UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
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 001-13958
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3317783
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
HARTFORD PLAZA, HARTFORD, CONNECTICUT 06115-1900
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: the following, all
of which are listed on the New York Stock Exchange, Inc.:
Common Stock, par value $0.01 per share
7.45% Trust Originated Preferred Securities, Series C, issued by Hartford
Capital III
6% Equity Units
7% Equity Units
Securities registered pursuant to Section 12(g) of the Act:
7.75% Notes due June 15, 2005 6.375% Notes due November 1, 2008
2.375% Notes due June 1, 2006 4.1% Equity Unit Notes due November 16, 2008
4.7% Notes due September 1, 2007 7.9% Notes due June 15, 2010
2.56% Equity Unit Notes due August 4.625% Notes due July 15, 2013
16, 2008 7.3% Debentures due November 1, 2015
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [X] No [ ].
The aggregate market value of the shares of Common Stock held by non-affiliates
of the registrant as of June 30, 2003, was $14,167,000,000 based on the closing
price of $50.36 per share of the Common Stock on the New York Stock Exchange on
June 30, 2003.
As of February 20, 2004, there were outstanding 291,345,148 shares of Common
Stock, $0.01 par value per share, of the registrant.
Documents Incorporated by Reference:
Portions of the Registrant's definitive proxy statement for its 2004 annual
meeting of shareholders are incorporated by reference in Part III of this Form
10-K.
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CONTENTS
ITEM DESCRIPTION PAGE
PART I 1 Business 2
2 Properties 14
3 Legal Proceedings 14
4 Submission of Matters to a Vote of Security Holders 16
PART II 5 Market for The Hartford's Common Equity and Related
Stockholder Matters 16
6 Selected Financial Data 18
7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
7A Quantitative and Qualitative Disclosures About Market Risk 80
8 Financial Statements and Supplementary Data 80
9 Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 80
9A Controls and Procedures 80
PART III 10 Directors and Executive Officers of The Hartford 80
11 Executive Compensation 81
12 Security Ownership of Certain Beneficial Owners and
Management 81
13 Certain Relationships and Related Transactions 81
14 Principal Accounting Fees and Services 81
PART IV 15 Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 81
Signatures II-1
Exhibits Index II-2
PART I
ITEM 1. BUSINESS
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR PER SHARE DATA, UNLESS OTHERWISE STATED)
GENERAL
The Hartford Financial Services Group, Inc. (together with its subsidiaries,
"The Hartford" or the "Company") is a diversified insurance and financial
services company. The Hartford, headquartered in Connecticut, is among the
largest providers of investment products, individual life, group life and group
disability insurance products, and property and casualty insurance products in
the United States. Hartford Fire Insurance Company, founded in 1810, is the
oldest of The Hartford's subsidiaries. The Hartford writes insurance and
reinsurance in the United States and internationally. At December 31, 2003,
total assets and total stockholders' equity of The Hartford were $225.9 billion
and $11.6 billion, respectively.
ORGANIZATION
The Hartford strives to maintain and enhance its position as a market leader
within the financial services industry and to maximize shareholder value. The
Company pursues a strategy of developing and selling diverse and innovative
products through multiple distribution channels, continuously developing and
expanding those distribution channels, achieving cost efficiencies through
economies of scale and improved technology, maintaining effective risk
management and prudent underwriting techniques and capitalizing on its brand
name and customer recognition of The Hartford Stag Logo, one of the most
recognized symbols in the financial services industry.
As a holding company that is separate and distinct from its subsidiaries, The
Hartford Financial Services Group, Inc. has no significant business operations
of its own. Therefore, it relies on the dividends from its insurance company and
other subsidiaries as the principal source of cash flow to meet its obligations.
Additional information regarding the cash flow and liquidity needs of The
Hartford Financial Services Group, Inc. may be found in the Capital Resources
and Liquidity section of Management's Discussion and Analysis of Financial
Condition and Results of Operations ("MD&A").
The Company maintains a retail mutual fund operation, whereby the Company,
through wholly-owned subsidiaries, provides investment management and
administrative services to The Hartford Mutual Funds, Inc. and The Hartford
Mutual Funds II, Inc. ("The Hartford mutual funds"), families of 34 mutual
funds. Investors can purchase "shares" in the mutual funds, all of which are
registered with the Securities and Exchange Commission in accordance with the
Investment Company Act of 1940. The mutual funds are owned by the shareholders
of those funds and not by the Company.
On April 2, 2001, The Hartford acquired the United States individual life
insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as
"Fortis Financial Group", or "Fortis") for $1.12 billion in cash. The Company
effected the acquisition through several reinsurance agreements with
subsidiaries of Fortis and the purchase of 100% of the stock of Fortis Advisors,
Inc. and Fortis Investors, Inc., wholly-owned subsidiaries of Fortis.
On December 31, 2003 the Company acquired certain of CNA Financial Corporation's
group life and accident, and short-term and long-term disability businesses for
$485 in cash. The purchase price paid on December 31, 2003 was based on a
September 30, 2003 valuation of the businesses acquired. During the first
quarter of 2004, the purchase price will be adjusted to reflect a December 31,
2003 valuation of the businesses acquired. Currently the Company estimates that
adjustment to the purchase price to be an increase of $51. As a result of the
acquisition being effective on December 31, 2003, there were no income statement
effects recorded for the year ended December 31, 2003, although the acquired CNA
assets and liabilities were reflected on the Company's balance sheet. For
additional information, see the Capital Resources and Liquidity section of the
MD&A and Note 18 of Notes to Consolidated Financial Statements.
REPORTING SEGMENTS
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, Corporate includes certain interest
expense, capital raising and purchase accounting adjustment activities, as well
as capital raised that has not been contributed to the Company's insurance
subsidiaries.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI"). The
Company also includes in "Other" corporate items not directly allocable to any
of its reportable operating segments, principally interest expense as well as
its international operations, which are primarily located in Japan and Brazil,
realized capital gains and losses and intersegment eliminations.
Property & Casualty is organized into five reportable operating segments: the
North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance; and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of the
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments. Property & Casualty also includes income and expense
items not directly allocated to these segments, such as net investment income,
net realized capital gains and losses, other expenses including interest,
severance and income taxes.
The following is a description of Life and Property & Casualty along with each
of their segments, including a discussion of principal products, marketing and
distribution and competitive environments. Additional information on The
Hartford's reporting segments may be found in the MD&A and Note 17 of Notes to
Consolidated Financial Statements.
LIFE
Life's business is conducted by the subsidiaries of Hartford Life, Inc. ("HLI"),
a leading financial services and insurance organization. Through Life, The
Hartford provides (i) investment products, including variable annuities, fixed
market value adjusted ("MVA") annuities, mutual funds and retirement plan
services for the savings and retirement needs of over 1.5
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million customers, (ii) life insurance for wealth protection, accumulation and
transfer needs for approximately 735,000 customers, (iii) group benefits
products such as group life and group disability insurance for the benefit of
millions of individuals and (iv) corporate owned life insurance, which includes
life insurance policies purchased by a company on the lives of its employees.
The Company is one of the largest sellers of individual variable annuities,
variable universal life insurance and group disability insurance in the United
States. The Company's strong position in each of its core businesses provides an
opportunity to increase the sale of The Hartford's products and services as
individuals increasingly save and plan for retirement, protect themselves and
their families against the financial uncertainties associated with disability or
death and engage in estate planning. In an effort to advance the Company's
strategy of growing its businesses, The Hartford acquired the group life and
accident, and short-term and long-term disability businesses of CNA Financial
Corporation on December 31, 2003, and the individual life insurance, annuity and
mutual fund businesses of Fortis on April 2, 2001. For additional information,
see the Capital Resources and Liquidity section of the MD&A and Note 18 of Notes
to Consolidated Financial Statements. In addition, The Hartford's Japanese
operation achieved $3.7 billion, $1.4 billion and $462 in variable annuity sales
for the years ended December 31, 2003, 2002 and 2001, respectively. The growth
in sales was the primary reason for the increased account values related to
Japan, which grew to more than $6.2 billion as of December 31, 2003 up from $1.7
billion as of December 31, 2002.
HLI is among the largest consolidated life insurance groups in the United States
based on statutory assets as of December 31, 2003. In the past year, Life's
total assets under management, which include $22.5 billion of third-party assets
invested in the Company's mutual funds and 529 College Savings Plans, increased
27% to $210.1 billion at December 31, 2003 from $165.1 billion at December 31,
2002. Life generated revenues of $8.1 billion, $6.9 billion and $7.4 billion in
2003, 2002 and 2001, respectively. Additionally, Life generated net income of
$769, $557 and $685 in 2003, 2002 and 2001, respectively.
CUSTOMER SERVICE, TECHNOLOGY AND ECONOMIES OF SCALE
Life maintains advantageous economies of scale and operating efficiencies due to
its growth, attention to expense and claims management and commitment to
customer service and technology. These advantages allow the Company to
competitively price its products for its distribution network and policyholders.
In addition, the Company utilizes computer technology to enhance communications
within the Company and throughout its distribution network in order to improve
the Company's efficiency in marketing, selling and servicing its products and,
as a result, provides high-quality customer service. In recognition of
excellence in customer service for variable annuities, HLI was awarded the 2003
Annuity Service Award by DALBAR Inc., a recognized independent financial
services research organization, for the eighth consecutive year. HLI is the only
company to receive this prestigious award in every year of the award's
existence. Also, in 2003 the Company earned its first DALBAR Awards for Mutual
Fund and Retirement Plan Service which recognize Hartford Life as the No. 1
service provider of mutual funds and retirement plans in the industry.
Additionally, the Company's Individual Life segment won its third consecutive
DALBAR award for service of life insurance customers and its second DALBAR
Intermediary Service Award in 2003.
RISK MANAGEMENT
Life's product designs, prudent underwriting standards and risk management
techniques are intended to protect it against disintermediation risk, greater
than expected mortality and morbidity experience and, for certain product
features, specifically the guaranteed minimum death benefit ("GMDB") and
guaranteed minimum withdrawal benefit ("GMWB") offered with variable annuity
products, equity market volatility. As of December 31, 2003, the Company had
limited exposure to disintermediation risk on approximately 96% of its domestic
life insurance and annuity liabilities through the use of non-guaranteed
separate accounts, MVA features, policy loans, surrender charges and
non-surrenderability provisions. The Company effectively utilizes prudent
underwriting to select and price insurance risks and regularly monitors
mortality and morbidity assumptions to determine if experience remains
consistent with these assumptions and to ensure that its product pricing remains
appropriate. The Company also enforces disciplined claims management to protect
itself against greater than expected morbidity experience. The Company uses
reinsurance structures and has modified benefit features to mitigate the
mortality exposure associated with GMDB. The Company also uses reinsurance in
combination with derivative instruments to minimize the volatility associated
with the GMWB liability.
INVESTMENT PRODUCTS
The Investment Products segment focuses, through the sale of individual variable
and fixed annuities, mutual funds, retirement plan services and other investment
products, on the savings and retirement needs of the growing number of
individuals who are preparing for retirement or who have already retired. This
segment's assets under management grew to $146.5 billion at December 31, 2003
from $110.2 billion at December 31, 2002. Investment Products generated revenues
of $3.8 billion, $3.1 billion and $3.3 billion in 2003, 2002 and 2001,
respectively, of which individual annuities accounted for $1.8 billion for 2003
and $1.5 billion for 2002 and 2001. Net income in the Investment Products
segment was $510, $432 and $463 in 2003, 2002 and 2001, respectively.
The Company sells both variable and fixed individual annuity products through a
wide distribution network of national and regional broker-dealer organizations,
banks and other financial institutions and independent financial advisors. The
Company is a market leader in the annuity industry with sales of $16.5 billion,
$11.6 billion and $10.0 billion in 2003, 2002 and 2001, respectively. The
Company was the largest seller of individual retail variable annuities in the
United States with sales of $15.7 billion, $10.3 billion and $9.0 billion in
2003, 2002 and 2001, respectively. In addition, the Company continues to be the
largest seller of individual retail variable annuities through banks in the
United States.
The Company's total account value related to individual annuity products was
$97.7 billion as of December 31, 2003. Of this total account value, $86.5
billion, or 89%, related to individual variable annuity products and $11.2
billion, or 11%, related primarily to fixed MVA annuity products. At December
31, 2002, the Company's total account value related to individual
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annuity products was $74.9 billion. Of this total account value, $64.3 billion,
or 86%, related to individual variable annuity products and $10.6 billion, or
14%, related primarily to fixed MVA annuity products.
In addition to its leading position in individual annuities, Life continues to
emerge as a significant participant in the mutual fund business. In 2003 The
Hartford mutual funds reached $20 billion in assets faster than any other
retail-oriented mutual fund family in history, according to Strategic Insight.
As of December 31, 2003, retail mutual fund assets were $20.3 billion. The
Company is also among the top providers of retirement products and services,
including asset management and plan administration sold to small and medium size
corporations pursuant to Section 401(k) of the Internal Revenue Code of 1986, as
amended (referred to as "401(k)") and to municipalities pursuant to Section 457
and 403 of the Internal Revenue Code of 1986, as amended (referred to as
"Section 457" and "403(b)", respectively). The Company also provides structured
settlement contracts, terminal funding products and other investment products
such as guaranteed investment contracts ("GICs"). In 2002, the Company began
selling 529 college savings products.
Principal Products
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Individual Variable Annuities -- Life earns fees, based on policyholders'
account values, for managing variable annuity assets and maintaining
policyholder accounts. The Company uses specified portions of the periodic
deposits paid by a customer to purchase units in one or more mutual funds as
directed by the customer, who then assumes the investment performance risks and
rewards. As a result, variable annuities permit policyholders to choose
aggressive or conservative investment strategies, as they deem appropriate,
without affecting the composition and quality of assets in the Company's general
account. These products offer the policyholder a variety of equity and fixed
income options, as well as the ability to earn a guaranteed rate of interest in
the general account of the Company. The Company offers an enhanced guaranteed
rate of interest for a specified period of time (no longer than twelve months)
if the policyholder elects to dollar-cost average funds from the Company's
general account into one or more non-guaranteed separate accounts. 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.
Policyholders may make deposits of varying amounts at regular or irregular
intervals and the value of these assets fluctuates in accordance with the
investment performance of the funds selected by the policyholder. To encourage
persistency, many of the Company's individual variable annuities are subject to
withdrawal restrictions and surrender charges. Surrender charges range up to 8%
of the contract's deposits less withdrawals, and reduce to zero on a sliding
scale, usually within seven years from the deposit date. Individual variable
annuity account values of $86.5 billion as of December 31, 2003, have grown from
$64.3 billion as of December 31, 2002, due to strong net cash flow, resulting
from high levels of sales, low levels of surrenders and equity market
appreciation. Approximately 90% and 88% of the individual variable annuity
account values were held in non-guaranteed separate accounts as of December 31,
2003 and 2002, respectively.
In August 2002, the Company introduced Principal First, a new guaranteed
withdrawal benefit rider which is sold in conjunction with the Company's
variable annuity contracts. The Principal First rider provides the policyholder
with a guaranteed remaining balance ("GRB") if the account value is reduced to
zero through a combination of market declines and withdrawals. The GRB is
generally equal to premiums less withdrawals. However, annual withdrawals that
exceed 7% of the premiums paid may reduce the GRB by an amount greater than the
withdrawals and may also impact the guaranteed annual withdrawal amount that
subsequently applies after the excess annual withdrawals occur. The policyholder
also has the option, after a specified time period, to reset the GRB to the
then-current account value, if greater.
The assets underlying the Company's variable annuities are managed both
internally and by independent money managers, while the Company provides all
policy administration services. The Company utilizes a select group of money
managers, such as Wellington Management Company, LLP ("Wellington"); Hartford
Investment Management Company ("Hartford Investment Management"), a wholly-owned
subsidiary of The Hartford; Putnam Financial Services, Inc. ("Putnam"); American
Funds; MFS Investment Management ("MFS"); Franklin Templeton Group; and AIM
Investments ("AIM"). All have an interest in the continued growth in sales of
the Company's products and enhance the marketability of the Company's annuities
and the strength of its product offerings. Hartford Leaders, which is a
multi-manager variable annuity that combines the product manufacturing,
wholesaling and service capabilities of the Company with the investment
management expertise of four of the nation's most successful investment
management organizations: American Funds, Franklin Templeton Group, AIM and MFS,
has emerged as the industry leader in terms of retail sales. In addition, the
Director variable annuity, which is managed in part by Wellington, ranks second
in the industry in terms of retail sales.
Fixed MVA Annuities -- Fixed MVA annuities are fixed rate annuity contracts
which guarantee a specific sum of money to be paid in the future, either as a
lump sum or as monthly income. In the event that a policyholder surrenders a
policy prior to the end of the guarantee period, the MVA feature increases or
decreases the cash surrender value of the annuity in respect of any interest
rate decreases or increases, respectively, thereby protecting the Company from
losses due to higher interest rates at the time of surrender. The amount of
payment will not fluctuate due to adverse changes in the Company's investment
return, mortality experience or expenses. The Company's primary fixed MVA
annuities have terms varying from one to ten years with an average term of
approximately four years. Account values of fixed MVA annuities were $11.2
billion and $10.6 billion as of December 31, 2003 and 2002, respectively.
Mutual Funds -- In September 1996, Life launched a family of retail mutual funds
for which the Company provides investment management and administrative
services. The fund family has grown significantly from 8 funds at inception to
the current
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offering of 34 funds, including the addition of the Hartford Equity Income Fund
introduced in 2003. The Company's funds are managed by Wellington and Hartford
Investment Management. The Company has entered into agreements with over 960
financial services firms to distribute these mutual funds.
The Company charges fees to the shareholders of the mutual funds, which are
recorded as revenue by the Company. Investors can purchase shares in the mutual
funds, all of which are registered with the Securities and Exchange Commission,
in accordance with the Investment Company Act of 1940. The mutual funds are
owned by the shareholders of those funds and not by the Company. As such, the
mutual fund assets and liabilities, as well as related investment returns, are
not reflected in the Company's consolidated financial statements. Total retail
mutual fund assets under management were $20.3 billion and $14.1 billion as of
December 31, 2003 and 2002, respectively.
Governmental -- The Company sells retirement plan products and services to
municipalities under Section 457 plans. The Company offers a number of different
investment products, including variable annuities and fixed products, to the
employees in Section 457 plans. Generally, with the variable products, Hartford
Investment Management manages the fixed income funds and certain other outside
money managers act as advisors to the equity funds offered in Section 457 plans
administered by the Company. As of December 31, 2003, the Company administered
over 3,000 plans under Section 457 and 403(b). Total governmental assets under
management were $9.7 billion and $7.9 billion as of December 31, 2003 and 2002,
respectively.
Corporate -- The Company sells retirement plan products and services to
corporations under Section 401(k) plans targeting the small and medium case
markets. The Company believes these markets are under-penetrated in comparison
to the large case market. As of December 31, 2003, the Company administered over
4,100 Section 401(k) plans. Total corporate assets under management were $5.2
billion and $3.4 billion as of December 31, 2003 and 2002, respectively.
Institutional Investment Products -- The Company sells the following products:
institutional investment products, structured settlements, GICs and other
short-term funding agreements, institutional mutual funds and other annuity
contracts for special purposes such as funding of terminated defined benefit
pension plans. Structured settlement contracts provide for periodic payments to
an injured person or survivor for a generally determinable number of years,
typically in settlement of a claim under a liability policy in lieu of a lump
sum settlement. The Company's structured settlements are sold through The
Hartford's Property & Casualty insurance operations as well as specialty
brokers. Total institutional investment products assets under management were
$13.1 billion and $9.9 billion as of December 31, 2003 and 2002, respectively.
The increase in the institutional investment products assets under management
was the result of strong sales totaling $3.4 billion, $2.0 billion and $2.6
billion for the years ended December 31, 2003, 2002 and 2001, respectively.
Section 529 Plans - Life introduced a tax-advantaged college savings product
("529 plan") in March 2002 called SMART 529. SMART 529 is a state-sponsored
education savings program established by the State of West Virginia which offers
an easy way for both residents of West Virginia and out-of-state participants to
plan for a college education. In 1996, Congress created a tax-advantaged college
savings program as part of Section 529 of the Internal Revenue Code (the
"Code"). The 529 Plan is an investment plan operated by a state, designed to
help families save for future college costs. On January 1, 2002, 529 Plans
became federal tax-exempt for qualified withdrawals. In July 2003, the Company
began selling a multi-manager 529 product.
SMART 529 is designed to be flexible by allowing investors to choose from a wide
variety of investment portfolios to match their risk preference to help
investors accumulate savings for college. An individual can open a SMART 529
account for anyone, at any age. The SMART 529 product complements the Company's
existing offering of investment products (mutual funds, variable annuities,
401(k), 457 and 403 plans). It also leverages the Company's capabilities in
distribution, service and fund performance. Total 529 Plan assets under
management were $259 and $87 as of December 31, 2003 and 2002, respectively.
Marketing and Distribution
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The Investment Products distribution network is based on management's strategy
of utilizing multiple and competing distribution channels to achieve the
broadest distribution to reach target customers. The success of the Company's
marketing and distribution system depends on its product offerings, fund
performance, successful utilization of wholesaling organizations, quality of
customer service, and relationships with national and regional broker-dealer
firms, banks and other financial institutions, and independent financial
advisors (through which the sale of the Company's retail investment products to
customers is consummated).
Life maintains a distribution network of approximately 1,500 broker-dealers and
approximately 500 banks. As of December 31, 2003, the Company was selling
products through the 25 largest retail banks in the United States. The Company
periodically negotiates provisions and terms of its relationships with
unaffiliated parties, and there can be no assurance that such terms will remain
acceptable to the Company or such third parties. The Company's primary
wholesaler of its individual annuities and mutual funds is its wholly-owned
subsidiary, PLANCO Financial Services, Inc. and its affiliate, PLANCO,
Incorporated (collectively "PLANCO"). PLANCO is one of the nation's largest
wholesalers of individual annuities and has played a significant role in The
Hartford's growth over the past decade. As a wholesaler, PLANCO distributes the
Company's fixed and variable annuities, mutual funds, 401(k) plans and 529 Plans
by providing sales support to registered representatives, financial planners and
broker-dealers at brokerage firms and banks across the United States. Owning
PLANCO secures an important distribution channel for the Company and gives the
Company a wholesale distribution platform which it can expand in terms of both
the number of individuals wholesaling its products and the portfolio of products
which they wholesale. In addition, the Company uses internal personnel with
extensive experience in the Section 457 market, as well as access to the Section
401(k) market, to sell its products and services in the retirement plan and
institutional markets.
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Competition
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The Investment Products segment competes with numerous other insurance companies
as well as certain banks, securities brokerage firms, independent financial
advisors and other financial intermediaries marketing annuities, mutual funds
and other retirement-oriented products. Product sales are affected by
competitive factors such as investment performance ratings, product design,
visibility in the marketplace, financial strength ratings, distribution
capabilities, levels of charges and credited rates, reputation, and customer
service.
Regulatory Developments
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Recently, there has been a significant increase in federal and state regulatory
activity relating to financial services companies, particularly mutual funds
companies. These regulatory inquiries have focused on a number of mutual fund
issues. The Company, like many others in the financial services industry, has
received requests for information from the Securities and Exchange Commission
and a subpoena from the New York Attorney General's Office, in each case
requesting documentation and other information regarding various mutual fund
regulatory issues. The Company continues to cooperate fully with these
regulatory agencies in responding to these requests. In addition,
representatives from the SEC's Office of Compliance Inspections and Examinations
recently concluded an on-site compliance examination of the Company's variable
annuity and mutual fund operations.
The Company's mutual funds are available for purchase by the separate accounts
of different variable life insurance policies, variable annuity products, and
funding agreements, and they are offered directly to certain qualified
retirement plans. Although existing products contain transfer restrictions
between subaccounts, some products, particularly older variable annuity
products, do not contain restrictions on the frequency of transfers. In
addition, as a result of the settlement of litigation against the Company with
respect to certain owners of older variable annuity products, the Company's
ability to restrict transfers by these owners is limited.
A number of companies recently have announced settlements of enforcement actions
with various regulatory agencies, primarily the Securities and Exchange
Commission and the New York Attorney General's Office. No such action has been
initiated against the Company. It is possible that one or more regulatory
agencies may pursue action against the Company in the future.
INDIVIDUAL LIFE
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of its
affluent, emerging affluent and business insurance clients. The individual life
business acquired from Fortis in 2001 added significant scale to the Company's
Individual Life segment, contributing to a significant increase in life
insurance in force in that year. As of December 31, 2003, life insurance in
force increased 3% to $130.8 billion, from $126.7 billion as of December 31,
2002. Account values increased 15% to $8.7 billion as of December 31, 2003 from
$7.6 billion as of December 31, 2002. Revenues were $982, $958 and $890 for the
years ended December 31, 2003, 2002 and 2001, respectively. Net income in the
Individual Life segment was $145, $133 and $121 for the years ended December 31,
2003, 2002 and 2001, respectively.
Principal Products
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Life holds a significant market share in the variable universal life product
market and is the number one seller of variable life insurance, according to the
Tillinghast Value Survey. In 2003, the Company's sales of individual life
insurance were 54% variable universal life, 41% universal life and other, and 5%
term life insurance.
Variable Universal Life -- Variable universal life provides life insurance with
a return linked to an underlying investment portfolio and the Company allows
policyholders to determine their desired asset mix among a variety of underlying
mutual funds. As the return on the investment portfolio increases or decreases,
the surrender value of the variable universal life policy will increase or
decrease, and, under certain policyholder options or market conditions, the
death benefit may also increase or decrease. The Company's second-to-die
products are distinguished from other products in that two lives are insured
rather than one, and the policy proceeds are paid upon the death of both
insureds. Second-to-die policies are frequently used in estate planning for a
married couple. Variable universal life account values were $4.7 billion and
$3.6 billion as of December 31, 2003 and 2002, respectively.
Universal Life and Interest Sensitive Whole Life -- Universal life and interest
sensitive whole life insurance coverages provide life insurance with adjustable
rates of return based on current interest rates. Universal life provides
policyholders with flexibility in the timing and amount of premium payments and
the amount of the death benefit, provided there are sufficient policy funds to
cover all policy charges for the coming period. The Company also sells
second-to-die universal life insurance policies similar to the variable
universal life insurance product offered. Universal life and interest sensitive
whole life account values were $3.3 and $3.1 billion as of December 31, 2003 and
2002, respectively.
Marketing and Distribution
- --------------------------
Consistent with the Company's strategy to access multiple distribution outlets,
the Individual Life distribution organization has been developed to penetrate a
multitude of retail sales channels. These include independent life insurance
sales professionals; agents of other companies; national, regional and
independent broker-dealers; banks, financial planners, certified public
accountants and property and casualty insurance organizations. The primary
organization used to wholesale Hartford Life's products to these outlets is a
group of highly qualified life insurance professionals with specialized training
in sophisticated life insurance sales. These individuals are generally employees
of the Company who are managed through a regional sales office system.
Additional distribution is provided through Woodbury Financial Services, a
subsidiary retail broker dealer and other marketing relationships.
Competition
- -----------
The Individual Life segment competes with approximately 1,200 life insurance
companies in the United States, as well as
- 6 -
other financial intermediaries
marketing insurance products. Competitive factors related to this segment are
primarily the breadth and quality of life insurance products offered, pricing,
relationships with third-party distributors, effectiveness of wholesaling
support, pricing and availability of reinsurance, and the quality of
underwriting and customer service.
GROUP BENEFITS
The Group Benefits segment sells group life and group disability insurance, as
well as other products, including medical stop loss, accidental death and
dismemberment, travel accident and other special risk coverage to employers and
associations. The Company also offers disability underwriting, administration,
claims processing services and reinsurance to other insurers and self-funded
employer plans. Generally, policies sold in this segment are term insurance.
This allows the Company to adjust the rates or terms of its policies in order to
minimize the adverse effect of various market trends, including declining
interest rates and other factors. Typically policies are sold with one, two or
three year rate guarantees depending upon the product. In the disability market,
the Company focuses on strong risk and claims management to derive a competitive
advantage. The Group Benefits segment generated revenues of $2.6 billion for the
years ended December 31, 2003 and 2002, and $2.5 billion for the year ended
December 31, 2001, of which group disability insurance accounted for $1.1
billion in each of the three years and group life insurance accounted for $935,
$887 and $763, respectively. The Company held group disability reserves of $4.0
billion and $2.5 billion and group life reserves of $1.2 billion and $765, as of
December 31, 2003 and 2002, respectively. Net income in the Group Benefits
segment was $148, $128 and $106 for the years ended December 31, 2003, 2002 and
2001, respectively.
As previously mentioned, Life acquired the group life and accident, and
short-term and long-term disability businesses of CNA Financial Corporation on
December 31, 2003. This acquisition will increase the scale of the Company's
group life and disability operations, expand the Company's distribution and
enhance the Company's capability to deliver outstanding products and services.
Principal Products
- ------------------
Group Disability -- Life is one of the largest participants in the "large case"
market of the group disability insurance business. The large case market, as
defined by the Company, generally consists of group disability policies covering
over 500 employees in a particular company. The Company is continuing its focus
on the "small case" and "medium case" group markets, emphasizing name
recognition and reputation as well as the Company's managed disability approach
to claims and administration. The Company's efforts in the group disability
market focus on early intervention, return-to-work programs and successful
rehabilitation. Over the last several years, the focus of new disability
products introduced is to provide incentives for employees to return to
independence. The Company also works with disability claimants to improve the
receipt rate of Social Security offsets (i.e., reducing payment of benefits by
the amount of Social Security payments received).
The Company's short-term disability benefit plans provide a weekly benefit
amount (typically 60% to 70% of the employee's earned income up to a specified
maximum benefit) to insured employees when they are unable to work due to an
accident or illness. Long-term disability insurance provides a monthly benefit
for those extended periods of time not covered by a short-term disability
benefit plan when insured employees are unable to work due to disability.
Employees may receive total or partial disability benefits. Most of these
policies begin providing benefits following a 90 or 180 day waiting period and
generally continue providing benefits until the employee reaches age 65.
Long-term disability benefits are paid monthly and are limited to a portion,
generally 50-70%, of the employee's earned income up to a specified maximum
benefit.
Group Life -- Group term life insurance provides term coverage to employees and
their dependents for a specified period and has no accumulation of cash values.
The Company offers options for its basic group life insurance coverage,
including portability of coverage and a living benefit option, whereby
terminally ill policyholders can receive death benefits prior to their deaths.
In addition, the Company offers premium waiver and accidental death and
dismemberment coverages to employee groups.
Other -- Life provides excess of loss medical coverage (known as stop loss
insurance) to employers who self-fund their medical plans and pay claims using
the services of a third party administrator. The Company also provides travel
accident, hospital indemnity and other coverages (including group life and
disability) primarily to individual membership of various associations, as well
as employee groups. A significant Medicare supplement customer of the company
had been the members of the Retired Officers Association, an organization
consisting of retired military officers. Congress passed legislation, effective
in the fourth quarter of 2001, whereby retired military officers age 65 and
older will receive full medical insurance, eliminating the need for Medicare
supplement insurance. This legislation reduced the Company's Medicare supplement
premium revenue to zero after 2001.
Marketing and Distribution
- --------------------------
The Company uses an experienced group of Company employees, managed through a
regional sales office system, to distribute its group insurance products and
services through a variety of distribution outlets, including brokers,
consultants, third-party administrators and trade associations. The Company
intends to continue to expand the system over the coming years in areas that
offer the highest growth potential.
Competition
- -----------
The Group Benefits business remains highly competitive. Competitive factors
primarily affecting Group Benefits are the variety and quality of products and
services offered, the price quoted for coverage and services, the Company's
relationships with its third-party distributors, and the quality of customer
service. Group Benefits competes with numerous other insurance companies and
other financial intermediaries marketing insurance products. However, many of
these businesses have relatively high barriers to entry and there have been very
few new entrants over the past few years.
CORPORATE OWNED LIFE INSURANCE ("COLI")
Life is a leader in the COLI market, which includes life insurance policies
purchased by a company on the lives of its employees, with the company or a
trust sponsored by the
- 7 -
company named as the beneficiary under the policy. Until the passage of Health
Insurance Portability and Accountability Act of 1996 ("HIPAA"), the Company sold
two principal types of COLI, leveraged and variable products. Leveraged COLI is
a fixed premium life insurance policy owned by a company or a trust sponsored by
a company. HIPAA phased out the deductibility of interest on policy loans under
leveraged COLI at the end of 1998, virtually eliminating all future sales of
leveraged COLI. Variable COLI continues to be a product used by employers to
fund non-qualified benefits or other post-employment benefit liabilities.
Variable COLI account values were $21.0 billion and $19.7 billion as of December
31, 2003 and 2002, respectively. Leveraged COLI account values decreased to $2.5
billion as of December 31, 2003 from $3.3 billion as of December 31, 2002,
primarily due to surrender activity. COLI generated revenues of $483, $592 and
$719 for the years ended December 31, 2003, 2002 and 2001, respectively and net
income (loss) of ($1), $32 and $37 for the years ended December 31, 2003, 2002
and 2001, respectively.
PROPERTY & CASUALTY
Property & Casualty provides (1) workers' compensation, property, automobile,
liability, umbrella, specialty casualty, marine, agricultural and bond coverages
to commercial accounts primarily throughout the United States; (2) professional
liability coverage and directors and officers liability coverage, as well as
excess and surplus lines business not normally written by standard commercial
lines insurers; (3) automobile, homeowners and home-based business coverage to
individuals throughout the United States; and (4) insurance related services.
The Hartford is the tenth largest property and casualty insurance operation in
the United States based on written premiums for the year ended December 31, 2002
according to A.M. Best Company, Inc. ("A.M. Best"). Property & Casualty
generated revenues of $10.7 billion, $9.5 billion and $8.6 billion in 2003, 2002
and 2001, respectively. Earned premiums for 2003, 2002 and 2001 were $8.8
billion, $8.1 billion and $7.3 billion, respectively. Additionally, net income
(loss) was $(811), $469 and $(115) for 2003, 2002 and 2001, respectively. The
net loss for 2003 and 2001 includes the after-tax effect of the asbestos charge
of $1,701 and $420 of after-tax losses related to the September 11 terrorist
attack ("September 11"), respectively. Total assets for Property & Casualty were
$37.2 billion and $31.1 billion as of December 31, 2003 and 2002, respectively.
BUSINESS INSURANCE
Business Insurance provides standard commercial insurance coverage to small and
middle market commercial businesses primarily throughout the United States. This
segment also provides commercial risk management products and services as well
as marine coverage. Earned premiums for 2003, 2002 and 2001 were $3.7 billion,
$3.1 billion and $2.6 billion (2001 includes $15 of reinsurance cessions related
to September 11), respectively. The segment had underwriting income (loss) of
$101, $44 and $(242) (2001includes $245 of underwriting loss related to
September 11) in 2003, 2002 and 2001, respectively.
Principal Products
- ------------------
The Business Insurance segment offers workers' compensation, property,
automobile, liability, umbrella and marine coverages. Commercial risk management
products and services are also provided.
Marketing and Distribution
- --------------------------
Business Insurance provides insurance products and services through its home
office located in Hartford, Connecticut, and multiple domestic regional office
locations and insurance centers. The segment markets its products nationwide
utilizing brokers and independent agents and involving trade associations and
employee groups. Brokers and independent agents, who often represent other
companies as well, receive commissions and other forms of incentive compensation
from the Company based on written premium, growth in written premium and
participation in underwriting profitability. Brokers and independent agents are
not employees of The Hartford.
Competition
- -----------
The commercial insurance industry is a highly competitive environment regarding
product, price, service and technology. The Hartford competes with other stock
companies, mutual companies, alternative risk sharing groups and other
underwriting organizations. These companies sell through various distribution
channels and business models, across a broad array of product lines, and with a
high level of variation regarding geographic, marketing and customer
segmentation. The Hartford is the ninth largest commercial lines insurer in the
United States based on written premiums for the year ended December 31, 2002
according to A.M. Best. The relatively large size and underwriting capacity of
The Hartford provide opportunities not available to smaller companies. In
addition, the marketplace is affected by available capacity of the insurance
industry as measured by policyholders' surplus. Surplus expands and contracts
primarily in conjunction with profit levels generated by the industry. The low
interest rate environment is impacting returns and making underwriting decisions
even more critical. Overall, in 2003, market conditions in the commercial
industry have continued to improve as a result of increased underwriting
discipline and a firmer pricing environment. Industry consolidation continues to
take place.
PERSONAL LINES
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 Company's Omni
Insurance Group, Inc. ("Omni") subsidiary 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 Hartford's exclusive
licensing arrangement with AARP, which was renewed during the fourth quarter of
2001, continues through January 1, 2010 for automobile, homeowners and
home-based business. The Health Care Options agreement continues through 2007.
These agreements provide Personal Lines with an important competitive advantage.
Personal lines had earned premiums of $3.2 billion, $3.0 billion and $2.7
billion in 2003,
- 8 -
2002 and 2001, respectively. Underwriting income (loss) for 2003, 2002 and 2001
was $117, $(46) and $(87) (2001 includes $9 of underwriting loss related to
September 11), respectively.
Principal Products
- ------------------
Personal Lines provides standard and non-standard automobile, homeowners and
home-based business coverages to individuals across the United States, including
a special program designed exclusively for members of AARP.
Marketing and Distribution
- --------------------------
Personal Lines reaches diverse markets through multiple distribution channels
including brokers, independent agents, direct mail, the internet and advertising
in publications. This segment provides customized products and services to
customers through a network of independent agents in the standard personal lines
market, and in the non-standard automobile market through Omni. Independent
agents, who often represent other companies as well, receive commissions and
other forms of incentive compensation from the Company based on written premium,
growth in written premium and participation in underwriting profitability.
Brokers and independent agents are not employees of The Hartford. Personal Lines
has an important relationship with AARP and markets directly to its over 35
million members.
Competition
- -----------
The personal lines automobile and homeowners businesses continue to remain
highly competitive. Personal lines insurance is written by insurance companies
of varying sizes that sell products through various distribution channels,
including independent agents, captive agents and directly to the consumer. The
personal lines market competes on the basis of price; product; service,
including claims handling; stability of the insurer and name recognition. The
Hartford is the twelfth largest personal lines insurer in the United States
based on written premiums for the year ended December 31, 2002 according to A.M.
Best. Industry consolidation continues to take place, and the effective
utilization of technology is becoming increasingly important. A major
competitive advantage of The Hartford is the exclusive licensing arrangement
with AARP to provide personal automobile, homeowners and home-based business
insurance products to its members. This arrangement was renewed during the
fourth quarter of 2001 and is in effect through January 1, 2010. Management
expects favorable "baby boom" demographics to increase AARP membership during
this period. In addition, The Hartford provides customer service for all health
insurance products offered through AARP's Health Care Options, with an agreement
that continues through 2007.
SPECIALTY COMMERCIAL
Specialty Commercial provides a wide variety of property and casualty insurance
products and services through retailers and wholesalers to large commercial
clients and insureds requiring a variety of specialized coverages. Excess and
surplus lines coverages not normally written by standard line insurers are also
provided, primarily through wholesale brokers. Specialty Commercial had earned
premiums of $1.6 billion, $1.2 billion and $1.0 billion (2001 includes $7 of
reinsurance cessions related to September 11) in 2003, 2002 and 2001,
respectively. Underwriting losses were $29, $23 and $262 (2001 includes $167 of
underwriting loss related to September 11) in 2003, 2002 and 2001, respectively.
Principal Products
- ------------------
Specialty Commercial offers a variety of customized insurance products and risk
management services. Specialty Commercial provides standard commercial insurance
products including workers' compensation, automobile and liability coverages to
large-sized companies. Specialty Commercial also provides bond, professional
liability, specialty casualty and agricultural coverages, as well as core
property and excess and surplus lines coverages not normally written by standard
lines insurers. Alternative markets, within Specialty Commercial, provides
insurance products and services primarily to captive insurance companies, pools
and self-insurance groups. In addition, Specialty Commercial provides
third-party administrator services for claims administration, integrated
benefits, loss control and performance measurement through Specialty Risk
Services, a subsidiary of the Company.
Marketing and Distribution
- --------------------------
Specialty Commercial provides insurance products and services through its home
office located in Hartford, Connecticut and multiple domestic office locations.
The segment markets its products nationwide utilizing a variety of distribution
networks including independent agents and brokers as well as wholesalers.
Independent agents, who represent other companies as well, receive commissions
and other forms of incentive compensation from the Company based on written
premium, growth in written premium and participation in underwriting
profitability. Brokers and independents agents are not employees of The
Hartford.
Competition
- -----------
The commercial insurance industry is a highly competitive environment regarding
product, price, service and technology. Specialty Commercial is comprised of a
diverse group of businesses that are unique to commercial lines. Each line of
business operates independently with its own set of business objectives, and
focuses on the operational dynamics of their specific industry. These
businesses, while somewhat interrelated, have a unique business model and
operating cycle. Specialty Commercial is considered a transactional business
and, therefore, competes with other companies for business primarily on an
account by account basis due to the complex nature of each transaction.
Specialty Commercial competes with other stock companies, mutual companies,
alternative risk sharing groups and other underwriting organizations. The
relatively large size and underwriting capacity of The Hartford provide
opportunities not available to smaller companies. Overall, in 2003, market
conditions in the commercial industry have continued to improve as a result of
increased underwriting discipline and a firmer pricing environment. Industry
consolidation continues to take place.
REINSURANCE
On May 16, 2003, as part of the Company's decision to withdraw from the assumed
reinsurance business, the Company entered into a quota share and purchase
agreement with Endurance Reinsurance Corporation of America ("Endurance"),
- 9 -
whereby the Reinsurance segment retroceded the majority of its inforce book of
business as of April 1, 2003 and sold renewal rights to Endurance. Under the
quota share agreement, Endurance reinsured most of the segment's assumed
reinsurance contracts that were written on or after January 1, 2002 and that had
unearned premium as of April 1, 2003. In consideration for Endurance reinsuring
the unearned premium as of April 1, 2003, the Company paid Endurance an amount
equal to unearned premium less the related unamortized commissions/deferred
acquisition costs net of an override commission which was established by the
contract. In addition, Endurance will pay a profit sharing commission based on
the loss performance of property treaty, property catastrophe and aviation pool
unearned premium. Under the purchase agreement, Endurance will pay additional
amounts, subject to a guaranteed minimum of $15, based on the level of renewal
premium on the reinsured contracts over the two year period following the
agreement. The guaranteed minimum is reflected in net income for the year ended
December 31, 2003. The Company remains subject to reserve development relating
to all retained business.
Prior to the Endurance transaction, the Reinsurance segment assumed reinsurance
in North America and primarily wrote treaty reinsurance through professional
reinsurance brokers covering various property, casualty, property catastrophe,
marine and alternative risk transfer ("ART") products. ART included
non-traditional reinsurance products such as multi-year property catastrophe
treaties, aggregate excess of loss agreements and quota share treaties with
single event caps. International property catastrophe, marine and ART were also
written outside of North America through a London contact office. The
Reinsurance segment had earned premiums of $352, $713, $851 (2001 includes $69
of reinsurance cessions related to September 11) in 2003, 2002 and 2001,
respectively. Underwriting losses were $125, $59 and $375 (2001 includes $226 of
underwriting loss related to September 11) in 2003, 2002 and 2001, respectively.
OTHER OPERATIONS
Property & Casualty's Other Operations consists of certain property and casualty
insurance operations of The Hartford that have ceased writing new business.
These operations primarily include First State Insurance Company, located in
Boston, Massachusetts; Heritage Reinsurance Company, Ltd., headquartered in
Bermuda; and Excess Insurance Company Limited, located in the United Kingdom.
Also included in Other Operations are Property & Casualty's international
businesses up until their dates of sales, and for 2002 and 2003, the activity in
the exited international lines of the Reinsurance segment following its
restructuring in the fourth quarter of 2001. In addition, claims for asbestos,
environmental and certain other liabilities under general liability policies are
managed in Other Operations regardless of the writing company. Most of the
policies against which these claims were made were written before 1985.
Property & Casualty's international businesses have historically consisted
primarily of Western European companies offering a variety of insurance products
designed to meet the needs of local customers. The Company's strategic shift to
emphasize growth opportunities in asset accumulation businesses has resulted in
the sale of all of its international property and casualty businesses in a
series of transactions concluded in 2001.
The Hartford was a global reinsurer through its Hartford Reinsurance Company
("HartRe") operations in the United Kingdom, France, Italy, Germany, Spain, Hong
Kong and Taiwan, writing treaty and facultative assumed reinsurance including
property, casualty, fidelity, and specialty coverages. In October 2001, HartRe
announced that it was exiting most international lines, and in January 2002,
these lines were moved to Other Operations.
The primary objectives of Other Operations are the proper disposition of claims,
the resolution of disputes, and the collection of reinsurance proceeds. As such,
Other Operations has no new product sales, distribution systems or competitive
issues.
The Other Operations segment had earned premiums of $18, $69 and $17 in 2003,
2002 and 2001, respectively, and underwriting losses of $2,716 (includes $2,604
of net asbestos reserve strengthening), $164 and $132 for each of the respective
periods.
LIFE RESERVES
In accordance with applicable insurance regulations under which the Company
operates, life insurance subsidiaries of Life establish and carry as liabilities
actuarially determined reserves which are calculated to meet the Company'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
Company'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 Company's policy obligations at their
maturities or in the event of an insured's disability or death. Reserves also
include unearned premiums, premium deposits, claims incurred but not reported
and claims reported but not yet paid. Reserves for assumed reinsurance are
computed in a manner that is comparable to direct insurance reserves. Additional
information on Life reserves may be found in the Critical Accounting Estimates
section of the MD&A under "Reserves".
PROPERTY & CASUALTY RESERVES
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims under insurance policies written by The
Hartford. These reserves include estimates for both claims that have been
reported and those that have been incurred but not reported to The Hartford and
include estimates of all expenses associated with processing and settling these
claims. This estimation process is primarily based on historical experience and
involves a variety of actuarial techniques to analyze current trends and other
relevant factors. Examples of current trends include increases in medical cost
inflation rates and physical damage repair costs, changes in internal claim
practices, changes in the legislative and regulatory environment over workers'
compensation claims, evolving exposures to construction defects and other mass
torts and the potential for further adverse development of asbestos and
environmental claims.
- 10 -
As a result of September 11, the Company established estimated gross and net
reserves of $1.1 billion and $556 million, respectively, related to property and
casualty operations. This loss estimate includes coverages related to property,
business interruption, workers' compensation and other liability exposures,
including those underwritten by the Company's assumed reinsurance operation. The
Company based this loss estimate upon a review of insured exposures using a
variety of assumptions and actuarial techniques, including estimated amounts for
incurred but not reported policyholder losses and costs incurred in settling
claims. The Company continues to carry the original incurred amount related to
September 11, less any paid losses. Actual experience in some cases appears to
be developing favorably to our original expectations, such as the higher than
anticipated rate of participation in the victim's compensation fund. There is
still uncertainty, particularly with respect to coverage disputes and the
potential for the emergence of latent injuries. Furthermore, the deadline for
filing a liability claim with respect to September 11 has been extended to March
11, 2004. As various deadlines pass and more coverage disputes are settled
either out of court or through a court decision, the uncertainty about various
aspects of the reserves is reduced. The Company will continue to evaluate these
reserves on a quarterly basis throughout 2004 and will make appropriate
adjustments to reserve levels.
The Hartford continues to receive claims that assert damages from
asbestos-related and environmental-related exposures. Asbestos claims relate
primarily to bodily injuries asserted by those who came in contact with asbestos
or products containing asbestos.
Environmental claims relate primarily to pollution related clean-up costs. As
discussed further in the Critical Accounting Estimates and Other Operations
sections of the MD&A, significant uncertainty limits the Company's ability to
estimate the ultimate reserves necessary for unpaid losses and related expenses
with regard to environmental and particularly asbestos claims.
Most of the Company's property and casualty reserves are not discounted.
However, certain liabilities for unpaid claims, where the amount and timing of
payments are fixed and reliably determinable, principally for permanently
disabled claimants and certain structured settlement contracts that fund loss
run-offs for unrelated parties have been discounted to present value using an
average interest rate of 4.8% in 2003 and 5.0% in 2002. At December 31, 2003 and
2002, such discounted reserves totaled $799 and $720, respectively (net of
discounts of $525 and $527, respectively). Accretion of this discount did not
have a material effect on net income during 2003, 2002 and 2001, respectively.
As of December 31, 2003, net property and casualty reserves for claims and claim
adjustment expenses reported on a statutory basis exceeded those reported under
Generally Accepted Accounting Principles ("GAAP") by $61. The primary difference
resulted from the discounting of GAAP-basis workers' compensation reserves at
risk-free interest rates, which exceeded the statutory discount rates set by
regulators, partially offset by the required exclusion from statutory reserves
of assumed retroactive reinsurance and a portion of the GAAP provision for
uncollectible reinsurance.
Further discussion on The Hartford's property and casualty reserves, including
asbestos and environmental claims reserves, may be found in the Reserves section
of the MD&A- Critical Accounting Estimates.
A reconciliation of liabilities for unpaid claims and claim adjustment expenses
is herein referenced from Note 7 of Notes to Consolidated Financial Statements.
A table depicting the historical development of the liabilities for unpaid
claims and claim adjustment expenses, net of reinsurance, follows.
- 11 -
LOSS DEVELOPMENT TABLE
PROPERTY AND CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSE LIABILITY DEVELOPMENT - NET OF REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, [1], [2]
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities for unpaid claims and
claim adjustment expenses, net of
reinsurance $11,212 $11,271 $11,574 $12,702 $12,770 $12,902 $12,476 $12,316 $12,860 $13,141 $16,218
CUMULATIVE PAID CLAIMS AND CLAIM EXPENSES
One year later 2,590 2,715 2,467 2,625 2,472 2,939 2,994 3,272 3,339 3,480
Two years later 4,281 4,273 4,126 4,188 4,300 4,733 5,019 5,315 5,621 --
Three years later 5,390 5,469 5,212 5,540 5,494 6,153 6,437 6,972 -- --
Four years later 6,306 6,258 6,274 6,418 6,508 7,141 7,652 -- -- --
Five years later 6,912 7,135 6,970 7,201 7,249 8,080 -- -- -- --
Six years later 7,662 7,721 7,630 7,800 8,036 -- -- -- -- --
Seven years later 8,174 8,311 8,147 8,499 -- -- -- -- -- --
Eight years later 8,715 8,781 8,786 -- -- -- -- -- -- --
Nine years later 9,161 9,332 -- -- -- -- -- -- -- --
Ten years later 9,701 -- -- -- -- -- -- -- -- --
LIABILITIES REESTIMATED
One year later 11,306 11,618 12,529 12,752 12,615 12,662 12,472 12,459 13,153 15,965
Two years later 11,608 12,729 12,598 12,653 12,318 12,569 12,527 12,776 16,176 --
Three years later 12,681 12,781 12,545 12,460 12,183 12,584 12,698 15,760 -- --
Four years later 12,811 12,787 12,399 12,380 12,138 12,663 15,609 -- -- --
Five years later 12,858 12,741 12,414 12,317 12,179 15,542 -- -- -- --
Six years later 12,824 12,782 12,390 12,322 15,047 -- -- -- -- --
Seven years later 12,912 12,791 12,380 15,188 -- -- -- -- -- --
Eight years later 12,960 12,775 15,253 -- -- -- -- -- -- --
Nine years later 12,955 15,604 -- -- -- -- -- -- -- --
Ten years later 15,807 -- -- -- -- -- -- -- -- --
DEFICIENCY (REDUNDANCY), NET OF
REINSURANCE $4,595 $4,333 $3,679 $2,486 $2,277 $2,640 $3,133 $3,444 $3,316 $2,824
- ------------------------------------------------------------------------------------------------------------------------------------
The table above shows the cumulative deficiency (redundancy) of the Company's
reserves, net of reinsurance, as now estimated with the benefit of additional
information. Those amounts are comprised of changes in estimates of gross losses
and changes in estimates of related reinsurance recoveries.
The table below, for the periods presented, reconciles the net reserves to the
gross reserves, as initially estimated and recorded, and as currently estimated
and recorded, and computes the cumulative deficiency (redundancy) of the
Company's reserves before reinsurance.
PROPERTY AND CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSE LIABILITY DEVELOPMENT - GROSS
FOR THE YEARS ENDED DECEMBER 31, [1], [2]
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
- ------------------------------------------------------------------------------------------------------------------------------------
NET RESERVE, AS INITIALLY ESTIMATED $11,271 $11,574 $12,702 $12,770 $12,902 $12,476 $12,316 $12,860 $13,141 $16,218
Reinsurance and other recoverables, as
initially estimated 5,156 4,829 4,357 3,996 3,275 3,706 3,871 4,176 3,950 5,497
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS RESERVE, AS INITIALLY ESTIMATED $16,427 $16,403 $17,059 $16,766 $16,177 $16,182 $16,187 $17,036 $17,091 $21,715
- ------------------------------------------------------------------------------------------------------------------------------------
NET REESTIMATED RESERVE $15,604 $15,253 $15,188 $15,047 $15,542 $15,609 $15,760 $16,176 $15,965
Reestimated and other reinsurance
recoverables 6,621 6,001 5,365 5,190 4,749 5,554 5,664 5,994 5,494
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS REESTIMATED RESERVE $22,225 $21,254 $20,553 $20,237 $20,291 $21,163 $21,424 $22,170 $21,459
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS DEFICIENCY (REDUNDANCY) $5,798 $4,851 $3,494 $3,471 $4,114 $4,981 $5,237 $5,134 $4,368
====================================================================================================================================
<FN>
[1] The above tables exclude Hartford Insurance, Singapore as a result of its sale in September 2001, Hartford Seguros as a result
of its sale in February 2001, Zwolsche as a result of its sale in December 2000 and London & Edinburgh as a result of its sale
in November 1998.
[2] The above tables include the liabilities and claim developments for certain reinsurance coverages written for affiliated
parties.
</FN>
- 12 -
The following table is derived from the Loss Reserve Development table and
summarizes the effect of reserve re-estimates, net of reinsurance, on calendar
year operations for the ten-year period ended December 31, 2003. The total of
each column details the amount of reserve re-estimates made in the indicated
calendar year and shows the accident years to which the re-estimates are
applicable. The amounts in the total accident year column on the far right
represent the cumulative reserve re-estimates during the ten year period ended
December 31, 2003 for the indicated accident year(s).
EFFECT OF NET RESERVE RE-ESTIMATES ON CALENDAR YEAR OPERATIONS
CALENDAR YEAR
---------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
By Accident year
1993 & Prior $94 $302 $1,073 $130 $47 $(34) $88 $48 $(5) $2,852 $4,595
1994 -- 45 38 (78) (41) (12) (47) (39) (11) (23) (168)
1995 -- -- (156) 17 (59) (100) (26) (33) 6 44 (307)
1996 -- -- -- (19) (46) (47) (95) (39) 15 (7) (238)
1997 -- -- -- -- (56) (104) (55) 18 36 2 (159)
1998 -- -- -- -- -- 57 42 60 38 11 208
1999 -- -- -- -- -- -- 89 40 92 32 253
2000 -- -- -- -- -- -- -- 88 146 73 307
2001 -- -- -- -- -- -- -- -- (24) 39 15
2002 -- -- -- -- -- -- -- -- -- (199) (199)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $94 $347 $955 $50 $(155) $(240) $(4) $143 $293 $2,824 $4,307
====================================================================================================================================
CEDED REINSURANCE
Consistent with industry practice, The Hartford cedes insurance risk to
reinsurance companies. For Property & Casualty operations, these reinsurance
arrangements are intended to provide greater diversification of business and
limit The Hartford's maximum net loss arising from large risks or catastrophes.
A major portion of The Hartford's property and casualty reinsurance is effected
under general reinsurance contracts known as treaties, or, in some instances, is
negotiated on an individual risk basis, known as facultative reinsurance. The
Hartford also has in-force excess of loss contracts with reinsurers that protect
it against a specified part or all of certain losses over stipulated amounts.
Reinsurance does not relieve The Hartford of its primary liability and, as such,
failure of reinsurers to honor their obligations could result in losses to The
Hartford. The Hartford evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk. The Company's monitoring procedures
include careful initial selection of its reinsurers, structuring agreements to
provide collateral funds where possible, and regularly monitoring the financial
condition and ratings of its reinsurers.
In accordance with normal industry practice, Life is involved in both the
cession and assumption of insurance with other insurance and reinsurance
companies. As of December 31, 2003, the largest amount of life insurance
retained on any one life by any one of the life operations was approximately
$2.5. In addition, the Company has reinsured the majority of the minimum death
benefit guarantees and the guaranteed minimum withdrawal benefits offered in
connection with its variable annuity contracts. The majority of variable annuity
contracts issued since August 2002 include a guaranteed minimum withdrawal
benefit ("GMWB") rider. The GMWB represents an embedded derivative in the
variable annuity contract that is required to be reported separately from the
host variable annuity contract. Beginning July 7, 2003, substantially all new
contracts with the GMWB were not covered by reinsurance as the Company had
exceeded the limit in the existing reinsurance agreement prior to that date. As
of December 31, 2003, approximately $11 billion or 64% of variable annuity
account value with GMWB was reinsured. The Company also assumes reinsurance from
other insurers. The Company evaluates the financial condition of its reinsurers
and monitors concentrations of credit risk. For the years ended December 31,
2003, 2002 and 2001, the Company did not make any significant changes in the
terms under which reinsurance is ceded to other insurers except for the
Company's recapture of a block of business previously reinsured with an
unaffiliated reinsurer. For further discussion see Note 14 of Notes to
Consolidated Financial Statements.
INVESTMENT OPERATIONS
An important element of the financial results of The Hartford is return on
invested assets. The Hartford's investment portfolios are primarily divided
between Life and Property & Casualty. The investment portfolios are managed
based on the underlying characteristics and nature of each operation's
respective liabilities and within established risk parameters.
The investment portfolios of Life and Property & Casualty are managed by
Hartford Investment Management. Hartford Investment Management is responsible
for monitoring and managing the asset/liability profile, establishing investment
objectives and guidelines and determining, within specified risk tolerances and
investment guidelines, the appropriate asset allocation, duration, convexity and
other characteristics of the portfolios. Security selection and monitoring are
performed by asset class specialists working within dedicated portfolio
management teams.
The primary investment objective of Life's general account and guaranteed
separate accounts is to maximize after-tax returns consistent with acceptable
risk parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity, relative to that of
policyholder and corporate obligations.
- 13 -
The investment objective for the majority of Property & Casualty is to maximize
economic value while generating after-tax income and sufficient liquidity to
meet policyholder and corporate obligations. For Property & Casualty's Other
Operations segment, the investment objective is to ensure the full and timely
payment of all liabilities. Property & Casualty investment strategies are
developed based on a variety of factors including business needs, regulatory
requirements and tax considerations.
For a further discussion of The Hartford's approach to managing risks, including
derivative utilization, see the Investments and Capital Markets Risk Management
sections, of the MD&A, as well as Note 1 of Notes to Consolidated Financial
Statements.
REGULATION AND PREMIUM RATES
Although there has been some deregulation with respect to large commercial
insureds in recent years, insurance companies, for the most part, are still
subject to comprehensive and detailed regulation and supervision throughout the
United States. The extent of such regulation varies, but generally has its
source in statutes which delegate regulatory, supervisory and administrative
powers to state insurance departments. Such powers relate to, among other
things, the standards of solvency that must be met and maintained; the licensing
of insurers and their agents; the nature of and limitations on investments;
establishing premium rates; claim handling and trade practices; restrictions on
the size of risks which may be insured under a single policy; deposits of
securities for the benefit of policyholders; approval of policy forms; periodic
examinations of the affairs of companies; annual and other reports required to
be filed on the financial condition of companies or for other purposes; fixing
maximum interest rates on life insurance policy loans and minimum rates for
accumulation of surrender values; and the adequacy of reserves and other
necessary provisions for unearned premiums, unpaid claims and claim adjustment
expenses and other liabilities, both reported and unreported.
Most states have enacted legislation that regulates insurance holding company
systems such as The Hartford. This legislation provides that each insurance
company in the system is required to register with the insurance department of
its state of domicile and furnish information concerning the operations of
companies within the holding company system which may materially affect the
operations, management or financial condition of the insurers within the system.
All transactions within a holding company system affecting insurers must be fair
and equitable. Notice to the insurance departments is required prior to the
consummation of transactions affecting the ownership or control of an insurer
and of certain material transactions between an insurer and any entity in its
holding company system. In addition, certain of such transactions cannot be
consummated without the applicable insurance department's prior approval.
The extent of insurance regulation on business outside the United States varies
significantly among the countries in which The Hartford operates. Some countries
have minimal regulatory requirements, while others regulate insurers
extensively. Foreign insurers in many countries are faced with greater
restrictions than domestic competitors domiciled in that particular
jurisdiction. The Hartford's international operations are comprised of insurers
licensed in their respective countries and, therefore, are subject to the
generally less restrictive domestic insurance regulations.
EMPLOYEES
The Hartford had approximately 30,000 employees as of December 31, 2003.
AVAILABLE INFORMATION
The Hartford files annual, quarterly and current reports, proxy statements and
other documents with the Securities and Exchange Commission (the "SEC") under
the Securities Exchange Act of 1934 (the "Exchange Act"). The public may read
and copy any materials that The Hartford files with the SEC at the SEC's Public
Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains
reports, proxy and information statements, and other information regarding
issuers, including The Hartford, that file electronically with the SEC. The
public can obtain reports that The Hartford files with the SEC at
http://www.sec.gov.
The Hartford also makes available free of charge on or through its Internet
website (http://www.thehartford.com) The Hartford's annual report on Form 10-K,
-------------------
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13 or 15(d) of the Exchange
Act as soon as reasonably practicable after The Hartford electronically files
such material with, or furnishes it to, the SEC.
ITEM 2. PROPERTIES
The Hartford owns the land and buildings comprising its Hartford location and
other properties within the greater Hartford, Connecticut area which total
approximately 1.9 million of the 2.2 million square feet owned. In addition, The
Hartford leases approximately 5.4 million square feet throughout the United
States and 39 thousand square feet in other countries. All of the properties
owned or leased are used by one or more of all nine operating segments,
depending on the location. (For more information on operating segments see Part
1, Item 1, Business of The Hartford - Reporting Segments.) The Company believes
its properties and facilities are suitable and adequate for current operations.
ITEM 3. LEGAL PROCEEDINGS
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the uncertainties
discussed in Note 16 of Notes to Condensed Consolidated Financial Statements
under the caption "Asbestos and Environmental Claims," management expects that
the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and
costs of defense, will not be material to the consolidated financial condition,
results of operations or cash flows of The Hartford.
- 14 -
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, and improper sales practices in
connection with the sale of life insurance and other investment products. The
Hartford also is involved in individual actions in which punitive damages are
sought, such as claims alleging bad faith in the handling of insurance claims.
Management expects that the ultimate liability, if any, with respect to such
lawsuits, after consideration of provisions made for potential losses and costs
of defense, will not be material to the consolidated financial condition of The
Hartford. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, it is
possible that an adverse outcome in certain matters could, from time to time,
have a material adverse effect on the Company's consolidated results of
operations or cash flows in particular quarterly or annual periods.
As further discussed in the MD&A under the caption "Other Operations," The
Hartford continues to receive asbestos and environmental claims that involve
significant uncertainty regarding policy coverage issues. Regarding these
claims, The Hartford continually reviews its overall reserve levels,
methodologies and reinsurance coverages.
The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford
A&I"), a subsidiary of the Company, issued primary general liability policies to
Mac Arthur Company and its subsidiary, Western MacArthur Company, both former
regional distributors of asbestos products (collectively or individually,
"MacArthur"), during the period 1967 to 1976. In 1987, Hartford A&I notified
MacArthur that its available limits for asbestos bodily injury claims under
these policies had been exhausted, and MacArthur ceased submitting claims to
Hartford A&I under these policies. Thirteen years later, MacArthur filed an
action against Hartford A&I seeking for the first time additional coverage for
asbestos bodily injury claims under the Hartford A&I primary policies on the
theory that Hartford A&I had not exhausted limits MacArthur alleged to be
available for non-products liability. Following the voluntary dismissal of
MacArthur's original action, the coverage litigation proceeded in the Superior
Court in Alameda County, California. MacArthur sought a declaration of coverage
and damages, alleging that its liability for liquidated but unpaid asbestos
bodily injury claims was $2.5 billion, of which more than $1.8 billion consisted
of unpaid judgments, and that it had substantial additional liability for
unliquidated and future claims. Four asbestos claimants holding default
judgments against MacArthur also were joined as plaintiffs and asserted a right
to an accelerated trial. Hartford A&I has been vigorously defending that action.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. On November 22,
2002, pursuant to the terms of its settlement with St. Paul, MacArthur filed a
bankruptcy petition and proposed plan of reorganization. A month-long
confirmation trial was held during the fourth quarter of 2003. Hartford A&I
objected to the proposed plan and took the leading role for the objectors at
trial.
On December 19, 2003, Hartford A&I entered into a settlement agreement with
MacArthur, the Official Unsecured Creditors Committee representing the asbestos
plaintiffs, the Futures Representative appointed by the court, and the
plaintiffs' lawyers representing the holders of default judgments against
MacArthur. The settlement is contingent on the occurrence of certain conditions,
including final, non-appealable court orders approving the settlement agreement
and confirming a bankruptcy plan under which, among other things, all claims
against the Company relating to the asbestos liability of MacArthur are
enjoined. If the conditions are met, the settlement will resolve all disputes
concerning Hartford A&I's alleged obligations arising from MacArthur's asbestos
liability. Under the settlement agreement, Hartford A&I will pay $1.15 billion
into an escrow account in the first quarter of 2004, and the funds will be
disbursed to a trust to be established for the benefit of present and future
asbestos claimants pursuant to the bankruptcy plan once all conditions precedent
to the settlement have occurred.
In January 2004, the bankruptcy court approved the settlement agreement and
entered an order confirming a plan of reorganization that provides for the
injunctions and other protections required under the settlement agreement. The
injunctions will become effective when they are affirmed by the district court.
Management expects that all conditions to the settlement will be satisfied, but
it is not certain whether or when those conditions will be satisfied.
Bancorp Services, LLC - In the third quarter of 2003, Hartford Life Insurance
Company ("HLIC") and its affiliate International Corporate Marketing Group, LLC
("ICMG") settled their intellectual property dispute with Bancorp Services, LLC
("Bancorp"). The dispute concerned, among other things, Bancorp's claims for
alleged patent infringement, breach of a confidentiality agreement, and
misappropriation of trade secrets related to certain stable value
corporate-owned life insurance products.
Under the terms of the settlement, The Hartford will pay a minimum of $70 and a
maximum of $80, depending on the outcome of the patent appeal, to resolve all
disputes between the parties. The appeal from the trade secret and breach of
contract judgment will be dismissed. The settlement resulted in the recording of
an additional charge of $40 after-tax in the third quarter of 2003, reflecting
the maximum amount payable under the settlement. In November of 2003, the
Company paid the initial $70 of the settlement.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed reinsurance arbitration between subsidiaries
of The Hartford and one of their primary reinsurers relating to policies with
guaranteed death benefits written from 1994 to 1999. The arbitration involved
alleged breaches under the reinsurance treaties. Under the terms of the final
decision and award, the reinsurer's reinsurance
- 15 -
obligations to The Hartford's subsidiaries were unchanged and not limited or
reduced in any manner. The award was confirmed by the Connecticut Superior Court
on May 5, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of The Hartford during the
fourth quarter of 2003.
PART II
ITEM 5. MARKET FOR THE HARTFORD'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Hartford's common stock is traded on the New York Stock Exchange ("NYSE")
under the trading symbol "HIG".
The following table presents the high and low closing prices for the common
stock of The Hartford on the NYSE for the periods indicated, and the quarterly
dividends declared per share.
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- -----------------------------------------------------------------
2003
Common Stock Price
High $48.71 $51.84 $55.75 $59.03
Low 32.30 36.18 49.88 53.10
Dividends Declared 0.27 0.27 0.27 0.28
2002
Common Stock Price
High $68.56 $69.97 $58.63 $50.10
Low 59.93 58.04 41.00 37.38
Dividends Declared 0.26 0.26 0.26 0.27
=================================================================
As of February 20, 2004, the Company had approximately 126,000 shareholders. The
closing price of The Hartford's common stock on the NYSE on February 20, 2004
was $65.42.
On October 16, 2003, The Hartford's Board of Directors declared a quarterly
dividend of $0.28 per share payable on January 2, 2004 to shareholders of record
as of December 1, 2003. The dividend represented a 4% increase from the prior
quarter. Dividend decisions are based on and affected by a number of factors,
including the operating results and financial requirements of The Hartford and
the impact of regulatory restrictions discussed in the Capital Resources and
Liquidity section of the MD&A under "Liquidity Requirements".
There are also various legal limitations governing the extent to which The
Hartford's insurance subsidiaries may extend credit, pay dividends or otherwise
provide funds to The Hartford Financial Services Group, Inc. as discussed in the
Capital Resources and Liquidity section of the MD&A under "Liquidity
Requirements".
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2003 about the
securities authorized for issuance under the Company's equity compensation
plans. The Company maintains The Hartford Incentive Stock Plan, The Hartford
Employee Stock Purchase Plan (the "ESPP"), and The Hartford Restricted Stock
Plan for Non-Employee Directors (the "Director's Plan"), pursuant to which it
may grant equity awards to eligible persons. In addition, the Company maintains
the 2000 PLANCO Non-employee Option Plan (the "PLANCO Plan"), pursuant to which
it may grant awards to non-employee wholesalers of PLANCO products.
(a) (b) (c)
-------------------------- ---------------------- -------------------------------------
Number of Securities to Weighted-average Number of Securities Remaining
be Issued Upon Exercise Exercise Price of Available for Future Issuance Under
of Outstanding Options, Outstanding Options, Equity Compensation Plans (Excluding
Warrants and Rights Warrants and Rights Securities Reflected in Column (a))
- ------------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by
stockholders 20,937,715 48.63 9,475,461 [1] [2] [3]
Equity compensation plans not
approved by stockholders 280,762 53.15 167,720
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL 21,218,477 48.69 9,643,181
====================================================================================================================================
<FN>
[1] Of these shares, 3,091,671 shares remain available for purchase under the ESPP.
[2] Of these shares, a maximum of 2,933,086 shares remain available for issuance as restricted stock or performance shares under
The Hartford Incentive Stock Plan.
[3] Of these shares, 130,569 shares remain available for issuance under the Director's Plan.
</FN>
- 16 -
SUMMARY DESCRIPTION OF THE 2000 PLANCO NON-EMPLOYEE OPTION PLAN
The Company's Board of Directors adopted the PLANCO Plan on July 20, 2000, and
amended it on February 20, 2003 to increase the number of shares of the
Company's common stock subject to the plan to 450,000 shares. The stockholders
of the Company have not approved the PLANCO Plan.
Eligibility - Any non-employee independent contractor serving on the wholesale
sales force as an insurance agent who is an exclusive agent of the Company or
who derives more than 50% of his or her annual income from the Company is
eligible.
Terms of options - Nonqualified stock options ("NQSOs") to purchase shares of
common stock are available for grant under the PLANCO Plan. The administrator of
the PLANCO Plan, the Compensation and Personnel Committee, (i) determines the
recipients of options under the PLANCO Plan, (ii) determines the number of
shares of common stock covered by such options, (iii) determines the dates and
the manner in which options become exercisable (which is typically in three
equal annual installments beginning on the first anniversary of the date of
grant), (iv) sets the exercise price of options (which may be less than, equal
to or greater than the fair market value of common stock on the date of grant)
and (v) determines the other terms and conditions of each option. Payment of the
exercise price may be made in cash, other shares of the Company's common stock
or through a same day sale program. The term of an NQSO may not exceed ten years
and two days from the date of grant.
If an optionee's required relationship with the Company terminates for any
reason, other than for cause, any exercisable options remain exercisable for a
fixed period of three months, not to exceed the remainder of the option's term.
Any options that are not exercisable at the time of such termination are
cancelled on the date of such termination. If the optionee's required
relationship is terminated for cause, the options are canceled immediately.
Acceleration in Connection with a Change in Control - Upon the occurrence of a
change in control, each option outstanding on the date of such change in
control, and which is not then fully vested and exercisable, shall immediately
vest and become exercisable. In general, a "Change in Control" will be deemed to
have occurred upon the acquisition of 20% or more of the outstanding voting
stock of the Company, a tender or exchange offer to acquire 15% or more of the
outstanding voting stock of the Company, certain mergers or corporate
transactions resulting in the shareholders of the Company before the
transactions owning less than 55% of the entity surviving the transactions,
certain transactions involving a transfer of substantially all of the Company's
assets or a change in greater than 50% of the Board members over a two year
period. See Note 11 of Notes to Consolidated Financial Statements for a
description of The Hartford Incentive Stock Plan and the ESPP.
PRIVATE PLACEMENTS
On July 10, 2003, the Company issued $320 in aggregate principal amount of its
unregistered 4.625% senior notes, due 2013. The unregistered senior notes were
offered and sold only to qualified institutional buyers in compliance with Rule
144A of the Securities Act of 1933 and, outside the United States, in compliance
with Regulation S of the Securities Act of 1933. The initial purchasers of the
senior notes were Banc of America Securities LLC, Wachovia Capital Markets, LLC
and Banc One Capital Markets, Inc. The net proceeds from the offering, along
with available cash, were used to redeem $320 net aggregate principal amount of
the Company's then outstanding 7.70% junior subordinated deferrable interest
debentures, series A, due February 28, 2016, underlying the 7.70% cumulative
quarterly income preferred securities, series A, originally issued by Hartford
Capital I. On January 22, 2004, pursuant to terms and conditions set forth in
the registration statement on Form S-4 (Reg. No. 333-110274) effective as of
January 20, 2004 and the related prospectus, the Company commenced an exchange
offer whereby the unregistered senior notes can be exchanged for registered
senior notes with identical terms. The exchange offer terminated on February 25,
2004.
- 17 -
ITEM 6. SELECTED FINANCIAL DATA
(IN MILLIONS, EXCEPT FOR PER SHARE DATA AND COMBINED RATIOS)
2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA
Total revenues [1] $ 18,733 $ 16,417 $ 15,980 $ 15,312 $ 13,945
Income (loss) before cumulative effect of accounting
changes [2] (91) 1,000 541 974 862
Net income (loss) [2] [3] (91) 1,000 507 974 862
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets $ 225,853 $ 181,975 $ 181,593 $ 171,951 $ 167,486
Long-term debt 4,613 4,064 3,377 3,105 2,798
Total stockholders' equity 11,639 10,734 9,013 7,464 5,466
- ------------------------------------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) PER SHARE DATA
BASIC EARNINGS (LOSS) PER SHARE [2]
Income (loss) before cumulative effect of accounting
changes [2] $ (0.33) $ 4.01 $ 2.27 $ 4.42 $ 3.83
Net income (loss) [2] [3] (0.33) 4.01 2.13 4.42 3.83
DILUTED EARNINGS (LOSS) PER SHARE [2] [4]
Income (loss) before cumulative effect of accounting
changes [2] (0.33) 3.97 2.24 4.34 3.79
Net income (loss) [2] [3] (0.33) 3.97 2.10 4.34 3.79
Dividends declared per common share 1.09 1.05 1.01 0.97 0.92
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER DATA
Mutual fund assets [5] $ 22,462 $ 15,321 $ 16,809 $ 11,432 $ 6,374
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING DATA
COMBINED RATIOS
North American Property & Casualty [6] 98.0 99.8 112.5 102.9 102.7
====================================================================================================================================
<FN>
[1] 2001 includes a $91 reduction in premiums from reinsurance cessions related to September 11.
[2] 2003 includes an after-tax charge of $1,701 related to the Company's 2003 asbestos reserve addition, $40 of after-tax expense
related to the settlement of the Bancorp Services, LLC litigation dispute, $30 of tax benefit in Life primarily related to the
favorable treatment of certain tax items arising during the 1996-2002 tax years, and $27 after-tax of severance charges in
Property & Casualty. 2002 includes $76 tax benefit in Life, $11 after-tax expense in Life related to Bancorp and an $8
after-tax benefit in Life's September 11 exposure. 2001 includes $440 of losses related to September 11 and a $130 tax benefit
in Life.
[3] 2001 includes a $34 after-tax charge related to the cumulative effect of accounting changes for the Company's adoption of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" and EITF Issue No. 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets".
[4] As a result of the net loss for the year ended December 31, 2003, Statement of Financial Accounting Standards No. 128,"Earnings
per Share" requires the Company to use basic weighted average common shares outstanding in the calculation of the year ended
December 31, 2003 diluted earnings (loss) per share, since the inclusion of options of 1.8 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 274.2.
[5] Mutual funds are owned by the shareholders of those funds and not by the Company. As a result, they are not reflected in total
assets on the Company's balance sheet.
[6] 2001 includes the impact of September 11. Before the impact of September 11, the 2001 combined ratio was 103.5.
</FN>
- 18 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR PER 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 December 31, 2003, compared with December 31, 2002, and its
results of operations for each of the three years in the period ended December
31, 2003. This discussion should be read in conjunction with the Consolidated
Financial Statements and related Notes beginning on page F-1. Certain
reclassifications have been made to prior year financial information to conform
to the current year presentation.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company'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, including the Company's dispute
with Mac Arthur Company and its subsidiary, Western MacArthur Company
(collectively, or individually, "MacArthur") if the conditions to the
consummation of our settlement with MacArthur are not satisfied; 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
uncertain effect on the Company of the Jobs and Growth Tax Relief Reconciliation
Act of 2003, in particular the reduction in tax rates on long-term capital gains
and most dividend distributions; the response of reinsurance companies under
reinsurance contracts, the impact of increasing reinsurance rates and the
availability and adequacy of reinsurance to protect the Company against losses;
the inability to effectively mitigate the impact of equity market volatility on
the Company's financial position and results of operations arising from
obligations under annuity product guarantees; 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.
- --------------------------------------------------------------------------------
INDEX
- --------------------------------------------------------------------------------
Overview 19
Critical Accounting Estimates 21
Consolidated Results of Operations: Operating Summary 28
Life 31
Investment Products 33
Individual Life 34
Group Benefits 35
Corporate Owned Life Insurance (COLI) 36
Property & Casualty 37
Business Insurance 42
Personal Lines 44
Specialty Commercial 46
Reinsurance 48
Other Operations (Including Asbestos and
Environmental Claims) 49
Investments 55
Investment Credit Risk 59
Capital Markets Risk Management 64
Capital Resources and Liquidity 71
Effect of Inflation 78
Impact of New Accounting Standards 78
- --------------------------------------------------------------------------------
OVERVIEW
- --------------------------------------------------------------------------------
The Hartford provides investment products and life and property and casualty
insurance to both individual and business customers in the United States and
internationally. The Company is organized into two major operations: Life and
Property & Casualty. An overview of these operations and the principal factors
that drive the profitability of these operations follows.
LIFE
Life provides investment and retirement products such as variable and fixed
annuities, mutual funds and retirement plan services and other institutional
products; individual and corporate owned life insurance; and, group benefit
products, such as group life and group disability insurance.
- 19 -
Life derives its revenues principally from: (a) fee income, including asset
management fees, on separate account and mutual fund assets and mortality and
expense fees, as well as cost of insurance charges; (b) fully insured premiums;
(c) certain other fees; and (d) net investment income on general account assets.
Asset management fees and mortality and expense fees are primarily generated
from separate account assets, which are deposited with the Company through the
sale of variable annuity and variable universal life products and from mutual
funds. Cost of insurance charges are assessed on the net amount at risk for
investment-oriented life insurance products.
Premium revenues are derived primarily from the sale of group life and group
disability insurance products.
Life's expenses essentially consist of interest credited to policyholders on
general account liabilities, insurance benefits provided, dividends to
policyholders, costs of selling and servicing the various products offered by
the Company, and other general business expenses.
Life's profitability in its variable annuity, mutual fund and, to a lesser
extent, variable universal life businesses depends largely on the amount of its
assets under management on which it earns fees and the level of fees charged.
Changes in assets under management are comprised of two main factors: net flows,
which measure the success of Life's asset gathering and retention efforts (sales
and other deposits less surrenders) and the market return of the funds, which is
heavily influenced by the return on the equity markets. The profitability of
Life's fixed annuities depends largely on its ability to earn target spreads
between earned investment rates on its general account assets and interest
credited to policyholders. Profitability is also influenced by operating expense
management including the benefits of economies of scale in its variable annuity
businesses in particular. In addition, the size and persistency of gross profits
from these businesses is an important driver of earnings as it affects the
amortization of the deferred policy acquisition costs.
Life's profitability in its individual life insurance and group benefits
businesses depends largely on the size of its in force block, the adequacy of
product pricing and underwriting discipline, and the efficiency of its claims
and expense management.
PROPERTY & CASUALTY
Property & Casualty provides a number of coverages to businesses throughout the
United States, including workers' compensation, property, automobile, liability,
umbrella, specialty casualty, marine, agriculture, bond, professional liability
and directors and officer's liability coverage. Property & Casualty also
provides automobile, homeowners and home-based business coverage to individuals
throughout the United States as well as insurance related services to
businesses.
Property & Casualty derives its revenues principally from premium earned for
insurance coverages provided to insureds, investment income, net realized
capital gains and losses, and, to a lesser extent, from fees earned for services
provided to third parties. Premiums are earned on a pro rata basis over the
terms of the related policies in force.
Service fees principally include revenues from third party claims administration
services provided by Specialty Risk Services and revenues from member contact
center services provided through AARP's Health Care Options program.
Property & Casualty underwriting segments are evaluated by The Hartford's
management primarily based upon underwriting results. Underwriting results
represent earned premiums less incurred claims, claim adjustment expenses and
underwriting expenses. Underwriting results are influenced significantly by the
adequacy of the Company's pricing. Property & Casualty seeks to price its
insurance policies such that insurance premiums and net investment income earned
on premiums received will cover underwriting expenses and the ultimate cost of
paying claims reported on the policies and provide for a profit margin. For some
of its insurance products, Property & Casualty is required to obtain approval
for its premium rates from state insurance departments.
Underwriting profitability is also greatly influenced by the Company's
underwriting discipline which seeks to manage exposure to loss through favorable
risk selection and by its ability to manage its expense ratio which it
accomplishes through economies of scale and its management of underwriting
expenses.
In setting its pricing, Property & Casualty assumes an expected level of losses
from natural or man-made catastrophes that will cover the Company's exposure to
catastrophes over the long-term. In any one year, however, Property & Casualty's
actual losses from catastrophes may be significantly more or less than that
assumed in its pricing. A catastrophe loss is an event that causes $25 or more
in industry insured property losses and affects a significant number of property
and casualty policyholders and insurers.
Also, given the lag in the period from when claims are incurred to when they are
reported and paid, final claim settlements may vary from current estimates of
incurred losses and loss expenses, particularly when those payments may not
occur until well into the future. Adjustments to previously established loss and
loss expense reserves, if any, are reflected in underwriting results in the
period in which the adjustment is determined to be necessary.
Through its Other Operations segment, Property & Casualty is responsible for
managing the operations of The Hartford that have discontinued writing new
business as well as managing the claims related to asbestos and environmental
exposures. As such, the underwriting loss in Other Operations is principally
related to development on claim and claim adjustment expense reserves.
- 20 -
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The Company has identified the following estimates as critical in
that they involve a higher degree of judgment and are subject to a significant
degree of variability; reserves; investments; deferred policy acquisition costs
and present value of future profits; pension and other postretirement benefits;
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
RESERVES
LIFE
The Company's life insurance subsidiaries 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
Company'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 Company's policy obligations at their
maturities or in the event of an insured's death. Changes in or deviations from
the assumptions used for mortality, morbidity, expected future premiums and
interest can significantly affect the Company's reserve levels and related
future operations. 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.
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. Certain investment contracts include provisions whereby a guaranteed
minimum death benefit ("GMDB") 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. In addition,
these contracts contain various provisions for determining the amount of the
death benefit guaranteed following the withdrawal of a portion of the account
value by the policyholder. Partial withdrawals under certain of these contracts
may not result in a reduction in the guaranteed minimum death benefit in
proportion to the account value surrendered. The Company records the death
benefit costs, net of reinsurance, upon death. See Impact of New Accounting
Standards section for a discussion of the Company's adoption of Statement of
Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts" (the "SOP") in
2004 and the recording of a liability for GMDB in accordance with the provisions
of the SOP.
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.
PROPERTY & CASUALTY
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims made under policies written by the Company.
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. Reserve estimates can change over time because of unexpected
changes in the external environment. Potential external factors include (1)
changes in the inflation rate for goods and services related to covered damages
such as medical care, hospital care, auto parts, wages and home repair, (2)
changes in the general economic environment that could cause unanticipated
changes in the claim frequency per unit insured, (3) changes in the litigious
environment as evidenced by changes in claimant attorney representation in the
claims negotiation and settlement process, (4) changes in the judicial
environment regarding the interpretation of policy provisions relating to the
determination of coverage and/or the amount of damages awarded for certain types
of damages, (5) changes in the social environment regarding the general attitude
of juries in the determination of liability and damages, (6) changes in the
regulatory environment regarding rates, rating plans and policy forms, (7)
changes in the legislative environment regarding the definition of damages and
(8) new types of injuries caused by new types of exposure to injury: past
examples include breast implants, tobacco products, lead paint, construction
defects and blood product contamination. Reserve estimates can also change over
time because of changes in internal company operations. Potential internal
factors include (1) periodic changes in claims handling procedures, (2) growth
in new lines of business where exposure and loss development patterns are not
well established or (3) changes in the quality of risk selection in the
underwriting process. In the case of reinsurance, all of the above risks apply.
In addition, changes in ceding company case reserving and
- 21 -
reporting patterns create additional factors that need to be considered in
estimating the reserves. Due to the inherent complexity of the assumptions used,
final claim settlements may vary significantly from the present estimates,
particularly when those settlements may not occur until well into the future.
The Hartford, like other insurance companies, categorizes and tracks its
insurance reserves for its segments by "line of business", such as general
liability, commercial multi-peril, workers' compensation, auto bodily injury,
auto physical damage, homeowners and assumed reinsurance. Furthermore, The
Hartford regularly reviews the appropriateness of reserve levels at the line of
business level, taking into consideration the variety of trends that impact the
ultimate settlement of claims for the subsets of claims in each particular line
of business. Adjustments to previously established reserves, if any, are
reflected in the operating results of the period in which the adjustment is
determined to be necessary. In the judgment of management, all information
currently available has been properly considered in the reserves established for
claims and claim adjustment expenses.
The Hartford is a multiline company in the property and casualty business. The
Hartford is therefore subject to reserve uncertainty stemming from conditions,
including but not limited to, those noted above, any of which could be material
at any point in time for any segment. Certain issues may become more or less
important over time as external or internal conditions change. As various market
conditions develop, management must assess whether those conditions constitute a
long-term trend that should result in a reserving action (i.e. increasing or
decreasing the reserve). Below is a discussion of certain market conditions that
Company management has observed during 2003.
The Company continues to carry the original incurred amount related to September
11, less any paid losses. Actual experience in some cases appears to be
developing favorably to our original expectations, such as the higher than
anticipated rate of participation in the victim's compensation fund. There is
still uncertainty, particularly with respect to coverage disputes and the
potential for the emergence of latent injuries. Furthermore, the deadline for
filing a liability claim with respect to September 11 has been extended to March
11, 2004. As various deadlines pass and more coverage disputes are settled
either outside of court or through a court decision, the uncertainty about
various aspects of the reserves will likely be reduced. The Company will
continue to evaluate these reserves on a quarterly basis throughout 2004 and
will make adjustments where appropriate.
Within the commercial segments and the Other Operations segment, the Company has
exposure to losses from construction defects and other mass torts. Construction
defect losses involve the allegation of property damage from poor construction.
The Company also has exposure to claims asserted for bodily injury as a result
of long-term or continuous exposure to harmful products or substances. Examples
include, but are not limited to, pharmaceutical products, latex gloves, silica
and lead paint. Such exposures involve potentially long latency periods and the
spreading of coverage across years. These factors make reserves for such claims
more uncertain than other bodily injury or property damage claims.
In Personal Lines, reserving estimates are generally less variable than for the
Company's other property and casualty segments. This is largely due to the
coverages having relatively shorter periods of loss emergence. Estimates,
however, can still vary due to a number of factors, including interpretations of
frequency and severity trends and their impact on recorded reserve levels. With
respect to severity, the Company's current accident year case reserves indicated
a moderation in claim severity trends, which may be attributable in whole or in
part to recent changes in internal claim practices. Changes in claim practices
increase the uncertainty in the interpretation of case reserve data which,
therefore, increases the uncertainty in recorded reserve levels.
In Business Insurance, workers' compensation is the Company's single biggest
line and the line with the longest pattern of loss emergence. Reserve estimates
for workers' compensation are particularly sensitive to assumptions about
medical inflation, which has been increasing steadily over the past few years.
In addition, changes in state legislative and regulatory environments impact the
Company's estimates. In particular, the California environment has been very
volatile. The California legislature has recently passed a slate of reforms with
the intention of reducing loss costs. Some of the reforms will impact open
claims, and therefore, will potentially impact reserve estimates. How these
reforms will impact the amount and timing of loss payments is still unknown.
In the Specialty Commercial segment, many lines of insurance, such as excess
insurance and deductible workers' compensation insurance are "long-tailed" lines
of insurance. For long-tailed lines, the period of time between the incidence of
the insured loss and either the reporting of the claim to the insurer, the
settlement of the claim, or the payment of the claim can be substantial and in
some cases several years. As a result of this extended period of time for losses
to emerge, reserve estimates for these lines are more uncertain (i.e. more
variable) than reserve estimates for shorter-tailed lines of insurance.
Estimating required reserve levels for deductible workers compensation insurance
is further complicated by the uncertainty of whether losses that are
attributable to the deductible amount can be paid by the insured; if such losses
are not paid by the insured due to financial difficulties, the Company would be
contractually liable. Another example of reserve variability relates to reserves
for directors and officers insurance. The required level of reserves for the
recent financial and Wall Street scandals, including those involving the mutual
fund industry, the investment banking industry and various highly-publicized
bankruptcies, is still uncertain.
In the Reinsurance segments, much of the business is long-tailed; reserve
estimates for this business are therefore subject to variability caused by
extended loss emergence periods that were described for the Specialty Commercial
segment. In the case of assumed reinsurance, there is the added complexity of
further reporting delays between the time of the incidence of the loss and the
reporting of the claim to the direct insurer and the reporting by the direct
insurer to the reinsurer. There is also the complexity of the dependence on the
quality and consistency of the loss reporting of the ceding company. And
finally, there is the added variability caused by the reinsurer generally not
having loss information as detailed as the direct insurer. The Company's
reinsurance casualty business for accident years 1997-2001 has proven
particularly difficult to project.
- 22 -
In the opinion of management, based upon the known facts and current law, the
reserves recorded for The Hartford's property and casualty businesses at
December 31, 2003 represent the Company's best estimate of its ultimate
liability for claims and claim adjustment expenses related to losses covered by
policies written by the Company. However, because of the significant
uncertainties surrounding environmental and particularly asbestos exposures, it
is possible that management's estimate of the ultimate liabilities for these
claims may change and that the required adjustment to recorded reserves could
exceed the currently recorded reserves by an amount that could be material to
The Hartford's results of operations, financial condition and liquidity.
ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from
asbestos-related and environmental-related exposures. Asbestos claims relate
primarily to bodily injuries asserted by those who came in contact with asbestos
or products containing asbestos. Environmental claims relate primarily to
pollution and related clean-up costs.
The Hartford wrote several different categories of insurance coverage to which
asbestos and environmental claims may apply. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhausted 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. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
In establishing reserves for asbestos and environmental claims, The Hartford
evaluates both each insured's probable liability for such claims and each
insured's total available insurance coverage for such claims. In evaluating each
insured's probable liability for asbestos and environmental claims; The Hartford
considers a variety of factors that are unique to each insured. With respect to
each insured's probable liability for asbestos claims, these factors include the
jurisdictions where underlying claims have been brought, past and anticipated
future claim activity, past settlement values of similar claims, allocated claim
adjustment expense, and potential bankruptcy impact. The Hartford's evaluation
of each insured's probable liability for environmental claims involves
consideration of similar factors, including historical values of similar claims,
the number of sites involved, the insured's alleged activities at each site, the
alleged environmental damage at each site, the respective shares of liability of
potentially responsible parties at each site, the appropriateness and cost of
remediation at each site, the nature of governmental enforcement activities at
each site, the ownership and general use of each site, and potential bankruptcy
impact.
Having evaluated the insured's probable liability for asbestos and/or
environmental claims, The Hartford then evaluates each insured's insurance
coverage program for such claims. The Hartford considers each insured's total
available insurance coverage, including the coverage issued by The Hartford.
This evaluation includes consideration of the number of years of coverage,
applicable limits of liability, self-insured retentions, deductibles,
exclusions, insolvencies, and "bare" periods. The Hartford also considers
relevant judicial interpretations of policy language and applicable coverage
defenses or determinations, if any, including in the case of asbestos claims
whether some or all of the claims for which an insured seeks coverage are
products or completed operations claims subject to aggregate limits.
For both asbestos and environmental reserves, The Hartford also compares its
historical direct net loss and expense paid and incurred experience, and net
loss and expense paid and incurred experience year by year, to assess any
emerging trends, fluctuations or characteristics suggested by the aggregate paid
and incurred activity.
Once the gross ultimate exposure for indemnity and allocated claim adjustment
expense is determined for each insured by each policy year, The Hartford
calculates its ceded reinsurance projection based on any applicable facultative
and treaty reinsurance and the Company's experience with reinsurance
collections.
Uncertainties Regarding Adequacy of Asbestos and Environmental Reserves
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related 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 inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation, and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular 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, plaintiffs'
increased focus on new and previously peripheral defendants, and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings including "pre-packaged" bankruptcies to accelerate and
increase loss payments by insurers. In addition, some policyholders have begun
to assert new classes of claims for so-called "non-products" coverages to which
an aggregate limit of liability may not apply. Recently, many insurers,
including The Hartford, also have been sued directly by asbestos claimants
asserting that insurers had a duty to protect the public from the dangers of
asbestos. Management believes these issues are not likely to be resolved in the
near future.
- 23 -
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court decisions that have interpreted the
insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layers of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. Additionally, the reporting pattern for excess insurance
and reinsurance claims is much longer than direct claims. In many instances, it
takes months or years to determine that the customer's own obligations have been
met and how the reinsurance in question may apply to such claims. The delay in
reporting reinsurance claims and exposures adds to the uncertainty of estimating
the related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos exposures. The Hartford continually
evaluates new information and new methodologies in assessing its potential
asbestos exposures. At any time, The Hartford may be conducting an analysis of
newly identified information. Completion of exposure analyses could cause The
Hartford to change its estimates of its asbestos reserves, and the effect of
these changes could be material to the Company's consolidated operating results,
financial condition and liquidity.
In the first quarter of 2003, The Hartford conducted a detailed study of its
asbestos exposures. The Company undertook the study consistent with its practice
of regularly updating its reserve estimates as new information becomes
available. The Company strengthened its gross and net asbestos reserves by $3.9
billion and $2.6 billion, respectively, during the first quarter ended March 31,
2003.
The process of estimating asbestos reserves remains subject to a wide variety of
uncertainties, which are detailed in Note 16 of Notes to Consolidated Financial
Statements. Due to these uncertainties, further developments could cause The
Hartford to change its estimates of asbestos reserves, and the effect of these
changes could be material to the Company's consolidated operating results,
financial condition and liquidity.
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" as defined in 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, as adjusted for the effect of deducting the life
and pension policyholders' share of the immediate participation guaranteed
contracts and certain life and annuity deferred policy acquisition costs,
reflected in stockholders' equity as a component of accumulated other
comprehensive income ("AOCI"). Policy loans are carried at outstanding balance,
which approximates fair value. Other investments primarily consist of limited
partnership interests, derivatives and mortgage loans. The limited partnerships
are accounted for under the equity method and accordingly the partnership
earnings are included in net investment income. Derivatives are carried at fair
value and mortgage loans on real estate are recorded at the outstanding
principal balance adjusted for amortization of premiums or discounts and net of
valuation allowances, if any.
Valuation of Fixed Maturities
The fair value for fixed maturity securities is largely determined by one of
three primary pricing methods: independent third party pricing services,
independent broker quotations or pricing matrices, which use data provided by
external sources. With the exception of short-term securities for which
amortized cost is predominantly used to approximate fair value, security pricing
is applied using a hierarchy or "waterfall" approach whereby prices are first
sought from independent pricing services with the remaining unpriced securities
submitted to brokers for prices or lastly priced via a pricing matrix.
Prices from independent pricing services are often unavailable for securities
that are rarely traded or are traded only in privately negotiated transactions.
As a result, a significant percentage of the Company's asset-backed and
commercial mortgage-backed securities are priced via broker quotations. A
pricing matrix is used to price securities for which the Company is unable to
obtain either a price from a third party service or an independent broker
quotation. The pricing matrix begins with current treasury rates and uses credit
spreads and issuer-specific yield adjustments received from an independent third
party source to determine the market price for the security. The credit spreads
incorporate the issuer's credit rating as assigned by a nationally recognized
rating agency and a risk premium, if warranted, due to the issuer's industry and
security's time to maturity. The issuer-specific yield adjustments, which can be
positive or negative, are updated twice annually, as of June 30 and December 31,
by an independent third-party source and are intended to adjust security prices
for issuer-specific factors. The matrix-priced securities at December 31, 2003
and 2002, primarily consisted of non-144A private placements and have an average
duration of 4.5.
- 24 -
The following table identifies the fair value of fixed maturity securities by
pricing source as of December 31, 2003 and 2002:
2003 2002
----------------------------------------- ----------------------------------------
General and Guaranteed Percentage General and Guaranteed Percentage
Separate Account Fixed of Total Separate Account Fixed of Total
Maturities at Fair Value Fair Value Maturities at Fair Value Fair Value
- ------------------------------------------------------------------------------------------------------------------------------------
Priced via independent market quotations $ 60,871 83.4% $ 48,680 81.1%
Priced via broker quotations 4,113 5.6% 5,809 9.7%
Priced via matrices 4,253 5.8% 3,232 5.4%
Priced via other methods 337 0.5% 234 0.4%
Short-term investments [1] 3,424 4.7% 2,019 3.4%
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 72,998 100.0% $ 59,974 100.0%
- ------------------------------------------------------------------------------------------------------------------------------------
Total general accounts $ 61,263 83.9% $ 48,889 81.5%
Total guaranteed separate accounts $ 11,735 16.1% $ 11,085 18.5%
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Short-term investments are valued at amortized cost, which approximates fair value.
</FN>
The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. As such, the estimated fair value of a
financial instrument may differ significantly from the amount that could be
realized if the security was sold immediately.
Other-Than-Temporary Impairments
One of the significant estimations inherent in the valuation of investments is
the evaluation of other-than-temporary impairments. The evaluation of
impairments is a quantitative and qualitative process, which is subject to risks
and uncertainties and is intended to determine whether declines in the fair
value of investments should be recognized in current period earnings. The risks
and uncertainties include changes in general economic conditions, the issuer's
financial condition or near term recovery prospects and the effects of changes
in interest rates. The Company's accounting policy requires that a decline in
the value of a security below its amortized cost basis be assessed to determine
if the decline is other-than-temporary. If so, the security is deemed to be
other-than-temporarily impaired, and a charge is recorded in net realized
capital losses equal to the difference between the fair value and amortized cost
basis of the security. The fair value of the other-than-temporarily impaired
investment becomes its new cost basis. The Company has a security monitoring
process overseen by a committee of investment and accounting professionals that
identifies securities that, due to certain characteristics, as described below,
are subjected to an enhanced analysis on a quarterly basis.
Securities not subject to 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 ("non-EITF Issue No. 99-20
securities"), that are depressed by twenty percent or more for six months are
presumed to be other-than-temporarily impaired unless the depression is the
result of rising interest rates or significant objective verifiable evidence
supports that the security price is temporarily depressed and is expected to
recover within a reasonable period of time. Non-EITF Issue No. 99-20 securities
depressed less than twenty percent or depressed twenty percent or more but for
less than six months are also reviewed to determine if an other-than-temporary
impairment is present. The primary factors considered in evaluating whether a
decline in value for non-EITF Issue No. 99-20 securities 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, credit rating and near-term
prospects of the issuer, (c) whether the debtor is current on contractually
obligated interest and principal payments and (d) the intent and ability of the
Company to retain the investment for a period of time sufficient to allow for
recovery.
For certain securitized financial assets with contractual cash flows (including
asset-backed securities), EITF Issue No. 99-20 requires the Company to
periodically update its best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
carrying amount and there has been a decrease in the present value of the
estimated cash flows since the last revised estimate, considering both timing
and amount, then an other-than-temporary impairment charge is recognized.
Projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral.
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 amortized cost prior to the expected date of sale. Once an impairment
charge has been recorded, the Company continues to review the
other-than-temporarily impaired securities for additional other-than-temporary
impairments.
Valuation of Derivative Instruments
Derivative instruments are reported at fair value based upon either independent
market quotations for exchange traded derivative contracts, independent third
party pricing sources or pricing valuation models which utilize independent
third party data as inputs. An embedded derivative instrument is reported at
fair value based upon internally established valuations that are consistent with
external valuation models, quotations furnished by dealers in such instrument or
market quotations. The Company has calculated the fair value of the guaranteed
minimum withdrawal benefit ("GMWB") embedded derivative liability based on
actuarial assumptions related to the projected cash flows, including benefits
and related contract charges, over the lives of the contracts, incorporating
expectations concerning policyholder behavior. Because of the dynamic and
complex nature of these cash flows, stochastic techniques under a variety of
market return scenarios and other best estimate assumptions are used. Estimating
these cash flows involves numerous estimates and subjective judgments including
those regarding expected market rates of return, market volatility, correlations
of market returns and discount rates. At each valuation date, the Company
assumes expected returns based on risk-free rates as represented by the current
LIBOR forward curve rates; market
- 25 -
volatility assumptions for each underlying index is based on a blend of observed
market "implied volatility" data and annualized standard deviations of monthly
returns using the most recent 20 years of observed market performance;
correlations of market returns across underlying indices is based on actual
observed market returns and relationships over the ten years preceding the
valuation date; and current risk-free spot rates as represented by the current
LIBOR spot curve is used to determine the present value of expected future cash
flows produced in the stochastic projection process.
DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
LIFE
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy acquisition costs and present value of future profits ("DAC"). At
December 31, 2003 and 2002, the carrying value of the Company's Life operations
DAC was $6.6 billion and $5.8 billion, respectively. For statutory accounting
purposes, such costs are expensed as incurred.
DAC related to traditional policies are amortized over the premium-paying period
in proportion to the present value of annual expected premium income. DAC
related to investment contracts and universal life-type contracts are deferred
and amortized using the retrospective deposit method. Under the retrospective
deposit method, acquisition costs are amortized in proportion to the present
value of estimated gross profits ("EGPs"), arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's variable annuity and to a lesser extent, variable
universal life insurance businesses. The average annual long-term rate of
assumed separate account fund performance (before mortality and expense charges)
used in estimating gross profits for the variable annuity and variable universal
life insurance business was 9% for the years ended December 31, 2003 and 2002.
For other products including fixed annuities and other universal life-type
contracts, the average assumed investment yield ranged from 5% to 8.5% for both
years ended December 31, 2003 and 2002.
The Company has developed sophisticated modeling capabilities to evaluate its
DAC asset, which allowed it to run a large number of stochastically determined
scenarios of separate account fund performance. These scenarios were then
utilized to calculate a statistically significant range of reasonable estimates
of EGPs. This range was then compared to the present value of EGPs currently
utilized in the DAC amortization model. As of December 31, 2003, the present
value of the EGPs utilized in the DAC amortization model fall within a
reasonable range of statistically calculated present value of EGPs. As a result,
the Company does not believe there is sufficient evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of December 31,
2003 is necessary; however, if in the future the EGPs utilized in the DAC
amortization model were to exceed the margin of the reasonable range of
statistically calculated EGPs, a revision could be necessary. Furthermore, the
Company has estimated that the present value of the EGPs is likely to remain
within a reasonable range if overall separate account returns decline by 15% or
less for 2004, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved.
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with SFAS No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts and for Realized Gains and Losses from the Sale of Investments", and
reproject its future EGPs based on current account values at the end of the
quarter in which a revision is deemed to be necessary. To illustrate the effects
of this process, assume the Company had concluded that a revision of the
Company's EGPs was required at December 31, 2003. If the Company assumed a 9%
average long-term rate of growth from December 31, 2003 forward along with other
appropriate assumption changes in determining the revised EGPs, the Company
estimates the cumulative increase to amortization would be approximately
$45-$50, after-tax. If instead the Company were to assume a long-term growth
rate of 8% in determining the revised EGPs, the adjustment would be
approximately $60-$70, after-tax. Assuming that such an adjustment were to have
been required, the Company anticipates that there would have been immaterial
impacts on its DAC amortization for the 2004 and 2005 years exclusive of the
adjustment, and that there would have been positive earnings effects in later
years. Any such adjustment would not affect statutory income or surplus, due to
the prescribed accounting for such amounts that is discussed above.
Aside from absolute levels and timing of market performance assumptions,
additional factors that will influence this determination include the degree of
volatility in separate account fund performance and shifts in asset allocation
within the separate account made by policyholders. The overall return generated
by the separate account is dependent on several factors, including the relative
mix of the underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings. The Company's overall separate account fund
performance has been reasonably correlated to the overall
- 26 -
performance of the S&P 500 Index (which closed at 1,112 on December 31, 2003),
although no assurance can be provided that this correlation will continue in the
future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of December 31, 2003, the Company believed variable annuity
separate account assets could fall by at least 40% before portions of its DAC
asset would be unrecoverable.
PENSION AND OTHER POSTRETIREMENT BENEFIT OBLIGATIONS
Pursuant to accounting principles related to the Company's pension and other
postretirement benefit obligations to employees under its various benefit plans,
the Company is required to make a significant number of assumptions in order to
estimate the related liabilities and expenses each period. The two economic
assumptions that have the most impact on pension expense are the discount rate
and the expected long-term rate of return. In determining the discount rate
assumption, the Company utilizes current market information provided by its plan
actuaries, including a discounted cash flow analysis of the Company's pension
obligation and general movements in the current market environment. In
particular, the Company uses an interest rate yield curve developed by its plan
actuaries. The yield curve is comprised of AAA/AA bonds with maturities between
zero and thirty years. Based on all available information, it was determined
that 6.25% is the appropriate discount rate as of December 31, 2003 to calculate
the Company's accrued benefit cost liability. Accordingly, the 6.25% discount
rate will also be used to determine the Company's 2004 pension expense. At
December 31, 2002 the discount rate was 6.5%.
The Company determines the long-term rate of return assumption for the pension
plan's asset portfolio based on analysis of the portfolio's historical rates of
return balanced with future long-term return expectations. Based on its
long-term outlook with respect to the markets, which has been influenced by the
poor equity market performance in recent years as well as the recent decline in
fixed income security yields, the Company lowered its long-term rate of return
assumption from 9.00% to 8.50% as of December 31, 2003.
To illustrate the impact of these assumptions on annual pension expense for 2004
and going forward, a 25 basis point change in the discount rate will
increase/decrease pension expense by approximately $12 and a 25 basis point
change in the long-term asset return assumption will increase/decrease pension
expense by approximately $5.
CONTINGENCIES
Management follows the requirements of SFAS No. 5 "Accounting for
Contingencies". This statement requires management to evaluate each contingent
matter separately. The evaluation is a two-step process, including: determining
a likelihood of loss, and, if a loss is probable, developing a potential range
of loss. Management establishes reserves for these contingencies at its "best
estimate", or, if no one number within the range of possible losses is more
probable than any other, the Company records an estimated reserve at the low end
of the range of losses. The majority of contingencies currently being evaluated
by the Company relate to litigation and tax matters, which are inherently
difficult to evaluate and subject to significant changes.
- 27 -
- --------------------------------------------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums [1] $ 11,891 $ 10,811 $ 10,242
Fee income 2,760 2,577 2,633
Net investment income 3,233 2,929 2,842
Other revenues 556 476 491
Net realized capital gains (losses) 293 (376) (228)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 18,733 16,417 15,980
------------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 13,548 10,034 10,597
Amortization of deferred policy acquisition costs and present value of future
profits 2,411 2,241 2,214
Insurance operating costs and expenses 2,424 2,317 2,037
Goodwill amortization -- -- 60
Other expenses 900 757 731
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 19,283 15,349 15,639
------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGES (550) 1,068 341
Income tax expense (benefit) (459) 68 (200)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES (91) 1,000 541
Cumulative effect of accounting changes, net of tax [2] -- -- (34)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) [3] $ (91) $ 1,000 $ 507
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] 2001 includes a $91 reduction in premiums from reinsurance cessions
related to September 11.
[2] Represents the cumulative impact of the Company's adoption of SFAS No.
133, as amended, "Accounting for Derivative Instruments and Hedging
Activities" of $(23) and EITF Issue No. 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets" of $(11).
[3] 2003 includes an after-tax charge of $1,701 related to the Company's 2003
asbestos reserve addition, $40 of after-tax expense related to the
settlement of the Bancorp Services, LLC litigation dispute, $30 of tax
benefit in Life primarily related to the favorable treatment of certain
tax items arising during the 1996-2002 tax years, and $27 after-tax of
severance charges in Property & Casualty. 2002 includes $76 tax benefit in
Life, $11 after-tax expense in Life related to Bancorp and an $8 after-tax
benefit in Life's September 11 exposure. 2001 includes $440 of losses
related to September 11 and a $130 tax benefit at Life.
</FN>
OPERATING RESULTS
2003 COMPARED TO 2002--Revenues for the year ended December 31, 2003 increased
$2.3 billion over the comparable 2002 period. Revenues increased due to earned
premium growth within the Business Insurance, Specialty Commercial and Personal
Lines segments, primarily as a result of earned pricing increases, higher earned
premiums and net investment income in the Investment Products segment and net
realized capital gains in 2003 as compared to net realized capital losses in
2002.
Total benefits, claims and expenses increased $3.9 billion for the year ended
December 31, 2003 over the comparable prior year period primarily due to the
Company's $2.6 billion asbestos reserve strengthening actions during the first
quarter of 2003 and due to increases in the Investment Products segment
associated with the growth in the individual annuity and institutional
investments businesses.
The net loss for the year ended December 31, 2003 is primarily due to the
Company's first quarter 2003 asbestos reserve strengthening of $1.7 billion,
after-tax. Included in net loss for the year ended December 31, 2003 are $40 of
after-tax expense related to the settlement of litigation with Bancorp Services,
LLC ("Bancorp") and $27 of severance charges, after-tax, in Property & Casualty.
Included in net income for the year ended December 31, 2002 are the $8 after-tax
benefit recognized by Hartford Life, Inc. ("HLI") related to the reduction of
HLI's reserves associated with September 11 and $11 of after-tax expense related
to litigation with Bancorp.
2002 COMPARED TO 2001 - Revenues increased $437 driven by strong earned premium
growth within Business Insurance, Personal Lines and Specialty Commercial, whose
earned premiums increased by $496, $237 and $200, respectively. Also
contributing to the growth was Group Benefits and Individual Life, whose
revenues increased $75 and $68, respectively. Partially offsetting the increases
described above were decreases in Investment Products, as a result of lower
earned premiums in the institutional investment products business and a decline
in revenues within the individual annuity operation, decreases in COLI, as a
result of the decrease in leveraged COLI account values as compared to 2001, and
higher net realized capital losses, which were $376 in 2002 compared with $228
in 2001. The increase in the net realized capital losses was due primarily to
other than temporary write-downs of corporate and asset-backed securities
including those in the telecommunication, utility and airline industries.
Net income increased $493, or 97%. The increase was partially due to $440 in
losses, after-tax and net of reinsurance, included in 2001 results related to
September 11 and the Company's adoption of SFAS No. 142, "Goodwill and Other
intangible Assets", which precluded the amortization of goodwill beginning on
January 1, 2002. The Company's goodwill amortization totaled $52, after-tax in
2001. Improved underwriting results in Property & Casualty, as well as increased
net income in the Group Benefits segment also contributed to the increase.
Partially offsetting these increases were lower net income in the Investment
Products segment and
- 28 -
higher after-tax net realized capital losses in 2002 compared to 2001.
NET REALIZED CAPITAL GAINS AND LOSSES
See "Investment Results" in the Investments section.
INCOME TAXES
The effective tax rate for 2003, 2002 and 2001 was 83%, 6% and (59%)
respectively. Tax-exempt interest earned on invested assets and the
dividends-received deduction were the principal causes of the effective rates
differing from the 35% United States statutory rate. Income taxes received in
2003, 2002, and 2001 were $107, $102 and $52, respectively. For additional
information, see Note 15 of Notes to Consolidated Financial Statements.
PER COMMON SHARE
The following table represents earnings per common share data for the past three
years:
2003 2002 2001
- --------------------------------------------------------------------
Basic earnings (loss) per share $(0.33) $4.01 $2.13
Diluted earnings (loss) per share [1] $(0.33) $3.97 $2.10
Weighted average common shares
outstanding (basic) 272.4 249.4 237.7
Weighted average common shares
outstanding and dilutive
potential common shares (diluted) [1] 272.4 251.8 241.4
- --------------------------------------------------------------------
[1] As a result of the net loss for the year ended December 31, 2003, SFAS No.
128, "Earnings Per Share", requires the Company to use basic weighted
average common shares outstanding in the calculation of the year ended
December 31, 2003 diluted earnings (loss) per share, since the inclusion
of options of 1.8 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
274.2.
ADOPTION OF FAIR-VALUE RECOGNITION PROVISIONS FOR STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of FASB Statement No. 123", which provides three optional
transition methods for entities that decide to voluntarily adopt the fair value
recognition principles of SFAS No. 123, "Accounting for Stock-Based
Compensation", and modifies the disclosure requirements of SFAS No. 123. In
January 2003, the Company adopted the fair value recognition provisions of
accounting for employee stock compensation and used the prospective transition
method. Under the prospective method, stock-based compensation expense is
recognized for awards granted or modified after the beginning of the fiscal year
in which the change is made. The fair value of stock-based awards granted during
the year ended December 31, 2003 was $42, after-tax. The fair value of these
awards will be recognized as expense over the awards' vesting periods, generally
three years.
All stock-based awards granted or modified prior to January 1, 2003 continue to
be valued using the intrinsic value-based provisions set forth in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees". Under the intrinsic value method, compensation expense is determined
on the measurement date, which is the first date on which both the number of
shares the employee is entitled to receive and the exercise price are known.
Compensation expense, if any, is measured based on the award's intrinsic value,
which is the excess of the market price of the stock over the exercise price on
the measurement date. The expense, including non-option plans, related to
stock-based employee compensation included in the determination of net income
for the years ended December 31, 2003, 2002 and 2001 is less than that which
would have been recognized if the fair value method had been applied to all
awards since the effective date of SFAS No. 123. For further discussion of the
Company's stock-based compensation plans, see Notes 1 and 11 of Notes to
Consolidated Financial Statements.
The following table illustrates net income (loss) and earnings (loss) per share
(basic and diluted) as if the fair value method had been applied to all
outstanding and unvested awards in each period:
For the years ended December 31,
--------------------------------------------------
(In millions, except for per share data) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ (91) $ 1,000 $ 507
Add: Stock-based employee compensation expense included in reported net income
(loss), net of related tax effects [1] 20 6 8
Deduct: Total stock-based employee compensation expense determined under the
fair value method for all awards, net of related tax effects (50) (59) (52)
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) [2] $ (121) $ 947 $ 463
====================================================================================================================================
Earnings (loss) per share:
Basic - as reported $ (0.33) $ 4.01 $ 2.13
Basic - pro forma [2] $ (0.44) $ 3.80 $ 1.95
Diluted - as reported [3] $ (0.33) $ 3.97 $ 2.10
Diluted - pro forma [2][3] $ (0.44) $ 3.76 $ 1.92
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Includes the impact of non-option plans of $6, $3 and $6 for the years
ended December 31, 2003, 2002 and 2001, respectively.
[2] The pro forma disclosures are not representative of the effects on net
income (loss) and earnings (loss) per share in future years.
[3] As a result of the net loss for the year ended December 31, 2003, SFAS No.
128 requires the Company to use basic weighted average common shares
outstanding in the calculation of the year end December 31, 2003 diluted
earnings (loss) per share, since the inclusion of options of 1.8 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 274.2.
</FN>
- 29 -
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 2003, 2002 and 2001:
2003 2002 2001
- ------------------------------------------------------------------
Dividend yield 2.3% 1.6% 1.6%
Expected price variability 39.8% 40.8% 29.1%
Risk-free interest rate 2.77% 4.27% 4.98%
Expected life 6 years 6 years 6 years
- ------------------------------------------------------------------
The use of the fair value recognition method results in compensation expense
being recognized in the financial statements in different amounts and in
different periods than the related income tax deduction. Generally, the
compensation expense recognized under SFAS No. 123 will result in a deferred tax
asset since the stock compensation expense is not deductible for tax until the
option is exercised. Deferred tax assets arising under SFAS No. 123 are
evaluated as to future realizability to determine whether a valuation allowance
is necessary.
NET INCOME (LOSS)
The following is a summary of net income (loss) for each of the Life segments,
aggregate net income (loss) for the Property & Casualty operations and net loss
for Corporate.
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 510 $ 432 $ 463
Individual Life 145 133 121
Group Benefits 148 128 106
COLI (1) 32 37
Other (33) (168) (42)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 769 557 685
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty (811) 469 (115)
Corporate (49) (26) (63)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (91) $ 1,000 $ 507
====================================================================================================================================
UNDERWRITING RESULTS (BEFORE-TAX)
The following is a summary of Property & Casualty underwriting results by
segment.
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Business Insurance $ 101 $ 44 $ (242)
Personal Lines 117 (46) (87)
Specialty Commercial (29) (23) (262)
Reinsurance (125) (59) (375)
Other Operations [1] (2,716) (164) (132)
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Includes $2,604 in 2003 of before-tax impact of asbestos reserve addition.
</FN>
In the sections that follow, the Company analyzes the results of operations of
its various segments using the performance measurements that the Company
believes are meaningful.
- 30 -
- --------------------------------------------------------------------------------
LIFE
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income $ 2,760 $ 2,577 $ 2,633
Earned premiums 3,086 2,697 2,975
Net investment income 2,041 1,849 1,782
Other revenues 131 120 128
Net realized capital gains (losses) 40 (308) (136)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 8,058 6,935 7,382
-------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 4,616 4,158 4,444
Insurance operating costs and expenses 1,535 1,438 1,390
Amortization of deferred policy acquisition costs and present value of future profits 769 628 642
Goodwill amortization -- -- 24
Other expenses 189 144 117
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 7,109 6,368 6,617
-------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGES 949 567 765
Income tax expense 180 10 54
Cumulative effect of accounting changes, net of tax [1] -- -- (26)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 769 $ 557 $ 685
====================================================================================================================================
<FN>
[1] For the year ended December 31, 2001, represents the cumulative impact of
the Company's adoption of SFAS No. 133 of $(23) and EITF Issue 99-20 of
$(3).
</FN>
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Life also includes in "Other" corporate items not directly allocated to any of
its reportable operating segments, principally interest expense as well as its
international operations, which are primarily located in Japan and Brazil,
realized capital gains and losses and intersegment eliminations.
On December 31, 2003, the Company acquired CNA Financial Corporation's group
life and accident, and short-term and long-term disability businesses for $485
in cash. The purchase price paid on December 31, 2003, was based on a September
30, 2003 valuation of the businesses acquired. During the first quarter of 2004,
the purchase price will be adjusted to reflect a December 31, 2003 valuation of
the businesses acquired. The Company currently estimates that adjustment to the
purchase price to be an increase of $51 which primarily reflects the increase in
the surplus of the businesses acquired in the fourth quarter of 2003. As a
result of the acquisition being effective on December 31, 2003, there were no
income statement effects recorded for the year ended December 31, 2003. On April
2, 2001, the Company acquired the United States individual life insurance,
annuity and mutual fund businesses of Fortis. This transaction was accounted for
as a purchase and, as such, the revenues and expenses generated by this business
from April 2, 2001 forward are included in the Company's consolidated results of
operations. For further discussion see Note 18 of Notes to Consolidated
Financial Statements.
2003 COMPARED TO 2002 -- Revenues increased as a result of realized gains in
2003 as compared to realized losses in 2002. See the Investments section for
further discussion of investment results and related realized capital gains and
losses. Also contributing to the increased revenues were higher earned premiums
and net investment income in the Investment Products segment as compared to the
prior year. The increase in earned premiums in Investment Products is attributed
to higher sales in the institutional investment products business specifically
in the terminal funding and structured settlement businesses. Additionally, net
investment income increased due to higher general account assets in the
individual annuity business and growth in assets in the institutional
investments business. Fee income in the Investment Products segment was higher
in 2003 compared to a year ago, as a result of higher average account values,
specifically in individual annuities and mutual fund businesses, due primarily
to stronger variable annuity sales. The Individual Life segment reported an
increase in revenues in 2003 compared to a year ago driven by increases in fees
and cost of insurance as life insurance in-force grew and aged, and variable
universal life account values increased 30% due primarily to the growth in the
equity markets. In addition, Group Benefits experienced an increase in revenues
driven by increases in net investment income and earned premiums in 2003 as
compared to a year ago. Partially offsetting these increases were lower fee
income and net investment income in the COLI segment. The decrease in COLI net
investment income for 2003 was primarily due to lower average leveraged COLI
account values as a result of surrender activity. In addition, COLI had lower
fee income due in part to lower sales in 2003, as compared to the prior year.
Benefits, claims and expenses increased primarily due to increases in the
Investment Products segment associated with the growth in the individual annuity
and institutional investments businesses discussed above. Partially offsetting
this increase was a decrease in interest credited expenses in COLI related to
the decline in leveraged COLI account values. For the year ended December 31,
2003, COLI other expenses increased due to a $40 after-tax charge, associated
with the settlement for the Bancorp Services, LLC ("Bancorp") litigation. For
further discussion of the Bancorp litigation, see Note 16 of Notes to
Consolidated Financial Statements.
Net income increased for the year ended December 31, 2003 due primarily to the
growth in the Investment Products segment and a decrease in net realized capital
losses compared to a year ago. Additionally, Group Benefits net income increased
due
- 31 -
principally to more favorable claims experience as compared to the prior year
and continued expense management. Individual Life experienced earnings growth in
2003 due to increases in fee income, favorable mortality and growth in the
in-force business. Partially offsetting these increases was a decrease in COLI
net income of $(33) for the year ended December 31, 2003, as compared to the
prior year period. This decrease includes the effects of a year over year
increase of $29 in the charge for the Bancorp litigation. In addition, there was
an $8 after-tax impact recorded in the first quarter of 2002 related to
favorable development on the Company's estimated September 11 exposure.
The effective tax rate increased in 2003 when compared with 2002 as a result of
higher earnings and lower dividends-received deduction ("DRD") related tax
items. The tax provision recorded during 2003 reflects a benefit of $30,
consisting primarily of a change in estimate of the DRD tax benefit reported
during 2002. The change in estimate was the result of actual 2002 investment
performance on the related separate accounts being unexpectedly out of pattern
with past performance, which had been the basis for the estimate. This compares
with a tax benefit of $76 recorded in 2002. See Note 16 of Notes Consolidated
Financial Statements. The total DRD benefit related to the 2003 tax year for the
year ended December 31, 2003 was $87 as compared to $63 for the year ended
December 31, 2002.
2002 COMPARED TO 2001 -- Revenues decreased, primarily driven by an increase in
realized capital losses in 2002 as compared to the prior year. See the
Investments section for further discussion of investment results and related
realized capital losses. Additionally, COLI experienced a decline in revenues,
as a result of the decrease in leveraged COLI account values as compared to a
year ago, which was partially offset by revenue growth across the other
operating segments. Revenues related to the Investment Products segment
decreased, as a result of lower earned premiums in the institutional investment
product business, and a decline in revenues within the individual annuity
operation. Lower assets under management due to the decline in the equity
markets are the principal driver of declining revenues for the individual
annuity operation. The Group Benefits segment experienced 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
increased, as a result of increased life insurance in-force and the Fortis
acquisition.
Total benefits, claims and expenses decreased due primarily to the revenue
changes described above. Expenses decreased in the Investment Products segment,
principally due to a lower change in reserve as a result of the lower earned
premiums discussed above and a $31 increase in death benefits related to the
individual annuity operation, as a result of depressed contractholder account
values driven by the lower equity markets. In addition, 2002 expenses 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 16
of Notes to Consolidated Financial Statements. Also included in 2002 expenses
was an after-tax benefit of $8, recorded within "Other", associated with
favorable development related to the estimated September 11 exposure.
Net income decreased, due primarily to lower income in Other as a result of
higher realized capital losses and lower income in the Investment Products
segment as a result of the lower equity markets. These declines were partially
offset by increases in Group Benefits as a result of business growth and stable
loss ratios and Individual Life primarily due to the Fortis acquisition. In
addition, the Company recorded, in 2002, an $11 after-tax expense associated
with the Bancorp litigation and recognized an $8 after-tax benefit due to
favorable development related to September 11. In 2001, the Company recorded a
$20 after-tax loss related to September 11.
A description of each of Life's segments as well as an analysis of the operating
results summarized above are included on the following pages.
- 32 -
- --------------------------------------------------------------------------------
INVESTMENT PRODUCTS
- --------------------------------------------------------------------------------
OPERATING SUMMARY
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 1,744 $ 1,631 $ 1,724
Earned premiums 764 397 729
Net investment income 1,273 1,070 884
Net realized capital gains 27 9 2
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 3,808 3,107 3,339
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 1,993 1,454 1,652
Insurance operating costs and other expenses 652 648 608
Amortization of deferred policy acquisition costs
and present value of future profits 542 444 461
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 3,187 2,546 2,721
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 621 561 618
Income tax expense 111 129 155
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 510 $ 432 $ 463
- ------------------------------------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 86,501 $ 64,343 $ 74,581
Other individual annuity account values 11,215 10,565 9,572
Other investment products account values 26,279 19,921 19,322
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES 123,995 94,829 103,475
Mutual fund assets under management 22,462 15,321 16,809
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS UNDER MANAGEMENT $ 146,457 $ 110,150 $ 120,284
====================================================================================================================================
The Investment Products segment focuses on the savings and retirement needs of
the growing number of individuals who are preparing for retirement, or have
already retired, through the sale of individual variable and fixed annuities,
mutual funds, retirement plan services and other investment products. The
Company is both a leading writer of individual variable annuities and a top
seller of individual variable annuities through banks in the United States.
2003 COMPARED TO 2002 -- Revenues in the Investment Products segment increased
primarily driven by higher earned premiums and higher net investment income. The
increase in earned premiums is due to higher sales of terminal funding and
structured settlement products in the institutional investment products
business. Net investment income increased due to higher general account assets.
General account assets for the individual annuity business were $9.4 billion as
of December 31, 2003, an increase of approximately $800 or 9% from 2002, due
primarily to an increase in individual annuity sales, with the majority of those
new sales electing to use the dollar cost averaging ("DCA") feature. The DCA
feature allows policyholders to earn a credited interest rate in the general
account for a defined period of time as their invested assets are systematically
invested into the separate account funds. Additionally, net investment income
related to other investment products increased as a result of the growth in
average assets over the last twelve months in the institutional investment
business, where related general account assets under management increased $2.4
billion, since December 31, 2002, to $10.4 billion as of December 31, 2003.
Assets under management is an internal performance measure used by the Company
since a significant portion of the Company's revenue is based upon asset values.
These revenues increase or decrease with a rise or fall, respectively, in the
level of average assets under management. Fee income in the Investment Products
segment was higher in 2003 compared to a year ago, as a result of higher average
account values, specifically in individual annuities and mutual fund businesses,
due primarily to stronger variable annuity sales and the higher equity market
values compared to the prior year.
Total benefits, claims and expenses increased primarily due to higher terminal
funding and structured settlement sales in the institutional investment business
causing an increase in reserve levels and increased interest credited in the
individual annuity operation as a result of higher general account asset levels.
Additionally, amortization of deferred policy acquisition costs related to the
individual annuity business increased due to higher gross profits.
Net income was higher driven by an increase in revenues in the individual
annuity and other investment product operations as a result of the strong net
flows and growth in the equity markets during 2003 and strong expense
management. In addition, net income increased in 2003 compared to 2002 due to
the favorable impact of $21, resulting from the Company's previously discussed
change in estimate of the DRD tax benefit reported during 2002. The change in
estimate was the result of 2002 actual investment performance on the related
separate accounts being unexpectedly out of pattern with past performance, which
had been the basis for the estimate. The total DRD benefit related to the 2003
tax year for the year ended December 31, 2003 was $81 as compared to $59 for the
year ended December 31, 2002.
2002 COMPARED TO 2001 -- Revenues in the Investment Products segment decreased
primarily due to lower earned premiums in the institutional investment products
business and lower fee income related to the individual annuity operation as
average account values decreased from $85.7 billion to $79.5 billion compared to
prior year, primarily due to the lower equity markets. Partially offsetting
these declines was an increase in
- 33 -
net investment income, primarily driven by growth in the institutional
investment product business, where related assets under management increased
$699, or 7%, to $9.7 billion as of December 31, 2002.
Total benefits, claims and expenses decreased, due primarily to a lower change
in reserve as a result of the lower earned premiums discussed above.
Additionally, there was a decrease in amortization of policy acquisition costs
related to the individual annuity business, which declined as a result of lower
gross profits, driven by the decrease in fee income and the increase in death
benefit costs. Partially offsetting these decreases were increases of $84, or
11%, in interest credited on general account assets, $61, or 6%, in commissions
and wholesaling expenses, and $31 in individual annuity death benefit costs due
to the lower equity markets. The increase in operating expenses was primarily
driven by the mutual fund business.
Net income decreased, driven by the lower equity markets resulting in the
decline in revenues in the individual annuity operation and increases in the
death benefit costs incurred by the individual annuity operation.
OUTLOOK
Management believes the market for retirement products continues to expand as
individuals increasingly save and plan for retirement. Demographic trends
suggest that as the "baby boom" generation matures, a significant portion of the
United States population will allocate a greater percentage of their disposable
incomes to saving for their retirement years due to uncertainty surrounding the
Social Security system and increases in average life expectancy. In addition,
the Company believes that it has developed and implemented strategies to
maintain and enhance its position as a market leader in the financial services
industry. This was demonstrated by record individual annuity sales in 2003 of
$16.5 billion (a 42% increase) compared to $11.6 billion and $10.0 billion in
2002 and 2001, respectively.
Significantly contributing to the growth in sales was the introduction of
Principal First, a guaranteed minimum withdrawal benefit rider, which was
developed in response to our customers' needs. However, the competition is
increasing in this market and as a result, the Company may not be able to
sustain the level of sales attained in 2003. Based on VARDS, the Company had
12.6% market share as of December 31, 2003 as compared to 9.4% at December 31,
2002. Additionally, in 2003 The Hartford mutual funds reached $20 billion in
assets faster than any other retail-oriented mutual fund family in history,
according to Strategic Insight.
The growth and profitability of the individual annuity and mutual fund
businesses is dependent to a large degree on the performance of the equity
markets. In periods of favorable equity market performance, the Company may
experience stronger sales and higher net cash flows, which will increase assets
under management and thus increase fee income earned on those assets. In
addition, higher equity market levels will generally reduce certain costs to the
Company of individual annuities, such as GMDB and GMWB benefits. Conversely
though, weak equity markets may dampen sales activity and increase surrender
activity causing declines in assets under management and lower fee income. Such
declines in the equity markets will also increase the cost to the Company of
GMDB and GMWB benefits associated with individual annuities. The Company
attempts to mitigate some of the volatility associated with the GMDB and GMWB
benefits using reinsurance or other risk management strategies, such as hedging.
Future net income for the Company will be affected by the effectiveness of the
risk management strategies the Company has implemented to mitigate the net
income volatility associated with the GMDB and GMWB benefits of variable annuity
contracts. For spread based products sold in the Investment Products segment,
the future growth will depend on the ability to earn targeted returns on new
business, given competition and the future interest rate environment.
- --------------------------------------------------------------------------------
INDIVIDUAL LIFE
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 747 $ 705 $ 643
Earned premiums (20) (8) 4
Net investment income 256 262 244
Net realized capital losses (1) (1) (1)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 982 958 890
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 436 443 385
Amortization of deferred policy acquisition costs 176 160 168
Insurance operating costs and other expenses 161 159 159
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 773 762 712
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 209 196 178
Income tax expense 64 63 57
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 145 $ 133 $ 121
--------------------------------------------------------------------------------------------------------------------------
Variable universal life account values $ 4,725 $ 3,648 $ 3,993
Total account values $ 8,726 $ 7,557 $ 7,868
- ------------------------------------------------------------------------------------------------------------------------------------
Variable universal life insurance in force $ 67,031 $ 66,715 $ 61,617
Total life insurance in force $ 130,798 $ 126,680 $ 120,269
====================================================================================================================================
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients.
- 34 -
2003 COMPARED TO 2002 -- Revenues in the Individual Life segment increased
primarily driven by increases in fees and cost of insurance charges as life
insurance in-force grew and aged, and variable universal life account values
increased 30%, driven by the growth in the equity markets in 2003. These
increases were partially offset by lower earned premiums and net investment
income in 2003. The decrease in net investment income was due primarily to lower
investment yields. Earned premiums, which include premiums for ceded
reinsurance, decreased primarily due to increased use of reinsurance.
Total benefits, claims and expenses increased, principally driven by an increase
in amortization of deferred policy acquisition costs. These increases were
partially offset by a decrease in benefit costs in 2003 as compared to 2002 due
to favorable mortality rates compared to the prior year.
Net income increased due to increases in fee income and unusually favorable
mortality. Additionally, net income for the year ended December 31, 2003
includes the favorable impact of $2 DRD benefit resulting from the Company's
previously discussed change in estimate of the DRD tax benefit reported during
2002. The total DRD benefit related to the 2003 tax year for the year ended
December 31, 2003 was $4 as compared to $3 for the year ended December 31, 2002.
2002 COMPARED TO 2001 -- Revenues in the Individual Life segment increased,
primarily driven by business growth including the impact of the Fortis
transaction. Total benefits, claims and expenses increased, driven by the growth
in the business including the impact of the Fortis acquisition. In addition,
mortality rates for 2002 increased as compared to the prior year, but were in
line with management's expectations. Individual Life's earnings increased for
the year ended December 31, 2002, principally due to the contribution to
earnings from the Fortis transaction. The increase in net income was also
impacted by an after-tax loss of $3 related to September 11 in the third quarter
of 2001.
OUTLOOK
The Individual Life segment benefited from unusually favorable mortality during
the fourth quarter. It is not anticipated that similar experience would be
likely to continue. Individual Life sales grew to $196 in 2003 from $173 in 2002
with the successful introduction of new universal life and whole life products.
Improved equity markets should help increase variable universal life sales. The
Company also continues to introduce new and enhanced products, which are
expected to increase sales. However, the Company continues to face uncertainty
surrounding estate tax legislation and aggressive competition from life
insurance providers. The Company is actively pursuing broader distribution
opportunities to fuel growth, including our Pinnacle Partners marketing
initiative, and anticipates growth at Woodbury Financial Services.
- --------------------------------------------------------------------------------
GROUP BENEFITS
- --------------------------------------------------------------------------------
OPERATING SUMMARY
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums and other $ 2,362 $ 2,327 $ 2,259
Net investment income 264 258 255
Net realized capital losses (2) (3) (7)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,624 2,582 2,507
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 1,862 1,878 1,874
Insurance operating costs and other expenses 571 541 498
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,433 2,419 2,372
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE 191 163 135
Income tax expense 43 35 29
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 148 $ 128 $ 106
- ------------------------------------------------------------------------------------------------------------------------------------
Fully insured - ongoing premiums $ 2,302 $ 2,295 $ 2,014
Buyout premiums 40 13 97
Military Medicare supplement -- -- 131
Other 20 19 17
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 2,362 $ 2,327 $ 2,259
====================================================================================================================================
The Company is a leading provider of group benefits, and through this segment
sells group life and group disability insurance as well as other products,
including medical stop loss and supplementary medical coverages to employers and
employer sponsored plans, accidental death and dismemberment, travel accident
and other special risk coverages to employers and associations. The Company also
offers disability underwriting, administration, claims processing services and
reinsurance to other insurers and self-funded employer plans.
2003 COMPARED TO 2002 -- Revenues in the Group Benefits segment increased in
2003 as compared to 2002, driven by increases in earned premiums and other and
net investment income in 2003 as compared to a year ago. Premiums growth was not
as high as anticipated due to lower sales to new customers in 2003 and lower
persistency on renewals reflecting a competitive marketplace. However, the
segment reported an increase in total buyout premiums. Buyouts involve the
acquisition of claim liabilities from another carrier for a purchase price
calculated to cover the run off of those liabilities plus administration
expenses and profit. Due to the nature of the buyout marketplace, the
predictability of buyout premiums is uncertain.
- 35 -
Total benefits, claims and expenses increased for the year ended December 31,
2003, which is consistent with the increase in buyout premiums previously
described. Excluding buyouts, total benefits, claims and expenses decreased $43,
or 2%, over the same period. The segment's loss ratio (defined as benefits,
claims and claim adjustment expenses as a percentage of premiums and other
considerations excluding buyouts) was 79%, down from 81% in 2002. Insurance
operating costs and other expenses increased due to the premium growth
previously described and continued investments in technology, service and
distribution. The segment's ratio of insurance operating costs and other
expenses to premiums and other considerations was 24%, increasing slightly from
23% in 2002.
The increase in net income was due primarily to favorable claims experience.
2002 COMPARED TO 2001 -- Revenues in the Group Benefits segment increased,
driven primarily by growth in premiums, which increased in 2002 as compared to
2001. The growth in premiums was due to an increase in fully insured ongoing
premiums, as a result of steady persistency and pricing actions on the in-force
block of business and strong sales. Fully insured ongoing sales were $597, an
increase of $66, or 12%. Offsetting this increase was a decrease in military
medicare supplement premiums 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
2002 were partially offset by a decrease in total buyout premiums.
Total benefits, claims and expenses increased from 2001 to 2002. The increase in
expenses is consistent with the growth in revenues previously described.
Benefits and claims expenses, excluding buyouts, increased over the same period;
however, the segment's loss ratio was 81% down slightly from 82% in 2001.
Insurance operating costs and other expenses increased, due to the fully insured
ongoing premium growth previously described and continued investments in
technology and service. The segment's ratio of insurance operating costs and
other expenses to premiums and other considerations was 23%, consistent with
prior year.
The increase in net income was due to the increase in premium revenues and
favorable loss costs, which was partially offset by increased insurance
operating costs and other expenses as previously described. Group Benefits
incurred an after-tax loss of $2 related to September 11 in the third quarter of
2001.
OUTLOOK
Despite the current market conditions, including low interest rates, rising
medical costs, the changing regulatory environment and cost containment pressure
on employers, the Group Benefits segment continues to leverage off of its
strength in claim and risk management, service and distribution, enabling the
Company to capitalize on market opportunities. Additionally, employees continue
to look to the workplace for a broader and ever expanding array of insurance
products. As employers design benefit strategies to attract and retain
employees, while attempting to control their benefit costs, management believes
that the need for the Group Benefits segment's products will continue to expand.
This, combined with the significant number of employees who currently do not
have coverage or adequate levels of coverage, creates unique opportunities for
our products and services. Furthermore, on December 31, 2003, the Company
acquired the group life and accident, and short-term and long-term disability
businesses of CNA Financial Corporation. This acquisition will increase the
scale of the Company's group life and disability operations and expand the
Company's distribution of its products and services. This acquisition is
expected to be slightly accretive to earnings in 2004. Please refer to
"Subsequent events" in the Stockholders' Equity section of the Capital Resources
and Liquidity section for information on the financing of this transaction.
- --------------------------------------------------------------------------------
CORPORATE OWNED LIFE INSURANCE ("COLI")
- --------------------------------------------------------------------------------
OPERATING SUMMARY
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 267 $ 316 $ 367
Net investment income 216 275 352
Net realized capital gains -- 1 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 483 592 719
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 324 401 514
Insurance operating costs and expenses 103 82 84
Dividends to policyholders 60 62 66
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 487 545 664
--------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (4) 47 55
Income tax expense (benefit) (3) 15 18
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (1) $ 32 $ 37
--------------------------------------------------------------------------------------------------------------------------
Variable COLI account values $ 20,993 $ 19,674 $ 18,019
Leveraged COLI account values 2,524 3,321 4,315
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $ 23,517 $ 22,995 $ 22,334
====================================================================================================================================
The Company is a leader in the COLI market, which includes life insurance
policies purchased by a company on the lives of its employees, with the company
or a trust sponsored by the company named as beneficiary under the policy. Until
the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), the
Company sold two principal types of COLI business: leveraged and variable
products. Leveraged COLI is a fixed premium life insurance policy owned by a
company or a trust sponsored by a company. HIPAA phased out the deductibility of
interest on policy loans under leveraged COLI
- 36 -
through the end of 1998, virtually eliminating all future sales of this product.
Variable COLI continues to be a product used by employers to fund non-qualified
benefits or other post-employment benefit liabilities.
2003 COMPARED TO 2002 -- COLI revenues decreased, primarily driven by lower net
investment and fee income. Net investment income and fee income decreased due to
the decline in leveraged COLI account values as a result of surrender activity.
Fee income also decreased as the result of lower sales volume in 2003 as
compared to prior year.
Total benefits, claims and expenses decreased in 2003, primarily as a result of
a decline in interest credited. This was due to the decline in general account
assets as compared to 2002. This is related to the surrender activity noted
above. These decreases were partially offset by an increase in insurance
operating costs and expenses due primarily to a $40 after-tax expense, related
to the Bancorp litigation expense recorded in 2003 compared with the $11
after-tax expense recorded in 2002. For a discussion of the Bancorp litigation,
see Note 16 of Notes to Consolidated Financial Statements.
Net income decreased in 2003 compared to 2002 principally as a result of the
Bancorp litigation expense. Excluding the expenses associated with the Bancorp
litigation discussed above, net income decreased $4 or 9%, primarily due to the
decline in leveraged COLI account values discussed above.
2002 COMPARED TO 2001 -- COLI revenues decreased, primarily related to lower net
investment and fee income due to the declining block of leveraged COLI compared
to a year ago. Total benefits, claims and expenses decreased, which is
relatively consistent with the decrease in revenues described above. However,
the decrease was partially offset by an $11 after-tax expense related to the
Bancorp litigation. COLI's net income decreased principally due to the $11
after-tax expense accrued in connection with the Bancorp litigation. The
decrease in net income was also impacted by an after-tax loss of $2 related to
September 11 recorded in the third quarter of 2001.
OUTLOOK
The focus of this segment is variable COLI, which continues to be a product
generally used by employers to fund non-qualified benefits or other
post-employment benefit liabilities. The leveraged COLI product has been an
important contributor to The Hartford's profitability in recent years and will
continue to contribute to the profitability of the Company in the future,
although the level of profit has declined in 2003, compared to 2002. COLI
continues to be subject to a changing legislative and regulatory environment
that could have a material adverse effect on its business.
- --------------------------------------------------------------------------------
PROPERTY & CASUALTY
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 8,805 $ 8,114 $ 7,267
Net investment income 1,172 1,060 1,042
Other revenue [1] 428 356 363
Net realized capital gains (losses) 253 (68) (92)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 10,658 9,462 8,580
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 8,926 5,870 6,146
Amortization of deferred policy acquisition costs 1,642 1,613 1,572
Insurance operating costs and expenses 889 879 647
Goodwill amortization -- -- 3
Other expenses [2] 625 559 560
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 12,082 8,921 8,928
--------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE (1,424) 541 (348)
Income tax expense (benefit) (613) 72 (241)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (811) 469 (107)
Cumulative effect of accounting change, net of tax [3] -- -- (8)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) [4] $ (811) $ 469 $ (115)
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH AMERICAN PROPERTY & CASUALTY UNDERWRITING RATIOS [5]
Loss ratio [6] 58.7 59.6 70.3
Loss adjustment expense ratio [6] 12.1 11.2 12.5
Expense ratio [6] 26.8 28.3 29.2
Policyholder dividend ratio 0.4 0.7 0.5
- ------------------------------------------------------------------------------------------------------------------------------------
COMBINED RATIO [6] 98.0 99.8 112.5
- ------------------------------------------------------------------------------------------------------------------------------------
Catastrophe ratio 3.0 1.3 10.6
- ------------------------------------------------------------------------------------------------------------------------------------
COMBINED RATIO BEFORE CATASTROPHES [6] 95.0 98.5 101.9
====================================================================================================================================
<FN>
[1] Primarily servicing revenue.
[2] Includes severance charges of $41 for 2003 and restructuring charges of
$15 for 2001.
[3] Represents the cumulative impact of the Company's adoption of EITF Issue
No. 99-20.
[4] 2001 includes $420 of after-tax losses related to September 11.
[5] Ratios do not include the effects of Other operations. Refer to the
"Ratios" section below for definitions of the underwriting ratios.
[6] For 2001, before the impact of September 11, loss ratio was 62.8, loss
adjustment expense ratio was 11.4, expense ratio was 28.8 and combined
ratio was 103.5.
</FN>
- 37 -
Property & Casualty is organized into five reportable operating segments: the
North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance: and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures.
2003 COMPARED TO 2002 -- Revenues for Property & Casualty increased $1.2 billion
for the year ended December 31, 2003. The improvement was due primarily to
earned premium growth in the Business Insurance, Specialty Commercial and
Personal Lines segments, primarily as a result of earned pricing increases, as
well as an improvement in net realized capital gains and losses, and net
investment income. Partially offsetting the increase was a $361 earned premium
decline in the Reinsurance segment as a result of the Company's decision to
withdraw from the assumed reinsurance business as discussed more fully below.
On May 16, 2003, as part of the Company's decision to withdraw from the assumed
reinsurance business, the Company entered into a quota share and purchase
agreement with Endurance Reinsurance Corporation of America ("Endurance")
whereby the Reinsurance segment retroceded the majority of its inforce book of
business as of April 1, 2003 and sold renewal rights to Endurance. Under the
quota share agreement, Endurance reinsured most of the segment's assumed
reinsurance contracts that were written on or after January 1, 2002 and that had
unearned premium as of April 1, 2003. In consideration for Endurance reinsuring
the unearned premium as of April 1, 2003, the Company paid Endurance an amount
equal to unearned premiums less the related unamortized commissions/deferred
acquisition costs net of an override commission, which was established by the
contract. In addition, Endurance will pay a profit sharing commission based on
the loss performance of property treaty, property catastrophe and aviation pool
unearned premium. Under the purchase agreement, Endurance will pay additional
amounts, subject to a guaranteed minimum of $15, based on the level of renewal
premium on the reinsured contracts over the two year period following the
agreement. The guaranteed minimum is reflected in net income for the year ended
December 31, 2003. The Company remains subject to ongoing reserve development
relating to all retained business.
Net income decreased $1.3 billion for the year ended December 31, 2003 primarily
due to the net asbestos reserve strengthening of $1.7 billion, after-tax, in the
first quarter. Results for the year were favorably impacted by an increase in
net realized capital gains (losses) and improved underwriting results in the
Personal Lines and Business Insurance segments. Strong earned pricing and
favorable frequency loss costs resulted in an increase in underwriting results
in both the Personal Lines and Business Insurance segments. In addition, net
investment income, after-tax, rose $69 for the year ended December 31, 2003 due
to higher invested assets, primarily from strong cash flows and additional
capital raised during the second quarter of 2003.
On September 1, 2003, the Company sold a wholly owned subsidiary, Trumbull
Associates, LLC, for $33, resulting in a gain of $15, after-tax. The gain is
included in net realized capital gains. The revenues and net income of Trumbull
Associates, LLC were not material to the Company or the Property & Casualty
Operation.
2002 COMPARED TO 2001 -- Revenues for Property & Casualty increased $882, or
10%, for the year ended December 31, 2002. The improvement was due primarily to
earned premium growth in the Business Insurance, Personal Lines and Specialty
Commercial segments, primarily as a result of earned pricing increases. The 2001
reinsurance cessions related to September 11 increased the earned premium
variance for the year by $91. Partially offsetting the increase was a decline in
earned premium in the Reinsurance segment due to the exclusion of the exited
international business, which in January 2002 was transferred to Other
Operations, and a reduction in the alternative risk transfer line of business. A
decrease in net realized capital losses and improvement in net investment income
also contributed to the increase in revenues.
Net income increased $584 primarily due to after-tax losses related to September
11 of $420 in 2001, improved underwriting results across each of the North
American underwriting segments, particularly in Specialty Commercial and
Reinsurance, and a decrease in net realized capital losses. Partially offsetting
the improvement was an increase in other expenses primarily as a result of an
increase in e-business research and development expenses and certain employee
benefits costs, as well as 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 previous table and the following segment discussions for the years ended
December 31, 2003, 2002 and 2001 include various underwriting ratios. Management
believes that these ratios are useful in understanding the underlying trends in
The Hartford's current insurance underwriting business. However, these measures
should only be used in conjunction with, and not in lieu of, underwriting income
and net income for the combined property and casualty segments 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 "loss and loss
expense incurred ratio" is the sum of the loss and loss adjustment expense
ratios. The "expense ratio" is the ratio of underwriting expenses, excluding bad
debt expense, to earned premiums. The "policyholder dividend ratio" is the ratio
of policyholder dividends to earned premiums. The "combined ratio" is the sum of
the loss ratio, the loss adjustment expense ratio, the expense ratio and the
policyholder dividend ratio. These ratios are relative measurements that
describe for every $100 of net premiums earned, the cost of losses and expenses
as defined above, respectively. A combined ratio below 100 demonstrates
underwriting profit; a combined ratio above 100 demonstrates underwriting
losses. The "loss and loss expense paid ratio" represents the ratio of paid
claims and claim adjustment expenses to earned premiums. The "catastrophe ratio"
represents the ratio of catastrophe losses to earned premiums. A catastrophe is
an event that causes $25 or more in industry insured property losses and affects
a significant number of property and casualty policyholders and insurers.
- 38 -
PREMIUM MEASURES
Written premiums are a non-GAAP financial measure which represents the amount of
premiums charged for policies issued during a fiscal period. Earned premiums is
a GAAP measure. Premiums are considered earned and are included in the financial
results on a pro rata basis over the policy period. The following segment
discussions for the years ended December 31, 2003, 2002, and 2001 respectively,
include the presentation of written premiums in addition to earned premiums.
Management believes that this performance measure is useful to investors as it
reflects current trends in the Company's sale of property and casualty insurance
products, as compared to earned premium. Premium renewal retention is defined as
renewal premium written in the current period divided by total premium written
in the prior period. Reinstatement premium represents additional ceded premium
paid for the reinstatement of the amount of reinsurance coverage that was
reduced as a result of a reinsurance loss payment.
RISK MANAGEMENT STRATEGY
The Hartford's property and casualty operations have well-developed processes to
manage catastrophic risk exposures to natural catastrophes, such as hurricanes
and earthquakes, and other perils, such as terrorism. These processes involve
establishing underwriting guidelines for both individual risk and in aggregate
including individual policy limits and aggregate exposure limits by geographic
zone and peril. The Company establishes exposure limits and actively monitors
the risk exposures as a percent of North American property-casualty surplus.
Generally the Company limits its exposure from a single 250-year event to less
than 30% of statutory surplus for losses prior to reinsurance and to less than
15% of statutory surplus for losses net of reinsurance. The Company monitors
exposures monthly and employs both internally developed and externally purchased
loss modeling tools.
The Hartford utilizes reinsurance to manage risk and transfer exposures to
well-established and financially secure reinsurers. Reinsurance is used to
manage both aggregate exposures as well as specific risks based on accumulated
property and casualty liabilities in certain geographic zones. All treaty
purchases are administered by a centralized function to support a consistent
strategy and ensure that the reinsurance activities are fully integrated into
the organization's risk management processes.
A variety of traditional reinsurance products are used in the development and
execution of the overall corporate risk management strategy. The risk transfer
products used include both excess of loss occurrence-based products, protecting
aggregate property and workers compensation exposures, and individual risk or
quota share products, protecting specific classes or lines of business. Finite
risk products may be used on a limited basis as a cost-effective alternative to
traditional products. There are currently no significant finite risk contracts
in place and the current statutory surplus benefit from all such prior year
contracts is immaterial. Facultative reinsurance is also used to manage
policy-specific risk exposures based on established underwriting guidelines. The
Hartford also participates in governmentally administered reinsurance facilities
such as the Florida Hurricane Catastrophe Fund ("FHCF").
To minimize the potential credit risk resulting from the use of reinsurance, a
centralized group evaluates the credit standing of potential reinsurers and
establishes the Company's schedule of approved reinsurers. The assessment
process reviews reinsurers against a set of predetermined financial and
management criteria and distinguishes between long-tail casualty and short-tail
property business. A committee meets regularly to review activity with each
reinsurer and affirm the schedule of approved reinsurers.
REINSURANCE RECOVERABLES
The Company's net reinsurance recoverables from various property and casualty
reinsurance arrangements amounted to $5.4 billion and $4.2 billion at December
31, 2003 and 2002, respectively. Of the total net reinsurance recoverables as of
December 31, 2003, $446 relates to the Company's mandatory participation in
various involuntary assigned risk pools, which are backed by the financial
strength of the property and casualty insurance industry. Of the remainder, $3.5
billion, or 71%, was due from companies rated by A.M. Best. Of the total rated
by A.M. Best, 92% of the companies were rated A- (excellent) or better. The
remaining $1.4 billion, or 29%, of net recoverables from reinsurers was
comprised of the following: 5% related to voluntary pools, 2% related to captive
insurance companies, and 22% related to companies not rated by A.M. Best.
Where its contracts permit, the Company secures its collection of these future
claim obligations with various forms of collateral including irrevocable letters
of credit, secured trusts such as New York Regulation 114 trusts, funds held
accounts and group wide offsets.
The net recoverables include an allowance for doubtful accounts. The allowance
for unrecoverable reinsurance was $381 and $211 at December 31, 2003 and 2002,
respectively. The significant increase was primarily related to the Company's
asbestos reserve strengthening actions during the first quarter of 2003. The
Company's allowance for unrecoverable reinsurance is regularly reviewed based on
management's assessment of the credit quality of its reinsurers as well as an
estimate for the cost (if any) of resolution of reinsurer disputes.
RESERVES
Reserving for property and casualty losses is an estimation process. As
additional experience and other relevant claim data become available, reserve
levels are adjusted accordingly. Such adjustments of reserves related to claims
incurred in prior years are a natural occurrence in the loss reserving process
and are referred to as "reserve development". Reserve development that increases
previous estimates of ultimate cost is called "reserve strengthening". Reserve
development that decreases previous estimates of ultimate cost is called
"reserve releases". Reserve development can influence the comparability of year
over year underwriting results and is set forth in the paragraphs and tables
that follow. The "prior accident year development (pts.)" in the following
tables for the years ended December 31, 2003, 2002 and 2001 represents the ratio
of reserve development to earned premiums. For a detailed discussion of the
Company's reserve policies, see Notes 1, 7 and 16 of Notes to Consolidated
Financial Statements and the Critical Accounting Estimates section of the MD&A.
- 39 -
For the Year Ended December 31, 2003
There was no significant reserve strengthening or release in the Business
Insurance and Personal Lines segments for the year ended December 31, 2003.
Specialty Commercial strengthened prior accident year reserves by $52 for the
year ended December 31, 2003 primarily as a result of losses in the bond and
professional liability lines of business. The bond reserve strengthening was
isolated to a few severe contract surety claims related to accident year 2002.
The professional liability reserve strengthening involved a provision for
anticipated settlements of reinsurance obligations for contracts outstanding at
the time of the original acquisition of Reliance Group Holdings' auto residual
value portfolio in the third quarter of 2000. Reserve strengthening of $94 in
the Reinsurance segment for the year occurred across multiple accident years,
primarily 1997 through 2000, and principally in the casualty line of traditional
reinsurance. In addition, the Other Operations segment for the year ended
December 31, 2003 reflects the Company's net asbestos reserve strengthening of
$2.6 billion during the first quarter of 2003.
For the Year Ended December 31, 2002
Reserve strengthening in the Business Insurance segment for the year ended
December 31, 2002 was not significant. In Personal Lines, prior accident year
loss and loss adjustment expenses for non-standard auto were strengthened due to
heavier than expected frequency, severity and litigation rates on prior accident
years. In addition, the prior accident year provision was increased modestly for
mold losses. Virtually all of the strengthening in Specialty Commercial is due
to deductible workers' compensation losses on a few large accounts. Reserve
strengthening in the Reinsurance segment occurred across multiple accident
years, primarily 1997 through 2000, and across several lines of business. High
reported losses from ceding companies have persisted throughout 2002 and loss
ratios have been revised upward. Virtually all of the reserve strengthening in
the Other Operations segment related to asbestos.
For the Year Ended December 31, 2001
There was little reserve strengthening or weakening by segment in 2001 with the
exception of Other Operations, where the strengthening was related primarily to
non-asbestos and environmental exposures. (For further discussion of reserve
activity related to asbestos and environmental, see the Other Operations section
of the MD&A.)
A rollforward of liabilities for unpaid claims and claim adjustment expenses by
segment for Property & Casualty follows:
FOR THE YEAR ENDED DECEMBER 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH
BUSINESS PERSONAL SPECIALTY AMERICAN OTHER
INSURANCE LINES COMMERCIAL REINSURANCE P&C OPERATIONS TOTAL P&C
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,744 $ 1,692 $ 4,957 $ 1,614 $ 13,007 $ 4,084 $ 17,091
REINSURANCE AND OTHER RECOVERABLES 366 49 1,998 388 2,801 1,149 3,950
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-NET 4,378 1,643 2,959 1,226 10,206 2,935 13,141
- ------------------------------------------------------------------------------------------------------------------------------------
PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 2,346 2,324 1,130 287 6,087 15 6,102
Prior years (6) (6) 52 94 134 2,690 2,824
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES 2,340 2,318 1,182 381 6,221 2,705 8,926
- ------------------------------------------------------------------------------------------------------------------------------------
PAYMENTS (1,761) (2,211) (1,015) (409) (5,396) (453) (5,849)
OTHER [1] (56) (60) (106) (3) (225) 225 --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND 4,901 1,690 3,020 1,195 10,806 5,412 16,218
CLAIM ADJUSTMENT EXPENSES-NET
REINSURANCE AND OTHER RECOVERABLES 395 43 2,088 496 3,022 2,475 5,497
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 5,296 $ 1,733 $ 5,108 $ 1,691 $ 13,828 $ 7,887 $ 21,715
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 3,696 $ 3,181 $ 1,558 $ 352 $ 8,787 $ 18 $ 8,805
Combined ratio 95.7 95.9 99.3 135.3 98.0
Loss and loss expense paid ratio 47.7 69.5 65.1 116.3 61.4
Loss and loss expense incurred ratio 63.3 72.9 75.8 108.4 70.8
Catastrophe ratio 2.7 4.1 1.7 1.4 3.0
Prior accident year development (pts.) [2] (0.2) (0.2) 3.3 26.7 1.5
====================================================================================================================================
<FN>
[1] Represents the transfer of reserves pursuant to the MacArthur settlement.
[2] In addition to prior year loss reserve development of $94, Reinsurance had $10 of earned premiums in 2003 that related to
exposure periods prior to 2003.
</FN>
- 40 -
FOR THE YEAR ENDED DECEMBER 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH
BUSINESS PERSONAL SPECIALTY AMERICAN OTHER TOTAL
INSURANCE LINES COMMERCIAL REINSURANCE P&C OPERATIONS P&C
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,440 $ 1,530 $ 5,073 $ 1,956 $ 12,999 $ 4,037 $ 17,036
REINSURANCE AND OTHER RECOVERABLES 375 51 2,088 448 2,962 1,214 4,176
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-NET 4,065 1,479 2,985 1,508 10,037 2,823 12,860
- ------------------------------------------------------------------------------------------------------------------------------------
PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 1,943 2,244 820 492 5,499 78 5,577
Prior years 19 75 29 77 200 93 293
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES 1,962 2,319 849 569 5,699 171 5,870
- ------------------------------------------------------------------------------------------------------------------------------------
PAYMENTS (1,649) (2,155) (875) (551) (5,230) (359) (5,589)
OTHER [1] -- -- -- (300) (300) 300 --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 4,378 1,643 2,959 1,226 10,206 2,935 13,141
- ------------------------------------------------------------------------------------------------------------------------------------
REINSURANCE AND OTHER RECOVERABLES 366 49 1,998 388 2,801 1,149 3,950
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,744 $ 1,692 $ 4,957 $ 1,614 $ 13,007 $ 4,084 $ 17,091
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 3,126 $ 2,984 $ 1,222 $ 713 $ 8,045 $ 69 8,114
Combined ratio 97.0 101.0 99.4 107.9 99.8
Loss and loss expense paid ratio 52.7 72.2 71.7 77.1 65.0
Loss and loss expense incurred ratio 62.7 77.7 69.4 79.9 70.8
Catastrophe ratio 0.8 2.5 0.5 0.7 1.3
Prior accident year development (pts.) 0.6 2.5 2.4 10.8 2.5
====================================================================================================================================
<FN>
[1] $300 represents the transfer of the international lines of the Reinsurance segment to Other Operations.
</FN>
FOR THE YEAR ENDED DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH
BUSINESS PERSONAL SPECIALTY AMERICAN OTHER TOTAL
INSURANCE LINES COMMERCIAL REINSURANCE P&C OPERATIONS P&C
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 3,954 $ 1,403 $ 5,628 $ 1,416 $ 12,401 $ 3,892 $ 16,293
REINSURANCE AND OTHER RECOVERABLES 195 42 2,011 234 2,482 1,389 3,871
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-NET 3,759 1,361 3,617 1,182 9,919 2,503 12,422
- ------------------------------------------------------------------------------------------------------------------------------------
PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 1,944 2,156 897 983 5,980 12 5,992
Prior years (10) 17 28 (11) 24 119 143
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES 1,934 2,173 925 972 6,004 131 6,135
- ------------------------------------------------------------------------------------------------------------------------------------
PAYMENTS (1,628) (2,055) (955) (646) (5,284) (308) (5,592)
OTHER [1] [2] -- -- (602) -- (602) 497 (105)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 4,065 1,479 2,985 1,508 10,037 2,823 12,860
- ------------------------------------------------------------------------------------------------------------------------------------
REINSURANCE AND OTHER RECOVERABLES 375 51 2,088 448 2,962 1,214 4,176
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,440 $ 1,530 $ 5,073 $ 1,956 $ 12,999 $ 4,037 $ 17,036
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 2,630 $ 2,747 $ 1,022 $ 851 $ 7,250 $ 17 $ 7,267
Combined ratio 108.0 102.7 124.2 144.0 112.5
Loss and loss expense paid ratio 61.7 74.7 94.3 75.8 72.8
Loss and loss expense incurred ratio 73.5 79.1 90.7 114.2 82.8
Catastrophe ratio 10.0 2.7 17.9 29.5 10.6
Prior accident year development (pts.) (0.4) 0.6 2.7 (1.3) 0.3
====================================================================================================================================
<FN>
[1] $602 represents the transfer of asbestos and environmental reserves to Other Operations.
[2] Includes $(101) related to the sale of international subsidiaries.
</FN>
- 41 -
IMPACT OF RE-ESTIMATES
As explained in connection with the Company's discussion of Critical Accounting
Estimates, the establishment of Property and Casualty reserves is an estimation
process. Ultimate losses may vary significantly from the current estimates. Many
factors can contribute to these variations and the need to subsequently change
the previous estimate of required reserve levels. Subsequent changes can
generally be thought of as being the result of the emergence of additional facts
that were not known or anticipated at the time of the prior reserve estimate
and/or changes in interpretations of information and trends.
The table below shows the range of reserve re-estimates experienced by The
Hartford over the past three years. The amount of prior accident year
development (as shown in the reserve rollforward) for a given year is expressed
as a percent of the beginning reserves. The range below represents the range of
such calculations for the last three years. The percentage relationships
presented are significantly influenced by the facts and circumstances of each
particular year and by the fact that only the last three years are included in
the range. Accordingly, these percentages are not intended to be a prediction of
the range of possible future variability.
- ------------------------------------------------------------------------------------------------------------------------------------
BUSINESS PERSONAL SPECIALTY NORTH OTHER TOTAL
INSURANCE LINES COMMERCIAL REINSURANCE AMERICAN P&C OPERATIONS P&C
- ------------------------------------------------------------------------------------------------------------------------------------
RANGE OF PRIOR ACCIDENT YEAR
DEVELOPMENT FOR THE THREE
YEARS ENDED DECEMBER 31,
2003 [1] [2] (0.3) - 0.5 (0.4) - 5.1 0.8 - 1.8 (0.9) - 7.7 0.3 - 2.5 3.3 - 91.7 1.2 - 21.5
====================================================================================================================================
<FN>
[1] Bracketed prior accident development indicates favorable development. Unbracketed amounts represent unfavorable development.
[2] Before the $2.6 billion of reserve strengthening for asbestos during 2003, over the past five years, reserve re-estimates for
total Property & Casualty ranged from (1.3%) to 2.3%.
</FN>
The potential variability of the Company's Property and Casualty reserves would
normally be expected to vary by segment and the types of loss exposures insured
by those segments. Illustrative factors influencing the potential reserve
variability for each of the segments are discussed under Critical Accounting
Estimates. In general, the Company would expect the variability of its Personal
Lines reserve estimates to be relatively less than the variability of the
reserve estimates for its other property and casualty segments. The Company
would expect the degree of variability of the other segment's reserve estimates,
from lower variability to higher variability, to be generally Business
Insurance, Specialty Commercial, Reinsurance, and Other Operations. The actual
relative variability could prove to be different.
- --------------------------------------------------------------------------------
BUSINESS INSURANCE
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2001
----------------------------------
INCLUDING BEFORE
2003 2002 SEPTEMBER 11 SEPTEMBER 11
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 3,957 $ 3,412 $ 2,871 $ 2,886
Change in unearned premium reserve 261 286 241 241
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 3,696 $ 3,126 $ 2,630 $ 2,645
Benefits, claims and claim adjustment expenses 2,340 1,962 1,934 1,704
Amortization of deferred policy acquisition costs 913 779 681 681
Insurance operating costs and expenses 342 341 257 257
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ 101 $ 44 $ (242) $ 3
-----------------------------------------------------------------------------------------------------------------------------
Loss ratio 50.8 50.7 59.9 52.3
Loss adjustment expense ratio 12.5 12.0 13.7 12.1
Expense ratio 31.8 32.7 33.2 33.0
Policyholder dividend ratio 0.6 1.5 1.3 1.3
COMBINED RATIO 95.7 97.0 108.0 98.7
Catastrophe ratio 2.7 0.8 10.0 0.7
COMBINED RATIO BEFORE CATASTROPHES 93.0 96.2 98.0 98.0
====================================================================================================================================
2001
-------------------------------------
INCLUDING BEFORE SEPTEMBER
2003 2002 SEPTEMBER 11 11
- ------------------------------------------------------------------------------------------------------------------------------------
WRITTEN PREMIUMS BREAKDOWN [1]
- ------------------------------------------------------------------------------------------------------------------------------------
Small Commercial $ 1,862 $ 1,678 $ 1,447 $ 1,447
Middle Market 2,095 1,734 1,439 1,439
September 11 Terrorist Attack -- -- (15) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,957 $ 3,412 $ 2,871 $ 2,886
- ------------------------------------------------------------------------------------------------------------------------------------
EARNED PREMIUMS BREAKDOWN [1]
Small Commercial $ 1,782 $ 1,555 $ 1,335 $ 1,335
Middle Market 1,914 1,571 1,310 1,310
September 11 Terrorist Attack -- -- (15) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,696 $ 3,126 $ 2,630 $ 2,645
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
</FN>
- 42 -
Business Insurance provides standard commercial insurance coverage to small and
middle market commercial businesses primarily throughout the United States. This
segment offers workers' compensation, property, automobile, liability, umbrella
and marine coverages. The Business Insurance segment also provides commercial
risk management products and services.
2003 COMPARED TO 2002 -- Business Insurance achieved written premium growth of
$545, or 16%, for the year ended December 31, 2003. Growth was primarily due to
written pricing increases of 9%, and new business growth of 17%. Premium renewal
retention remained strong at 87%. The written premium increase in middle market
business of $361, or 21%, was driven primarily by continued strong written
pricing increases and new business growth. Small commercial business increased
$184, or 11%, reflecting strong written pricing increases.
Earned premiums increased $570, or 18%, due to strong 2002 and 2003 written
pricing increases impacting 2003 earned premium. Earned premiums increased $343,
or 22%, and $227, or 15%, for middle market and small commercial, respectively,
reflecting double-digit earned pricing increases.
Underwriting results improved $57, with a corresponding 1.3 point decrease in
the combined ratio, for the year ended December 31, 2003, despite a significant
increase in catastrophe losses due largely to Hurricane Isabel and severe
tornadoes in the Midwest. Before catastrophes, underwriting results improved
$133, or 196%, with a corresponding 3.2 point decrease in the combined ratio.
The improvement was driven by a decrease in the loss ratio before catastrophes
for both small commercial and middle market, primarily due to improved frequency
of loss and double-digit earned pricing increases. In addition, double-digit
earned pricing increases and prudent expense management favorably impacted the
expense ratio for the year ended December 31, 2003.
2002 COMPARED TO 2001 -- Business Insurance achieved written premium growth of
$541 (including $15 of reinsurance cessions related to September 11), or 19%,
due to strong growth in both middle market and small commercial.
The increase in middle market of $295, or 21%, was due primarily to double-digit
pricing increases as well as continued strong new business growth. Small
commercial increased $231, or 16%, reflecting double-digit written pricing
increases, particularly in the property line of business.
Business Insurance earned premiums increased $496 (including $15 of reinsurance
cessions related to September 11), or 19%, due to strong 2002 and 2001 written
pricing increases impacting 2002 earned premiums. Middle market increased $260,
or 20%, and small commercial increased $221, or 16%, reflecting double-digit
earned pricing increases.
Underwriting results improved $286 (including $245 of underwriting loss related
to September 11 in 2001), with a corresponding 11 point decrease (including a
9.3 point impact related to September 11) in the combined ratio. The improvement
in underwriting results and combined ratio before September 11, was primarily
due to double-digit earned pricing increases and minimal loss costs. Business
Insurance continued to benefit from favorable frequency loss costs. In addition,
the beneficial effects of strong pricing on the underwriting expense ratio have
been offset by an increase in taxes, licenses and fees rates, and increased
technology spending.
OUTLOOK
Management expects the Business Insurance segment to continue to deliver strong
results in 2004. Although price increases within many markets of the commercial
industry are expected to moderate, double-digit premium growth is expected to be
achieved, in part, due to continued strategic actions being implemented. These
include providing a complete product solution for agents and customers,
expanding non-traditional distribution alternatives, executing geographic market
share strategies and developing technology solutions that deliver superior
business tools to The Hartford's agents and alliances. These initiatives are
focused on growing the businesses, deepening market share and leveraging
resources, all while developing synergies and efficiencies to streamline the
cost of doing business. While loss costs are expected to increase, continued
pricing and underwriting actions are expected to have a positive impact on the
segment's overall profitability in 2004.
- 43 -
- --------------------------------------------------------------------------------
PERSONAL LINES
- --------------------------------------------------------------------------------
OPERATING SUMMARY
2001
- ---------------------------------------------------------------------------------------------------------------------------------
INCLUDING BEFORE
2003 2002 SEPTEMBER 11 SEPTEMBER 11
- ---------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 3,272 $ 3,050 $ 2,860 $ 2,860
Change in unearned premium reserve 91 66 113 113
- ---------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 3,181 $ 2,984 $ 2,747 $ 2,747
Benefits, claims and claim adjustment expenses 2,318 2,319 2,173 2,164
Amortization of deferred policy acquisition costs 386 415 385 385
Insurance operating costs and expenses 360 296 276 276
- ---------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ 117 $ (46) $ (87) $ (78)
----------------------------------------------------------------------------------------------------------------------------
Loss ratio 61.6 66.1 67.4 67.2
Loss adjustment expense ratio 11.3 11.6 11.7 11.6
Expense ratio 23.0 23.3 23.6 23.6
Combined ratio 95.9 101.0 102.7 102.4
Catastrophe ratio 4.1 2.5 2.7 2.4
Combined ratio before catastrophes 91.8 98.6 100.0 100.0
Other revenues [1] $ 123 $ 123 $ 150 $ 150
- ---------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Represents servicing revenue.
</FN>
WRITTEN PREMIUMS BREAKDOWN [1] 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Business Unit
AARP $ 2,066 $ 1,855 $ 1,638
Other Affinity 148 179 201
Agency 804 756 783
Omni 254 260 238
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,272 $ 3,050 $ 2,860
=================================================================================================================================
Product Line
Automobile $ 2,508 $ 2,352 $ 2,224
Homeowners 764 698 636
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,272 $ 3,050 $ 2,860
=================================================================================================================================
EARNED PREMIUMS BREAKDOWN [1] 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Business Unit
AARP $ 1,956 $ 1,747 $ 1,559
Other Affinity 163 192 182
Agency 807 794 765
Omni 255 251 241
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,181 $ 2,984 $ 2,747
=================================================================================================================================
Product Line
Automobile $ 2,458 $ 2,326 $ 2,131
Homeowners 723 658 616
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,181 $ 2,984 $ 2,747
=================================================================================================================================
Combined Ratios
Automobile 98.0 103.1 105.8
Homeowners 88.8 93.8 92.1
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL 95.9 101.0 102.7
=================================================================================================================================
<FN>
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
</FN>
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 ("Standard") and in the
non-standard automobile market through the Company's Omni Insurance Group, Inc.
("Omni") subsidiary. Personal Lines also operates a member contact center for
health insurance products offered through AARP's Health Care Options. The
Hartford's exclusive licensing arrangement with AARP, which was renewed during
the fourth quarter of 2001, continues through January 1, 2010 for automobile,
homeowners and home-based business. The Health Care Options agreement continues
through 2007.
- 44 -
2003 COMPARED TO 2002--Written premiums increased $222, or 7%, due to growth in
both the automobile and homeowners lines. The increase in automobile of $156, or
7%, was primarily due to written pricing increases of 10%. Automobile premium
renewal retention remained strong at 91% for the year ended December 31, 2003.
Homeowners growth of $66, or 9%, was largely driven by written pricing increases
of 14%. Premium renewal retention was 101%. The increases in both automobile and
homeowners written premiums were primarily due to growth in the AARP program.
AARP increased $211, or 11%, primarily as a result of strong written pricing
increases. Partially offsetting the increase was a $31, or 17%, decrease in
other affinity business due to a planned reduction in policy counts as a result
of the Company's strategic decision to de-emphasize other affinity business.
Earned premiums increased $197, or 7%, due primarily to growth in AARP. AARP
increased $209, or 12%, as a result of earned pricing increases.
Underwriting results increased $163, with a corresponding 5.1 point decrease in
the combined ratio. The improvement was primarily due to the successful
execution of the segment's state-specific strategies to manage pricing and loss
costs. Automobile results improved 5.1 combined ratio points and homeowners
results improved 5.0 combined ratio points, both due primarily to earned pricing
increases and favorable frequency loss costs. Personal Lines financial
performance was negatively affected by an increase in pre-tax catastrophe losses
over prior year of $58, or 1.6 points due largely to Hurricane Isabel,
California wildfires and severe tornadoes in the Midwest. Double-digit earned
pricing increases and prudent expense management resulted in a 0.3 point
decrease in the expense ratio.
2002 COMPARED TO 2001 -- Personal Lines written premiums increased $190, or 7%,
primarily driven by growth in AARP, partially offset by a reduction in Agency.
AARP increased $217, or 13%, primarily as a result of written pricing increases
and improved premium renewal retention. Agency decreased $27, or 3%, due
primarily to the conversion to six-month policies in certain states.
Earned premiums increased $237, or 9%, due primarily to growth in AARP and
Agency. AARP increased $188, or 12%, and Agency increased $29, or 4%, due
primarily to earned pricing increases. Underwriting results improved $41
(including $9 of underwriting loss related to September 11), with a
corresponding 1.7 point decrease (including a 0.3 point impact related to
September 11) in the combined ratio. While automobile results improved due to
favorable frequency loss costs, the line of business was negatively impacted by
the increasing severity of automobile claims as a result of medical inflation
and higher repair costs. The underwriting experience relating to homeowners has
remained favorable due to improved frequency of claims, despite an increase in
the severity of individual homeowners' claims. An improvement in the
underwriting expense ratio, primarily due to written pricing increases and
prudent expense management, resulted in a 0.3 point decrease in the expense
ratio over the prior year.
OUTLOOK
While the personal lines industry operating fundamentals are expected to be
strong in 2004, the market will continue to face significant challenges. Price
increases in automobile and homeowners are expected to temper. Regulatory
requirements applying to premium rates vary from state to state, and, in most
states, rates are subject to prior regulatory approval. State regulatory
constraints may prevent companies from obtaining the necessary rates to achieve
an underwriting profit. Industry rates may still remain inadequate in certain
states in 2004. Loss cost inflation is expected to rise in 2004, and it is
uncertain whether favorable frequency loss cost trends can continue. Automobile
repair costs and medical inflation are expected to continue to outpace general
inflation trends.
The Personal Lines segment is expected to deliver growth in written premiums and
underwriting results in 2004 due, in part, to a new auto class plan product and
technology platform in the agency channel which were introduced in a majority of
states in 2003. These new product and technology investments deliver a
competitive value proposition to independent agents. Improved financial results
in 2004 for the Personal Lines segment are also expected as a result of
continued state-driven pricing product and underwriting actions. Personal Lines'
product breadth, channel diversity and technology position this segment to
effectively manage the market risks that face the personal lines industry.
- 45 -
- --------------------------------------------------------------------------------
SPECIALTY COMMERCIAL
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2001
-----------------------------------
INCLUDING BEFORE
2003 2002 SEPTEMBER 11 SEPTEMBER 11
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 1,612 $ 1,362 $ 989 $ 996
Change in unearned premium reserve 54 140 (33) (33)
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 1,558 $ 1,222 $ 1,022 $ 1,029
Benefits, claims and claim adjustment expenses 1,182 849 925 766
Amortization of deferred policy acquisition costs 254 240 267 267
Insurance operating costs and expenses 151 156 92 91
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (29) $ (23) $ (262) $ (95)
-----------------------------------------------------------------------------------------------------------------------------
Loss ratio 62.5 57.6 73.1 59.5
Loss adjustment expense ratio 13.3 11.8 17.6 15.0
Expense ratio 22.9 29.3 33.1 32.8
Policyholder dividend ratio 0.7 0.7 0.4 0.4
Combined ratio 99.3 99.4 124.2 107.7
Catastrophe ratio 1.7 0.5 17.9 1.4
Combined ratio before catastrophes 97.6 98.9 106.3 106.3
Other Revenues [1] $ 306 $ 233 $ 213 $ 213
====================================================================================================================================
<FN>
[1] Represents servicing revenue.
</FN>
2001
-------------------------------------
INCLUDING BEFORE
2003 2002 SEPTEMBER 11 SEPTEMBER 11
- ------------------------------------------------------------------------------------------------------------------------------------
WRITTEN PREMIUMS BREAKDOWN [1]
- ------------------------------------------------------------------------------------------------------------------------------------
Property $ 440 $ 405 $ 284 $ 284
Casualty 670 556 434 434
Bond 162 157 138 138
Professional Liability 324 239 168 168
Other 16 5 (28) (28)
September 11 Terrorist Attack -- -- (7) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,162 $ 1,362 $ 989 $ 996
- ------------------------------------------------------------------------------------------------------------------------------------
EARNED PREMIUMS BREAKDOWN [1]
Property $ 429 $ 346 $ 281 $ 281
Casualty 615 498 438 438
Bond 152 148 127 127
Professional Liability 296 200 117 117
Other 66 30 66 66
September 11 Terrorist Attack -- -- (7) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,558 $ 1,222 $ 1,022 $ 1,029
====================================================================================================================================
<FN>
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
</FN>
Specialty Commercial offers a variety of customized insurance products and risk
management services. The segment provides standard commercial insurance products
including workers' compensation, automobile and liability coverages to
large-sized companies. Specialty Commercial also provides bond, professional
liability, specialty casualty and agricultural coverages, as well as core
property and excess and surplus lines coverages not normally written by standard
lines insurers. Alternative markets, within Specialty Commercial, provides
insurance products and services primarily to captive insurance companies, pools
and self-insurance groups. In addition, Specialty Commercial provides third
party administrator services for claims administration, integrated benefits,
loss control and performance measurement through Specialty Risk Services.
2003 COMPARED TO 2002--Written premiums increased $250, or 18%, for the year
ended December 31, 2003, primarily due to double-digit growth in casualty and
professional liability. Casualty and professional liability written premiums
grew $114, or 21%, and $85, or 36%, respectively, due to strong written pricing
increases. While property pricing began to turn negative in the latter half of
2003, written premiums in property increased $35, or 9%, for the year ended
December 31, 2003. Bond growth for the year was negatively impacted by ceded
reinstatement premium.
Earned premiums increased $336, or 27%, for the year ended December 31, 2003,
due primarily to earned premium growth in the property, casualty and
professional liability lines of business as a result of strong earned pricing
increases.
Underwriting results deteriorated $6 for the year ended December 31, 2003, due
primarily to higher catastrophe losses compared to unusually low catastrophe
losses in the prior period
- 46 -
and an increase in loss reserve development that was driven by prior accident
year loss reserve strengthening of $20 in the bond and $25 in the professional
liability lines of business. The bond reserve strengthening is isolated to a few
severe contract surety claims related to accident year 2002. The professional
liability reserve strengthening involved a provision for anticipated settlements
of reinsurance obligations for contracts outstanding at the time of the original
acquisition of Reliance Group Holdings' auto residual value portfolio in the
third quarter of 2000. In addition, an increase in doubtful accounts expense of
$10 contributed to the decrease in underwriting results. Excluding catastrophes,
property underwriting results continued to be favorable due to earned pricing
increases and improved significantly over prior year. Casualty continued to show
underwriting improvement over prior year due to a lower loss ratio. The
Specialty Commercial combined ratio improved 0.1 points for the year ended
December 31, 2003 as the reserve strengthening and higher catastrophes
referenced above mitigated the impact of strong earned pricing, higher ceding
commissions in the professional liability line of business and prudent expense
management.
2002 COMPARED TO 2001 -- Specialty Commercial written premiums increased $373
(including $7 of reinsurance cessions related to September 11), or 38%,
primarily driven by the property, casualty and professional liability lines of
business. Written premiums for property grew $121, or 43%, while specialty
casualty grew $122, or 28%, both primarily due to significant price increases
and new business growth reflecting an improving operating environment.
Professional liability written premiums grew $71, or 42%, also due to
significant price increases.
Earned premiums increased $200 (including $7 of reinsurance cessions related to
September 11), or 20%, primarily driven by robust earned premium growth in
property of $65, or 23%, casualty of $60, or 14%, and professional liability of
$83, or 71%, as a result of double-digit earned pricing increases.
Underwriting results improved $239 (including $167 of underwriting loss related
to September 11), with a corresponding 24.8 point decrease (including a 16.5
point impact related to September 11) in the combined ratio. The improvement in
underwriting results and combined ratio before September 11 was primarily due to
favorable property, casualty and professional liability results, as a result of
the favorable pricing environment. Increased losses incurred in property due to
the Midwest drought; casualty due to deductible workers' compensation losses on
a few large accounts; and bond partially mitigated the improvement. In addition,
the underwriting expense ratio improved primarily due to pricing increases and
prudent expense management. Lower catastrophes, primarily as a result of the
Seattle earthquake in the first quarter of 2001, also contributed to the
improvement in underwriting results.
OUTLOOK
Specialty Commercial is made up of a diverse group of businesses that are unique
to commercial lines. Each line of business operates independently with its own
set of business objectives and focuses on the operational dynamics of its
specific industry. These businesses, while somewhat interrelated, each have a
unique business model and operating cycle. Although written price increases
within some markets of the commercial industry are expected to moderate or
possibly be negative in 2004, casualty and professional liability pricing is
expected to be firm. Strong written pricing in 2003 will contribute to earned
premium growth expected in 2004. Management believes that continued strategic
actions being taken, which include focusing on maximizing growth in the
segment's most profitable lines; providing innovative new products; expanding
non-traditional distribution alternatives; and further leveraging underwriting
discipline and capabilities will continue to enable the segment to deliver
underwriting improvement and premium growth.
- 47 -
- --------------------------------------------------------------------------------
REINSURANCE
- --------------------------------------------------------------------------------
OPERATING SUMMARY 2001
---------------------------------
INCLUDING BEFORE
2003 2002 SEPTEMBER 11 SEPTEMBER 11
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 210 $ 703 $ 849 $ 918
Change in unearned premium reserve (142) (10) (2) (2)
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 352 $ 713 $ 851 $ 920
Benefits, claims and claim adjustment expenses 381 569 972 815
Amortization of deferred policy acquisition costs 88 179 239 239
Insurance operating costs and expenses 8 24 15 15
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (125) $ (59) $ (375) $ (149)
-------------------------------------------------------------------------------------------------------------------------------
Loss ratio 98.2 74.9 108.9 83.7
Loss adjustment expense ratio 10.2 4.9 5.3 4.9
Expense ratio 26.9 28.0 29.8 27.6
Combined ratio 135.3 107.9 144.0 116.2
Catastrophe ratio 1.4 0.7 29.5 2.7
Combined ratio before catastrophes 133.8 107.2 114.6 113.5
====================================================================================================================================
WRITTEN PREMIUMS BREAKDOWN [1] 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Traditional reinsurance $ 154 $ 618 $ 736
Alternative risk transfer ("ART") 56 85 182
September 11 Terrorist Attack -- -- (69)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 210 $ 703 $ 849
====================================================================================================================================
EARNED PREMIUMS BREAKDOWN [1]
Traditional reinsurance $ 299 $ 621 $ 734
Alternative risk transfer ("ART") 53 92 186
September 11 Terrorist Attack -- -- (69)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 352 $ 713 $ 851
====================================================================================================================================
<FN>
[1] The difference between written premiums and earned premiums is attributable to the change in unearned premium reserve.
</FN>
During the second quarter of 2003, the Company decided to withdraw from the
assumed reinsurance business due mainly to the Company's lack of scale necessary
to compete effectively in the assumed reinsurance market. On May 16, 2003, the
Company entered into a quota share and purchase agreement with Endurance
Reinsurance Corporation of America ("Endurance"), whereby the Reinsurance
segment retroceded the majority of its inforce book of business as of April 1,
2003 and sold renewal rights to Endurance. Under the quota share agreement,
Endurance reinsured most of the segment's assumed reinsurance contracts that
were written on or after January 1, 2002 and that had unearned premium as of
April 1, 2003. In consideration for Endurance reinsuring the unearned premium as
of April 1, 2003, the Company paid Endurance an amount equal to unearned premium
less the related unamortized commissions/deferred acquisition costs net of an
override commission which was established by the contract. In addition,
Endurance will pay a profit sharing commission based on the loss performance of
property treaty, property catastrophe and aviation pool unearned premium. Under
the purchase agreement, Endurance will pay additional amounts, subject to a
guaranteed minimum of $15, based on the level of renewal premium on the
reinsured contracts over the two year period following the agreement. The
guaranteed minimum is reflected in net income for the year ended December 31,
2003. The Company remains subject to reserve development relating to all
retained business.
Prior to the Endurance transaction, the Reinsurance segment assumed reinsurance
in North America and primarily wrote treaty reinsurance through professional
reinsurance brokers covering various property, casualty, property catastrophe,
marine and alternative risk transfer ("ART") products. ART included
non-traditional reinsurance products such as multi-year property catastrophe
treaties, aggregate of excess of loss agreements and quota share treaties with
single event caps. International property catastrophe, marine and ART were also
written outside of North America through a London contact office.
2003 COMPARED TO 2002 -- Reinsurance written premiums decreased $493, or 70%,
and earned premiums decreased $361, or 51%, primarily due to the Company's
decision to withdraw from the assumed reinsurance business as discussed above.
The decrease in written premiums also reflects the $145 cession of the unearned
premium to Endurance related to certain contracts written by the Company prior
to April 1, 2003.
Underwriting losses increased $66, with a corresponding 27.4 point increase in
the combined ratio, primarily as a result of underwriting losses on the business
not ceded to Endurance and adverse loss development on prior underwriting years,
primarily1997 through 2000, particularly in the casualty lines of traditional
reinsurance.
- 48 -
2002 COMPARED TO 2001 -- Reinsurance written premiums decreased $146 (including
$69 of reinsurance cessions related to September 11), or 17%, and earned
premiums decreased $138 (including $69 related to September 11), or 16%, due to
the exclusion of the exited international business, which in January 2002, was
transferred to Other Operations, and a reduction in the ART line of business.
Written and earned premiums from the international business in 2001 were $131
and $136, respectively. ART written and earned premiums decreased $97, or 53%,
and $94, or 51%, respectively, 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, international and the
impact of September 11, written premiums increased $13, or 2%, and earned
premiums increased $23, or 4%, due primarily to significant pricing increases as
a result of continued market firming, substantially offset by premium reductions
due to underwriting requirements to maintain profitability targets.
Underwriting results improved $316 (including $226 of underwriting loss related
to September 11), with a corresponding 36.1 point decrease (including a 27.8
point impact related to September 11) in the combined ratio. The improvement in
underwriting results and combined ratio before September 11 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, an intense focus on returns and lower catastrophes.
Underwriting results and the combined ratio were negatively impacted by adverse
loss development on prior underwriting years.
OUTLOOK
The Company exited the assumed reinsurance business during 2003. In connection
therewith, the Company will continue to manage the runoff of premium and the
settlement of claims. The Company remains subject to reserve development
relating to all retained business.
- --------------------------------------------------------------------------------
OTHER OPERATIONS (INCLUDING ASBESTOS AND ENVIRONMENTAL CLAIMS)
- --------------------------------------------------------------------------------
OPERATING SUMMARY
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 14 $ 57 $ 17
Change in unearned premium reserve (4) (12) --
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums 18 69 17
Benefits, claims and claim adjustment expenses 2,705 171 142
Amortization of deferred policy acquisition costs 1 -- --
Insurance operating costs and expenses 28 62 7
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (2,716) $ (164) $ (132)
====================================================================================================================================
The Other Operations segment includes operations that are under a single
management structure, Heritage Holdings, which 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 include First
State Insurance Company and two affiliated subsidiaries, located in Boston,
Massachusetts; Heritage Reinsurance Company, Ltd ("Heritage Re"), headquartered
in Bermuda; and Excess Insurance Company, Ltd, located in the United Kingdom.
Each of these companies is primarily focused on managing claims, resolving
disputes and collecting reinsurance proceeds. 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 businesses of the Reinsurance segment, exited in the fourth
quarter of 2001.
2003 COMPARED TO 2002 -- The decline in written and earned premiums was due to
the runoff of the international assumed reinsurance business that was
transferred to the Other Operations segment in January 2002. The underwriting
loss was due primarily to the first quarter net asbestos reserve strengthening
of $2.6 billion as discussed in the section that follows.
2002 COMPARED TO 2001 --The increase in written and earned premiums reflects the
January 2002 transfer of the exited international business of the Reinsurance
segment to Other Operations in January 2002.
The paragraphs that follow are background information and a discussion of
asbestos and environmental claims, the deteriorating trends with respect to
asbestos, and a summary of the Company's detailed study of asbestos reserves.
Asbestos and Environmental Claims
The Hartford continues to receive asbestos and environmental claims, both of
which affect Other Operations. These claims are made pursuant to several
different categories of insurance coverage. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhaust their underlying liability insurance coverage. Third, The Hartford acted
as a reinsurer assuming a
- 49 -
portion of risks previously assumed by other insurers writing primary, excess
and reinsurance coverages. Fourth, The Hartford participated as a London Market
company that wrote both direct insurance and assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related expenses. Traditional
actuarial reserving techniques cannot reasonably estimate the ultimate cost of
these claims, particularly during periods when theories of law are in flux. As a
result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation, and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular 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, plaintiffs'
increased focus on new and previously peripheral defendants, and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and
increase loss payments by insurers. In addition, some policyholders have begun
to assert new classes of claims for so-called "non-products" coverages to which
an aggregate limit of liability may not apply. Recently, many insurers,
including The Hartford, also have been sued directly by asbestos claimants
asserting that insurers had a duty to protect the public from the dangers of
asbestos. Management believes these issues are not likely to be resolved in the
near future.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims that cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layers of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims.
It is unknown whether a potential Federal bill concerning asbestos litigation
approved by the Senate Judiciary Committee, or some other potential Federal
asbestos-related legislation, will be enacted and, if so, what its effect will
be on The Hartford's aggregate asbestos liabilities. Additionally, the reporting
pattern for excess insurance and reinsurance claims is much longer than direct
claims. In many instances, it takes months or years to determine that the
policyholder's own obligations have been met and how the reinsurance in question
may apply to such claims. The delay in reporting excess and reinsurance claims
adds to the uncertainty of estimating the related reserves.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court decisions that have interpreted the
insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
regularly evaluates new information in assessing its potential asbestos and
environmental exposures.
Reserve Activity
Reserves and reserve activity in the Other Operations segment are categorized
and reported as asbestos, environmental or "all other" activity. The discussion
below relates to reserves and reserve activity, net of applicable reinsurance.
There are a wide variety of claims that drive the reserves associated with
asbestos, environmental and the "all other" category the Company has included in
Other Operations. Asbestos claims relate primarily to bodily injuries asserted
by those who came in contact with asbestos or products containing asbestos.
Environmental claims relate primarily to pollution and related clean-up costs.
The "all other" category of reserves covers a wide range of exposures, including
potential liability for breast implants, blood products, construction defects,
lead paint and other long-tail liabilities.
The Other Operations historic book of business contains policies written from
the 1940's to 1992, with the majority of the business spanning the interval 1960
to 1990. The Hartford's experience has been that this book of business has over
time produced significantly higher claims and losses than were contemplated at
inception. The areas of active claim activity have also shifted based on changes
in plaintiff focus and the overall litigation environment. A significant portion
of the claim reserves of the Other Operations segment relates to exposure to the
insurance businesses of other insurers or reinsurers ("whole account" exposure).
Many of these whole account exposures arise from reinsurance agreements
previously written by The Hartford. The Hartford's net exposure in these
- 50 -
arrangements has increased for a variety of reasons, including The Hartford's
commutation of previous retrocessions of such business. Due to the reporting
practices of cedants to their reinsurers, determination of the nature of the
individual risks involved in these whole account exposures (such as asbestos,
environmental, or other exposures) requires various assumptions and estimates,
which are subject to uncertainty, as previously discussed.
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 trends for environmental liabilities. In the same period, consistent
with the reports of other insurers, The Hartford experienced 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, some policyholders had begun to
assert that their asbestos-related claims fell within so-called "non-products"
coverage contained within their policies rather than products hazard coverage
and that the claimed non-products coverage was not subject to any aggregate
limit. 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.
During 2002, as part of the Company's ongoing monitoring of reserves, the
Company reclassified $600 of reserves from the all other reserve category, of
which $540 was reclassified to asbestos and $60 was reclassified to
environmental claim reserves. The increase in reserves categorized as
environmental of $60 (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
determined the resulting changes in category. A portion of the 2002
reclassification relates to re-estimates of the appropriate allocation among the
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 (among 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.
In the first quarter of 2003, several events occurred that in the Company's view
confirmed the existence of a substantial long-term deterioration in the asbestos
litigation environment. For example, in February 2003, Combustion Engineering,
long a major asbestos defendant, filed a pre-packaged bankruptcy plan under
which it proposed to emerge from bankruptcy within five weeks, before opponents
of the plan could have a meaningful opportunity to object, and included many
novel features in its plan that its insurers found objectionable. In December
2002, Halliburton had announced its intention to file a similar plan through one
or more subsidiaries and in January 2003, Honeywell announced that it had
reached an agreement with the plaintiffs' bar that would enable it to file a
pre-negotiated plan through its former NARCO subsidiary, then already in
bankruptcy. In January 2003, Congoleum, a floor tile manufacturer, which
previously had defended claims successfully in the tort system, announced its
intention to file a pre-packaged plan of reorganization to be funded almost
entirely with insurance proceeds. Moreover, prominent members of the plaintiffs'
and policyholders' bars announced publicly their intention to file many more
such plans. These events represented a worsening of conditions the Company
observed in 2002.
As a result of these worsening conditions, the Company conducted a
comprehensive, ground-up study of its asbestos exposures in the first quarter of
2003 in an effort to project, beginning at the individual account level, the
effect of these trends on the Company's estimated total exposure to asbestos
liability. Based on the Company's evaluation of the deteriorating conditions
described above, the Company strengthened its gross and net asbestos reserves by
$3.9 billion and $2.6 billion, respectively. The reserve strengthening related
primarily to policies effective in 1985 or prior years. The Company had
incorporated an absolute asbestos exclusion in most of its general liability
policies written after 1985. The Company believes that its current asbestos
reserves are reasonable and appropriate. However, analyses of future
developments could cause The Hartford to change its estimates of its asbestos
and environmental reserves, and the effect of these changes could be material to
the Company's consolidated operating results, financial condition and liquidity.
Consistent with the Company's long-standing reserving practices, The Hartford
will continue to review and monitor these reserves regularly and, where future
developments indicate, make appropriate adjustments to the reserves. The loss
reserving assumptions, drawn from both industry data and the Company's
experience, have been applied over time to all of this business and have
resulted in reserve strengthening or reserve releases at various times over the
past decade.
The following table presents reserve activity, inclusive of estimates for both
reported and incurred but not reported claims, net of reinsurance, for Other
Operations, categorized by asbestos, environmental and all other claims, for the
years ended December 31, 2003, 2002 and 2001. Also included are the remaining
asbestos and environmental exposures of North American Property & Casualty.
- 51 -
OTHER OPERATIONS CLAIMS AND CLAIM ADJUSTMENT EXPENSES
2003 Asbestos Environmental All Other[1] Total
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net $ 1,118 $ 591 $ 1,250 $ 2,959
Claims and claim adjustment expenses incurred 2,612 2 102 2,716
Claims and claim adjustment expenses paid (161) (185) (119) (465)
Other [2] 225 -- -- 225
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 3,794 $ 408 $ 1,233 $ 5,435
====================================================================================================================================
2002
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net $ 616 $ 654 $ 1,591 $ 2,861
Claims and claim adjustment expenses incurred 88 (11) 89 166
Claims and claim adjustment expenses paid (126) (112) (130) (368)
Transfer of international lines of Reinsurance [1] -- -- 300 300
Other [5] 540 60 (600) --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 1,118 $ 591 $ 1,250 $ 2,959
====================================================================================================================================
2001
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net [6] $ 572 $ 911 $ 1,753 $ 3,236
Claims and claim adjustment expenses incurred 28 15 116 159
Claims and claim adjustment expenses paid (84) (172) (176) (432)
Other [5] 100 (100) (102) (102)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 616 $ 654 $ 1,591 $ 2,861
====================================================================================================================================
<FN>
[1] Includes unallocated loss adjustment expense reserves.
[2] Represents the transfer of reserves pursuant to the MacArthur settlement.
[3] Ending liabilities include asbestos and environmental reserves reported in
North American Property & Casualty of $13 and $10, respectively, as of
December 31, 2003, of $14 and $10 respectively, as of December 31, 2002,
and of $6 and $32, respectively, as of December 31, 2001.
[4] Gross of reinsurance, reserves for asbestos and environmental were $5,884
and $542, respectively, as of December 31, 2003, $1,994 and $682,
respectively, as of December 31, 2002 and $1,633 and $919, respectively,
as of December 31, 2001.
[5] The nature of these reallocations is described in the preceding
discussions.
[6] Represents the January 1, 2002 transfer of reserves from the exited
international reinsurance business from the Reinsurance segment to Other
Operations.
</FN>
At December 31, 2003, asbestos reserves were $3.8 billion, an increase of $2.7
billion compared to $1.1 billion as of December 31, 2002. Net incurred losses
and loss adjustment expenses were $2.6 billion for the year ended December 31,
2003. The increase in reserves as well as the increase in paid losses reflect
asbestos claim and litigation trends.
On December 19, 2003, Hartford Accident and Indemnity Company ("Hartford A&I")
entered into a settlement agreement with MacArthur Company and its subsidiary,
Western MacArthur Company. (For further discussion of the MacArthur settlement
see Part I, Item 3. Legal Proceedings.) Under the settlement agreement, Hartford
A&I will pay $1.15 billion into an escrow account in the first quarter of 2004,
and the funds will be disbursed to a trust to be established for the benefit of
present and future asbestos claimants pursuant to the bankruptcy plan once all
conditions precedent to the settlement have occurred. Management expects that
all conditions to the settlement will be satisfied, but it is not certain
whether or when those conditions will be satisfied.
In comparing environmental claims and claim adjustment expenses paid from year
to year, 2003 payments reflect the final settlement of a number of disputed
claims that had been in the process resolution for an extended period of time.
As a result of the timing of these settlements, the Company believes the level
of payments in 2003 is not representative of annual payments. Trends in asbestos
paids and incurreds are addressed in the paragraphs preceding the table. All
other paid losses continue to decline year to year.
The Company classifies its asbestos reserves into three categories: direct
insurance, assumed reinsurance and London Market. Direct insurance includes
primary and excess coverage. Assumed Reinsurance includes both "treaty"
reinsurance (covering broad categories of claims or blocks of business) and
"facultative" reinsurance (covering specific risks or individual policies of
primary or excess insurance companies). London Market business includes the
business written by one or more of The Hartford's subsidiaries in the United
Kingdom, which are no longer active in the insurance or reinsurance business.
Such business includes both direct insurance and assumed reinsurance.
Exposures on direct policies are the easiest to identify because specific
policies can be associated with specific accounts and reserves established,
where appropriate, for claims presented. Over the last three years, including
the current reporting period, the Company experienced a reduction in newly
reported environmental claims on Direct business, and actual claim payments have
been made at levels within the Company's previously established provisions for
loss. However, with respect to asbestos claims, the Company experienced a
variety of negative trends, including increasing numbers of policyholders making
claims, an apparent increase in the number of claimants under such policies, and
an accelerated rate of policyholder bankruptcies. Due to the combination of
these events, the Company estimates that the total value of potential claims
will reach higher into the excess layers of the Company's policies and into
later years of coverage than had been expected.
In reporting the results of the asbestos study, the Company has divided its
direct asbestos exposures into the following categories:
- 52 -
Major Asbestos Defendants (the "Top 70" accounts in Tillinghast's published
Tiers 1 and 2 and Wellington accounts collectively divided into: structured
settlements, Wellington, and Other Major Asbestos Defendants), Accounts with
Future Expected Exposures greater than $2.5, Accounts with Future Expected
Exposures less than $2.5 and Unallocated.
Structured settlements are those accounts where the Company has reached an
agreement with the insured as to the amount and timing of the claim payments to
be made to the insured.
The Wellington category includes insureds that entered into the "Wellington
Agreement" dated June 19, 1985. The Wellington Agreement provided terms and
conditions for how the signatory asbestos producers would access their coverage
from the signatory insurers.
The Other Major Asbestos Defendants subcategory represents insureds included in
Tiers 1 and 2, as defined by Tillinghast. The Tier 1 and 2 classifications are
meant to capture the insureds for which there is expected to be significant
exposure to asbestos claims.
The unallocated category includes an estimate of the reserves necessary for
asbestos claims related to direct insureds who have not previously tendered
asbestos claims to the company and potential non-products exposures.
Assumed Reinsurance exposures are inherently less predictable than direct
insurance exposures because the Company may not receive notice of a reinsurance
claim until the underlying direct insurance claim is mature. This causes a delay
in the receipt of information at the reinsurer level reflecting changes in the
asbestos tort litigation and direct insurance coverage environments.
The asbestos and environmental liability components of the London Market book of
business consist of both direct policies of insurance and contracts of assumed
reinsurance. As a participant in the London Market (comprised of both Lloyd's of
London and London Company Markets), the Company wrote business on a subscription
basis, with the Company's involvement being limited to a relatively small
percentage of a total contract placement. Claims are reported, via a broker, to
the "lead" underwriter and, once agreed to, are presented to the following
markets for concurrence. This reporting and claim agreement process makes
estimating liabilities for this business the most uncertain of the three
categories of claims (Direct, Assumed - Domestic and London Market).
The following table displays gross asbestos reserves and other statistics by
policyholder category as of December 31, 2003.
SUMMARY OF GROSS ASBESTOS RESERVES
As of December 31, 2003
--------------------------------------------------------------
% of 3 Year Gross
Number of All Time Total Asbestos All Time 3 Year Total Survival Ratio
Accounts [4] Paid Reserves Reserves Ultimate Paid Losses [1] [2] [5]
- ------------------------------------------------------------------------------------------------------------------------------------
(in years)
Major asbestos defendants
Structured settlements (includes 2
Wellington accounts) 5 $ 224 $ 279 5% $ 503 $ 93 9.0
Wellington (direct only) 31 628 300 5% 928 168 5.4
Other major asbestos defendants 29 179 420 7% 599 66 19.1
No known policies (includes 3
Wellington accounts) 5 -- -- -- -- -- --
Accounts with future exposure > $2.5 127 415 1,354 23% 1,769 202 20.1
Accounts with future exposure < $2.5 826 308 111 2% 419 28 11.9
MacArthur Settlement -- -- 1,150 20% 1,150
Unallocated -- 16 936 15% 952 16
- ------------------------------------------------------------------------------------------------------------------------------------
Total direct [3] 1,770 4,550 77% 6,320 611 22.3
Assumed reinsurance 560 854 15% 1,414 180 14.2
London market 373 480 8% 853 106 13.6
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL GROSS ASBESTOS RESERVES $ 2,703 $ 5,884 100% $ 8,587 $ 897 19.7
====================================================================================================================================
<FN>
[1] Survival ratio is a commonly used industry ratio for comparing reserve
levels between companies. While the method is commonly used, it is not a
predictive technique. Survival ratios may vary over time due to numerous
factors such as large payments due to the final resolution of certain
asbestos liabilities, or reserve re-estimates. The survival ratio presented
in the above table is computed by dividing the recorded reserves by the
average of the past three years of payments. The ratio is the calculated
number of years the recorded reserves would survive if future annual
payments were equal to the historical three-year average.
[2] The one year gross paid amount for total asbestos claims is $319 resulting
in a one year gross survival ratio of 18.4 years.
[3] Three year total paid losses include payments of $38 on closed claims (not
presented by category).
[4] Number of accounts by category established as of December 2002.
[5] If the ratio was calculated without considering the $1.15 billon of
reserves that are allocated for the MacArthur payments, which will be paid
in 2004, the one year survival ratio would be 14.8 years and the three
year survival ratio would be 15.7 years.
</FN>
In reporting gross environmental results, the Company has divided the gross
exposure into Direct (accounts with future exposure greater than $2.5, accounts
with future exposure less than $2.5, and Other direct), Assumed Reinsurance and
London Market. The unallocated category includes historical paid loss and
expense on closed accounts, an estimate of the necessary reserves for
environmental claims related to direct insureds who have not previously tendered
environmental claims to the company and reserves for pools and associations.
- 53 -
The following table displays gross environmental reserves and other statistics
by category as of December 31, 2003.
SUMMARY OF GROSS ENVIRONMENTAL RESERVES
As of December 31, 2003
------------------------------------------
% of 3 Year Gross
Number of Total Environmental Survival
Accounts[4] Reserves Reserves Ratio [1] [3]
--------------------------------------------------------
Accounts with future exposure > $2.5 24 $ 107 20% 3.5
Accounts with future exposure < $2.5 593 98 18% 2.2
Other direct [2] -- 56 10% 1.1
- ------------------------------------------------------------------------------------------------------------------------------------
Total direct 617 261 48% 2.1
Assumed reinsurance 192 36% 5.9
London market 89 16% 3.5
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL GROSS ENVIRONMENTAL RESERVES $ 542 100% 2.9
====================================================================================================================================
<FN>
[1] Survival ratio is a commonly used industry ratio for comparing reserve
levels between companies. While the method is commonly used, it is not a
predictive technique. Survival ratios may vary over time due to numerous
factors such as large payments due to the final resolution of certain
environmental liabilities, or reserve re-estimates. The survival ratio
presented in the above table is computed by dividing the recorded reserves
by the average of the past three years of payments. The ratio is the
calculated number of years the recorded reserves would last if future
annual payments were equal to the historical three-year average.
[2] Includes pools and associations, closed accounts and unallocated IBNR.
[3] The one year gross paid amount for total environmental claims is $141
resulting in a one year gross survival ratio of 3.8 years.
[4] Number of accounts by category established as of June 2003.
</FN>
The following table sets forth, for the three years ended December 31, 2003,
paid and incurred loss activity by the three categories of claims for asbestos
and environmental. The table shows that in this timeframe asbestos payments and
incurred losses have been increasing, while environmental activity generally has
been improving. During the fourth quarter of 2003, The Hartford conducted a
comprehensive review of reported environmental claims which reaffirmed that its
carried reserves reflect its current best estimate of future exposure. Such
estimate is, however, subject to the uncertainties noted earlier.
PAID AND INCURRED LOSS AND LOSS ADJUSTMENT EXPENSE ("LAE") DEVELOPMENT - ASBESTOS AND ENVIRONMENTAL
ASBESTOS ENVIRONMENTAL
-------------------------------------------- ----------------------------------
PAID INCURRED PAID INCURRED
2003 LOSS & LAE LOSS & LAE LOSS & LAE LOSS & LAE
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS
Direct $ 226 $ 3,113 $ 109 $ 12
Assumed - Domestic 53 585 15 (3)
London Market 40 286 17 (8)
- ------------------------------------------------------------------------------------------------------------------------------------
Total 319 3,984 141 1
Ceded [1] (158) (1,372) 44 1
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 161 $ 2,612 $ 185 $ 2
====================================================================================================================================
2002
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS
Direct $ 212 $ 559 $ 124 $ (9)
Assumed - Domestic 66 89 15 (39)
London Market 35 26 24 (26)
- ------------------------------------------------------------------------------------------------------------------------------------
Total 313 674 163 (74)
Ceded (187) (46) (51) 123
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 126 $ 628 $ 112 $ 49
====================================================================================================================================
2001
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS
Direct $ 173 $ 329 $ 148 $ (247)
Assumed - Domestic 61 63 68 (65)
London Market 31 -- 36 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total 265 392 252 (312)
Ceded (181) (264) (80) 227
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 84 $ 128 $ 172 $ (85)
====================================================================================================================================
<FN>
[1] 2003 environmental paid losses reflect ceded commutation settlement of
previously disputed balances.
</FN>
OUTLOOK
The Other Operations segment will continue to manage the discontinued operations
of The Hartford as well as claims (and associated reserves) related to asbestos
and environmental exposure. The Hartford will continue to review various
components of all of its reserves on a periodic basis.
- 54 -
- --------------------------------------------------------------------------------
INVESTMENTS
- --------------------------------------------------------------------------------
GENERAL
The Hartford's investment portfolios are primarily divided between Life and
Property & Casualty. The investment portfolios are managed based on the
underlying characteristics and nature of each operation's respective liabilities
and within established risk parameters. (For a further discussion of The
Hartford's approach to managing risks, see the Investment Credit Risk and
Capital Markets Risk Management sections.)
The investment portfolios of Life and Property & Casualty are managed by
Hartford Investment Management Company ("Hartford Investment Management"), a
wholly-owned subsidiary of The Hartford. Hartford Investment Management is
responsible for monitoring and managing the asset/liability profile,
establishing investment objectives and guidelines and determining, within
specified risk tolerances and investment guidelines, the appropriate asset
allocation, duration, convexity and other characteristics of the portfolios.
Security selection and monitoring are performed by asset class specialists
working within dedicated portfolio management teams.
Return on general account invested assets is an important element of The
Hartford's financial results. Significant fluctuations in the fixed income or
equity markets could weaken the Company's financial condition or its results of
operations. Additionally, changes in market interest rates may impact the period
of time over which certain investments, such as mortgage-backed securities, are
repaid and whether certain investments are called by the issuers. Such changes
may, in turn, impact the yield on these investments and also may result in
reinvestment of funds received from calls and prepayments at rates below the
average portfolio yield. Net investment income and net realized capital gains
and losses accounted for approximately 19%, 16% and 17% of the Company's
consolidated revenues for the years ended December 31, 2003, 2002 and 2001,
respectively.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, general account fixed maturity investments, which comprised
approximately 93% and 90% of the fair value of its invested assets as of
December 31, 2003 and 2002, respectively. Other events beyond the Company's
control could also adversely impact the fair value of these investments.
Specifically, a downgrade of an issuer's credit rating or default of payment by
an issuer could reduce the Company's investment return.
The Company invests in private placement securities, mortgage loans and limited
partnership arrangements in order to further diversify its investment portfolio.
These investment types comprised approximately 17% and 15% of the fair value of
its invested assets as of December 31, 2003 and 2002, respectively. These
security types are typically less liquid than direct investments in publicly
traded fixed income or equity investments. However, generally these securities
have higher yields to compensate for the liquidity risk.
A decrease in the fair value of any investment that is deemed
other-than-temporary would result in the Company's recognition of a net realized
capital loss in its financial results prior to the actual sale of the
investment. (For a further discussion, see the Company's discussion of the
evaluation of other-than-temporary impairments in Critical Accounting Estimates
under "Investments".)
LIFE
The primary investment objective of Life's general account is to maximize
after-tax returns consistent with acceptable risk parameters, including the
management of the interest rate sensitivity of invested assets and the
generation of sufficient liquidity relative to that of policyholder and
corporate obligations, as discussed in the Capital Markets Risk Management
section under "Market Risk - Life".
The following table identifies the invested assets by type held in the general
account as of December 31, 2003 and 2002.
COMPOSITION OF INVESTED ASSETS
----------------------------------------------------------------------------------------------------------------------------------
2003 2002
AMOUNT PERCENT AMOUNT PERCENT
-------------- ----------- --------------- -------------
Fixed maturities, at fair value $ 37,462 91.0% $ 29,377 86.7%
Equity securities, at fair value 357 0.9% 458 1.3%
Policy loans, at outstanding balance 2,512 6.1% 2,934 8.7%
Mortgage loans, at cost 466 1.1% 334 1.0%
Limited partnerships, at fair value 177 0.4% 519 1.5%
Other investments 180 0.5% 269 0.8%
----------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 41,154 100.0% $ 33,891 100.0%
==================================================================================================================================
During 2003, fixed maturity investments increased 28%, primarily the result of
investment and universal life contract sales, operating cash flows, redeployment
of invested assets from limited partnerships and the acquisition of CNA's group
life and accident, long-term and short-term disability and certain specialty
businesses. In March 2003, the Company decided to liquidate its hedge fund
limited partnership investments and reinvest the proceeds in fixed maturity
investments. Hedge fund liquidations totaled $397 during the year. As of
December 31, 2003 the hedge fund investment have been liquidated.
- 55 -
INVESTMENT RESULTS
The following table summarizes Life's investment results.
(before-tax) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income - excluding policy loan income [1] $ 1,831 $ 1,595 $ 1,475
Policy loan income 210 254 307
-------------------------------------------------------
Net investment income - total [1] $ 2,041 $ 1,849 $ 1,782
Yield on average invested assets [2] 6.0% 6.1% 7.0%
- ------------------------------------------------------------------------------------------------------------------------------------
Gross gains on sale $ 267 $ 175 $ 106
Gross losses on sale (95) (112) (120)
Impairments (162) (380) (105)
Periodic net coupon settlements on non-qualifying derivatives [1] 26 9 (3)
GMWB derivatives, net [3] 6 -- --
Other, net [4] (2) -- (14)
-------------------------------------------------------
Net realized capital gains (losses), before-tax [1] $ 40 $ (308) $ (136)
====================================================================================================================================
<FN>
[1] Prior periods reflect the reclassification of periodic net coupon
settlements on non-qualifying derivatives from net investment income to net
realized capital gains (losses).
[2] Represents net investment income (excluding net realized capital gains
(losses)) divided by average invested assets at cost or amortized cost, as
applicable. Average invested assets are calculated by dividing the sum of
the beginning and ending period amounts by two, excluding the collateral
obtained from the securities lending program and the fixed maturities
associated with the acquisition of CNA's group life and accident, long-term
and short-term disability and certain specialty businesses.
[3] Net gains on GMWB derivatives were due principally to a $4 gain associated
with international funds for which hedge positions were initiated in the
first quarter of 2004 and $2 due to modeling refinements to improve
valuation estimates. Ineffectiveness on S&P 500 and NASDAQ economic hedge
positions for the year was not significant.
[4] Primarily consists of changes in fair value and hedge ineffectiveness on
derivative instruments as well as the amortization of deferred acquisition
costs.
</FN>
2003 COMPARED TO 2002 -- Net investment income, excluding policy loan income,
increased $236, or 15%, compared to the prior year. The increase was primarily
due to income earned on a higher invested asset base partially offset by lower
investment yields. Policy loan income decreased primarily due to the decline in
leveraged COLI policies, as a result of surrender activity and lower sales.
Yield on average invested assets decreased as a result of lower rates on new
investment purchases and decreased policy loan income.
Net realized capital gains (losses) for 2003 improved by $348 compared to the
prior year, primarily as a result of net gains on sales of fixed maturities and
a decrease in other-than-temporary impairments on fixed maturities. (For a
further discussion of other-than-temporary impairments, see the
Other-Than-Temporary Impairments commentary in this section of the MD&A.)
2002 COMPARED TO 2001 -- Net investment income, excluding policy loan income,
increased $120, or 8%. The increase was primarily due to income earned on a
higher invested asset base partially offset by $36 lower income on limited
partnerships and the impact of lower interest rates on new investment purchases.
Policy loan income decreased primarily due to the decline in leveraged COLI
policies, as a result of surrender activity and lower sales. Yield on average
invested assets decreased as a result of lower rates on new investment
purchases, decreased policy loan income and decreased income on limited
partnerships.
Net realized capital losses for 2002 increased $172, or 126%, compared to the
prior year as a result of higher other-than-temporary impairments. (For a
further discussion of other-than-temporary impairments, see the
Other-Than-Temporary Impairments commentary in this section of the MD&A.)
SEPARATE ACCOUNT PRODUCTS
Separate account products are those for which a separate investment and
liability account is maintained on behalf of the policyholder. The Company's
separate accounts reflect two categories of risk assumption: non-guaranteed
separate accounts totaling $124.5 billion and $95.3 billion as of December 31,
2003 and 2002, respectively, wherein the policyholder assumes substantially all
the risk and reward; and guaranteed separate accounts totaling $12.1 billion and
$11.8 billion as of December 31, 2003 and 2002, respectively, wherein the
Company contractually guarantees either a minimum return or the account value to
the policyholder. Guaranteed separate account products primarily consist of
modified guaranteed individual annuities and modified guaranteed life insurance
and generally include market value adjustment features and surrender charges to
mitigate the risk of disintermediation. The primary investment objective of
guaranteed separate accounts is to maximize after-tax returns consistent with
acceptable risk parameters, including the management of the interest rate
sensitivity of invested assets relative to that of policyholder obligations, as
discussed in the Capital Markets Risk Management section under "Market Risk -
Life". Effective January 1, 2004, these investments will be included with
general account assets pursuant to Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" (the "SOP").
Investment objectives for non-guaranteed separate accounts, which consist of the
participants' account balances, vary by fund account type, as outlined in the
applicable fund prospectus or separate account plan of operations.
Non-guaranteed separate account products include variable annuities, variable
universal life insurance contracts and variable COLI. The separate accounts
associated with variable annuity products sold in Japan do not meet the criteria
to be recognized as a separate account because the assets are not legally
insulated from the Company.
- 56 -
These assets will also be included with general account assets effective January
1, 2004.
PROPERTY & CASUALTY
The investment objective for the majority of Property & Casualty is to maximize
economic value while generating after-tax income and sufficient liquidity to
meet policyholder and corporate obligations. For Property & Casualty's Other
Operations segment, the investment objective is to ensure the full and timely
payment of all liabilities. Property & Casualty's investment strategies are
developed based on a variety of factors including business needs, regulatory
requirements and tax considerations.
The following table identifies the invested assets by type held as of December
31, 2003 and 2002.
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
AMOUNT PERCENT AMOUNT PERCENT
-------------- -------------- -------------- -------------
Fixed maturities, at fair value $ 23,715 96.4% $ 19,446 94.5%
Equity securities, at fair value 208 0.8% 459 2.2%
Real estate/Mortgage loans, at cost 328 1.3% 131 0.7%
Limited partnerships, at fair value 168 0.7% 362 1.8%
Other investments 186 0.8% 175 0.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 24,605 100.0% $ 20,573 100.0%
====================================================================================================================================
During 2003, fixed maturity investments increased 22% primarily due to increased
operating cash flow, changes in portfolio allocation and the May 2003 capital
raising proceeds. In March 2003, the Company decided to liquidate its hedge fund
limited partnership investments and certain equity securities and reinvest the
proceeds into fixed maturity investments. Equity securities and hedge fund
investment liquidations have totaled $289 and $191, respectively, during 2003.
As of December 31, 2003, the hedge fund investments have been liquidated.
INVESTMENT RESULTS
The following table below summarizes Property & Casualty's investment results.
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income, before-tax [1] $ 1,172 $ 1,060 $ 1,042
Net investment income, after-tax [1] [2] $ 889 $ 820 $ 812
Yield on average invested assets, before-tax [3] 5.5% 5.8% 6.0%
Yield on average invested assets, after-tax [2] [3] 4.2% 4.5% 4.7%
- ------------------------------------------------------------------------------------------------------------------------------------
Gross gains on sale $ 397 $ 282 $ 223
Gross losses on sale (125) (181) (216)
Impairments (38) (199) (91)
Periodic net coupon settlements on non-qualifying derivatives [1] 18 15 11
Other, net [4] 1 15 (19)
-------------------------------------------------------
Net realized capital gains (losses), before-tax [1] $ 253 $ (68) $ (92)
====================================================================================================================================
<FN>
[1] Prior periods reflect the reclassification of periodic net coupon
settlements on non-qualifying derivatives from net investment income to net
realized capital gains (losses).
[2] Due to significant holdings in tax-exempt investments, after-tax net
investment income and yield are also included.
[3] Represents net investment income (excluding net realized capital gains
(losses)) divided by average invested assets at cost or amortized cost, as
applicable. Average invested assets are calculated by dividing the sum of
the beginning and ending period amounts by two, excluding the collateral
obtained from the securities lending program.
[4] Primarily consists of changes in fair value and hedge ineffectiveness on
derivative instruments.
</FN>
2003 COMPARED TO 2002 -- Before-tax net investment income increased $112, or
11%, and after-tax net investment income increased $69, or 8%, compared to the
prior year. The increases in net investment income were primarily due to income
earned on a higher invested asset base partially offset by lower investment
yields. Yields on average invested assets decreased from the prior year as a
result of lower rates on new investment purchases.
Net realized capital gains (losses) for 2003 improved by $321 compared to the
prior year. The improvement was primarily the result of net gains on sales of
fixed maturity investments, Trumbull Associates, LLC and a decrease in
other-than-temporary impairments. (For a further discussion of
other-than-temporary impairments, see the Other-Than-Temporary Impairments
commentary in this section of the MD&A.)
2002 COMPARED TO 2001 -- Before and after-tax net investment income increased 2%
and 1%, respectively, compared to the prior year as increased operating cash
flow resulted in higher investment income on the higher invested asset base.
Yields on average invested assets declined due to the lower interest rate
environment.
Net realized capital losses for 2002 improved by $24, or 26%, as higher
other-than-temporary impairments in 2002 were offset by a reduction in other
losses, as 2001 included losses on international subsidiary sales. (For a
further discussion of other-than-temporary impairments, see the
Other-than-Temporary Impairments commentary in this section of the MD&A.)
CORPORATE
Certain proceeds from the Company's September 2002 and May 2003 capital raising
activities have been retained in Corporate.
- 57 -
As of December 31, 2003 and 2002 Corporate held $86 and $66, respectively, of
short-term fixed maturity investments. In addition, Corporate held $2 of other
investments as of December 31, 2003.
OTHER-THAN-TEMPORARY IMPAIRMENTS
The following table identifies the Company's other-than-temporary impairments by
type.
OTHER-THAN-TEMPORARY IMPAIRMENTS BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
LIFE PROPERTY & CASUALTY CONSOLIDATED
----------------------------- ----------------------------- ---------------------------
(before-tax) 2003 2002 2001 2003 2002 2001 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Asset-backed securities ("ABS")
Aircraft lease receivables $ 29 $ 73 $ 2 $ -- $ 11 $ 2 $ 29 $ 84 $ 4
Corporate debt obligations ("CDO") 21 35 14 10 12 9 31 47 23
Credit card receivables 12 9 -- 2 -- -- 14 9 --
Interest only securities 5 3 10 7 4 11 12 7 21
Manufacturing housing ("MH")
receivables 9 14 -- -- 8 -- 9 22 --
Mutual fund fee receivables 3 16 -- -- 2 -- 3 18 --
Other ABS 3 13 5 -- 3 -- 3 16 5
- ------------------------------------------------------------------------------------------------------------------------------------
Total ABS 82 163 31 19 40 22 101 203 53
Commercial mortgage-backed securities
("CMBS") 5 4 -- -- -- -- 5 4 --
Corporate
Basic industry 1 -- 9 1 -- 2 2 -- 11
Consumer non-cyclical 7 -- -- 2 -- -- 9 -- --
Financial services 4 6 -- -- 4 -- 4 10 --
Food and beverage 25 -- -- -- -- -- 25 -- --
Technology and communications 3 142 17 2 116 42 5 258 59
Transportation 7 1 -- 3 5 -- 10 6 --
Utilities -- 23 37 1 17 16 1 40 53
Other Corporate -- 13 -- -- 11 4 -- 24 4
- ------------------------------------------------------------------------------------------------------------------------------------
Total Corporate 47 185 63 9 153 64 56 338 127
Equity 21 17 -- 9 3 5 30 20 5
Foreign government -- 11 11 -- 3 -- -- 14 11
Mortgage-backed securities ("MBS") -
interest only securities 7 -- -- 1 -- -- 8 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total other-than-temporary impairments $ 162 $ 380 $ 105 $ 38 $ 199 $ 91 $ 200 $ 579 $ 196
====================================================================================================================================
ABS -- During 2003, other-than-temporary impairments were recorded for various
ABS security types as a result of a continued deterioration of cash flows
derived from the underlying collateral. A significant number of these
impairments were recorded on the Company's investments in lower tranches of ABS
supported by aircraft lease and enhanced equipment trust certificates (together,
"aircraft lease receivables") due to continued lower aircraft lease rates and
the prolonged decline in airline travel. CDO impairments were primarily the
result of increasing default rates and lower recovery rates on the collateral.
Impairments on ABS backed by credit card receivables were a result of issuers
extending credit to sub-prime borrowers and the higher default rates on these
loans, while impairments on securities supported by MH receivables were
primarily the result of repossessed units liquidated at depressed levels.
Interest only security impairments recorded during 2003, 2002 and 2001 were due
to the flattening of the forward yield curve.
Impairments of ABS during 2002 and 2001 were driven by deterioration of
collateral cash flows. Numerous bankruptcies, collateral defaults, weak economic
conditions and reduced airline travel were all factors contributing to lower
collateral cash flows and broker quoted market prices of ABS.
CORPORATE -- The decline in corporate bankruptcies and improvement in general
economic conditions have contributed to lower corporate impairment levels in
2003 compared to 2002. A significant portion of corporate impairments during
2003 resulted from issuers who experienced fraud or accounting irregularities.
The most significant of these was the Italian dairy concern, Parmalat SpA, and
one consumer non-cyclical issuer in the healthcare industry, which resulted in a
$25 and $7 before-tax loss, respectively. A loss of $5 was recorded relating to
one communications sector issuer in the cable television industry due to
deteriorating earnings forecasts, debt restructuring issues and accounting
irregularities. Additional impairments were incurred as a result of the
deterioration in the transportation sector during the first half of the year,
specifically issuers of airline debt, as a result of a continued decline in
airline travel.
During 2002, impairments of corporate securities were concentrated in the
technology and communications sector and included a $110 before-tax loss related
to securities issued by WorldCom.
During 2001, impairments of corporate securities were concentrated in the
technology and communications and the utilities sectors, which included a $53
before-tax loss related to securities issued by Enron Corporation.
OTHER -- Other-than-temporary impairments were also recorded in 2003 on various
diversified mutual funds and preferred stock investments. In 2002 and 2001
other-than-temporary impairments were recognized on various common stock
investments, primarily in the technology and communications
- 58 -
sector, which had experienced declines in fair value for an extended period of
time.
In addition to the impairments described above, fixed maturity and equity
securities were sold during 2003, 2002 and 2001 at total gross losses of $196,
$256 and $221, respectively. No single security was sold at a loss in excess of
$10, $13 and $8 during 2003, 2002 and 2001, respectively.
Based upon the general improvement in corporate credit quality, favorable
overall market conditions and the apparent stabilization in certain ABS types,
the Company expects other-than-temporary impairments to trend lower in 2004 from
the 2003 and 2002 amounts.
- --------------------------------------------------------------------------------
INVESTMENT CREDIT RISK
- --------------------------------------------------------------------------------
The Hartford has established investment credit policies that focus on the credit
quality of obligors and counterparties, limit credit concentrations, encourage
diversification and require frequent creditworthiness reviews. Investment
activity, including setting of policy and defining acceptable risk levels, is
subject to regular review and approval by senior management and by the Company's
Finance Committee of the Board of Directors.
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 and counterparty.
Creditworthiness of specific obligors is determined by an internal credit
evaluation supplemented by consideration of external determinants of
creditworthiness, typically ratings assigned by nationally recognized ratings
agencies. Obligor, asset sector and industry concentrations are subject to
established limits and monitored on a regular basis.
The Hartford is not exposed to any credit concentration risk of a single issuer
greater than 10% of the Company's stockholders' equity.
DERIVATIVE INSTRUMENTS
The Company's derivative counterparty exposure policy establishes market-based
credit limits, favors long-term financial stability and creditworthiness and
typically requires credit enhancement/credit risk reducing agreements. Credit
risk is measured as the amount owed to the Company based on current market
conditions and potential payment obligations between the Company and its
counterparties. Credit exposures are generally quantified weekly and netted, and
collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds exposure policy thresholds.
The Company also minimizes the credit risk in derivative instruments by entering
into transactions with high quality counterparties which are reviewed
periodically by the Company's internal compliance unit, reviewed frequently by
senior management and reported to the Company's Finance Committee of the Board
of Directors. The Company also maintains a policy of requiring that all
derivative contracts be governed by an International Swaps and Derivatives
Association Master Agreement which is structured by legal entity and by
counterparty and permits right of offset.
The Company periodically enters into swap agreements in which the Company
assumes credit exposure from a single entity, referenced index or asset pool.
Total return swaps involve the periodic exchange of payments with other parties,
at specified intervals, calculated using the agreed upon index and notional
principal amounts. Generally, no cash or principal payments are exchanged at the
inception of the contract. Typically, at the time a swap is entered into, the
cash flow streams exchanged by the counterparties are equal in value.
Credit default swaps involve a transfer of credit risk from one party to another
in exchange for periodic payments. One party to the contract will make a payment
based on an agreed upon rate and a notional amount. The second party, who
assumes credit exposure, will only make a payment when there is a credit event,
and such payment will be equal to the notional value of the swap contract, and
in return, the second party will receive the debt obligation of the first party.
A credit event is generally defined as default on contractually obligated
interest or principal payments or bankruptcy.
As of December 31, 2003 and 2002, the notional value of total return and credit
default swaps totaled $1.0 billion and $1.0 billion, respectively, and the swap
fair value totaled $(33) and $(78), respectively.
- 59 -
FIXED MATURITIES
The following table identifies fixed maturity securities by type on a
consolidated basis, including guaranteed separate accounts, as of December 31,
2003 and December 31, 2002.
CONSOLIDATED FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
---------------------------------------------------- --------------------------------------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMORTIZED UNREALIZED UNREALIZED FAIR FAIR AMORTIZED UNREALIZED UNREALIZED FAIR FAIR
COST GAINS LOSSES VALUE VALUE COST GAINS LOSSES VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
ABS $ 6,483 $ 154 $ (113) $ 6,524 8.9% $ 6,109 $ 155 $ (173) $ 6,091 10.1%
CMBS 10,230 545 (44) 10,731 14.7% 6,964 607 (10) 7,561 12.6%
Collateralized mortgage
obligations ("CMO") 1,059 17 (3) 1,073 1.5% 909 45 (2) 952 1.6%
Corporate
Basic industry 4,035 286 (15) 4,306 5.9% 2,931 194 (19) 3,106 5.2%
Capital goods 1,850 133 (11) 1,972 2.7% 1,399 92 (10) 1,481 2.5%
Consumer cyclical 3,167 210 (12) 3,365 4.6% 1,873 121 (5) 1,989 3.3%
Consumer non-cyclical 3,572 236 (18) 3,790 5.2% 3,101 220 (22) 3,299 5.5%
Energy 2,036 142 (10) 2,168 3.0% 1,812 137 (10) 1,939 3.2%
Financial services 7,767 536 (45) 8,258 11.3% 6,454 441 (100) 6,795 11.3%
Technology and
communications 4,955 489 (18) 5,426 7.5% 3,972 337 (92) 4,217 7.0%
Transportation 777 51 (6) 822 1.1% 707 57 (20) 744 1.2%
Utilities 2,941 221 (20) 3,142 4.3% 2,371 147 (60) 2,458 4.1%
Other 720 33 (5) 748 1.0% 483 23 -- 506 0.9%
Government/Government
agencies
Foreign 1,605 171 (3) 1,773 2.4% 1,780 162 (8) 1,934 3.2%
United States 1,401 33 (4) 1,430 1.9% 764 53 -- 817 1.4%
MBS - agency 2,794 43 (3) 2,834 3.9% 2,739 79 -- 2,818 4.7%
Municipal
Taxable 625 19 (15) 629 0.9% 147 20 (1) 166 0.3%
Tax-exempt 9,445 775 (4) 10,216 14.0% 10,029 822 (5) 10,846 18.1%
Redeemable preferred stock 77 3 -- 80 0.1% 97 6 (1) 102 0.2%
Short-term 3,708 3 -- 3,711 5.1% 2,151 2 -- 2,153 3.6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 69,247 $ 4,100 $ (349) $ 72,998 100.0% $ 56,792 $ 3,720 $ (538) $ 59,974 100.0%
====================================================================================================================================
Total general account
fixed maturities $ 58,127 $ 3,413 $ (277) $ 61,263 83.9% $ 46,241 $ 3,062 $ (414) $ 48,889 81.5%
Total guaranteed separate
account fixed maturities $ 11,120 $ 687 $ (72) $ 11,735 16.1% 10,551 $ 658 $ (124) $ 11,085 18.5%
====================================================================================================================================
The Company's fixed maturity gross unrealized gains and losses have improved by
$380 and $189, respectively from December 31, 2002 to December 31, 2003,
primarily due to improved corporate credit quality and to a lesser extent
recognition of other-than-temporary impairments and asset sales, partially
offset by an increase in interest rates. The improvement in corporate credit
quality was largely due to the security issuers' renewed emphasis on improving
liquidity, reducing leverage and various cost cutting measures. Throughout 2003,
the general economic outlook has continued to rebound, the result of improved
profitability supported by improved manufacturing demand, a continued strong
housing market and robust consumer and government spending. The apparent
economic acceleration has resulted in the 10 year Treasury rate increasing over
40 basis points since December 31, 2002 and more than 100 basis points from its
low in June 2003.
Investment allocations as a percentage of total fixed maturities have remained
materially consistent since December 31, 2002, except for CMBS, municipal
tax-exempt and short-term securities.
Portfolio allocations to CMBS increased due to the asset class's stable spreads
and high quality. CMBS securities have lower prepayment risk than MBS due to
contractual penalties. The Company decreased its percentage of tax-exempt
municipal holdings due to alternative minimum tax implications. Short-term
securities have increased primarily due to the receipt of operating cash flows
awaiting investment in longer term securities, securities received as part of
the CNA transaction and collateral obtained related to the Company's securities
lending program.
Effective December 31, 2003, the Company purchased CNA's group life and
accident, long-term and short-term disability and certain specialty business.
Associated with the purchase, CNA transferred to the Company $2.3 billion of
fixed maturities on December 31, 2003. The securities were recorded at fair
value on the date of acquisition resulting in no unrealized gain or loss as of
December 31, 2003. The acquired fixed maturities were concentrated in corporate
and short-term securities but did not significantly alter the Company's overall
investment allocations as a percentage of total fixed maturities. The corporate
securities are distributed into several sectors, most notably the financial
services, technology and communications and consumer cyclical sectors.
As of December 31, 2003 and 2002, 18% of the fixed maturities were invested in
private placement securities, including 11% of Rule 144A offerings to qualified
institutional buyers. Private
- 60 -
placement securities are generally less liquid than public securities. Most of
the private placement securities are rated by nationally recognized rating
agencies.
(For a further discussion of risk factors associated with sectors with
significant unrealized loss positions, see the sector risk factor commentary
under the Consolidated Total Securities with Unrealized Loss Greater than Six
Months by Type schedule in this section of the MD&A.)
The following table identifies fixed maturities by credit quality on a
consolidated basis, including guaranteed separate accounts, as of December 31,
2003 and 2002. The ratings referenced below are based on the ratings of a
nationally recognized rating organization or, if not rated, assigned based on
the Company's internal analysis of such securities.
CONSOLIDATED FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
-------------------------------------- -------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
United States Government/Government agencies $ 5,274 $ 5,357 7.3% $ 4,234 $ 4,397 7.3%
AAA 15,672 16,552 22.7% 13,344 14,358 24.0%
AA 7,377 7,855 10.8% 7,267 7,784 13.0%
A 17,646 18,750 25.7% 15,082 16,034 26.7%
BBB 16,143 17,114 23.4% 11,531 12,121 20.2%
BB & below 3,427 3,659 5.0% 3,183 3,127 5.2%
Short-term 3,708 3,711 5.1% 2,151 2,153 3.6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 69,247 $ 72,998 100.0% $ 56,792 $ 59,974 100.0%
====================================================================================================================================
Total general account fixed maturities $ 58,127 $ 61,263 83.9% $ 46,241 $ 48,889 81.5%
Total guaranteed separate account fixed maturities $ 11,120 $ 11,735 16.1% $ 10,551 $ 11,085 18.5%
====================================================================================================================================
As of December 31, 2003 and 2002, 95% and over 94%, respectively, of the fixed
maturity portfolio was invested in short-term securities or securities rated
investment grade (BBB and above).
The following table presents the Below Investment Grade ("BIG") fixed maturities
by type, including guaranteed separate accounts, as of December 31, 2003 and
2002.
CONSOLIDATED BIG FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
-------------------------------------- -------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
ABS $ 293 $ 275 7.5% $ 237 $ 209 6.7%
CMBS 185 190 5.2% 196 214 6.8%
Corporate
Basic industry 365 381 10.4% 338 339 10.8%
Capital goods 177 187 5.1% 177 180 5.8%
Consumer cyclical 377 408 11.2% 289 298 9.5%
Consumer non-cyclical 423 442 12.1% 263 255 8.2%
Energy 113 123 3.4% 111 113 3.6%
Financial services 20 20 0.5% 53 45 1.4%
Technology and communications 418 505 13.8% 612 571 18.3%
Transportation 58 61 1.7% 44 40 1.3%
Utilities 529 549 15.0% 415 376 12.0%
Foreign government 416 463 12.7% 397 441 14.1%
Other 53 55 1.4% 51 46 1.5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 3,427 $ 3,659 100.0% $ 3,183 $ 3,127 100.0%
====================================================================================================================================
Total general account fixed maturities $ 2,681 $ 2,877 78.6% $ 2,494 $ 2,443 78.1%
Total guaranteed separate account fixed maturities $ 746 $ 782 21.4% $ 689 $ 684 21.9%
====================================================================================================================================
As of December 31, 2003 and 2002, the Company held no issuer of a BIG security
with a fair value in excess of 3% and 4%, respectively, of the total fair value
for BIG securities.
The following table presents the Company's unrealized loss aging for total fixed
maturity and equity securities on a consolidated basis, including guaranteed
separate accounts, as of December 31, 2003 and 2002, by length of time the
security was in an unrealized loss position.
- 61 -
CONSOLIDATED UNREALIZED LOSS AGING OF TOTAL SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
-------------------------------------- --------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 4,867 $ 4,826 $ (41) $ 2,042 $ 1,949 $ (93)
Greater than three months to six months 3,991 3,854 (137) 1,542 1,463 (79)
Greater than six months to nine months 404 382 (22) 703 611 (92)
Greater than nine months to twelve months 151 142 (9) 1,820 1,719 (101)
Greater than twelve months 1,844 1,688 (156) 2,351 2,103 (248)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 11,257 $ 10,892 $ (365) $ 8,458 $ 7,845 $ (613)
====================================================================================================================================
Total general accounts $ 9,234 $ 8,941 $ (293) $ 6,339 $ 5,852 $ (487)
Total guaranteed separate accounts $ 2,023 $ 1,951 $ (72) $ 2,119 $ 1,993 $ (126)
====================================================================================================================================
The decrease in the unrealized loss amount since December 31, 2002 is primarily
the result of improved corporate fixed maturity credit quality and to a lesser
extent recognition of other-than-temporary impairments and asset sales,
partially offset by an increase in interest rates. (For a further discussion,
see the economic commentary under the Consolidated Fixed Maturities by Type
table in this section of the MD&A.)
As of December 31, 2003, fixed maturities represented $349, or 96%, of the
Company's total unrealized loss. There were no fixed maturities as of December
31, 2003 with a fair value less than 80% of the security's amortized cost basis
for six continuous months other than certain asset-backed and commercial
mortgage-backed securities. Other-than-temporary impairments for certain
asset-backed and commercial mortgage-backed securities are recognized if the
fair value of the security, as determined by external pricing sources, is less
than its carrying amount and there has been a decrease in the present value of
the expected cash flows since the last reporting period. There were no
asset-backed or commercial mortgage-backed securities included in the table
above, as of December 31, 2003 and 2002, for which management's best estimate of
future cash flows adversely changed during the reporting period. As of December
31, 2003, no asset-backed or commercial mortgage-backed securities had an
unrealized loss in excess of $15. (For a further discussion of the
other-than-temporary impairments criteria, see "Investments" included in the
Critical Accounting Estimates section of the MD&A and in Note 1 of Notes to
Consolidated Financial Statements.)
The Company held no securities of a single issuer that were at an unrealized
loss position in excess of 5% and 6% of the total unrealized loss amount as of
December 31, 2003 and 2002, respectively.
The total securities in an unrealized loss position for longer than six months
by type as of December 31, 2003 and 2002 are presented in the following table.
CONSOLIDATED TOTAL SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
------------------------------------------------- -------------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
ABS and CMBS
Aircraft lease receivables $ 174 $ 116 $ (58) 31.0% $ 94 $ 79 $ (15) 3.4%
CDOs 176 153 (23) 12.3% 262 217 (45) 10.2%
Credit card receivables 123 111 (12) 6.4% 408 359 (49) 11.1%
Other ABS and CMBS 693 673 (20) 10.7% 784 768 (16) 3.6%
Corporate
Financial services 747 710 (37) 19.8% 910 831 (79) 17.9%
Technology and communications 55 52 (3) 1.6% 609 536 (73) 16.6%
Transportation 42 38 (4) 2.1% 89 72 (17) 3.9%
Utilities 103 95 (8) 4.3% 361 325 (36) 8.2%
Other 268 248 (20) 10.7% 821 781 (40) 9.1%
Diversified equity mutual funds 4 4 -- -- 113 88 (25) 5.7%
Other securities 14 12 (2) 1.1% 423 377 (46) 10.3%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 2,399 $ 2,212 $ (187) 100.0% $ 4,874 $ 4,433 $ (441) 100.0%
- ------------------------------------------------------------------------------------------------------------------------------------
Total general accounts $ 1,760 $ 1,619 $ (141) 75.4% $ 3,597 $ 3,258 $ (339) 76.9%
Total guaranteed separate accounts $ 639 $ 593 $ (46) 24.6% $ 1,277 $ 1,175 $ (102) 23.1%
====================================================================================================================================
The ABS securities in an unrealized loss position for six months or more as of
December 31, 2003, were primarily supported by aircraft lease receivables, CDOs
and credit card receivables. The Company's current view of risk factors relative
to these fixed maturity types is as follows:
AIRCRAFT LEASE RECEIVABLES -- The securities supported by aircraft lease
receivables continued to decline in value during 2003 due to a reduction in
lease payments and aircraft values driven by a prolonged decline in airline
travel, which has resulted in the financial difficulties of many airline
carriers. As a result of the uncertainty surrounding the timing of any
- 62 -
potential recovery in this industry, significant risk premiums have been
required by the market for these securities, resulting in reduced liquidity and
lower broker quoted prices. Air travel began to improve in the second half of
2003, which resulted in lease rates stabilizing on certain aircrafts. While the
Company saw some modest price increases and greater liquidity in this sector
during the fourth quarter of 2003, additional price recovery will depend on
continued improvement in economic fundamentals, political stability and airline
operating performance.
CDOS -- Adverse CDO experience can be attributed to higher than expected default
rates and downgrades of the collateral supporting these securities, particularly
in the technology and utilities sectors, causing a deterioration in the
subordinated tranches of these structures. As a result, significant risk
premiums have been required by the market for these securities, resulting in
reduced liquidity and lower broker quoted prices. Improved economic and
operating fundamentals of the underlying security issuers, along with better
market liquidity, should lead to improved pricing levels.
CREDIT CARD RECEIVABLES -- The unrealized loss position in credit card
securities has primarily been caused by exposure to companies originating loans
to sub-prime borrowers. While the unrealized loss position improved for these
holdings during the year due to the better than expected performance of the
underlying collateral of credit card receivables, concerns remain regarding the
long-term viability of certain issuers within this sub-sector.
As of December 31, 2003, security types other than ABS and CMBS that were in a
significant unrealized loss position for greater than six months were corporate
fixed maturities primarily within the financial services sector.
FINANCIAL SERVICES -- As of December 31, 2003, the securities in the financial
services sector unrealized loss position for greater than six months were
comprised of approximately 50 different securities. The securities in this
category are primarily investment grade and substantially all of these
securities are priced at or greater than 90% of amortized cost as of December
31, 2003. These positions are primarily variable rate securities with extended
maturity dates, which have been adversely impacted by the reduction in forward
interest rates resulting in lower expected cash flows. Unrealized loss amounts
for these securities have declined during the year as interest rates have risen.
Additional changes in fair value of these securities are primarily dependent on
future changes in forward interest rates. A substantial percentage of these
securities are currently hedged with interest rate swaps, which convert the
variable rate earned on the securities to a fixed amount. The swaps receive cash
flow hedge accounting treatment and are currently in an unrealized gain
position.
As part of the Company's ongoing security monitoring process by a committee of
investment and accounting professionals, the Company has reviewed its investment
portfolio and concluded that there were no additional other-than-temporary
impairments as of December 31, 2003 and 2002. Due to the issuers' continued
satisfaction of the securities' obligations in accordance with their contractual
terms and the expectation that they will continue to do so, management's intent
and ability to hold these securities, as well as the evaluation of the
fundamentals of the issuers' financial condition and other objective evidence,
the Company believes that the prices of the securities in the sectors identified
above were temporarily depressed.
The evaluation for other-than-temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are
other-than-temporary. The risks and uncertainties include changes in general
economic conditions, the issuer's financial condition or near term recovery
prospects and the effects of changes in interest rates. In addition, for
securitized financial assets with contractual cash flows (e.g. ABS and CMBS),
projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral. As of December 31, 2003,
management's expectation of the discounted future cash flows on these securities
was in excess of the associated securities' amortized cost. (For a further
discussion, see "Investments" included in the Critical Accounting Estimates
section of MD&A and in Note 1 of Notes to Consolidated Financial Statements.)
The following table presents the Company's unrealized loss aging for BIG and
equity securities on a consolidated basis, including guaranteed separate
accounts, as of December 31, 2003 and 2002.
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED UNREALIZED LOSS AGING OF BIG AND EQUITY SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
-------------------------------------- -------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 133 $ 129 $ (4) $ 274 $ 229 $ (45)
Greater than three months to six months 134 129 (5) 308 267 (41)
Greater than six months to nine months 81 73 (8) 266 213 (53)
Greater than nine months to twelve months 18 17 (1) 576 515 (61)
Greater than twelve months 417 349 (68) 610 517 (93)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 783 $ 697 $ (86) $ 2,034 $ 1,741 $ (293)
- ------------------------------------------------------------------------------------------------------------------------------------
Total general accounts $ 663 $ 593 $ (70) $ 1,702 $ 1,444 $ (258)
Total guaranteed separate accounts $ 120 $ 104 $ (16) $ 332 $ 297 $ (35)
====================================================================================================================================
Similar to the decrease in the Consolidated Unrealized Loss Aging of Total
Securities table from December 31, 2002 to December 31, 2003, the decrease in
the BIG and equity security unrealized loss amount was primarily the result of
improved corporate fixed maturity credit quality and to a lesser extent
recognition of other-than-temporary impairments and asset sales, partially
offset by an increase in interest rates. (For a further discussion, see the
economic commentary under the
- 63 -
Consolidated Fixed Maturities by Type table in this section of the MD&A.)
The BIG and equity securities in an unrealized loss position for longer than six
months by type as of December 31, 2003 and 2002 are presented in the following
table.
CONSOLIDATED BIG AND EQUITY SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002
---------------------------------------------- ---------------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
ABS and CMBS
Aircraft lease receivables $ 55 $ 36 $ (19) 24.6% $ 4 $ 2 $ (2) 1.0%
CDOs 44 34 (10) 13.0% 4 2 (2) 1.0%
Credit card receivables 45 34 (11) 14.3% 36 23 (13) 6.3%
Other ABS and CMBS 59 49 (10) 13.0% 45 39 (6) 2.9%
Corporate
Financial services 142 128 (14) 18.2% 141 131 (10) 4.8%
Technology and communications 6 6 -- -- 325 267 (58) 28.0%
Transportation 21 18 (3) 3.9% 33 26 (7) 3.4%
Utilities 76 70 (6) 7.8% 209 182 (27) 13.0%
Other 63 59 (4) 5.2% 379 346 (33) 15.9%
Diversified equity mutual funds 4 4 -- -- 113 88 (25) 12.1%
Other securities 1 1 -- -- 163 139 (24) 11.6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 516 $ 439 $ (77) 100.0% $ 1,452 $ 1,245 $(207) 100.0%
- ------------------------------------------------------------------------------------------------------------------------------------
Total general accounts $ 417 $ 355 $ (62) 80.5% $ 1,191 $ 1,012 $(179) 86.5%
Total guaranteed separate accounts $ 99 $ 84 $ (15) 19.5% $ 261 $ 233 $ (28) 13.5%
====================================================================================================================================
(For a further discussion of the Company's current view of risk factors relative
to certain security types listed above, see the Consolidated Total Securities
with Unrealized Loss Greater Than Six Months by Type table in this section of
the MD&A.)
- --------------------------------------------------------------------------------
CAPITAL MARKETS RISK MANAGEMENT
- --------------------------------------------------------------------------------
The Hartford has a disciplined approach to managing risks associated with its
capital markets and asset/liability management activities. Investment portfolio
management is organized to focus investment management expertise on specific
classes of investments, while asset/liability management is the responsibility
of dedicated risk management units supporting Life, including guaranteed
separate accounts, 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.
Derivatives play an important role in facilitating the management of interest
rate risk, mitigating equity market risk exposure associated with certain
variable annuity products and changes in currency exchange rates.
MARKET RISK
The Company is exposed to market risk, primarily relating to the market price
and/or cash flow variability associated with changes in interest rates, market
indices or foreign currency exchange rates.
Interest Rate Risk
- ------------------
The Company's exposure to interest rate risk relates to the market price and/or
cash flow variability associated with the changes in market interest rates. The
Company manages its exposure to interest rate risk through asset allocation
limits, asset/liability duration matching and through the use of derivatives.
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.
Measures the Company uses to quantify its exposure to interest rate risk
inherent in its invested assets and interest rate sensitive liabilities are
duration and key rate duration. Duration is the weighted average
term-to-maturity of a security's cash flows, and is used to approximate the
percentage change in the price of a security for a 100-basis-point change in
market interest rates. For example, a duration of 5 means the price of the
security will change by approximately 5% for a 1% change in interest rates. The
key rate duration analysis considers the expected future cash flows of assets
and liabilities assuming non-parallel interest rate movements.
To calculate duration, projections of asset and liability cash flows are
discounted to a present value using interest rate assumptions. These cash flows
are then revalued at alternative interest rate levels to determine the
percentage change in fair value due to an incremental change in rates. Cash
flows from corporate obligations are assumed to be consistent with the
contractual payment streams on a yield to worst basis. The primary assumptions
used in calculating cash flow projections include expected asset payment streams
taking into account prepayment speeds, issuer call options and contract holder
behavior. Asset-backed securities, collateralized mortgage obligations and
mortgage-backed securities are modeled based on estimates of the rate of future
prepayments of principal over the remaining life of the securities. These
estimates are developed using prepayment speeds provided in broker consensus
data. Such estimates are derived from prepayment speeds previously experienced
at the interest rate levels
- 64 -
projected for the underlying collateral. Actual prepayment experience may vary
from these estimates.
The Company is also exposed to interest rate risk based upon the discount rate
assumption associated with the Company's pension and other postretirement
benefit obligation. The discount rate assumption is based upon an interest rate
yield curve comprised of AAA/AA bonds with maturities between zero and thirty
years. Declines in long-term interest rates have had a negative impact on the
funded status of the plans. (For a further discussion of interest rate risk
associated with the plans, see Capital Resources and Liquidity, "Pension Plans
and Other Postretirement Benefits" and Note 12 of Notes to Consolidated
Financial Statements.)
Equity Risk
- -----------
The Company's primary exposure to equity risk relates to the potential for lower
earnings associated with certain of the Life's businesses such as variable
annuities where fee income is earned based upon the fair value of the assets
under management. In addition, Life offers certain guaranteed benefits,
primarily associated with variable annuity products, which increases the
Company's potential benefit exposure as the equity markets decline. (For a
further discussion, see the Life "Equity Risk" section.)
The Company does not have significant equity risk exposure from invested assets.
In March 2003, the Company decided to liquidate its hedge fund limited
partnership investments and certain equity securities and reinvest the proceeds
into fixed maturity investments, thereby reducing its exposure to equity price
risk. The Company has not materially changed other aspects of its overall asset
allocation position or market risk since December 31, 2002.
The Company is also subject to equity risk based upon the expected long-term
rate of return assumption associated with the Company's pension and other
postretirement benefit obligation. The Company determines the long-term rate of
return assumption for the plans' portfolios based upon an analysis of historical
returns. Declines in equity returns have had a negative impact on the funded
status of the plans. (For a further discussion of equity risk associated with
the plans, see Capital Resources and Liquidity, "Pension Plans and Other
Postretirement Benefits" and Note 12 of Notes to Consolidated Financial
Statements.
Foreign Currency Exchange Risk
- ------------------------------
The Company's currency exchange risk is related to non-US dollar denominated
investments, which primarily consist of fixed maturity investments and the
investment in the Japanese Life operation. A significant portion of the
Company's foreign currency exposure is mitigated through the use of derivatives.
Derivative Instruments
- ----------------------
The Hartford utilizes a variety of derivative instruments, including swaps,
caps, floors, forwards, futures and options, in compliance with Company policy
and regulatory requirements to mitigate interest rate, equity market or currency
exchange rate risk or volatility.
Interest rate swaps involve the periodic exchange of payments with other
parties, at specified intervals, calculated using the agreed upon rates and
notional principal amounts. Generally, no cash or principal payments are
exchanged at the inception of the contract. Typically, at the time a swap is
entered into, the cash flow streams exchanged by the counterparties are equal in
value.
Interest rate cap and floor contracts entitle the purchaser to receive from the
issuer at specified dates, the amount, if any, by which a specified market rate
exceeds the cap strike rate or falls below the floor strike rate, applied to a
notional principal amount. A premium payment is made by the purchaser of the
contract at its inception, and no principal payments are exchanged.
Forward contracts are customized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument.
Financial futures are standardized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument. Futures
contracts trade on organized exchanges. Margin requirements for futures are met
by pledging securities, and changes in the futures' contract values are settled
daily in cash.
Option contracts grant the purchaser, for a premium payment, the right to either
purchase from or sell to the issuer a financial instrument at a specified price,
within a specified period or on a stated date.
Foreign currency swaps exchange an initial principal amount in two currencies,
agreeing to re-exchange the currencies at a future date, at an agreed upon
exchange rate. There is also periodic exchange of payments at specified
intervals calculated using the agreed upon rates and exchanged principal
amounts.
Derivative activities are monitored by an internal compliance unit, reviewed
frequently by senior management and reported to the Finance Committee of the
Board of Directors. The notional amounts of derivative contracts represent the
basis upon which pay or receive amounts are calculated and are not reflective of
credit risk. Notional amounts pertaining to derivative instruments used in the
management of market risk for both the general and guaranteed separate accounts
at December 31, 2003 and 2002 were $37.3 billion and $18.7 billion,
respectively. The increase in the derivative notional amount during 2003 was
primarily due to the embedded derivatives and reinsurance contract associated
with the GMWB product feature.
The following discussions focus on the key market risk exposures within Life and
Property & Casualty portfolios.
- 65 -
LIFE
Life is responsible for maximizing after-tax returns within acceptable risk
parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity to support
policyholder and corporate obligations. Life's fixed maturity portfolios and
certain investment contracts and insurance product liabilities have material
market exposure to interest rate risk. In addition, Life's 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. Life's foreign currency
exposure is primarily related to non-US dollar denominated fixed income
securities and the investment in the Japanese Life operation.
Interest Rate Risk
- ------------------
Life's exposure to interest rate risk relates to the market price and/or cash
flow variability associated with changes in market interest rates. Changes in
interest rates can potentially impact Life's profitability. In certain scenarios
where interest rates are volatile, Life could be exposed to disintermediation
risk and a reduction in net interest rate spread or profit margins. The
investments and liabilities primarily associated with interest rate risk are
included in the following discussion. Certain product liabilities, including
those containing guaranteed minimum withdrawal or death benefits, expose the
Company to interest rate risk but also have significant equity risk. These
liabilities are discussed as part of the Equity Risk section below.
Fixed Maturity Investments
Life's general account and guaranteed separate account investment portfolios
primarily consist of investment grade fixed maturity securities, including
corporate bonds, asset-backed securities, commercial mortgage-backed securities,
tax-exempt municipal securities and collateralized mortgage obligations. The
fair value of these investments was $49.2 billion and $40.5 billion at December
31, 2003 and 2002, respectively. The fair value of these and Life's other
invested assets fluctuates depending on the interest rate environment and other
general economic conditions. During periods of declining interest rates,
paydowns on mortgage-backed securities and collateralized mortgage obligations
increase as the underlying mortgages are prepaid. During such periods, the
Company generally will not be able to reinvest the proceeds of any such
prepayments at comparable yields. Conversely, during periods of rising interest
rates, the rate of prepayments generally declines, exposing the Company to the
possibility of asset/liability cash flow and yield mismatch. The weighted
average duration of the fixed maturity portfolio was approximately 4.8 and 4.5
as of December 31, 2003 and 2002, respectively.
Liabilities
Life's investment contracts and certain insurance product liabilities, other
than non-guaranteed separate accounts, include asset accumulation vehicles such
as fixed annuities, guaranteed investment contracts, other investment and
universal life-type contracts and other insurance products such as long-term
disability. Asset accumulation vehicles primarily require a fixed rate payment,
often for a specified period of time. Product examples include fixed rate
annuities with a market value adjustment feature and fixed rate guaranteed
investment contracts. The duration of these contracts generally range from less
than one year to ten years. In addition, certain products such as universal life
contracts and the general account portion of Life's variable annuity products,
credit interest to policyholders subject to market conditions and minimum
interest rate guarantees. The duration of these products is
short-to-intermediate term.
While interest rate risk associated with many of these products has been reduced
through the use of market value adjustment features and surrender charges, the
primary risk associated with these products is that the spread between
investment return and credited rate may not be sufficient to earn targeted
returns.
The Company also manages the risk of other insurance liabilities similarly to
investment type products due to the relative predictability of the aggregate
cash flow payment streams. Products in this category may contain significant
actuarial (including mortality and morbidity) pricing and cash flow risks.
Product examples include structured settlement contracts, on-benefit annuities
(i.e., the annuitant is currently receiving benefits thereon) and short and
long-term disability contracts. The cash out flows associated with these policy
liabilities are not interest rate sensitive but do vary based on the timing and
amount of benefit payments. The primary risks associated with these products are
that the benefits will exceed expected actuarial pricing and/or that the actual
timing of the cash flows differ from those anticipated, resulting in an
investment return lower than that assumed in pricing. Contract duration can
range from less than one year to typically up to ten years.
Product Liability Characteristics
- ---------------------------------
Life's product liabilities, other than non-guaranteed separate accounts, include
accumulation vehicles such as fixed and variable annuities, other investment and
universal life-type contracts, and other insurance products such as long-term
disability and term life insurance. The table below shows carrying values of
insurance policy liabilities as of December 31, 2003 and 2002.
2003 2002
DESCRIPTION TOTAL TOTAL
-----------------------------------------------------------------
Fixed rate asset accumulation vehicles $ 14.6 $ 13.6
Weighted average credited rate 6.0% 5.8%
Indexed asset accumulation vehicles $ 1.6 $ 0.7
Weighted average credited rate 1.8% 3.0%
Interest credited asset accumulation
vehicles $ 17.2 $ 16.0
Weighted average credited rate 3.8% 4.2%
Long-term pay out liabilities $ 11.8 $ 9.1
Short-term pay out liabilities $ 1.2 $ 1.0
=================================================================
Life employs several risk management tools to quantify and manage risk arising
from investment contracts and other insurance liabilities, such as duration and
key rate duration and the use of derivative instruments. For certain portfolios,
management monitors the changes in present value between
- 66 -
assets and liabilities resulting from various interest rate scenarios using
integrated asset/liability measurement systems and a proprietary system that
simulates the impacts of parallel and non-parallel yield curve shifts. Based on
this current and prospective information, management implements risk reducing
techniques to improve the match between assets and liabilities, including the
use of derivative instruments. Derivatives used to mitigate interest rate risk
are discussed in more detail below.
Derivatives
Life utilizes a variety of derivative instruments to mitigate interest rate
risk. Interest rate swaps are primarily used to convert interest receipts to a
fixed or variable rate. In addition, interest rate swaps are used to convert the
contract rate on certain liability products offered by the Company into a rate
that trades in a more liquid and efficient market. The use of such swaps enables
the Company to customize contract terms and conditions to customer objectives
and satisfies the operation's asset/liability duration matching policy.
Occasionally, swaps are also used to hedge the variability in the cash flow of a
forecasted purchase or sale due to changes in interest rates.
Interest rate caps and floors, swaptions and option contracts are primarily used
to hedge against the risk of liability contract holder disintermediation in a
rising interest rate environment, and to offset the changes in fair value of
corresponding derivatives embedded in certain of the Company's fixed maturity
investments.
At December 31, 2003 and 2002, notional amounts pertaining to derivatives
utilized to manage interest rate risk totaled $9.5 billion and $10.0 billion,
respectively ($7.8 billion and $8.3 billion, respectively related to insurance
investments and $1.7 billion and $1.7 billion, respectively related to life
insurance liabilities). The fair value of these derivatives as reflected on the
consolidated balance sheets was $142 and $357 as of December 31, 2003 and 2002,
respectively.
Calculated Interest Rate Sensitivity
The after-tax change in the net economic value of investment contracts (e.g.
guaranteed investment contracts) and other insurance product liabilities (e.g.
short and long-term disability contracts), that are not substantially affected
by changes in interest rates ("fixed liabilities") and for which the investment
experience is substantially absorbed by Life, are included in the following
table along with the corresponding general and guaranteed separate account
assets. Also included in this analysis are the interest rate sensitive
derivatives used by Life to hedge its exposure to interest rate risk. Certain
financial instruments, such as limited partnerships, have been omitted from the
analysis because the investments are accounted for under the equity method and
lack sensitivity to interest rate changes. Interest rate sensitive investment
contracts and universal life-type contracts are excluded from the hypothetical
calculation below because the contracts generally allow Life significant
flexibility to adjust credited rates to reflect actual investment experience and
thereby pass through a substantial portion of actual investment experience to
the policyholder. Non-guaranteed separate account assets and liabilities are
excluded from the hypothetical calculation below because gains and losses in
separate accounts generally accrue to policyholders. The estimated change in net
economic value assumes a 100 basis point upward and downward parallel shift in
the yield curve.
CHANGE IN NET ECONOMIC VALUE
AS OF DECEMBER 31,
2003 2002
------------------------------------------
Basis point shift - 100 + 100 - 100 + 100
- -----------------------------------------------------------------
Amount $ (27) $ (19) $ 17 $ (51)
=================================================================
The fixed liabilities included above represented approximately 60% of Life's
general and guaranteed separate account liabilities as of December 31, 2003 and
2002. The assets supporting the fixed liabilities are monitored and managed
within rigorous duration guidelines using scenario simulation techniques, and
are evaluated on an annual basis, in compliance with regulatory requirements.
The after-tax change in fair value of the general account invested asset
portfolios that support interest rate sensitive investment contracts and
universal life-type contracts and other insurance contracts that possess
significant mortality risk are shown in the following table. The cash flows
associated with these liabilities are less predictable than fixed liabilities.
The Company identifies the most appropriate investment strategy based upon the
expected policyholder behavior and liability crediting needs. The hypothetical
calculation of the estimated change in fair value below, assumes a 100 basis
point upward and downward parallel shift in the yield curve.
CHANGE IN FAIR VALUE
AS OF DECEMBER 31,
2003 2002
------------------------------------------
Basis point shift - 100 + 100 - 100 + 100
- -----------------------------------------------------------------
Amount $ 481 $ (473) $ 415 $ (401)
=================================================================
The above quantitative presentation was adopted in the current year and is in
lieu of the tabular presentation historically disclosed. The Company believes
the current presentation is preferable in understanding the Company's invested
asset interest rate risk exposure.
The selection of the 100 basis point parallel shift in the yield curve was made
only as a hypothetical illustration of the potential impact of such an event and
should not be construed as a prediction of future market events. Actual results
could differ materially from those illustrated above due to the nature of the
estimates and assumptions used in the above analysis. The Company's sensitivity
analysis calculation assumes that the composition of invested assets and
liabilities remain materially consistent throughout the year and that the
current relationship between short-term and long-term interest rates will remain
constant over time. As a result, these calculations may not fully capture the
impact of portfolio re-allocations, significant product sales or non-parallel
changes in interest rates.
In addition, Life carries other obligations (non-insurance liabilities) that
have, to a lesser extent, exposure to interest rate risk.
- 67 -
The table below provides information as of December 31, 2003 on debt obligations
and reflects principal cash flows and related weighted average interest rates by
maturity year. Comparative totals are included as of December 31, 2002.
2003 2002
2004 2005 2006 2007 2008 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM DEBT
Fixed Rate
Amount $ 200 $ -- $ -- $ -- $ -- $ -- $ 200 $ --
Weighted average interest rate 6.9% -- -- -- -- -- 6.9% --
Fair value $ 205 $ -- $ -- $ -- $ -- $ -- $ 205 $ --
LONG-TERM DEBT [1]
Fixed Rate
Amount $ -- $ -- $ -- $ 200 $ 305 $ 1,100 $ 1,605 $ 1,575
Weighted average interest rate -- -- -- 7.1% 2.9% 7.4% 6.5% 7.2%
Fair value $ -- $ -- $ -- $ 224 $ 367 $ 1,237 $ 1,828 $ 1,681
====================================================================================================================================
<FN>
[1] Includes junior subordinated debentures.
</FN>
Equity Risk
- -----------
The Company's operations are significantly influenced by changes in the equity
markets. The Company's profitability depends largely on the amount of assets
under management, which is primarily driven by the level of sales, equity market
appreciation and depreciation and the persistency of the in-force block of
business. Prolonged and precipitous declines in the equity markets can have a
significant impact on the Company's operations, as sales of variable products
may decline and surrender activity may increase, as customer sentiment towards
the equity market turns negative. Lower assets under management will have a
negative impact on the Company's financial results, primarily due to lower fee
income related to the Investment Products and, to a lesser extent, Individual
Life segments, where a heavy concentration of equity linked products are
administered and sold. Furthermore, the Company may experience a reduction in
profit margins if a significant portion of the assets held in the variable
annuity separate accounts move to the general account and the Company is unable
to earn an acceptable investment spread, particularly in light of the low
interest rate environment and the presence of contractually guaranteed minimum
interest credited rates, which for the most part are at a 3% rate.
In addition, prolonged declines in the equity market may also decrease the
Company's expectations of future gross profits, which are utilized to determine
the amount of DAC to be amortized in a given financial statement period. A
significant decrease in the Company's estimated gross profits would require the
Company to accelerate the amount of DAC amortization in a given period,
potentially causing a material adverse deviation in that period's net income.
Although an acceleration of DAC amortization would have a negative impact on the
Company's earnings, it would not affect the Company's cash flow or liquidity
position.
Additionally, the Investment Products segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, the Company pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary. 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 Investment Products segment's total gross exposure (i.e. before reinsurance)
to these guaranteed death benefits as of December 31, 2003 is $11.4 billion. Due
to the fact that 81% of this amount is reinsured, the Company's net exposure is
$2.2 billion. This amount is often referred to as the net amount at risk.
However, the Company will incur these guaranteed death benefit payments in the
future only if the policyholder has an in-the-money guaranteed death benefit at
their time of death. In order to analyze the total costs that the Company may
incur in the future related to these guaranteed death benefits, the Company
performed an actuarial present value analysis. This analysis included developing
a model utilizing stochastically generated scenarios and best estimate
assumptions related to mortality and lapse rates. A range of projected costs was
developed and discounted back to the financial statement date utilizing the
Company's cost of capital, which for this purpose was assumed to be 9.25%. Based
on this analysis, the Company estimated a 95% confidence interval of the present
value of the retained death benefit costs to be incurred in the future to be a
range of $88 to $282 for these contracts. The median of the stochastically
generated investment performance scenarios was $132. In addition, the Company's
gross and net exposure to GMDB and other benefits in its Japanese operation was
$0.1 billion at December 31, 2003.
On June 30, 2003, the Company recaptured a block of business previously
reinsured with an unaffiliated reinsurer. Under this treaty, Life reinsured a
portion of the GMDB feature associated with certain of its annuity contracts. As
consideration for recapturing the business and final settlement under the
treaty, the Company has received assets valued at approximately $32 and one
million warrants exercisable for the unaffiliated company's stock.
Prospectively, as a result of the recapture, Life will be responsible for all of
the remaining and ongoing risks associated with the GMDB's related to this block
of business. The recapture increased the net amount at risk retained by the
Company, which is included in the net amount at risk discussed above.
On January 1, 2004, the Company adopted the provisions of Statement of Position
03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration
- 68 -
Contracts and for Separate Accounts", (the "SOP"). The provisions of the SOP
include a requirement for recording a liability for variable annuity products
with a guaranteed minimum death benefit feature. The determination of this
liability is also based on models that involve numerous estimates and subjective
judgments, including those regarding expected market rates of return and
volatility, contract surrender rates and mortality experience. As of January 1,
2004, the Company has recorded a liability for GMDB's sold with variable annuity
products of $199 and a related reinsurance recoverable asset of $108. Net of
estimated DAC and income tax effects, the cumulative effect of establishing the
required GMDB reserves resulted in a reduction of net income of $54 during the
first quarter of 2004.
In addition, the Company offers certain variable annuity products with a GMWB
rider. The GMWB provides the policyholder with a guaranteed remaining balance
("GRB") if the account value is reduced to zero through a combination of market
declines and withdrawals. The GRB is generally equal to premiums less
withdrawals. However, annual withdrawals that exceed 7% of the premiums paid may
reduce the GRB by an amount greater than the withdrawals and may also impact the
guaranteed annual withdrawal amount that subsequently applies after the excess
annual withdrawals occur. The policyholder also has the option, after a
specified time period, to reset the GRB to the then-current account value, if
greater. The GMWB represents an embedded derivative liability in the variable
annuity contract that is required to be reported separately from the host
variable annuity contract. It is carried at fair value and reported in other
policyholder funds. The fair value of the GMWB obligations are calculated based
on actuarial assumptions related to the projected cash flows, including benefits
and related contract charges, over the lives of the contracts, incorporating
expectations concerning policyholder behavior. Because of the dynamic and
complex nature of these cash flows, stochastic techniques under a variety of
market return scenarios and other best estimate assumptions are used. Estimating
cash flows involves numerous estimates and subjective judgments including those
regarding expected market rates of return, market volatility, correlations of
market returns and discount rates.
Declines in the equity market may increase the Company's exposure to benefits
under the GMWB contracts. For all contracts in effect through July 6, 2003, the
Company entered into a reinsurance arrangement to offset its exposure to the
GMWB for the remaining lives of those contracts. As of July 6, 2003, the Company
exhausted all but a small portion of the reinsurance capacity for new business
under the current arrangement and will be ceding only a very small number of new
contracts subsequent to July 6, 2003. Substantially all new contracts with the
GMWB are not covered by reinsurance. These unreinsured contracts are expected to
generate volatility in net income as the underlying embedded derivative
liabilities are recorded at fair value each reporting period, resulting in the
recognition of net realized capital gains or losses in response to changes in
certain critical factors including capital market conditions and policyholder
behavior. In order to minimize the volatility associated with the unreinsured
GMWB liabilities, the Company established an alternative risk management
strategy. During the third quarter of 2003, the Company began hedging its
unreinsured GMWB exposure using interest rate futures, Standard and Poor's
("S&P") 500 and NASDAQ index put options and futures contracts.
The net impact of the change in value of the embedded derivative, net of the
results of the hedging program was a $6 pre-tax gain for the year ended December
31, 2003. The net gain is due principally to an approximate $4 gain associated
with international funds for which hedge positions had not been initiated prior
to December 31, 2003 but were initiated in the first quarter of 2004 and $2 due
to modeling refinements to improve valuation estimates. Excluding these items,
ineffectiveness on S&P 500 and NASDAQ economic hedge positions was not
significant.
Currency Exchange Risk
- ----------------------
Currency exchange risk exists with respect to investments in non-US dollar
denominated fixed maturities, primarily denominated in Euro, Sterling, Yen and
Canadian dollars, as well as Life's investment in foreign operations, primarily
Japan.
The functional currency of the Japanese operation is the Japanese yen.
Accordingly, the premiums, claims, commissions and investment income are paid or
received in yen. In addition, most of the Japanese operation's investments are
yen denominated.
The risk associated with these investments relates to potential decreases in
value and income resulting from unfavorable changes in foreign exchange rates.
At December 31, 2003 and 2002, Life had approximately $2.0 billion and $1.2
billion of non-US dollar denominated fixed maturities, respectively. The net
investment in the Japanese operation was approximately $250 and $113, as of
December 31, 2003 and 2002, respectively.
In order to manage its currency exposures, Life enters into foreign currency
swaps to hedge the variability in cash flow associated with certain foreign
denominated fixed maturities. These foreign currency swap agreements are
structured to match the foreign currency cash flows of the hedged foreign
denominated securities. As of December 31, 2002, substantially all the fixed
maturity investments were hedged into US dollars mitigating the foreign currency
exchange risk. In addition, during 2003, Life entered into yen denominated
forwards to hedge a substantial portion of the net investment in the Japanese
operation. At December 31, 2003 and 2002, the derivatives used to hedge currency
exchange risk had a total notional value of $1.6 billion and $1.3 billion,
respectively, and total fair value of $(303) and $(70), respectively.
Based on the fair values of Life's non-US dollar denominated investments and
derivative instruments (including its Japanese operation) as of December 31,
2003 and 2002, management estimates that a 10% unfavorable change in exchange
rates would decrease the fair values by a total of $36 and $13, respectively.
The estimated impact was based upon a 10% change in December 31 spot rates. The
selection of the 10% unfavorable change was made only for hypothetical
illustration of the potential impact of such an event and should not be
construed as a prediction of future market events. Actual results could differ
materially from those illustrated above due to the nature of the estimates and
assumptions used in the above analysis.
- 69 -
PROPERTY & CASUALTY
Property & Casualty attempts to maximize economic value while generating
appropriate after-tax income and sufficient liquidity to meet policyholder and
corporate obligations. Property & Casualty's portfolio has material exposure to
interest rates. The Company continually monitors these exposures and makes
portfolio adjustments to manage these risks within established limits.
Interest Rate Risk
- ------------------
The primary exposure to interest rate risk in Property & Casualty relates to its
fixed maturity investments, including corporate bonds, asset-backed securities,
municipal bonds, commercial mortgage-backed securities and collateralized
mortgage obligations. The fair value of these investments was $23.7 billion and
$19.4 billion at December 31, 2003 and 2002, respectively. The fair value of
these and Property & Casualty's other invested assets fluctuates depending on
the interest rate environment and other general economic conditions. During
periods of declining interest rates, embedded call features within securities
are exercised with greater frequency and paydowns on mortgage-backed securities
and collateralized mortgage obligations increase as the underlying mortgages are
prepaid. During such periods, the Company generally will not be able to reinvest
the proceeds of any such prepayments at comparable yields. Conversely during
periods of rising interest rates, the rate of prepayments generally decline.
Derivative instruments such as swaps, caps and options are used to manage
interest rate risk and had a total notional amount as of December 31, 2003 and
2002 of $1.4 billion and $1.1 billion, respectively, and fair value of $19 and
$36, respectively.
One of the measures Property & Casualty uses to quantify its exposure to
interest rate risk inherent in its invested assets is duration. The weighted
average duration of the fixed maturity portfolio was 4.7 as of December 31, 2003
and 2002.
Calculated Interest Rate Sensitivity
The following table provides an analysis showing the estimated after-tax change
in the fair value of Property & Casualty's fixed maturity investments and
related derivatives, assuming 100 basis point upward and downward parallel
shifts in the yield curve as of December 31, 2003 and 2002. Certain financial
instruments, such as limited partnerships, have been omitted from the analysis
due to the fact the investments are accounted for under the equity method and
lack sensitivity to interest rate changes.
CHANGE IN FAIR VALUE
2003 2002
------------------------------------------
Basis point shift - 100 + 100 - 100 + 100
- -----------------------------------------------------------------
Amount $ 738 $ (714) $ 571 $ (562)
=================================================================
The above quantitative presentation was adopted in the current year and is in
lieu of the tabular presentation used by the Company in previous years. The
Company believes the current presentation is preferable in understanding the
Company's exposure to interest rate risk and how such exposure is managed. The
selection of the 100 basis point parallel shift in the yield curve was made only
for hypothetical illustration of the potential impact of such an event and
should not be construed as a prediction of future market events. Actual results
could differ materially from those illustrated above due to the nature of the
estimates and assumptions used in the above analysis. The Company's sensitivity
analysis calculation assumes that the composition of invested assets remains
materially consistent throughout the year and that the current relationship
between short-term and long-term interest rates will remain constant over time.
As a result, these calculations may not fully capture the impact of portfolio
re-allocations or non-parallel changes in interest rates.
Interest rate risk also exists, to a lesser extent, on debt issued. The table
below provides information as of December 31, 2003 on debt obligations and
reflects principal cash flows and related weighted average interest rates by
maturity year. Comparative totals are included as of December 31, 2002.
2003 2002
2004 2005 2006 2007 2008 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM DEBT
Variable Rate
Amount $ 315 $ -- $ -- $ -- $ -- $ -- $ 315 $ 315
Weighted average interest rate 1.3% -- -- -- -- -- 1.3% 1.5%
Fair value $ 315 $ -- $ -- $ -- $ -- $ -- $ 315 $ 315
LONG-TERM DEBT [1]
Fixed Rate
Amount $ -- $ -- $ -- $ 300 $ 350 $ 1,020 $ 1,670 $ 1,850
Weighted average interest rate -- -- -- 4.7% 5.4% 6.5% 6.0% 6.7%
Fair value $ -- $ -- $ -- $ 314 $ 398 $ 1,102 $ 1,814 $ 1,904
====================================================================================================================================
<FN>
[1] Includes junior subordinated debentures.
</FN>
Currency Exchange Risk
- ----------------------
Currency exchange risk exists with respect to investments in non-US dollar
denominated fixed maturities, primarily Euro, Sterling and Canadian dollar
denominated securities. The risk associated with these securities relates to
potential decreases in value resulting from unfavorable changes in foreign
exchange rates. The fair value of these fixed maturity securities at December
31, 2003 and 2002 was $1.2 billion and $1.0 billion, respectively.
In order to manage its currency exposures, Property & Casualty enters into
foreign currency swaps and forward contracts to hedge the variability in cash
flow associated with certain foreign denominated securities. These foreign
currency swap agreements are structured to match the foreign currency cash flows
of the hedged foreign denominated securities. At
- 70 -
December 31, 2003 and 2002, the derivatives used to hedge currency exchange risk
had a total notional value of $325 and $793, respectively, and total fair value
of $(26) and $(4), respectively.
Based on the fair values of Property & Casualty's non-US dollar denominated
securities and derivative instruments as of December 31, 2003 and 2002,
management estimates that a 10% unfavorable change in exchange rates would
decrease the fair values by a total of approximately $75 and $49, respectively.
The estimated impact was based upon a 10% change in December 31 spot rates. The
selection of the 10% unfavorable change was made only for hypothetical
illustration of the potential impact of such an event and should not be
construed as a prediction of future market events. Actual results could differ
materially from those illustrated above due to the nature of the estimates and
assumptions used in the above analysis.
CORPORATE
Interest Rate Risk
- ------------------
The primary exposure to interest rate risk in Corporate relates to the debt
issued in connection with The HLI Repurchase.
The table below provides information as of December 31, 2003 and 2002 on
Corporate's debt obligations and reflects principal cash flows and related
weighted average interest rates by maturity year. Comparative totals are
included as of December 31, 2003.
2003 2002
2004 2005 2006 2007 2008 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM DEBT [1]
Variable Rate
Amount $ 535 $ -- $ -- $ -- $ -- $ -- $ 535 $ --
Weighted average interest rate 1.3% -- -- -- -- -- 1.3% --
Fair value $ 535 $ -- $ -- $ -- $ -- $ -- $ 535 $ --
LONG-TERM DEBT
Fixed Rate
Amount $ -- $ 250 $ 250 $ -- $ 565 $ 275 $ 1,340 $ 630
Weighted average interest rate -- 7.8% 2.4% -- 2.8% 7.9% 4.7% 7.2%
Fair value $ -- $ 269 $ 248 $ -- $ 681 $ 333 $ 1,531 $ 698
====================================================================================================================================
<FN>
[1] $411 of short-term debt was repaid in January 2004.
</FN>
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND LIQUIDITY
- --------------------------------------------------------------------------------
Capital resources and liquidity represent the overall financial strength of The
Hartford and its ability to generate strong cash flows from each of the business
segments, borrow funds at competitive rates and raise new capital to meet
operating and growth needs.
LIQUIDITY REQUIREMENTS
The liquidity requirements of The Hartford have been and will continue to be met
by funds from operations as well as the issuance of commercial paper, common
stock, debt securities and borrowings from its credit facilities. The principal
sources of operating funds are premiums and investment income, while investing
cash flows originate from maturities and sales of invested assets.
The Hartford endeavors to maintain a capital structure that provides financial
and operational flexibility to its insurance subsidiaries, ratings that support
its competitive position in the financial services marketplace (see the Ratings
section below for further discussion), and strong shareholder returns. As a
result, the Company may from time to time raise capital from the issuance of
stock, debt or other capital securities. The issuance of common stock, debt or
other capital securities could result in the dilution of shareholder interests
or reduced net income due to additional interest expense.
The Hartford Financial Services Group, Inc. ("HFSG") and HLI are holding
companies which rely upon operating cash flow in the form of dividends from
their subsidiaries, which enable them to service debt, pay dividends, and pay
certain business expenses.
Dividends to HFSG from its subsidiaries are restricted. The payment of dividends
by Connecticut-domiciled insurers is limited under the insurance holding company
laws of Connecticut. Under these laws, the insurance subsidiaries may only make
their dividend payments out of unassigned surplus. These laws require notice to
and approval by the state insurance commissioner for the declaration or payment
of any dividend, which, together with other dividends or distributions made
within the preceding twelve months, exceeds the greater of (i) 10% of the
insurer's policyholder surplus as of December 31 of the preceding year or (ii)
net income (or net gain from operations, if such company is a life insurance
company) for the twelve-month period ending on the thirty-first day of December
last preceding, in each case determined under statutory insurance accounting
policies. In addition, if any dividend of a Connecticut-domiciled insurer
exceeds the insurer's earned surplus, it requires the prior approval of the
Connecticut Insurance Commissioner. The insurance holding company laws of the
other jurisdictions in which The Hartford's insurance subsidiaries are
incorporated (or deemed commercially domiciled) generally contain similar
(although in certain instances somewhat more restrictive) limitations on the
payment of dividends. For the year ended December 31, 2003, the Company's
insurance subsidiaries paid $326 to HFSG and HLI and are permitted to pay up to
a maximum of approximately $1.4 billion in dividends to HFSG and HLI in 2004
without prior approval from the applicable insurance commissioner.
The primary uses of funds are to pay claims, policy benefits, operating expenses
and commissions and to purchase new
- 71 -
investments. In addition, The Hartford has a policy of carrying a significant
short-term investment position and accordingly does not anticipate selling
intermediate- and long-term fixed maturity investments to meet any liquidity
needs. (For a discussion of the Company's investment objectives and strategies,
see the Investments and Capital Markets Risk Management sections.)
SOURCES OF LIQUIDITY
Shelf Registrations
- -------------------
On December 3, 2003, The Hartford's shelf registration statement (Registration
No. 333-108067) for the potential offering and sale of debt and equity
securities in an aggregate amount of up to $3.0 billion was declared effective
by the Securities and Exchange Commission. The Registration Statement allows for
the following types of securities to be offered: (i) debt securities, preferred
stock, common stock, depositary shares, warrants, stock purchase contracts,
stock purchase units and junior subordinated deferrable interest debentures of
the Company, and (ii) preferred securities of any of one or more capital trusts
organized by The Hartford ("The Hartford Trusts"). The Company may enter into
guarantees with respect to the preferred securities of any of The Hartford
Trusts. As of December 31, 2003, the Company had $3.0 billion remaining on its
shelf. Subsequently, in January 2004, the Company issued approximately 6.7
million shares of common stock pursuant to an underwritten offering at a price
to the public of $63.25 per share and received net proceeds of $411.
Accordingly, as of February 27, 2004, the Company had $2.6 billion remaining on
its shelf.
On May 15, 2001, HLI filed with the SEC a shelf registration statement for the
potential offering and sale of up to $1.0 billion in debt and preferred
securities. The registration statement was declared effective on May 29, 2001.
As of December 31, 2003, HLI had $1.0 billion remaining on its shelf.
Commercial Paper and Revolving Credit Facilities
- ------------------------------------------------
The table below details the Company's short-term debt programs and the
applicable balances outstanding.
As of December 31,
-----------------------------
Description Effective Date Expiration Date Maximum Available 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 850 $ 315
HLI 2/7/97 N/A 250 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 850 $ 315
Revolving Credit Facility
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ --
3-year revolving credit facility 12/31/02 12/31/05 490 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total Revolving Credit Facilities $ 1,490 $ -- $ --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL OUTSTANDING COMMERCIAL PAPER AND
REVOLVING CREDIT FACILITIES $ 3,740 $ 850 $ 315
====================================================================================================================================
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS
On June 30, 2003, the Company entered into a sale-leaseback of certain furniture
and fixtures with a net book value of $40. The sale-leaseback resulted in a gain
of $15, which was deferred and will be amortized into earnings over the initial
lease term of three years. The lease qualifies as an operating lease for
accounting purposes. At the end of the initial lease term, the Company has the
option to purchase the leased assets, renew the lease for two one-year periods
or return the leased assets to the lessor. If the Company elects to return the
assets to the lessor at the end of the initial lease term, the assets will be
sold, and the Company has guaranteed a residual value on the furniture and
fixtures of $20. If the fair value of the furniture and fixtures were to decline
below the residual value, the Company would have to make up the difference under
the residual value guarantee. Since the estimated fair value of the equipment at
the end of the initial lease term exceeds the residual value, the Company has
not recorded a liability for the residual value guarantee.
The Company has outstanding commitments to fund limited partnership investments.
These capital commitments can be called by the partnership at any time during
the commitment period (on average, 3-6 years) to fund working capital needs or
the purchase of new investments. If the commitment period expires and has not
been fully funded, The Hartford is not required to fund the remaining unfunded
commitment but may elect to do so. The Company is unable to predict the timing
of the funding of these outstanding commitments. The Company also has
outstanding commitments to fund obligations associated with investments in
mortgage loans. These have a commitment period that expires in one year.
The Company does not have any other off-balance sheet arrangements including
letters of credit, guarantees issued on behalf of unconsolidated entities,
trading activities involving non-exchange-traded contracts accounted for at fair
value, obligations under derivative financial instruments indexed to the
Company's stock, retained interests in assets transferred to unconsolidated
entities and obligations arising from a material interest in an unconsolidated
entity, except as disclosed in Note 1 of Notes to Consolidated Financial
Statements.
- 72 -
The following table identifies the Company's aggregate contractual obligations
due by payment period:
PAYMENTS DUE BY PERIOD
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LESS THAN 1 YEAR 1-3 YEARS 3-5 YEARS MORE THAN 5 YEARS
- ------------------------------------------------------------------------------------------------------------------------------------
Long-term debt obligations [1] [2] $ 6,239 $ 752 $ 541 $ 675 $ 4,271
Capital lease obligations -- -- -- -- --
Operating lease obligations 748 161 264 179 144
Purchase obligations [3] 857 698 142 17 --
Other long-term liabilities reflected on the
balance sheet [4] [5] 1,537 1,537 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 9,381 $ 3,148 $ 947 $ 871 $ 4,415
====================================================================================================================================
<FN>
[1] Includes contractual principal and interest payments. Payments exclude
amounts associated with fair-value hedges of certain of the Company's
long-term debt. All long-term debt obligations have fixed rates of
interest.
[2] On February 13, 2004, the Company provided notice that all outstanding 7.2%
junior subordinated debentures underlying trust preferred securities issued
by Hartford Life Capital I have been called for redemption on March 15,
2004. The principal and interest payable upon redemption of $253 has been
reflected in payments due in less than 1 year. Long-term debt obligations
also includes principal and interest payments of $700 and $2.5 billion,
respectively, related to junior subordinated debentures which are callable
beginning in 2006. See Note 8 of Notes to Consolidated Financial
Statements for additional discussion of long-term debt obligations.
[3] Includes $661 in commitments to purchase investments including $324 of
limited partnerships and $140 of mortgage loans. Outstanding commitments
under these limited partnerships and mortgage loans are included in
payments due in less than 1 year since the timing of funding these
commitments cannot be estimated. The remaining $197 relates to payables for
securities purchased which are reflected on the Company's consolidated
balance sheet.
[4] As of December 31, 2003, the Company has accepted cash collateral of $1.2
billion in connection with the Company's derivative instruments. Since the
timing of the return of the collateral is uncertain, the return of the
collateral has been included in the payments due in less than 1 year.
[5] Includes estimated contribution of $300 to the Company's pension plan in
2004.
</FN>
PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company maintains a U.S. qualified defined benefit pension plan (the "Plan")
that covers substantially all employees, as well as unfunded excess plans to
provide benefits in excess of amounts permitted to be paid to participants of
the Plan under the provisions of the Internal Revenue Code. Additionally, the
Company has entered into individual retirement agreements with certain current
and retired directors providing for unfunded supplemental pension benefits. The
Company maintains international plans which represent an immaterial percentage
of total pension assets, liabilities and expense and, for reporting purposes,
are combined with domestic plans.
In September 2003, the Company announced its approval to amend the Plan to
implement, effective January 1, 2009, the cash balance formula for purposes of
calculating future pension benefits for services rendered on or after January 1,
2009 for employees hired before January 1, 2001. These amounts are in addition
to amounts earned through December 31, 2008 under the traditional final average
pay formula. Employees hired on or after January 1, 2001 are currently covered
under the same cash balance formula.
The Company made voluntary contributions of $306, $0 and $90 in 2003, 2002 and
2001, respectively, to its defined benefit pension plan. Pension expense
reflected in the Company's net income was $120, $67 and $57 in 2003, 2002 and
2001, respectively. The Company estimates its 2004 pension expense will be
approximately $122, based on current assumptions provided below. The assumptions
that primarily impact the amount of the Company's pension obligations and
periodic pension expense are the weighted-average discount rate and the Plan
asset portfolio's expected long-term rate of return.
In determining the discount rate assumption, the Company utilizes current market
information provided by its plan actuaries, including a discounted cash flow
analysis of the Company's pension obligation and general movements in the
current market environment. In particular, the Company uses an interest rate
yield curve developed by its plan actuaries to make judgments pursuant to EITF
Topic No. D-36, "Selection of Discount Rates Used for Measuring Defined Benefit
Pension Obligations and Obligations of Postretirement Benefit Plans Other Than
Pensions". The yield curve is comprised of AAA/AA bonds with maturities between
zero and thirty years. Based upon all available information, it was determined
that 6.25% is the appropriate discount rate as of December 31, 2003 to calculate
the Company's accrued benefit cost liability. Accordingly, as prescribed by SFAS
No. 87, "Employers' Accounting for Pensions", the 6.25% discount rate will also
be used to determine the Company's 2004 pension expense. At December 31, 2002
the discount rate was 6.5%.
The Company determines the long-term rate of return assumption for the Plan's
asset portfolio based on analysis of the portfolio's historical compound rates
of return since 1979 (the earliest date for which comparable portfolio data is
available) over rolling 5 year, 10 year and 20 year periods, balanced along with
future long-term return expectations. The Company selected these periods, as
well as shorter durations, to assess the portfolio's volatility, duration and
total returns as they relate to pension obligation characteristics, which are
influenced by the Company's workforce demographics. While the historical return
of the Plan's portfolio has been 10.86% since 1979, management lowered its
long-term rate of return assumption from 9.00% to 8.50% as of December 31, 2003
based on its long-term outlook with respect to the markets, which has been
influenced by the poor equity market performance in recent years coupled with
the recent decline in fixed income security yields.
The Plan's asset portfolio is generally structured over time to include
approximately 60% equity securities (substantially securities issued by United
States-based companies) and 40% fixed income securities (substantially
investment grade and above). At December 31, 2003, the portfolio composition
varied slightly from the targeted mix and was approximately
- 73 -
61% equity securities and 39% fixed income securities due in part to a rebound
in the equity markets and declining interest rates.
As provided for under SFAS No. 87, the Company uses a five-year averaging method
to determine the market-related value of Plan assets, which is used to determine
the expected return component of pension expense. Under this methodology, asset
gains/losses that result from returns that differ from the Company's long-term
rate of return assumption are recognized in the market-related value of assets
on a level basis over a five year period. The actual asset return/(loss) for the
Plan of $334 and $ (119) for the years ended December 31, 2003 and 2002,
respectively, reflects the improved equity market performance in 2003, as
compared to an expected return of $184 and $183 for the years ended December 31,
2003 and 2002, respectively. These differentials will be fully reflected in the
market-related value of Plan assets over the next five years using the
methodology described above. Despite the favorable 2003 actual asset return, the
level of unrecognized net losses continues to exceed the allowable amortization
corridor as defined under SFAS No. 87. Based on the selected 2004 discount rate
of 6.25% and taking into account estimated future minimum funding, the
differential between actual and expected performance in 2003 will decrease
annual pension expense in future years by approximately $7 in 2004 and decrease
by approximately $37 in 2008. Additionally, the decrease in the long-term rate
of return assumption from 9.00% to 8.50% is expected to increase the Company's
annual pension expense by approximately $10.
At December 31, 2003, the change in the discount rate from 6.50% (as of December
31, 2002) to 6.25% (as of December 31, 2003) increased the projected benefit
obligation ("PBO") by $100. The effect of this increase in PBO will serve to
increase annual pension expense by approximately $7, assuming no future changes
in discount rates going forward. In addition, the decrease in discount rate will
also increase the service cost component of pension expense by approximately $5.
Changes in the economic assumptions used to determine pension expense will
impact the Company's pension expense. As mentioned earlier, the two economic
assumptions that have the most impact on pension expense are the discount rate
and the expected long-term rate of return. To illustrate the impact of these
assumptions on annual pension expense for 2004 and going forward, a 25 basis
point change in the discount rate will increase/decrease pension expense by
approximately $12, and a 25 basis point change in the long-term asset return
assumption will increase/decrease pension expense by approximately $5.
While the Company has significant discretion in making voluntary contributions
to the Plan, the Employee Retirement Income Security Act of 1974 regulations
mandate minimum contributions in certain circumstances. Under current
assumptions, assuming no continued pension relief in 2004 the required minimum
funding contributions are estimated to be approximately $160. If Congress
approves pension relief legislation for 2004, the Company is not expected to
have a minimum funding requirement in 2004.
CAPITALIZATION
The capital structure of The Hartford as of December 31, 2003 and 2002 consisted
of debt and equity, summarized as follows:
AS OF DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------------------
2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
Short-term debt (includes current maturities of long-term debt) $ 1,050 $ 315
Long-term debt [1] 4,613 4,064
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL DEBT $ 5,663 $ 4,379
----------------------------------------------------------------------------------------------------------------------------
Equity excluding accumulated other comprehensive income, net of tax ("AOCI") $ 10,393 $ 9,640
AOCI 1,246 1,094
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 11,639 $ 10,734
---------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION INCLUDING AOCI $ 17,302 $ 15,113
---------------------------------------------------------------------------------------------------------------------------
Debt to equity 49% 41%
Debt to capitalization 33% 29%
=================================================================================================================================
<FN>
[1] Includes junior subordinated debentures.
</FN>
The Hartford's total capitalization increased $2.2 billion during the year ended
and as of December 31, 2003 as compared with December 31, 2002. This increase
was due to the capital raising described below, partially offset by dividends
declared and the loss for the year, which reflected the $1.7 billion, after-tax,
charge taken to strengthen reserves for asbestos related exposure.
During the fourth quarter of 2003, the Company increased its capitalization by
$535 through the issuance of commercial paper to finance the acquisition of the
group life and accident, and short term and long term disability business of CNA
Financial Corporation. In January 2004, the company repaid $428 of the
outstanding commercial paper using $411 of proceeds from the common stock
offering.
During the second quarter of 2003, the Company increased its capitalization by
$2.1 billion through the issuance of $1.2 billion in common stock, $669 in
equity units and $249 in senior notes. Contributions of proceeds included: $300
to the Company's qualified pension plan, $150 to the life insurance
subsidiaries, $180 to redeem a portion of its Series A 7.7% Cumulative Quarterly
Income Preferred Securities due February 28, 2016, with the balance to be used
in the property and casualty insurance subsidiaries.
DEBT
The following discussion describes the Company's debt financing activities for
2003.
In December 2003, the Company issued $535 in commercial paper to finance the
acquisition of the group life and accident,
- 74 -
and short term and long term disability businesses of CNA Financial Corporation.
On July 10, 2003, the Company issued 4.625% senior notes due July 15, 2013 and
received net proceeds of $317. Interest on the notes is payable semi-annually on
January 15 and July 15, commencing on January 15, 2004. On July 10, 2003, the
Company issued $320 in aggregate principal amount of its unregistered 4.625%
senior notes, due 2013. The unregistered senior notes were offered and sold only
to qualified institutional buyers in compliance with Rule 144A of the Securities
Act of 1933 and, outside the United States, in compliance with Regulation S of
the Securities Act of 1933. The initial purchasers of the senior notes were Banc
of America Securities LLC, Wachovia Capital Markets, LLC and Banc One Capital
Markets, Inc. The net proceeds from the offering, along with available cash,
were used to redeem $320 net aggregate principal amount of the Company's then
outstanding 7.70% junior subordinated deferrable interest debentures, series A,
due February 28, 2016, underlying the 7.70% cumulative quarterly income
preferred securities, series A, originally issued by Hartford Capital I. On
January 22, 2004, pursuant to terms and conditions set forth in the registration
statement on Form S-4 (Reg. No. 333-110274) effective as of January 20, 2004 and
the related prospectus, the Company commenced an exchange offer whereby the
unregistered senior notes can be exchanged for registered senior notes with
identical terms. The exchange offer terminated on February 25, 2004.
On June 30, 2003, the Company redeemed $180 of its 7.7% junior subordinated
debentures underlying trust preferred securities issued by Hartford Capital I.
On September 30, 2003, the Company redeemed the remaining $320 of its 7.7%
junior subordinated debentures underlying trust preferred securities issued by
Hartford Capital I.
On May 23, 2003, The Hartford issued 12.0 million 7% equity units at a price of
fifty dollars per unit and received net proceeds of $582. Subsequently, on May
30, 2003, The Hartford issued an additional 1.8 million 7% equity units at a
price of fifty dollars per unit and received net proceeds of $87.
On May 23, 2003, The Hartford issued 2.375% senior notes due June 1, 2006 and
received net proceeds of $249. Interest on the notes is payable semi-annually on
June 1 and December 1, commencing on December 1, 2003.
Subsequent event -- On February 13, 2004, the Company provided notice that all
outstanding 7.2% junior subordinated debentures underlying the trust preferred
securities issued by Hartford Life Capital I have been called for redemption on
March 15, 2004. The Company intends to fund the redemption through the issuance
of $150 of commercial paper and the utilization of $100 from internal sources.
For additional information regarding debt, see Note 8 of Notes to Consolidated
Financial Statements.
STOCKHOLDERS' EQUITY
Issuance of common stock -- On May 23, 2003, The Hartford issued approximately
24.2 million shares of common stock pursuant to an underwritten offering at a
price to the public of $45.50 per share and received net proceeds of $1.1
billion. Subsequently, on May 30, 2003, The Hartford issued approximately 2.2
million shares of common stock at a price to the public of $45.50 per share and
received net proceeds of $97. On May 23, 2003 and May 30, 2003, The Hartford
issued 12.0 million 7% equity units and 1.8 million 7% equity units,
respectively. Each equity unit contains a purchase contract obligating the
holder to purchase and The Hartford to sell, a variable number of newly issued
shares of The Hartford's common stock. Upon settlement of the purchase contracts
on August 16, 2006, The Hartford will receive proceeds of approximately $690 and
will deliver between 12.1 million and 15.2 million shares in the aggregate. For
further discussion of the equity units issuance, see Note 8 of Notes to
Consolidated Financial Statements.
Subsequent events-- On January 22, 2004, The Hartford issued approximately 6.3
million shares of common stock pursuant to an underwritten offering at a price
to the public of $63.25 per share and received net proceeds of $388.
Subsequently, on January 30, 2004, The Hartford issued approximately 377,000
shares of common stock pursuant to an underwritten offering at a price to the
public of $63.25 per share and received net proceeds of $23. The Company used
the proceeds from these issuances to repay $411 of commercial paper issued in
connection with the acquisition of the group life and accident, and short-term
and long-term disability business of CNA Financial Corporation.
Dividends -- On October 16, 2003, The Hartford declared a dividend on its common
stock of $0.28 per share payable on January 2, 2004 to shareholders of record as
of December 1, 2003.
The Hartford declared $300 and paid $291 in dividends to shareholders in 2003,
declared $262 and paid $257 in 2002 and declared $242 and paid $235 in 2001.
AOCI - AOCI increased by $152 as of December 31, 2003 compared with December 31,
2002. The increase resulted primarily from the impact of decreased interest
rates on unrealized gains on the fixed maturity portfolio, partially offset by
net losses on cash-flow hedging instruments.
The funded status of the Company's pension and postretirement plans is dependent
upon many factors, including returns on invested assets and the level of market
interest rates. Declines in the value of securities traded in equity markets
coupled with declines in long-term interest rates have had a negative impact on
the funded status of the plans. As a result, the Company recorded a minimum
pension liability as of December 31, 2003, and 2002, which resulted in an
after-tax reduction of stockholders' equity of $375 and $383. respectively. This
minimum pension liability did not affect the Company's results of operations.
For additional information on stockholders' equity and AOCI see Notes 9 and 19,
respectively, of Notes to Consolidated Financial Statements.
CASH FLOW
2003 2002 2001
- -----------------------------------------------------------------
Net cash provided by
operating activities $ 3,896 $ 2,577 $ 2,261
Net cash used for investing
activities $ (8,387) $ (6,600) $ (5,528)
Net cash provided by
financing activities $ 4,608 $ 4,037 $ 3,399
Cash - end of year $ 462 $ 377 $ 353
=================================================================
- 75 -
2003 COMPARED TO 2002-- The increase in cash provided by operating activities
was primarily the result of the 2003 asbestos reserve addition, partially offset
by the related income statement effects of this addition and increases in
reinsurance recoverables. Financing activities increased primarily due to
capital raising activities related to the 2003 asbestos reserve addition and
decreased due to repayments on long-term debt and lower proceeds from investment
and universal life-type contracts. The increase in cash from financing
activities accounted for the majority of the change in cash used for investing
activities.
2002 COMPARED TO 2001 -- The increase in cash provided by operating activities
was primarily the result of higher net income reported for the year ended
December 31, 2002 than for the prior year as well as an increase in income tax
refunds received in 2002 compared with the prior year. The increase in cash
provided by financing activities was primarily the result of increased proceeds
from investment and universal life-type contracts, partially offset by lower
proceeds received from issuances of common stock and no issuances of junior
subordinated debentures in 2002. The increase in cash from financing activities
accounted for the majority of the change in cash for investing activities.
Operating cash flows in each of the last three years have been adequate to meet
liquidity requirements.
ACQUISITIONS
CNA
On December 31, 2003, the Company acquired CNA Financial Corporation's group
life and accident, and short-term and long-term disability businesses for $485
in cash. Purchase consideration for this transaction was obtained from the
issuance of commercial paper. The purchase price paid on December 31, 2003, was
based on a September 30, 2003 valuation of the business acquired. During the
first quarter of 2004, the purchase price will be adjusted to reflect a December
31, 2003 valuation of the business acquired. The Company currently estimates
that adjustment to the purchase price to be an increase of $51, which primarily
reflects the increase in the surplus of the business acquired in the fourth
quarter of 2003.
EQUITY MARKETS
For a discussion of the potential impact of the equity markets on capital and
liquidity, see the Capital Markets Risk Management section under "Market Risk".
RATINGS
Ratings are an important factor in establishing the competitive position in the
insurance and financial services marketplace. There can be no assurance that the
Company's ratings will continue for any given period of time or that they will
not be changed. In the event the Company's ratings are downgraded, the level of
revenues or the persistency of the Company's business may be adversely impacted.
Upon completion of the Company's asbestos reserve study and the Company's
capital-raising activities, certain of the major independent ratings
organizations revised The Hartford's financial ratings as follows:
On May 23, 2003, Fitch affirmed all ratings on The Hartford Financial Services
Group, Inc. including the fixed income ratings and the insurer financial
strength rating of the Hartford Fire Intercompany Pool. Further, these ratings
have been removed from Rating Watch Negative and now have a Stable Rating
Outlook.
On May 20, 2003, Standard & Poor's removed from CreditWatch and affirmed the
long-term counterparty credit and senior debt rating of The Hartford Financial
Services Group, Inc. and the counterparty credit and financial strength ratings
on the operating companies following the Company's completion of capital-raising
activities. The outlook is stable.
On May 14, 2003, Moody's downgraded the debt ratings of both The Hartford
Financial Services Group, Inc. and Hartford Life, Inc. to A3 from A2 and their
short-term commercial paper ratings to P-2 from P-1. The outlook on all of the
ratings except for the P-2 rating on commercial paper is negative.
On May 13, 2003, A.M. Best affirmed the financial strength ratings of A+
(Superior) of The Hartford Fire Intercompany Pool and the main operating life
insurance subsidiaries of HLI. Concurrently, A.M. Best downgraded to "a-" from
"a+" the senior debt ratings of The Hartford Financial Services Group, Inc. and
Hartford Life Inc. and removed the ratings from under review.
The following table summarizes The Hartford's significant United States member
companies' financial ratings from the major independent rating organizations as
of February 27, 2004.
A.M. STANDARD
BEST FITCH & POOR'S MOODY'S
- -----------------------------------------------------------------
INSURANCE FINANCIAL
STRENGTH RATINGS:
Hartford Fire A+ AA AA- Aa3
Hartford Life Insurance
Company A+ AA AA- Aa3
Hartford Life and
Accident A+ AA AA- Aa3
Hartford Life Group
Insurance Company A+ AA AA- --
Hartford Life and
Annuity A+ AA AA- Aa3
OTHER RATINGS:
The Hartford Financial
Services Group, Inc.:
Senior debt a- A A- A3
Commercial paper AMB-2 F1 A-2 P-2
Hartford Capital III
trust originated
preferred securities bbb A- BBB Baa1
Hartford Life, Inc.:
Senior debt a- A A- A3
Commercial paper -- F1 A-2 P-2
Hartford Life, Inc.:
Capital I and II trust
preferred securities bbb A- BBB Baa1
Hartford Life Insurance
Company:
Short Term Rating -- -- A-1+ P-1
=================================================================
These ratings are not a recommendation to buy or hold any of The Hartford's
securities and they may be revised or revoked at any time at the sole discretion
of the rating organization.
- 76 -
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.
2003 2002
- ------------------------------------------------------------------
Life Operations $ 4,470 $ 3,019
Property & Casualty Operations 5,900 4,878
- ------------------------------------------------------------------
TOTAL $ 10,370 $ 7,897
==================================================================
RISK-BASED CAPITAL
The National Association of Insurance Commissioners ("NAIC") has regulations
establishing minimum capitalization requirements based on risk-based capital
("RBC") formulas for both life and property and casualty companies. The
requirements consist of formulas, which identify companies that are
undercapitalized and require specific regulatory actions. The RBC formula for
life companies establishes capital requirements relating to insurance, business,
asset and interest rate risks. RBC is calculated for property and casualty
companies after adjusting capital for certain underwriting, asset, credit and
off-balance sheet risks. As of December 31, 2003, each of The Hartford's
insurance subsidiaries within Life and North American Property & Casualty had
more than sufficient capital to meet the NAIC's minimum RBC requirements.
TERRORISM RISK INSURANCE ACT OF 2002
The Terrorism Risk Insurance Act of 2002 ("the Act") established a program that
will run through 2005 that provides a backstop for insurance-related losses
resulting from any "act of terrorism" certified by the Secretary of the
Treasury, in concurrence with the Secretary of State and Attorney General. Under
the program, the federal government will pay 90% of covered losses after an
insurer's losses exceed a deductible determined by a statutorily prescribed
formula, up to a combined annual aggregate limit for the federal government and
all insurers of $100 billion. If an act of terrorism or acts of terrorism result
in covered losses exceeding the $100 billion annual limit, insurers with losses
exceeding their deductibles will not be responsible for additional losses.
The statutory formula for determining a company's deductible for each year is
based on the company's direct commercial earned premiums for the prior calendar
year multiplied by a specified percentage. The specified percentages are 10% for
2004 and 15% for 2005.
The Act applies to a significant portion of The Hartford's commercial property
and casualty contracts, but it specifically excludes some of The Hartford's
other insurance business, including crop or livestock insurance, reinsurance and
personal lines business. The Act currently does not apply to group life
insurance contracts but permits the Secretary of the Treasury to extend the
backstop protection to them.
On August 15, 2003, the Treasury Department announced that it would not use its
legislatively-granted authority to include group life insurance under the
Federal backstop for terrorism losses in the Terrorism Risk Insurance Act of
2002. In announcing this decision, the Treasury stated that they would continue
to monitor the group life situation.
The Act requires all property and casualty insurers, including The Hartford, to
make terrorism insurance coverage available in all of their covered commercial
property and casualty insurance policies (as defined in the Act). The Hartford
will evaluate risks with terrorism exposures by applying its internally
developed underwriting guidelines and control plans. The Hartford does not
anticipate significant increases in premiums due to the Act.
In the event the Act is not renewed, or is renewed in a materially different
form, the Company may have to attempt to obtain appropriate reinsurance for the
related terrorism risk, seek exclusions from coverage related to terrorism
exposure from the appropriate regulatory authorities, limit certain of its
writings, or pursue a solution encompassing aspects of one or all of the
foregoing.
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 and as an insurer defending coverage claims
brought against it. The Hartford accounts for such activity through the
establishment of unpaid claim and claim adjustment expense reserves. Subject to
the discussion of the litigation involving MacArthur in Part I, Item 3. 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, and improper sales practices in connection
with the sale of life insurance and other investment products. The Hartford also
is involved in individual actions in which punitive damages are sought, such as
claims alleging bad faith in the handling of insurance claims. Management
expects that the ultimate liability, if any, with respect to such lawsuits,
after consideration of provisions made for potential losses and costs of
defense, will not be material to the consolidated financial condition of The
Hartford. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, it is
possible that an adverse outcome in certain matters could, from time to time,
have a material adverse effect on the Company's consolidated results of
operations or cash flows in particular quarterly or annual periods.
- 77 -
Dependence on Certain Third Party Relationships - The Company distributes its
annuity, life and certain property and 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.
For further information on other contingencies, see Note 16 of Notes to
Consolidated Financial Statements.
LEGISLATIVE INITIATIVES
On July 10, 2003, the Senate Judiciary Committee approved legislation that, if
enacted, would provide for the creation of a Federal asbestos trust fund in
place of the current tort system for determining asbestos liabilities. The
prospects for enactment and the ultimate details of any legislation creating a
Federal asbestos trust fund are uncertain. Therefore, any potential effect on
the Company's financial condition or results of operations cannot be reasonably
estimated at this time.
Certain elements of the Jobs and Growth Tax Relief Reconciliation Act of 2003,
in particular the reduction in tax rates on long-term capital gains and most
dividend distributions, could have a material effect on the Company's sales of
variable annuities and other investment products. While sales of these products
do not appear to have been reduced to date, the long-term effect of the Jobs and
Growth Act of 2003 on the Company's financial condition or results of operations
cannot be reasonably estimated at this time.
There are proposals in the federal 2005 budget submitted by President Bush which
would create new investment vehicles with larger annual contribution limits for
individuals. Some of these proposed vehicles would have significant tax
advantages, and could have a material effect on sales of the Company's life
insurance and investment products. There also have been proposals regarding the
estate tax and deferred compensation arrangements that could have negative
effects on the Company's product sales. Prospects for enactment of this
legislation in 2004 are uncertain. Therefore, any potential effect on the
Company's financial condition or results of operations cannot be reasonably
estimated at this time.
In addition, other tax proposals and regulatory initiatives which have been or
are being considered by Congress could have a material effect on the insurance
business. These proposals and initiatives include changes pertaining to the tax
treatment of insurance companies and life insurance products and annuities, and
reductions in benefits currently received by the Company stemming from the
dividends received deduction. Legislation to restructure the Social Security
system and expand private pension plans incentives also may be considered.
Prospects for enactment and the ultimate effect of these proposals are
uncertain.
Congress is expected to consider provisions regarding age discrimination in
defined benefit plans, transition relief for older and longer service workers
affected by changes to traditional defined benefit pension plans and the
replacement of the interest rate used to determine pension plan funding
requirements. These changes could affect the Company's pension plan.
Congress may consider a number of legal reform proposals this year. Among them
is legislation that would reduce the number and type of national class actions
certified by state judges by updating the federal rules on diversity
jurisdiction. Prospects for enactment of these proposals in 2004 are uncertain.
INSOLVENCY FUND
In all states, insurers licensed to transact certain classes of insurance are
required to become members of an insolvency fund. In most states, in the event
of the insolvency of an insurer writing any such class of insurance in the
state, members of the fund are assessed to pay certain claims of the insolvent
insurer. A particular state's fund assesses its members based on their
respective written premiums in the state for the classes of insurance in which
the insolvent insurer is engaged. Assessments are generally limited for any year
to one or two percent of premiums written per year depending on the state. Such
assessments paid by The Hartford approximated $26 in 2003, $26 in 2002 and $6 in
2001.
- --------------------------------------------------------------------------------
EFFECT OF INFLATION
- --------------------------------------------------------------------------------
The rate of inflation as measured by the change in the average consumer price
index has not had a material effect on the revenues or operating results of The
Hartford during the three most recent fiscal years.
- --------------------------------------------------------------------------------
IMPACT OF NEW ACCOUNTING STANDARDS
- --------------------------------------------------------------------------------
For a discussion of accounting standards, see Note 1 of Notes to Consolidated
Financial Statements.
In July 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 03-1,
"Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts" (the "SOP"). The SOP
addresses a wide variety of topics, some of which have a significant impact on
the Company. The major provisions of the SOP require:
- - Recognizing expenses for a variety of contracts and contract features,
including guaranteed minimum death benefits ("GMDB"), certain death benefits
on universal-life type contracts and annuitization options, on an accrual
basis versus the previous method of recognition upon payment;
- - Reporting and measuring assets and liabilities of certain separate account
products as general account assets and liabilities when specified criteria
are not met;
- - Reporting and measuring the Company's interest in its separate accounts as
general account assets based on the
- 78 -
insurer's proportionate beneficial interest in the separate account's
underlying assets; and
- - Capitalizing sales inducements that meet specified criteria and amortizing
such amounts over the life of the contracts using the same methodology as
used for amortizing deferred acquisition costs ("DAC").
The SOP is effective for financial statements for fiscal years beginning after
December 15, 2003. At the date of initial application, January 1, 2004, the
estimated cumulative effect of the adoption of the SOP on net income and other
comprehensive income was comprised of the following individual impacts:
Cumulative Effect of Adoption Net Income Other Comprehensive Income
- ------------------------------------------------------------------------------------------------------------------------------------
Establishing GMDB and other benefit
reserves for annuity contracts $(54) $--
Reclassifying certain separate accounts to
general accounts 30 294
Other (1) (2)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CUMULATIVE EFFECT OF ADOPTION $(25) $292
====================================================================================================================================
Exclusive of the cumulative effect, overall application of the SOP is expected
to have a small positive impact to earnings over the next few years, with
individual impacts described below.
Death Benefits and Other Insurance Benefit Features
The Company sells variable annuity contracts that offer various guaranteed death
benefits. For certain guaranteed death benefits, Life 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. As of January 1, 2004, the Company has recorded a liability for GMDB
and other benefits sold with variable annuity products of $199 and a related
reinsurance recoverable asset of $108. The determination of the GMDB liability
and related reinsurance recoverable is based on models that involve a range of
scenarios and assumptions, including those regarding expected market rates of
return and volatility, contract surrender rates and mortality experience. The
assumptions used are consistent with those used in determining estimated gross
profits for purposes of amortizing deferred acquisition costs. Exclusive of the
cumulative effect adjustment, the establishment of the required liability at
January 1, 2004 is expected to result in slightly higher earnings in future
years as well as a more stable pattern of death benefit expense.
The Company sells universal life-type contracts with certain secondary
guarantees, such as a guarantee that the policy will not lapse, even if the
account value is reduced to zero, as long as the policyholder makes scheduled
premium payments. The assumptions used in the determination of the secondary
guarantee liability are consistent with those used in determining estimated
gross profits for purposes of amortizing deferred policy acquisition costs.
Based on current estimates, the Company expects the cumulative effect on net
income upon recording this liability to be not material. The establishment of
the required liability will change the earnings pattern of these products,
lowering earnings in the early years of the contract and increasing earnings in
the later years. Based on the current in-force of these products, the impact is
not expected to be material in the near term. Currently there is diversity in
industry practice and inconsistent guidance surrounding the application of the
SOP to universal life-type contracts. The Company believes consensus or further
guidance surrounding the methodology for determining reserves for secondary
guarantees will develop in the future. This may result in an adjustment to the
cumulative effect of adopting the SOP and could impact future earnings.
Separate Account Presentation
The Company has recorded certain market value adjusted ("MVA") fixed annuity and
modified guarantee life insurance products (primarily the Company's Compound
Rate Contract ("CRC") and associated assets) as separate account assets and
liabilities through December 31, 2003. Notwithstanding the market value
adjustment feature in this product, all of the investment performance of the
separate account assets is not being passed to the contractholder, and it
therefore, does not meet the conditions for separate account reporting under the
SOP. On January 1, 2004, the cumulative adjustments to earnings and other
comprehensive income as a result of recording the separate account assets and
liabilities in the general account were recorded net of amortization of deferred
acquisition costs and income taxes. Through December 31, 2003, the Company had
recorded CRC assets and liabilities on a market value basis with all changes in
value (market value spread) included in current earnings as a component of other
revenues. Upon adoption of the SOP, the component of CRC spread on a book value
basis will be recorded in net investment income and interest credited. Realized
gains and losses on investments and market value adjustments on contract
surrenders will be recognized as incurred. On balance, exclusive of the
cumulative effect gain recognized, these changes will result in smaller future
earnings from the in-force block of CRC contracts.
The Company has also recorded its variable annuity products offered in Japan in
separate account assets and liabilities through December 31, 2003. As the
separate account arrangement in Japan is not legally insulated from the general
account liabilities of the Company, it does not meet the conditions for separate
account reporting under the SOP. The adoption of the SOP will not change the
pattern of earnings in the future.
Certain other products offered by the Company recorded in separate account
assets and liabilities through December 31, 2003, were reclassified to the
general account upon adoption of the SOP.
- 79 -
Interests in Separate Accounts
As of December 31, 2003, the Company had $24 representing unconsolidated
interests in its own separate accounts. On January 1, 2004, the Company
reclassified $11 to investment in trading securities, where the Company's
proportionate beneficial interest in the separate account was less than 20%. In
instances where the Company's proportionate beneficial interest was between
20-50%, the Company reclassified $13 of its investment to reflect the Company's
proportionate interest in each of the underlying assets of the separate account.
Future impacts to net income as a result of adopting these provisions of the SOP
will be insignificant.
Sales Inducements
The Company currently offers enhanced or bonus crediting rates to
contract-holders on certain of its individual and group annuity products.
Effective January 1, 2004, upon adopting the SOP, the future expense associated
with offering a bonus will be deferred and amortized over the life of the
related contract in a pattern consistent with the amortization of deferred
acquisition costs. Effective January 1, 2004, amortization expense associated
with expenses previously deferred will be recorded over the remaining life of
the contract rather than over the contingent deferred sales charge period. Due
to the longer deferral periods, this provision is expected to have a small
positive impact to earnings in future periods.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth in the Capital Markets Risk
Management section of the Management's Discussion and Analysis of Financial
Condition and Results of Operations and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements and Schedules elsewhere herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's principal executive officer and its principal financial officer,
based on their evaluation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) have concluded that the Company's
disclosure controls and procedures are adequate and effective for the purposes
set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of
December 31, 2003.
CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change in the Company's internal control over financial reporting
that occurred during the Company's fourth fiscal quarter of 2003 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE HARTFORD
Certain of the information called for by Item 10 will be set forth in the
definitive proxy statement for the 2004 annual meeting of shareholders (the
"Proxy Statement") to be filed by The Hartford with the Securities and Exchange
Commission within 120 days after the end of the fiscal year covered by this Form
10-K under the captions "Item 1 Election of Directors", "Common Stock Ownership
of Directors, Executive Officers and Certain Shareholders", and "Governance of
the Company" and is incorporated herein by reference.
The Company has adopted a Code of Ethics and Corporate Conduct, which is
applicable to all employees of the Company, including the principal executive
officer, the principal financial officer and the principal accounting officer.
The Code of Ethics and Corporate Conduct is available on the Company's website
at: www.thehartford.com.
-------------------
EXECUTIVE OFFICERS OF THE HARTFORD
Information about the executive officers of The Hartford who are also nominees
for election as directors will be set forth in The Hartford's Proxy Statement.
Set forth below is information about the other executive officers of the
Company:
ANN M. DE RAISMES
(Group Senior Vice President, Human Resources)
Ms. de Raismes, 53, has held the position of Group Senior Vice President, Human
Resources, of the Company since March 2003. She previously served as Senior Vice
President of Human Resources of Hartford Life, Inc. ("Hartford Life"), a
wholly-owned subsidiary of the Company, from 1997 to March 2003. Ms. de Raismes
joined Hartford Life in 1984 as Manager of Staffing, and served successively at
Hartford Life as Assistant Director of Life Personnel from 1987 to 1991, as
Director of Human Resources from 1991 to 1992, as Assistant Vice President,
Human Resources from 1992 to 1994 and as Vice President from 1994 to 1997.
DAVID M. JOHNSON
(Executive Vice President and Chief Financial Officer)
Mr. Johnson, 43, has held the position of Executive Vice President and Chief
Financial Officer of the Company since May 1, 2001. Prior to joining the
Company, Mr. Johnson was Senior Executive Vice President and Chief Financial
Officer of Cendant Corporation since November 1998 and Managing Director,
Investment Banking Division, at Merrill Lynch, Pierce, Fenner and Smith from
1986 to 1998.
- 80 -
ROBERT J. PRICE
(Senior Vice President and Controller)
Mr. Price, 53, is Senior Vice President and Controller of the Company. Mr. Price
joined the Company in June 2002 in his current role. Prior to joining the
company, Mr. Price was President and Chief Executive Officer of CitiInsurance,
the international insurance indirect subsidiary of Citigroup, Inc., from May
2000 to December 2001. From April 1989 to April 2000, Mr. Price held various
positions at Aetna, Inc., including Senior Vice President and Chief Financial
Officer of Aetna International and Vice President and Corporate Controller.
NEAL S. WOLIN
(Executive Vice President and General Counsel)
Mr. Wolin, 42, has held the position of Executive Vice President and General
Counsel since joining the Company on March 20, 2001. Previously, Mr. Wolin
served as General Counsel of the U.S. Treasury from 1999 to January 2001. In
that capacity, he headed Treasury's legal division, composed of 2,000 lawyers
providing services to all of Treasury's offices and bureaus, including the
Internal Revenue Service, Customs, Secret Service, Public Debt, the Office of
Thrift Supervision, the Financial Management Service, the U.S. Mint and the
Bureau of Engraving and Printing. Mr. Wolin served as the Deputy General Counsel
of the Department of the Treasury from 1995 to 1999. Prior to joining the
Treasury Department, he served in the White House, first as the Executive
Assistant to the National Security Advisor and then as the Deputy Legal Advisor
to the National Security Council. Mr. Wolin joined the U.S. Government in 1991
as special assistant to the Directors of Central Intelligence, William H.
Webster, Robert M. Gates and R. James Woolsey.
DAVID M. ZNAMIEROWSKI
(Group Senior Vice President and Chief Investment Officer)
Mr. Znamierowski, 43, was appointed Group Senior Vice President and Chief
Investment Officer of the Company and President of Hartford Investment
Management, a wholly-owned subsidiary of the Company, effective November 5,
2001. Previously, he was Senior Vice President and Chief Investment Officer for
the Company's life operations since May 1999, Vice President since September
1998 and Vice President, Investment Strategy since February 1997. Prior to
joining the Company in April 1996, Mr. Znamierowski held a variety of positions
in the investment industry, including portfolio manager and Vice President of
Investment Strategy and Policy for Aetna Life & Casualty Company from 1991 to
April 1996 and Vice President of Corporate Finance for Salomon Brothers, Inc.
from 1986 to 1991. He also serves as a director and President of each of The
Hartford-sponsored mutual funds.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 will be set forth in the Proxy Statement
under the captions "Compensation of Executive Officers", "Governance of the
Company-Compensation of Directors" and "Performance of the Common Stock" and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Certain of the information called for by Item 12 will be set forth in the Proxy
Statement under the caption "Common Stock Ownership of Directors, Executive
Officers and Certain Shareholders" and is incorporated herein by reference.
Certain other information called for by Item 12 is set forth in Item 5 herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Any information called for by Item 13 will be set forth in the Proxy Statement
under the caption "Common Stock Ownership of Directors, Executive Officers and
Certain Shareholders" and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by Item 14 will be set forth in the Proxy Statement
under the caption "Audit Committee Charter and Report Concerning Financial
Matters - Fees to Independent Auditors for Years Ended December 31, 2003 and
2002" and is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Documents filed as a part of this report:
1. CONSOLIDATED FINANCIAL STATEMENTS. See Index to Consolidated Financial
Statements elsewhere herein.
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES. See Index to Consolidated
Financial Statement Schedules elsewhere herein.
3. EXHIBITS. See Exhibit Index elsewhere herein.
Reports on Form 8-K - During the fourth quarter of 2003, The Hartford filed the
following Current Reports on Form 8-K:
Filed December 2, 2003, Item 5, Other Events, to report the Company's
agreement to acquire certain group benefits businesses from CNA Financial
Corporation.
Filed December 23, 2003, Item 5, Other Events, to report the Company's
agreement to a global settlement of all claims arising out of its historical
insurance relationship with Mac Arthur Company and its subsidiary, Western
MacArthur Company.
(a) See Item 15(a)(3).
See Item 15(a)(2).
- 81 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page(s)
Report of Management F-1
Independent Auditors' Report F-2
Consolidated Statements of Operations for the three years ended
December 31, 2003 F-3
Consolidated Balance Sheets as of December 31, 2003 and 2002 F-4
Consolidated Statements of Changes in Stockholders' Equity for the
three years ended December 31, 2003 F-5
Consolidated Statements of Comprehensive Income for the three years
ended December 31, 2003 F-5
Consolidated Statements of Cash Flows for the three years ended
December 31, 2003 F-6
Notes to Consolidated Financial Statements F-7-51
Summary of Investments - Other Than Investments in Affiliates S-1
Condensed Financial Information of The Hartford Financial Services
Group, Inc. S-2-3
Supplementary Insurance Information S-4
Reinsurance S-5
Valuation and Qualifying Accounts S-6
Supplemental Information Concerning Property and Casualty Insurance
Operations S-6
REPORT OF MANAGEMENT
The management of The Hartford Financial Services Group, Inc. and its
subsidiaries ("The Hartford") is responsible for the preparation and integrity
of information contained in the accompanying consolidated financial statements
and other sections of the Annual Report. The financial statements are prepared
in accordance with accounting principles generally accepted in the United States
of America and, where necessary, include amounts that are based on management's
informed judgments and estimates. Management believes these statements present
fairly The Hartford's financial position and results of operations, and that any
other information contained in the Annual Report is consistent with the
financial statements.
Management has made available The Hartford's financial records and related data
to Deloitte & Touche LLP, independent auditors, in order for them to perform
their audits of The Hartford's consolidated financial statements. Their report
appears on page F-2.
An essential element in meeting management's financial responsibilities is The
Hartford's system of internal controls. These controls, which include accounting
controls and The Hartford's internal auditing program, are designed to provide
reasonable assurance that assets are safeguarded, and transactions are properly
authorized, executed and recorded. The controls, which are documented and
communicated to employees in the form of written codes of conduct and policies
and procedures, provide for careful selection of personnel and for appropriate
division of responsibility. Management continually monitors for compliance,
while The Hartford's internal auditors independently assess the effectiveness of
the controls and make recommendations for improvement.
Another important element is management's recognition and acknowledgement within
the organization of its responsibility for fostering a strong, ethical climate,
thereby firmly establishing an expectation that The Hartford's affairs be
transacted according to the highest standards of personal and professional
conduct. The Hartford has a long-standing reputation of integrity in business
conduct and utilizes communication and education to create and fortify a strong
compliance culture.
The Audit Committee of the Board of Directors of The Hartford, composed of
independent directors, meets periodically with the external and internal
auditors to evaluate the effectiveness of work performed by them in discharging
their respective responsibilities and to ensure their independence and free
access to the Committee.
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have audited the accompanying consolidated balance sheets of The Hartford
Financial Services Group, Inc. and its subsidiaries (collectively, the
"Company") as of December 31, 2003 and 2002, and the related consolidated
statements of operations, changes in stockholders' equity, comprehensive income
and cash flows for each of the three years in the period ended December 31,
2003. Our audits also included the financial statement schedules listed in the
Index at Item 15. These financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and financial statement
schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The Hartford Financial Services
Group, Inc. and its subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
As discussed in Note 1 of the consolidated financial statements, the Company
changed its method of accounting for goodwill and indefinite-lived intangible
assets in 2002. In addition, the Company changed its method of accounting for
derivative instruments and hedging activities and its method of accounting for
the recognition of interest income and impairment on purchased retained
beneficial interests in securitized financial assets in 2001.
Deloitte & Touche LLP
Hartford, Connecticut
February 25, 2004
F-2
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31,
---------------------------------------------
(In millions, except for per share data) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------
REVENUES
Earned premiums $ 11,891 $ 10,811 $ 10,242
Fee income 2,760 2,577 2,633
Net investment income 3,233 2,929 2,842
Other revenues 556 476 491
Net realized capital gains (losses) 293 (376) (228)
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 18,733 16,417 15,980
-------------------------------------------------------------------------------------------------------------------
BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 13,548 10,034 10,597
Amortization of deferred policy acquisition costs and present value of
future profits 2,411 2,241 2,214
Insurance operating costs and expenses 2,424 2,317 2,037
Goodwill amortization -- -- 60
Other expenses 900 757 731
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 19,283 15,349 15,639
-------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGES (550) 1,068 341
Income tax expense (benefit) (459) 68 (200)
- ----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES
(91) 1,000 541
Cumulative effect of accounting changes, net of tax -- -- (34)
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (91) $ 1,000 $ 507
-------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE
Income (loss) before cumulative effect of accounting changes $ (0.33) $ 4.01 $ 2.27
Cumulative effect of accounting changes, net of tax -- -- (0.14)
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (0.33) $ 4.01 $ 2.13
DILUTED EARNINGS (LOSS) PER SHARE
Income (loss) before cumulative effect of accounting changes $ (0.33) $ 3.97 $ 2.24
Cumulative effect of accounting changes, net of tax -- -- (0.14)
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (0.33) $ 3.97 $ 2.10
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 272.4 249.4 237.7
Weighted average common shares outstanding and dilutive potential common
shares 272.4 251.8 241.4
- ----------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per share $ 1.09 $ 1.05 $ 1.01
============================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31,
-----------------------------------
(In millions, except for share data) 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments
Fixed maturities, available-for-sale, at fair value (amortized cost of $58,127 and $46,241) $ 61,263 $ 48,889
Equity securities, available-for-sale, at fair value (cost of $505 and $937) 565 917
Policy loans, at outstanding balance 2,512 2,934
Other investments 1,507 1,790
- -----------------------------------------------------------------------------------------------------------------------------------
Total investments 65,847 54,530
Cash 462 377
Premiums receivable and agents' balances 3,085 2,611
Reinsurance recoverables 5,958 5,027
Deferred policy acquisition costs and present value of future profits 7,599 6,689
Deferred income taxes 845 545
Goodwill 1,720 1,721
Other assets 3,704 3,397
Separate account assets 136,633 107,078
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 225,853 $ 181,975
===========================================================================================================================
LIABILITIES
Reserve for future policy benefits and unpaid claims and claim adjustment expenses
Property and casualty $ 21,715 $ 17,091
Life 11,402 8,567
Other policyholder funds and benefits payable 26,185 23,956
Unearned premiums 4,423 3,989
Short-term debt 1,050 315
Long-term debt 4,613 4,064
Other liabilities 8,193 6,181
Separate account liabilities 136,633 107,078
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 214,214 171,241
===========================================================================================================================
COMMITMENTS AND CONTINGENCIES (NOTE 16)
STOCKHOLDERS' EQUITY
Common stock -750,000,000 shares authorized, 286,339,430 and 258,184,483 shares issued,
$0.01 par value 3 3
Additional paid-in capital 3,929 2,784
Retained earnings 6,499 6,890
Treasury stock, at cost - 2,959,692 and 2,943,565 shares (38) (37)
Accumulated other comprehensive income 1,246 1,094
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 11,639 10,734
===========================================================================================================================
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 225,853 $ 181,975
===========================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the years ended December 31,
---------------------------------------------------
(In millions, except for share data) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK/ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year $ 2,787 $ 2,364 $ 1,688
Issuance of common stock in underwritten offerings 1,161 330 569
Issuance of equity units (112) (33) --
Issuance of shares and compensation expense associated with incentive
and stock compensation plans 83 101 93
Tax benefit on employee stock options and awards 13 25 14
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year 3,932 2,787 2,364
- -----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance at beginning of year 6,890 6,152 5,887
Net income (loss) (91) 1,000 507
Dividends declared on common stock (300) (262) (242)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year 6,499 6,890 6,152
- -----------------------------------------------------------------------------------------------------------------------------------
TREASURY STOCK, AT COST
Balance at beginning of year (37) (37) (480)
Issuance of common stock in underwritten offerings -- -- 446
Issuance (return) of shares under incentive and stock compensation plans (1) -- 4
Treasury stock acquired -- -- (7)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year (38) (37) (37)
- -----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of year 1,094 534 369
Change in unrealized gain/loss on securities, net of tax
Change in unrealized gain/loss on securities 320 838 110
Cumulative effect of accounting change -- -- (1)
Change in net gain/loss on cash-flow hedging instruments, net of tax
Change in net gain/loss on cash-flow hedging instruments (170) 65 39
Cumulative effect of accounting change -- -- 24
Foreign currency translation adjustments (6) 21 (3)
Minimum pension liability adjustment, net of tax 8 (364) (4)
- -----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income 152 560 165
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year 1,246 1,094 534
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 11,639 $ 10,734 $ 9,013
===================================================================================================================================
OUTSTANDING SHARES (IN THOUSANDS)
Balance at beginning of year 255,241 245,536 226,290
Issuance of common stock in underwritten offerings 26,377 7,303 17,042
Issuance of shares under incentive and stock compensation plans 1,778 2,402 2,331
Return of shares under incentive and stock compensation plans to (16) -- --
treasury stock
Treasury stock acquired -- -- (127)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at end of year 283,380 255,241 245,536
===================================================================================================================================
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31,
--------------------------------------------------
(In millions) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME
Net income (loss) $ (91) $ 1,000 $ 507
- -----------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income
Change in unrealized gain/loss on securities, net of tax
Change in unrealized gain/loss on securities 320 838 110
Cumulative effect of accounting change -- -- (1)
Change in net gain/loss on cash-flow hedging instruments, net of tax
Change in net gain/loss on cash-flow hedging instruments (170) 65 39
Cumulative effect of accounting change -- -- 24
Foreign currency translation adjustments (6) 21 (3)
Minimum pension liability adjustment, net of tax 8 (364) (4)
- -----------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income 152 560 165
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME $ 61 $ 1,560 $ 672
===================================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
-------------------------------------------------
(In millions) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ (91) $ 1,000 $ 507
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING
ACTIVITIES
Amortization of deferred policy acquisition costs and present value
of future profits 2,411 2,241 2,214
Additions to deferred policy acquisition costs and present value of future
profits (3,313) (2,859) (2,739)
Change in:
Reserve for future policy benefits, unpaid claims and claim adjustment
expenses and unearned premiums 5,597 1,654 2,703
Reinsurance recoverables (1,105) 191 (599)
Receivables (47) (280) (245)
Payables and accruals 576 (2) 442
Accrued and deferred income taxes (327) 202 (119)
Net realized capital (gains) losses (293) 376 228
Depreciation and amortization 219 104 85
Cumulative effect of accounting changes, net of tax -- -- 34
Other, net 269 (50) (250)
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,896 2,577 2,261
===================================================================================================================================
INVESTING ACTIVITIES
Purchase of investments (28,918) (21,338) (16,871)
Sale of investments 17,320 12,017 9,858
Maturity of investments 3,731 2,910 2,760
Purchase of business/affiliate, net of cash acquired (464) -- (1,105)
Sale of affiliates 33 -- 39
Additions to property, plant and equipment, net (89) (189) (209)
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH USED FOR INVESTING ACTIVITIES (8,387) (6,600) (5,528)
===================================================================================================================================
FINANCING ACTIVITIES
Issuance of short-term debt, net 535 16 264
Issuance of long-term debt 1,235 617 1,084
Repayment of long-term debt (500) (300) (700)
Issuance of common stock in underwritten offering 1,162 330 1,015
Net receipts from investment and universal life-type contracts charged
against policyholder accounts 2,409 3,539 1,901
Dividends paid (291) (257) (235)
Return of shares under incentive and stock compensation plans to treasury (1) -- --
Acquisition of treasury stock -- -- (7)
Proceeds from issuances of shares under incentive and stock compensation
plans 59 92 77
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,608 4,037 3,399
- -----------------------------------------------------------------------------------------------------------------------------------
Foreign exchange rate effect on cash (32) 10 (6)
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in cash 85 24 126
Cash - beginning of year 377 353 227
- -----------------------------------------------------------------------------------------------------------------------------------
CASH - END OF YEAR $ 462 $ 377 $ 353
===================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- ------------------------------------------------
NET CASH PAID (RECEIVED) DURING THE YEAR FOR:
Income taxes $ (107) $ (102) $ (52)
Interest $ 258 $ 260 $ 275
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR PER SHARE DATA, UNLESS OTHERWISE STATED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries
("The Hartford" or the "Company") provide investment products and life and
property and casualty insurance to both individual and business customers in the
United States and internationally.
On December 31, 2003, the Company acquired the group life and accident, and
short-term and long-term disability business of CNA Financial Corporation.
Accordingly, there was no impact to the Company's results of operations for the
year ended December 31, 2003. For further discussion of the CNA Financial
Corporation acquisition, see Note 18.
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 operations. For further discussion of the Fortis acquisition, see Note 18.
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States of America, which
differ materially from the accounting practices prescribed by various insurance
regulatory authorities. Subsidiaries in which The Hartford has at least a 20%
interest, but less than a majority ownership interest, are reported using the
equity method. All material intercompany transactions and balances between The
Hartford, its subsidiaries and affiliates have been eliminated.
USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The most significant estimates include those used in determining reserves for
future policy benefits and unpaid claim and claim adjustment expenses; deferred
policy acquisition costs; investments; pension and other postretirement
benefits; and commitments and contingencies.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
ADOPTION OF NEW ACCOUNTING STANDARDS
In January 2004, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") No. FAS 106-1, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003", which addresses the accounting and disclosure implications that are
expected to arise as a result of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") enacted on December 8, 2003. The Act
introduces a prescription drug benefit under Medicare as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least equivalent to Medicare. The issue is whether any employer that
provides postretirement prescription drug coverage should recognize the effects
of the Act on the benefit obligation and net periodic postretirement benefit
cost and, if so, when and how to account for those costs. Under FSP No. FAS
106-1, companies have a one-time election to defer the effects of the new
legislation in financial statements ending after December 7, 2003. The Company
has elected to defer the effects of the Act. Companies electing to defer
recognition of the effects must defer recognition until the FASB issues
clarifying guidance on how the legislation should be interpreted. All measures
of the benefit obligation and net periodic postretirement benefit costs included
in the consolidated financial statements and Note 12 do not reflect the effects
of the Act. Future guidance, when issued by the FASB, could require the Company
to restate previously reported information. The Company is in the process of
reviewing the provisions of the Act in conjunction with the Company's
postretirement benefit plan and does not expect the impact of the Act to be
significant.
In December 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 132 (revised 2003), "Employers' Disclosures about Pensions and
Other Postretirement Benefits". This standard requires additional detailed
disclosures regarding pension plan assets, benefit obligations, cash flows,
benefit costs and related information. With the exception of disclosures related
to foreign plans, the new disclosures are required to be provided in annual
statements of public entities with fiscal years ending after December 15, 2003.
Companies with foreign plans may defer certain disclosures until fiscal years
ending after June 15, 2004. The Company adopted the new disclosure requirements
for all plans, including the foreign plans as of December 31, 2003. See Note 12.
Effective December 31, 2003, the Company adopted the disclosure requirements of
Emerging Issues Task Force ("EITF") Issue No. 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments".
Under the consensus, disclosures are required for unrealized losses on fixed
maturity and equity securities accounted for under SFAS No. 115, "Accounting for
Certain Investment in Debt and Equity Securities", and SFAS No. 124, "Accounting
for Certain Investments Held by Not-for-Profit Organizations", that are
classified as either available-for-sale or held-to-maturity. The disclosure
requirements include quantitative information regarding the aggregate amount of
unrealized losses and the associated fair value of the investments in an
unrealized loss position, segregated into time periods for which the investments
have been in an unrealized loss position. The consensus also requires certain
qualitative disclosures about the unrealized holdings in order to provide
additional information that the Company considered in concluding that the
unrealized losses
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
were not other-than-temporary. (For further discussion, see disclosures in Note
3.)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. Generally, SFAS No. 150 requires
liability classification for two broad classes of financial instruments: (a)
instruments that represent, or are indexed to, an obligation to buy back the
issuer's shares regardless of whether the instrument is settled on a net-cash or
gross-physical basis and (b) obligations that (i) can be settled in shares but
derive their value predominately from another underlying instrument or index
(e.g. security prices, interest rates, and currency rates), (ii) have a fixed
value, or (iii) have a value inversely related to the issuer's shares.
Mandatorily redeemable equity and written options requiring the issuer to
buyback shares are examples of financial instruments that should be reported as
liabilities under this new guidance.
SFAS No. 150 specifies accounting only for certain freestanding financial
instruments and does not affect whether an embedded derivative must be
bifurcated and accounted for in accordance with SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities".
SFAS No. 150 is effective for instruments entered into or modified after May 31,
2003 and for all other instruments beginning with the first interim reporting
period beginning after June 15, 2003. Adoption of this statement did not have a
material impact on the Company's consolidated financial condition or results of
operations.
In April 2003, the FASB issued guidance in Statement 133 Implementation Issue
No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt
Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only
Partially Related to the Creditworthiness of the Obligor of Those Instruments",
("DIG B36") that addresses the instances in which bifurcation of an instrument
into a debt host contract and an embedded derivative is required. The effective
date of DIG B36 was October 1, 2003. DIG B36 indicates that bifurcation is
necessary in a modified coinsurance arrangement when the yield on the receivable
and payable is based on a specified proportion of the ceding company's return on
either its general account assets or a specified block of those assets, rather
than the overall creditworthiness of the ceding company. The Company has
evaluated its modified coinsurance and funds withheld agreements and believes
all but one are not impacted by the provisions of DIG B36. The one modified
coinsurance agreement that requires the separate recording of an embedded
derivative contains two total return swap embedded derivatives that virtually
offset each other. Due to the offsetting nature of these total return swaps, the
net value of the embedded derivatives in the modified coinsurance agreement had
no material effect on the consolidated financial statements upon adoption of DIG
B36 on October 1, 2003 and at December 31, 2003.
DIG B36 is also applicable to corporate issued debt securities that incorporate
credit risk exposures that are unrelated or only partially related to the
creditworthiness of the obligor. The adoption of DIG B36, as it relates to
corporate issued debt securities, did not have a material effect on the
Company's consolidated financial condition or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". The Statement amended and
clarified accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133.
SFAS No. 149 amends SFAS No. 133 for decisions made as part of the Derivatives
Implementation Group ("DIG") process that effectively required amendments to
SFAS No. 133, in connection with other FASB projects dealing with financial
instruments. SFAS No. 149 also clarifies under what circumstances a contract
with an initial net investment and purchases and sales of when-issued securities
that do not yet exist meet the characteristics of a derivative as discussed in
SFAS No. 133. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003, except as stated below and for hedging relationships designated after June
30, 2003. The provisions of this Statement should be applied prospectively,
except as stated below.
The provisions of SFAS No. 149 that relate to SFAS No. 133 DIG issues that have
been effective for fiscal quarters that began prior to June 15, 2003, should
continue to be applied in accordance with their respective effective dates. In
addition, the guidance in SFAS No. 149 related to forward purchases or sales of
when-issued securities or other securities that do not yet exist, should be
applied to both existing contracts and new contracts entered into after June 30,
2003. The adoption of SFAS No. 149 did not have a material impact on the
Company's consolidated financial condition or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"), which
requires an enterprise to assess whether consolidation of an entity is
appropriate based upon its interests in a variable interest entity ("VIE"). A
VIE is an entity in which the equity investors do not have the characteristics
of a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. The initial determination of whether an entity is a
VIE shall be made on the date at which an enterprise becomes involved with the
entity. An enterprise shall consolidate a VIE if it has a variable interest that
will absorb a majority of the VIEs expected losses if they occur, receive a
majority of the entity's expected residual returns if they occur or both. FIN 46
was effective immediately for new VIEs established or purchased subsequent to
January 31, 2003. For VIEs established or purchased subsequent to January 31,
2003, the adoption of FIN 46 did not have a material impact on the Company's
consolidated financial condition or results of operations as there were no
material VIEs identified which required consolidation.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
In December 2003, the FASB issued a revised version of FIN 46 ("FIN 46R"), which
incorporates a number of modifications and changes made to the original version.
FIN 46R replaces the previously issued FIN 46 and, subject to certain special
provisions, is effective no later than the end of the first reporting period
that ends after December 15, 2003 for entities considered to be special-purpose
entities and no later than the end of the first reporting period that ends after
March 15, 2004 for all other VIEs. Early adoption is permitted. The Company
adopted FIN 46R in the fourth quarter of 2003. The adoption of FIN 46R did not
result in the consolidation of any material VIEs but resulted in the
deconsolidation of VIEs that issued Mandatorily Redeemable Preferred Securities
of Subsidiary Trusts ("trust preferred securities"). The Company is not the
primary beneficiary of the VIEs, which issued the trust preferred securities.
The Company does not own any of the trust preferred securities which were issued
to unrelated third parties. These trust preferred securities are considered the
principal variable interests issued by the VIEs. As a result, the VIEs, which
the Company previously consolidated, are no longer consolidated. The sole assets
of the VIEs are junior subordinated debentures issued by the Company with
payment terms identical to the trust preferred securities. Previously, the trust
preferred securities were reported as a separate liability on the Company's
consolidated balance sheets as "company obligated mandatorily redeemable
preferred securities of subsidiary trusts holding solely junior subordinated
debentures". At December 31, 2003 and 2002, the impact of deconsolidation was to
increase long-term debt and decrease the trust preferred securities by $952 and
$1.5 billion, respectively. (For further discussion, see Note 8 for disclosure
of information related to these VIEs as required under FIN 46R.)
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45" or the "Interpretation"). FIN 45 requires
certain guarantees to be recorded at fair value and also requires a guarantor to
make new disclosures, even when the likelihood of making payments under the
guarantee is remote. In general, the Interpretation applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying instrument or
indices (e.g., security prices, interest rates, or currency rates) that are
related to an asset, liability or an equity security of the guaranteed party.
The recognition provisions of FIN 45 are effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 15, 2002. For further discussion, see Notes 3 and
16. Adoption of this statement did not have a material impact on the Company's
consolidated financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and supercedes
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("Issue 94-3"). The principal difference between SFAS No.
146 and Issue 94-3 is that SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred, rather than at the date of an entity's commitment to an exit plan.
SFAS No. 146 is effective for exit or disposal activities initiated after
December 31, 2002. Adoption of SFAS No. 146 resulted in a change in the timing
of when a liability is recognized for certain restructuring activities after
December 31, 2002. Adoption of this statement did not have a material impact on
the Company's consolidated financial condition or results of operations.
In April 2002, the FASB issued 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
extinguishments 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. In the fourth quarter of 2002, the
Company early adopted the provisions of SFAS No. 145 related to the rescission
of SFAS No. 4, "Reporting Gains and Losses from Early Extinguishment of Debt",
retroactively and reclassified the 2001 extraordinary loss from early retirement
of debt of $13, before-tax, to other expenses. 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.
Effective September 2001, the Company adopted EITF Issue No. 01-10, "Accounting
for the Impact of the Terrorist Attacks of September 11, 2001". Under the
consensus, costs related to the terrorist act should be reported as part of
income from continuing operations and not as an extraordinary item. The Company
has recognized and classified all direct and indirect costs associated with the
attack of September 11 in accordance with the consensus. For discussion of the
impact of the September 11 terrorist attack ("September 11"), see Note 2.
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
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
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, effective January 1, 2002, 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.
SFAS No. 142 also requires that useful lives for intangibles other than goodwill
be reassessed and the remaining amortization periods be adjusted accordingly.
For further discussion of the impact of SFAS No. 142, see Note 5.
Effective April 1, 2001, the Company adopted EITF Issue No. 99-20, "Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets". Under the consensus, investors in certain
securities with contractual cash flows, primarily asset-backed securities, are
required to periodically update their best estimate of cash flows over the life
of the security. If the fair value of the securitized financial asset is less
than its carrying amount and there has been a decrease in the present value of
the estimated cash flows since the last revised estimate, considering both
timing and amount, an other-than-temporary impairment charge is recognized. The
estimated cash flows are also used to evaluate whether there have been any
changes in the securitized asset's estimated yield. All yield adjustments are
accounted for on a prospective basis. Upon adoption of EITF Issue No. 99-20, the
Company recorded an $11 charge as the net of tax cumulative effect of the
accounting change.
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS Nos. 137 and
138. The standard requires, among other things, that all derivatives be carried
on the balance sheet at fair value. The standard also specifies hedge accounting
criteria under which a derivative can qualify for special accounting. In order
to receive special accounting, the derivative instrument must qualify as a hedge
of either the fair value or the variability of the cash flow of a qualified
asset or liability, or forecasted transaction. Special accounting for qualifying
hedges provides for matching the timing of gain or loss recognition on the
hedging instrument with the recognition of the corresponding changes in value of
the hedged item. The Company's policy prior to adopting SFAS No. 133 was to
carry its derivative instruments on the balance sheet in a manner similar to the
hedged item(s).
Upon adoption of SFAS No. 133, the Company recorded a $23 charge as the net of
tax cumulative effect of the accounting change. This transition adjustment was
primarily comprised of gains and losses on derivatives that had been previously
deferred and not adjusted to the carrying amount of the hedged item. Also
included in the transition adjustment were gains and losses related to
recognizing at fair value all derivatives that are designated as fair-value
hedging instruments offset by the difference between the book values and fair
values of related hedged items attributable to the hedged risks. The entire
transition amount was previously recorded in Accumulated Other Comprehensive
Income ("AOCI") - Unrealized Gain/Loss on Securities in accordance with SFAS No.
115. Gains and losses on derivatives that were previously deferred as
adjustments to the carrying amount of hedged items were not affected by the
implementation of SFAS No. 133. Upon adoption, the Company also reclassified
$24, net of tax, to AOCI - Gain/(Loss) on Cash-Flow Hedging Instruments from
AOCI - Unrealized Gain/(Loss) on Securities. This reclassification reflects the
January 1, 2001 net unrealized gain for all derivatives that were designated as
cash-flow hedging instruments. For further discussion of the Company's
derivative-related accounting policies, see the Investment section of Note 1.
FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AcSEC") issued Statement of Position
03-3, "Accounting for Certain Loans or Debt Securities " (SOP 03-3). SOP 03-3
addresses the accounting for differences between contractual and expected cash
flows to be collected from an investment in loans or fixed maturity securities
(collectively hereafter referred to as "loan(s)") acquired in a transfer if
those differences are attributable, at least in part, to credit quality. SOP
03-3 limits the yield that may be accreted to the excess of the estimated
undiscounted expected principal, interest and other cash flows over the initial
investment in the loan. SOP 03-3 also requires that the excess of contractual
cash flows over cash flows expected to be collected not be recognized as an
adjustment of yield, loss accrual or valuation allowance. SOP 03-3 is effective
for loans acquired in fiscal years beginning after December 15, 2004. For loans
acquired in fiscal years beginning on or before December 15, 2004 and within the
scope of Practice Bulletin 6 "Amortization of Discounts on Certain Acquired
Loans", SOP 03-3, as it pertains to decreases in cash flows expected to be
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
collected, should be applied prospectively for fiscal years beginning after
December 15, 2004. Adoption of this statement is not expected to have a material
impact on the Company's consolidated financial condition or results of
operations.
In July 2003, AcSEC issued a final Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" (the "SOP"). The SOP addresses a wide
variety of topics, some of which have a significant impact on the Company. The
major provisions of the SOP require:
o Recognizing expenses for a variety of contracts and contract features,
including guaranteed minimum death benefits ("GMDB"), certain death
benefits on universal-life type contracts and annuitization options, on an
accrual basis versus the previous method of recognition upon payment;
o Reporting and measuring assets and liabilities of certain separate account
products as general account assets and liabilities when specified criteria
are not met;
o Reporting and measuring the Company's interest in its separate accounts as
general account assets based on the insurer's proportionate beneficial
interest in the separate account's underlying assets; and
o Capitalizing sales inducements that meet specified criteria and amortizing
such amounts over the life of the contracts using the same methodology as
used for amortizing deferred acquisition costs ("DAC").
The SOP is effective for financial statements for fiscal years beginning after
December 15, 2003. At the date of initial application, January 1, 2004, the
estimated cumulative effect of the adoption of the SOP on net income and other
comprehensive income was comprised of the following individual impacts:
Other
Net Comprehensive
Cumulative Effect of Adoption Income Income
- --------------------------------------------------------------------
Establishing GMDB and other benefit
reserves for annuity contracts [1] $(54) $--
Reclassifying certain separate
accounts to general accounts 30 294
Other (1) (2)
- --------------------------------------------------------------------
Total cumulative effect of adoption $(25) $292
- --------------------------------------------------------------------
[1] As of September 30, 2003, the Company estimated the cumulative effect of
adopting this provision of the SOP to be between $30 and $40, net of
amortization of DAC and taxes. During the fourth quarter, industry and the
largest public accounting firms reached general consensus on how to record
the reinsurance recovery asset related to GMDB's. This refinement resulted
in the increase to the cumulative effect adjustment as of January 1, 2004.
Death Benefits and Other Insurance Benefit Features
- ---------------------------------------------------
The Company sells variable annuity contracts that offer various guaranteed death
benefits. For certain guaranteed death benefits, the Company pays the greater of
(1) the account value at death; (2) the sum of all premium payments less prior
withdrawals; or (3) the maximum anniversary value of the contract, plus any
premium payments since the contract anniversary, minus any withdrawals following
the contract anniversary. The Company currently reinsures a significant portion
of these death benefit guarantees associated with its in-force block of
business. As of January 1, 2004, the Company has recorded a liability for GMDB
and other benefits sold with variable annuity products of $199 and a related
reinsurance recoverable asset of $108. The determination of the GMDB liability
and related reinsurance recoverable is based on models that involve a range of
scenarios and assumptions, including those regarding expected market rates of
return and volatility, contract surrender rates and mortality experience. The
assumptions used are consistent with those used in determining estimated gross
profits for purposes of amortizing deferred acquisition costs.
Through December 31, 2003, the Company had not recorded a liability for the
risks associated with GMDB offered on the Company's variable annuity business,
but had consistently recorded the related expenses in the period the benefits
were paid to contractholders. Net of reinsurance, the Company paid $54 and $49
for the years ended December 31, 2003 and 2002, respectively, in GMDB benefits
to contractholders.
At December 31, 2003, the Company held $92.4 billion of variable annuities that
contained guaranteed minimum death benefits. The Company's total gross exposure
(i.e. before reinsurance), or net amount at risk (the amount by which current
account values in the variable annuity contracts are not sufficient to meet its
GMDB commitments), related to these guaranteed death benefits as of December 31,
2003 was $11.5 billion. Due to the fact that 80% of this amount was reinsured,
the Company's net exposure was $2.3 billion. 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.
The Individual Life segment sells universal life-type contracts with certain
secondary guarantees, such as a guarantee that the policy will not lapse, even
if the account value is reduced to zero, as long as the policyholder makes
scheduled premium payments. The assumptions used in the determination of the
secondary guarantee liability are consistent with those used in determining
estimated gross profits for purposes of amortizing deferred policy acquisition
costs. Based on current estimates, the Company expects the cumulative effect on
net income upon recording this liability to be not material. The establishment
of the required liability will change the earnings pattern of these products,
lowering earnings in the early years of the contract and increasing earnings in
the later years. Currently there is diversity in industry practice and
inconsistent guidance surrounding the application of the SOP to universal
life-type contracts. The Company believes consensus or further guidance
surrounding the methodology for determining reserves for secondary guarantees
will develop in the future. This may result in an adjustment to the cumulative
effect of adopting the SOP and could impact future earnings.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
Separate Account Presentation
- -----------------------------
The Company has recorded certain market value adjusted ("MVA") fixed annuity
products and modified guarantee life insurance (primarily the Company's Compound
Rate Contract ("CRC") and associated assets) as separate account assets and
liabilities through December 31, 2003. Notwithstanding the market value
adjustment feature in this product, all of the investment performance of the
separate account assets is not being passed to the contractholder, and it
therefore, does not meet the conditions for separate account reporting under the
SOP. On January 1, 2004, market value reserves included in separate account
liabilities for CRC, of $10.8 billion, were revalued at current account value in
the general account to $10.1 billion. The related separate account assets of
$11.0 billion were also reclassified to the general account. Fixed maturities
and equity securities were reclassified to the general account, as available for
sale securities, and will continue to be recorded at fair value, however,
subsequent changes in fair value, net of amortization of deferred acquisition
costs and income taxes, will be recorded in other comprehensive income rather
than net income. On January 1, 2004, the Company recorded a cumulative effect
adjustment to earnings equal to the revaluation of the liabilities from fair
value to account value plus the adjustment to record unrealized gains (losses)
on available for sale invested assets, previously recorded as a component of net
income, as other comprehensive income. The cumulative adjustments to earnings
and other comprehensive income were recorded net of amortization of deferred
acquisition costs and income taxes. Through December 31, 2003, the Company had
recorded CRC assets and liabilities on a market value basis with all changes in
value (market value spread) included in current earnings as a component of other
revenues. Upon adoption of the SOP, the components of CRC spread on a book value
basis will be recorded in interest income and interest credited. Realized gains
and losses on investments and market value adjustments on contract surrenders
will be recognized as incurred.
The Company has also recorded its variable annuity products offered in Japan in
separate account assets and liabilities through December 31, 2003. As the
separate account arrangement in Japan is not legally insulated from the general
account liabilities of the Company, it does not meet the conditions for separate
account reporting under the SOP. On January 1, 2004, separate account
liabilities in Japan of $6.2 billion recorded at account value in the separate
account, were reclassified to the general account with no change in value. The
related separate account assets of $6.2 billion were also reclassified to the
general account with no change in value. The separate account assets are
primarily comprised of equity securities. These assets were recorded at fair
value in a trading securities portfolio and the subsequent changes in fair value
will be reflected in net investment income.
Certain other products offered by the Company recorded in separate account
assets and liabilities through December 31, 2003, were reclassified to the
general account upon adoption of the SOP.
Interests in Separate Accounts
- ------------------------------
As of December 31, 2003, the Company had $24 representing unconsolidated
interests in its own separate accounts. These interests were recorded as
available for sale equity securities, with changes in fair value recorded
through other comprehensive income. On January 1, 2004, the Company reclassified
$11 to investment in trading securities, where the Company's proportionate
beneficial interest in the separate account was less than 20%. Trading
securities are recorded at fair value with changes in fair value recorded to net
investment income. In instances where the Company's proportionate beneficial
interest was between 20-50%, the Company reclassified $13 of its investment to
reflect the Company's proportionate interest in each of the underlying assets of
the separate account. The Company has designated its proportionate interest in
these equity securities and fixed maturities as available-for-sale.
Sales Inducements
- -----------------
The Company currently offers enhanced or bonus crediting rates to
contract-holders on certain of its individual and group annuity products.
Through December 31, 2003, the expense associated with offering certain of these
bonuses was deferred and amortized over the contingent deferred sales charge
period. Others were expensed as incurred. Effective January 1, 2004, upon
adopting the SOP, the future expense associated with offering a bonus will be
deferred and amortized over the life of the related contract in a pattern
consistent with the amortization of deferred acquisition costs. Effective
January 1, 2004, amortization expense associated with expenses previously
deferred will be recorded over the remaining life of the contract rather than
over the contingent deferred sales charge period.
In May 2003, the EITF reached a consensus in EITF Issue No. 03-4, "Determining
the Classification and Benefit Attribution Method for a Cash Balance Pension
Plan", that cash balance plans should be considered defined benefit plans for
purposes of applying SFAS No. 87, "Employers' Accounting for Pension Plans". The
EITF also concluded that the attribution method used to determine the benefit
for the entire plan for certain cash balance plans should be the traditional
unit credit method. The consensus is effective as of the next measurement date
of the plan, which is December 31, 2003, for the Company's cash balance plan.
Any difference between the evaluation under the previous attribution method and
the new attribution method should be recognized as an actuarial gain or loss.
Adoption of this issue is not expected to have a material impact on the
Company's consolidated financial condition or results of operations.
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123", which provides three optional transition methods for entities that decide
to voluntarily adopt the fair value recognition principles of SFAS No. 123,
"Accounting for Stock-Based Compensation", and modifies the disclosure
requirements of SFAS No. 123. In January 2003, the Company adopted the fair
value recognition provisions of accounting for employee stock compensation and
used the prospective transition method. Under the prospective method,
stock-based compensation expense is recognized for awards granted or modified
after the beginning of the fiscal year in which the change is made. The fair
value of stock-based awards granted during the year ended December 31, 2003 was
$42, after-tax. The fair value of these awards will be recognized as expense
over the awards' vesting periods, generally three years.
All stock-based awards granted or modified prior to January 1, 2003 will
continue to be valued using the intrinsic value-based provisions set forth in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees". Under the intrinsic value method, compensation expense is
determined on the measurement date, which is the first date on which both the
number of shares the employee is entitled to receive and the exercise price are
known. Compensation expense, if any, is measured based on the award's intrinsic
value, which is the excess of the market price of the stock over the exercise
price on the measurement date. The expense, including non-option plans, related
to stock-based employee compensation included in the determination of net income
for the years ended December 31, 2003, 2002 and 2001 is less than that which
would have been recognized if the fair value method had been applied to all
awards since the effective date of SFAS No. 123. For further discussion of the
Company's stock-based compensation plans, see Note 11.
The following table illustrates the effect on net income (loss) and earnings
(loss) per share (basic and diluted) as if the fair value method had been
applied to all outstanding and unvested awards in each period.
For the years ended December 31,
------------------------------------------------
(In millions, except for per share data) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ (91) $ 1,000 $ 507
Add: Stock-based employee compensation expense included in reported net income
(loss), net of related tax effects [1] 20 6 8
Deduct: Total stock-based employee compensation expense determined under the
fair value method for all awards, net of related tax effects (50) (59) (52)
- ----------------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) [2] $ (121) $ 947 $ 463
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic - as reported $ (0.33) $ 4.01 $ 2.13
Basic - pro forma [2] $ (0.44) $ 3.80 $ 1.95
Diluted - as reported [3] $ (0.33) $ 3.97 $ 2.10
Diluted - pro forma [2] [3] $ (0.44) $ 3.76 $ 1.92
==================================================================================================================================
<FN>
[1] Includes the impact of non-option plans of $6, $3 and $6 for the years
ended December 31, 2003, 2002 and 2001, respectively.
[2] The pro forma disclosures are not representative of the effects on net
income (loss) and earnings (loss) per share in future years.
[3] As a result of the net loss for the year ended December 31, 2003, SFAS No.
128, "Earnings Per Share", requires the Company to use basic weighted
average common shares outstanding in the calculation of the year ended
December 31, 2003 diluted earnings (loss) per share, since the inclusion of
options of 1.8 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 274.2.
</FN>
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 2003, 2002 and 2001:
2003 2002 2001
- ------------------------------------------------------------------
Dividend yield 2.3% 1.6% 1.6%
Expected price variability 39.8% 40.8% 29.1%
Risk-free interest rate 2.77% 4.27% 4.98%
Expected life 6 years 6 years 6 years
- ------------------------------------------------------------------
The use of the fair value recognition method results in compensation expense
being recognized in the financial statements at different amounts and in
different periods than the related income tax deduction. Generally, the
compensation expense recognized under SFAS No. 123 will result in a deferred tax
asset since the stock compensation expense is not deductible for tax until the
option is exercised. Deferred tax assets arising under SFAS No. 123 are
evaluated as to future realizability to determine whether a valuation allowance
is necessary. (For further discussion, see Note 15.)
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" as defined in SFAS No. 115. Accordingly, these securities
are carried at fair value with the after-tax difference from amortized cost, as
adjusted for the effect of deducting the life and pension policyholders' share
of the immediate participation guaranteed contracts and certain life and annuity
deferred policy acquisition costs, reflected in stockholders' equity as a
component of AOCI. Policy loans are carried at outstanding
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
balance, which approximates fair value. Other investments primarily consist of
limited partnership interests, derivatives and mortgage loans. The limited
partnerships are accounted for under the equity method and accordingly the
partnership earnings are included in net investment income. Derivatives are
carried at fair value and mortgage loans on real estate are recorded at the
outstanding principal balance adjusted for amortization of premiums or discounts
and net of valuation allowances, if any.
Valuation of Fixed Maturities
The fair value for fixed maturity securities is largely determined by one of
three primary pricing methods: independent third party pricing services,
independent broker quotations or pricing matrices, which use data provided by
external sources. With the exception of short-term securities for which
amortized cost is predominantly used to approximate fair value, security pricing
is applied using a hierarchy or "waterfall" approach whereby prices are first
sought from independent pricing services with the remaining unpriced securities
submitted to brokers for prices or lastly priced via a pricing matrix.
Prices from independent pricing services are often unavailable for securities
that are rarely traded or are traded only in privately negotiated transactions.
As a result, a significant percentage of the Company's asset-backed and
commercial mortgage-backed securities are priced via broker quotations. A
pricing matrix is used to price securities for which the Company is unable to
obtain either a price from a third party service or an independent broker
quotation. The pricing matrix begins with current treasury rates and uses credit
spreads and issuer-specific yield adjustments received from an independent third
party source to determine the market price for the security. The credit spreads
incorporate the issuer's credit rating as assigned by a nationally recognized
rating agency and a risk premium, if warranted, due to the issuer's industry and
security's time to maturity. The issuer-specific yield adjustments, which can be
positive or negative, are updated twice annually, as of June 30 and December 31,
by an independent third-party source and are intended to adjust security prices
for issuer-specific factors. The matrix-priced securities at December 31, 2003
and 2002, primarily consisted of non-144A private placements and have an average
duration of 4.6.
The following table identifies the fair value of fixed maturity securities by
pricing source as of December 31, 2003 and 2002:
2003 2002
------------------------------------------ ---------------------------------------
General Account Fixed Percentage of General Account Fixed Percentage of
Maturities at Fair Value Total Fair Maturities at Fair Total Fair
Value Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
Priced via independent market quotations $ 51,554 84.2% $ 40,391 82.5%
Priced via broker quotations 3,090 5.0% 3,987 8.2%
Priced via matrices 3,297 5.4% 2,373 4.9%
Priced via other methods 209 0.3% 151 0.3%
Short-term investments [1] 3,113 5.1% 1,987 4.1%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 61,263 100.0% $ 48,889 100.0%
====================================================================================================================================
<FN>
[1] Short-term investments are valued at amortized cost, which approximates
fair value.
</FN>
The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. As such, the estimated fair value of a
financial instrument may differ significantly from the amount that could be
realized if the security was sold immediately.
Other-Than-Temporary Impairments
One of the significant estimations inherent in the valuation of investments is
the evaluation of other-than-temporary impairments. The evaluation of
impairments is a quantitative and qualitative process, which is subject to risks
and uncertainties and is intended to determine whether declines in the fair
value of investments should be recognized in current period earnings. The risks
and uncertainties include changes in general economic conditions, the issuer's
financial condition or near term recovery prospects and the effects of changes
in interest rates. The Company's accounting policy requires that a decline in
the value of a security below its amortized cost basis be assessed to determine
if the decline is other-than-temporary. If so, the security is deemed to be
other-than-temporarily impaired, and a charge is recorded in net realized
capital losses equal to the difference between the fair value and amortized cost
basis of the security. The fair value of the other-than-temporarily impaired
investment becomes its new cost basis. The Company has a security monitoring
process overseen by a committee of investment and accounting professionals that
identifies securities that, due to certain characteristics, as described below,
are subjected to an enhanced analysis on a quarterly basis.
Securities not subject to EITF Issue No. 99-20 ("non-EITF Issue No. 99-20
securities"), that are depressed by twenty percent or more for six months are
presumed to be other-than-temporarily impaired unless the depression is the
result of rising interest rates or significant objective verifiable evidence
supports that the security price is temporarily depressed and is expected to
recover within a reasonable period of time. Non-EITF Issue No.
99-20 securities depressed less than twenty percent or depressed twenty percent
or more but for less than six months are also reviewed to determine if an
other-than-temporary impairment is present. The primary factors considered in
evaluating whether a decline in value for non-EITF Issue No. 99-20 securities is
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
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, credit rating
and near-term prospects of the issuer, (c) whether the debtor is current on
contractually obligated interest and principal payments and (d) the intent and
ability of the Company to retain the investment for a period of time sufficient
to allow for recovery.
For certain securitized financial assets with contractual cash flows (including
asset-backed securities), EITF Issue No. 99-20 requires the Company to
periodically update its best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
carrying amount and there has been a decrease in the present value of the
estimated cash flows since the last revised estimate, considering both timing
and amount, then an other-than-temporary impairment charge is recognized.
Projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral.
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 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 additional other-than-temporary
impairments.
Net Realized Capital Gains and Losses
Net realized capital gains and losses on security transactions associated with
the Company's immediate participation guaranteed contracts are recorded and
offset by amounts owed to policyholders and were $1 for the years ended December
31, 2003, 2002, and 2001. Under the terms of the contracts, the net realized
capital gains and losses will be credited to policyholders in future years as
they are entitled to receive them. Net realized capital gains and losses, after
deducting the life and pension policyholders' share and related amortization of
deferred policy acquisition costs for certain Life products, are reported as a
component of revenues and are determined on a specific identification basis.
Net Investment Income
Interest income from fixed maturities is recognized when earned on a constant
effective yield basis. The Company stops recognizing interest income when it
does not expect to receive amounts in accordance with the contractual terms of
the security. Net investment income on these investments is recognized only when
interest payments are received.
DERIVATIVE INSTRUMENTS
Overview
- --------
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards, futures and options 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. (For a further discussion,
see Note 3.)
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 the State of New York insurance departments. The Company does
not make a market or trade in these instruments for the express purpose of
earning short-term trading profits.
Accounting and Financial Statement Presentation of Derivative Instruments and
- --------------------------------------------------------------------------------
Hedging Activities
- ------------------
Effective January 1, 2001, and in accordance with SFAS No. 133, all derivatives
are recognized on the balance sheet at their fair value. Fair value is based
upon either independent market quotations for exchange traded derivative
contracts, independent third party pricing sources or pricing valuation models
which utilize independent third party data as inputs The derivative contracts
are reported as assets or liabilities in other investments and other
liabilities, respectively, in the consolidated balance sheets, excluding
embedded derivatives and guaranteed minimum withdrawal benefit ("GMWB")
reinsurance contracts. Embedded derivatives are recorded in the consolidated
balance sheets with the associated host instrument. GMWB reinsurance contract
amounts are recorded in reinsurance recoverables in the consolidated balance
sheets.
On the date the derivative contract is entered into, the Company designates the
derivative as (1) a hedge of the fair value of a recognized asset or liability
("fair value" hedge), (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash-flow" hedge), (3) a foreign-currency, fair value or
cash-flow hedge ("foreign-currency" hedge), (4) a hedge of a net investment in a
foreign operation or (5) held for other investment and risk management
activities, which primarily involve managing asset or liability related risks
which do not qualify for hedge accounting under SFAS No. 133.
Fair-Value Hedges
Changes in the fair value of a derivative that is designated and qualifies as a
fair-value hedge, along with the changes in the fair value of the hedged asset
or liability that is attributable to the hedged risk, are recorded in current
period earnings with any differences between the net change in fair value of
derivative and the hedged item representing the hedge ineffectiveness. Periodic
derivative net coupon settlements are recorded in net investment income.
Cash-Flow Hedges
Changes in the fair value of a derivative that is designated and qualifies as a
cash-flow hedge are recorded in AOCI and are reclassified into earnings when the
variability of the cash flow of the hedged item impacts earnings. Gains and
losses on
F-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
derivative contracts that are reclassified from AOCI to current period earnings
are included in the line item in the consolidated statements of operations in
which the hedged item is recorded. Any hedge ineffectiveness is recorded
immediately in current period earnings. Periodic derivative net coupon
settlements are recorded in net investment income.
Foreign-Currency Hedges
Changes in the fair value of derivatives that are designated and qualify as
foreign-currency hedges are recorded in either current period earnings or AOCI,
depending on whether the hedged transaction is a fair-value hedge or a cash-flow
hedge, respectively. Any hedge ineffectiveness is recorded immediately in
current period earnings. Periodic derivative net coupon settlements are recorded
in net investment income.
Net Investment in a Foreign Operation Hedges
Changes in fair-value of a derivative used as a hedge of a net investment in a
foreign operation, to the extent effective as a hedge, are recorded in the
foreign currency translation adjustments account within AOCI. Cumulative changes
in fair value recorded in AOCI are reclassified into earnings upon the sale or
complete or substantially complete liquidation of the foreign entity. Any hedge
ineffectiveness is recorded immediately in current period earnings. Periodic
derivative net coupon settlements are recorded in net investment income.
Other Investment and Risk Management Activities
The Company's other investment and risk management activities primarily relate
to strategies used to reduce economic risk or enhance income, and do not receive
hedge accounting treatment under SFAS No. 133. Changes in the fair value,
including periodic net coupon settlements, of derivative instruments held for
other investment and risk management purposes are reported in current period
earnings as net realized capital gains and losses. During 2003, the Company
began recording periodic net coupon settlements in net realized capital gains
and losses and reclassified prior period amounts to conform to the current year
presentation.
Hedge Documentation and Effectiveness Testing
- ---------------------------------------------
At hedge inception, the Company formally documents all relationships between
hedging instruments and hedged items, as well as its risk-management objective
and strategy for undertaking each hedge transaction. In connection with the
implementation of SFAS No. 133, the Company designated anew all existing hedge
relationships. The documentation process includes linking all derivatives that
are designated as fair-value, cash-flow, foreign-currency or net-investment
hedges to specific assets and liabilities on the balance sheet or to specific
forecasted transactions. The Company also formally assesses, both at the hedge's
inception and on an ongoing basis, whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. At inception, and on a quarterly basis, the
change in value of the hedging instrument and the change in value of the hedged
item are measured to assess the validity of maintaining special hedge
accounting. Hedging relationships are considered highly effective if the changes
in the fair value or discounted cash flows of the hedging instrument are within
a ratio of 80-125% of the inverse changes in the fair value or discounted cash
flows of the hedged item. Hedge effectiveness is assessed using the quantitative
methods, prescribed by SFAS No. 133, as amended, including the "Change in
Variable Cash Flows Method," the "Change in Fair Value Method" and the
"Hypothetical Derivative Method " depending on the hedge strategy. If it is
determined that a derivative is no longer highly effective as a hedge, the
Company discontinues hedge accounting in the period in which the derivative
became ineffective and prospectively, as discussed below under discontinuance of
hedge accounting.
Discontinuance of Hedge Accounting
- ----------------------------------
The Company discontinues hedge accounting prospectively when (1) it is
determined that the derivative is no longer highly effective in offsetting
changes in the fair value or cash flows of a hedged item; (2) the derivative is
dedesignated as a hedge instrument, because it is unlikely that a forecasted
transaction will occur; or (3) the derivative expires or is sold, terminated, or
exercised. When hedge accounting is discontinued because it is determined that
the derivative no longer qualifies as an effective fair-value hedge, the
derivative continues to be carried at fair value on the balance sheet with
changes in its fair value recognized in current period earnings. The changes in
the fair value of the hedged asset or liability are no longer recorded in
earnings. When hedge accounting is discontinued because the Company becomes
aware that it is not probable that the forecasted transaction will occur, the
derivative continues to be carried on the balance sheet at its fair value, and
gains and losses that were accumulated in AOCI are recognized immediately in
earnings. In all other situations in which hedge
F-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
accounting is discontinued on a cash-flow hedge, including those where the
derivative is sold, terminated or exercised, amounts previously deferred in AOCI
are amortized into earnings when earnings are impacted by the variability of the
cash flow of the hedged item.
Embedded Derivatives
- --------------------
The Company occasionally purchases or issues financial instruments or products
that contain a derivative instrument that is embedded in the financial
instrument or products. When it is determined that (1) the embedded derivative
possesses economic characteristics that are not clearly and closely related to
the economic characteristics of the host contract, and (2) a separate instrument
with the same terms would qualify as a derivative instrument, the embedded
derivative is bifurcated from the host for measurement purposes. The embedded
derivative, which is reported with the host instrument in the consolidated
balance sheets, is carried at fair value with changes in fair value reported in
net realized capital gains and losses.
Credit Risk
- -----------
The Company's derivatives counterparty exposure policy establishes market-based
credit limits, favors long-term financial stability and creditworthiness, and
typically requires credit enhancement/credit risk reducing agreements. By using
derivative instruments, the Company is exposed to credit risk, which is measured
as the amount owed to the Company based on current market conditions and
potential payment obligations between the Company and its counterparties. When
the fair value of a derivative contract is positive, this indicates that the
counterparty owes the Company, and, therefore, exposes the Company to credit
risk. Credit exposures are generally quantified weekly and netted, and
collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds exposure policy thresholds. The Company
also minimizes the credit risk in derivative instruments by entering into
transactions with high quality counterparties that are reviewed periodically by
the Company's internal compliance unit, reviewed frequently by senior management
and reported to the Company's Finance Committee of the Board of Directors. The
Company also maintains a policy of requiring that all derivative contracts be
governed by an International Swaps and Derivatives Association Master Agreement
which is structured by legal entity and by counterparty and permits the right of
offset. In addition, the Company periodically enters into swap agreements in
which the Company assumes credit exposure from a single entity, referenced index
or asset pool.
Product Derivatives and Risk Management
The Company offers certain variable annuity products with a GMWB rider. The GMWB
provides the policyholder with a guaranteed remaining balance ("GRB") if the
account value is reduced to zero through a combination of market declines and
withdrawals. The GRB is generally equal to premiums less withdrawals. However,
annual withdrawals that exceed 7% of the premiums paid may reduce the GRB by an
amount greater than the withdrawals and may also impact the guaranteed annual
withdrawal amount that subsequently applies after the excess annual withdrawals
occur. The policyholder also has the option, after a specified time period, to
reset the GRB to the then-current account value, if greater. The GMWB represents
an embedded derivative in the variable annuity contract that is required to be
reported separately from the host variable annuity contract. It is carried at
fair value and reported in other policyholder funds. The fair value of the GMWB
obligations is calculated based on actuarial assumptions related to the
projected cash flows, including benefits and related contract charges, over the
lives of the contracts, incorporating expectations concerning policyholder
behavior. Because of the dynamic and complex nature of these cash flows,
stochastic techniques under a variety of market return scenarios and other best
estimate assumptions are used. Estimating these cash flows involves numerous
estimates and subjective judgments including those regarding expected market
rates of return, market volatility, correlations of market returns and discount
rates. In valuing the embedded derivative, the Company attributes a portion of
the fees collected from the policyholder equal to the present value of future
GMWB claims (the "Attributed Fees"). All changes in the fair value of the
embedded derivative are recorded in net realized capital gains and losses. The
excess of fees collected from the policyholder for the GMWB over the Attributed
Fees are recorded in fee income.
For all contracts in effect through July 6, 2003, the Company entered into a
reinsurance arrangement to offset its exposure to the GMWB for the lives of
those contracts. This arrangement is recognized as a derivative and carried at
fair value in reinsurance recoverables. Changes in the fair value of both the
derivative assets and liabilities related to the reinsured GMWB are recorded in
net realized capital gains and losses. As of July 6, 2003, the Company exhausted
all but a small portion of the reinsurance capacity under the current
arrangement, as it relates to new business, and will be ceding only a very small
number of new contracts subsequent to July 6, 2003. Substantially all new
contracts with the GMWB are not covered by reinsurance. As of December 31, 2003,
$6.2 billion or 36% of account value with the GMWB feature was unreinsured. In
order to minimize the volatility associated with the unreinsured GMWB
liabilities, the Company has established an alternative risk management
strategy. During the third quarter of 2003, the Company began hedging its
unreinsured GMWB exposure using interest rate futures, Standard and Poor's
("S&P") 500 and NASDAQ index put options and futures contracts. For the year
ended December 31, 2003, net realized capital gains and losses included the
change in market value of both the value of the embedded derivative related to
the GMWB liability and the related derivative contracts that were purchased as
economic hedges, the net effect of which was a $6 gain before deferred policy
acquisition costs and tax effects. The net gain is due principally to an
approximate $4 gain associated with international funds for which hedge
positions had not been initiated prior to December 31, 2003, but were initiated
in the first quarter of 2004 and $2 due to modeling refinements to improve
valuation estimates. Excluding these items our hedging strategy ineffectiveness
on S&P 500 and NASDAQ economic hedge positions was not significant.
F-17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
SEPARATE ACCOUNTS
The Company maintains separate account assets and liabilities, which are
reported at fair value. Separate account assets are segregated from other
investments and investment income and gains and losses accrue directly to the
policyholder. Separate accounts reflect two categories of risk assumption:
non-guaranteed separate accounts, wherein the policyholder assumes the
investment risk, and guaranteed separate accounts, wherein the Company
contractually guarantees either a minimum return or account value to the
policyholder. The fees earned for administrative and contractholder maintenance
services performed for these separate accounts are included in fee income.
Beginning January 1, 2004, products previously recorded in guaranteed separate
accounts through December 31, 2003, will be recorded in the general account in
accordance with the Company's adoption of the SOP. See the Adoption of New
Accounting Standards section of Note 1 for a more complete discussion of the
Company's adoption of the SOP.
DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
LIFE - Policy acquisition costs, which include commissions and certain other
expenses that vary with and are primarily associated with acquiring business,
are deferred and amortized over the estimated lives of the contracts, usually 20
years. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy acquisition costs and present value of future profits ("DAC"). At
December 31, 2003 and 2002, the carrying value of Life's DAC was $6.6 billion
and $5.8 billion, respectively. For statutory accounting purposes, such costs
are expensed as incurred.
DAC related to traditional policies are amortized over the premium-paying period
in proportion to the present value of annual expected premium income. DAC
related to investment contracts and universal life-type contracts are deferred
and amortized using the retrospective deposit method. Under the retrospective
deposit method, acquisition costs are amortized in proportion to the present
value of estimated gross profits ("EGPs"), arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's variable annuity and to a lesser extent, variable
universal life insurance businesses. The average annual long-term rate of
assumed separate account fund performance (before mortality and expense charges)
used in estimating gross profits for the variable annuity and variable universal
life business was 9% for the years ended December 31, 2003 and 2002. For other
products including fixed annuities and other universal life-type contracts, the
average assumed investment yield ranged from 5% to 8.5% for both years ended
December 31, 2003 and 2002.
The Company has developed sophisticated modeling capabilities to evaluate its
DAC asset, which allowed it to run a large number of stochastically determined
scenarios of separate account fund performance. These scenarios were then
utilized to calculate a statistically significant range of reasonable estimates
of EGPs. This range was then compared to the present value of EGPs currently
utilized in the DAC amortization model. As of December 31, 2003, the present
value of the EGPs utilized in the DAC amortization model fall within a
reasonable range of statistically calculated present value of EGPs. As a result,
the Company does not believe there is sufficient evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of December 31,
2003 is necessary; however, if in the future the EGPs utilized in the DAC
amortization model were to exceed the margin of the reasonable range of
statistically calculated EGPs, a revision could be necessary. Furthermore, the
Company has estimated that the present value of the EGPs is likely to remain
within a reasonable range if overall separate account returns decline by 15% or
less for 2004, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved.
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with SFAS No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts and for Realized Gains and Losses from the Sale of Investments", and
reproject its future EGPs based on current account values at the end of the
quarter in which a revision is deemed to be necessary. To illustrate the effects
of this process, assume the Company had concluded that a revision of the
Company's EGPs was required at December 31, 2003. If the Company assumed a 9%
average long-term rate of growth from December 31, 2003 forward along with other
appropriate assumption changes in determining the revised EGPs, the Company
estimates the cumulative increase to amortization would be approximately
$45-$50, after-tax. If instead the Company were to assume a long-term growth
rate of 8% in determining the revised EGPs, the adjustment would be
approximately $60-$70, after-tax. Assuming that such an adjustment were to have
been required, the Company anticipates that there would have been immaterial
impacts on its DAC amortization for the 2004 and 2005 years exclusive of the
F-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
adjustment, and that there would have been positive earnings effects in later
years. Any such adjustment would not affect statutory income or surplus, due to
the prescribed accounting for such amounts that is discussed above.
Aside from absolute levels and timing of market performance assumptions,
additional factors that will influence this determination include the degree of
volatility in separate account fund performance and shifts in asset allocation
within the separate account made by policyholders. The overall return generated
by the separate account is dependent on several factors, including the relative
mix of the underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings. The Company's overall separate account fund
performance has been reasonably correlated to the overall performance of the S&P
500 Index (which closed at 1,112 on December 31, 2003), although no assurance
can be provided that this correlation will continue in the future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of December 31, 2003, the Company believed variable annuity
separate account assets could fall by at least 40% before portions of its DAC
asset would be unrecoverable.
PROPERTY & CASUALTY - The Property & Casualty operations also incur costs
including commissions, premium taxes and certain underwriting and policy
issuance costs, that vary with and are related primarily to the acquisition of
property and casualty insurance business and are deferred and amortized ratably
over the period the related premiums are earned. Deferred acquisition costs are
reviewed to determine if they are recoverable from future income, and if not,
are charged to expense. Anticipated investment income is considered in the
determination of the recoverability of deferred policy acquisition costs. For
the years ended December 31, 2003, 2002 and 2001 no material amounts of deferred
policy acquisition costs were charged to expense based on the determination of
recoverability.
RESERVE FOR FUTURE POLICY BENEFITS AND UNPAID CLAIMS AND CLAIM ADJUSTMENT
EXPENSES
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 disability or death. Changes in or
deviations from the assumptions used for mortality, morbidity, expected future
premiums and interest can significantly affect the Company's reserve levels and
related future operations. Reserves also include unearned premiums, premium
deposits, claims incurred but not reported and claims reported but not yet paid.
Reserves for assumed reinsurance are computed in a manner that is comparable to
direct insurance reserves.
Liabilities for future policy benefits are computed by the net level premium
method using interest assumptions ranging from 3% to 11% and withdrawal and
mortality assumptions appropriate at the time the policies were issued. Claim
reserves, which are the result of sales of group long-term and short-term
disability, stop loss, and Medicare supplement, are stated at amounts determined
by estimates on individual cases and estimates of unreported claims based on
past experience.
The following table displays the development of the claim reserves (included in
reserve for future policy benefits and unpaid claims and claim adjustment
expenses in the Consolidated Balance Sheets) resulting primarily from group
disability products.
For the years ended December 31,
--------------------------------
2003 2002 2001
- -----------------------------------------------------------------
BEGINNING CLAIM RESERVES-GROSS $2,914 $2,764 $2,384
Reinsurance recoverables 275 264 177
- -----------------------------------------------------------------
BEGINNING CLAIM RESERVES-NET 2,639 2,500 2,207
- -----------------------------------------------------------------
INCURRED EXPENSES RELATED TO
Current year 1,140 1,154 1,272
Prior years (41) 4 (15)
- -----------------------------------------------------------------
TOTAL INCURRED 1,099 1,158 1,257
- -----------------------------------------------------------------
PAID EXPENSES RELATED TO
Current year 367 387 439
Prior years 638 632 525
- -----------------------------------------------------------------
TOTAL PAID 1,005 1,019 964
- -----------------------------------------------------------------
ENDING CLAIM RESERVES-NET 2,733 2,639 2,500
Acquisition of claim reserves 1,497 -- --
Reinsurance recoverables 250 275 264
- -----------------------------------------------------------------
ENDING CLAIM RESERVES-GROSS $4,480 $2,914 $2,764
=================================================================
RESERVE FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims made under policies written by the Company.
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 significantly 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.
F-19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
The Hartford continually reviews the adequacy of its estimated claims and claim
adjustment expense reserves on an overall basis. Adjustments to previously
established reserves, if any, are reflected in the operating results of the
period in which the adjustment is determined to be necessary. In the judgment of
management, all information currently available has been properly considered in
the reserves established for claims and claim adjustment expenses.
Most of the Company's property and casualty reserves are not discounted.
However, certain liabilities for unpaid claims, where the amount and timing of
payments are fixed and reliably determinable, principally for permanently
disabled claimants and certain structured settlement contracts that fund loss
run-offs for unrelated parties have been discounted to present value using an
average interest rate of 4.8% in 2003 and 5.0% in 2002. At December 31, 2003 and
2002, such discounted reserves totaled $799 and $720, respectively (net of
discounts of $525 and $527, respectively). Accretion of this discount did not
have a material effect on net income during 2003, 2002 and 2001, respectively.
OTHER POLICYHOLDER FUNDS AND BENEFITS PAYABLE
Other policyholder funds and benefits payable include reserves for investment
contracts without life contingencies, corporate owned life insurance and
universal life insurance contracts. Of the amounts included in this item, $25.6
billion and $22.3 billion, as of December 31, 2003 and 2002, respectively,
represent net policyholder obligations. The liability for policy benefits for
universal life-type contracts 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.
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.
REVENUE RECOGNITION
LIFE - For investment and universal life-type contracts, the amounts collected
from policyholders are considered deposits and are not included in revenue. Fee
income for investment and universal life-type contracts consists of policy
charges for policy administration, cost of insurance charges and surrender
charges assessed against policyholders' account balances and are recognized in
the period in which services are provided. Traditional life and the majority of
the Company's accident and health products are long duration contracts, and
premiums are recognized as revenue when due from policyholders. Retrospective
and contingent commissions and other related expenses are incurred and recorded
in the same period that the retrospective premiums are recorded or other
contract provisions are met.
PROPERTY & CASUALTY - Property and casualty insurance premiums are earned
principally on a pro rata basis over the lives of the policies and include
accruals for ultimate premium revenue anticipated under auditable and
retrospectively rated policies. Unearned premiums represent the portion of
premiums written applicable to the unexpired terms of policies in force.
Unearned premiums also include estimated and unbilled premium adjustments
related to a small percentage of the Company's loss-sensitive workers'
compensation business.
Other revenue consists primarily of revenues associated with the Company's
servicing businesses. Retrospective and contingent commissions and other related
expenses are incurred and recorded in the same period that the retrospective
premiums are recorded or other contract provisions are met.
FOREIGN CURRENCY TRANSLATION
Foreign currency translation gains and losses are reflected in stockholders'
equity as a component of AOCI. The Company's foreign subsidiaries' balance sheet
accounts are translated at the exchange rates in effect at each year end and
income statement accounts are translated at the average rates of exchange
prevailing during the year. Gains and losses on foreign currency transactions
are reflected in earnings. The national currencies of the international
operations are generally their functional currencies.
DIVIDENDS TO POLICYHOLDERS
Policyholder dividends are accrued using an estimate of the amount to be paid
based on underlying contractual obligations under policies and applicable state
laws.
LIFE - Participating life insurance in-force accounted for 6%, 6% and 8% as of
December 31, 2003, 2002 and 2001, respectively, of total life insurance
in-force. Dividends to policyholders were $63, $65 and $68 for the years ended
December 31, 2003, 2002 and 2001, respectively. There were no additional amounts
of income allocated to participating policyholders. If limitations exist on the
amount of net income from participating life insurance contracts that may be
distributed to stockholders, the policyholders' share of net income on those
contracts that cannot be distributed is excluded from stockholders' equity by a
charge to operations and a credit to a liability.
PROPERTY & CASUALTY - Net written premiums for participating property and
casualty insurance policies represented 9% of total net written premiums for
each of the years ended December 31, 2003, 2002 and 2001, respectively.
Dividends to policyholders were $34, $57 and $38 for the years ended December
31, 2003, 2002 and 2001, respectively.
MUTUAL FUNDS
The Company maintains a retail mutual fund operation, whereby the Company,
through wholly-owned subsidiaries, provides investment management and
administrative services to The Hartford Mutual Funds, Inc., and The Hartford
Mutual Funds II, Inc. families of 34 open-end mutual funds as of December 31,
2003. The Company charges fees to the shareholders of the mutual funds, which
are recorded as revenue by the Company. Investors can purchase "shares" in the
mutual funds, all of
F-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
which are registered with the Securities and Exchange Commission ("SEC"), in
accordance with the Investment Company Act of 1940. The mutual funds are owned
by the shareholders of those funds and not by the Company. As such, the mutual
fund assets and liabilities and related investment returns are not reflected in
the Company's consolidated financial statements since they are not assets,
liabilities and operations of the Company.
REINSURANCE
Written premiums, earned premiums and incurred insurance losses and loss
adjustment expense all reflect the net effects of assumed and ceded reinsurance
transactions. Assumed reinsurance refers to our acceptance of certain insurance
risks that other insurance companies have underwritten. Ceded reinsurance means
other insurance companies have agreed to share certain risks that the Company
has underwritten. Reinsurance accounting is followed for assumed and ceded
transactions when the risk transfer provisions of SFAS No. 113, "Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," have
been met.
For the years ended December 31, 2003, 2002 and 2001, the Company did not make
any significant changes in the terms under which reinsurance is ceded to other
insurers.
INCOME TAXES
The Company recognizes taxes payable or refundable for the current year and
deferred taxes for the tax consequences of differences between the financial
reporting and tax basis of assets and liabilities. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years the temporary differences are expected to reverse.
2. SEPTEMBER 11, 2001
As a result of September 11, the Company recorded in 2001 an estimated
before-tax loss amounting to $678, net of reinsurance: $647 related to property
and casualty operations and $31 related to life operations. The Property &
Casualty loss included a $1.1 billion gross reserve addition, an estimated net
reserve addition of $556 with cessions under reinsurance contracts of $569. Also
included in the Property & Casualty loss was $91 of reinstatement and other
reinsurance premiums. The property-casualty portion of the estimate includes
coverages related to property, business interruption, workers' compensation, and
other liability exposures, including those underwritten by the Company's assumed
reinsurance operation. The Company based this loss estimate upon a review of
insured exposures using a variety of assumptions and actuarial techniques,
including estimated amounts for incurred but not reported policyholder losses
and costs incurred in settling claims. The Company continues to carry the
original incurred amount related to September 11, less any paid losses. Actual
experience in some cases appears to be developing favorably to our original
expectations, such as the higher than anticipated rate of participation in the
victim's compensation fund. There is still uncertainty, particularly with
respect to coverage disputes and the potential for the emergence of latent
injuries. Furthermore, the deadline for filing a liability claim with respect to
September 11 has been extended to March 11, 2004. As various deadlines pass and
more coverage disputes are settled either out of court or through a court
decision, the uncertainty about various aspects of the reserves will be reduced.
The Company will continue to evaluate these reserves on a quarterly basis
throughout 2004 and will make appropriate adjustments to reserve levels.
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS
For the years ended December 31,
----------------------------------------------------------
COMPONENTS OF NET INVESTMENT INCOME 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Fixed maturities income $ 2,800 $ 2,510 $ 2,362
Policy loans income 210 254 307
Other investment income 267 208 209
- -----------------------------------------------------------------------------------------------------------------------------------
Gross investment income 3,277 2,972 2,878
Less: Investment expenses 44 43 36
- -----------------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME $ 3,233 $ 2,929 $ 2,842
===================================================================================================================================
COMPONENTS OF NET REALIZED CAPITAL GAINS (LOSSES)
- -----------------------------------------------------------------------------------------------------------------------------------
Fixed maturities $ 255 $ (378) $ (50)
Equity securities (29) (42) (34)
Periodic net coupon settlements on non-qualifying derivatives 44 24 8
Sale of affiliates 22 (4) (93)
Other [1] -- 23 (60)
Change in liability to policyholders for net realized capital gains 1 1 1
- -----------------------------------------------------------------------------------------------------------------------------------
NET REALIZED CAPITAL GAINS (LOSSES) $ 293 $ (376) $ (228)
===================================================================================================================================
<FN>
[1] 2003 includes $6 of net gains associated with the GMWB hedging program.
</FN>
F-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
For the years ended December 31,
----------------------------------------------------------
COMPONENTS OF UNREALIZED GAINS (LOSSES) ON EQUITY SECURITIES 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Gross unrealized gains $ 76 $ 57 $ 177
Gross unrealized losses (16) (77) (117)
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) 60 (20) 60
Deferred income taxes and other items 20 (7) 19
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses), net of tax 40 (13) 41
Balance - beginning of year (13) 41 90
- -----------------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED GAINS (LOSSES) ON EQUITY SECURITIES $ 53 $ (54) $ (49)
===================================================================================================================================
COMPONENTS OF UNREALIZED GAINS (LOSSES) ON FIXED MATURITIES
- -----------------------------------------------------------------------------------------------------------------------------------
Gross unrealized gains $ 3,413 $ 3,062 $ 1,369
Gross unrealized losses (277) (414) (477)
Net unrealized gains credited to policyholders (63) (58) (22)
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains 3,073 2,590 870
Deferred income taxes and other items 1,349 1,133 305
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains, net of tax 1,724 1,457 565
Balance - beginning of year 1,457 565 407
- -----------------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED GAINS (LOSSES) ON FIXED MATURITIES $ 267 $ 892 $ 158
===================================================================================================================================
COMPONENTS OF FIXED MATURITY INVESTMENTS
As of December 31, 2003
--------------------------------------------------------------------------
Amortized Gross Gross Fair
Cost Unrealized Gains Unrealized Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
BONDS AND NOTES
U.S. Gov't and Gov't agencies and authorities
(guaranteed and sponsored) $ 1,060 $ 13 $ (3) $ 1,070
U.S. Gov't and Gov't agencies and authorities
(guaranteed and sponsored) - asset-backed 3,315 51 (5) 3,361
States, municipalities and political subdivisions 10,003 786 (19) 10,770
International governments 1,436 148 (2) 1,582
Public utilities 2,316 151 (15) 2,452
All other corporate including international 23,323 1,714 (111) 24,926
All other corporate - asset-backed 13,235 543 (122) 13,656
Short-term investments 3,363 3 -- 3,366
Redeemable preferred stock 76 4 -- 80
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 58,127 $ 3,413 $ (277) $ 61,263
====================================================================================================================================
As of December 31, 2002
--------------------------------------------------------------------------
Amortized Gross Gross Fair
Cost Unrealized Gains Unrealized Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
BONDS AND NOTES
U.S. Gov't and Gov't agencies and authorities
(guaranteed and sponsored) $ 467 $ 17 $ -- $ 484
U.S. Gov't and Gov't agencies and authorities
(guaranteed and sponsored) - asset-backed 2,867 95 (3) 2,959
States, municipalities and political subdivisions 10,104 832 (7) 10,929
International governments 1,481 139 (6) 1,614
Public utilities 1,754 102 (49) 1,807
All other corporate including international 16,389 1,230 (186) 17,433
All other corporate - asset-backed 10,189 593 (136) 10,646
Short-term investments 2,097 3 -- 2,100
Certificates of deposit 795 45 (25) 815
Redeemable preferred stock 98 6 (2) 102
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 46,241 $ 3,062 $ (414) $ 48,889
====================================================================================================================================
The amortized cost and estimated fair value of fixed maturity investments at
December 31, 2003 by contractual maturity year are shown below. Estimated
maturities may differ from contractual maturities due to call or prepayment
provisions. Asset-backed securities, including mortgage-backed securities and
collateralized mortgage obligations, are distributed to maturity year based on
the Company's estimates of the rate of future prepayments of principal over the
remaining lives of the securities. These estimates are developed using
prepayment speeds provided in broker consensus data. Such estimates are derived
from prepayment speeds experienced at the interest rate levels projected for the
applicable underlying collateral. Actual prepayment experience may vary from
these estimates.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
Amortized Fair
MATURITY Cost Value
- -----------------------------------------------------------------
One year or less $ 6,129 $ 6,181
Over one year through five years 16,149 16,938
Over five years through ten years 16,874 17,827
Over ten years 18,975 20,317
- -----------------------------------------------------------------
TOTAL $ 58,127 $ 61,263
=================================================================
NON-INCOME PRODUCING INVESTMENTS
Investments that were non-income producing as of December 31 are as follows:
2003 2002
---------------------------------------------
Security Type Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------------------------
All other $ 3 $ 6 $ -- $ 1
corporate -
asset-backed
All other 19 50 37 56
corporate
including
international
International 12 12 32 31
governments
- --------------------------------------------------------------
TOTAL $ 34 $ 68 $ 69 $ 88
==============================================================
For 2003, 2002 and 2001, net investment income was $31, $26 and $3,
respectively, lower than it would have been if interest on non-accrual
securities had been recognized in accordance with the original terms of these
investments.
SALES OF FIXED MATURITY AND EQUITY SECURITY INVESTMENTS
For the years ended December 31,
-----------------------------------
2003 2002 2001
- ------------------------------------------------------------------
SALE OF FIXED MATURITIES
Sale proceeds $ 13,827 $ 9,174 $ 8,714
Gross gains 576 276 202
Gross losses (150) (134) (82)
SALE OF EQUITY SECURITIES
Sale proceeds $ 490 $ 649 $ 803
Gross gains 47 144 135
Gross losses (46) (122) (139)
==================================================================
CONCENTRATION OF CREDIT RISK
The Hartford is not exposed to any credit concentration risk of a single issuer
greater than 10% of the Company's stockholders' equity.
SECURITY UNREALIZED LOSS AGING
The following table presents the Company's unrealized loss, fair value and
amortized cost for fixed maturity and equity securities, excluding securities
subject to EITF Issue No. 99-20, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, as of December 31, 2003.
Less Than 12 Months 12 Months or More Total
------------------------------- ------------------------------- -----------------------------
Amortized Fair Unrealized Amortized Fair Unrealized Amortized Fair Unrealized
Cost Value Losses Cost Value Losses Cost Value Losses
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Gov't and Gov't agencies and
authorities (guaranteed and
sponsored) $ 310 $ 307 $ (3) $ -- $ -- $ -- $ 310 $ 307 $ (3)
U.S. Gov't and Gov't agencies and
authorities (guaranteed and
sponsored) - asset-backed 521 516 (5) 2 2 -- 523 518 (5)
States, municipalities and political
subdivisions 448 429 (19) -- -- -- 448 429 (19)
International governments 128 126 (2) -- -- -- 128 126 (2)
Public utilities 442 432 (10) 66 61 (5) 508 493 (15)
All other corporate including
international 3,394 3,308 (86) 451 431 (20) 3,845 3,739 (106)
All other corporate - asset-backed 1,906 1,876 (30) 151 149 (2) 2,057 2,025 (32)
- ------------------------------------------------------------------------------------------------------------------------------------
Total fixed maturities 7,149 6,994 (155) 670 643 (27) 7,819 7,637 (182)
Common stock 4 4 -- 4 4 -- 8 8 --
Nonredeemable preferred stock 70 63 (7) 80 71 (9) 150 134 (16)
- ------------------------------------------------------------------------------------------------------------------------------------
Total equity 74 67 (7) 84 75 (9) 158 142 (16)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL TEMPORARILY IMPAIRED SECURITIES$ 7,223 $ 7,061 $ (162) $ 754 $ 718 $ (36) $ 7,977 $ 7,779 $ (198)
====================================================================================================================================
The following discussion refers to the data presented in the table above.
There were no fixed maturities or equity securities as of December 31, 2003,
with a fair value less than 80% of the security's amortized cost. As of December
31, 2003, fixed maturities represented approximately 92% of the Company's
unrealized loss amount, which was comprised of approximately 800 different
securities. As of December 31, 2003, the Company held no securities presented in
the table above that were at an unrealized loss position in excess of $5.
The majority of the securities in an unrealized loss position for less than
twelve months are depressed due to the rise in long-term interest rates. This
group of securities was comprised of over 700 securities. Of the less than
twelve months total unrealized loss amount $148, or 91%, was comprised of
securities with fair value to amortized cost ratios as of December 31, 2003 at
or greater than 90%. As of December 31, 2003, $144 of the less than twelve
months total unrealized loss amount was comprised of securities in an unrealized
loss position for less than six continuous months.
F-23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
The securities depressed for twelve months or more were comprised of less than
100 securities. Of the twelve months or more unrealized loss amount $24, or 67%,
was comprised of securities with fair value to amortized cost ratio as of
December 31, 2003 at or greater than 90%.
As of December 31, 2003, the securities in an unrealized loss position for
twelve months or more were primarily interest rate related. The sector in the
greatest gross unrealized loss position in the schedule above was financial
services, which is included within the all other corporate, including
international and non-redeemable preferred stock categories above. A description
of the events contributing to the security type's unrealized loss position and
the factors considered in determining that recording an other-than-temporary
impairment was not warranted are outlined below.
Financial services represents approximately $23 of the securities in an
unrealized loss position for twelve months or more. All of these positions
continue to be priced at or greater than 80% of amortized cost. The financial
services securities in an unrealized loss position are primarily investment
grade variable rate securities with extended maturity dates, which have been
adversely impacted by the reduction in forward interest rates after the purchase
date, resulting in lower expected cash flows. Unrealized loss amounts for these
securities have declined during the year as interest rates have risen.
Additional changes in fair value of these securities are primarily dependent on
future changes in forward interest rates. A substantial percentage of these
securities are currently hedged with interest rate swaps, which convert the
variable rate earned on the securities to a fixed amount. The swaps generally
receive cash flow hedge accounting treatment and are currently in an unrealized
gain position.
The remaining balance of $13 in the twelve months or more unrealized loss
category is comprised of approximately 60 securities with fair value to
amortized cost ratios greater than 80%.
As part of the Company's ongoing security monitoring process by a committee of
investment and accounting professionals, the Company has reviewed its investment
portfolio and concluded that there were no additional other-than-temporary
impairments as of December 31, 2003 and 2002. Due to the issuers' continued
satisfaction of the securities' obligations in accordance with their contractual
terms and the expectation that they will continue to do so, management's intent
and ability to hold these securities, as well as the evaluation of the
fundamentals of the issuers' financial condition and other objective evidence,
the Company believes that the prices of the securities in the sectors identified
above were temporarily depressed.
The evaluation for other-than-temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are
other-than-temporary. The risks and uncertainties include changes in general
economic conditions, the issuer's financial condition or near term recovery
prospects and the effects of changes in interest rates.
DERIVATIVE INSTRUMENTS
Derivative instruments are recorded at fair value and presented in the
consolidated balance sheets as of December 31, as follows:
Asset Values Liability Values
-------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Other investments $ 199 $ 299 $ -- $ --
Reinsurance recoverables -- 48 89 --
Other policyholder funds and benefits payable 115 -- -- 48
Fixed maturities 7 15 -- --
Other liabilities -- -- 303 208
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 321 $ 362 $ 392 $ 256
====================================================================================================================================
The following table summarizes the primary derivative instruments used by the
Company and the hedging strategies to which they relate. Derivatives in the
Company's separate accounts are not included because associated gains and losses
generally accrue directly to policyholders. The notional value of derivative
contracts represent the basis upon which pay or receive amounts are calculated
and are not reflective of credit risk. The fair value amounts of derivative
assets and liabilities are presented on a net basis as of December 31 in the
following table.
F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
Notional Amount Fair Value
-------------------------- ------------------------
Hedging Strategy 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
CASH-FLOW HEDGES
Interest rate swaps
Interest rate swaps are primarily used to convert interest receipts on
floating-rate fixed maturity investments to fixed rates. These derivatives
are predominantly used to better match cash receipts from
assets with cash disbursements required to fund liabilities. $ 2,599 $ 2,784 $ 91 $ 206
Foreign currency swaps
Foreign currency swaps are used to convert foreign denominated cash flows
associated with certain foreign denominated fixed maturity investments to
U.S. dollars. The foreign fixed maturities are primarily denominated in
Euros and are swapped to minimize cash flow
fluctuations due to changes in currency rates. 1,060 389 (175) (29)
FAIR-VALUE HEDGES
Interest rate swaps
A portion of the Company's fixed debt is hedged against increases in LIBOR
(the benchmark interest rate). In addition, interest rate swaps are used to
hedge the changes in fair value of certain fixed rate
liabilities due to changes in LIBOR. 862 530 4 22
Interest rate caps and floors
Interest rate caps and floors are used to offset the changes in fair value
related to corresponding interest rate caps and floors that exist
in certain of the Company's variable-rate fixed maturity investments. 80 180 (1) (4)
Swaptions
Swaption arrangements are utilized to offset the change in the fair value of
call options embedded in certain municipal fixed maturity securities. The
swaptions give the Company the option to enter into a "received fixed" swap.
The purpose of the swaptions is to mitigate reinvestment risk arising from
the call option embedded in the
municipal security, providing for a fixed return over the original term
to maturity. 14 90 1 4
====================================================================================================================================
F-25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
Notional Amount Fair Value
-------------------------- ------------------------
Hedging Strategy 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT HEDGES
Forwards
Yen denominated forwards are used to hedge the net investment in the
Japanese Life operation from potential volatility in the yen to U.S.
dollar exchange rate. $ 200 $ -- $ (4) $ --
OTHER INVESTMENT AND RISK MANAGEMENT ACTIVITIES
Interest rate caps and swaption contracts
The Company is exposed to policyholder surrenders during a rising interest
rate environment. Interest rate cap and swaption contracts are used to
mitigate the Company's loss in a rising interest rate environment. The
increase in yield from the cap and swaption contract in a rising interest
rate environment may be used to raise credited rates, thereby increasing the
Company's competitiveness and reducing the policyholder's incentive to
surrender.
The Company also uses an interest rate cap as an economic hedge of the
interest rate risk related to the fixed rate debt. In a rising
interest rate environment, the cap will limit the net interest expense
on the hedged fixed rate debt. 1,966 1,016 19 11
Credit default and total return swaps
The Company enters into swap agreements in which the Company assumes credit
exposure from an individual entity, referenced index or asset pool. The
Company assumes credit exposure to individual entities through credit
default swaps. These contracts entitle the company to receive a periodic fee
in exchange for an obligation to compensate the derivative counterparty
should a credit event occur on the part of the issuer. Credit events
typically include failure on the part of the issuer to make a fixed dollar
amount of contractual interest or principal payments or bankruptcy. The
maximum potential future exposure to the Company is the notional value of
the swap contracts, $137, after-tax, as of December 31, 2003 and 2002.
The Company also assumes exposure to the change in value of indices or asset
pools through total return swaps. As of December 31, 2003 and 2002, the
maximum potential future exposure to the Company from such
contracts is $425 and $291, after-tax, respectively. 865 915 (34) (78)
Options
The Company writes option contracts for a premium to monetize the option
embedded in certain of its fixed maturity investments. The written option
grants the holder the ability to call the bond at a predetermined strike
value. The maximum potential future economic exposure is represented by the
then fair value of the bond in excess of the strike value, which is expected
to be entirely offset by the
appreciation in the value of the embedded long option. 333 1,013 1 --
====================================================================================================================================
F-26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
Notional Amount Fair Value
-------------------------- ------------------------
Hedging Strategy 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps
The Company enters into interest rates swaps to terminate existing swaps in
hedging relationships, and thereby offsetting the changes in value in the
original swap. In addition, the Company uses interest rate swaps to convert
interest receipts on floating-rate fixed maturity
investments to fixed rates. $ 3,077 $ 2,706 $ 11 $ (14)
Foreign currency swaps and put and call options
The Company enters into foreign currency swaps, purchases foreign put
options and writes foreign call options to hedge the foreign currency
exposures in certain of its foreign fixed maturity investments. Currency
options were closed in January 2003 for a loss of $3,
after-tax. 104 1,145 (31) (12)
Product derivatives
The Company offers certain variable annuity products with a GMWB rider. The
GMWB is an embedded derivative that provides the policyholder with a GRB if
the account value is reduced to zero through a combination of market
declines and withdrawals. The GRB is generally equal to premiums less
withdrawals. The policyholder also has the option, after a specified time
period, to reset the GRB to the then-current account value, if greater. (For
a further discussion, see Note 1.) The notional value of the embedded
derivative is the GRB balance. 14,961 2,760 115 (48)
Reinsurance contracts
Reinsurance arrangements are used to offset the Company's exposure to the
GMWB embedded derivative for the lives of the host variable annuity
contracts. The notional amount of the reinsurance contracts is the GRB
amount. 9,139 2,760 (89) 48
Futures contracts, equity index options and interest rate swap contracts The
Company enters into interest rate futures, Standard and Poor's ("S&P") 500
and NASDAQ index futures contracts and put and call options, as well as
interest rate swap contracts to hedge exposure to the volatility associated
with the portion of the GMWB liabilities
which are not reinsured. 544 -- 21 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 35,804 $ 16,288 $ (71) $ 106
====================================================================================================================================
For the years ended December 31, 2003, 2002 and 2001, the Company's gross gains
and losses representing the total ineffectiveness of all cash-flow, fair-value
and net investment hedges were immaterial. For the years ended December 31,
2003, 2002 and 2001, the Company recognized an after-tax net gain (loss) of $11,
$22 and ($18), respectively, (reported as net realized capital gains and losses
in the consolidated statements of operations), which represented the total
change in value for other derivative-based strategies which do not qualify for
hedge accounting treatment including the periodic net coupon settlements. The
net, after-tax, GMWB activity (including the embedded derivative liability,
reinsurance contracts and futures, swaps and option contracts) is included in
this amount and totaled $4, $0 and $0 for the years ended December 31, 2003,
2002 and 2001, respectively.
As of December 31, 2003 and 2002, the after-tax deferred net gains on derivative
instruments accumulated in AOCI that are expected to be reclassified to earnings
during the next twenty-four months are $7. This expectation is based on the
anticipated interest payments on hedged investments in fixed maturity securities
that will occur over the next twenty-four 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
twenty-four months. For the years ended December 31, 2003, 2002 and 2001, the
net reclassifications from AOCI to earnings resulting from the discontinuance of
cash-flow hedges were immaterial.
The net investment hedge of the Japanese Life operation was established in the
fourth quarter of 2003. The after-tax amount of gain (loss) included in the
foreign currency translation adjustment associated with the net investment hedge
was $(3) as of December 31, 2003. The net amount of gains (losses) recorded in
the foreign currency translation adjustments account pertaining to the net
investment hedge for the year ended December 31, 2003 was $(3).
F-27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
SECURITIES LENDING AND COLLATERAL ARRANGEMENTS
The Company participates in a securities lending program to generate additional
income, whereby certain domestic fixed income securities are loaned for a short
period of time from the Company's portfolio to qualifying third parties, via a
lending agent. Borrowers of these securities provide collateral of 102% of the
market value of the loaned securities. Acceptable collateral may be in the form
of cash or U.S. Government securities. The market value of the loaned securities
is monitored and additional collateral is obtained if the market value of the
collateral falls below 100% of the market value of the loaned securities. Under
the terms of the securities lending program, the lending agent indemnifies the
Company against borrower defaults. As of December 31, 2003, the fair value of
the loaned securities was approximately $1.1 billion and was included in fixed
maturities in the consolidated balance sheets. The Company retains a portion of
the income earned from the cash collateral or receives a fee from the borrower.
The Company recorded before-tax income from securities lending transactions, net
of lending fees, of $1 for the year ended December 31, 2003, which was included
in net investment income.
The Company enters into various collateral arrangements, which require both the
pledging and accepting of collateral in connection with its derivative
instruments. As of December 31, 2003 and 2002, collateral pledged of $275 and
$96, respectively, was included in fixed maturities in the consolidated balance
sheets.
The classification and carrying amount of the loaned securities associated with
the lending program and the collateral pledged at December 31, 2003 and 2002
were as follows:
LOANED SECURITIES AND COLLATERAL PLEDGED 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Gov't and Gov't agencies and authorities (guaranteed and sponsored) $ 464 $ 20
U.S. Gov't and Gov't agencies and authorities (guaranteed and sponsored - asset-backed) 33 76
International governments 20 --
Public utilities 28 --
All other corporate including international 612 --
All other corporate - asset-backed 244 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,401 $ 96
====================================================================================================================================
As of December 31, 2003 and 2002, the Company had accepted collateral relating
to the securities lending program and collateral arrangements consisting of
cash, U.S. Government, and U.S. Government agency securities with a fair value
of $1.4 billion and $454, respectively. At December 31, 2003 and 2002, only cash
collateral of $1.2 billion and $176, respectively, was invested and recorded in
the consolidated balance sheets in fixed maturities and with a corresponding
amount recorded in other liabilities. The Company is only permitted by contract
to sell or repledge the non-cash collateral in the event of a default by the
counterparty and none of the collateral has been sold or repledged at December
31, 2003 and 2002. As of December 31, 2003 and 2002, all collateral accepted was
held in separate custodial accounts.
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure about Fair Value of Financial Instruments", requires
disclosure of fair value information of financial instruments.
For certain financial instruments where quoted market prices are not available,
other independent valuation techniques and assumptions are used. Because
considerable judgment is used, these estimates are not necessarily indicative of
amounts that could be realized in a current market exchange. SFAS No. 107
excludes certain financial instruments from disclosure, including insurance
contracts, other than financial guarantees and investment contracts.
The Hartford uses the following methods and assumptions in estimating the fair
value of each class of financial instrument.
Fair value for fixed maturities and marketable equity securities approximates
those quotations published by applicable stock exchanges or received from other
reliable sources.
For policy loans, carrying amounts approximate fair value.
Fair value of limited partnerships and trusts is based on external market
valuations from partnership and trust management.
Derivative instruments are reported at fair value based upon internally
established valuations that are consistent with external valuation models,
quotations furnished by dealers in such instrument or market quotations. Other
policyholder funds and benefits payable fair value information is determined by
estimating future cash flows, discounted at the current market rate. For further
discussion of other policyholder funds and derivatives, see Note 1.
For short-term debt, carrying amounts approximate fair value.
Fair value for long-term debt is based on market quotations from independent
third party pricing services.
F-28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and fair values of The Hartford's financial instruments at
December 31, 2003 and 2002 were as follows:
2003 2002
---------------------------------------------------------------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed maturities $61,263 $61,263 $48,889 $48,889
Equity securities 565 565 917 917
Policy loans 2,512 2,512 2,934 2,934
Limited partnerships [1] 345 345 881 881
Other investments [2] 1,162 1,162 909 909
LIABILITIES
Other policyholder funds and benefits payable $24,284 $24,677 $20,744 $20,951
[3]
Short-term debt 1,050 1,055 315 315
Long-term debt 4,613 5,173 4,064 4,283
Derivative related liabilities [4] 303 303 208 208
==================================================================================================================================
<FN>
[1] Included in other investments on the consolidated balance sheets.
[2] 2003 and 2002 include $199 and $299 of derivative related assets,
respectively.
[3] Excludes group accident and health and universal life insurance contracts,
including corporate owned life insurance.
[4] Included in other liabilities on the consolidated balance sheets.
</FN>
5. 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 (loss)
and earnings (loss) per share for the years ended December 31, 2003, 2002 and
2001, with 2001 adjusted for goodwill amortization recorded.
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS)
Income (loss) before cumulative effect of accounting changes $ (91) $ 1,000 $ 541
Goodwill amortization, net of tax -- -- 52
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes (91) 1,000 593
Cumulative effect of accounting changes, net of tax -- -- (34)
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (91) $ 1,000 $ 559
====================================================================================================================================
BASIC EARNINGS (LOSS) PER SHARE
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ (0.33) $ 4.01 $ 2.27
Goodwill amortization, net of tax -- -- 0.22
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes (0.33) 4.01 2.49
Cumulative effect of accounting changes, net of tax -- -- (0.14)
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (0.33) $ 4.01 $ 2.35
====================================================================================================================================
DILUTED EARNINGS (LOSS) PER SHARE
Income (loss) before cumulative effect of accounting changes $ (0.33) $ 3.97 $ 2.24
Goodwill amortization, net of tax -- -- 0.22
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes (0.33) 3.97 2.46
Cumulative effect of accounting changes, net of tax -- -- (0.14)
- ------------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (0.33) $ 3.97 $ 2.32
====================================================================================================================================
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.
2003 2002
------------------------------------- ------------------------------------
Gross Carrying Accumulated Net Gross Carrying Accumulated Net
ACQUIRED INTANGIBLE ASSETS Amount Amortization Amount Amortization
- ------------------------------------------------------------------------------------------------------------------------------------
Present value of future profits $ 1,459 $ 380 $ 1,406 $ 274
Renewal rights 46 33 42 27
Other 11 1 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 1,516 $ 414 $ 1,448 $ 301
====================================================================================================================================
F-29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
Net amortization expense for the years ended December 31, 2003, 2002 and 2001
was $113, $117 and $128, respectively.
Estimated future net amortization expense for the succeeding five years is as
follows.
For the year ended December 31,
-----------------------------------------------------------
2004 $ 130
2005 $ 105
2006 $ 94
2007 $ 78
2008 $ 69
===========================================================
The carrying amounts of goodwill as of December 31, 2003 and 2002 are shown
below.
2003 2002
- --------------------------------------------------------
Life $ 796 $ 796
Property & Casualty 152 153
Corporate 772 772
- --------------------------------------------------------
TOTAL $ 1,720 $ 1,721
========================================================
The Company's tests of its goodwill for impairment in accordance with SFAS No.
142 resulted in no write-downs for the years ended December 31, 2003 and 2002.
For further discussions of the adoption of SFAS No. 142, see Note 1.
6. SEPARATE ACCOUNTS
The Hartford maintained separate account assets and liabilities totaling $136.6
billion and $107.1 billion at December 31, 2003 and 2002, respectively, which
are reported at fair value. Separate account assets, which are segregated from
other investments, reflect two categories of risk assumption: non-guaranteed
separate accounts totaling $124.5 billion and $95.3 billion at December 31, 2003
and 2002, respectively, wherein the policyholder assumes the investment risk and
reward and guaranteed separate accounts totaling $12.1 billion and $11.5 billion
at December 31, 2003 and 2002, respectively, wherein Life contractually
guarantees either a minimum return or the account value to the policyholder.
Included in the non-guaranteed category were policy loans totaling $139 and $384
at December 31, 2003 and 2002, respectively. Net investment income (including
net realized capital gains and losses ) and interest credited to policyholders
on separate account assets are not reflected in the consolidated statements of
operations. Beginning January 1, 2004, products previously recorded in
guaranteed separate accounts through December 31, 2003, will be recorded in the
general account in accordance with the Company's adoption of the SOP. See Note 1
for a more complete discussion of the Company's adoption of the SOP.
Separate account management fees and other revenues included in fee income were
$1.3 billion, $1.2 billion and $1.3 billion in 2003, 2002 and 2001,
respectively. The guaranteed separate accounts include fixed MVA individual
annuities and modified guaranteed life insurance. The average credited interest
rate on these contracts was 6.0% and 6.3% at December 31, 2003 and 2002,
respectively. The assets that support these liabilities were comprised of $11.7
billion and $11.1 billion in fixed maturities as of December 31, 2003 and 2002,
respectively, and $106 and $385 of other investments as of December 31, 2003 and
2002, respectively. The portfolios are segregated from other investments and are
managed to minimize liquidity and interest rate risk. In order to minimize the
risk of disintermediation associated with early withdrawals, fixed MVA annuity
and modified guaranteed life insurance contracts carry a graded surrender charge
as well as a market value adjustment. Additional investment risk is hedged using
a variety of derivatives which totaled $(81) and $135 in net carrying value and
$2.6 billion and $3.6 billion in notional amounts as of December 31, 2003 and
2002, respectively.
7. RESERVES FOR CLAIMS AND CLAIM ADJUSTMENT EXPENSES
As described in Note 1, The Hartford establishes reserves for claims and claim
adjustment expenses on reported and unreported claims. These reserve estimates
are based on known facts and interpretations of circumstances, and consideration
of various internal factors including The Hartford's experience with similar
cases, historical trends involving claim payment patterns, loss payments,
pending levels of unpaid claims, loss control programs and product mix. In
addition, the reserve estimates are influenced by consideration of various
external factors including court decisions, economic conditions and public
attitudes. The effects of inflation are implicitly considered in the reserving
process.
The establishment of appropriate reserves, including reserves for catastrophes
and asbestos and environmental claims, is inherently uncertain. The Hartford
regularly updates its reserve estimates as new information becomes available and
events unfold that may have an impact on unsettled claims. Changes in prior year
reserve estimates, which may be material, are reflected in the results of
operations in the period such changes are determined to be necessary. For
further discussion of asbestos and environmental claims, see Note 16.
F-30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RESERVES FOR CLAIM AND CLAIM ADJUSTMENT EXPENSES (CONTINUED)
A reconciliation of liabilities for unpaid claims and claim adjustment expenses
follows:
For the years ended December
31,
------------------------------
2003 2002 2001
- -----------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID
CLAIMS AND CLAIM ADJUSTMENT
EXPENSES-GROSS $17,091 $17,036 $16,293
Reinsurance and other recoverables 3,950 4,176 3,871
- -----------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID
CLAIMS AND CLAIM ADJUSTMENT
EXPENSES-NET 13,141 12,860 12,422
- -----------------------------------------------------------------
ADD PROVISION FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES
Current year 6,102 5,577 5,992
Prior years 2,824 293 143
- -----------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES 8,926 5,870 6,135
- -----------------------------------------------------------------
LESS PAYMENTS
Current year 2,369 2,257 2,349
Prior years 3,480 3,332 3,243
- -----------------------------------------------------------------
TOTAL PAYMENTS 5,849 5,589 5,592
- -----------------------------------------------------------------
Other [1] -- -- (105)
- -----------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID
CLAIMS AND CLAIM ADJUSTMENT
EXPENSES-NET 16,218 13,141 12,860
Reinsurance and other recoverables 5,497 3,950 4,176
- -----------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID
CLAIMS AND CLAIM ADJUSTMENT
EXPENSES-GROSS $21,715 $17,091 $17,036
=================================================================
[1] Includes $(101) related to the sales of international subsidiaries for the
year ended December 31, 2001.
The Company has an exposure to catastrophic losses, both natural and man made,
which can be caused by significant events including hurricanes, severe winter
storms, earthquakes, windstorms, fires and terrorist acts. The frequency and
severity of catastrophic losses are unpredictable, and the exposure to a
catastrophe is a function of both the total amount insured in an area affected
by the event and the severity of the event. Catastrophes generally impact
limited geographic areas; however, certain events may produce significant damage
in heavily populated areas. The Company generally seeks to reduce its exposure
to catastrophic losses through individual risk selection, aggregation of risk by
geographic location and the purchase of catastrophe reinsurance.
In the opinion of management, based upon the known facts and current law, the
reserves recorded for The Hartford's property and casualty businesses at
December 31, 2003 represent the Company's best estimate of its ultimate
liability for claims and claim adjustment expenses related to losses covered by
policies written by the Company. Based on information or trends that are not
presently known, future reserve reestimates may result in adjustments to these
reserves. Such adjustments could possibly be significant, reflecting any variety
of new and adverse or favorable trends.
Examples of current trends include increases in medical cost inflation rates and
physical damage repair costs, changes in internal claim practices, changes in
the legislative and regulatory environment over workers' compensation claims,
evolving exposures to construction defects and other mass torts and the
potential for further adverse development of asbestos and environmental claims.
8. DEBT
SHORT-TERM DEBT 2003 2002
--------------------
Commercial paper $ 850 $ 315
Current maturities of long-term debt 200 --
- ------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ 1,050 $ 315
==================================================================
LONG -TERM DEBT [1] Senior Notes and
Debentures 2003 2002
- ------------------------------------------------------------------
6.9% Notes, due 2004 $ -- $ 199
- ------------------------------------------------------------------
7.75% Notes, due 2005 249 247
2.375% Notes, due 2006 250 --
7.1% Notes, due 2007 198 198
4.7% Notes, due 2007 300 300
6.375% Notes, due 2008 200 200
4.1% Equity Units Notes, due 2008 330 330
2.56% Equity Units Notes, due 2008 690 --
7.9% Notes, due 2010 275 274
4.625% Notes, due 2013 321 --
7.3% Notes, due 2015 200 200
7.65% Notes, due 2027 248 248
7.375% Notes, due 2031 400 400
- ------------------------------------------------------------------
TOTAL SENIOR NOTES AND DEBENTURES $ 3,661 $ 2,596
- ------------------------------------------------------------------
Junior Subordinated Debentures
- ------------------------------------------------------------------
7.7% Notes, due 2016 -- 500
7.20% Notes, due 2038 245 245
7.625% Notes, due 2050 200 200
7.45% Notes, due 2050 507 523
- ------------------------------------------------------------------
TOTAL JUNIOR SUBORDINATED
DEBENTURES 952 1,468
- ------------------------------------------------------------------
TOTAL LONG-TERM DEBT $ 4,613 $ 4,064
==================================================================
[1] The Hartford's long-term debt securities are issued by either The Hartford
Financial Services Group, Inc. ("HFSG") or HLI and are unsecured
obligations of HFSG or HLI and rank on a parity with all other unsecured
and unsubordinated indebtedness of HSFG or HLI.
SHELF REGISTRATIONS
On December 3, 2003, The Hartford's shelf registration statement (Registration
No. 333-108067) for the potential offering and sale of debt and equity
securities in an aggregate amount of up to $3.0 billion was declared effective
by the SEC. The Registration Statement allows for the following types of
securities to be offered: (i) debt securities, preferred stock, common stock,
depositary shares, warrants, stock purchase contracts, stock purchase units and
junior subordinated deferrable interest debentures of the Company, and (ii)
preferred securities of any of one or more capital trusts organized by The
Hartford ("The Hartford Trusts"). The Company may enter into guarantees with
respect to the preferred securities of any of The Hartford Trusts. As of
December 31, 2003, The Hartford had $3.0 billion remaining on its shelf.
Subsequently, in January 2004, the Company issued approximately 6.7 million
shares of common stock pursuant to an underwritten offering at a price to the
public of $63.25 per share and received net proceeds of
F-31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT (CONTINUED)
$411. Accordingly, as of February 27, 2004, the Company had $2.6 billion
remaining on its shelf.
On May 15, 2001, HLI filed with the SEC a shelf registration statement for the
potential offering and sale of up to $1.0 billion in debt and preferred
securities. The registration statement was declared effective on May 29, 2001.
As of December 31, 2003, HLI had $1.0 billion remaining on its shelf.
COMMERCIAL PAPER AND REVOLVING CREDIT FACILITIES
As of December 31,
--------------- -------------
Description Effective Date Expiration Date Maximum Available 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 850 $ 315
HLI 2/7/97 N/A 250 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 850 $ 315
Revolving Credit Facility
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ --
3-year revolving credit facility 12/31/02 12/31/05 490 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total revolving credit facility $ 1,490 $ -- $ --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL OUTSTANDING COMMERCIAL PAPER AND
REVOLVING CREDIT FACILITIES $ 3,740 $ 850 $ 315
====================================================================================================================================
LONG-TERM DEBT OFFERINGS
Equity Units Offerings
- ----------------------
On May 23, 2003, The Hartford issued 12.0 million 7% equity units at a price of
fifty dollars per unit and received net proceeds of $582. Subsequently, on May
30, 2003, The Hartford issued an additional 1.8 million 7% equity units at a
price of fifty dollars per unit and received net proceeds of $87.
Each equity unit offered initially consists of a corporate unit with a stated
amount of fifty dollars per unit. Each corporate unit consists of one purchase
contract for the sale of a certain number of shares of the Company's stock and a
5% ownership interest in one thousand dollars principal amount of senior notes
due August 16, 2008.
The corporate unit may be converted by the holder into a treasury unit
consisting of the purchase contract and a 5% undivided beneficial interest in a
zero-coupon U.S. Treasury security with a principal amount of one thousand
dollars that matures on August 15, 2006. The holder of an equity unit owns the
underlying senior notes or treasury securities but has pledged the senior notes
or treasury securities to the Company to secure the holder's obligations under
the purchase contract.
The purchase contract obligates the holder to purchase, and obligates The
Hartford to sell, on August 16, 2006, for fifty dollars, a variable number of
newly issued common shares of The Hartford. The number of The Hartford's shares
to be issued will be determined at the time the purchase contracts are settled
based upon the then current applicable market value of The Hartford's common
stock. If the applicable market value of The Hartford's common stock is equal to
or less than $45.50, then the Company will deliver 1.0989 shares to the holder
of the equity unit, or an aggregate of 15.2 million shares. If the applicable
market value of The Hartford's common stock is greater than $45.50 but less than
$56.875, then the Company will deliver the number of shares equal to fifty
dollars divided by the then current applicable market value of The Hartford's
common stock to the holder. Finally, if the applicable market value of The
Hartford's common stock is equal to or greater than $56.875, then the Company
will deliver 0.8791 shares to the holder, or an aggregate of 12.1 million
shares. Accordingly, upon settlement of the purchase contracts on August 16,
2006, The Hartford will receive proceeds of approximately $690 and will deliver
between 12.1 million and 15.2 million common shares in the aggregate. The
proceeds will be credited to stockholders' equity and allocated between the
common stock and additional paid-in capital accounts. The Hartford will make
quarterly contract adjustment payments to the equity unit holders at a rate of
4.44% of the stated amount per year until the purchase contract is settled.
Each corporate unit also includes a 5% ownership interest in one thousand
dollars principal amount of senior notes that will mature on August 16, 2008.
The aggregate maturity value of the senior notes is $690. The notes are pledged
by the holders to secure their obligations under the purchase contracts. The
Hartford will make quarterly interest payments to the holders of the notes
initially at an annual rate of 2.56%. On May 11, 2006, the notes will be
remarketed. At that time, The Hartford's remarketing agent will have the ability
to reset the interest rate on the notes in order to generate sufficient
remarketing proceeds to satisfy the holder's obligation under the purchase
contract. If the initial remarketing is unsuccessful, the remarketing agent will
attempt to remarket the notes, as necessary, on June 13, 2006, July 12, 2006 and
August 11, 2006. If all remarketing attempts are unsuccessful, the Company will
exercise its rights as a secured party to obtain and extinguish the notes.
The total distributions payable on the equity units are at an annual rate of 7%,
consisting of interest (2.56%) and contract adjustment payments (4.44%). The
corporate units are listed on the New York Stock Exchange under the symbol "HIG
PrD".
The 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
F-32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT (CONTINUED)
price of a share of the Company's common stock is above the threshold
appreciation price of $56.875. Because the average market price of the
Hartford's common stock during the period from the date of issuance through
December 31, 2003 was below this threshold appreciation price, the shares
issuable under the purchase contract component of the equity units have not been
included in the diluted earnings (loss) per share calculation. On September 13,
2002, The Hartford issued 6.6 million 6% equity units at a price of fifty
dollars per unit and received net proceeds of $319.
Each equity unit offered initially consists of a corporate unit with a stated
amount of fifty dollars per unit. Each corporate unit consists of one purchase
contract for the sale of a certain number of shares of the Company's stock and
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.
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 equity units are 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 issuance of the shares of The Hartford's common stock upon 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
period from the date of issuance through December 31, 2002 and for the year
ended December 2003, was below this threshold appreciation price, the shares
issuable under the purchase contract component of the equity units have not been
included in the diluted earnings (loss) per share calculations.
Senior Notes Offerings
- ----------------------
On July 10, 2003, the Company issued 4.625% senior notes due July 15, 2013 and
received net proceeds of $317. Interest on the notes is payable semi-annually on
January 15 and July 15, commencing on January 15, 2004.
On May 23, 2003, The Hartford issued 2.375% senior notes due June 1, 2006 and
received net proceeds of $249. Interest on the notes is payable semi-annually on
June 1 and December 1, commencing on December 1, 2003.
JUNIOR SUBORDINATED DEBENTURES
The Hartford and its subsidiary HLI have formed statutory business trusts, which
exist for the exclusive purposes of (i) issuing Trust Securities representing
undivided beneficial interests in the assets of the Trust; (ii) investing the
gross proceeds of the Trust Securities in Junior Subordinated Deferrable
Interest Debentures ("Junior Subordinated Debentures") of The Hartford or HLI;
and (iii) engaging in only those activities necessary or incidental thereto. In
accordance with the adoption of FIN 46R, the Company has deconsolidated the
trust preferred securities. For further discussion of the adoption of FIN 46R,
see Note 1.
F-33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. DEBT (CONTINUED)
The financial structure of Hartford Capital I and III, and Hartford Life Capital
I and II, as of December 31, 2003 and 2002, were as follows:
Hartford Capital Hartford Life Hartford Life Hartford
III Capital II Capital I Capital I [4]
- ------------------------------------------------------------------------------------------------------------------------------------
JUNIOR SUBORDINATED DEBENTURES [1] [2]
Principal amount owed $500 $200 $250 $500
Balance December 31, 2003 $507 $200 $245 $--
Balance December 31, 2002 $523 $200 $245 $500
Coupon rate 7.45% 7.625% 7.20% 7.70%
Interest payable Quarterly Quarterly Quarterly Quarterly
Maturity date Oct. 26, 2050 Feb. 15, 2050 June 30, 2038 Feb. 28, 2016
Redeemable by issuer on or after Oct. 26, 2006 Mar. 6, 2006 June 30, 2003 Feb. 28, 2001
TRUST PREFERRED SECURITIES
Issuance date Oct. 26, 2001 Mar. 6, 2001 June 29, 1998 Feb. 28, 1996
Securities issued 20,000,000 8,000,000 10,000,000 20,000,000
Liquidation preference per security (in dollars) $25 $25 $25 $25
Liquidation value $500 $200 $250 $500
Coupon rate 7.45% 7.625% 7.20% 7.70%
Distribution payable Quarterly Quarterly Quarterly Quarterly
Distribution guaranteed by [3] The Hartford HLI HLI The Hartford
====================================================================================================================================
<FN>
[1] For each of the respective debentures, The Hartford or HLI, has the right at
any time, and from time to time, to defer payments of interest on the Junior
Subordinated Debentures for a period not exceeding 20 consecutive quarters
up to the debentures' maturity date. During any such period, interest will
continue to accrue and The Hartford or HLI may not declare or pay any cash
dividends or distributions on, or purchase, The Hartford's or HLI's capital
stock nor make any principal, interest or premium payments on or repurchase
any debt securities that rank equally with or junior to the Junior
Subordinated Debentures. The Hartford or HLI will have the right at any time
to dissolve the Trust and cause the Junior Subordinated Debentures to be
distributed to the holders of the Preferred Securities.
[2] The Hartford Junior Subordinated Debentures are unsecured and rank junior
and subordinate in right of payment to all senior debt of The Hartford and
are effectively subordinated to all existing and future liabilities of its
subsidiaries.
[3] The Hartford has guaranteed, on a subordinated basis, all of the Hartford
Capital III obligations under the Hartford Series C Preferred Securities,
including to pay the redemption price and any accumulated and unpaid
distributions to the extent of available funds and upon dissolution, winding
up or liquidation, but only to the extent that Hartford Capital III has
funds to make such payments.
[4] $180 of the securities for Hartford Capital I were redeemed on June 30,
2003. The remaining $320 of these securities were redeemed on September 30,
2003.
</FN>
Subsequent event -- On February 13, 2004, the Company provided notice that all
outstanding 7.2% junior subordinated debentures underlying the trust preferred
securities issued by Hartford Life Capital I have been called for redemption on
March 15, 2004. The Company intends to fund the redemption through the issuance
of $150 of commercial paper and the utilization of $100 from internal sources.
INTEREST EXPENSE
The following table presents interest expense incurred for 2003, 2002 and 2001,
respectively.
For the years ended December 31,
----------------------------------
2003 2002 2001
- ----------------------------------------------------------------
Short-term debt $ 5 $ 6 $ 2
Long-term debt [1] 266 259 293
- ----------------------------------------------------------------
TOTAL INTEREST EXPENSE $ 271 $ 265 $ 295
- ----------------------------------------------------------------
[1] Includes junior subordinated debentures.
9. STOCKHOLDERS' EQUITY
COMMON STOCK
On May 23, 2003, The Hartford issued approximately 24.2 million shares of common
stock pursuant to an underwritten offering at a price to the public of $45.50
per share and received net proceeds of $1.1 billion. Subsequently, on May 30,
2003, The Hartford issued approximately 2.2 million shares of common stock at a
price to the public of $45.50 per share and received net proceeds of $97.
On May 23, 2003 and May 30, 2003, The Hartford issued 12.0 million 7% equity
units and 1.8 million 7% equity units, respectively. Each equity unit contains a
purchase contract obligating the holder to purchase and The Hartford to sell, a
variable number of newly issued shares of The Hartford's common stock. Upon
settlement of the purchase contracts on August 16, 2006, The Hartford will
receive proceeds of approximately $690 and will deliver between 12.1 million and
15.2 million shares in the aggregate. For further discussion of the equity units
issuance, see Note 8 above.
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 8.
F-34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
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.
Subsequent events - On January 22, 2004, The Hartford issued approximately 6.3
million shares of common stock pursuant to an underwritten offering at a price
to the public of $63.25 per share and received net proceeds of $388.
Subsequently, on January 30, 2004, The Hartford issued approximately 377
thousand shares of common stock at a price to the public of $63.25 per share and
received net proceeds of $23. The Company used the proceeds from these issuances
to repay $411 of commercial paper issued in connection with the acquisition of
the group life and accident, and short term and long term disability business of
CNA Financial Corporation. (For further discussion of this acquisition, see Note
18.)
PREFERRED STOCK
The Company has 50,000,000 shares of preferred stock authorized, none of which
have been issued. In 1995, the Company approved The Hartford Stockholder Rights
Plan, pursuant to which a nonvoting right attaches to each share of common
stock. Upon the occurrence of certain triggering events, the right will permit
each shareholder to purchase a fraction of a share of the Series A Participating
Cumulative Preferred Stock (the "Series A Preferred Stock") of The Hartford.
There are 300,000 authorized shares of Series A Preferred Stock. No shares were
issued or outstanding at December 31, 2003 or 2002.
STATUTORY RESULTS
As of December 31,
---------------------------
2003 2002
- ------------------------------------------------------------------
STATUTORY SURPLUS
Life operations $ 4,470 $ 3,019
Property & Casualty operations 5,900 4,878
- ------------------------------------------------------------------
TOTAL $ 10,370 $ 7,897
==================================================================
For the years ended December 31,
---------------------------------
2003 2002 2001
- ------------------------------------------------------------------
STATUTORY NET INCOME (LOSS)
Life operations $ 1,026 $ (137) $ (364)
Property & Casualty operations (196) 4,779 (223)
- ------------------------------------------------------------------
TOTAL $ 830 $ 4,642 $ (587)
==================================================================
A significant percentage of the consolidated statutory surplus is permanently
invested or is subject to various state and foreign government regulatory
restrictions or other agreements which limit the payment of dividends without
prior approval. The payment of dividends by Connecticut-domiciled insurers is
limited under the insurance holding company laws of Connecticut. Under these
laws, the insurance subsidiaries may only make their dividend payments out of
unassigned surplus. These laws require notice to and approval by the state
insurance commissioner for the declaration or payment of any dividend, which,
together with other dividends or distributions made within the preceding twelve
months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as
of December 31 of the preceding year or (ii) net income (or net gain from
operations, if such company is a life insurance company) for the twelve-month
period ending on the thirty-first day of December last preceding, in each case
determined under statutory insurance accounting policies. In addition, if any
dividend of a Connecticut-domiciled insurer exceeds the insurer's earned
surplus, it requires the prior approval of the Connecticut Insurance
Commissioner. The insurance holding company laws of the other jurisdictions in
which The Hartford's insurance subsidiaries are incorporated (or deemed
commercially domiciled) generally contain similar (although in certain instances
somewhat more restrictive) limitations on the payment of dividends. As of
December 31, 2003, the maximum amount of statutory dividends which may be paid
to HFSG from its insurance subsidiaries in 2004, without prior approval, is $1.4
billion.
The domestic insurance subsidiaries of HFSG prepare their statutory financial
statements in accordance with accounting practices prescribed or permitted by
the applicable state insurance department which vary with GAAP. Prescribed
statutory accounting practices include publications of the National Association
of Insurance Commissioners ("NAIC"), as well as state laws, regulations and
general administrative rules. The differences between statutory financial
statements and financial statements prepared in accordance with GAAP vary
between domestic and foreign jurisdictions. The principal differences are that
statutory financial statements do not reflect deferred policy acquisition costs
and limit deferred income taxes, and for statutory reporting all bonds are
carried at amortized cost and reinsurance assets and liabilities are presented
net of reinsurance. The Company's use of permitted statutory accounting
practices does not have a significant impact on statutory surplus.
F-35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share amounts have been computed in accordance with the
provisions of SFAS No. 128. The following tables present a reconciliation of net
income (loss) and shares used in calculating basic earnings (loss) per share to
those used in calculating diluted earnings (loss) per share.
(In millions, except for per share data)
NET INCOME
2003 (LOSS) SHARES PER SHARE AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE
Net income (loss) available to common shareholders $ (91) 272.4 $ (0.33)
--------------------
DILUTED EARNINGS (LOSS) PER SHARE [1]
Options -- -- --
--------------------------
Net income (loss) available to common shareholders plus assumed conversions $ (91) 272.4 $ (0.33)
- ------------------------------------------------------------------------------------------------------------------------------------
2002
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 1,000 249.4 $ 4.01
-------------------
DILUTED EARNINGS PER SHARE
Options -- 2.4
----------------------------
Net income available to common shareholders plus assumed conversions $ 1,000 251.8 $ 3.97
- ------------------------------------------------------------------------------------------------------------------------------------
2001
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 507 237.7 $ 2.13
-------------------
DILUTED EARNINGS PER SHARE
Options -- 3.7
----------------------------
Net income available to common shareholders plus assumed conversions $ 507 241.4 $ 2.10
====================================================================================================================================
<FN>
[1] As a result of the net loss for the year ended December 31, 2003, SFAS No.
128 requires the Company to use basic weighted average common shares
outstanding in the calculation of the year ended December 31, 2003 diluted
earnings (loss) per share, since the inclusion of options of 1.8 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 274.2.
</FN>
Basic earnings (loss) per share are computed based on the weighted average
number of shares outstanding during the year. Diluted earnings (loss) per share
include the dilutive effect of outstanding options and the Company's equity
units, if any, using the treasury stock method, and also contingently issuable
shares. Under the treasury stock method, exercise of options is assumed with the
proceeds used to purchase common stock at the average market price for the
period. The difference between the number of shares assumed issued and number of
shares purchased represents the dilutive shares. Contingently issuable shares
are included upon satisfaction of certain conditions related to the contingency.
11. STOCK COMPENSATION PLANS
On May 18, 2000, the shareholders of The Hartford approved The Hartford
Incentive Stock Plan (the "2000 Plan"), which replaced The Hartford 1995
Incentive Stock Plan (the "1995 Plan"). The terms of the 2000 Plan were
substantially similar to the terms of the 1995 Plan except that the 1995 Plan
had an annual award limit and a higher maximum award limit.
Under the 2000 Plan, awards may be granted in the form of non-qualified or
incentive stock options qualifying under Section 422A of the Internal Revenue
Code, performance shares or restricted stock, or any combination of the
foregoing. In addition, stock appreciation rights may be granted in connection
with all or part of any stock options granted under the 2000 Plan. The aggregate
number of shares of stock, which may be awarded, is subject to a maximum limit
of 17,211,837 shares applicable to all awards for the ten-year duration of the
2000 Plan.
All options granted have an exercise price equal to the market price of the
Company's common stock on the date of grant, and an option's maximum term is ten
years and two days. Certain options become exercisable over a three year period
commencing one year from the date of grant, while certain other options become
exercisable upon the attainment of specified market price appreciation of the
Company's common shares. For any year, no individual employee may receive an
award of options for more than 1,000,000 shares. As of December 31, 2003, The
Hartford had not issued any incentive stock options under the 2000 Plan.
Performance awards of common stock granted under the 2000 Plan become payable
upon the attainment of specific performance goals achieved over a period of not
less than one nor more than five years, and the restricted stock granted is
subject to a restriction period. On a cumulative basis, no more than 20% of the
aggregate number of shares which may be awarded under the 2000 Plan are
available for performance shares and restricted stock awards. Also, the maximum
award of performance shares for any individual employee in any year is 200,000
shares. In 1997, the Company awarded special performance-based options and
restricted stock to certain key executives under the 1995 Plan. The awards
vested only if the Company's stock traded at certain predetermined levels for
ten consecutive days by March 1, 2001. Vested options could not
F-36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
be exercised nor restricted shares disposed of until March 1, 2001. As a result
of the Company's stock trading at predetermined levels for ten consecutive days,
in May 1999 and also in September 2000, the special performance-based options
and restricted stock vested. As a result, the Company began recognizing
compensation expense in May 1999 and continued to recognize expense through
March 1, 2001.
In 1996, the Company established The Hartford Employee Stock Purchase Plan
("ESPP"). Under this plan, eligible employees of The Hartford may purchase
common stock of the Company at a 15% discount from the lower of the closing
market price at the beginning or end of the quarterly offering period. The
Company may sell up to 5,400,000 shares of stock to eligible employees under the
ESPP. In 2003, 2002 and 2001, 443,467 and 408,304, and 315,101 shares were sold,
respectively. The per share weighted average fair value of the discount under
the ESPP was $11.96, $11.70, and $14.31 in 2003, 2002 and 2001, respectively.
Additionally, during 1997, The Hartford established employee stock purchase
plans for certain employees of the Company's international subsidiaries. Under
these plans, participants may purchase common stock of The Hartford at a fixed
price at the end of a three-year period.
Effective January 1, 2003, the Company adopted the fair value recognition
provisions of accounting for stock-based compensation awards granted or modified
after January 1, 2003. All stock-based awards granted or modified prior to
January 1, 2003, continue to be valued using the intrinsic value-based
provisions set forth in APB Opinion No. 25 and related interpretations. (See
Note 1 for discussion of accounting for stock compensation plans.) A summary of
the status of non-qualified options included in the Company's incentive stock
plan as of December 31, 2003, 2002 and 2001 and changes during the years ended
December 31, 2003, 2002 and 2001 is presented below:
------------------------------- ------------------------------- ------------------------------
2003 2002 2001
------------------------------- ------------------------------- ------------------------------
Weighted Average Weighted Average Weighted Average
(Shares in thousands) Shares Exercise Price Shares Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beg. of year 20,172 $49.66 18,937 $45.29 16,970 $39.96
Granted 2,904 37.54 3,800 65.56 4,237 62.10
Exercised (1,225) 33.89 (2,060) 37.32 (1,789) 34.28
Canceled/Expired (633) 56.37 (505) 54.63 (481) 45.04
----------- ----------- -----------
Outstanding at end of year 21,218 48.69 20,172 49.66 18,937 45.29
- ------------------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 14,661 46.02 12,099 43.47 10,716 40.30
Weighted average fair value of
options granted $15.46 $25.20 $20.35
====================================================================================================================================
The following table summarizes information about stock options outstanding and
exercisable (shares in thousands) at December 31, 2003:
Options Outstanding Options Exercisable
----------------------------------------------------------------- -----------------------------------------
Weighted Average Number Weighted
Range of Number Outstanding Remaining Contractual Weighted Average Exercisable at Average
Exercise Prices at December 31, 2003 Life (Years) Exercise Price December 31, 2003 Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
$15.31 - $22.97 382 1.2 $20.16 382 $20.16
22.97 - 30.63 487 2.1 26.02 487 26.02
30.63 - 38.28 6,001 6.9 35.69 3,798 34.72
38.28 - 45.94 3,835 4.6 43.16 3,786 43.17
45.94 - 53.59 2,084 4.2 48.27 2,040 48.25
53.59 - 61.25 1,132 5.5 57.42 731 57.63
61.25 - 68.91 7,262 7.3 64.00 3,403 63.47
68.91 - 76.56 35 6.9 71.98 34 72.11
- ------------------------------------------------------------------------------------------------------------------------------------
$15.31 - $76.56 21,218 6.1 $48.69 14,661 $46.02
====================================================================================================================================
12. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT
PLANS
The Company maintains a U.S. qualified defined benefit pension plan ("the Plan")
that covers substantially all employees. U.S. employees of the Company and
certain affiliates hired prior to January 1, 2001 and who have rendered 5 or
more years of service are entitled to annual pension benefits, beginning at
normal retirement age (65), equal to 2% of their final average pay per year
multiplied by the number of years of credited service up to a maximum of 60% of
the average, less 1 2/3% of primary Social Security per year of credited
service, up to a maximum of 50%. Final average pay represents the average of any
of their 60 highest paid calendar months during the last 120 calendar months of
credited service preceding termination or retirement. Effective for all
employees who joined the Company on or after January 1, 2001, a new component or
formula was applied under the Plan referred to as the "cash balance formula".
Under the cash balance formula, a notional account is established for each
employee that is credited with a percentage of the employee's pay for each pay
period, based on the employee's age and whether or not the employee's pay has
exceeded the Social Security taxable wage base at the time crediting occurs.
Interest is also credited on employee cash balance accounts.
F-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT
PLANS (CONTINUED)
Once they become vested, employees can elect to receive the value of their plan
benefit (the accumulated sum of their annual plan allocations with interest) in
a single cash payment when they leave the Company. In September 2003, the
Company announced its approval to amend the Plan to implement, as of January 1,
2009, the cash balance formula for the purposes of calculating future pension
benefits for services rendered on or after January 1, 2009, for all employees
hired before January 1, 2001. These amounts are in addition to amounts earned
through December 31, 2008 under the traditional final average pay formula.
Employees hired on or after January 1, 2001 date are currently covered under the
same cash balance formula. Under certain conditions, as described in the Plan
document, the Plan permits early retirement at ages 50-64 with a reduced
benefit. Employees may elect to receive their pension benefits in the form of a
life annuity or joint and survivor annuity. Employees covered under the cash
balance formula may elect a lump-sum distribution. Employees automatically
receive the portion of their accumulated plan benefits as a lump-sum
distribution upon retirement or termination, if less than five thousand dollars.
If employees terminate before rendering 5 years of service, they forfeit the
right to receive the portion of their accumulated plan benefits attributable to
the Company's contributions.
The Company also maintains unfunded excess plans to provide benefits in excess
of amounts permitted to be paid to participants of the Plan under the provisions
of the Internal Revenue Code. Additionally, the Company has entered into
individual retirement agreements with certain current and retired directors
providing for unfunded supplemental pension benefits.
The Hartford provides certain health care and life insurance benefits for
eligible retired employees. The Hartford's contribution for health care benefits
will depend upon the retiree's date of retirement and years of service. In
addition, the plan has a defined dollar cap which limits average Company
contributions. The Hartford has prefunded a portion of the health care
obligations through trust funds where such prefunding can be accomplished on a
tax effective basis. Effective January 1, 2002, retiree medical, retiree dental
and retiree life insurance benefits were eliminated for employees with original
hire dates with the Company on or after January 1, 2002.
As more fully discussed in Note 1, FASB issued FSP No. FAS 106-1, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003" which addresses the accounting and
disclosure implications that are expected to arise as a result of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") enacted
on December 8, 2003. The Act introduces a prescription drug benefit under
Medicare as well as a federal subsidy to sponsors of retiree health care benefit
plans that provide a benefit that is at least equivalent to Medicare. The issue
is whether any employer that provides postretirement prescription drug coverage
should recognize the effects of the Act on the benefit obligation and net
periodic postretirement benefit cost and, if so, when and how those costs should
be accounted for by the employer. Under the FSP, companies have a one-time
election to defer the effects of the new legislation in financial statements for
periods ending after December 7, 2003. The Company has elected to defer the
effects of the Act. Companies electing to defer recognition of the effects must
defer recognition until the FASB issues clarifying guidance on how the
legislation should be interpreted. All measures of the benefit obligation and
net periodic postretirement benefit costs included in the consolidated financial
statements and footnotes do not reflect the effects of the Act. Future guidance,
when issued by the FASB, could require the Company to restate previously
reported information. The Company is in the process of reviewing the provisions
of the Act in conjunction with the Company's postretirement benefit plan and
does not expect the impact of the Act to be significant.
OBLIGATIONS AND FUNDED STATUS
The following tables set forth a reconciliation of beginning and ending balances
of the benefit obligation and fair value of plan assets as well as the funded
status of The Hartford's defined benefit pension and postretirement health care
and life insurance benefit plans for the years ended December 31, 2003 and 2002.
International plans represent an immaterial percentage of total pension assets,
liabilities and expense and, for reporting purposes, are combined with domestic
plans. The Company uses a measurement date of December 31 for its pension and
other postretirement benefit plans.
Pension Benefits Other Postretirement Benefits
------------------------------- -------------------------------
CHANGE IN BENEFIT OBLIGATION 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Benefit obligation - beginning of year $ 2,588 $ 2,108 $ 434 $ 373
Service cost (excluding expenses) 101 80 12 9
Interest cost 167 156 28 27
Plan participants' contributions -- -- 6 6
Amendments (168) -- -- (5)
Actuarial loss 48 31 5 7
Change in assumption:
Discount rate 100 354 22 44
Salary scale -- (29) -- --
Benefits paid (113) (112) (30) (27)
Other / Foreign exchange adjustment 11 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
BENEFIT OBLIGATION - END OF YEAR $ 2,734 $ 2,588 $ 477 $ 434
====================================================================================================================================
F-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT
PLANS (CONTINUED)
CHANGE IN PLAN ASSETS Pension Benefits Other Postretirement Benefits
- ------------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets - beginning of year $ 1,487 $ 1,711 $ 96 $ 97
Actual return on plan assets 334 (119) 7 4
Employer contribution 306 -- -- --
Benefits paid (107) (101) (3) (5)
Expenses paid (4) (4) -- --
Other / Foreign exchange adjustment (1) -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
FAIR VALUE OF PLAN ASSETS - END OF YEAR $ 2,015 $ 1,487 $ 100 $ 96
====================================================================================================================================
Pension Benefits Other Postretirement Benefits
----------------------------- ------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Funded status $ (719) $ (1,101) $ (377) $ (338)
Unrecognized transition obligation -- -- 2 2
Unrecognized net actuarial (gain) loss 915 934 123 98
Unrecognized prior service cost (148) 26 (85) (108)
- ------------------------------------------------------------------------------------------------------------------------------------
NET AMOUNT RECOGNIZED $ 48 $ (141) $ (337) $ (346)
====================================================================================================================================
Amounts recognized in the consolidated balance sheets consist of:
Pension Benefits Other Postretirement Benefits
------------------------------- -------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Accrued benefit liability $ (529) $ (763) $ (337) $ (346)
Intangible asset -- 32 -- --
Accumulated other comprehensive income 577 590 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
NET AMOUNT RECOGNIZED $ 48 $ (141) $ (337) $ (346)
====================================================================================================================================
In 2003, the Company amended its defined benefit pension plan. Effective January
1, 2009, participants covered under the traditional final-average-pay formula
will accrue benefits under the cash balance formula for service rendered after
this date. As a result of this amendment the Plan benefit obligations decreased
approximately $168.
The funded status of the Company's defined benefit pension and other
postretirement plans is dependent upon many factors, including returns on
invested assets and the level of market interest rates. Declines in the value of
securities traded in equity markets coupled with declines in long-term interest
rates have had a negative impact on the funded status of the plans. As a result,
the Company has recorded a change in minimum liabilities as of December 31, 2003
and 2002 as presented below:
Pension Benefits
----------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation for under-funded plans $ 2,531 $ 2,250
Fair value of plan assets for under-funded plans 2,002 1,487
Unfunded accumulated benefit obligation 529 763
- ------------------------------------------------------------------------------------------------------------------------------------
Net amount recognized 48 (141)
Intangible asset -- (32)
- ------------------------------------------------------------------------------------------------------------------------------------
Minimum pension liability, end of year 577 590
Minimum pension liability, beginning of year 590 30
- ------------------------------------------------------------------------------------------------------------------------------------
Increase/(decrease) in minimum pension liability included in other comprehensive income, before-tax $ (13) $ 560
Increase/(decrease) in minimum pension liability included in other comprehensive income, after-tax $ (8) $ 364
====================================================================================================================================
COMPONENTS OF NET PERIODIC BENEFIT COST
Total net periodic benefit cost for the years ended December 31, 2003, 2002 and
2001 include the following components:
Pension Benefits Other Postretirement Benefits
----------------------------------- ----------------------------------
2003 2002 2001 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Service cost $ 105 $ 84 $ 70 $ 12 $ 9 $ 8
Interest cost 167 156 145 27 27 25
Expected return on plan assets (184) (183) (168) (8) (9) (9)
Amortization of prior service cost 6 6 6 (24) (24) (23)
Amortization of unrecognized net losses 26 4 4 4 2 --
- ------------------------------------------------------------------------------------------------------------------------------------
NET PERIODIC BENEFIT COST $ 120 $ 67 $ 57 $ 11 $ 5 $ 1
====================================================================================================================================
F-39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT
PLANS (CONTINUED)
ASSUMPTIONS
Weighted average assumptions used in calculating the benefit obligations and the
net amount recognized for the plans per year were as follows:
As of December 31,
------------------------------------------
2003 2002
- -------------------------------------------------------------------
Discount rate 6.25% 6.50%
Rate of increase in
compensation levels 4.00% 4.00%
===================================================================
Weighted average assumptions used in calculating the net pension cost for the
plans were as follows:
Twelve Months Ended
December 31,
-----------------------------
2003 2002 2001
- ------------------------------------------------------------------
Discount rate 6.50% 7.50% 7.75%
Expected long-term rate of return
on plan assets 9.00% 9.75% 9.75%
Rate of increase in compensation
levels 4.00% 4.25% 4.25%
==================================================================
In determining the discount rate assumption, the Company utilizes current market
information provided by its plan actuaries, including a discounted cashflow
analysis of the Company's pension obligation and general movements in the
current market environment. The Company determines the long-term rate of return
assumption for the pension plan's asset portfolio based on analysis of the
portfolio's historical rates of return balanced with future long-term return
expectations. Based on its long-term outlook with respect to the markets, which
has been influenced by the poor equity market performance in recent years as
well as the recent decline in fixed income security yields, the Company lowered
its long-term rate of return assumption from 9.00% to 8.50% as of December 31,
2003.
Assumed health care cost trend rates were as follows:
As of
December 31,
------------------------------
2003 2002 2001
- ------------------------------------------------------------------
Health care cost trend rate 9.00% 9.00% 10.00%
Rate to which the cost trend rate
is assumed to decline (the
ultimate trend rate) 5.00% 5.00% 5.00%
Year that the rate reaches the
ultimate trend rate 2008 2007 2007
==================================================================
Assumed health care cost trends have an effect on the amounts reported for the
postretirement health care and life insurance benefit plan.
Increasing/decreasing the health care trend rates by one percent would have the
effect of increasing/decreasing the benefit obligation as of December 31, 2003
by $16 and the annual net periodic expense for the year then ended by $1.
PLAN ASSETS
The Company's defined benefit pension plan weighted average asset allocation at
December 31, 2003 and 2002, and target allocation for 2004 by asset category are
as follows:
PERCENTAGE OF PENSION
PLAN ASSETS FAIR VALUE TARGET
AT DECEMBER 31, ALLOCATION
-------------------------
2003 2002 2004
- -----------------------------------------------------------------
Equity securities 61% 54% 50% - 70%
Debt securities 39% 46% 30% - 50%
Real estate --% --% 2% maximum
Other --% --% 5% maximum
- -----------------------------------------------------------------
TOTAL 100% 100%
=================================================================
There was no Company common stock included in the Plan's assets as of December
31, 2003 and 2002.
The Company's other benefit plans' weighted average asset allocation at December
31, 2003 and 2002, and target allocation for 2004 by asset category are as
follows:
PERCENTAGE OF OTHER
POSTRETIREMENT BENEFIT
PLAN ASSETS FAIR VALUE TARGET
AT DECEMBER 31, ALLOCATION
-------------------------
2003 2002 2004
- -----------------------------------------------------------------
Equity securities 38% 34% 25% - 45%
Debt securities 62% 66% 55% - 75%
- -----------------------------------------------------------------
TOTAL 100% 100%
=================================================================
Included in equity securities is the Company's common stock in the amounts of $1
(0.50% of total Other Postretirement Benefit plan assets) at December 31, 2003
and 2002.
The overall goal of the Plan is to maximize total investment returns to provide
sufficient funding for present and anticipated future benefit obligations within
the constraints of a prudent level of portfolio risk and diversification.
Investment decisions are approved by the Company's Pension Committee. The
Company believes that the asset allocation decision will be the single most
important factor determining the long-term performance of the Plan.
Divergent market performance among different asset classes may, from time to
time, cause the asset allocation to deviate from the desired asset allocation
ranges. The asset allocation mix is reviewed on a periodic basis. If it is
determined that an asset allocation mix rebalancing is required, future
portfolio additions and withdrawals will be used, as necessary, to bring the
allocation within tactical ranges.
In order to minimize risk, the Plan maintains a listing of permissible and
prohibited investments. In addition, the Plan has certain concentration limits
and investment quality requirements imposed on permissible investment options.
The Company employs a duration overlay program to adjust the duration of the
fixed income component in the plan assets to better match the duration of the
benefits obligations. The portfolio will invest primarily in U.S. Treasury notes
F-40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT
PLANS (CONTINUED)
and bond future contracts to maintain the duration within +/- 0.75 year of
target duration.
CASH FLOWS
The following table illustrates the Company's prior and anticipated future
contributions.
OTHER
EMPLOYER PENSION POSTRETIREMENT
CONTRIBUTIONS BENEFITS BENEFITS
- -----------------------------------------------------------------
2002 $-- $--
2003 $306 $--
2004 (best estimate) $300 $--
=================================================================
The Company presently anticipates contributing approximately $300 million to its
pension plan in 2004, based upon certain economic and business assumptions.
These assumptions include, but are not limited to, equity market performance,
changes in interest rates and the Company's other capital requirements. The
Company's 2004 required minimum funding contributions are estimated to be
approximately $160 assuming no continued pension relief. If Congress approves
the pension relief legislation for 2004, the Company is not expected to have a
minimum funding requirement during the year.
Employer contributions in 2003 were made in cash and do not include
contributions of the Company's common stock.
13. INVESTMENT AND SAVINGS PLAN
Substantially all U.S. employees are eligible to participate in The Hartford's
Investment and Savings Plan under which designated contributions may be invested
in common stock of The Hartford or certain other investments. These
contributions are matched, up to 3% of compensation, by the Company. In
addition, the Company allocates at least 0.5% of base salary to the plan for
each eligible employee. In 2004, the Company will allocate 1.5% of base salary
to the plan for eligible employees who have salaries of less than ninety
thousand dollars per year. The cost to The Hartford for this plan was
approximately $36, $34 and $30 for 2003, 2002 and 2001, respectively.
14. REINSURANCE
The Hartford cedes insurance to other insurers in order to limit its maximum
losses and to diversify its exposures. Such transfer does not relieve The
Hartford of its primary liability under policies it wrote and, as such, failure
of reinsurers to honor their obligations could result in losses to The Hartford.
The Hartford also assumes reinsurance from other insurers. The Hartford also is
a member of and participates in several reinsurance pools and associations. The
Hartford evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk. Virtually all of The Hartford's property and
casualty reinsurance is placed with reinsurers that meet strict financial
criteria established by a credit committee. As of December 31, 2003, The
Hartford had no reinsurance-related concentrations of credit risk greater than
10% of the Company's stockholders' equity.
LIFE
In accordance with normal industry practice, Life is involved in both the
cession and assumption of insurance with other insurance and reinsurance
companies. As of December 31, 2003, the largest amount of life insurance
retained on any one life by any one of the life operations was approximately
$2.5. In addition, the Company reinsures the majority of minimum death benefit
guarantees and the guaranteed withdrawal benefits offered in connection with its
variable annuity contracts.
Life insurance net retained premiums were comprised of the following:
For the years ended December 31,
-------------------------------------
2003 2002 2001
- -----------------------------------------------------------------
Gross premiums $ 6,247 $ 5,634 $ 5,950
Assumed 195 180 232
Ceded (465) (420) (446)
- -----------------------------------------------------------------
NET RETAINED PREMIUMS $ 5,977 $ 5,394 $ 5,736
=================================================================
Life reinsures certain of its risks to other reinsurers under yearly renewable
term, coinsurance, and modified coinsurance arrangements. Yearly renewable term
and coinsurance arrangements result in passing a portion of the risk to the
reinsurer. Generally, the reinsurer receives a proportionate amount of the
premiums less an allowance for commissions and expenses and is liable for a
corresponding proportionate amount of all benefit payments. Modified coinsurance
is similar to coinsurance except that the cash and investments that support the
liabilities for contract benefits are not transferred to the assuming company,
and settlements are made on a net basis between the companies.
Life also purchases reinsurance covering the death benefit guarantees on a
portion of its variable annuity business. On March 16, 2003, a final decision
and award was issued in the previously disclosed arbitration between
subsidiaries of the Company and one of their primary reinsurers relating to
policies with death benefits written from 1994 to 1999. (For further discussion
of this arbitration, see Note 16.)
The cost of reinsurance related to long-duration contracts is accounted for over
the life of the underlying reinsured policies using assumptions consistent with
those used to account for the underlying policies. Life insurance recoveries on
ceded reinsurance contracts, which reduce death and other benefits, were $541,
$484 and $392 for the years ended December 31, 2003, 2002 and 2001,
respectively.
F-41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. REINSURANCE (CONTINUED)
PROPERTY AND CASUALTY
The effect of reinsurance on property and casualty premiums written and earned
was as follows:
For the years ended December 31,
--------------------------------------
2003 2002 2001
- ----------------------------------------------------------------
PREMIUMS WRITTEN
Direct $ 10,393 $ 8,985 $ 7,625
Assumed 688 850 1,035
Ceded (2,016) (1,251) (1,075)
- ----------------------------------------------------------------
NET $ 9,065 $ 8,584 $ 7,585
================================================================
PREMIUMS EARNED
Direct $ 9,919 $ 8,404 $ 7,230
Assumed 731 872 1,016
Ceded (1,845) (1,162) (980)
- ----------------------------------------------------------------
NET $ 8,805 $ 8,114 $ 7,266
================================================================
Reinsurance cessions, which reduce claims and claim adjustment expenses
incurred, were $2.0 billion, $988 and $1.2 billion for the years ended December
31, 2003, 2002 and 2001, respectively.
The Hartford records a receivable for reinsured benefits paid and the portion of
insurance liabilities that are reinsured, net of a valuation allowance, if
necessary. The amounts recoverable from reinsurers are estimated based on
assumptions that are consistent with those used in establishing the reserves
related to the underlying reinsured contracts. Management believes the
recoverables are appropriately established; however, in the event that future
circumstances and information require The Hartford to change its estimate of
needed loss reserves, the amount of reinsurance recoverables may also require
adjustments.
As of December 31, 2003 and 2002, the allowance for uncollectible reinsurance
totaled $381 and $211, respectively.
REINSURANCE RECAPTURE
On June 30, 2003, the Company recaptured a block of business previously
reinsured with an unaffiliated reinsurer. Under this treaty, HLI reinsured a
portion of the GMDB feature associated with certain of its annuity contracts. As
consideration for recapturing the business and final settlement under the
treaty, the Company has received assets valued at approximately $32 and one
million warrants exercisable for the unaffiliated company's stock. This amount
represents to the Company an advance collection of its future recoveries under
the reinsurance agreement and will be recognized as future losses are incurred.
Prospectively, as a result of the recapture, HLI will be responsible for all of
the remaining and ongoing risks associated with the GMDB's related to this block
of business. The recapture increased the net amount at risk retained by the
Company, which is included in the net amount at risk discussed in Note 1. On
January 1, 2004, upon adoption of the SOP, the $32 was included in the Company's
GMDB reserve calculation as part of the net reserve benefit ratio and as a claim
recovery to date.
15. INCOME TAX
The provision (benefit) for income taxes consists of the following:
For the years ended December 31,
--------------------------------------------------------------------
2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME TAX EXPENSE (BENEFIT)
Current - U.S. Federal $ (120) $ 136 $ (240)
International 5 3 (2)
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT (115) 139 (242)
- -----------------------------------------------------------------------------------------------------------------------------------
Deferred - U.S. Federal $ (344) $ (70) $ 41
International -- (1) 1
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL DEFERRED (344) (71) 42
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE (BENEFIT) $ (459) $ 68 $ (200)
===================================================================================================================================
Deferred tax assets (liabilities) include the following as of December 31:
U.S. Federal
------------------------------------------------------------------
2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Loss reserves discounted on tax return $ 696 $ 677
Other insurance-related items (151) (212)
Employee benefits 255 377
Reserve for bad debts 48 32
Depreciation 23 27
Unrealized gains (1,121) (954)
Other investment-related items 23 33
Minimum tax credit 252 338
NOL benefit carryover 822 217
Other (2) 10
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 845 $ 545
==================================================================================================================================
In management's judgment, the net deferred tax asset will more likely than not
be realized as reductions of future taxable income. Accordingly, no valuation
allowance has been recorded. Included in the deferred tax asset is the expected
tax benefit attributable to net operating losses of $2.3 billion, which expire
in 2021 - 2023.
F-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. INCOME TAX (CONTINUED)
Prior to the Tax Reform Act of 1984, the Life Insurance Company Income Tax Act
of 1959 permitted the deferral from taxation of a portion of statutory income
under certain circumstances. In these situations, the deferred income was
accumulated in a "Policyholders' Surplus Account" and, based on current tax law,
will be taxable in the future only under conditions which management considers
to be remote; therefore, no federal income taxes have been provided on the
balance in this account, which for tax return purposes was $104 as of December
31, 2003.
A reconciliation of the tax provision at the U.S. Federal statutory rate to the
provision for income taxes is as follows:
For the years ended December 31,
-----------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Tax provision at U.S. Federal statutory rate $ (193) $ 374 $ 119
Tax-preferred investment income (243) (225) (221)
Sale of International subsidiaries (see Note 18) -- (8) 9
Internal Revenue Service audit settlement (see Note 16) -- (77) --
Tax adjustment - HLI (see Note 16) (30) -- (130)
Other 7 4 23
- ------------------------------------------------------------------------------------------------------------------------------------
PROVISION (BENEFIT) FOR INCOME TAX $ (459) $ 68 $ (200)
====================================================================================================================================
16. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the uncertainties
discussed 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 automobile,
premises liability and inland marine, and improper sales practices in connection
with the sale of life insurance and other investment products. The Hartford also
is involved in individual actions in which punitive damages are sought, such as
claims alleging bad faith in the handling of insurance claims. Management
expects that the ultimate liability, if any, with respect to such lawsuits,
after consideration of provisions made for potential losses and costs of
defense, will not be material to the consolidated financial condition of The
Hartford. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, it is
possible that an adverse outcome in certain matters could, from time to time,
have a material adverse effect on the Company's consolidated results of
operations or cash flows in particular quarterly or annual periods.
The Hartford continues to receive asbestos and environmental claims that involve
significant uncertainty regarding policy coverage issues. Regarding these
claims, The Hartford continually reviews its overall reserve levels,
methodologies and reinsurance coverages.
The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford
A&I"), a subsidiary of the Company, issued primary general liability policies to
Mac Arthur Company and its subsidiary, Western MacArthur Company, both former
regional distributors of asbestos products (collectively or individually,
"MacArthur"), during the period 1967 to 1976. In 1987, Hartford A&I notified
MacArthur that its available limits for asbestos bodily injury claims under
these policies had been exhausted, and MacArthur ceased submitting claims to
Hartford A&I under these policies. Thirteen years later, MacArthur filed an
action against Hartford A&I seeking for the first time additional coverage for
asbestos bodily injury claims under the Hartford A&I primary policies on the
theory that Hartford A&I had not exhausted limits MacArthur alleged to be
available for non-products liability. Following the voluntary dismissal of
MacArthur's original action, the coverage litigation proceeded in the Superior
Court in Alameda County, California. MacArthur sought a declaration of coverage
and damages, alleging that its liability for liquidated but unpaid asbestos
bodily injury claims was $2.5 billion, of which more than $1.8 billion consisted
of unpaid judgments, and that it had substantial additional liability for
unliquidated and future claims. Four asbestos claimants holding default
judgments against MacArthur also were joined as plaintiffs and asserted a right
to an accelerated trial. Hartford A&I has been vigorously defending that action.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. On November 22,
2002, pursuant to the terms of its settlement with St. Paul, MacArthur filed a
bankruptcy petition and proposed plan of reorganization. A month-long
confirmation trial was held during the fourth quarter of 2003. Hartford A&I
objected to the proposed plan and took
F-43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the leading role for the objectors at trial. On December 19, 2003, Hartford A&I
entered into a settlement agreement with MacArthur, the Official Unsecured
Creditors Committee representing the asbestos plaintiffs, the Futures
Representative appointed by the court, and the plaintiffs' lawyers representing
the holders of default judgments against MacArthur. The settlement is contingent
on the occurrence of certain conditions, including final, non-appealable court
orders approving the settlement agreement and confirming a bankruptcy plan under
which, among other things, all claims against the Company relating to the
asbestos liability of MacArthur are enjoined. If the conditions are met, the
settlement will resolve all disputes concerning Hartford A&I's alleged
obligations arising from MacArthur's asbestos liability. Under the settlement
agreement, Hartford A&I will pay $1.15 billion into an escrow account in the
first quarter of 2004, and the funds will be disbursed to a trust to be
established for the benefit of present and future asbestos claimants pursuant to
the bankruptcy plan once all conditions precedent to the settlement have
occurred.
In January 2004, the bankruptcy court approved the settlement agreement and
entered an order confirming a plan of reorganization that provides for the
injunctions and other protections required under the settlement agreement. The
injunctions will become effective when they are affirmed by the district court.
Management expects that all conditions to the settlement will be satisfied, but
it is not certain whether or when those conditions will be satisfied.
Bancorp Services, LLC - In the third quarter of 2003, Hartford Life Insurance
Company ("HLIC") and its affiliate International Corporate Marketing Group, LLC
("ICMG") settled their intellectual property dispute with Bancorp Services, LLC
("Bancorp"). The dispute concerned, among other things, Bancorp's claims for
alleged patent infringement, breach of a confidentiality agreement, and
misappropriation of trade secrets related to certain stable value
corporate-owned life insurance products. The dispute was the subject of
litigation in the United States District Court for the Eastern District of
Missouri, in which Bancorp obtained in 2002 a judgment exceeding $134 against
HLIC and ICMG after a jury trial on the trade secret and breach of contract
claims, and HLIC and ICMG obtained summary judgment on the patent infringement
claim. Based on the advice of legal counsel following entry of the judgment, the
Company recorded an $11 after-tax charge in the first quarter of 2002 to
increase litigation reserves. Both components of the judgment were appealed.
Under the terms of the settlement, The Hartford will pay a minimum of $70 and a
maximum of $80, depending on the outcome of the patent appeal, to resolve all
disputes between the parties. The appeal from the trade secret and breach of
contract judgment will be dismissed. The settlement resulted in the recording of
an additional charge of $40 after-tax in the third quarter of 2003, reflecting
the maximum amount payable under the settlement. In November 2003, the Company
paid the initial $70 of the settlement.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed reinsurance arbitration between subsidiaries
of The Hartford and one of their primary reinsurers relating to policies with
guaranteed death benefits written from 1994 to 1999. The arbitration involved
alleged breaches under the reinsurance treaties. Under the terms of the final
decision and award, the reinsurer's reinsurance obligations to The Hartford's
subsidiaries were unchanged and not limited or reduced in any manner. The award
was confirmed by the Connecticut Superior Court on May 5, 2003.
ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from
asbestos-related and environmental-related exposures. Asbestos claims relate
primarily to bodily injuries asserted by those who came in contact with asbestos
or products containing asbestos. Environmental claims relate primarily to
pollution and related clean-up costs.
The Hartford wrote several different categories of insurance coverage to which
asbestos and environmental claims may apply. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhausted their underlying liability insurance coverage. Third, The Hartford
acted as a reinsurer assuming a portion of risks previously assumed by other
insurers writing primary, excess and reinsurance coverages. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related expenses. Traditional
actuarial reserving techniques cannot reasonably estimate the ultimate cost of
these claims, particularly during periods where theories of law are in flux. As
a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other, more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation, and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular 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, plaintiffs'
increased focus on new and previously peripheral defendants, and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and
increase loss payments by insurers. In addition,
F-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
some policyholders have begun to assert new classes of claims for so-called
"non-products" coverages to which an aggregate limit of liability may not apply.
Recently, many insurers, including The Hartford, also have been sued directly by
asbestos claimants asserting that insurers had a duty to protect the public from
the dangers of asbestos. Management believes these issues are not likely to be
resolved in the near future.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims that cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layers of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It also is not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims.
It is unknown whether a potential Federal bill concerning asbestos litigation
approved by the Senate Judiciary Committee, or some other potential Federal
asbestos-related legislation, will be enacted and, if so, what its effect will
be on The Hartford's aggregate asbestos liabilities. Additionally, the reporting
pattern for excess insurance and reinsurance claims is much longer than direct
claims. In many instances, it takes months or years to determine that the
policyholder's own obligations have been met and how the reinsurance in question
may apply to such claims. The delay in reporting excess and reinsurance claims
and exposures adds to the uncertainty of estimating the related reserves.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court decisions that have interpreted the
insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
regularly evaluates new information in assessing its potential asbestos and
environmental exposures.
In the first quarter of 2003, several events occurred that in the Company's view
confirmed the existence of a substantial long-term deterioration in the asbestos
litigation environment. For example, in February 2003, Combustion Engineering,
long a major asbestos defendant, filed a pre-packaged bankruptcy plan under
which it proposed to emerge from bankruptcy within five weeks, before opponents
of the plan could have a meaningful opportunity to object, and included many
novel features in its plan that its insurers found objectionable. In December
2002, Halliburton had announced its intention to file a similar plan through one
or more subsidiaries and in January 2003, Honeywell announced that it had
reached an agreement with the plaintiffs' bar that would enable it to file a
pre-negotiated plan through its former NARCO subsidiary, then already in
bankruptcy. In January 2003, Congoleum, a floor tile manufacturer, which
previously had defended claims successfully in the tort system, announced its
intention to file a pre-packaged plan of reorganization to be funded almost
entirely with insurance proceeds. Moreover, prominent members of the plaintiffs'
and policyholders' bars announced publicly their intention to file many more
such plans. These events represented a worsening of conditions the Company
observed in 2002.
As a result of these worsening conditions, the Company conducted a
comprehensive, ground-up study of its asbestos exposures in the first quarter of
2003 in an effort to project, beginning at the individual account level, the
effect of these trends on the Company's estimated total exposure to asbestos
liability. Based on the Company's reevaluation of the deteriorating conditions
described above, the Company strengthened its gross and net asbestos reserves by
$3.9 billion and $2.6 billion, respectively. The reserve strengthening related
primarily to policies effective in 1985 or prior years. The Company had
incorporated an absolute asbestos exclusion in most of its general liability
policies written after 1985. The Company believes that its current asbestos
reserves are reasonable and appropriate.
As of December 31, 2003 and December 31, 2002, the Company reported $3.8 billion
and $1.1 billion of net asbestos reserves and $408 and $591 of net environmental
reserves, respectively. Because of the significant uncertainties previously
described, principally those related to asbestos, the ultimate liabilities may
exceed the currently recorded reserves. Any such additional liability (or any
range of additional amounts) cannot be reasonably estimated now but could be
material to The Hartford's future consolidated operating results, financial
condition and liquidity. 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.
LEASE COMMITMENTS
Total rental expense on operating leases was $158 in 2003, $155 in 2002 and $156
in 2001. Future minimum lease commitments are as follows:
2004 $ 161
2005 141
2006 123
2007 102
2008 77
Thereafter 144
- ----------------------------------------------------------------
TOTAL $ 748
================================================================
On June 30, 2003, the Company entered into a sale-leaseback of certain furniture
and fixtures with a net book value of $40. The sale-leaseback resulted in a gain
of $15, which was deferred and will be amortized into earnings over the initial
lease term of three years. The lease qualifies as an operating lease for
accounting purposes. At the end of the initial lease term, the Company has
F-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the option to purchase the leased assets, renew the lease for two one-year
periods or return the leased assets to the lessor. If the Company elects to
return the assets to the lessor at the end of the initial lease term, the assets
will be sold, and the Company has guaranteed a residual value on the furniture
and fixtures of $20. If the fair value of the furniture and fixtures were to
decline below the residual value, the Company would have to make up the
difference under the residual value guarantee.
As of December 31, 2003, no liability was recorded for this guarantee, as the
expected fair value of the furniture and fixtures at the end of the initial
lease term was greater than the residual value guarantee.
TAX MATTERS
The Hartford's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001
tax years. 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.
Throughout the IRS audit of the 1996-1997 years, the Company and the IRS engaged
in a dispute regarding what portion of the separate account dividends-received
deduction ("DRD") was 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.
Early 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 total DRD benefit related to
the 2002 tax year was $63.
During the second quarter of 2003, the Company recorded a benefit of $30,
consisting primarily of a change in the estimate of the DRD tax benefit reported
during 2002. The change in the estimate was the result of actual 2002 investment
performance on the related separate accounts being unexpectedly out of pattern
with past performance, which had been the basis for the estimate. The total DRD
benefit relating to the 2003 tax year recorded during the year ended December
31, 2003 was $87.
The Company will continue to monitor further developments surrounding the
computation of the separate account DRD, as well as other tax-related items, and
will adjust its estimate of the probable outcome of these issues as developments
warrant.
UNFUNDED COMMITMENTS
At December 31, 2003, The Hartford has outstanding commitments totaling $464, of
which $324 is committed to fund limited partnership investments. These capital
commitments can be called by the partnership during the commitment period (on
average 2 to 5 years) to fund working capital needs or purchase new investments.
Once the commitment period expires, the Company is under no obligation to fund
the remaining unfunded commitment but may elect to do so. The remaining $140 of
outstanding commitments are related to various funding obligations associated
with investments in mortgage loans. These have a commitment period that expires
in less than one year.
17. 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, Corporate includes certain interest
expense, capital raising and purchase accounting adjustment activities, as well
as capital raised that has not been contributed to the Company's insurance
subsidiaries.
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 universal life,
universal life, interest -sensitive whole life and term life insurance. Group
Benefits sells group insurance products, including group life and group
disability insurance, as well as other products, including stop loss and
supplementary medical coverage 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 "Other" corporate
items not directly allocable to any of its reportable operating segments,
principally interest expense as well as its international operations, which are
primarily located in Japan and Brazil, realized capital gains and losses and
intersegment eliminations.
F-46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
Property & Casualty is organized into five reportable operating segments: the
four North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance ("North American"); and the Other
Operations segment, which includes substantially all of the Company's asbestos
and environmental exposures. Property & Casualty also includes income and
expense items not directly allocated to these segments, such as net investment
income, net realized capital gains and losses, and other expenses including
interest, severance and income taxes.
Business Insurance provides standard commercial insurance coverage to small
commercial and middle market commercial business primarily throughout the United
States. This segment offers workers' compensation, property, automobile,
liability, umbrella and marine coverages. Commercial risk management products
and services also are provided.
Personal Lines provides automobile, homeowners' and home-based business
coverages to the members of AARP through a direct marketing operation; to
individuals who prefer local agent involvement through a network of independent
agents in the standard personal lines market; and through the Omni Insurance
Group in the non-standard automobile market. Personal Lines also operates a
member contact center for health insurance products offered through AARP's
Health Care Options.
The Specialty Commercial segment offers a variety of customized insurance
products and risk management services. Specialty Commercial provides standard
commercial insurance products including workers' compensation, automobile and
liability coverages to large-sized companies. Specialty Commercial also provides
bond, professional liability, specialty casualty and agricultural coverages, as
well as core property and excess and surplus lines coverages not normally
written by standard lines insurers. Alternative markets, within Specialty
Commercial, provides insurance products and services primarily to captive
insurance companies, pools and self-insurance groups. In addition, Specialty
Commercial provides third party administrator services for claims
administration, integrated benefits, loss control and performance measurement
through Specialty Risk Services, a subsidiary of the Company.
On May 16, 2003, as part of the Company's decision to withdraw from the assumed
reinsurance business, the Company entered into a quota share and purchase
agreement with Endurance Reinsurance Corporation of America ("Endurance")
whereby the Reinsurance segment retroceded the majority of its inforce book of
business as of April 1, 2003 and sold renewal rights to Endurance. Under the
quota share agreement, Endurance reinsured most of the segment's assumed
reinsurance contracts that were written on or after January 1, 2002 and that had
unearned premium as of April 1, 2003. In consideration for Endurance reinsuring
the unearned premium as of April 1, 2003, the Company paid Endurance an amount
equal to unearned premiums less the related unamortized commissions/deferred
acquisition costs and an override commission, which was established by the
contract. In addition, Endurance will pay a profit sharing commission based on
the loss performance of property treaty, property catastrophe and aviation pool
unearned premium. Under the purchase agreement, Endurance will pay additional
amounts, subject to a guaranteed minimum of $15, based on the level of renewal
premium on the reinsured contracts over the two year period following the
agreement. The guaranteed minimum is reflected in net income for the year ended
December 31, 2003. The Company remains subject to ongoing reserve development
relating to all retained business.
Prior to the Endurance transaction, the Reinsurance segment assumed reinsurance
in North America and primarily wrote treaty reinsurance through professional
reinsurance brokers covering various property, casualty, property catastrophe,
marine and alternative risk transfer ("ART") products. ART included
non-traditional reinsurance products such as multi-year property catastrophe
treaties, aggregate of excess of loss agreements and quota share treaties with
single event caps. International property catastrophe, marine and ART were also
written outside of North America through a London contact office.
The Other Operations segment consists of certain property and casualty insurance
operations of The Hartford which have discontinued writing new business and
includes substantially all of the Company's asbestos and environmental
exposures.
The measure of profit or loss used by The Hartford's management in evaluating
the performance of its Life segments is net income. Property & Casualty
underwriting segments are evaluated by The Hartford's management primarily based
upon underwriting results. Underwriting results represent earned premiums less
incurred claims, claim adjustment expenses and underwriting expenses.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided, security transfers and capital contributions. In addition, certain
reinsurance stop loss agreements exist between the segments which specify that
one segment will reimburse another for losses incurred in excess of a
predetermined limit. Also, one segment may purchase group annuity contracts from
another to fund pension costs and annuities to settle casualty claims. In
addition, certain intersegment transactions occur in Life. These transactions
include interest income on allocated surplus and the allocation of certain net
realized capital gains and losses through net investment income utilizing the
duration of the segment's investment portfolios. Consolidated Life net
investment income and net realized capital gains and losses are unaffected by
such insignificant transactions. During the year ended December 31, 2003, $1.8
billion of securities were sold by the Property & Casualty operation to the Life
operation. For segment reporting, the net gain on this sale was deferred and
will be reported by the Property & Casualty operation as realized when the
underlying securities are sold by the Life operation. On December 1, 2002, the
Property & Casualty segments entered into a contract with a subsidiary, whereby
reinsurance will be provided to the Property & Casualty operation. This
reinsurance program enables Property & Casualty to purchase reinsurance at the
overall Property & Casualty operation level rather than by the individual
segment. The financial results of this reinsurance program, net of retrocessions
to unrelated reinsurers, are included in the Specialty Commercial segment.
F-47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
The following tables present revenues, operating results and assets.
Underwriting results are presented for the Business Insurance, Personal Lines,
Specialty Commercial, Reinsurance and Other Operations segments, while net
income is presented for Life, Property & Casualty and Corporate.
REVENUES BY PRODUCT LINE
For the years ended December 31,
------------------------------------------------------------
REVENUES 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products
Individual annuity $ 1,750 $ 1,539 $ 1,532
Other 2,058 1,568 1,807
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Products 3,808 3,107 3,339
Individual Life 982 958 890
Group Benefits 2,624 2,582 2,507
COLI 483 592 719
Other [1] 161 (304) (73)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 8,058 6,935 7,382
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Business Insurance
Workers' Compensation 1,242 1,079 891
Property 1,116 927 770
Automobile 676 590 512
Liability 419 382 345
Other 242 148 127
- ------------------------------------------------------------------------------------------------------------------------------------
Total Business Insurance 3,695 3,126 2,645
Personal Lines
Automobile 2,325 2,232 2,067
Homeowners and other [2] 979 875 830
- ------------------------------------------------------------------------------------------------------------------------------------
Total Personal Lines 3,304 3,107 2,897
Specialty Commercial
Workers' Compensation 106 112 126
Property 238 198 108
Automobile 21 19 20
Liability 352 238 151
Other [2] 1,148 888 837
- ------------------------------------------------------------------------------------------------------------------------------------
Total Specialty Commercial 1,865 1,455 1,242
Reinsurance 351 713 920
Other Operations 18 69 17
Ceded premiums related to September 11 -- -- (91)
Net investment income 1,172 1,060 1,042
Net realized capital gains (losses) 253 (68) (92)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 10,658 9,462 8,580
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate 17 20 18
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 18,733 $ 16,417 $ 15,980
====================================================================================================================================
<FN>
[1] Amounts include net realized capital gains (losses) of $15, $(317) and
$(133) for the years ended December 31, 2003, 2002 and 2001, respectively.
[2] Includes servicing revenue.
</FN>
F-48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
For the years ended December 31,
-----------------------------------------------------
NET INCOME (LOSS) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 510 $ 432 $ 463
Individual Life 145 133 121
Group Benefits 148 128 106
COLI (1) 32 37
Other [1] (33) (168) (42)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 769 557 685
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
Underwriting results
Business Insurance 101 44 3
Personal Lines 117 (46) (78)
Specialty Commercial (29) (23) (95)
Reinsurance (125) (59) (149)
Other Operations (112) (164) (132)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results before September 11 and 2003 asbestos reserve addition (48) (248) (451)
September 11 [2] -- -- (647)
2003 asbestos reserve addition (2,604) -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total underwriting results (2,652) (248) (1,098)
Net servicing and other income [3] 8 15 22
Net investment income 1,172 1,060 1,042
Net realized capital gains (losses) 253 (68) (92)
Other expenses [4] (205) (218) (222)
Income tax (expense) benefit 613 (72) 241
Cumulative effect of accounting change, net of tax -- -- (8)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty (811) 469 (115)
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate (49) (26) (63)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (91) $ 1,000 $ 507
====================================================================================================================================
<FN>
[1] Amounts include net realized capital gains (losses), after-tax of $9, $(196)
and $(89) for the year ended December 31, 2003, 2002 and 2001, respectively.
[2] 2001 includes underwriting losses related to September 11 of $(245) in
Business Insurance, $(9) in Personal Lines, $(167) in Specialty Commercial
and $(226) in Reinsurance.
[3] Net of expenses related to service business.
[4] 2003 includes before-tax severance charges of $41.
</FN>
For the years ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Life $ 187,592 $ 149,794
Property & Casualty 37,159 31,129
Corporate 1,102 1,052
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 225,853 $ 181,975
====================================================================================================================================
GEOGRAPHICAL SEGMENT INFORMATION
For the years ended December 31,
------------------------------------------------------------
REVENUES 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
North America $ 18,480 $ 16,289 $ 15,836
Other 253 128 144
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 18,733 $ 16,417 $ 15,980
====================================================================================================================================
18. ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
CNA
- ---
On December 31, 2003, the Company acquired certain of CNA Financial
Corporation's group life and accident, and short-term and long-term disability
businesses, through a stock purchase, for $485 in cash. This acquisition will
increase the scale of the Company's group life and disability operations, expand
the Company's distribution and enhance the Company's capability to deliver
outstanding products and services. Purchase consideration for this transaction
was obtained from the issuance of commercial paper. The purchase price paid on
December 31, 2003, was based on a September 30, 2003 valuation of the businesses
acquired. During the first quarter of 2004, the purchase price will be adjusted
to reflect a December 31, 2003 valuation of the businesses acquired. The Company
currently estimates that adjustment to the purchase price to be an increase of
$51, which primarily reflects the increase of the surplus of the businesses
acquired in the fourth quarter of 2003. Through this acquisition assets
increased $2.6 billion, primarily comprised of fixed maturities and short-term
investments, and
F-49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
liabilities increased $2.1 billion, primarily comprised of reserve for future
policy benefits.
The assets and liabilities acquired in this transaction were recorded at fair
value. An intangible asset representing the present value of future profits
("PVP") of the acquired businesses was established in the amount of $53. The PVP
is amortized to expense in relation to the estimated gross profits of the
underlying insurance contracts, and interest is accreted on the unamortized
balance.
Fortis
- ------
On April 2, 2001, The Hartford acquired Fortis Financial Group for $1.12 billion
in cash. The Company effected the acquisition through several reinsurance
agreements with subsidiaries of Fortis, Inc. and the purchase of 100% of the
stock of Fortis Advisers, Inc. and Fortis Investors, Inc., wholly-owned
subsidiaries of Fortis, Inc. 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 operation purchase consideration for the transaction was as follows:
Issuance of:
- ------------
Common stock issuance (10 million shares
@ $64.00 per share), net of transaction costs $ 615
Long-term notes:
$400 7.375% notes due March 1, 2031 400
Junior subordinated debentures:
$200 7.625% Junior subordinated debentures
due February 15, 2050 200
- -----------------------------------------------------------------
Consideration raised $ 1,215
=================================================================
The assets and liabilities acquired in this transaction were recorded at values
prescribed by applicable purchase accounting rules, which represent estimated
fair value. In addition, an intangible asset representing the PVP of the
acquired business was established in the amount of $605.
The PVP is amortized to expense in relation to the estimated gross profits of
the underlying insurance contracts, and interest is accreted on the unamortized
balance. Goodwill of $553, representing the excess of the purchase price over
the amount of net assets (including PVP) acquired, has also been recorded and
was amortized on a straight-line basis until January 1, 2002, when amortization
ceased under the provisions of SFAS No. 142.
DISPOSITIONS
On September 1, 2003, the Company sold a wholly owned subsidiary, Trumbull
Associates, LLC, for $33, resulting in a gain of $15, after-tax. The gain is
included in net realized capital gains. The revenues and net income of Trumbull
Associates, LLC were not material to the Company or the Property & Casualty
operation.
On September 7, 2001, HLI completed the sale of its ownership interest in an
Argentine subsidiary, Sudamerica Holding S.A. The Company recorded an after-tax
net realized capital loss of $21 related to the sale.
On February 8, 2001, The Hartford completed the sale of its Spain-based
subsidiary, Hartford Seguros. The Hartford recorded an after-tax net realized
capital loss of $16.
19. ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in stockholders' equity, except
those arising from transactions with stockholders. Comprehensive income includes
net income (loss) and other comprehensive income, which for the Company consists
of changes in unrealized appreciation or depreciation of investments carried at
market value, changes in gains or losses on cash-flow hedging instruments,
changes in foreign currency translation gains or losses and changes in the
Company's minimum pension liability.
The components of AOCI or loss were as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 2003 Net Gain (Loss) Foreign
Unrealized on Cash-Flow Currency Minimum Pension Accumulated
Gain on Hedging Cumulative Liability Other
Securities, Instruments, Translation Adjustment, Comprehensive
net of tax net of tax Adjustments net of tax Income (Loss)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF YEAR $1,444 $128 $(95) $(383) $1,094
Unrealized gain on securities [1] [2] 320 -- -- -- 320
Foreign currency translation adjustments -- -- (6) -- (6)
Net gain (loss) on cash-flow hedging
instruments [1] [3] -- (170) -- -- (170)
Minimum pension liability adjustment [1] -- -- -- 8 8
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF YEAR $1,764 $(42) $(101) $(375) $1,246
====================================================================================================================================
<FN>
[1] Unrealized gain (loss) on securities is net of tax and other items of $136,
$810 and $60 for the years ended December 31, 2003, 2002 and 2001,
respectively. Net gain on cash-flow hedging instruments is net of tax of
$(92), $35 and $21 for the years ended December 31, 2003, 2002 and 2001,
respectively. Minimum pension liability adjustment is net of tax of $4,
$(196) and $(2) for the years ended December 31, 2003, 2002 and 2001,
respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net
income of $162, $(252) and $(72) for the years ended December 31, 2003,
2002 and 2001, respectively.
[3] Net of amortization adjustment of $20, $5 and $6 to net investment income
for the years ended December 31, 2003, 2002 and 2001, respectively.
[4] For the year ended December 31, 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>
F-50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2002
Net Gain (Loss) Foreign
Unrealized on Cash-Flow Currency Minimum Pension Accumulated
Gain on Hedging Cumulative Liability Other
Securities, Instruments, Translation Adjustment, Comprehensive
net of tax net of tax Adjustments net of tax Income (Loss)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF YEAR $606 $63 $(116) $(19) $534
Unrealized gain on securities [1] [2] 838 -- -- -- 838
Foreign currency translation adjustments -- -- 21 -- 21
Net gain on cash-flow hedging instruments [1] [3] -- 65 -- -- 65
Minimum pension liability adjustment [1] -- -- -- (364) (364)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF YEAR $1,444 $128 $(95) $(383) $1,094
====================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31, 2001
Net Gain (Loss) Foreign
Unrealized on Cash-Flow Currency Minimum Pension Accumulated
Gain on Hedging Cumulative Liability Other
Securities, Instruments, Translation Adjustment, Comprehensive
net of tax net of tax Adjustments net of tax Income (Loss)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF YEAR $497 $-- $(113) $(15) $369
Cumulative effect of accounting change [4] (1) 24 -- -- 23
Unrealized gain on securities [1] [2] 110 -- -- -- 110
Foreign currency translation adjustments -- -- (3) -- (3)
Net gain on cash-flow hedging instruments [1] [3] -- 39 -- -- 39
Minimum pension liability adjustment [1] -- -- -- (4) (4)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF YEAR $606 $63 $(116) $(19) $534
====================================================================================================================================
<FN>
[1] Unrealized gain (loss) on securities is net of tax and other items of $136,
$810 and $60 for the years ended December 31, 2003, 2002 and 2001,
respectively. Net gain on cash-flow hedging instruments is net of tax of
$(92), $35 and $21 for the years ended December 31, 2003, 2002 and 2001,
respectively. Minimum pension liability adjustment is net of tax of $4,
$(196) and $(2) for the years ended December 31, 2003, 2002 and 2001,
respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net
income of $162, $(252) and $(72) for the years ended December 31, 2003,
2002 and 2001, respectively.
[3] Net of amortization adjustment of $20, $5 and $6 to net investment income
for the years ended December 31, 2003, 2002 and 2001, respectively.
[4] For the year ended December 31, 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>
20. QUARTERLY RESULTS FOR 2003 AND 2002 (UNAUDITED)
Three Months Ended
-----------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
-----------------------------------------------------------------------------------
2003 2002 2003 2002 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 4,331 $ 4,060 $ 4,682 $ 3,992 $ 4,947 $ 4,085 $ 4,773 $ 4,280
Benefits, claims and expenses $ 6,556 $ 3,692 $ 4,053 $ 3,792 $ 4,511 $ 3,891 $ 4,163 $ 3,974
Net income (loss) [1] $ (1,395)$ 292 $ 507 $ 185 $ 343 $ 265 $ 454 $ 258
Basic earnings (loss) per share [1] $ (5.46)$ 1.19 $ 1.89 $ 0.75 $ 1.21 $ 1.06 $ 1.60 $ 1.01
Diluted earnings (loss) per share [1] [2] $ (5.46)$ 1.17 $ 1.88 $ 0.74 $ 1.20 $ 1.06 $ 1.59 $ 1.01
Weighted average common shares outstanding 255.4 246.1 268.8 247.4 282.5 248.9 283.0 255.2
Weighted average common shares outstanding and
dilutive potential common shares [2] 255.4 249.7 270.2 250.7 284.8 250.5 285.6 256.3
====================================================================================================================================
<FN>
[1] Included in the quarter ended March 31, 2003 is an after-tax charge of
$1,701 related to the Company's 2003 asbestos reserve addition. Included in
the quarter ended September 30, 2003 and March 31, 2002 are after-tax
expenses of $40 and $11, respectively, related to the settlement of the
Bancorp Services, LLC litigation dispute. Included in the quarters ended
June 30, 2003 and September 30, 2002 are $30 and $76, respectively, of tax
benefits in Life related to the favorable treatment of certain tax items
arising during the 1996-2002 tax years. The quarter ended June 30, 2003
includes $27 of after-tax severance charges in Property & Casualty.
[2] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128 requires the Company to use basic weighted average shares outstanding in
the calculation of first quarter 2003 diluted earnings per share, as the
inclusion of options of 0.7 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
256.1.
</FN>
F-51
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE I
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN AFFILIATES
(In millions) As of December 31, 2003
---------------------------------------------------------
Amount at which
shown on Balance
Type of Investment Cost Fair Value Sheet
- ----------------------------------------------------------------------------------------------------------------------------------
FIXED MATURITIES
Bonds and notes
U.S. Government and Government agencies and authorities
(guaranteed and sponsored) $ 1,060 $ 1,070 $ 1,070
U.S. Government and Government agencies and authorities
(guaranteed and sponsored) - asset-backed 3,315 3,361 3,361
States, municipalities and political subdivisions 10,003 10,770 10,770
International governments 1,436 1,582 1,582
Public utilities 2,316 2,452 2,452
All other corporate including international 23,323 24,926 24,926
All other corporate - asset-backed 13,235 13,656 13,656
Short-term investments 3,363 3,366 3,366
Redeemable preferred stock 76 80 80
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES 58,127 61,263 61,263
- ----------------------------------------------------------------------------------------------------------------------------------
EQUITY SECURITIES
Common stocks
Industrial and miscellaneous 115 169 169
Nonredeemable preferred stocks 390 396 396
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL EQUITY SECURITIES 505 565 565
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES AND EQUITY SECURITIES 58,632 61,828 61,828
- ----------------------------------------------------------------------------------------------------------------------------------
REAL ESTATE 2 2 2
OTHER INVESTMENTS
Mortgage loans on real estate 792 792 792
Policy loans 2,512 2,512 2,512
Investments in partnerships and trusts 392 345 345
Futures, options and miscellaneous 239 368 368
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER INVESTMENTS 3,935 4,017 4,017
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 62,569 $ 65,847 $ 65,847
==================================================================================================================================
S-1
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(REGISTRANT)
(In millions) As of December 31,
--------------------------------------
BALANCE SHEETS 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Receivables from affiliates $ 385 $ 333
Other assets 332 263
Investment in affiliates 15,447 13,351
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS 16,164 13,947
- ------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term debt 850 315
Long-term debt 3,319 2,574
Other liabilities 356 324
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 4,525 3,213
TOTAL STOCKHOLDERS' EQUITY 11,639 10,734
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,164 $ 13,947
==============================================================================================================================
(In millions)
STATEMENT OF OPERATIONS For the years ended December 31,
----------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Earnings of subsidiaries $ 21 $ 1,104 $ 641
Interest expense (net of interest income) 155 155 190
Other expenses 17 5 16
- ------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (151) 944 435
Income tax expense (benefit) (60) (56) (72)
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (91) $ 1,000 $ 507
==============================================================================================================================
S-2
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF
THE HARTFORD FINANCIAL SERVICES GROUP, INC. (CONTINUED)
(REGISTRANT)
(In millions) For the years ended December 31,
--------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
CONDENSED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES
Net income (loss) $ (91) $ 1,000 $ 507
Undistributed earnings of subsidiaries (197) (877) (555)
Change in working capital 163 (128) 45
- ------------------------------------------------------------------------------------------------------------------------------
CASH USED FOR OPERATING ACTIVITIES (125) (5) (3)
- ------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Net sale (purchase) of short-term investments 60 6 (41)
Capital contribution to subsidiary (2,135) (498) (854)
- ------------------------------------------------------------------------------------------------------------------------------
CASH USED FOR INVESTING ACTIVITIES (2,075) (492) (895)
- ------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase in debt 1,270 333 48
Issuance of common stock 1,162 330 1,015
Dividends paid (291) (257) (235)
Acquisitions of treasury stock (1) -- (7)
Proceeds from issuances of shares under incentive and stock
purchase plans 59 92 77
- ------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES 2,199 498 898
- ------------------------------------------------------------------------------------------------------------------------------
Net change in cash (1) 1 --
Cash - beginning of year 1 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Cash-end of year $ -- $ 1 $ --
==============================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
------------------------------------------------
NET CASH PAID DURING THE YEAR FOR:
Interest $ 148 $ 150 $ 186
S-3
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(In millions)
Future Policy
Deferred Benefits, Unpaid Other
Policy Claims and Claim Policyholder
Acquisition Adjustment Unearned Funds and Earned Premiums, Fee
Costs [1] Expenses Premiums Benefits Payable Income and Other
- ---------------------------------------------------------------------------------------------------------------------
2003
Life $ 6,623 $ 11,411 $ 58 $ 26,186 $ 5,977
Property & Casualty 975 21,715 4,372 -- 9,233
Corporate 1 (9) (7) (1) (3)
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 7,599 $ 33,117 $ 4,423 $ 26,185 $ 15,207
=====================================================================================================================
2002
Life $ 5,758 $ 8,583 $ 54 $ 23,957 $ 5,394
Property & Casualty 930 17,091 3,942 -- 8,470
Corporate 1 (16) (7) (1) --
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 6,689 $ 25,658 $ 3,989 $ 23,956 $ 13,864
=====================================================================================================================
2001
Life $ 5,572 $ 8,842 $ 45 $ 19,357 $ 5,736
Property & Casualty 847 17,036 3,399 -- 7,630
Corporate 1 (23) (8) (2) --
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 6,420 $ 25,855 $ 3,436 $ 19,355 $ 13,366
=====================================================================================================================
Benefits,
Claims and Amortization of
Net Claim Deferred Policy
Investment Adjustment Acquisition
Income Expenses Costs [1] Other Expenses Net Written Premiums
- ---------------------------------------------------------------------------------------------------------------------
2003
Life $ 2,041 $ 4,616 $ 769 $ 1,724 $ N/A
Property & Casualty 1,172 8,926 1,642 1,514 9,065
Corporate 20 6 -- 86 N/A
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 3,233 $ 13,548 $ 2,411 $ 3,324 $ 9,065
=====================================================================================================================
2002
Life $ 1,849 $ 4,158 $ 628 $ 1,582 $ N/A
Property & Casualty 1,060 5,870 1,613 1,438 8,584
Corporate 20 6 -- 54 N/A
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 2,929 $ 10,034 $ 2,241 $ 3,074 $ 8,584
=====================================================================================================================
2001
Life $ 1,782 $ 4,444 $ 642 $ 1,531 $ N/A
Property & Casualty 1,042 6,146 1,572 1,210 7,585
Corporate 18 7 -- 87 N/A
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 2,842 $ 10,597 $ 2,214 $ 2,828 $ 7,585
=====================================================================================================================
<FN>
[1] Also includes present value of future profits.
Note:Certain reclassifications have been made to prior year financial
information to conform to current year presentation.
N/A - Not applicable to life insurance pursuant to Regulation S-X.
</FN>
S-4
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE IV
REINSURANCE
Percentage
Assumed From of Amount
(In millions) Gross Ceded to Other Other Assumed to
Amount Companies Companies Net Amount Net
- ------------------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 2003
====================================================================================================================================
Life insurance in force $ 704,369 $ 288,758 $ 59,969 $ 475,580 13%
====================================================================================================================================
INSURANCE REVENUES
Property and casualty insurance $ 9,919 $ 1,845 $ 731 $ 8,805 8%
Life insurance and annuities 4,762 361 122 4,523 3%
Accident and health insurance 1,485 104 73 1,454 5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INSURANCE REVENUES $ 16,166 $ 2,310 $ 926 $ 14,782 6%
====================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31, 2002
====================================================================================================================================
Life insurance in force $ 629,028 $ 209,608 $ 65,590 $ 485,010 14%
====================================================================================================================================
INSURANCE REVENUES
Property and casualty insurance $ 8,404 $ 1,162 $ 872 $ 8,114 11%
Life insurance and annuities 4,067 279 84 3,872 2%
Accident and health insurance 1,567 141 96 1,522 6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INSURANCE REVENUES $ 14,038 $ 1,582 $ 1,052 $ 13,508 8%
====================================================================================================================================
FOR THE YEAR ENDED DECEMBER 31, 2001
Life insurance in force $ 534,489 $ 142,352 $ 50,828 $ 442,965 11%
====================================================================================================================================
INSURANCE REVENUES
Property and casualty insurance $ 7,230 $ 980 $ 1,016 $ 7,266 14%
Life insurance and annuities 4,542 323 68 4,287 2%
Accident and health insurance 1,408 123 164 1,449 11%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INSURANCE REVENUES $ 13,180 $ 1,426 $ 1,248 $ 13,002 10%
====================================================================================================================================
S-5
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
(In millions) Balance Charged to Costs Translation Write-offs/ Balance
January 1, and Expenses Adjustment Payments/Other December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2003
----
Allowance for doubtful accounts $ 142 $ 111 $ -- $ (81) $ 172
Allowance for uncollectible reinsurance 211 263 -- (93) 381
Accumulated depreciation of plant,
property and equipment 799 126 -- (166) 759
2002
----
Allowance for doubtful accounts $ 133 $ 96 $ (11) $ (76) $ 142
Allowance for uncollectible reinsurance 158 67 -- (14) 211
Accumulated depreciation of plant,
property and equipment 721 107 -- (29) 799
2001
----
Allowance for doubtful accounts $ 127 $ 60 $ (1) $ (53) $ 133
Allowance for uncollectible reinsurance 107 64 -- (13) 158
Accumulated depreciation of plant,
property and equipment 675 95 -- (49) 721
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
SCHEDULE VI
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY
AND CASUALTY INSURANCE OPERATIONS
Claims and Claim Adjustment
Discount Expenses Incurred Related to: Paid Claims and
Deducted From ------------------------------- Claim Adjustment
(In millions) Liabilities [1] Current Year Prior Year Expenses
- ------------------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
2003 $ 525 $ 6,102 $ 2,824 $ 5,849
2002 $ 527 $ 5,577 $ 293 $ 5,589
2001 $ 429 $ 5,992 $ 143 $ 5,592
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Reserves for permanently disabled claimants, terminated reinsurance treaties and certain reinsurance contracts have been
discounted using the rate of return The Hartford could receive on risk-free investments of 4.8%, 5.0% and 5.1% for 2003, 2002
and 2001, respectively.
</FN>
S-6
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Robert J. Price
----------------------------
Robert J. Price
Senior Vice President and
Controller
Date: February 27, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/S/ Ramani Ayer Chairman, President, Chief February 27, 2004
- ------------------------- Executive Officer and Director
Ramani Ayer (Principal Executive Officer)
/S/ Thomas M. Marra Executive Vice President and February 27, 2004
- ------------------------- Director
Thomas M. Marra
/S/ David K. Zwiener Executive Vice President and February 27, 2004
- ------------------------- Director
David K. Zwiener
/S/ David M. Johnson Executive Vice President and February 27, 2004
- ------------------------- Chief Financial Officer
David M. Johnson (Principal Financial Officer)
/S/ Robert J. Price Senior Vice President and Controller February 27, 2004
- ------------------------- (Principal Accounting Officer)
Robert J. Price
/S/ Rand V. Araskog Director February 27, 2004
- -------------------------
Rand V. Araskog
/S/ Donald R. Frahm Director February 27, 2004
- -------------------------
Donald R. Frahm
/S/ Edward J. Kelly, III Director February 27, 2004
- -------------------------
Edward J. Kelly, III
/S/ Paul G. Kirk, Jr. Director February 27, 2004
- -------------------------
Paul G. Kirk, Jr.
/S/ Gail J. McGovern Director February 27, 2004
- -------------------------
Gail J. McGovern
/S/ Robert W. Selander Director February 27, 2004
- -------------------------
Robert W. Selander
/S/ Charles B. Strauss Director February 27, 2004
- -------------------------
Charles B. Strauss
/S/ H. Patrick Swygert Director February 27, 2004
- -------------------------
H. Patrick Swygert
/S/ Gordon I. Ulmer Director February 27, 2004
- -------------------------
Gordon I. Ulmer
II-1
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
FORM 10-K
EXHIBITS INDEX
The exhibits attached to this Form 10-K are those that are required by Item 601
of Regulation S-K.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.01 Amended and Restated Certificate of Incorporation of The Hartford
Financial Services Group, Inc. ("The Hartford"), effective May 21, 1998,
as amended by Amendment No. 1, effective May 1, 2002 (incorporated
herein by reference to Exhibit 3.01 to The Hartford's Form 10-Q for the
quarterly period ended March 31, 2002).
3.02 Amended and Restated By-Laws of The Hartford, amended effective April
17, 2003 (incorporated herein by reference to Exhibit 3.01 to The
Hartford's Form 10-Q for the quarterly period ended March 31, 2003).
4.01 Amended and Restated Certificate of Incorporation and By-Laws of The
Hartford (incorporated herein by reference as indicated in Exhibits 3.01
and 3.02 hereto, respectively).
4.02 Rights Agreement dated as of November 1, 1995, (the "Rights Agreement"),
between The Hartford and The Bank of New York as Rights Agent
(incorporated herein by reference to Exhibit 4.26 to the Registration
Statement on Form S-3 (Registration No. 333-103915) of The Hartford,
Hartford Capital IV, Hartford Capital V and Hartford Capital VI).
4.03 Form of certificate of the voting powers, preferences and relative
participating, optional and other special rights, qualifications,
limitations or restrictions of Series A Participating Cumulative
Preferred Stock of The Hartford (attached as Exhibit A to the Rights
Agreement that is incorporated herein by reference as Exhibit 4.02
hereto).
4.04 Form of Right Certificate (attached as Exhibit B to the Rights Agreement
that is incorporated herein by reference as Exhibit 4.02 hereto).
4.05 Senior Indenture, dated as of October 20, 1995, between The Hartford and
The Chase Manhattan Bank (National Association) as Trustee (incorporated
herein by reference to Exhibit 4.03 to the Registration Statement on
Form S-3 (Registration No. 333-103915) of The Hartford, Hartford Capital
IV, Hartford Capital V and Hartford Capital VI).
4.06 Junior Subordinated Indenture, dated as of October 30, 1996, between The
Hartford and Wilmington Trust Company, as Trustee (incorporated herein
by reference to Exhibit 4.05 to the Registration Statement on Form S-3
(Registration No. 333-103915) of The Hartford, Hartford Capital IV,
Hartford Capital V and Hartford Capital VI).
4.07 Supplemental Indenture, dated as of October 26, 2001, between The
Hartford and Wilmington Trust Company, as Trustee, to the Junior
Subordinated Indenture filed as Exhibit 4.06 hereto between The Hartford
and Wilmington Trust Company, as Trustee (incorporated herein by
reference to Exhibit 4.27 to The Hartford's Form 10-K for the fiscal
year ended December 31, 2001).
4.08 Amended and Restated Trust Agreement, dated as of October 26, 2001, of
Hartford Capital III, relating to the 7.45% Trust Originated Preferred
Securities, Series C (the "Series C Preferred Securities") (incorporated
herein by reference to Exhibit 4.28 to The Hartford's Form 10-K for the
fiscal year ended December 31, 2001).
4.09 Agreement as to Expenses and Liabilities, dated as of October 26, 2001,
between The Hartford and Hartford Capital III (incorporated herein by
reference to Exhibit 4.29 to The Hartford's Form 10-K for the fiscal
year ended December 31, 2001).
4.10 Preferred Security Certificate for Hartford Capital III (incorporated
herein by reference to Exhibit 4.30 to The Hartford's Form 10-K for the
fiscal year ended December 31, 2001).
4.11 Guarantee Agreement, dated as of October 26, 2001, between The Hartford
and Wilmington Trust Company, relating to The Hartford's guarantee of
the Series C Preferred Securities (incorporated herein by reference to
Exhibit 4.31 to The Hartford's Form 10-K for the fiscal year ended
December 31, 2001).
II-2
EXHIBITS INDEX (CONTINUED)
EXHIBIT NO
- ----------
4.12 Supplemental Indenture No.1, dated as of December 27, 2000, to the
Senior Indenture filed as Exhibit 4.05 hereto, between The Hartford and
The Chase Manhattan Bank, as Trustee (incorporated herein by reference
to Exhibit 4.30 to The Hartford's Registration Statement on Form S-3
(Amendment No. 1) dated December 27, 2000) (Registration No. 333-49666).
4.13 Supplemental Indenture No. 2, dated as of September 13, 2002, to the
Senior Indenture filed as Exhibit 4.05 hereto, between The Hartford and
JPMorgan Chase Bank, as Trustee (incorporated herein by reference to
Exhibit 4.1 to The Hartford's Report on Form 8-K, filed September 17,
2002).
4.14 Form of Global Security (included in Exhibit 4.13).
4.15 Purchase Contract Agreement, dated as of September 13, 2002, between The
Hartford and JPMorgan Chase Bank, as Purchase Contract Agent
(incorporated herein by reference to Exhibit 4.2 to The Hartford's
Report on Form 8-K, filed September 17, 2002).
4.16 Form of Corporate Unit Certificate (included in Exhibit 4.15).
4.17 Pledge Agreement, dated as of September 13, 2002, among The Hartford 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 Hartford's
Report on Form 8-K, filed September 17, 2002).
4.18 Remarketing Agreement, dated as of September 13, 2002, between The
Hartford 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 Hartford's Report on Form 8-K, filed
September 17, 2002).
4.19 Supplemental Indenture No. 3, dated as of May 23, 2003, to the Senior
Indenture filed as Exhibit 4.05 hereto, between The Hartford and
JPMorgan Chase Bank, as Trustee (incorporated herein by reference to
Exhibit 4.1 of the Company's Current Report on Form 8-K filed May 30,
2003).
4.20 Purchase Contract Agreement, dated as of May 23, 2003, between The
Hartford and JPMorgan Chase Bank, as Purchase Contract Agent
(incorporated herein by reference to Exhibit 4.2 of the Company's
Current Report on Form 8-K filed May 30, 2003).
4.21 Pledge Agreement, dated as of May 23, 2003, between The Hartford and
JPMorgan Chase Bank, as Collateral Agent, Custodial Agent, Securities
Intermediary and Purchase Contract Agent (incorporated herein by
reference to Exhibit 4.3 of the Company's Current Report on Form 8-K
filed May 30, 2003).
4.22 Remarketing Agreement, dated as of May 23, 2003, between The Hartford,
Goldman, Sachs & Co., as the Remarketing Agent and JPMorgan Chase Bank,
as Purchase Contract Agent (incorporated herein by reference to Exhibit
4.4 of the Company's Current Report on Form 8-K filed May 30, 2003).
*10.01 Employment Agreement, dated July 1, 1997, between The Hartford and
Ramani Ayer (incorporated herein by reference to Exhibit 10.01 to The
Hartford's Form 10-Q for the quarterly period ended September 30, 1997).
*10.02 Employment Agreement, dated July 1, 1997, between The Hartford and David
K. Zwiener (incorporated herein by reference to Exhibit 10.03 to The
Hartford's Form 10-Q for the quarterly period ended September 30, 1997).
*10.03 Employment Agreement, dated July 1, 2000, between The Hartford and
Thomas M. Marra (incorporated herein by reference to Exhibit 10.1 to The
Hartford's Form 10-Q for the quarterly period ended September 30, 2000).
*10.04 Employment Agreement, dated as of March 20, 2001, between The Hartford
and Neal Wolin as Executive Vice President and General Counsel
(incorporated herein by reference to Exhibit 10.1 to The Hartford's Form
10-Q for the quarterly period ended March 31, 2001).
*10.05 Employment Agreement, dated as of April 26, 2001, between The Hartford
and David M. Johnson as Executive Vice President and Chief Financial
Officer (incorporated herein by reference to Exhibit 10.2 to The
Hartford's Form 10-Q for the quarterly period ended March 31, 2001).
II-3
EXHIBITS INDEX (CONTINUED)
EXHIBIT NO
- ----------
*10.06 Employment Agreement, dated as of November 5, 2001, between The Hartford
and David M. Znamierowski as Group Senior Vice President and Chief
Investment Officer. +
*10.07 Form of Key Executive Employment Protection Agreement between The
Hartford and certain executive officers of The Hartford. +
*10.08 The Hartford Restricted Stock Plan for Non-Employee Directors, as
amended (incorporated herein by reference to Exhibit 10.13 to The
Hartford's Form 10-K for the fiscal year ended December 31, 2002).
*10.09 The Hartford Incentive Stock Plan, as amended. +
*10.10 The Hartford Deferred Restricted Stock Unit Plan, as amended
(incorporated herein by reference to Exhibit 10.15 to The Hartford's
Form 10-K for the fiscal year ended December 31, 2002).
*10.11 The Hartford Deferred Compensation Plan, as amended (incorporated herein
by reference to Exhibit 10.16 to The Hartford's Form 10-K for the fiscal
year ended December 31, 2002).
*10.12 The Hartford Senior Executive Severance Pay Plan, as amended. +
*10.13 The Hartford Executive Severance Pay Plan I, as amended (incorporated
herein by reference to Exhibit 10.18 to The Hartford's Form 10-K for the
fiscal year ended December 31, 2002).
*10.14 The Hartford Planco Non-Employee Option Plan, as amended (incorporated
herein by reference to Exhibit 10.19 to The Hartford's Form 10-K for the
fiscal year ended December 31, 2002).
10.15 Second Amended and Restated Five-Year Competitive Advance and Revolving
Credit Facility Agreement (the "Five-Year Credit Facility"), dated as of
February 26, 2003, among The Hartford Financial Services Group, Inc.,
the lenders named therein, and The Chase Manhattan Bank and Bank of
America, N.A. as Co-Administrative Agents (incorporated herein by
reference to Exhibit 10.27 to The Hartford's Form 10-K for the fiscal
year ended December 31, 2002).
10.16 First Amendment, dated as of June 30, 2003, to the Five-Year Credit
Facility among The Hartford, the Lenders party thereto and JPMorgan
Chase Bank and Bank of America, N.A.,
as Co-Administrative Agents. +
10.17 Three-Year Competitive Advance and Revolving Credit Facility Agreement
(the "Three-Year Credit Facility"), dated as of December 31, 2002 among
The Hartford, Hartford Life, Inc., the Lenders named therein and JP
Morgan Chase Bank and Citibank, N.A. as Co-Administrative Agents
(incorporated herein by reference to Exhibit 10.28 to The Hartford's
Form 10-K for the fiscal year ended December 31, 2002).
10.18 First Amendment, dated as of June 30, 2003, to the Three-Year Credit
Facility among The Hartford, Hartford Life, Inc., the Lenders party
thereto and JPMorgan Chase Bank and Bank of America, N.A., as
Co-Administrative Agents. +
12.01 Statement Re: Computation of Ratio of Earnings to Fixed Charges. +
21.01 Subsidiaries of The Hartford Financial Services Group, Inc. +
23.01 Consent of Deloitte & Touche LLP the incorporation by reference into The
Hartford's Registration Statements on Forms S-8 and Forms S-3 of the
report of Deloitte & Touche LLP contained in this Form 10-K regarding
the audited financial statements is filed herewith. +
31.01 Certification of Ramani Ayer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. +
31.02 Certification of David M. Johnson pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.+
32.01 Certification of Ramani Ayer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. +
32.02 Certification of David M. Johnson pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.+
* Management contract, compensatory plan or arrangement.
+ Filed with the Securities and Exchange Commission as an exhibit to this
report.
II-4