EXHIBIT 99.2
ITEM 7. 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 Insurance
Company and its subsidiaries ("Hartford Life Insurance Company" or the
"Company") as of December 31, 2003, compared with December 31, 2002, and its
results of operations for the three years ended December 31, 2003, 2002 and
2001. This discussion should be read in conjunction with the Consolidated
Financial Statements and related Notes beginning on page F-1.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on the Company 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 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; 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 1
Consolidated Results of Operations: Operating Summary 5
Retail Products Group 8
Institutional Solutions Group 10
Individual Life 11
Investments 12
Investment Credit Risk 15
Capital Markets Risk Management 21
Capital Resources and Liquidity 28
Effect of Inflation 31
Impact of New Accounting Standards 31
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: deferred policy acquisition costs and present value of future
profits, valuation of investments; valuation of derivative instruments; reserves
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
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
1
acquisition costs and present value of future profits ("DAC"). At December 31,
2003 and 2002, the carrying value of the Company's DAC was $6.1 billion and $5.5
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 to a lesser extent, variable
universal life insurance businesses. The average annual long-term rate of
assumed separate account fund performance (before mortality and expense charges)
used in estimating gross profits for the variable annuity and variable universal
life business was 9% for the years ended December 31, 2003 and 2002. For other
products, including fixed annuities and other universal life-type contracts, the
average assumed investment yield ranged from 5% to 8.5% for both years ended
December 31, 2003 and 2002.
The Company has developed sophisticated modeling capabilities to evaluate its
DAC asset, which allowed it to run a large number of stochastically determined
scenarios of separate account fund performance. These scenarios were then
utilized to calculate a statistically significant range of reasonable estimates
of EGPs. This range was then compared to the present value of EGPs currently
utilized in the DAC amortization model. As of December 31, 2003, the present
value of the EGPs utilized in the DAC amortization model fall within a
reasonable range of statistically calculated present value of EGPs. As a result,
the Company does not believe there is sufficient evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of December 31,
2003 is necessary; however, if in the future the EGPs utilized in the DAC
amortization model were to exceed the margin of the reasonable range of
statistically calculated EGPs, a revision could be necessary. Furthermore, the
Company has estimated that the present value of the EGPs is likely to remain
within a reasonable range if overall separate account returns decline by 15% or
less for 2004, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved.
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with 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 December 31,
2003. If the Company assumed a 9% average long-term rate of growth from December
31, 2003 forward along with other appropriate assumption changes in determining
the revised EGPs, the Company estimates the cumulative increase to amortization
would be approximately $60-$70, 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 $75-$90, after-tax. Assuming that such an adjustment were
to have been required, the Company anticipates that there would have been
immaterial impacts on its DAC amortization for the 2004 and 2005 years exclusive
of the adjustment, and that there would have been positive earnings effects in
later years. Any such adjustment would not affect statutory income or surplus,
due to the prescribed accounting for such amounts that is discussed above.
Aside from absolute levels and timing of market performance assumptions,
additional factors that will influence this determination include the degree of
volatility in separate account fund performance and shifts in asset allocation
within the separate account made by policyholders. The overall return generated
by the separate account is dependent on several factors, including the relative
mix of the underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings. The Company's overall separate account fund
performance has been reasonably correlated to the overall performance of the S&P
500 Index (which closed at 1,112 on December 31, 2003), although no assurance
can be provided that this correlation will continue in the future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of December 31, 2003, the Company believed variable annuity
separate account assets could fall by at least 40% before portions of its DAC
asset would be unrecoverable.
2
VALUATION OF INVESTMENTS AND DERIVATIVE INSTRUMENTS
The Company's investments in both fixed maturities, which include bonds,
redeemable preferred stock and commercial paper and equity securities, which
include common and non-redeemable preferred stocks, are classified as
"available-for-sale" as defined in Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Accordingly, these securities are carried at fair value with the
after-tax difference from amortized cost, as adjusted for the effect of
deducting the life and pension policyholders' share of the immediate
participation guaranteed contracts and certain life and annuity deferred policy
acquisition costs, reflected in stockholders' equity as a component of
accumulated other comprehensive income ("AOCI"). Policy loans are carried at
outstanding balance, which approximates fair value. Other investments primarily
consist of limited partnership interests, derivatives and mortgage loans. The
limited partnerships are accounted for under the equity method and accordingly
the partnership earnings are included in net investment income. Derivatives are
carried at fair value and mortgage loans on real estate are recorded at the
outstanding principal balance adjusted for amortization of premiums or discounts
and net of valuation allowances, if any.
Valuation of Fixed Maturities
The fair value for fixed maturity securities is largely determined by one of
three primary pricing methods: independent third party pricing services,
independent broker quotations or pricing matrices which use data provided by
external sources. With the exception of short-term securities for which
amortized cost is predominantly used to approximate fair value, security pricing
is applied using a hierarchy or "waterfall" approach whereby prices are first
sought from independent pricing services with the remaining unpriced securities
submitted to brokers for prices or lastly priced via a pricing matrix.
Prices from independent pricing services are often unavailable for securities
that are rarely traded or are traded only in privately negotiated transactions.
As a result, a significant percentage of the Company's asset-backed and
commercial mortgage-backed securities are priced via broker quotations. A
pricing matrix is used to price securities for which the Company is unable to
obtain either a price from a third party service or an independent broker
quotation. The pricing matrix begins with current treasury rates and uses credit
spreads and issuer-specific yield adjustments received from an independent third
party source to determine the market price for the security. The credit spreads
incorporate the issuer's credit rating as assigned by a nationally recognized
rating agency and a risk premium, if warranted, due to the issuer's industry and
security's time to maturity. The issuer-specific yield adjustments, which can be
positive or negative, are updated twice annually, as of June 30 and December 31,
by an independent third-party source and are intended to adjust security prices
for issuer-specific factors. The matrix-priced securities at December 31, 2003
and 2002, primarily consisted of non-144A private placements and have an average
duration of 4.3 and 4.4, respectively.
The following table identifies the fair value of fixed maturity securities by
pricing source as of December 31, 2003 and 2002:
2003 2002
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GENERAL AND GUARANTEED PERCENTAGE GENERAL AND GUARANTEED PERCENTAGE
SEPARATE ACCOUNT FIXED OF TOTAL SEPARATE ACCOUNT FIXED OF TOTAL
MATURITIES AT FAIR VALUE FAIR VALUE MATURITIES AT FAIR VALUE FAIR VALUE
----------------------------------------------------------------------------
Priced via independent market
quotations $ 33,985 81.2% $ 27,437 76.5%
Priced via broker quotations 3,060 7.3% 4,641 12.9%
Priced via matrices 3,086 7.4% 2,685 7.5%
Priced via other methods 280 0.7% 239 0.7%
Short-term investments [1] 1,409 3.4% 869 2.4%
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TOTAL $ 41,820 100.0% $ 35,871 100.0%
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Total general accounts $ 30,085 71.9% $ 24,786 69.1%
Total guaranteed separate accounts $ 11,735 28.1% $ 11,085 30.9%
=================================================================================================================
[1] Short-term investments are valued at amortized cost, which approximates fair
value.
The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. As such, the estimated fair value of a
financial instrument may differ significantly from the amount that could be
realized if the security was sold immediately.
Other-Than-Temporary Impairments
One of the significant estimations inherent in the valuation of investments is
the evaluation of other-than-temporary impairments. The evaluation of
impairments is a quantitative and qualitative process, which is subject to risks
and uncertainties and is intended to determine whether declines in the fair
value of investments should be recognized in current period earnings. The risks
and uncertainties include changes in general economic conditions, the issuer's
financial condition or near term recovery prospects and the effects of changes
in interest rates. The Company's accounting policy requires that a decline in
the value of a security below its amortized cost basis be assessed to determine
if the decline is other-than-temporary. If so, the security is deemed to be
other-than-
3
temporarily impaired, and a charge is recorded in net realized capital losses
equal to the difference between the fair value and amortized cost basis of the
security. The fair value of the other-than-temporarily impaired investment
becomes its new cost basis. The Company has a security monitoring process
overseen by a committee of investment and accounting professionals that
identifies securities that, due to certain characteristics, as described below,
are subjected to an enhanced analysis on a quarterly basis.
Securities not subject to Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets" ("non-EITF Issue No. 99-20
securities"), that are depressed by twenty percent or more for six months are
presumed to be other-than-temporarily impaired unless the depression is the
result of rising interest rates or significant objective verifiable evidence
supports that the security price is temporarily depressed and is expected to
recover within a reasonable period of time. Non-EITF Issue No. 99-20 securities
depressed less than twenty percent or depressed twenty percent or more but for
less than six months are also reviewed to determine if an other-than-temporary
impairment is present. The primary factors considered in evaluating whether a
decline in value for non-EITF Issue No. 99-20 securities is other-than-temporary
include: (a) the length of time and the extent to which the fair value has been
less than cost, (b) the financial condition, credit rating and near-term
prospects of the issuer, (c) whether the debtor is current on contractually
obligated interest and principal payments and (d) the intent and ability of the
Company to retain the investment for a period of time sufficient to allow for
recovery.
For certain securitized financial assets with contractual cash flows (including
asset-backed securities), EITF Issue No. 99-20 requires the Company to
periodically update its best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
carrying amount and there has been a decrease in the present value of the
estimated cash flows since the last revised estimate, considering both timing
and amount, then an other-than-temporary impairment charge is recognized.
Projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral.
For securities expected to be sold, an other-than-temporary impairment charge is
recognized if the Company does not expect the fair value of a security to
recover to amortized cost prior to the expected date of sale. Once an impairment
charge has been recorded, the Company continues to review the
other-than-temporarily impaired securities for additional other-than-temporary
impairments.
Valuation of Derivative Instruments
Derivative instruments are reported at fair value based upon either independent
market quotations for exchange traded derivative contracts, independent third
party pricing sources or pricing valuation models which utilize independent
third party data as inputs. Valuation of derivatives underlying the GMWB
investment product is discussed below.
Valuation of Guaranteed Minimum Withdrawal Benefit Embedded Derivatives
An embedded derivative instrument is reported at fair value based upon
internally established valuations that are consistent with external valuation
models, quotations furnished by dealers in such instrument or market quotations.
The Company has calculated the fair value of the guaranteed minimum withdrawal
benefit ("GMWB") embedded derivative liability based on actuarial assumptions
related to the projected cash flows, including benefits and related contract
charges, over the lives of the contracts, incorporating expectations concerning
policyholder behavior. Because of the dynamic and complex nature of these cash
flows, stochastic techniques under a variety of market return scenarios and
other best estimate assumptions are used. Estimating these cash flows involves
numerous estimates and subjective judgments including those regarding expected
market rates of return, market volatility, correlations of market returns and
discount rates. At each valuation date, the Company assumes expected returns
based on risk-free rates as represented by the current LIBOR forward curve
rates; market volatility assumptions for each underlying index is based on a
blend of observed market "implied volatility" data and annualized standard
deviations of monthly returns using the most recent 20 years of observed market
performance; correlations of market returns across underlying indices is based
on actual observed market returns and relationships over the ten years preceding
the valuation date; and current risk-free spot rates as represented by the
current LIBOR spot curve is used to determine the present value of expected
future cash flows produced in the stochastic projection process.
RESERVES
The Company and its insurance subsidiaries establish and carry as liabilities
actuarially determined reserves which are calculated to meet Hartford Life
Insurance Company's future obligations. Reserves for life insurance and
disability contracts are based on actuarially recognized methods using
prescribed morbidity and mortality tables in general use in the United States,
which are modified to reflect the Company's actual experience when appropriate.
These reserves are computed at amounts that, with additions from estimated
premiums to be received and with interest on such reserves compounded annually
at certain assumed rates, are expected to be sufficient to meet the Company's
policy obligations at their maturities or in the event of an insured's death.
Changes in or deviations from the assumptions used for mortality, morbidity,
expected future premiums and interest can significantly affect the Company's
reserve levels and related future operations. Reserves also include unearned
premiums, premium deposits, claims incurred but not reported ("IBNR") and claims
reported but not yet paid. Reserves for assumed reinsurance are computed in a
manner that is comparable to direct insurance reserves.
4
The liability for policy benefits for universal life-type contracts and
interest-sensitive whole life policies is equal to the balance that accrues to
the benefit of policyholders, including credited interest, amounts that have
been assessed to compensate the Company for services to be performed over future
periods, and any amounts previously assessed against policyholders that are
refundable on termination of the contract.
For investment contracts, policyholder liabilities are equal to the accumulated
policy account values, which consist of an accumulation of deposit payments plus
credited interest, less withdrawals and amounts assessed through the end of the
period. Certain investment contracts include provisions whereby a guaranteed
minimum death benefit is provided in the event that the contractholder's account
value at death is below the guaranteed value. Although the Company reinsures the
majority of the death benefit guarantees associated with its in-force block of
business, declines in the equity market may increase the Company's net exposure
to death benefits under these contracts. In addition, these contracts contain
various provisions for determining the amount of the death benefit guaranteed
following the withdrawal of a portion of the account value by the policyholder.
Partial withdrawals under certain of these contracts may not result in a
reduction in the guaranteed minimum death benefit in proportion to the portion
surrendered. The Company records the death benefit costs, net of reinsurance, as
they are incurred. See Impact of New Accounting Standards section for a
discussion of the Company's adoption of Statement of Position 03-1, "Accounting
and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" (the "SOP") in 2004 and the recording of a
liability for GMDB in accordance with the provisions of the SOP.
For the Company's group disability policies, the level of reserves is based on a
variety of factors including particular diagnoses, termination rates and benefit
levels.
ACCOUNTING FOR CONTINGENCIES
Management follows the requirements of SFAS No. 5 "Accounting for
Contingencies". This statement requires management to evaluate each contingent
matter separately. The evaluation is a two-step process, including: determining
a likelihood of loss, and, if a loss is likely, developing a potential range of
loss. Management establishes reserves for these contingencies at its "best
estimate", or, if no one number within the range of possible losses is more
likely than any other, the Company records an estimated reserve at the low end
of the range of losses. The majority of contingencies currently being evaluated
by the Company relate to litigation and tax matters, which are inherently
difficult to evaluate and subject to significant changes.
CONSOLIDATED RESULTS OF OPERATIONS
EXECUTIVE OVERVIEW
Hartford Life Insurance Company provides investment and retirement products such
as variable and fixed annuities, and retirement plan services and other
institutional products; individual and corporate owned life insurance; and,
group benefit products, such as group life and group disability insurance that
is directly written by the Company and is substantially ceded to its parent,
Hartford Life and Accident Insurance Company (HLA).
The Company derives its revenues principally from: (a) fee income, including
asset management fees on separate account and mortality and expense fees, as
well as cost of insurance charges; (b) fully insured premiums; (c) certain other
fees; and (d) net investment income on general account assets. Asset management
fees and mortality and expense fees are primarily generated from separate
account assets, which are deposited with the Company through the sale of
variable annuity and variable universal life products. Cost of insurance charges
are assessed on the net amount at risk for investment-oriented life insurance
products. Premium revenues are derived primarily from the sale of group life and
group disability insurance products.
The Company's expenses essentially consist of interest credited to policyholders
on general account liabilities, insurance benefits provided, dividends to
policyholders, costs of selling and servicing the various products offered by
the Company, and other general business expenses.
The Company's profitability in its variable annuity business and to a lesser
extent, variable universal life depends largely on the amount of its assets
under management on which it earns fees and the level of fees charged. Changes
in assets under management are comprised of two main factors: net flows, which
measure the success of the Company's asset gathering and retention efforts
(sales and other deposits less surrenders) and the market return of the funds,
which is heavily influenced by the return on the equity markets. The
profitability of the Company's fixed annuities depends largely on its ability to
earn target spreads between earned investment rates on its general account
assets and interest credited to policyholders. Profitability is also influenced
by operating expense management including the benefits of economies of scale in
its variable annuity businesses in particular. In addition, the size and
persistency of gross profits from these businesses is an important driver of
earnings as it affects the amortization of the deferred policy acquisition
costs.
5
The Company's profitability in its individual life insurance business depends
largely on the size of its in force block, the adequacy of product pricing and
underwriting discipline, and the efficiency of its claims and expense
management.
OPERATING SUMMARY
2003 VS. 2002 2002 VS. 2001
2003 2002 2001 CHANGE CHANGE
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Fee income $ 2,169 $ 2,079 $ 2,157 4% (4%)
Earned premiums 806 453 799 78% (43%)
Net investment income 1,764 1,572 1,491 12% 5%
Other revenues 128 121 128 6% (5%)
Net realized capital gains (losses) 1 (276) (87) NM NM
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TOTAL REVENUES 4,868 3,949 4,488 23% (12%)
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Benefits, claims and claim adjustment expenses 2,726 2,275 2,536 20% (10%)
Amortization of deferred policy acquisition costs and
present value of future profits 660 531 566 24% (6%)
Insurance operating costs and expenses 636 625 610 2% 2%
Other expenses 52 90 80 (42%) 13%
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TOTAL BENEFITS, CLAIMS AND EXPENSES 4,074 3,521 3,792 16% (7%)
- -----------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 794 428 696 86% (39%)
Income Tax expense 168 2 44 NM (95%)
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Cumulative effect of accounting changes, net of tax [1] -- -- (6) -- 100%
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NET INCOME $ 626 $ 426 $ 646 47% (34%)
=================================================================================================================
[1] For the year ended December 31, 2001, represents the cumulative impact of
the Company's adoption of SFAS No. 133 of $(3) and EITF Issue 99-20 of
$(3).
The Company has changed its reportable operating segments from Investment
Products, Individual Life and Corporate Owned Life Insurance (COLI) to Retail
Products Group ("Retail"), Institutional Solutions Group ("Institutional") and
Individual Life. Retail offers individual variable and fixed annuities,
retirement plan products and services to corporations under Section 401(k) plans
and other investment products. Institutional primarily offers retirement plan
products and services to municipalities under Section 457 plans, other
institutional investment products and private placement life insurance (formerly
COLI). Individual Life sells a variety of life insurance products, including
variable universal life, universal life, interest sensitive whole life and term
life insurance. The Company also includes, in an Other category, net realized
capital gains and losses other than periodic net coupon settlements on
non-qualifying derivatives and net realized capital gains and losses related to
guaranteed minimum withdrawal benefits; corporate items not directly allocated
to any of its reportable operating segments; and intersegment eliminations, as
well as certain group benefit products including group life and group disability
insurance that is directly written by the Company and is substantially ceded to
the parent HLA. Periodic net coupon settlements on non-qualifying derivatives
and net realized capital gains and losses related to guaranteed minimum
withdrawal benefits are reflected in each applicable segment in net realized
capital gains and losses. The Company defines "NM" as not meaningful for
increases or decreases greater than 200%, or changes from a net gain to a net
loss position, or vice versa.
On April 2, 2001, The Hartford acquired the United States individual life
insurance, annuity and mutual fund businesses of Fortis. This transaction was
accounted for as a purchase and, as such, the revenues and expenses generated by
this business from April 2, 2001 forward are included in the Company's
consolidated results of operations. (For further disclosure, see Note 15 of
Notes to Consolidated Financial Statements).
2003 COMPARED TO 2002 -- Revenues increased as a result of realized gains in
2003 as compared to realized losses in 2002. (See the Investments section for
further discussion of investment results and related realized capital losses.)
Also contributing to the increased revenues were higher earned premiums in the
Institutional segment and higher net investment income in the Retail segment as
compared to the prior year.
The increase in earned premiums was primarily attributed to higher sales in the
institutional investment products business, specifically, in the institutional
annuities and structured settlement businesses. Additionally, net investment
income in the Retail segment increased due to higher general account assets in
the individual annuity business. Fee income in the Retail segment was higher in
2003 compared to a year ago, as a result of higher average account values,
specifically in the individual annuities business, due primarily to stronger
variable annuity sales compared to the prior year. The Individual Life segment
reported an increase in revenues in 2003 compared to a year ago driven by
increases in fees and cost of insurance as life insurance inforce grew and aged,
and variable universal life account values increased 30% due primarily to the
growth in the equity markets. Partially offsetting these increases was lower net
investment income in the Institutional segment, primarily due to lower average
leveraged COLI account values as a result of surrender activity.
Benefits, claims and expenses increased primarily due to increases in the Retail
and Institutional segments associated with the growth in the individual annuity
and institutional investments businesses discussed above. Partially offsetting
this increase was a decrease in interest credited expenses in Institutional
related to the decline in leveraged COLI account values. For the year ended
December 31,
6
2003, Institutional other expenses decreased as a result of a $9 after-tax
benefit, associated with the settlement for the Bancorp Services, LLC
("Bancorp") litigation. (For further discussion of the Bancorp litigation, see
Note 12 of Notes to Consolidated Financial Statements.)
Net income increased for the year ended December 31, 2003 due primarily to the
growth in the Retail and Institutional segments and a decrease in net realized
capital losses compared to a year ago. Additionally, Individual Life experienced
earnings growth in 2003 due to increases in fee income, favorable mortality and
growth in the in force business. Partially offsetting the increase was the $3
after-tax impact recorded in the first quarter of 2002 related to favorable
development on the Company's estimated September 11 exposure.
The effective tax rate increased in 2003 when compared with 2002 as a result of
higher earnings and lower DRD tax items. The tax provision recorded during 2003,
reflects a benefit of $23, consisting primarily of a change in estimate of the
DRD tax benefit reported during 2002. The change in estimate was the result of
actual 2002 investment performance on the related separate accounts being
unexpectedly out of pattern with past performance, which had been the basis for
the estimate. The total DRD benefit related to the 2003 tax year for the year
ended December 31, 2003 was $87 as compared to $63 for the year ended December
31, 2002.
2002 COMPARED TO 2001 -- Revenues decreased, primarily driven by an increase
in realized capital losses in 2002 as compared to the prior year. (See the
Investments section for further discussion of investment results and related
realized capital losses.) Additionally, Institutional experienced a decline in
revenues, as a result of the decrease in leveraged COLI account values as
compared to a year ago as well as lower earned premiums in the institutional
investment product business, which was partially offset by revenue growth across
the other operating segments. Partially offsetting these decreases were
increases in revenues in the Retail and Individual Life segments. Revenue in the
Retail segment increased primarily due to an increase in earned premiums. The
increase in Individual Life was primarily due to the Fortis acquisition and
increased life insurance in force.
Total benefits, claims and expenses decreased, due primarily to the revenue
changes described above. Expenses decreased in the Institutional segment,
principally due to a lower change in reserve as a result of the lower earned
premiums discussed above. In addition, 2002 expenses include $11, after-tax, of
accrued expenses recorded within the Institutional segment related to the
Bancorp litigation. (For a discussion of the Bancorp litigation, see Note 12 of
Notes to Consolidated Financial Statements.) Also included in 2002 expenses was
an after-tax benefit of $3, recorded within "Other", associated with favorable
development related to the Company's estimated September 11 exposure.
Net income decreased due primarily to lower income in Other as a result of
higher realized capital losses and lower income in the Retail segment as a
result of the lower equity markets. These declines were partially offset by an
increase in Individual Life primarily due to the Fortis acquisition. In
addition, the Company recorded, in 2002, an $11 after-tax expense associated
with the Bancorp Litigation and recognized an after-tax benefit of $3 due to
favorable development related to September 11. In 2001, the Company recorded a
$9 after-tax loss related to September 11.
SEGMENT RESULTS
Below is a summary of net income (loss) by segment.
2003 2002 2001
- ------------------------------------------------------
Retail Products Group $ 341 $280 $ 319
Institutional Solutions Group 119 94 92
Individual Life 134 116 106
Other 32 (64) 129
- ------------------------------------------------------
NET INCOME $ 626 $426 $ 646
======================================================
A description of each segment as well as an analysis of the operating results
summarized above is included on the following pages.
7
RETAIL PRODUCTS GROUP
OPERATING SUMMARY
2003 VS. 2002 2002 VS. 2001
2003 2002 2001 CHANGE CHANGE
- -----------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 1,302 $ 1,207 $ 1,305 8% (8)%
Earned premiums (37) (25) (63) (48%) 60%
Net investment income 493 367 279 34% 32%
Net realized capital gains 16 7 2 NM NM
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 1,774 1,556 1,523 14% 2%
Benefits, claims and claim adjustment expenses 567 486 375 17% 30%
Insurance operating costs and other expenses 374 358 337 5% 6%
Amortization of deferred policy acquisition costs 462 377 406 23% (7%)
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,403 1,221 1,118 15% 9%
- -----------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 371 335 405 11% (17%)
Income tax expense 30 55 86 (46%) (36%)
- -----------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 341 $ 280 $ 319 22% (12%)
=============================================================================================================================
Individual variable annuity account values $ 86,501 $ 64,343 $ 74,581 34% (14%)
Other individual annuity account values 11,215 10,565 9,572 6% 10%
Other investment products account values 4,606 2,972 2,518 56% 18%
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $ 102,322 $ 77,880 $ 86,671 31% (10%)
=============================================================================================================================
The Retail Products Group segment focuses on the savings and retirement needs of
the growing number of individuals who are preparing for retirement or have
already retired through the sale of individual variable and fixed annuities,
retirement plan services and other retail products. The Company is both a
leading writer of individual variable annuities and a top seller of individual
variable annuities through banks in the United States.
2003 COMPARED TO 2002 -- Revenues in the Retail Products Group segment
increased primarily driven by higher net investment income and higher fee
income. Net investment income increased due to higher general account assets.
General account assets for the individual annuity business were $9.4 billion as
of December 31, 2003, an increase of approximately $800 million or 9% from 2002,
due primarily to an increase in individual annuity sales, with a majority of
those new sales electing to use the dollar cost averaging ("DCA") feature. The
DCA feature allows policyholders to earn a credited interest rate in the general
account for a defined period of time as their invested assets are systematically
invested into the separate account funds. Fee income in the Retail Products
Group segment was higher in 2003 compared to a year ago, as a result of higher
average account values, specifically in individual annuities, due primarily to
stronger variable annuity sales and the higher equity market values compared to
the prior year. 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.
Total benefits, claims and expenses increased primarily due to increased
interest credited in the individual annuity operation as a result of higher
general account asset levels. Additionally, amortization of deferred policy
acquisition costs related to the individual annuity business increased due to
higher gross profits.
Net income was higher driven by an increase in revenues in the individual
annuity and 401(k) operations as a result of the strong net flows and growth in
the equity markets during 2003 and strong expense management. In addition, net
income increased in 2003 compared to 2002 due to the favorable impact of $20,
resulting from the Company's previously discussed change in estimate of the DRD
tax benefit reported during 2002. The change in estimate was the result of 2002
actual investment performance on the related separate accounts being
unexpectedly out of pattern with past performance, which had been the basis for
the estimate. The total DRD benefit related to the 2003 tax year for the year
ended December 31, 2003 was $79 as compared to $58 for the year ended December
31, 2002.
2002 COMPARED TO 2001 -- Revenues in the Retail Products Group segment
increased, primarily due to an increase in net investment income in the
individual annuity business. Partially offsetting this increase was lower fee
income related to the individual annuity operation as average account values
decreased compared to prior year, primarily due to the lower equity markets.
8
Total benefits, claims and expenses increased, due primarily to increases in
interest credited on general account assets, commissions and wholesaling
expenses and individual annuity death benefit costs due to the lower equity
markets. Partially offsetting these increases was a decrease in amortization of
policy acquisition cost related to the individual annuity business, which
declined as a result of lower gross profits, driven by the decrease in fee
income and the increase in death benefit costs.
Net income decreased, driven primarily by the lower equity markets resulting in
the decline in revenue and increases in the death benefit costs incurred by the
individual annuity operation.
OUTLOOK
Management believes the market for retirement products continues to expand as
individuals increasingly save and plan for retirement. Demographic trends
suggest that as the "baby boom" generation matures, a significant portion of the
United States population will allocate a greater percentage of their disposable
incomes to saving for their retirement years due to uncertainty surrounding the
Social Security system and increases in average life expectancy. In addition,
the Company believes that it has developed and implemented strategies to
maintain and enhance its position as a market leader in the financial services
industry. This was demonstrated by record individual annuity sales in 2003 of
$16.5 billion (a 42% increase) compared to $11.6 billion and $10.0 billion in
2002 and 2001, respectively. Significantly contributing to the growth in sales
was the introduction of Principal First, a guaranteed minimum withdrawal benefit
rider, which was developed in response to our customers' needs. However, the
competition is increasing in this market and as a result, the Company may not be
able to sustain the level of sales attained in 2003. Based on VARDS, the Company
had 12.6% market share as of December 31, 2003 as compared to 9.4% at December
31, 2002.
The growth and profitability of the individual annuity business is dependent to
a large degree on the performance of the equity markets. In periods of favorable
equity market performance, the Company may experience stronger sales and higher
net cash flows, which will increase assets under management and thus increase
fee income earned on those assets. In addition, higher equity market levels will
generally reduce certain costs to the Company of individual annuities, such as
GMDB and GMWB benefits. Conversely though, weak equity markets may dampen sales
activity and increase surrender activity causing declines in assets under
management and lower fee income. Such declines in the equity markets will also
increase the cost to the Company of GMDB and GMWB benefits associated with
individual annuities. The Company attempts to mitigate some of the volatility
associated with the GMDB and GMWB benefits using reinsurance or other risk
management strategies. Future net income for the Company will be affected by the
effectiveness of the risk management strategies the Company has implemented to
mitigate the net income volatility associated with the GMDB and GMWB benefits of
variable annuity contracts. For spread based products sold in the Retail
Products Group segment, the future growth will depend on the ability to earn
targeted returns on new business, given competition and the future interest rate
environment.
9
INSTITUTIONAL SOLUTIONS GROUP
OPERATING SUMMARY
2003 VS. 2002 2002 VS. 2001
2003 2002 2001 CHANGE CHANGE
- -----------------------------------------------------------------------------------------------------------------------
Fee income and other $ 301 $ 349 $ 411 (14%) (15%)
Earned premiums 793 420 792 89% (47%)
Net investment income 976 958 938 2% 2%
Net realized capital gains 12 3 - NM NM
- ---------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,082 1,730 2,141 20% (19%)
Benefits, claims and claim adjustment expenses 1,733 1,356 1,773 28% (24%)
Insurance operating costs and other expenses 140 226 227 (38%) NM
Amortization of deferred policy acquisition costs 33 8 7 NM 14%
- ---------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,906 1,590 2,007 20% (21%)
- ---------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 176 140 134 26% 4%
Income tax expense 57 46 42 24% (10%)
- ---------------------------------------------------------------------------------------------------------------
NET INCOME $ 119 $ 94 $ 92 27% 2%
===============================================================================================================
Institutional account values $12,357 $ 9,433 $ 8,659 31% 9%
Governmental account values 8,965 7,211 7,735 24% (7%)
Private Placement Life Insurance account values
Variable Products 20,993 19,674 18,019 7% 9%
Leveraged COLI 2,524 3,321 4,315 (24%) (23%)
- ---------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $44,839 $39,639 $38,728 13% 2%
===============================================================================================================
The Institutional Solutions Group primarily offers retirement plan products and
services to municipalities under Section 457 plans, other institutional
investment products and private placement life insurance ("PPLI") (formerly
Corporate Owned Life Insurance or "COLI").
2003 COMPARED TO 2002 -- Revenues in the Institutional Solutions Group
segment increased due to higher earned premiums and higher net investment
income. The increase in earned premiums is due primarily to higher sales of
institutional annuities and structured settlement products in the institutional
investment products business. Net investment income increased due to the
increase in average account values. Partially offsetting these increases was
lower fee income. Fee income decreased as a result of lower cost of insurance
charges due to the decline in leveraged COLI account values as a result of
surrender activity and lower sales volume of PPLI products in 2003 as compared
to prior year.
Total benefits, claims and expenses increased primarily due to higher
institutional annuities and structured settlement sales in the institutional
investment business causing an increase in reserve levels, partially offset by a
decline in interest credited due to a decline in the leveraged COLI account
assets as compared to 2002, related to the surrender activity noted above.
Amortization of deferred policy acquisition costs increased as a result of the
higher level of sales in the institutional investment products business.
Additionally, total benefits, claims and expenses decreased in 2003 as a result
of a $9 after-tax benefit recorded in insurance operating costs and expenses
related to the Bancorp litigation. (For further discussion of the Bancorp
litigation, see Note 12 of Notes to Consolidated financial Statements.) Total
benefits, claims and expenses for the year ended December 31, 2002 included an
$11 after-tax expense related to the Bancorp litigation accrued in the first
quarter of 2002.
Net income increased in 2003 compared to 2002 principally as a result of the
Bancorp litigation benefit of $9, after-tax, recorded in the third quarter of
2003, compared to the $11 after tax expense recorded in 2002. Additionally, net
income for the year ended December 31, 2003 includes the favorable impact of $1
DRD benefit resulting from the Company's previously discussed change in estimate
of the DRD tax benefit reported during 2002. The total DRD benefit related to
the 2003 tax year for the year ended December 31, 2003 was $4 as compared to $2
for the year ended December 31, 2002.
2002 COMPARED TO 2001 -- Revenues in the Institutional Solutions Group
segment decreased, primarily due to lower earned premiums in the institutional
investment products business and lower fee income was due primarily to the
declining block of leveraged COLI compared to a year ago. Total benefits, claims
and expenses decreased, which was relatively consistent with the decrease in
revenues described above. However, the decrease was partially offset by $11,
after-tax, in accrued litigation expenses related to the Bancorp dispute. The
segment's net income increased due to additional earnings from the institutional
investment products business, partially offset by the $11 after-tax expense
accrued in connection with the Bancorp litigation. The decrease in net income
was also impacted by an after-tax loss of $2 related to September 11 recorded in
the third quarter of 2001.
10
OUTLOOK
The future net income of this segment will depend on the Company's ability to
maintain its investment spread earnings on the majority of the products sold in
the institutional investment products and governmental business. The focus of
the private placement life insurance business is variable products, which
continues to be a product generally used by employers to fund non-qualified
benefits or other post employment benefit liabilities. The leveraged COLI
product has been an important contributor to PPLI's profitability in recent
years and will continue to contribute to the profitability of the Company in the
future, although the level of profit has declined in 2003, compared to 2002.
PPLI continues to be subject to a changing legislative and regulatory
environment that could have a material adverse effect on its business.
INDIVIDUAL LIFE
OPERATING SUMMARY
2003 VS. 2002 2002 VS. 2001
2003 2002 2001 CHANGE CHANGE
- -----------------------------------------------------------------------------------------------------------------------
Fee income and other $ 671 $ 635 $ 570 6% 11%
Net investment income 222 224 205 (1%) 9%
Net realized capital losses -- (1) (1) 100% --
- ------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 893 858 774 4% 11%
Benefits, claims and claim adjustment expenses 380 393 330 (3%) 19%
Insurance operating costs and other expenses 150 144 131 4% 10%
Amortization of deferred policy acquisition costs
165 146 153 13% (5%)
TOTAL BENEFITS, CLAIMS AND EXPENSES 695 683 614 2% 11%
- ------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 198 175 160 13% 9%
Income tax expense 64 59 54 8% 9%
- ------------------------------------------------------------------------------------------------------------------
NET INCOME $ 134 $ 116 $ 106 16% 9%
==================================================================================================================
Variable universal life account values $ 4,725 $ 3,648 $ 3,993 30% (9%)
- ------------------------------------------------------------------------------------------------------------------
Total account values $ 8,200 $ 7,019 $ 7,329 17% (4%)
==================================================================================================================
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients.
2003 COMPARED TO 2002 -- Revenues in the Individual Life segment increased
primarily driven by increases in fees and cost of insurance charges as life
insurance in force grew and aged, and variable universal life account values
increased 30%, driven by the growth in the equity markets in 2003. These
increases were partially offset by lower earned premiums and net investment
income in 2003. The decrease in net investment income was due primarily to lower
investment yields. Earned premiums, which include premiums for ceded reinsurance
decreased primarily due to increased use of reinsurance.
Total benefits, claims and expenses increased, principally driven by an increase
in amortization of deferred policy acquisition costs. These increases were
partially offset by a decrease in benefit costs in 2003 as compared to 2002 due
to favorable mortality rates compared to the prior year.
Net income increased due to increases in fee income and unusually favorable
mortality. Additionally, net income for the year ended December 31, 2003
includes the favorable impact of $2 DRD benefit resulting from the Company's
previously discussed change in estimate of the DRD tax benefit reported during
2002. The total DRD benefit related to the 2003 tax year for the year ended
December 31, 2003 was $4 as compared to $3 for the year ended December 31, 2002.
2002 COMPARED TO 2001 -- Revenues in the Individual Life segment increased,
primarily driven by business growth including the impact of the Fortis
transaction. Total benefit, claims and expenses increased, principally driven by
the growth in the business including the impact of the Fortis acquisition. In
addition, mortality experience (expressed as death claims as a percentage of net
amount at risk) for 2002 increased as compared to the prior year, but were in
line with management's expectations. Individual Life earnings increased for the
year ended December 31, 2002 , principally due to the contribution to earnings
from the Fortis transaction. The increase in net income was also impacted by an
after-tax loss of $3 related to September 11 in the third quarter of 2001.
OUTLOOK
The individual life segment benefited from unusually favorable mortality during
the fourth quarter. It is not anticipated that similar experience would be
likely to continue. Individual life sales grew to $196 in 2003 from $173 in 2002
with the successful introduction of new universal life and whole life products.
Improved equity markets should help increase variable universal life sales. The
11
Company also continues to introduce new and enhanced products, which are
expected to increase sales. However, the Company continues to face uncertainty
surrounding estate tax legislation and aggressive competition from life
insurance providers. The Company is actively pursuing broader distribution
opportunities to fuel growth, including our Pinnacle Partners marketing
initiative, and anticipates growth at Woodbury Financial Services.
INVESTMENTS
GENERAL
The investment portfolios are managed based on the underlying characteristics
and nature of each operation's respective liabilities and within established
risk parameters. (For a further discussion of Hartford Life Insurance Company's
approach to managing risks, see the Investment Credit Risk and Capital Markets
Risk Management sections.)
The investment portfolios are managed by Hartford Investment Management Company
("Hartford Investment Management"), a wholly-owned subsidiary of The Hartford.
Hartford Investment Management is responsible for monitoring and managing the
asset/liability profile, establishing investment objectives and guidelines and
determining, within specified risk tolerances and investment guidelines, the
appropriate asset allocation, duration, convexity and other characteristics of
the portfolios. Security selection and monitoring are performed by asset class
specialists working within dedicated portfolio management teams.
The primary investment objective of Hartford Life Insurance Company's general
account is to maximize after-tax returns consistent with acceptable risk
parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity relative to that of
policyholder and corporate obligations, as discussed in the Capital Markets Risk
Management section under "Market Risk -Key Market Risk Exposures".
Return on general account invested assets is an important element of Hartford
Life Insurance Company's financial results. Significant fluctuations in the
fixed income or equity markets could weaken the Company's financial condition or
its results of operations. Additionally, changes in market interest rates may
impact the period of time over which certain investments, such as
mortgage-backed securities, are repaid and whether certain investments are
called by the issuers. Such changes may, in turn, impact the yield on these
investments and also may result in reinvestment of funds received from calls and
prepayments at rates below the average portfolio yield. Net investment income
and net realized capital gains and losses accounted for approximately 36%, 33%
and 32% of the Company's consolidated revenues for the years ended December 31,
2003, 2002 and 2001, respectively.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, general account fixed maturity investments, which comprised
approximately 90% and 86% of the fair value of its invested assets as of
December 31, 2003 and 2002, respectively. Other events beyond the Company's
control could also adversely impact the fair value of these investments.
Specifically, a downgrade of an issuer's credit rating or default of payment by
an issuer could reduce the Company's investment return.
The Company invests in private placement securities, mortgage loans and limited
partnership arrangements in order to further diversify its investment portfolio.
These investment types comprised approximately 19% of the fair value of its
invested assets as of December 31, 2003 and 2002. These security types are
typically less liquid than direct investments in publicly traded fixed income or
equity investments. However, generally these securities have higher yields to
compensate for the liquidity risk.
A decrease in the fair value of any investment that is deemed
other-than-temporary would result in the Company's recognition of a net realized
capital loss in its financial results prior to the actual sale of the
investment. (For a further discussion, see the Company's discussion of the
evaluation of other-than-temporary impairments in Critical Accounting Estimates
under "Investments".)
The following table identifies the invested assets by type held in the general
account as of December 31, 2003 and 2002.
COMPOSITION OF INVESTED ASSETS
2003 2002
AMOUNT PERCENT AMOUNT PERCENT
-------------------------------------------
Fixed maturities, at fair value $ 30,085 90.4% $ 24,786 86.3%
Equity securities, at fair value 85 0.3% 120 0.4%
Policy loans, at outstanding balance 2,470 7.4% 2,895 10.1%
Mortgage loans, at cost 354 1.1% 243 0.8%
Limited partnerships, at fair value 169 0.5% 486 1.7%
Other investments 116 0.3% 189 0.7%
- --------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 33,279 100.0% $ 28,719 100.0%
======================================================================================
During 2003, fixed maturity investments increased 21%, primarily the result of
investment and universal life contract sales, operating cash flows and
redeployment of invested assets from limited partnerships. In March 2003, the
Company decided to liquidate its hedge
12
fund limited partnership investments and reinvest the proceeds in fixed maturity
investments. Hedge fund liquidations totaled $372 during the year and as of
December 31, 2003 were fully liquidated.
INVESTMENT RESULTS
The following table summarizes the Company's investment results.
(before-tax) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Net investment income - - excluding policy loan income [1] $ 1,557 $ 1,321 $ 1,187
Policy loan income 207 251 304
--------------------------------
Net investment income - - total [1] $ 1,764 $ 1,572 $ 1,491
Yield on average invested assets [2] 6.1% 6.2% 7.1%
- ----------------------------------------------------------------------------------------------------
Gross gains on sale 215 138 83
Gross losses on sale (95) (80) (59)
Impairments (139) (340) (93)
Periodic net coupon settlements on non-qualifying derivatives [1] 29 13 4
Other, net [3] (9) (7) (22)
--------------------------------
Net realized capital gains (losses), before-tax [1] $ 1 $ (276) $ (87)
====================================================================================================
[1] Prior periods reflect the reclassification of periodic net coupon
settlements on non-qualifying derivatives from net investment income to
net realized capital gains (losses).
[2] Represents net investment income (excluding net realized capital gains
(losses)) divided by average invested assets at cost or amortized cost, as
applicable. Average invested assets are calculated by dividing the sum of
the beginning and ending period amounts by two, excluding the collateral
obtained from the securities lending program.
[3] Primarily consists of changes in fair value and hedge ineffectiveness on
derivative instruments as well as the amortization of deferred acquisition
costs.
2003 COMPARED TO 2002 -- Net investment income, excluding policy loan income,
increased $236, or 18%, compared to the prior year. The increase was primarily
due to income earned on a higher invested asset base partially offset by lower
investment yields. Policy loan income decreased primarily due to the decline in
leveraged COLI policies, as a result of surrender activity and lower sales.
Yield on average invested assets decreased as a result of lower rates on new
investment purchases and decreased policy loan income.
Net realized capital gains (losses) for 2003 improved by $277 compared to the
prior year, primarily as a result of net gains on sales of fixed maturities and
a decrease in other-than-temporary impairments on fixed maturities. (For a
further discussion of other-than-temporary impairments, see the
Other-Than-Temporary Impairments commentary in this section of the MD&A.)
2002 COMPARED TO 2001 -- Net investment income, excluding policy loan income,
increased $134, or 11%. The increase was primarily due to income earned on a
higher invested asset base partially offset by lower income on limited
partnerships and the impact of lower interest rates on new investment purchases.
Policy loan income decreased primarily due to the decline in leveraged COLI
policies, as a result of surrender activity and lower sales. Yield on average
invested assets decreased as a result of lower rates on new investment
purchases, decreased policy loan income and decreased income on limited
partnerships.
Net realized capital losses for 2002 increased $189, or 217%, compared to the
prior year as a result of higher other-than-temporary impairments. (For a
further discussion of other-than-temporary impairments, see the
Other-Than-Temporary Impairments commentary in this section of the MD&A.)
SEPARATE ACCOUNT PRODUCTS
Separate account products are those for which a separate investment and
liability account is maintained on behalf of the policyholder. The Company's
separate accounts reflect two categories of risk assumption: non-guaranteed
separate accounts totaling $118.1 billion and $93.5 billion as of December 31,
2003 and 2002, respectively, wherein the policyholder assumes substantially all
the risk and reward; and guaranteed separate accounts totaling $12.1 billion and
$11.8 billion as of December 31, 2003 and 2002, respectively, wherein the
Company contractually guarantees either a minimum return or the account value to
the policyholder. Guaranteed separate account products primarily consist of
modified guaranteed individual annuities and modified guaranteed life insurance
and generally include market value adjustment features and surrender charges to
mitigate the risk of disintermediation. The primary investment objective of
guaranteed separate accounts is to maximize after-tax returns consistent with
acceptable risk parameters, including the management of the interest rate
sensitivity of invested assets relative to that of policyholder obligations, as
discussed in the Capital Markets Risk Management section under "Market Risk -Key
Market Risk Exposures". Effective January 1, 2004, these investments will be
included with general account assets pursuant to Statement of Position ("SOP")
03-01, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts".
13
Investment objectives for non-guaranteed separate accounts, which consist of the
participants' account balances, vary by fund account type, as outlined in the
applicable fund prospectus or separate account plan of operations.
Non-guaranteed separate account products include variable annuities, variable
universal life insurance contracts and variable private placement life
insurance.
OTHER-THAN-TEMPORARY IMPAIRMENTS
The following table identifies the Company's other-than-temporary impairments by
type.
OTHER-THAN-TEMPORARY IMPAIRMENTS BY TYPE
(before-tax) 2003 2002 2001
- ----------------------------------------------------------------------------------------
Asset-backed securities ("ABS")
Aircraft lease receivables $ 29 $ 65 $ 2
Corporate debt obligations ("CDO") 15 29 9
Credit card receivables 12 9 --
Interest only securities 5 3 10
Manufacturing housing ("MH") receivables 9 14 --
Mutual fund fee receivables 3 16 --
Other ABS 2 13 3
- ----------------------------------------------------------------------------------------
Total ABS 75 149 24
Commercial mortgage-backed securities ("CMBS") 5 4 --
Corporate
Basic industry 2 -- 4
Consumer non-cyclical 7 -- --
Financial services 2 6 --
Food and beverage 25 -- --
Technology and communications 2 137 17
- ----------------------------------------------------------------------------------------
Transportation 7 1 --
Utilities -- 22 37
- ----------------------------------------------------------------------------------------
Other Corporate -- 10 --
Total Corporate 45 176 58
Equity 8 -- --
Foreign government -- 11 11
Mortgage-backed securities ("MBS") - interest only securities 6 -- --
- ----------------------------------------------------------------------------------------
TOTAL OTHER-THAN-TEMPORARY IMPAIRMENTS $139 $340 $ 93
========================================================================================
ABS -- During 2003, other-than-temporary impairments were recorded for
various ABS security types as a result of a continued deterioration of cash
flows derived from the underlying collateral. A significant number of these
impairments were recorded on the Company's investments in lower tranches of ABS
supported by aircraft lease and enhanced equipment trust certificates (together,
"aircraft lease receivables") due to continued lower aircraft lease rates and
the prolonged decline in airline travel. CDO impairments were primarily the
result of increasing default rates and lower recovery rates on the collateral.
Impairments on ABS backed by credit card receivables were a result of issuers
extending credit to sub-prime borrowers and the higher default rates on these
loans, while impairments on securities supported by MH receivables were
primarily the result of repossessed units liquidated at depressed levels.
Interest only security impairments recorded during 2003, 2002 and 2001 were due
to the flattening of the forward yield curve.
Impairments of ABS during 2002 and 2001 were driven by deterioration of
collateral cash flows. Numerous bankruptcies, collateral defaults, weak economic
conditions and reduced airline travel were all factors contributing to lower
collateral cash flows and broker quoted market prices of ABS.
CORPORATE -- The decline in corporate bankruptcies and improvement in general
economic conditions have contributed to lower corporate impairment levels in
2003 compared to 2002.
A significant portion of corporate impairments during 2003 resulted from issuers
who experienced fraud or accounting irregularities. The most significant of
these was the Italian dairy concern, Parmalat SpA, and one consumer non-cyclical
issuer in the healthcare industry which resulted in a $25 and $6, before-tax
loss, respectively. A loss of $3 was recorded relating to one communications
sector issuer in the cable television industry due to deteriorating earnings
forecasts, debt restructuring issues and accounting irregularities. Additional
impairments were incurred as a result of the deterioration in the transportation
sector during the first half of the year, specifically issuers of airline debt,
as a result of a continued decline in airline travel.
During 2002, impairments of corporate securities were concentrated in the
technology and communications sector and included a $74, before-tax, loss
related to securities issued by WorldCom.
14
During 2001, impairments of corporate securities were concentrated in the
technology and communications and the utilities sectors, which included a $37,
before-tax, loss related to securities issued by Enron Corporation.
OTHER -- Other-than-temporary impairments were also recorded in 2003 on
various diversified mutual funds and preferred stock investments. In 2002 and
2001 other-than-temporary impairments were recognized on various common stock
investments, primarily in the technology and communications sector, which had
experienced declines in fair value for an extended period of time.
In addition to the impairments described above, fixed maturity and equity
securities were sold during 2003, 2002 and 2001 at total gross losses of $74,
$63 and $61, respectively. No single security was sold at a loss in excess of
$8, $13 and $6 during 2003, 2002 and 2001, respectively.
Based upon the general improvement in corporate credit quality, favorable
overall market conditions and the apparent stabilization in certain ABS types,
the Company expects other-than-temporary impairments to trend lower in 2004 from
the 2003 and 2002 amounts.
INVESTMENT CREDIT RISK
Hartford Life Insurance Company has established investment credit policies that
focus on the credit quality of obligors and counterparties, limit credit
concentrations, encourage diversification and require frequent creditworthiness
reviews. Investment activity, including setting of policy and defining
acceptable risk levels, is subject to regular review and approval by senior
management and by the Company's Finance Committee of the Board of Directors.
The Company invests primarily in securities which are rated investment grade and
has established exposure limits, diversification standards and review procedures
for all credit risks including borrower, issuer and counterparty.
Creditworthiness of specific obligors is determined by an internal credit
evaluation supplemented by consideration of external determinants of
creditworthiness, typically ratings assigned by nationally recognized ratings
agencies. Obligor, asset sector and industry concentrations are subject to
established limits and monitored on a regular basis.
Hartford Life Insurance Company is not exposed to any credit concentration risk
of a single issuer greater than 10% of the Company's stockholder's equity.
DERIVATIVE INSTRUMENTS
The Company's derivatives counterparty exposure policy establishes market-based
credit limits, favors long-term financial stability and creditworthiness and
typically requires credit enhancement/credit risk reducing agreements. Credit
risk is measured as the amount owed to the Company based on current market
conditions and potential payment obligations between the Company and its
counterparties. Credit exposures are generally quantified weekly and netted, and
collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds exposure policy thresholds. The Company
also minimizes the credit risk in derivative instruments by entering into
transactions with high quality counterparties which are reviewed periodically by
the Company's internal compliance unit, reviewed frequently by senior management
and reported to the Company's Finance Committee of the Board of Directors. The
Company also maintains a policy of requiring that all derivative contracts be
governed by an International Swaps and Derivatives Association Master Agreement
which is structured by legal entity and by counterparty and permits right of
offset.
The Company periodically enters into swap agreements in which the Company
assumes credit exposure from a single entity, referenced index or asset pool.
Total return swaps involve the periodic exchange of payments with other parties,
at specified intervals, calculated using the agreed upon index and notional
principal amounts. Generally, no cash or principal payments are exchanged at the
inception of the contract. Typically, at the time a swap is entered into, the
cash flow streams exchanged by the counterparties are equal in value.
Credit default swaps involve a transfer of credit risk from one party to another
in exchange for periodic payments. One party to the contract will make a payment
based on an agreed upon rate and a notional amount. The second party, who
assumes credit exposure will only make a payment when there is a credit event,
and such payment will be equal to the notional value of the swap contract, and
in return, the second party will receive the debt obligation of the first party.
A credit event is generally defined as default on contractually obligated
interest or principal payment or restructure.
As of December 31, 2003 and 2002, the notional value of total return and credit
default swaps totaled $450 and $437, respectively, and the swap fair value
totaled $(17) and $(41), respectively.
The following table identifies fixed maturity securities by type, including
guaranteed separate accounts, as of December 31, 2003 and December 31, 2002.
15
FIXED MATURITIES BY TYPE
2003 2002
--------------------------------------------------- ---------------------------------------------------
PERCENT PERCENT
OF OF
TOTAL TOTAL
AMORTIZED UNREALIZED UNREALIZED FAIR FAIR AMORTIZED UNREALIZED UNREALIZED FAIR FAIR
COST GAINS LOSSES VALUE VALUE COST GAINS LOSSES VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
ABS $ 5,118 $ 109 $ (96) $ 5,131 12.3% $ 5,115 $ 109 $ (143) $ 5,081 14.2%
CMBS 7,010 384 (21) 7,373 17.6% 4,979 416 (9) 5,386 15.0%
Collateralized mortgage
obligations ("CMO") 681 12 (2) 691 1.7% 752 33 (2) 783 2.2%
Corporate
Basic industry 2,680 208 (8) 2,880 6.9% 2,000 129 (7) 2,122 5.9%
Capital goods 1,222 98 (5) 1,315 3.1% 1,048 68 (7) 1,109 3.1%
Consumer cyclical 2,113 153 (5) 2,261 5.4% 1,425 88 (3) 1,510 4.2%
Consumer non-cyclical 2,576 190 (8) 2,758 6.6% 2,462 176 (16) 2,622 7.3%
Energy 1,389 116 (5) 1,500 3.6% 1,446 110 (8) 1,548 4.3%
Financial services 4,995 385 (24) 5,356 12.9% 4,956 307 (81) 5,182 14.4%
Technology and
communications 3,315 357 (10) 3,662 8.8% 2,911 247 (68) 3,090 8.6%
Transportation 568 41 (3) 606 1.4% 571 45 (11) 605 1.7%
Utilities 1,820 174 (11) 1,983 4.7% 1,757 114 (41) 1,830 5.1%
Other 507 23 (1) 529 1.3% 404 18 -- 422 1.2%
Government/Government
agencies
Foreign 810 77 (1) 886 2.1% 720 68 (5) 783 2.2%
United States 981 30 (4) 1,007 2.4% 553 44 -- 597 1.7%
MBS - agency 1,916 30 (2) 1,944 4.6% 2,035 58 -- 2,093 5.8%
Municipal
Taxable 374 14 (7) 381 0.9% 98 16 (1) 113 0.3%
Redeemable preferred
stock 1 -- -- 1 -- 1 -- -- 1 --
Short-term 1,555 1 -- 1,556 3.7% 993 1 -- 994 2.8%
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 39,631 $ 2,402 $ (213) $41,820 100.0% $ 34,226 $ 2,047 $ (402) $35,871 100.0%
==================================================================================================================================
Total general account
fixed maturities $ 28,511 $ 1,715 $ (141) $30,085 71.9% $ 23,675 $ 1,389 $ (278) $24,786 69.1%
Total guaranteed separate
account fixed maturities $ 11,120 $ 687 $ (72) $11,735 28.1% $ 10,551 $ 658 $ (124) $11,085 30.9%
==================================================================================================================================
The Company's fixed maturity gross unrealized gains and losses have improved by
$355 and $189, respectively from December 31, 2002 to December 31, 2003,
primarily due to improved corporate credit quality and to a lesser extent
recognition of other-than-temporary impairments and asset sales, partially
offset by an increase in interest rates. The improvement in corporate credit
quality was largely due to the security issuers' renewed emphasis on improving
liquidity, reducing leverage and various cost cutting measures. Throughout 2003,
the general economic outlook has continued to rebound, the result of improved
profitability supported by improved manufacturing demand, a continued strong
housing market and robust consumer and government spending. The apparent
economic acceleration has resulted in the 10 year Treasury rate increasing over
40 basis points since December 31, 2002 and more than 100 basis points from its
low in June 2003.
Investment allocations as a percentage of total fixed maturities have remained
materially consistent since December 31, 2002, except for ABS and CMBS.
Although the fair value of the Company's ABS fixed maturities improved slightly
during 2003, portfolio allocations to ABS decreased in favor of other sectors
with higher relative yields. Portfolio allocations to CMBS increased due to the
asset class's stable spreads and high quality. CMBS securities have lower
prepayment risk than MBS due to contractual penalties.
As of December 31, 2003 and 2002, 21% and 20%, respectively, of the fixed
maturities were invested in private placement securities, including 13% and 12%
of Rule 144A offerings to qualified institutional buyers. Private placement
securities are generally less liquid than public securities. Most of the private
placement securities are rated by nationally recognized rating agencies.
For a further discussion of risk factors associated with sectors with
significant unrealized loss positions, see the sector risk factor commentary
under the Total Securities with Unrealized Loss Greater than Six Months by Type
schedule in this section of the MD&A.
16
The following table identifies fixed maturities by credit quality, including
guaranteed separate accounts, as of December 31, 2003 and 2002. The ratings
referenced below are based on the ratings of a nationally recognized rating
organization or, if not rated, assigned based on the Company's internal analysis
of such securities.
FIXED MATURITIES BY CREDIT QUALITY
2003 2002
------------------------------------- --------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- -------------------------------------------------------------------------------------------------------------
United States
Government/Government
agencies $ 3,598 $ 3,661 8.8% $ 3,213 $ 3,341 9.3%
AAA 6,652 6,922 16.5% 5,077 5,399 15.1%
AA 3,326 3,504 8.4% 3,334 3,507 9.8%
A 11,743 12,576 30.1% 11,019 11,687 32.5%
BBB 10,833 11,561 27.6% 8,662 9,081 25.3%
BB & below 1,925 2,040 4.9% 1,928 1,862 5.2%
Short-term 1,554 1,556 3.7% 993 994 2.8%
- ----------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 39,631 $ 41,820 100.0% $ 34,226 $ 35,871 100.0%
==========================================================================================================
Total general account fixed
maturities $ 28,511 $ 30,085 71.9% $ 23,675 $ 24,786 69.1%
Total guaranteed separate
account fixed maturities $ 11,120 $ 11,735 28.1% $ 10,551 $ 11,085 30.9%
==========================================================================================================
As of December 31, 2003 and 2002, over 95% and 94%, respectively, of the fixed
maturity portfolio was invested in short-term securities or securities rated
investment grade (BBB and above).
The following table presents the Below Investment Grade ("BIG") fixed maturities
by type, including guaranteed separate accounts, as of December 31, 2003 and
2002.
BIG FIXED MATURITIES BY TYPE
2003 2002
------------------------------------- -------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------
ABS $ 231 $ 210 10.3% $ 149 $ 132 7.1%
CMBS 102 103 5.0% 102 108 5.8%
Corporate
Basic industry 183 192 9.4% 197 198 10.6%
Capital goods 103 106 5.3% 131 131 7.0%
Consumer cyclical 241 261 12.8% 213 218 11.7%
Consumer non-cyclical 256 268 13.1% 181 173 9.3%
Energy 78 85 4.2% 80 81 4.4%
Financial services 12 12 0.6% 25 18 1.0%
Technology and communications 274 326 16.0% 383 345 18.5%
Transportation 21 23 1.1% 19 18 1.0%
Utilities 268 278 13.6% 287 261 14.0%
Foreign government 145 164 8.0% 145 162 8.7%
Other 11 12 0.6% 16 17 0.9%
- --------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 1,925 $ 2,040 100.0% $ 1,928 $ 1,862 100.0%
- --------------------------------------------------------------------------------------------------------------
Total general account fixed
maturities $ 1,179 $ 1,258 61.7% $ 1,239 $ 1,178 63.3%
Total guaranteed separate
account fixed maturities $ 746 $ 782 38.3% $ 689 $ 684 36.7%
==============================================================================================================
As of December 31, 2003 and 2002 the Company held no issuer of a BIG security
with a fair value in excess of 3% and 4%, respectively, of the total fair value
for BIG securities.
The following table presents the Company's unrealized loss aging for total fixed
maturity and equity securities, including guaranteed separate accounts, as of
December 31, 2003 and 2002, by length of time the security was in an unrealized
loss position.
17
UNREALIZED LOSS AGING OF TOTAL SECURITIES
2003 2002
------------------------------------------ ----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------
Three months or less $ 2,636 $ 2,615 $ (21) $ 1,382 $ 1,316 $ (66)
Greater than three months
to six months 1,795 1,739 (56) 1,211 1,158 (53)
Greater than six months to
nine months 230 216 (14) 519 465 (54)
Greater than nine months to
twelve months 133 126 (7) 1,247 1,181 (66)
Greater than twelve months 1,450 1,331 (119) 1,873 1,693 (180)
- ------------------------------------------------------------------------------------------------------------------
TOTAL $ 6,244 $ 6,027 $ (217) $ 6,232 $ 5,813 $ (419)
==================================================================================================================
Total general accounts $ 4,221 $ 4,076 $ (145) $ 4,113 $ 3,820 $ (293)
- ------------------------------------------------------------------------------------------------------------------
Total guaranteed separate
accounts $ 2,023 $ 1,951 $ (72) $ 2,119 $ 1,993 $ (126)
==================================================================================================================
The decrease in the unrealized loss amount since December 31, 2002 is primarily
the result of improved corporate fixed maturity credit quality and to a lesser
extent recognition of other-than-temporary impairments and asset sales,
partially offset by an increase in interest rates. (For further discussion, see
the economic commentary under the Fixed Maturities by Type table in this section
of the MD&A.)
As of December 31, 2003, fixed maturities represented $213, or 98%, of the
Company's total unrealized loss. There were no fixed maturities as of December
31, 2003 with a fair value less than 80% of the security's amortized cost basis
for six continuous months other than certain asset-backed and commercial
mortgage-backed securities. Other-than-temporary impairments for certain
asset-backed and commercial mortgage-backed securities are recognized if the
fair value of the security, as determined by external pricing sources, is less
than its carrying amount and there has been a decrease in the present value of
the expected cash flows since the last reporting period. There were no
asset-backed or commercial mortgage-backed securities included in the table
above, as of December 31, 2003 and 2002, for which management's best estimate of
future cash flows adversely changed during the reporting period. As of December
31, 2003, no asset-backed or commercial mortgage backed securities had an
unrealized loss in excess of $12. (For a further discussion of the
other-than-temporary impairments criteria, see "Investments" included in the
Critical Accounting Estimates section of the MD&A and in Note 2 of Notes to
Consolidated Financial Statements.)
The Company held no securities of a single issuer that were at an unrealized
loss position in excess of 7% and 4% of the total unrealized loss amount as of
December 31, 2003 and 2002, respectively.
The total securities in an unrealized loss position for longer than six months
by type as of December 31, 2003 and 2002 are presented in the following table.
18
TOTAL SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
2003 2002
------------------------------------------- --------------------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
- --------------------------------------------------------------------------------------------------------------------------
ABS and CMBS
Aircraft lease receivables $ 153 $ 99 $ (54) 38.6% $ 90 $ 77 $ (13) 4.3%
CDOs 132 113 (19) 13.6% 204 172 (32) 10.7%
Credit card receivables 118 108 (10) 7.1% 358 317 (41) 13.7%
Other ABS and CMBS 569 555 (14) 10.0% 689 675 (14) 4.6%
Corporate Financial services 524 502 (22) 15.7% 614 557 (57) 19.0%
Technology and communications 37 36 (1) 0.7% 427 380 (47) 15.7%
Transportation 25 22 (3) 2.1% 60 50 (10) 3.3%
Utilities 80 74 (6) 4.3% 256 233 (23) 7.7%
Other 164 153 (11) 7.9% 585 563 (22) 7.3%
Diversified equity mutual funds 3 3 -- -- 64 48 (16) 5.3%
Other securities 8 8 -- -- 292 267 (25) 8.4%
- -----------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,813 $1,673 $ (140) 100.0% $ 3,639 $3,339 $ (300) 100.0%
- -----------------------------------------------------------------------------------------------------------------------
Total general accounts $ 1,174 $1,080 $ (94) 67.1% $ 2,362 $2,164 $ (198) 66.0%
Total guaranteed
separate accounts $ 639 $ 593 $ (46) 32.9% $ 1,277 $1,175 $ (102) 34.0%
=======================================================================================================================
The ABS securities in an unrealized loss position for six months or more as of
December 31, 2003, were primarily supported by aircraft lease receivables, CDOs
and credit card receivables. The Company's current view of risk factors relative
to these fixed maturity types is as follows:
AIRCRAFT LEASE RECEIVABLES -- The securities supported by aircraft lease
receivables continued to decline in value during 2003 due to a reduction in
lease payments and aircraft values driven by a prolonged decline in airline
travel, which has resulted in the financial difficulties of many airline
carriers. As a result of the uncertainty surrounding the timing of any potential
recovery in this industry, significant risk premiums have been required by the
market for these securities, resulting in reduced liquidity and lower broker
quoted prices. Air travel began to improve in the second half of 2003, which
resulted in lease rates stabilizing on certain aircrafts. While the Company saw
some modest price increases and greater liquidity in this sector during the
fourth quarter of 2003, additional price recovery will depend on continued
improvement in economic fundamentals, political stability and airline operating
performance.
CDOs -- Adverse CDO experience can be attributed to higher than expected
default rates and downgrades of the collateral supporting these securities,
particularly in the technology and utilities sectors, causing a deterioration in
the subordinated tranches of these structures. As a result, significant risk
premiums have been required by the market for these securities, resulting in
reduced liquidity and lower broker quoted prices. Improved economic and
operating fundamentals of the underlying security issuers, along with better
market liquidity, should lead to improved pricing levels.
CREDIT CARD RECEIVABLES -- The unrealized loss position in credit card
securities has primarily been caused by exposure to companies originating loans
to sub-prime borrowers. While the unrealized loss position improved for these
holdings during the year due to the better than expected performance of the
underlying collateral of credit card receivables, concerns remain regarding the
long-term viability of certain issuers within this sub-sector.
As of December 31, 2003, security types other than ABS and CMBS that were in a
significant unrealized loss position for greater than six months were corporate
fixed maturities primarily within the financial services sector.
FINANCIAL SERVICES -- As of December 31, 2003, the securities in the
financial services sector unrealized loss position for greater than six months
were comprised of less than 50 different securities. The securities in this
category are primarily investment grade and substantially all of these
securities are priced at or greater than 90% of amortized cost as of December
31, 2003. These positions are primarily variable rate securities with extended
maturity dates, which have been adversely impacted by the reduction in forward
interest rates resulting in lower expected cash flows. Unrealized loss amounts
for these securities have
19
declined during the year as interest rates have risen. Additional changes in
fair value of these securities are primarily dependent on future changes in
forward interest rates. A substantial percentage of these securities are
currently hedged with interest rate swaps, which convert the variable rate
earned on the securities to a fixed amount. The swaps receive cash flow hedge
accounting treatment and are currently in an unrealized gain position.
As part of the Company's ongoing security monitoring process by a committee of
investment and accounting professionals, the Company has reviewed its investment
portfolio and concluded that there were no additional other-than-temporary
impairments as of December 31, 2003 and 2002. Due to the issuers' continued
satisfaction of the securities' obligations in accordance with their contractual
terms and the expectation that they will continue to do so, management's intent
and ability to hold these securities, as well as the evaluation of the
fundamentals of the issuers' financial condition and other objective evidence,
the Company believes that the prices of the securities in the sectors identified
above were temporarily depressed.
The evaluation for other-than-temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are
other-than-temporary. The risks and uncertainties include changes in general
economic conditions, the issuer's financial condition or near term recovery
prospects and the effects of changes in interest rates. In addition, for
securitized financial assets with contractual cash flows (e.g. ABS and CMBS),
projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral. As of December 31, 2003,
management's expectation of the discounted future cash flows on these securities
was in excess of the associated securities' amortized costs. (For a further
discussion, see "Investments" included in the Critical Accounting Estimates
section of MD&A and in Note 2 of Notes to Consolidated Financial Statements.)
The following table presents the Company's unrealized loss aging for BIG and
equity securities, including guaranteed separate accounts, as of December 31,
2003 and 2002.
UNREALIZED LOSS AGING OF BIG AND EQUITY SECURITIES
2003 2002
------------------------------------- -------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------
Three months or less $ 47 $ 46 $ (1) $ 131 $ 104 $ (27)
Greater than three months
to six months 90 86 (4) 188 165 (23)
Greater than six months to
nine months 50 44 (6) 160 134 (26)
Greater than nine months to
twelve months 17 16 (1) 299 264 (35)
Greater than twelve months 266 217 (49) 354 299 (55)
- ------------------------------------------------------------------------------------------------------------------
TOTAL $ 470 $ 409 $ (61) $ 1,132 $ 966 $ (166)
==================================================================================================================
Total general accounts $ 350 $ 305 $ (45) $ 800 $ 669 $ (131)
Total guaranteed separate
accounts $ 120 $ 104 $ (16) $ 332 $ 297 $ (35)
==================================================================================================================
Similar to the decrease in the Unrealized Loss Aging of Total Securities table
from December 31, 2002 to December 31, 2003, the decrease in the BIG and equity
security unrealized loss amount was primarily the result of improved corporate
fixed maturity credit quality and to a lesser extent recognition of other-than
temporary impairments and assets sales, partially offset by an increase in
interest rates. (For a further discussion, see the economic commentary under the
Fixed Maturities by Type table in this section of the MD&A.)
The BIG and equity securities in an unrealized loss position for longer than six
months by type as of December 31, 2003 and 2002 are presented in the following
table.
20
BIG AND EQUITY SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
2003 2002
------------------------------------------ -----------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
- -----------------------------------------------------------------------------------------------------------------------------
ABS and CMBS
Aircraft lease receivables $ 45 $ 28 $ (17) 30.3% $ -- $ -- $ -- --
CDOs 37 28 (9) 16.1% 2 1 (1) 0.9%
Credit card receivables 40 30 (10) 17.9% 26 17 (9) 7.8%
Other ABS and CMBS 45 38 (7) 12.5% 37 32 (5) 4.3%
Corporate
Financial services 39 35 (4) 7.1% 9 8 (1) 0.9%
Technology and communications 4 3 (1) 1.8% 211 177 (34) 29.3%
Transportation 9 8 (1) 1.8% 13 10 (3) 2.6%
Utilities 66 61 (5) 8.9% 123 107 (16) 13.8%
Other 44 42 (2) 3.6% 226 210 (16) 13.8%
Diversified equity mutual funds 3 3 -- -- 64 48 (16) 13.8%
Other securities 1 1 -- -- 102 87 (15) 12.8%
- --------------------------------------------------------------------------------------------------------------------------
TOTAL $ 333 $ 277 $ (56) 100.0% $ 813 $ 697 $ (116) 100.0%
- --------------------------------------------------------------------------------------------------------------------------
Total general accounts $ 234 $ 193 $ (41) 73.2% $ 552 $ 464 $ (88) 75.9%
Total guaranteed
separate accounts $ 99 $ 84 $ (15) 26.8% $ 261 $ 233 $ (28) 24.1%
==========================================================================================================================
For a further discussion of the Company's current view of risk factors relative
to certain security types listed above, see the Total Securities with Unrealized
Loss Greater Than Six Months by Type table in this section of the MD&A.
CAPITAL MARKETS RISK MANAGEMENT
Hartford Life Insurance Company has a disciplined approach to managing risks
associated with its capital markets and asset/liability management activities.
Investment portfolio management is organized to focus investment management
expertise on specific classes of investments, while asset/liability management
is the responsibility of dedicated risk management units supporting the Company,
including 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. Derivatives play an
important role in facilitating the management of interest rate risk, mitigating
equity market risk exposure associated with certain variable annuity products
and changes in currency exchange rates.
MARKET RISK
The Company is exposed to market risk, primarily relating to the market price
and/or cash flow variability associated with changes in interest rates, market
indices or foreign currency exchange rates.
Interest Rate Risk
The Company's exposure to interest rate risk relates to the market price and/or
cash flow variability associated with the changes in market interest rates. The
Company manages its exposure to interest rate risk through asset allocation
limits, asset/liability duration matching and through the use of derivatives.
The Company analyzes interest rate risk using various models including
multi-scenario cash flow projection models that forecast cash flows of the
liabilities and their supporting investments, including derivative instruments.
Measures the Company uses to quantify its exposure to interest rate risk
inherent in its invested assets and interest rate sensitive liabilities are
duration and key rate duration. Duration is the weighted average
term-to-maturity of a security's cash flows, and is used to approximate the
percentage change in the price of a security for a 100-basis-point change in
market interest rates. For example, a duration of 5 means the price of the
security will change by approximately 5% for a 1% change in interest rates. The
key rate duration analysis considers the expected future cash flows of assets
and liabilities assuming non-parallel interest rate movements.
To calculate duration, projections of asset and liability cash flows are
discounted to a present value using interest rate assumptions. These cash flows
are then revalued at alternative interest rate levels to determine the
percentage change in fair value due to an incremental change in rates. Cash
flows from corporate
21
obligations are assumed to be consistent with the contractual payment streams on
a yield to worst basis. The primary assumptions used in calculating cash flow
projections include expected asset payment streams taking into account
prepayment speeds, issuer call options and contract holder behavior.
Asset-backed securities, collateralized mortgage obligations and mortgage-backed
securities are modeled based on estimates of the rate of future prepayments of
principal over the remaining life of the securities. These estimates are
developed using prepayment speeds provided in broker consensus data. Such
estimates are derived from prepayment speeds previously experienced at the
interest rate levels projected for the underlying collateral. Actual prepayment
experience may vary from these estimates.
Equity Risk
The Company's primary exposure to equity risk relates to the potential for lower
earnings associated with certain of the Company's businesses such as variable
annuities where fee income is earned based upon the fair value of the assets
under management. In addition, the Company offers certain guaranteed benefits,
primarily associated with variable annuity products, which increases the
Company's potential benefit exposure as the equity markets decline. (For a
further discussion, see the "Equity Risk" in the Key Market Risk Exposures
section.)
The Company does not have significant equity risk exposure from invested assets.
In March 2003, the Company decided to liquidate its hedge fund limited
partnership investments and certain equity securities and reinvest the proceeds
into fixed maturity investments, thereby reducing its exposure to equity price
risk. The Company has not materially changed other aspects of its overall asset
allocation position or market risk since December 31, 2002.
Foreign Currency Exchange Risk
The Company's currency exchange risk is related to non - US dollar denominated
investments, which primarily consist of fixed maturity investments. A
significant portion of the Company's foreign currency exposure is mitigated
through the use of derivatives.
Derivative Instruments
Hartford Life Insurance Company utilizes a variety of derivative instruments,
including swaps, caps, floors, forwards, futures and options, in compliance with
Company policy and regulatory requirements to mitigate interest rate, equity
market or currency exchange rate risk or volatility.
Interest rate swaps involve the periodic exchange of payments with other
parties, at specified intervals, calculated using the agreed upon rates and
notional principal amounts. Generally, no cash or principal payments are
exchanged at the inception of the contract. Typically, at the time a swap is
entered into, the cash flow streams exchanged by the counterparties are equal in
value.
Interest rate cap and floor contracts entitle the purchaser to receive from the
issuer at specified dates, the amount, if any, by which a specified market rate
exceeds the cap strike rate or falls below the floor strike rate, applied to a
notional principal amount. A premium payment is made by the purchaser of the
contract at its inception, and no principal payments are exchanged.
Forward contracts are customized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument.
Financial futures are standardized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument. Futures
contracts trade on organized exchanges. Margin requirements for futures are met
by pledging securities, and changes in the futures' contract values are settled
daily in cash.
22
Option contracts grant the purchaser, for a premium payment, the right to either
purchase from or sell to the issuer a financial instrument at a specified price,
within a specified period or on a stated date.
Foreign currency swaps exchange an initial principal amount in two currencies,
agreeing to re-exchange the currencies at a future date, at an agreed upon
exchange rate. There is also periodic exchange of payments at specified
intervals calculated using the agreed upon rates and exchanged principal
amounts.
Derivative activities are monitored by an internal compliance unit, reviewed
frequently by senior management and reported to the Finance Committee of the
Board of Directors. The notional amounts of derivative contracts represent the
basis upon which pay or receive amounts are calculated and are not reflective of
credit risk. Notional amounts pertaining to derivative instruments used in the
management of market risk for both the general and guaranteed separate accounts
at December 31, 2003 and 2002 were $38.6 billion and $15.1 billion,
respectively.
KEY MARKET RISK EXPOSURES
The following discussions focus on the key market risk exposures within the
Company's portfolios.
The Company is responsible for maximizing after-tax returns within acceptable
risk parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity to support
policyholder and corporate obligations. The Company's fixed maturity portfolios
and certain investment contract and insurance product liabilities have material
market exposure to interest rate risk. In addition, 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.
Interest Rate Risk
The Company's exposure to interest rate risk relates to the market price and/or
cash flow variability associated with changes in market interest rates. Changes
in interest rates can potentially impact the Company's profitability. In certain
scenarios where interest rates are volatile, the Company could be exposed to
disintermediation risk and a reduction in net interest rate spread or profit
margins. The investments and liabilities primarily associated with interest rate
risk are included in the following discussion. Certain product liabilities
expose the Company to interest rate risk but also have significant equity risk.
These liabilities are discussed as part of the Equity Risk section below.
Fixed Maturity Investments
The Company's general account and guaranteed separate account investment
portfolios primarily consist of investment grade fixed maturity securities,
including corporate bonds, asset-backed securities, commercial mortgage-backed
securities and collateralized mortgage obligations. The fair value of these
investments was $41.8 billion and $35.9 billion, at December 31, 2003 and 2002,
respectively. The fair value of these and other invested assets fluctuates
depending on the interest rate environment and other general economic
conditions. During periods of declining interest rates, paydowns on
mortgage-backed securities and collateralized mortgage obligations increase as
the underlying mortgages are prepaid. During such periods, the Company generally
will not be able to reinvest the proceeds of any such prepayments at comparable
yields. Conversely, during periods of rising interest rates, the rate of
prepayments generally declines, exposing the Company to the possibility of
asset/liability cash flow and yield mismatch. The weighted average duration of
the fixed maturity portfolio was approximately 4.6 and 4.2 as of December 31,
2003 and 2002, respectively.
Liabilities
The Company's investment contracts and certain insurance product liabilities,
other than non-guaranteed separate accounts, include asset accumulation vehicles
such as fixed annuities, guaranteed investment
23
contracts, other investment and universal life-type contracts and other
insurance products such as long-term disability.
Asset accumulation vehicles primarily require a fixed rate payment, often for a
specified period of time. Product examples include fixed rate annuities with a
market value adjustment feature and fixed rate guarantee investment contracts.
The duration of these contracts generally range from less than one year to ten
years. In addition, certain products such as universal life contracts and the
general account portion of the Company's variable annuity products, credit
interest to policyholders subject to market conditions and minimum interest rate
guarantees. The duration of these products is short-to-intermediate term.
While interest rate risk associated with many of these products has been reduced
through the use of market value adjustment features and surrender charges, the
primary risk associated with these products is that the spread between
investment return and credited rate may not be sufficient to earn targeted
returns.
The Company also manages the risk of other insurance liabilities similarly to
investment type products due to the relative predictability of the aggregate
cash flow payment streams. Products in this category may contain significant
actuarial (including mortality and morbidity) pricing and cash flow risks.
Product examples include structured settlement contracts, on-benefit annuities
(i.e., the annuitant is currently receiving benefits thereon) and short and
long-term disability contracts. The cash out flows associated with these policy
liabilities are not interest rate sensitive but do vary based on the timing and
amount of benefit payments. The primary risks associated with these products are
that the benefits will exceed expected actuarial pricing and/or that the actual
timing of the cash flows differ from those anticipated, resulting in an
investment return lower than that assumed in pricing. Contract duration can
range from less than one year to typically up to ten years.
PRODUCT LIABILITY CHARACTERISTICS
Hartford Life Insurance Company's product liabilities, other than non-guaranteed
separate accounts, include accumulation vehicles such as fixed and variable
annuities other investment and universal life-type contracts, and other
insurance products such as long-term disability and term life insurance. The
table below shows carrying values of insurance policy liabilities as of December
31, 2003 and 2002.
2003 2002
DESCRIPTION (1) TOTAL TOTAL
- ------------------------------------------------------------
Fixed rate asset accumulation vehicles $ 14.6 $ 13.6
Weighted average credited rate 6.0% 5.8%
Indexed asset accumulation vehicles $ 1.6 $ 0.7
Weighted average credited rate 1.8% 3.0%
Interest credited asset accumulation
vehicles $ 16.7 $ 17.4
Weighted average credited rate 3.7% 4.2%
Long-term pay out liabilities $ 6.8 $ 5.6
Short-term pay out liabilities $ 0.2 $ --
============================================================
The Company employs several risk management tools to quantify and manage risk
arising from investment contracts and other insurance liabilities, such as
duration and key rate duration and the use of derivative instruments. For
certain portfolios, management monitors the changes in present value between
assets and liabilities resulting from various interest rate scenarios using
integrated asset/liability measurement systems and a proprietary system that
simulates the impacts of parallel and non-parallel yield curve shifts. Based on
this current and prospective information, management implements risk reducing
techniques to improve the match between assets and liabilities, including the
use of derivative instruments. Derivatives used to mitigate interest rate risk
are discussed in more detail below.
Derivatives
The Company utilizes a variety of derivative instruments to mitigate interest
rate risk. Interest rate swaps are primarily used to convert interest receipts
to a fixed or variable rate. In addition, interest rate swaps are
24
used to convert the contract rate on certain liability products offered by the
Company into a rate that trades in a more liquid and efficient market. The use
of such swaps enables the Company to customize contract terms and conditions to
customer objectives and satisfies the operation's asset/liability duration
matching policy. Occasionally, swaps are also used to hedge the variability in
the cash flow of a forecasted purchase or sale due to changes in interest rates.
Interest rate caps and floors, swaptions and option contracts are primarily used
to hedge against the risk of liability contract holder disintermediation in a
rising interest rate environment, and to offset the changes in fair value of
corresponding derivatives embedded in certain of the Company's fixed maturity
investments.
At December 31, 2003 and 2002, notional amounts pertaining to derivatives
utilized to manage interest rate risk totaled $7.5 billion and $8.3 billion,
respectively ($5.9 billion and $6.8 billion, respectively related to insurance
investments and $1.6 billion and $1.5, respectively related to life insurance
liabilities). The fair value of these derivatives as reflected on the
Consolidated Balance Sheet was $168 and $358 as of December 31, 2003 and 2002,
respectively.
Calculated Interest Rate Sensitivity
The after-tax change in the net economic value of investment contracts (e.g.
guaranteed investment contracts) and other insurance product liabilities (e.g.
short and long-term disability contracts), that are not substantially affected
by changes in interest rates ("fixed liabilities") and for which the investment
experience is substantially absorbed by Life, are included in the following
table along with the corresponding general and guaranteed separate account
assets. Also included in this analysis are the interest rate sensitive
derivatives used by Life to hedge its exposure to interest rate risk. Certain
financial instruments, such as limited partnerships, have been omitted from the
analysis because the investments are accounted for under the equity method and
lack sensitivity to interest rate changes. Interest rate sensitive investment
contracts and universal life-type contracts are excluded from the hypothetical
calculation below because the contracts generally allow Life significant
flexibility to adjust credited rates to reflect actual investment experience and
thereby pass through a substantial portion of actual investment experience to
the policyholder. Non-guaranteed separate account assets and liabilities are
excluded from the hypothetical calculation below because gains and losses in
separate accounts generally accrue to policyholders. The estimated change in net
economic value assumes a 100 basis point upward and downward parallel shift in
the yield curve.
CHANGE IN NET ECONOMIC VALUE
AS OF DECEMBER 31,
2003 2002
------------------ ------------------
Basis point shift - 100 + 100 - 100 + 100
- -------------------------------------------------------------
Amount $ (40) $ 2 $ 8 $ (22)
=============================================================
These fixed liabilities included above represented approximately 50% and 46% of
Life's general and guaranteed separate account liabilities as of December 31,
2003 and 2002, respectively. The assets supporting the fixed liabilities are
monitored and managed within rigorous duration guidelines using scenario
simulation techniques, and are evaluated on an annual basis, in compliance with
regulatory requirements.
The after-tax change in fair value of the general account invested asset
portfolios that support interest rate sensitive investment contracts and
universal life-type contracts and other insurance contracts that possess
significant mortality risk are shown in the following table. The cash flows
associated with these liabilities are less predictable than fixed liabilities.
The Company identifies the most appropriate investment strategy based upon the
expected policyholder behavior and liability crediting needs. The hypothetical
calculation of the estimated change in fair value below, assumes a 100 basis
point upward and downward parallel shift in the yield curve.
25
CHANGE IN FAIR VALUE
AS OF DECEMBER 31,
2003 2002
------------------- -----------------
Basis point shift - 100 + 100 - 100 + 100
- -------------------------------------------------------------
Amount $ 462 $ (455) $ 403 $ (386)
=============================================================
The above quantitative presentation was adopted in the current year and is in
lieu of the tabular presentation historically disclosed. The Company believes
the current presentation is preferable in understanding the Company's invested
asset interest rate risk exposure.
The selection of the 100 basis point parallel shift in the yield curve was made
only as a hypothetical illustration of the potential impact of such an event and
should not be construed as a prediction of future market events. Actual results
could differ materially from those illustrated above due to the nature of the
estimates and assumptions used in the above analysis. The Company's sensitivity
analysis calculation assumes that the composition of invested assets and
liabilities remain materially consistent throughout the year and that the
current relationship between short-term and long-term interest rates will remain
constant over time. As a result, these calculations may not fully capture the
impact of portfolio re-allocations, significant product sales or non-parallel
changes in interest rates.
Equity Risk
The Company's operations are significantly influenced by changes in the equity
markets. The Company's profitability depends largely on the amount of assets
under management, which is primarily driven by the level of sales, equity market
appreciation and depreciation and the persistency of the in-force block of
business. Prolonged and precipitous decline in the equity markets can have a
significant impact on the Company's operations, as sales of variable products
may decline and surrender activity may increase, as customer sentiment towards
the equity market turns negative. 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 Retail Products Group and Institutional Solutions Group
and to a lesser extent Individual Life segments, where a heavy concentration of
equity linked products are administered and sold. Furthermore, the Company may
experience a reduction in profit margins if a significant portion of the assets
held in the variable annuity separate accounts move to the general account and
the Company is unable to earn an acceptable investment spread, 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 Retail Products Group segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, the Company pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary. The
Company currently reinsures a significant portion of these death benefit
guarantees associated with its in-force block of business. The Company currently
records 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 December 31, 2003 is $11.4 billion. Due to the fact that
81% of this amount is reinsured, the Company's net exposure is $2.2 billion.
This amount is often referred to as the net amount at risk. However, the Company
will only incur these guaranteed death benefit payments in the future if the
policyholder has an
26
in-the-money guaranteed death benefit at their time of death. In order to
analyze the total costs that the Company may incur in the future related to
these guaranteed death benefits, the Company performed an actuarial present
value analysis. This analysis included developing a model utilizing
stochastically generated scenarios and best estimate assumptions related to
mortality and lapse rates. A range of projected costs was developed and
discounted back to the financial statement date utilizing the Company's cost of
capital, which for this purpose was assumed to be 9.25%. Based on this analysis,
the Company estimated a 95% confidence interval of the present value of the
retained death benefit costs to be incurred in the future to be a range of $88
to $282 for these contracts. The median of the stochastically generated
investment performance scenarios was $132.
On June 30, 2003, the Company recaptured a block of business previously
reinsured with an unaffiliated reinsurer. Under this treaty, the Company
reinsured a portion of the GMDB feature associated with certain of its annuity
contracts. As consideration for recapturing the business and final settlement
under the treaty, the Company has received assets valued at approximately $32
and one million warrants exercisable for the unaffiliated company's stock.
Prospectively, as a result of the recapture, the Company will be responsible for
all of the remaining and ongoing risks associated with the GMDB's related to
this block of business. The recapture increased the net amount at risk retained
by the Company, which is included in the net amount at risk discussed above.
On January 1, 2004, the Company adopted the provisions of Statement of Position
03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts", (the "SOP").
The provisions of the SOP include a requirement for recording a liability for
variable annuity products with a guaranteed minimum death benefit feature. The
determination of this liability is also based on models that involve numerous
estimates and subjective judgments, including those regarding expected market
rates of return and volatility, contract surrender rates and mortality
experience. As of January 1, 2004, the Company has recorded a liability for GMDB
sold with variable annuity products of $191 and a related reinsurance
recoverable asset of $108. Net of estimated DAC and income tax effects, the
cumulative effect of establishing the required GMDB reserves resulted in a
reduction of net income of $50 during the first quarter of 2004.
In addition, the Company offers certain variable annuity products with a GMWB
rider. The GMWB provides the policyholder with a guaranteed remaining balance
("GRB") if the account value is reduced to zero through a combination of market
declines and withdrawals. The GRB is generally equal to premiums less
withdrawals. However, annual withdrawals that exceed 7% of the premiums paid may
reduce the GRB by an amount greater than the withdrawals and may also impact
that guaranteed annual withdrawal amount that subsequently applies after the
excess annual withdrawals occur. The policyholder also has the option, after a
specified time period, to reset the GRB to the then-current account value, if
greater. The GMWB represents an embedded derivative liability in the variable
annuity contract that is required to be reported separately from the host
variable annuity contract. It is carried at fair value and reported in other
policyholder funds. The fair value of the GMWB obligations are calculated based
on actuarial assumptions related to the projected cash flows, including benefits
and related contract charges, over the lives of the contracts, incorporating
expectations concerning policyholder behavior. Because of the dynamic and
complex nature of these cash flows, stochastic techniques under a variety of
market return scenarios and other best estimate assumptions are used. Estimating
cash flows involves numerous estimates and subjective judgments including those
regarding expected market rates of return, market volatility, correlations of
market returns and discount rates.
Declines in the equity market may increase the Company's exposure to benefits
under these contracts. For all contracts in effect through July 6, 2003, the
Company entered into a third party reinsurance arrangement to offset its
exposure to the GMWB for the remaining lives of those contracts. As of July 6,
2003, the Company exhausted all but a small portion of the reinsurance capacity
for new business under this current arrangement and will be ceding only a very
small number of new contracts subsequent to July 6, 2003. Substantially all new
contracts with the GMWB are covered by a reinsurance arrangement with a related
party. See Note 13 "Transactions with Affiliates" for information on this
arrangement.
27
Currency Exchange Risk
Currency exchange risk exists with respect to investments in non-US dollar
denominated fixed maturities, primarily denominated in Euro, Sterling, Yen and
Canadian dollars.
The risk associated with these investments relates to potential decreases in
value and income resulting from unfavorable changes in foreign exchange rates.
At December 31, 2003 and 2002, the Company had approximately $1.9 billion and
$1.2 billion of non-US dollar denominated fixed maturities, respectively.
In order to manage its currency exposures, the Company enters into foreign
currency swaps and options to hedge the variability in cash flow associated with
certain foreign denominated fixed maturities. These foreign currency swap
agreements are structured to match the foreign currency cash flows of the hedged
foreign denominated securities. As of December 31, 2002, substantially all the
fixed maturity investments were hedged into US dollars mitigating the foreign
currency exchange risk. At December 31, 2003 and 2002, the derivatives used to
hedge currency exchange risk had a total notional value of $1.2 billion and $1.3
billion, respectively, and total fair value of $(297) and $(71), respectively.
Based on the fair values of the Company's non-US dollar denominated investments
and derivative instruments as of December 31, 2003 and 2002, management
estimates that a 10% unfavorable change in exchange rates would decrease the
fair values by a total of $32 and $3, respectively. The estimated impact was
based upon a 10% change in December 31 spot rates. The selection of the 10%
unfavorable change was made only for hypothetical illustration of the potential
impact of such an event and should not be construed as a prediction of future
market events. Actual results could differ materially from those illustrated
above due to the nature of the estimates and assumptions used in the above
analysis.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall strength of Hartford Life
Insurance Company and its ability to generate strong cash flows from each of the
business segments, borrow funds at competitive rates and raise new capital to
meet operating and growth needs. The Company maintained cash and short-term
investments totaling $1.3 billion and $1.0 billion as of December 31, 2003 and
2002.
CASH FLOW
2003 2002 2001
- -------------------------------------------------------------------------
Cash provided by operating activities $ 1,221 $ 611 $ 1,067
Cash used for investing activities (3,634) (4,423) (3,654)
Cash provided by financing activities 2,430 3,802 2,620
CASH - END OF YEAR 96 79 87
2003 COMPARED TO 2002 -- The increase in cash provided by operating
activities was primarily the result of the timing of the settlement of
receivables, payables and other related liabilities. The decrease in cash
provided by financing activities primarily relates to the decrease in net
general account receipts from investment and universal life-type contracts
charged against policyholder accounts. Operating cash flows in the periods
presented have been more than adequate to meet liquidity requirements.
2002 COMPARED TO 2001 -- The decrease in cash provided by operating
activities was primarily the result of the timing of the settlement of
receivables, payables and other related liabilities. The increase in cash
provided by financing activities primarily relates to the increase in receipts
from investment and universal life-type contracts charged against policyholder
accounts. Operating cash flows in the periods presented have been more than
adequate to meet liquidity requirements.
DIVIDENDS
The Company declared $175 in dividends to HLA for 2003. Future dividend
decisions will be based on, and affected by, a number of factors, including the
operating results and financial requirements of the
28
Company on a stand-alone basis and the impact of regulatory restrictions
discussed in Liquidity Requirements below.
RATINGS
Ratings are an important factor in establishing the competitive position in the
insurance and financial services marketplace. There can be no assurance that the
Company's ratings will continue for any given period of time or that they will
not be changed. In the event the Company's ratings are downgraded, the level of
revenues or the persistency of the Company's business may be adversely impacted.
The following table summarizes Hartford Life Insurance Company's significant
United States member companies' financial ratings from the major independent
rating organizations as of February 20, 2004:
STANDARD &
A.M. BEST FITCH MOODY'S POOR'S
- ---------------------------------------------------------------------------------
INSURANCE RATINGS
Hartford Life Insurance Company A+ AA Aa3 AA-
Hartford Life and Annuity A+ AA Aa3 AA-
- ---------------------------------------------------------------------------------
OTHER RATINGS
Hartford Life Insurance Company:
Short Term Rating NR NR P-1 A-1+
Upon completion of the Hartford's asbestos reserve study and the Hartford's
capital-raising activities, certain of the major independent ratings
organizations revised The Hartford's financial ratings as follows:
On May 23, 2003, Fitch affirmed all ratings on The Hartford Financial Services
Group, Inc. including the fixed income ratings and the insurer financial
strength rating of the Hartford Fire Intercompany Pool. Further, these ratings
have been removed from Rating Watch Negative and now have a Stable Rating
Outlook.
On May 20, 2003, Standard & Poor's removed from CreditWatch and affirmed the
long-term counterparty credit and senior debt rating of The Hartford Financial
Services Group, Inc. and the counterparty credit and financial strength ratings
on the operating companies following the Company's completion of capital-raising
activities. The outlook is stable.
On May 14, 2003, Moody's downgraded the debt ratings of both The Hartford
Financial Services Group, Inc. and Hartford Life, Inc. to A3 from A2 and their
short-term commercial paper ratings to P-2 from P-1. The outlook on all of the
ratings except for the P-2 rating on commercial paper is negative.
On May 13, 2003, A.M. Best affirmed the financial strength ratings of A+
(Superior) of The Hartford Fire Intercompany Pool and the main operating life
insurance subsidiaries of Hartford Life, Inc. 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.
EQUITY MARKETS
For a discussion of equity markets impact to capital and liquidity, see the
Capital Markets Risk Management section under "Market Risk".
RISK-BASED CAPITAL
The National Association of Insurance Commissioners ("NAIC") has regulations
establishing minimum capitalization requirements based on risk-based capital
("RBC") formulas for both life and property and casualty companies. The
requirements consist of formulas, which identify companies that are
undercapitalized and require specific regulatory actions. The RBC formula for
life companies establishes capital requirements relating to insurance, business,
asset and interest rate risks. As of December 31, 2003, Hartford Life Insurance
Company had more than sufficient capital to meet the NAIC's minimum RBC
requirements.
29
REGULATORY INITIATIVES AND CONTINGENCIES
Legal Proceedings - The Company 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.
DEPENDENCE ON CERTAIN THIRD PARTY RELATIONSHIPS
Hartford Life Insurance Company distributes its annuity and life insurance
products through a variety of distribution channels, including broker-dealers,
banks, wholesalers, its own internal sales force and other third party
organizations. The Company periodically negotiates provisions and renewals of
these relationships and there can be no assurance that such terms will remain
acceptable to the Company or such third parties. An interruption in the
Company's continuing relationship with certain of these third parties could
materially affect the Company's ability to market its products.
TERRORISM RISK INSURANCE ACT OF 2002
The Terrorism Risk Insurance Act of 2002 ("the Act") created a program under
which the federal government will pay 90% of covered losses after an insurer's
losses exceed a deductible determined by a statutorily prescribed formula, up to
a combined annual aggregate limit for the federal government and all insurers of
$100 billion. If an act of terrorism or acts of terrorism result in covered
losses exceeding the $100 billion annual limit, insurers with losses exceeding
their deductibles will not be responsible for additional losses.
The statutory formula for determining a company's deductible for each year is
based on the company's direct commercial earned premium for the prior calendar
year multiplied by a specified percentage. The specified percentages are 10% for
2004 and 15% for 2005.
On August 15, 2003, the Treasury Department announced that it would not use its
legislatively-granted authority to include group life insurance under the
Federal backstop for terrorism losses in the Terrorism Risk Insurance Act of
2002. In announcing this decision, the Treasury stated that they would continue
to monitor the group life situation.
LEGISLATIVE INITIATIVES
Certain elements of the Jobs and Growth Tax Relief Reconciliation Act of 2003,
in particular the reduction in tax rates on long-term capital gains and most
dividend distributions, could have a material effect on the Company's sales of
variable annuities and other investment products. While sales of these products
do not appear to have been reduced to date, the long-term effect of the Jobs and
Growth Act of 2003 on the Company's financial condition or results of operations
cannot be reasonably estimated at this time.
There are proposals in the federal 2005 budget submitted by President Bush which
would create new investment vehicles with larger annual contribution limits for
individuals. Some of these proposed vehicles would have significant tax
advantages, and could have a material effect on the sales of the Company's life
insurance and investment products. There also have been proposals regarding the
estate tax and deferred compensation arrangements that could have negative
effects on the Company's product sales. Prospects for enactment of this
legislation in 2004 are uncertain. Therefore, any potential effect on the
Company's financial condition or results of operations cannot be reasonably
estimated at this time.
30
In addition, other tax proposals and regulatory initiatives which have been or
are being considered by Congress could have a material effect on the insurance
business. These proposals and initiatives include changes pertaining to the tax
treatment of insurance companies and life insurance products and annuities, and
reductions in benefits currently received by the Company stemming from the
dividends received deduction. Legislation to restructure the Social Security
system and expand private pension plans incentives also may be considered.
Prospects for enactment and the ultimate effect of these proposals are
uncertain.
Congress is likely to consider a number of legal reform proposals this year.
Among them is legislation that would reduce the number and type of national
class actions certified by state judges by updating the federal rules on
diversity jurisdiction. Prospects for enactment of these proposals in 2004 are
uncertain.
GUARANTY FUND
Under insurance guaranty fund laws in each state, the District of Columbia and
Puerto Rico, insurers licensed to do business can be assessed by state insurance
guaranty associations for certain obligations of insolvent insurance companies
to policyholders and claimants. Part of the assessments paid by the Company's
insurance subsidiaries pursuant to these laws may be used as credits for a
portion of the Company's insurance subsidiaries' premium taxes. There were $0
and $2 in guaranty fund assessment refunds in 2003 and 2002, respectively. There
was no guaranty fund assessment payments (net of refunds) in 2001.
NAIC CODIFICATION
The NAIC adopted the Codification of Statutory Accounting Principles
("Codification") in March 1998. The effective date for the statutory accounting
guidance was January 1, 2001. Each of Hartford Life's domiciliary states has
adopted Codification, and the Company has made the necessary changes in its
statutory accounting and reporting required for implementation. The overall
impact of applying the new guidance resulted in a benefit of $38 in statutory
surplus.
EFFECT OF INFLATION
The rate of inflation as measured by the change in the average consumer price
index has not had a material effect on the revenues or operating results of
Hartford Life Insurance Company during the three most recent fiscal years.
IMPACT OF NEW ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 2 of Notes to Consolidated
Financial Statements.
In July 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 03-1,
"Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts" (the "SOP"). The SOP
addresses a wide variety of topics, some of which have a significant impact on
the Company. The major provisions of the SOP require:
- - Recognizing expenses for a variety of contracts and contract features,
including guaranteed minimum death benefits ("GMDB"), certain death
benefits on universal-life type contracts and annuitization options, on an
accrual basis versus the previous method of recognition upon payment;
- - Reporting and measuring assets and liabilities of certain separate account
products as general account assets and liabilities when specified criteria
are not met;
- - Reporting and measuring the Company's interest in its separate accounts as
general account assets based on the insurer's proportionate beneficial
interest in the separate account's underlying assets; and
31
- - Capitalizing sales inducements that meet specified criteria and amortizing
such amounts over the life of the contracts using the same methodology as
used for amortizing deferred acquisition costs ("DAC").
The SOP is effective for financial statements for fiscal years beginning after
December 15, 2003. At the date of initial application, January 1, 2004, the
estimated cumulative effect of the adoption of the SOP on net income and other
comprehensive income was comprised of the following individual impacts:
OTHER COMPREHENSIVE
CUMULATIVE EFFECT OF ADOPTION NET INCOME INCOME
- ----------------------------------------------------------------------
Establishing GMDB reserves for
annuity contracts $ (50) $ --
Reclassifying certain separate
accounts to general accounts 30 294
Other (1) (2)
- ----------------------------------------------------------------------
Total cumulative effect of adoption $ (21) $ 292
======================================================================
Exclusive of the cumulative effect, overall application of the SOP is expected
to have a small positive impact to earnings over the next few years, with
individual impacts described below.
Death Benefits and Other Insurance Benefit Features
The Company sells variable annuity contracts that offer various guaranteed death
benefits. For certain guaranteed death benefits, Hartford Life pays the greater
of (1) the account value at death; (2) the sum of all premium payments less
prior withdrawals; or (3) the maximum anniversary value of the contract, plus
any premium payments since the contract anniversary, minus any withdrawals
following the contract anniversary. The Company currently reinsures a
significant portion of these death benefit guarantees associated with its
in-force block of business. As of January 1, 2004, the Company has recorded a
liability for GMDB and other benefits sold with variable annuity products of
$191 and a related reinsurance recoverable asset of $108. The determination of
the GMDB liability and related reinsurance recoverable is based on models that
involve a range of scenarios and assumptions, including those regarding expected
market rates of return and volatility, contract surrender rates and mortality
experience. The assumptions used are consistent with those used in determining
estimated gross profits for purposes of amortizing deferred acquisition costs.
Exclusive of the cumulative effect adjustment, the establishment of the required
liability at January 1, 2004 is expected to result in slightly higher earnings
in future years as well as a more stable pattern of death benefit expense.
The Company sells universal life-type contracts with certain secondary
guarantees, such as a guarantee that the policy will not lapse, even if the
account value is reduced to zero, as long as the policyholder makes scheduled
premium payments. The assumptions used in the determination of the secondary
guarantee liability are consistent with those used in determining estimated
gross profits for purposes of amortizing deferred policy acquisition costs.
Based on current estimates, the Company expects the cumulative effect on net
income upon recording this liability to be not material. The establishment of
the required liability will change the earnings pattern of these products,
lowering earnings in the early years of the contract and increasing earnings in
the later years. Based on the current in-force of these products, the impact is
not expected to be material in the near term. Currently there is diversity in
industry practice and inconsistent guidance surrounding the application of the
SOP to universal life-type contracts. The Company believes consensus or further
guidance surrounding the methodology for determining reserves for secondary
guarantees will develop in the future. This may result in an adjustment to the
cumulative effect of adopting the SOP and could impact future earnings.
Separate Account Presentation
The Company has recorded certain MVA fixed annuity and modified guarantee life
insurance products (primarily the Company's Compound Rate Contract ("CRC") and
associated assets) as separate account
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assets and liabilities through December 31, 2003. Notwithstanding the market
value adjustment feature in this product, all of the investment performance of
the separate account assets is not being passed to the contractholder, and it
therefore, does not meet the conditions for separate account reporting under the
SOP. On January 1, 2004, the cumulative adjustments to earnings and other
comprehensive income as a result of recording the separate account assets and
liabilities in the general account were recorded net of amortization of deferred
acquisition costs and income taxes. Through December 31, 2003, the Company had
recorded CRC assets and liabilities on a market value basis with all changes in
value (market value spread) included in current earnings as a component of other
revenues. Upon adoption of the SOP, the component of CRC spread on a book value
basis will be recorded in net investment income and interest credited. Realized
gains and losses on investments and market value adjustments on contract
surrenders will be recognized as incurred. On balance, exclusive of the
cumulative effect gain recognized, these changes will result in smaller future
earnings from the in-force block of CRC contracts.
Certain other products offered by the Company recorded in separate account
assets and liabilities through December 31, 2003, were reclassified to the
general account upon adoption of the SOP.
Interests in Separate Accounts
As of December 31, 2003, the Company had $24 representing unconsolidated
interests in its own separate accounts. On January 1, 2004, the Company
reclassified $11 to investment in trading securities, where the Company's
proportionate beneficial interest in the separate account was less than 20%. In
instances where the Company's proportionate beneficial interest was between
20-50%, the Company reclassified $13 of its investment to reflect the Company's
proportionate interest in each of the underlying assets of the separate account.
Future impacts to net income as a result of adopting these provisions of the SOP
are expected to be insignificant.
Sales Inducements
The Company currently offers enhanced or bonus crediting rates to
contractholders on certain of its individual and group annuity products.
Effective January 1, 2004, upon adopting the SOP, the future expense associated
with offering a bonus will be deferred and amortized over the life of the
related contract in a pattern consistent with the amortization of deferred
acquisition costs. Effective January 1, 2004, amortization expense associated
with expenses previously deferred will be recorded over the remaining life of
the contract rather than over the contingent deferred sales charge period. Due
to the longer deferral periods, this provision is expected to have a small
positive impact to earnings in future periods.
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