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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 0-19277
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3317783
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
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[ ]
As of October 31, 2002, there were outstanding 255,152,830 shares of Common
Stock, $0.01 par value per share, of the registrant.
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INDEX
PAGE
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Independent Accountants' Review Report 3
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS 4
Consolidated Statements of Income - Third Quarter and Nine Months
Ended September 30, 2002 and 2001 4
Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 5
Consolidated Statements of Changes in Stockholders' Equity - Nine Months
Ended September 30, 2002 and 2001 6
Consolidated Statements of Cash Flows - Nine Months Ended September 30,
2002 and 2001 7
Notes to Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 42
ITEM 4. CONTROLS AND PROCEDURES 42
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 42
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 43
Signature 45
Certifications 46
- 2 -
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Stockholders
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have reviewed the accompanying consolidated balance sheet of The Hartford
Financial Services Group, Inc. and subsidiaries (the "Company") as of September
30, 2002, and the related consolidated statements of income for the third
quarter and nine months then ended, and changes in stockholders' equity and cash
flows for the nine months then ended. These consolidated financial statements
are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial information as of December 31, 2001, and
for the third quarter and nine months ended September 30, 2001, were not audited
or reviewed by us and, accordingly, we do not express an opinion or any other
form of assurance on them.
Deloitte & Touche LLP
Hartford, Connecticut
November 12, 2002
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
(IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
REVENUES
Earned premiums $ 2,650 $ 2,287 $ 7,609 $ 6,954
Fee income 627 654 1,961 1,942
Net investment income 729 714 2,161 2,124
Other revenue 115 121 348 362
Net realized capital losses (160) (54) (333) (91)
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TOTAL REVENUES 3,961 3,722 11,746 11,291
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BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 2,433 2,886 7,064 7,435
Amortization of deferred policy acquisition costs and present value
of future profits 568 556 1,696 1,630
Insurance operating costs and expenses 567 513 1,661 1,461
Goodwill amortization -- 15 -- 43
Other expenses 199 178 563 532
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TOTAL BENEFITS, CLAIMS AND EXPENSES 3,767 4,148 10,984 11,101
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INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGES 194 (426) 762 190
Income tax (benefit) expense (71) (323) 20 (207)
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INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 265 (103) 742 397
Cumulative effect of accounting changes, net of tax -- -- -- (34)
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NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
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BASIC EARNINGS (LOSS) PER SHARE
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 3.00 $ 1.69
Cumulative effect of accounting changes, net of tax -- -- -- (0.15)
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NET INCOME (LOSS) $ 1.06 $ (0.43) $ 3.00 $ 1.54
DILUTED EARNINGS (LOSS) PER SHARE [1]
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 2.96 $ 1.66
Cumulative effect of accounting changes, net of tax -- -- -- (0.14)
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NET INCOME (LOSS) $ 1.06 $ (0.43) $ 2.96 $ 1.52
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Weighted average common shares outstanding 248.9 238.0 247.4 235.6
Weighted average common shares outstanding and dilutive potential
common shares [1] 250.5 238.0 250.3 239.5
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Cash dividends declared per share $ 0.26 $ 0.25 $ 0.78 $ 0.75
====================================================================================================================================
<FN>
[1] In the absence of the third quarter 2001 net loss, 241.7 weighted average
common shares and dilutive potential common shares outstanding would have
been used in the calculation of diluted earnings per share for the quarter
ended September 30, 2001.
</FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 4 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2002 2001
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(Unaudited)
ASSETS
Investments
-----------
Fixed maturities, available for sale, at fair value (amortized cost of $45,616 and
$39,154) $ 48,085 $ 40,046
Equity securities, available for sale, at fair value (cost of $1,082 and $1,289) 985 1,349
Policy loans, at outstanding balance 2,980 3,317
Other investments 2,051 1,977
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Total investments 54,101 46,689
Cash 413 353
Premiums receivable and agents' balances 2,628 2,432
Reinsurance recoverables 5,046 5,162
Deferred policy acquisition costs and present value of future profits 6,853 6,420
Deferred income taxes 281 693
Goodwill 1,722 1,722
Other assets 2,962 3,044
Separate account assets 101,533 114,720
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TOTAL ASSETS $ 175,539 $ 181,235
=========================================================================================================================
LIABILITIES
Future policy benefits, unpaid claims and claim adjustment expenses
Property & Casualty $ 16,782 $ 16,678
Life 9,327 8,819
Other policyholder funds and benefits payable 22,336 19,355
Unearned premiums 3,973 3,436
Short-term debt 615 599
Long-term debt 2,595 1,965
Company obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures 1,461 1,412
Other liabilities 5,974 5,238
Separate account liabilities 101,533 114,720
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164,596 172,222
COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY
Common stock - par value $0.01, 750,000,000 and 400,000,000 shares authorized,
257,952,460 and 248,477,367 shares issued 3 2
Additional paid-in capital 2,766 2,362
Retained earnings 6,701 6,152
Treasury stock, at cost - 2,943,565 and 2,941,340 shares (37) (37)
Accumulated other comprehensive income 1,510 534
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TOTAL STOCKHOLDERS' EQUITY 10,943 9,013
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 175,539 $ 181,235
=========================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 5 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2002 Accumulated Other Comprehensive Income (Loss)
--------------------------------------------------
Common Net Gain on Minimum
Stock/ Unrealized Cash-Flow Cumulative Pension Outstanding
Additional Treasury Gain on Hedging Translation Liability Shares
Paid-in Retained Stock, Securities, Instruments, Adjustments, Adjustment, (In
(In millions) (Unaudited) Capital Earnings at Cost net of tax net of tax net of tax net of tax Total thousands)
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BALANCE, BEGINNING OF PERIOD $2,364 $6,152 $(37) $606 $63 $(116) $(19) $9,013 245,536
Comprehensive income
Net income 742 742
Other comprehensive income, net
of tax [1]
Unrealized gain on securities [2] 899 899
Net gain on cash-flow hedging
instruments [3] 81 81
Translation adjustments (4) (4)
--------
Total other comprehensive income 976
--------
Total comprehensive income 1,718
--------
Issuance of shares under incentive
and stock purchase plans 89 89 2,170
Issuance of common stock in
underwritten offering 330 330 7,303
Issuance of equity units (33) (33)
Tax benefit on employee stock
options and awards 19 19
Dividends declared on common stock (193) (193)
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BALANCE, END OF PERIOD $2,769 $6,701 $(37) $1,505 $144 $(120) $(19) $10,943 255,009
==================================================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2001 Accumulated Other Comprehensive Income (Loss)
--------------------------------------------------
Common Unrealized Net Gain on Minimum
Stock/ Gain Cash-Flow Cumulative Pension Outstanding
Additional Treasury (Loss) on Hedging Translation Liability Shares
Paid-in Retained Stock, Securities, Instruments, Adjustments, Adjustment, (In
(In millions) (Unaudited) Capital Earnings at Cost net of tax net of tax net of tax net of tax Total thousands)
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BALANCE, BEGINNING OF PERIOD $1,688 $5,887 $(480) $497 $-- $(113) $(15) $7,464 226,290
Comprehensive income
Net income 363 363
Other comprehensive income, net
of tax [1]
Cumulative effect of
accounting change [4] (1) 24 23
Unrealized gain on securities [2] 334 334
Net gain on cash-flow hedging
instruments [3] 68 68
Translation adjustments (10) (10)
-------
Total other comprehensive income 415
-------
Total comprehensive income 778
-------
Issuance of shares under incentive
and stock purchase plans 76 4 80 1,924
Issuance of common stock in
underwritten offering 169 446 615 10,000
Tax benefit on employee stock
options and awards 14 14
Treasury stock acquired (7) (7) (127)
Dividends declared on common stock (178) (178)
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BALANCE, END OF PERIOD $1,947 $6,072 $(37) $830 $92 $(123) $(15) $8,766 238,087
==================================================================================================================================
<FN>
[1] Unrealized gain (loss) on securities is net of tax expense of $484 and $180
for the nine months ended September 30, 2002 and 2001, respectively. Net
gain on cash-flow hedging instruments is net of tax expense of $44 and $37
for the nine months ended September 30, 2002 and 2001, respectively. For the
nine months ended September 30, 2001, cumulative effect of accounting change
is net of tax benefit of $12. Translation adjustments are net of tax
benefits of $2 and $5 for the nine months ended September 30, 2002 and 2001,
respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net income
of $(207) and $2 for the nine months ended September 30, 2002 and 2001,
respectively.
[3] Net of amortization adjustment of $3 and $5 to net investment income for the
nine months ended September 30, 2002 and 2001, respectively.
[4] For the nine months ended September 30, 2001, unrealized gain (loss) on
securities, net of tax, includes cumulative effect of accounting change of
$(23) to net income and $24 to net gain on cash-flow hedging instruments.
</FN>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
(IN MILLIONS) 2002 2001
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(Unaudited)
OPERATING ACTIVITIES
Net income $ 742 $ 363
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Change in receivables, payables and accruals (168) (54)
Change in reinsurance recoverables and other related assets 208 (527)
Amortization of deferred policy acquisition costs and present value of future profits 1,696 1,630
Additions to deferred policy acquisition costs and present value of future profits (2,129) (2,047)
Change in accrued and deferred income taxes 229 (210)
Increase in liabilities for future policy benefits, unpaid claims and claim adjustment
expenses and unearned premiums 1,086 1,866
Net realized capital losses 333 91
Depreciation and amortization 61 38
Cumulative effect of accounting changes, net of tax -- 34
Other, net 34 (125)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 2,092 1,059
================================================================================================================================
INVESTING ACTIVITIES
Purchase of investments (15,992) (12,512)
Sale of investments 8,304 7,523
Maturity of investments 2,033 2,139
Purchase of business/affiliate -- (1,105)
Sale of affiliates 3 15
Additions to property, plant and equipment (128) (141)
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NET CASH USED FOR INVESTING ACTIVITIES (5,780) (4,081)
================================================================================================================================
FINANCING ACTIVITIES
Issuance of short-term debt 16 --
Issuance of long-term debt 617 400
Issuance of company obligated mandatorily redeemable preferred securities of subsidiary
trusts holding solely junior subordinated debentures -- 200
Issuance of common stock in underwritten offering 330 615
Net proceeds from investment and universal life-type contracts 2,885 2,027
Dividends paid (192) (176)
Acquisition of treasury stock -- (7)
Proceeds from issuance of shares under incentive and stock purchase plans 84 61
- --------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,740 3,120
================================================================================================================================
Foreign exchange rate effect on cash 8 --
- --------------------------------------------------------------------------------------------------------------------------------
Net increase in cash 60 98
Cash - beginning of period 353 227
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CASH - END OF PERIOD $ 413 $ 325
================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
- ------------------------------------------------
NET CASH (RECEIVED) PAID DURING THE PERIOD FOR:
Income taxes $ (162) $ 37
Interest $ 167 $ 150
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 7 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions except per share and per unit data or unless
otherwise stated)
(Unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of The Hartford
Financial Services Group, Inc. and its subsidiaries ("The Hartford" or the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States of America. Less than majority-owned subsidiaries
in which The Hartford has at least a 20% interest are reported on the equity
basis.
In the opinion of management, these financial statements include all normal
recurring adjustments necessary to present fairly the consolidated financial
position, results of operations and cash flows for the periods presented.
On April 2, 2001, The Hartford acquired the U.S. individual life insurance,
annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis
Financial Group" or "Fortis"). The acquisition was accounted for as a purchase
transaction and, as such, the revenues and expenses generated by this business
from April 2, 2001 forward are included in the Company's Consolidated Statements
of Income.
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
(B) SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 1 of Notes to Consolidated
Financial Statements included in The Hartford's 2001 Form 10-K Annual Report.
(C) ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". Under historical guidance, all gains and losses
resulting from the extinguishment of debt were required to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
SFAS No. 145 rescinds that guidance and requires that gains and losses from
extinguishment of debt be classified as extraordinary items only if they are
both unusual and infrequent in occurrence. SFAS No. 145 also amends SFAS No. 13,
"Accounting for Leases" for the required accounting treatment of certain lease
modifications that have economic effects similar to sale-leaseback transactions.
SFAS No. 145 requires that those lease modifications be accounted for in the
same manner as sale-leaseback transactions. The provisions of SFAS No. 145
related to the rescission of SFAS No. 4 are applicable in fiscal years beginning
after May 15, 2002 and will be effective for The Hartford January 1, 2003.
Adoption of the provisions of SFAS No. 145 related to the rescission of SFAS No.
4 is not expected to have a material impact on the Company's consolidated
financial condition or results of operations. The provisions of SFAS No. 145
related to SFAS No. 13 are effective for transactions occurring after May 15,
2002. Adoption of the provisions of SFAS No. 145 related to SFAS No. 13 did not
have a material impact on the Company's consolidated financial condition or
results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 establishes an accounting model for
long-lived assets to be disposed of by sale that applies to all long-lived
assets, including discontinued operations. SFAS No. 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. The provisions of SFAS No. 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001. Adoption
of SFAS No. 144 did not have a material impact on the Company's consolidated
financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". SFAS No.
141 eliminates the pooling-of-interests method of accounting for business
combinations, requiring all business combinations to be accounted for under the
purchase method. Accordingly, net assets acquired are recorded at fair value
with any excess of cost over net assets assigned to goodwill.
SFAS No. 141 also requires that certain intangible assets acquired in a business
combination be recognized apart from goodwill. The provisions of SFAS No. 141
apply to all business combinations initiated after June 30, 2001. Adoption of
SFAS No. 141 did not have a material impact on the Company's consolidated
financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". Under SFAS No. 142, amortization of goodwill is precluded, however, its
recoverability must be periodically (at least annually) reviewed and tested for
impairment.
Goodwill must be tested at the reporting unit level for impairment in the year
of adoption, including an initial test performed within six months of adoption.
If the initial test indicates a potential impairment, then a more detailed
analysis to determine the extent of impairment must be completed within twelve
months of adoption.
During the second quarter of 2002, the Company completed the review and analysis
of its goodwill asset in accordance with the provisions of SFAS No. 142. The
result of the analysis indicated that each reporting unit's fair value exceeded
its carrying amount, including goodwill. As a result, goodwill for each
reporting unit was not considered impaired. Adoption of all other provisions of
SFAS No. 142 did not have a material impact on the Company's consolidated
financial condition or results of operations.
SFAS No. 142 also requires that useful lives for intangibles other than goodwill
be reassessed and remaining amortization periods be adjusted accordingly. (For
further discussion of the impact of SFAS No. 142, see Note 2.)
- 8 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
(D) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In July 2002, the FASB issued SFAS No. 146 "Accounting for Certain Costs
Associated with Exit or Disposal Activities", which nullifies Emerging Issues
Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 establishes a change in the
requirements for recognition of a liability for a cost associated with an exit
or disposal activity. This statement now requires liabilities to be recognized
when a company actually incurs the liability. Previously, under EITF Issue No.
94-3, liabilities were recognized at the date an entity committed to an exit
plan. Provisions of SFAS No. 146 are effective for activities initiated after
December 31, 2002. Adoption of this statement is not expected to have a material
impact on the Company's consolidated financial condition or results of
operations.
(E) EXPENSING STOCK OPTIONS
Beginning in January 2003, the Company will adopt the fair-value recognition
provisions of accounting for employee stock options under SFAS No. 123,
"Accounting for Stock-Based Compensation". The Company believes the use of the
fair-value method to record employee stock-based compensation expense is
consistent with the Company's accounting for all other forms of compensation.
This method of accounting for stock options will be used for all awards granted
or modified after January 1, 2003. The Company currently applies the intrinsic
value based provisions set forth in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". SFAS No. 123 permits companies
either to use the fair-value method and recognize compensation expense upon the
issuance of stock options, thereby lowering earnings, or, alternatively, to
disclose the pro-forma impact of the issuance. Under current accounting rules,
if the Company had expensed options issued in 2002, the impact on earnings for
the full year would have been approximately $0.08 to $0.09 per diluted share. If
future options grants remain at the same level, the annual impact would increase
to approximately $0.25 to $0.27 per diluted share, considering the Company's
three-year vesting period.
The FASB is conducting a fast-track project, which proposes three optional
transition methods for entities that decide to voluntarily adopt the fair value
recognition principles of SFAS No. 123 and modifies the disclosure requirements
of that Statement. Under the guidance contained in an exposure draft issued by
the FASB, entities would have the ability to select any one of the three
proposed transition methods. While the Company is committed to expensing the
fair value of its option grants, the ultimate transition method to be used by
the Company will be determined at the completion of the FASB project.
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142 and accordingly
ceased all amortization of goodwill.
The following tables show net income and earnings per share for the third
quarter and nine months ended September 30, 2002 and 2001, with the 2001 periods
adjusted for goodwill amortization recorded during the specified period.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------
NET INCOME (LOSS) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 265 $ (103) $ 742 $ 397
Goodwill amortization, net of tax -- 13 -- 38
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 265 (90) 742 435
Cumulative effect of accounting changes, net of tax -- -- -- (34)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 265 $ (90) $ 742 $ 401
===================================================================================================================================
BASIC EARNINGS (LOSS) PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 3.00 $ 1.69
Goodwill amortization, net of tax -- 0.05 -- 0.16
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 1.06 (0.38) 3.00 1.85
Cumulative effect of accounting changes, net of tax -- -- -- (0.15)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 1.06 $ (0.38) $ 3.00 $ 1.70
===================================================================================================================================
DILUTED EARNINGS (LOSS) PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 2.96 $ 1.66
Goodwill amortization, net of tax -- 0.05 -- 0.15
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 1.06 (0.38) 2.96 1.81
Cumulative effect of accounting changes, net of tax -- -- -- (0.14)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 1.06 $ (0.38) $ 2.96 $ 1.67
===================================================================================================================================
- 9 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no intangible assets with indefinite useful lives.
AS OF SEPTEMBER 30, 2002
----------------------------------------------
GROSS CARRYING ACCUMULATED NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION
- ------------------------------------------------------------------------------------------------------------------------------------
Present value of future profits $ 1,406 $ 244
Renewal rights 42 26
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 1,448 $ 270
====================================================================================================================================
Net amortization expense for the third quarter and nine months ended September
30, 2002 was $35 and $87, respectively.
Estimated future net amortization expense for the succeeding five years is as
follows.
For the year ended December 31,
- -------------------------------------- -- -----------
2002 $ 122
2003 $ 120
2004 $ 114
2005 $ 104
2006 $ 93
====================================== == ===========
The carrying amounts of goodwill as of September 30, 2002 and December 31, 2001
are shown below.
SEPTEMBER 30, 2002 DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life $ 796 $ 796
Property & Casualty 154 154
Corporate 772 772
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 1,722 $ 1,722
====================================================================================================================================
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES
The Company utilizes a variety of derivative instruments in the ordinary course
of business, including swaps, caps, floors, forwards and exchange traded futures
and options, to manage risk through 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
income enhancement and replication transactions. All of 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 and State of
New York insurance departments.
For a detailed discussion of the Company's use of derivative instruments, see
Note 1(e) of Notes to Consolidated Financial Statements included in The
Hartford's December 31, 2001 Form 10-K Annual Report.
As of September 30, 2002, the Company reported $329 of derivative assets in
other investments and $204 of derivative liabilities in other liabilities.
Cash-Flow Hedges
For the third quarter and nine months ended September 30, 2002, the Company's
gross gains and losses representing the total ineffectiveness of all cash-flow
hedges were immaterial, with the net impact reported as realized capital gains
or losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness.
Gains and losses on derivative contracts that are reclassified from other
comprehensive income to current period earnings are included in the line item in
the Consolidated Statements of Income in which the hedged item is recorded. As
of September 30, 2002, approximately $5 of after-tax deferred net gains on
derivative instruments accumulated in other comprehensive income are expected to
be reclassified to earnings during the next twelve months. 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 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-rate debt) is twelve months. As of September 30, 2002, the Company held
approximately $2.9 billion in derivative notional value related to strategies
categorized as cash-flow hedges. For the third quarter and nine months ended
September 30, 2002 and 2001, the net gain reclassifications from other
comprehensive income to earnings resulting from the discontinuance of cash-flow
hedges were immaterial.
- 10 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
Fair-Value Hedges
For the third quarter and nine months ended September 30, 2002, the Company's
gross gains and losses representing the total ineffectiveness of all fair-value
hedges were immaterial, with the net impact reported as realized capital gains
or losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness. As of September 30, 2002, the Company held
approximately $845 in derivative notional value related to strategies
categorized as fair-value hedges.
Other Risk Management Activities
The Company's other risk management activities primarily relate to strategies
used to reduce economic risk or enhance income, and do not receive hedge
accounting treatment. Swap agreements, interest rate cap and floor agreements
and option contracts are used to reduce economic risk. Income enhancement and
replication transactions include the use of written covered call options which
offset embedded equity call options, total return swaps and synthetic
replication of cash market instruments. The change in the value of all
derivatives held for other risk management purposes is reported in current
period earnings as realized capital gains or losses. As of September 30, 2002,
the Company held approximately $5.4 billion in derivative notional value related
to strategies categorized as Other Risk Management Activities.
NOTE 4. EARNINGS PER SHARE
The following tables present a reconciliation of net income and shares used in
calculating basic earnings per share to those used in calculating diluted
earnings per share.
Third Quarter Ended Nine Months Ended
-------------------------------------- -------------------------------------
Net Income Per Share Net Per Share
SEPTEMBER 30, 2002 (Loss) Shares Amount Income Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Income available to common shareholders $ 265 248.9 $ 1.06 $ 742 247.4 $ 3.00
============== ============
DILUTED EARNINGS PER SHARE
Options and contingently issuable shares -- 1.6 -- 2.9
------------------------ -------------------------
Income available to common shareholders plus assumed
conversions $ 265 250.5 $ 1.06 $ 742 250.3 $ 2.96
====================================================================================================================================
SEPTEMBER 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE
Income (loss) available to common shareholders $ (103) 238.0 $ (0.43) $ 363 235.6 $ 1.54
============== ============
DILUTED EARNINGS (LOSS) PER SHARE
Options and contingently issuable shares [1] -- -- -- 3.9
------------------------ -------------------------
Income (loss) available to common shareholders plus
assumed conversions [1] $ (103) 238.0 $ (0.43) $ 363 239.5 $ 1.52
====================================================================================================================================
<FN>
[1] As a result of the net loss in the quarter ended September 30, 2001, SFAS
No. 128, "Earnings Per Share", requires the Company to use basic weighted
average shares outstanding in the calculation of third quarter 2001
diluted earnings per share, as the inclusion of options and contingently
issuable shares of 3.7 would have been antidilutive to the earnings per
share calculation. In the absence of the net loss, weighted average common
shares outstanding and dilutive potential common shares would have totaled
241.7.
</FN>
Basic earnings per share reflects the actual weighted average number of shares
outstanding during the period. Diluted earnings per share includes the dilutive
effect of outstanding options, using the treasury stock method, and contingently
issuable shares. Under the treasury stock method, exercise of options is
assumed, with the proceeds used to repurchase common stock at the average market
price for the period. Contingently issuable shares are included upon
satisfaction of certain conditions related to the contingency.
NOTE 5. COMMITMENTS AND CONTINGENCIES
(A) 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 or as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation involving MacArthur Company and its subsidiary, Western MacArthur
Company, both former regional distributors of asbestos products (collectively or
individually, "MacArthur") in (d) below under the caption "Subsequent Events"
and the uncertainties discussed in (b) below under the caption "Asbestos and
Environmental Claims," management expects that the ultimate liability, if any,
with respect to such ordinary-course claims litigation, after consideration of
provisions made for potential losses and costs of defense, will not be material
to the consolidated financial condition, results of operations or cash flows of
The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial
- 11 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(A) LITIGATION (CONTINUED)
automobile, premises liability, and inland marine. The Hartford also is involved
in individual actions in which punitive damages are sought, such as claims
alleging bad faith in the handling of insurance claims. Management expects that
the ultimate liability, if any, with respect to such lawsuits, after
consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition of The Hartford.
Nonetheless, given the large or indeterminate amounts sought in certain of these
actions, and the inherent unpredictability of litigation, it is possible that an
adverse outcome in certain matters could, from time to time, have a material
adverse effect on the Company's consolidated results of operations or cash flows
in particular quarterly or annual periods.
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al. in favor of Bancorp in the amount of $118.
The case involved claims of patent infringement, misappropriation of trade
secrets, and breach of contract against HLIC and its affiliate International
Corporate Marketing Group, Inc. ("ICMG"). The judge dismissed the patent
infringement claim on summary judgment. The jury's award was based on the last
two claims. On August 28, 2002, the Court entered an order awarding Bancorp
prejudgment interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have moved the district court for, among other things, judgment as
a matter of law or a new trial, and intend to appeal the judgment if the
district court does not set it aside or substantially reduce it. In either
event, the Company's management, based on the opinion of its legal advisers,
believes that there is a substantial likelihood that the jury award will not
survive at its current amount. Based on the advice of legal counsel regarding
the potential outcome of this litigation, the Company recorded an $11 after-tax
charge in the first quarter of 2002 to increase litigation reserves associated
with this matter. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future
related to this matter.
The Company is involved in arbitration with one of its primary reinsurers
relating to policies with death benefit guarantees written from 1994 to 1999.
The arbitration involves alleged breaches under the reinsurance treaties.
Although the Company believes that its position in this pending arbitration is
strong, an adverse outcome could result in a decrease to the Company's statutory
surplus and capital and potentially increase the death benefit costs incurred by
the Company in the future. The arbitration hearing began in October 2002.
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from asbestos and
environmental-related exposures. Asbestos claims relate primarily to 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 Hartford receives asbestos and environmental claims made pursuant to several
different categories of insurance coverage. First, The Hartford wrote policies
as a primary liability insurance carrier. Second, The Hartford wrote excess
insurance policies that provide additional coverage for insureds that exhaust
their primary liability insurance coverage. Third, The Hartford acted as a
reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Writers of excess insurance
and reinsurance often receive information regarding potential exposures
significantly later than primary writers covering the same risk. The Hartford
may experience more difficulty and delays in estimating its exposures arising
from excess and reinsurance policies than it does in estimating exposures
arising from its activity as a primary insurance writer.
With regard to both environmental and particularly asbestos claims, uncertainty
exists which affects the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty 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. There are complex legal issues concerning
the interpretation of various insurance policy provisions and whether those
losses are, or were ever intended to be, covered. Courts have reached
inconsistent conclusions as to when losses are deemed to have occurred and which
policies provide coverage; what types of losses are covered; whether there is an
insurer obligation to defend; how policy limits are determined; whether or not
particular claims are product/completed operation claims subject to an aggregate
limit and how policy exclusions and conditions are applied and interpreted.
Furthermore, insurers in general, including The Hartford, have recently
experienced an increase in the number of asbestos-related claims due to, among
other things, more intensive advertising by lawyers seeking asbestos claimants,
the increasing focus by plaintiffs on new and previously peripheral defendants
and an increase in the number of entities seeking bankruptcy protection as a
result of asbestos-related liabilities. Plaintiffs and insureds have sought to
utilize bankruptcy proceedings to accelerate and increase loss payments by
insurers. In addition, new classes of claims have been arising whereby some
asbestos-related defendants are asserting that their asbestos-related claims
fall within so-called non-products liability coverage contained within their
policies rather than products liability coverage and that the claimed
non-products coverage is not subject to any aggregate limit. Recently, many
insurers, including, in a limited number of instances, 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. An adverse
determination of issues
- 12 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS (CONTINUED)
relating to The Hartford's liability for asbestos claims could have a material
adverse effect on The Hartford's results of operations, financial condition and
liquidity.
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
paying claims for more traditional areas of insurance exposure are less
effective in estimating the necessary reserves for its asbestos exposures. The
Hartford continually evaluates new information and new methodologies to use in
evaluating its potential asbestos exposures. At any time, including the current
reporting period, The Hartford may be conducting one or more evaluations of
individual exposures, classes of exposures or all of its current and potential
exposures to asbestos claims. At any time analysis of newly identified
information or completion of one or more analyses could cause The Hartford to
change its estimates of its asbestos exposures and the effect of these changes
could be material to the Company's consolidated operating results and financial
condition in future periods.
Reserves and reserve activity in the Other Operations segment are categorized
and reported as either Asbestos, Environmental, or All Other activity.
Constantly evolving legal theories create significant uncertainties with respect
to what types of claims may ultimately arise from the generally older policies
and liabilities managed in the Other Operations segment. The Hartford's
experience has been that while this group of policies has over time produced
significantly higher claims and losses than were initially contemplated at
inception, the areas of active claim activity have shifted over time 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, but not
limited to, situations where The Hartford has commuted 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 variability and
uncertainty.
Consistent with the reports of other insurers, The Hartford has been
experiencing an increase in the number of new asbestos claims by policyholders
not previously identified as potentially significant claimants, including
installers or handlers of asbestos-containing products. In addition, new classes
of claims are beginning to arise whereby some asbestos-related defendants are
asserting that their asbestos-related claims fall within so-called non-products
liability coverage contained within their policies rather than products
liability coverage and that the claimed non-products coverage is not subject to
any aggregate limit. (An example of these non-products claims is presented in
the MacArthur litigation discussed in (d) below.)
On May 14, 2002, The Hartford announced its participation, along with several
dozen other insurance carriers, in a settlement in principle with its insured,
PPG Industries ("PPG"), of litigation arising from asbestos exposures involving
Pittsburgh Corning Corporation ("Pittsburgh Corning"), which is 50% owned by
PPG. The structure of the settlement will allow The Hartford to make fixed
payments to a settlement trust over a 20-year period beginning in 2004 and
allows The Hartford to prepay its obligations at any time at a fixed discount
rate of 5.5%. The settlement is subject to a number of contingencies, including
the negotiation of a definitive agreement among the parties and approval of the
bankruptcy court supervising the reorganization of Pittsburgh Corning. The
Hartford estimated the settlement amount to be approximately $130 (non
tax-effected) on a discounted basis and net of anticipated reinsurance
recoveries. The settlement was covered by existing asbestos reserves, and as a
result, did not have a material impact on The Company's consolidated financial
condition or results of operations.
As of September 30, 2002, the Company reported $1,133 and $642 of net Asbestos
and Environmental reserves, respectively. Based on currently known facts and the
Company's methodologies for estimating asbestos and environmental reserves, The
Hartford believes that the level of recorded reserves at September 30, 2002 is
reasonable and appropriate. Because of the significant uncertainties described
in this Note 5, principally those related to asbestos, the ultimate liabilities
may exceed the currently recorded reserves. Any such additional liability (or
any range of additional amounts) cannot be reasonably estimated now but could be
material to The Hartford's future consolidated operating results and financial
condition. Consistent with the Company's longstanding reserving practices, The
Hartford will continue to regularly review and monitor these reserves and, where
future circumstances indicate, make appropriate adjustments to the reserves.
(C) TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). Throughout the audit of the 1996-1997 years, the
Company and the IRS have been engaged in an ongoing dispute regarding what
portion of the separate account dividends-received deduction ("DRD") is
deductible by the Company. During 2001 the Company continued its discussions
with the IRS. As part of the Company's due diligence with respect to this issue,
the Company closely monitored the activities of the IRS with respect to other
taxpayers on this issue and consulted with outside tax counsel and advisors on
the merits of the Company's separate account DRD. The due diligence was
completed during the third quarter of 2001 and the Company concluded that it was
probable that a greater portion of the separate account DRD claimed on its filed
returns would be realized. Based on the Company's assessment of the probable
outcome, the Company concluded an additional $130 tax benefit was appropriate to
record in the third quarter of 2001, relating to the tax years 1996-2000.
Additionally, the Company increased its estimate of the separate account DRD
recognized with respect to tax year 2001 from $44 to $60.
- 13 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(C) TAX MATTERS (CONTINUED)
Earlier in 2002, the Company and its IRS agent requested advice from the
National Office of the IRS with respect to certain aspects of the computation of
the separate account DRD that had been claimed by the Company for the 1996-1997
audit period. During September 2002 the IRS National Office issued a ruling that
confirmed that the Company had properly computed the items in question in the
separate account DRD claimed on its 1996-1997 tax returns. Additionally, during
the third quarter, the Company reached agreement with the IRS on all other
issues with respect to the 1996-1997 tax years. The Company recorded a benefit
of $76 during the third quarter of 2002, primarily relating to the tax treatment
of such issues for the 1996-1997 tax years, as well as appropriate carryover
adjustments to the 1998-2002 years. The Company will continue to monitor further
developments surrounding the computation of the separate account DRD, as well as
other items, and will adjust its estimate of the probable outcome of these
issues as developments warrant. 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.
(D) SUBSEQUENT EVENTS
On October 7, 2002, an action was filed in the Superior Court in Alameda County,
California, against Hartford Accident & Indemnity Company ("Hartford A&I"), a
subsidiary of the Company, and two other insurers. The principal plaintiffs are
MacArthur Company and its subsidiary, Western MacArthur Company, both former
regional distributors of asbestos products (collectively or individually,
"MacArthur"). MacArthur seeks a declaration of coverage and damages for asbestos
bodily-injury claims. Five asbestos claimants who allegedly have obtained
default judgments against MacArthur also are joined as plaintiffs; they seek to
recover the amount of their default judgments and additional damages directly
from the defendant insurers and assert a right to an accelerated trial.
Hartford A&I issued primary general liability policies to MacArthur during the
period 1967-76. MacArthur sought coverage for asbestos-related claims from
Hartford A&I under these policies beginning in 1978. During the period 1978 to
1987, Hartford A&I paid out its full aggregate limits under these policies plus
defense costs. In 1987, Hartford A&I notified MacArthur that its available
limits under these policies had been exhausted, and MacArthur ceased submitting
claims to Hartford A&I under these policies.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization that MacArthur is to file. USF&G provided at
least 12 years of primary general liability coverage to MacArthur, but, unlike
Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date.
MacArthur seeks additional coverage from Hartford A&I on the theory that
Hartford A&I has exhausted only its products aggregate limit of liability, not
separate limits MacArthur alleges to be available for non-products liability.
The ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current and future claims, is currently unknown.
MacArthur indicates in its complaint that it will seek to have the full amount
of its current and future asbestos liability estimated in its anticipated
bankruptcy proceeding. If such an estimation is made, MacArthur intends to seek
a judgment against the defendants for the amount of its total liability,
including estimated claims, less the amount ultimately paid by St. Paul.
Hartford A&I intends to defend the MacArthur action vigorously. Based on the
information currently available, management believes that Hartford A&I's
liability, if any, to MacArthur will not be finally resolved for at least a year
and most probably not for several years. In the opinion of management, the
ultimate outcome is highly uncertain for many reasons. It is not yet known, for
example, in which venue Hartford A&I's liability, if any, will be determined;
whether Hartford A&I's defenses based on MacArthur's long delay in asserting
claims for further coverage will be successful; how other significant coverage
defenses will be decided; or the extent to which the claims and default
judgments against MacArthur involve injury outside of the products and completed
operations hazard definitions of the policies. In the opinion of management, an
adverse outcome could have a material adverse effect on the Company's results of
operations, financial condition and liquidity.
NOTE 6. SEGMENT INFORMATION
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to the June 27, 2000 acquisition of all
of the outstanding shares of Hartford Life, Inc. ("HLI") that the Company did
not already own ("The HLI Repurchase") are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Investment Products offers individual variable and fixed annuities, mutual
funds, retirement plan services and other investment products. Individual Life
sells a variety of life insurance products, including variable life, universal
life and term life insurance. Group Benefits sells group insurance products,
including group life and group disability insurance as well as other products,
including 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. COLI primarily
offers variable products used by employers to fund non-qualified benefits or
other postemployment benefit obligations as well as leveraged COLI. Life also
includes in an Other category its international operations, which are primarily
located in Latin America and Japan, as well as corporate
- 14 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
items not directly allocable to any of its reportable operating segments,
principally interest expense.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance (collectively, "North American"); and the
Other Operations segment, which includes substantially all of the Company's
asbestos and environmental exposures.
Business Insurance provides standard commercial insurance coverage to small
commercial and middle market insureds. This segment also provides commercial
risk management products and services to small and mid-sized members of affinity
groups in addition to marine coverage. 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. In addition, Specialty Commercial provides third party
administrator services for claims administration, integrated benefits, loss
control and performance measurement through Specialty Risk Services. The
Reinsurance segment assumes reinsurance mainly in North America and primarily
writes treaty reinsurance through professional reinsurance brokers covering
various property, casualty, specialty and marine classes of business. 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 Other Operations segment results also include activity for the
Company's international property and casualty businesses up until their dates of
sale, and for 2002 include the activity in the exited international lines of
HartRe as a result of its restructuring in October 2001. (For further discussion
of this restructuring, see Note 9.)
The measure of profit or loss used by The Hartford's management in evaluating
performance is operating income, except for its North American underwriting
segments, which 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. "Operating
income" is defined as after-tax operational results excluding, as applicable,
net realized capital gains or losses, the cumulative effect of accounting
changes and certain other items. While not considered segments, the Company also
reports and evaluates operating income results for Life, Property & Casualty and
North American. Property & Casualty includes operating income for North American
and the Other Operations segment. North American includes the combined
underwriting results of the North American underwriting segments along with
income and expense items not directly allocable to these segments, such as net
investment income.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided and capital contributions. Certain reinsurance stop loss agreements
exist between the segments which specify that one segment will reimburse another
for losses incurred in excess of a predetermined limit. Also, one segment may
purchase group annuity contracts from another to fund pension costs and claim
annuities to settle casualty claims. In addition to the above transactions,
certain intersegment transactions occur in Life. These transactions include
interest income on allocated surplus and the allocation of net realized capital
gains and losses through net invested income utilizing the duration of the
segment's investment portfolios.
The following tables present revenues and operating income (loss). Underwriting
results are presented for the Business Insurance, Personal Lines, Specialty
Commercial and Reinsurance segments, while operating income is presented for all
other segments, along with Life and Property & Casualty, including North
American.
- 15 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
REVENUES
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 637 $ 622 $ 1,946 $ 1,869
Individual Life 239 236 720 639
Group Benefits 645 617 1,943 1,871
COLI 145 171 451 536
Other (125) (41) (252) (25)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 1,541 1,605 4,808 4,890
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Earned premiums and other revenue
Business Insurance 795 680 2,293 1,940
Personal Lines 789 732 2,308 2,157
Specialty Commercial 414 334 1,037 922
Reinsurance 178 220 521 699
Ceded premiums related to September 11 -- (114) -- (114)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American earned premiums and other revenue 2,176 1,852 6,159 5,604
Net investment income 225 227 676 679
Net realized capital losses (28) (4) (49) (28)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 2,373 2,075 6,786 6,255
Other Operations 42 38 138 133
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 2,415 2,113 6,924 6,388
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate 5 4 14 13
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 3,961 $ 3,722 $ 11,746 $ 11,291
====================================================================================================================================
- 16 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
OPERATING INCOME THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 100 $ 116 $ 335 $ 344
Individual Life 33 30 99 86
Group Benefits 34 26 92 76
COLI 10 8 20 27
Other 55 102 40 86
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 232 282 586 619
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Underwriting results
Business Insurance 21 6 17 (7)
Personal Lines (13) (17) (48) (44)
Specialty Commercial 3 (18) 1 (56)
Reinsurance (4) (47) (17) (109)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 7 (76) (47) (216)
September 11 -- (647) -- (647)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American underwriting results 7 (723) (47) (863)
Net servicing and other income [1] 4 5 7 17
Net investment income 225 227 676 679
Other expenses (75) (50) (184) (153)
Income tax (expense) benefit (23) 222 (73) 209
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 138 (319) 379 (111)
Other Operations 1 -- 2 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 139 (319) 381 (109)
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate (6) (15) (18) (47)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) 365 (52) 949 463
Cumulative effect of accounting changes, net of tax -- -- -- (34)
Net realized capital losses, after-tax (100) (51) (207) (66)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
====================================================================================================================================
<FN>
[1] Net of expenses related to service business.
</FN>
NOTE 7. DEBT
On September 13, 2002 The Hartford issued 6.6 million 6% equity units at a price
of $50.00 per unit and received net proceeds of $319.
Each equity unit offered initially consists of a corporate unit with a stated
amount of $50.00 per unit. Each corporate unit consists of one purchase contract
for the sale of a certain number of shares of the Company's stock and fifty
dollars principal amount of senior notes due November 16, 2008.
The corporate unit may be converted by the holder into a treasury unit
consisting of the purchase contract and a 5% undivided beneficial interest in a
zero-coupon U.S. Treasury security with a principal amount of one thousand
dollars that matures on November 15, 2006. The holder of an equity unit owns the
underlying senior notes or treasury portfolio but has pledged the senior notes
or treasury portfolio to the Company to secure the holder's obligations under
the purchase contract.
The purchase contract obligates the holder to purchase, and obligates The
Hartford to sell, on November 16, 2006, for fifty dollars, a variable number of
newly issued common shares of The Hartford. The number of The Hartford's shares
to be issued will be determined at the time the purchase contracts are settled
based upon the then current applicable market value of The Hartford's common
stock. If the applicable market value of The Hartford's common stock is equal to
or less than $47.25, then the Company will deliver 1.0582 shares to the holder
of the equity unit, or an aggregate of 7.0 million shares. If the applicable
market value of The Hartford's common stock is greater than $47.25 but less than
$57.645, then the Company will deliver the number of shares equal to fifty
dollars divided by the then current applicable market value of The Hartford's
common stock to the holder. Finally, if the applicable market value of The
Hartford's common
- 17 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. DEBT (CONTINUED)
stock is equal to or greater than $57.645, then the Company will deliver 0.8674
shares to the holder, or an aggregate of 5.7 million shares. Accordingly, upon
settlement of the purchase contracts on November 16, 2006, The Hartford will
receive proceeds of approximately $330 and will deliver between 5.7 million and
7.0 million common shares in the aggregate. The proceeds will be credited to
stockholders' equity and allocated between the common stock and additional
paid-in-capital accounts. The Hartford will make quarterly contract adjustment
payments to the equity unit holders at a rate of 1.90% of the stated amount per
year until the purchase contract is settled.
Each corporate unit also includes fifty dollars principal amount of senior notes
that will mature on November 16, 2008. The aggregate maturity value of the
senior notes is $330. The notes are pledged by the holders to secure their
obligations under the purchase contracts. The Hartford will make quarterly
interest payments to the holders of the notes initially at an annual rate of
4.10%. On August 11, 2006, the notes will be remarketed. At that time, The
Hartford's remarketing agent will have the ability to reset the interest rate on
the notes in order to generate sufficient remarketing proceeds to satisfy the
holder's obligation under the purchase contract. In the event of an unsuccessful
remarketing, the Company will exercise its rights as a secured party to obtain
and extinguish the notes.
The total distributions payable on the equity units are at an annual rate of
6.0%, consisting of interest (4.10%) and contract adjustment payments (1.90%).
The corporate units are listed on the New York Stock Exchange under the symbol
"HIG PrA".
The present value of the contract adjustment payments of $24 was accrued upon
the issuance of the equity units as a charge to additional paid-in capital and
are included in other liabilities in the accompanying consolidated balance sheet
as of September 30, 2002. Subsequent contract adjustment payments will be
allocated between this liability account and interest expense based on a
constant rate calculation over the life of the transaction. Additional paid-in
capital as of September 30, 2002, also reflected a charge of $9 representing a
portion of the equity unit issuance costs that was allocated to the purchase
contracts.
The equity units have been reflected in the diluted earnings per share
calculation using the treasury stock method, which would be used for the equity
units at any time before the settlement of the purchase contracts. Under the
treasury stock method, the number of shares of common stock used in calculating
diluted earnings per share is increased by the excess, if any, of the number of
shares issuable upon settlement of the purchase contracts over the number of
shares that could be purchased by The Hartford in the market, at the average
market price during the period, using the proceeds received upon settlement. The
Company anticipates that there will be no dilutive effect on its earnings per
share related to the equity units, except during periods when the average market
price of a share of the Company's common stock is above the threshold
appreciation price of $57.645. Because the average market price of The
Hartford's common stock during the quarter ended September 30, 2002, was below
this threshold appreciation price, the shares issuable under the purchase
contract component of the equity units have not been included in the diluted
earnings per share calculation.
On August 29, 2002 The Hartford issued 4.7% senior notes due September 1, 2007
and received net proceeds of $298. Interest on the notes is payable
semi-annually on March 1 and September 1, commencing on March 1, 2003. The
Company used the proceeds to repay senior notes that matured on November 1,
2002.
NOTE 8. STOCKHOLDERS' EQUITY
On September 13, 2002, The Hartford issued approximately 7.3 million shares of
common stock pursuant to an underwritten offering at a price of $47.25 per share
and received net proceeds of $330. Also on September 13, 2002, The Hartford
issued 6.6 million 6% equity units. Each equity unit contains a purchase
contract obligating the holder to purchase and The Hartford to sell, a variable
number of newly-issued shares of The Hartford's common stock. Upon settlement of
the purchase contracts on November 16, 2006, The Hartford will receive proceeds
of approximately $330 and will deliver between 5.7 million and 7.0 million
shares in the aggregate. (For further discussion of this issuance, see Note 7.)
At the Company's annual meeting of shareholders held on April 18, 2002,
shareholders approved an amendment to Section (a) Article Fourth of the Amended
and Restated Certificate of Incorporation to increase the aggregate authorized
number of shares of common stock from 400 million to 750 million.
NOTE 9. RESTRUCTURING
During the fourth quarter of 2001, the Company approved and implemented plans
for restructuring the operations of both HartRe and The Hartford Bank, FSB ("The
Hartford Bank"). HartRe announced a restructuring of its entire international
and domestic operations, with the purpose of centralizing the underwriting
organization in Hartford, Connecticut. Also, the Boards of Directors for both
The Hartford Bank and The Hartford Financial Services Group, Inc. approved The
Hartford Bank's dissolution plan. Both plans will be completed during 2002.
As a result of these restructuring plans, the Company recorded a 2001 pre-tax
charge and accrual of approximately $16. This amount included $8 in
employee-related costs, $5 in occupancy-related costs and the remaining $3 in
other restructuring costs.
The 79 employees terminated under these restructuring plans primarily relate to
all levels of the underwriting and claims areas. The occupancy-related costs
represent the remaining lease liabilities for both the domestic and
international offices of HartRe to be closed pursuant to the restructuring plan.
As of September 30, 2002, the Company has paid approximately $5 in
employee-related restructuring costs, $1 in occupancy related costs and $1 in
other restructuring costs.
- 18 -
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 September 30, 2002, compared with December 31, 2001, and its
results of operations for the third quarter and nine months ended September 30,
2002, compared with the equivalent 2001 periods. This discussion should be read
in conjunction with the MD&A in The Hartford's 2001 Form 10-K Annual Report.
Certain of the statements contained herein (other than statements of historical
fact) 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, in particular, significant uncertainty with
regard to the outcome of the Company's current dispute with MacArthur Company
and its subsidiary, Western MacArthur Company (collectively or individually,
"MacArthur"); the uncertain nature of damage theories and loss amounts and the
development of additional facts related to the September 11 terrorist attack
("September 11"); the response of reinsurance companies under reinsurance
contracts, the impact of increasing reinsurance rates, and the adequacy of
reinsurance to protect the Company against losses; the possibility of more
unfavorable loss experience than anticipated; the possibility of general
economic and business conditions that are less favorable than anticipated; the
incidence and severity of catastrophes, both natural and man-made; the effect of
changes in interest rates, the stock markets or other financial markets;
stronger than anticipated competitive activity; unfavorable legislative,
regulatory or judicial developments; the Company'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.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
- --------------------------------------------------------------------------------
INDEX
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Critical Accounting Policies 19
Consolidated Results of Operations: Operating Summary 22
Life 24
Investment Products 26
Individual Life 26
Group Benefits 27
Corporate Owned Life Insurance ("COLI") 27
Property & Casualty 28
Business Insurance 29
Personal Lines 29
Specialty Commercial 30
Reinsurance 31
Other Operations (Including Asbestos and
Environmental Claims) 31
Investments 34
Capital Markets Risk Management 36
Capital Resources and Liquidity 39
Accounting Standards 42
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, 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 policies as critical accounting
policies because they involve a higher degree of judgment. In applying these
policies management makes subjective and complex judgments that frequently
require estimates about matters that are inherently uncertain. Although
variability is inherent in these estimates, management believes the amounts
provided are appropriate based upon the facts available at the time.
DEFERRED ACQUISITION COSTS
LIFE
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years.
Deferred policy acquisition costs ("DAC") related to investment contracts and
universal life-type contracts are deferred and amortized using the retrospective
deposit method. Under the retrospective deposit method, acquisition costs are
amortized in proportion to the present value of expected gross profits from
- 19 -
investment, mortality and expense margins and surrender charges. Actual gross
profits vary from management's estimates, resulting in increases or decreases in
the rate of amortization. Management periodically reviews these estimates and
evaluates the recoverability of the deferred acquisition cost asset. When
appropriate, management revises its assumptions on the estimated gross profits
of these contracts and the cumulative amortization for the books of business are
re-estimated and adjusted by a cumulative charge or credit to income. The
average long-term rate of assumed investment yield used in estimating expected
gross profits related to variable annuity and variable life business was 9.0% at
September 30, 2002, and for all other products including fixed annuities and
other universal life-type contracts the average assumed investment yield ranged
from 5.0% - 8.5%.
Deferred policy acquisition costs related to traditional policies are amortized
over the premium-paying period of the related policies in proportion to the
ratio of the present value of annual expected premium income to the present
value of total expected premium income. Adjustments are made each year to
recognize actual experience as compared to assumed experience for the current
period.
To date, our experience has generally been comparable to the assumptions used in
determining DAC amortization. However, if the Company was to experience a
material adverse deviation in certain critical assumptions, including surrender
rates, mortality experience, or investment performance, there could be a
negative effect on the Company's consolidated results of operations or financial
condition.
PROPERTY & CASUALTY
The Property & Casualty operations also incur costs related to the acquisition
of new and renewal insurance policies. These costs include agent and broker
commissions, premium taxes and certain other underwriting expenses. These costs
are deferred and amortized over policy terms. Estimates of the present value of
future revenues, including net investment income and tax benefits, are compared
to estimates of the present value of future costs, including amortization of
policy acquisition costs, to determine if the deferred acquisition costs are
recoverable, and if not, they are charged to expense. For the third quarter and
nine months ended September 30, 2002 and 2001 no material amounts of deferred
acquisition costs were charged to expense based on the results of these
estimates of recoverability.
RESERVES
LIFE
In accordance with applicable insurance regulations under which Life operates,
life insurance subsidiaries of The Hartford establish and carry as liabilities
actuarially determined reserves which are calculated to meet The Hartford's
future obligations. Reserves for life insurance and disability contracts are
based on actuarially recognized methods using prescribed morbidity and mortality
tables in general use in the United States, which are modified to reflect The
Hartford's actual experience when appropriate. These reserves are computed at
amounts that, with additions from estimated premiums to be received and with
interest on such reserves compounded annually at certain assumed rates, are
expected to be sufficient to meet The Hartford's policy obligations at their
maturities or in the event of an insured's death. Reserves also include unearned
premiums, premium deposits, claims incurred but not reported ("IBNR") and claims
reported but not yet paid. Reserves for assumed reinsurance are computed in a
manner that is comparable to direct insurance reserves.
The liability for policy benefits for universal life-type contracts and
interest-sensitive whole life policies is equal to the balance that accrues to
the benefit of policyholders, including credited interest, amounts that have
been assessed to compensate the Company for services to be performed over future
periods, and any amounts previously assessed against policyholders that are
refundable on termination of the contract. Certain contracts include provisions
whereby a guaranteed minimum death benefit is provided in the event that the
contractholder's account value at death is below the guaranteed value. Although
the Company reinsures the majority of the death benefit guarantees associated
with its in-force block of business, declines in the equity market may increase
the Company's net exposure to death benefits under these contracts. The Company
records the death benefit costs, net of reinsurance, as they are incurred. For
investment contracts, policyholder liabilities are equal to the accumulated
policy account values, which consist of an accumulation of deposit payments plus
credited interest, less withdrawals and amounts assessed through the end of the
period. For the Company's group disability policies, the level of reserves is
based on a variety of factors including particular diagnoses, termination rates
and benefit levels.
The persistency of The Hartford's annuity and other interest-sensitive life
insurance reserves is enhanced by policy restrictions on the withdrawal of
funds. Withdrawals in excess of allowable penalty-free amounts are assessed a
surrender charge during a penalty period, which is usually at least seven years.
This surrender charge is initially a percentage of either the accumulation value
or considerations received, which varies by product, and generally decreases
gradually during the penalty period. Surrender charges are set at levels to
protect The Hartford from loss on early terminations and to reduce the
likelihood of policyholders terminating their policies during periods of
increasing interest rates, thereby lengthening the effective duration of policy
liabilities and improving the Company's ability to maintain profitability on
such policies.
PROPERTY & CASUALTY
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims made by policyholders or against policyholders.
These reserves include estimates for both claims that have been reported and
those that have been incurred but not reported, and include estimates of all
expenses associated with processing and settling these claims. Estimating the
ultimate cost of future claims and claim adjustment expenses is an uncertain and
complex process. This estimation process is based largely on the assumption that
past developments are an appropriate predictor of future events, and involves a
variety of actuarial techniques that analyze experience, trends and other
relevant factors. The uncertainties involved with the reserving process have
become increasingly unpredictable due to a number of complex factors including
social and economic trends and changes in the concepts of legal liability and
damage awards. Accordingly, final claim settlements may vary from the present
estimates, particularly when those payments may not occur until well into the
future.
- 20 -
The Hartford continually reviews the adequacy of its estimated claims and claim
adjustment expense reserves on an overall basis. As additional experience and
other relevant data become available, reserve levels are adjusted accordingly.
Adjustments to previously established reserves, if any, are reflected in the
operating results of the period in which the adjustment is made. For the third
quarter and nine months ended September 30, 2002 and 2001 there were no changes
to these reserving assumptions that had a significant impact on the reserves or
results of operations. In the judgment of management, all information currently
available has been properly considered in the reserves established for claims
and claim adjustment expenses.
ENVIRONMENTAL & ASBESTOS CLAIMS
The Hartford continues to receive claims that assert damages from asbestos and
environmental-related exposures. Asbestos claims relate primarily to 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 Hartford receives asbestos and environmental claims made pursuant to several
different categories of insurance coverage. First, The Hartford wrote policies
as a primary liability insurance carrier. Second, The Hartford wrote excess
insurance policies that provide additional coverage for insureds that exhaust
their primary liability insurance coverage. Third, The Hartford acted as a
reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Writers of excess insurance
and reinsurance often receive information regarding potential exposures
significantly later than primary writers covering the same risk. The Hartford
may experience more difficulty and delays in estimating its exposures arising
from excess and reinsurance policies than it does in estimating exposures
arising from its activity as a primary insurance writer.
With regard to both environmental and particularly asbestos claims, uncertainty
exists which affects the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty 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. There are complex legal issues concerning
the interpretation of various insurance policy provisions and whether those
losses are, or were ever intended to be, covered. Courts have reached
inconsistent conclusions as to when losses are deemed to have occurred and which
policies provide coverage; what types of losses are covered; whether there is an
insurer obligation to defend; how policy limits are determined; whether or not
particular claims are product/completed operation claims subject to an aggregate
limit and how policy exclusions and conditions are applied and interpreted.
Furthermore, insurers in general, including The Hartford, have recently
experienced an increase in the number of asbestos-related claims due to, among
other things, more intensive advertising by lawyers seeking asbestos claimants,
the increasing focus by plaintiffs on new and previously peripheral defendants
and an increase in the number of entities seeking bankruptcy protection as a
result of asbestos-related liabilities. Plaintiffs and insureds have sought to
utilize bankruptcy proceedings to accelerate and increase loss payments by
insurers. In addition, new classes of claims have been arising whereby some
asbestos-related defendants are asserting that their asbestos-related claims
fall within so-called non-products liability coverage contained within their
policies rather than products liability coverage and that the claimed
non-products coverage is not subject to any aggregate limit. Recently, many
insurers, including, in a limited number of instances, 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.
An adverse determination of issues relating to The Hartford's liability for
asbestos claims could have a material adverse effect on The Hartford's results
of operations, financial condition and liquidity.
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
paying claims for more traditional areas of insurance exposure are less
effective in estimating the necessary reserves for its asbestos exposures. The
Hartford continually evaluates new information and new methodologies to use in
evaluating its potential asbestos exposures. At any time, including the current
reporting period, The Hartford may be conducting one or more evaluations of
individual exposures, classes of exposures or all of its current and potential
exposures to asbestos claims. At any time analysis of newly identified
information or completion of one or more analyses could cause The Hartford to
change its estimates of its asbestos exposures and the effect of these changes
could be material to the Company's consolidated operating results and financial
condition in future periods.
INVESTMENTS
The Hartford's investments in both fixed maturities, which include bonds,
redeemable preferred stock and commercial paper, and equity securities, which
include common and non-redeemable preferred stocks, are classified as "available
for sale" in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Accordingly, these securities are carried at fair value with the
after-tax difference from amortized cost reflected in stockholders' equity as a
component of accumulated other comprehensive income. Policy loans are carried at
outstanding balance, which approximates fair value. Other invested assets
consist primarily of limited partnership investments that are accounted for by
the equity method, except in instances in which the Company's interest is so
minor that it exercises virtually no influence over operating and financial
policies. In such instances, the Company applies the cost method of accounting.
The Company's net income from partnerships is included in net investment income.
Other investments also include mortgage loans at amortized cost and derivatives
at fair value.
- 21 -
The Company's accounting policy for impairment recognition requires other than
temporary impairment charges to be recorded when it is determined that the
Company is unable to recover its cost basis in the investment. Impairment
charges on investments are included in net realized capital gains and losses.
Factors considered in evaluating whether a decline in value is other than
temporary include: (a) the length of time and the extent to which the fair value
has been less than cost, (b) the financial condition and near-term prospects of
the issuer, and (c) the intent and ability of the Company to retain the
investment for a period of time sufficient to allow for any anticipated
recovery. In addition, for certain asset-backed and other securities, the
Company evaluates the future cash flows expected from the securitized assets in
determining whether a decline in fair value is other than temporary.
Furthermore, for securities expected to be sold, an other than temporary
impairment charge is recognized if the Company does not expect the fair value of
a security to recover to cost or amortized cost prior to the expected date of
sale. Once an impairment charge has been recorded, the Company then continues to
review the other than temporarily impaired securities for appropriate valuation
on an ongoing basis.
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards and exchange traded futures and options, in order 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 income enhancement and replication
transactions. When derivatives meet specific criteria, they may be designated as
hedges and accounted for as fair value or cash-flow hedges.
- --------------------------------------------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS: OPERATING SUMMARY
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------
2002 2001 2002 2001
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TOTAL REVENUES $ 3,961 $ 3,722 $ 11,746 $ 11,291
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
Less: Cumulative effect of accounting changes, net of tax [1] -- -- -- (34)
Net realized capital losses, after-tax (100) (51) (207) (66)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) $ 365 $ (52) $ 949 $ 463
====================================================================================================================================
<FN>
[1] For the nine months ended September 30, 2001, represents the cumulative
impact of the Company's adoption of Emerging Issues Task Force ("EITF")
Issue No. 99-20, "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial
Assets" and SFAS No. 133, as amended, "Accounting for Derivative
Instruments and Hedging Activities".
</FN>
"Operating income" is defined as after-tax operational results excluding, as
applicable, net realized capital gains or losses, the cumulative effect of
accounting changes and certain other items. Management believes that this
performance measure delineates the results of operations of the Company's
ongoing businesses in a manner that allows for a better understanding of the
underlying trends in the Company's current business. However, operating income
should only be analyzed in conjunction with, and not in lieu of, net income and
may not be comparable to other performance measures used by the Company's
competitors.
OPERATING RESULTS
Revenues for the third quarter and nine months ended September 30, 2002
increased $239, or 6%, and $455, or 4%, respectively, over the comparable prior
year periods. Excluding the effects of reinsurance cessions of $114 related to
September 11, revenues increased $125, or 3%, and $341, or 3%, for the third
quarter and nine months ended September 30, 2002, respectively, as compared to
the third quarter and nine months ended September 30, 2001. The increases were
related to continued new business growth in Group Benefits, increased net
investment income in Other Investment Products and earned premium growth in the
Business Insurance, Personal Lines and Specialty Commercial segments. Partially
offsetting the increased earned premiums were higher net realized capital
losses, primarily as a result of write-downs of corporate bonds and asset-backed
securities.
Included in operating income for the third quarter ended September 30, 2002 are
$76 in Hartford Life, Inc. ("HLI") tax benefits. Included in operating income
for the third quarter ended September 30, 2001 are $130 in HLI tax benefits,
$440 in after-tax losses related to September 11, and $13 in after-tax goodwill
amortization. (For further discussion of the HLI tax benefits and the after-tax
goodwill amortization, see Note 5(c) and Note 2, respectively, of Notes to
Consolidated Financial Statements.) Excluding these effects, operating income
for the third quarter ended September 30, 2002 increased $18, or 7%, over the
comparable prior year period. This increase was due to significantly improved
underwriting results in the Specialty Commercial, Reinsurance and Business
Insurance segments as well as strong operating results within Life's Other
Investment Products business and the Group Benefits segment. Partially
offsetting these results was a decrease in Life's Individual Annuity operating
income.
Included in operating income for the nine months ended September 30, 2002 are
the aforementioned $76 in HLI tax benefits, $8 of after-tax benefit related to
the reduction of HLI's reserves associated with September 11 and $11 in
after-tax expenses at HLI related to litigation with Bancorp Services, LLC
("Bancorp"). (For further discussion of the Bancorp litigation, see Note 5 (a)
of Notes to Consolidated Financial Statements.) Included in operating income for
the nine months ended September 30, 2001 are the aforementioned $130 in HLI tax
benefits, $440 in after-tax losses related to September 11, and $38 in after-tax
goodwill amortization. Excluding these items, operating income for the nine
months ended September 30, 2002 increased $65, or 8%, over the comparable prior
year period. The increase for the nine months ended September 30, 2002 over the
prior year period was a result of improvements in underwriting results in the
Specialty Commercial, Reinsurance and Business Insurance segments as well as
increased operating income in Life's Other Investment Products, Individual Life
and Group Benefits segments.
- 22 -
INCOME TAXES
Excluding the impacts of September 11, the HLI tax benefits and net realized
capital losses, the effective tax rate for the third quarter and nine months
ended September 30, 2002 was 18% and 20%, respectively, compared with 16% and
19%, respectively, for the comparable periods in 2001. The increase in the
effective tax rates was primarily the result of tax benefits received in 2001 in
connection with the sales of the Company's Spain-based Hartford Seguros and
Singapore-based Hartford Insurance Company (Singapore), Ltd. subsidiaries and
the sale of the Company's ownership interest in an Argentine subsidiary,
Sudamerica Holding S.A. Tax exempt interest earned on invested assets, together
with the dividends-received deduction ("DRD"), were the primary reasons for the
effective tax rates being lower than the 35% U.S. statutory rate.
SEGMENT RESULTS
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to the June 27, 2000 acquisition of all
of the outstanding shares of HLI that the Company did not already own ("The HLI
Repurchase") are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Life also includes in an Other category its international operations, which are
primarily located in Latin America and Japan, as well as corporate items not
directly allocable to any of its reportable operating segments, principally
interest expense.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance (collectively, "North American"); and the
Other Operations segment, which 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
performance is operating income, except for its North American underwriting
segments, which 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. While not
considered segments, the Company also reports and evaluates operating income
results for Life, Property & Casualty and North American. Property & Casualty
includes operating income for North American and the Other Operations segment.
North American includes the combined underwriting results of the North American
underwriting segments along with income and expense items not directly allocable
to these segments, such as net investment income.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided and capital contributions. Certain reinsurance stop loss agreements
exist between the segments which specify that one segment will reimburse another
for losses incurred in excess of a predetermined limit. Also, one segment may
purchase group annuity contracts from another to fund pension costs and claim
annuities to settle casualty claims. In addition to the above transactions,
certain intersegment transactions occur in Life. These transactions include
interest income on allocated surplus and the allocation of net realized capital
gains and losses through net invested income utilizing the duration of the
segment's investment portfolios.
The following is a summary of North American underwriting results by
underwriting segment within Property & Casualty.
UNDERWRITING RESULTS (BEFORE-TAX) THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------
North American 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Business Insurance $ 21 $ 6 $ 17 $ (7)
Personal Lines (13) (17) (48) (44)
Specialty Commercial 3 (18) 1 (56)
Reinsurance (4) (47) (17) (109)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 7 (76) (47) (216)
September 11 -- (647) -- (647)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NORTH AMERICAN UNDERWRITING RESULTS $ 7 $ (723) $ (47) $ (863)
====================================================================================================================================
- 23 -
The following is a summary of operating income and net income.
OPERATING INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- -------------- -------------- -----------
2002 2001 2002 2001
- --------------------------------------------------------------------------- -------------- -------------- -------------- -----------
Life
Investment Products $ 100 $ 116 $ 335 $ 344
Individual Life 33 30 99 86
Group Benefits 34 26 92 76
COLI 10 8 20 27
Other 55 102 40 86
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 232 282 586 619
Property & Casualty
North American 138 (319) 379 (111)
Other Operations 1 -- 2 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 139 (319) 381 (109)
Corporate (6) (15) (18) (47)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING INCOME (LOSS) $ 365 $ (52) $ 949 $ 463
====================================================================================================================================
NET INCOME (LOSS) THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- -------------- -------------- -----------
2002 2001 2002 2001
- --------------------------------------------------------------------------- -------------- -------------- -------------- -----------
Life
Investment Products $ 100 $ 116 $ 335 $ 344
Individual Life 33 30 99 86
Group Benefits 34 26 92 76
COLI 10 8 20 27
Other (16) 70 (114) 17
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 161 250 432 550
Property & Casualty
North American 119 (339) 347 (146)
Other Operations (9) 1 (19) 6
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 110 (338) 328 (140)
Corporate (6) (15) (18) (47)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
====================================================================================================================================
An analysis of the operating results summarized above is included on the
following pages. Investment results are discussed in the Investments section.
- --------------------------------------------------------------------------------
LIFE
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------
2002 2001 2002 2001
- --------------------------------------------------------------------------- -------------- -------------- -------------- -----------
Revenues $ 1,541 $ 1,605 $ 4,808 $ 4,890
Expenses 1,380 1,355 4,376 4,314
Cumulative effect of accounting changes, net of tax [1] -- -- -- (26)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME [2], [3] 161 250 432 550
Less: Cumulative effect of accounting changes, net of tax [1] -- -- -- (26)
Net realized capital losses, after-tax (71) (32) (154) (43)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME [2] [3] $ 232 $ 282 $ 586 $ 619
====================================================================================================================================
<FN>
[1] For the nine months ended September 30, 2001 represents the cumulative
impact of the Company's adoption of EITF Issue No. 99-20 and SFAS No. 133.
[2] Includes $76 and $130 for the third quarter and nine months ended September
30, 2002 and 2001, respectively, related to favorable tax items.
[3] Includes $20 of after-tax losses for the third quarter and nine months
ended September 30, 2001 related to September 11, and an $8 benefit for the
nine months ended September 30, 2002 due to favorable development related
to September 11. Additionally, for the nine months ended September 30,
2002, includes $11 after-tax expense related to the Bancorp litigation.
</FN>
Life has the following reportable operating segments: Investment Products,
Individual Life, Group Benefits and COLI. In addition, Life includes in an
"Other" category corporate items not directly allocable to any of its reportable
operating segments, principally
- 24 -
interest expense, as well as its international operations, which are primarily
located in Japan and Latin America.
On April 2, 2001, The Hartford acquired the U.S. individual life insurance,
annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis
Financial Group" or "Fortis"). (For further discussion, see Note 18(a) of Notes
to Consolidated Financial Statements included in The Hartford's December 31,
2001 Form 10-K Annual Report.)
Revenues in the Life operation decreased $64, or 4%, and $82, or 2%, for the
third quarter and nine months ended September 30, 2002, respectively, as
compared to the equivalent periods in 2001. The decreases were primarily driven
by realized capital losses of $118 and $253 for the third quarter and nine
months ended September 30, 2002, respectively, as compared to capital losses of
$50 and $67 for the equivalent periods in 2001. (See the Investments section for
further discussion of investment results and related realized capital losses.)
In addition, COLI experienced a decline in revenues as a result of the decrease
in leveraged COLI account values as compared to a year ago. However, the Life
operation experienced revenue growth across its other operating segments.
Revenues related to the Investment Products segment increased as a result of
continued growth related to its institutional investment product business, which
more than offset the decline in revenues within the individual annuity
operation. The individual annuity operation was impacted by lower assets under
management due to the decline in the equity markets. The Group Benefits segment
continued to experience an increase in revenues as a result of strong sales to
new customers and solid persistency within the in-force block of business.
Additionally, Individual Life revenues were higher as the result of the Fortis
acquisition and increased life insurance in force for the nine months ended
September 30, 2002.
Expenses increased $25, or 2%, for the third quarter ended September 30, 2002,
primarily due to a lower benefit recorded related to favorable resolution of
DRD-related tax items as compared to the same period in 2001. Expenses for the
nine months ended September 30, 2002 increased $62, or 1%, as compared to the
equivalent prior year period, which was primarily driven by the Fortis
acquisition and the Investment Products segment, principally related to the
growth in the institutional investment product business and an increase in death
benefits related to the individual annuity operation, as a result of the lower
equity markets. In addition, expenses for the nine months ended September 30,
2002 include $11, after-tax, of accrued expenses recorded within the COLI
segment related to the Bancorp litigation. (For a discussion of the Bancorp
litigation, see Note 5(a) of Notes to Consolidated Financial Statements.) Also
included in expenses for the nine months ended September 30, 2002 was an
after-tax benefit of $8, recorded within "Other", associated with favorable
development related to Life's estimated September 11 exposure.
Operating income decreased $50, or 18%, and $33, or 5%, for the third quarter
and nine months ended September 30, 2002, respectively. Excluding the impact of
September 11 in the third quarter of 2001, operating income decreased $70, or
23%, for the third quarter ended September 30, 2002. For the nine months ended
September 30, 2002 Life recognized an $8 after-tax benefit due to favorable
development related to September 11. Excluding the impact of September 11,
operating income for the nine months ended September 30, 2002 decreased $61, or
10%. For the third quarter and nine months ended September 30, 2002, Group
Benefits earnings increased $8, or 31%, and $16, or 21%, respectively. Excluding
the impact of September 11, Group Benefits earnings increased $6, or 21%, and
$14, or 18%, for the third quarter and nine months ended September 30, 2002,
respectively. The increases were principally driven by ongoing premium growth
and stable loss and expense ratios. Individual Life earnings increased $3, or
10%, and $13, or 15%, for the third quarter and nine months ended September 30,
2002 respectively. Excluding the impact of September 11, Individual Life's
earnings remained consistent and increased $10, or 11%, for the third quarter
and nine months ended September 30, 2002, respectively as the result of higher
fee income from the Fortis acquisition. COLI earnings increased $2, or 25%, for
the third quarter of 2002 due to lower death benefits, interest credited
expenses, and other insurance expenses, which more than offset the decline in
revenues discussed above. Excluding the impact of September 11, COLI's earnings
remained consistent for the third quarter ended September 30, 2002. For the nine
months ended September 30, 2002, COLI operating income decreased $7, or 26%.
Excluding the impact of September 11, COLI's earnings decreased $9, or 31%,
primarily the result of the charge associated with the Bancorp litigation.
Operating income for the Investment Products segment was down $16, or 14%, and
$9 or 3%, for the third quarter and nine months ended September 30, 2002,
respectively, as growth in the other investment products businesses,
particularly institutional investment products, was more than offset by the
decline in revenues in the individual annuity operation, which was negatively
impacted by the lower equity markets.
- 25 -
- --------------------------------------------------------------------------------
INVESTMENT PRODUCTS
- --------------------------------------------------------------------------------
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Revenues $ 637 $ 622 $ 1,946 $ 1,869
Expenses 537 506 1,611 1,525
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 100 $ 116 $ 335 $ 344
- ------------------------------------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 59,618 $ 68,545
Other individual annuity account values 10,513 9,421
Other investment products account values 19,368 17,638
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES 89,499 95,604
Mutual fund assets under management 14,092 14,380
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $ 103,591 $ 109,984
====================================================================================================================================
Revenues in the Investment Products segment increased $15, or 2%, and $77, or
4%, for the third quarter and nine months ended September 30, 2002,
respectively, primarily driven by growth in the institutional investment product
business, where related assets under management increased $1.2 billion, or 14%,
to $9.7 billion as of September 30, 2002. The revenue increase described above
was partially offset by lower fee income related to the individual annuity
operation as average account values decreased from prior year levels, primarily
due to the lower equity markets.
Expenses increased $31, or 6%, and $86, or 6%, for the third quarter and nine
months ended September 30, 2002, respectively, primarily driven by increases in
benefits and claim expenses and operating expenses as a result of the growth in
the institutional investment products business and an increase in the death
benefit costs incurred by the individual annuity operation, as a direct result
of the lower equity markets. Partially offsetting these increases were decreases
in amortization of policy acquisition costs related to the individual annuity
business, which declined as a result of lower estimated gross profits, driven by
the decrease in fee income and the increase in death benefit costs.
Operating income decreased $16, or 14%, and $9, or 3%, for the third quarter and
nine months ended September 30, 2002, respectively. The growth in revenues was
related to other investment products, particularly the institutional investment
product business. This growth was almost completely offset by the decline in
revenues in the individual annuity operation, which was negatively impacted by
the lower equity markets. Additionally, increases in the death benefit costs
incurred by the individual annuity operation as the result of the lower equity
markets contributed to the decreased earnings as compared to the equivalent
period in 2001. (For discussion of the potential future financial statement
impact of continued declines in the equity market on the Investment Products
segment, see the Capital Markets Risk Management section under "Market Risk".)
- --------------------------------------------------------------------------------
INDIVIDUAL LIFE
- --------------------------------------------------------------------------------
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Revenues $ 239 $ 236 $ 720 $ 639
Expenses 206 206 621 553
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 33 $ 30 $ 99 $ 86
- ------------------------------------------------------------------------------------------------------------------------------------
Variable life account values $ 3,458 $ 3,460
Total account values $ 7,360 $ 7,322
- ------------------------------------------------------------------------------------------------------------------------------------
Variable life insurance in force $ 65,797 $ 59,466
Total life insurance in force $ 125,138 $ 118,510
====================================================================================================================================
Revenues in the Individual Life segment increased $3, or 1%, and $81, or 13%,
for the third quarter and nine months ended September 30, 2002, respectively.
For the third quarter, the revenue growth was primarily driven by an increase in
fee income as the result of an increase in life insurance in force of $6.6
billion, or 6%, as of September 30, 2002 as compared to the equivalent period in
the prior year. The revenue growth related to the nine months ended September
30, 2002 was attributed to higher fee income and investment income related to
the Fortis transaction.
Expenses for the nine months ended September 30, 2002 increased $68, or 12%,
compared with the nine months ended September 30, 2001, principally driven by
the growth in the business resulting from the Fortis acquisition. In addition,
mortality experience (expressed as death claims as a percentage of net amount at
risk) for the nine months ended September 30, 2002 was higher than the
comparable prior year period primarily due to a higher than expected occurrence
of large claims during the first quarter of 2002.
Operating income increased $3, or 10%, and $13, or 15%, for the third quarter
and nine months ended September 30, 2002,
- 26 -
respectively. Individual Life incurred an after-tax charge of $3 related to
September 11 in the third quarter of 2001. Excluding this charge, Individual
Life's earnings remained consistent for the third quarter of 2002 and increased
$10, or 11%, for the nine months ended September 30, 2002. The increase for the
nine months ended September 30, 2002 was due to the contribution to earnings
from the Fortis transaction, which more than offset the unfavorable mortality
experience.
- --------------------------------------------------------------------------------
GROUP BENEFITS
- --------------------------------------------------------------------------------
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Revenues $ 645 $ 617 $ 1,943 $ 1,871
Expenses 611 591 1,851 1,795
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 34 $ 26 $ 92 $ 76
====================================================================================================================================
Revenues in the Group Benefits segment increased $28, or 5%, and $72, or 4%, and
excluding buyouts, increased $22, or 4%, and $126, or 7%, for the third quarter
and nine months ended September 30, 2002, respectively. These increases were
driven by growth in fully insured ongoing premiums, which increased $63, or 12%,
and $248, or 17%, for the third quarter and nine months ended September 30,
2002, respectively. The growth in premium revenues was due to steady persistency
and pricing actions on the in-force block of business and strong sales to new
customers. Offsetting these increases were decreases in military Medicare
supplement premiums of $43 and $127 for the third quarter and nine months ended
September 30, 2002, respectively, resulting from federal legislation effective
in the fourth quarter of 2001. This legislation provides retired military
officers age 65 and older with full medical insurance paid for by the
government, eliminating the need for Medicare supplement insurance.
Additionally, premium revenues for the nine months ended September 30, 2002 were
offset by a $54 decrease in total buyouts. Fully insured ongoing sales for the
nine months ended September 30, 2002 were $532, an increase of $108, or 25%, as
compared to the equivalent prior year period.
Expenses increased $20, or 3%, and $56, or 3%, and excluding buyouts, increased
$14, or 2%, and $110, or 6%, for the third quarter and nine months ended
September 30, 2002, respectively. The increase in expenses is consistent with
the growth in revenues described above. Benefits and claims expenses, excluding
buyouts, increased $10, or 2%, and $80, or 6%, for the third quarter and nine
months ended September 30, 2002, respectively. The segment's loss ratio (defined
as benefits and claims as a percentage of premiums and other considerations
excluding buyouts) was approximately 81% and 82% for third quarter and nine
months ended September 30, 2002, respectively, down slightly from 82% and 83%
for the third quarter and nine months ended September 30, 2001, respectively.
Other insurance expenses increased $2, or 2%, and $27, or 7%, for the third
quarter and nine months ended September 30, 2002, respectively, due to the
revenue growth previously described and continued investments in the business.
The segment's expense ratio (defined as insurance expenses as a percentage of
premiums and other considerations excluding buyouts) was approximately 23% for
both the third quarter and nine months ended September 30, 2002, respectively,
and essentially consistent with the prior year periods.
Operating income increased $8, or 31%, and $16, or 21%, for the third quarter
and nine months ended September 30, 2002, respectively. Group Benefits incurred
an after-tax charge of $2 related to September 11 in the third quarter of 2001.
Excluding this charge, earnings increased $6, or 21%, and $14, or 18%, for the
third quarter and nine months ended September 30, 2002, respectively, due to the
increase in premium revenue and the continued focus on maintaining loss costs
and other expenses as described above.
- --------------------------------------------------------------------------------
CORPORATE OWNED LIFE INSURANCE (COLI)
- --------------------------------------------------------------------------------
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Revenues $ 145 $ 171 $ 451 $ 536
Expenses 135 163 431 509
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 10 $ 8 $ 20 $ 27
- ------------------------------------------------------------------------------------------------------------------------------------
Variable COLI account values $ 19,298 $ 16,915
Leveraged COLI account values 3,601 4,835
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $ 22,899 $ 21,750
====================================================================================================================================
COLI revenues decreased $26, or 15%, and $85, or 16%, for the third quarter and
nine months ended September 30, 2002, respectively, primarily related to lower
net investment and fee income related to the declining block of leveraged COLI,
where related account values declined by $1.2 billion, or 26%. Net investment
income decreased $21, or 24%, and $59, or 22%, for the third quarter and nine
months ended September 30, 2002, respectively, while fee income decreased $5, or
6%, and $25, or 10%, over the comparable prior year periods.
Expenses decreased $28, or 17%, and $78, or 15%, for the third quarter and nine
months ended September 30, 2002, respectively, consistent with the decrease in
revenues described above. However, the decrease for the nine months ended
September 30,
- 27 -
2002 was partially offset by $11, after-tax, in accrued litigation expenses
related to the Bancorp dispute. (For a discussion of the Bancorp litigation, see
Note 5(a) of Notes to Consolidated Financial Statements.)
Operating income in the third quarter increased $2, or 25%, compared to prior
year. COLI incurred an after-tax charge of $2 related to September 11 in the
third quarter of 2001. Excluding this charge, COLI's earnings remained
consistent for the third quarter ended September 30, 2002 as the decrease in
benefits and claims expenses and other insurance expenses offset the decrease in
revenues discussed above. Operating income decreased $7, or 26%, for the nine
months ended September 30, 2002. Excluding the impact of September 11, COLI's
earnings decreased $9, or 31%, principally due to the $11 after-tax expense
accrued in connection with the Bancorp litigation.
- --------------------------------------------------------------------------------
PROPERTY & CASUALTY
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
TOTAL REVENUES [1] $ 2,415 $ 2,113 $ 6,924 $ 6,388
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) [2] $ 110 $ (338) $ 328 $ (140)
Less: Cumulative effect of accounting change, net of tax [3] -- -- -- (8)
Net realized capital losses, after-tax (29) (19) (53) (23)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) [2] $ 139 $ (319) $ 381 $ (109)
====================================================================================================================================
<FN>
[1] 2001 includes $114 of reinsurance cessions related to September 11.
[2] 2001 includes $420 of after-tax losses related to September 11.
[3] Represents the cumulative impact of the Company's adoption of EITF Issue
No. 99-20.
</FN>
Revenues for Property & Casualty increased $302, or 14%, for the third quarter
and $536, or 8%, for the nine months ended September 30, 2002, compared with the
same periods in 2001. The increase in revenues for both periods was due
primarily to earned premium growth in the Business Insurance, Personal Lines and
Specialty Commercial segments primarily as a result of price increases. New
business growth and strong premium renewal retention also contributed to the
increase. The 2001 reinsurance cessions related to September 11 increased the
third quarter and nine months earned premium variances by $114. Partially
offsetting the increase in revenues for both periods were additional capital
losses of $38 and $56, respectively, primarily due to impairments on securities.
Operating income increased $458 for the third quarter and $490 for the nine
months ended September 30, 2002, as compared to the same prior year periods.
Excluding the $420 impact of September 11 in the prior year, operating income
increased $38, or 38%, and $70, or 23%, for the third quarter and nine month
periods, respectively. The increases for both periods were primarily due to
strong earned pricing in the Business Insurance and Specialty Commercial
segments, the impact of underwriting initiatives in Reinsurance and lower
catastrophes. Partially offsetting the improvement was an increase in other
expenses primarily as a result of $9 in after-tax expenses incurred related to
the transfer of the Company's New Jersey personal lines agency auto business to
Palisades Safety and Insurance Association and Palisades Insurance Co.
Ratios
The following sections discuss the operations of the North American underwriting
segments for the third quarter and nine months ended September 30, 2002 and
include various operating ratios. Management believes that these ratios are
useful in understanding the underlying trends in the Company's current business.
However, these measures should only be used in conjunction with, and not in lieu
of, underwriting income and may not be comparable to other performance measures
used by the Company's competitors. The "loss ratio" is the ratio of claims
expense (exclusive of claim adjustment expenses) to earned premiums. The "loss
adjustment expense ratio" represents the ratio of claim adjustment expenses to
earned premiums. The "expense ratio" is the ratio of underwriting expenses
(commissions; taxes, licenses, and fees; as well as other underwriting expenses)
to written premiums. The "policyholder dividend ratio" is the ratio of
policyholder dividends to earned premiums. The "combined ratio" is the sum of
the loss ratio, the loss adjustment expense ratio, the expense ratio and the
policyholder dividend ratio.
- 28 -
- --------------------------------------------------------------------------------
BUSINESS INSURANCE
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Written premiums [1] $ 867 $ 703 $ 2,527 $ 2,119
Earned premiums [1] $ 795 $ 665 $ 2,293 $ 1,925
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 [2] $ 21 $ 6 $ 17 $ (7)
September 11 -- (245) -- (245)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results $ 21 $ (239) $ 17 $ (252)
====================================================================================================================================
Loss ratio [2] 50.1 52.2 51.6 53.2
Loss adjustment expense ratio [2] 11.5 12.1 11.7 12.2
Expense ratio [2] 32.4 32.3 32.0 31.6
Combined ratio excluding September 11 [2] [3] 95.6 97.5 96.8 98.3
Combined ratio impact of September 11 [3] -- 36.7 -- 12.7
Combined ratio [3] 95.6 134.2 96.8 111.0
====================================================================================================================================
<FN>
[1] 2001 includes $15 of reinsurance cessions related to September 11.
[2] 2001 excludes any impacts of September 11.
[3] Includes policyholder dividend ratios of 1.6 and 1.0 for the third quarter
ended September 30, 2002 and 2001, respectively, and 1.5 and 1.3 for the
nine months ended September 30, 2002 and 2001, respectively.
</FN>
Business Insurance written premiums increased $164, or 23%, for the third
quarter and $408, or 19%, for the nine months ended September 30, 2002, compared
to the same periods in 2001 due to strong growth in both small commercial and
middle market. Small commercial increased $59, or 16%, for the third quarter and
$169, or 16%, for the nine month period reflecting double-digit price increases,
particularly in the property line of business. The increase in middle market of
$90, or 25%, for the third quarter and $224, or 21%, for the nine month period
was due primarily to double-digit price increases as well as continued strong
new business growth and premium renewal retention. The 2001 reinsurance cessions
related to September 11 increased the third quarter and nine months premium
variances by $15.
Underwriting results, excluding September 11, improved $15, with a corresponding
1.9 point decrease in the combined ratio, for the third quarter and improved
$24, with a corresponding 1.5 point decrease in the combined ratio, for the nine
months ended September 30, 2002, as compared with the same periods in 2001. The
improvement in underwriting results and combined ratio for both periods was
primarily due to double-digit earned pricing and minimal loss costs. The loss
ratio improved 2.1 points and 1.6 points for the third quarter and nine months
ended September 30, 2002, respectively, compared with the same prior year
periods.
- --------------------------------------------------------------------------------
PERSONAL LINES
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Written premiums $ 779 $ 742 $ 2,294 $ 2,147
Earned premiums $ 758 $ 694 $ 2,218 $ 2,040
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 [1] $ (13) $ (17) $ (48) $ (44)
September 11 -- (9) -- (9)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results $ (13) $ (26) $ (48) $ (53)
====================================================================================================================================
Loss ratio [1] 67.0 66.5 66.5 66.3
Loss adjustment expense ratio [1] 11.1 11.9 11.7 11.6
Expense ratio [1] 22.2 23.8 23.0 24.1
Combined ratio excluding September 11 [1] 100.3 102.2 101.2 102.1
Combined ratio impact of September 11 -- 1.2 -- 0.4
Combined ratio 100.3 103.4 101.2 102.5
====================================================================================================================================
<FN>
[1] 2001 excludes any impacts of September 11.
</FN>
Written premiums increased $37, or 5%, for the third quarter and $147, or 7%,
for the nine months ended September 30, 2002, compared to the same periods in
2001, primarily driven by growth in AARP, partially offset by a reduction in
Standard. AARP increased $53, or 12%, for the third quarter and $171, or 14%,
for the nine months ended September 30, 2002, primarily as a result of pricing
increases and continued steady premium renewal retention. Standard decreased
$15, or 7%, for the third quarter and $28, or 5%, for the nine months ended
September 30, 2002,
- 29 -
due primarily to the conversion to six month policies in certain states.
Underwriting results, excluding the impact of September 11, improved $4 for the
third quarter, with a corresponding 1.9 point decrease in the combined ratio.
For the nine month period, underwriting results declined $4, while the combined
ratio decreased 0.9 points, excluding September 11. While automobile results
improved for the third quarter and nine month periods due to favorable frequency
loss costs, the line of business continues to be negatively impacted by
automobile severity loss costs as a result of medical inflation and higher
repair costs. Despite an increase in homeowners' severity loss costs,
underwriting results for both periods remained favorable due to negative
frequency. An improvement in the underwriting expense ratio, primarily due to
written pricing increases and prudent expense management, resulted in a 1.6
point and 1.1 point decrease in the expense ratio for the third quarter and nine
months ended September 30, 2002, respectively, over comparable prior year
periods.
- --------------------------------------------------------------------------------
SPECIALTY COMMERCIAL
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Written premiums [1] $ 383 $ 264 $ 1,028 $ 775
Earned premiums [1] $ 357 $ 274 $ 870 $ 766
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 [2] $ 3 $ (18) $ 1 $ (56)
September 11 -- (167) -- (167)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results $ 3 $ (185) $ 1 $ (223)
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio [2] 57.8 62.7 56.2 60.7
Loss adjustment expense ratio [2] 11.4 12.8 12.4 14.0
Expense ratio [2] 28.6 31.8 28.6 31.3
Combined ratio excluding September 11 [2] [3] 98.3 107.6 97.9 106.4
Combined ratio impact of September 11 [3] -- 61.6 -- 22.0
- ------------------------------------------------------------------------------------------------------------------------------------
Combined ratio [3] 98.3 169.2 97.9 128.4
====================================================================================================================================
<FN>
[1] 2001 includes $7 of reinsurance cessions related to September 11.
[2] 2001 excludes any impacts of September 11.
[3] Includes policyholder dividend ratios of 0.5 and 0.3 for the third quarter
ended September 30, 2002 and 2001, respectively, and 0.6 and 0.4, for the
nine months ended September 30, 2002 and 2001, respectively.
</FN>
Specialty Commercial written premiums increased $119, or 45%, for the third
quarter and $253, or 33%, for the nine months ended September 30, 2002, compared
with the same prior year periods. The improvement was driven by the Property,
Specialty Casualty and Professional Liability lines of business. Written
premiums for Property grew $33, or 31%, for the third quarter and $102, or 44%,
for the nine months ended September 30, 2002, compared with the same periods in
2001. Specialty Casualty written premiums grew $44, or 81%, and $83, or 55%, for
the third quarter and nine month periods, respectively. The written premium
growth in both lines of business was primarily due to significant price
increases and new business growth reflecting an improving business environment.
Professional Liability written premiums grew $22, or 45%, for the third quarter
and $54, or 49%, for the nine months ended September 30, 2002, compared with the
respective prior year periods, due to significant price increases and, for the
nine month period, lower premium cessions. Also contributing to the increases in
written premiums for the third quarter and nine month periods was $7 of
reinsurance cessions in the prior year related to September 11.
Underwriting results, excluding September 11, improved $21, with a corresponding
9.3 point decrease in the combined ratio for the third quarter and improved $57,
with a corresponding 8.5 point decrease in the combined ratio for the nine
months ended September 30, 2002, as compared with the same periods in 2001.
Improved underwriting and combined ratio results for the third quarter and nine
month periods were primarily due to favorable Property, Specialty Casualty and
Professional Liability results. In addition, an improvement in the underwriting
expense ratio, primarily due to written pricing increases and prudent expense
management, resulted in a 3.2 point and 2.7 point decrease in the expense ratio
for the third quarter and nine months ended September 30, 2002, respectively.
For the nine month period, lower catastrophes, primarily as a result of the
Seattle earthquake in the first quarter of 2001, also contributed to the
improvement in underwriting results.
- 30 -
- --------------------------------------------------------------------------------
REINSURANCE
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
Written premiums [1] $ 167 $ 89 $ 550 $ 657
Earned premiums [1] $ 178 $ 128 $ 521 $ 607
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 [2] $ (4) $ (47) $ (17) $ (109)
September 11 -- (226) -- (226)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results $ (4) $ (273) $ (17) $ (335)
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio [2] 68.3 83.8 71.0 85.0
Loss adjustment expense ratio [2] 6.2 4.7 4.7 3.9
Expense ratio [2] 28.5 33.6 26.2 26.4
Combined ratio excluding September 11 [2] 103.1 122.1 101.9 115.3
Combined ratio impact of September 11 -- 202.7 -- 39.2
- ------------------------------------------------------------------------------------------------------------------------------------
Combined ratio 103.1 324.8 101.9 154.5
====================================================================================================================================
<FN>
[1] 2001 includes $92 of reinsurance cessions related to September 11.
[2] 2001 excludes any impacts of September 11.
</FN>
Reinsurance written premiums increased $78, or 88%, for the third quarter and
decreased $107, or 16%, for the nine months ended September 30, 2002, compared
to the same periods in 2001. Excluding $92 of reinsurance cessions related to
September 11 in the prior year, written premiums decreased $14, or 8%, for the
third quarter and $199, or 27%, for the nine month period due to the planned
exit from nearly all international lines and a reduction in the Alternative Risk
Transfer ("ART") line of business written premiums. ART written premiums are
traditionally low in the third quarter, but decreased $90, or 52%, for the nine
month period due primarily to the expiration of a non-recurring loss portfolio
reinsurance contract and the non-renewal of a quota share treaty with one ceding
company. Excluding ART and international, third quarter written premiums
increased 10% for the quarter and 2% for the nine month periods, due primarily
to significant pricing increases as a result of continued market firming,
partially offset by premium reductions due to underwriting requirements to
maintain profitability targets.
Underwriting results, excluding September 11, improved $43, with a corresponding
19.0 point decrease in the combined ratio for the third quarter and improved
$92, with a corresponding 13.4 point decrease in the combined ratio for the nine
months ended September 30, 2002, as compared with the same periods in 2001. The
improvement for both periods was primarily due to underwriting initiatives
including a shift to excess of loss policies and increased property business
mix, as well as the exit from nearly all international lines and an intense
focus on returns. For the nine month period, significantly lower catastrophes
also contributed to the improvement.
- --------------------------------------------------------------------------------
OTHER OPERATIONS (INCLUDING ASBESTOS AND ENVIRONMENTAL CLAIMS)
- --------------------------------------------------------------------------------
OPERATING SUMMARY THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------ -------------- -------------- -------------- --------------
TOTAL REVENUES $ 42 $ 38 $ 138 $ 133
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (9) $ 1 $ (19) $ 6
Less: Net realized capital gains (losses), after-tax (10) 1 (21) 4
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 1 $ -- $ 2 $ 2
====================================================================================================================================
The Other Operations segment includes operations that are under a single
management structure, that was finalized in late 2001 to be 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.
The companies in this segment which are not writing new business are primarily
focused on managing claims, resolving disputes and collecting reinsurance
proceeds related largely to business underwritten and reinsured in 1985 and
prior years. While the business that was written in these units on either a
direct or reinsurance basis spanned a wide variety of insurance and reinsurance
policies and coverages, a significant and increasing proportion of current and
future claims activity arising from these businesses relates to environmental
and, to a greater extent, asbestos exposures. Other Operations also includes the
results of The Hartford's international property-casualty businesses
(substantially all of which were disposed of in a series of transactions
concluding in 2001) and the international reinsurance businesses of HartRe,
exited in the fourth quarter of 2001. (For further discussion of the
restructuring, see Note 9 of Notes to Consolidated Financial Statements.)
In 2001, The Hartford consolidated management and claims handling of all of its
asbestos and environmental exposures under the Other Operations' management
structure. This action was
- 31 -
taken to maximize The Hartford's management expertise in this area. As part of
this organizational change, the Company consolidated substantially all of its
asbestos and environmental loss reserves into one legal entity within Other
Operations through intercompany reinsurance agreements. These reinsurance
agreements ceded $602 of the then-carried reserves (net of reinsurance),
primarily related to asbestos and environmental exposures from 1985 and prior,
from the Specialty Commercial segment to Other Operations.
Discussion of Operations
Revenues for the third quarter and nine months ended September 30, 2002 were
relatively flat compared to the same prior year periods as higher earned premium
was offset by net realized capital losses. The increase in earned premium was
primarily renewal premium from the exited HartRe international business, which
was transferred to Other Operations in the first quarter of 2002.
Operating income also was relatively flat for the third quarter and nine months
ended September 30, 2002 compared to the same prior year periods.
Asbestos and Environmental Claims
The Hartford continues to receive claims that assert damages from asbestos and
environmental-related exposures, both of which affect Other Operations. Asbestos
claims relate primarily to 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 Hartford receives asbestos and environmental claims made pursuant to several
different categories of insurance coverage. First, The Hartford wrote policies
as a primary liability insurance carrier. Second, The Hartford wrote excess
insurance policies that provide additional coverage for insureds that exhaust
their primary liability insurance coverage. Third, The Hartford acted as a
reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Writers of excess insurance
and reinsurance often receive information regarding potential exposures
significantly later than primary writers covering the same risk. The Hartford
may experience more difficulty and delays in estimating its exposures arising
from excess and reinsurance policies than it does in estimating exposures
arising from its activity as a primary insurance writer.
With regard to both environmental and particularly asbestos claims, uncertainty
exists which affects the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty 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. There are complex legal issues concerning
the interpretation of various insurance policy provisions and whether those
losses are, or were ever intended to be, covered. Courts have reached
inconsistent conclusions as to when losses are deemed to have occurred and which
policies provide coverage; what types of losses are covered; whether there is an
insurer obligation to defend; how policy limits are determined; whether or not
particular claims are product/completed operation claims subject to an aggregate
limit and how policy exclusions and conditions are applied and interpreted.
Furthermore, insurers in general, including The Hartford, have recently
experienced an increase in the number of asbestos-related claims due to, among
other things, more intensive advertising by lawyers seeking asbestos claimants,
the increasing focus by plaintiffs on new and previously peripheral defendants
and an increase in the number of entities seeking bankruptcy protection as a
result of asbestos-related liabilities. Plaintiffs and insureds have sought to
utilize bankruptcy proceedings to accelerate and increase loss payments by
insurers. In addition, new classes of claims have been arising whereby some
asbestos-related defendants are asserting that their asbestos-related claims
fall within so-called non-products liability coverage contained within their
policies rather than products liability coverage and that the claimed
non-products coverage is not subject to any aggregate limit. Recently, many
insurers, including, in a limited number of instances, 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. An adverse
determination of issues relating to The Hartford's liability for asbestos claims
could have a material adverse effect on The Hartford's results of operations,
financial condition and liquidity.
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
paying claims for more traditional areas of insurance exposure are less
effective in estimating the necessary reserves for its asbestos exposures. The
Hartford continually evaluates new information and new methodologies to use in
evaluating its potential asbestos exposures. At any time, including the current
reporting period, The Hartford may be conducting one or more evaluations of
individual exposures, classes of exposures or all of its current and potential
exposures to asbestos claims. At any time analysis of newly identified
information or completion of one or more analyses could cause The Hartford to
change its estimates of its asbestos exposures and the effect of these changes
could be material to the Company's consolidated operating results and financial
condition in future periods.
Reserve Activity
Reserves and reserve activity in the Other Operations segment are categorized
and reported as either Asbestos, Environmental, or All Other activity. The
discussion below relates to reserves and reserve activity, net of applicable
reinsurance.
Constantly evolving legal theories create significant uncertainties with respect
to what types of claims may ultimately arise from the generally older policies
and liabilities managed in the Other Operations segment. The Hartford's
experience has been that while this group of policies has over time produced
significantly higher claims and losses than were initially contemplated at
- 32 -
inception, the areas of active claim activity have shifted over time 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, but not
limited to, situations where The Hartford has commuted 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 variability and
uncertainty.
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 third quarter and nine months ended September 30, 2002. Also included are
the remaining Asbestos and Environmental exposures of North American.
OTHER OPERATIONS
CLAIMS AND CLAIM ADJUSTMENT EXPENSES
- ------------------------------------------------------------------------------------------------------------------------------------
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
--------------------------------------------- ----------------------------------------------
Asbestos Environ. All Other Total Asbestos Environ. All Other Total
--------------------------------------------- ----------------------------------------------
Beginning liability - net $ 1,142 $ 658 $ 1,261 $ 3,061 $ 616 $ 654 $ 1,593 $ 2,863
Claims and claim adjustment
expenses incurred 25 (2) 17 40 58 (7) 80 131
Claims and claim adjustment
expenses paid (34) (14) (33) (81) (81) (65) (128) (274)
Transfer of HartRe
International [1] -- -- -- -- -- -- 300 300
Other [2] -- -- -- -- 540 60 (600) --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 1,133 $ 642 $ 1,245 $ 3,020 $ 1,133 $ 642 $ 1,245 $ 3,020
====================================================================================================================================
<FN>
[1] Represents the January 1, 2002 transfer of reserves from the exited
international reinsurance business of HartRe from the Reinsurance segment
to Other Operations.
[2] The nature of these reallocations is described in the two paragraphs
immediately following this table.
[3] Ending liabilities include reserves for Asbestos and Environmental reported
in North American of $11 and $15, respectively, as of September 30, 2002;
$11 and $16, respectively as of June 30, 2002; and $6 and $32,
respectively, as of December 31, 2001.
[4] Gross of reinsurance, reserves for Asbestos and Environmental were $1,804
and $743, respectively, as of September 30, 2002; $1,874 and $807,
respectively, as of June 30, 2002; and $1,633 and $919, respectively, as of
December 31, 2001.
</FN>
During 2001, the Company observed a decrease in newly reported environmental
claims as well as favorable settlements with respect to certain existing
environmental claims. Both observations were consistent with longer-term
positive development trends for environmental liabilities. In the same
timeframe, consistent with the reports of other insurers, The Hartford was
experiencing an increase in the number of new asbestos claims by policyholders
not previously identified as potentially significant claimants, including
installers or handlers of asbestos-containing products. In addition, new classes
of claims were beginning to arise whereby some asbestos-related defendants were
asserting that their asbestos-related claims fall within so-called non-products
liability coverage contained within their policies rather than products
liability coverage and that the claimed non-products coverage is not subject to
any aggregate limit. Also, as previously noted, The Hartford consolidated
management and claims handling responsibility of all of its asbestos and
environmental exposures within Other Operations in 2001. Based on a review of
the environmental claim trends that was completed in the fourth quarter of 2001
under the supervision of the then newly consolidated management structure and in
light of the further uncertainties posed by the foregoing asbestos trends, the
Company reclassified $100 of Environmental reserves to Asbestos reserves in
2001.
In the second quarter of 2002, The Hartford completed a review of its Other
Operations reserves and liabilities then categorized as "All Other". This review
was part of the Company's ongoing monitoring of reserves. The Hartford's primary
records of the reserves and policies managed in the Other Operations segment are
organized by individual insurance contract and by the type of insurance coverage
originally written. The review was conducted within the recently consolidated
asbestos and environmental management structure and was largely focused on the
appropriateness of the categorization of the All Other reserves, net of
reinsurance. In evaluating the appropriateness of the categorization of these
net reserves, management utilized the best information that was available to
ascertain the nature of the underlying exposures and focused significantly on
the reserves attributable to The Hartford's whole account reinsurance, including
those reserves that related to commutations of previous cessions of business.
The review also incorporated the most current information and payment and
settlement trends related to latent exposures that are not asbestos and
environmental exposures. As a result of this review, the Company reclassified
$600 of reserves from the All Other category, with $540 reclassified to Asbestos
and $60 reclassified to Environmental. The increase in reserves categorized as
Environmental of $60 in the second quarter (as contrasted with the $100 decrease
in the fourth quarter of 2001) occurred because the reviews in each of the two
periods employed actuarial techniques to analyze distinct and non-overlapping
blocks of reserves and associated exposures. Facts and circumstances associated
with each block then determined the resulting changes in category.
- 33 -
A portion of the 2002 reclassification relates to re-estimates of the
appropriate allocation between Asbestos, Environmental, and All Other categories
of the aggregate reserves (net of reinsurance) carried for certain assumed
reinsurance, commuted cessions and commuted retrocessions of whole account
business. As part of the 2002 reclassification, The Hartford also revised
formulas that it will use to allocate (between the Asbestos, Environmental and
All Other categories) future claim payments for which reinsurance arrangements
were commuted and to allocate claim payments made to effect commutations. As a
result of these revisions, payments categorized as asbestos and environmental
exposures will be higher in future periods than in prior periods. The Hartford
believes that any percent increase in claim payments caused by the
reclassification would be significantly less than the percent increase in total
Asbestos and Environmental reserves.
For the third quarter ended September 30, 2002, favorable pollution development
in North American of $2 was offset by unfavorable incurred development in the
international reinsurance business of HartRe of $17 as well as $25 of adverse
asbestos development primarily in assumed reinsurance.
Based on currently known facts and the Company's methodologies for estimating
and categorizing reserves for Other Operations, The Hartford believes that the
level of recorded reserves for Other Operations at September 30, 2002 is
reasonable and appropriate. Because of the significant uncertainties described
in the foregoing paragraphs, principally those related to asbestos, the ultimate
liabilities may exceed the currently recorded reserves. Any such additional
liability (or any range of additional amounts) cannot be reasonably estimated
now but could be material to The Hartford's future consolidated operating
results and financial condition. Consistent with the Company's long-standing
reserving practices, The Hartford will continue to regularly review and monitor
these reserves and, where future circumstances indicate, make appropriate
adjustments to the reserves.
- --------------------------------------------------------------------------------
INVESTMENTS
- --------------------------------------------------------------------------------
Return on invested assets is an important element of The Hartford's financial
results. Significant fluctuations in the fixed income or equity markets could
have a material impact on the Company's consolidated 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.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, fixed maturity investments, which comprised 89% and 86% of the fair
value of its invested assets as of September 30, 2002 and December 31, 2001,
respectively. Other events beyond the Company's control also could impact
adversely the fair value of these investments. For example, a downgrade of an
issuer's credit rating or default of payment by an issuer could reduce the fair
value of the investment and the Company's investment return.
A significant decrease in the fair value of any investment that is deemed other
than temporary would result in the Company's recognition of a loss in its
consolidated financial results prior to the actual sale of the investment and
may result in the recognition of either a gain or an additional loss upon the
ultimate disposition of the investment.
The Hartford's investment portfolios are 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 a further discussion on The Hartford's
approach to managing risks, see the Capital Markets Risk Management section.)
Please refer to the Investments section of the MD&A in The Hartford's 2001 Form
10-K Annual Report for a description of the Company's investment objectives and
policies.
LIFE
The following table identifies invested assets by type held in the Life general
account as of September 30, 2002 and December 31, 2001.
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
AMOUNT PERCENT AMOUNT PERCENT
-------------- -------------- -------------- -----------
Fixed maturities, at fair value $ 28,539 85.8% $ 23,301 82.1%
Equity securities, at fair value 374 1.1% 428 1.5%
Policy loans, at outstanding balance 2,980 9.0% 3,317 11.7%
Limited partnerships, at fair value 672 2.0% 811 2.9%
Other investments 687 2.1% 520 1.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 33,252 100.0% $ 28,377 100.0%
====================================================================================================================================
Fixed maturity investments increased 22% since December 31, 2001, primarily due
to increased institutional and retail operating cash flows, transfers into the
general account from the variable annuity separate account, and an increase in
fair value due to a lower interest rate environment. Other investments increased
32% since December 31, 2001 primarily due to market value appreciation of
derivative instruments in cash-flow hedging relationships.
The following table identifies fixed maturities by type held in the Life general
account as of September 30, 2002 and December 31, 2001.
- 34 -
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
---------------------------------------------------------
Corporate $ 13,713 48.1% $ 11,419 49.0%
Commercial mortgage-backed securities (CMBS) 4,073 14.3% 3,029 13.0%
Asset-backed securities (ABS) 3,873 13.6% 3,427 14.7%
Municipal - tax-exempt 2,021 7.1% 1,565 6.7%
Mortgage-backed securities (MBS) - agency 1,713 6.0% 981 4.2%
Collateralized mortgage obligations (CMO) 816 2.8% 767 3.3%
Government/Government agencies - Foreign 524 1.8% 390 1.7%
Government/Government agencies - United States 262 0.9% 374 1.6%
Municipal - taxable 31 0.1% 47 0.2%
Short-term 1,479 5.2% 1,245 5.3%
Redeemable preferred stock 34 0.1% 57 0.3%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 28,539 100.0% $ 23,301 100.0%
====================================================================================================================================
INVESTMENT RESULTS
The table below summarizes Life's investment results.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------
(before-tax) 2002 2001 2002 2001
- --------------------------------------------------------------------------- -------------- -------------- -------------- -----------
Net investment income - excluding policy loan income $ 401 $ 368 $ 1,164 $ 1,085
Policy loan income 61 79 196 235
---------------------------------------------------------
Net investment income - total $ 462 $ 447 $ 1,360 $ 1,320
Yield on average invested assets [1] 6.0% 6.7% 6.1% 7.0%
Net realized capital losses $ (118) $ (50) $ (253) $ (67)
====================================================================================================================================
<FN>
[1] Represents annualized net investment income (excluding net realized capital
gains (losses)) divided by average invested assets at cost (fixed
maturities at amortized cost).
</FN>
For the third quarter and nine months ended September 30, 2002, net investment
income, excluding policy loans, increased $33, or 9%, and $79, or 7%, compared
to the respective prior year periods. The increase was primarily due to income
earned on a higher invested asset base partially offset by lower investment
yields. Invested assets increased 19% from September 30, 2001 primarily due to
operating cash flows, transfers into the general account from the variable
annuity separate account, and an increase in fair value due to a lower interest
rate environment. Yields on average invested assets decreased as a result of
lower rates on new investment purchases and decreased policy loan income.
Net realized capital losses for the third quarter and nine months ended
September 30, 2002 increased $68 and $186 compared to the respective prior year
periods. Included in the third quarter and nine months ended September 30, 2002
were write-downs for other than temporary impairments on fixed maturities of
$118 and $277, respectively. The third quarter impairments were concentrated in
asset-backed securities principally due to weakness in the airline industry. The
year to date impairment losses were primarily due to write-downs on bonds in the
telecommunications industry. Also included in the third quarter and nine months
ended September 30, 2002 were write-downs for other than temporary impairments
on equity securities of $14.
PROPERTY & CASUALTY
The following table identifies invested assets by type as of September 30, 2002
and December 31, 2001.
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
AMOUNT PERCENT AMOUNT PERCENT
-------------- -------------- -------------- -----------
Fixed maturities, at fair value $ 18,899 93.5% $ 16,742 91.5%
Equity securities, at fair value 611 3.0% 921 5.0%
Limited partnerships, at fair value 412 2.1% 561 3.0%
Other investments 280 1.4% 85 0.5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 20,202 100.0% $ 18,309 100.0%
====================================================================================================================================
Fixed maturity investments increased 13% since December 31, 2001, due to the
investment of increased operating cash flows and an increase in fair value due
to a lower interest rate environment. Total equity securities decreased 34%
since December 31, 2001, due to the liquidation of foreign equity holdings and
declines in domestic equity market values. Other investments also increased
since December 31, 2001 due to the purchase of a corporate owned life insurance
contract and increased investment in mortgage loans. The following table
identifies fixed maturities by type as of September 30, 2002 and December 31,
2001.
- 35 -
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
-------------- -------------- -------------- -----------
Municipal - tax-exempt $ 8,931 47.2% $ 8,401 50.2%
Corporate 4,813 25.5% 4,179 25.0%
Commercial mortgage-backed securities (CMBS) 1,637 8.7% 1,145 6.8%
Government/Government agencies - Foreign 834 4.4% 613 3.6%
Asset-backed securities (ABS) 737 3.9% 717 4.3%
Mortgage-backed securities (MBS) - agency 589 3.1% 381 2.3%
Collateralized mortgage obligations (CMO) 98 0.5% 97 0.6%
Government/Government agencies - United States 66 0.3% 201 1.2%
Municipal - taxable 52 0.3% 47 0.3%
Short-term 1,073 5.7% 862 5.1%
Redeemable preferred stock 69 0.4% 99 0.6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 18,899 100.0% $ 16,742 100.0%
====================================================================================================================================
INVESTMENT RESULTS
The table below summarizes Property & Casualty's investment results.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------
2002 2001 2002 2001
- --------------------------------------------------------------------------- -------------- -------------- -------------- -----------
Net investment income, before-tax $ 262 $ 263 $ 787 $ 791
Net investment income, after-tax [1] $ 204 $ 205 $ 612 $ 616
---------------------------------------------------------
Yield on average invested assets, before-tax [2] 5.6% 6.1% 5.7% 6.2%
Yield on average invested assets, after-tax [1] [2] 4.4% 4.8% 4.5% 4.8%
Net realized capital losses, before-tax $ (42) $ (4) $ (80) $ (24)
====================================================================================================================================
<FN>
[1] Due to the significant holdings in tax-exempt investments, after-tax net
investment income and after-tax yield also are included.
[2] Represents annualized net investment income (excluding net realized capital
gains (losses)) divided by average invested assets at cost (fixed
maturities at amortized cost).
</FN>
For the third quarter and nine months ended September 30, 2002, both before- and
after-tax net investment income remained essentially unchanged compared to the
same periods in 2001. Yields on average invested assets declined due to the
lower interest rate environment, offsetting the impact of increased invested
assets.
Net realized capital losses for the third quarter and nine months ended
September 30, 2002 increased $38 and $56, respectively, compared to the
respective prior year periods. Included in the third quarter and nine months
ended September 30, 2002 were write-downs for other than temporary impairments
on fixed maturities of $35 and $129, respectively, and $8 and $32 on equities,
respectively, partially offset by net realized capital gains on sales of equity
securities. The fixed maturity impairment losses primarily reflect weakness in
the telecommunications and airline industries.
CORPORATE
In connection with The HLI Repurchase, the carrying value of the purchased fixed
maturity investments was adjusted to fair market value as of the date of the
repurchase. This adjustment was reported in Corporate. The amortization of the
adjustment to the fixed maturity investments' carrying values is reported in
Corporate's net investment income. The total amount of amortization for the
third quarter and nine months ended September 30, 2002 was $4 and $13,
respectively, before-tax. Also reported in Corporate as of September 30, 2002
were $647 of proceeds from third quarter Company debt and equity issuances. The
proceeds are invested in short-term fixed maturities and earned $1 of related
income.
- --------------------------------------------------------------------------------
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 separate and distinct 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.
The Company is exposed to two primary sources of investment and asset/liability
management risk: credit risk, relating to the uncertainty associated with the
ability of an obligor or counterparty to make timely payments of principal
and/or interest, and market risk, relating to the market price and/or cash flow
variability associated with changes in interest rates, securities prices, market
indices, yield curves or currency exchange rates. The Company does not hold any
financial instruments purchased for trading purposes.
- 36 -
Please refer to the Capital Markets Risk Management section of the MD&A in The
Hartford's 2001 Form 10-K Annual Report for a description of the Company's
objectives, policies and strategies.
CREDIT RISK
The Company invests primarily in securities which are rated investment grade and
has established exposure limits, diversification standards and review procedures
for all credit risks including borrower, issuer or counterparty.
Creditworthiness of specific obligors is determined by an internal credit
assessment and ratings assigned by nationally recognized ratings agencies.
Obligor, asset sector and industry concentrations are subject to established
limits and are monitored at regular intervals. 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 tables identify fixed maturity securities for Life, including
guaranteed separate accounts of $11.1 billion and $9.8 billion as of September
30, 2002 and December 31, 2001, respectively, and Property & Casualty, by credit
quality. The ratings referenced in the tables 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.
LIFE
As of September 30, 2002 and December 31, 2001, over 95% and 96%, respectively,
of the fixed maturity portfolio was invested in securities rated investment
grade. While the overall credit quality of the fixed maturity portfolio has
remained essentially unchanged, the percentage of BB & below holdings has
increased due to downgraded credit ratings primarily in public corporate bonds.
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
-------------- -------------- -------------- -----------
United States Government/Government agencies $ 3,685 9.3% $ 2,639 8.0%
AAA 6,736 17.0% 5,070 15.3%
AA 4,196 10.6% 3,644 11.0%
A 12,262 30.9% 11,528 34.8%
BBB 9,205 23.2% 7,644 23.1%
BB & below 1,791 4.5% 1,148 3.4%
Short-term 1,766 4.5% 1,470 4.4%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 39,641 100.0% $ 33,143 100.0%
====================================================================================================================================
PROPERTY & CASUALTY
As of September 30, 2002 and December 31, 2001, over 95% and 94%, respectively,
of the fixed maturity portfolio was invested in securities rated investment
grade. While the overall credit quality of the fixed maturity portfolio has
remained essentially unchanged, the percentage of BBB holdings has increased due
to downgraded credit ratings primarily in public corporate bonds.
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
-------------- -------------- -------------- -----------
United States Government/Government agencies $ 713 3.8% $ 639 3.8%
AAA 7,226 38.2% 6,160 36.8%
AA 3,432 18.2% 3,126 18.7%
A 3,257 17.2% 3,193 19.1%
BBB 2,288 12.1% 1,876 11.2%
BB & below 910 4.8% 886 5.3%
Short-term 1,073 5.7% 862 5.1%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 18,899 100.0% $ 16,742 100.0%
====================================================================================================================================
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.
The Company's Life operations are significantly influenced by changes in the
equity markets. Life'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. A prolonged and precipitous decline in the equity markets, as has been
experienced of late, 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. The lower assets
under management will have a negative impact on the Company's financial results,
primarily due to lower fee income related to the Investment Products and
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
- 37 -
Company is unable to earn an acceptable investment spread, 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. (For further discussion of the Company's exposure to interest rate risk,
please refer to the Capital Markets Risk Management section of the MD&A in The
Hartford's 2001 Form 10-K Annual Report.)
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 Company's expected 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 Investment Products segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, The Hartford 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. The
Company currently reinsures a significant portion of these death benefit
guarantees associated with its in-force block of business. The Company currently
records the death benefit costs, net of reinsurance, as they are incurred.
Declines in the equity market may increase the Company's net exposure to death
benefits under these contracts.
The Company's total gross exposure (i.e. before reinsurance) to these guaranteed
death benefits as of September 30, 2002 is $25.9 billion. Due to the fact that
81% of this amount is reinsured, the Company's net exposure is $4.9 billion.
This amount is often referred to as the net amount at risk. However, the Company
will only incur these guaranteed death benefit payments in the future if the
policyholder has an in-the-money guaranteed death benefit at their time of
death. In order to analyze the total costs that the Company may incur in the
future related to these guaranteed death benefits, the Company performed an
actuarial present value analysis. This analysis included developing a model
utilizing 250 stochastically generated investment performance scenarios and best
estimate assumptions related to mortality and lapse rates. A range of projected
costs was developed and discounted back to the statement date utilizing the
Company's cost of capital, which for this purpose was assumed to be 9.25%. Based
on this analysis, the Company estimated that the present value of the retained
death benefit costs to be incurred in the future fell within a range of $91 to
$378. This range was calculated utilizing a 95% confidence interval. The median
of the 250 stochastically generated scenarios was $184.
Furthermore, the Company is involved in arbitration with one of its primary
reinsurers relating to policies with such death benefit guarantees written from
1994 to 1999. The arbitration involves alleged breaches under the reinsurance
treaties. Although the Company believes that its position in this pending
arbitration is strong, an adverse outcome could result in a decrease to the
Company's statutory surplus and capital and potentially increase the death
benefit costs incurred by the Company in the future. The arbitration hearing
began in October 2002.
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 in order 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 income enhancement and replication transactions. The
Company does not make a market or trade derivatives for the express purpose of
earning trading profits. (For further discussion on The Hartford's use of
derivative instruments, see Note 3 of Notes to Consolidated Financial
Statements.)
- 38 -
- --------------------------------------------------------------------------------
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 and borrow funds at competitive rates to meet operating and growth
needs. The capital structure of The Hartford consists of debt and equity
summarized as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Short-term debt $ 615 $ 599
Long-term debt 2,595 1,965
Company obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures (trust preferred securities) 1,461 1,412
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL DEBT 4,671 3,976
-----------------------------------------------------------------------------------------------------------------------------
Equity excluding unrealized gain on securities and other, net of tax [1] 9,294 8,344
Unrealized gain on securities and other, net of tax [1] 1,649 669
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 10,943 9,013
-----------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION [2] $ 13,965 $ 12,320
-----------------------------------------------------------------------------------------------------------------------------
Debt to equity [2] [3] 50% 48%
Debt to capitalization [2] [3] 33% 32%
====================================================================================================================================
<FN>
[1] Other represents the net gain on cash-flow hedging instruments as a result
of the Company's adoption of SFAS No. 133.
[2] Excludes unrealized gain on securities and other, net of tax.
[3] Excluding trust preferred securities, the debt to equity ratio was 35% and
31% and the debt to capitalization ratio was 23% and 21% as of September
30, 2002 and December 31, 2001, respectively.
</FN>
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
There have been no significant changes to The Hartford's contractual obligations
and commitments since December 31, 2001.
CAPITALIZATION
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.
Consistent with these objectives, during the third quarter of 2002, the Company
increased its capitalization by $649 through the issuance of $330 in common
stock and $319 in equity units. Proceeds of $300 were contributed to the
property and casualty insurance subsidiaries, while the balance has been held
for general corporate purposes, which may include additional capital
contributions to the insurance subsidiaries.
During the nine months ended September 30, 2002, The Hartford's total
capitalization, excluding unrealized gain on securities and other, net of tax,
increased by $1,645. This increase was a result of the aforementioned third
quarter 2002 capital raising activities; the issuance of $298 in senior notes in
August 2002, the proceeds of which were used to repay senior notes that matured
on November 1, 2002; earnings; and stock issued related to stock compensation
plans. These increases were partially offset by dividends declared.
DEBT
On September 13, 2002 The Hartford issued 6.6 million 6% equity units at a price
of $50.00 per unit and received net proceeds of $319.
Each equity unit offered initially consists of a corporate unit with a stated
amount of $50.00 per unit. Each corporate unit consists of one purchase contract
for the sale of a certain number of shares of the Company's stock and fifty
dollars principal amount of senior notes due November 16, 2008.
The corporate unit may be converted by the holder into a treasury unit
consisting of the purchase contract and a 5% undivided beneficial interest in a
zero-coupon U.S. Treasury security with a principal amount of one thousand
dollars that matures on November 15, 2006. The holder of an equity unit owns the
underlying senior notes or treasury portfolio but has pledged the senior notes
or treasury portfolio to the Company to secure the holder's obligations under
the purchase contract.
The purchase contract obligates the holder to purchase, and obligates The
Hartford to sell, on November 16, 2006, for fifty dollars, a variable number of
newly issued common shares of The Hartford. The number of The Hartford's shares
to be issued will be determined at the time the purchase contracts are settled
based upon the then current applicable market value of The Hartford's common
stock. If the applicable market value of The Hartford's common stock is equal to
or less than $47.25, then the Company will deliver 1.0582 shares to the holder
of the equity unit, or an aggregate of 7.0 million shares. If the applicable
market value of The Hartford's common stock is greater than $47.25 but less than
$57.645, then the Company will deliver the number of shares equal to fifty
dollars divided by the then current applicable market value of The Hartford's
common stock to the holder. Finally, if the applicable market value of The
Hartford's common stock is equal to or greater than $57.645, then the Company
will deliver 0.8674 shares to the holder, or an aggregate of 5.7 million shares.
Accordingly, upon settlement of the purchase contracts on November 16, 2006, The
Hartford will receive proceeds of approximately $330 and will deliver between
5.7 million and 7.0 million common shares in the aggregate. The proceeds will be
credited to stockholders' equity and allocated between the common stock and
additional paid-in-capital accounts. The Hartford will make quarterly contract
adjustment payments to the equity unit holders at a rate of 1.90% of the stated
amount per year until the purchase contract is settled.
- 39 -
Each corporate unit also includes fifty dollars principal amount of senior notes
that will mature on November 16, 2008. The aggregate maturity value of the
senior notes is $330. The notes are pledged by the holders to secure their
obligations under the purchase contracts. The Hartford will make quarterly
interest payments to the holders of the notes initially at an annual rate of
4.10%. On August 11, 2006, the notes will be remarketed. At that time, The
Hartford's remarketing agent will have the ability to reset the interest rate on
the notes in order to generate sufficient remarketing proceeds to satisfy the
holder's obligation under the purchase contract. In the event of an unsuccessful
remarketing, the Company will exercise its rights as a secured party to obtain
and extinguish the notes.
The total distributions payable on the equity units are at an annual rate of
6.0%, consisting of interest (4.10%) and contract adjustment payments (1.90%).
The corporate units are listed on the New York Stock Exchange under the symbol
"HIG PrA".
The present value of the contract adjustment payments of $24 was accrued upon
the issuance of the equity units as a charge to additional paid-in capital and
are included in other liabilities in the accompanying consolidated balance sheet
as of September 30, 2002. Subsequent contract adjustment payments will be
allocated between this liability account and interest expense based on a
constant rate calculation over the life of the transaction. Additional paid-in
capital as of September 30, 2002, also reflected a charge of $9 representing a
portion of the equity unit issuance costs that was allocated to the purchase
contracts.
The equity units have been reflected in the diluted earnings per share
calculation using the treasury stock method, which would be used for the equity
units at any time before the settlement of the purchase contracts. Under the
treasury stock method, the number of shares of common stock used in calculating
diluted earnings per share is increased by the excess, if any, of the number of
shares issuable upon settlement of the purchase contracts over the number of
shares that could be purchased by The Hartford in the market, at the average
market price during the period, using the proceeds received upon settlement. The
Company anticipates that there will be no dilutive effect on its earnings per
share related to the equity units, except during periods when the average market
price of a share of the Company's common stock is above the threshold
appreciation price of $57.645. Because the average market price of The
Hartford's common stock during the quarter ended September 30, 2002, was below
this threshold appreciation price, the shares issuable under the purchase
contract component of the equity units have not been included in the diluted
earnings per share calculation.
On August 29, 2002 The Hartford issued 4.7% senior notes due September 1, 2007
and received net proceeds of $298. Interest on the notes is payable
semi-annually on March 1 and September 1, commencing on March 1, 2003. The
Company used the proceeds to repay senior notes that matured on November 1,
2002.
In March 2002, the Company borrowed $16 of short-term commercial notes for
general corporate purposes.
STOCKHOLDERS' EQUITY
Issuance of common stock - On September 13, 2002, The Hartford issued
approximately 7.3 million shares of common stock pursuant to an underwritten
offering at a price of $47.25 per share and received net proceeds of $330. Also
on September 13, 2002, The Hartford issued 6.6 million 6% equity units and
received net proceeds of $319. For further discussion of the equity units
issuance, see the Debt section above.
Increase in authorized shares - At the Company's annual meeting of shareholders
held on April 18, 2002, shareholders approved an amendment to Section (a)
Article Fourth of the Amended and Restated Certificate of Incorporation to
increase the aggregate authorized number of shares of common stock from 400
million to 750 million.
Dividends - On April 18, 2002, The Hartford declared a dividend on its common
stock of $0.26 per share payable on July 1, 2002 to shareholders of record as of
June 3, 2002.
On July 18, 2002, The Hartford declared a dividend on its common stock of $0.26
per share payable on October 1, 2002 to shareholders of record as of September
3, 2002.
On October 24, 2002, The Hartford declared a dividend on its common stock of
$0.27 per share payable on January 2, 2003 to shareholders of record as of
December 2, 2002.
Minimum pension liability adjustment - 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. Recent
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 expects to record a minimum
pension liability as of December 31, 2002 which would result in an after-tax
reduction of stockholders' equity of approximately $200-$300. This minimum
pension liability will not affect the Company's results of operations.
CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2002 2001
- ------------------------------------------------------------------
Cash provided by operating activities $ 2,092 $ 1,059
Cash used for investing activities $ (5,780) $ (4,081)
Cash provided by financing activities $ 3,740 $ 3,120
Cash - end of period $ 413 $ 325
==================================================================
The increase in cash provided by operating activities was primarily the result
of higher net income reported for the nine months ended September 30, 2002 than
for the comparable prior year period as well as income tax refunds received in
2002 compared with income tax payments made in the prior year period. The
increase in cash provided by financing activities was primarily the result of
increased proceeds from investment and universal life-type contracts. The
increase in cash from financing activities accounted for the majority of the
change in cash for investing activities. Operating cash flows in both periods
have been adequate to meet liquidity requirements.
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
- 40 -
level of revenues or the persistency of the Company's business may be adversely
impacted.
The following table summarizes The Hartford's significant United States member
companies' financial ratings from the major independent rating organizations as
of November 12, 2002.
A.M. STANDARD
BEST FITCH & POOR'S MOODY'S
- -----------------------------------------------------------------
INSURANCE RATINGS:
Hartford Fire A+ AA AA Aa3
Hartford Life Insurance
Company A+ AA AA Aa3
Hartford Life & Accident A+ AA AA Aa3
Hartford Life & Annuity A+ AA AA Aa3
- -----------------------------------------------------------------
OTHER RATINGS:
The Hartford Financial
Services Group, Inc.:
Senior debt a+ A A A2
Commercial paper AMB-1 F-1 A-1 P-1
Hartford Capital I
quarterly income
preferred securities a- A- BBB+ A3
Hartford Capital III
trust originated
preferred securities a- A- BBB+ A3
Hartford Life, Inc.:
Senior debt a+ A A A2
Commercial paper -- F-1 A-1 P-1
Hartford Life, Inc.:
Capital I and II trust
preferred securities a- A- BBB+ A3
=================================================================
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.
SEPT. 30, DEC. 31,
2002 2001
- ------------------------------------------------------------------
Life Operations $ 2,667 $ 2,991
Property & Casualty Operations 3,615 3,178
- ------------------------------------------------------------------
TOTAL $ 6,282 $ 6,169
==================================================================
The decrease in life operations' surplus is primarily due to the decline in the
equity markets and the difficult investment credit cycle. The increase in the
property and casualty operations' surplus is primarily due to the $300 capital
contribution from its parent and statutory net income.
On October 16, 2002, Standard & Poor's placed its ratings on The Hartford
Financial Services Group, Inc. and related entities on credit watch with
negative implications, reflecting concerns over the recent downturn in the
equity markets and the increasingly competitive environment for spread-based and
equity-linked retirement and savings products. In terms of possible outcomes,
Standard & Poor's stated it does not expect any downgrade to exceed one notch.
On September 19, 2002, Fitch Ratings lowered the ratings of the Hartford Life
Group as part of a comprehensive industry review of all North American life
insurance company ratings. For the Hartford Life Group, Fitch stated the rating
action was driven primarily by Fitch's opinion that most of the very strong,
publicly owned insurance organizations are more appropriately rated in the `AA'
rating category. Fitch also changed its view on the variable annuity business
and stated that it believes that the associated risks, mainly variable earnings,
are greater than previously considered. Fitch's long-term fixed income ratings
on The Hartford Financial Services Group, Inc. were also lowered, while the
affiliated property and casualty insurer financial strength ratings were
affirmed. The rating outlooks are stable.
On September 4, 2002, Moody's revised its outlook on The Hartford's debt ratings
to Stable from Negative citing The Hartford's commitment to maintaining its
capital strength in the event of a significant unforeseen loss or adverse
development that would weaken its capital position.
EQUITY MARKETS
For a discussion of equity markets impact to capital and liquidity, see the
Capital Markets Risk Management section under "Market Risk".
CONTINGENCIES
Legal proceedings - The Hartford is involved in claims litigation arising in the
ordinary course of business, both as a liability insurer defending third-party
claims brought against insureds or as an insurer defending coverage claims
brought against it. The Hartford accounts for such activity through the
establishment of unpaid claim and claim adjustment expense reserves. Subject to
the discussion of the litigation involving MacArthur in Part II, Item 1. Legal
Proceedings and the uncertainties related to asbestos and environmental claims
discussed in the MD&A under the caption "Other Operations," management expects
that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and
costs of defense, will not be material to the consolidated financial condition,
results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability, and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
Dependence on Certain Third Party Relationships - The Company distributes its
annuity, life and certain property and
- 41 -
casualty insurance products through a variety of distribution channels,
including broker-dealers, banks, wholesalers, its own internal sales force and
other third party organizations. The Company periodically negotiates provisions
and renewals of these relationships, and there can be no assurance that such
terms will remain acceptable to the Company or such third parties. An
interruption in the Company's continuing relationship with certain of these
third parties could materially affect the Company's ability to market its
products.
- --------------------------------------------------------------------------------
ACCOUNTING STANDARDS
- --------------------------------------------------------------------------------
For a discussion of accounting standards, see Note 1 of Notes to Consolidated
Financial Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in the Capital Markets Risk Management section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's principal executive officer and its principal financial officer,
based on their evaluation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-14(c)) as of a date within 90 days prior to
the filing of this Quarterly Report on Form 10-Q, 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-14(c).
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect the Company's internal controls
subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds or as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation involving MacArthur Company and its subsidiary, Western MacArthur
Company, both former regional distributors of asbestos products as discussed
below and the uncertainties discussed in Note 5(b) of Notes to Consolidated
Financial Statements under the caption "Asbestos and Environmental Claims,"
management expects that the ultimate liability, if any, with respect to such
ordinary-course claims litigation, after consideration of provisions made for
potential losses and costs of defense, will not be material to the consolidated
financial condition, results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability, and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
As further discussed in the MD&A under the caption "Other Operations," The
Hartford continues to receive environmental and asbestos claims that involve
significant uncertainty regarding policy coverage issues. Regarding these
claims, The Hartford continually reviews its overall reserve levels,
methodologies and reinsurance coverages.
On October 7, 2002, an action was filed in the Superior Court in Alameda County,
California, against Hartford Accident & Indemnity Company ("Hartford A&I"), a
subsidiary of the Company, and two other insurers. The principal plaintiffs are
MacArthur Company and its subsidiary, Western MacArthur Company, both former
regional distributors of asbestos products (collectively or individually,
"MacArthur"). MacArthur seeks a declaration of coverage and damages for asbestos
bodily-injury claims. Five asbestos claimants who allegedly have obtained
default judgments against MacArthur also are joined as plaintiffs; they seek to
recover the amount of their default judgments and additional damages directly
from the defendant insurers and assert a right to an accelerated trial.
Hartford A&I issued primary general liability policies to MacArthur during the
period 1967-76. MacArthur sought coverage for asbestos-related claims from
Hartford A&I under these policies beginning in 1978. During the period 1978 to
1987, Hartford A&I paid out its full aggregate limits under these policies plus
defense costs. In 1987, Hartford A&I notified MacArthur that its available
limits under these policies had been exhausted, and MacArthur ceased submitting
claims to Hartford A&I under these policies.
- 42 -
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization that MacArthur is to file. USF&G provided at
least 12 years of primary general liability coverage to MacArthur, but, unlike
Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date.
MacArthur seeks additional coverage from Hartford A&I on the theory that
Hartford A&I has exhausted only its products aggregate limit of liability, not
separate limits MacArthur alleges to be available for non-products liability.
The ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current and future claims, is currently unknown.
MacArthur indicates in its complaint that it will seek to have the full amount
of its current and future asbestos liability estimated in its anticipated
bankruptcy proceeding. If such an estimation is made, MacArthur intends to seek
a judgment against the defendants for the amount of its total liability,
including estimated claims, less the amount ultimately paid by St. Paul.
Hartford A&I intends to defend the MacArthur action vigorously. Based on the
information currently available, management believes that Hartford A&I's
liability, if any, to MacArthur will not be finally resolved for at least a year
and most probably not for several years. In the opinion of management, the
ultimate outcome is highly uncertain for many reasons. It is not yet known, for
example, in which venue Hartford A&I's liability, if any, will be determined;
whether Hartford A&I's defenses based on MacArthur's long delay in asserting
claims for further coverage will be successful; how other significant coverage
defenses will be decided; or the extent to which the claims and default
judgments against MacArthur involve injury outside of the products and completed
operations hazard definitions of the policies. In the opinion of management, an
adverse outcome could have a material adverse effect on the Company's results of
operations, financial condition and liquidity.
In addition, on May 14, 2002, The Hartford announced its participation, along
with several dozen other insurance carriers, in a settlement in principle with
its insured, PPG Industries ("PPG"), of litigation arising from asbestos
exposures involving Pittsburgh Corning Corporation, which is 50% owned by PPG.
(For further discussion, see Note 5(b) of Notes to Consolidated Financial
Statements.)
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al. in favor of Bancorp in the amount of $118.
The case involved claims of patent infringement, misappropriation of trade
secrets, and breach of contract against HLIC and its affiliate International
Corporate Marketing Group, Inc. ("ICMG"). The judge dismissed the patent
infringement claim on summary judgment. The jury's award was based on the last
two claims. On August 28, 2002, the Court entered an order awarding Bancorp
prejudgment interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have moved the district court for, among other things, judgment as
a matter of law or a new trial, and intend to appeal the judgment if the
district court does not set it aside or substantially reduce it. In either
event, the Company's management, based on the opinion of its legal advisers,
believes that there is a substantial likelihood that the jury award will not
survive at its current amount. Based on the advice of legal counsel regarding
the potential outcome of this litigation, the Company recorded an $11 after-tax
charge in the first quarter of 2002 to increase litigation reserves associated
with this matter. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future
related to this matter.
The Hartford also is involved in arbitration with one of its primary reinsurers
relating to variable annuity contracts with death benefit guarantees. The
arbitration is discussed more fully in the MD&A under the caption "Capital
Markets Risk Management - Market Risk".
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index.
(b) Reports on Form 8-K.
During the quarterly period ended September 30, 2002, the Company filed the
following current reports on Form 8-K:
o Dated September 9, 2002, Item 7, Financial Statements, Pro Forma
Financial Information and Exhibits, to incorporate by reference into
the Registration Statement the Underwriting Agreement General Terms
and Conditions, dated September 9, 2002, including the Pricing
Agreement, dated September 9, 2002 by and among the Company, BOA,
Morgan Stanley and Salomon Smith Barney, Inc. ("Salomon Smith Barney")
for the issuance and sale of the Company's Common Stock; to
incorporate by reference into the Registration Statement the
Underwriting Agreement General Terms and Conditions, dated September
9, 2002, including the Pricing Agreement, dated September 9, 2002, by
and among the Company, BOA, Morgan Stanley and Salomon Smith Barney
for the issuance and sale of the Company's 6% Corporate Units; to
incorporate by reference into the Registration Statement Supplemental
Indenture No. 2, dated as of September 13, 2002, to the Senior
Indenture, dated as of October 20, 1995, between ITT Hartford Group,
Inc. and The Chase Manhattan Bank (National Association) as Trustee,
between the Company and JPMorgan Chase Bank, as Trustee; to
incorporate into the Registration Statement the Purchase Contract
Agreement, dated as of September 13, 2002, between the Company and
JPMorgan Chase Bank, as Purchase Contract Agent; to incorporate into
the Registration Statement the Pledge Agreement, dated as of September
13, 2002, among the Company and JPMorgan Chase Bank, as Collateral
Agent, Custodial Agent, Securities Intermediary and JPMorgan Chase
Bank as Purchase Contract Agent; to incorporate by reference into the
Registration Statement the Remarketing Agreement, dated as of
September 13, 2002 by and between the Company, Morgan Stanley as
Remarketing Agent and JPMorgan Chase Bank as Purchase Contract Agent;
to incorporate by reference into the Registration Statement the
opinion of Debevoise & Plimpton rendered in connection with the
issuance and sale of the Company's Common Stock; and to incorporate by
reference into the Registration
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Statement the opinion of Debevoise & Plimpton rendered in connection
with the issuance and sale of the Company's 6% Corporate Units.
o Dated September 9, 2002, Item 5, Other Events, to report the filing of
an action on September 3, 2002 by Wal-Mart Stores, Inc. ("Wal-Mart")
against Hartford Life Insurance Company ("HLIC") and International
Corporate Marketing Group, LLC ("ICMG"), each a subsidiary of the
Company, in the Court of Chancery of the State of Delaware, New Castle
County, asserting claims arising from Wal-Mart's purchase of
corporate-owned life insurance from HLIC.
o Dated September 6, 2002, Item 5, Other Events, to report a press
release issued by the Company on September 6, 2002 relating to the
transfer of its New Jersey auto insurance book sold through
independent agents to state insurance carrier Palisades Safety and
Insurance Association and Palisades Insurance Company.
o Dated September 3, 2002, Item 7, Financial Statements, Pro Forma
Financial Information and Exhibits, to incorporate by reference into
the Registration Statement the Underwriting Agreement General Terms
and Conditions, dated August 26, 2002, including the Pricing
Agreement, dated August 26, 2002, by and among the Company, Bank of
America Securities LLC ("BOA") and Morgan Stanley & Co. Incorporated
("Morgan Stanley"), for the issuance and sale of the Company's 4.7%
Senior Notes due September 1, 2007; and to incorporate by reference
into the Registration Statement the opinion of Katherine Vines
Trumbull.
o Dated August 27, 2002, Item 7, Financial Statements, Pro Forma
Financial Information and Exhibits, to incorporate by reference into
the Company's Registration Statement on Form S-3 (File No. 333-88762)
filed with the Securities and Exchange Commission on May 21, 2001 (the
"Registration Statement") the Computation of Ratio of Earnings to
Fixed Charges.
o Dated August 12, 2002, Item 7, Financial Statements, Pro Forma
Financial Information and Exhibits, to file the certification of
Ramani Ayer, Chairman, President and Chief Executive Officer of the
Company with the Securities and Exchange Commission pursuant to the
Securities and Exchange Commission's Order of June 27, 2002 requiring
the filing of sworn statements, pursuant to Section 21(a)(1) of the
Securities Exchange Act of 1934 (the "Order"); to file the
certification of David M. Johnson, Executive Vice President and Chief
Financial Officer of the Company with the Securities and Exchange
Commission pursuant to the Order; to report the filing of the
certification of Ramani Ayer, Chairman, President and Chief Executive
Officer of the Company, which accompanied the Company's Form 10-Q for
the quarterly period ended June 30, 2002, pursuant to 18 United States
Code section 1350, as enacted by section 906 of the Sarbanes-Oxley Act
of 2002; and to report the filing of the certification of David M.
Johnson, Executive Vice President and Chief Financial Officer of the
Company, which accompanied the Company's Form 10-Q for the quarterly
period ended June 30, 2002, pursuant to 18 United States Code Section
1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002.
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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
November 13, 2002
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CERTIFICATIONS
I, Ramani Ayer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hartford
Financial Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 13, 2002
By : /s/ Ramani Ayer
-----------------------------------
Ramani Ayer
Chairman, President and Chief Executive Officer
(Signature and Title)
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I, David M. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hartford
Financial Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 13, 2002
By : /s/ David M. Johnson
------------------------------
David M. Johnson
Executive Vice President and Chief Financial Officer
(Signature and Title)
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THE HARTFORD FINANCIAL SERVICES GROUP, INC.
FORM 10-Q
EXHIBIT INDEX
EXHIBIT #
4.1 Senior Indenture, dated as of October 20, 1995, between
ITT Hartford Group, Inc. ("ITT Hartford") and The Chase
Manhattan Bank (National Association) as Trustee
(incorporated herein by reference to Exhibit 4.08 to ITT
Hartford's Report on Form 8-K, dated November 15, 1995).
4.2 Supplemental Indenture No.1, dated as of December 27,
2000, to the Senior Indenture filed as Exhibit 4.1
hereto, between the Company and The Chase Manhattan
Bank, as Trustee (incorporated herein by reference to
Exhibit 4.30 to the Registration Statement on Form S-3
(Registration No. 333-49666) of the Company, Hartford
Capital III, Hartford Capital IV and Hartford Capital
V).
4.3 Supplemental Indenture No. 2, dated as of September 13,
2002, to the Senior Indenture filed as Exhibit 4.1
hereto, between the Company and JPMorgan Chase Bank, as
Trustee (incorporated herein by reference to Exhibit 4.1
to the Form 8-K of the Company, filed September 17,
2002).
4.4 Form of Global Security (included in Exhibit 4.3).
4.5 Purchase Contract Agreement, dated as of September 13,
2002, between the Company and JPMorgan Chase Bank, as
Purchase Contract Agent (incorporated herein by
reference to Exhibit 4.2 to the Form 8-K of the Company,
filed September 17, 2002).
4.6 Form of Corporate Unit Certificate (included in Exhibit
4.5).
4.7 Pledge Agreement, dated as of September 13, 2002, among
the Company and JPMorgan Chase Bank, as Collateral
Agent, Custodial Agent, Securities Intermediary and
JPMorgan Chase Bank as Purchase Contract Agent
(incorporated herein by reference to Exhibit 4.3 to the
Form 8-K of the Company, filed September 17, 2002).
4.8 Remarketing Agreement, dated as of September 13, 2002,
between the Company and Morgan Stanley & Co.
Incorporated, as Remarketing Agent, and JPMorgan Chase
Bank, as Purchase Contract Agent (incorporated herein by
reference to Exhibit 4.4 to the Form 8-K of the Company,
filed September 17, 2002).
4.9 Global Security representing $300,000,000 of the
Company's 4.7% senior notes due September 1, 2007.
15.1 Accountants' Letter of Awareness
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