Cumulative | Pension | Other | ||||||||||||||||
Gain on | Hedging | Translation | Liability | Comprehensive | ||||||||||||||||
For the six months ended June 30, 2004 | Securities | Instruments | Adjustments | Adjustment | Income (Loss) | |||||||||||||||
Balance, beginning of period | $ | 1,764 | $ | (42 | ) | $ | (101 | ) | $ | (375 | ) | $ | 1,246 | |||||||
Unrealized gain/loss on securities [1] [2] | (990 | ) | — | — | — | (990 | ) | |||||||||||||
Foreign currency translation adjustments | — | — | (18 | ) | — | (18 | ) | |||||||||||||
Net gain/loss on cash-flow hedging instruments [1] [3] | — | (50 | ) | — | — | (50 | ) | |||||||||||||
Cumulative effect of accounting change [4] | 292 | — | — | — | 292 | |||||||||||||||
Balance, end of period | $ | 1,066 | $ | (92 | ) | $ | (119 | ) | $ | (375 | ) | $ | 480 | |||||||
For the six months ended June 30, 2003 | ||||||||||||||||||||
Balance, beginning of period | $ | 1,444 | $ | 128 | $ | (95 | ) | $ | (383 | ) | $ | 1,094 | ||||||||
Unrealized gain/loss on securities [1] [2] | 732 | — | — | — | 732 | |||||||||||||||
Foreign currency translation adjustments | — | — | 19 | — | 19 | |||||||||||||||
Net gain/loss on cash-flow hedging instruments [1] [3] | — | (38 | ) | — | — | (38 | ) | |||||||||||||
Balance, end of period | $ | 2,176 | $ | 90 | $ | (76 | ) | $ | (383 | ) | $ | 1,807 | ||||||||
[1] | Unrealized | |
[2] | Net of reclassification adjustment for gains (losses) realized in net income (loss) of | |
[3] | Net of amortization adjustment of $5 and $4 for the second quarter and $9 | |
[4] | Cumulative effect of accounting change is net of tax of $157 for the |
2124
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in millions except share data unless otherwise stated)
Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts in millions except share data unless otherwise stated) |
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the financial condition of The Hartford Financial Services Group, Inc. and its subsidiaries (collectively, “The Hartford” or the “Company”) as of March 31,June 30, 2004, compared with December 31, 2003, and its results of operations for the firstsecond quarter and six months ended March 31,June 30, 2004, compared to the equivalent 2003 period.periods. This discussion should be read in conjunction with the MD&A in The Hartford’s 2003 Form 10-K Annual Report.
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’s control and have been made based upon management’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 with management’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 the Company’s potential exposure for asbestos and environmental claims and related litigation; the possible occurrence of terrorist attacks; the response of reinsurance companies under reinsurance contracts and the availability, pricing and adequacy of reinsurance to protect the 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; the possibility 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; the Company’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 the Company’s claims-paying, financial strength or credit ratings; the ability of the Company’s subsidiaries to pay dividends to the Company; and other factors described in such forward-looking statements.
INDEX
INDEX | ||||
Critical Accounting Estimates | ||||
Consolidated Results of Operations | ||||
Life | ||||
Retail Products Group | ||||
Institutional Solutions Group | ||||
Individual Life | ||||
Group Benefits | ||||
Property & Casualty | ||||
Business Insurance | ||||
Personal Lines | ||||
Specialty Commercial | ||||
Other Operations (Including Asbestos and Environmental Claims) | ||||
Investments | ||||
Investment Credit Risk | ||||
Capital Markets Risk Management | ||||
Capital Resources and Liquidity | ||||
Accounting Standards |
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 for future policy benefits and unpaid claim and claim adjustment expenses; Life operations deferred policy acquisition 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.
Deferred Policy Acquisition Costs and Present Value of Future Profits
Life
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
25
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”). At March 31,June 30, 2004 and December 31, 2003, the carrying value of the Company’s Life operations’ DAC was $6.5$7.1 billion and $6.6 billion, respectively. For statutory accounting purposes, such costs are expensed as incurred.
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 gross profits or “EGPs”. This range was then compared to the present value of EGPs currently utilized in the DAC amortization model. As of March 31,June 30, 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 of March 31,June 30, 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 by 15%30% or less from June 30 levels for the balance of 2004, or 20% or less over the next twelve months, and if certain other assumptions that are implicit in the computations of the EGPs are achieved. For further discussion of these assumptions, see the Critical Accounting Estimates section of the Company’s 2003 Form 10-K Annual Report under the heading “Deferred Policy Acquisition Costs and Present Value of Future Profits”.
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”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of 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 the Company’s EGPs was required at March 31,June 30, 2004. If the Company assumed a 9% average long-term rate of growth from March 31,June 30, 2004 forward along with other appropriate assumption changes in determining the revised EGPs, the Company estimates the cumulative increase to amortization would be approximately $40-$25-$45,30 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 $60-$55-$70,60, 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 the 2004 and 2005 years exclusive of the adjustment, and that there would have been positive earnings effects in later years. Any such adjustment would not affect statutory income or surplus, due to the prescribed accounting for such amounts that is discussed above.
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’ funds in the separate accounts is invested in the equity market. As of March 31,June 30, 2004, the Company believed variable annuity separate account assets could fall by at least 45% before portions of its DAC asset would be unrecoverable.
Other Critical Accounting Estimates
There have been no material changes to the Company’s critical accounting estimates regarding reserves for future policy benefits and unpaid claims and claim adjustment expenses; investments; pension and other postretirement benefits; and contingencies since the filing of the Company’s 2003 Form 10-K Annual Report.
CONSOLIDATED RESULTS OF OPERATIONS
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 revenues | 5,732 | 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 expenses | 4,914 | 6,556 | (25 | %) | ||||||||
Income (loss) before income taxes and cumulative effect of accounting change | 818 | (2,225 | ) | NM | ||||||||
Income tax expense (benefit) | 227 | (830 | ) | NM | ||||||||
Income (loss) before cumulative effect of accounting change | 591 | (1,395 | ) | NM | ||||||||
Cumulative effect of accounting change, net of tax | (23 | ) | — | NM | ||||||||
Net income (loss) | $ | 568 | $ | (1,395 | ) | NM | ||||||
2326
CONSOLIDATED RESULTS OF OPERATIONS
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Earned premiums | $ | 3,323 | $ | 2,812 | 18 | % | $ | 6,504 | $ | 5,661 | 15 | % | ||||||||||||
Fee income | 793 | 656 | 21 | % | 1,579 | 1,273 | 24 | % | ||||||||||||||||
Net investment income | 1,158 | 796 | 45 | % | 2,675 | 1,584 | 69 | % | ||||||||||||||||
Other revenues | 118 | 147 | (20 | %) | 222 | 269 | (17 | %) | ||||||||||||||||
Net realized capital gains | 52 | 271 | (81 | %) | 196 | 226 | (13 | %) | ||||||||||||||||
Total revenues | 5,444 | 4,682 | 16 | % | 11,176 | �� | 9,013 | 24 | % | |||||||||||||||
Benefits, claims and claim adjustment expenses | 3,288 | 2,629 | 25 | % | 6,585 | 7,874 | (16 | %) | ||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 701 | 557 | 26 | % | 1,380 | 1,121 | 23 | % | ||||||||||||||||
Insurance operating costs and expenses | 653 | 584 | 12 | % | 1,345 | 1,122 | 20 | % | ||||||||||||||||
Interest expense | 62 | 69 | (10 | %) | 128 | 135 | (5 | %) | ||||||||||||||||
Other expenses | 163 | 214 | (24 | %) | 343 | 357 | (4 | %) | ||||||||||||||||
Total benefits, claims and expenses | 4,867 | 4,053 | 20 | % | 9,781 | 10,609 | (8 | %) | ||||||||||||||||
Income (loss) before income taxes and cumulative effect of accounting change | 577 | 629 | (8 | %) | 1,395 | (1,596 | ) | NM | ||||||||||||||||
Income tax expense (benefit) | 144 | 122 | 18 | % | 371 | (708 | ) | NM | ||||||||||||||||
Income (loss) before cumulative effect of accounting change | 433 | 507 | (15 | %) | 1,024 | (888 | ) | NM | ||||||||||||||||
Cumulative effect of accounting change, net of tax | — | — | — | (23 | ) | — | NM | |||||||||||||||||
Net income (loss) | $ | 433 | $ | 507 | (15 | %) | $ | 1,001 | $ | (888 | ) | NM | ||||||||||||
The Hartford defines “NM” as not meaningful for increases or decreases greater than 200%, or changes from a net gain to a net loss position, or vice versa.
Operating Results
Net income for the second quarter ended June 30, 2004 decreased $74 from the comparable prior year period, due primarily to a $118 provision related to the completion of the Company’s evaluation of the reinsurance recoverable asset associated with older, long-term casualty liabilities and a $145 decrease in net realized capital gains, after-tax. The remaining difference, an increase of $189, was primarily the result of improved underwriting results in the Personal Lines and Business Insurance segments and an increase in net income in the Group Benefits segment. Net income for the six months ended June 30, 2004 increased $2.0$1.9 billion, due primarily to $1.7 billion, after-tax, in reserve strengthening resulting from the completion of the Company’s asbestos reserve study in the first quarter of 2003. TheContributing to the remaining difference an increase of $262, was primarily the result of an increase in net realized capital gains, after-tax, of $124;were improved underwriting results in the Personal Lines and Business Insurance segments and Personal Lines segments;higher net income in the Group Benefits and Retail Products Group segments, partially offset by the 2004 evaluation of the reinsurance recoverable asset noted above.
Revenues for the second quarter and six months ended June 30, 2004 increased $762 and $2.2 billion over the comparable prior year periods, primarily due to an increase in net investment income of $362 for the second quarter and $1.1 billion for the six months ended June 30, 2004. The increase in the Retail Products Group and Group Benefits segments; partially offset by a $23 net of tax cumulative effect of accounting change charge resulting frominvestment income was due primarily to 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(“SOP 03-1”).
Revenues for the first quarter ended March 31, 2004 increased $1.4 billion over the comparable prior year period, primarily due to the adoption of the SOP, 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 the general account as a result of the adoption of the SOP). Also contributing to the increase was a $313 increase inwere higher earned premiums in the Group Benefits, segment, a $189 increase in net realized capital gains,Business Insurance and a $142 increase in fee income and other in the Retail Products Group segment.Personal Lines segments.
Income Taxes
The effective tax rate for the firstsecond quarter and six months ended March 31,June 30, 2004 was 28%25% and 27%, respectively, as compared with 37%19% and 44%, respectively, for the comparable periodperiods in 2003. Tax-exempt interest earned on invested assets and the dividends receiveddividends-received deduction were the principal causes of the effective tax rates being different thandiffering from the 35% U.S. statutory rate.
Organizational Structure
The Hartford is organized into two major operations: Life and Property & Casualty. In the first 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 the Life and Property & Casualty operations, The Hartford conducts business principally in eight 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 adjustment activities.
Life has changed its reportable operating segments from Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance (“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
27
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 and losses 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 operating 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 four reportable operating segments: the underwriting segments of Business Insurance, Personal Lines, and Specialty Commercial (collectively “Ongoing Operations”); and the Other Operations segment. Prior to the segment reporting change made in the first quarter of 2004, Property and& Casualty had also included a Reinsurance segment. With the discontinuance of writing new reinsurance assumed business, the reinsurance assumed business is now included in the Other Operations segment.
24
Segment Results
The following is a summary of net income (loss) for each of the Company’s Life segments and aggregate net income (loss) for the Company’s Property & Casualty operations.
Net Income (Loss)
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||||||
2004 | 2003 | Change | ||||||||||||||||||||||||||||||||||
Net Income (Loss) | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||
Life | ||||||||||||||||||||||||||||||||||||
Retail Products Group | $ | 107 | $ | 77 | 39 | % | $ | 128 | $ | 121 | 6 | % | $ | 235 | $ | 198 | 19 | % | ||||||||||||||||||
Institutional Solutions Group | 28 | 31 | (10 | %) | 28 | 29 | (3 | %) | 56 | 60 | (7 | %) | ||||||||||||||||||||||||
Individual Life | 33 | 32 | 3 | % | 37 | 36 | 3 | % | 70 | 68 | 3 | % | ||||||||||||||||||||||||
Group Benefits | 47 | 34 | 38 | % | 48 | 35 | 37 | % | 95 | 69 | 38 | % | ||||||||||||||||||||||||
Other | 66 | (29 | ) | NM | 28 | 41 | (32 | %) | 94 | 12 | NM | |||||||||||||||||||||||||
Total Life | 281 | 145 | 94 | % | 269 | 262 | 3 | % | 550 | 407 | 35 | % | ||||||||||||||||||||||||
Total Property & Casualty | 341 | (1,495 | ) | NM | 203 | 295 | (31 | %) | 544 | (1,200 | ) | NM | ||||||||||||||||||||||||
Corporate | (54 | ) | (45 | ) | (20 | %) | (39 | ) | (50 | ) | 22 | % | (93 | ) | (95 | ) | 2 | % | ||||||||||||||||||
Total net income (loss) | $ | 568 | $ | (1,395 | ) | NM | $ | 433 | $ | 507 | (15 | %) | $ | 1,001 | $ | (888 | ) | NM | ||||||||||||||||||
The following is a summary of Property & Casualty underwriting results by segment.
Underwriting Results (before-tax)results represent premiums earned less incurred claims, claim adjustment expenses and underwriting expenses.
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||
2004 | 2003 | |||||||||||||||||||||||||||||||
Underwriting Results (before-tax) | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||
Business Insurance | $ | 225 | $ | 7 | $ | 97 | $ | 50 | 94 | % | $ | 322 | $ | 57 | NM | |||||||||||||||||
Personal Lines | 106 | 56 | 75 | 8 | NM | 181 | 64 | 183 | % | |||||||||||||||||||||||
Specialty Commercial | (110 | ) | 5 | 29 | 25 | 16 | % | (81 | ) | 30 | NM | |||||||||||||||||||||
Other Operations [1] | (65 | ) | (2,651 | ) | (214 | ) | (89 | ) | (140 | %) | (279 | ) | (2,740 | ) | 90 | % | ||||||||||||||||
[1] | Includes $2,604 |
LIFE28
Operating SummaryLIFE
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||||||
2004 | 2003 | Change | ||||||||||||||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||
Earned premiums | $ | 995 | $ | 683 | 46 | % | $ | 970 | $ | 706 | 37 | % | $ | 1,965 | $ | 1,389 | 41 | % | ||||||||||||||||||
Fee income | 786 | 617 | 27 | % | 790 | 656 | 20 | % | 1,576 | 1,273 | 24 | % | ||||||||||||||||||||||||
Net investment income [1] | 1,201 | 503 | 139 | % | 858 | 504 | 70 | % | 2,059 | 1,007 | 104 | % | ||||||||||||||||||||||||
Other revenues | — | 27 | (100 | %) | — | 37 | (100 | %) | — | 64 | (100 | %) | ||||||||||||||||||||||||
Net realized capital gains (losses) | 76 | (44 | ) | NM | ||||||||||||||||||||||||||||||||
Net realized capital gains | 26 | 59 | (56 | %) | 102 | 15 | NM | |||||||||||||||||||||||||||||
Total revenues | 3,058 | 1,786 | 71 | % | 2,644 | 1,962 | 35 | % | 5,702 | 3,748 | 52 | % | ||||||||||||||||||||||||
Benefits, claims and claim adjustment expenses [1] | 1,877 | 1,083 | 73 | % | 1,531 | 1,086 | 41 | % | 3,408 | 2,169 | 57 | % | ||||||||||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 233 | 163 | 43 | % | 233 | 175 | 33 | % | 466 | 338 | 38 | % | ||||||||||||||||||||||||
Insurance operating costs and expenses | 526 | 351 | 50 | % | 511 | 395 | 29 | % | 1,037 | 746 | 39 | % | ||||||||||||||||||||||||
Other expenses | 1 | 4 | (75 | %) | 3 | 3 | — | 4 | 7 | (43 | %) | |||||||||||||||||||||||||
Total benefits, claims and expenses | 2,637 | 1,601 | 65 | % | 2,278 | 1,659 | 37 | % | 4,915 | 3,260 | 51 | % | ||||||||||||||||||||||||
Income before income taxes and cumulative effect of accounting change | 421 | 185 | 128 | % | 366 | 303 | 21 | % | 787 | 488 | 61 | % | ||||||||||||||||||||||||
Income tax expense | 117 | 40 | 193 | % | 97 | 41 | 137 | % | 214 | 81 | 164 | % | ||||||||||||||||||||||||
Income before cumulative effect of accounting change | 304 | 145 | 110 | % | 269 | 262 | 3 | % | 573 | 407 | 41 | % | ||||||||||||||||||||||||
Cumulative effect of accounting change, net of tax [2] | (23 | ) | — | NM | — | — | — | (23 | ) | — | — | |||||||||||||||||||||||||
Net income | $ | 281 | $ | 145 | 94 | % | $ | 269 | $ | 262 | 3 | % | $ | 550 | $ | 407 | 35 | % | ||||||||||||||||||
[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 | |
[2] | For the |
Life’s net income increased largelyfor the second quarter of 2004 compared to 2003 due primarily to a significant increasenet income increases in Group Benefits, Retail and international operations, partially offset by lower realized capital gains. (See the Investments section for further discussion of investment results and related realized capital gains.) Also contributing to the earnings growth were increases in net income in the Retail and Group Benefits segments. Net income in the Retail segment increased, principally driven by growth in the variable annuity and mutual fund businesses as a result of increasing assets under management. Partially offsetting these increases was lower spread 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”). Net income in the Retail segment increased, principally driven by growth in the variable annuity and mutual fund businesses as a result of increasing assets under management. Partially offsetting the increase in the Retail segment was lower spread income on market value adjusted (“MVA”) fixed annuities due to the adoption of SOP 03-1. Net income for the international operations, which is included in the other category, increased over the comparable prior year period primarily driven by the increase in assets under management of the Japan annuity business. Japan’s assets under management have grown to $9.3 billion at June 30, 2004 from $3.1 billion at June 30, 2003.
25
For the six months ended June 30, 2004 compared to 2003, net income increased primarily due to higher net realized capital gains, higher net income in the Retail segment, Group Benefits segment and international operations as discussed in the previous paragraph. Partially offsetting the positive earnings drivers discussed abovefor the six months ended June 30, 2004 was the cumulative effect of accounting change from the Company’s adoption of the SOP.SOP 03-1. The adoption of the SOP 03-1 also resulted in certain changes in presentation in the Company’s financial statements, including reporting of the spreads on the Company’s MVA fixed annuities and variable annuity products offered in Japan on a gross basis in net investment income and benefits expense. Exclusive of the cumulative effect, overall application of the SOP 03-1 resulted in an immaterial reduction in net income. (For further discussion of the impact of the Company’s adoption of the SOP 03-1 see Note 1 of Notes to Condensed Consolidated Financial Statements).
29
Retail Products Group
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Fee income and other | $ | 513 | $ | 401 | 28 | % | $ | 1,019 | $ | 765 | 33 | % | ||||||||||||
Earned premiums | (17 | ) | 1 | NM | (31 | ) | (8 | ) | NM | |||||||||||||||
Net investment income | 266 | 128 | 108 | % | 538 | 245 | 120 | % | ||||||||||||||||
Net realized capital gains | 2 | 3 | (33 | %) | 1 | 9 | (89 | %) | ||||||||||||||||
Total revenues | 764 | 533 | 43 | % | 1,527 | 1,011 | 51 | % | ||||||||||||||||
Benefits, claims and claim adjustment expenses | 259 | 153 | 69 | % | 516 | 300 | 72 | % | ||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 160 | 114 | 40 | % | 327 | 217 | 51 | % | ||||||||||||||||
Insurance operating costs and other expenses | 180 | 149 | 21 | % | 355 | 281 | 26 | % | ||||||||||||||||
Total benefits, claims and expenses | 599 | 416 | 44 | % | 1,198 | 798 | 50 | % | ||||||||||||||||
Income before income taxes and cumulative effect of accounting change | 165 | 117 | 41 | % | 329 | 213 | 54 | % | ||||||||||||||||
Income tax expense (benefit) | 37 | (4 | ) | NM | 75 | 15 | NM | |||||||||||||||||
Income before cumulative effect of accounting change | 128 | 121 | 6 | % | 254 | 198 | 28 | % | ||||||||||||||||
Cumulative effect of accounting change, net of tax [1] | — | — | — | (19 | ) | — | — | |||||||||||||||||
Net income | $ | 128 | $ | 121 | 6 | % | $ | 235 | $ | 198 | 19 | % | ||||||||||||
June 30, 2004 | June 30, 2003 | Change | ||||||||||
Individual variable annuity account values | $ | 92,504 | $ | 73,748 | 25 | % | ||||||
Other individual annuity account values | 11,372 | 10,587 | 7 | % | ||||||||
401K and specialty products account values | 5,588 | 3,720 | 50 | % | ||||||||
Total account values [2] | 109,464 | 88,055 | 24 | % | ||||||||
Mutual fund assets under management | 23,897 | 17,012 | 40 | % | ||||||||
Total assets under management | $ | 133,361 | $ | 105,067 | 27 | % | ||||||
S&P 500 Index value at end of period | 1,141 | 975 | 17 | % | ||||||||
Operating 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 revenues | 763 | 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 expenses | 599 | 382 | 57 | % | ||||||||
Income before income taxes and cumulative effect of accounting change | 164 | 96 | 71 | % | ||||||||
Income tax expense | 38 | 19 | 100 | % | ||||||||
Income before cumulative effect of accounting change | 126 | 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 period | 1,126 | 848 | 33 | % | ||||||||
[1] | ||||
[2] |
Net income in the Retail segment increased for the second quarter and six months ended June 30, 2004, principally driven by significant growth in the assets under management within the variable annuity and mutual fund businesses. AssetsThe Company uses assets under management isas an internal performance measure used bymeasure. Relative profitability of the Retail segment as relative profitability is highly correlated to the growth in assets under management which issince the segment generally earns fee income on a daily basis on its assets under management. Assets under management are driven by net flows andthe performance of the equity markets. markets and net flows. Net flows are comprised of new sales less surrenders, death benefits and annuitizations of variable annuity contracts. In the mutual fund business, net flows are known as net sales. Net sales are comprised of new sales less redemptions of mutual fund customers.
Fee income generated by the variable annuity operation increased, as average account values increasedwere higher in the firstsecond quarter asand six months ended June 30, 2004 compared to the respective prior year.year periods. The increase in average account values can be attributed to approximately $8.6equity market growth of $11.0 billion ofand net flows of $7.8 billion 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.quarters. The Company uses the S&P 500 Index as an indicator for evaluating market returns of the underlying account portfolios.portfolios, more specifically the average daily value of the S&P 500, which rose by approximately 17% from June 30, 2003 to June 30, 2004. Another contributing factor to the increase in fee income was the mutual fund business. Mutual fund assets under management increased 40% principally due to equity market growth as well as higherof $3.4 billion and net sales which were $1.1of $3.2 billion inover the first quarter as compared to $132 in the first quarter of 2003.past four quarters.
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 lowerwas a decrease in net income associated within the individual fixed annuity business.business, higher amortization of deferred policy acquisition costs, and higher income tax expense. 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 infor the firstsecond quarter ofand six months ended June 30, 2004 as compared to the comparable prior year. Withyear periods. In addition, with the adoption of the SOP 03-1, the Company includes the investment return from the product in net investment income and includes interest credited to contract holderscontractholders in the benefits, claims and claim adjustment expenses line onin the income statement rather than reporting the net spread in fee income.income and other. Additionally, the ratio of DAC amortization to gross profits for the individual annuity business (defined as amortization of deferred policy acquisition costs as a percentage of income before taxes and amortization of deferred policy acquisition costs) was slightly higher for the second quarter and six months ended June 30, 2004 as compared to the comparable prior year periods, which resulted in lower net income. Income tax expense was higher for the second quarter and the six months
30
ended June 30, 2004 due primarily to higher income earned by the segment and the $20 tax benefit recorded in the firstsecond quarter asof 2003 related to the change in estimate of the dividends received deduction reported during 2002. In addition, partially offsetting the earnings growth for the six months ended June 30, 2004 compared to the prior year which reduced net income.period was the cumulative effect of the accounting change from the Company’s adoption of SOP 03-1 recorded in the first quarter of 2004.
26
Institutional Solutions Group
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Fee income and other | $ | 76 | $ | 79 | (4 | %) | $ | 150 | $ | 156 | (4 | %) | ||||||||||||
Earned premiums | 95 | 142 | (33 | %) | 204 | 242 | (16 | %) | ||||||||||||||||
Net investment income | 262 | 244 | 7 | % | 519 | 488 | 6 | % | ||||||||||||||||
Net realized capital gains | 1 | 5 | (80 | %) | 3 | 6 | (50 | %) | ||||||||||||||||
Total revenues | 434 | 470 | (8 | %) | 876 | 892 | (2 | %) | ||||||||||||||||
Benefits, claims and claim adjustment expenses | 357 | 374 | (5 | %) | 712 | 709 | — | |||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 10 | 7 | 43 | % | 19 | 13 | 46 | % | ||||||||||||||||
Insurance operating costs and other expenses | 27 | 48 | (44 | %) | 64 | 84 | (24 | %) | ||||||||||||||||
Total benefits, claims and expenses | 394 | 429 | (8 | %) | 795 | 806 | (1 | %) | ||||||||||||||||
Income before income taxes and cumulative effect of accounting change | 40 | 41 | (2 | %) | 81 | 86 | (6 | %) | ||||||||||||||||
Income tax expense | 12 | 12 | — | 24 | 26 | (8 | %) | |||||||||||||||||
Income before cumulative effect of accounting change | 28 | 29 | (3 | %) | 57 | 60 | (5 | %) | ||||||||||||||||
Cumulative effect of accounting change, net of tax [1] | — | — | — | (1 | ) | — | — | |||||||||||||||||
Net income | $ | 28 | $ | 29 | (3 | %) | $ | 56 | $ | 60 | (7 | %) | ||||||||||||
June 30, 2004 | June 30, 2003 | Change | ||||||||||
Institutional account values | $ | 13,377 | $ | 11,224 | 19 | % | ||||||
Governmental account values | 9,445 | 7,811 | 21 | % | ||||||||
Private Placement Life Insurance account values | ||||||||||||
Variable products | 21,592 | 20,326 | 6 | % | ||||||||
Leveraged COLI | 2,508 | 3,137 | (20 | %) | ||||||||
Total account values [2] | 46,922 | 42,498 | 10 | % | ||||||||
Mutual fund assets under management | 1,272 | 850 | 50 | % | ||||||||
Total assets under management | $ | 48,194 | $ | 43,348 | 11 | % | ||||||
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 revenues | 442 | 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 expenses | 401 | 377 | 6 | % | ||||||||
Income before income taxes and cumulative effect of accounting change | 41 | 45 | (9 | %) | ||||||||
Income tax expense | 12 | 14 | (14 | %) | ||||||||
Income before cumulative effect of accounting change | 29 | 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] | ||||
[2] |
Net income for the Institutional segmentsecond quarter and six months ended June 30, 2004 decreased as compared to the comparable prior year period. This decrease was thea result of lower earningsincome from the private placement life insurance business and the institutional business, which includes structured settlements and institutional annuities.annuities, and the private placement life insurance business. Lower net income in private placement life insurancethe institutional business was due primarily to lower revenues earnedspread income as a result of the lower account values ininterest rates and slightly higher insurance operating costs for the leveraged COLI product due primarily to surrenders that occurred in 2003. The leveraged COLI product continues to contribute favorablysecond quarter and six months ended June 30, 2004 as compared to the segment’s profitability, although the contribution may decline in the future depending on the surrender activity of these policies.respective prior year periods. In addition, the institutional business contributed lower earnings infor the first quarter ofsix months ended June 30, 2004 compared to the same period in 2003 due to favorable mortality experience in 2003. This decrease wasPrivate placement life insurance also experienced lower net income for the second quarter and six months ended June 30, 2004 primarily theas a result of favorable mortality experiencedlower revenues earned due to the 20% decline in leveraged COLI account values, which resulted from surrenders that occurred in 2003. Partially offsetting these declines was a small increase inhigher income from the net income beforegovernmental business for the cumulative effect of accounting change of the Governmental business when compared to the same period in 2003.second quarter and six months ended June 30, 2004. 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 firstsecond quarter of 2003.
2731
Individual Life
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Fee income and other | $ | 181 | $ | 184 | (2 | %) | $ | 367 | $ | 366 | — | |||||||||||||
Earned premiums | (5 | ) | (6 | ) | 17 | % | (10 | ) | (10 | ) | — | |||||||||||||
Net investment income | 76 | 63 | 21 | % | 149 | 129 | 16 | % | ||||||||||||||||
Net realized capital losses | — | (1 | ) | 100 | % | — | (1 | ) | 100 | % | ||||||||||||||
Total revenues | 252 | 240 | 5 | % | 506 | 484 | 5 | % | ||||||||||||||||
Benefits, claims and claim adjustment expenses | 120 | 108 | 11 | % | 245 | 220 | 11 | % | ||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 40 | 43 | (7 | %) | 79 | 89 | (11 | %) | ||||||||||||||||
Insurance operating costs and other expenses | 39 | 39 | — | 79 | 78 | 1 | % | |||||||||||||||||
Total benefits, claims and expenses | 199 | 190 | 5 | % | 403 | 387 | 4 | % | ||||||||||||||||
Income before income taxes and cumulative effect of accounting change | 53 | 50 | 6 | % | 103 | 97 | 6 | % | ||||||||||||||||
Income tax expense | 16 | 14 | 14 | % | 32 | 29 | 10 | % | ||||||||||||||||
Income before cumulative effect of accounting change | 37 | 36 | 3 | % | 71 | 68 | 4 | % | ||||||||||||||||
Cumulative effect of accounting change, net of tax [1] | — | — | — | (1 | ) | — | — | |||||||||||||||||
Net income | $ | 37 | $ | 36 | 3 | % | $ | 70 | $ | 68 | 3 | % | ||||||||||||
Variable life account values | $ | 4,934 | $ | 4,141 | 19 | % | ||||||||||||||||||
Total account values | $ | 8,992 | $ | 8,066 | 11 | % | ||||||||||||||||||
Variable life insurance in force | $ | 67,537 | $ | 66,518 | 2 | % | ||||||||||||||||||
Total life insurance in force | $ | 134,420 | $ | 127,520 | 5 | % | ||||||||||||||||||
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 revenues | 254 | 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 expenses | 204 | 197 | 4 | % | ||||||||
Income before income taxes and cumulative effect of accounting change | 50 | 47 | 6 | % | ||||||||
Income tax expense | 16 | 15 | 7 | % | ||||||||
Income before cumulative effect of accounting change | 34 | 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 | % | ||||||
[1] |
Net income in the Individual Life segment increased slightly for the second quarter and six months ended June 30, 2004 as compared to the comparablerespective prior year period. This increase wasperiods. These increases were primarily driven by growth in account values and life insurance in-forcein force and favorable equity market conditions. The impact of this growth was partially offset by higher mortality costs thanin the priorcurrent year. However, the increased mortality costs reduced the amount of amortization of deferred policy acquisition costs recorded during the quarter.quarter and six months ended June 30, 2004. Net investment income increased partiallyprimarily due to the adoption of SOP 03-1 in the SOP,first quarter of 2004, which resulted in increases in net investment income and benefits, claims and claim adjustment expenses for the segment’s Modified Guarantee Life Insurance product, which was formerly classified as a separate account product.
Group Benefits
Operating Summary
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||||||
2004 | 2003 | Change | ||||||||||||||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||
Earned premiums and other | $ | 915 | $ | 602 | 52 | % | $ | 906 | $ | 573 | 58 | % | $ | 1,821 | $ | 1,175 | 55 | % | ||||||||||||||||||
Net investment income | 89 | 68 | 31 | % | 93 | 64 | 45 | % | 182 | 132 | 38 | % | ||||||||||||||||||||||||
Net realized capital losses | — | (3 | ) | 100 | % | |||||||||||||||||||||||||||||||
Net realized capital gains (losses) | 1 | 1 | — | 1 | (2 | ) | NM | |||||||||||||||||||||||||||||
Total revenues | 1,004 | 667 | 51 | % | 1,000 | 638 | 57 | % | 2,004 | 1,305 | 54 | % | ||||||||||||||||||||||||
Benefits, claims and claim adjustment expenses | 684 | 489 | 40 | % | 690 | 451 | 53 | % | 1,374 | 940 | 46 | % | ||||||||||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 5 | 4 | 25 | % | ||||||||||||||||||||||||||||||||
Amortization of deferred policy acquisition costs | 6 | 5 | 20 | % | 11 | 9 | 22 | % | ||||||||||||||||||||||||||||
Insurance operating costs and other expenses | 252 | 131 | 92 | % | 240 | 138 | 74 | % | 492 | 269 | 83 | % | ||||||||||||||||||||||||
Total benefits, claims and expenses | 941 | 624 | 51 | % | 936 | 594 | 58 | % | 1,877 | 1,218 | 54 | % | ||||||||||||||||||||||||
Income before income taxes | 63 | 43 | 47 | % | 64 | 44 | 45 | % | 127 | 87 | 46 | % | ||||||||||||||||||||||||
Income tax expense | 16 | 9 | 78 | % | 16 | 9 | 78 | % | 32 | 18 | 78 | % | ||||||||||||||||||||||||
Net income | $ | 47 | $ | 34 | 38 | % | $ | 48 | $ | 35 | 37 | % | $ | 95 | $ | 69 | 38 | % | ||||||||||||||||||
Fully insured – ongoing premiums | $ | 905 | $ | 568 | 59 | % | ||||||||||||||||||||||||||||||
Fully insured-ongoing premiums | $ | 897 | $ | 568 | 58 | % | $ | 1,802 | $ | 1,136 | 59 | % | ||||||||||||||||||||||||
Buyout premiums | — | 28 | (100 | %) | — | 1 | (100 | %) | — | 29 | (100 | %) | ||||||||||||||||||||||||
Other | 10 | 6 | 83 | % | 9 | 4 | 125 | % | 19 | 10 | 90 | % | ||||||||||||||||||||||||
Earned premiums and other | $ | 915 | $ | 602 | 52 | % | $ | 906 | $ | 573 | 58 | % | $ | 1,821 | $ | 1,175 | 55 | % | ||||||||||||||||||
28
Net income in the Group Benefits segment increased for the second quarter and six months ended June 30, 2004 as compared to the respective prior year periods due to earned premiumspremium growth and net investment income growth, both in the formerpre-acquisition Group Benefits business as well as the result of the CNA Acquisition. The increase in earned premiums was driven by sales (excluding buyouts) of $341, a 54% increase$104 and $445 for the second quarter and six months ended June 30, 2004, representing increases of 13% and 42%, respectively, over sales reported in the comparable prior year periodperiods, and favorable persistency. Although benefits, claims and claim adjustment expenses increased, the segment’s loss ratio (defined as benefits, claims and claim adjustment
32
expenses as a percentage of premiums and other considerations excluding buyouts) was 75%,76% for both the second quarter and six months ended June 30, 2004, down from 79% and 80% in first quarterfor the comparable periods of 2003, respectively, which contributed favorably to net income. Partially offsetting these favorable items were higher commissions due to higher sales and premiums previously discussed and sales from the CNA Acquisition.discussed. Additionally, operating costs increased due to the growth in the segment and the CNA Acquisition. Consistent with the increase in commissions and operating costs, the segment’s ratio of insurance operating costs and other expenses to premiums and other considerations (excluding buyouts) increased to 27% and 28%, for the second quarter and six months ended June 30, 2004, respectively, from 23% in 2003.25% and 24% for the comparable prior year periods, respectively. As part of the CNA Acquisition, a larger block of affinity business is now included in the Group Benefits segment in 2004.segment. This business 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
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Earned premiums | $ | 2,353 | $ | 2,106 | 12 | % | $ | 4,539 | $ | 4,272 | 6 | % | ||||||||||||
Net investment income | 295 | 286 | 3 | % | 606 | 567 | 7 | % | ||||||||||||||||
Other revenues [1] | 117 | 113 | 4 | % | 221 | 208 | 6 | % | ||||||||||||||||
Net realized capital gains | 27 | 212 | (87 | %) | 98 | 211 | (54 | %) | ||||||||||||||||
Total revenues | 2,792 | 2,717 | 3 | % | 5,464 | 5,258 | 4 | % | ||||||||||||||||
Benefits, claims and claim adjustment expenses | ||||||||||||||||||||||||
Current year | 1,535 | 1,541 | — | 3,004 | 2,978 | 1 | % | |||||||||||||||||
Prior year | 221 | — | — | 170 | 2,724 | (94 | %) | |||||||||||||||||
Total benefits, claims and claim adjustment expenses | 1,756 | 1,541 | 14 | % | 3,174 | 5,702 | (44 | %) | ||||||||||||||||
Amortization of deferred policy acquisition costs and present value of future profits | 468 | 382 | 23 | % | 914 | 783 | 17 | % | ||||||||||||||||
Insurance operating costs and expenses | 142 | 189 | (25 | %) | 308 | 376 | (18 | %) | ||||||||||||||||
Other expenses | 156 | 203 | (23 | %) | 319 | 336 | (5 | %) | ||||||||||||||||
Total benefits, claims and expenses | 2,522 | 2,315 | 9 | % | 4,715 | 7,197 | (34 | %) | ||||||||||||||||
Income (loss) before income taxes | 270 | 402 | (33 | %) | 749 | (1,939 | ) | NM | ||||||||||||||||
Income tax expense (benefit) | 67 | 107 | (37 | %) | 205 | (739 | ) | NM | ||||||||||||||||
Net income (loss) [2] | $ | 203 | $ | 295 | (31 | %) | $ | 544 | $ | (1,200 | ) | NM | ||||||||||||
Ongoing Operations Underwriting Ratios [3] | ||||||||||||||||||||||||
Loss and loss adjustment expense ratio | ||||||||||||||||||||||||
Current year | 65.2 | 68.9 | 3.7 | 65.9 | 69.4 | 3.5 | ||||||||||||||||||
Prior year | 0.7 | — | (0.7 | ) | (1.8 | ) | — | 1.8 | ||||||||||||||||
Total loss and loss adjustment expense ratio | 65.8 | 68.9 | 3.1 | 64.1 | 69.4 | 5.3 | ||||||||||||||||||
Expense ratio | 25.6 | 26.6 | 1.0 | 26.4 | 26.4 | — | ||||||||||||||||||
Policyholder dividend ratio | — | 0.5 | 0.5 | 0.1 | 0.5 | 0.4 | ||||||||||||||||||
Combined ratio | 91.4 | 96.0 | 4.6 | 90.6 | 96.3 | 5.7 | ||||||||||||||||||
Catastrophe ratio | 2.4 | 4.7 | 2.3 | (4.6 | ) | 3.7 | 8.3 | |||||||||||||||||
Combined ratio before catastrophes | 89.0 | 91.3 | 2.3 | 95.2 | 92.6 | (2.6 | ) | |||||||||||||||||
Combined ratio before catastrophes and prior accident year development | 88.5 | 91.3 | 2.8 | 90.5 | 92.6 | 2.1 | ||||||||||||||||||
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 revenues | 2,672 | 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 expenses | 2,193 | 4,882 | (55 | %) | ||||||||
Income (loss) before income taxes | 479 | (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 | |||||||||
[1] | Represents servicing revenue. | |||
[2] | Includes net realized capital gains, | |||
[3] | Excludes Other Operations. |
RevenuesTotal revenues for Property & Casualty increased $131$75 for the firstsecond quarter and $206 for the six months ended March 31, 2004 compared with the first quarter of 2003.June 30, 2004. The increase for both periods was due primarily to an increaseearned premium growth and increased net investment income, which were significantly offset by a decrease in net realized capital gains (losses) and net investment income as well as earned premium growth.gains. The increase in earned premiums for the second quarter and six months ended June 30, 2004 in the Business Insurance, and Personal Lines and Specialty Commercial segments was due primarily to earned pricing increases and new business growth.increases. Partially offsetting the growth in earned premiums was a decrease of $90 in Specialty Commercial earned premiums for the six months ended June 30, 2004 was a $90 decrease reflecting a reduction in estimated earned premium under retrospectively-rated policies.
Net income decreased $92 for the second quarter ended June 30, 2004, primarily due to a $118 after-tax provision related to a reduction in the reinsurance recoverable asset on older, long-term casualty liabilities and a $122 after-tax decrease in net realized capital gains, partially offset by improved underwriting results in the Business Insurance and Personal Lines segments. Net income increased $1.8$1.7 billion for the first quartersix months ended March 31,June 30, 2004 primarily due to the net asbestos reserve strengthening of $1.7 billion, after-tax, in the first quarter ended March 31, 2003. Results for the quarter also were favorably impacted by2003 and improved underwriting results in the Business Insurance and increases in net realized capital gains (losses) and net investment income. Pre-tax net investment income rose $30 for the quarter ending March 31, 2004, due to higher invested assets, primarily from strong cash flows.Personal Lines segments.
2933
Ratios
The previous table and the following segment discussions for the quarterssecond quarter and six months ended March 31,June 30, 2004 and 2003 include various operating ratios. Management believes that these ratios are useful in understanding the underlying trends in The Hartford’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 the Company’s competitors. The “loss and loss adjustment expense ratio” is the ratio of claims and claim adjustment expenses to earned premiums. The “expense ratio” is the ratio of underwriting expenses (amortization of deferred policy acquisition costs, as well as other underwriting expenses) to earned premiums. The “policyholder dividend ratio” is the ratio of policyholder dividends to earned premiums. The “combined ratio” is the sum of the loss and loss adjustment expense ratio, the expense ratio and the policyholder dividend ratio. These ratios are relative measurements that describe for every $100 of netearned premiums, earned, the cost of losses and expenses, respectively. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting losses. The “loss and loss expense paid ratio” represents the ratio of paid claims and claim adjustment expenses to earned premiums. The “catastrophe ratio” (a component of the loss 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 and affects a significant number of property and casualty policyholders and insurers. See the Reserve section for explanation of prior accident year development.
Premium Measures
Written premiums are a non-GAAP financial measure which represent the amount of premiums charged for policies issued, net of reinsurance, during a fiscal period. Earned premiums are 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 the quarters and six months ended March 31,June 30, 2004 and 2003 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 the Company’s sales of property and casualty insurance products, as compared to earned premiums. Premium renewal retention is defined as renewal premium written in the current period divided by total premium written in the prior period.
Reserves
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 that increases previous estimates of ultimate cost is called “reserve strengthening”. Reserve development that decreases previous estimates of ultimate cost is called “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 accident year development” in the following table represents the ratio of reserve development to earned premiums. For a detailed discussion of the Company’s reserve policies, see Notes 1, 7 and 16 of Notes to Consolidated Financial Statements and the Critical Accounting Estimates section of the MD&A included in The Hartford’s 2003 Form 10-K Annual Report.
DuringThere was no significant reserve strengthening or release in the Business Insurance, Personal Lines or Specialty Commercial segments for the quarter ended June 30, 2004. Within Other Operations, the Company completed a gross asbestos reserve evaluation during the first quarter of 2004 which indicated no change in the aggregateoverall required gross asbestos reserves. During the second quarter of 2004, the Company completed an evaluation of the reinsurance recoverable asset associated with older, long-term casualty liabilities reported in the Other Operations segment, including asbestos liabilities. As a result of this evaluation, the Company reduced its net reserve development relative toreinsurance recoverable by $181. The after-tax income effect of this action was $118.
For the Company’s Property & Casualty reserves was not material. Thesix months ended June 30, 2004, 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, in the first quarter of 2004, 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. NetAs of June 30, 2004, gross reserves and net reserves remaining are $152.related to September 11 were $423 and $149, respectively. 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 2004 study that used various predictive models and reflected the increasing severity of
34
construction defect claims, the Company concluded an increase in reserves of $190 was required.required during the first quarter. 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.$130 in the first quarter. 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 firstsecond quarter and six months ended March 31,June 30, 2004 for Property & Casualty follows:
First Quarter Ended March 31, 2004 | ||||||||||||||||||||||||||||||||||||||||||||||||
Second Quarter Ended June 30, 2004 | Second Quarter Ended June 30, 2004 | |||||||||||||||||||||||||||||||||||||||||||||||
Business Insurance | Personal Lines | Specialty Commercial | Ongoing Operations | Other Operations | Total P&C | 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 | $ | 5,302 | $ | 1,721 | $ | 5,066 | $ | 12,089 | $ | 8,157 | $ | 20,246 | ||||||||||||||||||||||||
Reinsurance and other recoverables | 395 | 43 | 2,096 | 2,534 | 2,963 | 5,497 | 369 | 42 | 1,932 | 2,343 | 2,693 | 5,036 | ||||||||||||||||||||||||||||||||||||
Beginning liabilities for unpaid claims and claim adjustment expenses-net | 4,901 | 1,690 | 3,052 | 9,643 | 6,575 | 16,218 | 4,933 | 1,679 | 3,134 | 9,746 | 5,464 | 15,210 | ||||||||||||||||||||||||||||||||||||
Add provision for unpaid claims and claim adjustment expenses | ||||||||||||||||||||||||||||||||||||||||||||||||
Current year | 626 | 533 | 293 | 1,452 | 17 | 1,469 | 634 | 588 | 302 | 1,524 | 11 | 1,535 | ||||||||||||||||||||||||||||||||||||
Prior year [1] | (147 | ) | 1 | 47 | (99 | ) | 48 | (51 | ) | 9 | 4 | 3 | 16 | 205 | 221 | |||||||||||||||||||||||||||||||||
Total provision for unpaid claims and claim adjustment expenses | 479 | 534 | 340 | 1,353 | 65 | 1,418 | 643 | 592 | 305 | 1,540 | 216 | 1,756 | ||||||||||||||||||||||||||||||||||||
Less payments [2] | (447 | ) | (545 | ) | (258 | ) | (1,250 | ) | (1,176 | ) | (2,426 | ) | ||||||||||||||||||||||||||||||||||||
Less payments | (499 | ) | (544 | ) | (199 | ) | (1,242 | ) | (231 | ) | (1,473 | ) | ||||||||||||||||||||||||||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-net [1] | 4,933 | 1,679 | 3,134 | 9,746 | 5,464 | 15,210 | ||||||||||||||||||||||||||||||||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-net | 5,077 | 1,727 | 3,240 | 10,044 | 5,449 | 15,493 | ||||||||||||||||||||||||||||||||||||||||||
Reinsurance and other recoverables | 369 | 42 | 1,932 | 2,343 | 2,693 | 5,036 | 366 | 42 | 2,150 | 2,558 | 2,511 | 5,069 | ||||||||||||||||||||||||||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-gross [1] | $ | 5,302 | $ | 1,721 | $ | 5,066 | $ | 12,089 | $ | 8,157 | $ | 20,246 | ||||||||||||||||||||||||||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-gross | $ | 5,443 | $ | 1,769 | $ | 5,390 | $ | 12,602 | $ | 7,960 | $ | 20,562 | ||||||||||||||||||||||||||||||||||||
Earned premiums | $ | 1,018 | $ | 835 | $ | 321 | $ | 2,174 | $ | 12 | $ | 2,186 | $ | 1,061 | $ | 861 | $ | 417 | $ | 2,339 | $ | 14 | $ | 2,353 | ||||||||||||||||||||||||
Loss and loss expense paid ratio | 43.9 | 65.4 | 80.5 | 57.6 | 46.9 | 63.0 | 48.5 | 53.1 | ||||||||||||||||||||||||||||||||||||||||
Loss and loss expense incurred ratio | 47.1 | 64.1 | 105.2 | 62.2 | 60.4 | 68.6 | 73.8 | 65.8 | ||||||||||||||||||||||||||||||||||||||||
Prior accident year development (pts.) | (14.5 | ) | 0.1 | 14.9 | (4.5 | ) | 0.8 | 0.5 | 0.6 | 0.7 | ||||||||||||||||||||||||||||||||||||||
[1] | The |
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Six Months Ended June 30, 2004
Business | Personal | Specialty | Ongoing | Other | ||||||||||||||||||||
Insurance | Lines | Commercial | Operations | Operations [3] | 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-net | 4,901 | 1,690 | 3,052 | 9,643 | 6,575 | 16,218 | ||||||||||||||||||
Add provision for unpaid claims and claim adjustment expenses | ||||||||||||||||||||||||
Current year | 1,260 | 1,121 | 595 | 2,976 | 28 | 3,004 | ||||||||||||||||||
Prior year [1] | (138 | ) | 5 | 50 | (83 | ) | 253 | 170 | ||||||||||||||||
Total provision for unpaid claims and claim adjustment expenses | 1,122 | 1,126 | 645 | 2,893 | 281 | 3,174 | ||||||||||||||||||
Less payments [2] | (946 | ) | (1,089 | ) | (457 | ) | (2,492 | ) | (1,407 | ) | (3,899 | ) | ||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-net [1] | 5,077 | 1,727 | 3,240 | 10,044 | 5,449 | 15,493 | ||||||||||||||||||
Reinsurance and other recoverables | 366 | 42 | 2,150 | 2,558 | 2,511 | 5,069 | ||||||||||||||||||
Ending liabilities for unpaid claims and claim adjustment expenses-gross [1] | $ | 5,443 | $ | 1,769 | $ | 5,390 | $ | 12,602 | $ | 7,960 | $ | 20,562 | ||||||||||||
[1] | ||||||||||||||||||||||||
Earned premiums | $ | 2,079 | $ | 1,696 | $ | 738 | $ | 4,513 | $ | 26 | $ | 4,539 | ||||||||||||
Loss and loss expense paid ratio | 45.4 | 64.2 | 62.4 | 55.3 | ||||||||||||||||||||
Loss and loss expense incurred ratio | 53.9 | 66.4 | 87.5 | 64.1 | ||||||||||||||||||||
Prior accident year development (pts.) | (6.7 | ) | 0.3 | 6.8 | (1.8 | ) | ||||||||||||||||||
[1] | The six months ended June 30, 2004 included a $181 provision associated with the evaluation of the reinsurance recoverable asset. The six month period also included a net reserve release related to September 11 of $175 in 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, and offsetting strengthening in large deductible workers compensation reserves and release in other liability reserves, each approximately $150. | |||
[2] | Other Operations reflects payments pursuant to the MacArthur settlement. | |||
[3] | Effective January 1, 2004, the financial results of the Company’s Reinsurance segment are reported in Other Operations and 2004 beginning liabilities have been reclassified to reflect this change. |
Reinsurance Recoverables
The Company’s net reinsurance recoverables from various property and casualty reinsurance arrangements amounted to $5.2$5.0 billion and $5.4 billion at March 31,June 30, 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.
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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 unrecoverableuncollectible reinsurance was $348$397 and $381 at March 31,June 30, 2004 and December 31, 2003, respectively. The allowance for unrecoverableuncollectible 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.
InDuring the second quarter of 2004, the Company expects to completecompleted an updated studyevaluation 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 $146 reflecting new business growth of 11% and written pricing increases of 4%. Premium renewal retention was 84% and 90% for the first quarter ending March 31, 2004 and 2003, respectively. Small commercial and middle market written premiums increased $80 and $66, respectively, asAs a result of new business growththis evaluation, the Company reduced its net reinsurance recoverable by $181. The after-tax income effect of this action was $118. The $181 primarily relates to a reduction of the amount of liabilities, principally asbestos, that it expects to cede to reinsurers and, written pricing increases. Premium renewal retention remains strongto a lesser extent, an increase in both small commercial and middle market.the allowance for uncollectible reinsurance recoverables.
36
Business Insurance
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Underwriting Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Written premiums | $ | 1,134 | $ | 974 | 16 | % | $ | 2,270 | $ | 1,964 | 16 | % | ||||||||||||
Change in unearned premium reserve | 73 | 77 | (5 | %) | 191 | 187 | 2 | % | ||||||||||||||||
Earned premiums | 1,061 | 897 | 18 | % | 2,079 | 1,777 | 17 | % | ||||||||||||||||
Benefits, claims and claim adjustment expenses | ||||||||||||||||||||||||
Current year | 634 | 561 | 13 | % | 1,260 | 1,159 | 9 | % | ||||||||||||||||
Prior year | 9 | — | NM | (138 | ) | — | NM | |||||||||||||||||
Total benefits, claims and claim adjustment expenses | 643 | 561 | 15 | % | 1,122 | 1,159 | (3 | %) | ||||||||||||||||
Amortization of deferred policy acquisition costs | 261 | 214 | 22 | % | 516 | 418 | 23 | % | ||||||||||||||||
Insurance operating costs and expenses | 60 | 72 | (17 | %) | 119 | 143 | (17 | %) | ||||||||||||||||
Underwriting results | $ | 97 | $ | 50 | 94 | % | $ | 322 | $ | 57 | NM | |||||||||||||
Loss and loss adjustment expense ratio | ||||||||||||||||||||||||
Current year | 59.6 | 62.6 | 3.0 | 60.6 | 65.2 | 4.6 | ||||||||||||||||||
Prior year | 0.8 | — | (0.8 | ) | (6.7 | ) | — | 6.7 | ||||||||||||||||
Total loss and loss adjustment expense ratio | 60.4 | 62.6 | 2.2 | 53.9 | 65.2 | 11.3 | ||||||||||||||||||
Expense ratio | 30.0 | 31.0 | 1.0 | 30.2 | 30.8 | 0.6 | ||||||||||||||||||
Policyholder dividend ratio | 0.4 | 0.8 | 0.4 | 0.4 | 0.8 | 0.4 | ||||||||||||||||||
Combined ratio | 90.8 | 94.4 | 3.6 | 84.5 | 96.8 | 12.3 | ||||||||||||||||||
Catastrophe ratio | 1.7 | 2.5 | 0.8 | (6.7 | ) | 3.5 | 10.2 | |||||||||||||||||
Combined ratio before catastrophes | 89.1 | 91.9 | 2.8 | 91.2 | 93.3 | 2.1 | ||||||||||||||||||
Combined ratio before catastrophes and prior accident year development | 88.3 | 91.9 | 3.6 | 89.3 | 93.3 | 4.0 | ||||||||||||||||||
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
2004 | 2003 | Change | 2004 | 2003 | Change | |||||||||||||||||||
Written Premiums [1] | ||||||||||||||||||||||||
Small Commercial | $ | 577 | $ | 459 | 26 | % | $ | 1,137 | $ | 939 | 21 | % | ||||||||||||
Middle Market | 557 | 515 | 8 | % | 1,133 | 1,025 | 11 | % | ||||||||||||||||
Total | $ | 1,134 | $ | 974 | 16 | % | $ | 2,270 | $ | 1,964 | 16 | % | ||||||||||||
Earned Premiums [1] | ||||||||||||||||||||||||
Small Commercial | $ | 521 | $ | 442 | 18 | % | $ | 1,002 | $ | 872 | 15 | % | ||||||||||||
Middle Market | 540 | 455 | 19 | % | 1,077 | 905 | 19 | % | ||||||||||||||||
Total | $ | 1,061 | $ | 897 | 18 | % | $ | 2,079 | $ | 1,777 | 17 | % | ||||||||||||
[1] | The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve. |
Earned premiums for the segment increased $138$164 for the second quarter and $302 for the six month period due to strongearned pricing increases and new business growth outpacing non-renewals during the last six months of 2003 and first six months of 2004. During the second quarter and six month periods ended June 30, 2004, writtenrespectively, earned pricing increases. Earned premiums increased $87increases of 8% for small commercial and $515% to 6% for middle market contributed to earned premium growth of $79 and $130 in small commercial respectively, reflecting strongand $85 and $172 in middle market.
As substantially all premiums in the segment are earned over a 12 month policy period, earned pricing increases.in the second quarter and six month period was primarily driven by written pricing increases of 8% to 11% in the last six months of 2003 and 3% to 4% in the first six months of 2004. New business premium in the second quarter and six month period ended June 30, 2004 was $275 and $565, respectively, which was up from $262 and $523, respectively, for the comparable periods of the prior year.
Premium renewal retention, which includes the impact of written pricing increases, decreased from 89% in the second quarter of 2003 to 85% in the second quarter of 2004 and decreased from 89% in the first six months of 2003 to 85% in the first six months of 2004. The moderation in written pricing increases from 2003 to 2004 contributed to the decrease in premium renewal retention.
Underwriting results improved $218,$47, with a corresponding 21.33.6 point decrease in the combined ratio, for the firstsecond quarter ended March 31,June 30, 2004. The improvement was driven bydue primarily to earned pricing increases and improved claim frequency versus that of the same prior year period. Underwriting results improved $265, with a corresponding 12.3 point decrease in the loss and loss adjustment expensecombined ratio, for the six months ended June 30, 2004. The improvement was 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 14.97.3 points of the 14.5 pointcombined ratio favorable development in prior year losses.development. The catastrophe ratio includes 17.28.4 points of favorable development related to the $175 decrease in September 11 reserves. Before this favorable
3237
Before this favorable impact, catastrophe losses infor the first quarter ofsix months ended June 30, 2004 decreased by 2.81.8 points from the same period in the prior year. Before catastrophes and all prior accident year development, underwriting results improved $52 and $103 with a corresponding 4.33.6 point decreaseand 4.0 point decreases in the combined ratio.ratios for the second quarter and six months ended June 30, 2004, respectively. The improvement in both periods was drivenprimarily due to improved claim frequency, partially offset by increased severity, and to earned pricing increases which drove a decrease in the loss and loss adjustment expense ratio for both small commercial and middle market, primarily due to improved frequency of loss and earned pricing increases.market.
Personal Lines
Underwriting Summary
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||||||
2004 | 2003 | Change | ||||||||||||||||||||||||||||||||||
Underwriting Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||
Written premiums | $ | 836 | $ | 770 | 9 | % | $ | 945 | $ | 854 | 11 | % | $ | 1,781 | $ | 1,624 | 10 | % | ||||||||||||||||||
Change in unearned premium reserve | 1 | (2 | ) | NM | 84 | 69 | 22 | % | 85 | 67 | 27 | % | ||||||||||||||||||||||||
Earned premiums | $ | 835 | $ | 772 | 8 | % | 861 | 785 | 10 | % | 1,696 | 1,557 | 9 | % | ||||||||||||||||||||||
Benefits, claims and claim adjustment expenses | ||||||||||||||||||||||||||||||||||||
Current year | 533 | 540 | (1 | %) | 588 | 602 | (2 | %) | 1,121 | 1,142 | (2 | %) | ||||||||||||||||||||||||
Prior year | 1 | — | — | 4 | — | — | 5 | — | — | |||||||||||||||||||||||||||
Total benefits, claims and claim adjustment expenses | 534 | 540 | (1 | %) | 592 | 602 | (2 | %) | 1,126 | 1,142 | (1 | %) | ||||||||||||||||||||||||
Amortization of deferred policy acquisition costs | 125 | 104 | 20 | % | 138 | 100 | 38 | % | 263 | 204 | 29 | % | ||||||||||||||||||||||||
Insurance operating costs and expenses | 70 | 72 | (3 | %) | 56 | 75 | (25 | %) | 126 | 147 | (14 | %) | ||||||||||||||||||||||||
Underwriting results | $ | 106 | $ | 56 | 89 | % | $ | 75 | $ | 8 | NM | $ | 181 | $ | 64 | 183 | % | |||||||||||||||||||
Loss and loss adjustment expense ratio | ||||||||||||||||||||||||||||||||||||
Current year | 64.0 | 69.7 | 5.7 | 68.1 | 76.8 | 8.7 | 66.1 | 73.3 | 7.2 | |||||||||||||||||||||||||||
Prior year | 0.1 | — | (0.1 | ) | 0.5 | — | (0.5 | ) | 0.3 | — | (0.3 | ) | ||||||||||||||||||||||||
Total loss and loss adjustment expense ratio | 64.1 | 69.7 | 5.6 | 68.6 | 76.8 | 8.2 | 66.4 | 73.3 | 6.9 | |||||||||||||||||||||||||||
Expense ratio | 23.3 | 23.0 | (0.3 | ) | 22.6 | 22.2 | (0.4 | ) | 22.9 | 22.6 | (0.3 | ) | ||||||||||||||||||||||||
Combined ratio | 87.4 | 92.7 | 5.3 | 91.3 | 99.0 | 7.7 | 89.4 | 95.9 | 6.5 | |||||||||||||||||||||||||||
Catastrophe ratio | 0.8 | 1.4 | 0.6 | 3.7 | 8.2 | 4.5 | 2.2 | 4.8 | 2.6 | |||||||||||||||||||||||||||
Combined ratio before catastrophes | 86.6 | 91.3 | 4.7 | 87.6 | 90.8 | 3.2 | 87.1 | 91.1 | 4.0 | |||||||||||||||||||||||||||
Combined ratio before catastrophes and prior accident year development | 86.1 | 91.3 | 5.2 | 87.2 | 90.8 | 3.6 | 86.6 | 91.1 | 4.5 | |||||||||||||||||||||||||||
Other revenues [1] | $ | 29 | $ | 28 | 4 | % | $ | 35 | $ | 32 | 9 | % | $ | 64 | $ | 60 | 7 | % | ||||||||||||||||||
[1] Represents servicing revenue.
Premium Breakdown
[1] | Represents servicing revenues. |
Written Premiums [1] | Earned Premiums [1] | Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||||||||||||||||||||||||
First Quarter Ended | First Quarter Ended | June 30, | June 30, | |||||||||||||||||||||||||||||||||||||||||||||
March 31, | March 31, | |||||||||||||||||||||||||||||||||||||||||||||||
2004 | 2003 | Change | 2004 | 2003 | Change | |||||||||||||||||||||||||||||||||||||||||||
Written Premiums [1] | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||||||||||||||
Business Unit | ||||||||||||||||||||||||||||||||||||||||||||||||
AARP | $ | 523 | $ | 475 | 10 | % | $ | 520 | $ | 466 | 12 | % | $ | 604 | $ | 550 | 10 | % | $ | 1,127 | $ | 1,025 | 10 | % | ||||||||||||||||||||||||
Other Affinity | 34 | 42 | (19 | %) | 36 | 44 | (18 | %) | 33 | 36 | (8 | %) | 67 | 78 | (14 | %) | ||||||||||||||||||||||||||||||||
Agency | 210 | 186 | 13 | % | 215 | 199 | 8 | % | 243 | 201 | 21 | % | 453 | 387 | 17 | % | ||||||||||||||||||||||||||||||||
Omni | 69 | 67 | 3 | % | 64 | 63 | 2 | % | 65 | 67 | (3 | %) | 134 | 134 | — | |||||||||||||||||||||||||||||||||
Total | $ | 836 | $ | 770 | 9 | % | $ | 835 | $ | 772 | 8 | % | $ | 945 | $ | 854 | 11 | % | $ | 1,781 | $ | 1,624 | 10 | % | ||||||||||||||||||||||||
Product Line | ||||||||||||||||||||||||||||||||||||||||||||||||
Automobile | $ | 649 | $ | 609 | 7 | % | $ | 633 | $ | 598 | 6 | % | $ | 706 | $ | 656 | 8 | % | $ | 1,355 | $ | 1,265 | 7 | % | ||||||||||||||||||||||||
Homeowners | 187 | 161 | 16 | % | 202 | 174 | 16 | % | 239 | 198 | 21 | % | 426 | 359 | 19 | % | ||||||||||||||||||||||||||||||||
Total | $ | 836 | $ | 770 | 9 | % | $ | 835 | $ | 772 | 8 | % | $ | 945 | $ | 854 | 11 | % | $ | 1,781 | $ | 1,624 | 10 | % | ||||||||||||||||||||||||
Combined Ratios | ||||||||||||||||||||||||||||||||||||||||||||||||
Automobile | 90.1 | 96.1 | 6.0 | |||||||||||||||||||||||||||||||||||||||||||||
Homeowners | 78.7 | 80.8 | 2.1 | |||||||||||||||||||||||||||||||||||||||||||||
Total | 87.4 | 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 due to growth in both the automobile and homeowners lines. The increase in automobile of $40 was due to strong new business growth and written pricing increases of 4%. Automobile premium renewal retention was 88% and 90% for the first quarter ending March 31, 2004 and 2003, respectively. Homeowners growth of $26 was also largely driven by increased new business and written pricing increases of 10%. Homeowners premium renewal retention was 101% and 103% for the first quarter ending March 31, 2004 and 2003, respectively. The increases in both automobile and homeowners written premiums were primarily due to growth in the AARP program and the agency business unit. AARP increased $48 and agency 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 the
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Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
2004 | 2003 | Change | 2004 | 2003 | Change | |||||||||||||||||||
Earned Premiums [1] | ||||||||||||||||||||||||
Business Unit | ||||||||||||||||||||||||
AARP | $ | 536 | $ | 481 | 11 | % | $ | 1,056 | $ | 947 | 12 | % | ||||||||||||
Other Affinity | 35 | 41 | (15 | %) | 71 | 85 | (16 | %) | ||||||||||||||||
Agency | 225 | 198 | 14 | % | 440 | 397 | 11 | % | ||||||||||||||||
Omni | 65 | 65 | — | 129 | 128 | 1 | % | |||||||||||||||||
Total | $ | 861 | $ | 785 | 10 | % | $ | 1,696 | $ | 1,557 | 9 | % | ||||||||||||
Product Line | ||||||||||||||||||||||||
Automobile | $ | 653 | $ | 610 | 7 | % | $ | 1,286 | $ | 1,208 | 6 | % | ||||||||||||
Homeowners | 208 | 175 | 19 | % | 410 | 349 | 17 | % | ||||||||||||||||
Total | $ | 861 | $ | 785 | 10 | % | $ | 1,696 | $ | 1,557 | 9 | % | ||||||||||||
Combined Ratios | ||||||||||||||||||||||||
Automobile | 95.2 | 98.0 | 2.8 | 92.7 | 97.0 | 4.3 | ||||||||||||||||||
Homeowners | 79.0 | 102.9 | 23.9 | 78.9 | 91.9 | 13.0 | ||||||||||||||||||
Total | 91.3 | 99.0 | 7.7 | 89.4 | 95.9 | 6.5 | ||||||||||||||||||
increase in written premiums for the Personal Lines segment was a $8 decrease in written premiums in other affinity due to an expected reduction in policy counts.
[1] | The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve. |
Earned premiums increased $63$76 for the second quarter and $139 for the six months ended June 30, 2004 due primarily to growth in AARP.AARP and agency. AARP increased $54$55 for the second quarter and $109 for the six months ended June 30, 2004 and agency increased $27 for the second quarter and $43 for the six month period primarily as a result of earned pricing increases and because new business growth over the prior 6 to 12 months has exceeded non-renewals. Both AARP and Agency have experienced increased earned premiums in both automobile and homeowners business.
Earned pricing increases in automobile of 6% in both the second quarter and six month period ended June 30, 2004 primarily reflect written pricing increases of 5% to 7% in the last 6 months of 2003 and 4% in the first six months of 2004. Earned pricing increases of 12% in homeowners for the second quarter and six month period ended June 30, 2004 primarily reflect written pricing increases of 11% to 14% in the last 6 months of 2003 and 9% in the first 6 months of 2004. During the second quarter and six months ended June 30, 2004, there was an increase in new business premiums for both automobile and homeowners. Automobile new business premiums were $127 and $241 for the second quarter and six month period ended June 30, 2004 respectively, and homeowners new business premiums were $31 and $53, respectively.
Premium renewal retention for automobile, which includes the impact of written pricing increases, decreased from a range of 93% to 94% in the second quarter and first six months of 2003 to 88% in the second quarter and first six months of 2004. For homeowners, premium renewal retention decreased less significantly, from 103% in the second quarter and first six months of 2003 to 101% in the second quarter and first six months of 2004. The decrease in premium renewal retention for both automobile and homeowners is driven largely by the impact of declining written pricing increases.
Underwriting results increased $50,$67 for the second quarter and $117 for the six months ended June 30, 2004, with a corresponding 5.37.7 point and 6.5 point decrease in the combined ratio.ratio, respectively. Pre-tax catastrophes decreased $32, or 4.5 points, for the second quarter and $37, or 2.6 points, for the six month period. Automobile results improved 6.02.8 combined ratio points for the second quarter and 4.3 combined ratio points for the six months ended June 30, 2004 due to earned pricing increases.increases and favorable claim frequency, offset by an increase in claim severity. The underwriting experience related to homeowners continued to remain favorable and improved 2.123.9 combined ratio points overfor the prior yearsecond quarter and 13.0 combined ratio points for the six month period due primarily to double-digit earned pricing increases, decreased catastrophes and favorable loss frequency.
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 change in unearned premium reserve.
Specialty Commercial written premiums increased $20, drivenclaim frequency, offset by an increase in claim severity.
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Specialty Commercial
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
Underwriting Summary | 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Written premiums | $ | 473 | $ | 399 | 19 | % | $ | 899 | $ | 805 | 12 | % | ||||||||||||
Change in unearned premium reserve | 56 | 44 | 27 | % | 161 | 95 | 69 | % | ||||||||||||||||
Earned premiums | 417 | 355 | 17 | % | 738 | 710 | 4 | % | ||||||||||||||||
Benefits, claims and claim adjustment expenses | ||||||||||||||||||||||||
Current year | 302 | 240 | 26 | % | 595 | 505 | 18 | % | ||||||||||||||||
Prior year | 3 | — | — | 50 | — | — | ||||||||||||||||||
Total benefits, claims and claim adjustment expenses | 305 | 240 | 27 | % | 645 | 505 | 28 | % | ||||||||||||||||
Amortization of deferred policy acquisition costs | 63 | 55 | 15 | % | 124 | 111 | 12 | % | ||||||||||||||||
Insurance operating costs and expenses | 20 | 35 | (43 | %) | 50 | 64 | (22 | %) | ||||||||||||||||
Underwriting results | $ | 29 | $ | 25 | 16 | % | $ | (81 | ) | $ | 30 | NM | ||||||||||||
Loss and loss adjustment expense ratio | ||||||||||||||||||||||||
Current year | 73.2 | 67.2 | (6.0 | ) | 80.6 | 71.1 | (9.5 | ) | ||||||||||||||||
Prior year | 0.6 | — | (0.6 | ) | 6.8 | — | (6.8 | ) | ||||||||||||||||
Total loss and loss adjustment expense ratio | 73.8 | 67.2 | (6.6 | ) | 87.5 | 71.1 | (16.4 | ) | ||||||||||||||||
Expense ratio | 20.4 | 25.3 | 4.9 | 23.8 | 23.9 | 0.1 | ||||||||||||||||||
Policyholder dividend ratio | (1.2 | ) | 0.7 | 1.9 | (0.3 | ) | 0.7 | 1.0 | ||||||||||||||||
Combined ratio | 93.1 | 93.2 | 0.1 | 110.9 | 95.8 | (15.1 | ) | |||||||||||||||||
Catastrophe ratio | 1.6 | 2.5 | 0.9 | (14.5 | ) | 1.7 | 16.2 | |||||||||||||||||
Combined ratio before catastrophes | 91.5 | 90.7 | (0.8 | ) | 125.4 | 94.1 | (31.3 | ) | ||||||||||||||||
Combined ratio before catastrophes and prior accident year development | 91.7 | 90.7 | (1.0 | ) | 102.9 | 94.1 | (8.8 | ) | ||||||||||||||||
Other revenues [1] | $ | 83 | $ | 81 | 2 | % | $ | 157 | $ | 148 | 6 | % | ||||||||||||
[1] | Represents servicing revenues. |
Second Quarter Ended | Six Months Ended | |||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||
| 2004 | 2003 | Change | 2004 | 2003 | Change | ||||||||||||||||||
Written Premiums [1] | ||||||||||||||||||||||||
Property | $ | 122 | $ | 116 | 5 | % | $ | 205 | $ | 213 | (4 | %) | ||||||||||||
Casualty | 182 | 149 | 22 | % | 374 | 336 | 11 | % | ||||||||||||||||
Bond | �� | 50 | 36 | 39 | % | 98 | 81 | 21 | % | |||||||||||||||
Professional Liability | 85 | 78 | 9 | % | 163 | 143 | 14 | % | ||||||||||||||||
Other | 34 | 20 | 70 | % | 59 | 32 | 84 | % | ||||||||||||||||
Total | $ | 473 | $ | 399 | 19 | % | $ | 899 | $ | 805 | 12 | % | ||||||||||||
Earned Premiums [1] | ||||||||||||||||||||||||
Property | $ | 99 | $ | 96 | 3 | % | $ | 186 | $ | 185 | 1 | % | ||||||||||||
Casualty | 163 | 141 | 16 | % | 244 | 289 | (16 | %) | ||||||||||||||||
Bond | 49 | 35 | 40 | % | 93 | 77 | 21 | % | ||||||||||||||||
Professional Liability | 82 | 72 | 14 | % | 164 | 136 | 21 | % | ||||||||||||||||
Other | 24 | 11 | 118 | % | 51 | 23 | 122 | % | ||||||||||||||||
Total | $ | 417 | $ | 355 | 17 | % | $ | 738 | $ | 710 | 4 | % | ||||||||||||
[1] | The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve. |
Earned premiums for the Specialty Commercial segment grew $62 and $28, respectively, for the second quarter and six month period ended June 30, 2004 due primarily to earned pricing increases, offset by a decline in new business premium and renewal retention over the comparable periods of the prior year. The increase in earned premium for the six month period is also offset by a $90 reduction in premiums receivable under retrospectively-rated policies, reflecting a decrease in estimated earned premium under the terms of these policies. As substantially all premiums in the segment are earned over a 12 month policy period, the earned pricing increases resulted from written pricing increases over the prior 12 months. All lines within Specialty Commercial except property experienced earned pricing increases in the six months ended June 30, 2004.
Written pricing during the six months ended June 30, 2004 has continued to be positive for casualty and bond, but has decreased for property and professional liability. While market conditions are still favorable, property and professional liability experienced written pricing decreases in the mid-single digits, which contributed to a business decision to write less new business and non-renew more premium in those lines. Casualty experienced single-digit written pricing increases, partially offset by a reductiondecreases in new business growth and premium renewal retentionretention. Casualty written premiums were up $33 in property. The increasethe second quarter and $38 in the six months ended June 30, 2004, primarily because of written premium growth in alternative markets business. In professional liability, despite the decrease in written premiumspricing, new business and renewal retention, written premium is up for professional liability is primarilyboth the second quarter and six month period ended June 30, 2004 due to a decrease in the portion of risks ceded to reinsurers, offset in part by a decrease inreinsurers. Within the
40
“other” category, 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, writtenearned premiums increased due to increased premiums on internal reinsurance arrangements.
Premiums receivable under retrospectively-rated policies were reduced by $90, reflecting a decreaseUnderwriting results improved $4 for the second quarter ended June 30, 2004 as improvements 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 andbond, professional liability lines of business as a result of strong earned pricing increases.
and property were offset by deterioration in casualty. Underwriting results decreased $115$111 for the first quarter as compared with the same prior year period,six months ended June 30, 2004 primarily 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$50 for the first quartersix months ended June 30, 2004 included $167 of reserve strengthening for
34
construction defect claims, a release of $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 the earned premium adjustment on retrospectively-rated policies caused a 34.715.6 point increase in the total loss and loss expense ratio, and a 41.118.1 point increase in the combined ratio.ratio for the six months ended June 30, 2004. Before considering the $116 release in September 11 reserves, the catastrophe ratio was 0.61.1 points for the six months ended June 30, 2004, which is down slightly from the prior year period.
Before catastrophes, all prior accident year accident development, and the earned premium adjustment on retrospectively-rated policies, underwriting results improved $24$26 with a corresponding 5.82.4 point decrease in the combined ratio for the six months ended June 30, 2004, primarily due to underwriting improvement over the prior year period in the casualty and professional liability linesline of business.
Other Operations (Including Asbestos and Environmental Claims)
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||||||||||||||
Operating Summary | 2004 | 2003 | Change | |||||||||||||||||||||||||||||||||
2004 | 2003 | Change | 2004 | 2003 | Change | |||||||||||||||||||||||||||||||
Written premiums | $ | (1 | ) | $ | 281 | NM | $ | (4 | ) | $ | (93 | ) | 96 | % | $ | (5 | ) | $ | 188 | NM | ||||||||||||||||
Change in unearned premium reserve | (13 | ) | 122 | NM | (18 | ) | (162 | ) | 89 | % | (31 | ) | (40 | ) | 23 | % | ||||||||||||||||||||
Earned premiums | 12 | 159 | (92 | %) | 14 | 69 | (80 | %) | 26 | 228 | (89 | %) | ||||||||||||||||||||||||
Benefits, claims and claim adjustment expenses | ||||||||||||||||||||||||||||||||||||
Current year | 17 | 101 | (83 | %) | 11 | 71 | (85 | %) | 28 | 172 | (84 | %) | ||||||||||||||||||||||||
Prior year | 48 | 2,657 | (98 | %) | 205 | 67 | NM | 253 | 2,724 | (91 | %) | |||||||||||||||||||||||||
Total benefits, claims and claim adjustment expenses | 65 | 2,758 | (98 | %) | 216 | 138 | 57 | % | 281 | 2,896 | (90 | %) | ||||||||||||||||||||||||
Amortization of deferred policy acquisition costs | 5 | 37 | (95 | %) | 6 | 13 | (54 | %) | 11 | 50 | (78 | %) | ||||||||||||||||||||||||
Insurance operating costs and expenses | 7 | 15 | (33 | %) | 6 | 7 | (14 | %) | 13 | 22 | (41 | %) | ||||||||||||||||||||||||
Underwriting results | $ | (65 | ) | $ | (2,651 | ) | 98 | % | $ | (214 | ) | $ | (89 | ) | (140 | %) | $ | (279 | ) | $ | (2,740 | ) | 90 | % | ||||||||||||
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.
TheEarned premiums continue to decline in written and earned premiums in the first quarter was due toOther Operations as a result of the Company’s decision to exit from the assumed domestic reinsurance business in Maythe second quarter of 2003. The Company entered into a quota share and purchase agreement withnegative written premiums in the second quarter of 2003 were primarily driven by the retrocession, as of April 1, 2003, to Endurance Reinsurance Corporation of America (“Endurance”), whereby the majorityof most of the Company’s inforce book of business was retroceded as of April 1, 2003domestic reinsurance. The negative written premiums in the second quarter and six months ended June 30, 2004 are primarily related to Endurance. Underassumed commutation activities and other premium adjustments.
Underwriting results decreased $125 for the quota share agreement, Endurance reinsured mostsecond quarter ended June 30, 2004 due to the $181 provision upon completion of the assumedevaluation of the reinsurance contracts that were written byrecoverable asset associated with older, long-term casualty liabilities reported in Other Operations, including asbestos liabilities. Partially offsetting this decrease in underwriting results from the Company on or after January 1, 2002 and that had unearned premium assecond quarter ended June 30, 2003 was a decrease of April 1, 2003. The Company remains subject$43 in all other prior accident year development.
Underwriting results increased $2.5 billion for the six months ended June 30, 2004, primarily due to ongoing reserve development relating to all retained business.
The underwriting loss in 2003 reflectsthe impact of $2.6 billion of asbestos reserve strengthening. As indicatedstrengthening in the Company’s first quarter 2003, which was partially offset by the $181 provision associated with the evaluation of the reinsurance recoverable asset in the second quarter 2004, as well as the strengthening of assumed reinsurance reserves discussion, for Other Operations,of $130, offset by a reduction in September 11 net reserves were reduced byof $97 and assumed reinsurance reserves, primarily for casualty business written during the 1997 – 2001 period and certain alternative risk transfer contracts, were increased by $130.
On December 19, 2003, Hartford 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, duringin the first quarter of 2004, 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 as a reduction in unpaid claim and claim adjustment expenses during the first quarter of 2004. Because the escrow funds would have reverted back to The Hartford’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 are paid into the trust.
Asbestos and Environmental Claims
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. The degree of variability of reserve estimates for these exposures is significantly greater than for other more traditional exposures. In particular, Thethe Company 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. Furthermore, insurers in general, including the Company, have recently experienced an increase in the number of asbestos-related claims due to, among other things, plaintiffs’
35
increased focus on new and previously peripheral defendants, and an increase in the number of insureds seeking bankruptcy
41
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 asserted new classes of claims for so-called “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 whether some policyholders’ liabilities will reach the umbrella or excess layers 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; insolvencies of other carriers; 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 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 whether potential Federal asbestos-related legislation will be enacted and, if so, what its effect will be on The Hartford’s aggregate asbestos liabilities.
The 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 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.sought.
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 other kinds of insurance exposure are less precise in estimating reserves for its asbestos and environmental exposures. For this reason, the Company relies on an exposure basedexposure-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” 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 within each category of 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. The “all other” category of reserves covers a wide range of insurance and reinsurance coverages, including potential liability for breast implants, blood products, construction defects, lead paint, silica, pharmaceutical products and other long-tail liabilities.
The Other Operations book of business contains policies written from the 1940’s to 2003. The Hartford’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 (“whole account” exposure). Many of these whole account exposures arise from reinsurance agreements previously written by The Hartford. The Hartford’s net exposure in these arrangements has increased for a variety of reasons, including The Hartford’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.
Consistent with the Company’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 the Company’s experience, have over time been applied to all of this business and have resulted in strengthening or reserve releases at various times over the past decade.
The following table 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 and “all other” claims, for the second quarter and six months ended March 31,June 30, 2004. Also included are the remaining asbestos and environmental exposures of Ongoing Operations.
3642
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 | |||||||
For the Second Quarter Ended June 30, 2004 | Asbestos | Environmental | All Other [1] | Total | ||||||||||||
Beginning liability - net [2] [3] | $ | 2,706 | $ | 392 | $ | 2,386 | $ | 5,484 | ||||||||
Change in reinsurance ceded, net | 181 | — | — | 181 | ||||||||||||
Claims and claim adjustment expenses incurred | 3 | 3 | 33 | 39 | ||||||||||||
Claims and claim adjustment expenses paid | (40 | ) | (19 | ) | (174 | ) | (233 | ) | ||||||||
Reclassification of allowance for uncollectible reinsurance | (330 | ) | (10 | ) | 340 | — | ||||||||||
Ending liability – net [2] [3] | $ | 2,520 [5] | $ | 366 | $ | 2,585 | $ | 5,471 | ||||||||
For the Six Months Ended June 30, 2004 | Asbestos | Environmental | All Other [1] | Total | ||||||||||||
Beginning liability - net | $ | 3,794 | $ | 408 | $ | 2,392 | $ | 6,594 | ||||||||
Change in reinsurance ceded, net | 180 | — | — | 180 | ||||||||||||
Claims and claim adjustment expenses incurred | 7 | 6 | 94 | 107 | ||||||||||||
Claims and claim adjustment expenses paid [4] | (1,131 | ) | (38 | ) | (241 | ) | (1,410 | ) | ||||||||
Reclassification of allowance for uncollectible reinsurance | (330 | ) | (10 | ) | 340 | — | ||||||||||
Ending liability – net [2] [3] | $ | 2,520 [5] | $ | 366 | $ | 2,585 | $ | 5,471 | ||||||||
[1] | Includes unallocated loss adjustment expense reserves and | |||
[2] | ||||
[3] | Gross of reinsurance, asbestos and environmental reserves were $4,583 and $499, respectively, as of June 30, 2004; $4,644 and $513, respectively, as of March 31, | |||
[4] | Asbestos payments include payments pursuant to the MacArthur settlement. | |||
[5] | The one year and average three year net paid amounts for asbestos claims are | |||
At March 31,June 30, 2004, asbestos reserves were $2.7$2.5 billion, a decrease of $1.1$1.3 billion compared to $3.8 billion as of December 31, 2003. The decrease in asbestos reserves is primarily driven by the MacArthur settlement payment made in the first quarter of 2004.
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 certain closed accounts. The Company also examined its London Market exposures for both direct insurance and assumed reinsurance. The evaluation indicated no change in the overall required gross asbestos reserves. It is anticipated that the net reserve evaluation will be completed during
During the second quarter of 2004, the Company completed an evaluation of the reinsurance recoverable asset associated with older, long-term casualty liabilities reported in the Other Operations segment, including asbestos liabilities. In conducting its Other Operations reinsurance recoverable review, the Company used its most recent detailed studies of gross asbestos, environmental and net reserve estimates could change asall other liabilities reported in the segment, including its estimate of the type and potential timing of future claims, and analyzed the legal entities through which each exposed coverage was written, the reinsurance arrangements in place at each of these legal entities and the years of potential reinsurance available. As part of its Other Operations reinsurance recoverable review, the Company also analyzed recent developments in commutation activity between reinsurers and cedants, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers and the overall credit quality of the Company’s reinsurers. As a result of this evaluation.evaluation, the Company reduced its net reinsurance recoverable by $181. The after-tax income effect of this action was $118. The following summarizes the components of the $181 reduction of reinsurance recoverables:
Reduction of ceded amounts | $ | 126 | ||
Increase in allowance for uncollectible reinsurance | 55 | |||
Total provision (before tax) | $ | 181 | ||
The Company reduced ceded amounts because while the Company’s estimate of total gross losses was unchanged, some of the individual components of the Company’s estimate changed, and less reinsurance coverage is available for the changed composition of losses. The increase in the allowance for uncollectible reinsurance reflects management’s current estimate of future reinsurance cessions that may be uncollectible due to reinsurers’ unwillingness or inability to pay. The net effect of the change in the allowance for uncollectible reinsurance was to increase the allowance as a percentage of ceded reinsurance from 8% at March 31, 2004 to 10% at June 30, 2004. The Company also consolidated within the “all other” category its allowance for insolvencies and disputes that might impact reinsurance coverage associated with Other Operations into a single $346 allowance, inclusive of other second quarter operating activity.
The Company currently expects to perform a comprehensive review of Other Operations reinsurance recoverables at least annually. In addition, at any time there are significant developments that affect particular exposures, reinsurance arrangements or the financial condition of particular reinsurers, the Company will respond by making adjustments in the portion of liabilities it expects to cede or in its allowance for uncollectible reinsurance.
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The Company classifies its asbestos reserves into three categories: direct insurance; assumed reinsurance and London Market. Direct insurance includes primary and excess coverage. Assumed Reinsurancereinsurance includes both “treaty” reinsurance (covering broad categories of claims or blocks of business) and “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 The Hartford’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 Reinsurancereinsurance 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.)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.
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On December 19, 2003 Hartford Accident and Indemnity Co. (“Hartford A&I”) entered into a settlement agreement with Mac Arthur Co. and its subsidiary, Western MacArthur Co. Under the settlement agreement, during the first quarter of 2004, Hartford A&I paid $1.15 billion into an escrow account owned by Hartford A&I. The following table displays grossfunds were held in the 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 reservesclaimants pursuant to the bankruptcy plan. The settlement payments have been accounted for as a reduction in unpaid claim and other statistics by policyholder category, asclaim adjustment expenses during the first quarter of March 31, 2004, reflecting the Company’s most recent gross reserve study:2004.
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 | ||||||||||||||||||||
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The following table sets forth, for the second quarter and six months ended March 31,June 30, 2004, paid and incurred loss activity by the three categories of claims for asbestos and environmental.environmental:
Paid and Incurred Loss and Loss Adjustment Expense (“LAE”) Development – Asbestos and Environmental
Asbestos | Environmental | Asbestos | Environmental | |||||||||||||||||||||||||||||
Paid | Incurred | Paid | Incurred | Paid | Incurred | Paid | Incurred | |||||||||||||||||||||||||
For the First Quarter Ended March 31, 2004 | Loss & LAE [1] | Loss & LAE | Loss & LAE | Loss & LAE | ||||||||||||||||||||||||||||
For the Second Quarter Ended June 30, 2004 | Loss & LAE | Loss & LAE | Loss & LAE | Loss & LAE | ||||||||||||||||||||||||||||
Gross | ||||||||||||||||||||||||||||||||
Direct | $ | 1,233 | $ | 4 | $ | 20 | $ | 3 | $ | 46 | $ | (27 | ) | $ | 12 | $ | 3 | |||||||||||||||
Assumed – Domestic | 7 | — | 3 | — | 12 | 30 | 3 | — | ||||||||||||||||||||||||
London Market | 4 | — | 9 | — | 6 | — | 3 | — | ||||||||||||||||||||||||
Total | 1,244 | 4 | 32 | 3 | 64 | 3 | 18 | 3 | ||||||||||||||||||||||||
Ceded | (153 | ) | (1 | ) | (13 | ) | — | (24 | ) | 181 | 1 | — | ||||||||||||||||||||
Net | $ | 1,091 | $ | 3 | $ | 19 | $ | 3 | $ | 40 | $ | 184 | $ | 19 | $ | 3 | ||||||||||||||||
Asbestos | Environmental | |||||||||||||||
Paid | Incurred | Paid | Incurred | |||||||||||||
For the Six Months Ended June 30, 2004 | Loss & LAE [1] | Loss & LAE | Loss & LAE | Loss & LAE | ||||||||||||
Gross | ||||||||||||||||
Direct | $ | 1,279 | $ | (23 | ) | $ | 32 | $ | 6 | |||||||
Assumed – Domestic | 19 | 30 | 6 | — | ||||||||||||
London Market | 10 | — | 12 | — | ||||||||||||
Total | 1,308 | 7 | 50 | 6 | ||||||||||||
Ceded | (177 | ) | 180 | (12 | ) | — | ||||||||||
Net | $ | 1,131 | $ | 187 | $ | 38 | $ | 6 | ||||||||
[1] Reflects payments pursuant to the MacArthur settlement.
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INVESTMENTS
General
The Hartford’s investment portfolios are primarily divided between Life and Property & Casualty. The investment portfolios are managed based on the underlying characteristics and nature of each operation’s respective liabilities and within established risk parameters. (For further discussion of The Hartford’s approach to managing risks, see the Investment Credit Risk section.)
The investment portfolios of Life and Property & Casualty are managed by Hartford Investment Management Company and its affiliates (“Hartford Investment Management”), a wholly-owned subsidiary of The Hartford. Hartford Investment Management is responsible for monitoring and managing the asset/liability profile, establishing investment objectives and 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.
AsPursuant to the adoption of SOP 03-1, as discussed in NoteNotes 1 and 4 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.account. Of this amount, $11.7 billion was associated with guaranteed separate accounts and was primarily comprised of fixed maturities. These assets are designatedclassified 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 designatedclassified as trading securities with changes in fair value reported in net investment income.
Return on invested assets is an important element of The Hartford’s financial results. Significant fluctuations in the fixed income or equity markets could weaken the Company’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%22% and 17%23% of the Company’s consolidated revenuesrevenue for the quarterssecond quarter ended March 31,June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 and 2003, net investment income and net realized capital gains and losses accounted for approximately 26% and 20%, respectively, of the Company’s consolidated revenues. The increase in the percentage of consolidated revenues for the six months ended June 30, 2004, as compared to the respective prior year period, is primarily due to income earned on separate account assets reclassified to the general account as a result of the adoption of the SOP.SOP 03-1.
Fluctuations in interest rates affect the Company’s return on, and the fair value of, fixed maturity investments, which comprised approximately 85%83% and 93% of the fair value of its invested assets as of March 31,June 30, 2004 and December 31, 2003, respectively. Other events beyond the Company’s control could also adversely impact the fair value of these investments. Specifically, a downgrade of an issuer’s credit rating or default of payment by an issuer could reduce the Company’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,June 30, 2004 and December 31, 2003, respectively.2003. 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-temporary would result in the Company’s recognition of a net realized capital loss in its financial results prior to the actual sale of the investment. (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 theThe 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.
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The following table identifies Life’s invested assets by type as of March 31,June 30, 2004 and December 31, 2003.
Composition of Invested Assets
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||
Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||
Fixed maturities, available-for-sale, at fair value | $ | 49,580 | 80.4 | % | $ | 37,462 | 91.0 | % | $ | 47,807 | 78.4 | % | $ | 37,462 | 91.0 | % | ||||||||||||||||
Equity securities, available-for-sale, at fair value | 406 | 0.7 | % | 357 | 0.9 | % | 383 | 0.6 | % | 357 | 0.9 | % | ||||||||||||||||||||
Equity securities, held for trading, at fair value | 7,831 | 12.7 | % | — | — | 8,995 | 14.7 | % | — | — | ||||||||||||||||||||||
Policy loans, at outstanding balance | 2,655 | 4.3 | % | 2,512 | 6.1 | % | 2,650 | 4.3 | % | 2,512 | 6.1 | % | ||||||||||||||||||||
Mortgage loans, at cost | 620 | 1.0 | % | 466 | 1.1 | % | 852 | 1.4 | % | 466 | 1.1 | % | ||||||||||||||||||||
Limited partnerships, at fair value | 197 | 0.3 | % | 177 | 0.4 | % | 234 | 0.4 | % | 177 | 0.4 | % | ||||||||||||||||||||
Other investments | 350 | 0.6 | % | 180 | 0.5 | % | 143 | 0.2 | % | 180 | 0.5 | % | ||||||||||||||||||||
Total investments | $ | 61,639 | 100.0 | % | $ | 41,154 | 100.0 | % | $ | 61,064 | 100.0 | % | $ | 41,154 | 100.0 | % | ||||||||||||||||
45
Fixed maturity investments and equity securities held for trading increased 32%28% and 100%, respectively, since December 31, 2003, primarily the result of fixed maturities and equity securities that were reclassified from separate accounts to the general account as a result of the adoption of the SOP.SOP 03-1. The remaining increase in fixed maturity investments was partially offset by a decline in market prices primarily due to an increase in market prices driven by a decline inlong-term interest rates during the firstsecond quarter of 2004.
Mortgage loans increased $386, or 83%, since December 31, 2003 as a result of a decision to increase Life’s investment in this asset class primarily due to its attractive yields and diversification opportunities.
Investment Results
The following table summarizes Life’s investment results.
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||
(Before-tax) | 2004 | 2003 | ||||||||||||||||||||||
Net investment income – excluding income on policy loan and trading securities [1] | $ | 661 | $ | 445 | ||||||||||||||||||||
(before-tax) | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||
Net investment income – excluding income on policy loans and trading securities [1] | $ | 662 | $ | 450 | $ | 1,323 | $ | 895 | ||||||||||||||||
Policy loan income | 45 | 58 | 47 | 54 | 92 | 112 | ||||||||||||||||||
Trading securities income [2] | 495 | — | 149 | — | 644 | — | ||||||||||||||||||
Net investment income – total [1] | $ | 1,201 | $ | 503 | $ | 858 | $ | 504 | $ | 2,059 | $ | 1,007 | ||||||||||||
Yield on average invested assets [3] | 5.7 | % | 6.1 | % | 5.8 | % | 5.8 | % | 5.8 | % | 5.9 | % | ||||||||||||
Gross gains on sale | $ | 100 | $ | 57 | $ | 84 | $ | 91 | $ | 184 | $ | 148 | ||||||||||||
Gross losses on sale | (18 | ) | (47 | ) | (70 | ) | (17 | ) | (88 | ) | (64 | ) | ||||||||||||
Impairments | (8 | ) | (67 | ) | (4 | ) | (17 | ) | (12 | ) | (84 | ) | ||||||||||||
Periodic net coupon settlements on non-qualifying derivatives [1] | 2 | 4 | 1 | 9 | 3 | 13 | ||||||||||||||||||
GMWB derivatives, net | (2 | ) | — | 6 | — | 4 | — | |||||||||||||||||
Other, net [4] | 2 | 9 | 9 | (7 | ) | 11 | 2 | |||||||||||||||||
Net realized capital gains (losses) [1] [5] | $ | 76 | $ | (44 | ) | |||||||||||||||||||
Net realized capital gains [1] | $ | 26 | $ | 59 | $ | 102 | $ | 15 | ||||||||||||||||
[1] | The prior | |||||
[2] | Represents the change in value of securities classified as trading. | |||||
[3] | Represents annualized net investment income (excluding the change in fair value of trading securities) divided by the monthly weighted average invested assets at cost or amortized cost, as applicable, for the | |||||
[4] | Primarily consists of changes in fair value on non-qualifying derivatives and hedge ineffectiveness on qualifying derivative instruments as well as the amortization of deferred policy acquisition costs associated with realized capital | |||||
For the second quarter and six months ended March 31,June 30, 2004, net investment income, excluding income on policy loans and trading securities, increased $216,$212, or 49%47%, and $428, or 48%, respectively, compared to the same periodrespective prior year periods. The increases in 2003. Approximately $154net investment income were primarily due to income earned on a higher average invested assets base, as compared to the respective prior year periods, partially offset by lower investment yields. The increase in the average invested assets base, as compared to the prior year periods, was primarily the result of separate account assets reclassified to the increase relatedgeneral account pursuant to incomethe adoption of SOP 03-1 and, to a lesser extent, assets acquired in the CNA Acquisition and operating cash flows. Income earned on separate account assets reclassified to the general account as a result ofwas $150 and $304 for the adoption of the SOPsecond quarter and approximately $26 of the increase related to incomesix months ended June 30, 2004, respectively. Income earned on assets acquired in the CNA acquisition, whichAcquisition was consummated on December 31, 2003. The remaining increase was primarily due to income earned on a higher invested asset base, as compared to$29 and $55 for the firstsecond quarter 2003, partially offset by lower investment yields. Yieldsand six months ended June 30, 2004, respectively.
For the six months ended June 30, 2004, the yield on average invested assets decreased from the respective prior year period 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 long-term 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 firstsecond quarter ofand six months ended June 30, 2004 of approximately 4.8%4.7%, before-tax, continues to be below the average portfolio yield.
Net realized capital gains (losses) for the firstsecond quarter ended March 31,June 30, 2004 improveddecreased by $120$33 compared to the samerespective prior year period, in 2003, primarily the result of higherlower net realized gains on sales of fixed maturity and equity securities andin 2004, partially offset by lower other-than-temporary impairments. RealizedNet realized capital gains for the six months ended June 30, 2004 improved by $87 compared to the respective prior year period primarily due to lower other-than-temporary impairments. (For further discussion of other-than-temporary impairments, see the Other-Than-Temporary Impairments commentary in this section of the MD&A.)
Gross gains on sales for the second quarter and six months ended June 30, 2004 were primarily within fixed maturities and were the result of decisions to reposition the portfolio primarily due to the spread tightening in certain sectors and changes in interest rates. Gross gains on sales of fixed maturity investments were concentrated in the corporate, foreign government and asset-backed securities (“ABS”) sectors. The majority of the gains on sales in the corporate and ABS sectors were the
40
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
Gross losses on sales for the second quarter ended June 30, 2004 resulted predominantly from sales of other-than-temporary impairments, seeU.S. government and government agencies securities, corporate securities and commercial mortgage-backed securities (“CMBS”) that were in an
46
unrealized loss position primarily due to changes in long-term interest rates.
Realized gains on sales for the Other-Than-Temporary Impairments commentarysecond quarter and six months ended June 30, 2003 primarily resulted from portfolio rebalancing of securities that had appreciated in this section of the MD&A.)value due to historically low interest rates.
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,June 30, 2004 and December 31, 2003.
Composition of Invested Assets
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||
Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||
Fixed maturities, available-for-sale, at fair value | $ | 23,196 | 96.4 | % | $ | 23,715 | 96.4 | % | $ | 22,774 | 96.3 | % | $ | 23,715 | 96.4 | % | ||||||||||||||||
Equity securities, available-for-sale, at fair value | 206 | 0.9 | % | 208 | 0.8 | % | 201 | 0.8 | % | 208 | 0.8 | % | ||||||||||||||||||||
Real estate/Mortgage loans, at cost | 309 | 1.3 | % | 328 | 1.3 | % | 306 | 1.3 | % | 328 | 1.3 | % | ||||||||||||||||||||
Limited partnerships, at fair value | 164 | 0.7 | % | 168 | 0.7 | % | 156 | 0.7 | % | 168 | 0.7 | % | ||||||||||||||||||||
Other investments | 177 | 0.7 | % | 186 | 0.8 | % | 220 | 0.9 | % | 186 | 0.8 | % | ||||||||||||||||||||
Total investments | $ | 24,052 | 100.0 | % | $ | 24,605 | 100.0 | % | $ | 23,657 | 100.0 | % | $ | 24,605 | 100.0 | % | ||||||||||||||||
Total fixed maturities decreased 2%$941, or 4%, 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 increasea decline in the fair value of fixed maturities as a result of a decreasean increase in long-term interest rates.rates, partially offset by operating cash flow.
Investment Results
The table below summarizes Property & Casualty’s investment results.
First Quarter Ended | Second Quarter Ended | Six Months Ended | ||||||||||||||||||||||
March 31, | June 30, | June 30, | ||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||||||
Net investment income, before-tax [1] | $ | 311 | $ | 281 | $ | 295 | $ | 286 | $ | 606 | $ | 567 | ||||||||||||
Net investment income, after-tax [1] [2] | $ | 232 | $ | 215 | $ | 222 | $ | 217 | $ | 454 | $ | 433 | ||||||||||||
Yield on average invested assets, before-tax [3] | 5.5 | % | 5.8 | % | 5.3 | % | 5.5 | % | 5.4 | % | 5.5 | % | ||||||||||||
Yield on average invested assets, after-tax [2] [3] | 4.1 | % | 4.4 | % | 3.9 | % | 4.2 | % | 4.0 | % | 4.2 | % | ||||||||||||
Gross gains on sale | $ | 72 | $ | 80 | $ | 49 | $ | 212 | $ | 121 | $ | 292 | ||||||||||||
Gross losses on sale | (5 | ) | (60 | ) | (27 | ) | (7 | ) | (32 | ) | (67 | ) | ||||||||||||
Impairments | (6 | ) | (22 | ) | — | (10 | ) | (6 | ) | (32 | ) | |||||||||||||
Periodic net coupon settlements on non-qualifying derivatives [1] | 4 | 4 | 3 | 5 | 7 | 9 | ||||||||||||||||||
Other, net [4] | 6 | (3 | ) | 2 | 12 | 8 | 9 | |||||||||||||||||
Net realized capital gains (losses), before-tax [1] | $ | 71 | $ | (1 | ) | |||||||||||||||||||
Net realized capital gains, before-tax [1] | $ | 27 | $ | 212 | $ | 98 | $ | 211 | ||||||||||||||||
[1] | The prior | |||||
[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 the monthly weighted average invested assets at cost or amortized cost, as applicable, for the | |||||
[4] | Primarily consists of changes in fair value on non-qualifying derivatives and hedge ineffectiveness on qualifying derivative instruments. |
For the firstsecond quarter and six months ended March 31,June 30, 2004, before-before-tax net investment income increased $9, or 3%, and $39, or 7%, respectively, and after-tax net investment income increased $30,$5, or 11%2%, and $17,$21, or 8%5%, respectively, compared to the respective prior year period.periods. The increaseincreases in net investment income wasfor the second quarter and six months ended June 30, 2004, were primarily due to income earned on a higher average invested asset base, as compared to the respective prior year periods, 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
The yield on average invested assets decreased from the prior year periodperiods 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 long-term 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 firstsecond quarter ofand six months ended June 30, 2004 of approximately 4.7%4.9% and 4.8%, before-tax, respectively, continues to be below the average portfolio yield.
Net realized capital gains (losses) for the firstsecond quarter and six months ended March 31,June 30, 2004 improveddecreased by $72$185 and $113, respectively, as compared to the same period in 2003,respective prior year periods, primarily the result of higherlower net realized gains on sales of fixed maturity securities andin 2004, partially offset by lower other-than-temporary impairments. (For further discussion of other-than-temporary impairments, see the Other-Than-Temporary Impairments commentary in this section of the MD&A.)
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impairments. RealizedGross gains on sales for the second quarter and six months ended June 30, 2004 were primarily within fixed maturities and were the result of decisions to reposition the portfolio primarily due to the spread tightening in certain sectors and changes in long-term interest rates. Gross gains on sales of fixed maturity investments were concentrated in the corporate, foreign government and ABS sectors. The majority of the gains on 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
Gross losses on sales for the second quarter ended June 30, 2004 resulted predominantly from sales of other-than-temporary impairments, seecorporate and CMBS securities that were in an unrealized loss position primarily due to changes in long-term interest rates.
Realized gains on sales for the Other-than-Temporary Impairments commentarysecond quarter and six months ended June 30, 2003 primarily resulted from portfolio rebalancing of securities that had appreciated in this section of the MD&A.)value due to historically low interest rates.
Corporate
Certain proceeds fromThe investment objective of Corporate is to raise capital through financing activities to support the Company’s September 2002Life and May 2003 capital raisingProperty & Casualty operations of the Company and to maintain sufficient funds to support the cost of those financing activities have been retained in Corporate.including the payment of interest for Hartford Financial Services Group, Inc. (“HFSG”) issued debt and dividends to shareholders of The Hartford common stock. As of March 31,June 30, 2004 and December 31, 2003, Corporate held $38$122 and $86, respectively, of short-term fixed maturity investments. In addition, Corporate held $28$6 and $2, respectively, of other investments as of March 31,June 30, 2004 and December 31, 2003, respectively.2003.
Other-Than-Temporary Impairments
For the second quarter and six months ended June 30, 2004, total consolidated other-than-temporary impairments were $4 and $18, respectively, as compared with $27 and $116, respectively, for the comparable periods in 2003.
The following table identifies the Company’s other-than-temporary impairments by type.type for the six months ended June 30, 2004 and 2003.
Other-Than-Temporary Impairments by Type
First Quarter Ended | First Quarter Ended | |||||||||||||||||||||||||||||||||||||||||||||||
March 31, 2004 | March 31, 2003 | Six Months Ended June 30, | ||||||||||||||||||||||||||||||||||||||||||||||
Property & | Property & | Life | Property & Casualty | Consolidated | ||||||||||||||||||||||||||||||||||||||||||||
(before-tax) | Life | Casualty | Consolidated | Life | Casualty | Consolidated | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||||||||||||||||||
ABS | ||||||||||||||||||||||||||||||||||||||||||||||||
Corporate debt obligations (“CDO”) | $ | 4 | $ | 1 | $ | 5 | $ | 10 | $ | 5 | $ | 15 | ||||||||||||||||||||||||||||||||||||
Corporate debt obligations (“CDOs”) | $ | 4 | $ | 10 | $ | 1 | $ | 5 | $ | 5 | $ | 15 | ||||||||||||||||||||||||||||||||||||
Credit card receivables | — | — | — | 12 | 2 | 14 | — | 12 | — | 2 | — | 14 | ||||||||||||||||||||||||||||||||||||
Other ABS | — | 5 | 5 | 4 | 1 | 5 | — | 4 | 5 | 1 | 5 | 5 | ||||||||||||||||||||||||||||||||||||
Total ABS | 4 | 6 | 10 | 26 | 8 | 34 | 4 | 26 | 6 | 8 | 10 | 34 | ||||||||||||||||||||||||||||||||||||
Commercial mortgages | 3 | — | — | — | 3 | — | ||||||||||||||||||||||||||||||||||||||||||
CMBS | 1 | 4 | — | — | 1 | 4 | ||||||||||||||||||||||||||||||||||||||||||
Corporate | ||||||||||||||||||||||||||||||||||||||||||||||||
Consumer non-cyclical | — | — | — | 7 | 2 | 9 | — | 7 | — | 2 | — | 9 | ||||||||||||||||||||||||||||||||||||
Technology and communications | — | — | — | 3 | 2 | 5 | — | 3 | — | 2 | — | 5 | ||||||||||||||||||||||||||||||||||||
Transportation | — | — | — | 7 | 3 | 10 | — | 7 | — | 3 | — | 10 | ||||||||||||||||||||||||||||||||||||
Other corporate | 3 | — | 3 | 3 | 1 | 4 | 3 | 4 | — | 1 | 3 | 5 | ||||||||||||||||||||||||||||||||||||
Total corporate | 3 | — | 3 | 20 | 8 | 28 | 3 | 21 | — | 8 | 3 | 29 | ||||||||||||||||||||||||||||||||||||
Equity | — | — | — | 21 | 6 | 27 | — | 21 | — | 9 | — | 30 | ||||||||||||||||||||||||||||||||||||
Mortgage-backed securities (“MBS”) – interest only securities | 1 | — | 1 | — | — | — | 1 | 12 | — | 7 | 1 | 19 | ||||||||||||||||||||||||||||||||||||
Total other-than-temporary impairments | $ | 8 | $ | 6 | $ | 14 | $ | 67 | $ | 22 | $ | 89 | $ | 12 | $ | 84 | $ | 6 | $ | 32 | $ | 18 | $ | 116 | ||||||||||||||||||||||||
ABS— DuringFor the first quarter ofsix months ended June 30, 2004, other-than-temporary impairments were recorded for variousprimarily comprised of ABS and commercial mortgages security types and were recorded as a result of a deterioration of cash flows derived from the underlying collateral of several securities.
The decrease in impairments in the second quarter and six months ended June 30, 2004, as compared to the respective prior year periodperiods, is primarily thea result of an improvement in general economic conditions and operating fundamentals, and improved pricing levels for ABS security types. In general, security issuers’ operating fundamentals have improved due to reduced company leverage, improved liquidity and successfully implementing various cost cutting measures. Improvement in pricing levels for ABS has been driven by 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 toand an increase in demand for these asset types driven bydue to improved economic and operating fundamentals of the underlying security issuers, better market liquidity and attractive yields. The increase in pricing levels for credit card receivables was
Impairments during the six months ended June 30, 2003 were primarily driven by improvement in collateral performance.
Impairments of ABS during the first quarter of 2003 were driven by a deterioration of collateral cash flows. CDO impairments were primarily the result of increasing default rates and lower recovery rates on collateral supporting certain ABS security types and the collateral. Impairments on ABS backed by credit card receivables weredecline in value of several corporate debt securities as a result of issuers extending credit to sub-prime borrowers and the higher default rates on these loans.
Corporate— The decline in corporate bankruptcies and improvement in general economic conditions have contributed to lower corporate impairment levels in the first quarter of 2004 compared to the first quarter of 2003.
A significant portion of corporate impairments during the quarter ended March 31, 2003 was 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. Additional impairmentsImpairments were also incurred as a result of the deterioration in the transportation sector, specifically issuers of airline debt, asdue to a result of asignificant decline in airline travel.
Other— Other-than-temporary Additionally, other-than-temporary impairments were also recorded in the first quarter of 2003 on various diversified mutual funds and preferred stock investments.interest only securities.
In addition toThe favorable other-than-temporary impairments trend will depend on continued strong economic fundamentals, political stability and collateral performance. (For further discussion of risk factors associated with sectors with significant unrealized loss positions, see the impairments described above, fixed maturity and equity securities were sold duringsector risk factor commentary under the quarters ended March 31, 2004 and 2003 at total gross lossesConsolidated Total Available-for-Sale Securities with Unrealized Loss Greater than Six Months by Type schedule in the Investment Credit Risk section of $22 and $99, respectively. No single security was sold at a loss in excess of $5 and $9 during the quarters ended March 31, 2004 and 2003, respectively.MD&A.)
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INVESTMENT CREDIT RISK
The Hartford has established investment credit policies that focus on the credit quality of obligors and counterparties, limit credit concentrations, encourage diversification and require frequent creditworthiness reviews. Investment activity, including setting of policy and defining acceptable risk levels, is subject to regular review and approval by senior management and by the Finance Committee of the Company’s Board of Directors.
Please refer to the Investment Credit Risk section of the MD&A in The Hartford’s 2003 Form 10-K Annual Report for a description of the Company’s objectives, policies and strategies, 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’ equity.
The following table identifies fixed maturity securities by type on a consolidated basis, as of March 31,June 30, 2004 and December 31, 2003.
Consolidated Fixed Maturities by Type
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent | Percent | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total | Total | of Total | of Total | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Fair | Amortized | Unrealized | Unrealized | Fair | Fair | Amortized | Unrealized | Unrealized | Fair | Fair | Amortized | Unrealized | Unrealized | Fair | Fair | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cost | Gains | Losses | Value | Value | Cost | Gains | Losses | Value | Value | 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 | % | $ | 6,554 | $ | 117 | $ | (97 | ) | $ | 6,574 | 9.3 | % | $ | 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 | % | 10,764 | 399 | (124 | ) | 11,039 | 15.6 | % | 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 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Collateralized mortgage obligations (“CMOs”) | 1,009 | 12 | (5 | ) | 1,016 | 1.4 | % | 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 | % | 3,206 | 157 | (38 | ) | 3,325 | 4.7 | % | 3,343 | 223 | (15 | ) | 3,551 | 4.8 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Capital goods | 2,076 | 179 | (4 | ) | 2,251 | 3.1 | % | 1,850 | 133 | (11 | ) | 1,972 | 2.7 | % | 2,093 | 93 | (31 | ) | 2,155 | 3.0 | % | 2,037 | 143 | (10 | ) | 2,170 | 3.0 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Consumer cyclical | 3,330 | 268 | (4 | ) | 3,594 | 4.9 | % | 3,167 | 210 | (12 | ) | 3,365 | 4.6 | % | 3,234 | 127 | (41 | ) | 3,320 | 4.7 | % | 3,305 | 217 | (11 | ) | 3,511 | 4.8 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Consumer non-cyclical | 3,373 | 298 | (7 | ) | 3,664 | 5.0 | % | 3,572 | 236 | (18 | ) | 3,790 | 5.2 | % | 3,287 | 157 | (47 | ) | 3,397 | 4.8 | % | 3,525 | 234 | (17 | ) | 3,742 | 5.1 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Energy | 2,070 | 190 | (2 | ) | 2,258 | 3.1 | % | 2,036 | 142 | (10 | ) | 2,168 | 3.0 | % | 1,931 | 97 | (25 | ) | 2,003 | 2.8 | % | 2,026 | 142 | (11 | ) | 2,157 | 3.0 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Financial services | 7,830 | 675 | (27 | ) | 8,478 | 11.6 | % | 7,767 | 536 | (45 | ) | 8,258 | 11.3 | % | 8,052 | 410 | (93 | ) | 8,369 | 11.9 | % | 7,848 | 560 | (44 | ) | 8,364 | 11.5 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Technology and communications | 5,001 | 561 | (8 | ) | 5,554 | 7.6 | % | 4,955 | 489 | (18 | ) | 5,426 | 7.5 | % | 4,889 | 303 | (73 | ) | 5,119 | 7.3 | % | 5,051 | 496 | (19 | ) | 5,528 | 7.6 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Transportation | 739 | 61 | (4 | ) | 796 | 1.1 | % | 777 | 51 | (6 | ) | 822 | 1.1 | % | 713 | 34 | (11 | ) | 736 | 1.0 | % | 778 | 52 | (7 | ) | 823 | 1.1 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Utilities | 3,110 | 269 | (11 | ) | 3,368 | 4.6 | % | 2,941 | 221 | (20 | ) | 3,142 | 4.3 | % | 3,176 | 167 | (51 | ) | 3,292 | 4.7 | % | 3,101 | 224 | (20 | ) | 3,305 | 4.5 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Other | 859 | 63 | (1 | ) | 921 | 1.3 | % | 720 | 33 | (5 | ) | 748 | 1.0 | % | 846 | 36 | (11 | ) | 871 | 1.2 | % | 806 | 46 | (6 | ) | 846 | 1.2 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Government/Government agencies | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Foreign | 1,385 | 154 | (4 | ) | 1,535 | 2.1 | % | 1,605 | 171 | (3 | ) | 1,773 | 2.4 | % | 1,329 | 75 | (24 | ) | 1,380 | 2.0 | % | 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 | % | 1,086 | 8 | (22 | ) | 1,072 | 1.5 | % | 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 | % | 2,212 | 18 | (17 | ) | 2,213 | 3.1 | % | 2,794 | 43 | (3 | ) | 2,834 | 3.9 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Municipal | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Taxable | 742 | 32 | (9 | ) | 765 | 1.1 | % | 625 | 19 | (15 | ) | 629 | 0.9 | % | 855 | 12 | (40 | ) | 827 | 1.2 | % | 625 | 19 | (15 | ) | 629 | 0.9 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Tax-exempt | 9,469 | 816 | (3 | ) | 10,282 | 14.1 | % | 9,445 | 775 | (4 | ) | 10,216 | 14.0 | % | 9,546 | 524 | (27 | ) | 10,043 | 14.2 | % | 9,445 | 775 | (4 | ) | 10,216 | 14.0 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Redeemable preferred stock | 71 | 3 | — | 74 | 0.1 | % | 77 | 3 | — | 80 | 0.1 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Redeemable preferred | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
stock | 36 | 1 | — | 37 | 0.1 | % | 77 | 3 | — | 80 | 0.1 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Short-term | 3,094 | 1 | — | 3,095 | 4.3 | % | 3,708 | 3 | — | 3,711 | 5.1 | % | 3,914 | 1 | — | 3,915 | 5.5 | % | 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 | % | $ | 68,732 | $ | 2,748 | $ | (777 | ) | $ | 70,703 | 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 | % | $ | 58,127 | $ | 3,413 | $ | (277 | ) | $ | 61,263 | 83.9 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total guaranteed separate account fixed maturities [1] | $ | 11,120 | $ | 687 | $ | (72 | ) | $ | 11,735 | 16.1 | % | $ | 11,120 | $ | 687 | $ | (72 | ) | $ | 11,735 | 16.1 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
The Company’s fixed maturity gross unrealized gains decreased $1,352 and gross unrealized losses have improved by $757 and $168, respectively,increased $428 from December 31, 2003 to March 31,June 30, 2004, primarily due to a declinean increase in long-term interest rates and, to a lesser extent, credit spread tightening associated with ABS, partially offset bywidening and sales of securities in a gain position. During the quartersix months ended March 31,June 30, 2004, the ten year U.S. treasury rate declinedincreased approximately 4035 basis points since December 31,and to more than 100 basis points from its low in June 2003, largely due to disappointing new job creation and athe result of continued economic growth evidenced by an increase in capacity utilization, percentage.employment growth and continued strong consumer spending. At the June 30, 2004 Federal Open Market Committee policy meeting, the overnight funds rate was raised a quarter point to 1.25%. The Company expects U.S. fiscal and monetary policyFed members signaled that interest rates will continue to rise at a measured pace as long as inflation risks remain stimulative until inflationary pressures return.stable.
Investment allocations as a percentage of total fixed maturities have remained materially consistent since December 31, 2003, except for CMBS and short-term securities.CMBS. CMBS increased as a result of a tactical decision to
49
increase the Company’s investment in the asset class due to its stable spreads, high quality and attractive yields. Investments in short-term securities decreased
43
primarily due to payments made pursuant to the MacArthur settlement.
(For further discussion of risk factors associated with sectors with significant unrealized loss positions, see the sector risk factor commentary under the Consolidated Total Available-for-Sale Securities with Unrealized Loss Greater than Six Months by Type schedule in this section of the MD&A.)
The following table identifies fixed maturities by credit quality on a consolidated basis, as of March 31,June 30, 2004 and December 31, 2003. The ratings referenced below are based on the ratings of a nationally recognized rating organization or, if not rated, assigned based on the Company’s internal analysis of such securities.
Consolidated Fixed Maturities by Credit Quality
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent of | Percent of | |||||||||||||||||||||||||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | 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 | % | $ | 4,299 | $ | 4,293 | 6.1 | % | $ | 5,274 | $ | 5,357 | 7.3 | % | ||||||||||||||||||||||||
AAA | 15,799 | 16,854 | 23.1 | % | 15,672 | 16,552 | 22.7 | % | 16,502 | 16,968 | 24.0 | % | 15,672 | 16,552 | 22.7 | % | ||||||||||||||||||||||||||||||||
AA | 7,479 | 8,043 | 11.0 | % | 7,377 | 7,855 | 10.8 | % | 7,458 | 7,769 | 11.0 | % | 7,377 | 7,855 | 10.8 | % | ||||||||||||||||||||||||||||||||
A | 16,863 | 18,220 | 25.0 | % | 17,646 | 18,750 | 25.7 | % | 17,022 | 17,683 | 25.0 | % | 17,646 | 18,750 | 25.7 | % | ||||||||||||||||||||||||||||||||
BBB | 17,025 | 18,350 | 25.2 | % | 16,143 | 17,114 | 23.4 | % | 16,565 | 17,036 | 24.1 | % | 16,143 | 17,114 | 23.4 | % | ||||||||||||||||||||||||||||||||
BB & below | 3,216 | 3,475 | 4.8 | % | 3,427 | 3,659 | 5.0 | % | 2,972 | 3,039 | 4.3 | % | 3,427 | 3,659 | 5.0 | % | ||||||||||||||||||||||||||||||||
Short-term | 3,094 | 3,095 | 4.3 | % | 3,708 | 3,711 | 5.1 | % | 3,914 | 3,915 | 5.5 | % | 3,708 | 3,711 | 5.1 | % | ||||||||||||||||||||||||||||||||
Total fixed maturities | $ | 68,138 | $ | 72,814 | 100.0 | % | $ | 69,247 | $ | 72,998 | 100.0 | % | $ | 68,732 | $ | 70,703 | 100.0 | % | $ | 69,247 | $ | 72,998 | 100.0 | % | ||||||||||||||||||||||||
Total general account fixed maturities | $ | 58,127 | $ | 61,263 | 83.9 | % | $ | 58,127 | $ | 61,263 | 83.9 | % | ||||||||||||||||||||||||||||||||||||
Total guaranteed separate account fixed maturities [1] | $ | 11,120 | $ | 11,735 | 16.1 | % | $ | 11,120 | $ | 11,735 | 16.1 | % | ||||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
As of March 31,June 30, 2004 and December 31, 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).
The following table presents the Below Investment Grade (“BIG”) fixed maturities by type, as of March 31,June 30, 2004 and December 31, 2003.
Consolidated BIG Fixed Maturities by Type
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent of | Percent of | |||||||||||||||||||||||||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | Cost | Fair Value | Value | Cost | Fair Value | Value | |||||||||||||||||||||||||||||||||||||
ABS | $ | 233 | $ | 239 | 6.9 | % | $ | 293 | $ | 275 | 7.5 | % | $ | 229 | $ | 220 | 7.2 | % | $ | 293 | $ | 275 | 7.5 | % | ||||||||||||||||||||||||
CMBS | 196 | 208 | 6.0 | % | 185 | 190 | 5.2 | % | 145 | 151 | 5.0 | % | 185 | 190 | 5.2 | % | ||||||||||||||||||||||||||||||||
Corporate | ||||||||||||||||||||||||||||||||||||||||||||||||
Basic industry | 364 | 385 | 11.0 | % | 365 | 381 | 10.4 | % | 369 | 379 | 12.5 | % | 395 | 413 | 11.3 | % | ||||||||||||||||||||||||||||||||
Capital goods | 181 | 189 | 5.4 | % | 177 | 187 | 5.1 | % | 141 | 141 | 4.6 | % | 177 | 187 | 5.1 | % | ||||||||||||||||||||||||||||||||
Consumer cyclical | 395 | 430 | 12.4 | % | 377 | 408 | 11.2 | % | 317 | 331 | 10.9 | % | 392 | 424 | 11.6 | % | ||||||||||||||||||||||||||||||||
Consumer non-cyclical | 350 | 367 | 10.6 | % | 423 | 442 | 12.1 | % | 279 | 281 | 9.2 | % | 413 | 430 | 11.7 | % | ||||||||||||||||||||||||||||||||
Energy | 115 | 124 | 3.6 | % | 113 | 123 | 3.4 | % | 108 | 110 | 3.6 | % | 96 | 105 | 2.9 | % | ||||||||||||||||||||||||||||||||
Financial services | 21 | 22 | 0.6 | % | 20 | 20 | 0.5 | % | 25 | 25 | 0.8 | % | 22 | 23 | 0.6 | % | ||||||||||||||||||||||||||||||||
Technology and communications | 379 | 454 | 13.1 | % | 418 | 505 | 13.8 | % | 342 | 363 | 11.9 | % | 418 | 505 | 13.8 | % | ||||||||||||||||||||||||||||||||
Transportation | 32 | 37 | 1.1 | % | 58 | 61 | 1.7 | % | 20 | 20 | 0.7 | % | 59 | 61 | 1.7 | % | ||||||||||||||||||||||||||||||||
Utilities | 465 | 488 | 14.0 | % | 529 | 549 | 15.0 | % | 486 | 491 | 16.2 | % | 509 | 530 | 14.5 | % | ||||||||||||||||||||||||||||||||
Foreign government | 429 | 476 | 13.7 | % | 416 | 463 | 12.7 | % | 450 | 466 | 15.3 | % | 416 | 463 | 12.7 | % | ||||||||||||||||||||||||||||||||
Other | 56 | 56 | 1.6 | % | 53 | 55 | 1.4 | % | 61 | 61 | 2.1 | % | 52 | 53 | 1.4 | % | ||||||||||||||||||||||||||||||||
Total fixed maturities | $ | 3,216 | $ | 3,475 | 100.0 | % | $ | 3,427 | $ | 3,659 | 100.0 | % | $ | 2,972 | $ | 3,039 | 100.0 | % | $ | 3,427 | $ | 3,659 | 100.0 | % | ||||||||||||||||||||||||
Total general account fixed maturities | $ | 2,681 | $ | 2,877 | 78.6 | % | $ | 2,681 | $ | 2,877 | 78.6 | % | ||||||||||||||||||||||||||||||||||||
Total guaranteed separate account fixed maturities [1] | $ | 746 | $ | 782 | 21.4 | % | $ | 746 | $ | 782 | 21.4 | % | ||||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
As of March 31,June 30, 2004 and December 31, 2003, the Company held no issuer of a BIG security with a fair value in excess of 3% 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.
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The following table presents the Company’s unrealized loss aging for total fixed maturity and equity securities classified as available-for-sale on a consolidated basis, as of March 31,June 30, 2004 and December 31, 2003, by length of time the security was in an unrealized loss position.
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Consolidated Unrealized Loss Aging of Total Available-for-Sale Securities
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||||||||||||
Cost | Value | Loss | Cost | Value | Loss | Cost | Value | Loss | Cost | Value | Loss | |||||||||||||||||||||||||||||||||||||
Three months or less | $ | 3,596 | $ | 3,551 | $ | (45 | ) | $ | 4,867 | $ | 4,826 | $ | (41 | ) | $ | 20,604 | $ | 20,093 | $ | (511 | ) | $ | 4,867 | $ | 4,826 | $ | (41 | ) | ||||||||||||||||||||
Greater than three months to six months | 233 | 229 | (4 | ) | 3,991 | 3,854 | (137 | ) | 815 | 760 | (55 | ) | 3,991 | 3,854 | (137 | ) | ||||||||||||||||||||||||||||||||
Greater than six months to nine months | 1,760 | 1,731 | (29 | ) | 404 | 382 | (22 | ) | 180 | 172 | (8 | ) | 404 | 382 | (22 | ) | ||||||||||||||||||||||||||||||||
Greater than nine months to twelve months | 235 | 225 | (10 | ) | 151 | 142 | (9 | ) | 1,545 | 1,444 | (101 | ) | 151 | 142 | (9 | ) | ||||||||||||||||||||||||||||||||
Greater than twelve months | 1,418 | 1,305 | (113 | ) | 1,844 | 1,688 | (156 | ) | 1,268 | 1,146 | (122 | ) | 1,844 | 1,688 | (156 | ) | ||||||||||||||||||||||||||||||||
Total | $ | 7,242 | $ | 7,041 | $ | (201 | ) | $ | 11,257 | $ | 10,892 | $ | (365 | ) | $ | 24,412 | $ | 23,615 | $ | (797 | ) | $ | 11,257 | $ | 10,892 | $ | (365 | ) | ||||||||||||||||||||
Total general account | $ | 9,234 | $ | 8,941 | $ | (293 | ) | $ | 9,234 | $ | 8,941 | $ | (293 | ) | ||||||||||||||||||||||||||||||||||
Total guaranteed separate accounts [1] | $ | 2,023 | $ | 1,951 | $ | (72 | ) | $ | 2,023 | $ | 1,951 | $ | (72 | ) | ||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
The decreaseincrease in the unrealized loss amount since December 31, 2003 is primarily the result of an increase in long-term interest rates, partially offset by slightly improved pricing levels for ABS securities a decline in long-term interest rates and, to a lesser extent, asset sales. (For further discussion, see the economic commentary under the Consolidated Fixed Maturities by Type table in this section of the MD&A.)
As of March 31,June 30, 2004 and December 31, 2003, fixed maturities represented $181,$777, or 90%97%, and $349, or 96%, of the Company’s total unrealized loss associated with securities classified as available-for-sale, respectively. There were no fixed maturities as of March 31,June 30, 2004 or December 31, 2003 with a fair value less than 80% of the security’s amortized cost basis for six continuous months other than certain asset-backed and commercial mortgage-backed securities. Other-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 of March 31,June 30, 2004 and December 31, 2003, for which management’s best estimate of future cash flows adversely changed during the reporting period. As of March 31,June 30, 2004 and December 31, 2003, no asset-backed or commercial mortgage-backed securities had an unrealized loss in excess of $13$14 and $15, respectively. (For further discussion of the other-than-temporary impairments criteria, see “Investments” included in the Critical Accounting Estimates section of the 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 Company held no securities of a single issuer that were at an unrealized loss position in excess of 8%3% and 5% of the total unrealized loss amount as of March 31,June 30, 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 March 31,June 30, 2004 and December 31, 2003 are presented in the following table.
Consolidated Total Available-for-Sale Securities with Unrealized Loss Greater Than Six Months by Type
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent of | Percent of | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total | Total | Total | Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Unrealized | Amortized | Fair | Unrealized | Unrealized | Amortized | Fair | Unrealized | Unrealized | ||||||||||||||||||||||||||||||||||||||||||||||||||
Cost | Value | Unrealized Loss | Loss | Cost | Value | Loss | Loss | Cost | Value | Loss | Loss | Cost | Value | Loss | Loss | |||||||||||||||||||||||||||||||||||||||||||||||||
ABS and CMBS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Aircraft lease receivables | $ | 149 | $ | 98 | $ | (51 | ) | 33.6 | % | $ | 174 | $ | 116 | $ | (58 | ) | 31.0 | % | $ | 170 | $ | 110 | $ | (60 | ) | 26.0 | % | $ | 174 | $ | 116 | $ | (58 | ) | 31.0 | % | ||||||||||||||||||||||||||||
CDOs | 90 | 86 | (4 | ) | 2.6 | % | 176 | 153 | (23 | ) | 12.3 | % | 69 | 65 | (4 | ) | 1.7 | % | 176 | 153 | (23 | ) | 12.3 | % | ||||||||||||||||||||||||||||||||||||||||
Credit card receivables | 79 | 75 | (4 | ) | 2.6 | % | 123 | 111 | (12 | ) | 6.4 | % | 59 | 56 | (3 | ) | 1.3 | % | 123 | 111 | (12 | ) | 6.4 | % | ||||||||||||||||||||||||||||||||||||||||
Other ABS and CMBS | 851 | 835 | (16 | ) | 10.6 | % | 693 | 673 | (20 | ) | 10.7 | % | 546 | 523 | (23 | ) | 9.9 | % | 693 | 673 | (20 | ) | 10.7 | % | ||||||||||||||||||||||||||||||||||||||||
Corporate | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Basic industry | 174 | 165 | (9 | ) | 3.9 | % | 74 | 70 | (4 | ) | 2.1 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Consumer cyclical | 135 | 125 | (10 | ) | 4.3 | % | 48 | 45 | (3 | ) | 1.6 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Consumer non-cyclical | 100 | 91 | (9 | ) | 3.9 | % | 52 | 49 | (3 | ) | 1.6 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Financial services | 952 | 910 | (42 | ) | 27.6 | % | 747 | 710 | (37 | ) | 19.8 | % | 832 | 786 | (46 | ) | 19.9 | % | 747 | 710 | (37 | ) | 19.8 | % | ||||||||||||||||||||||||||||||||||||||||
Technology and communications | 145 | 143 | (2 | ) | 1.3 | % | 55 | 52 | (3 | ) | 1.6 | % | 164 | 153 | (11 | ) | 4.8 | % | 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 | % | 216 | 199 | (17 | ) | 7.4 | % | 103 | 95 | (8 | ) | 4.3 | % | ||||||||||||||||||||||||||||||||||||||||
Other | 562 | 550 | (12 | ) | 7.9 | % | 268 | 248 | (20 | ) | 10.7 | % | 226 | 208 | (18 | ) | 7.8 | % | 136 | 122 | (14 | ) | 7.5 | % | ||||||||||||||||||||||||||||||||||||||||
Other securities | 295 | 287 | (8 | ) | 5.3 | % | 18 | 16 | (2 | ) | 1.1 | % | 302 | 281 | (21 | ) | 9.1 | % | 18 | 16 | (2 | ) | 1.1 | % | ||||||||||||||||||||||||||||||||||||||||
Total | $ | 3,413 | $ | 3,261 | $ | (152 | ) | 100.0 | % | $ | 2,399 | $ | 2,212 | $ | (187 | ) | 100.0 | % | $ | 2,993 | $ | 2,762 | $ | (231 | ) | 100.0 | % | $ | 2,399 | $ | 2,212 | $ | (187 | ) | 100.0 | % | ||||||||||||||||||||||||||||
Total general accounts | $ | 1,760 | $ | 1,619 | $ | (141 | ) | 75.4 | % | $ | 1,760 | $ | 1,619 | $ | (141 | ) | 75.4 | % | ||||||||||||||||||||||||||||||||||||||||||||||
Total guaranteed separate accounts [1] | $ | 639 | $ | 593 | $ | (46 | ) | 24.6 | % | $ | 639 | $ | 593 | $ | (46 | ) | 24.6 | % | ||||||||||||||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
51
The ABS securities in an unrealized loss position for six months or more as of March 31,June 30, 2004 and December 31, 2003, were primarily ABS securities supported by aircraft lease receivables CDOs and credit card receivables.corporate fixed maturities primarily within the financial services sector. The Company’s current view of risk factors relative to these fixed maturity types is as follows:
45
Aircraft lease receivables— DuringThe increase in the first quarterunrealized loss position from December 31, 2003 to June 30, 2004 was primarily the result of 2004, securities supportedrecent rating agency downgrades for certain issuers in this sector, partially offset by an upward trend and stabilization of prices of other aircraft lease receivables sustained a modest increase in value, continuing an upwardsecurities. This trend that began in the fourth quarter of 2003. This increase is primarily due to a modest improvement on certain aircraft lease rates, 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 travel and the uncertainty of a potential industry recovery. While the Company has seen modest price increases and greater liquidity in this sector during the first quarter of 2004, and fourth quarter of 2003, any additional price recovery will depend on continued improvement in economic fundamentals, political stability and airline operating performance.
CDOsFinancial services— Pricing levels for CDOs recovered modestly duringAs of June 30, 2004, the first quarter of 2004 due to an increase in demand for these asset types, driven by improved economic and operating fundamentals of the underlying security issuers, better market liquidity and attractive yields.
Credit card receivables— The decreaseCompany held approximately seventy different securities in the unrealized loss positionfinancial services sector that had been in credit card securities during the first quarter of 2004 is primarily the result of an increase in pricing levels, driven by an improvement in collateral performance. While the unrealized loss position has improved for these holdings, concerns remain regarding the long-term viability of certain issuers within this sub-sector.
As of 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 services sector.
Financial services— As of March 31, 2004, themonths. These securities in the financial services sector unrealized loss position for greater than six months were comprised of approximately 60 different securities. The securities in this category are primarily investment grade andwith the majority of these securities are priced at or greater than 90% of amortized cost as of March 31,June 30, 2004. These positions are primarilya mixture of fixed rate and variable rate securities with extended maturity dates, which have been adversely impacted by changes in interest rates. The increase in the reductionunrealized loss position for this sector since December 31, 2003 is primarily due to the increase in forward interest rates resultingadversely impacting the fixed rate securities partially offset by the variable rate securities which increased in lower expected cash flows. Unrealized loss amounts for these securities have increased during the first quarter of 2004value as interest rates have declined.rose. 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.
As part of the Company’s ongoing security monitoring process by a committee of investment and accounting professionals, the Company has reviewed its investment portfolio and concluded that there were no additional other-than-temporary impairments as of March 31,June 30, 2004 and December 31, 2003. Due to the issuers’ continued satisfaction of the 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 the issuers’ financial condition and other objective evidence, the Company believes that the prices of the securities in the sectors identified above were temporarily depressed.
The evaluation for other-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 are other-than-temporary. The risks and uncertainties include changes in general economic conditions, the issuer’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,June 30, 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’s unrealized loss aging for BIG and equity securities classified as available-for-sale on a consolidated basis, as of March 31,June 30, 2004 and December 31, 2003.
Consolidated Unrealized Loss Aging of Available-for-Sale BIG and Equity Securities
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||||||||||||
Cost | Value | Loss | Cost | Value | Loss | Cost | Value | Loss | Cost | Value | Loss | |||||||||||||||||||||||||||||||||||||
Three months or less | $ | 300 | $ | 292 | $ | (8 | ) | $ | 133 | $ | 129 | $ | (4 | ) | $ | 816 | $ | 779 | $ | (37 | ) | $ | 133 | $ | 129 | $ | (4 | ) | ||||||||||||||||||||
Greater than three months to six months | 43 | 41 | (2 | ) | 134 | 129 | (5 | ) | 156 | 143 | (13 | ) | 134 | 129 | (5 | ) | ||||||||||||||||||||||||||||||||
Greater than six months to nine months | 54 | 52 | (2 | ) | 81 | 73 | (8 | ) | 42 | 39 | (3 | ) | 81 | 73 | (8 | ) | ||||||||||||||||||||||||||||||||
Greater than nine months to twelve months | 75 | 67 | (8 | ) | 18 | 17 | (1 | ) | 48 | 47 | (1 | ) | 18 | 17 | (1 | ) | ||||||||||||||||||||||||||||||||
Greater than twelve months | 271 | 229 | (42 | ) | 417 | 349 | (68 | ) | 308 | 258 | (50 | ) | 417 | 349 | (68 | ) | ||||||||||||||||||||||||||||||||
Total | $ | 743 | $ | 681 | $ | (62 | ) | $ | 783 | $ | 697 | $ | (86 | ) | $ | 1,370 | $ | 1,266 | $ | (104 | ) | $ | 783 | $ | 697 | $ | (86 | ) | ||||||||||||||||||||
Total general accounts | $ | 663 | $ | 593 | $ | (70 | ) | $ | 663 | $ | 593 | $ | (70 | ) | ||||||||||||||||||||||||||||||||||
Total guaranteed separate accounts [1] | $ | 120 | $ | 104 | $ | (16 | ) | $ | 120 | $ | 104 | $ | (16 | ) | ||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
Similar to the decreaseincrease in the Consolidated Unrealized Loss Aging of Total Available-for-Sale Securities table from December 31, 2003 to March 31,June 30, 2004, the decreaseincrease in the BIG and equity security unrealized loss amount for securities classified as available-for-sale was primarily the result of an increase in long-term interest rates, partially offset by slightly improved pricing levels for ABS securities a decline in long-term interest rates and, to a lesser extent, asset sales. (For further discussion, see the economic
46
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 March 31,June 30, 2004 and December 31, 2003 are presented in the following table.
52
Consolidated Available-for-Sale BIG and Equity Securities with Unrealized Loss Greater Than Six Months by Type
March 31, 2004 | December 31, 2003 | June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Percent of | Percent of | Percent of | Percent of | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total | Total | Total | Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Unrealized | Amortized | Fair | Unrealized | Unrealized | Amortized | Fair | Unrealized | Unrealized | Amortized | Fair | Unrealized | Unrealized | |||||||||||||||||||||||||||||||||||||||||||||||||
Cost | Value | Loss | Loss | Cost | Value | Loss | Loss | Cost | Value | Loss | Loss | Cost | Value | Loss | Loss | |||||||||||||||||||||||||||||||||||||||||||||||||
ABS and CMBS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Aircraft lease receivables | $ | 31 | $ | 17 | $ | (14 | ) | 26.9 | % | $ | 55 | $ | 36 | $ | (19 | ) | 24.6 | % | $ | 38 | $ | 19 | $ | (19 | ) | 35.1 | % | $ | 55 | $ | 36 | $ | (19 | ) | 24.6 | % | ||||||||||||||||||||||||||||
CDOs | 22 | 21 | (1 | ) | 1.9 | % | 44 | 34 | (10 | ) | 13.0 | % | 22 | 21 | (1 | ) | 1.9 | % | 44 | 34 | (10 | ) | 13.0 | % | ||||||||||||||||||||||||||||||||||||||||
Credit card receivables | 42 | 38 | (4 | ) | 7.7 | % | 45 | 34 | (11 | ) | 14.3 | % | 34 | 33 | (1 | ) | 1.9 | % | 45 | 34 | (11 | ) | 14.3 | % | ||||||||||||||||||||||||||||||||||||||||
Other ABS and CMBS | 40 | 33 | (7 | ) | 13.6 | % | 59 | 49 | (10 | ) | 13.0 | % | 21 | 17 | (4 | ) | 7.4 | % | 59 | 49 | (10 | ) | 13.0 | % | ||||||||||||||||||||||||||||||||||||||||
Corporate | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Financial services | 143 | 125 | (18 | ) | 34.6 | % | 142 | 128 | (14 | ) | 18.2 | % | 151 | 134 | (17 | ) | 31.4 | % | 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 | % | 50 | 45 | (5 | ) | 9.3 | % | 76 | 70 | (6 | ) | 7.8 | % | ||||||||||||||||||||||||||||||||||||||||
Other | 60 | 58 | (2 | ) | 3.8 | % | 69 | 65 | (4 | ) | 5.2 | % | 67 | 62 | (5 | ) | 9.3 | % | 90 | 83 | (7 | ) | 9.1 | % | ||||||||||||||||||||||||||||||||||||||||
Other securities | 2 | 2 | — | — | 5 | 5 | — | — | 15 | 13 | (2 | ) | 3.7 | % | 5 | 5 | — | — | ||||||||||||||||||||||||||||||||||||||||||||||
Total | $ | 400 | $ | 348 | $ | (52 | ) | 100.0 | % | $ | 516 | $ | 439 | $ | (77 | ) | 100.0 | % | $ | 398 | $ | 344 | $ | (54 | ) | 100.0 | % | $ | 516 | $ | 439 | $ | (77 | ) | 100.0 | % | ||||||||||||||||||||||||||||
Total general accounts | $ | 417 | $ | 355 | $ | (62 | ) | 80.5 | % | $ | 417 | $ | 355 | $ | (62 | ) | 80.5 | % | ||||||||||||||||||||||||||||||||||||||||||||||
Total guaranteed separate accounts [1] | $ | 99 | $ | 84 | $ | (15 | ) | 19.5 | % | $ | 99 | $ | 84 | $ | (15 | ) | 19.5 | % | ||||||||||||||||||||||||||||||||||||||||||||||
[1] | Effective January 1, 2004, guaranteed separate account assets were included with general account assets as a result of adopting |
The decrease in the consolidated available-for-sale BIG and equity securities greater than six months unrealized loss amount since December 31, 2003 was primarily the result of improved pricing levels for ABS securities supported by CDOs and credit card receivables and, to a lesser extent, asset sales.
For aadditional discussion of the Company’s current view of risk factors relative to certain security types listed above, please refer to the Consolidated Total Available-for-Sale Securities with Unrealized Loss Greater Than Six Months by Type table in this section of the MD&A.
CAPITAL MARKETS RISK MANAGEMENT
The Hartford 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,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’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 the Company’s operations, as sales of variable products may decline and surrender activity may increase, as customer sentiment towards the equity market turns negative. Lower assets under management will have a negative impact on the Company’s financial results, primarily due to lower fee income related to the Retail Products Group and Institutional Solutions Group and, to a lesser extent, Individual Life segments, where a heavy concentration of equity 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,
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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’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 the
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Company’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 that period’s net income. Although an acceleration of DAC amortization would have a negative impact on the Company’s earnings, it would not affect the Company’s cash flow or liquidity position.
Additionally, the Retail Products Group segment 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. The Company currently reinsures a significant portion of these death benefit guarantees associated with its in-force block of business. The Company maintains a liability for the death benefit costs, net of reinsurance, of $117,$120, as of March 31,June 30, 2004. Declines in the equity market may increase the Company’s net exposure to death benefits under these contracts.
The Retail ProductsProduct Group segment’s total gross exposure (i.e. before reinsurance) to these guaranteed death benefits as of March 31,June 30, 2004 is $10.5$10.1 billion. Due to the fact that 80% of this amount is reinsured, the net exposure is $2.0 billion. This amount is often referred to as the net 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 addition, the Company offers certain variable annuity products with a GMWB rider. Declines in the equity market may increase the Company’s exposure to benefits under the 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 using 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, AsiaAustralasia and Far East (“EAFE”) Index swaps to hedge GMWB exposure to international equity markets. The hedging program involves a detailed monitoring of policyholder behavior and capital markets conditions on a daily basis and rebalancing of the hedge position as needed. While the Company actively manages this hedge position, hedge ineffectiveness may result due to factors including, but not limited to, policyholder behavior, capital markets dislocation or discontinuity and divergence between the performance of the underlying funds and the hedging indices.
The net impact of the change in value of the embedded derivative, net of the results of the hedging program was a $2 loss$4 gain before deferred policy acquisition costs and tax effects for the threesix months ended March 31,June 30, 2004.
Interest Rate Risk
The Company believes that the moderate increase in interest rates from the levels prevailing in the first quarter of 2004 is generally a favorable development for the Company. The rate increases are expected to provide additional net investment income, increased sales of fixed rate Life investment products, reduce the cost of the GMWB hedging program, limit the potential risk of margin erosion due to minimum guaranteed crediting rates in certain Life products and, if sustained through the end of 2004, could reduce the Company’s prospective pension expense. Conversely, a rise in interest rates will reduce the net unrealized gain position of the investment portfolio, increase interest expense on the Company’s variable rate debt obligations and, if long-term interest rates rise dramatically within a six to twelve month time period, certain Life businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders will surrender their contracts in a rising interest rate environment requiring the Company to liquidate assets in an unrealized loss position. To help mitigate disintermediation risk, the Company analyzes interest rate risk using various models including multi-scenario cash flow projections that forecast cash flows of the liabilities and their supporting investments, including derivative instruments. Measures used by the Company to quantify its exposure to interest rate risk inherent in its invested assets and interest rate sensitive liabilities are duration and key rate duration. In conjunction with the interest rate risk measurement and management techniques, significant portions of Life’s fixed income product offerings have market value adjustment provisions at contract surrender.
The Company believes that a gradual rise in interest rates should increase net investment income and sales of fixed rate Life investment products while the potential adverse consequences of increased rates, primarily the reduction of the investment portfolio’s net unrealized gain and disintermediation risk, is mitigated by the Company’s disciplined asset liability management techniques and product design.
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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, borrow funds at competitive rates and raise new capital to meet operating and growth needs.
Liquidity Requirements
The liquidity requirements of The Hartford have been and will continue to be met by funds from operations as well as the issuance of commercial paper, common stock, debt securities and borrowings 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.
The Hartford Financial Services Group, Inc. (“HFSG”) and HLI are holding companies which rely upon operating cash flow in the form 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 bysubject to statutory limitations established for 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,July 31, 2004, the Company’s insurance subsidiaries had paid $301$651 to HFSG and HLI and are permitted to pay up to a maximum of approximately $1.1 billion$705 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, and (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.
In January 2004, the Company issued approximately 6.7 million 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 $411. On March 9, 2004, the Company issued $200 of 4.75% senior notes due March 1, 2014. As of March 31,June 30, 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 29, 2001. As of March 31,June 30, 2004, HLI had $1.0 billion remaining on its shelf.
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Commercial Paper and Revolving Credit Facilities
The table below details the Company’s short-term debt programs and the applicable balances outstanding.
Outstanding | Outstanding | |||||||||||||||||||||||||||||||||||||||||||
As of | As of | |||||||||||||||||||||||||||||||||||||||||||
Effective | Expiration | Maximum | March 31, | December 31, | Effective | Expiration | Maximum | June 30, | December 31, | |||||||||||||||||||||||||||||||||||
Description | Date | Date | Available | 2004 | 2003 | Change | Date | Date | Available | 2004 | 2003 | Change | ||||||||||||||||||||||||||||||||
Commercial Paper | ||||||||||||||||||||||||||||||||||||||||||||
The Hartford | 11/10/86 | N/A | $ | 2,000 | $ | 373 | $ | 850 | (56 | %) | 11/10/86 | N/A | $ | 2,000 | $ | 373 | $ | 850 | (56 | %) | ||||||||||||||||||||||||
HLI | 2/7/97 | N/A | 250 | — | — | — | 2/7/97 | N/A | 250 | — | — | — | ||||||||||||||||||||||||||||||||
Total commercial paper | $ | 2,250 | $ | 373 | $ | 850 | (56 | %) | $ | 2,250 | $ | 373 | $ | 850 | (56 | %) | ||||||||||||||||||||||||||||
Revolving Credit Facility | ||||||||||||||||||||||||||||||||||||||||||||
5-year revolving credit facility | 6/20/01 | 6/20/06 | $ | 1,000 | $ | — | $ | — | — | 6/20/01 | 6/20/06 | $ | 1,000 | $ | — | $ | — | — | ||||||||||||||||||||||||||
3-year revolving credit facility | 12/31/02 | 12/31/05 | 490 | — | — | — | 12/31/02 | 12/31/05 | 490 | — | — | — | ||||||||||||||||||||||||||||||||
Total revolving credit facility | $ | 1,490 | $ | — | $ | — | — | $ | 1,490 | $ | — | $ | — | — | ||||||||||||||||||||||||||||||
Total Outstanding Commercial Paper and Revolving Credit Facility | $ | 3,740 | $ | 373 | $ | 850 | $ | (56 | %) | $ | 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.
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Capitalization
The capital structure of The Hartford as of March 31,June 30, 2004 and December 31, 2003 consisted of debt and equity, summarized as follows:
March 31, | December 31, | June 30, | December 31, | |||||||||||||||||||||
2004 | 2003 | Change | 2004 | 2003 | Change | |||||||||||||||||||
Short-term debt (includes current maturities of long-term debt) | $ | 573 | $ | 1,050 | (45 | %) | $ | 622 | $ | 1,050 | (41 | %) | ||||||||||||
Long-term debt | 4,580 | 4,613 | (1 | %) | 4,304 | 4,613 | (7 | %) | ||||||||||||||||
Total debt | $ | 5,153 | $ | 5,663 | (9 | %) | $ | 4,926 | $ | 5,663 | (13 | %) | ||||||||||||
Equity excluding accumulated other comprehensive income, net of tax (“AOCI”) | $ | 11,369 | $ | 10,393 | 9 | % | $ | 11,795 | $ | 10,393 | 13 | % | ||||||||||||
AOCI | 2,168 | 1,246 | 74 | % | 480 | 1,246 | (61 | %) | ||||||||||||||||
Total stockholders’ equity | $ | 13,537 | $ | 11,639 | 16 | % | $ | 12,275 | $ | 11,639 | 5 | % | ||||||||||||
Total capitalization including AOCI | $ | 18,690 | $ | 17,302 | 8 | % | $ | 17,201 | $ | 17,302 | (1 | %) | ||||||||||||
Debt to equity | 38 | % | 49 | % | 40 | % | 49 | % | (9 | %) | ||||||||||||||
Debt to capitalization | 28 | % | 33 | % | 29 | % | 33 | % | (4 | %) | ||||||||||||||
The Hartford’s total capitalization increased $1.4 billiondecreased $101 as of March 31,June 30, 2004 as compared with December 31, 2003. This increasedecrease was due to a decrease in debt offset by an increase in stockholders’ equity partially offset by a decrease in debt.equity. The increase in total stockholders’ equity is primarily due to an increase in AOCI of $922,the issuance of common stock of $411 and net income of $568.$1 billion, partially offset by a decrease in AOCI of $766. The increasedecrease in AOCI is primarily a result of an increasea decrease in unrealized gains of $574 and$990, partially offset by 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 senior notes of $200 and the redemption of $250 of junior subordinated debentures, partially offset by issuance of $199$200 in long-term debt.4.75% senior notes.
Debt
The following discussion describes the Company’s debt financing activities for the first quartersix months ended June 30, 2004.
During the six months ended June 30, 2004, the Company repaid $477 of 2004.commercial paper utilizing the proceeds from the equity offering and internal sources.
On June 15, 2004, HLI repaid $200 of 6.9% senior notes at maturity.
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
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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 6.3 million 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 $388. Subsequently, on January 30, 2004, The Hartford issued approximately 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. The Company used the proceeds from these issuances to repay $411 of commercial paper issued in connection with the acquisition of the group life and accident, and short-term and long-term disability business of CNA Financial Corporation.Acquisition.
Dividends— On February 19,May 20, 2004, The Hartford declared a dividend on its common stock of $0.28 per share payable on AprilJuly 1, 2004 to shareholders of record as of MarchJune 1, 2004.
On July 22, 2004, The Hartford declared a dividend on its common stock of $0.28 per share payable on October 1, 2004 to shareholders of record as of September 1, 2004.
AOCI-— AOCI increaseddecreased by $922$766 as of March 31,June 30, 2004 compared with December 31, 2003. The increasedecrease in AOCI is primarily a result of an increasea decrease in unrealized gains of $574 and$990, partially offset by Life’s adoption of SOP 03-1, in the first quarter of 2004 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 funded status of the Company’s pension and 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,June 30, 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 Hartford’s 2003 Form 10-K Annual Report.
Cash Flow
Six Months Ended | ||||||||||||||||
First Quarter Ended March 31, | June 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Net cash provided by operating activities | $ | 99 | $ | 667 | $ | 631 | $ | 1,336 | ||||||||
Net cash provided by (used for) investing activities | $ | 386 | $ | (1,607 | ) | $ | 195 | $ | (5,380 | ) | ||||||
Net cash provided by (used for) financing activities | $ | (307 | ) | $ | 1,216 | |||||||||||
Cash – end of period | $ | 638 | $ | 655 | ||||||||||||
Net cash provided by (used for) financing | $ | (591 | ) | $ | 4,092 | |||||||||||
activities Cash – end of period | $ | 695 | $ | 429 |
The decrease in cash from operating activities was primarily due to the resultdecrease in change in reserves including an asbestos reserve addition of the funding of $1.15$1.7 billion in settlement of the MacArthur litigation2003 partially offset by net income in 2004.2004 compared to a net loss in 2003. Investing activities increased primarily due to a $1.15 billion settlement of the MacArthur litigation in 2004 and decreased capital proceeds from financing activities compared to 2003. Financing activities decreased primarily due to decreased proceeds from investment and universal life-type contracts, anddecreased 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 increasedebentures in cash
50
from financing activities and settlement of the MacArthur litigation accounted for the majority of the change in cash from investing activities.2004 compared to 2003.
Operating cash flows for the quarterssix months ended March 31,June 30, 2004 and 2003 have been adequate to meet liquidity requirements.
Equity Markets
For a discussion of the potential impact of the equity markets on capital and liquidity, see the Capital 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’s ratings will continue for any given period of time or that they will not be changed. In the event the Company’s ratings are downgraded, the level of revenues or the persistency of the Company’s business may be adversely impacted.
The following table summarizes The Hartford’s significant member companies’ financial ratings from the major independent rating organizations as of AprilJuly 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 | — | |||||
Hartford Life and Annuity | A+ | AA | AA- | Aa3 | ||||
Hartford Life Insurance KK (Japan) | — | — | 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 |
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These ratings are not a recommendation to buy or hold any of The Hartford’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’s insurance companies.
March 31, | December 31, | June 30, | December 31, | |||||||||||||
(in billions) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
Life Operations | $ | 4.6 | $ | 4.5 | $ | 4.3 | $ | 4.5 | ||||||||
Property & Casualty Operations | 6.1 | 5.9 | 5.9 | 5.9 | ||||||||||||
Total | $ | 10.7 | $ | 10.4 | $ | 10.2 | $ | 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 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. RepresentativesThe Company continues to respond to requests for documents and information from representatives from the SEC’s Office of Compliance Inspections and Examinations continue to request documents and information in connection with their ongoing compliance examination.examinations regarding market timing and late trading, revenue sharing and directed brokerage, fees, fund service providers and transfer agents, and other mutual fund-related issues. 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 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 the future. If such an action is brought, it could have a material effect on the Company.
Like numerous other insurance carriers, The Hartford has received a subpoena from the New York Attorney General’s Office in connection with its inquiry into compensation arrangements between brokers and carriers. The Hartford is cooperating with the inquiry. Consistent with long-standing and wide-spread industry practice, The Hartford makes incentive compensation payments to brokers that may be based on the volume, growth and/or profitability of business placed with The Hartford. The Hartford expects the independent brokers with whom we work to comply with all applicable laws, including any concerning the disclosure of compensation arrangements. At this early stage, it is too soon to tell what impact, if any, the investigation will have on The Hartford.
The Financial Services Agency, the Company’s primary regulator in Japan, is considering new reserving methodologies and Solvency Margin Ratio (“SMR”) standards for variable annuity contracts. The industry and Institute of Actuaries of Japan (“IAJ”) have been consulting with the regulators on the development of the new methodologies and SMR standards. While there has been no formal time frame established, it is expected that the IAJ should conclude its discussions in September and new regulations could go into force as early as April 2005. Although the new reserve methodologies and SMR standards would only apply to capital requirements for Japanese regulatory purposes, it is possible in the future that the Company would need to provide additional capital to support its Japanese operations, which would lower the Company’s return on invested capital for this business. At this time, it is not possible to predict the final form of any reserve methodology or SMR standard changes.
For further information on other contingencies, see Note 16 of Notes to Consolidated Financial Statements included in The Hartford’s 2003 Form 10-K Annual Report.
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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.
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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 March 31,June 30, 2004.
Change in internal control over financial reporting
There was no change in the Company’s internal control over financial reporting that occurred during the firstsecond quarter ofended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal ProceedingsLEGAL 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 uncertainties discussed in Note 16 of Notes to Condensed Consolidated Financial Statements under the caption “Asbestos and Environmental Claims” in The Hartford’s 2003 Form 10-K 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 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,property and inland 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 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 Operations,” The Hartford continues to receive asbestos and environmental claims that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartford continually reviews its overall reserve levels methodologies and reinsurance coverages.coverages, as well as the methodologies it uses to estimate its exposures. Because of the significant uncertainties whichthat limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses, principallyparticularly 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.
Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND PURCHASES OF EQUITY SECURITIES BY THE ISSUER
Purchases of Equity Securities by the Issuer
The MacArthur Litigation– following table summarizes the Company’s repurchases of its common stock for the three months ended June 30, 2004: Total Number of Shares Purchased as Maximum Number of Part of Publicly Shares that May Yet Total Number of Average Price Paid Announced Plans or Be Purchased as Part Period Shares Purchased Per Share Programs of the Plans or Programs April 2004 1,390 1 $ 66.40 N/A N/A May 2004 3,145 1 $ 63.70 N/A N/A June 2004 975 1 $ 66.38 N/A N/A
(1) Represents shares acquired from employees of the Company for tax withholding purposes in connection with the Company’s benefit plans.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 20, 2004, The Hartford held its annual meeting of shareholders. The following matters were considered and voted upon: (1) the election of eleven directors, each to serve for a one-year term; (2) a proposal to ratify the appointment of the Company’s Independent Registered Public Accounting Firm, Deloitte & Touche LLP, for the fiscal year ended December 19, 2003, Hartford Accident31, 2004; and Indemnity Company (“Hartford A&I”) entered into(3) a conditional settlement to resolve all claimsshareholder proposal relating to general liability policies that Hartford A&I issuedexecutive compensation.
Only shareholders of record as of the close of business on March 22, 2004 were entitled to Mac Arthur Company and its subsidiary, Western MacArthur Company, both former regional distributorsvote at the annual meeting. As of asbestos products (collectively or individually, “MacArthur”), during the period 1967 to 1976. MacArthur had filed a pre-negotiated bankruptcy and planMarch 22, 2004, 291,638,836 shares of reorganization in November 2002 pursuant to a settlement with anothercommon stock of its 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 relatingwere outstanding and entitled to vote at 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 concerning Hartford A&I’s alleged obligations arising from MacArthur’s asbestos liability.annual meeting.
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Bancorp Services, LLC– InSet forth below is 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 confidentiality agreement, and misappropriation of trade secrets relatedvote tabulation relating to certain stable value corporate-owned life insurance products. The settlement provided that The Hartford would pay a minimum of $70 and a maximum of $80, depending on the outcome of a patent appeal,three items presented to resolve all disputes between the parties. The settlement resulted inshareholders at the recording of an additional charge of $40, after-tax, in the third quarter of 2003, reflecting the maximum amount payable under the settlement, and in November of 2003, The Hartford paid the initial $70 of the 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.annual meeting:
(1) | The shareholders elected each of the eleven nominees to the Board of Directors for a one-year term: |
Names of Director | Shares | |||||||
Nominees | Shares For | Withheld | ||||||
Ramani Ayer | 252,713,531 | 5,746,989 | ||||||
Ronald E. Ferguson | 255,370,567 | 3,089,953 | ||||||
Edward J. Kelly, III | 252,997,514 | 5,463,006 | ||||||
Paul G. Kirk, Jr. | 255,196,990 | 3,263,530 | ||||||
Thomas M. Marra | 255,283,647 | 3,176,873 | ||||||
Gail J. McGovern | 255,271,623 | 3,188,897 | ||||||
Robert W. Selander | 255,340,317 | 3,120,203 | ||||||
Charles B. Strauss | 255,361,224 | 3,099,296 | ||||||
H. Patrick Swygert | 255,256,100 | 3,204,420 | ||||||
Gordon I. Ulmer | 255,004,009 | 3,456,511 | ||||||
David K. Zwiener | 255,634,512 | 2,826,008 |
(2) | The shareholders ratified the appointment of the Company’s Independent Registered Public Accounting Firm: |
Shares For: | 255,167,079 | |||
Shares Against: | 1,624,820 | |||
Shares Abstained: | 1,668,621 |
(3) | The shareholders defeated a shareholder proposal relating to executive compensation: |
Shares For: | 20,130,164 | |||
Shares Against: | 211,305,658 | |||
Shares Abstained: | 4,481,902 | |||
Broker Non-Votes: | 22,542,796 |
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits and– See Exhibit Index.
(b) Reports on Form 8-K
During the second quarter ended March 31,June 30, 2004, the Company filed the followingno Current Reports on Form 8-K: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 Hartford Financial Services Group, Inc., Hartford Capital 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 Registration Statement on Form S-3 (File No. 333-108067), as amended, of The Hartford Financial Services Group, Inc., Hartford Capital IV, Hartford Capital V and Hartford Capital VI.
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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 | ||||
MayAugust 4, 2004
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THE HARTFORD FINANCIAL SERVICES GROUP, INC.
FOR THE FIRST QUARTERQUARTERLY PERIOD ENDED MARCH 31,JUNE 30, 2004
FORM 10-Q
EXHIBITS INDEX
Exhibit No. | Description | |
3.01 | Amended and Restated By-Laws of The Hartford, amended effective May 20, 2004. | |
10.01 | ||
10.02 | ||
10.03 | ||
The Hartford Incentive Stock Plan, as | ||
15.01 | Deloitte & Touche LLP Letter of Awareness. | |
31.01 | Certification of Ramani Ayer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.02 | Certification of David M. Johnson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.01 | Certification of Ramani Ayer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.02 | Certification of David M. Johnson pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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