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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 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 1-12749
HARTFORD LIFE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1470915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 HOPMEADOW STREET, SIMSBURY, CONNECTICUT 06089
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes [ ] No[X]
As of July 31, 2003 there were outstanding 1,000 shares of Common Stock, $0.01
par value per share, of the registrant, all of which were directly owned by
Hartford Holdings, Inc., a direct wholly owned subsidiary of The Hartford
Financial Services Group, Inc.
The registrant meets the conditions set forth in General Instruction H (1) (a)
and (b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.
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INDEX
PAGE
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Independent Accountants' Review Report 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income - Second Quarter and Six Months
Ended June 30, 2003 and 2002 4
Condensed Consolidated Balance Sheets - June 30, 2003
and December 31, 2002 5
Condensed Consolidated Statements of Changes in
Stockholder's Equity - Six Months Ended June 30, 2003 and 2002 6
Condensed Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2003 and 2002 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30
ITEM 4. CONTROLS AND PROCEDURES 30
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
Signature 31
Exhibits Index 32
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Stockholder
Hartford Life, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of
Hartford Life, Inc and subsidiaries (the "Company") as of June 30, 2003, and the
related condensed consolidated statements of income for the second quarters and
six-month periods ended June 30, 2003 and 2002, and changes in stockholder's
equity, and cash flows for the six-month period ended June 30, 2003 and 2002.
These interim financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of December 31, 2002, and the related consolidated statements of
income, changes in stockholder's equity, and cash flows for the year then ended
(not presented herein); and in our report dated February 19, 2003, which
includes an explanatory paragraph relating to the Company's change in its method
of accounting for goodwill and indefinite-lived intangible assets in 2002, we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of December 31, 2002 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
August 1, 2003
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
SECOND QUARTER SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
- ----------------------------------------------------------------------------------------------------------
(In millions) (Unaudited) 2003 2002 2003 2002
REVENUES
Fee income $ 656 $ 672 $ 1,273 $ 1,334
Earned premiums and other 743 696 1,453 1,437
Net investment income 513 450 1,020 898
Net realized capital gains (losses) 50 (120) 2 (135)
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TOTAL REVENUES 1,962 1,698 3,748 3,534
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BENEFITS, CLAIMS AND EXPENSES
Benefits and claims 1,086 1,028 2,169 2,085
Insurance expenses and other 373 346 713 717
Amortization of deferred policy acquisition costs and
present value of future profits 175 171 338 323
Dividends to policyholders 25 16 40 22
Interest expense 29 28 58 56
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TOTAL BENEFITS, CLAIMS AND EXPENSES 1,688 1,589 3,318 3,203
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INCOME BEFORE INCOME TAX EXPENSE 274 109 430 331
Income tax expense 31 8 61 60
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NET INCOME $ 243 $ 101 $ 369 $ 271
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
(In millions, except for share data) 2003 2002
- -----------------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Investments
Fixed maturities, available for sale, at fair value (amortized cost of
$31,684 and $27,982) $ 34,060 $ 29,377
Equity securities, available for sale, at fair value (cost of $426 and $483) 452 458
Policy loans, at outstanding balance 2,889 2,934
Other investments 937 1,122
- -----------------------------------------------------------------------------------------------------------------
Total investments 38,338 33,891
Cash 190 179
Premiums receivable and agents' balances 192 208
Reinsurance recoverables 797 796
Deferred policy acquisition costs and present value of future profits 5,927 5,758
Deferred income taxes (562) (274)
Goodwill 796 796
Other assets 1,540 1,362
Separate account assets 122,556 107,078
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TOTAL ASSETS $ 169,774 $ 149,794
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LIABILITIES
Reserve for future policy benefits $ 8,928 $ 8,583
Other policyholder funds 26,255 23,957
Short-term debt 200 --
Long-term debt 1,075 1,125
Company obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely parent junior subordinated debentures 450 450
Other liabilities 3,813 2,913
Separate account liabilities 122,556 107,078
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TOTAL LIABILITIES 163,277 144,106
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STOCKHOLDER'S EQUITY
Common Stock - 1,000 shares authorized, issued and outstanding;
par value $0.01 -- --
Capital surplus 1,970 1,970
Accumulated other comprehensive income
Net unrealized capital gains on securities, net of tax 1,221 747
Foreign currency translation adjustments (38) (39)
Total accumulated other comprehensive income 1,183 708
Retained earnings 3,344 3,010
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TOTAL STOCKHOLDER'S EQUITY 6,497 5,688
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TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 169,774 $ 149,794
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 2003
ACCUMULATED OTHER
COMPREHENSIVE INCOME
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NET NET
UNREALIZED GAINS ON
CAPITAL CASH FLOW
GAINS ON HEDGING FOREIGN
SECURITIES INSTRUMENTS CURRENCY TOTAL
COMMON CAPITAL NET NET TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS OF TAX OF TAX ADJUSTMENTS EARNINGS EQUITY
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Balance, December 31, 2002 $ -- $1,970 $621 $126 $(39) $3,010 $5,688
Comprehensive income
Net income 369 369
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Other comprehensive income, net of tax (1)
Unrealized gain on securities (2) 510 510
Net loss on cash flow hedging
Instruments (36) (36)
Cumulative translation adjustments 1 1
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Total other comprehensive income 475
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Total comprehensive income 844
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Dividends declared (35) (35)
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BALANCE, JUNE 30, 2003 $ -- $1,970 $1,131 $90 $(38) $3,344 $6,497
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SIX MONTHS ENDED JUNE 30, 2002
ACCUMULATED OTHER
COMPREHENSIVE INCOME
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NET NET
UNREALIZED GAINS ON
CAPITAL CASH FLOW
GAINS ON HEDGING FOREIGN
SECURITIES INSTRUMENTS CURRENCY TOTAL
COMMON CAPITAL NET NET TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS OF TAX OF TAX ADJUSTMENTS EARNINGS EQUITY
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Balance, December 31, 2001 $ -- $ 1,895 $ 163 $ 62 $ (29) $ 2,519 $ 4,610
Comprehensive income
Net income 271 271
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Other comprehensive income, net of tax (1)
Unrealized gain on securities (2) 103 103
Net gain on cash flow hedging
Instruments 13 13
Cumulative translation adjustments (9) (9)
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Total other comprehensive income 107
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Total comprehensive income 378
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Dividends declared (33) (33)
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BALANCE, JUNE 30, 2002 $ -- $ 1,895 $ 266 $ 75 $ (38) $ 2,757 $ 4,955
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(1) Unrealized gain on securities is reflected net of tax provision of $275
and $55 for the six months ended June 30, 2003 and 2002, respectively. Net
(loss) gain on cash flow hedging instruments is net of tax (benefit)
provision of $(19) and $7 for the six months ended June 30, 2003 and 2002.
There is no tax effect on cumulative translation adjustments.
(2) There were reclassification adjustments for after-tax losses in the amount
of $17 and $83 realized in net income for the six months ended June 30,
2003 and 2002, respectively.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
(In millions) (Unaudited) 2003 2002
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 369 $ 271
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net realized capital (gains) losses (2) 135
Amortization of deferred policy acquisition costs and present value of future profits
338 323
Additions to deferred policy acquisition costs and present value of future profits (728) (552)
Depreciation and amortization 72 18
Decrease in premiums receivable and agents' balances 16 21
Decrease (increase) in receivables (22) 12
Decrease in accrued liabilities and payables (20) (12)
Increase (decrease) in other liabilities 276 (156)
Decrease (increase) in accrued tax (27) 109
Increase in deferred income tax 34 116
Increase in future policy benefits 345 322
Increase in reinsurance recoverables (18) (17)
Other, net (290) (101)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 343 489
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INVESTING ACTIVITIES
Purchases of investments (7,769) (5,892)
Sales of investments 3,179 3,257
Maturities and principal paydowns of fixed maturity investments 1,833 1,037
Capital expenditures and other (3) (45)
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NET CASH USED FOR INVESTING ACTIVITIES (2,760) (1,643)
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FINANCING ACTIVITIES
Dividends paid (34) (33)
Proceeds from issuance of long-term debt 150 --
Net receipts from investment and universal life-type contracts 2,313 1,136
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NET CASH PROVIDED BY FINANCING ACTIVITIES 2,429 1,103
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Net increase (decrease) in cash 12 (51)
Impact of foreign exchange (1) 2
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Cash -- beginning of period 179 167
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CASH -- END OF PERIOD $ 190 $ 118
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
NET CASH PAID DURING THE PERIOD FOR
Income taxes $ 20 $ 34
Interest $ 56 $ 55
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
(Unaudited)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Hartford Life, Inc. (a Delaware corporation), together with its consolidated
subsidiaries ("Hartford Life" or the "Company"), is a leading financial services
and insurance organization which provides, primarily in the United States,
investment, retirement, estate planning and group benefits products. Hartford
Life, Inc. was formed on December 13, 1996 and capitalized on December 16, 1996
with the contribution of all the outstanding common stock of Hartford Life and
Accident Insurance Company ("HLA"), a subsidiary of The Hartford Financial
Services Group, Inc. ("The Hartford"). Pursuant to an initial public offering
(the "IPO") on May 22, 1997, Hartford Life sold to the public 26 million shares
of Class A Common Stock at $28.25 per share and received proceeds, net of
offering expenses, of $687. The 26 million shares sold in the IPO represented
approximately 18.6% of the equity ownership in Hartford Life. On June 27, 2000,
The Hartford acquired all of the outstanding common shares of Hartford Life not
already owned by The Hartford ("The Hartford Acquisition"). As a result of The
Hartford Acquisition, Hartford Life became a direct subsidiary of Hartford Fire
Insurance Company ("Hartford Fire"), a direct wholly-owned subsidiary of The
Hartford. During the third quarter of 2002, Hartford Life became a direct
subsidiary of Hartford Holdings, Inc., a direct wholly owned subsidiary of The
Hartford. Hartford Life, Inc. is a holding company, and as such, has no material
business of its own.
2. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The Condensed Consolidated Financial Statements have been prepared on the basis
of accounting principles generally accepted in the United States of America
("GAAP"), which differ materially from the accounting practices prescribed by
various insurance regulatory authorities. Less than majority-owned subsidiaries
in which the Company has at least a 20% interest are reported on the equity
basis. All intercompany transactions and balances between Hartford Life, its
subsidiaries and affiliates have been eliminated.
The accompanying condensed consolidated financial statements as of June 30,
2003, and for the second quarter and six-month periods ended June 30, 2003 and
2002 are unaudited. These condensed consolidated financial statements reflect
all adjustments (consisting only of normal accruals) which are, in the opinion
of management, necessary for the fair presentation of the financial position,
results of operations, and cash flows for the interim periods. These financial
statements and condensed notes should be read in conjunction with the
consolidated financial statements and notes thereto included in Hartford Life's
2002 Form 10-K Annual Report. The results of operations for the interim periods
should not be considered indicative of results to be expected for the full year.
(B) RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
(C) 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,
deferred policy acquisition costs, valuation of investments and derivative
instruments, income taxes and contingencies.
(D) SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 2 of Notes to Consolidated
Financial Statements included in Hartford Life's 2002 Form 10-K Annual Report.
(E) ADOPTION OF NEW ACCOUNTING STANDARDS
In May 2003, the Financial Accounting Standards Board ("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 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 buy back 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 January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("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 is effective immediately
for new VIEs established or purchased subsequent to January 31, 2003. For VIEs
entered into prior to February 1, 2003, FIN 46 is effective for interim periods
beginning after June 15, 2003. The adoption of FIN 46 did not have a material
impact on the Company's financial condition or results of operations as there
were no material VIEs identified which required consolidation. FIN 46 further
requires the disclosure of certain information related to VIEs in which the
Company holds a significant variable interest. As of June 30, 2003, the Company
did not own any such interests that required disclosure.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45" or "the Interpretation"). FIN 45 requires
certain guarantees to be recorded at fair value and also requires a guarantor to
make new disclosures, even when the likelihood of making payments under the
guarantee is remote. In general, the Interpretation applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying instrument or
indices (e.g., security prices, interest rates, or currency rates) that are
related to an asset, liability or an equity security of the guaranteed party.
The recognition provisions of FIN 45 are effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 15, 2002. For further discussion, see Note 2(h),
"Other Investment and Risk Management Activities - Specific Strategies",
of Notes to Consolidated Financial Statements included in Hartford Life's 2002
Form 10-K Annual Report. Adoption of this statement did not have a material
impact on the Company's consolidated financial condition or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Action
(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 after December 31, 2002. Adoption of SFAS No. 146 will
result in a change in the timing of when a liability is recognized if the
Company has restructuring activities after December 31, 2002. Adoption of this
statement did not have a material impact on the Company's consolidated financial
condition or results of operations.
(F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In July 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants has issued a final Statement of
Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts" (the "SOP").
The SOP addresses a wide variety of topics, some of which may have a significant
impact on the Company. The major provisions of the SOP require:
- Recognizing expenses for a variety of contracts and contract
features, including guaranteed minimum death benefits ("GMDB") and
annuitization options, on an accrual basis versus the previous
method of recognition upon payment;
- 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 seed money in separate accounts as general
account assets based on the insurer's proportionate beneficial
interest in the separate account's underlying assets; and
- 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 of this SOP, the Company
will have to make various determinations, such as qualification for separate
account treatment, classification of securities in separate account arrangements
not meeting the criteria of the SOP, significance of mortality and morbidity
risk, adjustments to contract holder liabilities, and adjustments to estimated
gross profits, all of which may have a significant effect on the Company's
financial condition and results of operations.
Based on management's preliminary review of the SOP and market conditions as of
June 30, 2003, it appears that a significant impact to the Company is the
requirement for recording a liability for variable annuity products with a
guaranteed minimum death benefit feature. The determination of this liability is
based on models that involve numerous estimates and subjective judgments,
including those regarding expected market rates of return and volatility,
contract surrender rates and mortality experience. Based on management's
preliminary review of the SOP, the unrecorded GMDB liabilities, net of
anticipated reinsurance recoverable of approximately $300, are estimated to be
between $75 and $85 at June 30, 2003. Net of estimated DAC and income tax
effects, the cumulative effect of establishing the required GMDB reserves as of
June 30, 2003 would result in an estimated reduction of net income of between
$35 and $45. The ultimate actual impact on the Company's financial statements
may differ significantly from management's current estimates.
Since the SOP is not yet effective, the Company has not recorded any liabilities
for the risks associated with GMDB offered on Hartford Life's variable annuity
business, but has consistently recorded the related expenses in the period the
benefits are paid to contractholders. Net of reinsurance, the Company paid $14
and $31 for the second quarter and six months ended June 30, 2003, respectively,
and $9 and $16 for the second quarter and six months ended June 30, 2002,
respectively, in GMDB benefits to contractholders. Future downturns in the
equity markets could increase these payments. At June 30, 2003, the Company held
$64.8 billion of variable annuities in its separate accounts. The Company
estimates its net amount at risk relating to these variable annuities (the
amount by which current account values of its variable annuity contracts are not
sufficient to meet its GMDB commitments) is $17.4 billion. However, at June 30,
2003, approximately 78% of Hartford Life's net amount at risk was covered by
reinsurance, resulting in a retained net amount at risk of $3.8 billion.
In addition to the foregoing impact of the SOP, certain of the Company's fixed
annuity products which are currently recorded as separate account assets and
liabilities are expected to be revalued upon reclassification to the general
account. The Company is currently assessing this requirement and all the other
impacts of the SOP, and has not yet determined the total 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 credit derivative is required. 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 believes that the majority of its modified
coinsurance and funds withheld agreements are not impacted by DIG B36. While the
Company believes there will be no material effect on its results of operations
or financial condition due to the implementation of this guidance, it is
currently evaluating those potential impacts. The guidance is effective for
quarterly periods beginning after September 15, 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 Company is currently evaluating the impact
of DIG B36 on such corporate issued debt securities. The Company does not
believe the adoption of DIG B36 will have a material effect on the Company's
consolidated financial condition or results or operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities". The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133.
SFAS No. 149 amends SFAS No. 133 for decisions made as part of the Derivatives
Implementation Group (DIG) process that effectively required amendments to SFAS
No. 133, in connection with other FASB projects dealing with financial
instruments. SFAS No. 149 also clarifies under what circumstances a contract
with an initial net investment and purchases and sales of when-issued securities
that do not yet exist meet the characteristic 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 this statement 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 Company has determined that the adoption of SFAS No.
149 will not have a material impact on the Company's financial condition or
results of operations.
(G) STOCK-BASED COMPENSATION
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure an Amendment to FASB 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 Issued to Employees", and modifies the disclosure
requirements of SFAS No. 123. In January 2003, The Hartford 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 Hartford
expenses all stock-based compensation awards granted after January 1, 2003. The
allocated expense to the Company from The Hartford associated with these awards
for the second quarter ending June 30, 2003, was immaterial.
All stock-based compensation 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. For the quarter and six months ended
June 30, 2003, the Hartford's after-tax compensation expense related to its
stock-based compensation plans, including the expense associated with the
transition to SFAS
No. 123 and non-option plans, was $1 and $2, respectively. The Hartford's
after-tax compensation expense for those same plans was $2 and $3 for the
quarter and six months ended June 30, 2002, respectively. The expense, including
non-option plans, related to stock-based employee compensation included in the
determination of net income for the second quarter and six months ended June 30,
2003 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 compensation plans, see Note 11 of
Notes to Consolidated Financial Statements included in The Hartford's 2002 Form
10-K Annual Report.)
3. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and accordingly ceased all amortization of goodwill. The
carrying amount of goodwill is $796 as of June 30, 2003 and December 31, 2002.
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no intangible assets with indefinite useful lives.
AS OF JUNE 30, 2003
-----------------------
GROSS ACCUMULATED
CARRYING NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION
-------- ------------
Present value of future profits $511 $ 94
-------- ------------
TOTAL $511 $ 94
======== ============
Net amortization expense for the quarter and six months ended June 30, 2003 was
$9 and $14, respectively. Net amortization expense for the quarter and six
months ended June 30, 2002 was $11 and $19, respectively.
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDING DECEMBER 31,
- --------------------------------
2003 $ 42
2004 $ 39
2005 $ 36
2006 $ 34
2007 $ 31
4. INVESTMENTS AND DERIVATIVE INSTRUMENTS
(A) SECURITIES LENDING
The Company has engaged 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 June 30, 2003, the fair value of the
loaned securities was approximately $601 and was included in fixed maturities.
The cash collateral received as of June 30, 2003 of approximately $620 was
invested in short-term securities and was also included in fixed maturities,
with a corresponding liability recognized for the obligation to return the
collateral recorded in other liabilities. The Company retains a portion of the
income earned from the cash collateral or receives a fee from the borrower. The
Company recorded income from securities lending transactions, net of lending
fees, that was immaterial for the second quarter and six months ended June 30,
2003, which was included in net investment income.
(B) DERIVATIVE INSTRUMENTS
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards and exchange traded futures and options, for one of four
Company-approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into income enhancement and replication transactions.
All of the Company's derivative transactions are permitted uses of derivatives
under the derivatives use plan filed and/or approved, as applicable, by the
State of Connecticut and State of New York insurance departments. The Company
does not make a market or trade in these instruments for the express purpose of
earning short-term trading profits.
For a detailed discussion of the Company's use of derivative instruments, see
Note 2(h) of Notes to Consolidated Financial Statements included in Hartford
Life's 2002 Form 10-K Annual Report.
As of June 30, 2003 and December 31, 2002, the Company carried $278 and $257,
respectively, of derivative assets in other investments and $196 and $162,
respectively, of derivative liabilities in other liabilities. In addition, the
Company recognized embedded derivative liabilities related to guaranteed minimum
withdrawal benefits ("GMWB") on certain of its variable annuity contracts of $32
and $48 at June 30, 2003 and December 31, 2002, respectively, in other
policyholder funds. Offsetting reinsurance arrangements recognized as derivative
assets at June 30, 2003 and December 31, 2002 were $32 and $48, respectively,
and were included in reinsurance recoverables.
Cash-Flow Hedges
For the second quarter and six months ended June 30, 2003 and
2002, the Company's gross gains and losses representing the total
ineffectiveness of all cash-flow hedges were immaterial, with the net impact
reported as net realized capital gains and losses.
Gains and losses on derivative contracts that are reclassified from accumulated
other comprehensive income ("AOCI") to current period earnings are included in
the line item in the statement of income in which the hedged item is recorded.
As of June 30, 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 twelve months were $11 and $3, respectively. This expectation is
based on the anticipated interest payments on hedged investments in fixed
maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains and losses as an adjustment to
interest income over the term of the investment cash flows. The maximum term
over which the Company is hedging its exposure to the variability of future cash
flows (for all forecasted transactions, excluding interest payments on
variable-rate debt) is twelve months. As of June 30, 2003 and December 31, 2002,
the Company held derivative notional value related to strategies categorized as
cash-flow hedges of $2.8 billion and $3.1 billion, respectively. For the second
quarter and six months ended June 30, 2003 and 2002, the net reclassifications
from AOCI to earnings resulting from the discontinuance of cash-flow hedges were
immaterial.
Fair-Value Hedges
For the second quarter and six months ended June 30, 2003 and 2002, the
Company's gross gains and losses representing the total ineffectiveness of all
fair-value hedges were immaterial, with the net impact reported as net realized
capital gains and losses. All components of each derivative's gain or loss are
included in the assessment of hedge effectiveness. As of June 30, 2003 and
December 31, 2002, the Company held $228 and $300, respectively, in derivative
notional value related to strategies categorized as fair-value hedges.
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. Swap agreements, interest rate cap and floor
agreements and option contracts are used to reduce economic risk. Income
enhancement and replication transactions include the use of written covered call
options, which offset embedded equity call options, total return swaps and
synthetic replication of cash market instruments. The change in the value of all
derivatives held for other investment and risk management purposes is reported
in current period earnings as net realized capital gains and losses. As of June
30, 2003 and December 31, 2002, the Company held $5.8 billion and $4.8 billion,
respectively, in derivative notional value related to strategies categorized as
Other Investment and Risk Management Activities. In addition, Hartford Life,
Inc. issues certain variable annuity products that contain a Guaranteed Minimum
Withdrawal Benefit ("GMWB"). The GMWB gives the policyholder the right to make
periodic surrenders that total an amount equal to the policyholders' premium
payments. This guarantee will remain in effect if periodic surrenders each
contract year do not exceed an amount equal to 7% of total premium payments. If
the policyholder chooses to surrender an amount equal to more than 7% in a
contract year, then the guarantee may be reduced to an amount less than premium
payments. In addition, the policyholder has the option, after a specified time
period, to reset the guarantee value to the then-current account value, if
greater. The GMWB represents an embedded derivative liability in the 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 benefits and related contract charges over
the lives of the contracts. 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. This model involves numerous estimates
and subjective judgments including those regarding expected market rates of
return and volatility and policyholder behavior.
For all contracts in effect as of June 30, 2003, the Company has 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 asset and
carried at fair value in reinsurance recoverables. Changes in the fair value of
both the derivative assets and liabilities related to the GMWB are recorded in
net realized capital gains and losses. Beginning in July 2003, the Company has
utilized substantially all of its existing reinsurance under the current
arrangement and will be ceding only a very small number of new contracts.
Substantially all new contracts with the GMWB will not be covered by
reinsurance. These unreinsured contracts are expected to generate some
volatility in net income as the underlying embedded derivative liabilities are
marked to 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.
For further discussion of the Company's other investment and risk management
activities, see "Other Investments and Risk Management Activities" in Note 2(h)
of Notes of Consolidated Financial Statements included in Hartford Life's 2002
Form 10-K Annual Report.
5. COMMITMENTS AND CONTINGENCIES
(A) LITIGATION
Hartford Life is or may become involved in various legal actions, in the normal
course of its business, in which claims for alleged economic and punitive
damages have been or may be asserted, some for substantial amounts. Some of the
pending litigation has been filed as purported class actions and some actions
have been filed in certain jurisdictions that permit punitive damage awards that
are disproportionate to the actual damages incurred. Although there can be no
assurances, at the present time, the Company does not anticipate that the
ultimate liability arising from potential, pending or threatened legal actions,
after consideration of provisions made for estimated losses and costs of
defense, will have a material adverse effect on the financial condition or
operating results of the Company.
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al. in favor of Bancorp in the amount of $118.
The case
involved claims of patent infringement, misappropriation of trade secrets, and
breach of contract against HLIC and its affiliate International Corporate
Marketing Group, Inc. ("ICMG"). The judge dismissed the patent infringement
claim on summary judgment. The jury's award was based on the last two claims. On
August 28, 2002, the Court entered an order awarding Bancorp prejudgment
interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The appeal is fully briefed but has not been argued. The
Company's management, based on the advice of its legal counsel, believes that
there is a substantial likelihood that the judgment will not survive at its
current amount. Based on the advice of legal counsel regarding the potential
outcomes of this litigation, the Company recorded an $11 after-tax charge in the
first quarter of 2002 to increase litigation reserves. Should HLIC and ICMG not
succeed in eliminating or reducing the judgment, a significant additional
expense would be recorded in the future.
(B) TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001
tax years. No material issues have been raised to date by the IRS. Management
believes that adequate provision has been made in the financial statements for
any potential assessments that may result from tax examinations and other
tax-related matters for all open tax years.
The tax provision recorded during the second quarter of 2003 reflects a benefit
of $30, consisting primarily of a change in estimate of the dividends-received
deduction ("DRD") tax benefit reported during 2002. The change in estimate was
the result of 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. In addition to the foregoing change in estimate,
based on the financial information received by the Company in preparing its 2002
federal income tax returns, as well as its current best judgment, the Company
has revised its estimate of the 2003 fiscal year DRD benefit to $85, from its
prior estimate of $63. As a result of this revised estimate, in the second
quarter the Company revised its first quarter DRD benefit upwards by $5,
bringing the total DRD benefit related to the 2003 tax year for the six months
ended June 30, 2003 to $43.
6. DEBT
Effective May 29, 2003, Hartford Life signed a promissory note for $150 with its
ultimate parent The Hartford. The note matures on May 26, 2006. Interest on the
note is payable semi-annually on June 1 and December 1 commencing on December 1,
2003. If not earlier declared due and payable by the lender, the entire
principal balance of the note together with all accrued and unpaid interest
thereon shall be due and payable in full in one, lump sum, balloon payment on
May 26, 2006.
During the second quarter of 2003, $200 of long-term debt was reclassified to
short-term debt as it matures in June of 2004.
7. OTHER RELATED PARTY TRANSACTIONS
In connection with a comprehensive evaluation of various capital maintenance and
allocation strategies by The Hartford, an intercompany asset sale transaction
was completed in April 2003. The transaction resulted in certain of The
Hartford's Property & Casualty subsidiaries selling ownership interests in
certain high quality fixed maturity securities to Hartford Life for cash equal
to the fair value of the securities as of the effective date of the sale. For
the Property and Casualty subsidiaries, the transaction monetized the embedded
gain in certain securities on a tax deferred basis to The Hartford because no
capital gains tax will be paid until the securities are sold to unaffiliated
third parties. The transfer re-deployed to Hartford Life desirable investments
without incurring substantial transaction costs that would have been payable in
a comparable open market transaction. The fair value of securities transferred
was $1.8 billion.
During the second quarter of 2003, the Company sold certain of its furniture and
equipment with an estimated book value of $8 to Hartford Fire Insurance Company.
The furniture and equipment was sold at fair value and resulted in a gain of $4
before tax, which was recorded in other revenue.
8. SEPTEMBER 11 TERRORIST ATTACK
As a result of the September 11 terrorist attack, the Company recorded an
estimated loss amounting to $20, net of taxes and reinsurance, in the third
quarter of 2001. The Company based the loss estimate upon a review of insured
exposures using a variety of assumptions and actuarial techniques, including
estimated amounts for unknown and unreported policyholder losses. Also included
was an estimate of amounts recoverable under the Company's ceded reinsurance
programs, including the cost of additional reinsurance premiums. In the first
quarter of 2002, the Company recognized an $8 after-tax benefit related to
favorable development of reserves related to the September 11 terrorist attack.
9. REINSURANCE RECAPTURE
On June 30, 2003, the Company recaptured a block of business previously
reinsured with an unaffiliated reinsurer. Under this treaty, Hartford Life
reinsured a portion of the guaranteed minimum death benefit (GMDB) feature
associated with certain of its annuity contracts. As consideration for
recapturing the business and final settlement under the treaty, the Company has
received assets valued at approximately $32 and one million warrants exercisable
for the unaffiliated company's stock. This amount represents to the Company an
advance collection of its future recoveries under the reinsurance agreement and
will be recognized as future losses are recorded in 2003 or upon the adoption of
the SOP (see Note 2(f)). Prospectively, as a result of the recapture, Hartford
Life will be responsible for all of the remaining and ongoing risks associated
with the GMDB's related to this block of business. The recapture increased the
net amount at risk retained by the Company at June 30, 2003 by $799, which is
included in the net amount at risk discussed in Note 2 (f).
10. SEGMENT INFORMATION
Hartford Life is organized into four reportable operating segments: Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
(COLI). Investment Products offers individual variable and fixed annuities,
mutual funds, retirement plan services and other investment products. Individual
Life sells a variety of life insurance products, including variable life,
universal life, 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. The Company includes in an Other
category, its international operations, which are primarily located in Japan and
Brazil; realized capital gains and losses; as well as corporate items not
directly allocable to any of its reportable operating segments, principally
interest expense; and intersegment eliminations.
The accounting policies of the reportable operating segments are the same as
those described in "Basis of Presentation and Accounting Policies" in Note 2 in
the Company's 2002 Form 10-K Annual Report. Hartford Life evaluates performance
of its segments based on revenues, net income and the segment's return on
allocated capital. The Company charges direct operating expenses to the
appropriate segment and allocates the majority of indirect expenses to the
segments based on an intercompany expense arrangement. Intersegment revenues are
not significant and primarily occur between corporate and the operating
segments. These amounts include interest income on allocated surplus and the
allocation of net realized capital gains and losses through net investment
income utilizing the duration of the segment's investment portfolios. The
Company's revenues are primarily derived from customers within the United
States. The Company's long-lived assets primarily consist of deferred policy
acquisition costs and deferred tax assets from within the United States. The
following tables present summarized financial information concerning the
Company's segments.
Investment Individual Group
JUNE 30, 2003 Products Life Benefits COLI Other Total
- -------------------- ---------- ---------- -------- -------- -------- --------
SECOND QUARTER ENDED
Total revenues $ 877 $ 240 $ 638 $ 126 $ 81 $ 1,962
Net income (loss) 141 36 35 9 22 243
SIX MONTHS ENDED
Total revenues $ 1,650 $ 484 $ 1,305 $ 253 $ 56 $ 3,748
Net income (loss) 239 68 69 19 (26) 369
Investment Individual Group
JUNE 30, 2002 Products Life Benefits COLI Other Total
- -------------------- ---------- ---------- -------- -------- -------- --------
SECOND QUARTER ENDED
Total revenues $ 766 $ 249 $ 654 $ 146 $ (117) $ 1,698
Net income (loss) 118 35 30 10 (92) 101
SIX MONTHS ENDED
Total revenues $ 1,576 $ 481 $ 1,298 $ 306 $ (127) $ 3,534
Net income (loss) 235 66 58 10 (98) 271
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollar amounts in millions, unless otherwise stated)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of Hartford Life, Inc. and
its subsidiaries ("Hartford Life" or the "Company") as of June 30, 2003,
compared with December 31, 2002, and its results of operations for the second
quarter and three months ended June 30, 2003 compared with the equivalent
periods in 2002. This discussion should be read in conjunction with the MD&A
included in the Company's 2002 Form 10-K Annual Report.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on Hartford Life 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
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 effect of changes in interest rates, the stock markets or
other financial markets; stronger than anticipated competitive activity;
unfavorable legislative, regulatory or judicial developments; the Company's
ability to distribute its products through distribution channels, both current
and future; the uncertain effects of emerging claim and coverage issues; the
effect of assessments and other surcharges for guaranty funds and second-injury
funds and other mandatory pooling arrangements; a downgrade in the Company's
claims-paying, financial strength or credit ratings; the ability of the
Company's subsidiaries to pay dividends to the Company; and other factors
described in such forward-looking statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
INDEX
Critical Accounting Estimates 15
Consolidated Results of Operations - Operating Summary 17
Investment Products 18
Individual Life 19
Group Benefits 19
Corporate Owned Life Insurance (COLI) 20
Investments 20
Capital Markets Risk Management 22
Capital Resources and Liquidity 27
Accounting Standards 30
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The Company has identified the following estimates as critical in that they
involve a higher degree of judgment and are subject to a significant degree of
variability: reserves; valuation of investments and derivative instruments;
deferred policy acquisition costs; 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. There have been no significant changes to the
Company's critical accounting estimates since December 31, 2002 other than
deferred policy acquisition costs as discussed below.
DEFERRED POLICY ACQUISITION COSTS
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 June 30, 2003 and December 31, 2002, the carrying value of
the Company's DAC was $5.9 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 the estimated gross profits ("EGPs") arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's variable annuity and variable life insurance
businesses. The average annual long-term rate of assumed separate account fund
performance (before mortality and expense charges) used in estimating gross
profits for the variable annuity and variable life business was 9% for the
six-month periods ended June 30, 2003 and June 30, 2002. For other products,
including fixed annuities and other universal life-type contracts, the average
assumed investment yield ranged from 5% to 8.5% for the periods ended June 30,
2003 and June 30, 2002.
Due to increased volatility and the decline experienced by the U.S. equity
markets in recent periods, the Company continues to enhance its DAC evaluation
process. The Company has developed sophisticated modeling capabilities, 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 June 30, 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 June 30, 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 EGP's is likely to remain within a reasonable range if
overall separate account returns decline by 15% or less for the remainder of
2003, and if overall separate account returns decline by 10% or less for the
next twelve months, and if certain other assumptions that are implicit in the
computations of the EGP's are achieved.
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") 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 June 30,
2003. If the Company assumed a 9% average long-term rate of growth from June 30,
2003 forward along with other appropriate assumption changes in determining the
revised EGPs, the Company estimates the cumulative positive adjustment to
amortization would be approximately $125-$140, 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 $150-$170, 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 2003 and 2004
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 performance of the S&P
500 Index (which closed at 975 on June 30, 2003), although no assurance can be
provided that this correlation will continue in the future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of June 30, 2003, the Company believed variable annuity
separate account assets could fall by at least 31% before portions of its DAC
asset would be unrecoverable.
CONSOLIDATED RESULTS OF OPERATIONS - OPERATING SUMMARY
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2003 2002 CHANGE 2003 2002 CHANGE
------- ------- ------- ------- ------- -------
Earned premiums $ 706 $ 664 6% $ 1,389 $ 1,373 1%
Fee income 656 672 (2%) 1,273 1,334 (5%)
Net investment income 513 450 14% 1,020 898 14%
Other revenues 37 32 16% 64 64 --
Net realized capital gains (losses) 50 (120) 142% 2 (135) 102%
------- ------- ------- ------- ------- -------
TOTAL REVENUES 1,962 1,698 16% 3,748 3,534 6%
Benefits, claims and claim adjustment expenses 1,086 1,028 6% 2,169 2,085 4%
Amortization of deferred policy acquisition costs
and present value of future profits 175 171 2% 338 323 5%
Insurance operating costs and expenses 395 358 10% 746 715 4%
Other expenses 32 32 -- 65 80 (19%)
------- ------- ------- ------- ------- -------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,688 1,589 6% 3,318 3,203 4%
------- ------- ------- ------- ------- -------
INCOME BEFORE INCOME TAXES 274 109 151% 430 331 30%
Income tax expense 31 8 288% 61 60 2%
------- ------- ------- ------- ------- -------
NET INCOME $ 243 $ 101 141% $ 369 $ 271 36%
======= ======= ======= ======= ======= =======
Hartford 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 an Other category its international
operations, which are primarily located in Japan and Brazil; realized capital
gains and losses; as well as corporate items not directly allocated to any of
its reportable operating segments, principally interest expense; and
intersegment eliminations.
Revenues increased for the second quarter and six months ended June 30, 2003
primarily as a result of realized capital gains reported in the Other category
compared to realized capital losses in the prior year comparable periods and
higher net investment income and earned premiums in the Investment Products
segment. Partially offsetting the revenue increases was lower fee income in the
Investment Products and COLI segments as well as lower net investment income in
the COLI segment. Fee income in the Investment Products segment was lower for
the second quarter and six months ended June 30, 2003 as a result of lower
average account values, specifically in individual annuities and mutual fund
businesses, due primarily to the lower equity market values compared to the
prior year periods. The decrease in COLI revenues for the second quarter and six
months ended June 30, 2003 was primarily as a result of lower net investment
income due to lower average leveraged COLI account values as compared to a year
ago. In addition, COLI had lower fee income resulting from lower equity market
levels and lower sales in the second quarter of 2003 and for the six months
ended June 30, 2003, as compared to the prior year comparable periods.
Benefits, claims and expenses increased for the second quarter and six months
ended June 30, 2003 primarily due to increases in Investment Products interest
credited associated with the growth in the segment and death benefit costs.
Partially offsetting this increase was a decrease in the Group Benefits
segment's loss costs compared to the prior year and a decrease in COLI expenses
consistent with lower COLI revenues. Additionally, the COLI expenses for the six
months ended June 30, 2003 decreased due to a charge incurred in first quarter
of 2002, associated with the Bancorp Services, LLC ("Bancorp") litigation. (For
further discussion of the Bancorp litigation, see Note 5 of Notes to Condensed
Consolidated Financial Statements.)
Net income increased for the second quarter and six months ended June 30, 2003
as a result of the increase in revenues and net realized capital gains described
above compared to a year ago. Group Benefits net income increased driven
principally by decreased benefits and claims expenses. COLI net income increased
$9 for the six months ended June 30, 2003 as compared to the prior year period,
primarily due to the charge for the Bancorp litigation in 2002 discussed above.
Additionally, net income for the six month period ended June 30, 2002 was
positively impacted by an $8 after-tax benefit related to favorable development
on the Company's estimated September 11 exposure, which was recognized in the
first quarter of 2002.
The tax provision recorded during the second quarter of 2003 reflects a benefit
of $30, consisting primarily of a change in estimate of the dividends-received
deduction ("DRD") tax benefit reported during 2002. The change in estimate was
the result of 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. In addition to the foregoing change in estimate,
based on the financial information received by the Company in preparing its 2002
federal income tax returns, as well as its current best judgment, the Company
has revised its estimate of the 2003 fiscal year DRD benefit to $85, from its
prior estimate of $63. As a result of this revised estimate, in the second
quarter the Company revised its first quarter DRD benefit upwards by $5,
bringing the total DRD benefit related to the 2003 tax year for the six months
ended June 30, 2003 to $43.
INVESTMENT PRODUCTS
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
-------- -------- -------- -------- -------- --------
Fee income and other $ 411 $ 436 (6%) $ 784 $ 868 (10%)
Earned premiums 143 78 83% 234 210 11%
Net investment income 323 252 28% 632 498 27%
-------- -------- -------- -------- -------- --------
TOTAL REVENUES 877 766 14% 1,650 1,576 5%
Benefits, claims and claim adjustment expenses 451 327 38% 845 700 21%
Insurance operating costs and other expenses 161 164 (2%) 305 332 (8%)
Amortization of deferred policy acquisition costs 121 120 1% 230 234 (2%)
-------- -------- -------- -------- -------- --------
TOTAL BENEFITS, CLAIMS AND EXPENSES 733 611 20% 1,380 1,266 9%
-------- -------- -------- -------- -------- --------
INCOME BEFORE INCOME TAXES 144 155 (7%) 270 310 (13%)
Income tax expense 3 37 (92%) 31 75 (59%)
-------- -------- -------- -------- -------- --------
NET INCOME $ 141 $ 118 19% $ 239 $ 235 2%
======== ======== ======== ======== ======== ========
Individual variable annuity account values $ 73,748 $ 67,712 9%
Other individual annuity account values 10,587 10,413 2%
Other investment products account values 22,755 19,511 17%
-------- -------- --------
TOTAL ACCOUNT VALUES [1] 107,090 97,636 10%
Mutual fund assets under management 17,862 16,216 10%
-------- -------- --------
TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $124,952 $113,852 10%
======== ======== ========
[1] Includes policyholder balances for investment contracts and reserves for
future policy benefits for insurance contracts.
Revenues in the Investment Products segment increased for the second quarter and
six months ended June 30, 2003 primarily due to higher net investment income and
higher earned premiums. Net investment income increased due to higher general
account assets in the individual annuity business. General account individual
annuity assets were $9.9 billion as of June 30, 2003, an increase of $3.9
billion, or 65%, from June 30, 2002, due to policyholder transfer activity and
increased sales of individual annuities. Additionally, net investment income
related to other investment products increased as a result of the growth in
average assets over the last twelve months in the institutional investment
business, where related assets under management increased $1.8 billion, or 19%,
since June 30, 2002, to $11.2 billion as of June 30, 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. The increase in earned premiums is due to
higher sales of certain products in the institutional investment products
business. Partially offsetting the revenue increases was lower fee income for
the second quarter and six months ended June 30, 2003 as a result of lower
average assets, specifically in individual annuities and mutual fund assets, due
primarily to lower equity market levels.
Total benefits, claims and expenses increased for the second quarter and six
months ended June 30, 2003, primarily driven by increased interest credited as a
result of growth in the segment's general account assets discussed above, and
death benefit costs.
Net income increased for the second quarter and six months ended June 30, 2003,
primarily as a result of the favorable impact of $21, resulting from the
Company's previously discussed change in estimate of the dividends-received
deduction ("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. In addition to the foregoing change in estimate,
based on the financial information received by the Company in preparing its 2002
federal income tax returns, as well as its current best judgment, the Company
has revised its estimate of the 2003 fiscal year DRD benefit to $80, from its
prior estimate of $58. As a result of this revised estimate, in the second
quarter the Company revised its first quarter DRD benefit upwards by $5,
bringing the total DRD benefit related to the 2003 tax year for the six months
ended June 30, 2003 to $40. In addition, for the six months ended June 30, 2003,
net income was negatively affected by the lower average assets under management
discussed above.
Future net income for the Investment Products segment may be affected by the
effectiveness of the risk management strategies the Company plans to implement
to mitigate the market risk associated with the guaranteed minimum withdrawal
benefit ("GMWB") rider currently being sold with the majority of new variable
annuity contracts. The GMWB rider is considered an embedded derivative for
accounting purposes. Beginning in July 2003, substantially all new contracts
with the GMWB will not be covered by reinsurance. These unreinsured contracts
are expected to generate some volatility in net income as the underlying
embedded derivative liabilities are marked to 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. Hartford Life is evaluating alternative risk mitigation
strategies to limit future net income volatility that may be associated with new
sales of variable annuities with the GMWB rider. The Company will carefully
balance the value of product benefits to our policyholders with the Company's
profit objectives and risk tolerance.
INDIVIDUAL LIFE
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------- -----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
--------- --------- --------- --------- --------- ---------
Fee income and other $ 184 $ 180 2% $ 366 $ 350 5%
Earned premiums (6) (1) (500%) (10) (2) (400%)
Net investment income 62 70 (11%) 128 133 (4%)
--------- --------- --------- --------- --------- ---------
TOTAL REVENUES 240 249 (4%) 484 481 1%
Benefits, claims and claim adjustment expenses 108 112 (4%) 220 226 (3%)
Insurance operating costs and other expenses 39 40 (3%) 78 79 (1%)
Amortization of deferred policy acquisition costs 43 46 (7%) 89 79 13%
--------- --------- --------- --------- --------- ---------
TOTAL BENEFITS, CLAIMS AND EXPENSES 190 198 (4%) 387 384 1%
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 50 51 (2%) 97 97 --
Income tax expense 14 16 (13%) 29 31 (6%)
--------- --------- --------- --------- --------- ---------
NET INCOME $ 36 $ 35 3% $ 68 $ 66 3%
========= ========= ========= ========= ========= =========
Variable life account values $ 4,141 $ 3,760 10%
Total account values $ 8,066 $ 7,635 6%
--------- --------- ---------
Variable life insurance in force $ 66,518 $ 64,930 2%
Total life insurance in force $ 127,520 $ 123,896 3%
========= ========= =========
Revenues in the Individual Life segment decreased for the second quarter ended
June 30, 2003, primarily driven by decreases in net investment income and lower
earned premiums. For the six months ended June 30, 2003, revenues increased
slightly due primarily to higher cost of insurance charges resulting from the
growth in the total life insurance in force, partially offset by decreases in
net investment income and lower earned premiums. The decrease in investment
income was due primarily to lower investment yields. The lower earned premiums
were driven by higher ceded premiums and declining assumed premiums on the
Fortis block of business.
Total benefits, claims and expenses decreased for the second quarter principally
due to lower benefit costs resulting from favorable mortality experience when
compared to the prior year results. For the six months ended June 30, 2003,
total benefits, claims and expenses increased due primarily to higher
amortization of deferred policy acquisition costs resulting from higher gross
profits in the variable life business primarily due to improved mortality.
Net income increased for the second quarter and six months ended June 30, 2003
primarily due to the favorable impact of a $2 DRD benefit as discussed in the
Investment Products segment. In addition, growth in the in force business and
favorable comparable mortality experience were largely offset by lower net
investment income for the second quarter and six months ended June 30, 2003 and
higher amortization of deferred policy acquisition costs for the six months
ended June 30, 2003 when compared to the prior year comparable periods.
GROUP BENEFITS
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2003 2002 CHANGE 2003 2002 CHANGE
------ ------ ------ ------ ------ ------
Earned premiums and other $ 573 $ 590 (3%) $1,175 $1,172 --
Net investment income 65 64 2% 130 126 3%
------ ------ ------ ------ ------ ------
TOTAL REVENUES 638 654 (2%) 1,305 1,298 1%
Benefits, claims and claim adjustment expenses 451 486 (7%) 940 960 (2%)
Amortization of deferred policy acquisition costs 5 3 67% 9 7 29%
Insurance operating costs and other expenses 138 127 9% 269 258 4%
------ ------ ------ ------ ------ ------
TOTAL BENEFITS, CLAIMS AND EXPENSES 594 616 (4%) 1,218 1,225 (1%)
------ ------ ------ ------ ------ ------
INCOME BEFORE INCOME TAXES 44 38 16% 87 73 19%
Income tax expense 9 8 13% 18 15 20%
------ ------ ------ ------ ------ ------
NET INCOME $ 35 $ 30 17% $ 69 $ 58 19%
====== ====== ====== ====== ====== ======
Revenues, excluding buyout premiums, in the Group Benefits segment decreased for
the second quarter and six months ended June 30, 2003 primarily due to a
decrease in earned premiums. The premium buyouts were $1 and $29 for the second
quarter and six months ended June 30, 2003, respectively, compared to the prior
year periods that had no premium buyouts. Premiums, excluding buyouts, for the
second quarter and six months ended June 30, 2003 were lower as a result of the
Group Benefits
division's continued pricing and risk management discipline in light of a
challenging competitive and economic environment.
Total benefits, claims and expenses decreased for the second quarter and six
months ended June 30, 2003 due primarily to the favorable loss costs as compared
to the equivalent prior year periods. The segment's loss ratio (defined as
benefits and claims as a percentage of premiums and other considerations,
excluding buyouts) was 78.7% and 79.5% for the second quarter and six months
ended June 30, 2003, respectively, as compared to 82.4% and 81.9% for the
comparable prior year periods.
Net income increased for the second quarter and six months ended June 30, 2003
principally due to the favorable loss ratios noted above. However, future net
income growth will be dependent upon the Group Benefits segment's ability to
increase earned premiums and continue to control benefit costs within pricing
assumptions. Although the second quarter and six months ended June 30, 2003 have
been favorably impacted with lower benefit ratios, these ratios may not be
indicative of benefit and claim costs in subsequent periods.
CORPORATE OWNED LIFE INSURANCE (COLI)
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2003 2002 CHANGE 2003 2002 CHANGE
------- ------- ------- ------- ------- -------
Fee income and other $ 69 $ 75 (8%) $ 137 $ 159 (14%)
Net investment income 57 71 (20%) 116 147 (21%)
------- ------- ------- ------- ------- -------
TOTAL REVENUES 126 146 (14%) 253 306 (17%)
Benefits, claims and claim adjustment expenses 76 102 (25%) 164 217 (24%)
Insurance operating costs and expenses 11 15 (27%) 21 55 (62%)
Dividends to policyholders 25 15 67% 39 20 95%
------- ------- ------- ------- ------- -------
TOTAL BENEFITS, CLAIMS AND EXPENSES 112 132 (15%) 224 292 (23%)
------- ------- ------- ------- ------- -------
INCOME BEFORE INCOME TAXES 14 14 -- 29 14 107%
Income tax expense 5 4 25% 10 4 150%
------- ------- ------- ------- ------- -------
NET INCOME $ 9 $ 10 (10%) $ 19 $ 10 90%
======= ======= ======= ======= ======= =======
Variable COLI account values $20,326 $19,076 7%
Leveraged COLI account values 3,137 4,119 (24%)
------- ------- -------
TOTAL ACCOUNT VALUES $23,463 $23,195 1%
======= ======= =======
COLI revenues decreased for the second quarter and six months ended June 30,
2003 due to lower net investment and fee income. Net investment income
decreased, primarily related to the decline in leveraged COLI account values as
a result of surrender activity. Fee income was reduced as the result of lower
equity market levels and lower sales for the second quarter and six months ended
June 30, 2003 as compared to the equivalent prior year periods.
Total benefits, claims and expenses decreased for the second quarter and six
months ended June 30, 2003 as a result of the decline in the leveraged COLI
block noted above. Insurance operating costs and expenses for the six months
ended June 30, 2003 also decreased due to the $11 after-tax expense related to
the Bancorp litigation accrued in the first quarter of 2002. Dividends to
policyholders increased due to an increase in mortality dividends on the
leveraged COLI block.
Net income decreased for the second quarter 2003 as compared to the prior year
due to the decreased revenues and benefits, claims and expenses discussed above.
Net income increased for the six months ended June 30, 2003 as compared to prior
year, principally as a result of the Bancorp litigation expense recorded in the
first quarter of 2002.
INVESTMENTS
Hartford Life's general account and guaranteed separate account investment
portfolios are managed based on the underlying characteristics and nature of
each operation's respective liabilities and within established risk parameters.
(For a further discussion on Hartford Life's approach to managing risks, see the
Capital Markets Risk Management section.)
Please refer to the Investments section of the MD&A in Hartford Life's 2002 Form
10-K Annual Report for a description of the Company's investment objectives and
policies.
Return on general account invested assets is an important element of Hartford
Life'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.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, fixed maturity investments, which comprised approximately 89% and 87%
of the fair value of its general account invested assets as of June 30, 2003 and
December 31,
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.
A decrease in the fair value of any investment that is deemed other than
temporary would result in the Company's recognition of a realized loss in its
financial results prior to the actual sale of the investment.
The following table identifies invested assets by type held in the Company's
general account as of June 30, 2003 and December 31, 2002.
COMPOSITION OF INVESTED ASSETS
JUNE 30, 2003 DECEMBER 31, 2002
----------------- -----------------
AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- -------
Fixed maturities, at fair value $34,060 88.8% $29,377 86.7%
Equity securities, at fair value 452 1.2% 458 1.3%
Policy loans, at outstanding balance 2,889 7.5% 2,934 8.7%
Limited partnerships, at fair value 243 0.6% 519 1.5%
Other investments 694 1.9% 603 1.8%
------ ----- ------ -----
TOTAL INVESTMENTS $38,338 100.0% $33,891 100.0%
====== ===== ====== =====
Fixed maturity investments increased 16% since December 31, 2002, primarily the
result of investment and universal life contract sales and operating cash flows.
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 have totaled $298 since December 31, 2002. As of June
30, 2003, Hartford Life owned approximately $89 of hedge fund investments, all
of which are expected to be liquidated by March 31, 2004.
INVESTMENT RESULTS
The table below summarizes the Company's investment results.
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
(Before-tax) 2003 2002 2003 2002
- ------------ ---- ---- ---- ----
Net investment income - excluding policy loan income $ 459 $ 382 $ 908 $ 763
Policy loan income 54 68 112 135
----------- ----------- ---------- ----------
Net investment income - total $ 513 $ 450 $ 1,020 $ 898
Yield on average invested assets [1] 5.9% 6.2% 6.0% 6.2%
----------- ----------- ---------- ----------
Gross gains on sale $ 91 $ 37 $ 148 $ 74
Gross losses on sale (17) (10) (64) (47)
Impairments (17) (144) (84) (159)
Other, net [2] (7) (3) 2 (3)
----------- ----------- ---------- ----------
Net realized capital gains (losses) $ 50 $ (120) $ 2 $ (135)
=========== =========== ========== ==========
[1] Represents annualized net investment income (excluding net realized
capital losses) divided by average invested assets at cost (fixed
maturities at amortized cost).
[2] Primarily consists of changes in fair value and hedge ineffectiveness
on derivative instruments.
For the second quarter and six months ended June 30, 2003, net investment
income, excluding policy loan income, increased $77, or 20%, and $145, or 19%,
compared to the respective prior year periods. The increases in net investment
income were primarily due to income earned on a higher invested asset base, the
result of increased cash flow, partially offset by lower investment yields.
Yields on average invested assets decreased as a result of lower rates on new
investment purchases and decreased policy loan income.
Net realized capital gains (losses) for the second quarter and six months ended
June 30, 2003 improved by $170 and $137, respectively, compared to the
respective prior year periods, primarily as a result of a decrease in other than
temporary impairments on fixed maturities. For the second quarter ended June 30,
2003, fixed maturity impairment losses of $17 primarily consisted of interest
only securities of $12 and commercial mortgage-backed securities of $4. The
interest only security impairments were due to the flattening of the forward
yield curve. For the six months ended June 30, 2003, fixed maturity impairment
losses were $63 and consisted of asset-backed securities of $26, corporate
securities of $21 and interest only and commercial mortgage-backed securities,
as discussed above, of $16. The asset-backed securities impaired primarily
consisted of $12 backed by credit card receivables and $10 of corporate debt.
The corporate securities were concentrated in the following sectors: $7 in
consumer non-cyclical, $7 in transportation, $4 in financial services and $3 in
technology and communications. Also included in net realized capital gains and
losses for the second quarter and six months ended June 30, 2003 were
write-downs for other than temporary impairments on seeded equity and mutual
fund investments of $0 and $21, respectively.
For the second quarter and six months ended June 30, 2002, the fixed maturity
impairment losses of $144 and $159, respectively, consisted of corporate
securities of $110 and $122 and asset-backed securities of $34 and $37. For the
second quarter and six months ended June 30, 2002, impairments of corporate
securities were concentrated in the technology and communications sector and
included a $74 before-tax loss related to securities issued by WorldCom. For the
second quarter and six months ended June 30, 2002, impairments of asset-backed
securities were concentrated in securities backed by aircraft lease receivables
of $19, mutual fund fee receivables of $7, and corporate debt obligations of $6
and $9, respectively.
CAPITAL MARKETS RISK MANAGEMENT
Hartford Life 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 a dedicated risk management unit supporting Hartford Life, including the
Company's guaranteed separate accounts. Derivative instruments are utilized in
compliance with established Company policy and regulatory requirements and are
monitored internally and reviewed by senior management.
The Company is exposed to two primary sources of investment and asset/liability
management risk: credit risk, relating to the uncertainty associated with the
ability of an obligor or counterparty to make timely payments of principal
and/or interest, and market risk, relating to the market price and/or cash flow
variability associated with changes in interest rates, securities prices, market
indices, yield curves or currency exchange rates. The Company does not hold any
financial instruments purchased for trading purposes.
Please refer to the Capital Markets Risk Management section of the MD&A in
Hartford Life's 2002 Form 10-K Annual Report for a description of the Company's
objectives, policies and strategies.
CREDIT RISK
The Company invests primarily in securities, that are rated investment grade,
and has established exposure limits, diversification standards and review
procedures for all credit risks including borrower, issuer and counterparty.
Creditworthiness of specific obligors is determined by an internal credit
evaluation supplemented by consideration of external determinants of
creditworthiness, typically ratings assigned by nationally recognized ratings
agencies. Obligor, asset sector and industry concentrations are subject to
established limits and are monitored
on a regular basis. Hartford Life is not exposed to any credit concentration
risk of a single issuer greater than 10% of the Company's stockholder's equity.
The following table identifies fixed maturity securities by type, including
guaranteed separate accounts, as of June 30, 2003 and December 31, 2002.
FIXED MATURITIES BY TYPE
- -----------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2003 DECEMBER 31, 2002
----------------------------------------------- ----------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
---- ----- ------ ----- ---- ----- ------ -----
Asset-backed securities ("ABS") $ 5,518 $ 125 $ (172) $ 5,471 $ 5,403 $ 111 $ (154) $ 5,360
Commercial mortgage-backed
securities ("CMBS") 6,928 636 (11) 7,553 5,529 467 (8) 5,988
Collateralized mortgage
obligation ("CMO") 1,036 22 (1) 1,057 866 39 (2) 903
Corporate
Basic industry 2,672 247 (6) 2,913 2,155 144 (9) 2,290
Capital goods 1,136 118 (3) 1,251 1,097 75 (7) 1,165
Consumer cyclical 1,762 155 (7) 1,910 1,477 92 (4) 1,565
Consumer non cyclical 2,749 258 (7) 3,000 2,584 186 (18) 2,752
Energy 1,470 177 (3) 1,644 1,477 112 (8) 1,581
Financial services 5,405 527 (49) 5,883 5,210 333 (91) 5,452
Technology and communications 3,381 463 (8) 3,836 3,083 263 (71) 3,275
Transportation 607 59 (5) 661 601 49 (12) 638
Utilities 1,935 205 (13) 2,127 1,833 118 (43) 1,908
Other 529 35 (1) 563 429 20 -- 449
Government/Government agencies
- Foreign 846 109 (3) 952 774 77 (5) 846
Government/Government agencies
- United States 675 54 (1) 728 645 48 -- 693
Mortgage-backed securities
("MBS") - agency 1,652 35 (1) 1,686 2,233 63 -- 2,296
Municipal - tax-exempt 1,858 193 -- 2,051 1,854 146 -- 2,000
Municipal - taxable 225 20 (1) 244 99 16 (1) 114
Redeemable preferred stock 32 2 -- 34 31 3 -- 34
Short-term 2,033 2 -- 2,035 1,153 -- -- 1,153
--------- --------- -------- ---------- --------- ---------- --------- ----------
TOTAL FIXED MATURITIES $ 42,449 $ 3,442 $ (292) $ 45,599 $ 38,533 $ 2,362 $ (433) $ 40,462
========= ========= ======== ========== ========= ========== ========= ==========
Total general account fixed
maturities $ 31,684 $ 2,589 $ (213) $ 34,060 $ 27,982 $ 1,704 $ (309) $ 29,377
Total guaranteed separate
account fixed maturities $ 10,765 $ 853 $ (79) $ 11,539 $ 10,551 $ 658 $ (124) $ 11,085
--------- --------- -------- ---------- --------- ---------- --------- ----------
The Company's fixed maturity gross unrealized losses have declined by $141 from
December 31, 2002 to June 30, 2003 primarily as a result of the credit markets
experiencing a strong sustained rally, as issuers have taken concerted action to
improve their credit quality. An important element of credit remediation
includes a renewed emphasis on improving liquidity and reducing leverage. Many
companies have been able to improve their liquidity and leverage positions
through equity issuances and asset sales. These improving fundamental factors
have led to a sharp tightening of spreads over treasuries for most issuers. The
market value appreciation driven by tightening spreads has been further enhanced
by the general decline in interest rates.
As of June 30, 2003, the Company's fixed maturity portfolio had gross unrealized
losses of $292, of which 76% were concentrated in asset-backed securities and
corporate securities within the financial services sector. The Company's current
view of risk factors relative to these fixed maturity types is as follows:
ABS - As of June 30, 2003, ABS supported by aircraft lease receivables,
corporate debt obligations ("CDO"), credit card and manufactured housing
receivables were in a gross unrealized loss position of $81, $33, $33 and $12,
respectively.
The securities supported by aircraft, aircraft lease payments and enhanced
equipment trust certificates ("aircraft ABS") have continued to decline in value
due to a reduction in lease payments and aircraft values driven by a decline in
airline travel, which resulted in bankruptcies and other financial difficulties
of airline carriers. As a result of these factors, significant risk premiums
have been required by the market for securities in this sector, resulting in
reduced liquidity and lower broker quoted prices. The level of recovery will
depend on economic fundamentals and airline operating performance. Aircraft ABS
will be further stressed if passenger air traffic declines or airlines liquidate
rather than emerge from bankruptcy protection. Approximately 66% of
the Company's investments supported by aircraft ABS payments at June 30, 2003
were investment grade.
Adverse CDO experience can be attributed to higher than expected default rates
on the collateral, particularly in the technology and utilities sectors and
lower than expected recovery rates. Improved economic and operating fundamentals
of the underlying security issuers should lead to improved pricing levels.
Approximately 82% of the CDOs owned by the Company at June 30, 2003 were
investment grade.
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 first half of
this year, the Company believes that this sub-sector will continue to be under
stress and expects holdings to be very sensitive to changes in collateral
performance. Approximately 98% of the Company's investments supported by credit
card receivables at June 30, 2003 were investment grade.
The manufactured housing ("MH") sub-sector, over the past few months, has
continued to deteriorate as the liquidation of repossessed units has been
accelerated. This has caused a rapid increase in loss rates, which has eroded
credit protection and triggered numerous rating agency downgrades. The driving
force behind the increase in loss rates is primarily the relaxed underwriting
standards produced from intense competition among MH lenders beginning in the
mid-1990s. The Company expects elevated loss rates to remain at least over the
short term. In the long term, a less volatile and more sustainable loss rate
will depend, in large part, on general economic conditions and successful
servicing on existing loans. Approximately 95% of the Company's investments
supported by MH receivables at June 30, 2003 were investment grade.
Financial Services - The financial services securities in an unrealized loss
position 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. Future changes in fair value of these
securities are primarily dependent on forward interest rates. A substantial
percentage of these securities are 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.
The following table identifies fixed maturities by credit quality, including
guaranteed separate accounts, as of June 30, 2003 and December 31, 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.
FIXED MATURITIES BY CREDIT QUALITY
- -----------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2003 DECEMBER 31, 2002
------------------------------------- -------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
---- ---------- ----- ---- ---------- -----
United States Government/Government agencies $ 3,271 $ 3,376 7.4% $ 3,596 $ 3,737 9.2%
AAA 7,393 7,968 17.5% 6,519 6,960 17.2%
AA 4,032 4,341 9.5% 4,161 4,396 10.9%
A 12,558 13,693 30.0% 11,745 12,467 30.8%
BBB 10,912 11,841 26.0% 9,211 9,665 23.9%
BB & below 2,250 2,345 5.1% 2,148 2,084 5.2%
Short-term 2,033 2,035 4.5% 1,153 1,153 2.8%
----------- ----------- ----- ----------- ----------- -----
TOTAL FIXED MATURITIES $ 42,449 $ 45,599 100.0% $ 38,533 $ 40,462 100.0%
=========== =========== ===== =========== =========== =====
Total general account fixed maturities $ 31,684 $ 34,060 74.7% $ 27,982 $ 29,377 72.6%
Total guaranteed separate account fixed maturities $ 10,765 $ 11,539 25.3% $ 10,551 $ 11,085 27.4%
----------- ----------- ----- ----------- ----------- -----
As of June 30, 2003 and December 31, 2002, over 94% of the fixed maturity
portfolio was invested in securities rated investment grade (BBB and above). As
of June 30, 2003, below investment grade ("BIG") holdings were diversified by
sector and issuer with the greatest concentration of securities, based upon fair
value, in the following sectors: 17% in technology and communications, 16% in
utilities, 14% in consumer non-cyclical, 11% in consumer cyclical, 9% in basic
industry and 9% in foreign government. As of June 30, 2003, the Company held no
issuer of a BIG security with a fair value in excess of 4% of the total fair
value for BIG securities. As of December 31, 2002, BIG holdings were
concentrated, based upon fair value, in the following sectors: 20% in the
technology and communications, 17% in utilities, 11% in consumer cyclical, 11%
in basic industry, 9% in consumer non-cyclical, and 9% in foreign government. As
of December 31, 2002, the Company held no issuer of a BIG security with a fair
value in excess of 2% 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, including guaranteed separate accounts, as of
June 30, 2003 and December 31, 2002, by length of time the security was in an
unrealized loss position.
UNREALIZED LOSS AGING OF TOTAL SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2003 DECEMBER 31, 2002
------------------------------------ -----------------------------------------
AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED
COST VALUE LOSS COST VALUE LOSS
---- ----- ---- ---- ----- ----
Three months or less $ 2,465 $ 2,426 $ (39) $ 1,532 $ 1,459 $ (73)
Greater than three months to six months 418 399 (19) 1,294 1,239 (55)
Greater than six months to nine months 538 501 (37) 568 508 (60)
Greater than nine months to twelve months 370 348 (22) 1,334 1,264 (70)
Greater than twelve months 1,977 1,791 (186) 2,135 1,927 (208)
---------- ----------- ----- ---------- ----------- -----
TOTAL $ 5,768 $ 5,465 $(303) $ 6,863 $ 6,397 $(466)
========== =========== ===== ========== =========== =====
The total securities that were in an unrealized loss position for longer than
six months as of June 30, 2003 primarily consisted of asset-backed securities
and corporate debt. Asset-backed securities backed by aircraft lease
receivables, credit card receivables and corporate debt comprised 32%, 13% and
11%, respectively, of the greater than six months unrealized loss amount. The
significant corporate security industry sectors of financial services and
utilities comprised 19% and 5%, respectively, of the greater than six months
unrealized loss amount. As of June 30, 2003, the Company held no securities of a
single issuer that were at an unrealized loss in excess of 6% of total
unrealized losses. The total unrealized loss position of $303 consisted of $224
in general account losses and $79 in guaranteed separate account losses.
As of June 30, 2003, fixed maturities represented $292, or 96%, of the Company's
total unrealized loss. There were no fixed maturities as of June 30, 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 June 30, 2003 and
December 31, 2002, for which management's best estimate of future cash flows
adversely changed during the reporting period. For a detailed discussion of the
other than temporary impairment criteria, see "Valuation of Investments and
Derivative Instruments" included in the Critical Accounting Estimates section of
the MD&A and in Note 2(g) of Notes to Consolidated Financial Statements, both of
which are included in Hartford Life's 2002 Form 10-K Annual Report.
Fair values for asset-backed and commercial mortgage-backed securities are
obtained primarily from broker quotations. The Company believes that the recent
price appreciation realized in many corporate sectors has not yet been reflected
in many of the broker quotations received for ABS backed by corporate debt and
that the delay in price appreciation is likely due to the current lack of
liquidity in this sector and the significant risk premium currently attached to
these issues. As of June 30, 2003, no asset-backed securities had an unrealized
loss in excess of $20.
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2002 primarily consisted of corporate and
asset-backed debt. The significant corporate security industry sectors of
financial services, utilities, technology and communications and transportation
comprised 20%, 13%, 13%, and 3%, respectively, of the greater than six months
unrealized loss amount. Asset-backed securities backed by credit card
receivables, corporate debt and aircraft lease receivables comprised 13%, 11%
and 4%, respectively, of the greater than six month unrealized loss amount. At
December 31, 2002, the Company held no securities of a single issuer that were
at an unrealized loss in excess of 4% of total unrealized losses. The total
unrealized loss position of $466 consisted of $344 in general account losses and
$122 in guaranteed separate account losses.
As part of the Company's ongoing 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 June 30, 2003 and December 31, 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, as well as the
evaluation of the fundamentals of the issuers' financial condition, the Company
believes that the prices of the securities in the sectors identified above, were
temporarily depressed primarily as a result of a market dislocation and
generally poor cyclical economic conditions and sentiment. See "Valuation of
Investments and Derivative Instruments" included in the Critical Accounting
Estimates section of MD&A and in Note 2(g) of Notes to Consolidated Financial
Statements, both of which are included in Hartford Life's 2002 Form 10-K Annual
Report.
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. asset-backed securities), projections
of expected future cash flows may change based upon new information regarding
the performance of the underlying collateral.
The following table presents the Company's unrealized loss aging for BIG and
equity securities, including guaranteed separate accounts, as of June 30, 2003
and December 31, 2002.
UNREALIZED LOSS AGING OF BIG AND EQUITY SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2003 DECEMBER 31, 2002
-------------------------------------- -----------------------------------------
AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED
COST VALUE LOSS COST VALUE LOSS
Three months or less $ 195 $ 185 $(10) $ 162 $ 130 $ (32)
Greater than three months to six months 60 53 (7) 208 185 (23)
Greater than six months to nine months 83 67 (16) 175 145 (30)
Greater than nine months to twelve months 12 5 (7) 330 293 (37)
Greater than twelve months 372 306 (66) 501 431 (70)
---------- ---------- ---- ---------- ---------- -----
TOTAL $ 722 $ 616 (106) $ 1,376 $ 1,184 $(192)
========== ========== ==== ========== ========== =====
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of June 30, 2003 primarily consisted of asset-backed
securities backed by aircraft lease and credit card receivables and corporate
debt. The asset-backed securities along with corporate securities in the
utilities sector and diversified equity securities including mutual funds
comprised 68%, 10% and 7%, respectively, of the BIG and equity securities that
were in an unrealized loss position for greater than six months at June 30,
2003. The total unrealized loss position of BIG and equity securities of $106
consisted of $94 in general account losses and $12 in guaranteed separate
account losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2002 primarily consisted of corporate
securities in the technology and communications and utilities sectors as well as
asset-backed securities backed by corporate debt, equipment loans and credit
card receivables. The corporate securities in the technology and communications
and utilities sectors along with diversified equity mutual funds and
asset-backed securities comprised 26%, 22%, 18%, and 15%, respectively, of the
BIG and equity securities that were in an unrealized loss position for greater
than six months at December 31, 2002. The total unrealized loss position of BIG
and equity securities of $192 consisted of $157 in general account losses and
$35 in guaranteed separate account losses.
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. A prolonged and precipitous decline in the equity markets, as has been
experienced in recent periods, can have a significant impact on the Company's
operations, as sales of variable products may decline and surrender activity may
increase, as customer sentiment towards the equity market turns negative. The
lower assets under management will have a negative impact on the Company's
financial results, primarily due to lower fee income related to the Investment
Products and Individual Life segments, where a heavy concentration of
equity-linked products are administered and sold. Furthermore, the Company may
experience a reduction in profit margins if a significant portion of the assets
held in the variable annuity separate accounts move to the general account and
the 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 Hartford pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary. The
Company currently reinsures a significant portion of these death benefit
guarantees associated with its in-force block of business. The Company currently
records the death benefit costs, net of reinsurance, as they are incurred.
Declines in the equity market may increase the Company's net exposure to death
benefits under these contracts.
The Company's total gross exposure (i.e. before reinsurance) to these guaranteed
death benefits as of June 30, 2003 is $17.4 billion. Due to the fact that 78% of
this amount is reinsured, the Company's net exposure is $3.8 billion. This
amount is often referred to as the retained net amount at risk. However, the
Company will only incur these guaranteed death benefit payments in the future if
the policyholder has an in-the-money guaranteed death benefit at their time of
death. In order to analyze the total costs that the Company may incur in the
future related to these guaranteed death benefits, the Company performed an
actuarial present value analysis. This analysis included developing a model
utilizing stochastically generated investment performance scenarios and best
estimate assumptions related to mortality and lapse rates. A range of projected
costs was developed and discounted back to the 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 $121 to $387. The median of the stochastically
generated scenarios was $183.
On June 30, 2003, the Company recaptured a block of business previously
reinsured with an unaffiliated reinsurer. Under this treaty, Hartford Life
reinsured a portion of its guaranteed minimum death benefit (GMDB) feature
associated with certain of its annuity contracts. As consideration for
recapturing the business and final settlement under the treaty, the Company has
received assets valued at approximately $32 million 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 recorded in 2003 or upon
the adoption of SOP 03-1 (see discussion below). Prospectively, as a result of
the recapture, Hartford Life will be responsible for all of the risks associated
with the GMDB related to this block of business. The recapture increased the net
amount at risk retained by the Company at June 30, 2003 by $799.
In the first quarter of 2004, the Company will adopt the provisions of Statement
of Position 03-1 (SOP), "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Contracts and for Separate Accounts" (the
"SOP"). The provisions of the SOP include a requirement for recording a
liability for variable annuity products with a guaranteed minimum death benefit
feature. The determination of this liability is also based on models that
involve numerous estimates and subjective judgments, including those regarding
expected market rates of return and volatility, contract surrender rates and
mortality experience. Based on management's preliminary review of the SOP and
current market conditions, the unrecorded GMDB liabilities, net of reinsurance,
are estimated to be between $75 and $85 at June 30, 2003. Net of estimated DAC
and income tax effects, the cumulative effect of establishing the required GMDB
reserves is expected to result in a reduction of net income of between $35 and
$45. The ultimate actual impact on the Company's financial statements may differ
significantly from management's current estimates.
In addition, Hartford Life issues certain variable annuity products that contain
a guaranteed minimum withdrawal benefit ("GMWB"). The GMWB gives the
policyholder the right to make periodic surrenders that total an amount equal to
the policyholders' premium payments. This guarantee will remain in effect if
periodic surrenders each contract year do not exceed an amount equal to 7% of
total premium payments. If the policyholder chooses to surrender an amount equal
to more than 7% in a contract year, then the guarantee may be reduced to an
amount less than premium payments. In addition, the policyholder has the option,
after a specified time period, to reset the guarantee value to the then-current
account value, if greater. The GMWB obligations are derivatives which are
required to be carried at fair value on the financial statements. The fair value
of the GMWB obligations are calculated based on actuarial assumptions related to
the projected benefits and related contract charges over the lives of the
contracts. 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. This model involves numerous estimates and
subjective judgments including those regarding expected market rates of return
and volatility and policyholder behavior. Declines in the equity market may
increase the Company's exposure to benefits under these contracts. For all
contracts in effect as of June 30, 2003, the Company has entered into a
reinsurance arrangement to offset its exposure to the GMWB for the remaining
lives of those contracts. Beginning in July 2003, the Company has utilized
substantially all of its existing reinsurance under the current arrangement and
will be ceding only a small number of new contracts. Substantially all new
contracts with the GMWB will not be covered by reinsurance. In the absence of
reinsurance coverage, the Company is exposed to several risks including the risk
that fees collected on the GMWB rider may be inadequate to cover the cost of the
rider and provide acceptable profit margins. In addition, these unreinsured
contracts are expected to generate some volatility in net income as the
underlying embedded derivative liabilities are marked to 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 address these risks,
the Company is evaluating alternative risk mitigation strategies such as product
design changes and hedging its equity market risk using capital market
instruments.
MARKET RISK
Hartford Life has material exposure to both interest rate and equity market
risk. The Company analyzes interest rate risk using various models including
multi-scenario cash flow projection models that forecast cash flows of the
liabilities and their supporting investments, including derivative instruments.
There have been no material changes in market risk exposures from December 31,
2002.
DERIVATIVE INSTRUMENTS
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards and exchange traded futures and options, in compliance with
Company policy and regulatory requirements in order to achieve one of four
Company approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into income enhancement and replication transactions. The
Company does not make a market or trade derivatives for the express purpose of
earning short term trading profits. (For further discussion on The Company's use
of derivative instruments, refer to Note 4 of Notes to Condensed Consolidated
Financial Statements.)
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall financial strength of
Hartford Life and its ability to generate cash flows from each of the business
segments and borrow funds at competitive rates to meet operating and growth
needs. The Company maintained cash and short-term investments totaling
$2.0 billion and $1.3 billion as of June 30, 2003 and December 31, 2002,
respectively.
The capital structure of Hartford Life as of June 30, 2003 and December 31, 2002
consisted of debt and equity, summarized as follows:
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
Short-term debt $ 200 $ -
Long-term debt 1,075 1,125
Company obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely parent junior subordinated debentures (TruPS) 450 450
--------- ---------
TOTAL DEBT $ 1,725 $ 1,575
--------- ---------
Equity excluding net unrealized gains (losses) on securities, net of tax $ 5,276 $ 4,941
Net unrealized capital gains (losses) on securities, net of tax 1,221 747
--------- ---------
TOTAL STOCKHOLDER'S EQUITY $ 6,497 $ 5,688
--------- ---------
TOTAL CAPITALIZATION (1) $ 7,001 $ 6,516
--------- ---------
Debt to equity (1) (2) 33% 32%
Debt to capitalization (1) (2) 25% 24%
--------- ---------
(1) Excludes unrealized gain on securities and other, net of tax.
(2) Excluding TruPS, the debt to equity ratios were 24% and 23% as of June
30, 2003 and December 31, 2002, respectively, and the debt to
capitalization ratio was 18% and 17% as of June 30, 2003 and December
31, 2002, respectively.
CAPITALIZATION
The Company's total capitalization, excluding unrealized gain on securities and
other, net of tax, increased $485, or 7%, as of June 30, 2003, as compared to
December 31, 2002. This increase was primarily the result of earnings and
additional related party debt borrowings, partially offset by dividends
declared.
DIVIDENDS
The Company declared $35 in dividends for the six months ended June 30, 2003 to
Hartford Holdings, Inc. Future dividend decisions will be based on, and affected
by, a number of factors, including the operating results and financial
requirements of the Company on a stand-alone basis and the impact of regulatory
restrictions.
The Company's direct regulated life insurance subsidiary, Hartford Life and
Accident Insurance Company declared dividends of $92 for the six months ended
June 30, 2003.
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 Hartford's asbestos reserve study and capital-raising
activities, certain of the major independent ratings organizations revised The
Hartford's and the Company'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 on The Hartford Financial
Services Group, Inc. and the counterparty credit and financial strength ratings
on the operating companies following the Company's completion of the
capital-raising activities. The outlook is stable.
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 Hartford Life's significant United States member
companies' financial ratings from the major independent rating organizations as
of June 30, 2003:
STANDARD &
A.M. BEST FITCH MOODY'S POOR'S
--------- ----- ------- ------
INSURANCE RATINGS
Hartford Life Insurance Company A+ AA Aa3 AA-
Hartford Life and Accident A+ AA Aa3 AA-
Hartford Life and Annuity A+ AA Aa3 AA-
--------- ----- ------- ------
OTHER RATINGS
Hartford Life, Inc.
Senior debt a- A A3 A-
Commercial paper -- F1 P-2 A-2
Hartford Life Capital I and II
Trust preferred securities bbb A- Baa1 BBB
Hartford Life Insurance Company:
Short Term Rating -- -- P-1 A-1+
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 statutory
surplus for the Company was approximately $3.5 billion as of June 30, 2003 and
$3.0 billion as of December 31, 2002.
CASH FLOWS
SIX MONTHS ENDED
JUNE 30,
-------------------------
2003 2002
---- ----
Cash provided by operating activities $ 343 $ 489
Cash used for investing activities (2,760) (1,643)
Cash provided by financing activities 2,429 1,103
Cash - end of period 190 118
------- -------
The decrease in cash provided by operating activities was primarily the result
of the timing of the settlement of receivables and payables in the first six
months of 2003. The increase in cash provided by financing activities primarily
relates to new business sales during the first six months of 2003. The increase
in cash used for investing activities was primarily due to the purchase of
investments with funds received from the new business sold. Operating cash flows
in both periods have been more than adequate to meet liquidity requirements.
EQUITY MARKETS
For a discussion of the equity markets impact to capital and liquidity, see the
Capital Markets Risk Management under "Market Risk".
REGULATORY INITIATIVES AND CONTINGENCIES
LEGAL PROCEEDINGS
Hartford Life is or may become involved in various legal actions, in the normal
course of its business, in which claims for alleged economic and punitive
damages have been or may be asserted, some for substantial amounts. Some of the
pending litigation has been filed as purported class actions and some actions
have been filed in certain jurisdictions that permit punitive damage awards that
are disproportionate to the actual damages incurred. Although there can be no
assurances, at the present time, the Company does not anticipate that the
ultimate liability arising from potential, pending or threatened legal actions,
after consideration of provisions made for estimated losses and costs of
defense, will have a material adverse effect on the financial condition or
operating results of the Company.
Certain elements of the recently enacted 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. In addition, other tax proposals and regulatory initiatives which are
being considered by Congress could have a material effect on the insurance
business. These proposals and initiatives include changes pertaining to the tax
treatment of insurance companies and life insurance products and annuities,
reductions in certain individual tax rates and the estate tax, reductions in
benefits currently received by the Company stemming from the dividends received
deduction, changes to the tax treatment of deferred compensation arrangements,
and changes to investment vehicles
and retirement savings plans and incentives. Prospects for enactment and the
ultimate market effect of these proposals are uncertain. Any potential effect to
the Company's financial condition or results of operations from the Jobs and
Growth Act of 2003 or future tax proposals cannot be reasonably estimated at
this time.
ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 2 of Notes to Condensed
Consolidated Financial Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in the Capital Markets Risk Management section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
The Company's principal executive officer and its principal financial officer,
based on their evaluation of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)), have concluded that the Company's
disclosure controls and procedures are adequate and effective for the purposes
set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of June
30, 2003.
Change in internal controls over financial reporting.
There was no change in the Company's internal control over financial reporting
that occurred during the second quarter of 2003 that has materially affected, or
is reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Hartford Life is or may become involved in various legal actions, in the normal
course of its business, in which claims for alleged economic and punitive
damages have been or may be asserted, some for substantial amounts. Some of the
pending litigation has been filed as purported class actions and some actions
have been filed in certain jurisdictions that permit punitive damage awards that
are disproportionate to the actual damages incurred. Although there can be no
assurances, at the present time, the Company does not anticipate that the
ultimate liability arising from potential, pending or threatened legal actions,
after consideration of provisions made for estimated losses and costs of
defense, will have a material adverse effect on the financial condition or
operating results of the Company.
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al. in favor of Bancorp in the amount of $118.
The case involved claims of patent infringement, misappropriation of trade
secrets, and breach of contract against HLIC and its affiliate International
Corporate Marketing Group, Inc. ("ICMG"). The judge dismissed the patent
infringement claim on summary judgment. The jury's award was based on the last
two claims. On August 28, 2002, the Court entered an order awarding Bancorp
prejudgment interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The Company's management, based on the advice of its legal
counsel, believes that there is a substantial likelihood that the judgment will
not survive at its current amount. Based on the advice of legal counsel
regarding the potential outcomes of this litigation, the Company recorded an $11
after-tax charge in the first quarter of 2002 to increase litigation reserves.
Should HLIC and ICMG not succeed in eliminating or reducing the judgment, a
significant additional expense would be recorded in the future.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index.
(b) Reports on Form 8-K: None.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARTFORD LIFE, INC.
/s/ Ernest M. McNeill Jr.
--------------------------
Ernest M. McNeill Jr.
Vice President and Chief Accounting Officer
August 6, 2003
HARTFORD LIFE, INC. AND SUBSIDIARIES
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
FORM 10-Q
EXHIBITS INDEX
EXHIBIT #
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15.01 Deloitte & Touche LLP Letter of Awareness
31.1 Certificate of Thomas M. Marra pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certificate of Lizabeth H. Zlatkus pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certificate of Thomas M. Marra pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certificate of Lizabeth H. Zlatkus pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.